UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
(Mark One)
[x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the quarterly period ended September 30, 1999
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the transition period from ______to ______
Commission file number: 0-20124
ADFORCE, INC.
(Exact name of registrant as specified in its charter)
Delaware 33-0694260
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10590 North Tantau Avenue, Cupertino, California 95014
(Address of principal executive offices and zip code)
Registrant's telephone number: (408) 873-3680
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No __
The number of shares outstanding of the Registrant's Common Stock, $.001 par
value, was 19,987,656 at October 31, 1999.
ADFORCE, INC.
INDEX
DESCRIPTION PAGE NUMBER
- ------------------------------------------------------------------------ -----------
Cover Page 1
Index 2
Part I: Financial Information
Item 1: Financial Statements
Condensed Balance Sheets as of September 30, 1999
and December 31, 1998 3
Condensed Statements of Operations for the Three and
Nine Months Ended September 30, 1999 and 1998 4
Condensed Statements of Cash Flows for the Nine Months
Ended September 30, 1999 and 1998 5
Notes to Condensed Financial Statements 6
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3: Quantitative and Qualitative Disclosures about Market Risk 25
Part II: Other Information
Item 1: Legal Proceedings 26
Item 2: Changes in Securities and Use of Proceeds 26
Item 3: Defaults upon Senior Securities 26
Item 4: Submission of Matters to a Vote of Security Holders 26
Item 5: Other Information 26
Item 6: Exhibits and Reports on Form 8-K 27
Signature 28
2
ADFORCE, INC.
Part 1: Financial Information
Item 1: Financial Statements
CONDENSED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------ ------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 15,872 $ 10,045
Short-term investments 54,709 -
Accounts receivable, net 1,770 1,160
Prepaid expenses and other current assets 1,429 575
-------- --------
Total current assets 73,780 11,780
Property and equipment, net 8,843 4,208
Intangible assets, net 3,426 4,662
Other non-current assets 757 285
-------- --------
Total assets $ 86,806 $ 20,935
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,684 $ 1,078
Accrued compensation and related benefits 1,454 458
Deferred revenue 782 10
Other accrued liabilities 1,333 799
Current portion of capital lease obligations 2,800 1,460
-------- --------
Total current liabilities 9,053 3,805
Long-term portion of capital lease obligations 5,238 3,089
Stockholders' equity:
Common stock 20 5
Preferred stock - 5
Additional paid-in capital 120,576 41,609
Deferred stock compensation (6,520) (2,802)
Unrealized loss on available-for-sale securities (94) -
Accumulated deficit (41,467) (24,776)
-------- --------
Total stockholders' equity 72,515 14,041
-------- --------
Total liabilities and stockholders' equity $ 86,806 $ 20,935
======== ========
The accompanying notes are an integral part of these condensed
financial statements.
3
ADFORCE, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- --------------------------------
1999 1998 1999 1998
-------------- -------------- -------------- --------------
Net revenue $ 5,085 $ 1,064 $ 12,487 $ 2,262
Cost of revenue:
Data center operations 3,197 1,044 7,972 2,988
Amortization of intangible assets
and deferred stock compensation 434 301 1,103 787
-------- -------- -------- --------
Total cost of revenue 3,631 1,345 9,075 3,775
-------- -------- -------- --------
Gross profit (loss) 1,454 (281) 3,412 (1,513)
Operating expenses:
Research and development 2,405 1,241 6,888 3,031
Marketing and selling 3,231 1,389 6,977 3,223
General and administrative 1,311 509 2,604 1,352
Restructuring expense 263 - 263 -
Amortization of intangible assets
and deferred stock compensation 1,428 584 4,354 1,378
-------- -------- -------- --------
Total operating expenses 8,638 3,723 21,086 8,984
-------- -------- -------- --------
Loss from operations (7,184) (4,004) (17,674) (10,497)
Interest income (expense), net 724 37 983 (143)
-------- -------- -------- --------
Net loss $ (6,460) $ (3,967) $(16,691) $(10,640)
======== ======== ======== ========
Basic and diluted net loss per share $ (0.34) $ (1.30) $ (1.38) $ (4.18)
======== ======== ======== ========
Weighted average shares of common
stock outstanding used in computing
basic and diluted net loss per share 19,238 3,046 12,080 2,544
======== ======== ======== ========
Pro forma basic and diluted net loss per share $ (0.34) $ (0.33) $ (1.01) $ (1.05)
======== ======== ======== ========
Weighted average shares used in computing pro
forma basic and diluted net loss per share 19,238 12,205 16,525 10,120
======== ======== ======== ========
The accompanying notes are an integral part of these condensed
financial statements.
4
ADFORCE, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
(DOLLARS IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------
1999 1998
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net cash used in operating activities $ (6,461) $ (7,111)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases (sales) of short-term investments, net (54,455) -
Proceeds from sale of assets - 105
Investment in note receivable (500) -
Purchase of property and equipment (2,031) (888)
-------- --------
Net cash used in investing activities (56,986) (783)
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on capital lease obligations (1,648) (607)
Proceeds from issuance of common stock, net 70,922 87
Proceeds from issuance of preferred stock, net - 19,594
Proceeds from issuance of notes payable - 500
Repayment of notes payable - (113)
-------- --------
Net cash provided by financing activities 69,274 19,461
Net increase in cash and cash equivalents 5,827 11,567
Cash and cash equivalents at beginning of period 10,045 1,680
-------- --------
Cash and cash equivalents at end of period $ 15,872 $ 13,247
======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING/FINANCING ACTIVITIES
Property and equipment acquired under capital leases $ 5,089 $ 2,511
======== ========
Conversion of notes payable and accrued interest into
Series D convertible preferred stock $ - $ 506
======== ========
Conversion of convertible preferred stock to common stock $ 31,486 $ -
======== ========
Increase in deferred stock compensation $ 7,833 $ 3,477
======== ========
The accompanying notes are an integral part of these condensed financial
statements.
5
ADFORCE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
BASIS OF PRESENTATION
The unaudited condensed financial information of AdForce, Inc. ("AdForce" or
the "Company") furnished herein reflects all adjustments, consisting only of
normal recurring adjustments, which in the opinion of management are
necessary to fairly state the Company's financial position, results of
operations and cash flows for the periods presented. This Quarterly Report on
Form 10-Q should be read in conjunction with the audited financial statements
and notes thereto included in the Company's Registration Statement on Form
S-1, as amended, filed with the Securities and Exchange Commission on May 7,
1999. The results of operations for the three and nine month periods ended
September 30, 1999 are not necessarily indicative of the results to be
expected for any subsequent quarter or for the entire year ending December
31, 1999. The condensed balance sheet at December 31, 1998 has been derived
from the Company's audited financial statements at that date.
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 the Securities and
Exchange Commission's rules and regulations.
NET LOSS, AND PRO FORMA NET LOSS, PER SHARE
Basic and diluted net loss per share are presented in conformity with
Statement of Financial Accounting Standard No. 128, "EARNINGS PER SHARE"
("FAS 128"), for all periods presented. In accordance with FAS 128, basic and
diluted net loss per share have been computed using the weighted average
number of shares of common stock outstanding during the period, less shares
subject to repurchase. Options to purchase shares of common stock could
potentially dilute basic earnings per share in the future and have not been
included in the computation of diluted net loss per share because to do so
would have been antidilutive for the periods presented.
Pro forma net loss per share has been computed as described above and also
gives effect, under Securities and Exchange Commission guidance, to the
conversion of convertible preferred stock, using the if-converted method,
that automatically converted upon completion of AdForce's initial public
offering.
HISTORICAL AND PRO FORMA BASIC AND DILUTED NET LOSS PER SHARE ARE AS FOLLOWS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
1999 1998 1999 1998
---- ---- ---- ----
Historical:
Net loss $ (6,460) $ (3,967) $ (16,691) $ (10,640)
Basic and diluted shares:
Weighted average shares of common stock outstanding 19,983 4,655 13,012 4,248
Less weighted average shares subject to repurchase 745 1,609 932 1,704
--------- -------- --------- ---------
Weighted average shares of common stock
outstanding used in computing basic and diluted
net loss per share 19,238 3,046 12,080 2,544
========= ======== ========= =========
Basic and diluted net loss per share $ (0.34) $ (1.30) $ (1.38) $ (4.18)
========= ======== ========= =========
6
ADFORCE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
HISTORICAL AND PRO FORMA BASIC AND DILUTED NET LOSS PER SHARE ARE AS FOLLOWS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
1999 1998 1999 1998
---- ---- ---- ----
Pro forma:
Net loss $ (6,460) $ (3,967) $ (16,691) $ (10,640)
Weighted average shares of common stock
outstanding used in computing basic and diluted
net loss per share 19,238 3,046 12,080 2,544
Adjusted to reflect the assumed conversion of convertible
preferred stock from the date of issuance -- 9,159 4,445 7,576
--------- -------- --------- ---------
Weighted average shares used in computing pro forma
basic and diluted net loss per share 19,238 12,205 16,525 10,120
========= ======== ========= =========
Pro forma basic and diluted net loss per share $ (0.34) $ (0.33) $ (1.01) $ (1.05)
========= ======== ========= =========
If AdForce had reported net income, diluted net income per share would have
included the shares used in the computation of pro forma net loss per share,
as well as approximately 4,728,772 and 3,323,955 common equivalent shares
related to outstanding options and warrants to purchase common stock not
included above for the three and nine months ended September 30, 1999 and
September 30, 1998 respectively. The common equivalent shares from options
and warrants would be determined on a weighted average basis using the
treasury stock method.
MARKETABLE SECURITIES
The Company accounts for investments in marketable securities in accordance
with Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities" ("FAS 115"). AdForce
classifies its short-term investments as available-for-sale. Accordingly,
these investments, primarily commercial paper and corporate bonds, are
carried at fair value. Changes in market values are reflected as unrealized
gains or losses, calculated on the specific identification method, and
reported as a net amount in a separate component of stockholders' equity.
COMPREHENSIVE LOSS
AdForce adopted FAS 130 in the year ended December 31, 1998. There was no
impact on AdForce's financial statements as a result of the adoption of FAS
130 for 1998. During the three and nine months ended September 30, 1999,
unrealized loss on securities of $43,000 and $94,000, respectively increased
total comprehensive loss to $6.5 million and $16.8 million, respectively.
FINANCIAL INSTRUMENTS RISK
Financial instruments that potentially subject the Company to credit risk
consist of short-term investments and trade receivables. AdForce is subject
to concentrations of credit risk and interest rate risk related to its
short-term investments. AdForce's credit risk is managed by limiting the
amount of investments placed with any one portfolio manager, investing in
money market funds, short-term commercial paper, and A1 rated corporate bonds
with a weighted average months to maturity of approximately 6.5 months as of
September 30, 1999.
7
ADFORCE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
CONCENTRATION OF CREDIT RISK
AdForce sells and grants credit for its services to its customers without
requiring collateral or third-party guarantees. To date, we have derived a
substantial portion of our net revenue from a small number of Web sites and
ad rep firms. Many of our leading customers, including such major customers
as AdSmart Network and 24/7 Media, Inc. have limited operating histories and
have not achieved profitability. If one or more of our customers are unable
to pay for our services, our quarterly and annual results of operations could
be materially and adversely affected.
During the three months ended September 30, 1999, the Company's three major
customers, each representing more than 10% of net revenues, collectively
accounted for 67% of net revenue compared to four major customers accounting
for 70% for the comparable period in the previous year. For the nine months
ended September 30, 1999, the Company's four major customers accounted for
73% of net revenue compared to two major customers accounting for 62% of net
revenue for the comparable period in the previous year. Two of the major
customers collectively accounted for 69% of our net accounts receivable at
September 30, 1999. GeoCities, one of our top four customers for the nine
months ended September 30, 1999, was acquired by Yahoo!, Inc., effective May
28, 1999 and discontinued the use of AdForce's ad-serving services during
June 1999 for the majority of its ads. GeoCities, which had been a customer
since June 1998, accounted for 20%, 12%, and 3% of AdForce's net revenues
during the quarters ended March 31, 1999, June 30, 1999 and September
30,1999, respectively. Netscape was acquired by America Online during the
first quarter of 1999, and advised us in October 1999 of its intent to
transition Netscape's domestic and European Netcenter advertising serving
(which represent the substantial majority of our business with Netscape) from
AdForce to America Online's internal system following the expiration on
November 22, 1999 of our current contract with Netscape. Netscape accounted
for 12%, 10% and 20% of our net revenues during the quarters ended March 31,
1999, June 30, 1999, and September 30, 1999, respectively. In addition, 24/7
Media has stated that it is currently developing and implementing an internal
ad delivery technology that is intended to serve as its sole ad delivery
solution, and that they expect to deploy this system in the fourth quarter of
1999. It has also stated that, unless and until the development of and
transition to its own ad delivery technology is complete, it will be
primarily dependent on us to deliver ads to its networks and Web sites. 24/7
Media accounted for 23%, 29% and 24% of our net revenues during the quarters
ended March 31, 1999, June 30, 1999, and September 30, 1999, respectively.
OTHER NON-CURRENT ASSETS
During the third quarter, we provided financing of $500,000 in the form of an
unsecured convertible promissory note to Neta4, Ltd., a Delaware corporation
devoted to combining direct advertising with electronic mail technology. The
$500,000 unsecured convertible promissory note receivable is due on August
17, 2000, and bears interest at a rate of 8% per annum. The interest is
payable in monthly installments beginning November 17, 1999. Neta4 is a
development stage entity, with a history of operating losses. We wrote the
convertible promissory note down to its estimated net realizable value of
$320,000 at September 30, 1999.
DEFERRED STOCK COMPENSATION
In connection with the grant of certain options to employees during the nine
months ended September 30, 1999, AdForce recorded deferred compensation of
approximately $7.8 million for the aggregate difference between the exercise
prices of those options at their respective dates of grant and the deemed
fair values for accounting purposes of the shares of common stock subject to
such options. This amount is included as a reduction of stockholders' equity
and is being amortized on a graded vesting method to all operating expense
categories including data center operations. This expense has been
appropriately allocated between cost of revenues and operating expenses but
has not been separately allocated between operating expense categories.
STOCKHOLDERS' EQUITY
In May 1999, AdForce completed an initial public offering of 5,175,000 shares of
its common stock. Proceeds to AdForce from this initial public offering totaled
approximately $70.7 million, net of offering costs of $1.5 million and
underwriter
8
ADFORCE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
fees of $5.4 million. Upon the closing of the initial public offering,
AdForce's convertible preferred stock converted into 9,467,118 shares of
common stock.
AGREEMENT AND PLAN OF MERGER
On September 20, 1999, we entered into a definitive Agreement and Plan of
Merger with CMGI, Inc., which develops and operates Internet and direct
marketing companies, and a wholly-owned subsidiary of CMGI. Pursuant to the
Agreement and Plan of Merger and subject to the terms and conditions set
forth therein, the CMGI subsidiary will be merged with and into us, and we
will survive the merger and become a wholly-owned subsidiary of CMGI. At the
effective time of the merger, each outstanding share of our common stock will
be exchanged and converted into 0.262 share of CMGI's common stock, and
options and warrants to purchase shares of our common stock will be assumed
and become options and warrants, as applicable, to purchase shares of CMGI's
common stock. The exercise price and number of shares of our common stock
subject to each such assumed option and warrant will be appropriately
adjusted to reflect the exchange ratio. The merger is intended to qualify as
a tax-free reorganization and will be accounted for as a purchase.
In connection with the execution of the Agreement and Plan of Merger, we
entered into a Stock Option Agreement with CMGI, pursuant to which we granted
to CMGI an option to purchase up to 19.9% of the outstanding shares of our
common stock. The option is exercisable upon the occurrence of certain events
relating to the termination of the Agreement and Plan of Merger, all as
specified in the Stock Option Agreement. The merger is subject to various
conditions, including clearance under the Hart-Scott-Rodino Antitrust
Improvements Act and approval of our stockholders. Stockholders of AdForce
holding approximately 38% of our outstanding common stock have agreed to vote
in favor of the merger at our stockholder meeting called for such purpose.
The merger is expected to close in the first quarter of 2000.
We may be required to pay a substantial termination fee if the Agreement and
Plan of Merger is terminated for specified reasons. We have filed the
Agreement and Plan of Merger with the Securities and Exchange Commission on
October 4, 1999 under our Report on Form 8-K.
LEGAL MATTERS
In April 1999, Dirk Wray, a Company director, filed an action against Chad
Steelberg, a Company founder, in the Orange County, California Superior Court
alleging that Mr. Steelberg failed to perform certain obligations pursuant to
a 1996 agreement between Messrs. Wray and Steelberg.
In June 1999, Mr. Steelberg filed a cross-complaint (the "Cross-Complaint")
against Mr. Wray, certain investors in the Company, the Company, and the
Company's President, Chief Executive Officer and Chairman, Charles W. Berger,
claiming the Company is obligated to defend and indemnify Mr. Steelberg
against Mr. Wray's allegations, and seeking additional damages.
The Company believes the causes of action in the Cross-Complaint claimed
against the Company and Mr. Berger are without merit. On October 22, 1999 the
Company and Mr. Berger jointly filed a demurrer to the Cross-Complaint. A
hearing has been set for November 17, 1999. The Company intends to indemnify
Mr. Berger pursuant to the Company's certificate of incorporation, bylaws and
a written indemnification agreement, and to defend itself and Mr. Berger
vigorously.
Except as provided above, the Company is not subject to any material legal
proceedings. The Company may from time to time become a party to various
legal proceedings arising in the ordinary course of business.
9
ADFORCE, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
FORWARD-LOOKING STATEMENTS
Some of the statements contained in this Quarterly Report on Form 10-Q are
forward-looking and include statements about our plans, objectives,
expectations and intentions that are not historical facts. When used in this
document, the words expects, anticipates, intends, plans, believes, seeks and
estimates and similar expressions are generally intended to identify
forward-looking statements. You should not place undue reliance on these
forward-looking statements, which apply only as of the date of this document.
These forward-looking statements involve risks and uncertainties, and there
are important factors that could cause actual results to differ materially
from those expressed or implied by these forward-looking statements,
including the result of the proposed merger with CMGI and other factors
discussed under "Other Factors Affecting Operating Results, Liquidity and
Capital Resources" below.
THE FOLLOWING DISCUSSION SHOULD BE READ ONLY IN CONJUNCTION WITH OUR
UNAUDITED CONDENSED INTERIM FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED
IN PART I --ITEM 1 OF THIS QUARTERLY REPORT ON FORM 10-Q, OUR AUDITED
FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED IN OUR FORM S-1 FILED, AS
AMENDED, WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 7, 1999, AND THE
RISK FACTORS DESCRIBED BELOW.
OVERVIEW
AdForce is a leading provider of centralized, outsourced ad management and
delivery services on the Internet. We began operations on January 16, 1996 as
Imgis, Inc. and spent the first 15 months of our operations developing
technology that could be used to manage and deliver Internet ads for
advertisers, ad agencies, Web sites and ad rep firms. Initially, we did not
have an internal sales force to sell our services. To generate business, we
relied primarily on the sales forces of ad rep firms that used our services
to manage and deliver ads to the Web site customers they represented. In
December 1997, we began building a direct sales force to allow us to
penetrate the market for our services more effectively.
We began delivering ads and recognizing revenue during the second quarter of
1997, and increased our revenue as the ad volumes delivered by our ad rep
firm customers grew. 24/7 Media and its predecessor firms were responsible
for 92% of our net revenue in 1997. In November 1997, we also contracted to
deliver ads for Netcom and FortuneCity, and began to demonstrate the
applicability of our services to Web sites. In 1998, we continued to add
customers with material amounts of ad volume. AdSmart and Netscape began
using our services in early 1998, and GeoCities began using our services in
June 1998. Though we continue to derive the majority of our net revenue from
a limited number of customers, we broadened our customer base in 1998 and
have continued to do this through September 30, 1999. For the first nine
months of 1998, 24/7 Media and its predecessor firms and Fortune City
accounted for 51% and 11% of our net revenue. For the first nine months of
1999, our top four customers, 24/7 Media, AdSmart, Netscape and GeoCities
accounted for 25%, 22%, 15% and 11% of our net revenue. AdSmart is a CMGI
company. AdSmart and its predecessor firms were responsible for 21%, 21% and
24% of our net revenues for the quarters ended March 31, 1999, June 30, 1999,
and September 30, 1999, respectively. GeoCities was acquired by Yahoo!, Inc.
during the second quarter of 1999 and discontinued in June 1999 the use of
AdForce's ad-serving services for the majority of its ads. GeoCities
accounted for 20%, 12% and 3% of our net revenues during the quarters ended
March 31, 1999, June 30, 1999, and September 30, 1999, respectively. Netscape
was acquired by America Online during the first quarter of 1999, and advised
us in October 1999 of its intent to transition Netscape's domestic and
European Netcenter advertising serving (which represent the substantial
majority of our business with Netscape) from AdForce to America Online's
internal system following the expiration on November 22, 1999 of our current
contract with Netscape. Netscape accounted for 12%, 10% and 20% of our net
revenues during the quarters ended March 31, 1999, June 30, 1999, and
September 30, 1999, respectively. In addition, 24/7 Media has stated that it
is currently developing and implementing an internal ad delivery technology
that is intended to serve as its sole ad delivery solution, and that they
expect to deploy this system in the fourth quarter of 1999. It has also
stated that, unless and until the development of and transition to its own ad
delivery technology is complete, it will be primarily dependent on us to
deliver ads to its networks and Web sites. 24/7
10
ADFORCE, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONT'D)
Media accounted for 23%, 29% and 24% of our net revenues during the quarters
ended March 31, 1999, June 30, 1999, and September 30, 1999, respectively.
In 1997, 1998 and for the first nine months of 1999, we earned the vast
majority of our revenue by managing and delivering ads for ad rep firms, Web
sites and ad agencies. We also charged customers for other services, such as
developing custom reports, although revenue to date from these services has
not been significant. We plan to continue to develop and offer new services,
such as advanced consumer tracking and targeting capabilities, and expect
that an increasing proportion of our revenue will be generated by these
services.
We charge our customers based on each 1,000 ads delivered, and generally
offer lower rates as customers' ad volumes increase. During 1998 and the nine
months ended September 30, 1999, our monthly volume of ads delivered
increased significantly as our existing customers' Internet traffic increased
and we added new customers. However, our average rate per 1,000 ads delivered
generally declined during these periods due principally to pricing
competition and lower rates charged to higher-volume customers. We expect
these factors to cause future declines in average rates charged.
We believe our centralized ad management system is substantially less
expensive than on-site ad delivery alternatives available to most individual
Web sites. Generally, we expect favorable economies of scale for centralized
ad management and delivery to lead to reductions in our average cost per
1,000 ads delivered as we increase the ad volumes moving through our systems.
In addition, a portion of our research and development efforts is devoted to
continuously improving the performance and efficiency of our systems. As a
result, from the first quarter of 1998 through the first quarter of 1999, our
average cost to deliver each ad declined. This decline was at a higher rate
than the decrease in the average rate charged, resulting in improving gross
margins during those periods. However, in the second quarter of 1999 we
opened a second data center and substantially increased available capacity.
Accordingly, our average cost per 1,000 ads delivered increased during the
second quarter of 1999, and our gross margin percentage declined from 29% in
the first quarter to 24% during the second quarter. During the third quarter
of 1999, our average cost per 1,000 ads delivered declined and our gross
margin percentage increased to 29%, reflecting favorable economies of scale
resulting from greater ad volumes. As we continue to aggregate Web sites and
their ad volumes on our system, and to add additional advertisers, ad
agencies and rep firms as customers, we believe these volume increases can
again lower our average cost to deliver ads.
In the operating areas of research and development, sales and marketing, and
general and administrative costs, the single most significant cost is
personnel, including the related payroll, facilities and other overhead costs.
We have recorded deferred stock compensation, primarily for stock options
granted to employees. As of September 30, 1999, we had recorded aggregate
deferred stock compensation of $11.7 million. This deferred stock
compensation is generally being amortized over the vesting periods of the
stock options. We recognized a total of $1.2 million and $4.1 million in
stock compensation expense during 1998 and the nine months ended September
30, 1999, respectively. Since a portion of this expense was related to
persons involved in running our data center operations, we allocated that
portion to cost of revenue and thus reduced our gross margin. In addition, we
recorded stock compensation expense of $1.4 million during 1998 related to
unvested founders' stock that was not repurchased. The total charges to be
recognized in future periods from amortization of deferred stock compensation
as of September 30, 1999 are anticipated to be approximately $1.3 million,
$3.1 million, $1.5 million, $530,000 and $60,000 for the remaining three
months of 1999 and for 2000, 2001, 2002 and 2003, respectively.
In February 1998, we acquired StarPoint Software, Inc., principally by
exchanging AdForce shares for StarPoint shares. We accounted for this
transaction as a purchase with a total purchase price of $4.1 million. The
purchase price was primarily allocated to intangible assets, including
purchased technology of $2.6 million, personnel-related assets of $740,000,
and goodwill of $609,000, which are being amortized over the respective lives
of those assets, and in-process technology of $100,000 that was expensed at
the time of the acquisition. Amortization charges related to this purchase of
$1,330,000 were recognized during 1998, $1,080,000 were recognized for the
nine months ended September 30, 1999 and further amortization charges of $0.4
million, $1.1 million, and $0.1 million are expected to be recognized in the
remainder of 1999, 2000 and 2001 respectively.
11
ADFORCE, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONT'D)
We incurred net losses of $3.5 million for the period from January 16, 1996
(inception) to December 31, 1996, $5.7 million for 1997, $15.6 million for
1998 and $16.7 million for the nine months ended September 30, 1999. As of
September 30, 1999, our accumulated deficit was $41.5 million. We expect to
continue to incur significant operating expenditures, and capital
expenditures of approximately $6 million for the remainder of 1999. As a
result, we will need to generate significantly greater revenue than we have
generated to date to achieve and maintain profitability. In addition, our
operating costs are relatively fixed, and cannot quickly be reduced even if
we fail to generate significant revenue. Although we have experienced
significant growth in revenue in recent periods, we expect the growth rate to
decline substantially. We expect to continue to incur net losses on a
quarterly and annual basis for at least the next two years.
On May 7, 1999, we completed our initial public offering, issuing 5,175,000
shares of our Common Stock at $15 per share. Proceeds to us from this initial
public offering totaled approximately $70.7 million, net of offering costs of
$1.5 million and underwriter fees of $5.4 million.
Our engineering personnel are currently located in two separate locations,
Costa Mesa, California and Cupertino, California. In August 1999, we
commenced efforts to consolidate many of our engineering personnel into our
Cupertino, California facility. We expect this consolidation to be
substantially complete by December 31, 1999. We have recorded restructuring
charges of $263,000 related to the consolidation of the personnel as the
related actions were taken during the third quarter of 1999. We expect to
continue to record charges related to the consolidation of the personnel as
the related actions are taken during the fourth quarter of 1999.
CMGI MERGER
On September 20, 1999, we entered into a definitive Agreement and Plan of
Merger with CMGI, Inc., which develops and operates Internet and direct
marketing companies, and a wholly-owned subsidiary of CMGI. Pursuant to the
Agreement and Plan of Merger and subject to the terms and conditions set
forth therein, the CMGI subsidiary will be merged with and into us, and we
will survive the merger and become a wholly-owned subsidiary of CMGI. At the
effective time of the merger, each outstanding share of our common stock will
be exchanged and converted into 0.262 share of CMGI's common stock, and
options and warrants to purchase shares of our common stock will be assumed
and become options and warrants, as applicable, to purchase shares of CMGI's
common stock. The exercise price and number of shares of our common stock
subject to each such assumed option and warrant will be appropriately
adjusted to reflect the exchange ratio. The merger is intended to qualify as
a tax-free reorganization and will be accounted for as a purchase.
In connection with the execution of the Agreement and Plan of Merger, we
entered into a Stock Option Agreement with CMGI, pursuant to which we granted
to CMGI an option to purchase up to 19.9% of the outstanding shares of our
common stock. The option is exercisable upon the occurrence of certain events
relating to the termination of the Agreement and Plan of Merger, all as
specified in the Stock Option Agreement. The merger is subject to various
conditions, including clearance under the Hart-Scott-Rodino Antitrust
Improvements Act and approval of our stockholders. Stockholders of AdForce
holding approximately 37.2% of our outstanding common stock have agreed to
vote in favor of the merger at our stockholder meeting called for such
purpose. The merger is expected to close in the first quarter of 2000.
We may be required to pay a substantial termination fee if the Agreement and
Plan of Merger is terminated for specified reasons. We have filed the
Agreement and Plan of Merger with the Securities and Exchange Commission on
October 4, 1999 under our Report on Form 8-K.
RESULTS OF OPERATIONS
NET REVENUE
12
ADFORCE, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONT'D)
Our net revenue for the three and nine months ended September 30, 1999 was
$5.1 million and $12.5 million, compared to $1.1 million and $2.3 million for
the comparable periods in 1998, representing respective increases of 378% and
452%. Net revenue of $5.1 million for the third quarter of 1999 increased by
22% over net revenue of $4.2 million for the second quarter of 1999. These
increases in net revenue were due to increases in the volume of ads we
delivered on behalf of our customers in addition to increased installment
basis revenue. Our ad volumes were 22.2 billion and 53.8 billion for the
three and nine months ended September 30, 1999, compared to 3.2 billion and
5.8 billion ads for the same periods in 1998. The increases in net revenue
resulting from these volume increases were partially offset by declines in
the average rates charged for delivering those ads. Our volume increases
resulted primarily from growth in ad volumes experienced by many of our
existing customers, and to a significantly lesser extent from the addition of
new customers. In the first nine months of 1999, our volume increases were
partially offset by the fact that one of our major customers, GeoCities, was
acquired by Yahoo!, Inc., effective May 28, 1999, and discontinued in June
1999 the use of our ad-serving services for the majority of its ads.
GeoCities, a customer since June 1998, accounted for 20%, 12% and 3% of our
revenues for the first, second and third quarters of 1999. Netscape was
acquired by America Online during the first quarter of 1999, and advised us
in October 1999 of its intent to transition Netscape's domestic and European
Netcenter advertising serving (which represent the substantial majority of
our business with Netscape) from AdForce to America Online's internal system
following the expiration on November 22, 1999 of our current contract with
Netscape. Netscape accounted for 12%, 10% and 20% of our net revenues during
the quarters ended March 31, 1999, June 30, 1999, and September 30, 1999,
respectively. In addition, 24/7 Media has stated that it is currently
developing and implementing an internal ad delivery technology that is
intended to serve as its sole ad delivery solution, and that they expect to
deploy this system in the fourth quarter of 1999. It has also stated that,
unless and until the development of and transition to its own ad delivery
technology is complete, it will be primarily dependent on us to deliver ads
to its networks and Web sites. 24/7 Media accounted for 23%, 29% and 24% of
our net revenues during the quarters ended March 31, 1999, June 30, 1999, and
September 30, 1999, respectively. The declines in average rates charged in
the 1999 periods as compared to the 1998 periods were primarily the result of
competitive pricing pressure and lower rates charged to higher-volume
customers. We expect pricing pressures from competitors and discounts related
to large-contract pricing to continue for at least the next several quarters.
We expect that future revenue growth, if any, will not be as dramatic as in
recent periods.
GROSS PROFIT (LOSS)
Cost of revenues primarily consists of capital asset costs,
telecommunications costs, personnel-related costs and facilities costs
incurred to operate our data center operations. It also includes non-cash
charges for amortization of deferred stock compensation to data center
personnel, as well as charges for the amortization of intangible assets.
Gross margin improved to positive 29% and positive 27% from a negative 26%
and negative 67% for the three and nine months ended September 30, 1999 and
1998, respectively, primarily due to economies of higher ad delivery volumes
spread over relatively fixed costs. These increases were offset in part by
declines in the average rates charged to our customers. The gross margin of
29% for the third quarter of 1999 increased from a gross margin of 24% for
the second quarter of 1999. The increase was due to greater ad volumes during
the third quarter and favorable economies of scale resulting from the greater
ad volumes. The increase was partially offset by a decline in average rate
charged as a result of competitive pricing pressures and volume discounts.
RESEARCH AND DEVELOPMENT
Research and development expenses were $2.4 million and $6.9 million for the
three and nine months ended September 30, 1999, compared to $1.2 million and
$3.0 million for the comparable periods in 1998. The increase in absolute
dollars in the current periods was due primarily to increases in product
development personnel and consulting expenses. Product development expenses
incurred were primarily related to enhancements to the AdForce service
technology. Research and development expenses were 47% and 55% of net
revenues for the three and nine months ended September 30, 1999, compared to
117% and 134% of net revenues for the comparable periods in 1998. The decline
in research and development expenses as a percentage of net revenue in the
current periods was the result of higher revenues. We believe that continued
investment in product development is critical
13
ADFORCE, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONT'D)
to achieving our technical objectives of improved system reliability,
scalability, performance and cost; as well as developing new products and
services. As a result, we expect research and development expenses to
increase on an absolute dollar basis over the next several quarters.
MARKETING AND SELLING
Marketing and selling expenses were $3.2 million and $7.0 million for the
three and nine months ended September 30, 1999, compared to $1.4 million and
$3.2 million for the comparable periods in 1998. The increase in absolute
dollars in the current periods was primarily attributable to increase in
marketing and sales personnel and their related expenses, including
commissions associated with increased revenues, and costs related to the
continuing development and implementation of our marketing and branding
campaigns, including trade show participation activities. Marketing and
selling expenses were 64% and 56% of net revenues for the three and nine
months ended September 30, 1999, compared to 131% and 142% of net revenues
for the comparable periods in 1998. The decline in marketing and selling
expenses as a percentage of net revenue in the current periods was the result
of higher revenues. We expect marketing and selling expenses to increase on
an absolute dollar basis over the next several quarters as we continue our
marketing and branding campaigns, and continue to expand our sales efforts.
GENERAL AND ADMINISTRATIVE
General and administrative expenses were $1.3 million and $2.6 million for
the three and nine months ended September 30, 1999, compared to $0.5 million
and $1.4 million for the comparable periods in 1998. The increase in absolute
dollars in the current periods was primarily attributable to increased
general and administrative personnel, and to a lesser extent the costs
associated with corporate development activities, including work leading to
the proposed acquisition by CMGI of AdForce. General and administrative
expenses were 26% and 21% of net revenues for the three and nine months ended
September 30, 1999, compared to 48% and 60% of net revenues for the
comparable periods in 1998. The decline in general and administrative
expenses as a percentage of net revenue in the current periods was primarily
due to higher revenues. We expect general and administrative expenses to
remain approximately level with that experienced in the third quarter of 1999
on an absolute dollar basis over the next quarter due in part to the expected
activities relating to the proposed acquisition by CMGI of AdForce.
AMORTIZATION OF INTANGIBLE ASSETS AND DEFERRED STOCK COMPENSATION
We recognize expense for the amortization of deferred stock compensation to
personnel who have been granted options with an exercise price deemed for
financial reporting purposes to be below the fair market value of the
underlying common stock on the date of grant. We also record stock
compensation expense for unvested shares issued under employee incentive
stock options and founders' shares that were not repurchased pursuant to our
contractual right to purchase the shares, and on the acceleration of vesting
of options and restricted stock as part of certain employment termination
agreements. In connection with our acquisition of StarPoint in February 1998,
we recorded intangible assets that are being amortized to operations over the
lives of those assets. In connection with our agreements with America Online,
we issued a warrant to purchase 1,019,662 shares of our common stock. The
warrant was valued at $2,019,000, and is being amortized over the remaining
life of the agreement. These non-cash charges are included on our Condensed
Statement of Operations as "Amortization of Intangible Assets and Deferred
Stock Compensation." We recognized a total of $1.9 million and $5.5 million
in amortization of intangible assets and deferred stock compensation expense
for the three and nine months ended September 30, 1999, compared to $0.9
million and $2.2 million for the comparable periods in 1998. Since a portion
of these expenses was related to data center operations, we allocated that
portion of these non-cash expenses to cost of revenue which reduced our gross
margin. In addition, we recorded stock compensation expense of $1.4 million
during 1998 related to unvested founders' stock that was not repurchased.
INTEREST INCOME (EXPENSE), NET
14
ADFORCE, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONT'D)
Net interest income was $724,000 and $983,000 for the three and nine months
ended September 30, 1999, compared to net interest income of $37,000 and net
interest expense of $143,000 for the comparable periods in 1998. The increase
in interest income for the nine months ended September 30, 1999 is
attributable to a higher cash, cash equivalents and short-term investments
balance from public offering proceeds received in May 1999. Interest income,
net of expense, in future periods is expected to decline as a result of
declining cash balances and increased interest on capital leases.
LIQUIDITY AND CAPITAL RESOURCES
Prior to May 1999, we financed our operations primarily from sales of
preferred stock and capital lease financing, and to a lesser extent, net
proceeds from the issuance of notes payable and proceeds from the sale of
common stock. In May 1999, the Company sold 5,175,000 shares of the Company's
Common Stock at a price of $15.00 per share in its initial public offering.
Net proceeds to the Company from this offering were approximately $70.7
million.
Net cash used in operating activities was $6.5 million and $7.1 million for
the nine months ended September 30, 1999 and 1998, respectively. Cash used in
operating activities for the nine months ended September 30, 1999 resulted
primarily from net operating losses and an increase in accounts receivable
and prepaid expenses, partially offset by increases in accounts payable,
accrued expenses and deferred revenues. The increase in deferred revenue was
due to cash prepayments by customers for ad management and delivery services
to be provided.
Net cash used in investing activities was $57.0 million and $0.8 million for
the nine months ended September 30, 1999 and 1998, respectively. Cash used in
investing activities for the nine months ended September 30, 1999 was
primarily for the purchase, net of maturities, of short-term investments,
and, to a lesser extent, for the purchase of property and equipment. Cash
used in investing activities for the nine months ended September 30, 1998 was
primarily for the purchase of property and equipment, partially offset by
proceeds from the sale of equipment.
Net cash provided by financing activities was $69.3 million and $19.5 million
for the nine months ended September 30, 1999 and 1998, respectively. Cash
provided by financing activities for the nine months ended September 30, 1999
consisted primarily of $70.7 million in net proceeds from our initial public
offering, partially offset by principal repayments on capital lease
obligations.
As of September 30, 1999, we had $70.6 million of cash, cash equivalents and
short-term investments. Our principal commitments consisted of obligations
under operating and capital leases. These leases were used primarily to equip
our data centers and to expand our existing facilities. Pursuant to an
agreement with America Online we may be obligated to pay them quarterly fees
totaling at least $10.0 million during the three years following their
delivery of certain specified demographic data to us. However, we are
uncertain as to when, if ever, the demographic data may be made available to
us.
We expect to substantially increase our capital expenditures and lease
commitments consistent with our anticipated growth in operations,
infrastructure and personnel. We currently anticipate that we will continue
to experience significant growth in our operating expenses for the
foreseeable future and that our operating expenses will be a material use of
our cash resources. We believe that our existing cash, cash equivalents and
short-term investments will be sufficient to meet our anticipated cash needs
for working capital and capital expenditures for at least the next twelve
months. Thereafter, cash generated from operations, if any, may not be
sufficient to satisfy our liquidity requirements. We may therefore need to
sell additional equity or raise funds by other means. Any additional
financing, if needed, might not be available on reasonable terms or at all.
Failure to raise capital when needed could seriously harm our business and
operating results. If we raise additional funds through the issuance of
equity securities, the percentage of ownership of our current stockholders
would be reduced. Furthermore, these equity securities might have rights,
preferences or privileges senior to our common stock.
POTENTIAL YEAR 2000 RISKS MAY ADVERSELY AFFECT OUR BUSINESS
15
ADFORCE, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONT'D)
Many computer systems and software products are coded to accept only two
digit entries in the date code field. These date code fields will need to
accept four-digit entries to distinguish between 21st century and 20th
century dates. As a result, many companies' software and computer systems may
need to be upgraded or replaced to comply with these Year 2000 requirements.
In the ordinary course of our business, we have evaluated the internally
developed software included in our ad management and delivery system, and
believe this software is generally Year 2000 compliant, meaning that the use
or occurrence of dates on or after January 1, 2000 will not materially affect
the performance of this software or the ability of this software to correctly
create, store, process and output data involving dates. In the third quarter
of 1999, we implemented internal Year 2000 testing procedures for our
software, and believe the software to be Year 2000 compliant. Although such
testing is substantially complete, our efforts will continue in order to
provide ourselves reasonable assurance that all existing and future software
is Year 2000 compliant. We expect the costs of continuing our testing efforts
will be immaterial for the remainder of the year. During the course of such
testing, we may learn that our software does not contain all of the necessary
software routines and codes necessary for the accurate calculation, display,
storage and manipulation of data involving dates. We have warranted to some
of our customers that Year 2000 compliance issues will not adversely affect
the performance of our ad management and ad delivery services. If our
customers experience Year 2000 problems with our services, they could assert
claims against us for damages. Our standard service agreements provide
performance warranties, and we may need to incur costs to address Year 2000
problems that our customers encounter through the use of our services. To
date we have not received any Year 2000 related claims regarding our services.
We are also working with our external suppliers and service providers with
respect to both third-party applications in our ad management and delivery
system and third-party applications in our information technology
infrastructure to ensure that these third-party systems and applications will
be able to interoperate with our hardware and software infrastructure where
necessary and support our needs into the year 2000. We typically use
industry-standard third-party hardware and software. Where possible, we are
seeking assurances from our suppliers that we believe are critical to our
business that their products are Year 2000 compliant. While we have received
assurances as to the Year 2000 compliance of some of these third-party
products, we generally do not have any contractual rights with these
providers if their software or hardware fails to function due to Year 2000
issues. If these failures do occur, we may incur unexpected expenses to
remedy any problems, including purchasing replacement hardware and software.
Though we will continue these efforts, we do not believe we have significant
Year 2000 issues within our systems or services. Because we believe we are
Year 2000 compliant, we have not engaged any third parties to independently
verify our Year 2000 readiness, nor have we assessed potential costs
associated with Year 2000 risks or made any contingency plans to address
these risks. Further, we have not deferred any of our ongoing development
efforts to address Year 2000 issues. However, unanticipated costs associated
with any Year 2000 compliance may exceed our present expectations, which
could materially and adversely affect our quarterly and annual results of
operations.
We depend on the uninterrupted availability of the Internet infrastructure to
conduct our business as a centralized ad delivery and management service. We
also rely on the continued operations of our customers, in particular Web
sites hosting advertisements, for our revenue. We are heavily dependent upon
the success of Year 2000 compliance efforts of the many service providers
that support the Internet, and the Year 2000 compliance efforts of our
customers. Interruptions in the Internet infrastructure affecting us or our
customers, or failure of the Year 2000 compliance efforts of one or more of
our customers, could materially and adversely affect our ability to generate
revenue. The purchasing patterns of advertisers and agencies could be
affected by Year 2000 issues as companies expend significant resources to
correct their current systems for the year 2000; these expenditures may
result in reduced funds available for Internet advertising, which could in
turn materially and adversely affect our ability to generate revenue.
OTHER FACTORS AFFECTING OPERATING RESULTS, LIQUIDITY AND CAPITAL RESOURCES.
16
ADFORCE, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONT'D)
FAILURE TO COMPLETE THE MERGER WITH CMGI COULD NEGATIVELY IMPACT THE MARKET
PRICE OF OUR COMMON STOCK AND OUR OPERATING RESULTS.
If the merger with CMGI is not completed for any reason, we may be subject to
a number of material risks, including:
- - we may be required to pay CMGI a termination fee of $15 million and/or
reimburse CMGI for expenses of up to $500,000;
- - AdForce stockholders may experience dilutive effects to their stock
ownership because an option to acquire up to 19.9% of the outstanding
shares of our common stock granted to CMGI may become exercisable;
- - the market price of our common stock may decline to the extent that the
current market price of our common stock reflects a market assumption that
the merger will be completed; and
- - costs related to the merger, such as legal and accounting fees, must be
paid even if the merger is not completed.
If the merger with CMGI is terminated and our board of directors seeks
another merger or business combination, you cannot be certain that we will be
able to find a partner willing to pay an equivalent or more attractive price
than the price to be paid by CMGI in the merger. In addition, CMGI's option
to acquire up to 19.9% of the outstanding shares of our common stock which
may become exercisable upon termination of the Agreement and Plan of Merger
may impede an alternative merger or business combination.
OUR CUSTOMERS MAY DELAY OR CANCEL ORDERS AS A RESULT OF CONCERNS OVER THE
MERGER WITH CMGI.
The announcement and closing of the merger with CMGI could cause our
customers and our potential customers to delay or cancel contracts for
services as a result of customer concerns and uncertainty over service
evolution, integration and support over CMGI's or our services. Such a delay
or cancellation of orders could have a material adverse effect on our
business, operating results and financial condition.
OUR LIMITED OPERATING HISTORY MAKES IT DIFFICULT TO PREDICT FUTURE RESULTS OF
OPERATIONS AND TO ADDRESS RISKS AND UNCERTAINTIES
We incorporated in January 1996 and have a limited operating history. You
should consider the risks and difficulties frequently encountered by early
stage companies in new and rapidly evolving markets, particularly those
companies whose businesses depend on the Internet. These risks and
difficulties include our inability to predict future results of operations
accurately due to our lack of operating history and the unavailability of
comparable business models. We cannot assure you that our business strategy
will be successful or that we will address these risks and difficulties
successfully.
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE, WHICH COULD AFFECT THE MARKET
PRICE OF YOUR SHARES
Our quarterly results of operations have varied in the past. You should not
rely on quarter-to-quarter comparisons of our results of operations as an
indication of our future performance. It is likely that in future periods our
results of operations will be below the expectations of securities analysts
and investors. If so, the market price of your shares would likely decline.
Our revenue and quarterly results of operations depend on a variety of
factors, many of which are beyond our control. These factors include:
- - the timing and costs of improvements in our ad management and delivery
infrastructure, including the addition of more capacity;
17
ADFORCE, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONT'D)
- - our ability to satisfy and retain our existing customers;
- - any loss of existing customers due to consolidation in the industry;
- - the ability of our existing customers to maintain or increase their
Internet traffic or market share;
- - our ability to expand our customer base and the timing of new customers
commencing service with us;
- - changes in our pricing policies or those of our competitors resulting from
competitive pressures;
- - our ability to provide reliable and scalable service, including our ability
to avoid potential system failure;
- - the announcement or introduction of new technology or services by us or our
competitors, including database marketing capabilities;
- - seasonal trends in our business; and
- - general economic and market conditions
We expect to continue to make significant capital expenditures as we increase
the capacity and reliability of our existing technology infrastructure and
data centers. We also intend to open additional ad management and delivery
centers. We intend to continue to allocate a large portion of our budget for
research and development. Due to our operating costs being relatively fixed,
we would likely be unable to adjust spending quickly enough to offset any
unexpected revenue shortfall. If we have a shortfall in revenue relative to
our expenses, our quarterly and annual results of operations would be
materially and adversely affected, which in turn could affect the market
price of your shares.
WE HAVE A HISTORY OF LOSSES AND EXPECT FUTURE LOSSES
We expect to continue to incur net losses on a quarterly and annual basis for
at least the next two years. If our revenue does not grow or grows more
slowly than we anticipate, or if our operating or capital expenditures exceed
our expectations and cannot be reduced, our quarterly and annual results of
operations will be materially and adversely affected. We incurred net losses
of $3.5 million for the period from January 16, 1996 (inception) to December
31, 1996, $5.7 million for 1997, $15.6 million for 1998, $5.0 million for the
three months ended March 31, 1999, $5.2 million for the three months ended
June 30, 1999 and $6.5 million for the three months ended September 30, 1999.
We expect to continue to incur significant operating expenditures, and
capital expenditures of at least $6.0 million, for the remainder of 1999. As
a result, we will need to generate significantly greater revenue than we have
generated to date to achieve and maintain profitability. We expect that
future revenue growth, if any, will not be as rapid as in recent periods. We
may never achieve profitability on a quarterly or an annual basis.
WE DEPEND ON A SMALL NUMBER OF CUSTOMERS FOR OUR REVENUE, THE LOSS OF ANY OF
WHICH WOULD ADVERSELY AFFECT OUR ABILITY TO GENERATE REVENUE
We continue to derive a substantial portion of our net revenue from a small
number of Web sites and ad rep firms. Our quarterly and annual results of
operations would be materially and adversely affected by the loss of any of
these customers or any significant reduction in net revenue generated from
these customers. Our customer agreements can generally be terminated at any
time with little or no penalty.
Our three largest customers for each quarter of 1998 represented 94%, 81%,
60% and 63% of our net revenue. In the first, second and third quarter of
1999, four of our customers, 24/7 Media, AdSmart, GeoCities and Netscape,
accounted for approximately 77%, 72% and 74% of our net revenue. GeoCities
was acquired by Yahoo!, Inc.
18
ADFORCE, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONT'D)
during the second quarter of 1999 and discontinued in June 1999 the use of
AdForce's ad-serving services for the majority of its ads. GeoCities
accounted for 20%, 12% and 3% of our net revenues during the quarters ended
March 31, 1999, June 30, 1999, and September 30, 1999, respectively. Netscape
was acquired by America Online during the first quarter of 1999, and advised
us in October 1999 of its intent to transition Netscape's domestic and
European Netcenter advertising serving (which represent the substantial
majority of our business with Netscape) from AdForce to America Online's
internal system following the expiration on November 22, 1999 of our current
contract with Netscape. Netscape accounted for 12%, 10% and 20% of our net
revenues during the quarters ended March 31, 1999, June 30, 1999, and
September 30, 1999, respectively. In addition, 24/7 Media has stated that it
is currently developing and implementing an internal ad delivery technology
that is intended to serve as its sole ad delivery solution, and that they
expect to deploy this system in the fourth quarter of 1999. It has also
stated that, unless and until the development of and transition to its own ad
delivery technology is complete, it will be primarily dependent on us to
deliver ads to its networks and Web sites. 24/7 Media accounted for 23%, 29%
and 24% of our net revenues during the quarters ended March 31, 1999, June
30, 1999, and September 30, 1999, respectively.
CONSOLIDATION IN THE INTERNET INDUSTRY MAY ADVERSELY AFFECT OUR ABILITY TO
RETAIN OUR PRINCIPAL CUSTOMERS, THE LOSS OF ANY OF WHICH WOULD ADVERSELY
AFFECT OUR ABILITY TO GENERATE REVENUE
Many of our principal customers are now and may in the future be affected by
rapid consolidation in the Internet industry. Our quarterly and annual
results of operations would be materially and adversely affected if we lose
any of these customers as a result of consolidation or if our customers are
required to use the proprietary ad delivery technologies of the companies
that acquire them or other ad delivery technologies. For example, in May
1999, one of our major customers, GeoCities, was acquired by Yahoo! which
transitioned GeoCities' advertisement-serving requirements to its internal
system in June 1999. In addition, Netscape was acquired by America Online
during the first quarter of 1999, and advised us in October 1999 of its
intent to transition Netscape's domestic and European Netcenter advertising
serving (which represent the substantial majority of our business with
Netscape) from AdForce to America Online's internal system following the
expiration on November 22, 1999 of our current contract with Netscape.
WE MAY NOT BE ABLE TO SCALE OUR TECHNOLOGY INFRASTRUCTURE, WHICH WOULD
ADVERSELY AFFECT OUR ABILITY TO RETAIN OUR EXISTING CUSTOMERS AND TO ATTRACT
NEW CUSTOMERS
Our technology infrastructure may not be able to support higher volumes of
ads, additional customers or new types of advertising or direct marketing. If
we are not able to continue scaling our technology infrastructure, we may
have difficulty retaining existing customers and attracting new customers. If
our traffic increases because of heightened demand from existing or new
customers, we will need to accommodate large increases in the number of ads
that we manage and deliver and the amount of data that we store. We will also
need to support the introduction of new and evolving types of advertising and
direct marketing that require greater system resources than current methods
of Internet advertising. We may not be able to continue to scale our data
centers on time or within budget. The uninterrupted performance of our data
centers is critical to our success. We expect to add more data centers to
improve redundancy and to increase capacity. Adding capacity will be
expensive, and we may not be able to do so successfully. In addition, we
cannot assure you that we will be able to protect our new or existing data
centers from unexpected events as we scale our systems.
WE MAY NOT BE ABLE TO RESPOND TO RAPID TECHNOLOGICAL CHANGE, WHICH COULD
ADVERSELY AFFECT OUR ABILITY TO RETAIN OUR EXISTING CUSTOMERS AND TO ATTRACT
NEW CUSTOMERS
We may not be able to improve our technology infrastructure to respond to
technological change, changes in customer requirements or preferences, or new
industry standards. We must be able to continue to steadily increase our
system capacity, improve our existing services, and introduce new service
offerings without interrupting or interfering with our operations, and we
must be able to do so in a timely and cost-effective manner. We must ensure
19
ADFORCE, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONT'D)
that our technology infrastructure is flexible enough to accommodate
technology advancements, including our ability to deliver ads to a customer
base that uses multiple browsers and multiple versions of those browsers. We
must also ensure that our technology infrastructure is flexible enough to
accommodate new customer requirements and preferences.
WE MAY NOT BE ABLE TO ATTRACT AD AGENCIES AND ADVERTISERS AS CUSTOMERS, WHICH
COULD CAUSE US TO MISS OUR FINANCIAL PROJECTIONS OR THOSE OF SECURITIES
ANALYSTS
If we fail to continue to attract advertisers and ad agencies as customers or
do so more slowly than we anticipate, we may not meet our financial
projections or those of securities analysts. Individual advertisers and ad
agencies accounted for less than 7% of our net revenue for the nine months
ended September 30, 1999. The service and support requirements of advertisers
and ad agencies are significantly different from those of Web sites and ad
rep firms, and advertisers and ad agencies may not accept third-party
Internet ad management and delivery services or may not choose our services
over those offered by others. Moreover, advertisers and ad agencies may find
Internet advertising services to be too complex, ineffective or otherwise
unsatisfactory for managing and delivering their ad campaigns.
WE MAY NOT COMPETE SUCCESSFULLY IN THE MARKET FOR INTERNET AD MANAGEMENT AND
DELIVERY SERVICES, WHICH WOULD ADVERSELY AFFECT OUR ABILITY TO RETAIN OUR
EXISTING CUSTOMERS AND TO ATTRACT NEW CUSTOMERS
The market for Internet ad management and delivery services is extremely
competitive, and we expect this competition to increase. Our ability to
compete successfully in this market depends on many factors, including:
- - the performance, reliability, ease of use and price of services that we or
our competitors offer;
- - market acceptance of centralized, outsourced ad management and delivery
systems as compared to internally-developed or site-specific software and
hardware solutions;
- - our ability, relative to our competitors, to scale our technology
infrastructure as our customer needs grow;
- - timeliness and market acceptance of new services and enhancements to
existing services introduced by us or our competitors; and
- - customer service and support efforts by us or our competitors.
The market for Internet ad management and delivery services is subject to
intense competition as companies attempt to establish a market presence. We
expect that competition will increase as industry consolidation causes
certain early entrants in the marketplace to merge or be acquired. For
example, DoubleClick, Inc has acquired NetGravity, Inc. We have in the past
and may in the future be forced to reduce the prices for our services in
order to compete, which could materially and adversely affect our net revenue
and gross margins.
We currently compete with providers of outsourced ad services, including
DoubleClick, MatchLogic and Real Media, as well as providers of ad server
software and hardware solutions such as NetGravity. Many of our current
competitors have substantially greater resources and more developed sales and
marketing strategies than we do. We cannot assure you that we will be able to
compete effectively against such competitors now or in the future.
Another principal source of competition is Web sites that use
internally-developed Internet advertising and direct marketing services.
These Web sites include America Online, one of our principal stockholders,
and Yahoo!. As indicated above, Yahoo! has acquired GeoCities, and America
Online has acquired Netscape, another of our major customers. 24/7 Media,
another of our principal customers, acquired its own ad management and
delivery technology in 1998, and currently uses this technology to serve a
portion of its advertising needs. In addition, 24/7 Media has stated that it
is currently developing and implementing an internal ad delivery technology
that is intended to serve as its sole ad delivery solution, and that they
expect to deploy this system in the fourth quarter of 1999. It has also
stated that, unless and until the development of and transition to its own ad
delivery technology is complete, it will be primarily dependent on us to
deliver ads to its networks and Web sites. If 24/7 Media ceases doing
20
ADFORCE, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONT'D)
business with us or enters into competition with us, it would materially and
adversely affect our business, results of operations and financial condition.
Finally, a fourth major customer, 2CAN Media, was acquired by AdSmart, a
subsidiary of CMGI, earlier this year. CMGI also owns Engage Technologies,
which in turn owns Accipiter, a supplier of ad server software and equipment
services. If AdSmart transitions its business from us to Engage/Accipiter, it
would materially and adversely affect our business, results of operations and
financial condition.
We may also encounter a number of potential new competitors that have longer
operating histories, greater name recognition, larger customer bases and
significantly greater financial, technical and marketing resources than we
do. These qualities may allow them to respond more quickly than we can to new
or emerging technologies and changes in customer requirements. It may also
allow them to devote greater resources than we can to the development,
promotion and sale of their products and services. These competitors might
also engage in more extensive research and development, undertake more
far-reaching marketing campaigns, adopt more aggressive pricing policies and
make more attractive offers to existing and potential employees, strategic
partners, advertisers and Web sites. If such companies decided to enter the
market, we cannot assure you that we would be able to compete against them
effectively.
MANY OF OUR CUSTOMERS HAVE LIMITED OPERATING HISTORIES, ARE UNPROFITABLE AND
MAY NOT BE ABLE TO PAY FOR OUR SERVICES, WHICH COULD ADVERSELY AFFECT OUR
ABILITY TO RECOGNIZE REVENUE FROM THESE CUSTOMERS
Many of our leading customers, including 24/7 Media and AdSmart, have limited
operating histories and have not achieved profitability. If one or more of
our customers is unable to pay for our services, or pays more slowly than we
anticipate, our quarterly and annual results of operations could be
materially and adversely affected. You should evaluate the ability of our
customers to meet their payment obligations to us in light of the risks,
expenses and difficulties encountered by companies with limited operating
histories, particularly in the evolving Internet market. In the past, some of
our customers have failed to pay for our services on a timely basis.
WE MAY EXPERIENCE SYSTEM FAILURES OR DELAYS THAT WOULD ADVERSELY AFFECT OUR
OPERATIONS, WHICH COULD LEAD TO CUSTOMER DISSATISFACTION
Our operations depend on our ability to protect our computer systems against
damage from fire, water, power loss, telecommunications failures, computer
viruses, vandalism and other malicious acts, and similar unexpected adverse
events. In the past, interruptions or slowdowns in our services have resulted
from the failure of our telecommunications providers to supply the necessary
data communications capacity in the time frame we require, as well as from
deliberate acts. Unanticipated problems affecting our systems could in the
future cause interruptions or delays in our services. Slow response times or
system failures could also result from straining the capacity of our software
or hardware due to an increase in the volume of advertising delivered through
our servers. Our customers may become dissatisfied by any system failure or
delay that interrupts our ability to provide service to them or slows our
response time.
WE MAY NOT BE ABLE TO TARGET ADVERTISEMENTS, WHICH COULD ADVERSELY AFFECT OUR
ABILITY TO RETAIN OUR EXISTING CUSTOMERS AND TO ATTRACT NEW CUSTOMERS
We may not be able to continue to meet the needs of our customers or the
marketplace for more sophisticated targeting solutions. As more advertisers
demand targeting solutions, we will need to develop increasingly effective
tools and larger databases that can provide greater demographic precision in
ad management and delivery. The development of these tools and databases is
technologically challenging and expensive. We cannot assure you that we can
develop any of these tools or databases in a cost-effective and timely
manner, if at all. Moreover, privacy concerns may cause a reduction or
limitation in the use of user information, which could limit the
effectiveness of our technology and adversely affect our ability to retain
our existing customers and to attract new customers.
21
ADFORCE, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONT'D)
THE INTERNET ADVERTISING MARKET MAY FAIL TO DEVELOP OR DEVELOP MORE SLOWLY
THAN EXPECTED, WHICH COULD ADVERSELY AFFECT OUR ABILITY TO RETAIN OUR
EXISTING CUSTOMERS AND TO ATTRACT NEW CUSTOMERS
The Internet advertising market may fail to develop or develop more slowly
than expected. Our future growth largely depends on the continued growth in
Internet advertising generally, and on the willingness of our potential
customers to outsource their Internet advertising and direct marketing needs.
Companies doing business on the Internet must compete with traditional media,
including television, radio, cable and print, for a share of advertisers'
total advertising budgets. Advertisers may be reluctant to devote a
significant portion of their advertising budgets to Internet advertising if
they perceive the Internet to be a limited or ineffective advertising medium.
Substantially all of our revenue is derived from the delivery of
advertisements placed on Web sites. If advertisers determine that those ads
are ineffective or unattractive as an advertising medium, we may be unable to
make the transition to any other form of Internet advertising. Also, there
are filter software programs that limit or prevent advertising from being
delivered to a user's computer. The commercial viability of Internet
advertising would be materially and adversely affected by Internet users'
widespread adoption of these software programs.
THE INTERNET INFRASTRUCTURE MAY NOT BE ABLE TO ACCOMMODATE RAPID GROWTH,
WHICH COULD ADVERSELY AFFECT OUR ABILITY TO RETAIN OUR EXISTING CUSTOMERS AND
TO ATTRACT NEW CUSTOMERS
The Internet infrastructure may fail to support the growth of the Internet.
If the Internet continues to experience an increase in users, an increase in
frequency of use or an increase in the capacity requirements of users, we
cannot assure you that the Internet infrastructure will be able to support
the demands placed on it. Any actual or perceived failure of the Internet
could undermine the benefits of our services. In addition, the Internet could
lose its viability as a commercial medium due to delays in the development or
adoption of new technology required to accommodate increased levels of
Internet activity or due to increased government regulation. Changes in, or
insufficient availability of, telecommunications services to support the
Internet could result in slower response times and could hamper use of the
Internet. Even if the Internet infrastructure is able to accommodate rapid
growth, we may be required to spend heavily to adapt to new technologies.
WE MAY NOT BE ABLE TO RETAIN KEY PERSONNEL, AND OUR MANAGEMENT TEAM MAY NOT
WORK TOGETHER SUCCESSFULLY
Our future success depends on the continued service of our key technical,
sales and senior management personnel and their ability to execute our growth
strategy. Competition is intense for qualified personnel, particularly
technical and engineering personnel, and at times we have experienced
difficulties in retaining current personnel and attracting new personnel.
Further, current and prospective AdForce employees may experience uncertainty
about their future roles with CMGI. This uncertainty may adversely affect our
ability to attract and retain key management, sales, marketing and technical
personnel.
WE MAY NOT BE ABLE TO SUCCESSFULLY MANAGE THE CONSOLIDATION OF OUR
ENGINEERING STAFF, WHICH COULD LEAD TO PRODUCT DEVELOPMENT DELAYS AND
DISRUPTIONS IN SERVICE
Our engineering personnel are currently located in two separate locations,
Costa Mesa, California and Cupertino, California. In August 1999, we
commenced efforts to consolidate many of our engineering personnel into our
Cupertino, California location. We expect this consolidation to be
substantially complete by December 31, 1999. This consolidation will divert
management time and resources. During the course of this consolidation
effort, we may be less efficient in our product development efforts, and
could therefore experience delays in releasing new products. Further, this
transition could increase the risk of service disruptions. These delays and
disruptions, if they occur, could adversely affect our ability to retain our
existing customers and to attract new customers. Additionally, engineering
personnel may choose not to remain in our employment as a result of this
consolidation.
22
ADFORCE, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONT'D)
WE MAY NOT BE ABLE TO MANAGE OUR GROWTH, WHICH COULD ADVERSELY AFFECT OUR
ABILITY TO MANAGE OUR BUSINESS
During the third quarter of 1999 we continued to expand our research and
development, data center operations, sales, marketing and customer service
organizations, and increased our total number of employees from 146 as of
June 30, 1999 to 162 as of September 30, 1999. We may not be able to continue
to manage our internal growth effectively to keep pace with the expansion of
the Internet advertising market or our competitors' growth. Our rapid growth
has placed, and the anticipated future growth in our operations will continue
to place, a significant strain on our management systems and resources. We
expect that we will need to continue to improve our financial and managerial
controls and reporting systems and procedures, and will need to continue to
expand, train and manage our workforce.
WE MAY NOT BE ABLE TO PROTECT OUR TECHNOLOGY, WHICH COULD DIMINISH THE VALUE
OF OUR TECHNOLOGY AND OUR SERVICES
Our success and ability to compete are dependent on our internally developed
technologies and trademarks. If our proprietary rights are infringed by a
third party, the value of our services to our customers would be diminished
and additional competition might result from the third party's use of those
rights. We cannot assure you that our patent applications or trademark
registrations will be approved. Even if they are approved, our patents or
trademarks may be successfully challenged by others or invalidated. If our
trademark or copyright registrations are not approved because third parties
own those trademarks or copyrights, our use of these trademarks and/or
copyrighted materials would be restricted unless we entered into arrangements
with the third-party owners, which might not be possible on reasonable terms.
We cannot assure you that any of our proprietary rights will be viable or of
value since the validity, enforceability and scope of protection of
proprietary rights in Internet-related industries are uncertain and evolving.
We also cannot assure you that the steps we have taken will prevent
misappropriation of our solutions or technologies, particularly in foreign
countries where laws or law enforcement practices may not protect our
proprietary rights as fully as in the United States.
THIRD PARTIES MAY ASSERT INFRINGEMENT CLAIMS AGAINST US OR OUR CUSTOMERS,
WHICH COULD RESULT IN LIABILITY FOR DAMAGES, THE INVALIDATION OF OUR RIGHTS
OR THE DIVERSION OF OUR TIME AND ATTENTION
Third parties may assert infringement claims against us or our customers
based on our technology or our collection of user data. Any claims or
litigation, if they occur, could subject us to significant liability for
damages or could result in invalidation of our rights. Even if we were to
prevail, litigation could be time-consuming and expensive to defend, and
could result in diversion of our time and attention. Any claims or litigation
from third parties might also limit our ability to use the proprietary rights
subject to these claims or litigations.
OUR CONTRACTUAL RELATIONSHIP WITH AMERICA ONLINE COULD LEAD TO A DIVERSION OF
OUR DEVELOPMENT RESOURCES AND THE OBLIGATION TO PAY AMERICA ONLINE A LARGE
SUM OF MONEY
We have granted to America Online and its affiliates a royalty-free,
perpetual license to our ad management and delivery technology, including
source and object code, and any improvements to it that we make generally
available to our customers. Under the terms of this license agreement,
America Online could also require us to customize a version of our technology
for the exclusive use of America Online and its affiliates. We are obliged
under the license agreement to provide these services for an indefinite
period of time with little potential for significant profit, which could
significantly strain our development resources. We have also entered into a
demographic data agreement with America Online. Under the terms of this
agreement, America Online may elect to make demographic information available
to us at any time within three years, triggering substantial payment
obligations from us even if we do not use this information and even if we
have contracted to obtain similar information from an alternative source. If
America Online makes the demographic data available to us and then later
limits or denies access to the demographic information or significantly
changes its advertising or privacy policies, our ability to
23
ADFORCE, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONT'D)
market our technology and services with enhanced targeting abilities and to
generate additional revenue could be severely limited.
GOVERNMENT REGULATION OF THE INTERNET MAY INHIBIT THE COMMERCIAL ACCEPTANCE
OF THE INTERNET
New legislation regulating the Internet could inhibit the growth of the
Internet and decrease the acceptance of the Internet as a communications and
commercial medium. The applicability to the Internet of existing laws
governing issues such as property ownership, libel and personal privacy is
uncertain. Governmental authorities may seek to further regulate the Internet
with respect to issues such as user privacy (including tracking, targeting
and profiling users), pornography, acceptable content, electronic commerce,
taxation, and the pricing, characteristics and quality of products and
services.
POTENTIAL YEAR 2000 RISKS MAY ADVERSELY AFFECT OUR BUSINESS
There is significant uncertainty in the software industry regarding the
potential effects associated with Year 2000 compliance issues. We depend
heavily on the uninterrupted availability of the Internet infrastructure to
conduct our business as a centralized management and delivery service. We
also rely heavily on the continued operations of our customers, in particular
Web sites hosting advertisements, for our revenue. We are thus dependent upon
the success of the Year 2000 compliance efforts of the many service providers
that support the Internet, and the Year 2000 compliance efforts of our
customers. Interruptions in the Internet infrastructure affecting us or our
customers, or the failure of the Year 2000 compliance efforts of one or more
of our customers, could have a material adverse effect on our quarterly and
annual results of operations.
We are currently evaluating our internally developed software included in our
ad management and delivery system, and believe that this software is
generally Year 2000 compliant, meaning that the use of dates on or after
January 1, 2000 will not materially affect the performance of this software
or the ability of this software to correctly create, store, process and
output data involving dates. We are currently working with our external
suppliers and service providers to ensure that third-party systems and
applications will be able to interoperate with our hardware and software
infrastructure where necessary and support our needs into the year 2000. We
are also seeking contractual assurances from our suppliers that their systems
and services are Year 2000 compliant. To date, we have not made any
contingency plans to address risks of non-compliance, and cannot assure you
that there will not be unanticipated costs associated with any Year 2000
compliance.
WE MAY NOT HAVE ENOUGH CAPITAL TO CONTINUE TO EXECUTE OUR BUSINESS
OBJECTIVES, WHICH COULD ADVERSELY AFFECT OUR ABILITY TO MEET OUR FINANCIAL
PROJECTIONS OR THOSE OF SECURITIES ANALYSTS
We may need to raise additional funds, and we cannot be certain that we would
be able to obtain additional financing on favorable terms, if at all. We are
devoting at least an additional $5 million to our data center facilities in
Costa Mesa and Cupertino, California during the remainder of 1999, and will
need to continue to devote additional resources as we establish new ad
management and delivery centers. We also expect to make significant
investments in sales and marketing and the development of new services. The
failure to generate sufficient cash flows or to raise sufficient funds to
finance growth could require us to delay or abandon some or all of our plans
or forego new market opportunities, making it difficult for us to respond to
competitive pressures. If we issue equity securities to raise funds, our
stockholders will be diluted. The holders of the new equity securities may
also have rights, preferences or privileges senior to those of existing
holders of common stock.
THE PRICE OF OUR COMMON STOCK IS LIKELY TO BE VOLATILE AND SUBJECT TO WIDE
FLUCTUATIONS, AND WE COULD BE SUBJECT TO SECURITIES LITIGATION
The market price of our common stock has been and is likely to continue to be
subject to wide fluctuations. If our revenue does not grow or grows more
slowly than we anticipate, or if operating or capital expenditures exceed our
24
ADFORCE, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONT'D)
expectations or cannot be adjusted accordingly, the market price of our
common stock could fall. In addition, if the market for Internet-related
stocks or the stock market in general experiences a loss in investor
confidence, the market price of our common stock could fall for reasons
unrelated to our business or results of operations. Investors may be unable
to resell their shares of our common stock at or above the offering price. In
the past, companies that have experienced volatility in the market price of
their stock have been the subject of securities class action litigation. If
we were the subject of litigation, it could result in substantial costs and a
diversion of management's attention and resources.
PROVISIONS IN OUR CHARTER DOCUMENTS MAY DETER ACQUISITION BIDS FOR ADFORCE,
WHICH COULD ADVERSELY AFFECT THE MARKET PRICE OF YOUR SHARES
We have adopted a classified board of directors. In addition, our
stockholders are unable to act by written consent or to fill any vacancy on
the board of directors. Our stockholders cannot call special meetings of
stockholders to remove any director or the entire board of directors without
cause. These provisions and other provisions of Delaware law could make it
more difficult for a third party to acquire us, even if doing so would
benefit our stockholders.
OUR OFFICERS AND DIRECTORS EXERT SUBSTANTIAL INFLUENCE OVER ADFORCE, WHICH
COULD LIMIT YOUR ABILITY TO INFLUENCE ADFORCE AND WHICH COULD DELAY OR
PREVENT A CHANGE OF CONTROL OF ADFORCE
As of September 30, 1999, our executive officers, our directors and entities
affiliated with them and our 5% stockholders beneficially owned, in the
aggregate, approximately 62% of our outstanding common stock. These
stockholders may be able to exercise substantial influence over all 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 AdForce.
FUTURE SALES OF SHARES BY EXISTING STOCKHOLDERS COULD ADVERSELY AFFECT THE
MARKET PRICE OF YOUR SHARES
Sales of a substantial number of shares of our common stock in the public
market by our stockholders could depress the market price of our common stock
and could impair our ability to raise capital through the sale of additional
equity securities.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We provide our ad management and delivery services to companies in North
America, Europe and Asia. As a result, our financial results could be
affected by various factors, including changes in foreign currency exchange
rates or weak economic conditions in foreign markets. As all sales are
currently made in U.S. dollars, a strengthening of the dollar could make our
services less competitive in foreign markets.
Our investment policy requires us to invest funds in excess of current
operating requirements in obligations of the U.S. government and its agencies
and investment grade obligations of state and local governments and U.S.
corporations. Our interest income is sensitive to changes in the general
level of U.S. interest rates, particularly since the majority of our
investments are in short-term instruments. Due to the nature of our
short-term investments, we have concluded that there is no material market
risk exposure.
25
ADFORCE, INC.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In April 1999, Dirk Wray, a Company director, filed an action against Chad
Steelberg, a Company founder, in the Orange County, California Superior Court
alleging that Mr. Steelberg failed to perform certain obligations pursuant to
a 1996 agreement between Messrs. Wray and Steelberg.
In June 1999, Mr. Steelberg filed a cross-complaint (the "Cross-Complaint")
against Mr. Wray, certain investors in the Company, the Company and the
Company's President, Chief Executive Officer and Chairman, Charles W. Berger,
claiming the Company is obligated to defend and indemnify Mr. Steelberg
against Mr. Wray's allegations, and seeking additional damages.
The Company believes the causes of action in the Cross-Complaint claimed
against the Company and Mr. Berger are without merit. On October 22, 1999,
the Company and Mr. Berger jointly filed a demurrer to the Cross-Complaint. A
hearing has been set for November 17, 1999. The Company intends to indemnify
Mr. Berger pursuant to the Company's certificate of incorporation, bylaws and
a written indemnification agreement, and to defend itself and Mr. Berger
vigorously.
Except as provided above, the Company is not subject to any material legal
proceedings. The Company may from time to time become a party to various
legal proceedings arising in the ordinary course of business.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) SALES OF REGISTERED SECURITIES AND USE OF PROCEEDS
On May 7, 1999, the Company sold 5,175,000 shares of Common Stock in its
initial public offering at a price of $15.00 per share pursuant to a Form S-1
Registration Statement, No. 333-73231, as amended, which became effective May
7, 1999. The principal underwriters for the offering were Hambrecht and
Quist, LLC, Lehman Brothers, Volpe Brown Whelan & Company and Charles Schwab
& Co., Inc. The Company received gross proceeds from the offering of $77.6
million, $5.4 million of which was deducted for underwriting discounts and
commissions, and the Company paid $1.5 million for other offering expenses,
none of which were paid directly or indirectly to any directors, officers,
persons owning ten percent or more of any class of equity securities of the
Company or any affiliates of the Company. From the effective date of the
Registration Statement through June 30, 1999, the Company invested all of the
proceeds in cash, cash equivalents, and short-term investments. During the
third quarter of 1999 the Company used the funds as follows: approximately
$1.8 million was used for purchases of property, equipment and improvements,
approximately $1.5 million for payments on capital lease obligations, and the
remainder for working capital requirements of the Company, including $3.8
million to fund operating losses.
(c) SALES OF UNREGISTERED SECURITIES
WARRANT EXERCISES
From July to September of 1999, the Company issued Common Stock pursuant to
warrant exercises as follows: 9,360 shares of Common Stock to Robert A.
Kingsbrook pursuant to the net exercise of his warrants (as a result of which
no cash was paid to the Company) to purchase 10,018 shares of the Company's
Common Stock.
The sale of stock pursuant to this warrant exercise was made in reliance on
section 4(2) of the Securities Act of 1933.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
26
ADFORCE, INC.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed as part of this report:
Exhibit 2.1 Agreement & Plan of Merger by and between AdForce,
Inc., CMGI, Inc., and Artichoke Corporation dated
September 20, 1999 which is incorporated by reference
to the Company's report on form 8-k (file no. 0-20124)
filed with the Commission on October 4, 1999.
Exhibit 2.2 Stock Option Agreement between AdForce, Inc. and
CMGI, Inc. dated as of September 20, 1999 which is
incorporated by reference to the Company's report on
form 8-k (file no. 0-20124) filed with the Commission on
October 4, 1999.
Exhibit 4.1 Form of Stockholder Agreement and Irrevocable Proxy
which is incorporated by reference to the Company's
report on form 8-k (file no. 0-20124) filed with the
Commission on October 4, 1999.
Exhibit 10.01* Joint Venture Agreement by and between AdForce,
Inc., SINA.com, and Compuserve Consultants,
Ltd. dated August 31, 1999
Exhibit 27.1 Financial Data Schedule
Exhibit 99.1 Joint Press Release dated September 20, 1999 which is
incorporated by reference to the Company's report on
form 8-k (file no. 0-20124) filed with the Commission on
October 4, 1999.
(b) On October 4, 1999, the Company filed a Form 8-K under Item 5 announcing
that it had entered a definitive Agreement and Plan of Merger with
CMGI, Inc. and Artichoke Corporation.
*Confidential treatment has been requested.
27
ADFORCE, INC.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AdForce, Inc.
(Registrant)
Date: November 12, 1999
By: /s/ John A. Tanner
---------------------------
John A. Tanner
Executive Vice President, Chief
Financial Officer (Duly Authorized
and Principal Financial and Accounting
Officer)
28