<PAGE>
Filed Pursuant to Rule 424(b)(4)
Registration No. 333-95121
5,000,000 Shares
[Logo of Digital Island]
Common Stock
----------------
This is an offering of shares of common stock of Digital Island, Inc.
We are offering 3,850,000 of the shares to be sold in the offering. The
selling stockholders identified in this prospectus are offering an additional
1,150,000 shares. Digital Island will not receive any of the proceeds from the
sale of the shares being sold by the selling stockholders.
The common stock is quoted on the Nasdaq National Market under the symbol
"ISLD". The last reported sale price of the common stock on February 23, 2000
was $107.50 per share.
We are also offering $300 million in aggregate principal amount of our
convertible subordinated notes due 2005, under a separate debt prospectus.
Neither the completion of the note offering nor the completion of this common
stock offering are contingent upon the other.
See "Risk Factors" on page 9 to read about factors you should consider
before buying shares of the common stock.
----------------
Neither the Securities and Exchange Commission nor any other regulatory body
has approved or disapproved of these securities or passed upon the accuracy or
adequacy of this prospectus. Any representation to the contrary is a criminal
offense.
----------------
<TABLE>
<CAPTION>
Per
Share Total
------- ------------
<S> <C> <C>
Price to public............................................ $107.00 $535,000,000
Underwriting discount...................................... $ 4.81 $ 24,050,000
Proceeds, before expenses, to Digital Island............... $102.19 $393,431,500
Proceeds, before expenses, to the selling stockholders..... $102.19 $117,518,500
</TABLE>
To the extent that the underwriters sell more than 5,000,000 shares of
common stock, the underwriters have the option to purchase up to an additional
750,000 shares from Digital Island and the selling stockholders at the initial
price to public less the underwriting discount.
----------------
The underwriters expect to deliver the shares against payment in New York,
New York on February 29, 2000.
Goldman, Sachs & Co. Bear, Stearns & Co. Inc.
Lehman Brothers
Merrill Lynch & Co.
Thomas Weisel Partners LLC
Dain Rauscher Wessels
----------------
Prospectus dated February 23, 2000.
<PAGE>
[INSIDE FRONT COVER/GATEFOLD]
Digital Island, Inc. -- Providing the industry's leading global e-Business
delivery network, helping enterprises deliver a superior customer experience.
[Diagram of Digital Island network and access providers]
[World map showing locations of the company's headquarters, data centers,
local content managers and dedicated fiber lines]
[Digital Island logo]
Digital Island removes the barriers to global e-Business, providing a global
Delivery Network for enterprises that are using the Internet to deploy critical
business applications worldwide. Offering a suite of services that integrates
content delivery, hosting and intelligent networking, Digital Island delivers
three key benefits to our customers:
. A faster and more reliable end-user experience, enhancing brand loyalty,
sales and customer satisfaction.
. Greater geographic reach with the ability to transparently serve multiple
regions with more relevant content.
. Lower total cost of conducting global e-Business.
Digital Island provides a complete array of e-Business Delivery Network
components, offering enterprises a nimble, fully scalable Internet services
solution.
Proprietary technology and strategic partnerships enable Digital Island to
create a new platform for delivering Application Services, Content Delivery
services, Hosting Services and Intelligent Network services -- an integrated
suite of services all managed by Digital Island's global e-Business delivery
network.
[photographs of network operations center and regional data center]
By locating servers within any Digital Island's strategically located data
centers -- Hong Kong, Hawaii, Santa Clara, New York and London -- customers
enjoy the benefits of a fully redundant data center and network infrastructure.
Digital Island further reinforces its e-Business Delivery Network with on-site
24 X 7 X 365 personnel in each data center, two Network Operations Centers, and
a wide variety of fault detection, isolation and recovery applications.
[Diagram of the Company's Services]
Digital Island's Application Services improve the effectiveness of e-
Business applications, and shield the complexities of delivering distributed e-
Business solutions. Our Application Services seamlessly integrate and deliver a
customer's existing applications within our own e-Business delivery network,
while simultaneously enhancing the application's operational capabilities.
Digital Island's Content Delivery services intelligently manage content with
sophisticated caching and mirroring technologies. Business-critical content
resides closer to the customer, enabling fast, reliable delivery of e-Business
applications.
Digital Island's Hosting Services deliver a comprehensive Internet solution
that includes server and applications management by a team of highly qualified
engineers -- at a lower cost than in-house solutions.
Digital Island's Intelligent Network is a high-performance solution allowing
customers to deliver a fast, reliable and consistent end-user experience
worldwide. We provide a dedicated network, combining global fiber-optic
connections with advanced networking technology to deliver optimal reach and
performance.
Digital Island provides essential components of a Global e-Business Delivery
Network, offering customers a revolutionary combination of services that
reimagine the possibilities of e-Business. E-Business Without Limits --
exclusively from Digital Island.
<PAGE>
PROSPECTUS SUMMARY
This summary contains basic information about us and this offering. Because
it is a summary, it does not contain all of the information that you should
consider before investing. You should read the entire prospectus carefully,
including the section entitled "Risk Factors" and our consolidated financial
statements and the related notes before making an investment decision. Our
fiscal year ends on September 30. Unless we indicate otherwise, all information
in this prospectus assumes no exercise of the underwriters' over-allotment
option.
Digital Island, Inc.
We provide a global e-Business delivery network and suite of services for
enterprises that use the Internet to deploy critical business applications and
conduct e-commerce worldwide. We offer a comprehensive solution that integrates
content delivery, hosting, intelligent networking and applications services.
Our services enable enterprises to effectively deploy and manage their global
applications by combining the reliability, performance and broad range of
functions available in private networks with the ubiquitous access of the
public Internet. We target global enterprises that increasingly rely on the
Internet to conduct business, but are constrained by the unreliability, slow
performance and limited range of functions of the public Internet. Our
customers use our services and proprietary technology to facilitate the
deployment of a wide variety of electronic commerce applications, including
online marketing and sales, customer service, fulfillment, software, document
and multimedia distribution and online training. As of December 31, 1999, we
had contracts with 169 customers, of which 132 were deployed, including
Activision, America Online, Autodesk, Blue Mountain, Canon, Cisco Systems,
CNBC.com, E*TRADE, ft.com, Intuit, Microsoft, National Semiconductor,
NetGravity, PBS.org and Value America.
The Internet, a network of hundreds of interconnected, separately
administered public and private networks, was not originally designed to handle
either the large traffic levels or the vast array of content types being
transmitted today. Organizations cannot predict or control the network path
that their data will travel over the Internet and, as a result, are unable to
avoid network congestion or bottlenecks that degrade performance. For companies
conducting business over the Internet, poor website performance, such as failed
commerce transactions, slow downloads or site crashes, can create dissatisfied
users and result in lost customer goodwill and revenue opportunities. For
enterprises using the Internet for global operations, the U.S.-centric nature
of the public Internet also results in poor response times. Businesses are
increasingly demanding Internet networks that operate with the functionality
and performance levels previously available only on private corporate networks.
Our solution includes a global e-Business delivery network consisting of a
high speed network that connects our five geographically dispersed data centers
and a suite of services that integrates content delivery services, hosting,
intelligent networking and application services. Our core network architecture
has 55 different connection points to the Internet and connects directly to
local Internet service providers in 22 countries. The network is supplemented
by over 1,200 content distributors, which provide improved reach to countries
not directly accessed by our network. This minimizes the number of separate
transmissions necessary to transmit data, resulting in greater speed and
reliability for our customers' end-users. We also help our customers distribute
content over the Internet by replicating and storing their applications and
Internet content in multiple locations close to their end-users. This allows
our customers to benefit from the lower overall cost of data storage versus
transport and to provide a better online experience for their end-users.
We offer service level guarantees, customized billing, security services to
protect the integrity of data transmissions, network management and other high
quality services designed to improve the
3
<PAGE>
content and applications delivered through our network. In addition, we operate
Web sites and Internet applications, manage computer servers and maintain
networking equipment for our customers in our advanced network data centers,
and offer a range of data transport options which allow customers to reserve
network capacity consistent with their expected network usage. These services
are designed to allow customers to outsource Internet activities to us, thereby
transferring to us the burden of attracting and retaining scarce technical
staff and adopting continuously changing technologies, while lowering their
operating costs and speeding deployment of applications over the Internet.
Our objective is to become the leading global e-Business delivery network.
In order to achieve this objective, we intend to continue to:
. focus on leading global e-Business customers in targeted industries that
rely on the Internet to provide critical business applications;
. develop and implement new technologies and services that will allow our
customers to improve the deployment and operation of their Internet
applications globally;
. expand the size and reach of our e-Business delivery network;
. expand strategic technology and marketing/reselling relationships and
establish new relationships with systems integrators, hardware and
software vendors and application service providers; and
. expand our sales capabilities in the U.S., Asia and Europe by hiring more
direct sales personnel and developing additional agents and reseller
channels.
Recent Developments
Sandpiper Merger
On December 28, 1999, we completed our acquisition of Sandpiper Networks,
Inc. through the merger of a wholly owned subsidiary of Digital Island with and
into Sandpiper, in which Sandpiper survived as a wholly owned subsidiary of
Digital Island. We pursued this merger to enhance our comprehensive network
services for providing global e-Business applications.
In the merger, each outstanding share of Sandpiper capital stock was
converted into the right to receive 1.0727 shares of our common stock. We also
assumed outstanding options and warrants to acquire Sandpiper common stock and
converted those options and warrants into options and warrants to acquire our
common stock at the same exchange ratio. Overall, we issued or have reserved
for issuance approximately 24.6 million shares of our common stock in
connection with the merger.
Under the merger agreement, the former Sandpiper shareholders agreed to
indemnify and hold harmless Digital Island and some related parties from and
against losses, costs, damages, liabilities and expenses arising from any
breach of or default in any representation, warranty, covenant or agreement
made by Sandpiper in the merger agreement or related agreements and
instruments. To secure this indemnification obligation, 10% of the total number
of shares of our common stock issued in the merger to Sandpiper shareholders
have been deposited in escrow for a period of one year; the escrow will be our
sole recourse for any such breach or default absent fraud, intentional
misrepresentation or willful breach.
In connection with the merger, Digital Island and Sandpiper stockholders
holding approximately 57% of our common stock outstanding immediately after the
merger entered into market standoff
4
<PAGE>
agreements restricting them from selling or otherwise transferring any of our
equity securities. These market standoff agreements expire by their terms upon
the closing of this offering. However, as further described in "Underwriting",
a number of these holders have entered into lockup agreements in connection
with this offering.
In addition, we entered into employment agreements with Leo Spiegel, Andrew
Swart and David Farber, former executive officers of Sandpiper. Mr. Spiegel
became our President and agreed to restructure the vesting schedule of his
unvested shares of Digital Island common stock so that 50% will vest on March
24, 2000 and the balance will vest on November 24, 2000, the expiration date of
his employment agreement. Mr. Swart became our Vice President of Software
Engineering and Mr. Farber became our Chief Scientist. Each agreed to remain
with us for one year following the merger, and was granted a stock option
(vesting over a 50-month period following the merger) to purchase 150,000
shares. For a more detailed description of these arrangements, see "Certain
Transactions."
Upon completion of the merger, Leo Spiegel, the former president and chief
executive officer of Sandpiper, and G. Bradford Jones and Robert Kibble, former
directors of Sandpiper, became directors of Digital Island as Sandpiper
designees under the merger agreement.
SRI International Transaction
On November 22, 1999, we acquired Internet technology from SRI
International, a California nonprofit public benefit corporation, for
$6,000,000 of our common stock. Additionally, pursuant to the agreement, we
will obtain consulting services from SRI International for an additional
$4,000,000 of our common stock. SRI's patent-pending technology is designed to
improve download times for Internet content by intelligently avoiding network
congestion. We will incorporate SRI technology into our e-Business delivery
network to help ensure fast performance for e-Business applications, including
transactions and other forms of dynamic processing.
Strategic Relationship with Sun Microsystems and Inktomi
On December 7, 1999, we entered into memoranda of understanding with Sun
Microsystems, Inc. and Inktomi Corporation providing for a joint strategic
relationship. Under the relationship, we have agreed to purchase, over a two
year period, up to $150 million of Sun servers, storage operating systems and
server software, using Inktomi network caching applications. The total purchase
would consist of 5,000 Sun servers. Sun and Inktomi also agreed to participate
and invest in joint marketing and sales activities with us to support broadband
and streaming media content delivery over the Internet. Sun agreed to provide
$100 million of lease financing for the acquisition of the equipment,
consisting of:
. a $30 million initial line of credit;
. a $30 million line of credit available in nine months upon meeting
specified working capital maintenance and financing milestones; and
. a $40 million line of credit available in fifteen months upon meeting
specified additional working capital maintenance and financing
milestones.
In exchange for this lease financing, we agreed to grant Sun warrants to
purchase up to $10 million of our common stock in three tranches corresponding
on a pro rata basis with the above three lines of credit; the warrants will be
exercisable at the five-day average trading price preceding the grant dates,
and will expire in 48 months (in the case of the first warrant) and 36 months
(in the case of the second and third warrant). The lease financing facility and
the marketing and sales relationship are subject, in part, to definitive
documentation.
5
<PAGE>
In connection with this strategic relationship, in January 2000, Sun
purchased 391,869 shares of our common stock for $20 million, and Inktomi
purchased 117,561 shares of our common stock for $6 million.
Live On Line Acquisition
On January 18, 2000, we acquired Live On Line, Inc., a privately-held
company located in New York City, through the merger of a subsidiary of Digital
Island into Live On Line. As a result of the merger, Live On Line became a
wholly owned subsidiary of Digital Island. Live On Line provides internet
content and streaming media technology through its high-bandwidth, worldwide
server network to clients in the entertainment, media, consumer products,
pharmaceutical and education industries. In connection with this acquisition,
the former shareholders of Live On Line were issued a total of 799,989 shares
of our common stock, and will receive a total of $5,250,000 in exchange for all
outstanding shares of Live On Line common stock and our assumption of all
outstanding warrants of the company. The former shareholders of Live On Line
received fifty percent of the cash consideration on the closing date and the
remaining fifty percent will be paid upon the completion of this offering or
July 18, 2000, if earlier. In addition, the former shareholders of Live On Line
are entitled to require us to file a registration statement on Form S-3 with
the Securities and Exchange Commission to register the offering of shares of
common stock issued to them in the merger on or before July 17, 2000 or, if we
are not permitted to use Form S-3 at such date, as soon as practicable after we
become eligible to use such form.
----------------
We were incorporated in the State of California on February 10, 1994. We
changed our name to Digital Island, Inc. on August 15, 1996 and reincorporated
in the State of Delaware on June 22, 1999. Our principal headquarters are
located at 45 Fremont Street, 12th Floor, San Francisco, California 94105, and
our telephone number is (415) 738-4100. Information contained on our web site
is not a part of this prospectus.
The Digital Island name and logo, Digital Island Intelligent Network,
Digital Island Global IP Applications Network, Digital Island Application
Hosting and Content Distribution, Globeport, Digital Island Local Content
Managers, TraceWare, Footprint and the names of products and services offered
by Digital Island (including those referred to in "Business") are trademarks,
registered trademarks, service marks or registered service marks of Digital
Island. This prospectus also includes product names, trade names and trademarks
of other companies.
6
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered by
Digital Island............... 3,850,000 shares
Common Stock offered by the
selling stockholders......... 1,150,000 shares
Common Stock to be outstanding
after this offering(1)....... 64,534,804 shares
Use of proceeds............... We plan to use our net proceeds from this
offering, together with existing cash, for
general corporate purposes including capital
expenditures and working capital needs. We may
also use a portion of the proceeds for strategic
investments or acquisitions. See "Use of
Proceeds."
Nasdaq National Market symbol. ISLD
</TABLE>
- --------
(1) The common stock outstanding after this offering is based on the number of
shares outstanding as of December 31, 1999, and excludes:
. 7,594,453 shares of common stock issuable upon exercise of options
outstanding at December 31, 1999 with a weighted average exercise price
of $13.20 per share;
. 1,441,806 additional shares reserved as of December 31, 1999 for future
issuance under our 1999 stock incentive plan;
. 300,000 shares reserved as of December 31, 1999 for future issuance under
our 1999 employee stock purchase plan;
. 509,430 shares sold by us in January 2000 pursuant to the Sun and Inktomi
investments described in "--Recent Developments";
. 799,989 shares issued by us in January 2000 pursuant to the acquisition
of Live On Line described in "--Recent Developments"; and
. the shares issuable upon conversion of the $300 million in aggregate
principal amount of convertible subordinated notes we plan to sell in a
separate public offering, before giving effect to any exercise of the
underwriters' over-allotment option for the note offering. Neither the
completion of the note offering nor the completion of this common stock
offering are contingent upon the other.
7
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
Pro Forma
Pro Forma Three Months Ended Three Months
Year Ended December 31, Ended
Years Ended September 30, September 30, (unaudited) December 31,
-------------------------------- 1999(1) ---------------------- 1999(1)
1997 1998 1999 (unaudited) 1998 1999 (unaudited)
--------- --------- ---------- ------------- ---------- ---------- ------------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Consolidated Statements
of Operations Data:
Revenue................. $ 218 $ 2,343 $ 12,431 $ 12,650 $ 1,385 $ 7,600 $ 8,192
Total costs and
expenses............... 5,593 19,459 64,918 274,056 7,418 32,272 135,575
Loss from operations.... (5,375) (17,116) (52,487) (261,406) (6,033) (24,672) (127,383)
Net loss................ (5,289) (16,764) (50,938) (259,681) (5,939) (23,980) (126,666)
Basic and diluted net
loss per share......... (3.53) (7.50) (4.58) (7.28) (2.53) (0.65) (2.10)
Shares used in basic and
diluted net loss per
share.................. 1,497,711 2,236,452 11,127,462 35,683,550 2,345,984 36,676,137 60,431,483
Basic and diluted pro
forma net loss per
share(2)............... $ (2.02) $ (0.38)
Shares used in basic and
diluted pro forma net
loss per share(2)...... 25,233,080 15,746,641
</TABLE>
<TABLE>
<CAPTION>
December 31, 1999
(unaudited)
---------------------
As
Actual Adjusted
---------- ----------
(in thousands)
<S> <C> <C>
Consolidated Balance Sheet Data:
Cash, cash equivalents and short-term investments........ $ 37,104 $ 429,836
Total assets............................................. 1,078,349 1,471,081
Long-term obligations, including current portion......... 14,129 14,129
Total stockholders' equity............................... 1,029,747 1,422,479
</TABLE>
- --------
The above balance sheet data is shown:
. on an actual basis;
. on an as adjusted basis to reflect the sale by us of 3,850,000 shares of
our common stock after deducting the underwriting discounts and
commissions and offering expenses.
We are also conducting a separate public offering of $300 million in
aggregate principal amount of our convertible subordinated notes due 2005
pursuant to a registration statement filed with the Securities and Exchange
Commission. Neither the completion of this common stock offering nor that note
offering are contingent on the other. The above as adjusted balance sheet data
does not reflect the sale of these convertible subordinated notes.
(1) See the unaudited pro forma combined financial statements and the notes
thereto included elsewhere in this prospectus for more detailed information
on the Sandpiper merger.
(2) See notes 2 and 9 of the notes to our consolidated financial statements for
the determination of shares used in computing basic and diluted net loss
per share. All convertible preferred stock converted into common stock at
the time of our initial public offering in June 1999. Pro forma net loss
per share is presented to reflect per share data assuming the conversation
of all outstanding shares of convertible preferred stock into common stock
as if the conversion had taken place at the beginning of the fiscal year or
at the date of issuance, if later.
8
<PAGE>
RISK FACTORS
An investment in our shares is extremely risky. This section describes risks
involved in purchasing our common stock. Before you invest in our common stock,
you should consider carefully the following risks, in addition to the other
information presented in this prospectus, in evaluating us and our business.
Any of the following risks could seriously harm our business and financial
results and cause the trading price of our common stock to decline, which in
turn could cause you to lose all or part of your investment.
Risks Related to Digital Island
We have a short operating history upon which to base your investment decision.
Our limited operating history makes it difficult for us to predict future
results of operations, and makes it difficult to evaluate us or our prospects.
We were incorporated in 1994, and began offering our e-Business delivery
network services in January 1997. Prior to such time, we were engaged in
activities unrelated to our current operations, and as a result, the results of
operations for such periods are not comparable to our results of operations for
1997 or any subsequent periods.
We completed a merger with Sandpiper Networks, Inc. in December 1999.
Sandpiper commenced operations in December 1996 and introduced its service in
September 1998, and therefore also has a limited operating history. The limited
operating history of the combined company and the limited operating histories
of Digital Island and Sandpiper as individual entities may limit your ability
to evaluate our prospects and performance, and an investment in our common
stock, due to:
. our unproven potential to generate profits;
. our limited historical financial data;
. our limited experience in operating as a combined entity; and
. our limited experience in addressing emerging trends that may affect our
combined business.
You should consider our prospects in light of the risks, expenses and
difficulties we may encounter as an early stage company in the new and rapidly
evolving market for Internet content delivery solutions. As a result of such
risks, expenses and difficulties, we may not be able to:
. successfully market our content delivery solution;
. maintain and expand our market share in the highly competitive market for
Internet content delivery solutions;
. timely and effectively introduce new services and service enhancements
that are responsive to the needs of our customers; and
. attract, train and retain qualified sales, technical and customer support
personnel.
We have incurred operating losses since our inception and expect future
operating losses for the foreseeable future.
The revenue and income potential of our business and market is unproven.
From inception, we have experienced operating losses, negative cash flows from
operations and net losses in each quarterly and annual period. For the fiscal
year ended September 30, 1998, our operating loss, negative cash flow from
operations and net loss were $17.1 million, $15.7 million and $16.8 million,
respectively. For the fiscal year ended September 30, 1999, our operating loss,
negative cash flow from operations and net loss were $52.5 million, $39.7
million and $50.9 million, respectively. For the three months ended
December 31, 1999, our operating loss, negative cash flow from operations and
9
<PAGE>
net loss were $24.7 million, $25.9 million and $24.0 million, respectively.
Sandpiper has never been profitable and has incurred significant losses since
inception. Sandpiper reported a net loss of approximately $5.1 million for the
year ended December 31, 1998, and a net loss of approximately $54.0 million for
the period from October 1, 1999 to December 28, 1999.
Our operating expenses are largely based on anticipated revenue trends, and
a high percentage of our expenses are, and will continue to be, fixed in the
short term. In addition, we expect to continue to incur increasing expenses in
order to:
. expand sales and marketing activities through new programs and additional
personnel;
. increase product development activities;
. continue to grow our network infrastructure to maintain and increase our
ability to service new and existing customers;
. obtain access to additional bandwidth for the transport of increasing
volumes of data over our network; and
. expand our channels of distribution to increase our presence in our
target markets.
We have substantially increased the level of our anticipated capital
expenditures for network expansion, facilities and related costs over the next
12 months to approximately $80.0 million to $100.0 million. As a result, we
believe that we will continue to experience significant losses for the
foreseeable future.
We will need to generate significantly higher revenues to achieve and
maintain profitability. Although we have experienced growth in revenues in
recent periods, this growth rate may not be indicative of future operating
results. We may never be able to achieve or sustain profitability.
The unpredictability of our quarterly results may adversely affect the trading
price of our stock.
We expect our revenues and operating results to vary significantly from
quarter to quarter due to a number of factors, many of which we cannot control
and any of which may cause our stock price to fluctuate. These factors include
the following:
. demand for and market acceptance of our products and services may decline
or fail to increase enough to offset our costs;
. introductions of new products and services or enhancements by us and our
competitors may increase our costs or make our existing products or
services obsolete;
. the prices we can charge our customers may decline due to price
competition with our competitors;
. utilization of our global network may increase beyond our capacity and we
may incur significant expenses to increase such capacity;
. continuity of our service and network availability could be interrupted,
reducing revenue;
. the availability and cost of bandwidth may reduce our ability to increase
bandwidth as necessary;
. the length of our sales cycle and timing of customer installations and
expansion of our network infrastructure may vary from quarter to quarter;
. the mix of products and services we sell may change and the new mix may
generate less revenue;
. the timing and magnitude of our capital expenditures, including costs
relating to the expansion of operations, may vary from quarter to
quarter;
10
<PAGE>
. bandwidth used by customers may fluctuate from quarter to quarter; and
. conditions specific to the Internet industry and other general economic
factors may affect the prices we can charge or the expenses we incur.
Because a relatively large portion of our expenses are fixed in the short-
term, particularly with respect to telecommunications capacity, depreciation,
real estate and interest expenses and personnel, our results of operations are
particularly sensitive to fluctuations in revenues. Due to the foregoing, we
believe that period-to-period comparisons of our operating results are not
necessarily meaningful and that such comparisons cannot be relied upon as
indicators of future performance. It is likely that, in some future quarters,
our operating results may not meet the expectations of public market analysts
and investors. In that event, the price of our common stock may fall.
We must offer services priced above the overall cost of bandwidth, and any
failure to do so would jeopardize our operating results.
If we do not obtain adequate bandwidth capacity on acceptable terms and
realize appropriate customer volume for such bandwidth, we will not achieve
positive gross profit. We purchase our bandwidth capacity on a fixed-price
basis in advance of the sale of our services. We sell our services, by
contract, on the basis of actual usage. Our bandwidth costs currently exceed
our revenues from the sale of services, which results in negative gross profit.
Our data replication (mirroring) and storage (caching) business is
attractive to customers primarily because these services eliminate a
significant portion of the cost of transporting data by deploying data in close
proximity to the end users. To the extent bandwidth costs decrease, the prices
we may charge for these services will decrease as well. If the cost of
bandwidth decreases more than we expect, the value of these services could be
substantially reduced, which would harm our business and financial results.
We expect that the cost of obtaining bandwidth for the transport of data
over our network will decline over time as a result of, among other things, the
large amount of capital currently being invested to build infrastructure. We
expect the prices we charge for data transported over our network will also
decline over time as a result of, among other things, the lower cost of
obtaining bandwidth and existing and new competition in the markets we address.
If we fail to accurately predict the decline in costs of bandwidth, are unable
to sell our services at acceptable prices, or fail to offer additional services
from which we can derive additional revenues, our revenues will decrease and
our business and financial results will suffer.
We must retain and expand our customer base or else we will continue to be
unprofitable.
For the fiscal year ended September 30, 1999 we had 83 billing customers, of
which one, E*TRADE, accounted for approximately 35% of our revenues. After
giving effect to the Sandpiper merger, as of December 31, 1999, we had
contracts with 169 customers, of which 132 were deployed. E*TRADE accounted for
approximately 34% of our revenues during the quarter ended December 31, 1999
and another customer, ft.com, accounted for approximately 12% of our revenues
for the same period. We currently incur costs greater than our revenues and
need to increase customer revenue to become profitable. We incur significant
fixed costs to purchase our bandwidth capacity and maintain our network. We
also have payroll and other working capital needs. If we are unable to retain
or grow our customer base, we will not be able to achieve the economies of
scale necessary to offset our fixed and other operating costs. Our ability to
attract new customers depends on a variety of factors, including:
. the willingness of businesses to outsource their Internet operations;
. the reliability and cost-effectiveness of our services; and
. our ability to effectively market such services.
11
<PAGE>
To attract new customers we intend to significantly increase our sales and
marketing expenditures. However, our efforts might not result in more sales as
a result of the following factors:
. we may be unsuccessful in implementing our marketing strategies;
. we may be unsuccessful in hiring a sufficient number of qualified sales
and marketing personnel; and
. our marketing strategies may not result in increased sales.
Our network infrastructure may be subject to failure or disruptions, which
would seriously harm our business.
Our business is dependent on providing our customers with fast, efficient
and reliable network services. To meet these customer requirements we must
protect our network infrastructure against damage from:
. human error;
. fire;
. natural disasters;
. power loss;
. sabotage or vandalism;
. telecommunications failures; and
. similar events.
Despite precautions taken by us, the occurrence of a natural disaster or
other unanticipated problems at one or more of our data centers could result in
service interruptions or significant damage to equipment. We have experienced
temporary service interruptions in the past, and we could experience similar
interruptions in the future. We may be subject to legal claims and be liable
for losses suffered by our customers for disruptions resulting from failures on
our network. Our agreements with our customers generally attempt to eliminate
our liability for consequential or punitive damages not caused by our gross
negligence or willful acts. However, those provisions may not protect us from
being held liable for such damages. If our disruption rate is high, clients may
seek to terminate their contracts with us and our reputation could be harmed,
which would materially harm our business.
Our Internet content delivery service is complex and may have errors or defects
that could seriously harm our business.
Our Internet content delivery service is highly complex and is designed to
be deployed in very large and complex networks. Because of the nature of this
service, we can only fully test it when it is fully deployed in very large
networks with high traffic. We and our customers have from time to time
discovered errors and defects in our software. In the future, there may be
additional errors and defects in our software that may adversely affect our
service. If we are unable efficiently to fix errors or other problems that may
be identified in the future, we could experience:
. loss of or delay in revenue;
. loss of customers;
. failure to attract new customers or achieve market acceptance;
. diversion of development resources;
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. loss of reputation and credibility;
. increased service costs; and
. legal actions by our customers.
Future customer warranty claims based on service failures could exceed our
insurance coverage.
Our customer contracts currently provide a limited service level warranty
related to the continuous availability of service 24 hours a day, seven days
per week, except for certain scheduled maintenance periods. This warranty is
generally limited to a credit consisting of free service for a specified period
of time for disruptions in Internet transmission services. To date, we have
incurred no material expense related to such service level warranty. Should we
incur significant obligations in connection with system downtime, our liability
insurance may not be adequate to cover such expenses. Although our customer
contracts typically provide for no recovery with respect to incidental,
punitive, indirect and consequential damages resulting from damages to
equipment or disruption of service, in the event of such damages, we may be
found liable, and, in such event, such damages may exceed our liability
insurance.
Our business will suffer if we do not anticipate and meet specific customer
requirements or respond to technological change.
The market for Internet content delivery and network services is
characterized by rapid technological change, frequent new product introductions
and changes in customer requirements. We may be unable to respond quickly or
effectively to these developments. Our future success will depend to a
substantial degree on our ability to offer services that incorporate leading
technology, address the increasingly sophisticated and varied needs of our
current and prospective customers and respond to technological advances and
emerging industry standards and practices on a timely and cost-effective basis.
You should be aware that:
. our technology or systems may become obsolete upon the introduction of
alternative technologies;
. we may not have sufficient resources to develop or acquire new
technologies or to introduce new services capable of competing with
future technologies or service offerings; and
. the price of our services is likely to decline as rapidly as the cost of
any competitive alternatives.
The development of new or enhanced services through technology development
activities is a complex and uncertain process that requires the accurate
anticipation of technological and market trends. We may experience design,
manufacturing, marketing and other difficulties that could delay or prevent the
development, introduction or marketing of new services and enhancements. In
addition, our inability to effectively manage the transition from older
services to newer services could cause disruptions to customer orders and harm
our business and prospects.
If we do not successfully increase the capacity of our network, demand for our
services may decrease.
Due to the limited deployment of our services to date, the ability of our
network to connect and manage a substantially larger number of customers at
high transmission speeds is as yet unknown. Our network may not be able to
serve expected customer levels or meet performance expectations and we may be
unable to obtain additional network capacity from third-party suppliers. In
addition, as customers' usage of bandwidth increases, we will need to make
additional investments in our
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infrastructure to maintain adequate downstream data transmission speeds, the
cost of which may be significant. Upgrading our infrastructure may cause delays
or failures in our network. As a result, our network may be unable to achieve
or maintain a sufficiently high capacity of data transmission which could
significantly reduce demand for our services, reducing our revenues and
adversely affecting our business.
If our market does not grow as we expect, our revenues will be below our
expectations and our business and financial results will suffer.
The market for our services is new and unproven. If our customer base does
not expand or if there is not widespread acceptance of our products and our
services, our business and prospects will be harmed. The market for our
services depends on several uncertain events and factors, including:
. the effectiveness of our marketing strategy and efforts;
. our product and service differentiation and quality;
. the extent of our network coverage;
. our ability to provide timely, effective customer support;
. our distribution and pricing strategies as compared to our competitors;
. our industry reputation; and
. general economic conditions such as downturns in the e-Business or
software markets.
If the market for our services fails to develop, or develops more slowly
than expected, our business will be adversely affected.
We will require significant additional capital, and if we cannot obtain this
financing on commercially reasonable terms, our business will suffer.
Our ability to meet our planned growth will require substantial cash
resources. The timing and amount of future capital requirements may vary
significantly depending on numerous factors including regulatory,
technological, competitive and other developments in our industry. We do not
expect to generate significant cash flow from operations in the near term.
Accordingly, our ability to meet additional future capital needs will depend on
future equity or debt financing, which we may not be able to obtain on
satisfactory terms or at all. In addition, our credit agreements contain
covenants restricting our ability to incur further indebtedness, and future
borrowing instruments such as credit facilities and lease agreements are likely
to contain similar or more restrictive covenants and will likely require us to
pledge assets as security for borrowings thereunder. Additional equity
financing may not be available or may be dilutive to existing stockholders. Our
inability to obtain additional capital on satisfactory terms may delay or
prevent the expansion of our business and cause us to forego market
opportunities, which could materially adversely affect our growth and ability
to compete.
Rapid growth in our business could cause a significant strain on our business.
The planned expansion of our operations will place a significant strain on
our management, financial controls, operations systems, personnel and other
resources. We expect that our customers increasingly will demand additional
information and reports with respect to the services we provide. To handle
these demands and enable future traffic growth, we must develop and implement
an automated customer service system. In addition, if we are successful in
implementing our marketing strategy, we also expect the demands on our network
infrastructure and technical support resources to grow rapidly. We expect that
these demands will require investments in our infrastructure the
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addition of new management personnel, the development of additional expertise
by existing management personnel and the establishment of long-term
relationships with third-party service vendors. We may not be able to keep pace
with any growth, successfully implement and maintain our operational and
financial systems or successfully obtain, integrate and utilize the employees,
facilities, third-party vendors and equipment, or management, operational and
financial resources necessary to manage a developing and expanding business in
our evolving and increasingly competitive industry. If we are unable to manage
growth effectively, our business and financial results will suffer.
We could lose customers and expose our company to liability if breaches of our
network security disrupt service to our customers or jeopardize the security of
confidential information stored in our computer systems.
Despite the implementation of network security measures, our network
infrastructure is vulnerable to computer viruses, break-ins and similar
disruptive problems caused by our customers or Internet users. Any of these
acts could lead to interruptions, delays or cessation in service to our
customers and subscribers. Furthermore, such inappropriate use of the network
by third parties could also potentially jeopardize the security of confidential
information stored in our computer systems and our customers computer systems,
which may result in liability to us and may deter potential customers. Although
we intend to continue to implement industry-standard security measures, any
measures we implement may be circumvented in the future. The costs and
resources required to eliminate computer viruses and alleviate other security
problems may divert resources from other activities and may result in
interruptions or delays to our customers that could cause our business and
financial results to suffer.
We must retain and attract key employees or else we may not grow or be
successful.
In addition to key officers and employees who joined us through the
Sandpiper merger, we have recently hired a number of key employees and officers
including our Chief Executive Officer, Chief Financial Officer and our Chief
Technology Officer. Initially, such individuals must spend a significant amount
of time learning our business model and management system, in addition to
performing their regular duties. Accordingly, the integration of new personnel
has resulted and will continue to result in some disruption to our ongoing
operations.
We are highly dependent on key members of our management and engineering
staff, including, without limitation, our Chairman and Chief Executive Officer,
President, Chief Technology Officer and Vice President of Marketing. The loss
of one or more of these officers might impede the achievement of our business
objectives. Furthermore, recruiting and retaining qualified technical personnel
to perform research, development and technical support work is critical to our
success. If our business grows, we will also need to recruit a significant
number of management, technical and other personnel. Competition for employees
in our industry is intense. We may not be able to continue to attract and
retain skilled and experienced personnel on acceptable terms. The loss of the
services of any of our key employees, the inability to integrate new employees
or our failure to attract or retain qualified personnel in the future in a
timely manner could harm our business.
We depend on a limited number of third party suppliers for key components of
our network infrastructure, and the loss of one or more suppliers may slow our
growth or cause us to lose customers.
We are dependent on third party providers to supply key components of our
infrastructure, including bandwidth capacity leased from telecommunications
network providers and networking equipment that, in the quantities and quality
demanded by us, are available only from sole or limited
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sources. While we have entered into various agreements for carrier line
capacity, any failure to obtain additional capacity, if required, would impede
the growth of our business and cause our financial results to suffer. The
routers and switches used in our infrastructure are currently supplied
primarily by Cisco Systems. We purchase these components pursuant to purchase
orders placed from time to time, we do not carry significant inventories of
these components and we have no guaranteed supply arrangements with this
vendor. Any failure to obtain required products or services on a timely basis
and at an acceptable cost would impede the growth of our business and cause our
financial results to suffer. In addition, any failure of our suppliers to
provide products or components that comply with evolving Internet and
telecommunications standards could cause our business and financial results to
suffer.
Our failure to adequately protect our proprietary rights may harm our
competitive position.
We rely on a combination of copyrights, trademark, service mark and trade
secret laws and contractual restrictions to establish and protect proprietary
rights in our products and services. However, we will not be able to protect
our intellectual property if we are unable to enforce our rights or if we do
not detect unauthorized use of our intellectual property.
Although we have filed patent applications with the United States Patent and
Trademark Office with respect to our Footprint and TraceWare technologies, as
well as some Internet technology recently acquired from SRI International, such
applications are pending and we currently have no patented technology that
would preclude or inhibit competitors from entering our market. Moreover, none
of our technology is patented abroad, nor do we currently have any
international patent applications pending. We cannot be certain that any
pending or future patent applications will be granted, that any future patent
will not be challenged, invalidated or circumvented, or that rights granted
under any patent that may be issued will provide competitive advantages to us.
We have applied for trademarks and service marks on certain terms and
symbols that we believe are important for our business. In addition, we
generally enter into confidentiality or license agreements with our employees
and consultants and with our customers and corporations with whom we have
strategic relationships, and we attempt to maintain control over access to and
distribution of our software documentation and other proprietary information.
The steps we have taken to protect our technology or intellectual property
may be inadequate. Our competitors may independently develop technologies that
are substantially equivalent or superior to ours. Moreover, in other countries
where we do business, there may not be effective legal protection of patents
and other proprietary rights that we believe are important to our business.
Unauthorized use of any of our proprietary information could seriously harm our
business.
If we do not effectively manage the integration of future acquisitions, it
could disrupt our business and cause increased losses.
Part of our expansion strategy includes acquiring businesses and
technologies that we believe will complement our existing business. In the
event of any future acquisitions, we may:
. issue stock that would dilute the ownership of our stockholders,
including investors who purchase common stock in this offering;
. incur debt;
. assume liabilities;
. incur amortization expenses related to goodwill and other intangible
assets; and
. incur large and immediate write-offs.
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Acquisition transactions require a significant commitment of resources and are
accompanied by a number of risks, including:
. the difficulty of assimilating the operations and personnel of the
acquired companies;
. the potential disruption of our ongoing business and distraction of
management;
. the difficulty of incorporating acquired technology and rights into our
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.
We may need to complete these transactions to remain competitive. We cannot
be sure that we will succeed in addressing these risks or any other problems
encountered in connection with potential business combinations and
acquisitions.
We have anti-takeover defenses that could delay or prevent a takeover that
stockholders may consider favorable.
Certain provisions of our certificate of incorporation and bylaws and the
provisions of Delaware law could have the effect of delaying, deferring or
preventing an acquisition of Digital Island. For example, our board of
directors is divided into three classes to serve staggered three-year terms, we
may authorize the issuance of up to 10,000,000 shares of "blank check"
preferred stock, our stockholders may not take actions by written consent and
our stockholders are limited in their ability to make proposals at stockholder
meetings.
We may be unable to license necessary technology, and we may be subject to
infringement claims by third parties.
Our commercial success will also depend in part on our not infringing the
proprietary rights of others and not breaching technology licenses that cover
technology used in our products. It is uncertain whether any third party
patents will require us to develop alternative technology, alter our products
or processes, obtain licenses or cease activities that infringe on third
party's intellectual property rights. If any such licenses are required, we may
not be able to obtain such licenses on commercially favorable terms, if at all.
Our failure to obtain a license to any technology that we may require to
commercialize our products and services could cause our business and prospects
to suffer.
Companies in the Internet market are increasingly bringing suits alleging
infringement of their proprietary rights, particularly patent rights. Any
litigation or claims, whether or not valid, could result in substantial costs
and diversion of resources. Intellectual property litigation or claims could
force us to do one or more of the following:
. cease selling, incorporating or using products or services that
incorporate the challenged intellectual property;
. obtain a license from the holder of the infringed intellectual property
right, which license, if available at all, may not be available on
commercially favorable terms; and
. redesign products or services.
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If we are forced to take any of the foregoing actions, our business may be
seriously harmed. We expect that our insurance may not cover potential claims
of this type or may not be adequate to indemnify us in the event we are found
liable.
Our participation in joint ventures and strategic relationships may involve
risk associated with inconsistent goals, exposure to unknown liabilities and
unexpected obligations.
As part of our international expansion, we pursue relationships and joint
ventures with local Internet service providers and telecommunications carriers
in other countries. We may not have a majority interest or control of the
governing body of any such local operating joint venture and there is a risk
that the other joint venture partner may at any time have economic, business or
legal interests or goals that are inconsistent with those of the joint venture
or us. The risk also will be present that a joint venture partner may be unable
to meet its economic or other obligations and that we may be required to
fulfill those obligations. In addition, in any joint venture in which we do not
have a majority interest, we may not have control over the operations or assets
of such joint venture. We may not be able to establish peering relationships or
joint ventures with local Internet service providers and telecommunications
carriers in other countries on favorable terms or at all. Our failure to
establish these relationships may cause us to lose customers or slow our growth
and harm our business.
Sandpiper entered into strategic relationships with America Online, or AOL,
in April 1999 and with Microsoft in October 1999 for the joint development of
technology, services and/or products. We may not be successful in developing
such products. The AOL agreement expires in December 2001 and the agreement
with Microsoft expires in August 2002. Each agreement may be terminated by
either party if the other party materially breaches the agreement. A
termination of, or significant adverse change in our relationship with AOL or
Microsoft could have a material adverse effect on our business.
In addition, in December 1999 we entered into memoranda of understanding
with Sun Microsystems and Inktomi to purchase 5,000 Sun servers, as well as
storage operating systems and server software using Inktomi network caching
applications. Pursuant to this arrangement, Sun and Inktomi also agreed to
participate and invest in joint marketing and sales activities with us.
However, our strategic relationship with Sun and Inktomi is subject to
definitive documentation and the memoranda of understanding may be terminated
at any time prior to the execution of such definitive documentation. If
consummated, such relationship may not yield significant benefits, if any.
Risks Related To The Sandpiper Merger
If we do not successfully integrate Sandpiper's operations and personnel or
effectively manage the combined company, we may not achieve the benefits of the
merger and may lose key personnel and customers.
We undertook the Sandpiper merger with the expectation that the merger will
result in significant benefits. Achieving the benefits of the merger depends on
the timely, efficient and successful execution of a number of post-merger
events, including the current efforts to integrate the operations and personnel
of the two companies. We will need to overcome significant obstacles, however,
in order to realize any benefits or synergies from the merger. The successful
execution of these post-merger events will involve considerable risk and may
not be successful.
The market price of our common stock may decline as a result of the
Sandpiper merger if:
. the integration of Digital Island and Sandpiper is unsuccessful;
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. Digital Island 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 Digital Island's financial results is not
consistent with the expectations of financial or industry analysts.
Our failure to complete the integration successfully could also result in the
loss of key personnel and customers. In addition, the attention and effort
devoted to the integration of the two companies will significantly divert
management's attention from other important issues.
If we fail to successfully cross-market our products or develop new products,
we will not increase or maintain our customer base or our revenues.
With Sandpiper, we intend to offer our products and services to each other's
existing customers. We cannot assure you that our respective customers will
have any interest in the other company's products and services or that the
transactions or other data in Sandpiper's database will be predictive or useful
in other sales channels, including systems integrators, web site designers and
Internet service providers. The failure of these cross-marketing efforts would
diminish the benefits realized by this merger.
In addition, we intend to develop new products and services that combine the
knowledge and resources of the Digital Island and Sandpiper businesses. To
date, the companies have not thoroughly investigated the obstacles,
technological, market-driven or otherwise, to developing and marketing these
new products and services in a timely and efficient way. We cannot offer any
assurances that products or services will be successful or that there will be a
market for such products and services. As a result, we may not be able to
increase or maintain our customer base. Our failure or inability to develop and
market combined products and services could have a material adverse effect on
the combined company's business, financial condition and operating results.
Risks Related to Our Industry
Competition in our industry is intense and growing and we may be unable to
compete effectively.
Our market is highly competitive and fragmented. Our competitors include
companies such as AboveNet Communications, Adero, Akamai, AT&T, Concentric,
Digex, Exodus Communications, Global Crossing, GTE, InterNAP, MCI WorldCom and
Qwest. Many of our competitors have substantially greater financial, technical
and marketing resources, larger customer bases, longer operating histories,
greater name recognition and more established relationships in the industry
than we do. Some of our current and potential competitors have the financial
resources to withstand substantial price competition, and many may be able to
respond more quickly than we can to new or emerging technologies and changes in
customer requirements. Our competitors with more extensive customer bases,
broader customer relationships and broader industry alliances may be able to
use such resources to their advantage in competitive situations, including
relationships with many of our current and potential customers. In particular,
certain competitors have strategic alliances with entities that have entered
into similar alliances with us, including Microsoft.
There are few substantial barriers to entry and we expect that we will face
additional competition from existing competitors and new market entrants in the
future. We compete against information technology and Internet outsourcing
firms, national and regional Internet service providers, and global, regional
and local telecommunications companies. Our larger competitors may be able to
provide customers with additional benefits in connection with their Internet
systems and network solutions, including reduced communications costs. As a
result, these companies may be able to price their products and services more
competitively than we can and respond more quickly than us
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to new or emerging technologies and changes in customer requirements. If we are
unable to compete successfully against our current or future competitors, we
may lose market share, and our business and prospects would suffer.
We face competition, and in the future may face additional competition, from
providers of Internet content delivery services, including networking hardware
and software manufacturers, content distribution providers, traditional
hardware manufacturers, telecommunications providers, software database
companies, and large diversified software and technology companies. Some of
these competitors may bundle their services with other software or hardware in
a manner that may discourage website owners from purchasing our services or
Internet service providers from installing our servers. In addition, if those
third party telecommunications providers upon which we are currently dependent
for transmission capacity determine to compete with us in the Internet content
delivery market, their refusal to provide us with capacity, could result in a
degradation or termination of service to certain of our customers. As a result,
we could lose customers or fees charged to such customers, and our business and
financial results could suffer.
In addition, no assurances can be given that the Internet content delivery
market will develop in a way that we currently anticipate. For example, while
we currently intend to offer our customers the most comprehensive solution
available in the marketplace today, there currently exists an array of
competitors that offer partial solutions to the problems that we intend to
address, and a number of these companies have been and are likely to continue
to be quite successful. To the extent Internet service providers utilize other
technology that reduces the need for content delivery solutions, demand for our
services could decrease.
Increased competition could result in:
. price and revenue reductions and lower profit margins;
. increased cost of service from telecommunications providers;
. loss of customers or failure to obtain additional customers; and
. loss of market share.
Any one of these could materially and adversely affect our business,
financial condition and results of operations. See "Business--Competition."
Liability laws are unsettled in our industry and potential liability associated
with information disseminated through our network could harm our business and
prospects.
The law relating to the liability of online services companies and Internet
access providers for communications and commerce carried on or disseminated
through their networks is currently unsettled. The most recent session of the
United States Congress resulted in the enactment of Internet laws regarding
children's privacy, copyrights, taxation and the transmission of sexually
explicit material. The European Union issued a directive in December 1997 that
required member states to initiate the process for the adoption of privacy
regulations by October 1998. The European Union is also currently considering
copyright legislation that may extend the right of reproduction held by
copyright holders to include the right to make temporary copies for any reason.
It is possible that claims could be made against online services companies and
Internet access providers under both United States and foreign law for
defamation, negligence, copyright or trademark infringement, or other theories
based on the nature of the data or the content of the materials disseminated
through their networks. Several private lawsuits seeking to impose such
liability upon online services companies and Internet access providers are
currently pending.
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In addition, the growth and development of the market for online commerce
may prompt calls for more stringent consumer protection laws, both in the
United States and abroad, which may impose
additional burdens on companies conducting business online. Some countries may
regulate or prohibit the transport of telephony data in their territories. The
imposition upon us and other Internet network providers of potential liability
for information carried on or disseminated through our systems could require us
to implement measures to reduce our exposure to such liability, which may
require the expenditure of substantial resources, or to discontinue some of our
service or product offerings. Our ability to limit the types of data or content
distributed through our network is limited. Failure to comply with such
regulation in a particular jurisdiction could result in fines or penalties or
the termination of our service in such jurisdiction. The increased attention
focused upon liability issues as a result of these lawsuits and legislative
proposals could impact the growth of Internet use. Our professional liability
insurance may not be adequate to compensate or may not cover us in the event we
become liable for information carried on or disseminated through our networks.
Any costs not covered by insurance incurred as a result of such liability or
asserted liability could harm our business and prospects.
Risks associated with operating in international markets could restrict our
ability to expand globally and harm our business and prospects.
We market and sell our network services and products in the United States
and internationally. While the United States currently represents the majority
of our revenues, we expect the percentage of our international sales to
increase over time and expect to commit significant resources to expand our
international sales and marketing activities throughout year 2000. However, we
may not be able to successfully market, sell, deliver and support our
networking services and products internationally. We presently conduct
international sales through local subsidiaries in the United Kingdom,
Switzerland, Germany, the Netherlands, Japan, Malaysia and China and through
distributor relationships with third parties in countries where we have no
physical presence. Our failure to manage our international operations
effectively could limit the future growth of our business, increase our costs,
lengthen our sales cycle and require significant management attention. There
are certain risks inherent in conducting our business internationally, such as:
. changes in telecommunications regulatory requirements that may restrict
our ability to deliver services to our international customers;
. export restrictions, tariffs, differing regulatory regimes and other
trade barriers that may impede us from adequately equipping our network
facilities;
. challenges in recruiting, retaining, and managing qualified staff who
understand the highly technical aspects of our business that could hinder
our ability to grow and compete;
. differing technology standards across countries that may impede our
ability to integrate our product offerings across international borders;
. limited international collection experience in collecting accounts
receivable in foreign jurisdictions;
. political and economic instability that could lead to appropriation of
our physical assets, impeding our ability to deliver our services to
customers and harming our financial results;
. protectionist laws and business practices favoring local competition that
may give unequal bargaining leverage to key vendors in countries where
competition is scarce, significantly increasing our operating costs;
. increased expenses associated with marketing services in foreign
countries;
. potentially adverse tax consequences, including restrictions on the
repatriation of earnings due to unfavorable changes in tax laws or our
physical presence in foreign countries; and
. the risks related to the recent global economic turbulence.
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Any of these risks could harm our international operations. For example,
some European countries already have laws and regulations related to content
distributed on the Internet and technologies used on the Internet that are more
strict than those currently in force in the United States. Furthermore, there
is an on-going debate in Europe as to the regulation of certain technologies we
use, including caching and mirroring. That debate could result in a directive
relating to the reform of copyright in the European Community which will, if
made into law, restrict caching and mirroring. Any or all of these factors
could cause our business and prospects to suffer.
Foreign exchange fluctuations could decrease our revenues or cause us to lose
money, especially since we do not hedge against currency fluctuations.
Although, to date, all of our customers have paid for our services in U.S.
dollars, we currently pay some of our suppliers in foreign currencies, which
subjects us to currency fluctuation risks. For fiscal 1998 and fiscal 1999,
costs denominated in foreign currencies were nominal and we had no foreign
currency losses during those periods. However, we believe that in the future an
increasing portion of our revenues and costs will be denominated in foreign
currencies. In particular, we expect that with the introduction of the Euro, an
increasing portion of our international sales may be Euro-denominated. We
currently do not engage in foreign exchange hedging activities and, although we
have not yet experienced any material losses due to foreign currency
fluctuation, our international revenues are subject to the risks of foreign
currency fluctuations and such risks will increase as our international
revenues increase.
Year 2000 computer complications could disrupt our operations and harm our
business.
The "year 2000 issue" is the result of computer systems and programs using
two digits rather than four to identify a given year. Computer systems or
programs that have date sensitive software or embedded chips may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result
in system failures or miscalculations or other computer errors causing
disruptions of operations. The potential for failures encompasses all aspects
of our business, including our services, suppliers and customers. These
failures could cause, among other things, disruptions in our operations and a
temporary inability to engage in normal business activities.
The year 2000 issue creates significant risks for us including:
. potential warranty or other claims arising from our services;
. damage to our reputation;
. litigation costs;
. impairment of the systems we use to run our business; and
. impairment of the systems used by our suppliers and customers.
Although we believe our products are year 2000 compliant, we may see an
increase in warranty and other claims as a result of the year 2000 issues
arising from undetected defects or the non-compliance of the suppliers upon
whom we rely.
We believe that the most likely worst-case year 2000 scenario would involve
the non-compliance of the third-party telecommunications carriers, vendors and
other significant suppliers upon whom we depend for transmission capacity. If
these providers do not achieve year 2000 compliance, we cannot be certain that
we will have sufficient transmission capacity to continue our service without
interruption. In the event that any of our other suppliers do not achieve year
2000 compliance in a timely manner, and we are unable to replace them with
alternate sources, our business and financial results would also be harmed.
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Government regulation and legal uncertainties could limit our business or slow
our growth.
Our services include the transmission of data over public telephone lines.
These transmissions are subject to the regulatory authority of the Federal
Communications Commission and the state public utility commissions although, to
date, neither has elected to exercise such authority. Our services could be
affected by changes in federal and state law or regulation in the
telecommunications arena, especially changes relating to telecommunications
markets in general and the Internet in particular. Such changes could directly
or indirectly affect our costs, limit usage or subscriber-related information,
and increase the likelihood or scope of competition from Regional Bell
Operating Companies or other telecommunications companies.
As our services become available over the Internet in additional foreign
countries, and as we facilitate sales by our customers to end users located in
such foreign countries, these foreign jurisdictions may decide that we are
required to qualify to do business in their jurisdictions, which may subject us
to taxes and other costs. It is also possible that claims could be made against
online service companies and Internet service providers under foreign law for
defamation, negligence, copyright or trademark infringement, or other theories
based on the nature and content of the materials disseminated through their
networks.
Implementation of any future changes in law or regulation, including those
discussed herein, could cause our business and prospects to suffer. Our
business and prospects may also be harmed by the imposition of certain tariffs,
duties and other import restrictions on facilities and resources that we obtain
from non-domestic suppliers. As a result, changes in law or regulation in the
United States or elsewhere could cause our business and prospects to suffer.
Risks Related to Our Offering
Our stock has been and will likely continue to be subject to substantial price
and volume fluctuations due to a number of factors, some of which are beyond
our control.
Stock prices and trading volumes for many Internet companies fluctuate
widely for a number of reasons, including some reasons which may be unrelated
to their businesses or results of operations. This market volatility, as well
as general domestic or international economic, market and political conditions,
could materially adversely affect the price of our common stock without regard
to our operating performance. In addition, our operating results may fall below
the expectations of public market analysts and investors. If this were to
occur, the market price of our common stock would likely significantly
decrease.
After this offering, our executive officers, directors, and parties related to
them, in the aggregate, will control 31% of our voting stock and may have the
ability to control matters requiring stockholder approval.
Our executive officers, directors and parties related to them will own
approximately 31% of our outstanding common stock following completion of this
offering, a large enough stake to have an influence on the matters presented to
stockholders. As a result, these stockholders may have the ability to control
matters requiring stockholder approval, including the election and removal of
directors, the approval of significant corporate transactions, such as any
merger, consolidation or sale of all or substantially all of Digital Island's
assets, and the control of the management and affairs of Digital Island.
Accordingly, such concentration of ownership may have the effect of delaying,
deferring or preventing a change in control of Digital Island, impeding a
merger, consolidation, takeover or other business combination involving Digital
Island or discouraging a potential acquirer from making a tender offer or
otherwise attempting to obtain control of Digital Island, which in turn could
have an adverse effect on the market price of Digital Island's common stock.
23
<PAGE>
Substantial leverage and debt service obligations may adversely affect our cash
flow.
Concurrently with this offering, we anticipate offering convertible
subordinated notes in an aggregate principal amount of $300 million, or $345
million if the over-allotment option granted to the underwriters in connection
with the note offering is exercised in full. If the note offering is completed
as planned, we will have substantial amounts of outstanding indebtedness,
primarily consisting of the notes, upon the completion of this offering. As a
result of this indebtedness, our principal and interest payment obligations
will increase substantially. There is the possibility that we may be unable to
generate cash sufficient to pay the principal of, interest on and other amounts
due in respect of our indebtedness when due. We may also obtain additional
long-term debt and working capital lines of credit to meet future financing
needs. There can be no assurance that additional financing arrangements will be
available on commercially reasonable terms or at all.
Our substantial leverage could have significant negative consequences,
including:
. increasing our vulnerability to general adverse economic and industry
conditions;
. limiting our ability to obtain additional financing;
. requiring the dedication of a substantial portion of our expected cash
flow from operations to service our indebtedness, thereby reducing the
amount of our expected cash flow available for other purposes, including
capital expenditures;
. limiting our flexibility in planning for, or reacting to, changes in our
business and the industry in which we compete; and
. placing us at a possible competitive disadvantage vis-a-vis less
leveraged competitors and competitors that have better access to capital
resources.
There may be a substantial amount of our common stock available for future
sales after this offering which could depress our stock price.
Sales of substantial amounts of our common stock (including shares issued
upon the exercise of outstanding options and warrants) in the public market
following this offering, or the appearance that a large number of shares is
available for sale, could depress the market price for our common stock. All of
the shares sold in this offering will be freely tradable. Our executive
officers, directors and holders of 24,914,008 shares of our common stock, or
approximately 39% of our common stock outstanding on December 31, 1999, have
agreed not to sell or otherwise dispose of any of their shares for a period of
90 days after the date of this prospectus, subject in each case to certain
consents and exceptions. In addition, holders of 10,812,971 shares of our
common stock, or approximately 17% of our common stock outstanding as of
December 31, 1999, have agreed not to sell or otherwise dispose of any of their
shares for a period of 30 days after the date of this prospectus, subject in
each case to certain consents and exceptions. Goldman, Sachs & Co. may, in its
sole discretion and at anytime without notice, release all or any portion of
the shares subject to such agreements. As a result of the Sandpiper merger,
Digital Island and Sandpiper stockholders holding approximately 57% of our
common stock following the merger entered into market standoff agreements
prohibiting them from selling or otherwise transfering shares of our common
stock. These market standoff agreements, however, will expire with the
occurrence of this offering, and, as a result, all such shares which are not
subject to the foregoing lock-up agreements will become available for sale
following this offering.
In addition, the holders of up to 15,935,954 restricted shares of our stock
are entitled to certain rights with respect to registration of such shares for
sale in the public market. If these holders sell their shares in the public
market, such sales could have a material adverse effect on the market price of
our common stock. In addition to the adverse effect a price decline could have
on holders of our common stock, that decline would likely impede our ability to
raise capital through the issuance of additional shares of common stock or
other equity securities.
24
<PAGE>
Our management will have broad discretion in allocating proceeds from this
offering, which it may not use effectively.
The net proceeds to us from this offering, after deducting underwriting
commissions and expenses payable by us, will be approximately $392.7 million.
The primary purpose of this offering is to fund operating losses, working
capital needs and capital expenditures expected to be incurred in connection
with the execution of our business plan, including the expansion of our
operations. A portion of the net proceeds may also be used to repay currently
outstanding or future indebtedness, or to acquire or invest in complementary
businesses or products. Accordingly, our management will retain broad
discretion as to the allocation of most of the proceeds of this offering. The
failure of management to apply these funds effectively could negatively impact
our business and prospects.
The liquidity of our common stock is uncertain since it has been publicly
traded for a short period of time and may have a limited market.
Prior to our initial public offering in June 1999, there was no public
market for our common stock. We cannot predict the extent to which investor
interest in our company will lead to the development of an active, liquid
trading market. In this offering, we intend to sell our common stock primarily
to a limited number of institutional investors, which could limit the
development of an active trading market. Active trading markets generally
result in lower price volatility and more efficient execution of buy and sell
orders for investors.
25
<PAGE>
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the matters discussed in this prospectus include forward-looking
statements. We have based these forward-looking statements on our current
expectations and projections about future events, including, among other
things,
. implementing our business strategy;
. obtaining and expanding market acceptance of the services we offer;
. forecasts regarding the Internet and our market size and growth;
. predicting pricing trends in domestic and foreign telecommunications;
. meeting our requirements under key contracts; and
. competition in our market.
In some cases, you can identify forward-looking statements by terminology
such as "may," "will," "should," "could," "potential," "continue," "expects,"
"anticipates," "intends," "plans," "believes," "predicts," "estimates" and
similar expressions, although not all forward-looking statements are identified
by these words. These statements are based on our current beliefs, expectations
and assumptions and are subject to a number of risks and uncertainties. Actual
results and events may vary significantly from those discussed in the forward-
looking statements. A description of risks that could cause our results to vary
appears under the caption "Risk Factors" and elsewhere in this prospectus. In
light of these assumptions, risks and uncertainties, the forward-looking events
discussed in this prospectus may not occur. These cautionary statements qualify
all forward-looking statements attributable to us or persons acting on our
behalf. These forward-looking statements are made as of the date of this
prospectus, and we assume no obligation to update them even though our
situation may change in the future.
26
<PAGE>
PRICE RANGE OF COMMON STOCK
Our common stock has been quoted on the Nasdaq National market under the
symbol "ISLD" since June 29, 1999, the date upon which we commenced sale of our
common stock pursuant to our initial public offering. The following table lists
quarterly information on the price range of the common stock based on the high
and low reported sale prices for the common stock as reported on the Nasdaq
National Market for the periods indicated below:
<TABLE>
<CAPTION>
High Low
------- ------
<S> <C> <C>
Fiscal 1999
Third Quarter.............................................. $ 20.50 $ 8.66
Fourth Quarter............................................. $ 40.44 $12.75
Fiscal 2000
First Quarter.............................................. $156.94 $20.44
Second Quarter (through February 23, 2000)................. $118.81 $75.63
</TABLE>
The last reported sale price for the common stock on the Nasdaq National
Market was $107.50 per share on February 23, 2000. As of December 31, 1999,
there were approximately 364 holders of record of our common stock.
USE OF PROCEEDS
The net proceeds to us from our sale of common stock in this offering will
be approximately $392.7 million ($451.7 million if the underwriters' over-
allotment option is exercised in full), after deducting underwriting discounts
and commissions and expenses payable by us. We expect to use the net proceeds
from this offering, together with existing cash, to fund operating losses,
working capital needs and capital expenditures in connection with our
operations. Our management will retain broad discretion in the allocation of
such net proceeds. Although we may use a portion of the net proceeds to pursue
possible acquisitions of, make strategic investments in, or enter into joint
ventures with respect to, complementary businesses, technologies or products in
the future, there are no present understandings, commitments or agreements with
respect to any such acquisitions or joint ventures other than those discussed
in "Prospectus Summary--Recent Developments." Pending the use of such net
proceeds, we intend to invest these funds in short-term, investment grade
securities.
DIVIDEND POLICY
We have not declared or paid any dividends since our inception and do not
intend to pay cash dividends on our capital stock in the foreseeable future. We
anticipate that we will retain all future earnings, if any, for use in our
operations and the expansion of our business. Our credit agreements restrict
our ability to declare or pay any dividends.
27
<PAGE>
CAPITALIZATION
The following table sets forth, as of December 31, 1999:
. Our actual capitalization; and
. Our capitalization as adjusted to give effect to the sale by us of
3,850,000 shares of common stock offered by us in this offering after
deducting the underwriting discounts and commissions and offering
expenses payable by us, and the application of the net proceeds from this
offering.
This information should be read in conjunction with our consolidated
financial statements and the notes related thereto appearing elsewhere in this
prospectus.
<TABLE>
<CAPTION>
December 31, 1999
(unaudited)
-----------------------
Actual As Adjusted
---------- -----------
(in thousands except
share data)
<S> <C> <C>
Long-term obligations, less current portion........... $ 7,769 $ 7,769
Stockholders' equity:
Preferred stock, $0.001 par value, 10,000,000 shares
authorized; no shares issued and outstanding on an
actual basis and as adjusted....................... -- --
Common stock, $0.001 par value, 100,000,000 shares
authorized; 60,684,804 shares issued and
outstanding on an actual basis, 64,534,804 shares
issued and outstanding on a pro forma as adjusted
basis.............................................. 61 65
Stockholder note receivable......................... (424) (424)
Additional paid-in capital.......................... 1,130,430 1,523,162
Accumulated deficit................................. (97,042) (97,042)
Deferred compensation............................... (3,278) (3,278)
---------- ----------
Total stockholders' equity......................... 1,029,747 1,422,483
---------- ----------
Total capitalization............................... $1,037,516 $1,430,252
========== ==========
</TABLE>
The table above excludes:
. 7,594,453 shares of common stock issuable upon exercise of options
outstanding on December 31, 1999 with a weighted average exercise price
of $13.20 per share;
. 1,441,806 additional shares reserved as of December 31, 1999 for future
issuances under our 1999 stock incentive plan;
. 300,000 shares reserved as of December 31, 1999 for future issuance under
our 1999 employee stock purchase plan;
. 509,430 shares sold by us in January 2000 pursuant to the Sun and Inktomi
investments described in "Prospectus Summary--Recent Developments";
. 799,989 shares issued by us in January 2000 pursuant to the acquisition
of Live on Line described in "Prospectus Summary--Recent Developments";
and
. $300 million in aggregate principal amount of convertible subordinated
notes expected to be sold by us in a separate public offering we are
conducting as well as the shares issuable upon conversion of such notes,
before giving effect to any exercise of the underwriters' over-allotment
option. Neither the completion of the note offering nor the completion of
this common stock offering are contingent upon the other.
28
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this prospectus. The statement of operations
data for each of the years in the three-year period ended September 30, 1999
and the balance sheet data at September 30, 1998 and 1999, are derived from our
financial statements that have been audited by PricewaterhouseCoopers LLP,
independent accountants, included elsewhere in this prospectus. The statement
of operations data for the years ended September 30, 1995 and 1996 and the
balance sheet data at September 30, 1995, 1996 and 1997, are derived from our
audited financial statements that are not included in this prospectus. The
statement of operations data for the three months ended December 31, 1998 and
1999, and the balance sheet data at December 31, 1999, are derived from our
unaudited financial statements included elsewhere in this prospectus. We did
not begin offering our e-Business delivery network services until January 1997;
prior to such time, we were engaged in activities unrelated to our current
operations. Accordingly, our results of operations prior to January 1997 are
not comparable to our results of operations for 1997 or any subsequent periods.
In addition, financial data for periods ended at or prior to September 30, 1999
do not include the operating results, assets or liabilities of Sandpiper, which
we acquired in December 1999. As a result, our results of operations for these
periods will not be comparable to subsequent periods.
The unaudited selected pro forma financial data is derived from the
unaudited consolidated pro forma combined financial statements of Digital
Island and Sandpiper and should be read in conjunction with the pro forma
statements and notes to those statements, which are included elsewhere in this
prospectus. The consolidated pro forma information is presented for
illustrative purposes only and is not necessarily indicative of future
operating results or financial position.
<TABLE>
<CAPTION>
Three Months Pro Forma
Pro Forma Ended Three Months
Year Ended December 31, Ended
Years Ended September 30, September 30, (unaudited) December 31,
-------------------------------------------------- 1999 (2) --------------------- 1999
1995 1996 1997 1998 1999 (unaudited) 1998 1999 (unaudited)
------- ------- --------- --------- ---------- ------------- --------- ---------- ------------
(in thousands except share data)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Statement of
Operations Data:
Revenue........... $ -- $ -- $ 218 $ 2,343 $ 12,431 $ 12,650 $ 1,385 $ 7,600 $ 8,192
Cost and expenses:
Cost of revenue.. -- -- 2,508 9,039 29,496 33,837 2,923 16,264 18,733
Sales and
marketing....... -- -- 1,205 4,847 16,010 21,368 2,046 6,315 55,872
Product
development..... -- -- 378 1,694 6,357 8,714 843 2,543 3,326
General and
administrative.. 7 26 1,502 3,392 9,848 11,579 1,260 4,698 6,259
Amortization of
goodwill and
intangible
assets.......... -- -- -- -- -- 194,770 -- 1,697 50,390
Stock
compensation
expense......... -- -- -- 487 3,207 3,788 346 755 995
------- ------- --------- --------- ---------- ---------- --------- ---------- ----------
Total cost and
expenses....... 7 26 5,593 19,459 64,918 274,056 7,418 32,272 135,575
------- ------- --------- --------- ---------- ---------- --------- ---------- ----------
Loss from
operations....... (7) (26) (5,375) (17,116) (52,487) (261,406) (6,033) (24,672) (127,383)
Interest income
(expense), net... (2) (1) 87 354 1,551 1,730 96 697 722
------- ------- --------- --------- ---------- ---------- --------- ---------- ----------
Loss before income
taxes............ (9) (26) (5,288) (16,762) (50,936) (259,676) (5,937) (23,975) (126,661)
Provision for
income taxes..... 1 1 1 2 2 5 2 5 5
------- ------- --------- --------- ---------- ---------- --------- ---------- ----------
Net loss.......... $ (10) $ (27) $ (5,289) $ (16,764) $ (50,938) $ (259,681) $ (5,939) $ (23,980) $ (126,666)
======= ======= ========= ========= ========== ========== ========= ========== ==========
Basic and diluted
loss per share
(1).............. $ (0.04) $ (0.10) $ (3.53) $ (7.50) $ (4.58) $ (7.28) $ (2.53) $ (0.65) $ (2.10)
======= ======= ========= ========= ========== ========== ========= ========== ==========
Shares used in
basic and diluted
loss per share
(1).............. 275,000 275,000 1,497,711 2,236,452 11,127,462 35,683,550 2,345,984 36,676,137 60,431,483
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
September 30, December 31,
--------------------------------- 1999
1995 1996 1997 1998 1999 (unaudited)
---- ---- ------ ------- -------- ------------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents....... $ 7 $344 $4,584 $ 5,711 $ 43,315 $ 18,181
Investments..................... -- -- 1,983 10,123 31,691 18,923
Working capital................. 5 76 4,613 12,883 59,506 9,596
Total assets.................... 93 432 9,223 22,617 107,648 1,078,349
Long-term obligations, including
current portion................ -- -- 705 3,992 11,092 14,129
Total stockholders' equity...... $86 $ 84 $6,265 $15,490 $ 79,218 $1,029,747
</TABLE>
- --------
(1) See notes 2 and 9 of the notes to our consolidated financial statements for
the determination of shares used in computing basic and diluted loss per
share.
(2) Pro forma financial data reflects the acquisition of Sandpiper. See the
unaudited pro forma combined financial statements and the notes thereto
included elsewhere in this prospectus.
30
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of
operations of Digital Island should be read in conjunction with the
consolidated financial statements and notes thereto included elsewhere in this
prospectus. This discussion contains forward-looking statements that involve
risks and uncertainties. Our actual results could differ from those anticipated
in these forward-looking statements as a result of various factors including
but not limited to, those discussed in "Risk Factors," "Business" and elsewhere
in this prospectus.
Overview
We provide a global e-Business delivery network and suite of services for
enterprises that use the Internet to deploy critical business applications and
conduct e-commerce worldwide. We offer a comprehensive solution that integrates
content delivery, hosting, intelligent networking and applications services. We
target global enterprises that increasingly rely on the Internet to conduct
business, but are constrained by the unreliability, slow performance and
limited range of functions of the public Internet. Our customers use our
services and proprietary technology to facilitate the deployment of a wide
variety of electronic commerce applications, including online marketing and
sales, customer service, fulfillment, software, document and multimedia
distribution and online training. As of December 31, 1999, we had contracts
with 169 customers, of which 132 were deployed, including Activision, AOL,
Autodesk, Canon, Cisco Systems, CNBC.com, E*TRADE, Blue Mountain, ft.com,
Intuit, Microsoft, National Semiconductor, NetGravity, PBS.org and Value
America.
We did not begin offering our e-Business delivery network services until
January 1997; prior to such time we were engaged in activities unrelated to our
current operations and, accordingly, comparisons for the period ended September
30, 1997 are not meaningful. Since inception, we have incurred net losses and
experienced negative cash flow from operations. We expect to continue to
operate at a net loss and to experience negative cash flows at least through
the year 2000. Our ability to achieve profitability and positive cash flow from
operations will be dependent upon our ability to grow our revenues
substantially and achieve other operating efficiencies.
We derive our revenues from a suite of services, which include content
delivery and network services, hosting services and application and
professional services. We currently sell our services under contracts with
terms of one or more years.
Cost of revenues consists primarily of the cost of contracting for lines
from telecommunication service providers worldwide and, to a lesser extent, the
cost of our network operations. We lease lines under contracts of one year or
more. The leasing of transoceanic lines comprises the largest component of our
telecommunications expense, with additional costs arising from leasing local
circuits between our data centers and points of presence in the United States
and international markets. In the future, we expect to increase the size and
number of circuits leased, based on increases in network volume and geographic
expansion. The cost of our network operations is comprised primarily of data
centers, equipment maintenance, personnel and related costs associated with the
management and maintenance of the network.
Some options granted and common stock issued from May 1, 1998 to June 30,
1999 have been accounted for as compensation. Total stock compensation expense
associated with such equity transactions as of December 31, 1999 amounted to
$7.7 million. These amounts are being amortized over the vesting periods of the
relevant securities. Of the total stock compensation expense, $487,000 was
amortized in the year ended September 30, 1998, $3.2 million was amortized in
the year ended September 30, 1999, and $755,000 was amortized in the three
months ended December 31, 1999. We expect amortization of $2.4 million and $1.2
million in the years ending September 30, 2000 and 2001, respectively, relating
to these grants.
31
<PAGE>
In December 1999, we merged with Sandpiper Networks, Inc. The transaction
was accounted for using the purchase method of accounting. The acquisition
price included approximately 24.6 million shares of Digital Island common stock
with a fair value of $857.0 million, 3.1 million vested and unvested stock
options and warrants with a fair value of $96.6 million and estimated direct
transaction costs of approximately $14.0 million. Costs associated with the
merger of Digital Island and Sandpiper that impact future earnings include the
amortization of assembled workforce costs of $2.0 million, core technology
costs of $121.1 million and $850.8 million of goodwill to be amortized over a
period of 5 years.
In connection with the Sandpiper merger, we expect amortization costs over
the next five years as follows (in thousands):
<TABLE>
<CAPTION>
Year ending
September 30,
-------------
<S> <C>
2000........................................................... $147,650
2001........................................................... 194,770
2002........................................................... 194,770
2003........................................................... 194,770
2004........................................................... 194,770
2005........................................................... 47,123
</TABLE>
In addition, in January 2000, we acquired Live On Line, Inc. The transaction
will be accounted for using the purchase method of accounting. The acquisition
price included 799,989 shares of Digital Island common stock with a fair value
of approximately $63.5 million and $5.2 million in cash. We expect annual
amortization costs of approximately $14 million over the next five years in
conjunction with this acquisition.
The following discussion comparing our historical results of operations for
fiscal years 1997 to 1999 and the three months ended December 31, 1998 does not
reflect the results of operations of Sandpiper. The discussion comparing the
three months ended December 31, 1999 reflects the results of three days of
operations of Sandpiper, which we acquired on December 28, 1999.
Three Months Ended December 31, 1999 and 1998
Revenue. Revenue increased to $7.6 million for the three months ended
December 31, 1999 from $1.4 million for the three months ended December 31,
1998. The increase in revenue was primarily due to increased usage per customer
and an increase in the number of billing customers to 132 from 40.
Cost of revenue. Cost of revenue increased to $16.3 million for the three
months ended December 31, 1999 from $2.9 million for the three months ended
December 31, 1998. The increase in cost of revenue was due to the $11.1 million
of spending for additional network capacity and $2.3 million in recruitment and
compensation costs relating to the addition of network operations personnel.
Sales and Marketing. Sales and marketing expenses increased to $6.3 million
for the three months ended December 31, 1999 from $2.0 million for the three
months ended December 31, 1998. This increase was due to $3.5 million of growth
in personnel and related costs and $0.8 million of program expenses.
Product Development. Product development expenses increased to $2.5 million
for the three months ended December 31, 1999 from $0.8 million for the three
months ended December 31, 1998. This increase was due to $1.5 million in growth
of personnel and related costs and $0.2 million of costs arising from new
product initiatives, including TraceWare, mirroring and caching technologies.
General and Administrative. General and administrative expenses increased to
$4.7 million for the three months ended December 31, 1999 from $1.3 million for
the three months ended December 31, 1998.
32
<PAGE>
This increase was due to $1.7 million of depreciation of network equipment,
$1.1 million in growth of personnel and related expenses and $0.6 million of
office facility expenses, legal and accounting fees and other administrative
related expenses.
Interest Income, net. Interest income, net increased to $0.7 million for the
three months ended December 31, 1999 from $96,000 for the three months ended
December 31, 1998. This increase was due to a higher average cash balance
remaining primarily from the proceeds of the issuance of shares of our common
stock in our initial public offering.
Fiscal Years Ended September 30, 1999 and 1998
Revenue. Revenue increased to $12.4 million for the year ended September 30,
1999 from $2.3 million for the year ended September 30, 1998. The increase in
revenue was due primarily to increased usage per customer and an increase in
the number of billing customers to 83 from 31.
Cost of Revenue. Cost of revenue increased to $29.5 million for the year
ended September 30, 1999 from $9.0 million for the year ended September 30,
1998. The increase in cost of revenue was due to $17.5 million of spending for
additional network capacity and $3.0 million in recruitment and compensation
costs relating to the addition of network operations personnel.
Sales and Marketing. Sales and marketing expenses increased to $16.0 million
for the year ended September 30, 1999 from $4.8 million for the year ended
September 30, 1998. This increase was due to $10.6 million of growth in
personnel and related costs and $0.6 million of program expenses.
Product Development. Product development expenses increased to $6.3 million
for the year ended September 30, 1999 from $1.7 million for the year ended
September 30, 1998. This increase was due to $3.7 million in growth of
personnel and related costs and $0.9 million of costs arising from new product
initiatives, including TraceWare, mirroring and caching technologies.
General and Administrative. General and administrative expenses increased to
$9.8 million for the year ended September 30, 1999 from $3.4 million for the
year ended September 30, 1998. This increase was due to $2.4 million of
depreciation of network equipment, $2.4 million of growth in personnel and
related expenses, and $1.6 million office facility expenses, legal and
accounting fees and other administrative related expenses.
Interest Income, net. Interest income, net, increased to $1.6 million for
the year ended September 30, 1999 from $354,000 for the year ended September
30, 1998. This increase was due to a higher average cash balance as a result of
the proceeds of the issuance of shares of our convertible preferred stock in a
private placement and our common stock in our initial public offering.
Fiscal Years Ended September 30, 1998 and 1997
We did not begin offering our e-Business delivery network services until
January 1997; prior to such time we were engaged in activities unrelated to our
current operations. Additionally, during the periods prior to January 1997, we
had no revenues and our operating expenses, although not material, consisted of
general and administrative expenses associated with an unrelated technology
business venture. Accordingly, our results of operations prior to 1997 are not
comparable to our results of operations for 1997 or any subsequent periods.
Revenue. Revenue increased to $2.3 million for the year ended September 30,
1998 from $0.2 million for the year ended September 30, 1997. The increase in
revenue was due primarily to an increase in the number of billing customers to
31 from 6.
Cost of Revenue. Cost of revenue increased to $9.0 million for the year
ended September 30, 1998 from $2.5 million for the year ended September 30,
1997. The increase in cost of revenue was
33
<PAGE>
due to $5.7 million of spending for additional network capacity and $0.8
million in recruitment and compensation costs relating to the addition of
network operations personnel.
Sales and Marketing. Sales and marketing expenses increased to $4.8 million
for the year ended September 30, 1998 from $1.2 million for the year ended
September 30, 1997. This increase was due to $3.1 million of growth in
personnel and related costs and $0.5 million of program expenses.
Product Development. Product development expenses increased to $1.7 million
for the year ended September 30, 1998 from $0.4 million for the year ended
September 30, 1997. This increase was due primarily to $1.2 million in growth
of personnel and related costs and $0.1 million of costs arising from new
product initiatives, including TraceWare, mirroring and caching technologies.
General and Administrative. General and administrative expenses increased to
$3.4 million for the year ended September 30, 1998 from $1.5 million for the
year ended September 30, 1997. This increase was due to $0.7 million of
depreciation of network equipment, $0.7 million of growth in personnel and
related expenses, and $0.5 million office facility expenses, legal and
accounting fees and other administrative related expenses.
Interest Income, net. Interest income, net, increased to $353,000 for the
year ended September 30, 1998 from $87,000 for the year ended September 30,
1997. This increase was due to a higher average cash balance as a result of the
proceeds of the issuance of shares of our convertible preferred stock.
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Quarterly Results of Operations
The following tables set forth certain unaudited statements of operations
data for the nine quarters ended December 31, 1999. This data has been derived
from the unaudited interim financial statements prepared on the same basis as
the audited consolidated financial statements contained in this prospectus. In
the opinion of management, this data includes all adjustments, consisting only
of normal recurring adjustments, that we consider necessary for a fair
presentation of such information when read in conjunction with the consolidated
financial statements and notes thereto appearing elsewhere in this prospectus.
The operating results for any quarter should not be considered indicative of
results of any future period.
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------------------------------------------------------------------
Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31,
1997 1998 1998 1998 1998 1999 1999 1999 1999
-------- -------- -------- --------- -------- -------- -------- --------- --------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenue................. $ 277 $ 414 $ 725 $ 927 $ 1,385 $ 2,411 $ 3,700 $ 4,935 $ 7,600
Costs and expenses:
Cost of Revenue........ 1,961 2,065 2,267 2,746 2,923 4,827 8,055 13,691 16,264
Sales and Marketing.... 860 927 1,296 1,764 2,046 3,125 4,525 6,314 6,315
Product development.... 214 357 538 585 843 1,167 1,853 2,494 2,543
General and
Administrative........ 531 632 902 1,326 1,260 1,703 2,469 4,416 4,698
Amortization of
goodwill and
intangible assets .... -- -- -- -- -- -- -- -- 1,697
Stock compensation
expense............... -- -- 132 355 346 680 1,248 933 755
------- ------- ------- ------- ------- ------- -------- -------- --------
Total cost and
expenses............ 3,566 3,981 5,135 6,776 7,418 11,502 18,150 27,848 32,272
Loss from operations.... (3,289) (3,567) (4,410) (5,849) (6,033) (9,091) (14,450) (22,913) (24,672)
Other income (expense),
net.................... 45 19 123 166 96 160 387 908 697
------- ------- ------- ------- ------- ------- -------- -------- --------
Loss before income
taxes.................. (3,244) (3,548) (4,287) (5,683) (5,937) (8,931) (14,063) (22,005) (23,975)
Provision for income
taxes.................. -- 1 -- 1 2 -- -- -- 5
------- ------- ------- ------- ------- ------- -------- -------- --------
Net loss................ $(3,244) $(3,549) $(4,287) $(5,684) $(5,939) $(8,931) $(14,063) $(22,005) $(23,980)
======= ======= ======= ======= ======= ======= ======== ======== ========
</TABLE>
We expect to experience significant fluctuations in our future results of
operations due to a variety of factors, many of which are outside of our
control, including:
. demand for and market acceptance of our products and services may decline
or fail to increase enough to offset our costs;
. introductions of new products and services or enhancements by us and our
competitors may increase our costs or make our existing products or
services obsolete;
. the prices we can charge our customers may decline due to price
competition with our competitors;
. utilization of our global network may increase beyond our capacity and we
may incur expenses to increase such capacity;
. continuity of our service and network availability could be interrupted,
reducing revenue;
. the availability and cost of bandwidth may reduce our ability to increase
bandwidth as necessary, reducing our revenue;
. the timing of customer installations and the timing of expansion of our
network infrastructure may vary from quarter to quarter;
. the mix of products and services we sell may change and the new mix may
generate less revenue;
. the timing and magnitude of our capital expenditures, including costs
relating to the expansion of operations may vary from quarter to quarter;
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. bandwidth used by customers may fluctuate from quarter to quarter
affecting our profits from such customers; and
. conditions specific to the Internet industry and other general economic
factors may affect the prices we can charge and the expenses we incur.
In addition, a relatively large portion of our expenses are fixed in the
short-term, particularly with respect to telecommunications capacity,
depreciation, real estate and interest expenses and personnel, and therefore
our results of operations are particularly sensitive to fluctuations in
revenues. Due to the foregoing factors, we believe that period-to-period
comparisons of our operating results are not necessarily meaningful and that
such comparisons cannot be relied upon as indicators of future performance.
Liquidity and Capital Resources
From inception through our initial public offering in June 1999, we financed
our operations primarily through private equity placements of $86.9 million and
borrowings under notes payable and capital leases from financial institutions
of $5.7 million. We raised $63.1 million in net proceeds from our initial
public offering. At December 31, 1999, we had cash and cash equivalents and
short-term investments of $37.1 million.
Net cash used in our operating activities for the three months ended
December 31, 1999 was $25.9 million. The net cash used by operations was
comprised primarily of working capital requirements and net losses. Net cash
provided by our investment activities was $1.1 million for the three months
ended December 31, 1999 and was comprised primarily of equipment purchases of
$16.3 million and investments of $2.3 million in commercial paper with
maturities of less than one year, which were offset by proceeds from
investments which matured of $15.4 million and cash acquired through business
acquisitions of $4.3 million. Net cash used in financing activities was
$419,000 and was related primarily to repayments of debt obligations.
We have a $750,000 revolving line of credit with a commercial bank for the
purpose of financing equipment purchases. As of December 31, 1999, $259,000 was
outstanding thereunder. The loan contains standard covenants including minimum
working capital, minimum tangible net worth, debt to equity ratio, assets to
liabilities ratio and financial reporting requirements. Interest on borrowings
thereunder accrues at the lender's prime rate plus 0.75%, which was 9.25% at
December 31, 1999, and is payable monthly. No further advances were permitted
following October 18, 1997. At that date, the unpaid principal balance plus
interest became payable over 36 months in equal installments.
We also have a $7.5 million line of credit with a commercial bank,
consisting of a revolving credit facility of up to $5 million and equipment
loan facilities of up to $2.5 million. As of December 31, 1999, approximately
$230,000 was outstanding under the revolving credit facility, and approximately
$483,000 was outstanding under equipment loan facilities. No further amounts
may be borrowed under the equipment loan facilities. Advances under the line of
credit are limited to a percentage of our recurring contract revenue. The loan
contains standard covenants, including minimum working capital, minimum
tangible net worth, debt to equity ratio, assets to liabilities ratio and
financial reporting requirements. Interest on borrowings under the revolving
credit facility accrues at the lender's prime rate plus 0.25%, which was 8.75%
at December 31, 1999, and is payable monthly. Under the terms of the equipment
loan facilities, interest is charged at the lender's prime rate plus 0.75%,
which was 9.25% at December 31, 1999, and is payable monthly. The loans mature
at various times in 2001. Between October 1, 1998 and January 31, 1999, we did
not comply with the minimum tangible net worth and financial reporting
covenants. However, we obtained waivers for all covenant violations. We have
complied with all covenants since January 31, 1999.
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Pursuant to the merger with Sandpiper, we assumed from Sandpiper a line of
credit with a bank for $1,000,000, with a variable rate of interest, based on
the bank's prime rate plus 0.5%. At December 31, 1999, no amounts were extended
under this facility.
Pursuant to the merger with Sandpiper, we assumed from Sandpiper a
promissory note with a financial institution in the amount of $84,224 at a
stated interest rate of 7% per annum, principal and interest due monthly for 36
months and collateralized by equipment on August 31, 1998.
In addition, we have several lease lines of credit. Total borrowings under
these lease lines of credit were $13.1 million at December 31, 1999, of which
$2.4 million was assumed pursuant to the merger with Sandpiper.
In December 1999, Sun Microsystems agreed to provide $100 million of lease
financing for the acquisition of equipment, subject to certain milestones
further described in "Prospectus Summary--Recent Developments."
The execution of our business plan will require substantial additional
capital to fund our operating losses, working capital needs, sales and
marketing expenses, lease payments and capital expenditures. In order to
rapidly improve our competitive position, we anticipate making up to
approximately $80.0 million to $100.0 million of capital expenditures for
network expansion, facilities and related costs in the next 12 months. This
substantial increase in the level of our anticipated capital expenditures will
require up to $100.0 million to $150.0 million of additional financing, which
we expect to receive from the net proceeds of this offering and the net
proceeds of the $300 million in aggregate principal amount of convertible
subordinated notes we expect to receive in a separate public offering. Neither
the completion of the note offering nor the completion of this common stock
offering are contingent upon the other. We intend to consider future financing
alternatives, which may include the incurrence of indebtedness, additional
public or private equity offerings or an equity investment by a strategic
partner. Actual capital requirements may vary, based upon the timing and
success of the expansion of our operations. Our capital requirements may change
based upon technological and competitive developments. In addition, several
factors may affect our capital requirements:
. demand for our services or our anticipated cash flow from operations
being less than expected;
. our development plans or projections proving to be inaccurate;
. our engaging in acquisitions or other strategic transactions; or
. our accelerating deployment of our network services or otherwise altering
the schedule of our expansion plan.
There can be no assurance that any such equity or debt financing will be
available to us on favorable terms, or at all. If we do not obtain additional
financing, we believe that our existing cash resources will be adequate to
continue expanding operations on a reduced scale.
Recent Accounting Pronouncements
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging
Activities." SFAS 133 establishes accounting and reporting standards for
derivative instruments and for hedging activities. In June 1999, the FASB
issued SFAS 137, "Accounting for Derivative Instruments and Hedging Activities
Deferral of Effective Date of FASB Statement No. 133," which deferred the
effective date of SFAS to all fiscal quarters of fiscal years beginning after
June 15, 2000. We do not believe the adoption of SFAS 133 will have a material
effect on our consolidated results of operations or financial condition.
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Year 2000 Compliance
The "Year 2000 issue" contemplates that many currently installed computer
systems may be unable to distinguish 21st century dates from 20th century
dates. As a result, such computer systems and software may suffer major system
failures or miscalculations. If we or our key third party suppliers fail to
achieve Year 2000 compliance, we may experience operating difficulties,
including impaired ability to transport data over our network and impaired
ability to bill for our services. We recognize the need to ensure that our
operations will not be adversely affected by Year 2000 software failures. We
continue to assess the potential overall impact of this issue on our
operations.
Based on our assessment to date, we believe the current versions of our
software products and services are Year 2000 compliant, that is, they are
capable of adequately distinguishing 21st century dates from 20th century
dates. However, our products are generally integrated into enterprise systems
involving sophisticated hardware and complex software products, which may not
be Year 2000 compliant. We may in the future be subject to claims based on Year
2000 problems in others' products, or issues arising from the integration of
multiple products within an overall system. Although we have not been a party
to any litigation or arbitration proceeding to date involving our products or
services and related to Year 2000 compliance issues, there can be no assurance
that we will not in the future be required to defend our products or services
in such proceedings, or to negotiate resolutions of claims based on Year 2000
issues. The costs of defending and resolving Year 2000-related disputes,
regardless of the merits of such disputes, and any potential liability on our
part for Year 2000-related damages, including consequential damages, could
cause our business and financial results to suffer. In addition, we believe
that purchasing patterns of customers and potential customers may be affected
by Year 2000 issues as companies may continue to expend significant resources
to correct or upgrade their current software systems for Year 2000 compliance.
These expenditures may reduce funds available to purchase software products
such as those offered by us. To the extent that Year 2000 issues cause
significant delay in, or cancellation of, decisions to purchase our products or
services, our business and financial results could suffer.
We have formulated a contingency plan should we or any of our key third
parties sustain business interruptions caused by year 2000 problems. We are
reviewing our internal management information and other systems in order to
identify and modify any products, services or systems that are not year 2000
compliant. To date, we have not encountered any material year 2000 problems
with our computer systems, applications or any other equipment which might be
subject to these problems. In addition, we received an independent third-party
evaluation of the year 2000 compliance of our network equipment and carriers in
March 1999 and of our computer systems and applications in October 1999. We
will continue to monitor year 2000 compliance for our new products and services
as they arise.
In the event that any of our external vendors cannot timely provide us with
products, services or systems that meet the Year 2000 requirements, we may
incur unexpected expenses to remedy any problems. These expenses could
potentially include purchasing replacement hardware or software. In addition,
our business and our ability to deliver our products and services could be
severely affected, at least for a certain period of time, in the event that
Year 2000 related problems were to cause disruption or failure in the Internet
as a means of delivery of our products and services or more generally,
disruption to the infrastructure. The total cost of these Year 2000 compliance
activities has not been, and is not anticipated to be, material to our
business, results of operations and financial condition. These costs and the
timing in which we plan to complete our Year 2000 modification and testing
processes are based on our management's estimates. We may not be able to
remediate all significant Year 2000 problems on a timely basis. Our remediation
efforts may involve significant time and expense, and could cause our business
and prospects to suffer.
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To date, we have experienced no material complications to our operations due
to Year 2000 issues.
Qualitative and Quantitative Disclosure About Market Risk
We provide a global e-Business delivery network and suite of services and
sell such services in North America, Asia and Europe. As a result, our
financial results could be affected by factors such as changes in foreign
currency exchange rates or weak economic conditions in foreign markets. As all
sales are currently made in U.S. dollars, a strengthening of the dollar could
make our services less competitive in foreign markets. We do not use derivative
instruments to hedge our foreign exchange risks. Our interest income is
sensitive to changes in the general level of U.S. interest rates, particularly
since the majority of our investments are in short-term instruments. Due to the
nature of our short-term investments, we anticipate no material market risk
exposure. Therefore, no quantitative tabular disclosures are required.
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<PAGE>
BUSINESS
Overview
We provide a global e-Business delivery network and suite of services for
enterprises that use the Internet to deploy critical business applications and
conduct e-commerce worldwide. We offer a comprehensive solution that integrates
content delivery, hosting, intelligent networking and applications services. We
believe our continuum of Internet services provides our customers several key
benefits:
. a faster and more secure and consistent end-user experience, leading to
increased sales, brand loyalty and customer satisfaction;
. greater geographic reach and the ability to serve multiple geographies
with content that is more relevant to their end users; and
. a lower total cost of conducting e-Business.
Our services enable enterprises to effectively deploy and manage their
global applications by combining the reliability, performance and broad range
of functions available in private networks with the ubiquitous access of the
public Internet. Users access sites through links and web addresses as they
normally would; however, our services enhance availability, speed, security and
functionality, allowing our customers to manage transactions and content better
than they are able to do using the public Internet. Our unique infrastructure
and global service are capable of meeting the needs of e-Business where
applications such as a trade or purchase of goods requires fast "round-trip"
two way support.
We target global enterprises that increasingly rely on the Internet to
conduct business, but are constrained by the unreliability, slow performance
and limited range of functions of the public Internet. Our customers use our
services and proprietary technology to facilitate the deployment of a wide
variety of electronic commerce applications, including online marketing and
sales, customer service, fulfillment, software, document and multimedia
distribution and online training. As of December 31, 1999, we had contracts
with 169 customers, of which 132 were deployed, including Activision, AOL,
Autodesk, Blue Mountain, Canon, Cisco Systems, CNBC.com, E*TRADE, ft.com,
Intuit, Microsoft, National Semiconductor, NetGravity, PBS.org and Value
America.
Industry Background
The Internet continues to experience rapid growth and has become a critical
global communications and commerce medium. IDC expects worldwide e-commerce
sales to grow from approximately $50.4 billion in 1998 to approximately $1.3
trillion in 2003.
The Internet, a network of hundreds of interconnected, separately
administered public and private networks, was not originally designed to handle
either the large traffic levels or the vast array of content types being
transmitted today. The Internet provides any-to-any connectivity, but does not
intelligently monitor and optimize the distribution of media-rich content.
Organizations cannot predict or control the network path that their data will
travel over the Internet and, as a result, are unable to avoid network
congestion or bottlenecks that degrade performance. This problem is exacerbated
during the peak periods of network usage and bursts in traffic volumes that
result from news and other significant one-time events, when performance is
often the most critical. For companies conducting business over the Internet,
poor website performance, such as failed commerce transactions, slow downloads
or site crashes, can create dissatisfied users and result in lost customer
goodwill and revenue opportunities.
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For enterprises using the Internet for global operations, the U.S.-centric
nature of the public Internet results in poor response times. This occurs
because data transmittal between countries may be forced to travel through
telecommunications lines in the U.S., making a large number of connections
through various regional and national Internet service providers before
reaching its ultimate destination. Data packets often become lost in the
transfer process, especially in the case of data-intensive transfers involving
large software downloads, multimedia document distribution and audio or video
content.
As a result of the growth of Internet usage and the limitations of the
public Internet, it has become critical for businesses to continually expand
and enhance their Internet capabilities to deliver a superior experience for
their end-users. Businesses are increasingly demanding Internet networks that
operate with the functionality and performance levels previously available only
on private corporate networks. Businesses require Internet networks that
deliver fast, consistent, reliable, secure and relevant end-user experiences
worldwide; remain easy to upgrade as the scale and complexity of applications
grow and technologies change; operate continuously; and offer applications
support and functionality (e.g., user location, identification and usage
patterns). Corporate investment in Internet support and services has therefore
begun to increase dramatically.
The Digital Island Solution
We provide an e-Business delivery network and suite of services that
integrates content delivery, hosting, intelligent networking and applications
services. We have created an open platform that supports multiple data types
including voice, text, graphics, file transfer, and streaming audio and video
broadcast services as well as different access methods including dial-up,
Digital Subscriber Line, or DSL, cable and wireless. Customers can chose
between component solutions tailored to meet specific needs or a fully
integrated comprehensive solution, both of which are backed by industry-leading
service level agreements.
We believe that our global e-Business delivery network provides the
following benefits to its customers:
Faster End-user Experience. Our dedicated global private network and
Footprint content delivery services greatly enhance the performance of e-
Business applications. Using our proprietary technology, we are able to store
and deliver content in an optimal manner. For content that is repeatedly
delivered to many users, we operate over 1,200 content distributors located
throughout the Internet under the Footprint brand. For real-time transactions
and content that is unique or specific to a user and must therefore be stored
centrally, we utilize proprietary networking technology and we operate a global
high-speed private network that acts as a backbone connecting directly to 22
countries.
Increased Reliability, Security and Consistency. We design solutions for our
customers that minimize downtime. By locating servers within any of our five
strategically located data centers (Hong Kong, Honolulu, Santa Clara, New York
and London), our customers can take advantage of a fully redundant data center
and network infrastructure. We currently offer both Windows NT(TM) and
Solaris(TM) service level agreements that guarantee origin server uptime and
network reliability on the backbone and peering circuits. For customers using
Footprint, reliability levels are further increased as Footprint can reroute
around failures of any of the over 1,200 content distributors that form the
production network. We back our e-Business content delivery network with
continuous on-site personnel in each data center, two fully redundant network
operations centers, and a wide variety of fault detection, isolation and
recovery applications and expertise.
Global Reach, Scalability and Relevant Content. Our intelligent network
currently has direct connection points in 22 countries in Africa, Asia, Europe,
North America, South America and
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Australia. This network is supplemented by over 1,200 content distributors,
which provide improved reach to countries not directly accessed by our network.
We believe that this global reach provides our customers with direct access to
the majority of existing Internet users and indirect access to every Internet
user in the world, allowing them to deliver a fast, reliable and consistent
end-user experience regardless of market served.
Our network architecture can scale to accomodate millions of simultaneous
users, multiple access devices and all forms of content. We also provide
customers with the ability to serve multiple geographies with content relevant
to end-users in specific locations. Through a patent-pending technology called
TraceWare, we are able to detect the IP address of the end-user and determine,
with over 95% accuracy, the country where the end-user is located. This
technology allows our customers to develop country-specific advertising
campaigns, target specific content to countries, develop and manage multiple
price lists and check payment information for fraudulent behavior.
Comprehensive, Cost-Effective Outsourcing Solution. Our customers directly
benefit from the significant investments of technical expertise, capital, and
other resources that we have made to develop our e-Business delivery network.
Our comprehensive offering, including content delivery, hosting, intelligent
networking and application services, provides a high performance one-stop
solution allowing customers to manage both content and transactions. Most
enterprises today do not have the infrastructure that mission-critical Internet
operations require, including strategic, globally distributed data centers,
network redundancy for reliability, continuous operations and specialized
Internet technology expertise. Our network and suite of services allows
customers to overcome shortages of technical resources and keep up with
continuously changing technologies, including the ability to satisfy peak
period capacity requirements and accommodate one-time events, while
substantially lowering the costs of deploying and maintaining Internet
applications. Our solution is based on an open architecture that allows our
customers to easily integrate their existing applications with our delivery
network. We believe that our solutions and economies of scale are significantly
more cost-effective than most in-house alternatives. By providing a one-stop
solution that goes beyond traditional outsourcing, we substantially reduce the
administrative and logistical costs that come from managing multiple
outsourcing vendors.
Strategy
Our objective is to become the leading global e-Business delivery network.
In order to achieve this objective, we are implementing a business strategy
focused on the following key elements:
Target Leading e-Business Customers. We have designed our network to address
the sophisticated needs of medium to large-size global enterprises, that
increasingly rely on the Internet to provide critical business applications
globally and require consistent levels of high performance and reliability. We
target leading e-Business customers in financial services, high technology
manufacturing, application service provision, software, media publishing,
entertainment and other vertical markets whose constituents are heavy users of
the Internet for their businesses. We have tailored our services to enhance
performance for our multinational customers in electronic commerce and
services, who require multimedia distribution and high volume transaction
processing.
Enhance Service Offerings. We seek to be a leader in designing and deploying
a global e-Business infrastructure that enables customers to capture the
benefits of ubiquitous access to applications, a performance and range of
functions comparable to private intranets operated by individual companies for
their own users, and the fastest, most relevant and reliable applications and
content delivery system. We are committed to investing resources to implement
new Internet technology and services that will allow our customers to optimize
their deployment and operation of applications globally. Our solutions are
based on an open architecture that allows us to integrate leading technologies
from within Digital Island and through outside sources. We collaborate with
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providers of leading Internet technologies, including strategic relationships
with Inktomi and Sun, to develop and deploy proprietary technologies that
enhance our service offerings and address our customers' evolving needs. By
integrating additional Internet services into our e-Business delivery network
and by providing high-quality customer support, we believe that businesses will
increasingly rely on us for their Internet business needs, which in turn should
expand usage and increase demand for both application services and network
usage.
Extend Network and End-User Reach. We plan to expand the size of our e-
Business delivery network to increase the overall performance, scalability, and
cost-effectiveness of our solutions. Our network expansion will include
obtaining additional bandwidth and international circuits, the build-out of new
regional data centers, and the continued deployment of content distributors. We
plan to expand end-user reach by increasing our content distributor deployment
inside "last-mile" networks that connect to end-users. We believe that
establishing presence inside these last-mile networks is central to improving
web-site performance, and to developing new value-added service offerings. We
will be targeting network service providers across all major access categories,
including dial-up, cable, DSL, and wireless. We will be developing a network
service provider program to help accelerate the deployment of content
distributors inside last-mile networks.
Leverage Strategic Relationships. We believe that strategic technology and
marketing/reselling relationships enhance our ability to reach new customers.
Strategic relationships with our customers in our target markets, such as with
E*TRADE and AOL, bring not only a high level of understanding of the specific
needs of that market but also credibility and visibility with potential new
customers. We also have strategic relationships with companies that can enhance
our ability to develop and deliver new application services, such as Cisco,
Inktomi, Microsoft and Sun. These strategic relationships provide additional
sales channels for us; for example we will now be promoted by Sun's sales
force. Additionally, we hope to leverage these enterprises' research and
development expertise to cost effectively develop new networking, content
delivery and applications services. As opportunities arise, we look to
establish new relationships with system integrators, hardware and software
vendors and application service providers.
Enhance Global Sales and Channel Capabilities. We plan to extend our
leadership in the market for global Internet application services by continuing
to expand our base of customers. We target customers predominantly through a
direct sales force complemented by a range of external alliances and channel
partners. We currently have approximately 145 people in our sales and marketing
organization in offices in the U.S., Asia and Europe and intend to grow our
sales organization substantially over the next year. We co-market with other
companies, including content developers, system integrators and consulting
firms, to increase the effectiveness of our direct channel as well as to serve
additional market segments and geographies. In addition to co-marketing, we
sell through a growing number of independent sales agents or resellers in
countries where we do not sell directly. Furthermore, our strategic
relationships with companies such as Sun and AOL mean that we get references
and leads from their sales forces.
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Services
We offer a comprehensive suite of services designed to help corporations
deploy and manage e-Business applications. Our e-Business delivery network is
the foundation to providing solutions that are scalable, flexible and cost-
effective, and to guaranteeing fast, consistent and relevant end-user
experiences. Currently, our integrated network services platform consists of
four primary service categories: (1) content delivery, (2) hosting, (3)
intelligent networking, and (4) application services.
[Diagram of Company's Services]
We work with each of our customers to optimize cost and performance
requirements. Our software and network engineering team provides our customers
with global expertise and consultation in the design and deployment of their
applications on the Digital Island e-Business delivery network. We also provide
continuous operations support and security experts to keep their applications
up and running on a global basis.
We currently offer service level guarantees, customized billing, network
security services, network management and other application services designed
to improve the performance of applications deployed on our network. We plan to
continue to develop or acquire extensions to our application services to
further ongoing product and service delivery.
Content Delivery Services
Our Footprint content delivery services include mirroring, content delivery
and streaming services. Customers of our content delivery services benefit from
having their content and applications intelligently served from a network of
more than 1,200 enterprise class servers located at the edges of our network.
Our Footprint content delivery services avoid network congestion and can
significantly improve web site performance, scalability and reliability. Our
content delivery services also provide the scalability to meet the demand
requirements of special events and peak-usage periods. Our streaming content
delivery services provide comprehensive solutions for both live and on-demand
events, and support multiple streaming formats, including QuickTime(TM), Real
Audio(R) G2 and Real Video(R) G2, and the Microsoft(R) Windows Media(TM)
Player. The companies that use our content delivery services can leverage our
computing infrastructure and avoid the need to invest in the hardware and other
infrastructure necessary to serve content on their own.
Hosting Services
Our Hosting Services allow companies to quickly implement e-Business
networking and computing initiatives without prohibitive costs for equipment,
telecommunications networks and
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maintenance. Hosting e-Business applications with Digital Island reduces these
expenses, while providing access to an engineering team with global networking
expertise, an operations team that is always on call, security experts,
dedicated servers, network reporting and monitoring, and superior, proactive
customer service. We provide a suite of hosting services to support our
customers' business environment. These services include:
Server Management Package. Our Server Management Package is an all-inclusive
solution for customers seeking to outsource their day-to-day hardware and
server administration. We operate two production-ready environments: Sun
Solaris(TM) and Windows NT(TM), operating on Compaq servers. We host these
servers, as well as servers provided by our customers, in our data centers and
provide the network infrastructure as well as application monitoring,
performance optimization, server administration and security services. This
package provides a production-ready environment with maximum uptime.
Hardware Management Package. Our Hardware Management Package enables our
customers to outsource day-to-day hardware maintenance, while allowing our
customers' IT staff unhindered access to perform any needed system
administration functions. This package includes services from our data center
personnel for hardware management and repair, plus access to our network
infrastructure. Our centrally managed network architecture provides optimized
routing, resulting in the uptime, performance, and reliability required by our
customers.
Co-location Package. Our Co-location Package allows our customers to house
their own servers in one of our data centers, and provides a secure environment
designed to deliver maximum uptime for the server, plus access to our global
network.
Intelligent Network Services
We provide a dedicated network, combining advanced networking technology
with a global fiber optic network, to provide optimum reach and performance. We
have built an infrastructure that delivers content directly to multiple
countries, instead of relying on public networks to transport critical e-
Business applications. Our Intelligent Network services are available in a
number of different packages.
Open Bandwidth. Open Bandwidth enables our customers pay a fixed monthly fee
for access to our network. These customers are then charged additional amounts
for actual usage (per gigabit) above prescribed levels. Customers may also pay
for services based on distance traveled. Customers can generate utilization
reports which allow them to determine usage flows by country.
Reserved Bandwidth. Reserved Bandwidth is a network service that guarantees
a minimum throughput level, expressed in kilobytes per second, to a specified
connection point. Our customer is billed for a pre-specified minimum amount of
data transfer to that specified connection point. Unlike other methods of
relaying Internet traffic, such as frame relay services, our network is
engineered to accommodate peaks in traffic above the minimum guaranteed levels.
Gigabytes in excess of the reserved monthly amount are billed at the applicable
data transfer rate.
Managed Bandwidth. Managed Bandwidth is our premium network transport
service offering. Using a web browser interface, information technology
professionals can readily allocate bandwidth by geographic region at any time
from any location. Through this service, information technology professionals
can configure our network to meet their organization's international throughput
requirements.
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Application Services
We provide application services that help e-Business applications run more
effectively. Application services help to shield e-Businesses from the
complexity associated with managing mission-critical distributed computing
systems, and enable them to leverage the intelligence of our e-Business
delivery network. Our flagship application service offering, TraceWare, helps
e-Businesses provide relevant experiences by determining end user's
geographical point of information. Through our proprietary mapping technology,
TraceWare can assure 95% accuracy.
Professional Services
We augment our primary product and service offerings with a range of
professional service options for customers. Professional services include
helping our customers provide security on their networks, making
recommendations for network equipment and consulting as to Internet application
deployment.
Network
Architecture
Our Intelligent Network consists of an asynchronous transfer mode, or ATM,
backbone that connects geographically dispersed data centers. This ATM backbone
core serves as a high-speed network that offers a highly scalable, reliable and
cost effective path with minimal latency or delay. This architecture, unlike
typical Internet backbones, provides a predictable path between major
continents, which improves the speed of content transfer. Each regional data
center acts as a distribution hub within its region. Our Intelligent Network
forms a distributed architecture that minimizes the number of separate
transmissions necessary to transmit data, resulting in greater speed and
reliability for our customers' end-users. Our distributed data centers permit
us to disseminate information reliably on a global basis and, using our
sophisticated data tracking capability, allow us to optimize data transmissions
internationally, minimizing the use of expensive transoceanic fiber optic
circuits. Our network is designed to increase the speed and reliability of data
transmission and circumvents a design weakness of the public Internet, which
requires transmission of information over numerous routers and network inter-
exchange points, often leading to delays and loss of data.
Under our Footprint brand, we operate two forms of edge-computing
technologies: Commerce Content Distributors, or CCDs, and Content Distributors,
or CDs. Both technologies allow our customers' content to be stored throughout
the Internet, improving performance and lowering the cost of operating web
sites. CCDs have the following characteristics:
. the CCD is directly connected to Digital Island's Intelligent Network;
. the CCD is privately peered with multiple access networks within the
same geography; and
. the CCD includes processing and storage technology optimized to support
larger metropolitan locations.
CDs are located deeper at the edge of the Internet, do not have a direct
connection to our network and are sized to support fewer simultaneous
technologies. Both CCDs and CDs share common operating systems and software,
allowing easy migration or upgrading as demand warrants.
We believe our architecture is superior to traditional networks for the
distribution of applications because of the combination of regional data
centers, dedicated network connections and content distribution sites.
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Infrastructure
We currently have direct connections in 22 countries with one or more local
Internet service providers, providing customers with direct access to local
markets worldwide. Currently, we purchase dedicated capacity and transit from
AT&T, GTE, Sprint and MCI WorldCom in the United States, as well as numerous
carriers internationally. At this point in time, we are privately peered with
55 major access networks in the 22 countries comprising our Intelligent
Network. Unlike traditional peering relationships, these network service
providers carry the Internet traffic of our customers without any reciprocal
transit agreement. While we pay a fee to the network service providers for this
arrangement, it gives us access to thousands of Internet service providers
without the obligation of carrying traffic originating outside of our network.
Our distributed data centers peer with multiple backbone networks within the
local geography. In addition to the U.S., we have established private Internet
connection relationships in 21 other countries as listed below:
<TABLE>
<S> <C> <C>
Australia Israel South Africa
Brazil Italy South Korea
Canada Japan Spain
China Mexico Sweden
France Netherlands Switzerland
Germany Russia Taiwan
Ireland Singapore United Kingdom
</TABLE>
In China, we have connections in both Hong Kong and Beijing. With 55
different connection points to the Internet, we believe we offer our customers
one of the most diverse, redundant and reliable networks for the deployment of
business applications globally.
We currently have five data centers located in Hong Kong, Honolulu, Santa
Clara, New York and London. We also have two advanced state-of-the-art network
operations centers, headquartered in Honolulu and London, which provide
continuous real time end-to-end monitoring of our network. The network
operations centers help us to ensure the efficient and reliable performance of
our e-Business delivery network, enabling us to identify, and often prevent,
potential network disruptions and to respond immediately to actual disruptions.
In addition, through traffic management and forecasting, line performance
reporting and alarm monitoring, remote link restoration and coordination, and
provisioning of network services, the network operations centers enable us to
schedule and conduct maintenance with minimal interferences to the network. In
addition to our two network operations centers, we maintain a Level 2 support
center located in San Francisco. Level 2 support acts as an escalation point
for each of the primary network operations centers as well as a third redundant
location capable of managing our worldwide network.
We currently lease lines or bandwidth from multiple telecommunications
carriers. These carriers include MCI WorldCom, GTE and Sprint, as well as
several international carriers such as Cable & Wireless, IDC, Telstra and
Singapore Telecom. Redundant leasing from multiple carriers assists us in
achieving competitive pricing and provides us with a diversity of routes and
access to multiple sources of bandwidth on different cable systems globally.
Our lease contract term with a carrier is typically one year, which allows us
to benefit from declining bandwidth costs over time. In some cases we may
extend the term to three years, such as when there is a significant cost
advantage or when the route served is bandwidth constrained.
Network Reach
We currently have over 1,200 content distributors deployed in more than 35
networks, and 11 countries. Our content distributors are built on a computing
platform that includes Sun enterprise servers and storage devices, Inktomi
traffic servers and Cisco and Alteon network switches. Building out our content
distribution infrastructure on such hardware and software allows us to maintain
high
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levels of performance, scalability, and reliability for our customers. We also
deploy and manage Intel-based servers running Microsoft NT(TM) in connection
with our streaming service offerings and support of Microsoft's Windows Media
technologies. We plan to deploy 5,000 additional content distributors in
approximately 350 metropolitan areas over the next two years.
Open Platform with Integrated Solutions
Our open architecture enables customers to easily integrate their existing
application and publishing environment with our global e-Business delivery
network. Our open Application Programming Interfaces, or APIs, allow the
integration of our solution with other value-added services and applications,
whether created by us, by our customers or by third parties. Content providers
benefit from several third party applications that have been integrated into
our e-Business delivery network. These applications enable services such as
global ad-delivery, turnkey publishing networks, advanced reporting services,
broadcast-quality streaming services and content transformation services. The
architecture has been designed to shield complexity and add new services to
develop a best-in-class commerce platform for customers so that they can
accelerate time-to-revenue.
Customers
We have designed our network to address the sophisticated needs of medium-
to large-size global enterprises, that increasingly rely on the Internet to
provide critical business applications globally and require consistent levels
of high performance and reliability. We target leading e-Business customers in
financial services, high technology manufacturing, application service
provisioning, software, media publishing, entertainment and other vertical
markets whose constituents are heavy users of the Internet for their
businesses. We have tailored our services to enhance the performance of our
multinational customers in electronic commerce and services, such as digital
media distribution and high volume transaction processing. Our customers use
our services and proprietary technology to facilitate the deployment of a wide
variety of electronic commerce applications, including online marketing and
sales, customer service, fulfillment, software, document and multimedia
distribution and online training. As of December 31, 1999, we had contracts
with 169 customers, of which 132 were deployed, including Activision, AOL,
Autodesk, Blue Mountain, Canon, Cisco Systems, CNBC.com, E*TRADE, ft.com,
Intuit, Microsoft, National Semiconductor, NetGravity, PBS.org and Value
America.
The following examples, which are based on information furnished by the
companies listed below, illustrate how some of our customers use our global e-
Business delivery network and suite of services for deployment of business
applications:
Autodesk. Autodesk is a supplier of design software and multimedia tools
that address several markets including architectural and mechanical design,
filmmaking, videography and geographic information systems. Autodesk selected
our Server Management Package and Managed Bandwidth services to distribute
their technical documentation and software to customers in over 150 countries.
Cisco Systems. Cisco Systems is a leading provider of networking software
and hardware for the Internet. Cisco employed our services and technology to
enable engineers to access the Cisco customer care online website in order to
download Cisco software and upgrade routers in the field. Using a combination
of our Hardware and Server Management Packages and our Open Bandwidth services
and mirroring technology, Cisco was able to increase customer service by
allowing the field engineers and customers to access critical information and
download software while working at the client site.
CNBC.com. CNBC.com is a leading financial portal offering detailed and real-
time corporate information, stock quotes, data and analysis. We allow CNBC.com
to provide users with fast, reliable
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access to information on heavily trafficked pages of the CNBC.com site.
CNBC.com is a dynamic and complex site, and our support for multiple content
types helps to ensure a consistent user experience. Given CNBC.com's market-
driven user activity, our content delivery service also provides the
scalability to handle peak hour traffic demands.
E*TRADE. E*TRADE is an online financial services company that uses our
services to provide a broad range of network solutions to deliver mission-
critical applications and provide their customers with consistent performance
online. E*TRADE customers rely on the Internet for their trading and research
requests. As a result, the applications that provide these services are
critical to E*TRADE's business. The applications serving these requests also
require high levels of consistent bandwidth. By utilizing our customized
network services, E*TRADE has advised us that it provides its worldwide
customers with a more consistent, fast and high quality online experience.
Sales and Marketing
We plan to extend our leadership in the market for global Internet
application services by continuing to expand our base of customers. We target
our customers predominantly through a direct sales force complemented by a
range of external alliances and channels. We currently have approximately 145
people in our sales and marketing organization in offices in the U.S., Asia and
Europe and intend to grow our sales organization substantially over the next
year. We co-market with other companies to increase the effectiveness of our
direct channel sales force and to serve market segments and geographies that
are better served through alternative distribution channels. In addition to co-
marketing, we conduct sales activities through a growing number of other sales
agents or resellers in countries where we do not sell directly. Furthermore,
our strategic relationships with companies such as Sun and AOL provide us with
references and leads arising from their sales forces.
We are actively seeking to increase our sales and distribution capabilities
globally. Currently, most of our sales are derived from the efforts of our
direct sales force. We have begun developing indirect sales channels targeting
content developers (such as firms that develop Web sites), system integrators,
consulting companies, suppliers and international Internet service providers.
As of December 31, 1999, we had strategic relationships with 28 companies in
Europe and Asia to whom we pay commissions to refer customers.
Our marketing organization is responsible for strategy and business
planning, product management, product marketing, public relations, sales
support and marketing communications. Product management includes defining the
product plan and bringing to market our products and services. These activities
include product strategy and definition, pricing, competitive analysis, product
launches, channel program development and product life cycle management. We
stimulate product demand through a broad range of marketing communications and
public relations activities. Primary marketing communications activities
include public relations, collateral, advertising, direct response programs and
management of our Web site. Our public relations focuses on cultivating
industry analyst and media relationships with the goal of securing broad media
coverage and recognition as a leader and innovator in global Internet
applications deployment.
Strategic Relationships
We believe that strategic technology and marketing/reselling relationships
enhance our ability to reach new customers. Strategic relationships with our
customers in our target markets, such as with E*TRADE and AOL, bring not only a
high level of understanding of the specific needs of that market but also
credibility and visibility with potential new customers. We also have strategic
relationships with companies that can enhance our ability to develop and
deliver new application services, such as Cisco, Inktomi, Microsoft and Sun.
These strategic relationships provide powerful additional sales
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channels for us; for example we will be promoted by Sun's sales force.
Additionally, we hope to leverage these enterprises' research and development
expertise to develop new networking, content delivery and applications
services. As opportunities arise, we look to establish new relationships with
system integrators, hardware and software vendors and application service
providers that provide network equipment, software and consulting services to
companies. We have a dedicated team focused on creating new, and expanding
existing, relationships to enhance the success of future product developments.
Sun Microsystems and Inktomi. In December 1999, pursuant to our strategic
relationship with Sun and Inktomi, we agreed to purchase, over a two year
period, up to $150 million of Sun servers, storage operating systems and server
software, using Inktomi network caching applications. The total purchase would
consist of 5,000 Sun servers. Sun and Inktomi will participate and invest in
joint marketing and sales activities with us to support broadband and streaming
media content delivery over the Internet. Sun agreed to provide $100 million of
lease financing for the acquisition of the equipment.
AOL. In April 1999, Sandpiper entered into a strategic relationship with
AOL. As a result of the relationship, Sandpiper became the first provider of
content delivery services to deploy its servers directly inside the AOL
Network. As a result of this installation, our customers' content can be served
to AOL's users quickly and reliably, by avoiding the congestion that is
frequently encountered on the Internet. In August 1999, we deployed streaming
media servers inside AOL to provide high-quality streaming media services to
AOL's more than 18 million subscribers. Leveraging our proprietary technology,
AOL also opened up its caching infrastructure so that our customers can update
their content residing in the AOL caches and receive accurate traffic
statistics on AOL usage activity. In October 1999, AOL also agreed to use our
Footprint content delivery services for several of its key Internet properties,
including AOL.com, Netscape Netcenter and Spinner.com.
SRI International. In November 1999, we acquired Internet technology from
SRI International, forming a technology research alliance. The patent-pending
technology we acquired from SRI is designed to improve download times for
Internet content by intelligently avoiding network congestion. We will
incorporate SRI technology into our e-Business delivery network to help ensure
fast performance for e-Business applications, including transactions and other
forms of dynamic processing.
Microsoft. In October 1999, Sandpiper entered into a strategic relationship
with Microsoft. Microsoft is a leading provider of Internet streaming media
technology. As part of the relationship, we are integrating Windows Media
Technologies into our content delivery solution, and we are working with
Microsoft to build the Internet's first million-user streaming network. We also
joined Microsoft's Windows Media Broadband Jumpstart program, a consortium of
more than 30 companies focused on accelerating the availability of broadband
media. Microsoft has also agreed to purchase Footprint content delivery
services and has selected us as a content delivery partner for
Windowsmedia.com. We will engage in joint sales and marketing activities, and
continue to incorporate additional Microsoft technologies into our solution,
where appropriate.
Customer Support
We seek to provide superior customer service by understanding the technical
requirements and business objectives of our customers and fulfilling their
needs proactively on an individual basis. By working closely with the customer,
we seek to optimize the performance of our customers' Internet operations,
avoid downtime, quickly resolve any problems that may arise and make
adjustments in services as customer needs change over time.
Before sales are made, we provide technical advice to customers to help them
understand their networking needs and how our products and services can provide
solutions for particular needs.
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During the installation phase, we assign a support team led by our customer
advocacy group which also retains support responsibility for the account after
the customer's application is installed and operational. After commencing
services, primary technical support is provided by our network operations
centers, which operate 24 hours a day, seven days a week, and are staffed by
highly trained technicians who respond to customer calls, monitor site and
network operations and refer problems to engineering to solve problems quickly
and professionally. Our customer advocacy personnel are also available to
assist with billing and business issues and to assist in planning for
additional customer applications usage on the network.
We employ network engineers who collaborate with customers to design and
maintain their applications across the network. Our network engineers are
trained on Windows NT(TM), Solaris(TM) and other UNIX platforms, as well as
Cisco routers and switches, and they help resolve customer problems. We also
employ a team of network backbone engineers that constantly monitor the network
design and effectiveness to optimize performance for customers, rerouting and
redesigning their applications as conditions require.
Competition
Our market is highly competitive. There are few substantial barriers to
entry and we expect that we will face additional competition from existing
competitors and new market entrants in the future. The principal competitive
factors in this market include Internet system engineering expertise, customer
service, network capability, reliability, quality of service, ability to scale
to many users, broad geographic presence, brand name recognition, technical
expertise and range of functions, the variety of services offered, the ability
to maintain and expand distribution channels, price, the timing of
introductions of new services, network security, financial resources and
conformity with industry standards. We may not have the resources or expertise
to compete successfully in the future.
Our current and potential competitors in the market include:
. content delivery service providers;
. hosting companies;
. information technology and Internet outsourcing firms;
. national and regional Internet service providers; and
. global, regional and local telecommunications companies.
Our competitors may operate in one or more of these areas and include
companies such as AboveNet Communications, Adero, Akamai, AT&T, Concentric,
Digex, Exodus Communications, Global Crossing, GTE, InterNAP, MCI WorldCom and
Qwest. In particular, Akamai and Exodus provide services that directly compete
with services that we provide.
Many of our competitors have substantially greater financial, technical and
marketing resources, larger customer bases, longer operating histories, greater
name recognition and more established relationships in the industry than we do.
As a result, these competitors may be able to develop and expand their network
infrastructures and service offerings more quickly, adapt to new or emerging
technologies and changes in customer requirements more quickly, take advantage
of acquisition and other opportunities more readily, devote greater resources
to the marketing and sale of their products and adopt more aggressive pricing
policies than we can. In addition, these competitors have entered and will
likely continue to enter into joint ventures or consortiums to provide
additional services competitive with those that we provide.
Some of our competitors may be able to provide customers with additional
benefits, including reduced communications costs. We may not be able to offset
the effects of any such price
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reductions. In addition, we believe that the businesses in which we compete are
likely to encounter consolidation in the near future, which could result in
increased other competition on pricing and other terms that could cause our
business and prospects to suffer.
Intellectual Property Rights
We rely on a combination of copyright, trademark, service mark and trade
secret laws and contractual restrictions to establish and protect proprietary
rights in our products and services. Although we have filed patent applications
with the United States Patent and Trademark Office with respect to our
Footprint and TraceWare technologies, as well as some Internet technology
recently acquired from SRI International, such applications are pending and we
currently have no patented technology that would preclude or inhibit
competitors from entering our market. In addition, we have registered the mark
"Digital Island" and we have pending trademark applications for the "Footprint"
and "TraceWare" marks with the Patent and Trademark Office. Our "Digital
Island" mark is either registered or pending in several foreign countries. We
have entered into confidentiality and invention assignment agreements with our
employees, and nondisclosure agreements with our suppliers, distributors and
appropriate customers in order to limit access to and disclosure of our
proprietary information. These contractual arrangements or the other steps that
we take to protect our intellectual property may not be sufficient to prevent
misappropriation of our technology or to deter independent third-party
development of similar technologies. The laws of foreign countries may not
protect our products, services or intellectual property rights to the same
extent as do the laws of the United States.
To date, we have not been notified that our products infringe the
proprietary rights of any third parties, but third parties may in the future
claim that our current or future products infringe upon their proprietary
rights. We expect that participants in our markets will be increasingly subject
to infringement claims as the number of products and competitors in our
industry segment grows. Any such claim, whether meritorious or not, could be
time consuming, result in costly litigation, cause product installation delays
or require us to enter into royalty or licensing agreements. Such royalty or
licensing agreements may not be available on terms acceptable to us, or at all.
As a result, any such claim could harm our business and prospects.
Government Regulation
Federal Regulation. The FCC does not currently regulate network software or
computer equipment-related services that transport data or voice messages on
telecommunications facilities, except when provided by any of the Regional Bell
Operating Companies. However, our network services involve data transmissions
over public telephone lines, and those transmissions are governed to some
extent by federal regulatory policies establishing charges and terms for
wireline communications. Operators of networks that provide access to regulated
transmission facilities only as part of a data services package are not
currently subject to direct regulation as "telecommunications carriers" by the
FCC or any other federal agency, other than regulations generally applicable to
all businesses.
The absence of direct FCC regulation reflects, in part, the status of
Internet services as a relatively recent phenomenon. The federal legal and
regulatory framework for such services is therefore in its nascent state of
development.
The evolving state of federal law and regulation is reflected in the FCC's
April 10, 1998 Report to Congress. In the April 1998 Report, the FCC discussed
whether Internet service providers should be classified as telecommunications
carriers, and, on that basis, be required to contribute to the Universal
Service Fund. The Unversal Service Fund was created by federal statute and is
funded by interstate telecommunications carriers for the purpose of ensuring
that all segments of the population
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of the United States have access to basic telecommunications services. The
report concluded that Internet access service, which the FCC defined as an
offering combining computer processing, information storage, protocol
conversion, and routing transmissions, is an "information service" under the
Telecommunications Act of 1996 and thus not subject to regulation. In contrast,
the FCC found that the provision of transmission capabilities to Internet
service providers and other information service providers does constitute
"telecommunications services" under the Telecommunications Act of 1996.
Consequently, parties providing those latter services are presently subject to
FCC regulation (and the corresponding Universal Service Fund obligations).
New federal laws and regulations may be adopted in the future that would
subject the provision of our Internet services to government regulation.
Legislative initiatives currently being considered in Congress, for example,
may require taxation of Internet-related services like those that we offer or
impose access charges on Internet service providers. Any new laws regarding the
Internet, particularly those that impose regulatory or financial burdens, could
cause our business and prospects to suffer. We cannot predict the impact, if
any, that any future changes in law or regulation may have on our business.
Certain changes in federal laws and regulations could cause our business and
prospects to suffer. Changes of particular concern include those that directly
or indirectly affect the regulatory status of Internet services, increase the
cost telecommunications services (including the application of access charges
or Universal Service Fund contribution obligations to Internet services), or
increase the competition from the RBOCs and other telecommunications companies.
We cannot predict the impact, if any, that such legislative or regulatory
changes may have on our business. For instance, the FCC could determine through
any one of its ongoing or future proceedings that the Internet is subject to
regulation. In that event, we could be required to comply with:
. FCC entry or exit regulations;
. tariff filing, reporting, fee, and record-keeping requirements;
. marketing restrictions;
. access charge obligations; and
. Universal Service Fund contribution obligations.
Any one or more of those changes could adversely impact our ability to
provide services. The FCC could similarly conclude that providing Internet
transport or telephony services over an Internet protocol-based network is
subject to regulation. For example, the FCC currently has ongoing proceedings
in which it is considering whether to regulate certain transmissions provided
via the Internet, such as services functionally equivalent to traditional two-
way voice telephony. Such determination could cause our business and prospects
to suffer.
Another major and unresolved regulatory issue concerns the obligation of
information service providers, including Internet service providers, to pay
access charges to Incumbent Local Exchange Carriers. A proceeding initiated by
the FCC in December 1996 raises the issue of whether Incumbent Local Exchange
Carriers, which are local telephone companies that began providing service
prior to the enactment of the Telecommunications Act of 1996, can assess
interstate access charges on information service providers, including Internet
service providers. Unlike basic services, enhanced services, which the FCC has
concluded are synonymous with information services and include Internet access
services, are currently exempt from interstate access charges. The FCC has
reaffirmed that information service providers are exempt from access charges,
and a United States Court of Appeals has affirmed this decision by the FCC.
Another major regulatory issue concerns Internet-based telephony. In its
April 1998 Report, the FCC observed that Internet protocol telephony appears to
be a telecommunications service rather
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than an unregulated information service. The FCC explained that it would
determine on a case-by-case basis whether to regulate the service and thereby
require providers of Internet protocol telephony to contribute to the Universal
Service Fund. The ultimate resolution of Internet protocol telephony issues
could negatively impact the regulatory status, cost and other aspects of our
service offerings.
Another major unresolved regulatory proceeding that could affect the
benefits and costs of our service offerings (to the extent we become involved
in the exchange of communications traffic) involves reciprocal compensation.
Reciprocal compensation relates to the fees paid by one carrier to terminate
traffic on another carrier's network. In July 1997, the FCC was asked to
determine whether Competitive Local Exchange Carriers (local telephone
companies that provide service in competition with Incumbent Local Exchange
Carriers) that serve Internet service providers are entitled to reciprocal
compensation under the Telecommunications Act of 1996 for calls originated by
customers of an Incumbent Local Exchange Carriers to an Internet service
provider served by a Competitive Local Exchange Carriers within the same local
calling area. Prior to the time the FCC addressed the issue, every state that
addressed the issue from an intrastate perspective (at least twenty-nine in
number) determined that calls to Internet service providers are to be treated
as local for purposes of reciprocal compensation. In February 1999, the FCC
concluded that it would regulate calls to Internet service providers as
interstate traffic in the future. The FCC sought comment on how this traffic
should be compensated prospectively between carriers. Pending the FCC's
adoption of a prospective rule, a number of states have continued to treat
calls to Internet service providers as local for purposes of reciprocal
compensation. The FCC's ultimate resolution of the compensation issue could
increase Internet service provider costs in the future by increasing telephone
charges if the FCC adopts a rule that precludes compensation for calls to
Internet service providers or prescribes a rate that is substantially less than
the reciprocal compensation rates that were paid in the past and are currently
being paid under some existing inter-carrier agreements.
We could also be harmed by federal (as well as state) laws and regulations
relating to the liability of on-line services companies and Internet access
providers for information carried on or disseminated through their networks.
Several private lawsuits seeking to impose such liability upon on-line services
companies and Internet access providers are currently pending. In addition,
legislation has been enacted and new legislation imposes liability for the
transmission of, or prohibits the transmission of certain types of, information
on the Internet, including sexually explicit and gambling information. The
United States Supreme Court has already held unconstitutional certain sections
of the Communications Decency Act of 1996 that, among other provisions,
proposed to impose criminal penalties on anyone distributing "indecent"
material to minors over the Internet. Congress subsequently enacted legislation
that imposes both criminal and civil penalties on persons who knowingly or
intentionally make available materials through the Internet that are "harmful"
to minors. However, the new law generally excludes from the definition of
"person" Internet service providers that are not involved in the selection of
content disseminated through their networks.
Congress also enacted legislation that limits liability for online copyright
infringement. This legislation includes exemptions that enable Internet service
providers to avoid copyright infringement if they merely transmit material
produced and requested by others. It is possible that other laws and
regulations could be enacted in the future that would place copyright
infringement liability more directly on Internet service providers. The
imposition of potential liability on us and other Internet access providers for
information carried on or disseminated through their systems could require us
to implement measures to reduce our exposure to such liability, which may in
turn require us to expend substantial resources or discontinue certain service
or product offerings. The increased attention to liability issues as a result
of lawsuits and legislative action, could similarly impact the growth of
Internet use. While we carry professional liability insurance, this insurance
may not be adequate to compensate claimants or cover us in the event we become
liable for information carried on or
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disseminated through our networks. Any costs not covered by insurance that are
incurred as a result of such liability or asserted liability could cause our
business and prospects to suffer.
State Regulation. The proliferation of Internet use in the past several
years has prompted state legislators and regulators to consider the adoption of
laws and regulations to govern Internet usage. Much of the legislation that has
been proposed to date may, if enacted, handicap further growth in the use of
the Internet. It is possible that state legislatures and regulators will
attempt to regulate the Internet in the future, either by regulating
transactions or by restricting the content of the available information and
services. While state public utility commissions generally have declined to
directly regulate enhanced or information services, some states have continued
to regulate particular aspects of enhanced services in limited circumstances,
such as where they are provided by local telecommunications carriers. Moreover,
the public utility commissions of several states continue to consider potential
regulation of such service. Enactment of such legislation or adoption of such
regulations could cause our business and prospects to suffer.
Another area of adverse potential state regulation concerns taxes. The
United States Congress recently enacted a three-year moratorium on new state
and local taxes on the Internet (those not generally imposed or actually
enforced prior to October 1, 1998) as well as on taxes that discriminate
against commerce through the Internet. Congress also established an advisory
commission to study and make recommendations on the federal, state and local
taxation of Internet-related commerce. These recommendations are due to
Congress by April 2000 and could serve as the basis for additional legislation.
Previous to the enactment of the tax moratorium, a significant number of bills
had been introduced in state legislatures that would have taxed commercial
transactions on the Internet. Future laws or regulatory changes that lead to
state taxation of Internet transactions could cause our business and prospects
to suffer.
One issue of growing importance revolves around contract law. Although
customer-level use of the Internet to conduct commercial transactions is still
in its infancy, a growing number of corporate entities are engaging in Internet
transactions. This Internet commerce has spawned a number of state legal and
regulatory issues, such as whether and how provisions of the Uniform Commercial
Code (adopted by 49 states) apply to transactions carried out on the Internet
and which jurisdiction's laws are to be applied to a particular transaction. It
is not possible to predict how state law will evolve to address new
transactional circumstances created by Internet commerce or whether the
evolution of such laws will cause our business and prospects to suffer.
State legislators and regulators have also sought to restrict the transition
of or limit access to certain materials on the Internet. For example, in the
past several years, various state legislators have sought to limit or prohibit:
. certain communications between adults and minors;
. anonymous and pseudonymous use of the Internet;
. on-line gambling; and
. the offering of securities on the Internet.
Enforcement of such limitations or prohibitions in some states could affect
transmissions in other states. State laws and regulations that restrict access
to such materials on the Internet could inadvertently block access to other
permissible sites. We cannot predict the impact, if any, that any future laws
or regulatory changes in this area may have on our business.
Some states have also sought to impose tort liability or criminal penalties
on certain conduct involving the Internet, such as the use of "hate" speech,
invasion of privacy, and fraud. The adoption of such laws could adversely
impact the transmission of non-offensive material on the Internet and, to that
extent, could cause our business and prospects to suffer.
55
<PAGE>
Local Regulation. Although local jurisdictions generally have not sought to
regulate the Internet and related services, it is possible that such
jurisdictions will seek to impose regulations in the future. In particular,
local jurisdictions may attempt to tax various aspects of Internet access or
services, such as transactions handled through the Internet or subscriber
access, as a way of generating municipal revenue. The imposition of local taxes
and other regulatory burdens by local jurisdictions could cause our business
and prospects to suffer. Our networks may also be subject to numerous local
regulations such as building codes and licensing. Such regulations vary on a
city by city and county by county basis.
Foreign Regulation. As our services become available over the Internet in
foreign countries, and as we facilitate sales by our customers to end-users
located in such foreign countries, these foreign jurisdictions may decide that
we are required to qualify to do business in such country or obtain permits or
licenses to provide value-added network services. Such decisions could subject
us to taxes and other costs and could result in our inability to enforce
contracts in such jurisdictions. It is possible that claims could be made
against online service companies and Internet service providers under foreign
law for defamation, negligence, copyright or trademark infringement, or other
theories based on the nature and content of the materials disseminated through
their networks. Any such new legislation or regulation, or the application of
laws or regulations from jurisdictions whose laws do not currently apply to our
business, could cause our business and prospects to suffer.
Employees
As of December 31, 1999, we had 409 employees, including 146 people in sales
and marketing, 11 people in professional services, 101 people in engineering,
106 people in operations and 45 people in finance and administration. We
believe that our future success will depend in part on our continued ability to
attract, hire and retain qualified personnel. The competition for such
personnel is intense, and there can be no assurance that we will be able to
identify, attract and retain such personnel in the future. None of our
employees are represented by a labor union, and management believes that our
employee relations are good.
Facilities
We have the following facilities: our corporate headquarters in San
Francisco, regional offices in Thousand Oaks (California) and San Diego, and
data centers in Honolulu, Santa Clara (California), New York City, Hong Kong
and London. In addition, we have sales offices in Boston, New York City,
Minneapolis, Chicago, Philadelphia, Dallas, Houston, St. Louis, Atlanta, Reston
(Virginia), Japan, the Netherlands, Switzerland and the United Kingdom.
Legal Proceedings
We are not party to any material legal proceeding.
56
<PAGE>
MANAGEMENT
Officers, Directors and Senior Management
The following table sets forth the names and ages of our executive officers
and directors and certain members of our senior management as of December 31,
1999.
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Ruann F. Ernst(3)(5)............ 53 Chief Executive Officer and Chairman of the
Board of Directors
Leo S. Spiegel(4)............... 38 President and Director
T.L. Thompson................... 53 Chief Financial Officer and Secretary
Chris Albinson.................. 32 Vice President of Corporate Development
Scott Darling................... 41 Vice President of Business Development and
Professional Services
Paul Evenson.................... 39 Vice President of Operations
Allan Leinwand.................. 33 Vice President of Engineering and Chief
Technology Officer
Bruce Pinsky.................... 36 Vice President of Solutions Engineering and
Chief Information Officer
Rick Schultz.................... 41 Vice President, North American Sales
Eric Shepcaro................... 42 Vice President of International and Channel
Sales
Michael T. Sullivan............. 48 Vice President of Finance
Andrew Swart.................... 40 Vice President of Software Engineering
Tim Wilson...................... 40 Vice President of Marketing
Charlie Bass(2)................. 57 Director
Christos Cotsakos(2)............ 51 Director
Marcelo A. Gumucio(1)(4)........ 62 Director
Cliff Higgerson(1).............. 60 Director
G. Bradford Jones(1)(3)......... 44 Director
Robert Kibble(2)................ 56 Director
Shahan Soghikian(3)(4).......... 41 Director
</TABLE>
- --------
(1) Member of Audit Committee
(2) Member of Compensation Committee
(3) Member of Finance Committee
(4) Member of Nominating Committee
(5) Member of Special Stock Option Committee
Each director will hold office for the term described below in "--Classified
Board" and until such director's successor is elected and qualified or until
such director's earlier resignation or removal. Each officer serves at the
discretion of the board of directors of Digital Island. There are no other
family relationships among any of the directors, officers or key employees of
Digital Island.
57
<PAGE>
Ruann F. Ernst has served as Chairman of the Board since December 1999 and
as Chief Executive Officer and as a director since June 1998. She was President
from June 1998 until the closing of the Sandpiper merger in December 1999.
Prior to joining Digital Island, Ms. Ernst served with Hewlett Packard, a
computer equipment and services company, for approximately ten years, most
recently as general manager of the Financial Services Business Unit. Ms. Ernst
has also served as Director, Medical Computing Services Division and Assistant
Professor, Medicine and Computer Science at The Ohio State University and as a
Congressional Fellow in the Office of Technology Assessment. Ms. Ernst serves
on the Board of Directors of The Institute for the Future, Phoenix
International and Advanced Fibre Communications, Inc. Ms. Ernst holds a B.S. in
Mathematics, a Masters Degree in Computer Science and a Ph.D. in Technology and
Organizational Change from The Ohio State University.
Leo S. Spiegel has served as President since December 1999 and previously
served as Sandpiper's President and Chief Executive Officer and as a director
of Sandpiper since January 1998. From February 1996 to January 1998, Mr.
Spiegel served as Senior Vice President and Chief Technology Officer of
Donnelley Enterprise Solutions, Inc., an information management firm. From June
1995 to February 1996, Mr. Spiegel serves as a Senior Vice President of
Donnelley Business Services, a subsidiary of R.R. Donnelley and Sons Company.
From May 1991 to June 1995, Mr. Spiegel was the Executive Vice President and
Chief Technology Officer of LANSystems, a network utilities software developer
and international systems integration firm which he co-founded. Mr. Spiegel
holds a B.A. from the University of California, San Diego.
T.L. Thompson has served as Chief Financial Officer since January 1999. Mr.
Thompson served as Chief Financial Officer of Narrowline, an Internet marketing
firm, from October 1996 to November 1998. From 1989 to 1996 he served in
various financial capacities at Ziff-Davis Publishing Company, most recently as
Vice President of Business Development. Mr. Thompson holds a B.S. in Economics
and an M.B.A. from Northwestern University.
Chris Albinson has served as Vice President of Corporate Development since
September 1999. From 1993 to August 1999 Mr. Albinson served as Assistant Vice
President at Newbridge Networks Corp., manufacturer of digital electronic
network products. Mr. Albinson holds an M.B.A. from the University of Western
Ontario.
Paul Evenson has served as Vice President of Operations since November 1998.
From 1996 to 1998, Mr. Evenson served as Vice President of Sales and Operations
at Westech Communications, Inc., a communications services firm. From 1987 to
1998, Mr. Evenson served as Vice President of Information Technology at
Montgomery Securities, an investment banking firm. Mr. Evenson studied
Engineering at Oregon State University.
Scott Darling has served as Vice President of Professional Services since
December 1999 and previously served as Sandpiper's Vice President of Business
Development and Professional Services since May 1999. From September 1993 to
May 1999, Mr. Darling was the managing director for the Worldwide Consumer
Products and Retail and Financial Services at EDS with a heavy focus on e-
commerce and web enablement services. Mr. Darling holds a B.S. in Economics and
Business Administration from the University of Nebraska and an M.B.A. from
Colorado State University.
Allan Leinwand has served as Vice President of Engineering and Chief
Technology Officer since January 1997 and as a director from January 1997 to
February 1999. Prior to joining Digital Island, from August 1990 to February
1997, Mr. Leinwand served as Manager, Consulting Engineer at Cisco Systems, a
network equipment provider, where he designed and deployed global internetworks
for large corporations, governments and institutions. Mr. Leinwand also served
as a network design and implementation engineer at Hewlett Packard from 1988 to
1990. Mr. Leinwand holds a B.S. in Computer Science from the University of
Colorado, Boulder.
58
<PAGE>
Bruce Pinsky has served as Vice President of Solutions Engineering and Chief
Information Officer since March 1997. From August 1992 to March 1997, Mr.
Pinsky worked in Customer Engineering and Global Support Engineering for Cisco
Systems. Mr. Pinsky holds a B.S. in Computer Science from California State
University, Hayward.
Rick Schultz has served as Vice President of North American Sales since
March 1999. From December 1995 to February 1999, Mr. Schultz served as Vice
President of Sales at Pacific Bell Network Integration, a subsidiary of Pacific
Bell, a telecommunications company. Mr. Schultz also held various senior
management positions at AT&T from June 1980 to November 1995 in Sales, Product
Management and Sales Management. Mr. Schultz holds a B.S. in Commerce from De
Paul University and an M.B.A. from the University of San Francisco.
Eric Shepcaro has served as Vice President of International and Channel
Sales since December 1999 and previously served as Sandpiper's Vice President
of Sales since January 1998. Mr. Shepcaro has more than 20 years of technical
sales and marketing experience. Prior to joining Sandpiper, Mr. Shepcaro spent
over 17 years at Sprint Corporation. Most recently, he served as Vice President
of Sales Engineering and Application Support, where he led the organization
responsible for technical sales, business development, network engineering,
program, management, and service implementation for business and government
customers. Mr. Shepcaro holds a B.S. in Business from the State University of
New York at Albany and an M.B.A. from San Francisco State University.
Michael T. Sullivan has served as Vice President of Finance since May 1997
and served as Chief Financial Officer from October 1997 to January 1999. From
July 1993 to May 1996 Mr. Sullivan served as Vice President of Operations and
Chief Financial Officer for Tut Systems, a network equipment provider. Mr.
Sullivan holds a B.S. in Business Administration from the University of
California, Berkeley. Mr. Sullivan is a certified public accountant.
Andrew Swart has served as Vice President of Software Engineering since
December 1999, and previously served as Sandpiper's Vice President of
Engineering since January 1998 and as a director of Sandpiper since December
1996. Mr. Swart also served as Sandpiper's President and Chief Executive
Officer from December 1996 to January 1998. From November 1994 to December
1996, Mr. Swart was a managing director of Sandpiper Consulting LLC. Mr. Swart
holds a B.S. in Management Information Systems from the University of Texas at
Dallas.
Tim Wilson has served as Vice President of Marketing since March 1998. From
December 1996 to March 1998, Mr. Wilson served as General Manager within the
Business Communications Systems Division of Lucent Technologies, a
telecommunications equipment supplier. Mr. Wilson also served as Executive
Director and General Manager of the Business Communications Systems Division of
AT&T Australia from November 1994 to December 1996. Mr. Wilson holds a B.A. in
Physics from Bowdoin College and an M.B.A. from the Fuqua School of Business at
Duke University.
Charlie Bass has served as a director since March 1997. Dr. Bass is Trustee
of The Bass Trust, General Partner of Bass Associates and a Consulting
Professor of Electrical Engineering at Stanford University. He also serves on
the board of directors of Socket Communications, Inc. and on the board of
directors of several private communications companies. Prior to co-founding
Ungermann-Bass in 1979, Dr. Bass was at Zilog, Inc., and prior to the formation
of Zilog, Inc. in 1975, he was on the Electrical Engineering and Computer
Sciences faculty at the University of California at Berkeley from 1972 to 1975.
Dr. Bass holds a Ph.D. in Electrical Engineering from the University of Hawaii
where he participated in the Aloha System research in radio frequency-based
computer networks.
Christos Cotsakos has served as a director of Digital Island since July
1998. Mr. Cotsakos joined E*TRADE, an online financial services company, in
March 1996 as the President and Chief
59
<PAGE>
Executive Officer and as a director. Before joining E*TRADE, he served as
President, Chief Operating Officer, Co-Chief Executive Officer and a director
of AC Nielsen Inc., a marketing research company. Prior to joining AC Nielsen,
Mr. Cotsakos spent 19 years with Federal Express Corporation, where he held a
number of senior executive positions. In addition to E*TRADE, Mr. Cotsakos
serves on the boards of directors of Critical Path, Inc., Fox Entertainment
Group, Inc., National Processing, Inc., Official Payments Corp., PlanetRx.com,
Inc. and Tickets.com, Inc., as well as several private companies. A decorated
Vietnam veteran, he received a B.A. from William Paterson College and an M.B.A.
from Pepperdine University. Mr. Cotsakos is currently pursuing a Ph.D. degree
in economics at the University of London.
Marcelo A. Gumucio has served as a director since January 1998, and served
as Chairman of the board of directors from January 1998 until May 1998. He is
the managing partner of Gumucio Burke & Associates, a private investment firm.
In April 1996, Mr. Gumucio joined Micro Focus PLC, an enterprise software
provider, as its Chief Executive Officer. He had served as a non-executive
director of Micro Focus' board of directors since January 1996. Prior to
joining Micro Focus, from 1992 to 1996, Mr. Gumucio was President, Chief
Executive Officer and Chairman of the board of directors of Memorex Telex NV.
Mr. Gumucio's professional experience in the computer and communications
industry spans almost 30 years and includes senior management positions at Cray
Research, Inc., Northern Telecom Limited, Memorex Corporation and Hewlett-
Packard Company. Mr. Gumucio serves on the board of directors of BidCom Inc.,
Burr Brown Corporation and E-Stamp Corporation. Mr. Gumucio graduated cum laude
with a B.S. in mathematics from the University of San Francisco in 1960. He
received an M.S. in applied mathematics and operations research in 1963 from
the University of Idaho, where he was named a National Science Fellow and
graduated with honors. In 1982, he graduated from the Harvard Business School
Advanced Management Program.
Cliff Higgerson has served as a director since March 1997. Mr. Higgerson has
over 20 years experience with venture capital investments. Prior to forming
Communications Ventures II in the summer of 1997, he was a General Partner of
Vanguard Venture Partners, where he had been since 1992 and where he continues
to manage several portfolio companies. His 25 years of involvement in the
communications field include research, consulting, planning, investment
banking, and venture capital. Mr. Higgerson serves on the board of directors of
Advanced Fibre Communications, Inc. and Tut Systems, as well as several private
companies. Mr. Higgerson holds a B.S. in electrical engineering from the
University of Illinois and an M.B.A. from the Haas School of Business at the
University of California at Berkeley.
G. Bradford Jones has served as a director since December 1999. Mr. Jones is
a founding General Partner at Redpoint Ventures, a venture capital fund which
invests in Internet communications, media and commerce companies. Prior to
founding Redpoint Ventures in 1999, Mr. Jones was a General Partner with
Brentwood Venture Capital, which he joined in 1981. Mr. Jones also currently
serves on the board of directors of Onyx Acceptance Corporation, a specialized
consumer finance company, Interpore International, a medical device company,
and ISOCOR, a software developer, and several privately-held companies. Mr.
Jones received a B.S. in Chemistry from Harvard University, a M.S. degree in
Physics from Harvard University and a J.D./M.B.A. from Stanford University.
Robert Kibble has served as a director since December 1999. Mr. Kibble is a
founding Managing Partner of Mission Ventures, a San Diego-based early-stage
venture capital fund with $63 million under management. Mission Ventures
invests in information technology, healthcare and business service companies
throughout Southern California. Mr. Kibble is also a founding General Partner
of Paragon Venture Partners, a Bay Area venture firm, where he has been
actively investing for twenty years, including nearly four years as Vice
President of Citicorp Venture Capital. He is a director of a number of private
companies, including BizRate.com, KnowledgeLINK, Sitematic and enonymous. Mr.
Kibble holds an M.A. from Oxford University and an M.B.A. from the Darden
School, University of Virginia.
60
<PAGE>
Shahan Soghikian has served as a director since February 1999. He has over
fourteen years of private equity and investment banking experience, and is a
General Partner and head of the West Coast office of Chase Capital Partners.
Since joining Chase Capital in 1990, Mr. Soghikian has been involved with
numerous venture investments and was responsible for developing and managing
the firm's European activities from 1994 to 1998. He currently serves as a
director of Ninth House Network, Complient, Halo Data Devices, MetroOptix,
Coactive Networks, Nextec Applications and DJ Orthopedics. He received his B.A.
from Pitzer College and an M.B.A. from the Anderson School of Business at the
University of California at Los Angeles.
Director Compensation
Our directors do not currently receive compensation for their services as
members of the board of directors. All directors are reimbursed for their
reasonable out-of-pocket expenses arising from their service on the board of
directors or any committee thereof. Employee directors are eligible to
participate in and receive equity incentives, in the form of stock option
grants or direct stock issuances, under our 1999 stock incentive plan.
Non-employee board members will receive option grants at periodic intervals
under the automatic option grant program of the 1999 stock incentive plan and
will also be eligible to receive discretionary option grants under the
discretionary option grant program of such plan. See "Executive Compensation
and Other Information--Employee Benefit Plans."
Classified Board
Our certificate of incorporation provides for a classified board of
directors consisting of three classes of directors, each serving staggered
three-year terms. As a result, a portion of our board of directors will be
elected each year. Ruann Ernst, Cliff Higgerson and Robert Kibble have been
designated Class I directors whose term expires at the 2000 annual meeting of
stockholders. Charlie Bass, Shahan Soghikian and Leo Spiegel have been
designated Class II directors whose term expires at the 2001 annual meeting of
stockholders. Christos Cotsakos, Marcelo Gumucio and G. Bradford Jones have
been designated Class III directors whose term expires at the 2002 annual
meeting of stockholders. See "Description of Capital Stock--Antitakeover
Effects of Provisions of Certain Charter Provisions, Bylaws and Delaware Law."
Board Committees
The audit committee of the board of directors consists of Marcelo Gumucio,
Cliff Higgerson and G. Bradford Jones. The audit committee reviews our
financial statements and accounting practices, makes recommendations to the
board of directors regarding the selection of independent auditors and reviews
the results and scope of our annual audit and other services provided by our
independent auditors.
The compensation committee of the board of directors consists of Charlie
Bass, Christos Cotsakos and Robert Kibble. The compensation committee makes
recommendations to the board of directors concerning salaries and incentive
compensation for our officers and employees and administers our employee
benefit plans including the grant of options under those plans.
The finance committee of the board of directors consists of Ruann Ernst, G.
Bradford Jones and Shahan Soghikian. The finance committee makes
recommendations to the board of directors concerning financing transactions,
investments, acquisitions and partnerships. The finance committee has the
authority to approve the final terms and conditions of acquisitions and
investments of $50 million or less.
61
<PAGE>
The nominating committee of the board of directors consists of Marcelo
Gumucio, Shahan Soghikian and Leo Spiegel. The nominating committee makes
recommendations to the board of directors concerning candidates for
directorships.
The special stock option committee of the board of directors consists solely
of Ruann Ernst. The special stock option committee has the authority, separate
from the compensation committee, to make discretionary option grants to
eligible individuals other than officers or non-employee members of the board
of directors.
Compensation Committee Interlocks and Insider Participation
None of the members of the compensation committee of the board of directors
was at any time since the formation of Digital Island an officer or employee of
Digital Island. No executive officer of Digital Island serves as a member of
the board of directors or compensation committee of any entity that has one or
more executive officers serving on our board of directors or our compensation
committee of the board of directors.
Summary of Cash and Certain Other Compensation
The following table sets forth the compensation earned by our named
executive officers which include our Chief Executive Officer and our four most
highly compensated executive officers for the fiscal year ended September 30,
1999. Since such date, certain of these executive officers have been succeeded
by other persons and we have added additional officers, including as a result
of our merger with Sandpiper. For a list of our current executive officers and
certain members of senior management, see "Management."
The options listed in the following table were originally granted under
either our 1997 stock option and incentive plan or our 1998 stock option/stock
issuance plan. These options have been incorporated into the new 1999 stock
incentive plan, but will continue to be governed by their existing terms. See
"Executive Compensation and Other Information--Employee Benefit Plans."
<TABLE>
<CAPTION>
Long-Term
Compensation
------------
Annual
Compensation
---------------- Securities All Other
Salary Bonus Underlying Compensation
Name and Principal Position(s) Year ($) ($) Options ($)
- ------------------------------ ---- -------- ------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Ruann F. Ernst................ 1999 $185,961 $64,250 1,044,159 $24,620(1)
President and Chief Executive
Officer
Ron Higgins (2)............... 1999 150,000 40,000 400,000 --
Chairman of the Board of
Directors
Paul Evenson.................. 1999 146,635 27,222 200,000 --
Vice President of Operations
Allan Leinwand................ 1999 163,333 44,000 323,000 --
Vice President of Engineering
and Chief Technology Officer
Michael T. Sullivan........... 1999 150,000 37,250 110,000 --
Vice President of Finance
Tim Wilson.................... 1999 180,446 51,250 280,000 --
Vice President of Marketing
</TABLE>
- --------
(1) Consists of reimbursement of rent for Ms. Ernst's apartment in San
Francisco, California.
(2) Mr. Higgins served as President and Chief Executive Officer of Digital
Island from February 1994 until June 1998 and Chairman of the Board of
Directors from June 1998 to September 1999, when he resigned from the
Board of Directors.
62
<PAGE>
Stock Options and Stock Appreciation Rights
The following table sets forth information regarding option grants to each
of the named executive officers during the fiscal year ended September 30,
1999. No stock appreciation rights were granted to the named executive officers
during the 1999 fiscal year.
Stock Option Grants in Fiscal Year 1999
<TABLE>
<CAPTION>
Potential
Realizable
Value at Assumed
Annual Rates of
Number of Percent of Stock Price
Securities Total Options Exercise Appreciation for
Underlying Granted to of Base Option Term
Options Employees in Price Expiration -------------------
Name Granted(#) 1999 ($/Sh) Date 5% 10%
---- ---------- ------------- -------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Ruann F. Ernst.......... 250,000 10.4% $4.25 3/18/09 $668,201 $1,693,351
Ron Higgins (1)......... -- -- -- -- -- --
Paul Evenson............ 150,000 6.2% 3.50 10/26/08 330,170 836,715
50,000 2.1% 4.25 3/18/09 133,640 338,670
Allan Leinwand.......... 35,000 1.5% 4.25 3/18/09 93,548 237,069
Michael T. Sullivan..... 10,000 0.4% 4.25 3/18/09 26,728 67,734
Tim Wilson.............. 40,000 1.7% 3.50 10/16/08 88,045 223,124
100,000 4.1% 4.25 3/18/09 267,280 677,341
</TABLE>
- --------
(1) Mr. Higgins served as President and Chief Executive Officer of Digital
Island from February 1994 until June 1998 and Chairman of the Board of
Directors from June 1998 to September 1999, when he resigned from the
Board of Directors.
The exercise price per share of each option was determined by our board of
directors in its good faith judgment and generally reflects its best estimate
of the fair value of our common stock on the date of each grant, taking into
account factors such as our operating performance, recent sales of securities,
and market conditions.
Each option has a maximum term of 10 years, subject to earlier termination
upon the optionee's cessation of service with Digital Island. Ms. Ernst joined
Digital Island as our President and Chief Executive Officer on June 1, 1998 and
was granted an option for 794,159 shares with an exercise price of $1.50 per
share, effective on her June 1, 1998 start date. The first 635,327 shares,
subject to her options, will vest in a series of 50 successive equal monthly
installments upon her completion of each month of service over the 50-month
period measured from her hire date, and the remaining 158,832 shares will vest
in a series of 50 successive equal monthly installments over the 50-month
period measured from the first anniversary of her hire date. Following an
acquisition of Digital Island by merger, sale of substantially all the assets
or sale of more than 50% of our outstanding voting securities, all of the
option shares will vest immediately if not assumed by the acquiror. If the
options are assumed by the acquiror, all the option shares will vest upon an
involuntary termination of her employment (other than for cause) within 18
months of the acquisition. Upon any other involuntary termination of her
employment (other than for cause), the vesting of her option shares will be
accelerated by six months.
The actual stock price appreciation over the 10-year option term may not be
at the above 5% and 10% assumed annual rates of compounded stock price
appreciation or at any other defined level. Unless the market price of common
stock appreciates over the option term, no value will be realized from the
option grant made to the named executive officer.
63
<PAGE>
Aggregated Option/SAR Exercises and Fiscal Year-End Values
The following table sets forth information with respect to the named
executive officers concerning their exercise of stock options during the fiscal
year ended September 30, 1999 and the number of shares subject to unexercised
stock options held by them as of the close of such fiscal year. No stock
appreciation rights were exercised during the fiscal year ended September 30,
1999, and no stock appreciation rights were outstanding at the close of such
year. In the following table, "Value Realized" is equal to the difference
between the fair value of the shares at the time of exercise ($9.90 per share)
and the exercise price paid for the shares and the "Value of Unexercised In-
The-Money Options at Year-End" is based upon the fair value per share at the
close of the 1999 fiscal year ($26.00 per share) less the exercise price
payable per share.
Aggregated Option Exercises in 1999 and Year-End Values
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options
Shares Options at Year-End at Year-End
Acquired on Value ------------------------- -------------------------
Name Exercise(#) Realized($) Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Ruann F. Ernst.......... 133,332 $1,119,989 392,076 418,751 $9,519,925 $9,657,837
Ron Higgins (1)......... 216,000 2,052,000 42,333 141,667 1,083,725 3,626,675
Paul Evenson............ -- -- -- 200,000 -- 4,462,500
Allan Leinwand.......... 163,733 1,555,464 14,775 144,492 361,396 3,528,289
Michael T. Sullivan..... 46,000 437,000 22,000 42,000 524,700 1,075,200
Tim Wilson.............. 53,249 445,307 49,649 177,102 1,134,256 4,152,129
</TABLE>
- --------
(1) Mr. Higgins served as President and Chief Executive Officer of Digital
Island from February 1994 until June 1998 and Chairman of the Board of
Directors from June 1998 to September 1999, when he resigned from the Board
of Directors.
Employee Benefit Plans
1999 Stock Incentive Plan
Our 1999 stock incentive plan is the successor equity incentive program to
our 1998 stock option/stock issuance plan which was the successor equity
incentive program to our 1997 stock option and incentive plan. The 1999 stock
incentive plan became effective on June 29, 1999, the effective date of our
initial public offering. All outstanding options under our predecessor plan
were at that time incorporated into the 1999 stock incentive plan, and no
further option grants will be made under such predecessor plan. The
incorporated options will continue to be governed by their existing terms,
unless the plan administrator elects to extend one or more features of the 1999
stock incentive plan to those options. Except as otherwise noted below, the
incorporated options have substantially the same terms as will be in effect for
grants made under the discretionary option grant program of the 1999 stock
incentive plan.
An initial reserve of 7,544,000 shares of common stock was authorized for
issuance under the 1999 stock incentive plan. This initial share reserve
consisted of (i) the number of shares estimated to remain available for
issuance under our predecessor plan, including the shares subject to
outstanding options thereunder, plus (ii) an additional increase of
approximately 2,500,000 shares. The number of shares of common stock reserved
for issuance under the 1999 stock incentive plan will automatically increase on
the first trading day in January each calendar year, beginning in calendar year
2000, by an amount equal to four percent (4%) of the total number of shares of
common stock outstanding on the last trading day in December in the preceding
calendar year, but in no event will this annual increase exceed 2,000,000
shares. Accordingly, in January 2000, the
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reserve under the plan increased by 2,000,000 shares. In addition, no
participant in the 1999 stock incentive plan may be granted stock options,
separately exercisable stock appreciation rights and direct stock issuances for
more than 750,000 shares of common stock in the aggregate per calendar year.
The 1999 stock incentive plan is divided into five separate components:
. the discretionary option grant program, under which eligible individuals
in our employ or service (including officers, non-employee board members
and consultants) may, at the discretion of the plan administrator, be
granted options to purchase shares of common stock at an exercise price
not less than 100% of the fair market value of those shares on the grant
date;
. the stock issuance program under which eligible individuals may, in the
plan administrator's discretion, be issued shares of common stock
directly, upon the attainment of designated performance milestones or
upon the completion of a specified service requirement or as a bonus for
past services;
. the salary investment option grant program, which may, at the plan
administrator's sole discretion, be activated for one or more calendar
years and, if so activated, will allow executive officers and other key
executives selected by the plan administrator the opportunity to apply a
portion of their base salary each year to the acquisition of special
below-market stock option grants;
. the automatic option grant program, under which option grants will
automatically be made at periodic intervals to eligible non-employee
board members to purchase shares of common stock at an exercise price
equal to 100% of the fair market value of those shares on the grant date;
and
. the director fee option grant program, which may, in the plan
administrator's sole discretion, be activated for one or more calendar
years and, if so activated, will allow non-employee board members the
opportunity to apply all or a portion of the annual retainer fee
otherwise payable to them in cash each year to the acquisition of special
below-market option grants.
The discretionary option grant program and the stock issuance program are
administered by the compensation committee. However, a secondary committee of
one or more board members also has concurrent authority to administer those
programs with respect to individuals who are neither officers nor directors.
The compensation committee or secondary committee as plan administrator have
complete discretion to determine which eligible individuals are to receive
option grants or stock issuances under those programs, the time or times when
the grants or issuances are to be made, the number of shares subject to each
grant or issuance, the status of any granted option as either an incentive
stock option or a non-statutory stock option under the Federal tax laws, the
vesting schedule to be in effect for the option grant or stock issuance and the
maximum term for which any granted option is to remain outstanding. However,
the board acting by a disinterested majority has the exclusive authority to
make any discretionary option grants or stock issuances to members of the
compensation committee. The compensation committee has the exclusive authority
to select the executive officers and other highly compensated employees who may
participate in the salary investment option grant program in the event that
program is activated for one or more calendar years. Neither the compensation
committee nor the board will exercise any administrative discretion with
respect to option grants under the salary investment option grant program or
under the automatic option grant or director fee option grant program for the
non-employee board members. All grants under those latter three programs will
be made in strict compliance with the express provisions of each program.
The exercise price for the shares of common stock subject to option grants
made under the 1999 stock incentive plan may be paid in cash or in shares of
common stock valued at fair market
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value on the exercise date. The option may also be exercised through a same-day
sale program without any cash outlay by the optionee.
The plan administrator has the authority to effect the cancellation of
outstanding options under the discretionary option grant program (including
options incorporated from our predecessor plan) in return for the grant of new
options for the same or different number of option shares with an exercise
price per share based upon the fair market value of the common stock on the new
grant date.
Stock appreciation rights are authorized for issuance under the
discretionary option grant program. These rights will provide the holders with
the election to surrender their outstanding options for an appreciation
distribution from us equal to the excess of (i) the fair market value of the
vested shares of common stock subject to the surrendered option over (ii) the
aggregate exercise price payable for those shares. Such appreciation
distribution may be made in cash or in shares of common stock. None of the
incorporated options from our predecessor plan contain any stock appreciation
rights.
In the event that we are acquired by merger or asset sale, each outstanding
option under the discretionary option grant program which is not to be assumed
by the successor corporation will automatically accelerate in full, and all
unvested shares under the discretionary option grant and stock issuance
programs will immediately vest, except to the extent our repurchase rights with
respect to those shares are to be assigned to the successor corporation. The
plan administrator has complete discretion to grant one or more options under
the discretionary option grant program which will vest and become exercisable
for all the option shares in the event those options are assumed in the
acquisition and the optionee's service with us or the acquiring entity is
terminated within a designated period (not to exceed eighteen months) following
that acquisition. The vesting of outstanding shares under the stock issuance
program may be accelerated upon similar terms and conditions.
The plan administrator is also authorized to grant options and structure
repurchase rights so that the shares subject to those options or repurchase
rights will immediately vest in connection with a change in ownership or
control (whether by successful tender offer for more than fifty percent of our
outstanding voting stock or by a change in the majority of our board through
one or more contested elections for board membership). Such accelerated vesting
may occur either at the time of such change or upon the subsequent termination
of the individual's service within a designated period (not to exceed eighteen
months) following the change.
The options to be incorporated from our predecessor plan will immediately
vest and become exercisable for all the option shares if we are acquired by
merger or asset sale, unless the options are assumed by the successor
corporation and our repurchase rights with respect to the unvested shares
subject to those options are concurrently assigned to the successor entity. For
some of these options, the board also has the authority to provide for their
cancellation in return for a cash payment to the option holders in an amount
per cancelled option share equal to the excess of the price to be paid per
share of our common stock in the acquisition over the option exercise price
payable per share under the cancelled option. Other of these options contain a
special acceleration feature. Under that feature, should the optionee's service
be terminated within a designated period following an acquisition in which the
option is assumed and our repurchase rights are assigned, then the option will
vest at that time and become immediately exercisable for all the option shares,
and all unvested shares held by such individual will also vest at that time.
There are no other change in control provisions currently in effect for the
outstanding options under the predecessor plan. However, the plan administrator
will have the discretion to extend the acceleration provisions of the 1999
stock incentive plan to any or all of the options outstanding under our
predecessor plan.
In the event the plan administrator elects to activate the salary investment
option grant program for one or more calendar years, each executive officer and
other key employee selected for
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participation may elect, prior to the start of the calendar year, to reduce his
or her base salary for that calendar year by a specified dollar amount not less
than $10,000 nor more than $50,000. Each selected individual who files this
timely election will automatically be granted, on the first trading day in
January of the calendar year for which that salary reduction is to be in
effect, a non-statutory option to purchase that number of shares of common
stock determined by dividing the salary reduction amount by two-thirds of the
fair market value per share of common stock on the grant date. The option will
be exercisable at a price per share equal to one-third of the fair market value
of the option shares on the grant date. As a result, the total spread on the
option shares at the time of grant (the fair market value of the option shares
on the grant date less the aggregate exercise price payable for those shares)
will be equal to the amount of salary invested in that option. The option will
vest and become exercisable in a series of twelve equal monthly installments
over the calendar year for which the salary reduction is to be in effect.
Under the automatic option grant program, eligible non-employee board
members will receive a series of option grants over their period of board
service. Each individual who becomes a non-employee board member will receive
an option grant for 15,000 shares of common stock on the date such individual
joins the board, provided such individual has not been in our prior employ. In
addition, on the date of each annual stockholders meeting, each non-employee
board member who is to continue to serve as a non-employee board member
(including the individuals who are currently serving as non-employee board
members) will automatically be granted an option to purchase 5,000 shares of
common stock, provided such individual has served on the board for at least six
months. There will be no limit on the number of such 5,000 share option grants
any one eligible non-employee board member may receive over his or her period
of continued board service, and non-employee board members who have previously
been in our employ will be eligible to receive one or more such annual option
grants over their period of board service.
Each automatic grant will have an exercise price per share equal to the fair
market value per share of common stock on the grant date and will have a term
of 10 years, subject to earlier termination following the optionee's cessation
of board service. Each automatic option will be immediately exercisable for all
of the option shares; however, any unvested shares purchased under the 15,000-
share option will be subject to repurchase by Digital Island, at the exercise
price paid per share, should the optionee cease to serve on the board prior to
vesting in those shares. The shares subject to each initial 15,000-share
automatic option grant will vest in a series of six successive equal semi-
annual installments upon the optionee's completion of each month of board
service over the 36 month period measured from the grant date. However, the
shares will immediately vest in full upon specified changes in control or
ownership or upon the optionee's death or disability while a board member. The
shares subject to each annual 5,000-share automatic grant will be fully-vested
when granted. Following the optionee's cessation of board service for any
reason, each option will remain exercisable for a 12-month period and may be
exercised during that time for any or all shares in which the optionee is
vested at the time of such cessation of service.
If the director fee option grant program is activated in the future, each
non-employee board member will have the opportunity to apply all or a portion
of any annual retainer fee otherwise payable in cash to the acquisition of a
below-market option grant. The option grant will automatically be made on the
first trading day in January in the year for which the retainer fee would
otherwise be payable in cash. The option will have an exercise price per share
equal to one-third of the fair market value of the option shares on the grant
date, and the number of shares subject to the option will be determined by
dividing the amount of the retainer fee applied to the program by two-thirds of
the fair market value per share of common stock on the grant date. As a result,
the total spread on the option (the fair market value of the option shares on
the grant date less the aggregate exercise price payable for those shares) will
be equal to the portion of the retainer fee invested in that option. The option
will vest and become exercisable for the option shares in a series of twelve
equal monthly
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installments over the calendar year for which the election is to be in effect.
However, the option will become immediately exercisable and vested for all the
option shares upon (i) certain changes in the ownership or control or (ii) the
death or disability of the optionee while serving as a board member.
The shares subject to each option under the salary investment option grant,
automatic option grant and director fee option grant programs will immediately
vest upon (i) an acquisition of us by merger or asset sale or (ii) the
successful completion of a tender offer for more than 50% of our outstanding
voting stock or a change in the majority of our board effected through one or
more contested elections for board membership.
Limited stock appreciation rights will automatically be included as part of
each grant made under the automatic option grant, salary investment option
grant and director fee option grant programs and may be granted to one or more
officers as part of their option grants under the discretionary option grant
program. Options with this limited stock appreciation right may be surrendered
to us upon the successful completion of a hostile tender offer for more than
50% of our outstanding voting stock. In return for the surrendered option, the
optionee will be entitled to a cash distribution from us in an amount per
surrendered option share equal to the excess of (i) the highest price per share
of common stock paid in connection with the tender offer over (ii) the exercise
price payable for such share.
The board may amend or modify the 1999 stock incentive plan at any time,
subject to any required stockholder approval. The 1999 stock incentive plan
will terminate on the earliest of (i) April 15, 2009, (ii) the date on which
all shares available for issuance under the 1999 stock incentive plan have been
issued as fully-vested shares or (iii) the termination of all outstanding
options in connection with specified changes in control or ownership.
1999 Employee Stock Purchase Plan
Our 1999 employee stock purchase plan became effective on June 29, 1999, the
date of execution of the underwriting agreement relating to our initial public
offering. The plan is designed to allow our eligible employees and those of our
participating subsidiaries to purchase shares of common stock, at semi-annual
intervals, through their periodic payroll deductions under the plan. 300,000
shares of common stock were initially reserved for issuance under the plan. The
reserve will automatically increase on the first trading day in January each
year, beginning in calendar year 2000, by an amount equal to one percent (1%)
of the total number of outstanding shares of our common stock on the last
trading day in December in the prior year. In no event will any such annual
increase exceed 500,000 shares. Accordingly, in January 2000, the reserve under
the plan increased by 500,000 shares.
The plan has a series of successive offering periods, each with a maximum
duration of 24 months. However, the initial offering period began on the
execution date of the underwriting agreement for our initial public offering
and will end on the last business day in July 2001. The next offering period
will commence on the first business day in August 2001, and subsequent offering
periods will commence as designated by the plan administrator.
Individuals who are eligible employees (employees scheduled to work more
than 20 hours per week for more than five calendar months per year) on the
start date of any offering period may enter the plan on that start date or on
any subsequent semi-annual entry date (the first business day of February or
August each year). Individuals who become eligible employees after the start
date of the offering period may join the plan on any subsequent semi-annual
entry date within that offering period.
Payroll deductions may not exceed 15% of the participant's base salary, and
the accumulated payroll deductions of each participant will be applied to the
purchase of shares on his or her behalf
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on each semi-annual purchase date (the last business day in January and July
each year) at a purchase price per share equal to 85% of the lower of (i) the
fair market value of the common stock on the participant's entry date into the
offering period or (ii) the fair market value on the semi-annual purchase date.
In no event, however, may any participant purchase more than 1,200 shares on
any semi-annual purchase date, nor may all participants in the aggregate
purchase more than 200,000 shares on any semi-annual purchase date. The initial
purchase date under the plan will occur on January 31, 2000.
If the fair market value per share of our common stock on any purchase date
is less than the fair market value per share on the start date of the two-year
offering period, then that offering period will automatically terminate, and a
new two-year offering period will begin on the next business day, with all
participants in the terminated offering to be automatically transferred to the
new offering period.
Should we be acquired by merger, sale of substantially all our assets or
sale of securities possessing more than fifty percent of the total combined
voting power of our outstanding securities, then all outstanding purchase
rights will automatically be exercised immediately prior to the effective date
of that acquisition. The purchase price will be equal to 85% of the lower of
(i) the fair market value per share of common stock on the participant's entry
date into the offering period in which the acquisition occurs or (ii) the fair
market value per share of common stock immediately prior to the acquisition.
The limitation on the maximum number of shares purchasable in the aggregate on
any one purchase date will not be in effect for any purchase date attributable
to such an acquisition.
The plan will terminate on the earlier of (i) the last business day of July
2009, (ii) the date on which all shares available for issuance under the plan
shall have been sold pursuant to purchase rights exercised thereunder or (iii)
the date on which all purchase rights are exercised in connection with an
acquisition of us by merger or asset sale.
The board may at any time alter, suspend or discontinue the plan. However,
certain amendments, such as increasing the number of shares reserved for
issuance under the plan, require stockholder approval.
401(k) Plan
We sponsor the Digital Island, Inc. 401(k) Plan. Employees are eligible to
participate in the 401(k) Plan and may contribute up to 15% of their current
compensation, but in no event may they contribute more than the maximum dollar
amount allowable per calendar year under the federal tax laws. Each participant
is fully vested in his or her salary reduction contributions. Participant
contributions are held in trust and the individual participants may direct the
trustee to invest their accounts in a number of investment alternatives. We may
make contributions to the 401(k) Plan which match a percentage of each
participant's contributions for the year, with the actual percentage match (if
any) for one or more plan years to be determined by us in our discretion. In
addition, we may make discretionary contributions for one or more plan years
which would be allocated to participants on the basis of their compensation for
the plan year. Any discretionary and matching contributions which we may make
to the 401(k) Plan would be subject to a vesting schedule tied to the
participant's years of service with us. To date, we have not made any matching
or discretionary contributions to the 401(k) Plan. We may also make fully
vested qualified non-elective contributions to the 401(k) Plan on behalf of
participants who are not "highly compensated," but have not done so to date.
Employment Contracts and Change of Control Arrangements
We have entered into employment agreements with Ms. Ernst, Mr. Leinwand, Mr.
Wilson, Mr. Evenson and Mr. Sullivan, each of whom are officers of Digital
Island. All outstanding options held by
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the foregoing officers will automatically vest in full upon an acquisition of
Digital Island by merger, sale of substantially all the assets or sale of more
than 50% of our outstanding voting securities, unless those options are assumed
or otherwise continued in effect by a successor entity or our repurchase rights
for any unvested shares subject to those options are to remain in force
following such acquisition. The exercise price per share of the options below
were determined by our board of directors as described in "--Stock Options and
Stock Appreciation Rights."
Ruann F. Ernst. On May 20, 1998, Ruann F. Ernst, our Chief Executive Officer
and President, entered into an employment agreement with us. This agreement
provided for an annual salary of $150,000. Ms. Ernst is also entitled to
incentive compensation in an amount not less than forty percent (40%) of her
base salary upon the achievement of performance milestones mutually agreed upon
with our Board of Directors. On March 1, 1999, Ms. Ernst's annual salary was
increased to $200,000. In connection with her employment agreement we granted
Ms. Ernst options to purchase up to 794,159 shares of our common stock at a per
share exercise price of $1.50 per share.
Allan Leinwand. On February 3, 1997, Allan Leinwand, our Vice President of
Engineering and Chief Technology Officer, entered into an employment agreement
with us. This agreement provided for an annual salary of $105,000. Mr. Leinwand
is also eligible for a discretionary quarterly bonus of up to $10,000. Should
we terminate Mr. Leinwand other than for cause, we must pay Mr. Leinwand a
severance payment equal to one hundred percent of his then current annual base
salary. Currently, Mr. Leinwand's annual salary is $170,000, and he is eligible
for a discretionary quarterly bonus of up to $12,500. In connection with his
employment agreement, we granted to Mr. Leinwand options to purchase up to
240,000 shares of our common stock at a per share exercise price of $0.40 per
share.
Tim Wilson. On March 16, 1998, Tim Wilson, Digital Island's vice president
of marketing and international sales, entered into an employment agreement with
Digital Island. This agreement provided for an annual salary of $150,000. Mr.
Wilson is also eligible for a discretionary quarterly bonus of $12,500. On
March 1, 1999, Mr. Wilson's annual salary was increased to $165,000 and his
discretionary quarterly bonus was increased to $15,000. In connection with his
employment agreement, Digital Island granted Mr. Wilson options to purchase up
to 140,000 shares of Digital Island common stock at a per share exercise price
of $0.90 per share.
Paul Evenson. On October 26, 1998, Paul Evenson, Digital Island's vice
president of operations, entered into an employment agreement with Digital
Island. This agreement provided for an annual salary of $150,000. Mr. Evenson
is also eligible for an annual bonus of not less than $40,000 upon achievement
of specified milestones. In connection with his employment agreement, Digital
Island granted Mr. Evenson options to purchase up to 150,000 shares of Digital
Island common stock at a per share exercise price of $3.50 per share.
Michael T. Sullivan. On May 5, 1997, Michael T. Sullivan, our Vice President
of Finance, entered into an employment agreement with us. This agreement
provided for an annual salary of $120,000. Mr. Sullivan is also eligible for a
discretionary quarterly bonus of up to $5,000. On March 16, 1998, Mr.
Sullivan's annual salary was increased to $150,000 and his discretionary
quarterly bonus was increased to $7,500. In connection with his employment
agreement, we granted to Mr. Sullivan options to purchase up to 100,000 shares
of our common stock at a per share exercise price of $0.40 per share.
Limitation of Liability and Indemnification
Our certificate of incorporation eliminates, to the fullest extent permitted
by Delaware law, liability of a director to Digital Island or our stockholders
for monetary damages for conduct as a director.
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Although liability for monetary damages has been eliminated, equitable remedies
such as injunctive relief or rescission remain available. In addition, a
director is not relieved of his or her responsibilities under any other law,
including the federal securities laws.
Our certificate of incorporation requires us to indemnify our directors to
the fullest extent permitted by Delaware law. We have also entered into
indemnification agreements with each of our directors. We believe that the
limitation of liability provisions in our certificate of incorporation and
indemnification agreements may enhance our ability to attract and retain
qualified individuals to serve as directors. See "Description of Capital
Stock."
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CERTAIN TRANSACTIONS
Some of our directors, executive officers and affiliates have entered into
transactions with us as follows:
Preferred Stock Financings
Since October 1, 1997 we have sold 4,283,181 shares of our Series C
Preferred Stock at a price of $3.45 per share, 2,022,476 shares of our Series D
Preferred Stock at a price of $5.25 per share and 11,764,706 shares of our
Series E Preferred Stock at a price of $4.25 per share in a series of private
financings. We sold these securities pursuant to preferred stock purchase
agreements and an investors' rights agreement on substantially similar terms
(except for terms relating to date and price), under which we made standard
representations, warranties, and covenants, and pursuant to which we provided
the purchasers thereunder with registration rights, information rights, and
rights of first refusal, among other provisions standard in venture capital
financings. Each share of our preferred stock was converted into one share of
our common stock upon the completion of our initial public offering, except
that each share of Series D Preferred Stock was converted into 1.088084 shares
of our common stock, to give effect to an antidilution adjustment resulting
from the sale of the Series E Preferred Stock. The purchasers of the preferred
stock included, among others, the following holders of 5% or more of our common
stock, directors, and entities associated with directors:
<TABLE>
<CAPTION>
Shares of Preferred Stock
Purchased
-----------------------------------
Name Series C Series D Series E
- ---- --------- --------- ---------
<S> <C> <C> <C>
Bass Trust U/D/T dated April 29,
1988(1)................................ 39,420 34,095 27,765
Chase Venture Capital Associates,
L.P.(2)................................ -- -- 2,823,529
The Cotsakos Revocable Trust dated
9/3/87(3).............................. -- 28,571 --
Crescendo II, L.P.(4)................... 289,855(5) 143,429(5) 463,294(5)
Crosspoint Venture Partners............. 289,855 -- 926,824
E*TRADE Group, Inc.(6).................. -- 1,333,334 562,588
FW Ventures III, L.P. .................. -- -- 1,822,353
Marcelo Gumucio......................... 29,000 -- --
Merrill Lynch KECALP.................... -- -- 1,482,824
Tudor Global Trading, Inc. ............. 1,015,000 190,476 744,470
Vanguard V, L.P.(7)..................... 260,870 142,857 --
</TABLE>
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(1) Charlie Bass, a director of Digital Island, is the Trustee of the Bass
Trust U/D/T dated April 29, 1998.
(2) Shahan Soghikian, a director of Digital Island, is a General Partner of
Chase Capital Partners.
(3) Christos Cotsakos, a director of Digital Island, is the Trustee of The
Cotsakos Revocable Trust dated 9/3/87.
(4) David Spreng, a director of Digital Island from July 1997 until December
1999, is the Managing Member of Crescendo Ventures II, LLC, the general
partner of Crescendo II, L.P.
(5) Includes shares held by Eagle Ventures II, LLC pursuant to a parallel
investment agreement with Crescendo.
(6) Mr. Cotsakos, a director of Digital Island, is Chairman of the Board of
E*TRADE.
(7) Cliff Higgerson, a director of Digital Island, is the General Partner of
Vanguard V, L.P.
Investors' Rights Agreement
Pursuant to the terms of the Amended and Restated Investors' Rights
Agreement dated February 19, 1999, as amended, by and among Digital Island and
the holders of our preferred stock, the investors acquired certain registration
rights with respect to their capital stock of Digital Island.
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Beginning on the earlier of (i) February 19, 2001, or (ii) one year after our
initial public offering, holders of more than two-thirds of the currently
outstanding preferred stock may require us to effect up to two demand
registrations under the Securities Act covering the lesser of 50% of the
outstanding common stock issued upon conversion of the preferred stock or a
number of shares of such common stock yielding gross aggregate proceeds in
excess of $15.0 million, subject in either case to the board of directors'
right if such registration would harm Digital Island to defer such registration
for a period up to 60 days. In addition, if we propose to issue equity
securities under the Securities Act for our own account in an underwritten
public offering, then such holders have the right (subject to quantity
limitations determined by the underwriters) to request that Digital Island
register such common stock. Also, such holders have the right to request an
unlimited number of registrations of such common stock on Form S-3 under the
Securities Act. All registration expenses incurred in connection with the first
two demand registrations described above, the first two registrations on Form
S-3 described above and all piggyback registrations will be borne by Digital
Island. The participating investors will pay for underwriting discounts and
commissions incurred in connection with any such registrations. We have agreed
to indemnify the investors against certain liabilities in connection with any
registration effected pursuant to the foregoing Investors' Rights Agreement,
including Securities Act liabilities.
Employment, Indemnification and Non-Disclosure Agreements
We have entered into employment agreements with Ms. Ernst, Mr. Leinwand, Mr.
Wilson and Mr. Evenson and Mr. Sullivan, who are named executive officers. We
have also entered into indemnification agreements with each of our other
directors and officers. See "Executive Compensation and Other Information--
Employment Contracts and Change of Control Arrangements," and "--Limitation of
Liability and Indemnification."
Agreements with Former Sandpiper Officers
Concurrently with the effectiveness of our merger with Sandpiper, Leo
Spiegel, Andrew Swart, and David Farber, former executive officers of
Sandpiper, entered into employment agreements with us. Under the terms of the
employment agreements, Mr. Swart and Mr. Farber each agree to remain employed
by us for a period of one year from the closing of the merger unless we
terminate them earlier. In Mr. Spiegel's case, he agrees to remain employed
with us until November 24, 2000 unless we terminate him earlier.
If the employment of Messrs. Spiegel, Swart or Farber is terminated by us
"without cause" prior to the end of the one-year period following the closing
of the merger (or prior to November 24, 2000 in Mr. Spiegel's case), then that
individual will be entitled to receive his base salary as a severance payment
until the earlier of (1) one year after the termination of his employment or
(2) the date the employee begins employment with another employer. If the
employment is terminated for "cause" prior to the end of the one-year period
following the closing of the merger (or prior to November 24, 2000 in Mr.
Spiegel's case), then the employee will be paid all salary, bonus and benefits
earned through the date of termination of employment, but nothing else.
As to Mr. Swart and Mr. Farber, "cause" shall mean the employee's
termination as a result of the employee: (a) failing to perform the duties of
his position after receipt of a written warning; (b) engaging in serious
misconduct; (c) being convicted of a felony; (d) committing an act of fraud
against, or the misappropriation of property belonging to, us; or (e)
materially breaching of the employment agreement or the confidentiality or
proprietary information agreement between the employee and us.
In Mr. Spiegel's case, a termination for "cause" shall mean a termination
for any of the following reasons: (a) willful and repeated failure or refusal
to comply in any material respect with reasonable
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directives from the chief executive officer which are consistent with his job
responsibilities and stature, provided that such failure or refusal continues
for 45 days after written notice is given to him describing such failure or
refusal in reasonable detail and stating the company's intention to terminate
his employment if such continues, (b) conviction of a felony which has a
material adverse impact on us or (c) the intentional and known unauthorized use
or disclosure of the confidential proprietary information of ours or any of our
subsidiaries, including Sandpiper after the merger, which has a material
adverse impact on us. Mr. Spiegel will also be entitled to severance as
provided for above if he terminates his employment for "good reason" before
November 24, 2000. A termination for "good reason" shall mean a termination by
him of his employment for any of the following reasons: (x) diminution of
responsibilities consistent with his position of president as agreed upon at
the time of merger, after providing notice to the chief executive officer and
allowing for reasonable opportunity to cure the diminution of responsibilities;
(y) change in title or reporting relationship; or (z) involuntary relocation
from his principal place of employment in San Diego, California.
At October 31, 1999, Mr. Spiegel held 858,917 shares of Sandpiper common
stock (921,360 shares of Digital Island common stock, as converted), issued
pursuant to a restricted stock purchase agreement, which were subject to
repurchase by Sandpiper at $0.07 per share upon a termination of his
employment. Although his restricted stock purchase agreement with Sandpiper
provided that all of these shares would vest free of this repurchase right upon
certain events such as the merger, in connection with his employment agreement
with Digital Island described above, Mr. Spiegel waived these acceleration
rights and instead agreed that 50% of his unvested shares, as converted, would
vest on March 24, 2000 and the balance on November 24, 2000, unless he
terminates his employment without "good reason" or is terminated by Sandpiper
for "cause" prior to vesting. This accelerated vesting schedule, together with
the accelerated vesting of common stock of certain other Sandpiper executives,
was approved by the Sandpiper shareholders pursuant to Section 280G of the
Internal Revenue Code on December 8, 1999.
Mr. Swart and Mr. Farber were each granted a stock option for 150,000 shares
of Digital Island's common stock following the closing of the merger. The
option vests over 50 months of successive employment with us. In the event of a
change in control following the closing of the merger, the employee's option
will accelerate in full unless the acquiring company assumes the option. If the
employee is terminated by the acquiring company, other than for cause, or
resigns due to specified adverse changes in his terms of employment, upon or
within eighteen (18) months following a change in control but more than twelve
months (12) after the date the employee commences employment with Digital
Island, the employee's option will immediately vest and become exercisable for
all the shares at the time subject to that option.
For purposes of these agreements, "change in control" shall mean any of the
following transactions effecting a change in ownership or control of Digital
Island:
(a) a merger, consolidation or reorganization approved by Digital Island
stockholders in which securities representing more than fifty percent (50%)
of the total combined voting power of Digital Island's outstanding
securities are transferred to a person or persons different from the
persons holding those securities immediately prior to such transaction;
(b) any stockholder-approved transfer or other disposition of all or
substantially all of Digital Island's assets in complete liquidation or
dissolution of Digital Island; or
(c) the acquisition, directly or indirectly by any person or related
group of persons (other than Digital Island or a person that directly or
indirectly controls, is controlled by, or is under common control with,
Digital Island), of beneficial ownership (within the meaning of Rule 13d-3
of the Securities Exchange Act of 1934, as amended) of securities
possessing more than fifty percent (50%) of the total combined voting power
of Digital Island's outstanding securities pursuant to a tender or exchange
offer made directly to Digital Island's stockholders.
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The employment agreements contain non-competition provisions that require
each employee during his employment and continuing until the latter of (1) one
year after the closing date of the merger (or November 24, 2000 in Mr.
Spiegel's case) or (2) one year after the date of termination, to not render
any services to any content distribution company that operates networks which
serve content in one or two ways to multiple devices distributed throughout
deployed networks of distributed servers (including without limitation Adero,
Akamai, Real Broadcast Networks, Exodus, AT&T) in the United States or
throughout the world.
Concurrently with the execution of their employment agreements, Leo Spiegel,
Andrew Swart, and David Farber executed non-disclosure agreements with us. The
non-disclosure agreements require the employee:
(i) during his employment with Digital Island and thereafter, not to
divulge or disclose any confidential information of Digital Island without
the written consent of Digital Island; and
(ii) during his employment and for one year thereafter, not to engage,
individually or on behalf of other persons, in soliciting any employees of
Digital Island to leave their employment with Digital Island or to accept a
position of any kind with another employer.
Director Arrangements and Stockholder Notes
In February 1998, Digital Island granted a nonstatutory option to purchase a
total of 183,000 shares of our common stock to Marcelo Gumucio, then the
Chairman of the board of directors and now a director of Digital Island. These
options were immediately exercisable and subject to repurchase by Digital
Island, with the right to repurchase expiring in 16 equal quarterly
installments. At the time of the option grant, Mr. Gumucio exercised the option
to purchase the entire 183,000 shares of common stock, in exchange for a
$109,800 note. Under the terms of the note, interest accrues on outstanding
amounts at 5.61% per annum. Interest is to be repaid in four equal annual
installments commencing February 24, 1999. The entire principal amount is due
and payable in one lump sum on February 24, 2002. In August 1999, Mr. Gumucio
repaid the entire principal amount as well as all accrued interest.
Officer Loans
On April 21, 1999, Ms. Ernst, our current Chairman of the Board and Chief
Executive Officer, and Mr. Higgins, our then-Chairman of the Board, each
delivered a promissory note to us in payment of the exercise price of certain
outstanding stock options they hold under our 1998 stock option/stock issuance
plan. Ms. Ernst delivered a full-recourse promissory note in the principal
amount of $199,998 in payment of the exercise price for 133,332 shares of our
common stock, and Mr. Higgins delivered a full-recourse promissory note in the
amount of $86,400 in payment of the exercise price for 216,000 shares of our
common stock. Each note bears interest at the rate of 7.75% per annum,
compounded semi-annually, and is secured by the purchased shares. Accrued
interest is due and payable at successive quarterly intervals over the four-
year term of the note, and the principal balance will become due and payable in
one lump sum at the end of such four-year term. However, the entire unpaid
balance of the note will become due and payable upon termination of employment
or failure to pay any installment of interest when due. None of the shares
serving as security for the note may be sold unless the principal portion of
the note attributable to those shares, together with the accrued interest on
that principal portion, is paid to us. In December 1999, Mr. Higgins repaid the
entire principal amount of his note, as well as all accrued interest.
On June 14, 1999, Ms. Ernst borrowed an additional $128,000 from us in order
to finance the tax liability she incurred in connection with the exercise of
her stock options on April 21, 1999 for 133,332 shares of our common stock. The
loan is evidenced by a full-recourse promissory note with interest at the rate
of 7.75% per annum, compounded semi-annually, and secured by the same
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133,332 shares which serve as collateral for Ms. Ernst's April 21, 1999
promissory note. The terms of her note, including the due dates for payment of
principal and accrued interest and the acceleration provisions, are
substantially the same as the terms in effect for her April 21, 1999 note. The
April 21 and June 14, 1999 promissory notes from Ms. Ernst aggregate to a
principal total indebtedness to Digital Island of $327,998.
On July 13, 1999 Chris Albinson, Digital Island's vice president of
corporate development, borrowed $100,000 from Digital Island. The borrowing is
interest-free, and $50,000 of the borrowings is being forgiven ratably over
five years. The remaining $50,000 is due in one lump sum on July 13, 2004.
E*TRADE Agreements
We have entered into a global data distribution agreement with E*TRADE dated
August 1, 1997 where we provide network connectivity for E*TRADE. Mr. Costakos,
a member of our board of directors, is President, Chief Executive Officer and a
director of E*TRADE.
We believe that all of the transactions set forth above were made on terms
no less favorable to us than could have been obtained from unaffiliated third
parties. We intend that all future transactions, including loans, between us
and our officers, directors, principal stockholders and their affiliates will
be approved by a majority of the board of directors, and be on terms no less
favorable to us than could be obtained from unaffiliated third parties.
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PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information as of December 31,1999
(except as indicated in the footnotes below) with respect to the beneficial
ownership of our common stock by:
. each person known by us to own beneficially more than 5%, in the
aggregate, of the outstanding shares of our common stock;
. the directors and named executive officers of Digital Island who hold
securities of Digital Island;
. each stockholder selling shares of our common stock in this offering; and
. all executive officers and directors as a group.
Unless otherwise indicated, the address for each stockholder is c/o Digital
Island, Inc., 45 Fremont, 12th Floor, San Francisco, California 94105. Except
as indicated by footnote, we understand that the persons named in the table
below have sole voting and investment power with respect to all shares shown as
beneficially owned by them, subject to community property laws where
applicable. In the table below "Beneficial Ownership of Shares After Offering"
reflects the beneficial ownership of the common stock after giving effect to
the offering. Shares of common stock subject to options, which are currently
exercisable or exercisable within 60 days of December 31, 1999, are deemed
outstanding for computing the percentages of the person holding such options
but are not deemed outstanding for computing the percentages of any other
person. Percentage ownership is based on 60,684,804 shares of common stock
outstanding as of December 31, 1999.
<TABLE>
<CAPTION>
Beneficial Ownership of Beneficial Ownership of
Shares Before the Offering Shares After the Offering
----------------------------- Number of -----------------------------
Name of Beneficial Owner Number Percent Shares Offered Number Percent
- ------------------------ --------------- ------------- -------------- --------------- -------------
<S> <C> <C> <C> <C> <C>
5% Stockholders:
Brentwood Venture
Capital(1)............ 3,910,493 6.4% 212,999 3,697,494 5.7%
Media Technology
Ventures(2)........... 3,475,993 5.7% 189,333 3,286,660 5.1%
Crosspoint Venture
Partners(3)........... 3,246,679 5.4% -- 3,246,679 5.0%
Officers and Directors:
Ruann F. Ernst(4)...... 733,740 1.2% 30,000 703,740 1.1%
Leo S. Spiegel(5)...... 1,637,973 2.7% 30,000 1,607,973 2.5%
T. L. Thompson(6)...... 53,481 * 6,275 47,206 *
Chris Albinson......... -- -- -- -- --
Scott Darling(7)....... 150,178 * -- 150,178 *
Paul Evenson(8)........ 53,416 * -- 53,416 *
Allan Leinwand(9)...... 199,486 * 8,075 191,411 *
Rick Schultz........... -- -- -- -- --
Eric Shepcaro(10)...... 289,629 * -- 289,629 *
Michael T.
Sullivan(11).......... 101,000 * -- 101,000 *
Andrew Swart........... 1,884,276 3.1% 40,000 1,844,276 2.9%
Tim Wilson(12)......... 127,313 * 7,000 120,313 *
Bruce Pinsky(13)....... 129,791 * -- 129,791 *
Charlie Bass(14)....... 419,283 * 20,000 399,283 *
Marcelo A. Gumucio..... 212,000 * 11,547 200,453 *
Christos Cotsakos(15).. 47,199 * -- 47,199 *
Cliff Higgerson(16).... -- -- -- -- --
G. Bradford Jones(17).. -- -- -- -- --
Robert Kibble(18)...... -- -- -- -- --
Shahan Soghikian(19)... -- -- -- -- --
All directors and
executive officers as
a group
(20 people)(20)....... 6,038,765 10.0% 152,897 5,885,868 9.1%
Other Selling
Stockholders:
Chase Venture Capital
Associates, L.P.(21).. 2,823,529 4.65% 153,794 2,669,735 4.1%
Vanguard V L.P.(22).... 2,561,310 4.22% 139,511 2,421,799 3.8%
David Farber(23)....... 1,895,004 3.12% 40,000 1,855,004 2.9%
Mission Ventures(24)... 2,780,793 4.58% 151,466 2,629,327 4.1%
Ronald Higgins(25)..... 2,066,000 3.40% 100,000 1,966,000 3.0%
Gretchen Knoell........ 116,361 * 10,000 106,361 *
</TABLE>
- -------
* Less than one percent.
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(1) Consists of 3,754,075 shares held by Brentwood Associates VIII, L.P., and
156,418 shares held by Brentwood Affiliates Fund, L.P. Mr. G. Bradford
Jones is a general partner or managing member of the general partners of
each of these shareholders, and as such may be deemed to be the beneficial
owner of such shares. Mr. Jones disclaims beneficial ownership of such
shares except to the extent of his pecuniary interest therein. The
business address of Brentwood Venture Capital is 11150 Santa Monica
Boulevard, Suite 1200, Los Angeles, California 90025.
(2) Includes 3,078,340 shares held by Media Technology Ventures, L.P. and
397,653 shares held by Media Technology Entrepreneurs Fund, L.P. The
business address of Media Technology Ventures is 1 First Street, Suite 12,
Los Altos, California 94022.
(3) Stock consists of 1,450,000 shares held directly by Crosspoint Venture
Partners, 869,855 shares held directly by Crosspoint Venture Partners 1996
and 926,824 shares held directly by Crosspoint Venture Partners LS 1997
(collectively, with Crosspoint Venture Partners 1996 and Crosspoint
Venture Partners, the "Crosspoint Entities"). The address for the
Crosspoint Entities is 2925 Woodside Road, Woodside, California 94062.
(4) Stock consists of 233,332 shares of common stock held directly by Ms.
Ernst and 500,408 shares of common stock subject to options exercisable
within 60 days of December 31, 1999.
(5) Consists of 1,466,341 shares of common stock held directly by Mr. Spiegel,
85,816 shares held directly by The Hunter L. Spiegel Educational Trust and
85,816 shares held directly by The Madison H. Spiegel Educational Trust.
Mr. Spiegel is a trustee of both of these trusts.
(6) Consists of 53,481 shares of common stock subject to options exercisable
within 60 days of December 31, 1999.
(7) Consists of 150,178 shares of common stock subject to options exercisable
within 60 days of December 31, 1999.
(8) Consists of 53,416 shares of common stock subject to options exercisable
within 60 days of December 31, 1999.
(9) Consists of 163,733 shares of common stock held directly by Mr. Leinwand
and 35,753 shares of common stock subject to options exercisable within 60
days of December 31, 1999.
(10) Consists of 289,629 shares of common stock subject to options exercisable
within 60 days of December 31, 1999.
(11) Consists of 71,000 shares of common stock held directly by Mr. Sullivan
and 30,000 shares of common stock subject to options exercisable within 60
days of December 31, 1999.
(12) Consists of 53,249 shares of common stock held directly by Mr. Wilson and
74,064 shares subject to options exercisable within 60 days of December
31, 1999.
(13) Consists of 112,708 shares of common stock held directly by Mr. Pinsky and
17,083 shares of common stock subject to options exercisable within 60
days of December 31, 1999.
(14) Stock consists of 419,283 shares of common stock held directly by the Bass
Trust U/D/T dated April 29, 1988 (the "Bass Trust"). Mr. Bass, a director
of Digital Island, is the Trustee of the Bass Trust.
(15) Stock consists of 10,555 shares of common stock subject to options
exercisable within 60 days of December 31, 1999 and 31,087 shares of
common stock held directly by The Cotsakos Revocable Trust dated September
3, 1987. Excludes 2,013,367 shares of common stock, held by E*TRADE Group,
Inc. Mr. Cotsakos, a director of Digital Island, is the Trustee of the
Cotsakos Trust and Chairman of the Board and Chief Executive Officer of
E*TRADE Group, Inc. Mr. Cotsakos disclaims beneficial ownership of the
shares of common stock held by E*TRADE Group, Inc. except to the extent of
his pecuniary interest therein.
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(16) Excludes an aggregate of 2,561,310 shares held by Vanguard V, L.P. Mr.
Higgerson, a director of Digital Island, is the General Partner of
Vanguard V, L.P. Mr. Higgerson disclaims beneficial ownership of the
shares of common stock held by Vanguard V, L.P. except to the extent of
his pecuniary interest therein.
(17) Excludes an aggregate of 3,910,493 shares held by the Brentwood Venture
Capital entities. Mr. Jones, a director of Digital Island, is a General
Partner of Brentwood Venture Capital. Mr. Jones disclaims beneficial
ownership of the shares of common stock held by the Brentwood Venture
Capital entities except to the extent of his pecuniary interest therein.
(18) Excludes an aggregate of 2,780,793 shares held collectively by Mission
Ventures, L.P. and Mission Ventures Affiliates, L.P. Mr. Kibble, a
director of Digital Island, is a managing member of the general partner of
the Mission Venture entities. Mr. Kibble disclaims beneficial ownership of
the shares of common stock held by the Mission Venture entities except to
the extent of his pecuniary interest therein.
(19) Excludes 2,823,529 shares of common stock, as converted, held by Chase
Venture Capital Associates, L.P. Mr. Soghikian, a director of Digital
Island, is the General Partner of Chase Capital Partners, the General
Partner of Chase Venture Capital Associates, L.P. Mr. Soghikian disclaims
beneficial ownership of the shares of common stock held by Chase Venture
Capital Associates, L.P. except to the extent of his pecuniary interest
therein.
(20) See footnotes 4 through 18 above. Includes options exercisable for
1,212,760 shares of common stock within 60 days of December 31, 1999.
(21) Mr. Soghikian, a director of Digital Island, is a General Partner of Chase
Capital Partners, the General Partner of Chase Venture Capital Associates,
L.P. The address of Chase Venture Capital Associates, L.P. is 50
California Street, Suite 2940, San Francisco, California 94111.
(22) Mr. Higgerson, a director of Digital Island, is a General Partner of
Vanguard V, L.P. The address of Vanguard V, L.P. is 505 Hamilton Avenue,
Suite 305, Palo Alto, California 94301.
(23) Consists of 1,734,099 shares of common stock held directly by David
Farber, 53,635 shares held directly by the Farber Irrevocable Trust for
the Benefit of Alicia Claire Farber, 53,635 shares held directly by the
Farber Irrevocable Trust for the Benefit of Aaron Nathaniel Farber and
53,635 shares held directly by the Farber Irrevocable Trust for the
Benefit of Zachary Andrew Farber. Mr. Farber is the trustee of the above
trusts.
(24) Mr. Kibble, a director of Digital Island, is the managing member of the
general partner of the Mission Venture entities.
(25) Consists of 1,666,000 shares of common stock directly held by Ron Higgins,
150,000 shares held by the Ron and Sanne Higgins 1998 Irrevocable Trust
Agreement, 100,000 shares held by the Ron and Sanne Higgins 1998
Irrevocable Grandchildren's Trust Agreement and 150,000 shares held by the
Ron and Sanne Higgins 1998 Irrevocable Trust Agreement. Ron Higgins is the
trustee of the above trusts.
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DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of Digital Island consists of 100,000,000
shares of common stock, $0.001 par value per share, and 10,000,000 shares of
preferred stock, $0.001 par value per share.
Common Stock
As of December 31, 1999, 60,684,804 shares of our common stock were
outstanding and held of record by 364 stockholders. After this offering, and
after taking into account the 509,430 shares issued to Sun and Inktomi and
799,989 shares issued in connection with our acquisition of Live On Line in
January 2000, 65,844,223 shares will be outstanding, assuming no exercise of
the underwriters' over-allotment option and no exercise of options after
December 31, 1999.
Holders of common stock are entitled to receive dividends as may from time
to time be declared by our board of directors out of funds legally available
therefor. See "Dividend Policy." Holders of common stock are entitled to one
vote per share on all matters on which the holders of common stock are entitled
to vote and do not have any cumulative voting rights. Holders of common stock
have no preemptive, conversion, redemption or sinking fund rights. In the event
of a liquidation, dissolution or winding up of Digital Island, holders of
common stock are entitled to share equally and ratably in the assets of the
Digital Island, if any, remaining after the payment of all our liabilities and
the liquidation preference of any then outstanding class or series of preferred
stock. The rights, preferences and privileges of holders of common stock are
subject to any series of preferred stock that we may issue in the future, as
described below.
Preferred Stock
Our board of directors has the authority to issue preferred stock in one or
more series and to fix the number of shares constituting any such series and
the preferences, limitations and relative rights, including dividend rights,
dividend rate, voting rights, terms of redemption, redemption price or prices,
conversion rights and liquidation preferences of the shares constituting any
series, without any further vote or action by our stockholders. The issuance of
preferred stock by our board of directors could adversely affect the rights of
holders of common stock.
The potential issuance of preferred stock may have the effect of delaying or
preventing a change in control of Digital Island, may restrict dividends on our
common stock, may discourage bids for our common stock at a premium over the
market price of the common stock, may impair the liquidation rights of the
common stock and may adversely affect the market price of, and the voting and
other rights of the holders of, common stock. Immediately after this offering
there will be no shares of preferred stock outstanding, and we have no current
plans to issue shares of preferred stock.
Warrants
At December 31, 1999, there were warrants outstanding to purchase a total of
26,818 shares of common stock at $96.95 per share. These warrants will expire
in December 2000.
Anti-Takeover, Limited Liability and Indemnification Provisions
Effect of Delaware Anti-takeover Statute. We are subject to Section 203 of
the Delaware General Corporation Law, as amended, which prohibits a Delaware
corporation from engaging in any business combination with any interested
stockholder for a period of three years following the date that such
stockholder became an interested stockholder, unless:
. prior to such date, the board of directors of the corporation approved
either the business combination or the transaction that resulted in the
stockholder becoming an interested stockholder;
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. upon consummation of the transaction that resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned at
least 85% of the voting stock of the corporation outstanding at the time
the transaction commenced, excluding for purposes of determining the
number of shares outstanding those shares owned (1) by persons who are
directors and also officers and (2) by employee stock plans in which
employee participants do not have the right to determine confidentially
whether shares held subject to the plan will be tendered in a tender or
exchange offer; or
. on or subsequent to such date, the business combination is approved by
the board of directors and authorized at an annual or special meeting of
stockholders, and not by written consent, by the affirmative vote of at
least 66 2/3% of the outstanding voting stock that is not owned by the
interested stockholder.
Section 203 of the Delaware General Corporation Law defines business
combinations to include:
. any merger or consolidation involving the corporation and any interested
stockholder;
. any sale, transfer, pledge or other disposition of 10% or more of the
assets of the corporation to an interested stockholder;
. any transaction that results in the issuance or transfer by the
corporation of any stock of the corporation to an interested stockholder;
. any transaction involving the corporation that has the effect of
increasing the proportionate share of the stock of any class or series of
the corporation beneficially owned by an interested stockholder; or
. any receipt by an interested stockholder of the benefit of any loans,
advances, guarantees, pledges or other financial benefits provided by or
through the corporation.
In general, Section 203 of the Delaware General Corporation Law defines an
interested stockholder as any entity or person beneficially owning 15% or more
or the outstanding voting stock of the corporation and any entity or person
affiliated with, controlling or controlled by such entity or person.
Certificate of Incorporation and Bylaw Provisions. Our certificate of
incorporation and bylaws include provisions that may have the effect of
discouraging, delaying or preventing a change in control of Digital Island or
an unsolicited acquisition proposal that a stockholder might consider
favorable, including a proposal that might result in the payment of a premium
over the market price for the shares held by stockholders. These provisions
are summarized in the following paragraphs.
Classified Board of Directors. Our certificate of incorporation and bylaws
provide for our board to be divided into three classes of directors serving
staggered, three year terms. The classification of the board has the effect of
requiring at least two annual stockholder meetings, instead of one, to replace
a majority of the members of the board of directors, which may have the effect
of discouraging a change in control by increasing the time required for a
change in control to be effected.
Supermajority Voting. Our certificate of incorporation requires the
approval of the holders of at least 66 2/3% of our combined voting power to
effect certain amendments to the certificate of incorporation with respect to
the bylaws, directors, stockholder meetings and indemnification. Our bylaws
may be amended by either a majority of the board of directors, or the holders
of at least 66 2/3% of our voting stock.
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Authorized but Unissued or Undesignated Capital Stock. Our authorized
capital stock consists of 100,000,000 shares of common stock and 10,000,000
shares of preferred stock. No preferred stock will be designated upon
consummation of this offering. After this offering and after taking into
account shares issued pursuant to the Sun and Inktomi investments and Live On
Line acquisition in January 2000, we will have outstanding 65,844,223 shares of
common stock assuming no exercise of the underwriters' over-allotment option
and no exercises of options after December 31, 1999. The authorized but
unissued (and in the case of preferred stock, undesignated) stock may be issued
by the board of directors in one or more transactions. In this regard, our
certificate of incorporation grants the board of directors broad power to
establish the rights and preferences of authorized and unissued preferred
stock. The issuance of shares of preferred stock pursuant to the board of
director's authority described above could decrease the amount of earnings and
assets available for distribution to holders of common stock and adversely
affect the rights and powers, including voting rights, of such holders and may
have the effect of delaying, deferring or preventing a change in control of
Digital Island. The board of directors does not currently intend to seek
stockholder approval prior to any issuance of preferred stock, unless otherwise
required by law or the rules of any exchange on which our securities are then
traded.
Special Meetings of Stockholders. Our certificate of incorporation and
bylaws provide that special meetings of stockholders of Digital Island may be
called only by the board of directors.
No Stockholder Action by Written Consent. Our certificate of incorporation
and bylaws provide that an action required or permitted to be taken at any
annual or special meeting of the stockholders of Digital Island may only be
taken at a duly called annual or special meeting of stockholders. This
provision prevents stockholders from initiating or effecting any action by
written consent.
Notice Procedures. Our bylaws establish advance notice procedures with
regard to all stockholder proposals to be brought before meetings of
stockholders of Digital Island, including proposals relating to the nomination
of candidates for election as directors, the removal of directors and
amendments to our certificate of incorporation or bylaws. These procedures
provide that notice of such stockholder proposals must be timely given in
writing to the Secretary of Digital Island prior to the meeting. Generally, to
be timely, notice must be received by our Secretary not less than 120 days
prior to the meeting. The notice must contain certain information specified in
the bylaws.
Other Anti-Takeover Provisions. See "Executive Compensation and Other
Information--Employee Benefit Plans" for a discussion of certain provisions of
the 1999 stock incentive plan. Under this plan and its predecessor plans, the
board and the plan administrator have broad authority to issue options and
stock appreciation rights that may have the effect of discouraging, delaying or
preventing a change in control of Digital Island or unsolicited acquisition
proposals.
Limitation of Director Liability. Our certificate of incorporation limits
the liability of our directors (in their capacity as directors but not in their
capacity as officers) to Digital Island or our stockholders to the fullest
extent permitted by Delaware law. Specifically, directors of Digital Island
will not be personally liable for monetary damages for breach of a director's
fiduciary duty as a director, except for liability:
. for any breach of the director's duty of loyalty to Digital Island or our
stockholders;
. for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
. under Section 174 of the Delaware General Corporation Law, which relates
to unlawful payments of dividends or unlawful stock repurchases or
redemptions; or
. for any transaction from which the director derived an improper personal
benefit.
82
<PAGE>
Indemnification Arrangements. Our bylaws provide that the directors and
officers of Digital Island shall be indemnified and provide for the advancement
to them of expenses in connection with actual or threatened proceedings and
claims arising out of their status as such to the fullest extent permitted by
the Delaware General Corporation Law. We have entered into indemnification
agreements with each of our directors and executives officers that provide them
with rights to indemnification and expense advancement to the fullest extent
permitted under the Delaware General Corporation Law.
Transfer Agent and Registrar
The transfer agent and registrar for the common stock is BankBoston, N.A.
83
<PAGE>
UNDERWRITING
Digital Island, the selling stockholders and the underwriters for the
offering (the "Underwriters") named below have entered into an underwriting
agreement with respect to the shares being offered. Subject to some conditions,
each Underwriter has severally agreed to purchase the number of shares
indicated in the following table. Goldman, Sachs & Co., Bear, Stearns & Co.
Inc., Lehman Brothers Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated,
Thomas Weisel Partners LLC and Dain Rauscher Incorporated are the
representatives of the Underwriters.
<TABLE>
<CAPTION>
Underwriter Number of Shares
----------- ----------------
<S> <C>
Goldman, Sachs & Co. ....................................... 1,142,500
Bear, Stearns & Co. Inc..................................... 1,142,500
Lehman Brothers Inc......................................... 685,500
Merrill Lynch, Pierce, Fenner & Smith
Incorporated............................................ 571,250
Thomas Weisel Partners LLC.................................. 571,250
Dain Rauscher Incorporated.................................. 457,000
E*Offering.................................................. 107,500
First Albany Corporation.................................... 107,500
Pacific Crest Securities.................................... 107,500
Soundview Technology Group Inc.............................. 107,500
---------
Total .................................................... 5,000,000
=========
</TABLE>
If the Underwriters sell more shares than the total number set forth in the
table above, the Underwriters have an option to buy up to an additional 697,500
shares from Digital Island and the selling stockholders to cover such sales.
They may exercise that option for 30 days. If any shares are purchased pursuant
to this option, the Underwriters will severally purchase shares in
approximately the same proportion as set forth in the table above.
The following tables show the per share and total underwriting discounts and
commissions to be paid to the Underwriters by Digital Island and the selling
stockholders. Such amounts are shown assuming both no exercise and full
exercise of the Underwriters' option to purchase additional shares.
<TABLE>
<CAPTION>
Paid by the Company
-------------------------
No Exercise Full Exercise
----------- -------------
<S> <C> <C>
Per Share.......................................... $ 4.81 $ 4.81
Total.............................................. $18,518,500 $2,777,775
</TABLE>
<TABLE>
<CAPTION>
Paid by the Selling
Stockholders
-------------------------
No Exercise Full Exercise
----------- -------------
<S> <C> <C>
Per Share.......................................... $ 4.81 $ 4.81
Total.............................................. $5,531,500 $829,725
</TABLE>
Shares sold by the Underwriters to the public will initially be offered at
the initial price to public set forth on the cover of this prospectus. Any
shares sold by the Underwriters to securities dealers may be sold at a discount
of up to $2.89 per share from the initial price to public. Any such securities
dealers may resell any shares purchased from the Underwriters to certain other
brokers or dealers at a discount of up to $.10 per share from the initial price
to public. If all the shares are not sold at the initial price to public, the
representatives may change the offering price and the other selling terms.
84
<PAGE>
Digital Island, its directors, executive officers and certain of its
stockholders have agreed with the Underwriters not to dispose of or hedge any
of their common stock or securities that are convertible into or exchangeable
for shares of common stock during the period from the date of this prospectus
continuing through the date 90 days after the date of this prospectus, except
with the prior written consent of Goldman, Sachs & Co. Certain other of Digital
Island's stockholders have agreed with the Underwriters not to dispose of or
hedge any of their common stock or securities convertible into or exchangeable
for shares of common stock during the period from the date of this prospectus
continuing through the date 30 days after the date of this prospectus, except
with the prior written consent of Goldman, Sachs & Co. Goldman, Sachs & Co. has
agreed to permit Digital Island to issue, sell, offer or agree to sell up to
10% of its outstanding shares within 90 days after the date of this prospectus
in connection with third party investments in its securities or mergers,
acquisitions or other business combinations, at the higher of the public
offering price or the then current market price, provided that the acquiror or
buyer of such shares agrees not to issue, sell, offer or agree to sell such
shares during such 90-day period. This agreement does not apply to any existing
employee benefit plans. See "Shares Eligible for Future Sale" for a discussion
of certain transfer restrictions.
In connection with the offering, the Underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the Underwriters of a greater
number of shares than they are required to purchase in the offering.
Stabilizing transactions consist of certain bids or purchases made for the
purpose of preventing or retarding a decline in the market price of the common
stock while the offering is in progress.
The Underwriters also may impose a penalty bid. This occurs when a
particular Underwriter repays to the Underwriters a portion of the underwriting
discount received by it because the representatives have repurchased shares
sold by or for the account of such Underwriter in stabilizing or short covering
transactions.
These activities by the Underwriters may stabilize, maintain or otherwise
affect the market price of the common stock. As a result, the price of the
common stock may be higher than the price that otherwise might exist in the
open market. If these activities are commenced, they may be discontinued by the
Underwriters at any time. These transactions may be effected on the Nasdaq
National Market in the over-the-counter market or otherwise.
Thomas Weisel Partners LLC, one of the representatives of the underwriters,
was organized and registered as a broker-dealer in December 1998. Since
December 1998, Thomas Weisel Partners has been named as a lead or co-manager on
110 filed public offerings of equity securities, of which 79 have been
completed, and has acted as a syndicate member in an additional 54 public
offerings of equity securities. Thomas Weisel Partners does not have any
material relationship with us or any of our officers, directors or other
controlling persons, except with respect to its contractual relationship with
us pursuant to the underwriting agreement entered into in connection with this
offering.
Digital Island estimates that the total expenses of the offering, excluding
underwriting discounts and commissions, will be approximately $700,000.
Digital Island and the selling stockholders have agreed to indemnify the
several Underwriters against certain liabilities, including liabilities under
the Securities Act of 1933.
85
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Future sales of substantial amounts of common stock, including shares issued
upon exercise of outstanding options or warrants, in the public market could
adversely affect prevailing market prices from time to time. Furthermore, many
sales of substantial amounts of common stock in the public market after
contractual and legal restrictions lapse could adversely affect the prevailing
market price and our ability to raise equity capital in the future.
Upon completion of this offering, and after taking into account shares
issued pursuant to the Sun and Inktomi investments and Live On Line acquisition
in January 2000, 65,844,223 shares of common stock will be outstanding,
assuming no exercise of the underwriters' over-allotment option and no exercise
of options after December 31, 1999. Of these shares, all of the shares sold in
this offering will be freely tradeable without restriction under the Securities
Act, unless purchased by an "affiliate" of Digital Island, as that term is
defined in Rule 144. Of the remaining 62,344,223 shares outstanding after
completion of this offering, approximately 41,653,456 are "restricted
securities" as defined in Rule 144 and may be sold in the public market only if
registered under the Securities Act or if they qualify for an exemption from
registration, including an exemption pursuant to Rule 144.
Certain of our stockholders holding approximately 35,726,979 of our shares
of common stock have entered into agreements restricting the offer, sale or
disposition of such shares. Pursuant to such agreements, Digital Island, our
executive officers, directors and certain of our stockholders, holding a total
of approximately 24,914,008 shares, have agreed that, subject to certain
exceptions and consents, during the period beginning from the date of this
prospectus, and continuing to and including the date 90 days after the date of
this prospectus, they will not offer, sell, contract to sell or otherwise
dispose of any securities of Digital Island. Certain other of our stockholders,
holding a total of approximately 10,812,971 shares, have agreed that, subject
to certain exceptions and consents, during the period beginning from the date
of this prospectus, and continuing to and including the date 30 days after the
date of this prospectus, they will not offer, sell, contract to sell or
otherwise dispose of any securities of Digital Island. Goldman, Sachs & Co.,
may in its sole discretion and at any time without notice, release all or any
portion of the shares subject to such agreements. Upon effectiveness of this
offering, a total of 7,794,921 shares that were previously subject to market
standoff agreements restricting the sale and transfer of such shares will be
eligible for immediate resale in the public market. A total of approximately
20,340,767 shares held by holders of our outstanding common stock as of the
date hereof will be eligible for immediate resale in the public market
immediately upon the effectiveness of this offering. Goldman, Sachs & Co. has
agreed to permit Digital Island to issue, sell, offer or agree to sell up to
10% of our outstanding shares within 90 days after the date of this prospectus
in connection with third party investments in our securities or mergers,
acquisitions or other business combinations, at the higher of the public
offering price or the then current market price, provided that the acquiror or
buyer of such shares agrees not to issue, sell, offer or agree to sell such
shares during such 90-day period.
In general, under Rule 144, a person, including an "affiliate" of Digital
Island, who has beneficially owned restricted shares for at least one year is
entitled to sell within any three-month period a number of shares that does not
exceed the greater of 1% of the then outstanding shares of common stock
(approximately 650,000 shares immediately following this offering) or the
average weekly trading volume of the common stock during the four calendar
weeks preceding such sale. Sales under Rule 144 are subject to certain manner
of sale limitations, notice requirements and the availability of current public
information about Digital Island. Rule 144(k) provides that a person who is not
an "affiliate" of the issuer at any time during the three months preceding a
sale and who has beneficially owned shares for at least two years is entitled
to sell those shares at any time without compliance with the public
information, volume limitation, manner of sale and notice provisions of Rule
144.
86
<PAGE>
As of December 31, 1999, options to purchase 7,594,453 shares of common
stock were outstanding under our 1999 stock incentive plan and otherwise. All
of these shares will be eligible for sale in the public market from time to
time, subject to vesting provisions, Rule 144 volume limitations applicable to
our affiliates, and in the case of some of the options, the expiration of the
lock-up agreements.
VALIDITY OF COMMON STOCK
The validity of the common stock offered hereby will be passed upon for us
by Brobeck, Phleger & Harrison LLP, Palo Alto, California, and will be passed
upon for the underwriters by Sullivan & Cromwell, Los Angeles, California. As
of the date of this prospectus, attorneys of Brobeck, Phleger & Harrison LLP
beneficially own an aggregate of 18,750 shares of our common stock.
EXPERTS
The consolidated Financial Statements of Digital Island as of September 30,
1999 and 1998 and for each of the years in the three-year period ended
September 30, 1999 included in this prospectus have been audited by
PricewaterhouseCoopers LLP, independent accountants, as stated in their report
appearing herein.
The consolidated Financial Statements of Sandpiper at December 31, 1998 and
1997 and for each of the two years in the period ended December 31, 1998
appearing in this prospectus and Registration Statement have been audited by
Ernst & Young LLP, independent auditors, as set forth in their report thereon
appearing elsewhere herein, and are included in reliance upon such report given
on the authority of such firm as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
Digital Island has filed with the Securities and Exchange Commission,
Washington, D.C. 20549, a Registration Statement on Form S-1 under the
Securities Act with respect to the common stock offered in this offering. This
prospectus omits certain information set forth in the Registration Statement
and the exhibits and schedules thereto. For further information with respect to
Digital Island and the common stock offered in this offering, reference is made
to such Registration Statement, exhibits and schedules. Statements contained in
this prospectus as to the contents of any contract or other document referred
to are complete in all material respects, and you should refer to the copy of
such contract or other document filed as an exhibit to the Registration
Statement. After consummation of this offering we will be subject to the
informational requirements of the Securities Exchange Act of 1934, as amended,
and in accordance therewith, will be required to file annual and quarterly
reports, proxy statements and other information with the Commission. The
Registration Statement, including the exhibits and schedules filed therewith,
as well as such reports and other information filed by us may be inspected
without charge at the public reference facilities maintained by the Securities
and Exchange Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C.
20549 and at the regional offices of the Securities and Exchange Commission
located at Seven World Trade Center, Suite 1300, New York, New York 10048 and
Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661.
Copies of such materials may be obtained from the Public Reference Section of
the Securities and Exchange Commission, Room 1024, 450 Fifth Street, N.W.,
Washington, D.C. 20549 at prescribed rates and from the Commission's Internet
Web site at http://www.sec.gov.
87
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
INDEX TO DIGITAL ISLAND, INC. AND SUBSIDIARIES FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Digital Island, Inc. Independent Accountants.................... F-2
Consolidated Balance Sheets............................................... F-3
Consolidated Statements of Operations..................................... F-4
Consolidated Statements of Stockholders' Equity........................... F-5
Consolidated Statements of Cash Flows..................................... F-7
Notes to Consolidated Financial Statements................................ F-8
INDEX TO DIGITAL ISLAND, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
Unaudited Pro Forma Combined Financial Statements......................... F-23
Unaudited Pro Forma Combined Statements of Operations..................... F-24
Notes to Unaudited Pro Forma Combined Financial Statements................ F-26
INDEX TO SANDPIPER NETWORKS, INC. FINANCIAL STATEMENTS
Report of Sandpiper Networks, Inc. Independent Auditors................... F-27
Consolidated Balance Sheets as of December 31, 1997 and December 31,
1998..................................................................... F-28
Consolidated Statements of Operations for the Years Ended December 31,
1997 and December 31, 1998............................................... F-29
Consolidated Statements of Shareholders' Deficit.......................... F-30
Consolidated Statements of Cash Flows for the Years Ended December 31,
1997 and December 31, 1998............................................... F-31
Notes to Consolidated Financial Statements................................ F-32
Consolidated Balance Sheet as of September 30, 1999 (unaudited)........... F-39
Consolidated Statement of Operations for the Nine Months Ended September
30, 1999 (unaudited)..................................................... F-40
Consolidated Statements of Shareholders' Deficit (unaudited).............. F-41
Consolidated Statement of Cash Flows for the Nine Months Ended September
30, 1999 (unaudited)..................................................... F-42
Notes to Unaudited Consolidated Financial Statements...................... F-43
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Digital Island, Inc. and Subsidiaries:
In our opinion, the accompanying balance sheets and the related statements
of operations, stockholders' equity and cash flows present fairly, in all
material respects, the financial position of Digital Island, Inc. and
Subsidiaries (the Company) at September 30, 1999 and 1998, and the results of
its operations and its cash flows for each of the three years in the period
ended September 30, 1999, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
San Francisco, California
October 29, 1999, except as to Note 16,
which is as of December 8, 1999
F-2
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
September 30,
----------------- December 31,
1998 1999 1999
------- -------- ------------
<S> <C> <C> <C>
ASSETS (unaudited)
------
Current assets:
Cash and cash equivalents..................... $ 5,711 $ 43,315 $ 18,181
Investments................................... 10,123 31,691 18,923
Accounts receivable, net of allowance of $55,
$380 and $280, respectively.................. 662 3,557 6,964
Restricted cash............................... 263 763 763
Loan receivable............................... 532 -- --
Deferred offering costs....................... 132 -- --
Prepaid expenses and other.................... 152 1,825 5,213
------- -------- -----------
Total current assets...................... 17,575 81,151 50,044
Property and equipment, net.................... 4,938 25,273 54,297
Goodwill, net.................................. -- -- 847,998
Intangible assets, net......................... -- -- 124,279
Other assets................................... 104 1,224 1,731
------- -------- -----------
Total assets.............................. $22,617 $107,648 $ 1,078,349
======= ======== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Bank borrowings............................... $ 801 $ 801 $ 840
Capital lease obligations..................... 756 3,916 5,520
Accounts payable.............................. 2,408 8,621 14,167
Accrued liabilities........................... 716 4,931 19,508
Cash overdraft................................ -- 3,058 --
Deferred revenue.............................. 11 318 413
------- -------- -----------
Total current liabilities................. 4,692 21,645 40,448
Bank borrowings, less current portion.......... 884 314 216
Capital lease obligations, less current
portion....................................... 1,551 6,061 7,553
Deferred revenue............................... -- 410 335
Other.......................................... -- -- 50
------- -------- -----------
Total liabilities......................... 7,127 28,430 48,602
Commitments (Note 8)
Stockholders' equity:
Series A through E convertible preferred
stock, $0.001 par value: Authorized:
14,000,000 shares in 1998 and no shares at
September 30, 1999 and December 31, 1999;
issued and outstanding: 13,305,657 shares in
1998 and no shares at September 30, 1999 and
December 31, 1999............................ 13 -- --
Preferred stock, $0.001 par value:
Authorized: no shares in 1998 and 10,000,000
shares at September 30, 1999 and December
31, 1999; no shares issued and
outstanding................................ -- -- --
Common stock, $0.001 par value:
Authorized: 30,000,000 shares in 1998, and
100,000,000 shares at September 30, 1999
and December 31, 1999; issued and outstand-
ing: 2,519,835 shares in 1998, 35,941,727
shares at September 30, 1999 and 60,684,804
shares at December 31, 1999................ 3 36 61
Additional paid-in capital.................. 39,182 156,791 1,130,430
Deferred compensation....................... (1,503) (4,033) (3,278)
Stockholder note receivable................. (110) (514) (424)
Common stock warrants....................... 29 -- --
Accumulated deficit......................... (22,124) (73,062) (97,042)
------- -------- -----------
Total stockholders' equity................ 15,490 79,218 1,029,747
------- -------- -----------
Total liabilities and stockholders'
equity................................... $22,617 $107,648 $ 1,078,349
======= ======== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
F-3
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
Three Months Ended
Year Ended September 30, December 31,
--------------------------------- ------------------------
1997 1998 1999 1998 1999
--------- ---------- ---------- ----------- -----------
(unaudited) (unaudited)
<S> <C> <C> <C> <C> <C>
Revenue................. $ 218 $ 2,343 $ 12,431 $ 1,385 $ 7,600
Costs and expenses:
Cost of revenue....... 2,508 9,039 29,496 2,923 16,264
Sales and marketing... 1,205 4,847 16,010 2,046 6,315
Product development... 378 1,694 6,357 843 2,543
General and
administrative....... 1,502 3,392 9,848 1,260 4,698
Amortization of
goodwill and
intangibles.......... -- -- -- -- 1,697
Stock compensation
expense.............. -- 487 3,207 346 755
--------- ---------- ---------- ---------- ----------
Total costs and
expenses............. 5,593 19,459 64,918 7,418 32,272
--------- ---------- ---------- ---------- ----------
Loss from operations.. (5,375) (17,116) (52,487) (6,033) (24,672)
--------- ---------- ---------- ---------- ----------
Interest income, net.... 87 354 1,551 96 697
--------- ---------- ---------- ---------- ----------
Loss before income
taxes................ (5,288) (16,762) (50,936) (5,937) (23,975)
Provision for income
taxes.................. 1 2 2 2 5
--------- ---------- ---------- ---------- ----------
Net loss.............. $ (5,289) $ (16,764) $ (50,938) $ (5,939) $(23,980)
========= ========== ========== ========== ==========
Basic and diluted net
loss per share......... $ (3.53) $ (7.50) $ (4.58) $ (2.53) $ (0.65)
========= ========== ========== ========== ==========
Weighted average shares
outstanding used in per
share calculation...... 1,497,711 2,236,452 11,127,462 2,345,984 36,676,137
========= ========== ========== ========== ==========
Pro forma basic and
diluted net loss per
share.................. $ (1.39) $ (2.02) $ (0.38)
========== ========== ==========
Weighted average shares
outstanding used in pro
forma per share
calculation............ 12,042,539 25,233,080 15,746,641
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
F-4
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
<TABLE>
<CAPTION>
Convertible
Preferred
Stock Common Stock Additional Stockholder Common Total
-------------- -------------- Paid-in Deferred Note Stock Accumulated Stockholders
Shares Amount Shares Amount Capital Compensation Receivable Warrants Deficit Equity
------ ------ ------ ------ ---------- ------------ ----------- -------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances, September
30, 1996........... 2,000 $ 2 275 $ -- $ 129 $ -- $ -- $23 $ (71) $ 83
Common stock issued
for professional
services........... -- -- 71 -- 28 -- -- -- -- 28
Conversion of
preferred stock
into common stock.. (2,000) (2) 2,000 2 -- -- -- -- -- --
Repurchase of
common stock....... -- -- (130) -- (1) -- -- -- -- (1)
Series A preferred
stock issued for
cash, net of
issuance costs of
$17................ 3,342 3 -- -- 3,322 -- -- -- -- 3,325
Series B preferred
stock issued for
cash, net of
issuance costs of
$46................ 3,000 3 -- -- 7,451 -- -- -- -- 7,454
Warrants issued in
connection with
convertible note... -- -- -- -- -- -- -- 6 -- 6
Conversion of notes
payable into Series
A preferred Stock.. 658 1 -- -- 657 -- -- -- -- 658
Net loss........... -- -- -- -- -- -- -- -- (5,289) (5,289)
------ --- ----- ----- ------ ------ ----- --- ------- -------
Balances, September
30, 1997........... 7,000 7 2,216 2 11,586 -- -- 29 (5,360) 6,264
Series C preferred
stock issued for
cash, net of
issuance costs of
$34................ 4,283 4 -- -- 14,739 -- -- -- -- 14,743
Series D preferred
stock issued for
cash, net of
issuance costs of
$33................ 2,023 2 -- -- 10,583 -- -- -- -- 10,585
Issuance of
stockholder note in
exchange for common
Stock.............. -- -- 183 1 110 -- (110) -- -- 1
Common stock issued
for professional
services........... -- -- 6 -- 18 -- -- -- -- 18
Common stock issued
for cash upon
exercise of
options............ -- -- 115 -- 156 -- -- -- -- 156
Deferred
compensation in
connection with
issuance of stock
options............ -- -- -- -- 1,990 (1,990) -- -- -- --
Amortization of
deferred
compensation....... -- -- -- -- -- 487 -- -- -- 487
Net loss........... -- -- -- -- -- -- -- -- (16,764) (16,764)
------ --- ----- ----- ------ ------ ----- --- ------- -------
Balances, September
30, 1998........... 13,306 13 2,520 3 39,182 (1,503) (110) 29 (22,124) 15,490
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY--(Continued)
(In thousands)
<TABLE>
<CAPTION>
Convertible
Preferred
Stock Common Stock Additional Stockholder Common Total
--------------- ------------- Paid-in Deferred Note Stock Accumulated Stockholders
Shares Amount Shares Amount Capital Compensation Receivable Warrants Deficit Equity
------- ------ ------ ------ ---------- ------------ ----------- -------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Series E preferred
stock issued for
cash, net of
issuance costs of
$2,539............ 11,765 12 -- -- 47,450 -- -- -- -- 47,462
Common stock
issued for cash
upon exercise of
options........... -- -- 829 1 964 -- -- -- -- 965
Deferred
compensation in
connection with
issuance of stock
options........... -- -- -- -- 5,737 (5,737) -- -- -- --
Amortization of
deferred
compensation...... -- -- -- -- -- 3,207 -- -- -- 3,207
Issuance of
stockholder note
in exchange for
common stock...... -- -- 349 -- 286 -- (286) -- -- --
Common stock
issued for cash
upon exercise of
warrants.......... -- -- 95 -- 38 -- -- (29) -- 9
Additional shares
of Series D
preferred stock
issued upon
Conversion........ 178 -- -- -- -- -- -- -- -- --
Conversion of
preferred stock... (25,249) (25) 25,249 25 -- -- -- -- -- --
Issuance of common
stock in public
offering, net of
issuance costs of
$5,858............ -- -- 6,900 7 63,134 -- -- -- -- 63,141
Notes issued to
officers in
exchange for
cash.............. -- -- -- -- -- -- (228) -- -- (228)
Repayment of
stockholder note.. -- -- -- -- -- -- (110) -- -- 110
Net loss.......... -- -- -- -- -- -- -- -- (50,938) (50,938)
------- ----- ------ ---- ---------- ------- ------ ---- -------- ----------
Balances,
September 30,
1999.............. -- -- 35,942 36 156,791 (4,033) (514) -- (73,062) 79,218
Common stock
issued for cash
upon exercise of
options........... -- -- 67 -- 63 -- -- -- -- 63
Issuance of common
stock in exchange
for fixed asset... -- -- 120 -- 5,965 -- -- -- -- 5,965
Common stock
issued in
connection with
acquisition....... -- -- 24,556 25 967,611 -- -- -- -- 967,636
Amortization of
deferred
compensation...... -- -- -- -- -- 755 -- -- -- 755
Repayment of
stockholder note.. -- -- -- -- -- -- 86 -- -- 86
Forgiveness of
stockholder note.. -- -- -- -- -- -- 4 -- -- 4
Net loss.......... -- -- -- -- -- -- -- -- (23,980) (23,980)
------- ----- ------ ---- ---------- ------- ------ ---- -------- ----------
Balances, December
31, 1999.......... -- $ -- 60,685 $ 61 $1,130,430 $(3,278) $ (424) $-- $(97,042) $1,029,747
======= ===== ====== ==== ========== ======= ====== ==== ======== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended
Year Ended September 30, December 31,
--------------------------- -----------------------
1997 1998 1999 1998 1999
------- -------- -------- ----------- -----------
(unaudited) (unaudited)
<S> <C> <C> <C> <C> <C>
Cash flows from operating
activities:
Net loss................ $(5,289) $(16,764) $(50,938) $(5,939) $(23,980)
Adjustments to
reconcile net loss to
net cash used in
operating activities:
Depreciation and
amortization......... 158 547 1,735 285 1,265
Amortization of
capital lease
obligations.......... -- 263 1,507 133 976
Amortization of
intangible assets.... -- -- -- -- 1,576
Stock compensation
expense.............. -- 487 3,207 346 755
Non-cash revenue in
connection with
barter agreement..... (132) -- -- -- --
Debt discount in
conjunction with
convertible notes.... 29 -- -- -- --
Amortization of
discounts on
investments.......... (24) (227) (817) (93) (338)
Professional services
in exchange for
common stock......... 28 18 -- -- --
Loss on disposal of
property and
equipment............ -- 2 5 -- --
Change in operating
assets and
liabilities, net of
business acquisitions
Accounts receivable... (73) (589) (2,895) (683) (2,852)
Prepaid expenses and
other................ 27 (98) (1,673) (22) (3,042)
Deferred offering
costs................ -- (132) 132 (89) --
Accounts payable...... 1,901 486 6,213 (186) 133
Accrued liabilities... 322 394 4,215 140 (455)
Deferred revenue...... 9 2 717 (1) 20
Other liabilities..... -- -- -- -- 50
Other assets.......... (36) (68) (1,138) (28) 21
------- -------- -------- ------- --------
Net cash used in
operating
activities......... (3,080) (15,679) (39,730) (6,137) (25,871)
------- -------- -------- ------- --------
Cash flows from investing
activities:
Purchases of property
and equipment.......... (2,128) (1,234) (14,337) (89) (16,262)
Proceeds from
maturities of short-
term investments....... 1,000 5,600 31,478 8,200 15,395
Decrease (increase) in
restricted cash........ (384) 121 (500) -- --
Business acquisition,
cash acquired.......... -- -- -- -- 4,312
Purchases of short-term
investments............ (2,959) (13,513) (52,229) (1,968) (2,289)
------- -------- -------- ------- --------
Net cash provided by
(used in) investing
activities......... (4,471) (9,026) (35,588) 6,143 1,156
------- -------- -------- ------- --------
Cash flows from financing
activities:
Proceeds from issuance
of preferred stock,
net.................... 10,779 25,328 47,462 -- --
Proceeds from issuance
of common stock, net... -- 156 64,115 35 63
Proceeds from issuance
of notes payable....... 308 -- -- -- --
Proceeds from bank
borrowings............. 705 647 532 532 --
Repayments of bank
borrowings............. -- (199) (570) (141) (143)
Repayments of capital
lease obligations...... -- (100) (1,557) (144) (429)
Repayment of
stockholder note
receivable............. -- -- 110 -- 90
Issuance of loans to
officers............... -- -- (228) -- --
Cash overdraft.......... -- -- 3,058 -- --
Repurchase of common
stock.................. (1) -- -- -- --
------- -------- -------- ------- --------
Net cash provided by
(used in) financing
activities......... 11,791 25,832 112,922 282 (419)
------- -------- -------- ------- --------
Net increase
(decrease) in cash
and cash
equivalents........ 4,240 1,127 37,604 288 (25,134)
Cash and cash
equivalents, beginning
of period............... 344 4,584 5,711 5,711 43,315
------- -------- -------- ------- --------
Cash and cash
equivalents, end of
period.................. $ 4,584 $ 5,711 $ 43,315 $ 5,999 $ 18,181
======= ======== ======== ======= ========
Supplemental disclosures
of cash flow
information:
Cash paid for
interest............... $ 27 $ 129 $ 494 $ 90 $ 219
======= ======== ======== ======= ========
Cash paid for income
taxes.................. $ 2 $ 2 $ 2 $ 2 $ 5
======= ======== ======== ======= ========
Supplemental schedule of
noncash investing and
financing activities:
Common stock issued for
professional
services............... $ 28 $ 18 $ -- $ -- $ --
======= ======== ======== ======= ========
Receivable on bank
borrowings............. $ -- $ 532 $ -- $ -- $ --
======= ======== ======== ======= ========
Notes payable converted
into preferred stock... $ 658 $ -- $ -- $ -- $ --
======= ======== ======== ======= ========
Conversion of preferred
stock into common
stock.................. $ 21 $ -- $ 25 $ -- $ --
======= ======== ======== ======= ========
Note receivable issued
in exchange for common
stock.................. $ -- $ 110 $ 286 $ -- $ --
======= ======== ======== ======= ========
Capital lease
obligations for
equipment.............. $ -- $ 2,406 $ 9,227 $ 350 $ 1,112
======= ======== ======== ======= ========
Acquisition of
subsidiary in exchange
for stock.............. $ -- $ -- $ -- $ -- $976,478
======= ======== ======== ======= ========
Fixed asset acquired in
exchange for stock..... $ -- $ -- $ -- $ -- $ 5,965
======= ======== ======== ======= ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
F-7
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information as of and relating to the three months ended December 31, 1999 and
1998 is unaudited)
1. The Company:
Digital Island, Inc. and Subsidiaries (the "Company") offers a global
internet protocol applications network designed to deploy business-critical
applications worldwide. The Company also offers services such as network
management and application services to customers deployed on its network.
Together, these services provide a product offering that enables multinational
corporations to reach end users in worldwide local markets.
2. Summary of Significant Accounting Policies:
Principles of Consolidation:
The accompanying consolidated financial statements of the Company include
the accounts of Digital Island, Inc. and its wholly-owned subsidiaries,
Sandpiper Networks, Inc., Digital Island B.V., Digital Island Ltd., Digital
Island (Europe) SA, Digital Island (Hong Kong), Ltd., and Digital Island
(Japan) KK. All significant intercompany accounts and transactions are
eliminated in consolidation.
Use of Estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Unaudited Interim Financial Information:
The accompanying interim consolidated financial statements as of and for the
three months ended December 31, 1998 and 1999, together with the related notes
are unaudited but include all adjustments, consisting of only normal recurring
adjustments, which the Company considers necessary to present fairly, in all
material respects, the consolidated financial position, and consolidated
results of operations and cash flows for the three month periods ended
December 31, 1998 and 1999. Results for the three months ended December 31,
1999 are not necessarily indicative of results for the entire year.
Restatement:
The balance sheet at December 31, 1999 has been restated to record certain
warrants issued by Sandpiper Networks, Inc. prior to its acquisition by the
Company in conjunction with strategic agreements. Previously, these warrants
were not recorded on Sandpiper's books. The effect of this restatement on the
Company's financial statements was a reduction of deferred revenue and goodwill
of $2.9 million. This restatement has no effect on recorded revenue or expense
amounts.
Revenue Recognition:
Revenues are comprised primarily of bandwidth charges, equipment co-location
and storage fees, and one-time fees for installation if required to provide
services. Bandwidth charges are billed and recognized monthly, based on
customer usage. All other revenues are based on flat-rate monthly charges.
Installation fees are typically recognized at the time that installation
occurs. To date, such revenues have not significantly exceeded the direct costs
of installation.
F-8
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of and relating to the three months ended December 31, 1999 and
1998
is unaudited)
Computation of Historical Net Loss Per Share and Pro Forma Net Loss Per Share:
In accordance with SFAS 128, basic earnings per share is computed using the
weighted average number of common shares outstanding during the period. Diluted
earnings per share is computed using the weighted average number of common and
dilutive common equivalent shares outstanding during the period, using either
the as if converted method for convertible preferred stock or the treasury
stock method for options and warrants.
Diluted net loss per share for the years ended September 30, 1997, 1998 and
1999, and the three months ended December 31, 1998 and 1999 does not include
the effect of 1,583,500,
2,993,765, 3,847,569, 3,054,830 and 7,594,453 stock options, respectively, and
95,000, 95,000, 0, 95,000 and 26,818 common stock warrants, respectively, or
7,000,000, 13,305,657, 0, 13,305,657 and 0 shares of convertible preferred
stock on an "as if converted" basis, respectively, as the effect of their
inclusion is antidilutive during each period.
Pro forma basic and diluted net loss per share is presented to reflect per
share data assuming the conversion of all outstanding shares of convertible
preferred stock into common stock as if the conversion had taken place at the
beginning of the fiscal year or at the date of issuance, if later.
Cash and Cash Equivalents:
Cash and cash equivalents are stated at cost, which approximates fair value.
The Company includes in cash equivalents all highly liquid investments that
mature within three months of their purchase date.
Fair Value of Financial Instruments:
The carrying amounts of certain of the Company's financial instruments,
including cash and cash equivalents, accounts receivable, notes payable,
capital leases, accounts payable and accrued liabilities, approximate fair
value due to their short maturities.
Investments:
At September 30, 1998 and 1999, and December 31, 1999 the Company's
investments consisted of commercial paper. Remaining maturities at the time of
purchase are generally less than one year.
Investments are accounted for in accordance with Statement of Financial
Accounting Standards No. 115 ("SFAS 115") "Accounting for Certain Investments
in Debt and Equity Securities." This statement requires that securities be
classified as "held to maturity," "available for sale" or "trading," and the
securities in each classification be accounted for at either amortized cost or
fair market value, depending upon their classification. The Company has the
intent and the ability to hold investments until maturity. Therefore, all such
investments are classified as held to maturity investments and carried at
amortized cost in the accompanying consolidated financial statements.
The Company's investments consist of the following (in thousands):
<TABLE>
<CAPTION>
September 30, September 30,
1998 1999 December 31, 1999
----------------- ----------------- -----------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- ------- --------- ------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
Commercial paper...... $10,123 $10,125 $31,691 $31,683 $18,923 $18,910
</TABLE>
F-9
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of and relating to the three months ended December 31, 1999 and
1998
is unaudited)
Restricted Cash:
Restricted cash consists of irrevocable standby letters of credit issued by
the Company's banks. Funds are generally held in certificates of deposit at the
Company's bank, and have been established in favor of a third party
beneficiary. The funds are released to the beneficiary in the event that the
Company fails to comply with certain specified contractual obligations.
Provided the Company meets these contractual obligations, the letter of credit
is discharged and the Company is no longer restricted from use of the cash.
Property and Equipment:
Property and equipment are recorded at cost and depreciated using the
straight-line method over their useful lives. Equipment recorded under capital
leases is amortized using the straight-line method over the shorter of the
respective lease term or the estimated useful life of the asset. Network and
communications equipment is depreciated over five years, computer equipment and
software is depreciated over three years, and furniture and fixtures are
depreciated over seven years. Maintenance and repairs are charged to expense as
incurred, and improvements and betterments are capitalized. When assets are
retired or otherwise disposed of, the cost and accumulated depreciation are
removed from the accounts and any resulting gain or loss is reflected in
operations in the period realized.
Long-lived Assets:
The Company evaluates the recoverability of its long-lived assets in
accordance with Statement of Financial Accounting Standards No. 121, ("SFAS
121") "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of." SFAS 121 requires recognition of impairment of long-
lived assets in the event the net book value of such assets exceeds the future
undiscounted cash flows attributable to such assets. No such impairments have
been identified to date. The Company assesses the impairment of long-lived
assets when events or changes in circumstances indicate that the carrying value
of an asset may not be recoverable.
Income Taxes:
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, ("SFAS 109") "Accounting for Income
Taxes." Under SFAS 109, deferred tax liabilities and assets are determined
based on the difference between the financial statement and tax bases of assets
and liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. Valuation allowances are established when
necessary to reduce deferred tax assets to the amounts expected to be realized.
Income tax expense represents the tax payable for the current period and the
change during the period in the deferred tax assets and liabilities.
Software Development Costs:
Software development costs have been accounted for in accordance with
Statement of Financial Accounting Standards No. 86, ("SFAS 86") "Accounting for
the Costs of Computer Software to be Sold, Leased or Otherwise Marketed." Under
the standard, capitalization of software development costs begins upon the
establishment of technological feasibility. To date, all such amounts have been
insignificant, and accordingly, the Company has charged all such costs to
research and development expenses.
F-10
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of and relating to the three months ended December 31, 1999 and
1998
is unaudited)
Deferred Revenues:
Deferred revenues primarily represent advanced billings to customers, or
prepayments by customers prior to completion of installation or prior to
provision of contractual bandwidth usage.
Concentration of Credit Risk:
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of temporary cash investments
and accounts receivable. The Company places its temporary investments with one
major financial institution.
The Company performs ongoing credit evaluations, does not require
collateral, and maintains reserves for potential credit losses on customer
accounts when deemed necessary. For the year ended September 30, 1997, three
customers accounted for approximately 56%, 20%, and 10%, respectively, of all
revenue generated by the Company, and 0%, 57%, and 31% of accounts receivable
at September 30, 1997, respectively. For the year ended September 30, 1998, the
same customers accounted for approximately 13%, 20%, and 4%, respectively, of
all revenue generated by the Company, and 19%, 5%, and 0% of accounts
receivable at September 30, 1998, respectively. In addition, a fourth customer
accounted for 12% of all revenues generated by the Company for the year ended
September 30, 1998, and 14% of accounts receivable at September 30, 1998. For
the year ended September 30, 1999, the same four customers accounted for
approximately 4%, 35%, 1%, and 4%, respectively, of all revenues generated by
the Company, and 6%, 41%, 0%, and 3%, respectively, of accounts receivable at
September 30, 1999. For the three months ended December 31, 1998, the same
customers accounted for 7%, 5%, 1%, and 9%, respectively, of all revenues
generated by the Company. For the three months ended December 31, 1999 the same
customers accounted for 3%, 34%, 0%, and 2%, respectively, of all revenues
generated by the Company, and 6%, 26%, 0%, and 1%, respectively, of accounts
receivable at December 31, 1999. In addition, a fifth customer accounted for
12% of all revenues generated by the Company for the three months ended
December 31, 1999, and 14% of all accounts receivable at December 31, 1999.
Risks and Uncertainties:
Factors that may materially and adversely affect the Company's future
operating results include: demand for and market acceptance of the Company's
products and services; introductions of products and services or enhancements
by the Company and its competitors; competitive factors that affect our
pricing; capacity utilization of the Digital Island Global IP applications
network; reliable continuity of service and network availability; the ability
and cost of bandwidth and our ability to increase bandwidth as necessary; the
timing of customer installations; the mix of products and services sold by the
Company; customer retention; the timing and success of marketing efforts and
product and service introductions by the Company; the timing and magnitude of
capital expenditures, including costs relating to the expansion of operations;
the timely expansion of its network infrastructure; fluctuations in bandwidth
used by customers; the retention of key personnel; conditions specific to the
Internet industry and other general economic factors; and new government
legislation and regulation.
Comprehensive Income:
The Company has adopted the accounting treatment prescribed by Financial
Accounting Statement No. 130, "Comprehensive Income." The adoption of this
statement had no impact on the Company's financial statements for the periods
presented, as net loss equals comprehensive loss.
F-11
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of and relating to the three months ended December 31, 1999 and
1998
is unaudited)
Segment Information:
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." This
statement establishes standards for the way companies report information about
operating segments in financial statements. It also establishes standards for
related disclosures about products and services, geographic areas, and major
customers. In accordance with the provisions of SFAS No. 131, the Company has
determined that it does not currently have any separately reportable operating
segments. Revenues from foreign operations have been insignificant.
Recently Issued Accounting Pronouncements:
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging
Activities." SFAS 133 establishes accounting and reporting standards for
derivative instruments and for hedging activities. SFAS 133 is effective for
fiscal years beginning after June 15, 2000. The Company does not believe the
adoption of SFAS 133 will have a material effect on the Company's consolidated
results of operations or financial condition.
3. Property and Equipment:
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
September 30,
-------------- December 31,
1998 1999 1999
------ ------- ------------
<S> <C> <C> <C>
Network equipment and technology................ $2,299 $ 7,404 $18,673
Communications equipment........................ 194 217 296
Computer equipment and software................. 515 3,316 8,432
Furniture, fixtures, and leasehold
improvements................................... 491 6,339 17,615
Equipment and fixtures under capital leases..... 2,407 12,189 15,714
------ ------- -------
5,906 29,465 60,730
Less accumulated depreciation and amortization.. 968 4,192 6,433
------ ------- -------
Total property and equipment, net............... $4,938 $25,273 $54,297
====== ======= =======
</TABLE>
F-12
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of and relating to the three months ended December 31, 1999 and
1998
is unaudited)
4. Income Taxes:
For the years ended September 30, 1997, 1998, and 1999 and the three months
ended December 31, 1999, the provision for income taxes consists of state
taxes.
The primary components of the net deferred tax asset are as follows (in
thousands):
<TABLE>
<CAPTION>
September 30,
-----------------
1998 1999
------- --------
<S> <C> <C>
Net operating loss carryforwards, federal and state....... $ 8,635 $ 26,999
Accrued employee benefits................................. 61 274
Sales tax................................................. 1 2
Accounts receivable allowance............................. 22 152
Deferred Revenue.......................................... -- 267
Property and equipment.................................... (358) (1,628)
------- --------
8,361 26,066
Less valuation allowance.................................. (8,361) (26,066)
------- --------
$ -- $ --
======= ========
</TABLE>
Due to the uncertainty surrounding the realization of the favorable tax
attributes in future tax returns, the Company has placed a valuation allowance
against its otherwise recognizable net deferred tax assets. The valuation
allowance increased by $6.2 million and $17.7 million for the years ended
September 30, 1998 and 1999, respectively. The effective income tax rate
differs from the statutory federal income tax rate primarily due to the
inability to recognize the benefit of net operating losses.
At September 30, 1999, the Company had NOL carryforwards of approximately
$72.0 million for both federal and state income tax purposes. These
carryforwards expire beginning 2009 and 2002, respectively.
Pursuant to the provisions of Section 382 of the Internal Revenue Code,
utilization of the NOLs are subject to annual limitations through 2014 due to a
greater than 50% change in the ownership of the Company which occurred during
fiscal 1998.
5. Bank Borrowings:
Bank borrowings consist of (in thousands):
<TABLE>
<CAPTION>
September 30,
-------------- December 31,
1998 1999 1999
------ ------ ------------
<S> <C> <C> <C>
Line of credit.................................. $ 230 $ 230 $ 230
Revolving credit facility....................... 579 323 259
Equipment term facilities....................... 876 562 567
------ ------ -----
1,685 1,115 1,056
Current maturities.............................. (801) (801) (840)
------ ------ -----
Long-term bank borrowings....................... $ 884 $ 314 $ 216
====== ====== =====
</TABLE>
F-13
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of and relating to the three months ended December 31, 1999 and
1998
is unaudited)
On November 21, 1996, the Company entered into a revolving credit agreement
(the "Revolving Agreement") with a commercial lender. The aggregate credit
under the Revolving Agreement was originally $250,000, and was increased to
$750,000 on April 18, 1997. Interest under the Revolving Agreement is 0.75%
over the "Prime Rate" as announced from time to time by the lender. At
September 30, 1998 and 1999 and December 31, 1999, the effective interest rate
was 9.25% 9.00%, and 9.25% respectively. The weighted average interest rates
for the years ended September 30, 1998 and 1999, and the three months ended
December 31, 1999 were 9.25%, 8.61%, and 9.16%, respectively. Under the terms
of the Revolving Agreement, advances could be made for the purchase of
equipment until October 18, 1997. At that date, the unpaid principal balance of
equipment advances plus interest became payable over 36 months in equal
installments. Outstanding borrowings under Revolving Agreement at September 30,
1998 and 1999, and December 31, 1999, were $579,000, $323,000, and $259,000,
respectively. All amounts outstanding related to advances for equipment
purchases.
On November 19, 1997, the Company entered into a loan agreement (the Loan
Agreement) with the same commercial lender associated with the Revolving
Agreement. Under the terms of the Loan Agreement, the Company was extended a
$5,000,000 line of credit, as well as an equipment loan term facility for
$2,500,000. Any borrowings under this line of credit are collateralized by
substantially all assets of the Company. Certain of the Loan Agreement's
provisions restrict the ability of the Company to declare or pay any dividends
while the credit agreement is in effect.
Advances under the line of credit are limited to a percentage of the
Company's recurring contract revenues, as defined in the Loan Agreement. The
Loan Agreement contains certain standard covenants. $230,0000 was outstanding
under the line of credit at September 30, 1998 and 1999, and December 31, 1999.
Interest on borrowings are charged at the lender's prime rate plus 0.25%, which
was 8.75%, 8.50% and 8.75%, at September 30, 1998 and 1999, and December 31,
1999, respectively. The weighted average interest rates for the years ended
September 30, 1998 and 1999, and the three months ended December 31, 1999 were
8.75%, 8.13%, and 8.67% respectively. Advances under the line of credit can be
repaid and reborrowed at any time until the maturity date of May 31, 2000.
Under the terms of one of the equipment loan term facilities, the Company
had the ability to borrow up to $1,250,000 for equipment purchases from
November 19, 1997 to May 19, 1998 (Equipment Line A), as well as borrow an
additional $1,250,000 from February 1, 1998 to September 30, 1998 (Equipment
Line B). At September 30, 1998 and 1999, and December 31, 1999, $224,000,
$140,000, and $119,000 respectively, was outstanding related to advances made
under Equipment Line A, and $652,000, $422,000, and $364,000 respectively, was
outstanding related to advances made under Equipment Line B. Interest on these
borrowings are charged at the lender's prime rate plus 0.75%, which was 9.25%,
9.00% and 9.25% at September 30, 1998 and 1999, and December 31, 1999,
respectively. The weighted average interest rates for the years ended September
30, 1998 and 1999 and the three months ended December 31, 1999 were 9.25%,
8.61%, and 9.16% respectively. Repayments of advances on Equipment Line A
commenced on June 19, 1998, with the unpaid principal balance as of May 19,
1998, plus interest, being repaid in 36 equal monthly installments. Repayments
of advances on Equipment Line B commenced on October 19, 1998 in 34 monthly
installments of principal and interest.
The Loan Agreement was due to mature on November 19, 1998. On November 18,
1998, the Loan Agreement was modified to extend the maturity date to February
15, 1999. On February 15, 1999 the
F-14
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of and relating to the three months ended December 31, 1999 and
1998
is unaudited)
Loan Agreement was modified again to extend the maturity date to May 31, 1999.
On May 31, 1999, the Loan Agreement was modified yet again to extend the
maturity date to May 31, 2000.
The Company assumed an equipment facility pursuant to the merger with
Sandpiper Networks, Inc. The outstanding principal due at the time the debt was
assumed was $84,000. Interest is charged at a rate of 7% per annum. Principal
and interest are due monthly over a total period of 36 months.
The Company did not comply with certain financial covenants at various
points during fiscal 1998, and accordingly, received an amendment and waiver
dated October 6, 1998 from its lender, which waived covenant violations for
periods prior to September 30, 1998 and eliminated one financial covenant with
respect to a minimum profitability threshold. Subsequent to September 30, 1998,
the Company did not comply with certain financial covenants. The Company
obtained waivers for all covenant violations from October 1, 1998 to January
31, 1999. Since the date of this most recent waiver the Company has been in
compliance with all covenants.
Interest expense for the years ended September 30, 1997, 1998 and 1999 and
the three months ended December 31,1998 and 1999 was $36,000, $94,000,
$123,000, $34,000 and $30,000 respectively.
Principal maturities of bank borrowings are as follows (in thousands):
<TABLE>
<CAPTION>
Year ending September 30,
-------------------------
<S> <C>
2000............................................................... $ 801
2001............................................................... 314
------
$1,115
======
</TABLE>
6. Notes Payable:
Between September 27, 1996 and January 31, 1997, the Company issued three
convertible notes totalling $600,000 to a commercial lender. These notes had a
simple interest rate of 6%. In March 1997, all three notes plus accrued
interest of $8,454 were converted into 608,454 shares of Series A preferred
stock.
Prior to October 1, 1996, the Company had issued a $50,000 convertible note
to a related party. In March 1997, this note was converted into 50,000 shares
of Series A preferred stock.
7. Accrued Liabilities:
Accrued liabilities consist of the following (in thousands):
<TABLE>
<CAPTION>
September
30,
----------- December 31,
1998 1999 1999
---- ------ ------------
<S> <C> <C> <C>
Employee compensation............................... $596 $2,254 $ 3,956
Accrued merger expense.............................. -- -- 12,765
Other accrued liabilities........................... 120 2,677 2,787
---- ------ -------
Total............................................. $716 $4,931 $19,508
==== ====== =======
</TABLE>
F-15
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of and relating to the three months ended December 31, 1999 and
1998
is unaudited)
8. Commitments:
Leases:
The Company leases office and data center space under noncancelable
operating leases expiring through April, 2014. Rent expense for the years ended
September 30, 1997, 1998, and 1999, and the three months ended December 31,
1998 and 1999 was $137,000, $715,000, $3.2 million, $299,000 and $1.6 million,
respectively.
The Company's future minimum lease payments under noncancelable operating
leases having an initial or remaining term of more than one year, and capital
leases are as follows (in thousands):
<TABLE>
<CAPTION>
Year ending September 30, Operating Capital
------------------------- --------- -------
<S> <C> <C>
2000..................................................... $ 5,389 $4,531
2001..................................................... 6,506 4,113
2002..................................................... 6,477 2,297
2003..................................................... 6,268 10
2004..................................................... 5,337 --
Thereafter............................................... 20,838 --
------- ------
Total minimum lease payments........................... $50,815 10,951
=======
Less amounts representing interest....................... (974)
------
Present value of minimum lease payments.................. 9,977
Less current portion of capital lease obligations........ (3,916)
------
Long-term portion of capital lease obligations........... $6,061
======
</TABLE>
Carrier Line Agreements:
The Company has entered into various bandwidth capacity agreements with
domestic and foreign carriers. These agreements are generally cancelable and
provide for termination fees if cancelled by the Company prior to expiration.
F-16
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of and relating to the three months ended December 31, 1999 and
1998
is unaudited)
9. Earnings Per Share:
The following is a reconciliation of the numerator and denominator of basic
and diluted earnings per share ("EPS"):
<TABLE>
<CAPTION>
Three Months Ended
Years Ended September 30, December 31,
--------------------------------- ------------------------
1997 1998 1999 1998 1999
--------- ---------- ---------- ----------- -----------
(unaudited) (unaudited)
----------- -----------
<S> <C> <C> <C> <C> <C>
Numerator--Basic and
Diluted EPS
Net Loss (in
thousands)........... $ (5,289) $ (16,764) $ (50,938) $ (5,939) $ (23,980)
========= ========== ========== ========== ==========
Denominator--Basic and
Diluted EPS
Weighted average
Common Stock
outstanding.......... 1,497,711 2,361,010 11,280,534 2,558,433 36,829,358
Common Stock subject
to repurchase........ -- (124,558) (153,072) (212,449) (153,221)
--------- ---------- ---------- ---------- ----------
Total weighted average
Common Stock
outstanding.......... 1,497,711 2,236,452 11,127,462 2,345,984 36,676,137
========= ========== ========== ========== ==========
Basic and diluted loss
per share.............. $ (3.53) $ (7.50) $ (4.58) $ (2.53) $ (0.65)
========= ========== ========== ========== ==========
Pro forma:
Denominator--Basic and
Diluted EPS
Weighted Average
Common Stock......... 2,361,010 4,752,354 2,558,433 36,829,358
Conversion of
Preferred Stock...... 9,711,087 20,538,798 13,305,657 --
Conversion of
Warrants............. 95,000 95,000 95,000 --
Common Stock subject
to repurchase........ (124,558) (153,072) (212,449) (153,221)
---------- ---------- ---------- ----------
Total weighted average
Common Stock
outstanding pro
Forma................ 12,042,539 25,233,080 15,746,641 36,676,137
========== ========== ========== ==========
Basic and diluted pro
forma loss per share... $ (1.39) $ (2.02) $ (0.38) $ (0.65)
========== ========== ========== ==========
</TABLE>
10. Stockholders' Equity:
In June 1999, the Company completed its initial public offering ("IPO") of
6,000,000 shares of its common stock. Subsequent to the IPO, the underwriters
purchased an additional 900,000 shares to cover over-allotments. The net
proceeds to the Company after deducting underwriting discounts and commissions
and offering expenses, was approximately $63.1 million. In conjunction with the
IPO, all shares of Series A, B, C, D and E convertible preferred stock were
converted to common stock.
F-17
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of and relating to the three months ended December 31, 1999 and
1998
is unaudited)
Immediately prior to this conversion, an additional 178,138 shares of Series D
preferred stock were issued in accordance with certain anti-dilution
provisions. All of these additional shares were converted into common stock. In
addition, all outstanding warrants were exercised prior to the IPO for 95,000
shares of common stock.
In June 1999, the Company was reincorporated in the state of Delaware.
Pursuant to the reincorporation, each share of common and preferred stock of
the Company's California predecessor entity was exchanged for one share of
common and preferred stock of the newly formed Delaware entity. Pursuant to the
reincorporation, the number of authorized shares of common stock increased to
100,000,000 with a par value of $0.001 per share. Additionally, 10,000,000
shares of undesignated preferred stock were authorized with a par value of
$0.001 per share.
Convertible preferred stock issued and outstanding prior to the IPO was as
follows:
<TABLE>
<CAPTION>
Liquidation
Shares Issued and Value
Series Designated Outstanding (in thousands)
------ ---------- ----------- -------------
<S> <C> <C> <C>
A.................................... 4,000,000 4,000,000 $ 4,000
B.................................... 3,000,000 3,000,000 $ 7,500
C.................................... 4,300,000 4,283,181 $ 14,777
D.................................... 2,700,000 2,200,614 $ 10,618
E.................................... 11,764,706 11,764,706 $ 50,000
---------- ---------- --------
25,764,706 25,248,501 $ 86,895
========== ========== ========
</TABLE>
In December 1999, Sun Microsystems, Inc. (Sun) agreed to make an equity
investment in the Company of $20,000,000. Sun also agreed to extend to the
Company a $100,000,000 credit facility for the acquisition of Sun equipment,
under the terms of the Master Lease Line of Credit and Warrant Agreement (the
Sun Agreement). The terms of the Sun Agreement calls for the credit to be made
available upon the achievement of certain milestones. The achievement of these
milestones also triggers granting of warrants to Sun to purchase up to a
maximum of $10,000,000 worth of the Company's common stock. Sun and the Company
have also agreed to a joint marketing campaign to be partially funded by Sun.
The credit facility and the acquisition of Sun equipment will be accounted for
as a capital lease. The fair value of warrants granted under the agreement will
be recorded as debt discount.
In December 1999, Inktomi Corporation (Inktomi) agreed to make an equity
investment in the Company of $6,000,000 under the terms of a Strategic Alliance
agreement. The terms of this agreement also calls for a joint marketing
campaign to be partially funded by Inktomi. The Company has previously licensed
certain products from Inktomi in the ordinary course of business, under the
terms of the Inktomi License Agreement (License Agreement) which was executed
in January 1999. The Company has agreed to license additional products under
the terms of an amendment to the License Agreement that was executed in
December 1999. Payments made by the Company under the joint marketing campaign
will be recorded as sales and marketing expenses as incurred.
In December 1999, the Company agreed to purchase patented technology from
SRI International (SRI). Under terms of the agreement, the Company is to
acquire the technology in exchange for $6,000,000 of common stock, to be
distributed upon the occurrence of certain milestones. As of
F-18
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of and relating to the three months ended December 31, 1999 and
1998
is unaudited)
December 31, 1999 a total of 120,434 shares of common stock with a value of
$6.0 million had thus far been issued. The Company also will issue $4,000,000
of common stock in exchange for consulting services from SRI. The value of
stock issued under the agreement is recorded as network equipment and
technology. The Company guarantees that the value of all stock issued to SRI
will be $10,000,000 at the time of issuance, and at the time that SRI can
dispose of the stock.
11. Stock Plans:
Stock Option Plans:
In January 1997, the Company established the 1997 Stock Option and Incentive
Plan (the "1997 Plan") and reserved up to 1,689,125 shares of common stock
issuable upon exercise of options granted to certain employees, directors, and
consultants. In May 1998, the Company adopted the 1998 Stock Option/Stock
Issuance Plan (the "1998 Plan"). The 1998 Plan was designed to serve as the
successor to the 1997 Plan. Upon adoption of the 1998 Plan the existing share
reserve under the 1997 Plan was transferred to the 1998 Plan, and all
outstanding options under the 1997 Plan were incorporated into the 1998 Plan.
The Company increased the maximum number of shares issuable to a total of
3,833,284. In November 1998 and February 1999, the Company increased the stock
option pool by another 600,000 shares and 1,000,000 shares, respectively,
bringing the total to 5,433,284. This number of shares was reserved for
issuance under the 1998 Plan. In June 1999, concurrent with the IPO, the
Company adopted the 1999 Stock Incentive Plan (the "1999 Plan"). The 1999 Plan
was designed to serve as the successor to the 1998 Plan. Upon the initial
public offering of the Company's common stock, all outstanding options under
the 1998 Plan, together with the remaining shares reserved under that plan,
were incorporated into the 1999 Plan, with no further grants of common stock
options to be made under the 1998 Plan. Upon implementation of the 1999 Plan,
an additional 2,110,716 shares of common stock were reserved for issuance. On
January 1, 2000, another 2,000,000 shares were reserved for issuance. A total
of 9,544,000 shares are now reserved for issuance.
Under the terms of the 1999 Plan, the Company has the ability to grant
incentive and nonstatutory stock options, as well as issue vested and unvested
shares of the Company's common stock. Exercise prices of stock options are
generally not less than 100% and 85% of the fair value of the common stock on
the date of grant of incentive stock options and nonstatutory stock options,
respectively, and have a term of up to ten years. Options generally vest
rateably over a period of up to fifty months after the grant date, subject to
accelerated vesting in connection with certain changes in control or ownership
of the Company. The plan provides that management can grant employees the right
to exercise options prior to vesting. Upon termination of an employee's
employment with the Company for any reason, the Company has the right to
repurchase all or any portion of the unvested shares acquired by the employee
upon exercise of options at a repurchase price that is equal to the exercise
price, within 90 days following the date of termination. At September 30, 1999,
1998, and 1997, and December 31, 1999 205,700, 254,125, 0, and 153,221 shares
of common stock were subject to repurchase by the Company.
F-19
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of and relating to the three months ended December 31, 1999 and
1998
is unaudited)
A summary of the activity under the 1997 Plan, the 1998 Plan, and the 1999
Plan is as follows (dollars in thousands):
<TABLE>
<CAPTION>
Weighted
Aggregate Average
Exercise Price Exercise Exercise
Shares Per Share Price Price
---------- -------------- ------------ --------
<S> <C> <C> <C> <C>
Outstanding at September 30,
1996........................ -- -- -- --
Granted.................... 1,688,500 $ 0.40 $ 675,400 $ 0.40
Terminated................. (105,000) $ 0.40 (42,000) 0.40
---------- -------------- ------------
Outstanding at September 30,
1997........................ 1,583,500 $ 0.40 633,400 0.40
Granted.................... 1,903,009 $ 0.40-$ 3.35 3,283,649 1.73
Exercised.................. (297,960) $ 0.40-$ 1.50 (265,784) 0.89
Terminated................. (194,784) $ 0.40-$ 3.25 (91,564) 0.47
---------- -------------- ------------
Outstanding at September 30,
1998........................ 2,993,765 $ 0.40-$ 3.35 3,559,701 1.19
Granted.................... 2,412,350 $ 3.35-$ 26.00 19,109,274 7.92
Exercised.................. (1,178,391) $ 0.40-$ 9.90 (1,142,950) 0.97
Terminated................. (380,155) $ 0.40-$ 10.00 (1,167,204) 3.07
---------- -------------- ------------
Outstanding at September 30,
1999........................ 3,847,569 $ 0.40-$ 26.00 20,358,821 $ 5.29
Granted.................... 944,250 $23.31-$137.69 63,299,060 $67.04
Exercised.................. (66,555) $ 0.40-$ 4.25 (63,418) 0.95
Terminated................. (165,976) $ 0.40-$ 10.00 (229,552) 1.38
Assumed in merger.......... 3,035,165 $ 0.07-$ 67.15 16,845,167 5.56
---------- -------------- ------------
Outstanding at December 31,
1999........................ 7,594,453 $ 0.07-$137.69 $100,210,078 $13.20
========== ============== ============
</TABLE>
The Company accounts for the 1997 Plan, the 1998 Plan, and the 1999 Plan
using the intrinsic value based method in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. For financial reporting purposes, the Company has determined
that the deemed fair value on the date of grant of employee stock options
granted between May 1, 1998 and April 21, 1999 was in excess of the exercise
price of the options. Consequently, the Company recorded deferred compensation
of $2.0 million for the year ended September 30, 1998, and an additional $5.7
million for the year ended September 30, 1999. Of the total deferred
compensation, $487,000 was amortized during the year ended September 30, 1998
and $3.2 million was amortized during the year ended September 30, 1999, and
$755,000 was amortized during the three months ended December 31, 1999.
At September 30, 1999 and December 31, 1999 options to purchase 1,541,814
and 1,161,062 shares of common stock, respectively, were exercisable with a
weighted average exercise price of $1.60 and $1.49 per share, respectively.
At September 30, 1999 and December 31, 1999, options to purchase 2,220,080
and 1,441,806 shares of common stock, respectively, remain available for
issuance.
F-20
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of and relating to the three months ended December 31, 1999 and
1998
is unaudited)
The following summarizes information with respect to stock options
outstanding at September 30, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------- --------------------
Weighted Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life (Years) Prices Exercisable Prices
--------------- ----------- ---------------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$0.40-$0.60......... 561,607 7.49 $ 0.41 166,921 $ 0.40
$0.90-$1.50......... 877,923 8.92 $ 1.43 454,862 $ 1.49
$2.75-$3.35......... 123,905 8.88 $ 3.10 123,905 $ 3.10
$3.50-$4.25......... 1,396,084 9.52 $ 4.02 397,052 $ 3.96
$7.50-$10.00........ 489,300 9.69 $ 9.46 398,683 $ 9.41
$18.875-$20.50...... 331,750 9.82 $20.10 391 $20.21
$23.750-$26.00...... 67,000 9.96 $24.46 -- --
</TABLE>
The following information concerning the Company's 1999 Plan is provided in
accordance with Statement of Financial Accounting Standards No. 123 ("SFAS
123"), "Accounting for Stock-Based Compensation."
The fair value of each option grant has been estimated on the date of grant
using the minimum value method with the following weighted average assumptions
used for grants in the years ended September 30, 1998 and 1999:
<TABLE>
<CAPTION>
September 30, September 30, September 30,
1997 1998 1999
------------- ------------- -------------
<S> <C> <C> <C>
Risk-free interest rates........ 5.85%-6.86% 4.23%-6.08% 5.80%
Expected life................... 5 years 5 years 4 years
Expected dividend yield......... -- -- --
Expected volatility............. -- -- 80%
</TABLE>
The weighted average fair value for options granted was $0.10, $0.36 and
$1.71 for the years ended September 30, 1997, 1998, and 1999, respectively.
The pro forma net loss for the Company for the years ended September 30,
1997, 1998 and 1999 following the provisions of SFAS 123, was $5.3 million,
$16.8 million and $51.6 million respectively. The pro forma basic and diluted
net loss per share for the years ended September 30, 1997, 1998 and 1999 was
$3.55, $7.53 and $4.63, respectively.
Employee Stock Purchase Plan:
In June 1999, the Company adopted the 1999 Employee Stock Purchase Plan
("1999 ESPP"). Under the 1999 ESPP, eligible employees are allowed to have
salary withholdings of up to a certain specified percentage of their base
compensation to purchase shares of common stock at a price equal to 85% of the
lower of the market value of the stock at the beginning or end of defined
purchase periods. The initial purchase period commenced on July 1, 1999. A
total of 300,000 shares is reserved for issuance under the 1999 ESPP. At
December 31, 1999 a total of $1,101,425 had been withheld from employees for
future purchases under this plan.
12. Stockholder Notes Receivable:
On February 25, 1998, the Company granted a nonstatutory option to purchase
a total of 183,000 shares of the Company's common stock to a director of the
Company (the "Director").
F-21
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of and relating to the three months ended December 31, 1999 and
1998
is unaudited)
These options were immediately exercisable and the shares purchased thereunder
are subject to repurchase by the Company, with the right to repurchase expiring
in 16 equal quarterly installments. At the time of the option grant, the
Director exercised the option to purchase the entire 183,000 shares of common
stock, in exchange for a $109,800 note (the "Note"). The Note was
collateralized by the 183,000 shares of common stock and by other assets of the
Director. Under the terms of the note, interest was accrued at 5.61% per annum.
Interest was to be repaid in four equal annual installments commencing February
24, 1999. The entire principal amount was due and payable in one lump sum on
February 24, 2002. In August 1999, the Director extinguished the Note by paying
the full amount of principal and accrued interest. At December 31, 1999, a
total of 102,937 shares of the Director's stock was subject to repurchase.
On April 20, 1999, executive officers of the Company exercised stock options
to purchase 349,332 shares of common stock in exchange for full-recourse notes.
The total principal amount of these notes is $286,398. The notes bear interest
at the rate of 7.75% per annum, compounded semiannually. Accrued interest is
due and payable at successive quarterly intervals over the four-year term of
the note, and the principal balance will become due and payable in one lump sum
at the end of the four-year term. None of the shares purchased with the notes
may be sold unless the principal portion of the note attributable to those
shares, together with the accrued interest on that principal portion, is paid
in full. In December 1999, one of the executive officers repaid the entire
principal balance of his Note. The amount repaid, $86,400, related to 216,000
shares.
On June 14, 1999, one of the executive officers who had exercised options on
April 20, 1999 in exchange for a full-recourse note, borrowed an additional
$128,000 in order to finance the tax liability she incurred in connection with
the exercise of her stock options on April 20, 1999 for 133,332 shares of
common stock. The loan is evidenced by a full-recourse promissory note with
interest at the rate of 7.75% per annum, compounded semi-annually, and secured
by the same 133,332 shares which serve as collateral for the April 20, 1999
promissory note, as well as other assets. The terms of her note, including the
due dates for payment of principal and accrued interest and the acceleration
provisions, are substantially the same as the terms in effect for her April 20,
1999 note.
In July 1999, the Company loaned an officer of the Company $100,000. The
loan is interest free, with $50,000 being forgiven ratably over a period of
five years. At the end of the five year term, the $50,000 portion of the loan
that has not been forgiven is to be repaid in one lump sum. In the event that
the officer's employment terminates during the five year period, the
outstanding unforgiven balance of the loan is to be repaid at the time of the
termination. The amount being forgiven, plus imputed interest are charged to
operations.
13. Warrants:
In connection with the issuance of certain convertible notes (see Note 6),
the Company issued warrants to purchase shares of the Company's common stock to
the note holders. Warrants to purchase 75,000 and 20,000 shares of the
Company's common stock were granted in September 1996 and January 1997,
respectively. The exercise price of the warrants was equal to $0.10 per share.
The warrants were due to expire upon the earlier of (i) five years from the
date of grant, (ii) the closing of a underwritten public offering of the
Company's common stock for not less than $2.50 per share and gross proceeds of
at least $10,000,000, or (iii) the closing of a consolidation or merger of the
Company. The fair value of the warrants was determined using the Black-Scholes
model and was accounted for as interest expense over the time period the notes
were outstanding. In June 1999, prior to the IPO, the warrants were exercised.
F-22
<PAGE>
DIGITAL ISLAND, INC. AND SUBIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of and relating to the three months ended December 31, 1999 and
1998
is unaudited)
The Company also assumed outstanding warrants in connection with its merger
with Sandpiper Networks, Inc. These warrants are to purchase a total of 26,818
shares of common stock at $96.95 per share. The warrants expire in December
2000.
14. Related Party Transactions:
One shareholder also is a significant customer of the Company. For the years
ended September 30, 1997, 1998, and 1999, and the three months ended December
31, 1998 and 1999 the Company earned $122,000, $310,000, $524,000, $97,000, and
$222,000 respectively, in revenue from sales to this customer, and had
$139,000, $200,000 and $424,000 in total receivables at September 30, 1998 and
1999, and December 31, 1999 respectively. The Company owed this customer
$992,000, $3.8 million and $4.0 million at September 30, 1998 and 1999, and
December 31, 1999 respectively, under terms of the master lease agreement, and
also owed another $94,000, $68,000, and $253,000 respectively, in other trade-
related payables.
One other significant shareholder is also a customer of the Company. For the
years ended September 30, 1997, 1998, and 1999, and the three months ended
December 31, 1998 and 1999 the Company earned $43,000, $458,000, $4.4 million,
$74,000, and $2.6 million respectively, in revenue from sales to this customer,
and had $39,000, $1.4 million and $1.8 million in total receivables at
September 30, 1998 and 1999, and December 31, 1999, respectively. In addition,
$715,000 and $636,000 of the deferred revenue balance at September 30, 1999 and
December 31, 1999, respectively, related to this customer.
The Company has outstanding payables owed to Sun at December 31, 1999. A
total of $3,000 was owed for trade-related payables, and $2.2 million was owed
under terms of lease agreements that were executed prior to the recent $100
million facility (see Note 10).
15. Retirement Savings Plan:
On November 1, 1997, the Company established the Digital Island Retirement
Savings Plan ("Retirement Plan"), a defined contribution plan, covering all
eligible employees. Employees may elect to contribute from 1%-15% of their
annual compensation to the Retirement Plan. Matching contributions by the
Company are discretionary. The Company has made no contributions during the
years ended September 30, 1998 and 1999, or the three months ended December 31,
1999.
16. Acquisition
On October 25, 1999, the Company agreed to merge with Sandpiper Networks,
Inc. ("Sandpiper") in a transaction to be accounted for as a purchase. On
December 28, 1999, the stockholders of both companies approved the merger, and
the merger was consummated. Digital Island exchanged 1.07 shares of its common
stock for every share of Sandpiper stock. A total of 24.6 million shares were
exchanged.
17. Subsequent Events:
On January 18, 2000, the Company acquired Live On Line, Inc. (LOL), a
privately-held company. Shareholders of LOL were issued 799,989 shares of
common stock and $5,250,000 in cash for all outstanding shares of LOL.
In relation to the arrangements with Sun and Inktomi (see Note 10), the
Company issued 391,869 shares of stock to Sun for $20,000,000 and 117,561
shares to Inktomi for $6,000,000 in January 2000.
F-23
<PAGE>
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
The following unaudited pro forma combined financial statements have been
prepared to give effect to the merger between Digital Island and Sandpiper as
if it had occurred at the beginning of the period presented. This transaction
was accounted for using the purchase method of accounting.
The unaudited pro forma combined statement of operations for the year ended
September 30, 1999 combines the historical consolidated statement of operations
of Digital Island for the year ended September 30, 1999 with the unaudited
historical consolidated results of operations of Sandpiper for the twelve-month
period ended September 30, 1999. The historical pro forma information assumes
that for purposes of reporting combined information, the historical
consolidated financial information of Sandpiper will be restated to conform
Sandpiper's fiscal year-end of December 31 to Digital Island's fiscal year-end
of September 30.
The unaudited pro forma combined statement of operations for the three
months ended December 31, 1999 combines the consolidated statement of
operations of Digital Island for the three months ended December 31, 1999 with
the unaudited consolidated results of operations of Sandpiper for the period
from October 1, 1999 to December 28, 1999.
The total purchase price of approximately $967.6 million consists of
approximately 24.6 million shares of Digital Island's common stock with a fair
value of $857.0 million, 3.1 million vested and unvested stock options and
warrants with a fair value of $96.6 million, and estimated direct transaction
costs of approximately $14.0 million. The fair value of Digital Island's common
stock was determined as the average market price from October 21, 1999 to
October 27, 1999, which includes two days prior and two days subsequent to the
public announcement of the merger. The fair value of the common stock options
and warrants was estimated using the Black Scholes model with the following
weighted-average assumptions: risk-free interest rate of 5.8%, expected life of
4 years, expected dividend rate of 0%, and volatility of 80%. The total
purchase price was allocated as follows:
<TABLE>
<S> <C>
Net assets acquired.......................................... $ 7.7 million
Accrued transaction costs.................................... (14.0) million
Assembled workforce.......................................... 2.0 million
Core technology.............................................. 121.1 million
Goodwill..................................................... 850.8 million
</TABLE>
The intangible assets will be amortized over their estimated useful lives of 60
months.
Unaudited pro forma combined financial information is presented for
illustrative purposes only and is not necessarily indicative of the combined
financial position or results of operations of future periods or the results
that actually would have been realized had the entities been a single entity
during this period. These unaudited pro forma combined financial statements are
based upon the respective historical consolidated financial statements of
Digital Island and Sandpiper and notes thereto, included elsewhere in this
prospectus and should be read in conjunction with those statements and the
related notes.
F-24
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
(in thousands, except share and per share data)
Year Ended September 30, 1999
<TABLE>
<CAPTION>
Digital Sandpiper
Island, Networks, Pro forma Pro forma
Inc. Inc. adjustments combined
---------- --------- ----------- ----------
<S> <C> <C> <C> <C>
Revenues...................... $ 12,431 $ 219 $ -- $ 12,650
Costs and expenses: --
Cost of revenue............. 29,496 4,341 -- 33,837
Sales and marketing......... 16,010 5,358 -- 21,368
Product development......... 6,357 2,357 -- 8,714
General and administrative.. 9,848 1,731 -- 11,579
Amortization of goodwill and
intangible assets.......... -- -- 194,770(1) 194,770
Stock compensation expense.. 3,207 581 -- 3,788
---------- -------- ---------- ----------
Total costs and expenses...... 64,918 14,368 194,770 274,056
---------- -------- ---------- ----------
Loss from operations.......... (52,487) (14,149) (194,770) (261,406)
---------- -------- ---------- ----------
Interest income, net.......... 1,551 179 -- 1,730
---------- -------- ---------- ----------
Loss before income taxes...... (50,936) (13,970) (194,770) (259,676)
Provision for income taxes.... 2 3 -- 5
---------- -------- ---------- ----------
Net loss...................... $ (50,938) $(13,973) $ (194,770) $ (259,681)
========== ======== ========== ==========
Basic and diluted net loss per
share........................ $ (4.58) -- $ (7.28)
========== ==========
Weighted average shares
outstanding used in per share
calculation.................. 11,127,462 24,556,088 (3) 35,683,550
========== ========== ==========
</TABLE>
See accompanying notes to unaudited pro forma combined financial statements
F-25
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
(in thousands, except share and per share data)
Three Months Ended December 31, 1999
<TABLE>
<CAPTION>
Digital Sandpiper
Island, Networks, Pro forma Pro forma
Inc. Inc. adjustments combined
---------- --------- ----------- ----------
<S> <C> <C> <C> <C>
Revenues...................... $ 7,600 $ 854 $ (262) (2) $ 8,192
Costs and expenses: --
Cost of revenue............. 16,264 2,731 (262) (2) 18,733
Sales and marketing......... 6,315 49,557 -- 55,872
Product development......... 2,543 783 -- 3,326
General and administrative.. 4,698 1,561 -- 6,259
Amortization of goodwill and
intangibles................ 1,697 -- 48,693 (1) 50,390
Stock compensation expense.. 755 240 -- 995
---------- -------- ---------- ----------
Total costs and expenses...... 32,272 54,872 48,431 135,575
---------- -------- ---------- ----------
Loss from operations.......... (24,672) (54,018) ( 48,693) (127,383)
---------- -------- ---------- ----------
Interest income, net.......... 697 25 -- 722
---------- -------- ---------- ----------
Loss before income taxes...... (23,975) (53,993) ( 48,693) (126,661)
Provision for income taxes.... 5 -- -- 5
---------- -------- ---------- ----------
Net loss...................... $ (23,980) $(53,993) $ ( 48,693) $ (126,666)
========== ======== ========== ==========
Basic and diluted net loss per
share........................ $ (0.65) $ (2.10)
========== ==========
Weighted average shares
outstanding used in per share
calculation.................. 36,676,137 23,755,346 (3) 60,431,483
========== ========== ==========
</TABLE>
See accompanying notes to unaudited pro forma combined financial statements.
F-26
<PAGE>
Notes to Unaudited Pro Forma Combined Financial Statements
(1) Goodwill and intangible assets are amortized on a straight-line basis over
five years.
(2) Reflects elimination of inter-company transactions.
(3) Adjustment to weighted average shares outstanding used in computing basic
and diluted loss per share reflects issuance of 24,556,088 shares of common
stock in connection with the Sandpiper acquisition.
F-27
<PAGE>
REPORT OF SANDPIPER NETWORKS, INC. INDEPENDENT AUDITORS
The Board of Directors
Sandpiper Networks, Inc.
We have audited the accompanying consolidated balance sheets of Sandpiper
Networks, Inc. as of December 31, 1997 and 1998, and the related consolidated
statements of operations, shareholders' deficit, and cash flows for the years
then ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Sandpiper
Networks, Inc. at December 31, 1997 and 1998, and the results of its operations
and its cash flows for the years then ended, in conformity with generally
accepted accounting principles.
/s/ Ernst & Young LLP
February 3, 1999
Los Angeles, California
F-28
<PAGE>
SANDPIPER NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
------------------------
1997 1998
----------- -----------
<S> <C> <C>
ASSETS
------
Current assets:
Cash and cash equivalents.......................... $ 5,728,826 $ 603,812
Accounts receivable................................ -- 2,176
Prepaid and other current assets................... 2,022 82,301
----------- -----------
Total current assets................................. 5,730,848 688,289
Property and equipment, net.......................... 38,730 1,072,791
Other assets......................................... 4,598 63,640
----------- -----------
Total assets......................................... $ 5,774,176 $ 1,824,720
=========== ===========
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED
STOCK AND SHAREHOLDERS' DEFICIT
-------------------------------
Current liabilities:
Current portion of debt............................ $ 125,000 $ 46,010
Current portion of capital lease obligations....... -- 310,327
Accounts payable................................... 175,023 8,462
Accrued expenses................................... 88,772 225,024
----------- -----------
Total current liabilities............................ 388,795 589,823
Debt, less current portion........................... -- 71,558
Capital lease obligations, less current portion...... -- 639,205
----------- -----------
Total liabilities.................................... 388,795 1,300,586
Series A redeemable convertible preferred stock,
$0.001 par value: 9,599,999 and 10,278,569 shares
authorized as of December 31, 1997 and 1998,
respectively; 9,428,570 and 9,607,141 issued and
outstanding as of December 31, 1997 and 1998,
respectively........................................ 6,552,920 6,674,442
Shareholders' deficit:
Common Stock, $0.001 par value: 30,000,000 shares
authorized as of December 31, 1997 and 1998;
5,095,658 and 6,685,405 issued and outstanding as
of December 31, 1997 and 1998, respectively....... 1,000 112,383
Accumulated deficit................................ (1,168,539) (6,262,691)
----------- -----------
Total shareholders' deficit.......................... (1,167,539) (6,150,308)
----------- -----------
$ 5,774,176 $ 1,824,720
=========== ===========
</TABLE>
See accompanying notes.
F-29
<PAGE>
SANDPIPER NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year ended December 31,
------------------------
1997 1998
----------- -----------
<S> <C> <C>
Revenues............................................. $ -- $ 5,700
Cost and expenses:
Cost of revenues................................... -- 1,695,057
Product development................................ 1,159,715 1,382,635
Marketing and sales................................ -- 1,272,441
General and administrative......................... 28,149 876,093
----------- -----------
Total operating expenses............................. 1,187,864 5,226,226
----------- -----------
Operating (loss)..................................... (1,187,864) (5,220,526)
Interest expense..................................... 23,649 29,119
Interest (income).................................... (42,974) (155,493)
----------- -----------
Net (loss)........................................... $(1,168,539) $(5,094,152)
=========== ===========
</TABLE>
See accompanying notes.
F-30
<PAGE>
SANDPIPER NETWORKS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIT
<TABLE>
<CAPTION>
Common Stock Total
------------------- Accumulated Shareholders'
Shares Amount Deficit Equity (Deficit)
--------- -------- ----------- ----------------
<S> <C> <C> <C> <C>
Balance as of January 1,
1997....................... 5,095,658 $ 1,000 $ -- $ 1,000
Net loss.................. -- -- (1,168,539) (1,168,539)
--------- -------- ----------- -----------
Balance as of December 31,
1997....................... 5,095,658 1,000 (1,168,539) (1,167,539)
Repurchase of Common
Stock.................... (509,566) (35,670) -- (35,670)
Issuance of Common Stock
in connection with
exercise of stock
options.................. 2,099,313 147,053 -- 147,053
Net loss.................. -- -- (5,094,152) (5,094,152)
--------- -------- ----------- -----------
Balance as of December 31,
1998....................... 6,685,405 $112,383 $(6,262,691) $(6,150,308)
========= ======== =========== ===========
</TABLE>
See accompanying notes.
F-31
<PAGE>
SANDPIPER NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended December 31,
------------------------
1997 1998
----------- -----------
<S> <C> <C>
Operating activities
Net loss............................................. $(1,168,539) $(5,094,152)
Adjustments to reconcile net loss to net cash used
for operating activities:
Depreciation and amortization...................... 3,025 444,257
Changes in operating assets and liabilities:
Accounts receivable............................... -- (2,176)
Prepaid and other current assets.................. (2,022) (80,279)
Accounts payable.................................. 175,023 (166,561)
Accrued expenses.................................. 88,772 136,252
----------- -----------
Net cash used in operating activities................ (903,741) (4,762,659)
----------- -----------
Investing activities
Purchases of property and equipment.................. (41,755) (1,478,317)
Other assets......................................... (4,598) (59,042)
----------- -----------
Net cash used in investing activities................ (46,353) (1,537,359)
----------- -----------
Financing activities
Proceeds from issuance of Common Stock............... -- 147,053
Net proceeds from issuance of Series A redeemable
convertible preferred stock......................... 5,952,920 --
Proceeds from credit line............................ -- 800,000
Proceeds from debt................................... 846,924 117,568
Proceeds from capital lease obligations.............. -- 1,094,453
Repurchase of Common Stock........................... -- (35,670)
Repayment of credit line............................. -- (800,000)
Repayment of debt.................................... (121,924)
Repayment of capital lease obligations............... -- (144,921)
Other financing activities........................... -- (3,479)
----------- -----------
Net cash provided by financing activities............ 6,677,920 1,175,004
----------- -----------
Net increase (decrease) in cash and cash
equivalents......................................... 5,727,826 (5,125,014)
Cash and cash equivalents at beginning of year....... 1,000 5,728,826
----------- -----------
Cash and cash equivalents at end of year............. $ 5,728,826 $ 603,812
=========== ===========
Supplemental schedule of non-cash transactions:
Conversion of notes payable to Series A redeemable
convertible preferred stock........................ $ 600,000 $ 125,000
=========== ===========
</TABLE>
See accompanying notes.
F-32
<PAGE>
SANDPIPER NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Organization and Basis of Presentation
Sandpiper Networks, Inc. (the "Company") was incorporated in December 1996.
The Company and its wholly owned subsidiary, Sandpiper Leasing Corporation
("SLC") provide a subscription-based service that enables web publishers to
migrate their content onto a professionally managed content delivery network.
The Company's service provides publishers with unlimited scalability and
improved performance by avoiding Internet congestion and intelligently
delivering content closer to end-users. The Company has had limited sales of
products, and its customers are Internet publishing companies, located
principally in the United States.
As of December 31, 1998, the Company has an accumulated deficit of
$6,262,691. The Company anticipates that, in the event that profitability is
not attained, the required funding for expenditures will come from sources such
as additional equity (see Note 11) or debt financing, collaborative
arrangements or partnership agreements. While management believes that any
additional funding required will be available as necessary, there is no
assurance that additional financing will be available and on terms acceptable
to the Company, when required. If additional funding were not available when
needed, the Company would be required to reduce the rate of administrative
costs and research and development expenditures.
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosures of contingencies at the date of the financial statements, and
affect the reported amount of revenues and expenses during the reporting
period. Actual results could differ from the Company's estimates.
In October 1998, the Company commenced the planned principal operations by
introducing the first service offering through the launch of the Footprint
product. Accordingly, the Company is not presented as a development stage
company in the accompanying financial statements.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiary, SLC. All significant intercompany
accounts have been eliminated.
Stock Split
In 1997, the Company's Board of Directors approved a Common Stock split
whereby each outstanding share of Common Stock was converted into 8.1530496
shares of Common Stock. Such stock split has been retroactively reflected in
the accompanying consolidated financial statements.
Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of cash deposits at financial institutions.
The Company places its cash deposits with high credit quality financial
institutions. At times, balances in the Company's cash accounts may exceed the
Federal Deposit Limitation ("FDIC") limit.
F-33
<PAGE>
SANDPIPER NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Property and Equipment
Property and equipment are stated at cost and depreciated or amortized over
the estimated useful lives of the assets on a straight-line basis. The
estimated useful lives of the assets are as follows:
<TABLE>
<S> <C>
Equipment........................................................ 3 years
Furniture and fixtures........................................... 3-5 years
</TABLE>
Included in this caption are the following assets:
<TABLE>
<CAPTION>
December 31,
-------------------
1997 1998
------- ----------
<S> <C> <C>
Operations equipment.................................. $ -- $1,069,560
Other property and equipment.......................... 41,755 450,513
------- ----------
41,755 1,520,073
Accumulated depreciation.............................. (3,025) (447,282)
------- ----------
Net property and equipment............................ $38,730 $1,072,791
======= ==========
</TABLE>
Revenue recognition
The Company recognizes subscription revenues over the period the services
are provided.
Advertising Expenses
Advertising costs are expensed as incurred. Advertising expenses for the
year ended December 31, 1998 was $119,432. There were no advertising expenses
in 1997.
Research and Development Expenses
Research and development costs are expensed as incurred.
Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, Accounting for Stock-
Based Compensation ("SFAS 123"), requires that stock awards granted subsequent
to January 1, 1995, be recognized as compensation expense based on their fair
market value at the date of grant. Alternatively, a company may use APB Opinion
No. 25, Accounting for Stock Issued to Employees ("APB 25"), and disclose the
pro forma results of operations which would have resulted from recognizing such
rewards at their fair market value. The Company accounts for stock option
grants in accordance with APB Opinion No. 25, Accounting for Stock Issued to
Employees, and, accordingly, does not recognize compensation expense for stock
option grants. Stock Options are granted under the Company's Stock Incentive
Plan with an exercise price equal to the fair market value of the shares at the
date of grant.
2. Credit Arrangements and Long-Term Debt
On February 19, 1998, the Company entered into a $1,000,000 line of credit
with a bank, with a variable rate of interest, based on the bank's lending
rate. Under the terms of the line of credit, up to $750,000 of the credit
facility could be converted to a three-year term loan with similar interest
terms on August 19, 1999, to the extent that Company draws on credit were
supported by capital equipment invoices. At December 31, 1998 no amounts are
extended under this facility.
F-34
<PAGE>
SANDPIPER NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
On August 31, 1998, the Company executed a promissory note with a financial
institution in the amount of $117,568, at a stated interest rate of 7% per
annum, principal and interest due monthly for 36 months and collateralized by
equipment. Aggregate maturities for 1999, 2000 and 2001 are $46,010, $36,816
and $31,743, respectively.
3. Leases
The Company entered into a $1,500,000 equipment lease line of credit through
which non-cancelable capital lease obligations for computers and equipment were
executed during the year ended December 31, 1998. In addition, the Company
entered into a lease agreement for its facilities on January 6, 1999 under non-
cancelable operating lease agreements expiring through 2005. This operating
lease provides for free rent and escalations.
Future minimum lease payments as of December 31, 1998 are as follows:
<TABLE>
<CAPTION>
Operating Capital
Lease Leases
---------- ----------
<S> <C> <C>
1999................................................ $ 174,549 $ 366,643
2000................................................ 299,227 394,729
2001................................................ 318,913 283,273
2002................................................ 322,850 --
2003................................................ 335,974 --
Thereafter.......................................... 395,032 --
---------- ----------
Total minimum lease payments........................ $1,846,545 $1,044,645
==========
Less amounts representing interest.................. 95,113
----------
Present value of lease payments..................... $ 949,532
==========
</TABLE>
At December 31, 1998, computers, software and equipment under capital leases
had an original cost basis and a net book value of $1,094,453 and $670,263,
respectively.
Rent expense was $13,716 and $123,412 for the years ended December 31, 1997
and 1998, respectively.
F-35
<PAGE>
SANDPIPER NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Income Taxes
The deferred income tax assets and liabilities of the Company consist of the
differences between the financial statements and tax basis of assets and
liabilities, and are measured at the current enacted tax rates. The temporary
differences related to the following as of December 31, 1997 and 1998,
respectively, are as follows:
<TABLE>
<CAPTION>
1997 1998
--------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating losses and tax credits............. $ 517,236 $ 2,754,031
--------- -----------
Total deferred tax assets.......................... 517,236 2,754,031
Deferred tax liabilities:
Federal benefit for state income taxes........... 31,214 156,025
--------- -----------
Total deferred liabilities......................... 31,214 156,025
--------- -----------
Net deferred tax assets............................ 486,022 2,598,006
Less valuation reserve............................. (486,022) (2,598,006)
--------- -----------
$ -- $ --
========= ===========
</TABLE>
The Company has net operating loss carryforwards for federal and state
income tax purposes of $6,262,691, which begin to expire in 2004. Research tax
credit carryforwards of $248,956 are available for federal and state tax
purposes that expire beginning in 2013. Utilization of the above carryforwards
is subject to utilization limitations that may inhibit the Company's ability to
use carryforwards in the future.
5. Redeemable Convertible Preferred Stock
At December 31, 1998, the Company is authorized to issue up to 10,278,569
shares of redeemable convertible preferred stock which have been designated as
Series A. As of December 31, 1998, 9,607,141 of Series A have been issued.
In January 1999, the shareholders approved an increase to authorized
redeemable convertible preferred stock to 13,697,640, of which 9,885,981 have
been designated as Series A and 3,811,659 have been designated as Series B.
Series A
Series A shares were issued at $0.70 per share and are convertible to one
share of Common Stock. Series A shares are redeemable at $0.70 per share on the
seventh anniversary of the issuance of the first shares issued under this
series (November 17, 2004).
Series B
Series B shares are convertible to one share of Common Stock. Series B
shares are redeemable at $4.46 per share on November 17, 2004.
All Preferred Stock
The redeemable convertible preferred stock contains a liquidation preference
of an amount equal to the price for which such share of redeemable convertible
preferred stock was issued, adjusted for
F-36
<PAGE>
SANDPIPER NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
any stock dividends, combinations or splits with respect to such shares, plus
any declared and unpaid dividends on the redeemable convertible preferred
stock.
The redeemable convertible preferred stock is generally convertible at any
time, at the holder's option, into Common Stock based on the conversion ratios
above, subject to future adjustment as defined. The redeemable convertible
preferred stock shall automatically convert into shares of Common Stock upon
the closing of an initial public offering of the Company's Common Stock, if the
per share price of the stock sold in the offering is not less than $5.00 per
share and the aggregate purchase price of the Common Stock sold in the offering
is not less than $10.0 million. The redeemable convertible preferred stock
contains voting rights identical to those of the Common Stock.
6. Convertible Notes Payable
In 1997, in contemplation of the Series A redeemable convertible preferred
stock financing (see Note 5), the Company issued convertible notes payable and
warrants (see Note 8) for $600,000 (the "bridge financing"). In connection with
the close of the Series A redeemable convertible preferred stock financing, the
$600,000 in convertible notes payable were converted into 857,143 shares of
Series A redeemable convertible preferred stock. In addition, during 1997, as
part of the bridge financing, the Company converted accounts payable of
$246,924 to a related party (see Note 11) to a promissory note convertible into
Series A redeemable convertible preferred stock. During 1997, in accordance
with the terms of the agreement, the Company repaid $121,924 of the promissory
note plus interest, and, in 1998, the holder converted the remaining $125,000
to Series A redeemable convertible preferred stock at $0.70 per share.
7. Stock Plan
The 1997 Stock Plan (the "Plan") provides for the grant of both incentive
stock options and non-statutory stock options to employees, directors and
consultants. The exercise price of the incentive stock options must equal or
exceed the fair market value of the Common Stock at the grant date and the non-
statutory stock options may be less than the fair market value of the Common
Stock at the grant date. The incentive stock options generally vest over four
years whereas the non-statutory stock options generally vest after one year.
The Company has allocated 3,599,629 shares for the Plan. All options under the
Plan must be exercised within ten years from the date of grant.
Following is a summary of all stock option activity:
<TABLE>
<CAPTION>
Exercise Number of Shares
Price --------------------------------------------
Per Share Employees Directors Consultants Total
--------- ---------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C>
Granted................. $0.07 -- -- 58,499 58,499
Outstanding at
December 31, 1997.... -- -- 58,499 58,499
Granted............... $0.07 3,130,670 70,000 117,474 3,318,144
Exercised............. $0.07 (1,976,545) (70,000) (52,768) (2,099,313)
Canceled.............. (39,978) -- (5,706) (45,684)
----- ---------- ------- ------- ----------
Outstanding at
December 31, 1998.... 1,114,147 -- 117,499 1,231,646
===== ========== ======= ======= ==========
Vested at December 31,
1998................. 147,154 -- 81,445 228,599
===== ========== ======= ======= ==========
</TABLE>
The weighted average exercise price of options granted during the year ended
December 31, 1998 was $0.10 and the weighted average exercise price of options
outstanding at December 31,
F-37
<PAGE>
SANDPIPER NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1998 was $0.15. The weighted average exercise price of options canceled during
the year ended December 31, 1998 was $0.07 and the weighted average contractual
life for options outstanding at December 31, 1998 was 9.5 years.
Pro forma information regarding net income is required by SFAS No. 123,
Accounting for Stock-Based Compensation, and has been determined as if the
Company has accounted for its employee stock options under the fair value
method of that Statement. The fair value for these options was estimated at the
date of grant using a "minimum value" option pricing model with the following
assumptions for 1997 and 1998: risk-free interest rate of 6.0% and 5.4%,
respectively; no dividend yields for either year; and an expected option life
of 1 and 6, respectively. The weighted average fair value of options granted
during 1997 and 1998 was $0.01 per share and $0.02 per share, respectively.
Based on the "minimum value" option pricing model, proforma net loss for the
years ended December 31, 1997 and 1998 would not be materially different from
the amounts of net loss reported in the Company's accompanying statements of
operations.
The "minimum value" option valuation model requires the input of highly
subjective assumptions. Because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the
fair value of its employee stock options.
The pro forma net loss for the years ended December 31, 1997 and 1998 is not
representative of the pro forma effect on net income in future years, as pro
forma information in future years will reflect the amortization of a larger
number of stock options granted in succeeding years.
8. Warrants
In 1997, in connection with a financing arrangement, the Company issued
warrants to purchase 171,428 shares of the Company's Series A redeemable
convertible preferred stock at $0.70 per share. These warrants expire on March
31, 2003.
In 1998, in connection with a financing arrangement, the Company issued
warrants to purchase 107,412 shares of the Company's Series A redeemable
convertible preferred stock at $0.70 per share. This warrant expires at the
shorter of ten years from the date of grant or five years from the date of an
initial public offering of the Company's Common Stock.
9. Defined Contribution Plan
In 1998, the Company established defined contribution plan for certain
qualified employees as defined in the plan. Participants may contribute up to
the lesser of 6% of pretax compensation subject to certain limitations, or
$6,000. The plan provides for required contributions of 1% to 3% by the Company
as defined in the plan. The Company accrued contribution for the year ended
December 31, 1998 was $10,228.
10. Related Party Transactions
Prior to financing, the Company's operating activities were performed and
funded by Sandpiper Consulting, a Limited Liability Company (the "LLC") owned
by several common stockholders and officers of the Company. These expenditures
were accumulated at cost and converted to a
F-38
<PAGE>
SANDPIPER NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
convertible note in the bridge financing (see Note 6). Subsequent to the bridge
financing, LLC continued to provide services directly to the Company, which
were billed at cost and reimbursed from Company funds. As of December 31, 1998,
the Company no longer obtains services from LLC. Payments to LLC relating to
the years ended December 31, 1997 and 1998 were $924,431 (including $168,810
included in accounts payable) and $212,700, respectively.
The LLC was a holder of 509,566 shares of the Company's Common Stock. Under
an agreement with the investors in the Series A redeemable convertible
preferred stock financing, LLC agreed to hold these shares exclusively for the
benefit of the employees of LLC. During 1998, all LLC employees were
transferred to the Company. As a result, under the terms of the agreement,
these shares were purchased from the LLC for $35,670. Further, during 1998
these shares were allocated to the 1997 Stock Option Plan (see Note 7).
11. Subsequent Event (Unaudited)
On January 29, 1999, the Company effected the first close on the issuance of
Series B redeemable convertible preferred shares (see Note 5). Under the first
closing, 2,242,152 Series B redeemable convertible preferred shares were issued
at $4.46 per share, with total gross proceeds amounting to $9,999,998. The
Company has available another 1,569,507 shares of Series B redeemable
convertible preferred stock available for sale at the same price per share, to
certain specific investors agreed to by the Company and the largest investor
participating in the first close. These additional shares are available for
sale for 90 days following the first closing.
12. Year 2000 Issue (Unaudited)
The Company has developed a plan to modify its information technology, as
necessary, to be ready for the Year 2000. The Company currently expects the
project to be substantially complete by September 1999 and to cost
approximately $50,000. This estimate includes internal costs, but excludes the
costs to upgrade and replace systems in the normal course of business. The
Company does not expect this project to have a significant impact on
operations.
F-39
<PAGE>
SANDPIPER NETWORKS, INC.
UNAUDITED CONSOLIDATED BALANCE SHEET
September 30, 1999
<TABLE>
<S> <C>
ASSETS
------
Current assets:
Cash and cash equivalents........................................ $ 10,853,468
Accounts receivable.............................................. 120,749
Prepaid and other current assets................................. 295,654
------------
Total current assets............................................... 11,269,871
Property and equipment, net........................................ 6,046,531
Other assets....................................................... 434,396
------------
Total assets....................................................... $ 17,750,798
============
LIABILITIES, REDEEMABLE CONVERTIBLE
PREFERRED STOCK AND SHAREHOLDERS' DEFICIT
-----------------------------------------
Current liabilities:
Current portion of debt.......................................... $ 39,126
Current portion of capital lease obligations..................... 1,010,363
Accounts payable................................................. 2,015,180
Accrued expenses................................................. 394,502
------------
Total current liabilities.......................................... 3,459,171
Debt, less current portion......................................... 45,098
Capital lease obligations, less current portion.................... 1,621,075
------------
Total liabilities.................................................. 5,125,344
Series A redeemable convertible preferred stock, $0.001 par value:
9,885,981 shares authorized as of September 30, 1999; 9,607,141
issued and outstanding as of September 30, 1999................... 6,674,442
Series B redeemable convertible preferred stock, $0.001 par value:
6,026,694 shares authorized and 4,820,628 issued and outstanding
as of September 30, 1999.......................................... 21,426,766
Shareholders' deficit:
Common Stock, $0.001 par value: 40,000,000 shares authorized and
6,979,067 issued and outstanding as of September 30, 1999....... 4,413,247
Deferred Compensation............................................ (3,573,432)
Warrants......................................................... 1,897,499
Accumulated deficit.............................................. (18,213,068)
------------
Total shareholders' equity......................................... (15,475,754)
------------
$ 17,750,798
============
</TABLE>
See accompanying notes.
F-40
<PAGE>
SANDPIPER NETWORKS, INC.
UNAUDITED CONSOLIDATED STATEMENT OF OPERATIONS
For the nine months ended September 30, 1999
<TABLE>
<S> <C>
Revenues......................................................... $ 213,079
Cost and expenses:
Cost of revenues............................................... 3,637,269
Product development............................................ 1,820,986
Marketing and sales............................................ 4,821,605
General and administrative..................................... 1,480,912
Amortization of deferred compensation.......................... 580,827
------------
Total operating expenses......................................... 12,341,599
------------
Operating (loss)................................................. (12,128,520)
Interest expense................................................. 181,332
Interest (income)................................................ (362,331)
Provision for income taxes....................................... 2,856
------------
Net (loss)....................................................... $(11,950,377)
============
</TABLE>
See accompanying notes.
F-41
<PAGE>
SANDPIPER NETWORKS, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIT
<TABLE>
<CAPTION>
Total
Common Stock Shareholders'
-------------------- Deferred Accumulated Equity
Shares Amount Compensation Warrants Deficit Deficit
--------- ---------- ------------ ---------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Balance as of December 31,
1998...................... 6,685,405 $ 112,383 $ (6,262,691) $ (6,150,308)
Issuance of Common Stock
in connection with
exercise of stock
options.................. 293,662 146,605 146,605
Issuance of warrants in
connection with lease
line..................... $ 106,672 106,672
Issuance of warrants in
connection with strategic
agreements............... $1,790,827 1,790,827
Deferred Compensation..... 4,154,259 $(4,154,259)
Amortization of deferred
compensation............. 580,827 580,827
Net loss.................. -- -- -- (11,950,377) (11,950,377)
--------- ---------- ----------- ---------- ------------ ------------
Balance as of September 30,
1999...................... 6,979,067 $4,413,247 $(3,573,432) $1,897,499 $(18,213,068) $(15,475,754)
========= ========== =========== ========== ============ ============
</TABLE>
See accompanying notes.
F-42
<PAGE>
SANDPIPER NETWORKS, INC.
UNAUDITED CONSOLIDATED STATEMENT OF CASH FLOWS
For the nine months ended September 30, 1999
<TABLE>
<S> <C>
Operating activities
Net loss......................................................... $(11,950,377)
Adjustments to reconcile net loss to net cash used for
operating activities:
Depreciation and amortization................................ 1,043,071
Amortization of deferred compensation........................ 580,827
Non-cash charges for warrants................................ 1,897,499
Changes in operating assets and liabilities:
Accounts receivable........................................ (118,573)
Prepaid and other current assets........................... (213,353)
Accounts payable........................................... 2,006,718
Accrued expenses........................................... 169,478
------------
Net cash used in operating activities............................ (6,584,710)
------------
Investing activities
Purchases of property and equipment.............................. (6,016,812)
Other assets..................................................... (370,756)
------------
Net cash used in investing activities............................ (6,387,568)
------------
Financing activities
Proceeds from issuance of Common Stock........................... 146,605
Net proceeds from issuance of Series B redeemable convertible
preferred stock............................................... 21,426,766
Proceeds from credit line........................................ 300,000
Proceeds from capital lease obligations.......................... 2,080,232
Repayment of credit line......................................... (300,000)
Repayment of debt................................................ (33,344)
Repayment of capital lease obligations........................... (398,326)
------------
Net cash provided by financing activities........................ 23,221,933
------------
Net increase (decrease) in cash and cash equivalents............. 10,249,656
Cash and cash equivalents at beginning of period................. 603,812
------------
Cash and cash equivalents at end of period....................... $ 10,853,468
============
</TABLE>
See accompanying notes.
F-43
<PAGE>
SANDPIPER NETWORKS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Organization and Basis of Presentation
Sandpiper Networks, Inc. (the "Company") was incorporated in December 1996.
The Company and its wholly owned subsidiary, Sandpiper Leasing Corporation
("SLC") provide a subscription-based service that enables web publishers to
migrate their content onto a professionally managed content delivery network.
The Company's service provides publishers with unlimited scalability and
improved performance by avoiding Internet congestion and intelligently
delivering content closer to end-users. The Company has had limited sales of
products, and its customers are Internet publishing companies, located
principally in the United States.
As of September 30, 1999, the Company has an accumulated deficit of
$16,315,569. The Company anticipates that, in the event that profitability is
not attained, the required funding for expenditures will come from sources such
as additional equity or debt financing, collaborative arrangements or
partnership agreements. While management believes that any additional funding
required will be available as necessary, there is no assurance that additional
financing will be available and on terms acceptable to the Company, when
required. If additional funding were not available when needed, the Company
would be required to reduce the rate of administrative costs and research and
development expenditures.
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosures of contingencies at the date of the financial statements, and
affect the reported amount of revenues and expenses during the reporting
period. Actual results could differ from the Company's estimates.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiary, SLC. All significant intercompany
accounts have been eliminated.
Stock Split
In 1997, the Company's Board of Directors approved a Common Stock split
whereby each outstanding share of Common Stock was converted into 8.1530496
shares of Common Stock.
Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of cash deposits at financial institutions.
The Company places its cash deposits with high credit quality financial
institutions. At times, balances in the Company's cash accounts may exceed the
Federal Deposit Limitation ("FDIC") limit.
F-44
<PAGE>
SANDPIPER NETWORKS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Property and Equipment
Property and equipment are stated at cost and depreciated or amortized over
the estimated useful lives of the assets on a straight-line basis. The
estimated useful lives of the assets are as follows:
<TABLE>
<S> <C>
Equipment........................................................ 3 years
Furniture and fixtures........................................... 3-5 years
Software......................................................... 2 years
</TABLE>
Included in this caption are the following assets:
<TABLE>
<CAPTION>
September 30,
1999
-------------
<S> <C>
Operations equipment......................................... $ 4,097,400
Operations software licenses................................. 1,963,200
Other property and equipment................................. 1,476,284
-----------
7,536,884
Accumulated depreciation..................................... (1,490,353)
-----------
Net property and equipment................................... $ 6,046,531
===========
</TABLE>
Revenue recognition
The Company recognizes subscription revenues over the period the services
are provided.
Advertising Expense
Advertising costs are expensed as incurred. Advertising expense for the nine
months ended September 30, 1999 was $734,894.
Research and Development Expenses
Research and development costs are expensed as incurred.
Stock-Based Compensation
The Company accounts for stock option grants in accordance with APB Opinion
No. 25, Accounting for Stock Issued to Employees, which requires the
recognition of expense when the option price is less than the fair value of the
stock at the date of grant.
The Company generally awards options for a fixed number of shares at an
option price equal to the fair value at the date of grant. The Company has
adopted the disclosure-only provisions of FASB's Statement of Financial
Accounting Standards No. 123, Accounting for Stock Based Compensation ("SFAS
123").
2. Credit Arrangements and Long-Term Debt
On February 19, 1998, the Company entered into a $1,000,000 line of credit
with a bank, with a variable rate of interest, based on the bank's lending
rate. Under the terms of the line of credit, up to $750,000 of the credit
facility could be converted to a three-year term loan with similar interest
terms on August 19, 1999, to the extent that Company draws on credit were
supported by capital equipment invoices. At August 19, 1999 there were no
amounts extended on the facility and the facility expired.
F-45
<PAGE>
SANDPIPER NETWORKS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
On August 31, 1998, the Company executed a promissory note with a financial
institution in the amount of $117,568, at a stated interest rate of 7% per
annum, principal and interest due monthly for 36 months and collateralized by
equipment. Aggregate maturities for 1999, 2000 and 2001 are $46,010, $36,816
and $31,743, respectively.
On August 6, 1999, the Company entered into an equipment lease line for $2.0
million that is available over the 12 months following the date of the lease.
The annual interest rate is 7.24% and the line is payable over 36 months. The
lessor received a warrant for 22,425 shares of the Company's common stock at an
exercise price of $1.00 per share.
3. Leases
The Company entered into a $1,500,000 equipment lease line of credit through
which non-cancelable capital lease obligations for computers and equipment were
executed during the year ended December 31, 1998. In addition, the Company
entered into a lease agreement for its facilities on January 6, 1999 under non-
cancelable operating lease agreements expiring through 2005. This operating
lease provides for free rent and escalations.
Annual future minimum lease payments as of September 30, 1999 are as
follows:
<TABLE>
<CAPTION>
Operating Capital
Lease Leases
---------- ----------
<S> <C> <C>
Fiscal (Calendar) year ended
1999................................................ $ 74,805 $ 291,324
2000................................................ 299,227 1,165,297
2001................................................ 313,007 1,053,841
2002................................................ 322,850 411,546
2003................................................ 332,037
2004................................................ 338,599
Thereafter.......................................... 141,083
---------- ----------
Total minimum lease payments........................ $1,821,608 2,922,008
==========
Less amounts representing interest.................. 256,198
----------
Present value of lease payments..................... $2,665,810
==========
</TABLE>
At September 30, 1999, computers, software and equipment under capital
leases had an original cost basis and a net book value of $3,157,316 and
$2,532,985, respectively.
Rent expense was $197,793 for the nine months ended September 30, 1999.
F-46
<PAGE>
SANDPIPER NETWORKS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Income Taxes
The deferred income tax assets and liabilities of the Company consist of the
differences between the financial statements and tax basis of assets and
liabilities, and are measured at the current enacted tax rates. The temporary
differences related to the following as of September 30, 1999 are as follows:
<TABLE>
<CAPTION>
1999
-----------
<S> <C>
Deferred tax assets:
Net operating losses and tax credits........................ $ 4,327,004
-----------
Total deferred tax assets..................................... 4,327,004
Deferred tax liabilities:
Federal benefit for state income taxes........................ 277,694
-----------
Total deferred liabilities.................................... 277,694
-----------
Net deferred tax assets....................................... 4,049,310
Less valuation reserve........................................ (4,049,310)
-----------
$ --
===========
</TABLE>
The Company has net operating loss carryforwards for federal and state
income tax purposes of $17,946,276, which begin to expire in 2004. Research tax
credit carryforwards of $244,195 are available for federal and state tax
purposes that expire beginning in 2013. Utilization of the above carryforwards
is subject to utilization limitations that may inhibit the Company's ability to
use carryforwards in the future.
5. Redeemable Convertible Preferred Stock
At December 31, 1998, the Company is authorized to issue up to 10,278,569
shares of redeemable convertible preferred stock which have been designated as
Series A. As of December 31, 1998, 9,607,141 of Series A have been issued.
In January 1999, the shareholders approved an increase to authorized
redeemable convertible preferred stock to 13,697,640, of which 9,885,981 have
been designated as Series A and 3,811,659 have been designated as Series B.
In April 1999, the shareholders approved an increase to authorized
redeemable convertible preferred stock to 15,912,675, of which 9,885,981 have
been designated as Series A and 6,026,694 have been designated as Series B.
Series A
Series A shares were issued at $0.70 per share and are convertible to one
share of Common Stock. Series A shares are redeemable at $0.70 per share on the
seventh anniversary of the issuance of the first shares issued under this
series (November 17, 2004).
Series B
Series B shares were issued at $4.46 per share and are convertible to one
share of Common Stock. Series B shares are redeemable at $4.46 per share on
November 17, 2004.
F-47
<PAGE>
SANDPIPER NETWORKS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
All Preferred Stock
The redeemable convertible preferred stock contains a liquidation preference
of an amount equal to the price for which such share of redeemable convertible
preferred stock was issued, adjusted for any stock dividends, combinations or
splits with respect to such shares, plus any declared and unpaid dividends on
the redeemable convertible preferred stock.
The redeemable convertible preferred stock is generally convertible at any
time, at the holder's option, into Common Stock based on the conversion ratios
above, subject to future adjustment as defined. The redeemable convertible
preferred stock shall automatically convert into shares of Common Stock upon
the closing of an initial public offering of the Company's Common Stock, or
change of control if the per share price of the stock sold in the offering is
not less than $5.00 per share and the aggregate purchase price of the Common
Stock sold in the offering is not less than $10.0 million. The redeemable
convertible preferred stock contains voting rights identical to those of the
Common Stock.
6. Convertible Notes Payable
In 1997, in contemplation of the Series A redeemable convertible preferred
stock financing (see Note 5), the Company issued convertible notes payable and
warrants (see Note 8) for $600,000 (the bridge financing). In connection with
the close of the Series A redeemable convertible preferred stock financing, the
$600,000 in convertible notes payable were converted into 857,143 shares of
Series A redeemable convertible preferred stock. In addition, during 1997, as
part of the bridge financing, the Company converted accounts payable of
$246,924 to a related party to a promissory note convertible into Series A
redeemable convertible preferred stock. During 1997, in accordance with the
terms of the agreement, the Company repaid $121,924 of the promissory note plus
interest, and, in 1998, the holder converted the remaining $125,000 to Series A
redeemable convertible preferred stock at $0.70 per share.
7. Deferred Compensation
The Company recorded deferred compensation of $4,154,259 for the period from
inception to September 30, 1999. The amount recorded represents the difference
between the grant price and the deemed fair value of the Company's Common Stock
for share subject to options granted. The amortization of the deferred
compensation will be charged to operations over the vesting period of the
options, which is typically four years. Total amortization recognized was
$580,827 for the nine months ended September 30, 1999.
8. Stock
The 1997 Stock Option Plan (the "Plan") provides for the grant of both
incentive stock options and non-statutory stock options to employees, directors
and consultants. The exercise price of the incentive stock options must equal
or exceed the fair market value of the Common Stock at the grant date and the
non-statutory stock options may be less than the fair market value of the
Common Stock at the grant date. The incentive stock options generally vest over
four years whereas the non-statutory stock options generally vest after one
year. The Company has allocated 7,524,629 shares for the Plan. All options
under the Plan must be exercised within ten years from the date of grant.
F-48
<PAGE>
SANDPIPER NETWORKS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Following is a summary of all stock option activity:
<TABLE>
<CAPTION>
Exercise Number of Shares
Price Per ------------------------------------------
Share Employees Directors Consultants Total
---------- --------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Outstanding at December
31, 1998............... 1,114,147 -- 117,499 1,231,646
Granted................. $1.00-5.00 1,505,250 75,160 1,580,410
Exercised............... $0.07-1.25 (224,885) (68,777) (293,662)
Canceled................ (382,781) -- (31,905) (414,686)
---------- --------- ----- ------- ---------
Outstanding at September
30, 1999. 2,011,731 -- 91,977 2,103,708
========== ========= ===== ======= =========
Vested at September 30,
1999.................... 1,213,336 -- 177,962 1,410,256
========== ========= ===== ======= =========
</TABLE>
The weighted average exercise price of options granted during the nine
months ended September 30, 1999 was $1.67 and the weighted average exercise
price of options outstanding at September 30, 1999 was $1.20. The weighted
average exercise price of options canceled during the nine months ended
September 30, 1999 was $0.48 and the weighted average contractual life for
options outstanding at September 30, 1999 was 9.07 years.
Pro forma information regarding net income is required by SFAS No. 123,
Accounting for Stock-Based Compensation, and has been determined as if the
Company has accounted for its employee stock options under the fair value
method of that Statement. The fair value for these options was estimated at the
date of grant using a "minimum value" option pricing model with the following
assumptions for 1999: risk-free interest rate of 6.0%; no dividend yield; and
an expected option life of 4 years. The weighted average fair value of options
granted during 1999 was $0.29 per share.
Based on the "minimum value" option pricing model, pro forma net loss for
the nine months ended September 30, 1999 would not be materially different from
the amounts of net loss reported in the Company's accompanying statements of
operations.
The "minimum value" option valuation model requires the input of highly
subjective assumptions. Because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the
fair value of its employee stock options.
The pro forma net loss for the nine months ended September 30, 1999 is not
representative of the pro forma effect on net income in future years, as pro
forma information in future years will reflect the amortization of a larger
number of stock options granted in succeeding years.
9. Warrants
In 1997, in connection with a financing arrangement, the Company issued
warrants to purchase 171,428 shares of the Company's Series A redeemable
convertible preferred stock at $0.70 per share. These warrants expire on March
31, 2003.
In 1998, in connection with a financing arrangement, the Company issued
warrants to purchase 107,412 shares of the Company's Series A redeemable
convertible preferred stock at $0.70 per
F-49
<PAGE>
SANDPIPER NETWORKS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
share. This warrant expires at the shorter of ten years from the date of grant
or five years from the date of an initial public offering of the Company's
Common Stock or a change in control.
In 1999, in connection with strategic agreements, the Company issued
warrants to purchase 956,066 shares of the Company's Series B redeemable
convertible preferred stock at $4.46 per share, and 125,000 shares at $10.00
per share, and 125,000 at $5.00 per share. These warrants expire at five years
from the date of grant.
In 1999, in conjunction with a financing arrangement, the Company issued
warrants to purchase 22,425 shares of the Company's common stock (See note 2).
The warrants expire the earlier of July 2004 or one year after any applicable
lock up period applicable to the Holder after the Company's initial public
offering or a change in control.
10. Defined Contribution Plan
In 1998, the Company established defined contribution plan for certain
qualified employees as defined in the plan. Participants may contribute up to
the lesser of 6% of pretax compensation subject to certain limitations, or
$6,000. The plan provides for required contributions of 1% to 3% by the Company
as defined in the plan. The Company's accrued contribution for the nine months
ended September 30, 1999 was $19,660.
11. Related Party Transactions
Prior to financing, the Company's operating activities were performed and
funded by Sandpiper Consulting, a Limited Liability Company (the "LLC") owned
by several common stockholders and officers of the Company. These expenditures
were accumulated at cost and converted to a convertible note in the bridge
financing (see Note 6). Subsequent to the bridge financing, LLC continued to
provide services directly to the Company, which were billed at cost and
reimbursed from Company funds. As of September 30, 1999, the Company no longer
obtains services from LLC. There were no payments to LLC relating to the nine
months ended September 30, 1999.
The LLC was a holder of 509,566 shares of the Company's Common Stock. Under
an agreement with the investors in the Series A redeemable convertible
preferred stock financing, LLC agreed to hold these shares exclusively for the
benefit of the employees of LLC. During 1998, all LLC employees were
transferred to the Company. As a result, under the terms of the agreement,
these shares were purchased from the LLC for $35,670. Further, during 1998
these shares were allocated to the 1997 Stock Option Plan (see Note 8).
12. Year 2000 Issue
The Company developed a plan to modify its information technology, as
necessary, to be ready for the Year 2000. The Company completed this project at
a total cost of $44,427. This amount includes internal costs, but excludes the
costs to upgrade and replace systems in the normal course of business. This
project did not have a significant impact on operations.
F-50
<PAGE>
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- -------------------------------------------------------------------------------
No dealer, salesperson or other person is authorized to give any informa-
tion or to represent anything not contained in this prospectus. You must not
rely on any unauthorized information or representations. This prospectus is an
offer to sell only the shares offered hereby, but only under circumstances and
in jurisdictions where it is lawful to do so. The information contained in
this prospectus is current only as of its date.
---------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 9
Special Note Regarding Forward-Looking Statements......................... 26
Price Range of Common Stock............................................... 27
Use of Proceeds........................................................... 27
Dividend Policy........................................................... 27
Capitalization............................................................ 28
Selected Consolidated Financial Data...................................... 29
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 31
Business.................................................................. 40
Management................................................................ 57
Certain Transactions...................................................... 72
Principal and Selling Stockholders........................................ 77
Description of Capital Stock.............................................. 80
Underwriting.............................................................. 84
Shares Eligible for Future Sale........................................... 86
Validity of Common Stock.................................................. 87
Experts................................................................... 87
Where You Can Find More Information....................................... 87
Index to Consolidated Financial Statements................................ F-1
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
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5,000,000 Shares
Digital Island, Inc.
Common Stock
---------------
[LOGO OF Digital Island, Inc.]
---------------
Goldman, Sachs & Co.
Bear, Stearns & Co. Inc.
Lehman Brothers
Merrill Lynch & Co.
Thomas Weisel Partners LLC
Dain Rauscher Wessels
Representatives of the Underwriters
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
