<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2000.
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to.
Commission File Number: 000-26283
Digital Island, Inc.
(Exact name of Registrant as specified in its charter)
Delaware 68-0322824
(State or other jurisdiction of (IRS Employer Identification No.)
Incorporation or organization)
45 Fremont Street, Suite 1200, San Francisco, California 94105
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (415) 228-4100
----------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of April 30, 2000, there were 66,862,910 shares of the Registrant's
Common Stock outstanding, par value $0.001.
<PAGE>
DIGITAL ISLAND, INC.
Form 10-Q Quarterly Report
For the Quarter Ended March 31, 2000
TABLE OF CONTENTS
Page
Number
------
PART I. Financial Information
Item 1 Financial Statements......................................... 3
Condensed Consolidated Balance Sheets as of September 30,
1999 and March 31, 2000(unaudited) ......................... 3
Condensed Consolidated Statements of Operations for the
three and six months ended March 31, 1999 and 2000
(unaudited)................................................. 4
Condensed Consolidated Statements of Cash Flows for the
six months ended March 31, 1999 and 2000 (unaudited)....... 5
Notes to Condensed Consolidated Financial Statements........ 6
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 10
Item 3 Quantitative and Qualitative Disclosures About Market Risk... 15
PART II. Other Information
Item 1 Legal Proceedings............................................ 39
Item 2 Changes in Securities and Use of Proceeds.................... 39
Item 3 Defaults Upon Senior Securities.............................. 42
Item 4 Submission of Matters to a Vote of Security Holders.......... 42
Item 5 Other Information............................................ 42
Item 6 Exhibits and Reports on Form 8-K............................. 42
Signatures............................................................ 45
2
<PAGE>
PART I--FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
DIGITAL ISLAND, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
September 30, March 31,
1999 2000
----------- -----------
(Unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents ...................... $ 43,315 $ 627,042
Investments .................................... 31,691 87,856
Accounts receivable, net ....................... 3,557 11,570
Restricted cash ................................ 763 2,063
Prepaid expenses and other ..................... 1,825 14,078
----------- -----------
Total current assets ......................... 81,151 742,609
Investments ...................................... -- 4,999
Property and equipment, net ...................... 25,273 91,192
Goodwill, net .................................... -- 870,024
Intangible assets, net ........................... -- 121,641
Unamortized convertible note issuance costs ...... -- 10,521
Other assets, net ................................ 1,224 2,328
----------- -----------
Total assets ................................. $ 107,648 $ 1,843,314
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Bank borrowings ................................ $ 801 $ 122
Capital lease obligations ...................... 3,916 11,258
Accounts payable ............................... 8,621 20,348
Accrued liabilities ............................ 4,931 8,365
Cash overdraft ................................. 3,058 5,548
Interest payable ............................... -- 1,725
Deferred revenue ............................... 318 486
----------- -----------
Total current liabilities .................... 21,645 47,852
Bank borrowings, less current portion ............ 314 --
Convertible notes ................................ -- 345,000
Capital lease obligations, less current portion .. 6,061 6,908
Deferred revenue ................................. 410 602
Other liabilities ................................ -- 137
----------- -----------
Total liabilities ............................ 28,430 400,499
----------- -----------
Stockholders' equity:
Preferred stock, $0.001 par value: Authorized:
10,000,000 shares; no shares issued and
outstanding ................................... -- --
Common stock, $0.001 par value: Authorized:
100,000,000 shares; issued and outstanding:
35,941,727 shares at September 30, 1999 and
66,802,946 shares at March 31, 2000
(unaudited) ................................... 36 67
Additional paid-in capital ..................... 156,791 1,634,043
Deferred compensation .......................... (4,033) (2,650)
Stockholder notes receivable ................... (514) (422)
Common stock warrants .......................... -- 1,530
Accumulated deficit ............................ (73,062) (189,753)
----------- -----------
Total stockholders' equity ................... 79,218 1,442,815
----------- -----------
Total liabilities and stockholders' equity ... $ 107,648 $ 1,843,314
=========== ===========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
March 31, March 31,
---------------------------- ----------------------------
1999 2000 1999 2000
------------ ------------ ------------ ------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Revenue ...................... $ 2,411 $ 11,329 $ 3,795 $ 18,929
Costs and expenses:
Cost of revenue ............ 4,827 22,887 7,750 39,151
Sales and marketing ........ 3,125 14,775 5,170 21,090
Product development ........ 1,167 4,492 2,010 7,035
General and administrative . 1,703 11,253 2,963 15,951
Amortization of intangible
assets .................. -- 51,795 -- 53,492
Stock compensation expense . 680 628 1,026 1,383
------------ ------------ ------------ ------------
Total costs and expenses . 11,502 105,830 18,919 138,102
------------ ------------ ------------ ------------
Loss from operations ..... (9,091) (94,501) (15,124) (119,173)
------------ ------------ ------------ ------------
Interest income,net .......... 160 1,792 257 2,489
------------ ------------ ------------ ------------
Loss before income taxes . (8,931) (92,709) (14,867) (116,684)
Provision for income taxes ... -- 2 2 7
------------ ------------ ------------ ------------
Net loss ................. $ (8,931) $ (92,711) $ (14,869) $ (116,691)
============ ============ ============ ============
Basic and diluted net loss per
share ....................... $ (3.77) $ (1.49) $ (6.28) $ (2.36)
============ ============ ============ ============
Weighted average shares
outstanding used in per share
calculation ................. 2,370,602 62,209,533 2,366,951 49,386,278
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
For the six months
Ended March 31,
--------------------------
1999 2000
----------- -----------
(unaudited) (unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net loss ........................................ $ (14,869) $ (116,691)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization ................. 924 61,776
Stock compensation expense .................... 1,026 1,383
Amortization of discounts on investments ...... (171) (986)
Change in operating assets and liabilities, net
of business acquisitions ..................... 2,695 (16,923)
----------- -----------
Net cash used in operating activities ....... (10,395) (71,441)
----------- -----------
Cash flows from investing activities:
Purchases of property and equipment ............. (2,284) (52,412)
Proceeds from maturities of short-term
investments .................................... 12,200 34,454
Business acquisitions, net cash paid ............ -- (543)
Restricted cash ................................. -- (1,300)
Purchases of short-term investments ............. (22,822) (94,632)
----------- -----------
Net cash used in investing activities ....... (12,906) (114,433)
----------- -----------
Cash flows from financing activities:
Repayment of stockholder note ................... -- 90
Proceeds from issuance of common stock,net ...... 41 437,802
Proceeds from issuance of convertible notes,net . -- 334,289
Proceeds from issuance of preferred stock ....... 47,462 --
Proceeds from bank borrowings ................... 532 --
Repayments of bank borrowings ................... (286) (1,077)
Repayments of capital lease obligations ......... (408) (1,503)
----------- -----------
Net cash provided by financing activities ... 47,341 769,601
----------- -----------
Net increase in cash and cash equivalents ... 24,040 583,727
Cash and cash equivalents, beginning of period .... 5,711 43,315
----------- -----------
Cash and cash equivalents, end of period .......... $ 29,751 $ 627,042
=========== ===========
Supplemental disclosures of cash flow information:
Cash paid for interest .......................... $ 168 $ 657
=========== ===========
Cash paid for income taxes ...................... $ 2 $ 7
=========== ===========
Supplemental schedule of non-cash investing and
financing activities:
Fixed asset acquired in exchange for stock ...... $ -- $ 5,965
=========== ===========
Acquisition of subsidiaries in exchange for
stock ........................................ $ -- $ 1,033,516
=========== ===========
Capital lease obligations for equipment ......... $ 740 $ 6,977
=========== ===========
Warrants issued in exchange for services ........ $ -- $ 1,530
=========== ===========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying condensed consolidated financial statements include the
accounts of Digital Island, Inc. and its wholly-owned subsidiaries, Sandpiper
Networks, Inc., Live On Line, Inc., Digital Island B.V., Digital Island,
Ltd., Digital Island (Europe) SA, Digital Island (Hong Kong), Ltd., and Digital
Island (Japan) KK, (collectively, "Digital Island"). All intercompany accounts
and transactions have been eliminated in the accompanying condensed consolidated
financial statements.
In the opinion of management, the condensed consolidated financial
statements reflect all normal and recurring adjustments that are necessary for a
fair presentation of the results for the periods shown. The results of
operations for such periods are not necessarily indicative of the results
expected for the full fiscal year or for any future period.
2. Stock Offering and Convertible Note Issuance
On February 23, 2000, Digital Island completed an offering of its common
stock, as well as an offering of convertible subordinated notes. Digital Island
issued 4,014,273 shares of common stock for net proceeds of approximately $409.7
million. Digital Island also issued convertible subordinated notes for net
proceeds of approximately $334.3 million. The notes bear interest at a rate of
6% per annum, which is paid twice a year, on each February 15 and August 15. The
notes mature on February 15, 2005. The notes are convertible at any time prior
to the maturity date. The conversion price is approximately $131.61 per share.
3. Acquisitions
On December 28, 1999, Digital Island acquired Sandpiper Networks, Inc.
("Sandpiper") through the merger of a wholly owned subsidiary of Digital Island
with and into Sandpiper. In the merger, each outstanding share of Sandpiper
capital stock was exchanged for 1.0727 shares of Digital Island's common stock
and all outstanding stock options and warrants were assumed. Digital Island
issued 24.6 million shares of common stock and 3.1 million stock options and
warrants. The total purchase price of approximately $967.6 million was allocated
primarily to intangible assets and goodwill which will be amortized over 5
years.
6
<PAGE>
Pro Forma Disclosure of Sandpiper Networks, Inc. Acquisition
The following summary, prepared on a pro forma basis, combines the results
of Digital Island as if the acquisition had been made on the first day of the
fiscal years presented, after including the impact of certain pro forma
adjustments such as increased amortization expense due to recording of
intangible assets:
<TABLE>
<CAPTION>
Six Months
Ended March 31,
(unaudited)
-------------------------
1999 2000
---------- ----------
(in thousands
except per share
data)
<S> <C> <C>
Revenues ............................... $ 3,837 $ 19,783
Net Loss ............................... (116,454) (219,143)
Basic and diluted loss per share ....... (12.99) (4.15)
</TABLE>
On January 18, 2000, Digital Island acquired Live On Line, Inc. ("LOL")
through the merger of a wholly owned subsidiary of Digital Island with and into
LOL. In the merger, the former shareholders of LOL received a total of 799,989
shares of Digital Island's common stock, and $5.3 million in cash, in exchange
for all outstanding shares of LOL and the assumption of outstanding warrants.
The total purchase price of approximately $71.1 million was allocated primarily
to intangible assets and goodwill.
4. Purchase of Technology
In December 1999, Digital Island agreed to purchase patented technology
from SRI International ("SRI"). Under terms of the agreement, Digital Island
is to acquire the technology in exchange for $10 million of common stock, to
be distributed upon the occurrence of certain milestones. As of March 31,
2000, a total of 120,434 shares of common stock had thus far been issued. The
value of stock issued under the agreement is recorded as network equipment and
technology. Digital Island guarantees that the value of the stock issued to
SRI will have a value of $10 million at the time of issuance, and at the time
that SRI can dispose of the stock.
7
<PAGE>
DIGITAL ISLAND, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. Strategic Relationship
In December 1999, Digital Island entered into a memoranda of understanding
with Sun Microsystems, Inc. ("Sun") and Inktomi Corporation ("Inktomi")
providing for a joint strategic relationship. Under the terms of the
arrangement, Digital Island has agreed to purchase up to $150 million of Sun
equipment. Sun is to provide Digital Island with $100 million in lease financing
for the acquisition of the equipment, to be made available upon the achievement
of certain milestones. In addition, there is to be joint sales and marketing
efforts between Digital Island, and Sun and Inktomi. Sun also received warrants
to purchase up to $10 million of Digital Island's common stock at points in time
corresponding to the achievement of certain milestones.
In connection with this strategic relationship, Sun purchased 391,869
shares of Digital Island's common stock for $20 million, and Inktomi purchased
117,561 shares for $6 million in January 2000.
6. Warrant
In December 1999, Digital Island entered into a Co-Location and Content
Distribution Agreement the ("Agreement") with ServiceCo LLC ("ServiceCo") The
Agreement allows Digital Island to physically locate its servers in ServiceCo
regional data center facilities, and runs for a period of two years. In
connection with the Agreement, Digital Island agreed to grant warrants to
ServiceCo to purchase common stock of Digital Island. The warrants are issued
upon the achievement of specified performance. Upon ServiceCo making space
available to Digital Island in at least four regional data centers, Digital
Island agreed to grant a warrant for 26,817 shares with an exercise price of
$96.95 per share. Digital Island further agreed to grant a warrant for another
26,817 shares with an exercise price of $96.95 per share at such time as
ServiceCo makes a total of eight regional data centers available to Digital
Island.
As of March 31, 2000, ServiceCo had made four regional data centers
available, and had thus earned the right to the first warrant. The charge
associated with this warrant, based on the use of the Black-Scholes valuation
method, is currently valued at $1.5 million. The charge will be amortized over
the term that services are received, which is the term of the Agreement, and
is subject to remeasurement at the end of each accounting period.
7. Calculation of Net Loss Per Share
Shares used in computing basic and diluted net loss per share are based on
the weighted average shares outstanding in each period. The effect of
8
<PAGE>
outstanding stock options and warrants is excluded from the calculation of
diluted net loss per share as their inclusion would be antidilutive.
The following is a reconciliation of the numerator and denominator of the
basic and diluted earnings per share (EPS) calculation (in thousands, except for
share and per share amounts):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
March 31, March 31,
---------------------------- ----------------------------
1999 2000 1999 2000
------------ ------------ ------------ ------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Numerator--Basic and Diluted
EPS Net Loss ................. $ (8,931) $ (92,711) $ (14,869) $ (116,691)
=========== ============ ============ ============
Denominator--Basic and Diluted
EPS
Weighted average Common Stock
Outstanding ................ 2,589,852 63,784,282 2,586,201 50,186,509
Common Stock subject to
repurchase ................. (219,250) (1,574,749) (219,250) (800,231)
----------- ------------ ------------ ------------
Total weighted average Common
Stock outstanding .......... 2,370,602 62,209,533 2,366,951 49,386,278
============ ============ ============ ============
Basic and diluted loss per
share ........................ $ (3.77) $ (1.49) $ (6.28) $ (2.36)
============ ============ ============ ============
</TABLE>
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF
DIGITAL ISLAND CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION
27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934, AS AMENDED. DIGITAL ISLAND'S ACTUAL RESULTS AND THE TIMING
OF CERTAIN EVENTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE
FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING, BUT NOT
LIMITED TO, THOSE SET FORTH UNDER "RISK FACTORS" AND ELSEWHERE IN THIS QUARTERLY
REPORT AND IN OTHER DOCUMENTS FILED BY DIGITAL ISLAND WITH THE SECURITIES AND
EXCHANGE COMMISSION.
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 March 31, 2000, we had contracts with 269 customers, of which
194 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.
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
10
<PAGE>
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 March 31, 2000 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 $1.4 million was amortized in the six
months ended March 31, 2000. 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.
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 market value of $857.0 million, 3.1 million vested and unvested stock
options and warrants with a fair market 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 was accounted for using the purchase method of accounting. The
acquisition price included 799,989 shares of Digital Island common stock with a
fair market value of $65.9 million and $5.2 million in cash. Costs associated
with the merger of Digital Island and Live On Line that impact future
earnings include the amortization of assembled workforce costs of $500,000, core
technology costs of $3.1 million and $67.4 million of goodwill to be amortized
over a period of 5 years.
11
<PAGE>
In connection with the Live On Line merger, we expect amortization costs over
the next five years as follows (in thousands):
<TABLE>
<CAPTION>
Year ending
September 30,
<S> <C>
2000......................... $ 9,962
2001......................... 14,204
2002......................... 14,204
2003......................... 14,204
2004......................... 14,204
2005......................... 4,240
</TABLE>
The following discussion comparing our historical results of operations for
the three and six months ended March 31, 1999 does not reflect the results of
operations of Sandpiper or Live On Line. The discussion comparing the three
and six months ended March 31, 2000 reflects the results of operations of
Sandpiper from the date of acquisition, December 28, 1999, and Live On Line
from the date of acquisition, January 18, 2000.
Three months Ended March 31, 2000 and 1999
Revenue. Revenue increased to $11.3 million for the months ended March 31,
2000 from $2.4 million for the three months ended March 31, 1999. The increase
in revenue was primarily due to increase usage per customer and an increase in
the number of deployed customers to 194 from 48.
Cost of revenue. Cost of revenue increased to $22.9 million for the three
months ended March 31, 2000 from $4.8 million for the three months ended March
31, 2000. The increase in cost of revenue was due to $10.2 million of spending
for additional network capacity, $3.4 million in recruitment and compensation
costs relating to the addition of network operations personnel, and $4.5
million in additional costs associated with expansion of existing data center
facilities and the deployment of the San Jose facility.
Sales and Marketing. Sales and marketing expenses increased to $14.8 million
for the three months ended March 31, 2000 from $3.1 million for the three
months ended March 31, 1999. This increase was due to $7.0 million of growth
in personnel and related costs and $4.7 million of program expenses.
Product Development. Product development expenses increase to $4.5 million for
the three months ended March 31, 2000 from $1.2 million for the three months
ended March 31, 1999. This increase was due to $3.3 million growth in
personnel and related expenses.
General and Administrative. General and administrative expenses increased to
$11.3 million for the three months ended March 31, 2000 from $1.7 million for
the three months ended March 31, 1999. This increase was due to $5.6 million
of depreciation of network equipment, $1.7 million in growth of personnel and
related expenses and $2.3 million of office facility expenses, legal and
accounting fees and other administrative related expenses.
Interest income, net. Interest income, net increased to $1.8 million for the
three months ended March 31, 2000 from $160,000 for the three months ended
March 31, 1999. 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 secondary stock offering and issuance of convertible notes, and
was offset by accrued interest expense on the convertible notes.
Six Months Ended March 31, 2000 and 1999
Revenue. Revenue increased to $18.9 million for the six months ended March 31,
2000 from $3.8 million for the six months ended March 31, 1999. The increase in
revenue was primarily due to increased usage per customer and an increase in the
number of deployed customers to 194 from 48.
Cost of Revenue. Cost of revenue increased to $39.1 million for the six months
ended March 31, 2000 from $7.8 million for the six months ended March 31, 1999.
The increase in cost of revenue was due to the $21.7 million of spending for
additional network capacity and $5.6 million in recruitment and compensation
costs relating to the addition of network operations personnel and $4.0
million in additional costs associated with expansion of existing data center
facilities and the deployment of the San Jose facility.
Sales and Marketing. Sales and marketing expenses increased to $21.1 million for
the six months ended March 31, 2000 from $5.2 million for the six months ended
March 31, 1999. This increase was due to $10.4 million of growth in personnel
and related costs and $5.5 million of program expenses.
Product Development. Product development expenses increased to $7.0 million for
the six months ended March 31, 2000 from $2.0 million for the six months ended
March 31, 1999. This increase was due to $5.0 million in growth of personnel
and related expenses.
General and Administrative. General and administrative expenses increased to
$16.0 million for the six months ended March 31, 2000 from $3.0 million for the
six months ended March 31, 1999. This increase was due to $7.4 million of
depreciation of network equipment, $2.3 million in growth of personnel and
related expenses and $3.3 million of office facility expenses, legal and
accounting fees and
12
<PAGE>
other administrative related expenses.
Interest Income, net. Interest income, net increased to $2.5 million for the six
months ended March 31, 2000 from $257,000 for the six months ended March 31,
1999. 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 secondary
stock offering and issuance of convertible notes, and was offset by accrued
interest expense on the convertible notes.
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. In February 2000, we raised $744.0 million in net
proceeds from our secondary offering of common stock and issuance of convertible
subordinated notes as of March 31, 2000, we had cash, cash equivalents and
short-term investments totaling $714.9 million.
Net cash used in our operating activities for the six months ended March
31, 2000 was $71.4 million. The net cash used by operations was comprised
primarily of working capital requirements and net losses, net of amortization of
intangible assets. Net cash used in our investment activities was $114.4
million for the six months ended March 31, 2000 and was comprised primarily of
equipment purchases of $52.4 million, investments of $94.6 million in commercial
paper with maturities of less than one year, cash paid in the acquisition of
Live On Line of $5.3 million, and a $1.3 million increase in restricted cash,
which were offset by proceeds from investments which matured of $34.4 million
and cash acquired through business acquisitions of $4.7 million. Net cash
provided by financing activities was $769.6 million and was related primarily to
proceeds from the issuance of stock and notes of $772.1 million, which was
offset by repayments of debt of $2.6 million.
We have a $750,000 revolving line of credit with a commercial bank for the
purpose of financing equipment purchases. 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%,
and is payable monthly.
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. 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%, and is payable monthly. Under the terms
of the equipment loan facilities, interest is charged at the lender's prime rate
plus 0.75%,
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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.
At March 31, 2000, there were no borrowings under any of these credit
facilities.
Pursuant to the merger with Sandpiper, we assumed from Sandpiper a
$1,000,000 line of credit with a bank. The line of credit has a variable rate
of interest, based on the bank's prime rate plus 0.5%. At March 31, 2000, 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 $18.2 million at March 31, 2000, 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, subject to certain milestones, for the acquisition of equipment.
The execution of our business plan will require substantial 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 $150.0 million of capital
expenditures for network expansion, facilities and related costs in the next 12
months.
We believe that the net proceeds from our secondary offering of common
stock and issuance of convertible subordinated notes, together with our existing
cash and funds available under our existing credit facilities, will be
sufficient to fund our operating losses, working capital needs and capital
expenditures for at least the next 12 months. The execution of our business plan
will require substantial capital to fund our operating losses, working capital
needs, sales and marketing expenses, lease payments and capital expenditures
thereafter. We intend to continue to consider our future financing alternatives,
which may include the incurrence of additional 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;
. development plans or projections proving to be inaccurate;
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. our engaging in acquisitions or other strategic transactions; or
. 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 in the near term.
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 133 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.
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation, an Interpretation of APB Opinion No. 25" (the "Interpretation").
The Interpretation is intended to clarify certain issues that have arisen in
practice since the issuance of APB 25. The Company will adopt the interpretation
on July 1, 2000 and does not expect such adoption to have an impact on the
Company's results of operations, financial position or cash flow.
In December 1999, the Securities Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
101"). SAB 101 is effective no later than the quarter ended March 31, 2001. The
Company does not expect that the adoption of SAB 101 will have a material effect
on the consolidated financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES 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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RISK FACTORS
Set forth below and elsewhere in this Quarterly Report and in the other
documents we file with the SEC are risks and uncertainties that could cause
actual results to differ materially from the results contemplated by the
forward looking statements contained in this Quarterly Report.
Risks Related to Digital Island
We have a short operating history.
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 six months ended March 31,
2000, our operating loss, negative cash flow from operations and net loss were
$119.2 million, $71.4 million and $116.7 million, respectively.
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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 $150 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;
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. 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;
. 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.
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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 contracts with 83
billing customers, of which one, E*TRADE, accounted for approximately 35% of our
revenues. As of March 31, 2000, we had contracts with 269 customers of which
194 were deployed. E*TRADE accounted for approximately 30% of our revenues
during the six months ended March 31, 2000. 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.
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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
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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;
. 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.
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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 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.
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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.
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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 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
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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 and Live On Line mergers, 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 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
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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:
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. 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.
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.
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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.
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
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<PAGE>
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 and Live On Line Mergers
If we do not successfully integrate Sandpiper's or Live On Line'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 mergers with the expectation that the mergers will result
in significant benefits. Achieving the benefits of the mergers 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
three companies. We will need to overcome significant obstacles, however, in
order to realize any benefits or synergies from the mergers. 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 and Live On Line mergers if:
. the integration of Digital Island, Sandpiper and Live On Line is
unsuccessful;
. Digital Island does not achieve the perceived benefits of the mergers
as rapidly or to the extent anticipated by financial or industry
analysts; or
. the effect of the mergers 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 three companies will significantly divert
management's attention from other important issues.
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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 and Live On Line, 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 and Live On
Line's databases 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 these mergers.
In addition, we intend to develop new products and services that combine
the knowledge and resources of the Digital Island, Sandpiper and Live On Line
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.
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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 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.
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
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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.
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.
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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;
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<PAGE>
. 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.
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.
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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.
Substantial leverage and debt service obligations may adversely affect our cash
flow.
We have substantial amounts of outstanding indebtedness, primarily
consisting of the convertible subordinated notes that were issued in February
2000. As a result of this indebtedness, our principal and interest payment
obligations have increased 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 any financing arrangements
will be available.
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.
The notes are subordinated to all other senior debt.
The notes are unsecured and subordinated in right of payment to all of
our existing and future senior indebtedness, as defined in the indenture
governing the notes. As a result, in the event of bankruptcy, liquidation or
reorganization or upon acceleration of the notes due to an event of default,
as defined herein, and in specific other events, our assets will be available
to pay obligations on the notes only after all senior indebtedness has been
paid in full in cash or other payment satisfactory to the holders of senior
indebtedness. There may not be sufficient assets remaining to pay amounts due
on any or all of the notes then outstanding. The notes are also effectively
subordinated to the liabilities, including trade payables, of any of our
subsidiaries. The indenture governing the notes does not prohibit or limit the
incurrence of senior indebtedness or the incurrence of other indebtedness and
other liabilities by us or our subsidiaries. The incurrence of additional
indebtedness and other liabilities by us or our subsidiaries could adversely
affect our ability to pay obligations on the notes. As of March 31, 2000, we
had approximately $18.2 million of indebtedness outstanding that would have
constituted senior indebtedness. We anticipate that from time to time we will
incur additional indebtedness, including senior indebtedness.
The notes contain limitations on redemption upon a change in control.
Upon a change in control, as defined herein, each holder of the notes has
rights, at the holder's option, to require us to redeem all or a portion of
the holder's notes. Although the indenture allows us, subject to satisfaction
of conditions, to pay the redemption price in shares of common stock, if a
change in control were to occur, we may not have sufficient funds to pay the
redemption price for all the notes tendered by holders. Any future credit
agreements or other agreements relating to other indebtedness, including other
senior indebtedness, to which we become a party may contain restrictions or
prohibitions on the payment of the redemption price while such indebtedness is
outstanding. In the event a change in control occurs at a time when we are
prohibited from purchasing or redeeming the notes, we could seek the consent of
lenders to the purchase of the notes or could attempt to refinance the
borrowings that contain this prohibition. If we do not obtain a consent or repay
these borrowings, we would remain prohibited from purchasing or redeeming the
notes. Our failure to redeem tendered notes would constitute an event of default
pursuant to the indenture under which the notes will be issued, which might
constitute a default under the terms of other indebtedness that we may enter
into from time to time. In these circumstances, the subordination provisions in
the indenture would likely restrict payments to the holders of the notes. The
term "change in control" is limited to specified transactions and may not
include other events that might adversely affect our financial condition. In
addition, the requirement that we offer to repurchase the notes upon a change in
control does not necessarily afford holders of the notes protection in the event
of a highly leveraged transaction, reorganization, merger or similar transaction
involving us.
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.
Sales of substantial amounts of our common stock (including shares issued
upon the exercise of outstanding options and warrants) in the public, or the
appearance that a large number of shares is available for sale, could depress
the market price for our common stock. Our executive officers, directors and
stockholders holding 20,691,749 shares of our common stock, or approximately 31%
of our common stock outstanding on March 31, 2000, have agreed not to sell or
otherwise dispose of any of their shares for a period of 90 days after the
effective date of our secondary stock offering, 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 transferring shares of our common stock. These market standoff
agreements, however, expired with the occurrence of the secondary stock
offering, and as a result all such shares which are not subject to the foregoing
lock-up agreements became available for sale.
In addition, as of January 31, 2000, 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.
Our executive officers, directors and parties related to them own
approximately 31% of our outstanding common, 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.
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Our management has broad discretion in allocating proceeds from the February
2000 secondary stock offering and convertible subordinated note issuance, which
it may not use effectively.
The net proceeds to us from our recent offerings, after deducting any
underwriting commissions and expenses payable by us, were approximately $744
million. The primary purpose of our recent offerings were 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 the recent
offerings. The failure of management to apply these funds effectively could
negatively impact our business and prospects.
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PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(c) Recent Sales of Unregistered Securities
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 received a total of $5.3 million in
exchange for all outstanding shares of Live On Line common stock and our
assumption of all outstanding warrants of Digital Island. 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. The shares
were issued pursuant to an
39
<PAGE>
exemption from registration under Section 4(2) of the Securities Act of 1933, as
amended.
(d) Use of Proceeds. Paragraph references herein refer to the respective
paragraphs of Item 701(f) of Regulations S-K.
(1) Effective date of the Registration Statement and Commission File No.:
June 28, 1999; 333-77039.
(2) Offering Date: June 29, 1999.
(3) N/A.
(4) Information regarding the offering.
(i) The offering has terminated and all registered shares were sold.
(ii) Managing Underwriters: Bear, Stearns & Co. Inc., Lehman Brothers
Inc. and Thomas Weisel Partners LLC.
(iii) Title of Securities Registered: Common Stock.
(iv) 6,900,000 shares were registered, all on behalf of the Company;
all shares were sold for an aggregate offering price of $69,000,000.
(v) Amount of expenses incurred for the Company's account:
. underwriting discount: $4,830,000
. other expenses: estimated at approximately $1,000,000
. total expenses: : estimated at approximately $5,830,000
A. All of such total expenses were payments to others (i.e., not to
directors, officers, and 10% stockholders of the Company.)
(vi) Net proceeds: $63,170,000
(vii) Actual amount of net proceeds used for:
. construction of plant, building and facilities: $14,742,000
. purchase and installation of machinery and equipment: $
9,853,000
. purchases of real estate: $0
. acquisition of other businesses: $0
. repayment of indebtedness: $1,540,000
. working capital: $37,035,000
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. temporary short-term investments: $0
. Total: $63,170,000
41
<PAGE>
A. N/A. No payments were made from the effective date of the Registration
Statement to the end of the reporting period
(viii) N/A
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
2.1* Agreement and Plan of Reorganization dated as of October
24, 1999, by and among the Registrant, Beach Acquisition
Corp. and Sandpiper Network, Inc.
3.1* Amended and Restated Certificate of Incorporation
3.2* Bylaws, as amended to date
4.1 Reference is made to Exhibit 3.1
4.2 Reference is made to Exhibit 3.2
4.3* Specimen Common Stock Certificate
4.4* Amended and Restated Investors' Rights Agreement, among
the Registrant and the parties listed on the signature
pages thereto, dated February 19, 1999
4.5* Amendment No. 1 to Amended and Restated Investors'
Rights Agreement, dated April 9, 1999.
4.6**** Form of Indenture
10.1* 1997 Stock Option and Incentive Plan
10.2* 1998 Stock Option/Stock Issuance Plan, as amended to
date
10.3* 1999 Stock Incentive Plan
10.4* 1999 Employee Stock Purchase Plan
10.5* Form of Indemnification Agreement for Officers and
Directors
10.6* Employment Agreement between the Registrant and Ruann
Ernst
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<PAGE>
10.7* Employment Agreement between the Registrant and Allan
Leinwand
10.8* Employment Agreement between the Registrant and Timothy
M. Wilson
10.9* Employment Agreement between the Registrant and Paul
Evenson
10.10** Employment Agreement between the Registrant and Michael
T. Sullivan
10.11* Employment Agreement between the Registrant and Leo S.
Spiegal
10.12* Employment Agreement between the Registrant and Andrew
Swart
10.13* Employment Agreement between the Registrant and David
Farber
10.14* Lease between the Registrant and Bishop Street
Associates, dated October 21, 1996, as amended to date.
10.15* Lease Agreement between the Registrant and Forty-Five
Fremont Associates, dated May 5, 1999.
10.16* Note Secured by Stock Pledge Agreement by Ruann Ernst to
Registrant, dated April 21, 1999.
21.1*** Subsidiaries of the Registrant
27.1 Financial Data Schedule
*Incorporated by reference to Exhibits of the Registrant's Registration
Statement on Form S-4 (File No. 333-92393), filed on December 9, 1999.
**Incorporated by reference to Exhibit of the Registrant's Registration
Statement on Form S-1 (File No. 333-77039) filed on April 26, 1999.
***Incorporated by reference to Exhibit of the Registrant's Registration
Statement on Form S-1 (File No. 333-95121), as amended, filed on February 1,
2000.
****Incorporated by reference to Exhibits of the Registrant's
Registration Statement on S-1 (File no. 333-95123), filed on February 1, 2000.
43
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(b) Reports on Form 8-K.
On January 5, 2000, Digital Island filed a Current Report on Form 8-K,
announcing the completion of the merger and acquisition of Sandpiper
Networks, Inc.
44
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
Date: May 12, 2000 DIGITAL ISLAND, INC.
(Registrant)
Date: May 12, 2000 By: /s/ Ruann F. Ernst
-----------------------------------
Ruann F. Ernst,
Chief Executive Officer and
President
(Principal Executive Officer)
Date: May 12, 2000 By: /s/ T.L. Thompson
-----------------------------------
T.L. Thompson,
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
45
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<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-START> JAN-1-2000
<PERIOD-END> MAR-31-2000
<CASH> 627,042
<SECURITIES> 87,856
<RECEIVABLES> 12,292
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</TABLE>
