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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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 MARCH 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NUMBER 000-29405
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ORGANIC, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 94-3258989
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
</TABLE>
510 THIRD STREET
SAN FRANCISCO, CALIFORNIA 94107
(Address of principal executive offices)
(415) 365-5500
(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 number of shares outstanding of the Registrant's Common Stock, par
value $.0001, as of April 30, 2000 was 87,712,080.
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ORGANIC, INC.
FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
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PAGE
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of March 31, 2000
(unaudited) and December 31, 1999........................... 3
Condensed Consolidated Statements of Operations for the
Three Months Ended March 31, 2000 and 1999 (unaudited)...... 4
Condensed Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2000 and 1999 (unaudited)...... 5
Notes to Condensed Consolidated Financial Statements........ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 9
Item 3. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 22
Item 2. Changes in Securities and Use of Proceeds................... 22
Item 6. Exhibits and Reports on Form 8-K............................ 23
SIGNATURES........................................................... 24
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ORGANIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
(IN THOUSANDS, EXCEPT SHARE DATA) 2000 1999
- ------------------------------------------------------------ ----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 91,534 $ 8,385
Short-term investments.................................... 194 --
Accounts receivable, net of allowance of $3,238 at March
31, 2000 and $1,078 at December 31, 1999................ 27,932 15,487
Accounts receivable -- media spending..................... 2,495 3,282
Costs in excess of billings............................... 4,462 5,248
Deposits and prepaid expenses............................. 2,659 1,327
Other assets.............................................. 473 265
-------- -------
Total current assets................................ 129,749 33,994
Property and equipment, net............................... 15,924 10,759
Long-term investments..................................... 1,990 1,990
Deferred bank facility charge, net of accumulated
amortization of $3,530 at March 31, 2000 and $2,017 at
December 31, 1999....................................... 14,621 16,134
Other assets.............................................. 439 1,387
-------- -------
Total assets........................................ $162,723 $64,264
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 2,861 $ 3,232
Current portion of long-term debt......................... 313 13,450
Current portion of obligations under capital leases....... 43 44
Accrued expenses.......................................... 5,615 5,245
Accrued employee costs.................................... 3,883 4,206
Deferred rent............................................. 351 345
Deferred revenue.......................................... 9,127 6,357
Deferred revenue -- media spending........................ 4,585 5,795
-------- -------
Total current liabilities........................... 26,778 38,674
Long-term debt, net of current portion.................... 301 381
Obligations under capital leases, net of current
portion................................................. 87 97
-------- -------
Total liabilities................................... 27,166 39,152
-------- -------
Minority interest in consolidated subsidiary................ 287 334
Stockholders' equity:
Series A convertible preferred stock, $.0001 par value,
21,675,000 shares authorized, 0 and 21,675,000 shares
issued and outstanding at March 31, 2000 and December
31, 1999, respectively (aggregate liquidation preference
$64,664)................................................ -- 2
Series B convertible preferred stock, $.0001 par value,
1,488,000 shares authorized, 0 and 1,488,000 shares
issued and outstanding at March 31, 2000 and December
31, 1999, respectively (aggregate liquidation preference
$10,724)................................................ -- --
Common stock, $.0001 par value, 200,000,000 shares
authorized, 87,553,746 and 2,844,642 shares issued and
outstanding at March 31, 2000 and December 31, 1999,
respectively............................................ 9 --
Additional paid-in capital................................ 304,787 151,743
Notes receivable from stockholders........................ (4,431) --
Deferred stock-based compensation......................... (90,226) (83,370)
Accumulated deficit....................................... (74,832) (43,607)
Accumulated other comprehensive income.................... (37) 10
-------- -------
Total stockholders' equity.......................... 135,270 24,778
-------- -------
Total liabilities and stockholders' equity.......... $162,723 $64,264
======== =======
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
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ORGANIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-----------------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 2000 1999
- ------------------------------------------------------------ ----------- --------
<S> <C> <C>
Revenues.................................................... $ 29,214 $ 10,087
Operating expenses:
Professional services (exclusive of $9,844 and $301
reported below of stock-based compensation for the
three months ended March 31, 2000 and 1999)............ 16,336 5,568
Selling, general and administrative (exclusive of $14,551
and $422 reported below of stock-based compensation for
the three months ended March 31, 2000 and 1999)........ 19,910 4,649
Stock compensation and other stock-based charges.......... 24,395 723
----------- --------
Total operating expenses.......................... 60,641 10,940
----------- --------
Operating loss.............................................. (31,427) (853)
Minority interest in operations of consolidated
subsidiary................................................ 55 23
Interest income (expense), net.............................. 346 (21)
----------- --------
Net loss before taxes................................ (31,026) (851)
Income tax expense.......................................... 199 15
----------- --------
Net loss............................................. $ (31,225) $ (866)
=========== ========
Basic and diluted net loss per share........................ $ (0.65) $ (0.96)
=========== ========
Weighted average common shares outstanding -- basic and
diluted................................................... 48,178,445 900,656
=========== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
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ORGANIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 2000
---------------------
(IN THOUSANDS) 2000 1999
- ------------------------------------------------------------ -------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(31,225) $ (866)
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization........................... 2,149 585
Stock compensation and other stock-based charges........ 24,395 723
Provision for doubtful accounts and sales returns....... 2,358 130
Minority interest in operations of consolidated
subsidiary............................................. (47) 243
Changes in assets and liabilities:
Increase in accounts receivable....................... (14,190) (4,107)
Decrease (increase) in costs in excess of billings.... 786 (826)
(Increase) decrease in deposits and prepaid
expenses............................................. (1,332) 4
Decrease (increase) in other assets................... 892 (339)
Decrease in accounts payable and accrued expenses..... (489) (2,080)
Increase in deferred revenue.......................... 1,560 2,434
Increase in deferred rent............................. 6 36
Increase in income taxes payable...................... 165 --
-------- -------
Net cash used in operating activities............... (14,972) (4,063)
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment........................ (7,292) (947)
Purchase of short-term investments........................ (194) (1,754)
-------- -------
Net cash used in investing activities............... (7,486) (2,701)
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of convertible preferred stock,
net..................................................... -- 7,718
Proceeds from issuance of common stock, net............... 115,918 --
Proceeds from exercises of common stock options........... 3,011 5
Payments on long-term debt................................ (16,718) (184)
Proceeds from long-term debt.............................. 3,500 3,000
Payments on capital leases................................ (10) (9)
Payments for repurchase of common stock options........... (47) --
-------- -------
Net cash provided by financing activities........... 105,654 10,530
Effect of exchange rate changes on cash and cash
equivalents......................................... (47) 9
-------- -------
Net increase in cash and cash equivalents........... 83,149 3,775
Cash and cash equivalents at beginning of period............ 8,385 1,667
-------- -------
Cash and cash equivalents at end of period.................. $ 91,534 $ 5,442
======== =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION:
Cash paid for interest.................................... $ 236 $ 59
======== =======
Cash paid for income taxes................................ $ 42 $ --
======== =======
NONCASH INVESTING AND FINANCING ACTIVITIES:
Property and equipment acquired under financing
obligations............................................. $ -- $ 35
======== =======
Conversion of debt into preferred stock................... $ -- $ 3,000
======== =======
Deferred stock-based compensation......................... $ 34,752 $ 3,679
======== =======
Common stock issuance in exchange for notes receivable
from stockholders....................................... $ 4,453 $ --
======== =======
Common stock repurchased in exchange for notes receivable
from stockholders....................................... $ (22) $ --
======== =======
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
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ORGANIC, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 -- BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Organic, Inc. and subsidiaries ("the Company") have been prepared in accordance
with accounting principles generally accepted in the United States ("GAAP") for
interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. However, they do not include all of the disclosures necessary
for annual consolidated financial statements in conformity with GAAP.
Accordingly, these unaudited condensed consolidated financial statements should
be read in conjunction with the audited consolidated financial statements and
notes thereto included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1999. The accompanying unaudited financial statements reflect
all normal recurring adjustments which are, in the opinion of management,
necessary for a fair presentation of results for the interim periods presented.
The results of operations for the interim period ended March 31, 2000 are not
necessarily indicative of the operating results to be expected for the fiscal
full year or any other interim period.
On February 8, 2000, the Company's Board of Directors effected a 3-for-1
split of its outstanding shares of common stock. All share and per share
information included in the accompanying financial statements have been
retroactively adjusted to reflect this stock split.
Certain amounts for prior periods have been reclassified to conform to
current financial statement presentation.
NOTE 2 -- INITIAL PUBLIC OFFERING
In February 2000, the Company completed its initial public offering ("IPO")
of 6,325,000 shares of its common stock (including the exercise of the
underwriters' over-allotment option) at $20.00 per share. The Company sold all
of the shares of common stock and realized proceeds, after deducting
underwriting discounts, commissions and offering expenses, of approximately
$115.9 million. Upon the closing date of the IPO, all of the convertible
preferred stock outstanding prior to the IPO was converted into 69,489,000
shares of common stock. In addition, a warrant issued to Omnicom Group was
exercised for 2,249,076 shares of common stock.
NOTE 3 -- NET LOSS PER SHARE
The Company computes basic net loss per share by dividing net loss
available to common stockholders for the period by the weighted average number
of common shares outstanding during the period. Diluted net loss per share is
computed by dividing net loss available to common stockholders for the period by
the weighted average number of common and, when dilutive, common equivalent
shares outstanding during the period. Common equivalent shares consist of common
stock subject to repurchase rights, the incremental common shares issuable upon
the exercise of the stock options and warrant (using the treasury stock method),
and the incremental common shares issuable upon the conversion of the
convertible preferred stock (using the if-converted method).
6
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ORGANIC, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3 -- NET LOSS PER SHARE (CONTINUED)
The following table sets forth the computation of basic and diluted net
loss per share for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-----------------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 2000 1999
- ------------------------------------------------------------ ----------- --------
<S> <C> <C>
Numerator:
Net loss attributable to common stockholders................ $ (31,225) $ (866)
=========== ========
Denominator:
Weighted average common shares outstanding.................. 51,872,529 932,391
Less: weighted average unvested common shares subject to
repurchase................................................ (3,694,084) (31,735)
----------- --------
Weighted average common shares used in computing basic and
diluted net loss per share................................ 48,178,445 900,656
=========== ========
Basic and diluted net loss per share........................ $ (0.65) $ (0.96)
=========== ========
</TABLE>
The following table sets forth common stock equivalents that were not
included in the calculation of diluted net loss per share because to do so would
be anti-dilutive for those periods presented.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------
2000 1999
---------- ----------
<S> <C> <C>
Weighted average effect of common stock equivalents:
Series A convertible preferred stock...................... 28,582,418 65,025,000
Series B convertible preferred stock...................... 1,962,198 3,075,200
Unvested common shares subject to repurchase.............. 3,694,084 31,735
Common stock options...................................... 12,336,027 6,994,739
Common stock warrants..................................... 988,605 --
</TABLE>
NOTE 4 -- COMPREHENSIVE INCOME
The Company has adopted Statement of Financial Accounting Standards
("SFAS") No. 130, "Reporting Comprehensive Income", which requires that an
enterprise report and display, by major components and as a single total, the
change in its net assets during the period from non-owner sources. The
components of comprehensive loss for the three months ended March 31, 2000 and
1999 were as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------
(IN THOUSANDS) 2000 1999
- ------------------------------------------------------------ --------- ------
<S> <C> <C>
Net loss.................................................... $(31,225) $(866)
Foreign currency translation adjustments.................... (47) 9
-------- -----
Comprehensive loss.......................................... $(31,272) $(857)
======== =====
</TABLE>
The tax effects of comprehensive loss were not considered material.
Accumulated other comprehensive loss at March 31, 2000 and 1999 was comprised
solely of foreign currency translation adjustments.
7
<PAGE> 8
ORGANIC, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 5 -- DEFERRED STOCK-BASED COMPENSATION
For the three months ended March 31, 2000 and 1999, the Company recorded
aggregate deferred stock-based compensation of $34.8 million and $3.7 million,
respectively. This amount has been included as a component of stockholders'
equity and is being amortized on an accelerated basis by charges to operations
over the vesting period of the related options, generally 4 years, consistent
with the method described in Financial Accounting Standards Board Interpretation
("FIN") No. 28. During the three months ended March 31, 2000 and 1999, the
Company recognized stock compensation expense of $22.9 million and $723,000,
respectively. As of March 31, 2000, the Company had an aggregate of $90.2
million of deferred stock-based compensation remaining to be amortized.
NOTE 6 -- RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities". The
Statement will require the Company to recognize all derivatives on the balance
sheet at fair value. The Statement requires that derivative instruments used to
hedge be identified specifically to assets, liabilities, unrecognized firm
commitments or forecasted transactions. The gains or losses resulting from
changes in the fair value of derivative instruments will either be recognized in
current earnings or in other comprehensive income, depending on the use of the
derivative and whether the hedging instrument is effective or ineffective when
hedging changes in fair value or cash flows. This Statement, as amended, is
effective for fiscal years beginning after June 15, 2000. Although the Company
has not fully assessed the implications of SFAS No. 133, management does not
believe that the adoption of this Statement will have a material effect on the
Company's consolidated financial position, results of operations or cash flows.
In November 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 100, "Restructuring and Impairment
Charges". In December 1999, the SEC issued SAB No. 101, "Revenue Recognition in
Financial Statements". SAB No. 100 expresses the views of the SEC staff
regarding the accounting for and disclosure of certain expenses not commonly
reported in connection with exit activities and business combinations. This
includes the accrual of exit and employee termination costs and the recognition
of impairment charges. SAB No. 101 expresses the views of the SEC staff in
applying accounting principles generally accepted in the United States to
certain revenue recognition issues. Management does not anticipate that these
SABs will have a material impact on the Company's consolidated financial
position, results of operations or cash flows.
In March 2000, the FASB issued FIN No. 44, "Accounting for Certain
Transactions Involving Stock Compensation -- an interpretation of Accounting
Principles Board ("APB") Opinion No. 2". FIN No. 44 clarifies the application of
APB Opinion No. 25 regarding the definition of an employee for purposes of
applying APB Opinion No. 25, the criteria for determining whether a plan
qualifies as a non-compensatory plan, the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and the
accounting for an exchange of stock compensation awards in a business
combination. This interpretation is effective July 1, 2000. Management does not
anticipate that this Interpretation will have a material impact on the Company's
consolidated financial position, results of operations or cash flows.
NOTE 7 -- SUBSEQUENT EVENTS
On April 27, 2000, the Company entered into a promissory note agreement for
$3.0 million bearing an annual interest rate of 9% with an Executive Officer of
the Company. The amount due including interest was fully repaid on May 5, 2000.
In addition, on April 11, 2000, this Executive Officer also repaid to the
Company the principal amount due of $200,000 relating to a promissory note
agreement that was entered into on March 31, 1999.
8
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information in this report contains forward-looking statements that are
based on management's current expectations. These forward-looking statements are
subject to a number of risks and uncertainties that could cause actual results
to differ significantly from those described in this report. Any statements that
are not statements of historical facts may be deemed to be forward-looking
statements. These forward-looking statements include statements regarding, among
other things, our business strategy and operations, future expansion plans,
future prospects, financial position, anticipated revenues or losses and
projected costs, and objectives of management. For example, words such as "may",
"will", "should", "believes", "anticipates", "intends", "estimates", "expects",
"projects", "plans", "predicts", "potential", "continue", "strategy" and similar
expressions are intended to identify forward-looking statements. Factors that
might cause or contribute to such a discrepancy include, but are not limited to,
those discussed under the heading "Factors That May Affect Results" and the
risks discussed in our Registration Statement on Form S-1 declared effective on
February 9, 2000 by the Securities and Exchange Commission (File No. 333-91627)
and Annual Report on Form 10-K filed May 8, 2000.
OVERVIEW
Since our founding in 1993 as a sole proprietorship and our incorporation
in January 1995, we believe that we have been an innovator and leader in the
Internet professional services industry. We focus on providing an integrated
suite of services to our clients including strategic consulting and research,
Web site design, software engineering and technical program management, online
marketing including media buying and management, public relations, and customer
service and fulfillment consulting and transaction management. As the Internet
continues to evolve, these services provide our clients with the necessary tools
to effectively manage and grow their customer and business relationships. We
have performed work for over 250 major offline and online companies to establish
or enhance brands and have introduced several new service lines to address
particular client needs.
We are rapidly growing to accommodate the increasing demand for Internet
professional service offerings and to better serve our existing clients in both
their various domestic and international locations. We expect that our revenues
will be driven primarily by the number, size and scope of our client engagements
and by our professional services headcount. The number, size, and scope of our
engagements have been increasing and we expect this trend to continue. We also
anticipate our clients will engage us in more of our service offerings over
time. For the three months ended March 31, 2000, five clients accounted for
approximately 44% of our revenues, with DaimlerChrysler accounting for
approximately 18%. Revenues from any given client will vary from period to
period; however, we expect that significant concentration will continue for the
foreseeable future. To the extent that any significant client reduces its use of
our services or terminates its relationship with us, our revenues could decline.
As a result, the loss of any significant client could negatively impact our
business and results of operations.
A significant amount of our revenues are derived from providing
professional services on a fixed-fee, retainer or time and materials basis. We
generally enter into a service agreement with a client that establishes the
legal and general business terms of our relationship. Our engagements vary
depending on what type of services we provide and they range in duration from a
few months to more than a year. Generally our client relationships span several
years. Revenues from fixed-fee contracts are generally recognized as services
are rendered using the percentage-of-completion method of accounting in
accordance with Statement of Position 81-1, "Accounting for Performance of
Construction Type and Certain Production Type Contracts", based on the
percentage of costs incurred to date to total estimated project costs. We
periodically evaluate the actual status of each project to ensure that the
estimated cost to complete each contract remains accurate and any adjustments
for estimated losses, if necessary, are made in the period in which such losses
are determined. To date, such losses have not been significant. Revenues
pursuant to retainer contracts are generally recognized over the life of the
contract on a straight-line basis. Revenues pursuant to time and materials
contracts are generally recognized as services are provided. Revenues exclude
reimbursable expenses charged to clients. During the three months ended March
31, 2000, we opened a permanent office in Toronto, Canada.
9
<PAGE> 10
Our international operations collectively accounted for 8.9% of our total
revenues for the three months ended March 31, 2000. As we continue to expand
internationally, we expect to generate a greater percentage of our revenues
outside of the United States.
Our professional services expenses include the direct costs associated with
our billable employees and contractors. These expenses include salaries,
bonuses, benefits, vacation, travel and entertainment expenses. Professional
services margins reflect revenues less professional services expenses which are
incurred regardless of whether or not a billable employee's time is billed to a
client. Historically our professional services expenses have increased and we
expect these expenses will continue to increase in the foreseeable future due to
increased hiring, wage increases and inflation. Our professional services
margins are affected by many factors, including the efficiency with which we
utilize our employees and the continuation of our clients in retaining our
services. Any significant decline in fees billed to clients or the loss of a
significant client would adversely affect our professional services margins. If
a client defers, modifies or cancels an engagement or chooses not to retain our
services for additional phases of a project as expected, we must rapidly
re-deploy professional services personnel to other engagements in order to
minimize under-utilization which, in turn, would adversely affect professional
services margins.
Our selling, general and administrative expenses primarily consist of our
investment in our corporate support services, our employee recruitment, training
and retention programs, and our research and development and knowledge
management initiatives. Our selling, general and administrative expenses also
include the direct costs associated with employees and contractors in
non-billable departments, real estate costs and other investments in our
corporate support services. As our business continues to grow and expand
globally, we expect these expenses will continue to increase as we continue to
hire additional personnel, invest in our knowledge management initiatives, and
incur additional infrastructure costs.
Although revenues have consistently increased from year to year, we have
incurred significant investment costs in order to create a leadership position
in the highly competitive market in which we operate. As a result, we have
incurred significant losses since inception, and, as of March 31, 2000, had an
accumulated deficit of $74.8 million. We believe our success depends on
increasing our client base, hiring and retaining professionals, and continuing
our global expansion. Accordingly, we expect associated headcount and
infrastructure costs to continue to increase. We therefore expect to continue to
incur substantial operating losses for the foreseeable future.
Our clients tend to spend proportionally more on our services during the
second and third quarters and we expect this seasonality trend to continue in
the near future. This has caused our past operating results to fluctuate
significantly from quarter to quarter, thus making the prediction of future
operating results very difficult. Our expansion places significant demands on
our management and operational resources. We may be unable to manage our growth
effectively and as a result, our expenses could increase more quickly than our
revenues. To the extent that future revenues do not increase significantly in
the same periods in which operating expenses increase, our operating results
would be adversely affected. In addition, although we have experienced
significant percentage growth in annual revenues to date, we do not believe that
prior growth rates are sustainable or indicative of future operating results.
Please refer to the section entitled "Factors That May Affect Results" for
additional information.
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RESULTS OF OPERATIONS
The following table presents our consolidated statement of operations as a
percentage of revenues for the periods indicated. We derived this data from our
unaudited condensed consolidated financial statements contained in this
Quarterly Report on Form 10-Q which, in our opinion, include all normal
recurring adjustments necessary to fairly present the results of operations for
the periods shown. This information should be read in conjunction with our
audited consolidated financial statements and notes thereto included in our
Annual Report on Form 10-K for the year ended December 31, 1999. The operating
results for any period are not necessarily indicative of the results that may be
expected for any future period.
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31,
---------------
2000 1999
------ -----
<S> <C> <C>
Revenues.................................................... 100.0% 100.0%
Operating expenses:
Professional services..................................... 55.9 55.2
Selling, general and administrative....................... 68.2 46.1
Stock compensation and other stock-based charges.......... 83.5 7.2
------ -----
Total operating expenses.......................... 207.6 108.5
Operating loss.............................................. (107.6) (8.5)
Minority interest in operations of consolidated
subsidiary................................................ 0.2 0.2
Interest income (expense), net.............................. 1.2 (0.2)
------ -----
Net loss before taxes............................. (106.2) (8.5)
Income tax expense.......................................... 0.7 0.1
------ -----
Net loss.......................................... (106.9)% (8.6)%
====== =====
</TABLE>
COMPARISON OF THREE MONTHS ENDED MARCH 31, 2000 AND 1999
REVENUES
Our revenues were $29.2 million for the three months ended March 31, 2000,
an increase of 190% over $10.1 million for the three months ended March 31,
1999. This increase was primarily due to increases in the number of clients and
the size and scope of our engagements, partly attributable to the addition of
customer service and fulfillment consulting services to our service offerings.
Our increased sales and marketing efforts resulted in the addition of many new
accounts and the expansion of our relationship with many existing clients since
March 31, 2000, most notably DaimlerChrysler, which accounted for approximately
18% of our total revenues for the three months ended March 31, 2000. Since March
31, 1999, we continued our international expansion by opening permanent offices
in London, Singapore and Toronto. Revenues from our international locations were
significantly higher than the amounts generated during the first quarter of
1999, representing 8.9% of our total revenues for the three months ended March
31, 2000.
PROFESSIONAL SERVICES
Our professional services expenses were $16.3 million for the three months
ended March 31, 2000, an increase of 193% over $5.6 million for the three months
ended March 31, 1999. This increase was primarily due to an increase in our
salary and contractor costs associated with the increase in professional
services personnel. The global increase in professional services headcount
resulted from opening new offices in Detroit, Sao Paulo, London, Singapore and
Toronto as well as continued growth in our San Francisco, New York and Chicago
offices in order to accommodate the increase in the size and number of our
projects. As a percentage of revenues, professional services expenses remained
relatively constant at 56% for the three months ended March 31, 2000, as
compared to 55% for the three months ended March 31, 1999.
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SELLING, GENERAL AND ADMINISTRATIVE
Our selling, general and administrative expenses were $19.9 million for the
three months ended March 31, 2000, an increase of 328% over $4.6 million for the
three months ended March 31, 1999. This increase resulted from the hiring of key
corporate officers, increased facilities, rent and depreciation costs associated
with our new offices as previously mentioned, and increased recruiting
associated with the increase in personnel. As a percentage of revenues, selling,
general and administrative expenses were 68% and 46% for the three months ended
March 31, 2000 and 1999, respectively. This increase was the result of our
aggressive investment in infrastructure support costs relative to our revenue
growth. We believe that our current investments in our infrastructure will
result in a global, scalable organization that, in turn, will result in greater
efficiencies in the future.
STOCK COMPENSATION AND OTHER STOCK-BASED CHARGES
Stock compensation and other stock-based charges consist of non-cash
compensation expenses arising from stock option grants and the issuance of a
warrant to Omnicom Group. For the three months ended March 31, 2000 and 1999, we
recorded aggregate deferred stock-based compensation of $34.8 million and $3.7
million, respectively. This increase was primarily due to an increase in the
number of option grants since March 31, 1999 and the larger differences between
the market values at the dates of and the exercise prices at which the options
were granted from March 31, 1999 through January 18, 2000. This amount has been
included as a component of stockholders' equity and is being amortized on an
accelerated basis by charges to operations over the vesting period of the
related options, generally 4 years. During the three months ended March 31, 2000
and 1999, we recognized stock compensation expense of approximately $22.9
million and $723,000, respectively. As of March 31, 2000, we had $90.2 million
of deferred stock-based compensation remaining to be amortized. The amortization
of deferred stock-based compensation will result in additional charges to
operations through fiscal 2003.
In connection with the $30.0 million revolving credit facility obtained on
August 27, 1999, we issued a warrant on September 13, 1999 that entitled Omnicom
Group to purchase 2,249,076 shares of common stock and recorded a deferred bank
facility charge of approximately $18.2 million. This amount is being amortized
on a straight-line basis over the longer of 36 months, the term of the credit
facility, or until the credit facility is terminated. For the three months ended
March 31, 2000, we recognized bank facility expense of $1.5 million.
INTEREST INCOME (EXPENSE), NET
Interest income (expense), net is the difference between interest income
generated from our cash and cash equivalents and short-term investments and
interest expense related to our financing obligations. We incurred interest
income, net of $346,000 for the three months ended March 31, 2000 and interest
expense, net of approximately $21,000 for the three months ended March 31, 1999.
We invested our cash balances in money market funds as of March 31, 2000. We
expect interest income to increase, as we intend to invest the proceeds from our
initial public offering in interest-bearing securities.
LIQUIDITY AND CAPITAL RESOURCES
On February 10, 2000, we completed an initial public offering of 6,325,000
shares of our common stock (including the exercise of the underwriters'
over-allotment option) at $20.00 per share and realized net proceeds of
approximately $115.9 million. The primary purposes of this offering were to
obtain additional equity capital to assist with our present growth strategies,
create a public market for our common stock, and facilitate future access to
public markets. We have used, and expect to continue to use, the proceeds for
general corporate purposes, including working capital and capital expenditures.
A portion of the proceeds may also be used for the acquisition of businesses
that are complimentary to ours. Pending such uses, we have invested the net
proceeds of this offering in money market funds. Prior to our initial public
offering, we primarily financed our operations through the issuance of
convertible preferred stock, borrowings under equipment lines of credit, and
borrowings under a revolving credit facility. As of March 31, 2000, we had $91.5
million in cash and cash equivalents.
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Net cash used in operating activities was $15.0 million and $4.1 million
for the three months ended March 31, 2000 and 1999, respectively. Net cash flows
used in operating activities in each period reflect increasing net losses and
increases in accounts receivable, offset by an increase in the amortization of
deferred stock-based compensation.
Net cash used in investing activities was $7.5 million and $2.7 million for
the three months ended March 31, 2000 and 1999, respectively. Net cash flows
used in investing activities in each period reflect increased purchases of
property and equipment, partially offset by a decrease in short-term
investments.
Net cash provided by financing activities was $105.7 million and $10.5
million for the three months ended March 31, 2000 and 1999, respectively. Net
cash provided by financing activities for the three months ended March 31, 2000
was primarily due to our initial public offering and, to a lesser extent, the
exercises of common stock options, partially offset by the repayment of our
borrowings under the revolving credit facility as described below. Net cash
provided by financing activities for the three months ended March 31, 1999 was
primarily due to the issuance of Series B convertible preferred stock as
described below.
Capital expenditures, excluding capital leases, were $7.3 million and $0.9
million for the three months ended March 31, 2000 and 1999. Our capital
expenditures consisted of purchases of operating resources, including computer
equipment, computer software, other internal software implementations and
leasehold improvements. Since inception, we have generally funded capital
expenditures through the use of capital leases, equipment lines of credit and
software financing agreements. We expect that our capital expenditures will
continue to increase in the future, in part due to the relocation of our
headquarters in San Francisco, and that these expenditures will be primarily for
the purchase of computer equipment, computer software, internal software
implementations and leasehold improvements.
In February 1999, we issued 1,488,000 shares of Series B convertible
preferred stock to Omnicom Group for net cash proceeds of $7.7 million plus the
settlement of a $3.0 million short-term bridge loan that was extended to us in
January 1999.
On August 27, 1999, we entered into a revolving credit facility with
Omnicom Group that allowed us to borrow up to $30.0 million at the lender's
commercial paper rate plus 3.0% until the closing of our initial public
offering. The revolving credit facility is primarily used for working capital
purposes. This credit facility contains certain restrictions and any borrowings
under the credit facility require us to comply with financial covenants and are
secured by some of our investments. These financial covenants include minimum
revenue targets and limitations on capital equipment purchases. Upon the closing
of our initial public offering on February 18, 2000, the borrowing limit
available under the revolving credit facility was reduced to $15.0 million at
the lender's commercial paper rate plus 1.25% through September 30, 2002 and the
amount outstanding including interest was repaid in full.
FACTORS THAT MAY AFFECT RESULTS
In addition to other information in this Quarterly Report on Form 10-Q, the
following risk factors should be read carefully when evaluating us and our
business because such factors currently may have a significant impact on our
business, operating results, financial condition and cash flows. Our actual
results could differ materially from those projected in any forward-looking
statements as a result of the risk factors set forth below and elsewhere in this
Quarterly Report on Form 10-Q and the risks discussed in our Registration
Statement on Form S-1 declared effective on February 9, 2000 by the Securities
and Exchange Commission (File No. 333-91627) and Annual Report on Form 10-K
filed on May 8, 2000.
RISKS RELATED TO ORGANIC
WE MAY BE UNABLE TO RECRUIT AND RETAIN THE TALENTED PERSONNEL WHO ARE ESSENTIAL
FOR COMPLETING CLIENT PROJECTS, WHICH COULD HARM OUR PERFORMANCE ON EXISTING
PROJECTS AND REDUCE OUR ABILITY TO OBTAIN NEW PROJECTS.
Our business is labor intensive, and thus our success depends on
identifying, hiring, training and retaining talented professionals. All of our
current employees and senior managers are employed on an at-will basis. If a
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significant number of our current employees, contractors or any of our senior
managers leave, we may be unable to complete or retain existing projects or bid
for new projects of similar scope and revenues.
Even if we retain our current employees and contractors, our management
must continually recruit talented professionals for our business to grow.
However, competition for these employees is intense, particularly in the
Internet and high technology industries. As a result, we may be unable to
successfully attract, assimilate or retain qualified personnel. As of March 31,
2000, we had 983 employees, but we still need to hire additional personnel to
support our business. The failure to retain or attract the necessary personnel
would reduce our capacity to handle new client engagements and therefore our
revenue growth, which would seriously harm our business, financial condition,
results of operations and cash flows.
WE MAY BE UNABLE TO EFFECTIVELY MANAGE OUR RAPID GROWTH, WHICH COULD RESULT IN
OUR BEING UNABLE TO EFFECTIVELY CONTROL OUR COSTS AND IMPLEMENT OUR BUSINESS
STRATEGIES.
We began expanding our operations both domestically and internationally in
the past year. We believe further expansion will be required to address the
anticipated growth in our client base and market opportunities. We also believe
expansion into new geographic areas is important in order to more efficiently
and effectively serve clients. Our current expansion has placed, and any future
expansion may continue to place, a significant strain on our managerial,
operational, financial and other resources.
If we are unable to manage growth effectively or if we experience
disruptions during our expansion, our expenses could increase more quickly than
revenues or our revenues might be reduced as a result of failure to adequately
service new client engagements, either of which would seriously harm our
business, financial condition, results of operations and cash flows.
OUR REVENUES COULD BE SIGNIFICANTLY REDUCED BY THE LOSS OF A MAJOR CLIENT.
We derive a significant portion of our revenues from a limited number of
clients. The loss of any major client, if not replaced, could dramatically
reduce our revenues. For example, for the three months ended March 31, 2000, our
five largest clients accounted for approximately 44% of our total revenues, with
DaimlerChrysler accounting for approximately 18% of our revenues.
WE MAY HAVE MORE DIFFICULTY COLLECTING OUR ACCOUNTS RECEIVABLE FROM EMERGING
GROWTH AND START-UP CLIENTS THAN OTHER CLIENTS, WHICH MAY AFFECT OUR REVENUES
AND DAMAGE OUR POTENTIAL PROFITABILITY.
Approximately 30% of our revenues are currently derived from services
provided to emerging growth and start-up companies. We believe that we may face
certain risks in doing business with emerging growth and start-up clients that
we may not face with our mature or established "brick and mortar" clients.
Unless we are diligent in invoicing and collecting amounts during the beginning
stages of our engagements, we believe we may experience longer payment cycles
and problems in collecting accounts receivable with respect to emerging growth
and start-up clients.
OUR LACK OF LONG-TERM CONTRACTS WITH OUR CLIENTS REDUCES THE PREDICTABILITY OF
OUR REVENUES.
We generally do not have long-term contracts with our clients but instead
are generally retained on an engagement-by-engagement basis. These engagements
vary in size and scope and cause our revenues to be difficult to predict. In
addition, generally our contract provides for termination by either party after
notice and a transition period of up to 180 days. Our operating expenses are
relatively fixed and cannot be reduced on short notice to compensate for
unanticipated variations in the number or size of engagements in progress.
Because we incur costs based on our expectations of revenues from future
engagements, our failure to predict our revenues accurately may cause the
increase in our expenses to substantially outpace our revenue growth, which
would seriously harm our financial condition, results of operations and cash
flows.
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IF WE FAIL TO ACCURATELY PREDICT COSTS RELATED TO OUR FIXED-FEE PROJECTS, WE MAY
LOSE MONEY.
Most of our current projects are on a fixed-fee basis, rather than on a
time and materials basis. Often, we fix the fee and timeframe before we finalize
the design specifications. The risk of miscalculations in pricing is high
because we work with complex technologies in compressed timeframes, and
therefore it can be difficult to judge the time and resources necessary to
complete a project. If we miscalculate the resources or time necessary to
complete our projects, we could have cost overruns and we could lose money on
these projects, which could seriously harm our operating results.
WE MAY HAVE DIFFICULTY IN MANAGING OUR INTERNATIONAL EXPANSION AND OPERATIONS,
WHICH COULD HARM OUR BUSINESS AND FINANCIAL CONDITION.
A key element of our strategy is to expand our business into international
markets. In addition to our domestic operations, we have operations in Sao
Paulo, Brazil, which opened in February 1999; London, England, which opened in
April 1999; Singapore, which opened in September 1999; and Toronto, Canada,
which opened in January 2000. Our international offices provide the same or
similar services as our domestic offices, sometimes in conjunction with our
domestic offices. Our management may have difficulty in managing our
international operations because of distance, as well as language and cultural
differences. Our management cannot assure you that they will be able to market
and deliver our services successfully in foreign markets.
Other risks related to our international operations include:
- failure in finding or acquiring suitable strategic acquisition
candidates;
- difficulties arising from staffing and managing foreign operations;
- compliance with legal and regulatory requirements of various countries,
including differing tax or labor laws;
- difficulties in using equity incentives for employees;
- international currency issues, including fluctuations in currency
exchange rates;
- restrictions on the import and export of sensitive technologies,
including data security and encryption technologies that we may wish to
use in solutions we develop for clients; and
- political or economic instability.
If any of these risks should materialize, our international and domestic
businesses, financial conditions, results of operations and cash flows could be
harmed. Our revenues derived from international operations were 8.9% of our
total revenues for the three months ended March 31, 2000.
OUR BILLABLE EMPLOYEES MAY BE UNDERUTILIZED IF CLIENTS DO NOT RETAIN OUR
SERVICES, WHICH MAY DAMAGE OUR PROFITABILITY.
Some of our clients who utilize our services in multiple stages or
engagements may choose not to retain our services for additional stages of a
project or may choose to cancel or delay additionally planned projects. Such
cancellations or delays could result from factors entirely unrelated to our
work, but instead related to general business or financial condition of the
client. If a client defers, modifies or cancels an engagement or chooses not to
retain our services for additional phases of a project, we may be unable to
rapidly re-deploy our employees to other engagements, to minimize
under-utilization of those employees. This under-utilization could reduce our
revenues and gross margins and damage our potential profitability.
For example, if DaimlerChrysler, the sole client of our Detroit, Michigan
office in 1999, chose not to retain our services, the billable employees in our
Detroit office could be underutilized.
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HISTORICALLY WE HAVE GRANTED OPTIONS TO PURCHASE COMMON STOCK AT LOW EXERCISE
PRICES, WHICH WILL RESULT IN ADDITIONAL COMPENSATION EXPENSE IN THE FUTURE AND
REDUCE OUR REPORTED EARNINGS.
Historically we have granted employees options to purchase our common stock
at exercise prices below the deemed fair market value on the date of grant.
During the three months ended March 31, 2000, we granted options to purchase
2,728,006 shares of common stock to employees with exercise prices ranging from
$3.00 to $30.13 per share. We recognized stock-based compensation expense of
$22.9 million for the three months ended March 31, 2000 relating to the
difference between the exercise price of the options and the fair market value
of our common stock. As of March 31, 2000, we had $90.2 million of deferred
stock-based compensation remaining that will be recognized as the options vest
over the next four years which will dilute any future earnings that we may
achieve.
WE ARE LIKELY TO EXPERIENCE SIGNIFICANT FLUCTUATIONS IN OUR QUARTERLY OPERATING
RESULTS THAT MAY MAKE THE PRICE OF OUR COMMON STOCK DIFFICULT TO PREDICT.
Our quarterly operating results have varied in the past and we expect that
our revenues and operating results will continue to fluctuate significantly from
quarter to quarter due to a variety of factors, many of which are outside of our
control. Some important factors affecting our revenues and operating results
from quarter to quarter, in order of their relative magnitude are:
- changes in our operating expenses as we expand globally;
- timing and execution of major client engagements;
- the timing and cost of advertising and related media;
- timing of employee hiring and utilization rates;
- increases in the number of independent contractors we must hire to meet
client needs, which would result in increased costs versus an equivalent
number of employees;
- our ability to develop, market and introduce new and significant online
business solutions on a timely basis;
- our success in obtaining suitable locations for expansion;
- our clients' purchasing cycles;
- pricing changes in the industry;
- demand for our Internet professional services;
- economic conditions in the Internet professional services market; and
- legal or regulatory developments regarding the Internet.
Furthermore, we are subject to employer payroll taxes when our employees
exercise their non-qualified stock options. The employer payroll taxes are
assessed on each employee's gain, which is the difference between the price of
our common stock on the date of exercise and the exercise price. These employer
payroll taxes will be recorded as operating expenses in the period those options
are exercised based on the aggregate gains realized by employees. During a
particular quarter, these payroll taxes could be material. However, because we
are unable to predict our future stock price and the number of optionees who may
exercise during any particular quarter, we cannot predict what, if any, expense
will be recorded in a future quarter and the impact on our future operating
results.
Our quarterly revenues and operating results are volatile and difficult to
predict. It is likely that in some future quarter or quarters our operating
results will be below the expectations of public market analysts or investors.
In such event, the market price of our common stock may decline significantly.
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THE HISTORICAL SEASONALITY OF OUR REVENUES COULD CAUSE OUR QUARTERLY OPERATING
RESULTS TO FALL BELOW THE EXPECTATIONS OF MARKET ANALYSTS AND INVESTORS, WHICH
COULD HAVE A NEGATIVE EFFECT ON THE MARKET PRICE OF OUR COMMON STOCK.
Historically, our clients have concentrated their expenditures on our
services in the second and third quarters of the calendar year. This
concentration of expenditures has resulted in quarterly fluctuations in
revenues, and could cause our revenues to decline on a sequential basis in the
future. If these fluctuations or declines are greater than market analysts or
investors expect, our stock price could decline.
WE HAVE A HISTORY OF LOSSES AND WE MAY EXPERIENCE LOSSES IN THE FUTURE, WHICH
COULD RESULT IN A DECLINE IN THE MARKET PRICE OF OUR COMMON STOCK.
We have experienced operating losses as well as net losses during the three
months ended March 31, 2000 and 1999. For the three months ended March 31, 2000
and 1999, our net losses were $31.2 million and $866,000, respectively. For the
three months ended March 31, 2000 and 1999, our net losses were 106.9% and 8.6%
of total revenues, respectively. We may not be able to sustain the revenue
growth we have experienced or the levels of revenues obtained previously. In
addition, we intend to continue to invest heavily in development of our
infrastructure and recruiting. As a result, we will need to generate significant
revenues to achieve profitability. We cannot assure you that we will achieve
profitability in the future or, if we achieve profitability, that we will be
able to sustain it. If we do not achieve and maintain profitability, the market
price for our common stock may decline substantially.
WE RELY ON THE SERVICES OF OUR SENIOR MANAGEMENT AND OTHER KEY PERSONNEL, WHOSE
KNOWLEDGE OF OUR BUSINESS AND TECHNICAL EXPERIENCE WOULD BE DIFFICULT TO
REPLACE.
We believe that our success will depend on the continued employment of our
senior management team and other key personnel. Any of our officers or employees
can terminate his or her employment relationship at any time. Currently, our key
executives are Jonathan Nelson, our Chief Executive Officer and Chairman of the
Board, and Michael Hudes, our President. The loss of either of these key
employees or our inability to attract or retain other qualified employees could
harm our business, financial condition and results of operations. While we
currently maintain a key person life insurance policy for Jonathan Nelson, the
amount of this insurance may be inadequate to compensate us for his loss.
WE WILL LIKELY CONTINUE TO FACE INTENSE COMPETITION WHICH COULD HARM OUR
OPERATING RESULTS.
The market for Internet professional services is relatively new, intensely
competitive, quickly evolving and subject to rapid technological change. In
addition, our industry is experiencing rapid consolidation. Moreover, many of
our competitors have longer operating histories, larger client bases, greater
brand recognition, greater financial, marketing, service, support, technical,
intellectual property and other resources than we do. As a result, our
competitors may be able to devote greater resources to marketing campaigns,
adopt more aggressive pricing policies or devote substantially more resources to
client and business development than us. We also anticipate facing additional
competition from new entrants into our markets due to the low barriers of entry.
This increased competition may result in reduced operating margins, loss of
market share and a diminished brand. In addition, we may from time to time make
pricing, service or marketing decisions or acquisitions as a strategic response
to changes in the competitive environment. These actions could reduce our
profits and harm our financial condition, results of operations and cash flows.
OUR INVESTMENTS IN CLIENT COMPANIES INVOLVE RISK, INCLUDING LOSING SOME OR ALL
OF OUR INVESTMENT, WHICH COULD HARM OUR OPERATING RESULTS.
In exchange for our services we have from time to time made investments in
some of our clients. As of March 31, 2000, we had $2.0 million of such
investments accounted for on our balance sheet. We may continue to invest in our
clients as opportunities arise. In general, these equity investments are
structured so our clients pay for all of the costs related to their engagement
in cash and use equity incentives to compensate us for a portion of our profit
margin. The businesses of the clients in which we invest, however, are generally
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unproven and involve substantial risk. If these clients' businesses do not
succeed, we could lose some or all of our investment, which would harm our
operating results and cause our profitability to be lower than it would have
been if we had taken payment for our entire engagement in cash.
OUR BUSINESS OPPORTUNITIES MAY BE RESTRAINED BY CONFLICTS BETWEEN POTENTIAL
CLIENTS, WHICH COULD REDUCE OUR POTENTIAL PROFITABILITY.
Conflicts between potential clients are inherent in our business. We have
in the past, and will likely in the future, be unable to pursue certain
opportunities because they would result in offering similar services to direct
competitors of existing clients. Moreover, we risk alienating existing clients
if we provide services to even indirect competitors. Because these potential
conflicts may jeopardize revenues generated from existing clients and hinder
future prospects, these conflicts could cause our operating results to suffer.
Furthermore, in limited circumstances, we have agreed not to reuse some software
code developed by us for a client for competitors of the client and, in the case
of DaimlerChrysler, not to perform work for particular competitors. These type
of agreements reduce the number of our prospective clients and the number of
potential sources of revenues. In addition, these type of agreements magnify the
importance of our client selection process because many of our clients compete
in markets where only a limited number of players gain meaningful market share.
If we agree not to perform services for a particular client's competitors and
our client fails to capture a significant portion of its market, our future
revenues in that particular market will be negatively impacted.
WE FACE POTENTIAL LIABILITY FOR DEFECTS OR ERRORS IN THE SOLUTIONS WE DEVELOP,
THE OCCURRENCE OF WHICH COULD REDUCE OUR REVENUES.
Many of the solutions we develop are critical to the operations of our
clients' businesses. Any defects or errors in these solutions could result in:
- delayed or lost client revenues;
- adverse client reaction to us;
- negative publicity;
- additional expenditures to correct the problem; or
- claims against us for negligence in performing our services or for errors
in the software code provided by us.
Our standard contracts limit our damages arising from our negligent conduct
and for other potential liabilities in rendering our services. However, these
contractual provisions may not protect us from liability for damages. In
addition, large claims may not be adequately covered by insurance or may raise
our insurance costs.
IF WE ARE UNABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, OUR
REPUTATION COULD BE DAMAGED AND OUR COMPETITIVE POSITION COULD BE HARMED.
We believe our trademarks, trade secrets and other proprietary rights in
our intellectual property, including our trademark name, Organic, software code
and Internet business processes we have developed, are important to our success
and competitive position. In particular, our trademarks help establish our brand
identity and enhance the marketability of our services. Our trade secrets,
including the Internet business processes we have developed, are a significant
aspect of the services we provide. If we are unable to protect our trademarks,
trade secrets and other intellectual property against unauthorized use by
others, our reputation among existing and potential clients could be damaged and
our competitive position could be harmed. We generally enter into
confidentiality or license agreements with our employees and consultants, and
generally control access to and distribution of our documentation and other
proprietary intellectual property. Despite these precautions, our management
cannot ensure that these strategies will be adequate to deter misappropriation
of our proprietary intellectual property.
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Despite efforts to protect our intellectual property, we also face the
following risks:
- non-recognition or inadequate protection of our proprietary rights;
- undetected misappropriation of our proprietary intellectual property or
materials;
- development of similar technologies by competitors;
- unenforceability of non-competition agreements entered into by our
employees; and
- infringement claims, even if not meritorious, against us.
If any of these risks materialize, we could be required to pay significant
amounts to defend our rights and in some cases to indemnify our customers.
WE MAY BE UNABLE TO MEET OUR FUTURE CAPITAL REQUIREMENTS AND MAY REQUIRE
ADDITIONAL FINANCINGS.
Our future liquidity and capital requirements will depend on numerous
factors, including:
- timing and amount of funds required for, or generated by, operations;
- success and duration of our global expansion program; and
- unanticipated opportunities or challenges.
If our cash flows from operations and existing liquidity resources are
insufficient to fund our operations, we may need to obtain additional equity or
debt financing. In this case, we may seek to raise additional funds through
public or private financings, strategic relationships or other arrangements.
This additional funding may not be available on terms acceptable to us, or at
all. We may have to sell stock at prices lower than those paid by existing
stockholders, which would result in dilution, or we may have to sell stock or
bonds with rights superior to rights of holders of common stock. Also, any debt
financing might involve restrictive covenants that would limit our operating
flexibility. Moreover, strategic arrangements may require us to relinquish our
rights to certain of our intellectual property. Finally, if adequate funds are
not available on acceptable terms, we may be unable to develop or enhance our
services, take advantage of future opportunities or respond to the competitive
market.
RISKS RELATED TO OUR INDUSTRY
OUR SUCCESS DEPENDS ON OUR CLIENTS' WILLINGNESS TO ADOPT AN INTERNET BUSINESS
MODEL AND OUTSOURCE THEIR INTERNET NEEDS TO INTERNET PROFESSIONAL SERVICE
PROVIDERS.
The market for our services depends upon the adoption and assimilation of
Internet professional services by companies. Critical issues concerning the use
of the Internet remain unresolved and may affect the use of these technologies
to solve business problems. Critical issues that influence a client to adopt an
Internet business model or expand its business on the Internet include:
- security of Internet technologies and client information;
- reliability of the technology and services;
- cost of development of an electronic business Web site; and
- administration and bandwidth of the Internet itself.
The process of implementing or expanding a business on the Internet can be
difficult. The difficulty expected or experienced by clients in utilizing the
Internet and the expected costs of outsourcing compared to the expected costs of
internal development will affect their decisions on hiring and retaining
Internet professional services providers. Many entities may choose not to
outsource their Internet needs.
Additionally, some entities would have to make significant changes in their
current business practice to adapt to the Internet. Thus, even if the above
listed issues were resolved, businesses may just choose not to adopt an Internet
business model.
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IF WE ARE UNABLE TO KEEP UP WITH RAPID TECHNOLOGICAL AND OTHER CHANGES IN THE
INTERNET AND THE ELECTRONIC COMMERCE INDUSTRY, OUR BUSINESS WILL BE HARMED.
To remain competitive, we must continue to enhance and improve the
responsiveness, functionality and features of our online business solutions. The
Internet and the electronic commerce industry are characterized by rapid
technological change, changes in user and client requirements and preferences,
frequent new product and service introductions embodying new technologies, and
the emergence of new industry standards and practices. The evolving nature of
the Internet could render obsolete both our proprietary technology and the
skills of our employees. Our success will depend, in part, on our ability to:
- effectively use leading technologies critical to our business;
- enhance our existing solutions;
- continue to develop new solutions and technology that address the
increasingly sophisticated and varied needs of our current and
prospective clients and their customers; and
- influence and respond to technological advances, emerging industry and
regulatory standards and practices and competitive service offerings.
Our ability to remain technologically competitive may require substantial
expenditures and lead-time. If we are unable to adapt in a timely manner to
changing market conditions or customer requirements, our business, financial
condition, results of operations and cash flows could be seriously harmed.
OUR REVENUES COULD BE HARMED IF GROWTH IN THE USE OF THE INTERNET OR GROWTH OF
ELECTRONIC COMMERCE DOES NOT CONTINUE.
Our future success is substantially dependent upon continued growth in the
use of the Internet, particularly growth in commerce over the Internet. However,
consumer use of the Internet for commerce may not grow as quickly as projected.
If the number of users on the Internet does not increase or commerce over the
Internet does not become more accepted and widespread, demand for our services
may decrease and, as a result, our revenues would decline. Capacity constraints
caused by growth in Internet usage may, unless resolved, impede further growth
in Internet use. Other factors that may affect Internet usage or electronic
commerce adoption include:
- actual or perceived lack of security of information;
- lack of access and ease of use;
- congestion of Internet traffic;
- inconsistent quality or availability of Internet or customer service;
- possible outages due to difficulties or other damage to the Internet;
- excessive governmental regulation;
- uncertainty regarding intellectual property ownership;
- costs associated with the obsolescence of existing infrastructure; and
- level of consumer satisfaction with electronic commerce experiences.
Further, the adoption of the Internet for commerce and communication,
particularly by those individuals and companies that have historically relied
upon alternative means of commerce and communication, generally require the
understanding and acceptance of a new way of conducting business and exchanging
information. In particular, companies that have already invested substantial
resources in traditional means of conducting commerce and exchanging information
may be particularly reluctant or slow to adopt a new Internet-based strategy. If
the necessary infrastructure, products, services or facilities are not
developed, or if the Internet does not become a viable commercial medium, our
business, financial condition, results of operations and cash flows could be
harmed.
20
<PAGE> 21
THE APPLICATION OR ADOPTION OF GOVERNMENT REGULATIONS AND THE EXISTENCE OF LEGAL
UNCERTAINTIES MAY HARM OUR BUSINESS.
Our clients and us are subject to both regulations applicable to businesses
generally and to regulations directly applicable to electronic commerce.
However, laws and regulations may at any time be modified or adopted with
respect to the Internet relating to user privacy, pricing, content, copyrights,
distribution and characteristics and quality of products and services. The
modification or adoption of any additional laws or regulations may stall the
expansion of the Internet, which could increase our cost of doing business or
decrease demand for our online business solutions.
In addition, the applicability of existing laws to the Internet remains
uncertain with regard to many issues including property ownership, export of
encryption technology, sales tax, libel and personal privacy. Any new
legislation or regulation in these areas could potentially harm our business,
financial condition and results of operations.
Finally, the application of laws and regulations of jurisdictions where we
plan to offer our Internet services could also limit our business. Other states
or foreign countries may:
- require us to qualify to do business as a foreign corporation in each
state or foreign country, or otherwise subject us to taxes and penalties;
- attempt to regulate our Internet solutions;
- prosecute us for unintentional violations of their laws; or
- modify or enact new laws in the near future.
YEAR 2000
The information provided below constitutes a "Year 2000 Readiness
Disclosure" for purposes of the Year 2000 Information and Readiness Disclosure
Act.
The year 2000 problem existed because many computer systems and software
products use only the last two digits to refer to a year, creating the potential
for computerized programs to treat "00" as the year 1900, rather than as the
year 2000, in date-sensitive calculations. In our Registration Statement on Form
S-1 declared effective on February 9, 2000 by the Securities and Exchange
Commission (File No. 333-91627), we discussed the nature and progress of our
plans to prepare for any system or processing failures that could occur as a
result of this problem. In late 1999, we completed our review of our year 2000
readiness programs, including our assessment of our internal systems as well as
those of third parties with whom we have material interactions. As a result of
our planning and implementation efforts, we have experienced to date no
significant disruptions in either our internal operations or in our client
deliverables. The few issues that have been noted were dealt with at the time
they arose. Our costs to date concerning the year 2000 problem have not been
material. We are not aware of any material problems resulting from year 2000
issues, either with our internal systems, our software products, or the products
and services we deliver to our clients. We will continue to monitor both our
internal operations and those of our vendors and clients throughout the year
2000 to ensure that any latent year 2000 matters that may arise are addressed
promptly.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information concerning our exposure to market risk, which has remained
relatively unchanged from December 31, 1999, is incorporated by reference to the
discussion under the caption "Quantitative and Qualitative Disclosures About
Market Risk" in Part II, Item 7A of our Annual Report on Form 10-K for the year
ended December 31, 1999.
21
<PAGE> 22
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On February 17, 2000, a former employee filed an action against Organic
Holdings, Inc., Organic, Inc., and Jonathan Nelson, our Chief Executive Officer
and Chairman of the Board, in the California Superior Court in San Francisco.
(Haig v. Organic Holdings, Inc., et al.) An amended complaint was filed on March
22, 2000. The amended complaint asserts several claims based on allegations that
the former employee was prevented from exercising his stock options in Organic
Holdings. The amended complaint seeks substantial actual and exemplary damages
apparently based on the increase in the value of Organic Holdings stock after
the initial public offering of two companies in which it owns substantial
stakes, including Organic, Inc. The case is in its earliest stages, no response
to the complaint has been filed, and no discovery has been taken. We and our
co-defendants believe that these claims lack any merit, and intend to contest
them vigorously.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) SALES OF UNREGISTERED SECURITIES
During the three months ended March 31, 2000, we issued stock options to
employees, officers, and consultants under our 1997 and 1999 stock option plans
to purchase an aggregate of 2,728,006 shares of our common stock, with exercise
prices ranging from $3.00 to $30.125. Options to purchase an aggregate of
6,773,962 shares were exercised for an aggregate consideration of $7,463,577, of
which $3,010,711 related to cash consideration and $4,452,866 related to amounts
due from stockholders. These issuances of securities were deemed to be exempt
from registration in reliance on Section 3(b) of the Securities Act of 1933 and
Rule 701 promulgated thereunder by the Securities and Exchange Commission
relating to compensatory benefit plans.
(d) USE OF PROCEEDS SOLD IN INITIAL PUBLIC OFFERING
On February 18, 2000, we completed the initial public offering of our
common stock. The managing underwriters in the offering were Goldman Sachs &
Company, Donaldson, Lufkin & Jenrette, and Thomas Weisel Partners LLC. Our
shares of the common stock sold in the offering were registered under the
Securities Act of 1933 in a Registration Statement on Form S-1 (File No.
333-91627). The Securities and Exchange Commission declared the Registration
Statement effective on February 9, 2000.
We commenced our offering on February 10, 2000 and consummated our offering
on February 18, 2000 after we had sold all of the 6,325,000 shares of common
stock registered under the Registration Statement (including 825,000 shares sold
in connection with the exercise of the underwriters' over-allotment option). The
initial public offering price was $20.00 per share for an aggregate sales price
of $126.5 million.
We paid a total of approximately $8.9 million in underwriting discounts and
commissions and approximately $1.7 million in offering expenses. None of the
expenses related to the offering were paid directly or indirectly to any of our
directors, officers, general partners or their associates, or to any persons
owning 10% or more of any class of our equity securities, or to any of our
affiliates.
We received net proceeds from the offering of approximately $115.9 million
after deducting the underwriting discounts and commissions and the offering
expenses. The net offering proceeds have been used for general working capital
purposes, to expand our corporate infrastructure, for capital expenditures and
for the repayment of our outstanding debt to Omnicom Group under our revolving
credit facility.
22
<PAGE> 23
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS INDEX:
The following is a list of exhibits filed as part of this Quarterly Report
on Form 10-Q. Where so indicated by footnote, exhibits that were previously
filed are incorporated by reference. For exhibits incorporated by reference, the
location of the exhibit in the previous filing is the same as those set forth
below.
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- ------------------------------------------------------------
<C> <S>
3.1 Amended and Restated Certificate of Incorporation of
Registrant(1)
3.2 Amended and Restated Bylaws of Registrant(1)
4.1 Reference is made to Exhibits 3.1 and 3.2
4.2 Specimen Certificate of the Registrant's common stock(1)
4.3 Rights Agreement between Registrant and EquiServe Trust
Company, N.A., as Rights Agent(2)
4.4 Investors' Rights Agreement by and among Registrant, Organic
Holdings, Inc. and Omnicom Group, Inc., dated February 8,
2000(1)
10.1 Form of Indemnification Agreement between Registrant and
each of its executive officers and Directors(1)
10.2 Registrant's 1997 Stock Option Plan, as amended and
restated, including forms of agreements thereunder(1)(4)
10.3 Registrant's 1999 Long-Term Stock Incentive Plan, including
forms of agreements thereunder(1)(4)
10.4 Employment Agreement between Registrant and Jonathan Nelson,
dated January 29, 1997 and amended February 24, 1997(1)(4)
10.5 Employment Agreement between Registrant and Michael Hudes,
dated January 29, 1997 and amended February 24, 1997(1)(4)
10.6 Employment Agreement between Registrant and Susan L. Field,
dated June 22, 1999(1)(4)
10.7 Loan Agreement between Registrant and Omnicom Group, Inc.,
dated August 27, 1999(1)
10.8 Guaranty and Security Agreement by and among Registrant,
Organic Media, Inc. and Omnicom Group, Inc., dated August
27, 1999(1)
10.9 Revolving Note of Registrant payable to Omnicom Group, Inc.,
dated August 27, 1999(1)
10.10 Lease between 500 Third Street Associates and Registrant,
dated July 22, 1996(1)
10.11 Lease between 500 Third Street Associates and Registrant,
dated July 22, 1996(1)
10.12 Lease between 500 Third Street Associates and Registrant,
dated December 5, 1996(1)
10.13 Lease between Trustees of the Masonic Hall and Asylum Fund
and Registrant, dated June 1998(1)
10.14 Lease between Trustees of the Masonic Hall and Asylum Fund
and Registrant, dated September 15, 1999(1)
10.15 Lease between Baker Hamilton Properties, LLC and Registrant,
dated November 8, 1999(1)
10.16 Lease between 233 Broadway Owners LLC and Registrant, dated
November 4, 1999(1)
10.17 Registrant's 2000 Employee Stock Purchase Plan(1)
10.18 Sublease between Looksmart, Ltd. and Registrant, dated
January 14, 2000(1)
10.19 Omnibus Service Agreement between Registrant and
Blockbuster, Inc., dated February 1, 1999(1)
</TABLE>
23
<PAGE> 24
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- ------------------------------------------------------------
<C> <S>
10.20 DaimlerChrysler Corporation Agreement with Registrant, dated
March 15, 1999(1)
27.1 Financial Data Schedule(3)
</TABLE>
- ---------------
(1) Incorporated herein by reference to the Company's Registration Statement on
Form S-1 (File No. 333-91627).
(2) Incorporated herein by reference to the Company's Annual Report on Form 10-K
for the year ended December 31, 1999.
(3) Filed herewith.
(4) Management contract or compensatory plan, contract or arrangement.
(b) REPORTS ON FORM 8-K
None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, Organic, Inc. has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
ORGANIC, INC. (Registrant)
By: /s/ SUSAN L. FIELD
------------------------------------
Susan L. Field
Executive Vice President and
Chief Financial Officer
By: /s/ SHELLY A. SAUNDERS
------------------------------------
Shelly A. Saunders
Vice President, Corporate Controller
and Treasurer
Dated: May 15, 2000
24
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM (A)
CONSOLIDATED FINANCIAL STATEMENTS FOR THE PERIODS ENDED MARCH 31, 1999 AND MARCH
31, 2000 (UNAUDITED) AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH (B)
FORM S-1
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 91,534
<SECURITIES> 194
<RECEIVABLES> 33,665
<ALLOWANCES> 3,238
<INVENTORY> 0
<CURRENT-ASSETS> 129,749
<PP&E> 23,234
<DEPRECIATION> 7,310
<TOTAL-ASSETS> 162,723
<CURRENT-LIABILITIES> 26,778
<BONDS> 0
0
0
<COMMON> 9
<OTHER-SE> 135,261
<TOTAL-LIABILITY-AND-EQUITY> 162,723
<SALES> 0
<TOTAL-REVENUES> 29,214
<CGS> 0
<TOTAL-COSTS> 60,641
<OTHER-EXPENSES> (55)
<LOSS-PROVISION> 2,358
<INTEREST-EXPENSE> (346)
<INCOME-PRETAX> (31,026)
<INCOME-TAX> 199
<INCOME-CONTINUING> (31,225)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (31,225)
<EPS-BASIC> (0.65)
<EPS-DILUTED> (0.65)
</TABLE>
