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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarter ended September 30, 2000 Commission File Number 0-21860
LEADINGSIDE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 06-1232140
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
One Canal Park 02141
Cambridge, MA (Zip Code)
(Address of principal executive offices)
617-621-0820
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
------- ____
Number of shares outstanding of the issuer's classes of common stock as
of October 31, 2000:
Class Number of Shares Outstanding
-------------------------------------- ----------------------------
Common Stock, par value $.01 per share 10,944,338
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LEADINGSIDE, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NUMBER
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<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets as of
September 30, 2000 and December 31, 1999 3
Consolidated Statements of Operations for the Three
and Nine Months Ended September 30, 2000 and 1999 4
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2000 and 1999 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk 17
PART II. OTHER INFORMATION
Item 2. Changes in Securities 18
Item 5. Other Information 18
Item 6. Exhibits and Reports Filed on Form 8-K 18
SIGNATURE 19
EXHIBIT INDEX 20
</TABLE>
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Part I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
LeadingSide, Inc.
Consolidated Balance Sheets
(in thousands, except share data)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
ASSETS (unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 1,314 $ 9,361
Accounts receivable, less allowance for doubtful
accounts of $647 and $803 at September 30, 2000
and December 31, 1999, respectively 4,293 5,292
Prepaid expenses and other current assets 828 862
------------- ------------
Total current assets 6,435 15,515
Property and equipment, net 3,248 3,092
Computer software costs, net 442 1,927
Investment in Northern Light 256 256
Goodwill, net 1,615 2,584
------------- ------------
Total assets $ 11,996 $ 23,374
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings $ --- $ 1,350
Accounts payable 2,884 1,499
Accrued compensation 897 1,355
Other accrued expenses 1,374 2,094
Income taxes payable 248 232
Deferred revenue 2,659 4,069
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Total current liabilities 8,062 10,599
------------- ------------
Commitments and contingencies (Note F) --- ---
Stockholders' equity:
Preferred stock, $.01 par value, 8,000,000 shares authorized; 350 shares
issed and outstanding at September 30, 2000; no shares issued and
outstanding at December 31, 1999 --- ---
Common stock, $.01 par value, 30,000,000 shares authorized;
10,893,138 shares issued and 10,819,138 shares outstanding at
September 30, 2000; 10,006,273 shares issued and 9,932,273 shares outstanding
at December 31, 1999 109 100
Additional paid-in capital 55,888 49,184
Accumulated deficit (51,274) (35,555)
Unearned compensation (383) (469)
Accumulated comprehensive loss (148) (227)
Treasury stock, 74,000 shares at cost (258) (258)
------------- ------------
Total stockholders' equity 3,934 12,775
------------- ------------
Total liabilities and stockholders' equity $ 11,996 $ 23,374
============= ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements
3
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LeadingSide, Inc.
Consolidated Statements of Operations
(In thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Software license fees $ 1,373 $ 4,122 $ 3,818 $ 10,916
Services 4,215 2,880 9,755 9,149
----------- ----------- ----------- -----------
Total revenues 5,588 7,002 13,573 20,065
----------- ----------- ----------- -----------
Cost of revenues:
Software license fees 483 839 1,553 2,498
Services 3,737 2,388 11,086 6,895
----------- ----------- ----------- -----------
Total cost of revenues 4,220 3,227 12,639 9,393
----------- ----------- ----------- -----------
Gross profit 1,368 3,775 934 10,672
----------- ----------- ----------- -----------
Operating expenses:
Sales and marketing 1,874 2,855 5,402 9,240
Product development 424 1,690 1,113 5,467
General and administrative 3,011 2,155 8,733 5,238
Restructuring and special items --- --- 1,035 ---
Restructuring and special items - noncash --- --- 308 ---
----------- ----------- ----------- -----------
Total operating expenses 5,309 6,700 16,591 19,945
----------- ----------- ----------- -----------
Loss from operations (3,941) (2,925) (15,657) (9,273)
Interest income (expense), net 18 79 (37) 557
Gain on Investment in Northern Light --- --- --- 5,056
Other income (expense), net (109) 107 (26) 125
----------- ----------- ----------- -----------
Loss before income taxes (4,032) (2,739) (15,720) (3,535)
Benefit from income taxes --- (373) --- (360)
----------- ----------- ----------- -----------
Net loss (4,032) (2,366) (15,720) (3,175)
Preferred stock beneficial conversion feature (1,382) --- (1,382) ---
----------- ----------- ----------- -----------
Net loss applicable to common shareholders $ (5,414) $ (2,366) $ (17,102) $ (3,175)
=========== =========== =========== ===========
Net loss per common share -- basic and diluted $ (0.51) $ (0.25) $ (1.64) $ (0.33)
=========== =========== =========== ===========
Weighted average number of common shares
outstanding - basic and diluted 10,636 9,536 10,438 9,489
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements
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LeadingSide, Inc.
Consolidated Statements of Cash Flows
(in thousands, unaudited)
<TABLE>
<CAPTION>
Nine months ended September 30,
2000 1999
------------- ------------
<S> <C> <C>
Cash flows used in operating activities:
Net loss $ (15,720) $ (3,175)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 3,421 4,321
Provision for doubtful accounts 96 235
Gain on Investment in Northern Light --- (5,056)
Gain on foreign currency transactions 10 (11)
Noncash stock option compensation 251 ---
Stock options issued to consultants, partners and bank 158 116
Stock options issued at below fair market value 86 ---
Changes in operating assets and liabilities:
Accounts receivable 852 (1,698)
Prepaid expenses and other current assets (1) 198
Accounts payable 1,460 (768)
Accrued expenses and compensation (1,166) (307)
Accrued acquisition costs --- (401)
Income taxes payable 20 (468)
Deferred revenue (1,471) 1,332
------------- ------------
Net cash used in operating activities (12,004) (5,682)
------------- ------------
Cash flows provided by (used in) investing activities:
Additions to property and equipment (1,172) (1,142)
Proceeds from Investment in Northern Light, net of costs incurred --- 5,312
Acquisition of third party software license --- (130)
Additions to capitalized software costs --- (1,122)
------------- ------------
Net cash provided by (used in) investing activities (1,172) 2,918
------------- ------------
Cash flows provided by financing activities:
Paydown of short-term borrowings (1,350) ---
Proceeds from issuance of convertible preferred stock 3,130 ---
Proceeds from issuance of common stock and exercise of
stock options and warrants 3,175 276
------------- ------------
Net cash provided by financing activities 4,955 276
------------- ------------
Effect of exchange rate changes on cash and cash equivalents 174 6
------------- ------------
Net change in cash and cash equivalents (8,047) (2,482)
Cash and cash equivalents at beginning of period 9,361 12,468
------------- ------------
Cash and cash equivalents at end of period $ 1,314 $ 9,986
============= ============
Supplemental disclosure of non-cash operating and financing transactions:
Waiver of escrow shares transferred from accrued liabilities to additional paid-in capital $ --- $ 200
============= ============
Beneficial conversion feature of convertible preferred stock $ 1,382 $ ---
============= ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements
5
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LEADINGSIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
A. Basis of Presentation
The accompanying consolidated financial statements of LeadingSide, Inc.
(formerly Dataware Technologies, Inc.) (the "Company") have been prepared in
accordance with generally accepted accounting principles for interim information
and should be read in conjunction with the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1999, and the financial statements and
footnotes included therein. The interim financial data as of September 30, 2000
and for the three and nine months ended September 30, 2000 and September 30,
1999 is unaudited; however, in the opinion of the Company's management, the
interim data includes all adjustments, consisting of only normal recurring
adjustments, necessary for a fair statement of the results for the interim
periods. The year-end balance sheet was derived from audited financial
statements, but does not include all disclosures required by generally accepted
accounting principles. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to Securities and
Exchange Commission rules and regulations.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from these estimates.
The Company recognized $20,065,000 and $13,573,000 in revenues during the nine
months ended September 30, 1999 and 2000, respectively. The decrease in revenues
is a direct result of major changes that the Company made to its business and
operating models beginning in 1999, transitioning from a product licensing
oriented business to one emphasizing e-Business services. The Company has
suffered recurring losses from operations, has negative recurring cash flow from
operations, and had an accumulated deficit of $51,274,000 at September 30, 2000,
all of which raise substantial doubt about its ability to continue as a going
concern. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
The Company requires additional cash to fund operations. At September 30, 2000,
the Company had $1,314,000 in cash and cash equivalents. During the third
quarter of 2000, a financing of convertible preferred stock (Note K) in the
amount of $3,130,000 was completed. The Company expects to generate revenues
from operations during the next twelve months. However, it believes that cash
generated from existing and future customers, existing cash and cash equivalents
and other sources of operating capital may not be sufficient to fund operations
through fiscal year 2000. The Company, therefore, is continuing to attempt to
raise additional capital through the sale of securities, the sale of its legacy
software products business, and/or obtaining additional debt financing from a
bank.
B. Net Loss per Common Share
The Company computes basic and diluted earnings per share in accordance with
Statement of Financial Accounting Standard No. 128 ("SFAS 128"), "Earnings per
Share." The following table reconciles the numerator and denominator of the
basic and diluted earnings per share computations shown in the Consolidated
Statements of Operations:
<TABLE>
<CAPTION>
For the Three Months Ended September 30, For the Nine Months Ended September 30,
(In thousands, except per share data) 2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Basic and Diluted EPS
Numerator:
Net loss $ (4,032) $ (2,366) $ (15,720) $ (3,175)
Preferred stock conversion feature (1,382) --- (1,382) ---
-----------------------------------------------------------------------------------
Net loss applicable to
</TABLE>
6
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<TABLE>
<S> <C> <C> <C> <C>
common stockholders $ (5,414) $ (2,366) $ (17,102) $ (3,175)
==================================================================================
Denominator:
Common shares outstanding-basic 10,636 9,536 10,438 9,489
Dilutive options -- -- -- --
Dilutive warrants -- -- -- --
----------------------------------------------------------------------------------
Common shares outstanding-diluted 10,636 9,536 10,438 9,489
==================================================================================
Basic and Diluted EPS $ (0.51) $ (0.25) $ (1.64) $ (0.33)
==================================================================================
</TABLE>
Options to purchase 3,456,616 and 2,912,725 shares of common stock outstanding
with weighted average exercise prices of $4.32 and $2.22 as of the three month
periods ended September 30, 2000 and 1999, respectively, and 3,456,616 and
2,201,036 shares of common stock outstanding with weighted average exercise
prices of $4.32 and $2.68 as of the nine month periods ended September 30, 2000
and 1999, respectively, were excluded from the calculation of diluted net loss
per common share as the effect of their inclusion would have been anti-dilutive.
Warrants to purchase 336,550 shares of common stock outstanding with a weighted
average exercise price of $3.83 as of the three and nine month periods ended
September 30, 1999 and 585,153 shares of common stock outstanding with a
weighted average exercise price of $4.375 as of the three and nine month periods
ended September 30, 2000 were also excluded from the calculation of diluted net
loss per common share as the effect of their inclusion would have been
anti-dilutive.
C. Comprehensive Loss
The Company's comprehensive losses were as follows:
<TABLE>
<CAPTION>
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
(In thousands) 2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C>
Net loss applicable to common stockholders $ (5,414) $ (2,366) $ (17,102) $ (3,175)
------------------ ---------------- ----------------- ----------------
Foreign currency translation adjustment 77 23 79 (45)
------------------ ---------------- ----------------- ----------------
Total comprehensive loss $ (5,337) $ (2,343) $ (17,023) $ (3,220)
================== ================ ================= ================
</TABLE>
D. New Accounting Standards
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements," ("SAB 101") as
amended by SAB 101A and SAB 101B, which is effective no later than the quarter
ending December 31, 2000. SAB 101 clarifies the Securities and Exchange
Commission's views regarding recognition of revenue. The Company is currently
evaluating the effects of this change but anticipates that the adoption of SAB
101 will not have a material effect on the Company's 2000 financial position and
results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This statement was originally effective for all fiscal
year ends beginning after June 15, 1999. In June 1999, the FASB issued Statement
137, which delayed the effective date of Statement 133 by one year. Statement
133 will be effective for the Company's fiscal year beginning January 1, 2001.
SFAS 133 requires that all derivative instruments be recorded on the balance
sheet at their fair value. Changes in the fair value of derivatives are recorded
each period in current earnings or other comprehensive income, depending on
whether a derivative is designated as part of a hedge transaction and, if it is,
the type of hedge transaction. The Company is currently evaluating the effects
of this change but anticipates that the adoption of SFAS 133
7
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will not have a significant effect on the Company's financial position or
results of operations in the near term.
E. Segment Information
The Company is in accordance with Statement of Financial Accounting Standard No.
131, "Disclosures About Segments of an Enterprise and Related Information"
("SFAS 131"). There are two reportable operating segments: North America and
International.
Although the Company prepares full balance sheets for the International business
unit, it reports only certain assets for the North America segment. This segment
is not considered capital-intensive and, thus, other balance sheet information
is not considered meaningful on a segment basis.
A summary of the segment financial information reported is as follows:
<TABLE>
<CAPTION>
NORTH CORPORATE AND
Nine months ended September 30, AMERICA INTERNATIONAL ELIMINATIONS TOTAL
2000
<S> <C> <C> <C>
----------------------------------------------------------------
Revenues from unaffiliated $ 8,315 $ 5,258 $ - $ 13,573
customers
Operating loss (3,420) (2,256) (9,981) (15,657)
Total assets 2,296 3,763 5,937 11,996
NORTH CORPORATE AND
Nine months ended September 30, AMERICA INTERNATIONAL ELIMINATIONS TOTAL
1999 ----------------------------------------------------------------
Revenues from unaffiliated customers $ 13,748 $ 6,317 $ - $ 20,065
Operating income (loss) 5,177 (562) (13,888) (9,273)
Total assets 2,563 5,221 17,426 25,210
</TABLE>
F. Pending Litigation
The Company was named in a suit brought by the former employer of several of the
Company's senior managers, which alleges a number of claims arising primarily
out of the alleged breach of the employees' obligations to the former employer.
The Company strongly denies the claims and will defend itself vigorously if the
matter is tried, as will the individual employees. To date, the plaintiff's
motion for a preliminary injunction against LeadingSide, which was filed in the
second quarter, has not been granted and the parties are engaged in settlement
discussions. However, any adverse ruling against the Company or any of the
employees could have a material adverse effect on the Company.
G. Restructuring
As described above, during the first quarter of 1999 the Company announced a
program to reposition and restructure as an e-Business solutions provider and
began making strategic and organizational changes toward that goal. Headcount
was reduced from 209 at December 31, 1999 to 171 at March 31, 2000. During the
second quarter of 2000, headcount increased to 183, consisting of key hires,
partially offset by additional reductions that further aligned skills and
staffing to the new business model. Net headcount remained flat in the third
quarter of 2000. The reductions included 42, 12 and 15 involuntary terminations
in the quarters ended March 31, June 30 and September 30, 2000, respectively,
primarily in the field sales and product engineering groups. These terminations
resulted in a charge of $1.0 million for severance and related outplacement and
medical benefit costs in the nine months ended September 30, 2000.
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Approximately $0.2 million of these charges had not been paid as of September
30, 2000 and will be paid through May of 2001.
The Company also recorded a non-cash charge in the amount of $2.8 million in the
first quarter of 2000, representing the effect of modifications for changes in
stock options related to terminating employees and a director. During the second
quarter of 2000, the Company recorded a net non-cash credit in the amount of
$2.5 million for the effects of variable accounting for these options as well as
a small amount for additional option modifications related to second quarter
terminations. Variable accounting will not be applied to these options going
forward as the terms of the agreements were fixed during the second quarter of
2000.
H. Special Items
The Company periodically reviews and evaluates the recoverability of its
long-term assets when events or changes in circumstances indicate that the
carrying amount of these assets may not be recoverable. The Company's assessment
of impairment considers the future cash flows that are expected to be realized
from the assets. Because of the Company's shift from a product licensing-
oriented business model to one emphasizing e-Business services, it was
determined that goodwill related to the acquisition of Sovereign Hill Software,
Inc. in December of 1998 should be amortized over 3 years rather than the 5 year
life that had previously been estimated. As of January 1, 2000, the Company
began amortizing the $2.6 million of goodwill that was on the balance sheet at
December 31, 1999 prospectively over the remaining period. The Company,
therefore, recorded goodwill amortization amounting to $323,000 in each of the
first three quarters of 2000, resulting in a charge of $969,000 for the nine
months ended September 30, 2000, and compared with $162,000 recorded in each of
the first three quarters of 1999 and $486,000 for the nine months ended
September 30, 1999.
The Company also determined that, because of this change in focus, capitalized
software costs of $1.9 million on the balance sheet at December 31, 1999 should
be amortized prospectively over one year as opposed to the two-year life
previously used. This resulted in amortization expense of $464,000 and $1.5
million in the three and nine-month periods ended September 30, 2000,
respectively, as compared with $812,000 and $2.2 million in the three and
nine-month periods ended September 30, 1999.
I. Gain on Investment in Northern Light
During the second quarter of 1999, Northern Light Technology, developer of the
world's first research engine, announced that it had completed a $35 million
equity financing. Following this announcement, the Company sold one-half of its
interest back to Northern Light for $4.1 million in cash. In addition, Northern
Light repaid the Company for its $1.2 million promissory note held by the
Company. These transactions resulted in a $5.1 million gain after adjusting for
legal costs incurred and the investment in Northern Light that was carried on
the Company's books. After these transactions, the Company retained an
approximate 4% interest in Northern Light.
J. Income Tax Benefit
The Company recorded a $373,000 income tax benefit in the three months ended
September 30, 1999. The benefit represented the reversal of a reserve
established in previous years for taxes on a foreign subsidiary that the Company
now believes are not owed.
K. Sale of Common Stock, Series C Convertible Preferred Stock and Common Stock
Warrants
On August 3, 2000, the Company issued a total of 162,305 shares of its common
stock for net proceeds of $460,000.
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In August 2000, the Company authorized a new class of 8% Convertible Preferred
Stock ("Preferred Stock"), of which a total of 350 shares were issued with a
stated value of $3.5 million for net proceeds of $3.1 million. The Preferred
Stock is convertible, at any time at the option of the holder, into shares of
the Company's common stock. Holders are entitled to receive cumulative dividends
at the rate of 8% per annum of the stated value and are payable on the
conversion date. In no circumstances may either the Company or any holder
require redemption of any shares of Preferred Stock held by such holder without
the other's consent.
The Preferred Stock contains a beneficial conversion feature that allows the
holders to convert to common stock at a conversion price less than fair market
value. Preferred Stock shares are convertible into common stock shares at the
option of the holder at any time. The conversion price for each share of
Preferred Stock is the lesser of $4.69518 or 95% of the average of the three
lowest per share market values of the Company's common stock during the thirty
consecutive trading day period immediately preceding the conversion date. Upon
the occurrence of a Material Event, defined as failure of the Company's common
stock to be suspended or listed for trading for a total of three days, failure
to observe or perform any other material agreement, covenant or warranty, the
above conversion price will be automatically adjusted downward by 10 percentage
points from its then current discount (for example, to 85% for the first
occurrence, and 75% for the second occurrence). Accordingly, a portion of the
proceeds from the issuance of the preferred Stock equal to the value of this
beneficial conversion feature of approximately $1.3 million has been recorded as
a charge before net income attributable to common stockholders.
If a Material Event, as defined, occurs, the Company will be obligated to pay
liquidated damages, as defined, to the holders of the Preferred Stock. The
payment amount can not exceed 33% of the gross proceeds from the issuance of
Preferred Stock. The Company does not have the right to call the Preferred Stock
to prevent the payment of such liquidated damages. Accordingly, the Company may
be obligated to pay liquidated damages up to approximately $1.1 million.
The Preferred Stock contains other features that may in certain circumstances
limit the rights of holders of the Company's common stock. First, although the
Company has never paid dividends on its common stock and does not foresee doing
so, the Company may not pay dividends on the common stock as long as shares of
the Preferred Stock are outstanding. Second, in the event of a liquidation of
the Company, the holders of the Preferred Stock would be entitled to receive an
amount equal to the stated value of the Preferred Stock before any payment may
be made to the holders of common stock. In the event of a change in control, the
holders of Preferred Stock will be entitled to convert shares into shares of
stock and other securities, cash and property receivable held by holders of
common stock following the merger, consolidation or sale. Also, the holders of
Preferred Stock will be entitled to receive 150% of the amount of securities,
cash and property as the holders of the number of shares of common stock into
which such shares of Preferred Stock could have been converted immediately prior
to such merger, consolidation or sale would have been entitled to receive.
In conjunction with the issuance of the preferred Stock, the Company also
issued warrants to purchase a total of 362,500 shares of common stock at an
exercise price equal to $4.69518 per share. The warrants vest immediately and
expire five years from issuance.
On September 27, 2000, the Company issued a total of 106,631 shares of its
common stock for net proceeds of $206,000.
The Company plans to use the proceeds of these investments to fund operations
while it completes the final stages of its transition from a product to a
solutions company.
10
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Statements concerning the Company's anticipated performance, including future
revenues, costs, profits and liquidity, or about the development of the
Company's products or markets, made throughout this Form 10-Q, may be deemed
forward-looking statements. Such statements are based on the current assumptions
of the Company's management, which are believed to be reasonable. However, they
are subject to significant risks and uncertainties, including but not limited to
the important factors described under "Gross Profit," "Liquidity and Capital
Resources" and "Certain Factors That May Affect Future Results" below and in
Exhibit 99.1 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1999 (which is incorporated herein by reference), that could cause
actual results to differ materially from those described in the forward-looking
statements.
Change of Corporate Name
On October 3, 2000, the Company changed its name from Dataware Technologies,
Inc. to LeadingSide, Inc. The new name emphasizes the significant changes made
over the past year to the Company's business model, as further described in
"Results of Operations" below.
RESULTS OF OPERATIONS
General
In 1999, the Company made several major changes to its business and operational
models as it began its transition from a product licensing-oriented business
model to one emphasizing e-Business services. During the first nine months of
2000, the Company aggressively continued this shift, reducing product sales
activity in favor of large solutions engagements. At the same time, the Company
reduced headcount in the product engineering and field sales groups, made some
key management hires and reorganized its remaining employees, moving the
majority of individuals who had been engaged in component development activities
into the solutions delivery organization. The Company also increased headcount
in the solutions delivery group, resulting in a net 12% reduction in headcount
during the first nine months of 2000. These and other related changes had a
significant impact on revenues as well as all classifications of expenses during
the first nine months of 2000. Because of this, comparisons with prior periods
are difficult to make at a detailed level and percentage changes from period to
period are, in many cases, not meaningful.
The Company expects to continue to incur significant operating expenses to
support its solution development and service opportunities. It is also expected
that results of operations will vary significantly from quarter to quarter for
the foreseeable future as the Company transitions towards an e-business service
business model.
Relationship with IHS
On September 30, 1997, the Company sold a portion of its data services business
to Information Handling Services Group, Inc. ("IHS") in exchange for cash and
the stock of IHS's subsidiary, Creative Multimedia Corporation. The portion of
the business sold included certain contracts and other assets of Dataware, as
well as the stock of the Company's Australian, Canadian, German, Italian and
Swedish subsidiaries. The activities of the data services business sold
consisted of processing customer text and data and using it to create
information-distribution products.
The Company also entered into a distribution agreement with IHS on September 30,
1997, under which IHS took over the software distribution activities formerly
performed by the five divested foreign subsidiaries (primarily involving the
Company's legacy products). In addition, the Company entered into agreements
with IHS under which it provided software and multimedia services for use by IHS
internally and in its publishing activities, and IHS provided software that the
Company incorporated into certain of its products. IHS accounted for 3% of total
revenues in the third quarter of 2000 compared with 20% during the third quarter
of 1999. IHS also accounted for 3% of total revenues for the first nine months
of 2000, compared with 23% in the first nine months of 1999. The final
guaranteed payments under these agreements were made to the Company during the
fourth quarter of 1999; revenues from IHS have, therefore, continued to be
materially lower during 2000.
11
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Revenues
The Company's total revenues decreased 20% from $7.0 million in the third
quarter of 1999 to $5.6 million in the third quarter of 2000. The Company's
total revenues decreased 32% from $20.1 million in the first nine months of 1999
to $13.6 million in the first nine months of 2000. These revenue numbers have
changed since the Company issued its press release on October 12, 2000 as
described in the paragraph below. The decline in revenues was a direct result of
the Company's accelerated shift from a product licensing-oriented business model
to one emphasizing e-Business services.
Quarter over quarter, software license fees decreased 67% from $4.1 million to
$1.4 million. Software license fees include revenues from source code licenses,
systems and tools, applications and custom software products. Year over year,
software licenses decreased 65% from $10.9 million to $3.8 million. The Company
continues to engage in efforts to sell its legacy software product business and
is currently negotiating the terms of a sale with a prospective buyer. If a sale
of this business is accomplished, software license fees would be eliminated in
future periods.
Revenues in the third quarter of 2000 and 1999 included $0.2 and $1.2 million,
respectively, related to agreements with IHS. For the nine months ended
September 30, 2000 and 1999, these revenues included $0.6 and $4.7 million,
respectively. As part of the ongoing relationship, the Company and IHS amended
existing agreements during the third quarter of 1998 to provide for IHS to make
guaranteed minimum payments called for by those agreements, at the discretion of
the Company, on an accelerated, discounted basis. Software revenues in the third
quarter and first nine months of 1999 included $0.8 and $2.3 million of such
discounted payments accelerated from future periods. There were no such revenues
in the first nine months of 2000, as all guaranteed payments under these
agreements had been made as of December 31, 1999.
Service revenues increased 46% from $2.9 million in the third quarter of 1999 to
$4.2 million in the same period for 2000. Service revenues increased 7% from
$9.1 million in the first nine months of 1999 to $9.8 million in the same
period for 2000. Service revenues are primarily derived from interactive
multimedia development, production services, software maintenance, web site
hosting, custom software development and project management. The year and
quarter to date increases show improvement in the Company's utilization rates.
If the sale of the legacy software product business referred to above is
accomplished, maintenance revenues would be eliminated, but the Company expects
that they would be replaced by revenues from solutions-related services.
Software revenues decreased from 59% of total revenues in the third quarter of
1999 to 25% in the third quarter of 2000, and services revenues increased from
41% of total revenues in the third quarter of 1999 to 75% in the third quarter
of 2000. Software revenues decreased from 54% of total revenues in the first
nine months of 1999 to 28% in the same period in 2000, and services revenues
increased from 46% of total revenues in the first nine months of 1999 to 72% in
the same period in 2000.
Change in Revenue for Third Quarter
The third quarter's revenues have been reduced by $0.4 million from the amount
the Company publicly announced on October 12, 2000. The Company did not
receive payment of that amount from a customer in connection with a solutions
contract.
Cost of Revenues
Cost of revenues increased 31% from $3.2 million in the third quarter of 1999 to
$4.2 million during the same period in 2000. Cost of revenues increased 35% from
$9.4 million in the first nine months of 1999 to $12.6 million in the first nine
months of 2000. As a percentage of revenues, total cost of revenues increased
from 46% of total revenues for the three months ended September 30, 1999 to 76%
for the three months ended September 30, 2000 and from 47% to 93% for the nine
months ended September 30, 1999 and 2000, respectively. The increases were in
both the cost of services and software license fees as described below.
The cost of software licenses as a percentage of software license fees increased
from 20% in the third quarter of 1999 to 35% during the third quarter of 2000
and from 23% in the first nine months of 1999 to 41% in the same period in 2000.
The increase was caused by the decline in software revenues while fixed costs
such as amortization of capitalized software were accelerated due to the
reduction of their estimated useful lives.
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The cost of services as a percentage of service revenues increased from
83% for the third quarter of 1999 to 89% during the third quarter of 2000 and
increased from 75% to 114% for the first nine months of 1999 and 2000,
respectively. The increase year over year resulted primarily from the transfer
of a significant portion of the Company's component development employees into
the solutions delivery organization in the first half of 2000 and the resulting
continuing underutilization of the solutions delivery group as they bring the
solutions business up to speed.
Gross Profit
Total gross profit was $3.8 million or 54% of total revenues for the third
quarter of 1999 compared to a gross profit of $1.4 million, or 24% of total
revenues for the third quarter of 2000. For the first nine months of 1999, total
gross profit amounted to $10.7 million as compared with a gross profit of $0.9
million for the same period in 2000, representing 53% and 7%, respectively.
Quarter to quarter, software margins decreased from 80% in 1999 to 65% in 2000
and services margins decreased from 17% in 1999 to 11% in 2000. On a
year-to-year basis, software margins decreased from 77% to 59% and services
margins decreased from 25% to (14%) in 1999 and 2000, respectively.
Gross margins may improve in the long run if the Company attains additional
improvements in service margins. However, there are a number of important
factors that could adversely affect the Company's future gross margins,
resulting in higher than anticipated costs and/or lower than anticipated
revenues. These include the inherent risks and costs of providing a unique
solution for each customer, including uncertainty of customer acceptance, the
impact of employee underutilization if significant solutions business
engagements take longer to materialize than anticipated, and increased
employment costs stemming from the high level of competition for qualified
personnel in the e-commerce and software industries.
Sales and Marketing Expenses
Sales and marketing expenses decreased 34%, from $2.9 million to $1.9 million,
in the third quarters of 1999 and 2000, respectively, and 42%, from $9.2 million
to $5.4 million, during the first nine months of 1999 and 2000. This decrease
was caused by a reduction in the number of sales employees and spending on
marketing programs. Sales and marketing expenses decreased as a percentage of
revenues from 41% to 34% on a quarter-to-quarter basis and from 46% to 40% on a
year-to-year basis due to the decline in spending.
Product Development Expenses
Product development expenses, which exclude capitalized software costs,
decreased 75% from $1.7 million in the third quarter of 1999 to $0.4 million in
the third quarter of 2000, and decreased 80% from $5.5 million during the first
nine months of 1999 to $1.1 million during the same period in 2000. The decrease
is due to the Company's transition to a solutions model from a product-based
model and the redeployment of a significant portion of product development
employees to the solutions delivery group at the beginning of 2000.
The Company capitalized software development costs in the amount of $0.3 million
in the third quarter and $1.1 million in the first nine months of 1999. There
were no software development costs capitalizable in accordance with Financial
Accounting Standard No. 86 in the first nine months of 2000.
Product development expenses as a percentage of total revenues decreased from
24% for the three months ended September 30, 1999 to 8% for the three months
ended September 30, 2000 and from 27% to 8% for the nine months ended September
30, 1999 and 2000, respectively.
General and Administrative Expenses
General and administrative expenses were $2.2 million in the third quarter of
1999 and $3.0 million in the third quarter of 2000, and $5.2 million in the
first nine months of 1999 as compared with $8.7 million in the first nine months
of 2000. This increase was caused by: additional headcount in key management
positions worldwide as well as the human resources and internal systems areas;
an increase in goodwill amortization; and credits recorded in the first nine
months of 1999. General and administrative expenses as a percent of total
revenues were 31% and 54% for the quarters ended September 30, 1999 and 2000,
respectively, and 26% and 64% for the comparative nine-month periods.
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The Company's full-time employee headcount at September 30, 2000 was 183,
compared with 209 at December 31, 1999.
Restructuring and Special Items
As described above, during 1999 the Company announced a program to reposition
and restructure as an e-Business solutions provider and began making strategic
and organizational changes toward that goal. Headcount was reduced from 209 at
December 31, 1999 to 171 at March 31, 2000. During the second quarter, headcount
increased to 183, consisting of key hires, partially offset by additional
reductions that further aligned skills and staffing to the new business model.
Net headcount remained flat at 183 during the third quarter of 2000. The
reductions included 42, 12 and 15 involuntary terminations in the quarters ended
March 31, June 30 and September 30, 2000, primarily in the field sales and
product engineering groups. These terminations resulted in a charge of $1.0
million for severance and related outplacement and medical benefit costs in the
first nine months of 2000. Approximately $0.2 million of these charges had not
been paid as of September 30, 2000 and will be paid through May of 2001.
The Company also recorded a non-cash charge in the amount of $2.8 million in the
first quarter of 2000, representing the effect of modifications for changes in
stock options related to terminating employees and a director. During the second
quarter, the Company recorded a net non-cash credit in the amount of $2.5
million for the effects of variable accounting for these options as well as a
small amount for additional option modifications related to second quarter
terminations. Variable accounting will not be applied to these options going
forward as the terms of the agreements were fixed during the second quarter of
2000.
The Company periodically reviews and evaluates the recoverability of its
long-term assets when events or changes in circumstances indicate that the
carrying amount of these assets may not be recoverable. The Company's assessment
of impairment considers the future cash flows that are expected to be realized
from the assets. Because of the Company's shift from a product
licensing-oriented business model to one emphasizing e-Business services, it was
determined that goodwill related to the acquisition of Sovereign Hill Software,
Inc. in December of 1998 should be amortized over 3 years rather than the 5 year
life that had previously been estimated. As of January 1, 2000, the Company
began amortizing the $2.6 million of goodwill that was on the balance sheet at
December 31, 1999 prospectively over the remaining period. The Company,
therefore, recorded goodwill amortization amounting to $323,000 in each of the
first three quarters of 2000, resulting in a charge of $969,000 for the nine
months ended September 30, 2000, and compared with $162,000 recorded in each of
the first three quarters of 1999 and $486,000 for the nine months ended
September 30, 1999.
The Company also determined that, because of this change in focus, capitalized
software costs of $1.9 million on the balance sheet at December 31, 1999 should
be amortized prospectively over one year as opposed to the two-year life
previously used. This resulted in amortization expense of $464,000 and $1.5
million in the three and nine-month periods ended September 30, 2000,
respectively, as compared with $1.0 million and $2.2 million in the three and
nine-month periods ended September 30, 1999.
Other Income (Expense), Net
During the third quarter of 2000, the Company reported approximately $18,000 in
net interest income as compared with approximately $79,000 of net interest
income in the third quarter of 1999. During the first nine months of 2000, the
Company recorded $37,000 in net interest expense as compared with $557,000 in
net interest income during the same period in 1999. The interest income earned
during the first nine months of 1999 included interest collected on a secured
note receivable. For the three months ended September 30, 2000, the Company
recorded $109,000 in net other expense compared with $107,000 in net other
income during the same period in 1999. For the first nine months of 2000, the
Company recorded approximately $26,000 in net other expense compared with
$125,000 of net other income in the first nine months of 1999 (mostly foreign
exchange gains on intercompany balances).
Benefit (Provision) for Income Taxes
The Company did not record a provision for income taxes for the three or
nine-month periods ended September 30, 2000, respectively. The Company recorded
a $373,000 income tax benefit in the three
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months ended September 30, 1999. The benefit represented the reversal of a
reserve established in previous years for taxes on a foreign subsidiary that the
Company now believes are not owed.
At September 30, 2000, the Company had a net operating loss carryforward of
approximately $26.9 million. Use of the Company's net operating loss
carryforward is limited due to changes in ownership of the Company's stock.
LIQUIDITY AND CAPITAL RESOURCES
The Company has incurred cumulative losses aggregating $51.3 million from its
inception through September 30, 2000, and it is expected that additional
operating losses will be incurred for the foreseeable future. During the first
nine months of 2000, the Company's cash requirements were satisfied primarily
from cash and cash equivalents as of December 31, 1999, proceeds from the sale
of equity securities of $3.8 million in the third quarter, the collection from
customers of outstanding receivables and proceeds received from stock option
exercises. The Company believes that cash generated from existing and future
customers, existing cash and cash equivalents and other sources of operating
capital may not be sufficient to fund operations through fiscal year 2000. The
Company, therefore, is continuing to attempt to raise additional capital through
the sale of securities, the sale of its legacy software products business,
and/or obtaining additional debt financing from a bank.
As of September 30, 2000, the Company had cash and cash equivalents of $1.3
million and negative working capital of $1.6 million. Operating activities used
$12.0 million of the Company's cash during the first nine months of 2000. Days
sales outstanding decreased from 74 days at December 31, 1999, to 71 days at
September 30, 2000.
The Company's investing activities used cash of $1.2 million during the first
nine months of 2000, consisting of additions to property and equipment.
The Company's financing activities provided cash of $5.0 million during the
first nine months of 2000. This consisted of proceeds from the sale of the
Company's common stock for a total of $0.7 million, the sale of 8% Series C
Convertible Preferred Stock in the amount of $3.1 million, issuance of common
stock under the Company's Equity Incentive and Employee Stock Purchase Plans and
warrant agreements with third parties offset against amounts paid down on short-
term borrowings. The sales of common and preferred stock are further described
in Part II, Item 2 of this Form 10-Q.
At September 30, the Company had a line of credit with a financial institution
under which it could borrow up to $3 million, assuming that covenants related to
certain assets and tangible net worth were met. At December 31, 1999 the Company
had borrowed $1.4 million under this line of credit, which was paid in full in
January 2000. The Company renegotiated the line of credit during the second
quarter of 2000 to reduce certain covenant restrictions to a level that
management believed would provide access to the minimum level of capital
required to support operations. The Company may borrow up to $2 million under
the new line of credit; this amount will increase to $3 million in December of
2000 provided that the Company demonstrates full compliance with all terms and
conditions of the loan agreement. However, the Company was not in compliance
with the covenants at September 30, 2000 and had not drawn on this line of
credit as of that date. During the fourth quarter, the Company has financed
receivables through the same bank.
The Company's working capital and other capital requirements may change because
of unanticipated changes in business conditions or delays in market acceptance
of new products. Other considerations such as further expansion of operations or
research and development activities, competitive and technological developments,
and possible future acquisitions of businesses and/or product rights may
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also affect the Company's capital requirements. There is no assurance that the
Company will be able to raise sufficient debt or equity capital on terms that it
considers acceptable, if at all. Accordingly, there can be no assurance that the
Company may not experience significant liquidity problems as a result or because
of adverse market conditions or other unfavorable events. In addition to or as
an alternative to raising capital, the Company may be required to cut back
operations to extend its resources.
RECENTLY ISSUED ACCOUNTING STANDARDS
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements," ("SAB 101") as
amended by SAB 101A and SAB 101B, which is effective no later than the quarter
ending December 31, 2000. SAB 101 clarifies the Securities and Exchange
Commission's views regarding recognition of revenue. The Company is currently
evaluating the effects of this change but anticipates that the adoption of SAB
101 will not have a material effect on the Company's 2000 financial position and
results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This statement was originally effective for all fiscal
year ends beginning after June 15, 1999. In June 1999, the FASB issued Statement
137, which delayed the effective date of Statement 133 by one year. Statement
133 will be effective for the Company's fiscal year beginning January 1, 2001.
SFAS 133 requires that all derivative instruments be recorded on the balance
sheet at their fair value. Changes in the fair value of derivatives are recorded
each period in current earnings or other comprehensive income, depending on
whether a derivative is designated as part of a hedge transaction and, if it is,
the type of hedge transaction. The Company is currently evaluating the effects
of this change but anticipates that the adoption of SFAS 133 will not have a
significant effect on the Company's financial position or results of operations
in the near term.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
Forward looking statements in this Form 10-Q are subject to significant risks
and uncertainties, including but not limited to the important factors described
below that could cause actual results to differ materially from those described
in the forward-looking statements:
The Company's adoption of an e-Business solutions model has involved an
extensive personnel reorganization, as well as the introduction of new sales and
marketing strategies that it may not be able to implement successfully. Some of
the risks associated with the revised approach include that the Company may not
be able to convert its backlog (contracts signed, but not yet executed) into
revenues; that the lead time to finalize large engagements may be longer than
expected; that pending customer agreements on which the company has begun work
may not actually be finalized; that the Company may not be able to continue to
hire sufficient qualified personnel to deliver the level of business it is
anticipating; the inherent risks and costs of providing a unique solution for
each customer, including uncertainty of customer acceptance; and that the
Company may not be able to effectively compete against larger, more established
e-business solutions providers.
In recent years the Company has had significant operating losses, and it expects
losses to continue at least for the next few quarters, and possibly longer. The
Company expects its operating expenses and capital expenditures to continue to
increase as it completes the transition to an e-Business solutions provider. The
Company cannot be certain that it will become profitable after it fully
implements the e-Business solutions model. There are a number of important
factors that could adversely affect profitability, resulting in higher than
anticipated costs and/or lower than anticipated revenues including: the impact
of significant fixed costs while sales cycles lengthen due to the move from
selling software products to providing solutions; increased employment costs and
turnover stemming from the high level of competition for qualified personnel in
the e-commerce and software industries; and customers may be less able to buy
the Company's services due to reduced support from the capital markets.
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If the Company's revenue does not increase as expected or operating expenditures
exceed projections, the Company's business, prospects, financial condition and
results of operations could be adversely affected. The company may not secure
additional financing when required, and even if the Company raises additional
capital, it may not be able to expand or may have to cut back operations. If the
Company cannot increase revenues or suffers additional liquidity problems, it
may be required to cut back operations to extend its resources. In general,
factors such as the following may cause liquidity problems in the future: a
possible delisting from the Nasdaq National Market as described in Part II, Item
5 below; unanticipated changes in business conditions or delays in market
acceptance of new solutions; expansion of operations or research and development
activities; development of new distribution channels; competitive and
technological developments; and future acquisitions of businesses and/or product
rights.
Other factors, including those described in Exhibit 99.1 to Dataware's 1999 Form
10-K and in its other filings with the Securities and Exchange Commission also
could cause future results to differ materially from those depicted in
forward-looking statements made in this Form 10-Q or elsewhere by the Company
and its officers.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There has been no material change from the information provided in response to
Item 7A of the Company's 1999 annual report on Form 10-K.
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PART II. OTHER INFORMATION
Item 2. Changes in Securities
On August 31, 2000, the Company authorized a new class of 8% Series C
Convertible Preferred Stock, of which it issued a total of 350 shares. This
Preferred Stock contains certain features that may in certain circumstances
limit the rights of holders of Common Stock. In particular, (a) although the
Company has never paid dividends on the Common Stock and does not foresee doing
so, the Company may not pay dividends on the Common Stock as long as shares of
the Preferred Stock are outstanding and (b) in the event of a liquidation of the
Company, the holders of the Preferred Stock would be entitled to receive an
amount equal to the Stated Value (as defined in the Company's Restated
Certificate of Incorporation, as amended) of the Preferred Stock before any
payment may be made to the holders of Common Stock.
Item 5. Other Information
The Company has received notice from Nasdaq proposing to delist the Common Stock
from being quoted on the Nasdaq National Market because the Company's net
tangible assets were $1.75 million at June 30, 2000, and $2.72 million at
September 30, 2000, below the $4 million required for continued quotation. The
Company believes that its accelerating pipeline of solutions business and its
proposed sale of the legacy software products business will result in an
increase in net tangible assets above the threshold and has requested an
extension of time to comply. Nasdaq will hold a hearing on the Company's request
on November 30, 2000.
Item 6. Exhibits and Reports Filed on Form 8-K
(a) Exhibits. See exhibit list on page 20.
(b) Reports on Form 8-K.
The Company filed the following reports on Form 8-K during the quarter ended
September 30, 2000:
(i) August 4, 2000. Filed to furnish (via incorporation by reference) the
opinion of counsel to the Company as an exhibit to a registration statement on
Form S-3 in connection with the Company's sale of Common Stock pursuant to the
registration statement.
(ii) September 1, 2000. Filed to disclose the Company's sale of Preferred Stock
and Common Stock warrants pursuant to such registration statement and to furnish
(via incorporation by reference) the opinion of counsel to the Company as an
exhibit to the registration statement in connection with such sale.
(iii) September 27, 2000. Filed to furnish (via incorporation by reference) the
opinion of counsel to the Company as an exhibit to such registration statement
in connection with the Company's sale of Common Stock pursuant to the
registration statement.
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LEADINGSIDE, INC.
SIGNATURE
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.
LEADINGSIDE, INC.
(Registrant)
Date: November 14, 2000 By: /s/ Michael Gonnerman
----------------------------
Michael Gonnerman
Vice President, Chief Financial
Officer, Treasurer
(Principal Financial and
Principal Accounting Officer)
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Exhibit Index
3.1 Restated Certificate of Incorporation, as amended through
October 3, 2000. (Incorporated by reference from Exhibits 3.1
and 3.2 of the Company's Form 8-K filed October 3, 2000)
4.1 Warrant Agreement between the Company and Deephaven Private
Placement Trading Ltd. dated as of August 31, 2000
(Incorporated by reference from Exhibit 4.3 of the Company's
Form 8-K filed September 1, 2000).
4.2 Third Amendment dated August 31, 2000 to Rights Agreement
between the Company and American Stock Transfer & Trust
Company, as Rights Agent (Incorporated by reference from
Exhibit 4.2 of the Company's Form 8-K filed
September 1, 2000).
10.1 Convertible Preferred Stock Purchase Agreement dated August
31, 2000 (Incorporated by reference from Exhibit 4.1 of the
Company's Form 8-K filed September 1, 2000)
27.1 Financial Data Schedule
99.1 Important Factors Regarding Future Results. Filed as Exhibit
99.1 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1999, and incorporated herein by reference.
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