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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NUMBER 000-29405
------------------------
ORGANIC, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 94-3258989
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
</TABLE>
601 TOWNSEND STREET
SAN FRANCISCO, CALIFORNIA 94103
(Address of principal executive offices)
(415) 581-5300
(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 October 31, 2000 was 88,257,207.
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<PAGE> 2
ORGANIC, INC.
FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of September 30,
2000 (unaudited) and December 31, 1999...................... 1
Condensed Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 2000 and 1999
(unaudited)................................................. 2
Condensed Consolidated Statements of Cash Flows for the Nine
Months Ended September 30, 2000 and 1999 (unaudited)........ 3
Notes to Condensed Consolidated Financial Statements........ 4
Management's Discussion and Analysis of Financial Condition
Item 2. and Results of Operations................................... 9
Quantitative and Qualitative Disclosures About Market
Item 3. Risk........................................................ 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 24
Item 4. Submission of Matters to a Vote of Security Holders......... 24
Item 5. Other Information........................................... 24
Item 6. Exhibits and Reports on Form 8-K............................ 25
SIGNATURES........................................................... 26
</TABLE>
i
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ORGANIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 82,956 $ 8,385
Accounts receivable, net of allowance of $1,852 at
September 30, 2000 and $1,078 at December 31, 1999..... 19,151 18,769
Costs in excess of billings............................... 7,300 5,248
Deposits, prepaid expenses and other current assets....... 3,422 1,592
--------- --------
Total current assets.............................. 112,829 33,994
Property and equipment, net............................... 32,159 10,759
Long-term investments in marketable securities............ 4,887 1,990
Deferred bank facility charge, net of accumulated
amortization of $6,554 at September 30, 2000 and $2,017
at December 31, 1999................................... 11,596 16,134
Other assets.............................................. 380 1,387
--------- --------
Total assets...................................... $ 161,851 $ 64,264
========= ========
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 1,979 $ 3,232
Current portion of long-term debt......................... 324 13,450
Current portion of obligations under capital leases....... 35 44
Accrued expenses.......................................... 15,869 9,451
Deferred rent............................................. 1,646 345
Deferred revenue.......................................... 12,124 12,152
--------- --------
Total current liabilities......................... 31,977 38,674
Long-term debt, net of current portion.................... 136 381
Obligations under capital leases, net of current
portion................................................ 76 97
--------- --------
Total liabilities................................. 32,189 39,152
--------- --------
Commitments and Contingencies (Note 8)
Minority interest in consolidated subsidiary................ 203 334
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 September 30, 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 September 30, 2000 and
December 31, 1999, respectively (aggregate liquidation
preference $10,724).................................... -- --
Common stock, $.0001 par value, 200,000,000 shares
authorized, 88,210,140 and 2,844,642 shares issued and
outstanding at September 30, 2000 and December 31,
1999, respectively..................................... 9 --
Additional paid-in capital................................ 285,805 151,743
Notes receivable from stockholders........................ (4,577) --
Deferred stock-based compensation......................... (49,849) (83,370)
Accumulated deficit....................................... (104,367) (43,607)
Accumulated other comprehensive income.................... 2,438 10
--------- --------
Total stockholders' equity........................ 129,459 24,778
--------- --------
Total liabilities and stockholders' equity........ $ 161,851 $ 64,264
========= ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
1
<PAGE> 4
ORGANIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2000 1999 2000 1999
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) ----------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Revenues................................... $ 37,351 $ 24,427 $ 103,726 $ 51,781
Operating expenses:
Professional services (exclusive of stock-
based compensation reported below of
$3,576 and $2,254 for the three months
ended September 30, 2000 and 1999, and
$17,526 and $3,355 for the nine months
ended September 30, 2000 and 1999,
respectively)......................... 20,480 16,098 54,972 29,929
Selling, general and administrative
(exclusive of stock-based compensation
reported below of $8,291 and $6,304 for
the three months ended September 30, 2000
and 1999, and $29,313 and $8,102 for the
nine months ended September 30, 2000 and
1999, respectively)................... 22,712 13,044 64,854 26,018
Stock compensation and other stock-based
charges............................... 11,867 8,558 46,839 11,457
----------- ---------- ----------- ----------
Total operating expenses......... 55,059 37,700 166,665 67,404
----------- ---------- ----------- ----------
Operating loss............................. (17,708) (13,273) (62,939) (15,623)
Minority interest in operations of consolidated
subsidiary............................... 52 (66) 128 (39)
Investment loss............................ (90) -- (443) --
Interest expense........................... (14) (123) (279) (247)
Interest income............................ 1,139 97 3,038 236
----------- ---------- ----------- ----------
Net loss before taxes............ (16,621) (13,365) (60,495) (15,673)
Income tax (benefit) expense............... (147) 26 265 64
----------- ---------- ----------- ----------
Net loss......................... $ (16,474) $ (13,391) $ (60,760) $ (15,737)
=========== ========== =========== ==========
Basic and diluted net loss per share....... $ (0.19) $ (9.36) $ (0.84) $ (13.76)
=========== ========== =========== ==========
Weighted average common shares
outstanding -- basic and diluted......... 85,102,416 1,429,927 72,455,249 1,143,427
=========== ========== =========== ==========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
<PAGE> 5
ORGANIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
2000 1999
(IN THOUSANDS) -------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(60,760) $(15,737)
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization.......................... 6,835 2,226
Stock compensation and other stock-based charges....... 46,839 11,457
Other non-cash charges................................. 9,700 1,401
Changes in assets and liabilities:
Increase in accounts receivable...................... (4,156) (14,763)
Increase in costs in excess of billings.............. (2,051) (5,133)
Increase in accounts payable and accrued expenses.... 4,868 8,576
(Decrease) increase in deferred revenue.............. (28) 7,814
Other assets and liabilities......................... 738 (590)
-------- --------
Net cash provided by (used) in operating
activities...................................... 1,985 (4,749)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment........................ (33,812) (6,195)
Purchase of short-term investments........................ (194) (2,005)
Proceeds from the sale and maturity of short-term
investments............................................ -- 2,405
Other investing activities................................ (347) --
-------- --------
Net cash used in investing activities............. (34,353) (5,795)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of convertible preferred stock,
net.................................................... -- 7,718
Proceeds from issuance of common stock, net............... 117,537 --
Proceeds from long-term debt.............................. 3,505 7,000
Payments on long-term debt................................ (16,876) (2,675)
Other financing activities................................ 3,145 52
-------- --------
Net cash provided by financing activities......... 107,311 12,095
Effect of exchange rate changes on cash and cash
equivalents..................................... (372) (14)
-------- --------
Net increase in cash and cash equivalents......... 74,571 1,537
Cash and cash equivalents at beginning of period............ 8,385 1,667
-------- --------
Cash and cash equivalents at end of period.................. $ 82,956 $ 3,204
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION:
Cash paid for interest.................................... $ 258 $ 231
======== ========
Cash paid for income taxes................................ $ 270 $ 86
======== ========
NONCASH INVESTING AND FINANCING ACTIVITIES:
Unrealized gains on available for sale securities......... $ 2,799 $ --
======== ========
Conversion of debt into preferred stock................... $ -- $ 3,000
======== ========
Deferred stock-based compensation......................... $ 34,752 $ 49,011
======== ========
Issuance of common stock warrants......................... $ -- $ 18,151
======== ========
Net common stock issuance in exchange for notes receivable
from stockholders...................................... $ 4,613 $ --
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE> 6
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 periods presented are not necessarily
indicative of the operating results to be expected for any subsequent interim
period or for the fiscal year ending December 31, 2000.
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 an 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
$115.8 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, Inc. 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).
4
<PAGE> 7
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2000 1999 2000 1999
----------- ---------- ----------- ----------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<S> <C> <C> <C> <C>
Numerator:
Net loss attributable to common
stockholders....................... $ (16,474) $ (13,391) $ (60,760) $ (15,737)
=========== ========== =========== ==========
Denominator:
Weighted average common shares
outstanding........................ 88,086,384 1,528,205 75,938,240 1,209,591
Less: weighted average unvested common
shares subject to repurchase....... (2,983,968) (98,278) (3,482,991) (66,164)
----------- ---------- ----------- ----------
Weighted average common shares used in
computing basic and diluted net
loss per share..................... 85,102,416 1,429,927 72,455,249 1,143,427
=========== ========== =========== ==========
Basic and diluted net loss per share.... $ (0.19) $ (9.36) $ (0.84) $ (13.76)
=========== ========== =========== ==========
</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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- -----------------------
2000 1999 2000 1999
--------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Weighted average effect of common stock
equivalents:
Series A convertible preferred stock........... -- 65,025,000 9,492,701 65,025,000
Series B convertible preferred stock........... -- 4,464,000 651,679 4,006,154
Unvested common shares subject to repurchase... 2,983,968 98,278 3,482,991 66,164
Common stock options........................... 8,099,890 8,388,447 10,226,575 7,515,644
Common stock warrants.......................... -- 440,037 328,332 148,291
</TABLE>
NOTE 4 -- COMPREHENSIVE LOSS
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 were as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
2000 1999 2000 1999
(IN THOUSANDS) -------- -------- -------- --------
<S> <C> <C> <C> <C>
Net loss........................................ $(16,474) $(13,391) $(60,760) $(15,737)
Unrealized (losses) gains on available for sale
securities.................................... (1,208) -- 2,799 --
Foreign currency translation adjustment......... (186) 11 (371) (14)
-------- -------- -------- --------
Comprehensive loss.............................. $(17,868) $(13,380) $(58,332) $(15,751)
======== ======== ======== ========
</TABLE>
5
<PAGE> 8
ORGANIC, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 4 -- COMPREHENSIVE LOSS (CONTINUED)
The tax effects of comprehensive loss were not considered material. The
following is a summary of the components of accumulated other comprehensive
income:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
(IN THOUSANDS) ------------- ------------
<S> <C> <C>
Balance, beginning of period....................... $ 10 --
Unrealized gains on available for sale
securities....................................... 2,799 --
Foreign currency translation adjustment............ (371) 10
------ ---
Balance, end of period............................. $2,438 $10
====== ===
</TABLE>
NOTE 5 -- INVESTMENTS
The Company's investments are primarily composed of common stock received
from its customers in exchange for services rendered. Initially, the Company
records the common stock on the consolidated balance sheet based on the
estimated fair value of the services provided to the customers or, if
publicly-traded, the market value of the stock as of the measurement date. The
Company classified these investments as available-for-sale. In accordance with
the provisions of SFAS No. 115, available-for-sale securities are carried at
fair value, with unrealized gains and losses reported as a separate component of
stockholders' equity net of applicable income taxes. For the three months and
nine months ended September 30, 2000, the Company recorded unrealized (losses)
and gains of $(1.2) million and $2.8 million for HomeGrocer, which was acquired
by Webvan Group in September 2000, and Stan Lee Media, based on the fair market
values of their publicly traded common stock.
Realized gains and losses and declines in value judged to be
other-than-temporary on available-for-sale securities are included in other
income. The cost basis for realized gains and losses on available-for-sale
securities is determined on a specific identification basis. In the second
quarter of 2000, the Company made an investment of $500,000 in Retail Options
LLC, a joint venture that includes Federated Department Stores, Sears Roebuck &
Co., Groupe Carrefour and St. Paul Fire & Marine Insurance Company. The alliance
was created to identify, invest in, develop and distribute brands and
technologies that present opportunities in both brick-and-mortar and e-commerce
retailing. For the three months ended September 30, 2000, the Company recorded
an investment loss of $90,000, related to Retail Options. For the nine months
ended September 30, 2000, the Company recorded an investment loss of $90,000,
related to Retail Options and a non-recurring write-off of $353,000 for our
investments in NextPlanetOver, which was purchased by eHobbies with no residual
value to the existing shareholders. This amount had been recorded as an
investment loss on the condensed consolidated statements of operations.
NOTE 6 -- DEFERRED STOCK-BASED COMPENSATION
The Company recorded aggregate deferred stock-based compensation of $0 and
$31.0 million for the three months ended September 30, 2000 and 1999,
respectively, and $34.8 million and $49.0 million for the nine months ended
September 30, 2000 and 1999, respectively. These amounts have been included as a
component of stockholders' equity and are being amortized 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. The Company recognized stock compensation expense
of $10.4 million and $8.1 million for the three months ended September 30, 2000
and 1999, respectively, and $42.3 million and $10.9 million for the nine months
ended September 30, 2000 and 1999, respectively. As of September 30, 2000, the
Company had an aggregate of $49.8 million of deferred stock-based compensation
remaining to be amortized.
6
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ORGANIC, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 7 -- 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 by SFAS
No. 137, 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 commonly
reported in connection with exit activities and business combinations, including
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. SAB No. 101, as amended by SAB No. 101B, is effective no
later than the fourth quarter of fiscal years beginning after December 15, 1999.
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. 25." 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 8 -- CONTINGENCIES
On February 17, 2000, a former employee filed an action against Organic
Holdings, Inc., Organic, Inc., and Jonathan Nelson, the Company's 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. On June 13, 2000, the Court granted defendants' motion
to dismiss the amended complaint, dismissing some claims without leave to amend
and other claims with leave to amend. A second amended complaint, filed on June
29, 2000, asserts several claims based on allegations that the former employee
was prevented from exercising his stock options in Organic Holdings, and seeks
not less than $20 million in special damages plus exemplary damages. On July 31,
2000, defendants filed a motion to dismiss the second amended complaint. On
September 28, 2000, the Court heard oral argument on the motion to dismiss. The
Court has not yet ruled on that motion to dismiss. The case is in its earliest
stages, and no discovery has been taken. The Company and its co-defendants
believe that these claims lack any merit, and intend to contest them vigorously.
On May 16, 2000, an individual real estate broker and former employee of a
real estate brokerage company which had performed some work for the Company
filed suit in United States District Court in New
7
<PAGE> 10
ORGANIC, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
York City seeking recovery from the Company and others for broker's commissions
he claims due. (Kades v. Organic, Inc., et al.) The complaint alleges claims for
violation of the Racketeering Influenced Corrupt Organizations (RICO) Act,
misrepresentation, interference with contractual relations and other causes of
action and seeks compensatory and punitive damages against all defendants. The
lawsuit is in its initial stages. The Company believes the complaint is without
merit and is contesting the claims vigorously.
8
<PAGE> 11
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 services including media buying and management, 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 300 major offline and online companies to establish or
enhance brands and have introduced several new service lines to address
particular client needs.
We plan to scale our growth to accommodate the demand from potential
clients 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 nine months ended September 30, 2000,
five clients accounted for 50.2% of our revenues, with DaimlerChrysler
accounting for 22.8%. Revenues from any given client will vary from period to
period; however, we expect that significant concentration will continue for the
foreseeable future as we execute on our strategy of developing deeper
multi-service line relationships with our clients. 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. A typical client
relationship consists of a series of engagements. 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 we accrue for estimated losses, if necessary, 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
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exclude reimbursable expenses charged to clients. Provision for sales credits
are offset against revenue recognized when the need for such sales credits are
determined.
During the nine months ended September 30, 2000, we opened offices in
Toronto, Atlanta and Boston. Our international operations collectively accounted
for 11.7% and 10.4% of our total revenues for the three and nine months ended
September 30, 2000, respectively. Because we intend 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 in
absolute dollars and may continue to increase in the foreseeable future due to
wage increases and inflation. However, any expected increase in professional
services expenses may be offset by savings realized by voluntary or involuntary
reductions in personnel. Our professional services margins are affected by many
factors, including utilization rate, 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 we continue to leverage our investments in
infrastructure, we expect these expenses will continue to increase in absolute
dollars when we 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 September 30, 2000, had
an accumulated deficit of $104.4 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. Including the effects of stock
compensation and other stock-based charges, we 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 may continue in
the near future. This has caused our past operating results to fluctuate
significantly from quarter to quarter. Our growth has and will continue to place
significant demands on our management and operational resources. If we are
unable to manage our growth effectively then 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.
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
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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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2000 1999 2000 1999
------ ------ ------ ------
<S> <C> <C> <C> <C>
Revenues.............................................. 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Professional services............................... 54.8% 65.9% 53.0% 57.8%
Selling, general and administrative................. 60.8% 53.4% 62.5% 50.2%
Stock compensation and other stock-based charges.... 31.8% 35.0% 45.2% 22.1%
----- ----- ----- -----
Total operating expenses.................... 147.4% 154.3% 160.7% 130.1%
Operating loss........................................ (47.4)% (54.3)% (60.7)% (30.1)%
Minority interest in operations of consolidated
subsidiary.......................................... 0.1% (0.3)% 0.1% 0.0%
Investment loss....................................... (0.2)% 0.0% (0.4)% 0.0%
Interest expense...................................... (0.2)% (0.5)% (0.3)% (0.5)%
Interest income....................................... 3.0% 0.3% 2.9% 0.5%
----- ----- ----- -----
Net loss before taxes....................... (44.7)% (54.8)% (58.4)% (30.1)%
Income tax (benefit) expense.......................... (0.4)% 0.1% 0.3% 0.1%
----- ----- ----- -----
Net loss.................................... (44.3)% (54.9)% (58.7)% (30.2)%
===== ===== ===== =====
</TABLE>
COMPARISON OF THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
REVENUES
Our revenues were $37.4 million for the three months ended September 30,
2000, an increase of 52.9% over $24.4 million for the three months ended
September 30, 1999. Our revenues were $103.7 million for the nine months ended
September 30, 2000, an increase of 100.3% over $51.8 million for the nine months
ended September 30, 1999. These increases were primarily due to increases in the
number of clients and the size and scope of our engagements. These increases
were attributable in part to our development of deeper multi-service line
relationships with our clients, and our rate card increase effected in the first
quarter of 2000. In addition our increased sales and marketing efforts resulted
in the addition of new accounts. For the nine months ended September 30, 2000,
$38.0 million related to revenue generated from new clients. Our efforts also
resulted in the expansion of our relationship with many existing clients since
September 30, 1999, most notably DaimlerChrysler, which accounted for 30.6% and
22.8% of our total revenues for the three and nine months ended September 30,
2000, respectively. Since September 30, 1999, we continued our global expansion
by opening offices in Toronto, Atlanta and Boston. Revenues from our
international locations were significantly higher than the amounts generated
during the comparable periods in the prior year, representing 11.7% and 10.4% of
our total revenues for the three and nine months ended September 30, 2000,
respectively.
PROFESSIONAL SERVICES
Our professional services expenses were $20.5 million for the three months
ended September 30, 2000, an increase of 27.2% over $16.1 million for the three
months ended September 30, 1999. Our professional services expenses were $55.0
million for the nine months ended September 30, 2000, an increase of 83.7% over
$29.9 million for the nine months ended September 30, 1999. These increases were
primarily due to increases in our salary costs associated with the increase in
professional services personnel. However, in the near term, we expect these
salary costs to remain flat or decline as we moderate hiring, take advantage of
voluntary attrition and consider voluntary and involuntary reduction in
personnel where employees appear to be underutilized. Our global increase in
professional services headcount resulted from opening new offices since
September 30, 1999 in Toronto, Atlanta and Boston as well as continued growth in
our other worldwide offices in order to accommodate the increase in the size and
number of our projects. As a percentage of revenues, professional services
expenses decreased to 54.8% from 65.9% for the three months ended September 30,
2000 and 1999, respectively, and to 53.0% from 57.8% for the nine months ended
September 30, 2000 and 1999,
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respectively, due to the conversion of contractors to employees and a general
reduction in the use of contractors.
SELLING, GENERAL AND ADMINISTRATIVE
Our selling, general and administrative expenses were $22.7 million for the
three months ended September 30, 2000, an increase of 74.1% over $13.0 million
for the three months ended September 30, 1999. Our selling, general and
administrative expenses were $64.9 million for the nine months ended September
30, 2000, an increase of 149.3% over $26.0 million for the nine months ended
September 30, 1999. These increases resulted from the hiring of key corporate
officers, increased facilities, rent and depreciation costs associated with our
new offices since September 30, 1999 in Toronto, Atlanta and Boston, and
increased recruiting costs associated with the increase in personnel. As a
percentage of revenues, selling, general and administrative expenses increased
to 60.8% from 53.4% for the three months ended September 30, 2000 and 1999,
respectively, and to 62.5% from 50.2% for the nine months ended September 30,
2000 and 1999, respectively. These increases were the result of our aggressive
investment in infrastructure relative to our revenue growth, partly attributable
to costs associated with hiring executive management and personnel to fill open
positions within the corporate services departments. We believe that our current
commitment to building our global platform and scalable infrastructure will, in
turn, 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 to employees and
executives and the issuance of a warrant to Omnicom Group. For the three months
ended September 30, 2000 and 1999, we recorded aggregate deferred stock-based
compensation of $0 and $31.0 million, respectively. This decrease was due to no
options being granted during the three months ended September 30, 2000 at
exercise prices that were less than the market values at the time of grant. For
the nine months ended September 30, 2000 and 1999, we recorded aggregate
deferred stock-based compensation of $34.8 million and $49.0 million,
respectively. This decrease was primarily due to a decrease in the number of
option grants since September 30, 1999 that had larger differences between the
market values at the dates of grant and the exercise prices at which the options
were granted from September 30, 1999 through January 18, 2000. These amounts
have been included as a component of stockholders' equity and are being
amortized by charges to operations over the vesting period of the related
options, generally 4 years. We recognized stock compensation expense of $11.9
million and $8.6 million for the three months ended September 30, 2000 and 1999,
respectively, and $42.3 million and $9.9 million for the nine months ended
September 30, 2000 and 1999, respectively. As of September 30, 2000, we had
$49.8 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. We expect the annual amortization of
deferred stock-based compensation for fiscal years ended 2000, 2001, 2002, and
2003 to be $60.2 million, $25.3 million, $11.9 million, and $3.1 million,
respectively, based on current vesting periods.
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 and nine
months ended September 30, 2000 and September 30, 1999, we recognized bank
facility expense of $1.5 million and $4.5 million and $504,000 and $2.0 million,
respectively, these charges are included stock-based compensation.
INVESTMENT LOSS
In the second quarter of 2000, we made an investment of $500,000 in Retail
Options LLC, a joint venture that includes Federated Department Stores, Sears
Roebuck & Co., Groupe Carrefour and St. Paul Fire & Marine Insurance Company.
The alliance was created to identify, invest in, develop and distribute brands
and technologies that present opportunities in both brick-and-mortar and
e-commerce retailing. For the three months ended September 30, 2000, we recorded
an investment loss of $90,000, related to Retail Options. For
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the nine months ended September 30, 2000, we recorded an investment loss of
$90,000, related to Retail Options and a non-recurring write-off of $353,000 for
our investment in NextPlanetOver, which was purchased by eHobbies with no
residual value to the existing shareholders. This amount has been recorded as an
investment loss on the condensed consolidated statements of operations.
INTEREST EXPENSE
Interest expense represents interest expense incurred on our financing
obligations. We recognized interest expense of $14,000 and $123,000 for the
three months ended September 30, 2000 and 1999, respectively, and $279,000 and
$247,000 for the nine months ended September 30, 2000 and 1999, respectively.
The decrease for the three months ended September 30, 2000 was due to the fact
that there were no outstanding borrowings under the revolving credit facility
during the third quarter of 2000 as there were in the third quarter of 1999. The
increase for the nine months ended September 30, 2000 was due to the fact that
the outstanding borrowings under the revolving credit facility were greater
throughout the nine months ended September 30, 2000 compared with the nine
months ended September 30, 1999.
INTEREST INCOME
Interest income represents interest income generated from our cash and cash
equivalents and short-term investments. We recognized interest income of $1.1
million and $97,000 for the three months ended September 30, 2000 and 1999,
respectively, and $3.0 million and $236,000 for the nine months ended September
30, 2000 and 1999, respectively. The increases were due to additional income
generated from our initial public offering proceeds. We invested our cash
balances in treasury securities as of September 30, 2000.
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 $115.8 million. The primary purposes of this offering were to
obtain additional equity capital to assist with our present growth strategies,
create a public securities 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 complementary to ours. Pending such uses, we have invested
the net proceeds of this offering in treasury securities. 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 September 30, 2000, we had
$83.0 million in cash and cash equivalents and our principal commitments
consisted of obligations outstanding under capital leases and software financing
agreements.
Net cash provided by (used) in operating activities was $2.0 million and
($4.7) million for the nine months ended September 30, 2000 and 1999,
respectively. Net cash flows provided by (used) in operating activities in each
period reflect net losses and increases in accounts receivable and costs in
excess of billings, offset by an increase in the depreciation and amortization
of fixed assets, amortization of deferred stock-based compensation and other non
cash activities.
Net cash used in investing activities was $34.4 million and $5.8 million
for the nine months ended September 30, 2000 and 1999, respectively. Net cash
flows used in investing activities for the nine months ended September 30, 2000
primarily reflect increased purchases of property and equipment. Net cash flows
used in investing activities for the nine months ended September 30, 1999
reflect increased purchases of property and equipment and short-term
investments, partly offset by the proceeds from sales of short-term investments.
Net cash provided by financing activities was $107.3 million and $12.1
million for the nine months ended September 30, 2000 and 1999, respectively. Net
cash provided by financing activities for the nine months ended September 30,
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
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as described below. Net cash provided by financing activities for the nine
months ended September 30, 1999 was primarily due to the issuance of Series B
convertible preferred stock as described below.
Capital expenditures, excluding capital leases, were $33.8 million and $6.2
million for the nine months ended September 30, 2000 and 1999, respectively. 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. As of September 30,
2000 there were no borrowings outstanding under this credit facility.
We believe that our current level of cash and cash equivalents will be
sufficient to meet our anticipated liquidity needs for working capital and
capital expenditures for at least twelve months from September 30, 2000.
RECENT ACCOUNTING PRONOUNCEMENTS
We continually assess the effects of recently issued accounting standards.
The impact of all recently adopted and issued accounting standards has been
disclosed in the notes to the unaudited condensed consolidated interim financial
statements in this Quarterly Report on Form 10-Q.
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 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 with the SEC.
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
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.
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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. In addition, our industry and business
are subject to high turnover rates among employees. As a result, we may be
unable to successfully attract, assimilate or retain qualified personnel. As of
September 30, 2000, we had 1,223 employees, and we expect 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 GROWTH, WHICH COULD RESULT IN OUR
BEING UNABLE TO EFFECTIVELY CONTROL OUR COSTS AND IMPLEMENT OUR BUSINESS
STRATEGIES.
We have been expanding our operations both domestically and internationally
over 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 serve clients more
efficiently and effectively. Because competition for employees in many of these
new geographic areas is intense, our employee recruitment in these areas may at
times exceed or fall below our requirements for engagements in these geographic
areas. 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
difficulties in effecting our expansion, our expenses could increase more
quickly than our revenues or our revenues could decline as a result of our
failure to service new client engagements adequately, 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 of these major clients, if not replaced, could
dramatically reduce our revenues. For example, for the three and nine months
ended September 30, 2000, respectively, our five largest clients accounted for
approximately 72.3% and 50.2% of our total revenues, with DaimlerChrysler
accounting for approximately 30.6% and 22.8% 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.
For the three months ended September 30, 2000, approximately 8% of our
revenues were 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, including the ability of these clients
to make timely payments from existing funds or to raise additional funds on
favorable terms or at all. 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. Additionally, our clients
or potential clients' inability to raise additional funds may cause them to
terminate or reduce the scope of the services we provide them, which could
affect our business, financial condition and operating results.
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 retained on an engagement-by-engagement basis. These engagements vary in
size and scope and thus make our revenues difficult to predict. In addition, our
standard contract provides for termination by either party after notice and a
transition period of up to 180 days. Our clients also could unilaterally reduce
or modify the scope or use of our services. Our operating expenses are
relatively fixed and cannot be reduced on short notice to compensate for such
unanticipated variations in the number or size of engagements in progress.
Because we incur costs
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based on our expectations of revenues from future engagements, our failure to
predict our revenues accurately may cause the increase in our expenses to
outpace our revenue growth substantially, which would seriously harm our
financial condition, results of operations and cash flows.
IF WE FAIL TO ACCURATELY PREDICT COSTS RELATED TO OUR FIXED-FEE PROJECTS, WE MAY
LOSE MONEY ON THESE PROJECTS.
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 11.7% and 10.4%
of our total revenues for the three and nine months ended September 30, 2000,
respectively.
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.
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For example, if DaimlerChrysler, the primary client of our Detroit,
Michigan office, chose not to retain our services, the billable employees in our
Detroit office could be underutilized.
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 September 30, 2000, we granted options to purchase
2,573,877 shares of common stock to employees with an exercise price of $4.53
per share. We recognized stock-based compensation expense of $10.4 million and
$42.3 million for the three and nine months ended September 30, 2000,
respectively, relating to the difference between the exercise price of the
options and the fair market value of our common stock. As of September 30, 2000,
we had $49.8 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 quarterly revenues and operating
results, listed in order of their relative magnitude are:
- changes in our operating expenses as we expand globally;
- timing and execution of major client engagements;
- timing and cost of advertising and related media;
- timing of employee hiring and billable employee 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, calculated as 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, our aggregate 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 any future quarter and any impact on
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
and nine months ended September 30, 2000 and 1999, respectively. For the three
and nine months ended September 30, 2000 and 1999, our net losses were $16.5
million and $13.4 million and $60.8 million and $15.7 million, respectively. For
the three months ended September 30, 2000 and 1999, our net losses were 44.7%
and 54.8% of total revenues, respectively. For the nine months ended September
30, 2000 and 1999, our net losses were 58.4% and 30.1% 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. 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 ARE AT RISK OF SECURITIES CLASS ACTION LITIGATION BECAUSE OF OUR EXPECTED
STOCK PRICE VOLATILITY.
In the past, securities class action litigation has been brought against a
company following periods of volatility in the market price of its securities.
Because of the volatility of our stock price, we may be the target of similar
litigation in the future. Securities litigation could result in substantial
costs and divert our management's attention and resources, which could adversely
affect our financial condition and results of operations.
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
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<PAGE> 21
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 September 30, 2000, we had $4.9 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
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, for
instance, in the case of DaimlerChrysler, not to perform work for particular
competitors. These types of agreements reduce the number of our prospective
clients and the number of potential sources of revenues. Accordingly, our use of
these types of agreements magnifies 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 the solutions we provide 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 that result from our negligent
conduct and for other potential liabilities in rendering our services. However,
these contractual provisions may not fully protect us from liability for
damages. In addition, large claims may not be adequately covered by insurance or
may raise our insurance costs.
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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 safeguard against any
misappropriation of our proprietary intellectual property.
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 between us
and 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 clients.
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.
FUTURE SALES OF OUR COMMON STOCK IN THE PUBLIC MARKET COULD ADVERSELY AFFECT OUR
STOCK PRICE AND OUR ABILITY TO RAISE FUNDS IN NEW EQUITY OFFERINGS.
We cannot predict the effect, if any, that future sales of shares of common
stock or the availability for future sales of shares of common stock or options
to acquire our common stock will have on the market price of common stock
prevailing from time to time. Sale, or the availability for sale, of substantial
amounts of common stock by existing stockholders under Rule 144, Rule 701,
through the exercise of registration rights or the issuance of shares of common
stock upon the exercise of stock options, or the perception that such sales or
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<PAGE> 23
issuances could occur, could adversely affect prevailing market prices for our
common stock and could materially impair our future ability to raise capital
through an offering of equity securities.
PROVISIONS OF DELAWARE LAW, OUR CERTIFICATE OF INCORPORATION, BYLAWS AND SOME OF
OUR CONTRACTS COULD DETER POTENTIAL ACQUISITION BIDS THAT A STOCKHOLDER MAY
BELIEVE ARE DESIRABLE, AND THE MARKET PRICE OF OUR COMMON STOCK MAY BE LOWER AS
A RESULT.
Our board of directors has the authority to issue up to 25,000,000 shares
of preferred stock. The board of directors can fix the price, rights,
preferences, privileges and restrictions of the preferred stock without any
further vote or action by stockholders. The issuance of shares of preferred
stock may delay or prevent a change in control transaction. As a result, the
market price of our common stock and the voting and other rights of our
stockholders may be adversely affected. The issuance of preferred stock may
result in the loss of voting control to other stockholders. We have no current
plans to issue any shares of preferred stock.
Other provisions of our certificate of incorporation and bylaws may
discourage, delay or prevent a merger or acquisition that a stockholder may
consider favorable. These provisions include:
- authorizing our board of directors to issue additional preferred stock;
- limiting the persons who can call special meetings of stockholders;
- prohibiting stockholder actions by written consent;
- creating a classified board of directors under which our directors serve
staggered three-year terms;
- establishing advance notice requirements for nominations for election to
the board of directors or for proposing matters that can be acted on by
stockholders at stockholder meetings;
- limiting the ability of stockholders to remove directors without cause;
and
- adopting a stockholder rights plan, which would cause substantial
dilution to any person or group that attempts to acquire our company on
terms not approved in advance by our board of directors.
Further, some of our existing contracts may require a notice of assignment.
Since our contracts generally provide for termination by either party after
notice and a transition period of up to 180 days, a client may choose to
terminate our contract if the client does not like the assignment.
In addition, we are subject to the antitakeover provisions of Section 203
of the Delaware General Corporation Law, which regulates corporate acquisitions,
and these provisions may discourage, delay or inhibit potential acquisition bids
for our company.
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
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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.
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,
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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.
THE APPLICATION OR ADOPTION OF GOVERNMENT REGULATIONS AND THE EXISTENCE OF LEGAL
UNCERTAINTIES MAY HARM OUR BUSINESS.
We and our clients are subject both to 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.
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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.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In our Annual Report on Form 10-K for the year ended December 31, 1999, we
reported that 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. On June 13, 2000, the Court granted defendants' motion
to dismiss the amended complaint, dismissing some claims without leave to amend
and other claims with leave to amend. A second amended complaint, filed on June
29, 2000, asserts several claims based on allegations that the former employee
was prevented from exercising his stock options in Organic Holdings, and seeks
not less than $20 million in special damages plus exemplary damages. On July 31,
2000, defendants filed a motion to dismiss the second amended complaint. On
September 28, 2000, the Court heard oral argument on the motion to dismiss. The
Court has not yet ruled on that motion to dismiss. The case is in its earliest
stages, 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The following matters were submitted to a vote of stockholders at our
Annual Meeting of Stockholders on July 25, 2000.
Stockholders elected five incumbent directors for one- to three-year terms
as indicated below. The vote tabulation for individual directors was:
<TABLE>
<CAPTION>
DIRECTOR TERM OF OFFICE SHARES FOR SHARES WITHHELD
-------- -------------- ---------- ---------------
<S> <C> <C> <C>
Jonathan Nelson.................................... 1 year 73,782,145 42,739
Michael Hudes...................................... 2 years 73,784,706 40,178
Gerald Bruce Redditt............................... 2 years 73,788,556 36,328
Gary F. Hromadko................................... 3 years 73,806,345 18,539
Peter Rip.......................................... 3 years 73,806,000 18,884
</TABLE>
Our stockholders also approved the appointment of PricewaterhouseCoopers
LLP as our independent auditor by a vote of 73,779,131 for and 38,701 against.
There were 7,052 abstentions.
ITEM 5. OTHER INFORMATION
A stockholder may recommend nominees for director to the Board of Directors
by giving the Secretary a written notice by February 23, 2001 in order to be
considered for presentation at the 2001 Annual Meeting of Stockholders. The
notice must include the full name, age, business and residence addresses, and
principal occupation or employment of the nominee. It must also include the
number of shares of Organic common stock the nominee beneficially owns, any
other information about the nominee that must be disclosed in proxy
solicitations under Rule 14(a) of the Securities Exchange Act of 1934 and the
nominee's written consent to the nomination and agreement to serve, if elected.
In order to be considered for the 2001 Annual Meeting of Stockholders, a
stockholder must give written notice to the Secretary no earlier than April 26,
2001 and no later than May 26, 2001.
Under our bylaws, a stockholder must give written notice to our corporate
Secretary between 60 and 90 days prior to the first anniversary of the preceding
year's Annual Meeting of the matter to be presented at
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that year's Annual Meeting. To present a matter at the 2001 Annual Meeting, the
stockholder must give written notice to the Secretary no earlier than April 26,
2001 and no later than May 26, 2001.
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)
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.
(b) REPORTS ON FORM 8-K
None.
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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.
By: /s/ SUSAN L. FIELD
------------------------------------
Susan L. Field
Executive Vice President, Chief
Financial Officer and Chief
Accounting Officer
26
