<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to _________
Commission File Number 0-26923
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U.S. INTERACTIVE, INC.
----------------------
(Exact name of registrant as specified in its charter)
Delaware 23-3316696
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(State or Other Jurisdiction of (I.R.S. Employer)
Incorporation or Organization) (Identification Number)
2012 Renaissance Boulevard,
King of Prussia, Pennsylvania 19406
----------------------------- -----
(Address of principal executive offices) (Zip Code)
(610) 313-9700
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes _X_ No__
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 19,378,505 shares of common
stock, $.001 par value per share, as of October 31, 1999.
<PAGE>
U.S. Interactive, Inc. and Subsidiaries
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
<S> <C> <C>
Item 1. Condensed Consolidated Financial Statements
Page No.
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Consolidated Balance Sheets as of September 30, 1999 (Unaudited) and December 31, 1998. 1
Consolidated Statements of Operations for the three and nine months ended September 30,
1999 and 1998 (Unaudited).............................................................. 2
Consolidated Statements of Cash Flows for the nine months ended September 30, 1999 and
1998 (Unaudited)....................................................................... 3
Notes to Condensed Consolidated Financial Statements................................... 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................................. 7
Item 3. Quantitative and Qualitative Disclosures about Market Risk............................. 12
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.............................................. 13
Item 6. Exhibits and Reports on Form 8-K....................................................... 13
SIGNATURES............................................................................. 15
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
U.S. INTERACTIVE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
---- ----
(unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents........................... $ 40,889 $ 3,698
Accounts receivable (net of allowance of
$438 in 1999 and $526 in 1998).................. 10,197 3,388
Fees and expenditures in excess of billings......... 1,149 731
Prepaid expenses and other current assets........... 680 305
-------- --------
Total current assets .......................... 52,915 8,122
Furniture and equipment, net............................. 3,867 1,375
Goodwill and other intangibles, net............. 8,366 12,542
Other assets.................................... 159 223
-------- --------
Total Assets ............................................ $ 65,307 $ 22,262
======== ========
Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Accounts payable ..................................... $ 3,628 $ 1,334
Accrued expenses...................................... 5,733 2,354
Notes payable - bank ................................. - 1,706
Current portion of long-term debt..................... 882 162
Billings in excess of fees and expenditures .......... 1,970 650
-------- --------
Total current liabilities................................ 12,213 6,206
Long-term debt, net of current portion................... 548 583
-------- --------
Total Liabilities........................................ 12,761 6,789
Mandatorily redeemable convertible preferred stock, $.001 par
value, 15,000,000 shares authorized, 5,341,096 issued and
outstanding in 1998, including accreted dividends of $477
in 1998:.............................................. - 17,293
Preferred stock, $.001 per value, 15,000,000 shares authorized,
none issued or outstanding in 1999....................... - -
Common Stock-90,000,000 shares authorized, $.001 par value
20,360,369 shares issued in 1999 (unaudited), 9,124,999 shares
issued in 1998........................................ 20 9
Additional paid in capital............................... 78,892 12,418
Treasury stock, 1,062,709 shares, at cost................ (5,055) (4,812)
Accumulated deficit...................................... (21,311) (9,435)
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Total Stockholders' Equity (Deficit)..................... 52,546 (1,820)
------- -------
Total Liabilities and Stockholders' Equity (Deficit)..... $ 65,307 $ 22,262
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements
1
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U.S. INTERACTIVE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
1999 1998 1999 1998
---- ---- ---- ----
(unaudited) (unaudited) (unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenue............................... $ 9,887 $ 4,554 $ 23,650 $ 9,478
Operating costs and expenses:
Project personnel and related expenses 5,521 2,412 12,819 5,085
Management and administrative.... 5,007 2,747 11,601 4,637
Marketing and sales.............. 1,013 623 2,464 1,464
Depreciation and amortization.... 2,680 2,181 7,737 2,395
-------- -------- ---------- --------
14,221 7,963 34,621 13,581
Operating loss........................ (4,334) (3,409) (10,971) (4,103)
-------- -------- ---------- --------
Other income (expense):
Interest expense ................ (74) (82) (314) (127)
Interest income.................. 289 6 347 22
-------- -------- ---------- --------
Net loss.............................. (4,119) (3,485) (10,938) (4,208)
Accretion of mandatorily redeemable preferred
stock to redemption value............ (168) (251) (916) (251)
-------- -------- ---------- --------
Net loss attributable to common stockholders $ (4,287) $ (3,736) $ (11,854) $ (4,459)
======== ======== ========== ========
Basic and diluted loss per common share: $ (.30) $ (.41) $ (1.14) (.73)
======== ======== ========== ========
Weighted average shares outstanding used in
the loss per common share calculation:
Basic and diluted.................... 14,414 9,020 10,447 6,121
======== ======== ========== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements
2
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U.S. INTERACTIVE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
1999 1998
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(unaudited) (unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net loss................................................ $(10,938) $ (4,208)
Adjustments to reconcile net loss to net cash used in
operating activities:
Amortization of deferred stock compensation and other
non-cash charges .................................... 473 --
Depreciation and amortization .......................... 7,737 2,395
Changes in operating assets and liabilities, net of
effects of acquisitions:
Increase in accounts receivable...................... (6,777) (35)
Increase in fees and expenditures in excess of
billings............................................ (417) (541)
Increase in prepaid expenses and other current assets (339) (326)
Increase in accounts payable and accrued expenses .. 5,606 1,691
Increase (decrease) in billings in excess of fees and
expenditures ....................................... 1,320 (256)
-------- ---------
Net cash used in operating activities .................. (3,335) (1,281)
-------- ---------
Cash flows from investing activities:
Purchase of furniture and equipment...................... (2,840) (368)
Acquisition, net of cash acquired ....................... - (725)
Other.................................................... (24) (58)
-------- ---------
Net cash used in investing activities.................... (2,864) (1,151)
-------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock................... 45,987 10,807
Payments to acquire treasury stock....................... - (4,812)
Retirement of preferred stock............................ - (1,020)
Net (repayments) borrowings under bank line of credit.... (1,700) 1,225
Net proceeds of note payable............................ 387 438
Net proceeds from the exercise of stock options.......... 194 --
Deferred offering costs.................................. (1,478) --
-------- ---------
Net cash provided by financing activities............... 43,390 6,638
-------- ---------
Net increase in cash and cash equivalents ............... 37,191 4,206
Cash and cash equivalents, beginning of period........... 3,698 786
Cash and cash equivalents, end of period................. $ 40,889 $ 4, 992
======== =========
Supplemental disclosure of cash flow information:
Cash paid for interest ............................. $ 176 $ 63
======== =========
</TABLE>
See accompanying notes to condensed consolidated financial statements
3
<PAGE>
U.S. INTERACTIVE, INC. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Unaudited Interim Financial Information
The interim condensed consolidated financial statements of the Company
for the three and nine months ended September 30, 1998 and 1999, included herein
have been prepared by the Company, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC). Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations relating to interim financial
statements. These unaudited consolidated financial statements should be read in
conjunction with the audited consolidated financial statements and notes thereto
as of December 31, 1998 included in the Company's registration statement on Form
S-1, as amended (File No. 333-78751). In the opinion of management, the
accompanying unaudited interim consolidated financial statements reflect all
adjustments, consisting only of normal recurring adjustments, necessary to
present fairly the financial position of the Company at September 30, 1999, and
the results of its operations for the three and nine months ended September 30,
1998 and 1999, and the results of its cash flows for the nine months ended
September 30, 1998 and 1999.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
U.S. Interactive, Inc. (the Company) is a provider of Internet
professional services helping companies take advantage of the business
opportunities presented by the Internet. The Company provides integrated
Internet strategy consulting, marketing and technology services that enable
clients to align their people, processes and systems to form an electronic
enterprise.
As more fully described in Note (4), in August 1999 the Company
completed an Initial Public Offering of its common stock.
Principles of Consolidation
The accompanying consolidated financial statements include the
financial statements of the Company and its two wholly owned subsidiaries, Web
Access, Inc., and Digital Bindery, LLC. All significant intercompany balances
and transactions have been eliminated in consolidation. Digital Bindery, LLC had
no meaningful assets or operations during the periods presented.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of any potential contingent assets and liabilities at the date of the
financial statements and reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Deferred Offering Costs
Specific incremental costs directly attributable to the Company's
initial public offering process aggregate approximately $1,478,000 and were
charged against additional paid-in-capital in connection with the consummation
of its initial public offering.
Historical Net Loss Per Share
The Company computes earnings per share in accordance with SFAS No.
128, "Earnings per Share" ("SFAS No. 128"). Basic earnings per share is computed
using the weighted average number of common shares outstanding during the
period. Diluted earnings per share is computed using the weighted-average number
4
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U.S. INTERACTIVE, INC. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
of common and common equivalent shares outstanding during the period. For all
loss periods, the effect of common equivalent shares were excluded from the
computation as their effect is anti-dilutive. Net loss per share amounts for all
periods have been presented to conform to SFAS No. 128 requirements and the
accounting rules set forth in Staff Accounting Bulletin No. 98 issued by the SEC
in February 1998.
2. ACQUISTIONS
On July 2, 1998, the Company completed a merger (the Merger) with
Digital Evolution, Inc. (DE) an Internet professional services firm that
provided development services for Internet, intranet and extranet applications.
The shareholders of DE agreed to exchange their common and preferred shares for
common and preferred shares of the Company.
The Merger resulted in the Company issuing 4,383,954 shares of common
stock, 1,573,533 shares of Series A mandatorily redeemable convertible preferred
stock and options to purchase a total of 1,043,945 shares of Company common
stock. The aggregate purchase price was approximately $17 million. In connection
with the Merger, the holders of the Company's original Series A and B
convertible preferred stock exchanged their shares for Series B and C
mandatorily redeemable convertible preferred stock.
The Merger was accounted for under the purchase method of accounting.
The results of operations of DE have been included in the Company's consolidated
financial statements since July 1, 1998.
The excess of the purchase price over the fair value of the net
identifiable assets acquired of $16,128,000 has been recorded as goodwill and
other intangible assets and is amortized on a straight-line basis over its
estimated life of two years.
The purchase price was allocated as follows (in thousands):
Fair value of assets acquired (Primarily accounts
receivable and fixed assets).............................. $ 2,064
Goodwill and related intangible assets..................... 15,283
Assembled workforce........................................ 845
Fair value of liabilities acquired......................... (1,192)
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$17,000
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In March 1999, the Company acquired certain assets and assumed certain
liabilities of InVenGen LLC, a regional Internet professional service firm, in
exchange for 584,800 shares of the Company's common stock having an estimated
fair market value of $2,924,000 at the time of the transaction. The acquisition
was accounted for using the purchase method of accounting. Accordingly, a
portion of the purchase price was allocated to the net assets acquired and
liabilities assumed. The balance of the purchase price was recorded as goodwill
and is being amortized over two years.
The Company also issued 275,200 shares of restricted common stock in
connection with the transaction. The former employees of InVenGen LLC who became
employees of the Company are required to be employed by the Company during the
next two year period in order for the restricted shares to be released. If an
employee leaves the Company during the two-year period all unvested shares for
such employee are forfeited. As of September 30, 1999, no shares have been
forfeited. The Company recorded $1,376,000 of deferred stock compensation in
connection with these restricted shares that will be amortized over the two-year
period. The historical results of operations of InVenGen, LLC are not material
to the Company.
5
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U.S. INTERACTIVE, INC. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. ACQUISITIONS - (Continued)
The following table reflects unaudited pro forma combined results of
operations of the Company, DE and InVenGen LLC on the basis that the
acquisitions had taken place at the beginning of 1998 (in thousands, except per
share data).
<TABLE>
<CAPTION>
Three Months Ending Nine Months Ending
September 30, September 30,
1998 1999 1998
---- ---- ----
<S> <C> <C> <C>
Revenue ................................................. $ 4,916 $ 23,650 $14,035
Net loss attributable to common stockholders.............. (3,959) (11,854) (4,644)
Basic and diluted loss per common share................... $ (.40) $ (1.11) $ (.47)
</TABLE>
In management's opinion, the unaudited pro forma combined results of
operations are not indicative of the actual results that would have occurred had
the acquisitions been consummated at the beginning of 1998 or of future
operations of the combined companies under the ownership and management of the
Company.
3. LITIGATION
The Company is involved in certain claims and legal proceedings including
the collection of accounts receivable. While it is not feasible to predict or
determine the financial outcome of these proceedings management does not believe
that they should result in a materially adverse effect on the Company's
financial position, results of operations or liquidity.
4. INITIAL PUBLIC OFFERING
In August 1999, the Company completed its Initial Public Offering of
securities and issued a total of 4,865,848 shares of common stock at $10.00 per
share (including a total of 692,250 shares issued to the underwriters upon
exercise of the option which the Company had granted to them solely to cover
overallotments). An additional 441,402 shares were sold by existing stockholders
at $10.00 per share. Upon the initial closing of the public offering, all
5,341,096 of the outstanding shares of manditorily redeemable convertible
preferred stock were converted to 5,341,096 shares of common stock. Proceeds to
the Company from its Initial Public Offering net of underwriting discounts and
costs of the offering were approximately $44.5 million. The Company used a total
of $ 2.9 million of the net proceeds to repay all outstanding debt under its
line of credit and term loan.
6
<PAGE>
U.S. INTERACTIVE, INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of the financial condition and results of
operations of U.S. Interactive, Inc. should be read in conjunction with the
unaudited condensed consolidated financial statements and notes thereto included
elsewhere in this report. This Quarterly Report on Form 10-Q contains
forward-looking statements within the meaning of Section 27A of the Securities
act of 1933, as amended, and Section 1E of the Securities Exchange Act of 1934,
as amended. These forward-looking statements involve risks and uncertainties,
and actual results could be significantly different than those discussed in this
Quarterly Report on Form 10-Q. These forward-looking statements include
statements about the following:
o implementing our business strategy
o managing our growth and employee costs
o our business and growth strategies and other statements contained
herein that are not historical facts.
When used in this Report, the words "anticipate, "believe," "estimate,"
"expect," "seek," "intend," "may" and similar expressions are generally intended
to identify forward-looking statements. There are important factors that could
cause actual results to differ materially from those expressed or implied by
such forward-looking statements including: changes in general economic and
business conditions and those in the Internet professional services market in
particular; changes in Internet-related technologies; actions of competitors;
the extent to which we are able to expand our business into new markets; our
inability to effectively manage our growth (including growth through
acquisitions), including problems which may arise in integrating acquired
businesses into the Company's operations and in achieving satisfactory operating
results from the acquired businesses; the level of demand for our services;
changes in our business strategies; Year 2000 issues including those affecting
the Company or its clients; our inability to obtain financing when required and
other factors discussed under the caption "Risk Factors" in our prospectus dated
August 9, 1999.
Overview
Revenue. Revenue is derived from fixed-fee or time and materials
contracts. Revenue under fixed-fee arrangements is recognized on the
percentage-of-completion method based on the ratio of costs incurred to total
estimated costs. Fees and expenditures in excess of billings represent the costs
incurred on projects and anticipated profits earned on projects in excess of
amounts billed to date. These amounts are recorded as an asset. Billings in
excess of fees and expenditures represent amounts billed in excess of costs
incurred and estimated profit earned. These amounts are recorded as a liability.
Revenues exclude reimbursable expenses charged to clients. Losses on projects in
progress are recognized when known.
Approximately 65% of our revenue for the nine months ended September 30,
1999, was derived from fixed-fee arrangements. The percentage of our revenue
that is derived from fixed-fee arrangements may increase in the future.
Substantially all of our client projects may be terminated early by the client
without penalty.
Cost Structure. The largest portion of our costs consists of
employee-related expenses for our project personnel and other direct costs, such
as third-party vendor costs. The remainder of our costs are associated with the
development of our business and support of our project personnel, such as
marketing and sales, and management and administrative support. Marketing and
sales consists primarily of personnel costs and commissions as well as the cost
associated with our development and maintenance of our marketing materials and
programs. Management and administrative expense consists primarily of the costs
associated with:
o operations
o finance
o human resources
o information systems
o facilities
o other administrative support for project personnel
7
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We regularly review our fees for services, compensation and overhead
costs in an effort to remain competitive within our industry. In addition, we
monitor the progress of client projects with client senior management from time
to time. Monitoring the costs and progress associated with each project is aided
by our intranet-based project management systems. We manage the activities of
our service delivery personnel by monitoring project schedules closely and
staffing requirements for new projects. Most of our client projects can, and may
in the future, be terminated by the client without penalty. As a result, an
unanticipated termination of a client project could require us to maintain
underutilized employees, resulting in higher than expected percentage and number
of inactive professionals. While we intend to adjust our professional staff to
reflect our active projects, we must maintain a sufficient number of senior
professionals to oversee existing and anticipated client projects and
participate with our sales efforts to secure new client projects.
Variability of Operating Results. Our operating results have fluctuated
from quarter to quarter and may continue to fluctuate in the future. These
fluctuations may be significant. It is difficult for us to forecast accurately
the frequency and duration of our projects. We incur expenses, which are mainly
fixed expenses, based on our expectations concerning the costs of our future
projects. We may not be able to adjust our spending in a timely manner to
compensate for any shortfall in our projected revenues. In the event of such a
shortfall, our expenses as a percentage of our revenue would increase. We also
have experienced seasonality with respect to our revenues that has resulted in
lower revenue during summer, year-end vacation and holiday periods.
In July 1998, the Company completed the Digital Evolution merger which
resulted in issuance of 4,383,954 shares of common stock and 1,573,533 shares of
series A preferred stock to the shareholders of Digital Evolution. Prior to the
merger, Digital Evolution was an Internet professional services firm. The
Digital Evolution merger has been accounted for using the purchase method of
accounting. Of the total value of the consideration paid of $17.0 million,
$872,000 has been allocated to the fair value of the net tangible assets
acquired and liabilities assumed, and $16.1 million has been allocated to
goodwill and other intangible assets, which will be amortized over a two-year
period. The annual amortization expense associated with this goodwill and other
intangible assets is approximately $8.0 million. The results of operations of
Digital Evolution have been consolidated with the Company's results of
operations since July 1, 1998.
In March 1999, the Company acquired certain assets and assumed certain
liabilities of InVenGen LLC, a regional Internet professional service firm, in
exchange for 584,800 shares of the Company's common stock having an estimated
fair market value of $2,924,000 at the time of the transaction. The acquisition
was accounted for using the purchase method of accounting. Accordingly, a
portion of the purchase price was allocated to the net assets acquired and
liabilities assumed. The balance of the purchase price was recorded as goodwill
and is being amortized over two years. The results of operations of InVenGen LLC
have been consolidated with the Company's results of operations since April 1,
1999.
Results of Operations
The following table presents, for the periods indicated, the relative
composition of revenue and selected statements of operations data as a
percentage of revenue:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
Sept. 30, Sept. 30, Sept. 30, Sept. 30
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenues.................................... 100% 100% 100% 100%
Operating expenses:
Project personnel and related ......... 56 53 54 54
Management and administration.......... 51 60 49 49
Marketing and sales.................... 10 14 10 15
Depreciation and amortization ......... 27 48 33 25
Total operating expenses............... 144 175 146 143
--- --- --- ---
Loss from operations............................ (44) (75) (46) (43)
Other income (expense), net..................... 2 (2) - (1)
--- --- --- ---
Net loss ....................................... (42)% (77)% (46)% (44)%
=== === === ===
</TABLE>
8
<PAGE>
Three Months Ended September 30, 1999 Compared to the Three Months Ended
September 30, 1998
Revenue. Revenue increased $5.3 million, or 117%, to $9.9 million for
the three months ended September 30, 1999, from $4.6 million for the three
months ended September 30, 1998. The increase in revenue was primarily due to
growth in services delivered to new clients, additional projects for existing
clients and larger average project size as well as the acquisition of InVenGen,
LLC.
Project Personnel and Related Expenses. Project personnel and related
expenses consist primarily of payroll, associated taxes, employee benefits and
any third-party fees incurred in the delivery of our services. These costs
increased $3.1 million, or 129%, to $5.5 million for the three months ended
September 30, 1999, from $2.4 million for the three months ended September 30,
1998. The increase was primarily due to the increase in the hiring of project
personnel as well as contracted services associated with the increased demand
for the Company's services as well as additional personnel related expenses
associated with the InVenGen, LLC acquisition.
Management and Administrative. Management and administrative expenses
increased $2.3 million, or 82%, to $5.0 million for the three months ended
September 30, 1999, from $2.7 million for the three months ended September 30,
1998. The increase was principally due to expenses incurred to accommodate
current and anticipated growth, including the expansion of office facilities and
the increased cost of management and administrative personnel and other general
operating expenses in the areas of legal, accounting, human resources and
general operations.
Marketing and Sales. Marketing and sales expenses increased $390,000,
or 63%, to $1.0 million for the three months ended September 30, 1999, from
$623,000 for the three months ended September 30, 1998. The increase was
attributable to the continuing investment in the Company's marketing and sales
programs including the hiring of new business development and marketing
personnel.
Depreciation and Amortization. Depreciation and amortization increased
$499,000 to $2.7 for the three months ended September 30, 1999 as compared to
$2.2 million for the three months ended September 30, 1998. The increase was
primarily due to amortization of approximately $370,000 from the InVenGen LLC
acquisition. The amount is being amortized over a 2 year period. There was also
increased capital expenditures for new equipment and leasehold improvements.
Other Income (Expense). Other income increased $291,000 to $215,000 for
the three months ended September 30, 1999 compared to an expense of $76,000 for
the three months ended September 30, 1998. The increases were primarily
attributable to increased interest income from cash equivalents primarily the
result of the Company's initial public offering.
Income Tax Expense. As a result of the Company's losses there was no
income tax expense for the three months ended September 30, 1999 or the three
months ended September 30, 1998.
Nine Months Ended September 30, 1999 Compared to the Nine Months Ended September
30, 1998
Revenue. Revenue increased $14.2 million, or 150%, to $23.7 million for
the nine months ended September 30, 1999 from $9.5 million for the nine months
ended September 30, 1998. The increase in revenue was primarily due to growth in
services delivered to new clients, additional projects for existing clients and
larger average project size as well as the merger with Digital Evolution, Inc.
and the acquisition of InVenGen, LLC.
Project Personnel and Related Expenses. Project personnel and related
expenses consist primarily of payroll, associated taxes, employee benefits and
any third-party fees incurred in the delivery of our services. These costs
increased $7.7 million, or 152%, to $12.8 million for the nine months ended
September 30, 1999, from $5.1 million for the comparable period of 1998. The
increase was primarily due to the increase in the hiring of project personnel as
well as increased contracted services associated with the increased demand for
the Company's services as well as additional personnel related expenses
associated with the Digital Evolution merger and the InVenGen, LLC acquisition.
Management and Administrative. Management and administrative expenses
increased $7.0 million, or 150%, to $11.6 million for the nine months ended
September 30, 1999, from $4.6 million for the same period of 1998. The increase
was principally due to expenses incurred to accommodate current and anticipated
growth, including the expansion of office facilities and the increased cost of
management and administrative personnel and other general operating expenses in
the areas of legal, accounting, human resources, travel and general operations.
9
<PAGE>
Marketing and Sales. Marketing and sales expenses increased $1.0
million, or 68%, to $2.5 million for the nine months ended September 30, 1999
from $1.5 million for the same period in 1998. The increase was attributable to
the continuing investment in the Company's marketing and sales programs
including the hiring of new business development and marketing personnel.
Depreciation and Amortization. Depreciation and amortization increased
$5.3 million to $7.7 million for the nine months ended September 30, 1999 from
$2.4 million for the comparable period in 1998. The increase was primarily due
to amortization of approximately $6.0 million recognized from the Digital
Evolution merger and $897,000 from the InVenGen LLC acquisition. These amounts
are being amortized over 2 year periods. There was also increased capital
expenditures for new equipment and leasehold improvements.
Other Income (Expense). Other income increased $138,000 to $33,000 for
the nine months ended September 30, 1999 compared to an expense of $105,000 for
the same period in 1998. The increases were primarily attributable to increased
interest income from cash investments which was partially offset by increased
interest expense from borrowings under the bank line of credit and term loan.
Income Tax Expense. As a result of the Company's losses there was no
income tax expense for the nine months ended September 30, 1999 or the nine
months ended September 30, 1998.
Liquidity and Capital Resources
Prior to the completion of our initial public offering in August 1999,
the Company had financed operations primarily from sales of preferred stock and
borrowings under a line of credit and term loan from a commercial bank. Through
December 31, 1998 we had raised approximately $12.7 million, net of offering
expenses, through the sale of our preferred stock. At September 30, 1999 the
Company had approximately $40.1 million in cash and cash equivalents.
Net cash used in operating activities was $3.3 million for the nine
month period ended September 30, 1999 and as compared to $1.3 million for the
comparable period in 1998. Cash used in operating activities in each of these
periods was primarily the result of net losses, which were partially offset by
non-cash charges for depreciation and amortization, as well as increases in
accounts receivable and other assets which were offset by increases in accounts
payable and other liabilities.
Net cash used in investing activities was $2.9 million for the nine
months ended September 30, 1999 as compared to $1.2 million for the nine months
ended September 30, 1998. The increase in net cash used was primarily due to
increased purchases of furniture and equipment.
Net cash provided by financing activities was $43.4 million for the
nine months ended September 30, 1999 as compared to $6.6 million for the six
months ended September 30, 1998.
In August 1999, the Company completed its Initial Public Offering of
securities and issued a total of 4,865,848 shares of common stock at $10.00 per
share (including a total of 692,250 shares issued to the underwriters upon
exercise of the option which the Company had granted to them solely to cover
overallotments). An additional 441,402 shares were sold by existing stockholders
at $10.00 per share. Upon the initial closing of the public offering, all
5,341,096 of the outstanding shares of manditorily redeemable convertible
preferred stock were converted to 5,341,096 shares of common stock. Proceeds to
the Company from its Initial Public Offering net of underwriting discounts and
costs of the offering were approximately $44.5 million. The Company used a total
of $2.9 million of the net proceeds to repay all outstanding debt under its line
of credit and term loan.
The Company believes that the net proceeds from the recently completed
public offering, combined with current cash balances and borrowings available
under the credit facilities, will be sufficient to fund requirements for working
capital and capital expenditures for at least the next twenty one months. The
Company may seek to obtain additional capital from time to time through the sale
of equity or debt securities, through additional credit facilities or otherwise.
Sales of additional equity or convertible debt securities would result in
additional dilution to the Company's stockholders. The Company may need to raise
additional funds sooner in order to support more rapid expansion, develop new or
enhanced services and products, respond to competitive pressures, acquire
complementary businesses or technologies or take advantage of unanticipated
opportunities. Future liquidity and capital requirements will depend on numerous
factors, including the success of existing and new service offerings and
competing technological and market developments. Additional financing, if any,
may not be available on satisfactory terms.
10
<PAGE>
Year 2000 Readiness
General. Many older computer systems, software products, and embedded
microprocessor chips that are in use today were programmed to accept two digit
entries in the date code field (e.g., "98" for "1998"). These systems, software
and embedded microprocessor chips need to be modified or upgraded to distinguish
twenty-first century dates (e.g., "2002") from twentieth century dates (e.g.,
"1902"), in order to avoid the possibility of erroneous results or systems
failures.
We have reviewed and continue to evaluate and update our formal
processes and procedures to address any potential Year 2000 compliance issues
relating to our corporate infrastructure and our current and future client
projects. We believe that we have allocated adequate resources for this purpose
and expect our Year 2000 compliance program to be completed before the end of
1999.
Corporate State of Readiness. We believe that our identification of
Year 2000 compliance issues is complete with respect to our internal operating
systems. The infrastructure is composed of Information Technology ("IT") systems
(e.g., financial, human resources, client support, voicemail) and non-IT systems
(e.g., elevators, fire suppression systems). We have identified those systems
which are not affected and those systems which need replacement or modification.
We believe that all material identified systems that are at risk will be made
Year 2000 compliant or will be replaced before December 31, 1999 and that our
business critical systems that have date sensitivity will be fixed, tested, and
in place before the year 2000.
We have communicated with all of our material vendors, suppliers and
other third parties regarding Year 2000 compliance of embedded processors in
products and facilities which we obtain from such third parties. We anticipate
that affected embedded processors will be replaced before the year 2000. We have
also required all vendors who provide material hardware or software for our
information technology systems to provide assurances of their Year 2000
compliance. For network infrastructure, servers and other shared technologies,
all changes identified by the vendors and providers as required for Year 2000
compliance of their systems have been implemented. Changes required for Year
2000 compliance of desktop systems are currently being implemented and are
scheduled for completion by November 24, 1999, although in the judgment of
management any failure of these systems would have a negligible impact on the
our operations and would take only a few days to resolve. Although we have
completed our assessment of the Year 2000 compliance issues with respect to the
products, facilities, and services which we obtain from third parties, we
continue to monitor and assess Year 2000 issues relating to such products,
facilities and services.
We retained a third party consulting organization to inventory, assess,
remediate and test certain solutions software delivered to our clients. We
attempted to have assessed a cross-section of the solutions software delivered
to date. Such assessment was not exhaustive. Based on such assessment, such
software solutions have required only very minor revisions.
Costs. Based on work performed to date, we expect that the cost for
material, labor and upgrades to complete our year 2000 certification process
will be approximately $400,000. This includes the cost of material upgrades,
software modification and related consulting fees. As of September 30, 1999, we
have expended approximately $267,000 on our Year 2000 compliance efforts. To
date, our Year 2000 remediation costs total approximately $300,000.
Risk Factors. Since we utilize third-party vendor equipment,
telecommunications products, and software products in the development of our
Internet solutions, we are currently taking steps to address the impact, if any,
of the Year 2000 compliance issue surrounding such third-party products. We have
communicated with such third parties about their plans and progress in
addressing the Year 2000 problem, and we have requested assurances that
equipment, products and services provided by such third parties will be Year
2000 compliant. We have received assurances from certain of the third-party
vendors. However, such third parties' Year 2000 compliance efforts are not
within our control. In the event that such additional assurances are not timely
received, we will switch to another vendor or take such other action as we shall
then deem appropriate.
11
<PAGE>
Software products as complex as those utilized by us in the performance
of our services might contain undetected errors or failures when first
introduced or when new versions are released. This includes the risk that
products thought to be Year 2000 compliant are not Year 2000 compliant. While we
believe that the products utilized in the performance of our services are Year
2000 compliant, there can be no assurance that these products contain or will
contain all necessary date code changes or that errors will not be found in new
products or product enhancements after commercial release, which could result in
potential liability to our clients or other third parties. The failure of any
critical technology components to operate properly may have a material impact on
business operations or require us to incur unanticipated expenses to remedy any
problems.
Although as a general matter, we do not specifically warrant to a
client that its work will be Year 2000 compliant, certain clients have requested
and received such warranties. In such cases, we do not warrant the compliance of
third party software; rather, we warrant only that software created by us will
be Year 2000 compliant. However, even absent a specific Year 2000 warranty,
there is a risk that clients for whom we have created or implemented software
will attempt to hold us liable for any damages that result in connection with
Year 2000 problems.
We may experience difficulties caused by undetected errors or defects
in the technology we use in our internal systems. In addition, there are
substantial operation risks beyond our control, including the risk that vital
services provided by utilities and governmental agencies will be interrupted. It
is possible that interruptions in vital services in late calendar year 1999 and
early calendar year 2000 will interfere with normal business operations, and
that such failures could materially and adversely affect our results of
operations, financial condition and cash flows.
Many companies, including our clients and prospects, might need to
modify or upgrade their information systems to address this Year 2000 issue. The
effects of this issue and of the efforts by companies to address it are unclear.
The Year 2000 issues might affect the purchasing patterns of clients and
prospective clients. Many companies are allocating significant resources to
attain Year 2000 compliance. These allocations might result in reduced resources
available to utilize our services. Additionally, Year 2000 issues inherent in a
client's other software programs might significantly limit that client's ability
to realize the intended benefits to be derived from our services.
Contingency Plans. We have prepared a contingency plan that provides
for backup systems and procedures and a full compliment of information services
support staff to deal with unforeseen information systems failures. We have
redundant servers for a number of systems to ensure our ability to reconstruct
failed systems quickly and a backup data center is being constructed to reduce
the effect of regional infrastructure failures.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company's exposure to market risk for changes in interest rates
relates primarily to the increase or decrease in the amount of interest income
we can earn on our available funds for investment and on the increase or
decrease in the amount of interest expense we must pay with respect to our
various outstanding debt instruments. The risk associated with fluctuating
interest expense is limited, however, to the exposure related to those debt
instruments and credit facilities which are tied to variable market rates. We do
not plan to use derivative financial instruments in our investment portfolio. We
plan to ensure the safety and preservation of our invested principal funds by
limiting default risks, market risk and reinvestment risk. We plan to mitigate
default risk by investing in high-credit, quality securities. If market interest
rates were to increase by 10% from rates as of November 15,1999, we do not
believe that the effect would be material to the Company.
All of our revenues are realized currently in U.S. dollars and are from
customers primarily in the United States. Therefore, we do not believe that we
currently have any significant direct foreign currency exchange rate risk.
12
<PAGE>
PART II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.
(c) Sales of Unregistered Securities.
During the three months ended September 30, 1999, the Company issued a
total of 68,556 shares of Common Stock which were not registered for sale
under the Securities Act in reliance on exemptions from registration
provided in Section 4(2) of the Act or Rule 701 under the Act. All such
shares were issued upon exercise of options granted to employees under the
Company's 1997 Stock Option Plan, at exercise prices ranging from $1.50 to
$5.00, for an aggregate exercise price of $264,465, $21,719 of which was
paid in cash and $242,746 of which was paid in outstanding shares of the
Company valued at $10 3/8 per share, the closing price for a share of the
Company's common stock as quoted on NASDAQ on the date of exercise.
(d) Use of Proceeds of Public Offering
On August 5, 1999, the Company's registration statement on Form S-1 (SEC
File No. 333-78571) was declared effective, for the Initial Public Offering
by the Company (the "IPO") of a total of 4,865,848 shares of its common
stock, at $10.00 per share (including a total of 692,250 shares issued to
the underwriters upon exercise of the option which the Company had granted
to them solely to cover overallotments). An additional 441,402 shares were
sold by existing stockholders of the Company at the same price. Lehman
Brothers, Hambrecht & Quist, and Adams, Harkness & Hill, Inc. acted as
managing underwriters for the IPO. The 4,865,848 shares consisted of
3,115,848 shares offered by the Company to the managing underwriters and
1,750,000 shares offered to eligible shareholders of Safeguard Scientifics,
Inc. in a Directed Share Subscription program (the "DSSP"). The IPO was
completed in August 1999.
The Company paid to the underwriters underwriting discounts in the total
amount of $ 2,181,093 and a management fee in connection with the DSSP in
the amount of $490,000. In addition, in connection with its IPO, the
Company paid an estimated $1,478,000 million in expenses through September
30, 1999. The Company received $44.5 million in proceeds from the Offering,
net of underwriting discounts, DSSP management fee and expenses of the IPO.
None of the Company's expenses in connection with the IPO were paid
directly or indirectly to directors or officers of the Company or their
associates, or to persons owning 10% or more of the Company's common stock
or other affiliates of the Company.
The Company has used a total of $2.9 million of the net proceeds to repay
all outstanding debt under its line of credit and term loan, $1.3 million
for the purchase of fixed assets including leasehold improvements,
equipment and furniture and $500,000 for working capital. The balance of
the net proceeds of $39.8 million has been invested in short-term
investment grade securities and will be used for general corporate purposes
and for future acquisitions.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
The exhibits required by Item 601 of Regulation S-K are listed below
and are incorporated as indicated. Except for Exhibit 4.2, Exhibits 3.1
through 10.12 are incorporated herein by reference to the exhibit with
the corresponding number filed as part of the Company's Registration
Statement on Form S-1 filed on May 19, 1999, and all amendments thereto
(File No. 333-78751).
Exhibit Number Description
-------------- -----------
3.1 Amended and Restated Certificate of Incorporation
3.2 Amended and Restated Bylaws
4.1 See exhibits 3.1 and 3.2 for provisions of the
Certificate of Incorporation and Bylaws defining
rights of holders of Common Stock
13
<PAGE>
4.2 Second Amended and Restated Investors' Rights
Agreement dated as of July 2, 1998, incorporated
herein by reference to Exhibit 4.3 filed as part
of the Company's Registration Statement on Form
S-1 filed on May 19, 1999, and all amendments
thereto (File No. 333-78751).
10.1 1998 Performance Incentive Plan and form of stock
option agreement
10.2 1998 Stock Option Plan and forms of Stock Option
Agreement and Stock Purchase Agreement
10.3 1997 Stock Option Plan and forms of Stock Option
Agreement and Stock Purchase Agreement
10.4 1996 Stock Option Plan and forms of Stock Option
Agreement and Stock Purchase Agreement
10.5 Lease Agreement, dated May 14, 1998, between U.S.
Interactive and BET Investments II, L.P.
10.6 Employment Agreement, dated July 2, 1998, between
U.S. Interactive and Eric Pulier
10.7 Employment Agreement, dated July 30, 1999, between
U.S. Interactive and Stephen T. Zarrilli
10.8 Professional Services and Consulting Agreement,
dated as of January 6, 1999, by and between U.S.
Interactive and Juggernaut Partners, LLC, certain
portions of which have been omitted based upon a
request for confidential treatment. The omitted
portions have been separately filed with the
Commission
10.9 Severance Agreement, dated May 18, 1999, between
U.S. Interactive and Richard J. Masterson
10.10 Severance Agreement, dated February 26, 1999,
between U.S. Interactive and Larry W. Smith
10.11 Lease Agreement, dated March 30, 1999, between
U.S. Interactive and Norton Plaza Associates
10.12 Letter agreement between U.S. Interactive and
Chromazone, dated April 6, 1999
27 Financial Data Schedule
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during the quarter for
which this report is filed.
14
<PAGE>
U.S. INTERACTIVE, INC. AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
U.S. INTERACTIVE, INC.
(Registrant)
Date: November 15, 1999 By: /s/ Stephen T. Zarrilli
-----------------------
Stephen T. Zarrilli
Chief Executive Officer
Date: November 15, 1999 By: /s/ Philip L. Calamia
---------------------
Philip L. Calamia
Vice President, Chief Financial Officer
(Principal Financial Officer and
Chief Accounting Officer)
15
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