<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[MARK ONE]
[X] Quarterly report under Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended June 30,
2000.
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from
__________ to __________.
Commission File No. 333-35402
CORIO, INC.
(Exact name of the Registrant as specified in its charter)
<TABLE>
<S> <C>
Delaware 77-0492528
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization
959 Skyway Road, Suite 100
San Carlos, California 94070
(Address of principal executive offices) (Zip Code)
</TABLE>
650-232-3000
(The 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 [ ] NO [X]
As of August 10, 2000, there were 48,485,419 shares of the Registrant's common
stock outstanding.
1
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CORIO, INC.
QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2000
INDEX
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. Condensed Financial Statements (Unaudited):
Condensed Balance Sheets
June 30, 2000 and December 31, 1999....................... 3
Condensed Statements of Operations
Three Months Ended June 30, 2000 and 1999 and the
Six Months Ended June 30, 2000 and 1999................... 4
Condensed Statements of Cash Flows
Six Months Ended June 30, 2000 and 1999................... 5
Notes to Condensed Financial Statements...................... 6
ITEM 2. Management's Discussion And Analysis Of
Financial Condition And Results Of Operations............. 9
ITEM 3. Quantitative And Qualitative Disclosures About
Market Risk............................................... 23
PART II OTHER INFORMATION
ITEM 1. Legal Proceedings............................................ 24
ITEM 2. Change in Securities and Use of Proceeds..................... 24
ITEM 3. Defaults Upon Senior Securities.............................. 24
ITEM 4. Submission of Matters to a Vote of Security
Holders................................................... 24
ITEM 5. Other Information............................................ 24
ITEM 6. Exhibits..................................................... 24
Signatures................................................... 25
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED FINANCIAL STATEMENTS
CORIO, INC.
CONDENSED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999(1)
-------------- --------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ....................................... $ 46,327 $ 37,177
Accounts receivable, net of allowance of $765 and $233 at June
30, 2000 and December 31, 1999, respectively .................. 8,150 2,941
Prepaid expenses and other current assets ....................... 2,939 2,107
--------- ---------
Total current assets .......................................... 57,416 42,225
Property and equipment, net ....................................... 26,700 14,380
Intangibles, net .................................................. 2,475 3,647
Other assets ...................................................... 4,202 1,344
--------- ---------
Total assets .................................................. $ 90,793 61,596
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................................ $ 16,429 $ 5,017
Accrued liabilities ............................................. 12,894 8,163
Deferred revenue ................................................ 3,176 1,888
Current portion of debt obligations ............................. 5,680 2,709
--------- ---------
Total current liabilities ..................................... 38,179 17,777
Long-term debt, less current portion .............................. 6,455 7,335
--------- ---------
Total liabilities ............................................. 44,634 25,112
Commitments
Senior series E mandatorily redeemable preferred stock ............ 54,460 -
Stockholders' equity (deficit):
Preferred stock: $0.001 par value; 44,127,000 shares authorized;
29,964,795 shares issued and outstanding at June 30, 2000 and
December 31, 1999 (liquidation value: $73,210)................. 30 30
Common stock: $0.001 par value; 138,000,000 shares authorized;
2,980,525 and 1,574,584 shares issued and outstanding at
June 30, 2000 and December 31, 1999, respectively ............. 3 2
Additional paid-in capital ...................................... 151,626 99,649
Note receivable from stockholder ................................ - (15)
Deferred stock-based compensation ............................... (54,102) (14,981)
Accumulated deficit ............................................. (105,858) (48,201)
--------- ---------
Total stockholders' equity (deficit) .............................. (8,301) 36,484
--------- ---------
Total liabilities and stockholders' equity ..................... $ 90,793 $ 61,596
========= =========
</TABLE>
(1) Derived from audited financial statements.
See accompanying notes to condensed financial statements.
3
<PAGE> 4
CORIO, INC.
CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- ---------------------------
2000 1999 2000 1999
--------- --------- -------- ------------
<S> <C> <C> <C> <C>
REVENUES:
Application management services .... $ 2,780 $ 50 $ 3,917 $ 85
Professional services and other .... 7,613 1,104 11,756 1,930
-------- -------- -------- --------
Total revenues ................... 10,393 1,154 15,673 2,015
COSTS AND EXPENSES:
Application management services .... 8,192 1,152 14,093 2,020
Professional services and other .... 7,211 1,014 12,682 1,942
Research and development ........... 3,037 429 5,270 696
Sales and marketing ................ 10,817 1,251 20,410 1,851
General and administrative ......... 6,033 2,158 10,783 3,941
Amortization of stock based
compensation ............ ........ 3,977 624 9,234 768
Amortization of intangible assets .. 531 547 1,172 1,094
-------- -------- -------- --------
Total operating expenses ......... 39,798 7,175 73,644 12,312
-------- -------- -------- --------
Loss from operations ................. (29,405) (6,021) (57,971) (10,297)
Interest and other income ............ 633 110 1,000 178
Interest and other expense ........... (366) (243) (686) (408)
-------- -------- -------- --------
Net loss ............................. $(29,138) $ (6,154) $(57,657) $(10,527)
======== ======== ======== ========
Basic and diluted net loss per share . $ (14.52) $ (5.31) $ (31.08) $ (9.77)
======== ======== ======== ========
Shares used in computation - basic and
diluted ............................ 2,007 1,160 1,855 1,078
======== ======== ======== ========
Pro forma net loss and net loss per
share (unaudited):
Net loss as reported ............. $(29,138) $(57,657)
Series E beneficial conversion
charge ......................... (20,158) (20,158)
-------- --------
Pro forma net loss attributable to
common stockholders ............ $(49,296) $(77,815)
======== ========
Basic and diluted net loss per
share .......................... $ (1.36) $ (2.28)
======== ========
Pro forma shares used in
computation .................... 36,191 34,082
======== ========
</TABLE>
See accompanying notes to condensed financial statements.
4
<PAGE> 5
CORIO, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
----------------------------
2000 1999
------------ -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ....................................................... $(57,657) $(10,527)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization ................................ 3,776 2,025
Amortization of intangibles .................................. 1,172 1,094
Amortization of deferred stock-based compensation ............ 9,234 768
Compensation for grants of stock, options and warrants in
exchange for services ...................................... 2,648 532
Changes in assets and liabilities:
Accounts receivable ........................................ (5,209) (139)
Prepaid expenses and other current assets .................. (573) 139
Accounts payable ........................................... 11,412 (654)
Accrued liabilities ........................................ 4,731 5,089
Deferred revenue ........................................... 1,288 (39)
Other liabilities .......................................... 241 -
-------- --------
Net cash used in operating activities .................... (28,937) (1,712)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ............................. (13,154) (9,969)
Other assets ................................................... (3,117) 154
-------- --------
Net cash used in investing activities .................... (16,271) (9,815)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of preferred stock, net ................. 54,460 20,979
Proceeds from sale of common stock and exercise of stock
options ...................................................... 975 16
Proceeds from note receivable from stockholder ................. 15 -
Payments on debt obligations ................................... (1,092) (61)
Borrowings on notes payable .................................... - 3,000
-------- --------
Net cash provided by financing activities ................ 54,358 23,934
-------- --------
Net increase in cash and cash equivalents ........................ 9,150 12,407
Cash and cash equivalents, beginning of period ................... 37,177 1,019
-------- --------
Cash and cash equivalents, end of period ......................... $ 46,327 $ 13,426
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest ......................................... $ 488 $ 175
======== ========
SUPPLEMENTAL NON-CASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of property and equipment under capital leases ..... $ 2,942 $ 1,607
======== ========
Issuance of preferred stock and common stock warrants .......... $ 36,928 $ 477
======== ========
Issuance of preferred stock in exchange for notes payable -
related party ................................................ $ - $ 254
======== ========
Deferred stock-based compensation .............................. $ 13,910 $ 4,641
======== ========
</TABLE>
See accompanying notes to condensed financial statements.
5
<PAGE> 6
CORIO, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements have been prepared
by Corio, Inc. ("Corio" or the "Company") and reflect all adjustments which are,
in the opinion of management, necessary for a fair presentation of the interim
periods presented. Such adjustments are of a normal recurring nature. The
results of operations for the interim periods presented are not necessarily
indicative of the results for any future interim period or for the entire fiscal
year. Certain information and footnote disclosures normally included in annual
financial statements prepared in accordance with generally accepted accounting
principles have been omitted, although the Company believes that the disclosures
included are adequate to make the information presented not misleading. The
unaudited condensed financial statements and notes included herein should be
read in conjunction with the audited financial statements and notes for the
fiscal year ended December 31, 1999.
NET LOSS PER SHARE
Basic net loss per share is computed by dividing the net loss for the period
by the weighted average number of shares of common stock outstanding during the
period (excluding shares subject to repurchase). Diluted net loss per share is
computed by dividing the net loss for the period by the weighted average number
of shares of common stock and potentially dilutive common securities outstanding
during the period. Potentially dilutive common shares are excluded from the
computation in loss periods as their effect would be antidilutive.
The following table sets forth potential shares of common stock that are not
included in the diluted net loss per share calculation as their effect would
have been antidilutive for the periods indicated (in thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
--------------------------
2000 1999
---------- ---------
<S> <C> <C>
Preferred stock 35,298 22,767
Preferred stock warrants 1,054 681
Common stock subject to repurchase 798 112
Common stock options and warrants 14,567 4,278
</TABLE>
PRO FORMA NET LOSS PER SHARE
Pro forma net loss per share for the three and six month periods ended June
30, 2000 is computed using the weighted-average number of shares of common stock
outstanding, including the pro forma effect of the automatic conversion of our
preferred stock into shares of our common stock. The weighted average number of
shares of common stock outstanding is determined as if the preferred stock was
converted on January 1, 2000, except for the senior series E mandatorily
redeemable preferred stock sold on April 20, 2000, which is assumed to have
converted on March 31, 2000. Pro forma common equivalents, consisting of
incremental common stock issuance upon the exercise of stock options and
warrants, as well as shares subject to repurchase agreements, are not included
in pro forma diluted net loss per share because they would be antidilutive.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 established new standards of
accounting and reporting for derivative instruments and hedging activities. In
July 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments
and
6
<PAGE> 7
Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133."
SFAS No. 137 deferred the effective date of SFAS No. 133 until fiscal years
beginning after June 15, 2000. The Company will adopt SFAS No. 133 during its
year ending December 31, 2001. To date, the Company has not engaged in any
derivative or hedging activities.
In December 1999, the Securities and Exchange Commission, or SEC, issued
Staff Accounting Bulletin, or SAB, No. 101. SAB No. 101 summarized certain of
the SEC Staff's views in applying generally accepted accounting principles to
revenue recognition in financial statements. SAB No. 101, and any resulting
change in accounting principles that a registrant would have to report, is
effective no later than our fourth fiscal quarter in 2000. We do not expect the
application of SAB No. 101 to have a material effect on our financial position
or results of operations.
NOTE 2 - ACCOUNTS RECEIVABLE
The Company records accounts receivable when amounts are billed in
accordance with the contract terms or as services are performed under
non-cancelable contractual services arrangements. Included in accounts
receivable at June 30, 2000 and December 31, 1999 were $732,000 and $401,000,
respectively, of unbilled receivables under various professional services
contracts.
NOTE 3 - DEBT
In April 2000, the Company entered into an equipment lease line of credit
agreement to purchase up to an aggregate of $5.0 million. In connection with the
agreement, the Company issued the lender a warrant to purchase up to $100,000 of
the Company's common stock at 90% of the price per share offered in the
Company's initial public offering of its common stock.
NOTE 4 - STOCKHOLDERS' EQUITY
In April 2000, the Company amended its certificate of incorporation to
provide for total authorized capital of 138,000,000 shares of common stock and
44,127,000 shares of preferred stock.
PREFERRED STOCK
In April 2000, the Company issued 5,450,000 shares of senior series E
mandatorily redeemable preferred stock at $10.00 per share, for aggregate gross
proceeds of approximately $54.5 million. The senior series E mandatorily
redeemable preferred stock converted into 5,332,681 shares of common stock upon
the completion of the Company's initial public offering in July 2000 (Note 6).
The Company will record a $20.2 million charge for the beneficial conversion
feature inherent in this transaction, which will increase net loss to derive net
loss attributable to common stockholders. Such adjustment will be recorded in
the third quarter of fiscal year 2000.
WARRANTS
In April 2000, the Company agreed to issue to Ernst & Young L.L.P. ("EY"),
on behalf of its consulting division, EY Consulting, four warrants to purchase
an aggregate of up to 7,000,000 shares of the Company's common stock at an
exercise price of $6.50 per share under the terms of a strategic alliance
arrangement. In May 2000, EY completed a sale of substantially all of the
business of E&Y Consulting to Cap Gemini, S.A. Upon the completion of this sale,
E&Y Consulting assigned to Cap Gemini, S.A. all of its rights and obligations
pursuant to its strategic alliance with the Company, including the right to
execute the warrants the Company issued to EY on behalf of E&Y Consulting. The
consulting business previously conducted by E&Y Consulting is now being carried
on by Cap Gemini Ernst & Young U.S., L.L.C. ("CGEY"). CGEY may exercise the
first of these warrants to acquire 4,666,666 shares of common stock during the
90 day period following the Company's July 20, 2000 IPO. The second, third and
fourth warrants become exercisable based upon the achievement of target volume
revenues resulting from referrals of CGEY in each of the Company's 2000, 2001
and 2002 fiscal years. The second, third and fourth warrants may be exercised to
acquire up to 933,333, 933,333 and 466,667 shares of common stock, respectively.
The warrants are subject to cancellation or repurchase in whole or part under
certain circumstances, such as if CGEY breaches a material provision of the
agreement. The agreement itself may be terminated prior to the end of the
seven-year term by consent of the parties or unilaterally by a party in the
event the other party defaults in the performance of a material provision of the
agreement subject to a cure period.
At June 30, 2000, the initial 4,666,667 warrant was issued and outstanding.
The fair value of this warrant was calculated using the Black-Scholes option
pricing model, using $12.00 as the fair value of the underlying common stock and
the following weighted-average assumptions: no dividends; contractual life of
1.5 years; risk-free interest rate of 7%; and expected volatility of 100%. The
fair value of the first warrant was $36.1 million at June 30, 2000. Amortization
expense of $1.5 million was recorded as a sales and marketing expense in the
quarter ended June 30, 2000.
7
<PAGE> 8
STOCK-BASED COMPENSATION
In connection with stock options granted to employees to purchase common
stock, the Company recorded deferred charges for stock-based compensation of
$13.4 million and $4.6 million for the six months ended June 30, 2000 and 1999,
respectively. Such amounts represent, for employee stock options, the difference
at the grant date between the exercise price of each stock option granted and
the fair value of the underlying common stock. The deferred charges for employee
options are being amortized to expenses using the graded vesting approach
through fiscal year 2005. Amortization of deferred stock-based compensation
expense was $9.2 million and $768,000 for the six months ended June 30, 2000 and
1999, respectively.
NOTE 5 - SIGNIFICANT CUSTOMER INFORMATION AND SEGMENT REPORTING INFORMATION
The Company's operations have been classified into two operating segments
(i) application management services and (ii) professional services. Corporate
expenses, including those for sales and marketing, general and administrative
and research and development, are not allocated to operating segments.
Disaggregated information is as follows (in thousands):
<TABLE>
<CAPTION>
APPLICATION
MANAGEMENT PROFESSIONAL
SERVICES SERVICES UNALLOCATED TOTAL
------------- ------------- ------------- ------------
<S> <C> <C> <C> <C>
FOR THE SIX MONTHS ENDED JUNE 30, 2000
Revenues $ 3,917 $ 11,756 $ -- $ 15,673
Depreciation and amortization $ 1,226 $ 108 $ 2,442 $ 3,776
Segment loss $ (10,175) $ (926) $ (46,556) $ (57,657)
FOR THE SIX MONTHS ENDED JUNE 30, 1999
Revenues $ 85 $ 1,930 $ - $ 2,015
Depreciation and amortization $ 465 $ 43 $ 1,517 $ 2,025
Segment loss $ (1,935) $ (12) $ (8,580) $ (10,527)
</TABLE>
The Company does not allocate all assets to its operating segments, nor does
it allocate interest revenue or interest expense. In addition, the Company has
no foreign operations.
For the six months ended June 30, 2000, one customer accounted for 10% of
total revenues. For the six month period ended June 30, 1999, one customer
accounted for 13% of total revenues.
No single customer accounted for more than 10% of total accounts receivable
at June 30, 2000. As of December 31, 1999, one customer represented 35% of total
accounts receivable.
NOTE 6 - SUBSEQUENT EVENTS
INITIAL PUBLIC OFFERING
In July 2000, the Company completed its initial public offering of 10
million shares of its common stock, for net proceeds to the Company of
approximately $129 million, excluding any exercise of the underwriter
overallotment option (the "IPO"). Upon the completion of the IPO, all
outstanding shares of preferred stock of the Company converted into
approximately 35.3 million shares of common stock.
8
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following management's discussion and analysis of our financial
condition and results of operations should be read together with our condensed
financial statements and related notes included in this report, and with
Management's Discussion and Analysis of Financial Condition and Results of
Operations and related financial information contained in the Company's
Registration Statement on Form S-1/A (File No. 333-35402).
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION
27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT
OF 1934, INCLUDING, WITHOUT LIMITATION, STATEMENTS REGARDING THE COMPANY'S
EXPECTATIONS, BELIEFS, INTENTIONS OR FUTURE STRATEGIES THAT ARE SIGNIFIED BY THE
WORDS "EXPECTS", "ANTICIPATES", "INTENDS", "BELIEVES", OR SIMILAR LANGUAGE. ALL
FORWARD-LOOKING STATEMENTS INCLUDED IN THIS DOCUMENT ARE BASED ON INFORMATION
AVAILABLE TO THE COMPANY ON THE DATE HEREOF, AND THE COMPANY ASSUMES NO
OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS AFTER THE DATE HEREOF.
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED IN THE
FORWARD-LOOKING STATEMENTS AS A RESULT OF MANY FACTORS, INCLUDING BUT NOT
LIMITED TO THOSE SET FORTH UNDER "ADDITIONAL FACTORS THAT MAY AFFECT FUTURE
RESULTS" HEREIN. IN EVALUATING THE COMPANY'S BUSINESS, PROSPECTIVE INVESTORS
SHOULD CAREFULLY CONSIDER THE INFORMATION SET FORTH BELOW UNDER THE CAPTION
"ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS" IN ADDITION TO THE OTHER
INFORMATION SET FORTH HEREIN. THE COMPANY CAUTIONS INVESTORS THAT ITS BUSINESS
AND FINANCIAL PERFORMANCE ARE SUBJECT TO SUBSTANTIAL RISKS AND UNCERTAINTIES.
OVERVIEW
We are a leading enterprise application service provider, or ASP, based on
our number of customers and customer contracts. We provide to our customers
application implementation, integration, management and various upgrade services
and related hardware and network infrastructure. We implement, integrate and
manage the Corio Intelligent Enterprise, a suite of enterprise software
applications from leading vendors. Following the rapid implementation of
software applications, usually performed for a fixed fee, our customers pay a
predictable monthly service fee based largely on the number of applications used
and total users.
RECENT EVENTS
INITIAL PUBLIC OFFERING
In July 2000, the Company completed its initial public offering of 10
million shares of its common stock, for net proceeds to the Company of
approximately $129 million, excluding any exercise of the underwriter
overallotment option (the "IPO"). Upon the completion of the IPO, all
outstanding shares of preferred stock of the Company converted into
approximately 35.3 million shares of common stock.
RESULTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 30, 2000 AND 1999
REVENUES
Total revenues increased to $10.4 million for the three months ended June
30, 2000 from $1.2 million for the three months ended June 30, 1999. For the
three months ended June 30, 2000, one customer accounted for 11% of total
revenues. For the three months ended June 30, 1999, two customers accounted for
20% and 12% of total revenues. Total revenues increased to $15.7 million for the
six months ended June 30, 2000 from $2.0 million for the six months ended June
30, 1999. At June 30, 2000, the Company's total number of customers was
approximately 70, compared to six at June 30, 1999. For the six months ended
June 30, 2000, one customer accounted for 10% of total revenues. For the six
months ended June 30, 1999, one customer accounted for 13% of total revenues.
APPLICATION MANAGEMENT SERVICES REVENUES. Revenues from our application
management services were $2.8 million for the three months ended June 30, 2000
and $50,000 for the three months ended June 30, 1999. Revenues from our
application management services were $4.0 million for the six months ended June
30, 2000 and $85,000 for the six months ended June 30, 1999. At June 30, 2000,
the Company had approximately 120 application management contracts, compared
with 10 at June 30, 1999, and, during the same periods, increased the number of
application publishers from one to six. At June 30, 2000, the Company had a
balance of $1.4 million for deferred application management services revenues
primarily from a customer who prepaid a portion of its contract. These deferred
revenues will be recognized as the related services are provided over the life
of the contract.
PROFESSIONAL SERVICES AND OTHER REVENUES. Our professional services and
other revenues were $7.6 million for the three months ended June 30, 2000 and
$1.1 million for the three months ended June 30, 1999. Our professional services
and other revenues were $11.8 million for the six months ended June 30, 2000 and
$1.9 million for the six months ended June 30, 1999. The increase in
professional services revenues from 1999 to 2000 was primarily due to the
increased number of customers and customer contracts. At June 30, 2000, we had a
balance of $1.7 million for deferred professional services revenues resulting
from customer payments that we required in advance of commencing our
professional services work.
9
<PAGE> 10
COSTS AND EXPENSES
APPLICATION MANAGEMENT SERVICES EXPENSES. Application management services
expenses were $8.2 million for the three months ended June 30, 2000 and $1.2
million for the three months ended June 30, 1999. Application management
services expenses were $14.1 million for the six months ended June 30, 2000 and
$2.0 million for the six months ended June 30, 1999. The largest component of
the increase was the growth in personnel costs. Other significant components of
the increase included costs for third-party license and support fees, costs of
our data center and network providers, facilities expenses and depreciation and
lease costs for equipment.
PROFESSIONAL SERVICES AND OTHER EXPENSES. Professional services and other
expenses were $7.2 million for the three months ended June 30, 2000 and $1.0
million for the three months ended June 30, 1999. Professional services and
other expenses were $12.7 million for the six months ended June 30, 2000 and
$1.9 million for the six months ended June 30, 1999. The largest component of
the increase was attributable to the growth in personnel costs. Other
significant components of the increase included costs for subcontractors to
perform services under professional services engagements and for facilities
related expenses.
RESEARCH AND DEVELOPMENT. Research and development expenses were $3.0
million for the three months ended June 30, 2000 and $429,000 for the three
months ended June 30, 1999. Research and development expenses as a percentage of
total revenues were 29% for the three months ended June 30, 2000 and 37% for the
three months ended June 30, 1999. Research and development expenses were $5.3
million for the six months ended June 30, 2000 and $696,000 for the six months
ended June 30, 1999. Research and development expenses as a percentage of total
revenues were 34% for the six months ended June 30, 2000 and 35% for the six
months ended June 30, 1999. The largest component of the increase was
attributable to the growth in personnel costs and facilities expense.
SALES AND MARKETING EXPENSES. Sales and marketing expenses were $10.8
million for the three months ended June 30, 2000 and $1.3 million for the three
months ended June 30, 1999. Sales and marketing expenses as a percentage of
total revenues were 104% for the three months ended June 30, 2000 and 108% for
the three months ended June 30, 1999. Sales and marketing expenses were $20.4
million for the six months ended June 30, 2000 and $1.9 million for the six
months ended June 30, 1999. Sales and marketing expenses as a percentage of
total revenues were 130% for the six months ended June 30, 2000 and 92% for the
six months ended June 30, 1999. The largest component of the increase was the
growth in personnel costs. Other significant components of the increase included
spending on new customer lead generation activities, advertising and tradeshows,
and on market research and collateral items. Sales and marketing expenses also
include amortization of costs associated with warrants issued to a software
vendor and Cap Gemini Ernst & Young of $1.8 million and $2.3 million for the
three and six months ended June 30, 2000, respectively. There were no similar
amortization costs during the comparable periods in 1999.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $6.0 million for the three months ended June 30, 2000 and $2.2 million for
the three months ended June 30, 1999. General and administrative expenses as a
percentage of total revenues were 58% for the three months ended June 30, 2000
and 187% for the three months ended June 30, 1999. General and administrative
expenses were $10.8 million for the six months ended June 30, 2000 and $3.9
million for the six months ended June 30, 1999. General and administrative
expenses as a percentage of total revenues were 69% for the six months ended
June 30, 2000 and 196% for the six months ended June 30, 1999. The largest
component of the increase was attributable to the growth in personnel costs,
professional services and facility related costs.
AMORTIZATION OF STOCK-BASED COMPENSATION. Amortization of deferred
stock-based compensation was $4.0 million for the three months ended June 30,
2000 and $624,000 for the three months ended June 30, 1999. Amortization of
deferred stock-based compensation was $9.2 million for the six months ended June
30, 2000 and $768,000 for the six months ended June 30, 1999. The increase in
amortization resulted from amortization of deferred stock-based compensation
related to stock options granted through June 30, 2000. For the three months
ended June 30, 2000, we recorded deferred stock-based compensation of $4.2
million compared to $1.7 million for the three months ended June 30, 1999. For
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the six months ended June 30, 2000, we recorded deferred stock-based
compensation of $13.9 million compared to $4.6 million for the six months ended
June 30, 1999.
INTEREST AND OTHER INCOME AND EXPENSE. Net interest and other income was
$267,000 for the three months ended June 30, 2000 and net interest and other
expense was $(133,000) for the three months ended June 30, 1999. Net interest
and other income was $314,000 for the six months ended June 30, 2000 and net
interest and other expense was $(230,000) for the six months ended June 30,
1999. The increase in net interest income was due primarily to higher average
cash and investment balances at June 30, 2000.
INCOME TAXES. Since inception, we have incurred net losses for federal and
state tax purposes, and anticipate losses for the foreseeable future. We have
therefore not recognized any material tax provision or benefit of income taxes
for the three and six months ended June 30, 2000 and 1999.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2000, we had cash and cash equivalents of $46.3 million, an
increase of $9.2 million from December 31, 1999. The increase was primarily a
result of cash generated by financing activities, mainly from the $54.5 million
proceeds from our issuance of senior series E mandatorily redeemable preferred
stock offset primarily by cash used in operating activities.
Net cash used in operating activities was $28.9 million and $1.7 million for
the six months ended June 30, 2000 and 1999, respectively. For those periods,
net cash used in operating activities was primarily used to fund ongoing
operations including increases in accounts receivable offset by increases in
accounts payable and accrued liabilities.
Net cash used in investing activities was $16.3 million for the six months
ended June 30, 2000. Investing activities consisted primarily of purchases of
computer equipment of $7.2 million, furniture and fixtures of $3.0 million and
leasehold improvements of $1.6 million for the completion of our new
headquarters facility in San Carlos, California. In addition, we purchased
$470,000 in computer software and capitalized $475,000 in payroll and payroll
related costs for employees directly associated with computer software developed
for internal use. In addition, net cash used in investing activities consisted
of an increase in other assets of $3.1 million. Net cash used in investing
activities was $9.8 million for the six months ended June 30, 1999. Investing
activities consisted primarily of purchases of computer software and equipment
of $10.0 million. Cash used in investing activities was offset by a decrease in
other assets.
Net cash provided by financing activities was $54.5 million and $23.9
million for the six months ended June 30, 2000 and 1999, respectively. Financing
activities consisted primarily of the proceeds from the issuance of preferred
stock, loans and exercise of stock options offset by repayments of loans and
capital leases. In 2000, we raised $54.5 million in gross proceeds through the
private sale of our senior series E mandatorily redeemable preferred stock, and
in 1999, we raised $21.0 million in proceeds through the private sale of our
series B preferred stock.
In April 2000, we issued 5,450,000 shares of senior series E mandatorily
redeemable preferred stock at $10.00 per share, for aggregate gross proceeds of
$54.5 million. The senior series E mandatorily redeemable preferred stock
converted to 5,332,681 shares of common stock upon the completion of our initial
public offering ("IPO") in July 2000. We will record a $20.2 million charge for
the beneficial conversion feature inherent in this transaction which will
increase net loss to derive net loss attributable to common stockholders. Such
adjustment will be recorded in the third quarter of fiscal year 2000. Also in
April 2000, we entered into an equipment lease line of credit agreement to
purchase up to an aggregate of $5.0 million. In connection with the equipment
lease line agreement, we issued the lender a warrant to purchase up to $100,000
of our common stock at 90% of the price per share of the common stock offered in
our IPO.
We have executed a ten-year build-to-suit lease for a facility in San
Carlos, California that will require minimum payments of $2.2 million in 2000
and $3.5 million in 2001. Total minimum payments under the lease term are $37.9
million.
In July 2000, the Company completed its initial public offering of 10
million shares of its common stock for net proceeds to the Company of
approximately $129 million, excluding any exercise of the underwriter
overallotment option (the "IPO"). Upon the completion of the IPO, all
outstanding shares of preferred stock of the Company converted into
approximately 35.3 million shares of common stock.
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As we execute our strategy, we expect significant increases in our operating
expenses, especially in application management services, professional services,
sales and marketing and research and development. We expect that our current
cash balances and existing debt arrangements, together with the proceeds from
the IPO, will be sufficient to meet our cash requirements for the next 12
months. We expect that we will need or desire to raise additional funds in order
to support more rapid expansion, develop new or enhanced services or
technologies, respond to competitive pressures, acquire complementary businesses
or respond to unanticipated requirements. We cannot be sure that additional
funding, if needed, will be available on acceptable terms or at all. If adequate
funds are not available, we may be required to curtail significantly or defer
one or more of our operating goals or programs. If we succeed in raising
additional funds through the issuance of equity securities, the issuance could
result in substantial dilution to existing stockholders. If we raise additional
funds through the issuance of debt securities or preferred stock, these new
securities would have rights, preferences and privileges senior to those of the
holders of our common stock. The terms of these securities could also impose
restrictions on our operations.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
RISKS RELATED TO OUR BUSINESS
WE HAVE A HISTORY OF LOSSES AND, BECAUSE FOR THE FORESEEABLE FUTURE WE EXPECT TO
INCREASE OUR INVESTMENT IN OUR BUSINESS FASTER THAN WE ANTICIPATE GROWTH IN OUR
REVENUES, WE EXPECT THAT WE WILL CONTINUE TO INCUR SIGNIFICANT OPERATING LOSSES
AND NEGATIVE CASH FLOW AND MAY NEVER BE PROFITABLE.
We have spent significant funds to date to develop and refine our current
services, to create an operations organization, consisting of application
management and customer support services personnel, to build a professional
services organization and to develop our sales and marketing resources. We have
incurred significant operating and net losses and negative cash flow and have
not achieved profitability. As of June 30, 2000, we had an accumulated deficit
of $8.3 million.
We expect to continue to invest significantly in our operations organization
and in research and development to enhance current services and expand our
service offerings. We also plan to continue to grow our professional services
organization and sales force and to spend significant funds to promote our
company and our services. We expect to continue to hire additional people in all
other areas of our company in order to support our growing business. In
addition, we expect to continue to incur significant fixed and other costs
associated with customer acquisitions and with the implementation and
configuration of software applications for customers. As a result of all of
these factors, to achieve operating profitability, excluding non-cash charges,
we will need to increase our customer base, to decrease our overall costs of
providing services, including the costs of our licensed technology and the costs
of customer acquisition, and to increase our number of users and revenues per
customer. We cannot assure you that we will be able to increase our revenues or
increase our operating efficiencies in this manner. Moreover, because we expect
to continue to increase our investment in our business faster than we anticipate
growth in our revenues, we expect that we will continue to incur significant
operating losses and negative cash flow for the foreseeable future and we may
never be profitable.
WE EXPECT TO INCUR SUBSTANTIAL ACCOUNTING CHARGES AS A RESULT OF WARRANTS HELD
BY CAP GEMINI ERNST & YOUNG WHICH WILL LIKELY RESULT IN SIGNIFICANT OPERATING
LOSSES OVER THE NEXT SEVERAL YEARS.
Even if we are able to generate revenues that exceed our operating costs, we
expect to incur substantial accounting charges over the next seven years
associated with warrants held by Cap Gemini Ernst & Young U.S. LLC, or CGEY.
Under the terms of a strategic alliance agreement with CGEY, CGEY holds four
warrants to purchase up to approximately 4.7 million shares of our common stock
at an exercise price of $6.50 per share upon consummation of this offering and
up to 2.3 million shares based on specific performance metrics achieved by CGEY
over the next three years. These warrants and other expenses related to our
strategic alliance with CGEY are likely to result in substantial expenses and
operating losses for us over the term of our agreement with them. Because of the
accounting policies applicable to these warrants, the charges associated with
these warrants are being measured and recorded each fiscal quarter in part using
the trading price of our common stock. Significant increases in our stock price
could result in non-cash accounting charges amounting to hundreds of millions of
dollars.
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OUR LIMITED HISTORY OF OFFERING ASP SERVICES TO CUSTOMERS AND THE FACT THAT WE
OPERATE IN A NEW INDUSTRY FOR APPLICATION SERVICES EXPOSE US TO RISKS THAT
AFFECT OUR ABILITY TO EXECUTE OUR BUSINESS MODEL.
We have offered our services for a relatively short period of time, and our
industry is new. Prior to September 1998, our predecessor company, DSCI, carried
on a different business. Accordingly, we have a limited operating history as a
provider of ASP services. We have a limited number of customers, have
implemented our services a limited number of times and only a portion of our
customers are operating on our system. Because our business model is new, it
continues to evolve. In the future, we may revise our pricing model for
different services, and our cost model for our license of third-party software
applications and other third-party services may also evolve. Changes in our
anticipated business and financial model could materially impact our ability to
become profitable in the future. An investor in our common stock must consider
these facts as well as the risks, uncertainties, expenses and difficulties
frequently encountered by companies in their early stages of development,
particularly companies in new and rapidly evolving markets such as the market
for Internet-based software application services. Some of the risks and
difficulties relate to our potential inability to:
- acquire new customers;
- reduce costs associated with the delivery of services to our customers;
- expand and maintain our pipeline of sales prospects in order to promote
greater predictability in our period-to-period sales levels;
- acquire or license third-party software applications at a reasonable cost
or at a cost structure beneficial to us;
- complete successful implementations of our software applications in a
manner that is repeatable and scalable;
- integrate successfully software applications we manage with each other and
with our customers' existing systems;
- continue to offer new services that complement our existing offerings;
- increase awareness of our brand; and
- maintain our current, and develop new, strategic relationships.
We cannot assure you that we will successfully address these risks or
difficulties. If we fail to address any of these risks or difficulties
adequately, we will likely be unable to execute our business model.
BECAUSE WE PLAN TO EXPEND SIGNIFICANT SUMS TO GROW OUR BUSINESS, WE MAY BE
UNABLE TO ADJUST SPENDING TO OFFSET ANY FUTURE REVENUE SHORTFALL, WHICH COULD
CAUSE OUR QUARTERLY OPERATING RESULTS TO FLUCTUATE AND OUR STOCK PRICE TO FALL.
In order to promote future growth, we expect to continue to expend
significant sums in all areas of our business, particularly in our operations,
professional services, research and development and sales and marketing
organizations. Because the expenses associated with these activities are
relatively fixed in the short-term, we may be unable to adjust spending quickly
enough to offset any unexpected shortfall in revenue growth or any decrease in
revenue levels. As our quarterly results fluctuate, they may fall short of the
expectations of public market analysts or investors. If this occurs, the price
of our common stock may fall.
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE DUE TO THE NATURE OF OUR ASP
BUSINESS AND OTHER FACTORS AFFECTING OUR REVENUES AND COSTS, WHICH COULD CAUSE
OUR STOCK PRICE TO FALL.
Our financial results will also vary over time as our ASP business matures.
For each individual customer, in the early months of our engagement we typically
recognize professional services revenues associated with implementation of our
applications. We then recognize monthly fees from the customer, consisting of
application management services revenues, over the balance of the contractual
relationship. As a result, for each customer we have a high proportion of up
front professional services revenues associated with implementation. Since we
have only offered ASP services since September 1998 and our customer base has
grown rapidly, professional services revenues associated with implementation
have been relatively high compared to monthly fees. We expect that our
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financial results will continue to vary over time as monthly fees increase as a
proportion of total revenue. Changes in our revenue mix from professional
services revenues to application management services revenues could be difficult
to predict and could cause our quarterly results and stock price to fluctuate.
Other important factors that could cause our quarterly results and stock
price to fluctuate materially include:
- the timing of obtaining, implementing and establishing connectivity with
individual customers;
- the loss of or change in our relationship with important customers;
- the timing and magnitude of expanding our operations and of other capital
expenditures;
- costs, including license fees, relating to the software applications we
use;
- changes in our pricing policies or those of our competitors;
- potential changes in the accounting standards associated with accounting
for stock or warrant issuances and for revenue recognition; and
- accounting charges associated with the warrants held by CGEY and a
software vendor, as well as potential accounting charges we may incur in
the future relating to stock or warrant issuances to future strategic
partners.
OUR FINANCIAL RESULTS COULD VARY OVER TIME AS OUR BUSINESS MODEL EVOLVES, WHICH
COULD CAUSE OUR STOCK PRICE TO FALL.
Our financial results could vary over time as our business and financial
model evolves. For example, we have historically included a broad range of
customer support in our fixed monthly fees, but may decide to bill customers for
support services in excess of specified limits. As another example, we may
determine to unbundle from our fixed monthly fee the cost of software licenses
and to require our customers to obtain licenses to applications directly from
third-party software providers. Any such changes to our business or financial
model would likely cause financial results to vary, which could cause our stock
price to fall.
In this regard, we are currently negotiating with two of our major
third-party software vendors to modify the pricing and other terms currently in
place with these vendors. We may agree to restructure our current pricing
arrangements with some of our third-party software providers to, for example,
pay more to the provider up-front in return for a pricing structure that we
believe is more beneficial to us overall. Any such new pricing structures may
not in fact be more beneficial to us and may ultimately hinder our ability to
become profitable.
WE DEPEND ON SOFTWARE VENDORS TO SUPPLY US WITH THE SOFTWARE NECESSARY TO
PROVIDE OUR SERVICES, AND THE LOSS OF ACCESS TO THIS SOFTWARE OR ANY DECLINE OR
OBSOLESCENCE IN ITS FUNCTIONALITY COULD CAUSE OUR CUSTOMERS' BUSINESSES TO
SUFFER, WHICH, IN TURN, COULD HARM OUR REVENUES AND INCREASE OUR COSTS.
We offer our customers software applications from third parties, such as
BroadVision, Commerce One, PeopleSoft, SAP and Siebel Systems, that we in turn
incorporate into the services we provide to customers. Our agreements with
third-party software vendors are non-exclusive, are for limited terms ranging
from two to five years and typically permit termination in the event of our
breach of the agreements. If we lose the right to use the software that we
license from third-parties, if the cost of licensing the software applications
becomes prohibitive, or if we change the vendors from whom we currently license
software, our customers' businesses could be significantly disrupted, which
could harm our revenues and increase our costs. Our financial results may also
be harmed if the cost structure we negotiate with the third-party software
vendors changes in a manner that is less beneficial to us compared to our
current cost structure with software vendors. We cannot assure you that our
services will continue to support the software of our third-party vendors, or
that we will be able to adapt our own offerings to changes in third-party
software. In addition, if our vendors were to experience financial or other
difficulties, it could adversely affect the availability of their software. It
is also possible that improvements in software by third-parties with whom we
have no relationship could render the software we offer to our customers less
compelling or obsolete.
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OUR LICENSES FOR THE THIRD-PARTY SOFTWARE WE USE TO DELIVER OUR SERVICES CONTAIN
LIMITS ON OUR ABILITY TO USE THEM THAT COULD IMPAIR OUR GROWTH AND OPERATING
RESULTS.
The licenses we have for the third-party software we use to deliver our
services typically restrict our ability to sell our services in specified
countries and to customers with revenue above or below specified revenue levels.
For example, some of our licenses restrict us from selling our services to
customers with annual revenues greater than various levels between $250 million
and $1 billion, and several of our licenses restrict our ability to sell to
customers outside of North America. In addition, some of these licenses contain
limits on our ability to sell our services to certain types of customers. For
example, our contract with BroadVision restricts our ability to sell our
BroadVision offerings to specified banking institutions. Our operating results
and ability to grow could be harmed to the extent these licenses prohibit us
from selling our services to customers to which we would otherwise sell our
services, or in countries in which we would otherwise sell our services.
POOR PERFORMANCE OF THE SOFTWARE WE DELIVER TO OUR CUSTOMERS OR DISRUPTIONS IN
OUR BUSINESS-CRITICAL SERVICES COULD HARM OUR REPUTATION, DELAY MARKET
ACCEPTANCE OF OUR SERVICES AND SUBJECT US TO LIABILITIES.
Our customers depend on our hosted software applications for their critical
systems and business functions, including enterprise resource planning, customer
relationship management, e-commerce and business intelligence. Our customers'
businesses could be seriously harmed if the applications we provide to them work
improperly or fail, even if only temporarily. Accordingly, if the software that
we license from our vendors or our implementation of such software performs
poorly, experiences errors or defects or is otherwise unreliable, our customers
would likely be extremely dissatisfied, which could cause our reputation to
suffer, force us to divert research and development and management resources,
cause a loss of revenues or hinder market acceptance of our services. It is also
possible that any customer disruptions resulting from failures in our
applications could force us to refund all or a portion of the fees customers
have paid for our services or result in other significant liabilities to our
customers.
WE MAY FAIL TO IMPLEMENT, HOST OR MANAGE ENTERPRISE SOFTWARE APPLICATIONS
SUCCESSFULLY DUE TO THE COMPLICATED NATURE OF THE SERVICES WE PROVIDE AND OUR
LIMITED EXPERIENCE IN PROVIDING THESE SERVICES, WHICH WOULD HARM OUR REPUTATION
AND SALES.
Implementations of integrated enterprise software applications can be
complicated and we have limited experience to date completing implementations
of integrated software applications for our customers. We cannot assure you that
we will develop the requisite expertise or that we can convince customers that
we have the expertise required to implement, host or manage these applications.
In addition, because PeopleSoft software applications were our first application
offerings, our customers to date have primarily implemented our PeopleSoft
application offerings. We have limited experience installing many of the
applications we offer, particularly some of the applications we have recently
begun to offer. Our reputation will be harmed and sales of our services would
decline significantly if we are not able to complete successfully repeated
implementations of our enterprise software applications, including those
applications with which we have limited or no implementation, hosting or
management experience to date.
WE HAVE ONLY IMPLEMENTED OUR ORION TECHNOLOGY PLATFORM FOR A SMALL NUMBER OF
CUSTOMERS, AND IT MAY NOT ACHIEVE MARKET ACCEPTANCE, PROVIDE THE PERFORMANCE WE
ANTICIPATE OR GENERATE SIGNIFICANT REVENUE FOR US.
We have only implemented Orion, our technology platform, for a small number
of customers and it may not be an effective means to integrate applications. In
addition, we are investing resources to continue to develop and improve this
platform. We cannot assure you that our Orion platform will achieve market
acceptance or will work in the manner we expect or that we will be able to
achieve a return on our investment.
IF OUR STRATEGIC ALLIANCE WITH CAP GEMINI ERNST & YOUNG DOES NOT GENERATE THE
BENEFITS WE EXPECT, WE MAY NOT BE ABLE TO GROW OUR BUSINESS AS EFFECTIVELY AS WE
ANTICIPATE AND MAY HAVE DIFFICULTY PROVIDING SYSTEMS INTEGRATION SERVICES TO OUR
CUSTOMERS.
Our agreement with Cap Gemini Ernst & Young U.S. LLC, or CGEY, provides for
exclusive client referrals from CGEY for emerging high-growth and middle-market
clients in the Americas. These limitations on exclusivity may limit our ability
to benefit from the marketing alliance. This strategic alliance will not be
considered a success if it does not generate a large number of customers for us
and does not grow our business. Moreover, this alliance may adversely affect our
ability to generate new customers through relationships with other systems
integration and consulting firms. Finally, it is possible that we may become
dependent on CGEY for implementation of our services and, if our relationship
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with CGEY terminates, we may not be able to find systems integrators to replace
the services CGEY is expected to provide us.
OUR RELATIONSHIP WITH CGEY MAY CHANGE IN A MANNER ADVERSE TO OUR BUSINESS
THROUGH CIRCUMSTANCES BEYOND OUR CONTROL.
In April 2000, we entered into a strategic alliance with Ernst & Young on
behalf of its consulting division, E&Y Consulting. In May 2000, Ernst & Young
completed a sale of substantially all of E&Y Consulting to Cap Gemini. At the
time of completion of this sale, E&Y Consulting assigned to Cap Gemini all of
its rights and obligations pursuant to its strategic alliance with us. We cannot
assure you that CGEY, the combined company, will consider the relationship with
us as strategic as E&Y Consulting did, or that the incentives we negotiated with
E&Y Consulting will be appropriate for CGEY. Accordingly, it is possible that
CGEY will fail to devote substantial resources towards generating referrals to
us and engaging in joint marketing and sales activities. If CGEY fails to do so,
we may be forced to terminate our agreement and cancel some of the warrants held
by CGEY. Under these scenarios, we would again fail to realize the benefits we
expect from this alliance. Additionally, as the personal relationships between
the professional staff at E&Y Consulting and the auditing group of Ernst & Young
LLP change over time as a result of E&Y Consulting's acquisition by Cap Gemini,
we may lose some benefit from referrals from Ernst & Young LLP. As a result of
all of the foregoing, E&Y Consulting's acquisition by Cap Gemini could result in
our relationship with CGEY providing fewer benefits to us that we initially
anticipated, and the benefits as a whole may not be substantial.
ANY INABILITY TO EXPAND SUFFICIENTLY OUR ENTERPRISE SOFTWARE IMPLEMENTATION AND
SYSTEMS CONSULTING CAPABILITIES COULD HARM OUR ABILITY TO SERVICE OUR CUSTOMERS
EFFECTIVELY AND COULD HINDER OUR GROWTH.
A failure to maintain and expand relationships with third-party systems
integrators that we use to implement our services could harm our ability to
service our customers effectively. Because of our relationship with CGEY, we may
have difficulty retaining the services of other systems integrators, which we
may need if our alliance with CGEY terminates or if CGEY performs services in a
manner below our customers' expectations. In addition, if sales increase rapidly
or if we were to agree to undertake client relationships requiring particularly
large or complex implementations, our internal professional services personnel
may be unable to meet the demand for implementation services. In that case, if
we are unable to retain or hire highly-trained third-party systems integrators
and consultants to implement our services, we would be unable to meet customer
demands for our implementation and consulting services, which could hinder our
ability to grow our business. In addition, we typically contract with our
customers for implementation on a fixed price basis. As a result, unexpected
complexities in implementing software applications for our customers could
result in unexpected losses for us or increases in losses. Our business and
reputation could also be seriously harmed if third party systems integrators
were unable to perform their services for our customers in a manner that meets
customer expectations.
INCREASED DEMAND FOR CUSTOMIZATION OF OUR SERVICES BEYOND WHAT WE CURRENTLY
PROVIDE OR ANTICIPATE COULD REDUCE THE SCALABILITY AND PROFITABILITY OF OUR
BUSINESS.
Companies may prefer more customized applications and services than our
business model contemplates. Most of our customers have required some level of
customization of our services, and our customers may continue to require
customization in the future, perhaps to a greater extent than we currently
provide or anticipate. If we do not offer the desired customization, there may
be less demand for our services. Conversely, providing customization of our
services increases our costs and reduces our flexibility to provide similar
services to many customers. Accordingly, increased demand for customization of
our services could reduce the scalability and profitability of our business and
increase risks associated with completing software upgrades.
CONTINUED RAPID GROWTH WOULD STRAIN OUR OPERATIONS AND WOULD REQUIRE US TO INCUR
COSTS TO UPGRADE OUR INFRASTRUCTURE AND EXPAND OUR PERSONNEL.
We have rapidly expanded our operations since our current business started in
September 1998. The number of our employees increased from 58 at December 31,
1998, to 108 at June 30, 1999, to 279 at December 31, 1999 and to 542 at June
30, 2000. We expect our business to continue to grow in terms of headcount,
geographic scope, number of customers and the number of services we offer. We
cannot be sure that we will successfully manage our growth. In order to manage
our growth successfully, we must:
- improve our management, financial and information systems and controls;
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- maintain a high level of customer service and support;
- expand our implementation and consulting resources internally and with
third-parties; and
- expand, train, manage and integrate our employee base effectively.
There will be additional demands on our customer service support, research
and development, sales and marketing and administrative resources as we try to
increase our service offerings and expand our target markets. The strains
imposed by these demands are magnified by our limited operating history. Any
delay in the implementation of, or disruption in the transition to, new or
enhanced systems and controls could harm our ability to accurately forecast
demand for our services, manage our sales cycle and implementation services and
record and report management and financial information on a timely and accurate
basis. Moreover, any inability to expand our service offerings and employee base
commensurate with the demand for our services could cause our revenues to
decline.
WE WILL NEED TO PERFORM SOFTWARE UPGRADES FOR OUR CUSTOMERS, AND ANY INABILITY
TO SUCCESSFULLY PERFORM THESE UPGRADES COULD CAUSE INTERRUPTIONS OR ERRORS IN
OUR CUSTOMERS' SOFTWARE APPLICATIONS, WHICH COULD INCREASE OUR COSTS AND DELAY
MARKET ACCEPTANCE OF OUR SERVICES.
Our software vendors from time to time will upgrade their software
applications, and at such time we will be required to implement these software
upgrades for our customers. For example, PeopleSoft, from whom we license a
substantial amount of software applications, has scheduled a new release of its
software in September 2000. Implementing software upgrades can be a complicated
and costly process, particularly implementation of an upgrade simultaneously
across multiple customers, and we have not performed a software upgrade to date.
Accordingly, we cannot assure you that we will be able to perform these upgrades
successfully or at a reasonable cost. We may also experience difficulty
implementing software upgrades to a large number of customers, particularly if
different software vendors release upgrades simultaneously. If we are unable to
perform software upgrades successfully and to a large customer base, our
customers could be subject to increased risk of interruptions or errors in their
business-critical software, our reputation and business would likely suffer and
the market would likely delay the acceptance of our services. It will also be
difficult for us to predict the timing of these upgrades, the cost to us of
these upgrades and the additional resources that we may need to implement these
upgrades. Additionally, if we evolve our business model to charge customers for
the cost of software upgrades, we may lose prospective customers who choose not
to pay for these upgrades. Therefore, any such upgrades could strain our
development and engineering resources, require significant unexpected expenses
and cause us to miss our financial forecasts or those of securities analysts.
Any of these problems could impair our customer relations and our reputation and
subject us to litigation.
SECURITY RISKS AND CONCERNS MAY DECREASE THE DEMAND FOR OUR SERVICES, AND
SECURITY BREACHES WITH RESPECT TO OUR SYSTEMS MAY DISRUPT OUR SERVICES OR MAKE
THEM INACCESSIBLE TO OUR CUSTOMERS.
Our services involve the storage and transmission of business-critical,
proprietary information, and security breaches could expose us to a risk of loss
of this information, litigation and possible liability. Anyone who circumvents
our security measures could misappropriate business-critical proprietary
information or cause interruptions in our services or operations. In addition,
computer "hackers" could introduce computer viruses into our systems or those of
our customers, which could disrupt our services or make them inaccessible to
customers. We may be required to expend significant capital and other resources
to protect against the threat of security breaches or to alleviate problems
caused by breaches. Our security measures may be inadequate to prevent security
breaches, and our business and reputation would be harmed if we do not prevent
them.
IF WE ARE UNABLE TO ADAPT OUR SERVICES TO RAPIDLY CHANGING TECHNOLOGY, OUR
REPUTATION AND OUR ABILITY TO GROW OUR REVENUES COULD BE HARMED.
The markets we serve are characterized by rapidly changing technology,
evolving industry standards, emerging competition and the frequent introduction
of new services, software and other products. We cannot assure you that we will
be able to enhance existing or develop new services that meet changing customer
needs in a timely and cost-effective manner. For example, as software
application architecture changes, the software for which we have licenses could
become out of date or obsolete and we may be forced to upgrade or replace our
technology. For example, this is of particular concern with regard to our
enterprise resource planning, or ERP, software, including PeopleSoft and SAP.
The architecture of the software we currently use for ERP applications is not
designed to be hosted. We believe that future software will be written to be
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hosted. Our existing software application providers may face competition from
new vendors who have written hostable software. It may be difficult for us to
acquire hostable ERP software from these new vendors and for our software
application providers to develop this software quickly or successfully. In
either event, the services we offer would likely become less attractive to our
customers, which could cause us to lose revenue and market share. Performing
upgrades may also require substantial time and expense and even then we cannot
be sure that we will succeed in adapting our business to these technological
developments. Prolonged delays resulting from our efforts to adapt to rapid
technological change, even if ultimately successful, could harm our reputation
within our industry and our ability to grow our revenues.
THE EMERGING HIGH-GROWTH AND MIDDLE-MARKET COMPANIES THAT CURRENTLY COMPRISE OUR
CUSTOMER BASE MAY BE VOLATILE, WHICH COULD RESULT IN GREATER THAN EXPECTED
CUSTOMER LOSS OR AN INABILITY TO COLLECT FEES IN A TIMELY MANNER OR AT ALL.
Our current customer base consists of emerging high-growth and middle-market
companies and is comprised primarily of e-commerce and "dot-com" companies.
These companies may be more likely to be acquired, experience financial
difficulties or cease operations than other companies. In particular, these
companies may experience difficulties in raising capital needed to fund their
operations when required or at all. As a result, our client base will likely be
more volatile than that of competitors whose customers consist of more mature
and established companies. If we experience greater than expected customer loss
or an inability to collect fees from our customers in a timely manner because of
this volatility, our operating results could be seriously harmed.
OUR APPLICATION MANAGEMENT AGREEMENTS ARE TYPICALLY LONG-TERM, FIXED-PRICE
CONTRACTS, WHICH MAY HINDER OUR ABILITY TO BECOME PROFITABLE.
We enter into agreements with our customers to provide application management
services for long periods, typically three to five years. Most of these
agreements are in the form of fixed-price contracts that do not provide for
price adjustments to reflect any cost overruns associated with providing our
services, such as potential increases in the costs of software applications we
license from third parties, the costs of upgrades or inflation. Furthermore, we
may be required to bundle implementation and application management services for
some of our customers for competitive reasons. As a result, unless we are able
to provide our services in a more cost-effective manner than we do today and
unless the number of users at individual customers increases to provide us
higher revenue levels per customer, we may never achieve profitability for a
particular customer. In addition, customers may not be able to pay us or may
cancel our services before becoming profitable for us.
OUR LONG-TERM, FIXED-PRICE APPLICATION MANAGEMENT CONTRACTS MAY HINDER OUR
ABILITY TO EVOLVE OUR BUSINESS AND TO ULTIMATELY BECOME PROFITABLE.
Our business is new and, accordingly, our business and financial models may
evolve as the understanding of our business evolves. We may be unable to adjust
our pricing or cost structure with respect to our current customers in response
to changes we make in our business or financial model due to the long-term,
fixed price nature of the application management agreements we have with our
customers. This potential inflexibility may result in our inability to become
profitable as rapidly as we would like or at all.
IF WE DO NOT MEET THE SERVICE LEVELS PROVIDED FOR IN OUR CONTRACTS WITH
CUSTOMERS, WE MAY BE REQUIRED TO GIVE OUR CUSTOMERS CREDIT FOR FREE SERVICE, AND
OUR CUSTOMERS MAY BE ENTITLED TO CANCEL THEIR SERVICE CONTRACTS, WHICH COULD
ADVERSELY AFFECT OUR REPUTATION AND HINDER OUR ABILITY TO GROW OUR REVENUES.
Our application management services contracts contain service level
guarantees that obligate us to provide our applications at a guaranteed level of
performance. If we fail to meet those service levels, we may be contractually
obligated to provide our customers credit for free service. If we were to
continue to fail to meet these service levels, our customers would then have the
right to cancel their contracts with us. These credits or cancellations could
harm our reputation and hinder our ability to grow our revenues.
IF WE CANNOT OBTAIN ADDITIONAL SOFTWARE APPLICATIONS THAT MEET THE EVOLVING
BUSINESS NEEDS OF OUR CUSTOMERS, THE MARKET FOR OUR SERVICES WILL NOT GROW AND
MAY DECLINE, AND SALES OF OUR SERVICES WILL SUFFER.
Part of our strategy is to expand our services by offering our customers
additional software applications that address their evolving business needs. We
cannot be sure, however, that we will be able to license these applications at a
commercially viable cost or at all or that we will be able to cost-effectively
develop the applications in-house. If we cannot obtain these applications
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on a cost-effective basis and, as a result, cannot expand the range of our
service offerings, the market for our services will not grow and may decline,
and sales of our services will suffer.
WE HAVE MANY COMPETITORS AND EXPECT NEW COMPETITORS TO ENTER OUR MARKET, WHICH
COULD ADVERSELY AFFECT OUR ABILITY TO INCREASE REVENUES, MAINTAIN OUR MARGINS OR
GROW OUR MARKET SHARE.
The market for our services is extremely competitive and the barriers to
entry in our market are relatively low. We currently have no patented technology
that would bar competitors from our market.
Our current and potential competitors primarily include:
- application service providers and business process outsourcers, such as
Applicast, AristaSoft, Breakaway Solutions, Interliant, NaviSite, Qwest
Cyber.Solutions, ReSourcePhoenix.com and USinternetworking;
- systems integrators, such as Andersen Consulting, Electronic Data Systems
and PricewaterhouseCoopers;
- Internet service providers and web hosting providers, such as Concentric
Network, DIGEX, Exodus Communications, Frontier Corporation, Genuity,
Worldcom and PSINet;
- software vendors, such as J.D. Edwards, Microsoft, Oracle, PeopleSoft, SAP
and Siebel Systems;
- major technology providers, such as Cisco Systems, IBM, Intel and Nortel
Networks;
- Internet portals, such as AOL, Excite@Home and Yahoo; and
- telecommunications companies.
Many of our competitors and potential competitors have substantially greater
financial, customer support, technical and marketing resources, larger customer
bases, longer operating histories, greater name recognition and more established
relationships in the industry than we do. We cannot be sure that we will have
the resources or expertise to compete successfully in the future. Our
competitors may be able to:
- develop and expand their network infrastructures and service offerings
more quickly;
- adapt to new or emerging technologies and changing customer needs faster;
- take advantage of acquisitions and other opportunities more readily;
- negotiate more favorable licensing agreements with software application
vendors;
- devote greater resources to the marketing and sale of their products; and
- address customers' service-related issues more effectively.
Some of our competitors may also be able to provide customers with additional
benefits at lower overall costs or to reduce their application service charges
aggressively in an effort to increase market share. We cannot be sure that we
will be able to match cost reductions by our competitors.
Our competitors and other companies may form strategic relationships with
each other to compete with us. These relationships may take the form of
strategic investments, joint-marketing agreements, licenses or other contractual
arrangements, which arrangements may increase our competitors' ability to
address customer needs with their product and service offerings. We believe that
there is likely to be consolidation in our markets, which could lead to
increased price competition and other forms of competition that could cause our
business to suffer.
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WE MAY BE UNABLE TO DELIVER EFFECTIVELY OUR SERVICES IF OUR DATA CENTER
MANAGEMENT SERVICES PROVIDERS, COMPUTER HARDWARE SUPPLIERS OR SOFTWARE PROVIDERS
DO NOT PROVIDE US WITH KEY COMPONENTS OF OUR TECHNOLOGY INFRASTRUCTURE IN A
TIMELY, CONSISTENT AND COST-EFFECTIVE MANNER.
We depend on third-parties, such as Concentric Network, for our data center
management services and for key components of our network infrastructure. Our
contracts with these data center and network infrastructure providers are for a
fixed term and for a specified amount of services, which may be insufficient to
meet our needs as our business grows. We depend on suppliers such as Sun
Microsystems for our computer hardware and Active Software and Netegrity for our
software technology platform. If any of these relationships fail to provide
needed products or services in a timely and consistent manner or at an
acceptable cost, we may be unable to deliver effectively our services to
customers. Some of the key components of our infrastructure are available only
from sole or limited sources in the quantity and quality we demand. We do not
carry significant inventories of those components that we obtain from
third-parties and have no guaranteed supply arrangements for some of these
components.
SYSTEM FAILURES CAUSED BY US OR FACTORS OUTSIDE OF OUR CONTROL COULD CAUSE US TO
LOSE OUR CUSTOMERS AND SUBJECT US TO LIABILITY.
Our operations depend upon our ability and the ability of our third-party
data center and network services providers to maintain and protect the computer
systems on which we host our customers' applications. Any loss of customer data
or an inability to provide service for a period of time could cause us to lose
our customers and subject us to significant potential liabilities. We currently
use two data centers to house our hardware and to provide network services, but
each of our customers is serviced at a single site. While our data center and
network providers maintain back-up systems, a natural disaster or similar
disruption at their site could impair our ability to provide our services to our
customers until the site is repaired or back-up systems become operable. Each of
our data center providers, as well as our corporate headquarters, is located in
Northern California, near known earthquake fault zones. Our systems and the data
centers are also vulnerable to damage from fire, flood, power loss,
telecommunications failures and similar events.
IF WE ARE UNABLE TO RETAIN OUR EXECUTIVE OFFICERS AND KEY PERSONNEL, OR TO
INTEGRATE NEW MEMBERS OF OUR SENIOR MANAGEMENT THAT ARE CRITICAL TO OUR
BUSINESS, WE MAY NOT BE ABLE TO SUCCESSFULLY MANAGE OUR BUSINESS OR ACHIEVE OUR
OBJECTIVES.
Our future success depends upon the continued service of our executive
officers and other key personnel. None of our executive officers or key
employees is bound by an employment agreement for any specific term. If we lose
the services of one or more of our executive officers or key employees, or if
one or more of them decides to join a competitor or otherwise compete directly
or indirectly with us, we may not be able to successfully manage our business or
achieve our business objectives.
In addition, most of the members of our senior management joined us in the
second half of 1999 and the beginning of 2000, including our Chief Executive
Officer and Chief Financial Officer. If our senior management is unable to
successfully become integrated and work together, our ability to manage our
business could be seriously harmed.
IF WE ARE UNABLE TO HIRE AND RETAIN SUFFICIENT SALES, MARKETING, TECHNICAL AND
OPERATIONS PERSONNEL, WE MAY BE UNABLE TO GROW OUR BUSINESS OR TO SERVICE OUR
CUSTOMERS EFFECTIVELY.
We need to expand substantially our sales operations and marketing efforts,
both domestically and internationally, in order to try to increase market
awareness and sales of our services. We will also need to increase our technical
staff in order to service customers and perform research and development.
Competition for qualified sales, marketing, technical and operations personnel
is intense as these personnel are in limited supply and in high demand,
particularly in Northern California, and we might not be able to hire and retain
sufficient numbers of these personnel to grow our business or to service our
customers effectively.
ANY FUTURE ACQUISITIONS OF BUSINESSES, TECHNOLOGIES OR SERVICES MAY RESULT IN
DISTRACTION OF OUR MANAGEMENT AND DISRUPTIONS TO OUR BUSINESS.
We expect significant consolidation in our industry to occur. We may acquire
or make investments in complementary businesses, technologies or services if
appropriate opportunities arise. From time to time we may engage in discussions
and negotiations with companies regarding acquiring or investing in their
businesses, technologies or services. We cannot make assurances that we will be
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able to identify suitable acquisition or investment candidates, or that if we
do identify suitable candidates, we will be able to make the acquisitions or
investments on commercially acceptable terms or at all. If we acquire or invest
in another company, we could have difficulty assimilating that company's
personnel, operations, technology or products and service offerings. In
addition, the key personnel of the acquired company may decide not to work for
us. These difficulties could disrupt our ongoing business, distract our
management and employees, increase our expenses and adversely affect our results
of operations. Furthermore, we may incur indebtedness or issue equity securities
to pay for any future acquisitions. The issuance of equity or convertible debt
securities could be dilutive to our existing stockholders.
ANY INABILITY TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS COULD REDUCE OUR
COMPETITIVE ADVANTAGE, DIVERT MANAGEMENT ATTENTION, REQUIRE ADDITIONAL
INTELLECTUAL PROPERTY TO BE DEVELOPED OR CAUSE US TO INCUR EXPENSES TO ENFORCE
OUR RIGHTS.
We cannot assure you that we will be able to protect or maintain our
intellectual property from infringement or misappropriation from others. In
particular, our business would be harmed if we were unable to protect our Orion
technology platform, our trademarks or our other software and confidential and
proprietary information. Agreements on which we rely to protect our intellectual
property rights and the trade secret, copyright and other laws on which we rely
may only afford limited protection to these rights. In addition, we currently
have no patents and no patent applications pending, which limits significantly
our ability to protect our proprietary rights in the event they are infringed.
Any infringement or misappropriation of our intellectual property could reduce
our competitive advantage, divert management attention, require us to develop
technology and cause us to incur expenses to enforce our rights.
ANY INFRINGEMENT CLAIMS INVOLVING OUR TECHNOLOGY OR THE APPLICATIONS WE OFFER
COULD COST A SIGNIFICANT AMOUNT OF MONEY AND COULD DIVERT MANAGEMENT'S ATTENTION
AWAY FROM OUR BUSINESS.
As the number of software applications used by our customers increases and
the functionality of these products further overlaps and integrates, software
industry participants may become increasingly subject to infringement claims. In
addition, we have agreed, and may agree in the future, to indemnify some of our
customers against claims that our services infringe upon the intellectual
property rights of others. Someone may claim that our technology or the
applications we offer infringes their proprietary rights. Any infringement
claims, even if without merit, can be time consuming and expensive to defend,
may divert management's attention and resources and could cause service delays.
Such claims could require us to enter into costly royalty or licensing
agreements. If successful, a claim of infringement against us and our inability
to modify or license the infringed or similar technology could adversely affect
our business. In addition, if our software vendors cease to offer their software
applications to us because of infringement claims against them, we would be
forced to license different software applications to our customers that may not
meet our customers' needs. This could result in a loss of customers and a
decline in our revenues.
RISKS RELATED TO OUR INDUSTRY
WE CANNOT ASSURE YOU THAT THE ASP MARKET WILL BECOME VIABLE OR GROW AT A RATE
THAT WILL ALLOW US TO ACHIEVE PROFITABILITY.
Growth in demand for and acceptance of ASPs and their hosted business
software applications is highly uncertain. We cannot assure you that this market
will become viable or, if it becomes viable, that it will grow at a rate that
will allow us to achieve profitability. The market for Internet services,
private network management solutions and widely distributed Internet-enabled
application software has only recently begun to develop and is now evolving
rapidly. We believe that many of our potential customers are not fully aware of
the benefits of hosted and managed solutions. It is possible that these
solutions will never achieve market acceptance. It is also possible that
potential customers will decide that the risks associated with hiring ASPs to
implement and manage their critical systems and business functions outweigh the
efficiencies associated with the products and services we provide. Concerns over
transaction security and user privacy, inadequate network infrastructure for the
entire Internet and inconsistent performance of the Internet could also limit
the growth of Internet-based business software solutions.
INCREASING GOVERNMENT REGULATION COULD LIMIT THE MARKET FOR, OR IMPOSE SALES AND
OTHER TAXES ON THE SALE OF, OUR SERVICES, WHICH COULD CAUSE OUR REVENUES TO
DECLINE OR INCREASE OUR EXPENSES.
We offer our suite of software applications over networks, which subjects us
to government regulation concerning Internet usage and electronic commerce. We
expect that state, federal and foreign agencies will adopt and modify
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regulations covering issues such as user and data privacy, pricing, taxation of
goods and services provided over the Internet, the use and export of
cryptographic technology and content and quality of products and services. It is
possible that legislation could expose us and other companies involved in
electronic commerce to liability or require permits or other authorizations,
which could limit the growth of electronic commerce generally. Legislation could
dampen the growth in Internet usage and decrease its acceptance as a
communications and commercial medium. If enacted, these laws, rules or
regulations could limit the market for or make it more difficult to offer our
services.
The taxation of commerce activities in connection with the Internet has not
been established, may change in the future and may vary from jurisdiction to
jurisdiction. One or more states or countries may seek to impose sales or other
taxes on companies that engage in or facilitate electronic commerce. A number of
proposals have been made at the local, state, national and international levels
that would impose additional taxes on the sale of products and services over the
Internet. These proposals, if adopted, could substantially impair the growth of
electronic commerce and could subject us to taxation relating to our use of the
Internet as a means of delivering our services. Moreover, if any state or
country were to assert successfully that we should collect sales or other taxes
on the exchange of products and services over the Internet, our customers may
refuse to continue using our services, which could cause our revenues to decline
significantly.
AS WE EXPAND OUR BUSINESS OUTSIDE THE UNITED STATES WE WILL BE SUBJECT TO
UNFAVORABLE INTERNATIONAL CONDITIONS AND REGULATIONS THAT COULD CAUSE OUR
INTERNATIONAL BUSINESS TO FAIL.
We plan to expand our business outside of the United States in the
foreseeable future and are presently exploring expansion opportunities in the
European Union, Japan and Korea. Conducting our business in these international
markets is subject to complexities associated with foreign operations and to
additional risks related to our business, including the possibility that the
scarcity of cost-effective, high-speed Internet access and the slow pace of
future improvements in access to the Internet will limit the market for hosting
software applications over the Internet or adversely affect the delivery of our
services to customers. Additionally, some countries outside of the United States
do not permit hosting applications on behalf of companies. The European Union
has adopted a privacy directive that regulates the collection and use of
information. This directive may inhibit or prohibit the collection and sharing
of personal information in ways that could harm us. The globalization of
Internet commerce may be harmed by these and similar regulations since the
European Union privacy directive prohibits transmission of personal information
outside the European Union unless the receiving country has enacted individual
privacy protection laws at least as strong as those enacted by the European
Union privacy directive. The United States and the European Union have not yet
resolved this matter and they may not ever do so in a manner favorable to our
customers or us.
CHANGES IN ACCOUNTING STANDARDS COULD ADVERSELY AFFECT THE CALCULATION OF OUR
FUTURE OPERATING RESULTS.
The ASP industry is new, and we anticipate the ASP business model is likely
to evolve over time. As a result, the application of accounting standards to the
ASP industry is also likely to change. Changes in the application of accounting
standards could force us to defer revenue recognition over a longer period of
time than is our current practice, result in large write-offs or cause us to
modify our customer contracts. For example, the Securities and Exchange
Commission has recently requested that the Emerging Issues Task Force of the
Financial Accounting Standards Board address issues of accounting for
multiple-element revenue arrangements. We currently recognize revenue for
professional services as the services are performed. If accounting standards
were modified to require deferral of professional services revenue and
recognition of that revenue over the life of the application management services
contract, our reported revenues would be substantially reduced. These changes
could adversely affect our operating results or require us to restate our
financial statements.
MARKET PRICES OF INTERNET AND TECHNOLOGY COMPANIES HAVE BEEN HIGHLY VOLATILE,
AND THE MARKET FOR OUR STOCK MAY BE VOLATILE AS WELL.
The stock market has experienced significant price and trading volume
fluctuations, and the market prices of technology companies generally, and
Internet-related software companies particularly, have been extremely volatile.
Many technology companies have experienced exceptional share price and trading
volume changes in the first weeks after their initial public offering. In the
past, following periods of volatility in the market price of a public company's
securities, securities class action litigation has often been instituted against
that company. Such litigation could result in substantial costs to us and a
diversion of our management's attention and resources.
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THE LARGE NUMBER OF OUR SHARES ELIGIBLE FOR PUBLIC SALE COULD CAUSE OUR STOCK
PRICE TO DECLINE.
The market price of our common stock could decline as a result of sales by
our existing stockholders of a large number of shares of our common stock in the
market or the perception that such sales could occur. After completion of our
initial public offering, based upon shares outstanding as of June 30, 2000, we
will have 47,955,171 shares of our common stock, which number excludes exercise
of options outstanding as of June 30, 2000. All of the shares sold in our
initial public offering may be resold in the public market immediately. Another
23,859,572 shares are subject to lock-up agreements and will become available
for resale in the public market beginning 180 days after the date of this
prospectus. In specified circumstances, the 180 day restriction will terminate
as to 15% of the shares subject to the restriction after 90 days and 20% of such
shares after 120 days. As restrictions on resale end, our stock price could drop
significantly if the holders of these restricted shares sell them or are
perceived by the market as intending to sell them. These sales also might make
it more difficult for us to sell equity securities in the future at a time and
at a price that we deem appropriate.
MANY SIGNIFICANT CORPORATE ACTIONS ARE CONTROLLED BY OUR OFFICERS, DIRECTORS AND
AFFILIATED ENTITIES REGARDLESS OF THE OPPOSITION OF OTHER INVESTORS OR THE
DESIRE OF OTHER INVESTORS TO PURSUE AN ALTERNATIVE CAUSE OF ACTION.
Our executive officers, directors and entities affiliated with them, in the
aggregate, beneficially own approximately 53.6% of our common stock. If they
were to act together, these stockholders would be able to exercise control over
most matters requiring approval by our stockholders, including the election of
directors and approval of significant corporate transactions. This concentration
of ownership may also have the effect of delaying or preventing a change in
control of our company, which could cause our stock price to drop. These actions
may be taken even if they are opposed by the other investors, including those
who purchase shares in this offering.
DELAWARE LAW AND OUR CHARTER, BYLAWS AND CONTRACTS PROVIDE ANTI-TAKEOVER
DEFENSES THAT COULD DELAY OR PREVENT AN ACQUISITION OF US, EVEN IF AN
ACQUISITION WOULD BE BENEFICIAL TO OUR STOCKHOLDERS.
Provisions of our certificate of incorporation, bylaws and contracts and of
Delaware law could delay, defer or prevent an acquisition or change of control
of us, even if an acquisition would be beneficial to our stockholders, and this
could adversely affect the price of our common stock.
- Our bylaws limit the ability of our stockholders to call a special meeting
and do not permit stockholders to act by written consent.
- We are subject to the anti-takeover provisions of Section 203 of the
Delaware General Corporation Law, which prohibits us from engaging in a
"business combination" with an "interested stockholder" for a period of
three years after the date of the transaction in which the person became
an interested stockholder, unless the business combination is approved in
a prescribed manner.
- Several members of our senior management have contracts with us that
provide for the acceleration of the vesting of their stock options upon
termination following a change of control.
- Our certificate of incorporation permits our board to issue shares of
preferred stock without stockholder approval. In addition to delaying or
preventing an acquisition, the issuance of a substantial number of shares
of preferred stock could adversely affect the price of the common stock.
- Additional provisions of our certificate of incorporation that may serve
to delay or prevent an acquisition include a staggered board, advance
notice procedures for stockholders to nominate candidates for election as
directors, authorization of our board to alter the number of directors
without stockholder approval and lack of cumulative voting.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We develop and market our services primarily in the United States. As we
expand our operations outside of the United States, our financial results could
be affected by factors such as changes in foreign currency rates or weak
economic conditions in foreign markets. Because all of our services are
currently denominated in U.S. dollars, a strengthening of the dollar could make
our services less competitive in international markets.
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We have an investment portfolio of money market funds. In view of the nature
and mix of our total portfolio, a 10% movement in market interest rates would
not have a significant impact on the total value of our portfolio as of June 30,
2000. Our interest expense is not sensitive to changes in the general level of
U.S. interest rates because all of our debt arrangements are based on fixed
interest rates.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS
(c) With the closing of the initial public offering, all outstanding shares
of Company's preferred stock automatically converted into 35,297,476 shares of
common stock. The issuance of common stock upon automatic conversion of the
Company's previously outstanding preferred stock upon consummation of the
initial public offer was made in reliance on Section 3 (a) (9) of the Securities
Act.
(d) On July 20, 2000, the Company affected an initial public offering (the
"IPO"), of 10,000,000 shares of its Common Stock at $14.00 per share, pursuant
to a registration statement (No. 333-35402) declared effective by the Securities
and Exchange Commission on July 20, 2000. The managing underwriters for the IPO
were Goldman, Sachs & Co., Merrill Lynch & Co., Robertson Stephens and Epoch
Partners. Aggregate proceeds from the Initial Offering were $140,000,000.
The Company incurred the following expenses in connection with the IPO:
underwriters' discounts and commissions of $9,800,000 and approximately
$1,000,000 in other expenses, for a total expense of $10,800,000. No payments
constituted direct or indirect payments to directors, officers or general
partners of the Company or their associates, to persons owning 10% or more of
any class of equity securities of the Company, or to any affiliates of the
Company.
After deducting expenses of the IPO, the net offering proceeds to the
Company were $129,200,000. As of July 26, 2000, all net offering proceeds from
the IPO were invested in short-term financial instruments.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders, through the
solicitation of proxies or otherwise, for the quarter ended June 30, 2000.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
None.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: August 14, 2000
CORIO, INC.
(Registrant)
By /s/ GEORGE KADIFA
--------------------------------------
George Kadifa
President and Chief Executive Officer
By /s/ ERIC J. KELLER
--------------------------------------
Eric J. Keller
Executive Vice President, Finance and
Chief Financial Officer
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EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit # Description
--------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
