UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 No. 000-31111
INTERLAND, INC.
(Exact name of registrant as specified in its charter)
Georgia 58-1632664
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
303 Peachtree Center Avenue
Suite 500
Atlanta, Georgia 30308
(Address, including zip code, of principal
executive offices)
(404) 720-8301
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has
filed all reports required to be filed by Section 13
or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period
that the registrant was required to file such
reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
---- ----
The registrant had 46,723,585 shares of Common Stock, no par value, outstanding
as of October 31, 2000.
<PAGE>
INTERLAND, INC.
FORM 10Q
SEPTEMBER 30, 2000
INDEX
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements Page
----
Condensed Consolidated Balance Sheets at September 30, 2000
(Unaudited) and December 31, 1999 3
Condensed Consolidated Statements of Operations for the three
months and nine months ended September 30, 2000 and 1999
(Unaudited) 4
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 30, 2000 and 1999 (Unaudited) 5
Notes to Condensed Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk 25
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 26
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 6. Exhibits and Reports on Form 8-K 28
Signatures 29
2
<PAGE>
PART I - FINANCIAL INFORMATION.
INTERLAND, Inc.
Condensed Consolidated Balance Sheets
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- --------------
ASSETS (unaudited)
<S> <C> <C>
Current Assets:
Cash and cash equivalents ........................................ $ 78,555 $ 24,510
Restricted cash .................................................. 2,692 1,007
Accounts receivable .............................................. 2,989 655
Prepaid commissions .............................................. 1,451 825
Notes receivable-related party ................................... 519 730
Other current assets ............................................. 3,255 481
--------- ---------
Total current assets ....................................... 89,461 28,208
--------- ---------
Property and Equipment:
Internet access and computer equipment ........................... 13,595 4,072
Construction in progress ......................................... 149 2,499
Other furniture and equipment .................................... 5,968 660
Office computer equipment and purchased software ................. 7,951 896
Leasehold improvements ........................................... 7,365 398
--------- ---------
35,028 8,525
Less accumulated depreciation and amortization ................... (4,626) (982)
--------- ---------
Property and equipment, net .................................... 30,402 7,543
--------- ---------
Other Long-Term Assets:
Intangible asset, net ............................................ 503 --
Deposits and other long-term assets .............................. 2,249 225
--------- ---------
Total other long-term assets ............................... 2,752 225
--------- ---------
Total assets ............................................... $ 122,615 $ 35,976
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable ................................................. $ 9,887 $ 3,387
Accrued expenses ................................................. 9,052 2,863
Capital lease obligations ........................................ 6,633 1,185
Deferred revenue ................................................. 14,302 7,042
--------- ---------
Total current liabilities .................................. 39,874 14,477
--------- ---------
Deferred revenue ................................................... 1,872 1,433
Capital lease obligations .......................................... 6,435 2,406
Other long-term liabilities ........................................ 165 165
Commitments and Contingencies
Shareholders' Equity:
Preferred stock, no par value, 25,000,000 shares authorized:
Series A, $2.02 stated value, 15,000,000 shares authorized;
0 and 12,392,258 shares issued and outstanding as of
September 30, 2000 and December 31, 1999, respectively .......... -- 34,423
Series B, 2,000,000 shares authorized, no shares issued and
outstanding as of September 30, 2000 and December 31, 1999 ...... -- --
Common stock, no par value; 200,000,000 shares authorized,
46,723,585 and 23,590,390 shares issued and outstanding as
of September 30, 2000 and December 31, 1999, respectively, ....... 144,719 3,252
Warrants ......................................................... 14,440 2,144
Deferred product development costs ............................... (5,418) (2,133)
Deferred marketing costs ......................................... (6,906) --
Deferred compensation ............................................ (6,453) (954)
Accumulated deficit .............................................. (66,113) (19,237)
--------- ---------
Total shareholders' equity .................................. 74,269 17,495
--------- ---------
Total liabilities and shareholders' equity .................. $ 122,615 $ 35,976
========= =========
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
3
<PAGE>
INTERLAND, INC.
Condensed Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, September 30,
------------- -------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
(In thousands, except share and per share data)
<S> <C> <C> <C> <C>
Revenues:
Shared ............................ $ 5,584 $ 1,926 $ 14,866 $ 4,201
Dedicated and managed services .... 2,430 252 5,420 444
Application hosting ............... 555 357 1,616 588
Professional services ............. 861 47 1,953 46
------------ ------------ ------------ ------------
9,430 2,582 23,855 5,279
------------ ------------ ------------ ------------
Operating expenses:
Cost of revenues (including
non-cash expense of $680 and
$1,888 for the three months and
nine months ended September 30,
2000) ............................ 8,159 1,953 22,389 4,036
Sales and marketing ............... 11,085 2,371 28,077 4,770
General and administrative
(including non-cash stock
compensation expense of $889
and $1,296 for the three months
ended September 30, 2000 and
1999, and $2,177 and $2,609 for
the nine months ended
September 30, 2000 and 1999) ..... 6,827 2,869 17,367 5,722
Depreciation and amortization ..... 2,019 264 3,710 571
------------ ------------ ------------ ------------
Total operating expenses ... 28,090 7,457 71,543 15,099
------------ ------------ ------------ ------------
Operating loss ...................... (18,660) (4,875) (47,688) (9,820)
------------ ------------ ------------ ------------
Other income (expense):
Interest income ................... 1,148 30 1,805 33
Interest expense .................. (612) (42) (999) (51)
------------ ------------ ------------ ------------
Total other income (expense) 536 (12) 806 (18)
------------ ------------ ------------ ------------
Net loss ............................ (18,124) (4,887) (46,882) (9,838)
Preferred stock beneficial
conversion and dividends ............ (245) -- (6,031) --
------------ ------------ ------------ ------------
Net loss applicable to common
shareholders ...................... $ (18,369) $ (4,887) $ (52,913) $ (9,838)
============ ============ ============ ============
Basic and diluted net loss per
common share ...................... ($0.45) ($0.23) ($1.70) ($0.47)
============ ============ ============ ============
Shares used in computing net loss
per share ......................... 40,794,229 21,623,646 31,071,579 20,817,342
============ ============ ============ ============
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
4
<PAGE>
INTERLAND, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
For the Nine Months
Ended September 30,
-----------------------
2000 1999
--------- -------
(in thousands)
<S> <C> <C>
Cash flows from operating activities:
Net loss .............................................. $ (46,882) $(9,838)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization ...................... 3,710 571
Amortization of non-cash stock
compensation expense ............................... 2,177 2,609
Amortization of deferred development
and marketing costs .............................. 1,888 --
Common stock issued for legal fees .................. 139 --
Changes in operating assets and liabilities:
Accounts receivable .............................. (2,334) (457)
Prepaid commissions .............................. (626) (431)
Other current assets ............................. (2,525) (361)
Notes receivable--related parties ................ (37) (400)
Other assets ..................................... 225 --
Bank overdraft ................................... -- 341
Accounts payable and accrued liabilities ......... 13,013 4,424
Deferred revenue ................................. 7,698 2,936
--------- -------
Total adjustments ............................. (23,330) 9,232
--------- -------
Net cash used in operating activities ......... (23,552) (606)
--------- -------
Cash flows from investing activities:
Purchases of property and equipment ................... (26,503) (2,352)
Deposit of restricted cash ............................ (1,685) (506)
Purchase of intangible asset .......................... (175) --
--------- -------
Net cash used in investing activities ......... (28,363) (2,858)
--------- -------
Cash flows from financing activities:
Net proceeds from issuance of common stock ............ 84,230 5,517
Net proceeds from issuance of preferred stock ......... 14,000 --
Payment of preferred dividend ......................... (1,746) --
Borrowings on capital lease obligations ............... 11,650 917
Payments on capital lease obligations ................. (2,174) (163)
--------- -------
Net cash provided by financing activities ..... 105,960 6,271
--------- -------
Net increase in cash and cash equivalents ............... 54,045 2,807
Cash and cash equivalents, beginning of period .......... 24,510 706
--------- -------
Cash and cash equivalents, end of period ................ $ 78,555 $ 3,513
========= =======
Supplemental cash flow disclosure:
Cash paid for interest ................................ 915 93
Non cash disclosure:
Issuance of stock and options for consultant
and employee compensation ............................. 7,676 2,909
Issuance of warrants to strategic partners............... 13,849 --
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
5
<PAGE>
Interland, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Business
Interland, Inc. (the "Company") commenced operations on September 18, 1997.
The Company provides a broad range of web site and application hosting and other
related web based business solutions which enable its customers to establish
e-commerce and other applications through which they can conduct transactions
and manage information over the internet. The Company focuses on delivering
high-quality, reliable, and flexible services that are backed by customer
support 24 hours a day, 7 days a week, and 365 days a year. The Company offers
its solutions directly and through third-party dealers that resell the Company's
web hosting services. Interland operates in one business segment and has
operations in the United States and Europe. International customers generated
approximately 11.0% and 8.9% of total revenue in the three-month and nine-month
periods ended September 30, 2000, respectively.
History of Operating Losses
The Company has incurred net losses since it commenced operations. As of
September 30, 2000, the Company had an accumulated deficit of $66 million. These
losses have occurred, in part, because of the costs incurred by the Company to
develop its products, build a customer support infrastructure, and expand its
market share in an extremely competitive market. The Company does not expect to
generate positive cash flow from its operations for at least two years. The
Company's success depends on its ability to achieve profitability and on its
ability to raise funds as needed. The Company plans to continue to increase its
operating expenses in order to fund higher levels of market share, increase its
sales and marketing efforts, broaden its customer support capabilities, and
expand its administrative resources in anticipation of future growth. To the
extent that increases in such expenses precede or are not offset by increased
revenues, the Company's business, results of operations, and financial condition
would be materially adversely affected.
The Company must expand and adapt its network infrastructure to meet the
increasing number of users and the amount of information they wish to transport
to meet changing customer requirements. This expansion depends on financial,
operational and management resources as well as telecommunications capacity and
pricing and third party suppliers. Any failure of these could adversely affect
our business.
Interim Unaudited Financial Information and Principles of Consolidation
The accompanying unaudited financial information as of September 30, 2000
and for the three-month and nine-month periods ended September 30, 2000 and
September 30, 1999 has been prepared in accordance with generally accepted
accounting principles for interim financial information. All significant
adjustments, consisting of only normal and recurring adjustments, which in the
opinion of management, are necessary for a fair presentation of the results for
the three-month and nine-month periods ended September 30, 2000 and September
30, 1999 have been included. Operating results for the three and nine-month
period ended September 30, 2000 are not necessarily indicative of the results
that may be expected for the full year.
The accompanying consolidated financial statements include the accounts of
Interland and its wholly owned subsidiary, Interland BV in The Netherlands. All
intercompany balances and transactions have been eliminated in consolidation.
The preparation of financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. The accompanying unaudited condensed consolidated financial statements
as of September 30, 2000 do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements and should be read in conjunction with the audited financial
statements and footnotes included in the Prospectus dated July 25, 2000.
2. Summary of Significant Accounting Policies
Cash, Cash Equivalents and Restricted Cash
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be the equivalent of cash for the
purpose of balance sheet and statement of cash flows presentation. Cash
equivalents, which consist primarily of money market accounts, are carried at
cost, which approximates market value.
6
<PAGE>
At September 30, 2000 and December 31, 1999 the Company held several
certificates of deposits which have maturities ranging from 6 to 12 months.
These investments are restricted to use by certain vendors for rent, credit card
processing, lease payments and other items. These deposits have been classified
as restricted cash in the accompanying condensed consolidated balance sheets.
Prepaid Commissions
The Company typically pays commissions to its sales representatives within
three months after cash for the sale is collected; however, the revenue for the
service provided is deferred and recognized ratably over the customer service
period. The Company defers commissions paid prior to the revenue being earned
and amortizes those commissions over the same period for which revenue is
recognized.
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided using
the straight-line method over the estimated useful lives of the various classes
of property, which is three years for all software, computer and Internet
equipment, including capital leases, and seven years for other furniture and
equipment. Leasehold improvements are amortized over the lesser of the useful
life of the asset or the term of the lease. Construction in progress represents
primarily computer equipment and leasehold improvements to expand the Company's
network and facilities that have not been placed in operation as of September
30, 2000 or December 31, 1999.
Expenditures for maintenance and repairs are charged to expense as incurred,
and the costs of renewals and betterments are capitalized. Cost and the related
accumulated depreciation of assets sold or retired are removed from the
respective accounts. Any resulting gain or loss is reflected in the statements
of operations. The Company leases certain Internet access and computer equipment
under capital leases. Equipment recorded under capital leases is amortized using
the straight-line method over the lease term.
Revenue Recognition
The Company realizes revenue from providing shared and dedicated hosting,
application hosting and consulting services. The Company recognizes revenues
when the services are provided. The Company's hosting contracts typically
require up-front payment for service periods ranging from 3 to 24 months. The
Company follows the guidance in Staff Accounting Bulletin No. 101 regarding
revenue recognition. Therefore, fees received from the customer, including
set-up fees for hosting services, are deferred and recognized ratably over the
contract period. Substantially all of the end-user subscribers pay for services
with major credit cards for which the Company receives daily remittances from
the credit card carriers. Deferred revenues represent the liability for advance
billing to customers for services not yet provided. Consulting revenue is
recognized as the services are performed, provided that no significant
obligations remain. The Company generally receives all payments for consulting
services prior to the services being performed; therefore, collection is
considered probable.
The Company provides a 30 day money back guarantee to its customers and
offers its customers a 99.9% service level warranty. The Company records an
allowance for returns and an accrual for warranty claims on a monthly basis
based on historical experiences. The Company has not experienced significant
returns or warranty claims to date and does not have a significant returns or
warranty claims reserve as of September 30, 2000 or December 31, 1999.
Basic and Diluted Net Loss Per Share
The Company follows Statement of Financial Accounting Standards ("SFAS") No.
128, "Earnings Per Share." That statement requires the disclosure of basic net
income (loss) per share and diluted net income (loss) per share. Basic net
income (loss) per share is computed by dividing net income (loss) available to
common shareholders by the weighted-average number of common shares outstanding
during the period and does not include any other potentially dilutive
securities. Diluted net income (loss) per share gives effect to all potentially
dilutive securities. The Company's convertible preferred stock, stock options
and stock warrants are potentially dilutive securities and are not included in
historical diluted net loss per share in any periods presented as they would
reduce the loss per share.
Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No.
98, for all periods presented, basic net loss per share is computed by using the
weighted average number of shares of common stock outstanding during the period.
Diluted net loss per share is computed using the weighted average number of
common stock outstanding during the period and nominal issuances of common stock
and common stock equivalents, regardless of whether they are antidilutive, as
well as the potential dilution of common stock equivalents, if dilutive. The
Company has not issued common stock or common stock equivalents for
considerations that management considers nominal.
Reclassifications
Certain prior period balances and amounts have been reclassified to conform to
current period presentation.
7
<PAGE>
3. Shareholder's Equity
Preferred Stock and Warrants
The Company is authorized to issue 25,000,000 shares of preferred stock,
including 15,000,000 shares which are designated as Series A preferred stock,
2,100,000 shares which are designated as Series A-1 preferred stock and
2,000,000 shares which are designated as Series B preferred stock. The remaining
preferred stock has not been designated by the Company.
The Series A and Series B preferred stock are convertible and rank junior to
any other preferred stock that may be issued by the Company, but rank senior to
common stockholders upon liquidation. The Series A preferred stockholders have
the right to receive dividends equal to 9% of the stated value of the preferred
stock. The dividends accrue on a semi-annual basis with the dividend period
ending on the last day of May and November. Dividends are cumulative from the
date the Series A preferred stock is issued and accrue whether or not declared
by the Company. Dividends can be paid in cash, or in the form of Series B
preferred stock or a combination of both at the option of the Company. The
preferred stock is convertible at the then current conversion price, which is
equal to the stated value on the date of issuance adjusted from time to time as
a result of stock splits, recapitalizations or if the Company issues stock at
prices below the stated value of the preferred stock.
On December 24, 1999 the Company issued warrants to purchase 546,480 shares
of common stock at an exercise price of $5.37 per share to Microsoft Corporation
("Microsoft"). This warrant was issued in connection with entering into a five
year Development, License, and Co-marketing Agreement (the "Agreement") with
Microsoft that expires December 23, 2004. The warrant can be exercised by paying
the cash exercise price or by surrendering common shares owned by Microsoft
equal to the exercise price. The Agreement grants to Microsoft a non-exclusive
perpetual license to proprietary installation tools for third-party hosted
applications on Windows NT or Windows 2000. Microsoft has the sole right to
terminate the Agreement if the Company fails to deliver the tools on a timely
basis or if the Company fails to correct any errors in the tools on a timely
basis and Microsoft will provide technical consulting and writing services
during the development of the tools. Additionally, in consideration of the
obligations of Microsoft, the Company agreed to pay Microsoft 5% of the total
gross revenues that the Company receives from third parties in consideration of
its licensing and other exploitation of the tools for the five years following
acceptance of the tools by Microsoft. The Company recorded the value of the
warrants, calculated using the Black-Scholes pricing model, of approximately
$2,144,000 as deferred development costs and will amortize this amount to the
cost of revenues over the five-year term of the Agreement. The Company
recognized non-cash stock compensation expense related to these warrants of
$107,000 and $321,000, respectively, for the three months and nine months ended
September 30, 2000.
In connection with a stock purchase agreement, on July 26, 2000 Microsoft
invested an additional $7,500,000 in the Company in exchange for 625,000 shares
of common stock. Microsoft also received an additional warrant to purchase
468,750 shares of common stock at an exercise price of $12.00 per share. The
value of the warrants of approximately $3,764,000 was recorded as additional
deferred development costs and will amortize over the remaining term of the
five-year Agreement. The Company recognized non-cash stock compensation expense
related to these warrants of $156,000 for the three month and nine month periods
ended September 30, 2000.
On January 28, 2000 the Company issued warrants to purchase up to 376,920
shares of common stock to Road Runner at an exercise price of $8.33 per share.
These warrants were issued in connection with the entering into a web hosting
reseller agreement. This agreement requires the Company to provide hosting
services at wholesale prices, to provide customers and technical support and to
provide other services. Upon signing the web hosting agreement, 108,000 of the
warrants vested immediately. The remaining 268,920 vest at the end of each
quarter of 2000 and at December 31, 2001 based on the number of new customers
provided through the web hosting agreement; therefore, the total remaining
warrants may never vest if the new customer targets are not met. In January 2000
the Company recorded expense of $654,000 related to the 108,000 warrants that
vested upon the signing of the agreement. The Company will record additional
expense in the future based on the number of warrants that vest based on
performance targets as valued using the Black-Scholes pricing model at the time
of vesting. As of September 30, 2000 no additional warrants have vested.
On March 15, 2000 the Company entered into a stock purchase agreement with
Network Solutions. In connection with this financing transaction, the Company
issued 744,827 shares of Series A preferred stock to Network Solutions, at a
purchase price of $5.37 per share for total proceeds of $4 million. The Company
also issued a warrant to Network Solutions to purchase 372,413 shares of common
stock at an exercise price of $5.37 per share. The number of shares subject to
the warrant may be adjusted to prevent dilution and each warrant will expire
five years after its issuance. In addition, under the stock purchase agreement,
on July 26, 2000, the Company issued 500,000 shares of common stock to Network
Solutions in exchange for an additional $6,000,000 in cash. In connection with
the additional investment,
8
<PAGE>
the Company issued an additional warrant to purchase 375,000 shares of common
stock at an exercise price of $12.00 per share. In conjunction with the initial
investment, the Company entered into a 4 year premier program agreement with
Network Solutions. The Company recorded deferred expense of $2,444,000 for the
value of the warrant issued on March 15, 2000, deferred expense of $2,207,000
for the difference between the purchase price of $5.37 per share and the fair
value of the Company's common stock on that date of $8.33 per share and deferred
expense of $3,011,000 for the values of the warrants issued on July 26, 2000.
This deferred expense will be amortized over the remaining 4 year term of the
premier program agreement entered into with Network Solutions and the Company
recognized non-cash cost of revenue of $278,000 and $456,000 for the three
months and nine months ended September 30, 2000, respectively.
On May 8, 2000 the Company entered into a stock purchase agreement with Bell
Atlantic Investments, Inc. In connection with this financing transaction, the
Company issued 1,199,999 shares of Series A preferred stock to Bell Atlantic at
a purchase price of $8.33 per share. As a result of the sale of the convertible
preferred stock at conversion prices below the fair market value of $12.00 for
the common stock on the date of the issuance of the preferred stock, the Company
recorded a preferred stock dividend of approximately $4,404,000 related to this
beneficial conversion feature in accordance with Emerging Issues Task Force
Issue 98-5 "Accounting for Convertible Securities with Beneficial Conversion
Features or Contingently Adjustable Conversion Ratios." This dividend is
reflected as an adjustment to arrive at net income applicable to common
shareholders in the statement of operations for the nine month period ended
September 30, 2000. In addition, under the stock purchase agreement on July 28,
2000, the Company issued 1,250,000 shares of common stock to Verizon
Communications ("Verizon") in exchange for an additional $15,000,000 in cash.
Additionally, on May 8, 2000 the Company entered into a non-binding letter
of intent with Verizon to enter into a business relationship. The non-binding
letter of intent indicated that the parties would work to complete final
versions of a marketing channel relationship agreement and a service provider
agreement. On October 11, 2000 the parties executed final versions of these
agreements. These agreements provide for Verizon to promote and co-brand the
Company's products and services. The term of the agreements is three years and
the Company will pay to Verizon 12.5% of any revenue received from customers
with whom Verizon originates contact. The Company will record this amount as an
offset to revenue in the income statement. In return for access to Verizon's
customer base and for other consideration, on October 11, 2000 the Company
issued to Verizon a warrant to purchase 3,132,000 shares of common stock at an
exercise price of $18 per share. The warrant is exercisable for three years. The
Company has measured the fair value of warrants issued to Verizon using the
Black-Scholes pricing model as $4,885,000 and will record this value of the
warrants as deferred expense to be amortized over the 3 year term of the
agreements starting in the fourth quarter of 2000.
Simultaneous with the Company's initial public offering and pursuant to the
contractual agreements with the preferred stockholders, all 14,337,082 shares of
the Company's Series A preferred stock were converted into shares of common
stock. Accrued dividends on preferred stock aggregated $1,746,000 on July 25,
2000, the date of conversion. All accrued dividends were paid in cash in
September 2000.
Common Stock
The Company completed its initial public offering on July 25, 2000. The
Company sold 5,000,000 shares of common stock to the public and received net
proceeds of approximately $53 million. On June 14, 2000, the Company's board of
directors approved a 1.08 for one stock split on the Company's common stock
which was effected in the form of a stock dividend on July 24, 2000. All share
and per share data in the accompanying financial statements have been adjusted
to reflect the split.
On July 1, 1999 the Company issued options to purchase 108,000 shares of
common stock to an employee at an exercise price of $0.01 per share. The fair
market value on the date of grant was estimated to be $2.78 per share. The
Company recorded deferred compensation of $300,000 related to this grant. The
deferred compensation will be amortized over the vesting period of the option,
which is three years from July 1, 1999. The Company amortized $25,000 and
$75,000 for the three and nine month periods ended September 30, 2000. The
compensation expense is included in non-cash general and administrative
compensation expense in the accompanying statements of operations.
During 1999 the Company issued options to purchase 432,000 shares of common
stock to a consultant at an exercise price of $2.78 per share. The Company
recognized non-cash compensation expense of $890,000 related to the issuance to
these options. The options were valued using the Black Scholes pricing model.
The Company amortized $223,000 and $669,000 for the three and nine month periods
ended September 30, 2000.
9
<PAGE>
Stock Options
During July 1999 the board of directors approved the Stock Incentive Plan
(the "Plan"). The Plan provides for the grant of options to eligible employees
and the board of directors determines the specific terms of each option grant,
including vesting period and exercise price. The options generally vest over a
three-year period.
At various dates in 2000 prior to the initial public offering on July 25,
2000 the Company issued options to purchase shares of common stock to employees
at exercise prices below fair market value. The Company recognized non-cash
compensation expense related to these options of $640,000 and $1,435,000,
respectively, during the three month and nine month periods ended September 30,
2000.
Shareholder Rights Plan
On July 12, 2000 the Company's Board of Directors declared a dividend of one
Right for each share of common stock held of record at the close of business on
July 24, 2000. The Rights are generally not exercisable until 10 days after an
announcement by the Company that a person has acquired at least 15% of the
Company's common stock. Each Right, should it become exercisable, will entitle
the owner to buy 1/100th of a share of new Series B participating preferred
stock at an exercise price of $100. The Rights, which do not have any voting
rights, may be redeemed by the Company at a price of $.001 per Right at any time
prior to a person's or group's acquisition of 15% or more of the Company's
common stock.
In the event the rights become exercisable as a result of the acquisition of
at least 15% of the Company's common stock, each Right will entitle the owner,
other than the acquiring person, to buy at the Rights' then current exercise
price a number of shares of common stock with a market value equal to twice the
exercise price. In addition, unless the acquiring person owns more than 50% of
the outstanding shares of common stock, the Board of Directors may elect to
exchange all outstanding Rights (other than those owned by such acquiring person
or affiliates thereof) at an exchange ratio of one share of common stock per
Right. The Rights expire on July 24, 2010 unless they are earlier exercised,
redeemed, or exchanged. As a result of the adoption of the Shareholders' Rights
Plan, 2,000,000 shares of authorized preferred stock have been reserved and
designated as Series B Participating Cumulative Preferred Stock.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
We provide a broad range of web hosting and applications hosting and other
related web-based business solutions specifically designed to meet the needs of
small and medium-sized businesses. Our business is rapidly evolving and we have
limited operating history. As a result, we believe that period-to-period
comparisons of our revenue and operating results, including our cost of revenue
and other operating expenses as a percentage of total revenue, are not
meaningful and should not be relied upon as indicators of future performance. We
do not believe that our historical growth rates are an indication of future
results.
Currently, we derive a substantial majority of our revenues from shared and
dedicated hosting services. We also derive revenue from applications hosting and
consulting services. Our strategy is to grow our customer base and revenues by
marketing value-added services to small and medium-sized businesses. We expect
that our number of customer accounts will grow rapidly, and that the revenue
from the sale of higher margin services, such as dedicated hosting, will
increase more rapidly than our base shared hosting revenue. Currently, most of
our hosting revenues are generated from recurring monthly fees. The remainder is
derived from one-time-set-up fees for installation. We currently sell our
services under agreements having terms of three months to two years. Most of our
customer agreements may be canceled within the first thirty days. We receive
payment in advance typically for the full contract amount by direct charges to
credit or debit cards. We recognize all revenues, including set-up fees, ratably
over the term of the contract.
Our expenses consist of:
o Cost of revenue, which is mainly comprised of compensation and related
expenses for technical operations, internet connectivity and other
related telecommunications expense, and lease expense in particular
related to our data centers;
o Sales and marketing, which is mainly comprised of compensation costs and
costs associated with marketing our products and services. Compensation
costs include salaries and related benefits, commissions and bonuses.
Our marketing expenses include the costs of direct mail, advertising and
other mass market programs; and
o General and administrative, which is mainly comprised of compensation
and related expenses, occupancy costs, and non-cash stock compensation
expense, which relates to stock and options granted before September 30,
2000 at exercise prices less than the fair market value of our common
stock at the time of grant.
We have incurred significant losses and experienced negative cash flow from
operations since our inception and, as of September 30, 2000, had an accumulated
deficit of approximately $66 million. We intend to invest heavily in sales and
marketing, the continued development of our network infrastructure and
technology, and the expansion of our international operations. We expect to
expand our operations and workforce, including our network operations, technical
support, and administrative resources. In addition, we intend to continue to
expand our existing inside sales force and add an outside sales force to develop
new sales channels and relationships. We expect to continue to incur substantial
losses for the foreseeable future. Our ability to achieve profitability and
positive cash flow from operations will be dependent upon our ability to grow
our revenues substantially and achieve operating efficiencies.
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Results of Operations
The following table shows percentage of revenue data for the three months
and the nine months ended September 30, 2000 and 1999.
<TABLE>
<CAPTION>
% of Revenues
-----------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September
2000 1999 2000 30, 1999
------------ ------------ ------------ ---------
<S> <C> <C> <C> <C>
Revenues .......................... 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Cost of revenue ................. 86.5 75.7 93.9 76.5
Sales and marketing ............. 117.6 91.8 117.7 90.4
General and administrative ...... 72.4 111.1 72.8 108.4
Depreciation and amortization ... 21.4 10.2 15.6 10.8
------ ------ ------ ------
Operating loss .................... (197.9) (188.8) (199.9) (186.0)
Interest income ................. 12.2 1.2 7.6 0.6
Interest expense ................ (6.5) (1.6) (4.2) (1.0)
------ ------ ------ ------
Net loss ................ (192.2)% (189.3)% (196.5)% (186.3)%
====== ====== ====== ======
</TABLE>
Comparison of the Three Months Ended September 30, 2000 and 1999
Revenues
Our revenues increased $6.8 million, or 265%, to $9.4 million during the
three months ended September 30, 2000 from $2.6 million during the three months
ended September 30, 1999. This increase was due mainly to internal growth of our
business and number of customers served. During the three months ended September
30, 2000 and 1999, we derived 59% and 75% of revenues from our shared services,
26% and 10% of revenues from dedicated services and 15% and 15% of revenues from
applications hosting and professional services, respectively.
Cost of revenue
Our cost of revenue increased $6.2 million to $8.2 million, or 87% of
revenue, during the three months ended September 30, 2000 from $2.0 million, or
76% of revenue during the three months ended September 30, 1999, due to the
growth of our business and related expenses, including $3.3 million in increased
salary expense related to a significant increase in the number of data center
and customer support personnel, non-cash expense of $680,000, increased
telecommunication and internet connection costs of $590,000, and increased
consulting fees of $462,000. The non-cash expense largely relates to deferred
expenses associated with our strategic relationships with Microsoft and Network
Solutions. The increase in cost of revenue as a percentage of revenue was
partially attributable to our incurring these costs in anticipation of growth
and in advance of revenues. We anticipate that costs of revenues will increase
in absolute dollars but decline as a percentage of revenues as we continue to
grow, expand our facilities and achieve a more cost-effective scale of
operations.
Sales and marketing
Sales and marketing expenses increased $8.7 million to $11.1 million, or
118% of revenues, during the three months ended September 30, 2000 from $2.4
million, or 92% of revenues, during the three months ended September 30, 1999.
This increase was due mainly to a $1.2 million increase in salary expense from a
higher number of sales personnel and a $7.1 million increase in advertising
expense. As we continue to grow, we expect our sales and marketing expenditures
to increase in absolute dollars but expect only limited changes as a percentage
of revenue in 2000, thereafter we expect sales and marketing costs to decline as
a percentage of revenue.
General and administrative
General and administrative expense increased $3.9 million to $6.8 million,
or 72% of revenue, during the three months ended September 30, 2000 from $2.9
million, or 111% of revenue, for the three months ended September 30, 1999. The
main factors contributing to this increase include an increase in salary expense
of $2.2 million, a $189,000 increase in rent and a $360,000 increase in
consulting and professional fees. The non-cash charges largely relate to
amortization of deferred compensation arising from stock options granted to
employees and consultants. We expect significant increases in our general and
administrative expenses in absolute dollars in the future to support a higher
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level of operations.
We recorded non-cash stock compensation expense of $889,000 during the three
months ended September 30, 2000 in connection with the grant of stock options to
employees. During the nine months ended September 30, 2000 we granted options to
purchase shares of our common stock to employees at exercise price below fair
market value. We recorded deferred compensation expense of approximately $7.7
million to additional paid in capital, which will be amortized over the vesting
period of the options, which is generally three years.
Depreciation and amortization
Depreciation and amortization expenses increased $1.8 million to $2.0
million, or 21% of revenues, during the three months ended September 30, 2000
from $264,000 during the three months ended September 30, 1999, as a result of
our investment in a new data center in Atlanta.
Interest income (expense), net
Interest income (expense), net consists primarily of interest income on our
cash and cash equivalent balances and interest expense on our capital lease
obligations. Interest earned on our cash and cash equivalents increased $1.1
million during the three months ended September 30, 2000 from $30,000 during the
three months ended September 30, 1999. This increase was primarily due to the
closing of the completion of an initial public offering on July 25, 2000, which
resulted in higher cash balances available for investment. During the three
months ended September 30, 2000 we incurred interest expense in the amount of
$612,000 on capital lease obligations.
Income taxes
No provision for federal income taxes has been recorded as we have
incurred net operating losses from inception through September 30, 2000. We have
recorded a valuation reserve for all our net deferred tax benefit in the three
month periods ended September 30, 2000 and 1999 due to uncertainty that we will
generate sufficient taxable income during the carry forward period to realize
the benefit of our net deferred tax asset.
Net Loss
Our net loss increased $13.2 million to $18.1 million during the three
months ended September 30, 2000 from $4.9 million during the three months ended
September 30, 1999. Our net loss increased mainly as a result of increased cost
of revenues, sales and marketing, and general and administrative expense. These
increases were partially offset by an increase in revenue of $6.8 million to
$9.4 million during the three months ended September 30, 2000 from $2.6 million
during the three months ended September 30, 1999.
Comparison of the Nine Months Ended September 30, 2000 and 1999
Revenues
Our revenues increased $18.6 million, or 352%, to $23.9 million during the
nine months ended September 30, 2000 from $5.3 million during the nine months
ended September 30, 1999. This increase was mainly due to the growth of our
business and number of customers served. The number of customer accounts
increased from 19,822 at September 30, 1999 to 47,578 at September 30, 2000.
During the nine months ended September 30, 2000 and 1999, we derived 62% and 80%
of revenues from our shared services, 23% and 8% of revenues from dedicated
services and 15% and 12% of revenues from applications hosting and professional
services, respectively.
Cost of revenue
Our cost of revenue increased $18.4 million to $22.4 million, or 94% of
revenue, during the nine months ended September 30, 2000 from $4.0 million, or
76% of revenue during the nine months ended September 30, 1999, due to the
growth of our business and related expenses, including increased salary costs of
$8.3 million related to additional systems and customer support personnel,
increased telecommunication and Internet connection costs of $2.1 million,
higher lease expense of $1.6 million and increased license fee payments of $1.5
million. We expect our cost of revenue to continue to increase in absolute
dollars as we increase capacity to meet customer demand.
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<PAGE>
Sales and marketing
Sales and marketing expenses increased $23.3 million to $28.1 million, or
118% of revenues, during the nine months ended September 30, 2000 from $4.8
million, or 90% of revenues during the nine months ended September 30, 1999.
This increase was a result of a $2.9 million increase in salary expense due to
an increase in the number of sales personnel at higher compensation levels and
increased placement of advertising of $19.6 million.
General and administrative
General and administrative expense increased $11.7 million to $17.4 million,
or 73% of revenue, during the nine months ended September 30, 2000 from $5.7
million, or 108% of revenue, during the nine months ended September 30, 1999.
This increase was mostly due to increased salary expense of $5.6 million,
increased consulting and professional fees of $592,000 and travel costs of
$435,000.
Depreciation and amortization
Depreciation and amortization expenses increased $3.1 million to $3.7
million, or 16% of revenues, during the nine months ended September 30, 2000
from $571,000 during the nine months ended September 30, 1999, as a result of
our investment in a new data center in Atlanta.
Interest income (expense), net
Interest income, net consists of interest income on our cash balances less
interest expense on our capital lease obligations. Interest earned on our cash
and cash equivalents increased $1.8 million during the nine months ended
September 30, 2000 from $33,000 during the nine months ended September 30, 1999.
This increase was mainly due to the closings of private placements of preferred
stock in December 1999, March 2000 and May 2000, and the completion of the
initial public offering in July 2000, which resulted in higher cash balances
available for investment. During the nine months ended September 30, 2000 and
1999 we incurred interest expense of $1.0 million and $51,000, respectively, on
capital lease obligations.
Income taxes
No provision for federal income taxes has been recorded as we have incurred
net operating losses from inception through September 30, 2000. We have recorded
a valuation reserve for all our net deferred tax benefits due to uncertainty
that we will generate sufficient taxable income during the carry-forward period
to realize the benefit of our net deferred tax asset.
Net Loss
Our net loss increased $37.1 million to $46.9 million during the nine months
ended September 30, 2000 from $9.8 million during the nine months ended
September 30, 1999. Our net loss increased mainly as a result of increased cost
of revenues, sales and marketing, and general and administrative expense. These
increases were partially offset by an increase in revenue of $18.6 million to
$23.9 million for the nine months ended September 30, 2000 from $5.3 million for
the nine months ended September 30, 1999.
Liquidity and Capital Resources
We have financed our operations to date mainly through public and private
equity placements and capital leases from vendors. At September 30, 2000 we had
an accumulated deficit of $66 million and unrestricted cash and cash equivalents
of $79 million. This balance of cash and cash equivalents is largely the result
of our completion of an initial public offering on July 25, 2000 which raised
net proceeds of $53 million and by our raising $28.5 million from the sale of
2,375,000 shares of common stock to three investors on July 26, 2000.
During the nine months ended September 30, 2000 and 1999, we used cash to
fund operations of $23.6 million, and $606,000, respectively. The increase in
cash used in operations was due mainly to working capital requirements and net
losses, offset by increases in accounts payable, deferred revenue and accrued
expenses. Net cash used in investing activities was $28.4 million and $2.9
million for the nine months ended September 30, 2000 and 1999, respectively, and
is comprised mainly of equipment purchases of $26.5 million and $2.4 million,
respectively. Net cash provided by financing activities was $106.0 million and
$6.3 million during the nine months ended September 30, 2000 and 1999,
respectively, and is related mainly to the sale of our Series A preferred stock
in private placements and common stock in the initial public offering, as well
as borrowings under capital leases. Total borrowings under our capital lease
obligations as of September 30, 2000 were approximately $13.1 million.
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<PAGE>
On December 24, 1999, we entered into a stock purchase agreement with
Microsoft Corporation. In connection with this financing transaction, we issued
2,484,000 shares of Series A preferred stock to Microsoft, at a purchase price
of $2.02 per share. We also issued a warrant to Microsoft to purchase 546,480
shares of common stock at an exercise price of $5.37 per share. In addition,
under the stock purchase agreement, on July 26, 2000 Microsoft invested an
additional $7,500,000 and we issued 625,000 shares of common stock to Microsoft,
at a purchase price of $12.00 per share. In connection with this issuance, we
also issued an additional warrant to purchase up to 468,750 shares of common
stock at an exercise price of $12.00 per share. In connection with the initial
investment, we entered into a five-year co-marketing agreement with Microsoft.
We recorded deferred development costs for the value of the warrant issued on
December 24, 1999 of $2,144,000. This deferred expense will be amortized over
the five-year term of the co-marketing agreement to cost of revenue. Other than
payments we will make to Microsoft in connection with the sale of software that
we have licensed to Microsoft, we do not have any further financial obligations
during the term of the co-marketing agreement.
On January 28, 2000, we issued a warrant to purchase up to 376,920 shares of
our common stock to Road Runner whose cable affiliates include Time Warner,
Media One, and Cox Communications, in connection with a co-marketing agreement.
Of the shares subject to this warrant, 108,000 vested immediately upon the
execution of our co-marketing agreement and the balance vest in equal
installments on September 30, 2000, December 31, 2000 and December 31, 2001,
subject to performance criteria. In January 2000, we recorded expense of
$654,000 associated with the vested portion of the warrant. We will record
additional expense to cost of revenue in the future based on the fair value of
the portion of the warrant that has been earned and that vests in each period
based on meeting the performance criteria. We do not have any further financial
obligations to Road Runner during the term of the co-marketing agreement.
On March 15, 2000, we entered into a stock purchase agreement with Network
Solutions. In connection with this financing transaction, we issued 744,827
shares of Series A preferred stock to Network Solutions, at a purchase price of
$5.37 per share, for a total proceeds of $4.0 million. We also issued a warrant
to Network Solutions to purchase 372,413 shares of common stock at an exercise
price of $5.37 per share. In addition, under the stock purchase agreement, on
July 26, 2000 Network Solutions invested an additional $6 million in the Company
and we issued 500,000 shares of common stock to Network Solutions at a purchase
price of $12.00 per share. In connection with this issuance, we issued an
additional warrant to purchase up to 375,000 shares of common stock at an
exercise price of $12.00 per share. In connection with the initial investment,
we entered into a four year premier program agreement with Network Solutions. We
recorded deferred expense of $2,444,000 for the value of the warrant issued on
March 15, 2000 and deferred expense of $2,207,000 for the difference between the
purchase price of $5.37 per share and the fair value of our common stock on that
date of $8.33 per share. This deferred expense will be amortized over the four
year term of the premier program agreement to cost of revenue. We do not have
any further financial obligations during the term of the premier program
agreement.
On May 8, 2000 we entered into a stock purchase agreement with a subsidiary
of Bell Atlantic Corporation. In connection with this financing transaction, we
issued 1,199,999 shares of Series A preferred stock to Bell Atlantic, at a
purchase price of $8.33 per share, for total proceeds of $10 million. As a
result of this sale of preferred stock at a conversion price below the fair
market value, determined as of May 8, 2000 to be equal to $12.00 per share of
common stock, we recorded a preferred stock dividend of approximately
$4,404,000. The net income applicable to common shareholders in our statement of
operations has been adjusted to reflect the dividend. In addition, under the
stock purchase agreement on July 28, 2000, Verizon invested an additional $15
million in the Company and we issued 1,250,000 shares of common stock at a
purchase price of $12.00 per share.
Additionally, on May 8, 2000 the Company entered into a non-binding letter
of intent with Verizon to enter into a business relationship. The non-binding
letter of intent indicated that the parties would work to complete final
versions of a marketing channel relationship agreement and a service provider
agreement. On October 11, 2000, the parties executed final versions of these
agreements. These agreements provide for Verizon to promote and co-brand the
Company's products and services. The term of the agreements is three years and
the Company will pay to Verizon 12.5% of any revenue received from customers
with whom Verizon originates contact. The Company will record this amount as an
offset to revenue in the income statement. In return for access to Verizon's
customer base and for other consideration, the Company issued to Verizon a
warrant to purchase 3,132,000 shares of common stock at an exercise price of $18
per share. The warrant will be exercisable for three years. The Company has
measured the fair value of warrants issued using the Black-Scholes pricing model
as $4,885,000 and will record this value as deferred expense to be amortized
over the 3 year term of the agreements starting in the fourth quarter of 2000.
We are pursuing an aggressive internal growth strategy that we anticipate
will require significant additional funding before we begin to generate positive
cash flow. We believe that our current cash and cash equivalent balances will be
sufficient to fund execution of our current business plan through the end of
2001. However, the execution of our business plan may require additional capital
to fund our operating losses, working capital needs, sales and marketing
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expenses, lease payments and capital expenditures. In view of future expansion
plans, we will consider our financing alternatives, which may include the
incurrence of debt, 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 also change based upon technological and competitive
developments. In addition, several factors may affect our capital requirements:
o demand for our services or our anticipated cash flow from operations
being less than expected;
o our development plans or projections proving to be inaccurate;
o our engaging in strategic relationships or acquisitions; and
o our acceleration of, or otherwise altering, the schedule of our
expansion plan.
At September 30, 2000 we have made commitments of approximately $1.7 million
in capital expenditures outstanding for expanded network and facilities. The
expansion of our network and facilities began in 1999 and will be completed
during the second quarter of 2001. The assets were classified as construction in
progress as of December 31, 1999 and September 30, 2000. On May 15, 2000, we
executed a loan agreement in the amount of $3.0 million to finance a portion of
these capital expenditures. The loan is secured by the related assets, bears
interest at 16.1% per year and has a three year term.
On June 30, 2000 we executed an amendment to a master lease and financing
agreement with Compaq Financial Services Corporation which provides a line of
credit for the purchase and lease of equipment in the amount of $29.5 million.
Additionally, on June 30, 2000 we executed a supplemental master lease and
financing agreement with Hewlett-Packard Corporation which increased the
equipment financing line of credit by $12.0 million to $20.0 million.
There can be no assurance that additional financing, if required, will be
available on satisfactory terms, or at all. If we do not obtain additional
financing, we believe that our existing cash balances may be adequate to
continue expanding the operations on a reduced scale.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative
Instruments and Hedging Activities." SFAS 133 established accounting and
reporting standards for derivative instruments and for hedging activities. SFAS
is effective for fiscal years beginning after June 15, 2000. We do not believe
the adoption of SFAS 133 will have a material effect on our results of
operations or financial condition.
Forward-Looking Statements
The statements contained in this Report that are not historical facts
are "forward-looking statements" (as such term is defined in Section 27A of the
Securities Act of 1933 and section 21E of the Securities Exchange Act of 1934).
Forward-looking statements are typically identified by the use of terms such as
"may," "will," "expect," "intend," "anticipate," "estimate" and similar words,
or by discussions of strategy that involve risks and uncertainties, although
some forward-looking statements are expressed differently. You should be aware
that our actual results could differ materially from those contained in the
forward-looking statements due to a number of factors, including without
limitation, changes in external competitive market factors, changes in our
business strategy or an inability to execute our strategy, unanticipated changes
in the hosting industry, the economy in general and changes in the use of the
Internet. We cannot guarantee future results, levels of activity, performance or
achievements. Our actual results could differ materially from those anticipated
in such forward-looking statements as a result of certain factors, including
those set forth in the section entitled "Factors Affecting Future Operating
Results." Readers are cautioned not to place undue reliance on any
forward-looking statements contained in this report. All written and oral
forward-looking statements made in connection with this Report that are
attributable to us or persons acting on our behalf are expressly qualified in
their entirety by the "Factors Affecting Future Operating Results" and other
cautionary statements included herein. We disclaim any obligation to update
information contained in any forward-looking statement. We undertake no
obligation to publish the results of any adjustments to these forward-looking
statements that may be made to reflect events on or after the date of this
report or to reflect the occurrence of unexpected events.
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Factors Affecting Future Operating Results
Our business and prospects are difficult to evaluate because we have a limited
operating history and our business model is still evolving.
We began operations as a web hosting business in September 1997. As a
result, we have a limited operating history and our business model is still
evolving. Our limited operating history therefore makes predicting our future
results difficult and makes it difficult to evaluate the execution of our
business model thus far. You should consider our ability to execute our plans
and our prospects in light of the risks, expenses and difficulties that
companies in the new and rapidly evolving market for web hosting and
applications hosting services encounter. We may not achieve a significant rate
of future revenue growth and may not achieve or sustain profitability in future
quarterly or annual periods.
We have a history of significant losses and expect these losses to continue in
the foreseeable future.
We have experienced operating losses and negative cash flows from operations
in each quarterly and annual period since we began operations as a web hosting
business in 1997. As of September 30, 2000, our accumulated losses since
September 17, 1997 have amounted to approximately $48.0 million. We had net
losses of $18.1 million and $46.9 million for the three month and nine months
ended September 30, 2000, respectively. While our revenues have grown in recent
periods, future growth will depend upon the success of our expansion plans. In
connection with our expansion plans, we anticipate making significant
investments in sales, marketing, technical and customer support personnel, as
well as in our data centers and related equipment. As a result of our expansion
plans, we expect our net losses and negative cash flow from operations to
continue for the foreseeable future.
We may not effectively execute our strategy and as a result, others may seize
the market opportunity that we have identified.
If we fail to execute our strategy in a timely or effective manner, our
competitors may be able to seize the opportunity we have identified to address
web hosting needs of small and medium-sized businesses. Our business strategy is
complex and requires that we successfully and simultaneously complete many
tasks, and the failure to complete any one of these may jeopardize our strategy
as a whole. Execution of our strategy may be more difficult because our
management team has worked together for less than nine months. In order to be
successful, we will need to:
o market our services and build our brand name effectively;
o provide reliable and cost-effective services that can be expanded to
meet the demands of our customers;
o continue to grow our infrastructure to accommodate additional customers
and increased use of our network bandwidth;
o expand our channels of distribution and our international operations;
o continue to respond to competitive developments; and
o attract, retain and motivate qualified personnel.
We operate in an extremely competitive market, and our business will suffer if
we are unable to compete effectively.
The web hosting and applications hosting markets are highly competitive and
are becoming more so. 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 may not have the resources, expertise or other
competitive factors to compete successfully in the future.
Many of our competitors have substantially greater financial, technical and
marketing resources, larger customer bases, longer operating histories, greater
name recognition and more established relationships in the industry than we do.
As a result, these competitors may be able to:
o develop and expand their network infrastructures and service offerings
more rapidly;
o adapt to new or emerging technologies and changes in customer
requirements more quickly;
17
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o take advantage of acquisition and other opportunities more readily; and
o devote greater resources to the marketing and sale of their services and
adopt more aggressive pricing policies than we can.
In an effort to gain market share, some of our competitors have offered web
hosting services similar to ours at lower prices than ours or with incentives
not matched by us, including free start-up and domain name registration, periods
of free service, low-priced Internet access or free software. In addition, some
of our competitors may be able to provide customers with additional benefits,
including reduced communications costs, which could reduce the overall costs of
their services relative to ours. We may not be able to reduce the pricing of our
services or offer incentives in response to the actions of our competitors
without harming our business. Because of the fierce competition in the web
hosting and applications hosting industry, the number of competitors could lead
to a surplus in service providers, leading to further reductions in the prices
of services. We also believe that the market in which we compete is likely to
consolidate in the near future, which could result in increased price and other
competition that could damage our business.
Our current and potential competitors in the market include web hosting
service providers, applications hosting providers, Internet service providers,
telecommunications companies, large information technology firms that provide a
wide array of information technology services and computer hardware suppliers.
Our competitors may operate in one or more of these areas and include companies
such as Concentric Network Corporation, Data Return Corp., Dell Computer
Corporation, Digex Corporation, EarthLink, Inc., Exodus Communications, Inc.,
Gateway, Inc., Verio Inc., and Navisite, Inc.
Our quarterly and annual results may fluctuate, resulting in fluctuations in the
price of our common stock.
As our business develops and expands, we may experience significant
quarterly fluctuations in our results of operations. Because of these
fluctuations, comparisons of our operating results from period to period are not
necessarily meaningful and you should not rely on them as an indicator of future
performance. We expect to continue to experience significant fluctuations in our
quarterly and annual results of operations due to a variety of factors, many of
which are outside our control. These factors include:
o demand for and market acceptance of our services;
o introductions of products or services or enhancements by us and our
competitors;
o the mix of services we sell;
o customer retention;
o the timing and success of our advertising and marketing efforts and
introductions of new services to customers and the timing and success of
the marketing efforts and introductions of new services to customers of
our resellers;
o the timing and magnitude of capital expenditures, including construction
costs relating to the expansion of operations;
o increased competition in the web hosting and applications hosting
markets;
o changes in our pricing policies and the pricing policies of our
competitors;
o gains or losses of key strategic relationships; and
o other general and industry-specific economic factors.
In addition, a relatively large portion of our expenses is fixed in the
short-term, and therefore our results of operations are particularly sensitive
to fluctuations in revenues. Also, if we were unable to continue using
third-party products in our services offerings, our service development costs
could increase significantly.
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We may need additional capital to fund our operations and finance our growth,
and we may not be able to obtain it on terms acceptable to us or at all.
We believe that our existing capital resources will enable us to implement
our current business plan through at least the end of 2001. However, we may
require additional funds during or after that period. Any required financing may
not be available or may be available only on terms that are not favorable to us.
Further, sales of our equity securities to raise additional funds would dilute
the percentage ownership of our shareholders. Any new equity securities may have
rights, preferences or privileges senior to those of our common stock. The
failure to generate sufficient cash flows or to raise sufficient funds may
require us to delay or abandon some or all of our development and expansion
plans or otherwise forego market opportunities and may make it difficult for us
to respond to competitive pressures, any of which could harm our business.
The international market for our services is unproven, and as a result, the
revenue generated by any current or future international operations may not be
adequate to offset the expense of establishing and maintaining those operations.
The international market for web site and applications hosting and
management services is unproven, and we may not be able to market, sell and
provide our services successfully to small and medium-sized businesses outside
the United States. In addition, our particular approach to providing hosting
services is unproven in international markets and may not be successful outside
the United States. During the nine months ended September 30, 2000, we derived
approximately 8.9% of our revenues from customers located outside the United
States, and we are seeking to expand our presence overseas. In April 2000, we
opened a sales and support center in Amsterdam as part of our plan to expand our
European operations. Our continued success depends in part on expanding our
international customer base.
If we are unable to expand our network infrastructure to meet increasing demand,
we could lose customers and we may not be able to sustain or increase our
revenues.
We must continue to expand and adapt our network infrastructure to meet the
increase in the number of users and the amount of information they wish to
transport and to meet changing customer requirements. The expansion and
adaptation of our telecommunications infrastructure will require substantial
financial, operational and management resources as we negotiate for access to
telecommunications systems with existing and other network infrastructure
suppliers. Significant and rapid expansion of our network due to increased usage
will place additional stress upon our network hardware and traffic management
systems. The ability of our network to connect and manage a substantially larger
number of customers at high transmission speeds is as yet unknown. In addition,
our ability to expand our network to its expected customer levels while
maintaining superior performance is unknown.
If we are unable to continue to obtain sufficient telecommunications network
capacity at reasonable costs, we may not be able to provide our services at
prices acceptable to our customers, thereby reducing demand for our services.
Our success will depend upon the capacity, ease of expansion, reliability
and security of our network infrastructure, including the capacity leased from
our telecommunications network suppliers. Our operating results depend, in part,
upon the pricing and availability of telecommunications network capacity from a
limited number of providers. If capacity is not available to us as our
customers' usage increases, our network may not be able to achieve or maintain
sufficiently high data transmission capacity, reliability or performance. In
addition, our business would suffer if our network suppliers increased the
prices for their services and we were unable to pass along any increased costs
to our customers. Any failure on our part or the part of our third-party
suppliers to achieve or maintain high data transmission capacity, reliability or
performance could significantly reduce customer demand for our services, damage
our business reputation and increase our costs.
We may not be able to deliver our services if our third-party suppliers do not
provide us with key components of our network infrastructure on reasonable terms
or at all.
We depend on other companies to supply key components of our network
infrastructure. Any failure to obtain needed products or services in a timely
fashion or at an acceptable cost could adversely affect our business. We have no
guaranteed supply arrangements with our vendors and do not carry significant
inventories. In the event of equipment failure, we may not have the necessary
hardware or parts on hand and may not be able to obtain them from our suppliers
in a timely manner. Our inability or failure to obtain the necessary hardware or
parts on a timely basis could result in sustained equipment failure and a loss
of revenue due to customer loss or claims for service credits under our
guaranteed levels of service. In addition, the inability to obtain equipment or
technical services on terms acceptable to
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us would force us to spend time and money selecting and obtaining new equipment,
training our personnel to use different equipment and deploying alternative
components needed to integrate the new equipment.
We depend on our reseller sales channel to market and sell many of our services.
We do not control our resellers, and if we fail to develop or maintain good
relations with resellers, we may not achieve the growth in customers and
revenues that we expect.
An element of our strategy for growth is to continue to develop our use of
third parties who resell our services. Many of our resellers are web development
or web consulting companies that also sell our web hosting services, but that
generally do not have established customer bases to which they can market our
services. Therefore, in those markets where we do not focus our direct marketing
efforts -- mainly international markets -- we are dependent on third parties to
stimulate demand for our services. Although we attempt to provide our resellers
with incentives such as price discounts on our services that the resellers seek
to resell at a profit, the failure of our services to be commercially accepted
in some markets, whether as a result of a reseller's performance or otherwise,
could cause our current resellers to discontinue their relationships with us,
and we may not be successful in establishing additional reseller relationships
as needed.
Because we operate in a new and evolving market with uncertain prospects for
growth, we may be unable to sustain growth in our customer base.
The market for web hosting and applications hosting services for small and
medium-sized businesses has only recently begun to develop and is evolving
rapidly. Our future growth, if any, will depend upon the willingness of small
and medium-sized businesses to outsource web hosting and applications hosting
services and our ability to increase our average revenue per customer and our
customers' willingness to execute long-term contracts for hosting services. The
market for our services may not develop further, consumers may not widely adopt
our services, and significant numbers of businesses or organizations may not use
the Internet for commerce and communication. If this market fails to develop
further or develops more slowly than expected, or if our services do not achieve
broader market acceptance, we will not be able to grow our customer base.
In addition, we must be able to differentiate ourselves from our competition
through our service offerings and brand recognition in order to attract
customers and to grow our average revenue per customer. These activities may be
more expensive than we anticipate, and we may not be successful in
differentiating ourselves, achieving market acceptance of our services or
selling additional services to our existing customer base. We may also
experience difficulties that could delay or prevent the successful development,
introduction or marketing of these services. If we are unable, for technical or
other reasons, to develop and introduce new services or products or enhancements
to existing services in a timely manner, or if new services do not achieve
market acceptance in a timely manner or at all, it would be difficult for us to
attract customers or to grow our average revenue per customer.
We may not be able to adapt to evolving technologies and customer demands.
In the web and applications hosting industry, service providers must keep
pace with evolving technologies in order to offer relevant, sophisticated
services on a timely basis to meet rapidly changing customer demands. Our future
success will depend, in part, upon our ability to offer services that
incorporate leading technologies, address the increasingly sophisticated and
varied needs of our current and prospective web and applications hosting
customers and respond to technological advances and emerging industry standards
and practices on a timely and cost-effective basis. The market for our services
is characterized by rapidly changing and unproven technologies, evolving
industry standards, changes in customer needs, emerging competition and frequent
introductions of new services. To be successful, we must continually improve the
performance, features and reliability of our services, including our proprietary
technologies, and modifying our business strategies accordingly. We could also
incur substantial costs if we need to modify our services or infrastructure in
order to adapt to these changes. Technological advances may have the effect of
encouraging some of our current or future customers to rely on in-house
personnel and equipment to furnish the services that we currently provide.
If we are unable to maintain the compatibility of our services with products
offered by our vendors, we could lose or fail to attract customers.
We believe that our ability to compete successfully also depends upon the
continued compatibility of our services with products offered by various
vendors. Enhanced or newly developed third-party products may not be compatible
with our infrastructure, and such products may not adequately address the needs
of our customers. Although we currently intend to support emerging standards,
industry standards may not be established, and, even if they are established, we
may not be able to conform to these new standards in a timely fashion in order
to maintain a competitive position in the market. Our failure to conform to the
prevailing standard, or the failure of a common
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standard to emerge, could cause us to lose customers or fail to attract new
customers. In addition, products, services or technologies developed by others
could render our services noncompetitive or obsolete.
Our recent growth has strained our resources, and if we are unable to manage our
anticipated growth, we may not be able to maintain the quality of our services
and operations or control our costs effectively.
We are currently experiencing a period of rapid expansion of our customer
base. In addition, the number of our employees increased from 17 on March 31,
1998 to 589 on September 30, 2000. This growth has placed and, if it continues,
will place a significant strain on our financial, management, operational and
other resources. In addition, we must manage relationships with a growing number
of third parties as we seek to complement our service offerings and increase our
indirect sales efforts. Our management, personnel, systems, procedures and
controls may not be adequate to support our existing and future operations. Our
ability to manage our growth effectively will require us to continue:
o enhancing management information systems and forecasting procedures;
o further developing our operating, administrative, financial, billing,
and accounting systems and controls;
o maintaining close coordination among our engineering, accounting,
finance, marketing, sales and operations organizations;
o expanding, training and managing our employee base; and
o expanding our finance, administrative and operations staff.
The failure to manage our growth effectively could adversely affect the
quality of our services, our business and our financial condition. We may not be
able to maintain the quality of our operations, to control our costs and to
expand our internal systems in order to support our desired growth.
If Internet usage does not continue to increase or if the Internet fails to
perform reliably, we may not be able to attract customers.
Use of the Internet for retrieving, sharing and transferring information
among businesses, consumers, suppliers and partners has recently begun to
increase rapidly. The adoption of the Internet for information retrieval and
exchange, commerce and communications, particularly by those enterprises that
have historically relied upon alternative means of information gathering,
commerce and communications, generally requires the adoption of a new medium of
conducting business and exchanging information. If the Internet as a commercial
or business medium fails to develop further or develops more slowly than
expected, we would not be able to grow our customer base as quickly as desired
and our customers would be less likely to require more complex, higher revenue
services from us.
As a web and applications hosting company, our success depends in large part
on continued growth in the use of the Internet. The lack of continued growth in
the usage of the Internet would adversely affect our business because we would
not gain additional customers and our existing customers might not have any
further use for our services. Internet usage and growth may be inhibited for a
number of reasons, such as:
o inadequate network infrastructure;
o security concerns;
o uncertainty of legal and regulatory issues concerning the use of the
Internet;
o inconsistent quality of service;
o lack of availability of cost-effective, reliable, high-speed service;
and
o failure of Internet use to expand internationally.
If Internet usage grows, the Internet infrastructure may not be able to
support the demands placed on it by this growth, or its performance and
reliability may decline. For example, web sites have experienced interruptions
in service as a result of outages and other delays occurring throughout the
Internet network infrastructure. If these outages or delays occur frequently,
use of the Internet as a commercial or business medium could in the future grow
more slowly or decline.
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We could experience system failures which could harm our reputation, cause
customers to seek reimbursement for services, and cause customers to seek
another provider for services.
We must be able to operate the systems that manage our network around the
clock without interruption. Our operations depend upon our ability to protect
our network infrastructure, equipment and customer files against damage from
human error, fire, earthquakes, hurricanes, floods, power loss,
telecommunications failures, sabotage, intentional acts of vandalism and similar
events. Despite precautions we have taken, and plan to take, we do not have a
formal disaster recovery plan and the occurrence of a natural disaster or other
unanticipated problems at our data centers could result in interruptions in our
services. Although we have attempted to build redundancy into our network, our
network is currently subject to various points of failure, and a problem with
one of our routers (devices that move information from one computer network to
another) or switches could cause an interruption in our services to a portion of
our customers. In the past we have experienced periodic interruptions in
service. In addition, failure of any of our telecommunications providers to
provide the data communications capacity we require, as a result of human error,
a natural disaster or other operational disruption, could result in
interruptions in our services. Any future interruptions could:
o cause customers or end users to seek damages for losses incurred;
o require us to replace existing equipment or add redundant facilities;
o damage our reputation for reliable service;
o cause existing customers to cancel their contracts; or
o make it more difficult for us to attract new customers.
We currently offer to all customers a 99.9% service level warranty. Under
this policy, we guarantee that each customer's Web site will be available at
least 99.9% of the time in each calendar month for as long as the customer is
using our web hosting services. If we were to experience widespread system
failures, we could incur significant costs under this warranty.
Our data centers and networks may be vulnerable to security breaches.
A significant barrier to electronic commerce and communications is the need
for secure transmission of confidential information over public networks. Some
of our services rely on security technology licensed from third parties that
provides the encryption and authentication necessary to effect the secure
transmission of confidential information. Despite our design and implementation
of a variety of network security measures, unauthorized access, computer
viruses, accidental or intentional actions and other disruptions could occur. In
the past, we have experienced and may in the future experience delays or
interruptions in service as a result of the accidental or intentional actions of
Internet users, current and former employees or others. In addition,
inappropriate use of the network by third parties could also potentially
jeopardize the security of confidential information, such as credit card and
bank account numbers stored in our computer systems. These security problems
could result in our liability and could also cause the loss of existing
customers and potential customers. In addition, third parties could interfere
with the operation of our customers' web sites through intentional attacks
including causing an overload of traffic to these web sites.
Although we intend to continue to implement industry-standard security
measures, third parties may be able to overcome any measures that we implement.
The costs required to eliminate computer viruses and alleviate other security
problems could be prohibitively expensive and the efforts to address such
problems could result in interruptions, delays or cessation of service to our
customers, and harm our reputation and growth. Concerns over the security of
Internet transactions and the privacy of users may also inhibit the growth of
the Internet, especially as a means of conducting commercial transactions.
Disruption of our services caused by unknown software defects could harm our
business and reputation.
Our service offerings depend on complex software, including our proprietary
software tools and software licensed from third parties. Complex software often
contains defects, particularly when first introduced or when new versions are
released. We may not discover software defects that affect our new or current
services or enhancements until after they are deployed. Although we have not
experienced any material software defects to date, it is possible that defects
may occur in the software. These defects could cause service interruptions,
which could damage our reputation or increase our service costs, cause us to
lose revenue, delay market acceptance or divert our development resources.
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Providing services to customers with critical web sites and web-based
applications could potentially expose us to lawsuits for customers' lost profits
or other damages.
Because our web hosting and applications hosting services are critical to
many of our customers' businesses, any significant interruption in our services
could result in lost profits or other indirect or consequential damages to our
customers. Although the standard terms and conditions of our customer contracts
disclaim our liability for any such damages, a customer could still bring a
lawsuit against us claiming lost profits or other consequential damages as the
result of a service interruption or other web site or application problems that
the customer may ascribe to us. A court might not enforce any limitations on our
liability, and the outcome of any lawsuit would depend on the specific facts of
the case and legal and policy considerations even if we believe we would have
meritorious defenses to any such claims. In such cases, we could be liable for
substantial damage awards. Such damage awards might exceed our liability
insurance by unknown but significant amounts, which would seriously harm our
business.
We may not be able to successfully sustain our growth if we are unable to
attract and retain additional highly skilled personnel.
We are currently experiencing rapid growth and intend to continue expanding.
Since beginning our operations as a web hosting business in September 1997, we
have grown to 589 employees as of September 30, 2000. We believe that we will
need to hire approximately 200 additional personnel in all areas of our business
over the next 12 months. Our future success will also depend on our ability to
attract, train, retain and motivate highly qualified technical, marketing, sales
and management personnel. Competition for qualified personnel among
Internet-related businesses is intense, and we may not be able to attract and
retain key personnel.
If our management team, which has worked together for only a brief time, is
unable to work together effectively, we may not be able to implement our plans
successfully.
During the nine months ended September 30, 2000 we have hired key employees
and officers, including our Executive Vice President and Chief Financial
Officer, Senior Vice President -- Sales, Marketing and Business Development,
General Counsel, Chief Technical Officer, and Chief Information Officer. As a
result, our management team has worked together for only a brief time. Our
success depends in significant part upon the continued services of our senior
management personnel. Any of our officers or employees can terminate his or her
relationship with us at any time. We currently have employment agreements with
only our most senior management personnel and we carry key-man life insurance
only for our President and Chief Executive Officer.
Impairment of our intellectual property rights could negatively affect the
reputation of our brand or could allow competitors to minimize any advantage
that our proprietary technology gives us.
We rely on a combination of copyright, trademark, service mark and trade
secret laws and contractual restrictions to establish and protect proprietary
rights in our services, particularly including the name "Interland" and our
proprietary customer management system. We have filed trademark registration
applications in the U.S. that, even if granted, may not fully protect our
ability to use these trademarks in all areas of the U.S. In addition, we have
spent and expect to continue to invest significant amounts to build brand
recognition of our name, and we could lose the return on this significant
marketing investment if we were to lose or be restricted in the use of the
Interland name to market our services. Third parties may object to our use of
some of our trademarks, service marks, trade names, slogans or other devices,
which could require that those indicia be changed or altered. At this point, we
have no patented technology that would preclude or inhibit competitors from
entering our market. While we believe that we may file several patent
applications on particular aspects of our technology, we cannot be sure that we
will receive any patents. We have entered into confidentiality and other
agreements with our employees and contractors, including agreements in which
they assign their rights in inventions to us. We have also entered into
nondisclosure agreements with our suppliers, distributors and some of customers
in order to limit access to and disclosure of our proprietary information. These
contractual arrangements or the other steps we have taken to protect our
intellectual property may not prove sufficient to prevent illegal use of our
technology or to deter independent third-party development of similar
technologies. The laws of some foreign countries may not protect our services or
intellectual property rights to the same extent as do the laws of the United
States. For example, there may be potential conflicts with the use of our name
in other countries. We do not know what the impact of being unable to use our
name in other countries may be, although this inability may cause us to incur
significant additional expenses to build brand recognition in those countries.
We also rely on several technologies that we license from third parties.
These third-party technology licenses may not continue to be available to us on
commercially reasonable terms. The loss of the ability to use such technology
could require us to obtain the rights to use substitute technology, which could
be more expensive or offer lower quality or performance.
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We may be accused of infringing the proprietary rights of others, which could
subject us to costly and time consuming litigation.
In addition to the technologies we develop or have developed, we license
technologies from third parties and may license additional technologies in the
future. To date, we have not been notified that our services infringe on the
proprietary rights of any third parties, but third parties could claim that we
have infringed on their technology with respect to current or future services.
We expect that participants in our markets will be increasingly subject to
infringement claims as the number of services and competitors in our industry
segment grows. Any such claim, whether meritorious or not, could be
time-consuming, result in costly litigation, cause service installation delays
or require us to enter into royalty or licensing agreements. These royalty or
licensing agreements might not be available on terms acceptable to us or at all.
In addition, third parties may change the terms of their license agreements in
ways that would prevent us from using technologies licensed from them on
commercially reasonable terms or that would prevent us from using them at all.
We may not be able to replace those technologies with technologies that have the
same features or functions on commercially reasonable terms or at all.
We could face liability for information distributed through our network.
The law relating to the liability of on-line services companies for
information carried on or distributed through their networks is currently
unsettled. On-line services companies could be subject to claims under both
United States and foreign law for defamation, negligence or copyright or
trademark infringement, or other theories based on the nature and content of the
materials distributed through their networks. Several private lawsuits seeking
to impose such liability upon other entities are currently pending against other
companies. In addition, we may become subject to proposed legislation that would
impose liability for or prohibit the transmission over the Internet of some
types of information. Other countries may also enact legislation or take action
that could impose liability on us or cause us not to be able to operate in those
countries. The imposition upon us and other on-line services of potential
liability for information carried on or distributed through our systems could
require us to implement measures to reduce our exposure to such liability, which
may require us to expend substantial resources, or to discontinue service
offerings. The increased attention focused upon liability issues as a result of
these lawsuits and legislative proposals also could affect the growth of
Internet use.
Our business may be impacted by government regulation and legal uncertainties.
We are not currently subject to direct federal, state or local government
regulation, other than regulations that apply to businesses generally. Only a
small body of laws and regulations currently applies specifically to access to,
or commerce on, the Internet. Due to the increasing popularity and use of the
Internet, however, laws and regulations with respect to the Internet may be
adopted at federal, state and local levels, covering issues such as user
privacy, freedom of expression, pricing, characteristics and quality of products
and services, taxation, advertising, intellectual property rights, information
security and the convergence of traditional telecommunications services with
Internet communications. We cannot fully predict the nature of future
legislation and the manner in which government authorities may interpret and
enforce. As a result, we and our customers could be subject to potential
liability under future legislation which in turn could have a material adverse
effect on our business, results of operations and financial condition. For
example, if legislation that makes transacting business over the Internet, such
as e-commerce, less favorable or otherwise curtails the growth of the Internet
is adopted in the U.S. or internationally, our business would suffer. The
adoption of any such laws or regulations might decrease the growth of the
Internet, which in turn could decrease the demand for our services or increase
the cost of doing business or in some other manner harm our business.
In addition, applicability to the Internet of existing laws governing issues
such as property ownership, copyright and other intellectual property issues,
taxation, libel, obscenity and personal privacy is uncertain. These laws
generally pre-date the advent of the Internet and related technologies and, as a
result, do not consider or address the unique issues of the Internet and related
technologies. Changes to laws intended to address these issues could create
uncertainty in the marketplace that could reduce demand for our services or
increase the cost of doing business as a result of costs of litigation or
increased service delivery costs, or could in some other manner have a material
adverse effect on our business, results of operations and financial condition.
In addition, because our services are available over the Internet virtually
worldwide, and because we facilitate sales by our customers to end users located
in multiple states and foreign countries, such jurisdictions may claim that we
are required to qualify to do business as a foreign corporation in each such
state or that we have a permanent establishment in each such foreign country.
We face risks inherent in doing business in international markets that could
adversely affect the success of our international operations.
Although we have historically derived a portion of our revenues from foreign
sales, we have just recently commenced business in our first foreign location
and must now deal more directly with the risks inherent in doing
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business in international markets. These risks include different regulatory
requirements, trade barriers, challenges in staffing and managing foreign
operations, currency risk, different tax structures which may adversely impact
earnings, and foreign political and economic instability, any of which could
adversely affect the success of our international operations. We also expect
that many of the costs of staffing and managing our international operations
will be greater than for comparable U.S. based operations, including higher
employee costs, longer accounts receivable collection periods and greater
difficulty in collecting accounts receivable.
In addition, as a web and applications hosting company, we face challenges
in offering these services to customers in foreign markets that can differ
significantly from the challenges we face in the United States, such as:
o different Internet access fees;
o different technology standards;
o different privacy, censorship and liability standards and regulations;
and
o less protective intellectual property laws.
Any of these risks could adversely affect our ability to operate or expand
internationally, which would limit the growth of our business. In addition, we
could suffer significant operating losses if the revenue generated by our
current sales and support center or any future international data center or
other operations is not adequate to offset the expense of establishing and
maintaining those international operations.
Some provisions of our articles of incorporation and bylaws may discourage
takeovers.
Our articles of incorporation and bylaws contain some provisions that may
delay, discourage or prevent an attempted acquisition or change in control. Our
articles and bylaws establish:
o the authority of the board of directors to issue series of preferred
stock with special powers, preferences and rights without shareholder
approval;
o the authority of the board of directors to consider constituencies other
than the shareholders -- including employees, customers, suppliers and
the community -- in making decisions, including decisions regarding
control of Interland;
o the right of the board of directors to alter our bylaws without prior
shareholder approval; and
o the right of the board of directors to elect a director to fill a
vacancy created by the expansion of the board of directors.
In addition, our bylaws establish three classes of directors to serve
three year staggered terms. These provisions of our articles of incorporation
and bylaws could discourage tender offers or other transactions that might
otherwise result in your receiving a premium over the market price for your
common stock.
We have adopted a shareholder rights plan. This plan entitles our
shareholders to acquire additional shares of our preferred stock when a third
party acquires 15% of our common stock or commences or announces its intent to
commence a tender offer for at least 15% of our common stock. This plan could
delay, deter, or prevent a change of control.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Most of our customer contracts are currently denominated in United States
dollars with an immaterial amount of contracts denominated in euro or pounds
sterling. We do not currently invest in derivative financial instruments.
However, we invest our excess cash balances in cash equivalents and are
therefore subject to market risk related to changes in interest rates. We
believe, but cannot be certain, that the effect on our financial position,
results of operation and cash flows of any reasonably likely changes in interest
rates would not be material.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds.
(a) Shareholder Rights Plan
On July 12, 2000, our board of directors approved a rights agreement with
SunTrust Bank as rights agent. This summary is not a full description of the
rights agreement or the terms of the rights. For a more complete description,
please read the rights agreement, dated as of July 12, 2000, between the Company
and SunTrust Bank, filed as Exhibit to our Registration Statement on Form S-1
(File No. 333-32556).
Rights and Rights Certificates
On July 12, 2000, our board of directors declared a dividend of one
preferred stock purchase right for each share of common stock outstanding
effective July 24, 2000. Each right entitles its registered holder to purchase
one one-hundredth of a share of newly designated Series B participating
cumulative preferred stock at a purchase price of $100.00. The terms of the
series B participating cumulative preferred stock are contained in a statement
of resolution that was filed with the Secretary of State of Georgia.
The rights are attached to and trade with shares of our common stock.
Currently, the rights are not exercisable and there are no separate certificates
representing the rights. If the rights become exercisable, we will distribute
separate rights certificates. Until that time, as long as the rights remain
outstanding, any transfer of shares of our common stock will also constitute the
transfer of the rights associated with those shares of common stock. The rights
will expire on July 24, 2010, unless we redeem or exchange the rights before
that date.
The rights will become exercisable upon the earlier to occur of:
o the public announcement that a person or group of persons has
acquired 15% or more of our common stock, except in connection with
an offer approved by the board of directors; or
o the close of business on the tenth business day, or a later date
determined by the board of directors, after the commencement of, or
announcement of an intention to commence, a tender or exchange offer
that would result in a person or group of persons acquiring 15% or
more of our common stock.
In addition, the purchase price payable and the number of shares of
preferred stock or other securities issuable upon exercise of the rights may be
adjusted to prevent dilution upon:
o stock splits, stock dividends, subdivisions, combinations or
reclassifications of the preferred stock;
o below market issuances of preferred stock or rights or warrants to
subscribe for or convert into preferred stock; or
o distributions to holders of the preferred stock of evidence of
indebtedness or assets (excluding regular quarterly cash dividends
or dividends payable in preferred stock) or of subscription rights
or warrants, with some exceptions.
The Series B participating cumulative preferred stock has been structured
so that each preferred share has dividend, liquidation and voting rights equal
to those of 100 shares of our common stock. Because of this, the value of the
one one-hundredth interest in a preferred share purchasable upon exercise of
each right should approximate the value of one share of common stock. The
preferred shares are not redeemable.
(b) Private Stock Offerings
On July 26, 2000 the Company issued 2,375,000 shares of common stock to
three investors for a purchase price of $28.5 million.
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These sales were deemed to be exempt from registration under the
Securities Act in reliance on section 4(2) of the Securities Act as transactions
by an issuer not involving a public offering.
(c) Initial Public Offering
On July 24, 2000 the Company's Registration Statement on Form S-1 (File
No. 333-32556) (the "Registration Statement") was declared effective by the
Commission. The Company commenced an initial public offering of its shares of
Common Stock (the "Offering") on July 25, 2000 and closed the Offering on July
28, 2000. The managing underwriters in the offering were Bear Stearns & Co.
Inc., Thomas Weisel Partners LLC and PaineWebber. All 5,000,000 shares of common
stock registered under the Registration Statement were sold at a price of $12.00
per share for gross proceeds to the Company of approximately $60 million. The
net proceeds of the Offering were approximately $53 million. The Company intends
to use the net proceeds to fund capital expenditures, consisting of the purchase
of servers and other hardware, and for working capital and other general
corporate purposes.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders.
None
Item 5. Other Information
On September 19, 2000 Nicholas Farsi joined the Company as its Senior Vice
President and Chief Information Officer.
27
<PAGE>
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits:
27 Financial Data Schedule.
(b) Reports on Form 8-K:
None
-------------------
28
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTERLAND, Inc.
Dated: October 31, 2000 By: /s/ David N. Gill
--------------------------------------------
David N. Gill, Executive Vice President -
Chief Financial Officer
(Principal Financial and Accounting Officer
and Authorized Officer)
29
