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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO __________ .
COMMISSION FILE NO. 0-24833
FUTURELINK CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-4763404
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
2 SOUTH POINTE DRIVE, LAKE FOREST 92630
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(949) 672-3000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock: as of May 11, 2001, 68,874,846 shares of the issuer's common
stock, par value $.0001 per share, were outstanding.
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FUTURELINK CORP.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001
PAGE
----
PART I -- FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements........................... 1
Condensed Consolidated Balance Sheets as of March 31, 2001
and December 31, 2000..................................... 1
Condensed Consolidated Statements of Operations for the
three months ended March 31, 2001 and 2000................ 2
Condensed Consolidated Statements of Stockholders' Equity to
March 31, 2001............................................ 3
Condensed Consolidated Statements of Cash Flows for the
three months ended March 31, 2001 and 2000................ 4
Notes to Condensed Consolidated Financial Statements........ 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 10
Item 3. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 14
PART II -- OTHER INFORMATION
Item 5. Other Information........................................... 20
Item 6. Exhibits and Reports on Form 8-K............................ 20
SIGNATURES........................................................... 22
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PART I
FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
FUTURELINK CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
MARCH 31, DECEMBER 31,
2001 2000
----------- ------------
(UNAUDITED)
Current assets:
Cash and cash equivalents................................. $ 3,109 $ 14,158
Restricted cash........................................... 660 660
Accounts receivable, net.................................. 25,197 25,076
Inventory................................................. 2,495 3,101
Prepaid expenses and other current assets................. 1,185 1,545
--------- ---------
Total current assets.............................. 32,646 44,540
Property and equipment, net................................. 31,386 34,100
Goodwill and other intangibles, net......................... 63,373 68,382
Other assets................................................ 1,662 1,682
--------- ---------
Total assets...................................... $ 129,067 $ 148,704
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Lines of credit........................................... $ 11,502 $ 10,507
Accounts payable and accrued liabilities.................. 29,232 33,049
Current portion of capital lease obligations.............. 10,901 8,116
Deferred revenue.......................................... 1,237 1,504
--------- ---------
Total current liabilities......................... 52,872 53,176
Capital lease obligations, less current portion............. 10,433 14,237
Deferred taxes.............................................. 608 588
--------- ---------
Total liabilities................................. 63,913 68,001
Stockholders' equity:
Preferred stock, no par value, 20,000,000 shares
authorized, 2,571,428 shares of Series A Convertible
Preferred Stock authorized and 1,428,571 shares issued
and outstanding aggregate liquidation preference of
$10,000................................................ 3,394 3,394
Common stock, $.0001 par value, 300,000,000 shares
authorized, 68,874,846 and 68,104,789 shares issued and
outstanding at March 31, 2001 and December 31, 2000,
respectively........................................... 8 8
Common stock issuable; 2,199,965 shares at March 31, 2001
and December 31, 2000.................................. 16,369 16,369
Additional paid-in capital................................ 393,894 393,671
Deferred compensation..................................... (1,073) (1,236)
Cumulative foreign currency translation adjustment........ (1,494) (1,190)
Accumulated deficit....................................... (345,944) (330,313)
--------- ---------
Total stockholders' equity........................ 65,154 80,703
--------- ---------
Total liabilities and stockholders' equity........ $ 129,067 $ 148,704
========= =========
See notes to condensed consolidated financial statements.
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FUTURELINK CORP.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
THREE MONTHS ENDED
MARCH 31,
--------------------------
2001 2000
----------- -----------
(UNAUDITED)
Revenue:
Hardware and software..................................... $ 23,311 $ 17,324
Service delivery.......................................... 12,473 5,320
----------- -----------
35,784 22,644
----------- -----------
Expenses:
Cost of hardware and software............................. 18,657 14,074
Cost of service delivery.................................. 7,702 3,666
Selling, general and administration....................... 15,662 14,426
Goodwill amortization..................................... 5,009 11,783
Depreciation and other amortization....................... 3,117 1,494
----------- -----------
50,147 45,443
----------- -----------
Loss from operations........................................ (14,363) (22,799)
Interest expense.......................................... 1,037 429
Interest income........................................... (138) (226)
----------- -----------
Loss before income taxes.................................... (15,262) (23,002)
Provision for income taxes.................................. 9 118
----------- -----------
Net loss.................................................... $ (15,271) $ (23,120)
Dividends for Series A Convertible Preferred Stock.......... (360) --
Net loss applicable to common stockholders.................. $ (15,631) $ (23,120)
=========== ===========
Loss per share -- basic and diluted......................... $ (0.23) $ (0.42)
=========== ===========
Weighted average shares -- basic and diluted................ 68,304,908 55,369,965
=========== ===========
See notes to condensed consolidated financial statements.
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FUTURELINK CORP.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
ACCUMULATED
PREFERRED STOCK COMMON STOCK COMMON ADDITIONAL OTHER
------------------ ------------------- STOCK PAID-IN DEFERRED COMPREHENSIVE
SHARES AMOUNT SHARES AMOUNT ISSUABLE CAPITAL COMPENSATION LOSS
--------- ------ ---------- ------ -------- ---------- ------------ -------------
BALANCE AT JANUARY 1,
2001............... 1,428,571 $3,394 68,104,789 $8 $16,369 $393,671 $(1,236) $(1,190)
Shares issued to
401(k) plans....... -- -- 770,057 -- -- 223 -- --
Amortization of
employee
stock-based
compensation....... 163
Foreign currency
translation
adjustment......... -- -- -- -- -- (304)
Preferred
dividends..........
Net loss for the
three months ended
March 31, 2001..... -- -- -- -- -- --
--------- ------ ---------- -- ------- -------- ------- -------
BALANCE AT MARCH 31,
2001............... 1,428,571 $3,394 68,874,846 $8 $16,369 $393,894 $(1,073) $(1,494)
========= ====== ========== == ======= ======== ======= =======
TOTAL
ACCUMULATED STOCKHOLDERS' COMPREHENSIVE
DEFICIT EQUITY LOSS
----------- ------------- -------------
BALANCE AT JANUARY 1,
2001............... $(330,313) $ 80,703 $(287,631)
=========
Shares issued to
401(k) plans....... -- 223 --
Amortization of
employee
stock-based
compensation....... 163
Foreign currency
translation
adjustment......... -- (304) (304)
Preferred
dividends.......... (360) (360)
Net loss for the
three months ended
March 31, 2001..... (15,271) (15,271) (15,271)
--------- -------- ---------
BALANCE AT MARCH 31,
2001............... $(345,944) $ 65,154 $(303,212)
========= ======== =========
See notes to condensed consolidated financial statements.
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FUTURELINK CORP.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
--------------------
2001 2000
-------- --------
(UNAUDITED)
OPERATING ACTIVITIES
Net loss.................................................... $(15,271) $(23,120)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................... 8,126 13,277
Deferred income taxes....................................... 20 --
Amortization of deferred compensation....................... 163 (1095)
Common stock, warrants and options issued for services...... 223 2,309
Change in operating assets and liabilities, net of effect of
business acquisitions:
Accounts receivable....................................... (121) (1,239)
Inventory................................................. 606 185
Prepaid expenses.......................................... 360 (1,030)
Deferred offering costs................................... -- (1,781)
Other assets.............................................. 20 (22)
Accounts payable and accrued expenses..................... (4,177) 4,478
Settlement payable........................................ -- (5,000)
Deferred revenues......................................... (267) (161)
-------- --------
NET CASH USED IN OPERATING ACTIVITIES............. (10,318) (13,199)
-------- --------
INVESTING ACTIVITIES
Purchases of property and equipment......................... (403) (444)
Business acquisitions, net of cash balances acquired........ -- (16,439)
Deposits on acquisitions.................................... -- (145)
Decrease in restricted cash................................. -- 961
-------- --------
NET CASH USED IN INVESTING ACTIVITIES............. (403) (16,067)
-------- --------
FINANCING ACTIVITIES
Net cash advanced (paid) under lines of credit.............. 995 (4,196)
Proceeds from exercise of employee stock options............ -- 958
Proceeds from exercise of warrants.......................... -- 18,009
Repayment of capital lease obligations...................... (1,019) (809)
-------- --------
NET CASH (USED IN) PROVIDED BY FINANCING
ACTIVITIES...................................... (24) 13,962
-------- --------
Effect of currency rate changes............................. (304) (486)
-------- --------
Decrease in cash............................................ (11,049) (15,790)
Cash at beginning of period................................. 14,158 19,185
-------- --------
Cash at end of period....................................... $ 3,109 $ 3,395
======== ========
NON CASH INVESTING AND FINANCING ACTIVITIES
Acquisition of businesses;
Assets acquired........................................... $ -- $ 96,349
Liabilities assumed....................................... -- (8,655)
Notes payable issued...................................... -- (7,250)
Common stock and options issued........................... -- (63,249)
-------- --------
Cash paid for acquisitions............................. -- 17,195
Capital lease obligations................................... 140 5,985
Conversion of convertible debt to equity.................... -- 218
SUPPLEMENTAL INFORMATION, CASH PAID FOR:
Interest.................................................... $ 819 $ 429
Income Taxes................................................ 9 118
See notes to condensed consolidated financial statements.
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FUTURELINK CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2001 AND 2000
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
reflect the results of operations for FutureLink Corp. (the "Company") and its
wholly owned subsidiaries and have been prepared in accordance with generally
accepted accounting principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals and
adjustments) considered necessary for a fair presentation have been included.
Operating results for the three-month period ended March 31, 2001 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2001. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's Annual Report on Form
10-KSB for the year ended December 31, 2000 filed with the Securities and
Exchange Commission (SEC) on April 2, 2001. Current and future financial
statements may not be directly comparable to the Company's historical financial
statements.
The Company is a Delaware corporation headquartered in Lake Forest,
California. The Company delivers information technology solutions for customers
who choose to outsource or augment all or part of their information technology
needs. The Company's professional services group provides consulting expertise
in server-based computing, information security, data communications management,
technical staffing and other related services. In connection with its delivery
of these services, the Company also purchases and resells hardware and software
products to its customers for a profit which generates a substantial portion of
the Company's revenue. The Company also is an application service provider, or
ASP, that delivers access to business-critical software applications. The
Company's customers, who pay a monthly fee for this service, connect to the
Company's facilities through the Internet, dedicated telecommunications lines or
by wireless connection.
The Company has prepared its consolidated financial statements under the
assumption that it will continue to operate as a going concern. The Company has
reported net losses of $15.3 million for the three months ended March 31, 2001
and it expects to incur additional losses for the foreseeable future as it
continues to develop and promote its services.
The losses arise in part from non-cash charges for amortization of
intangible assets, which is discussed further in "Management's Discussion and
Analysis of Financial Condition and Results of Operations." The remaining
portion of the accumulated losses are attributable to cash losses that arise
from revenue being insufficient to fund the Company's operating costs and
expenses, including those incurred in the development of its services and
infrastructure, and interest expense. These losses have resulted in the Company
using cash to finance its operations since its inception. As a result of cash
losses to date, the Company had a working capital deficit of approximately $20.2
million at March 31, 2001.
Given the levels of its cash resources and working capital at March 31,
2001, the Company believes that borrowings available under its lease and bank
credit facilities and anticipated cash to be generated by operations will be
insufficient to meet anticipated cash requirements for operations, working
capital, capital expenditures and debt service during 2001. Therefore, the
Company is seeking additional equity or debt financing, but there can be no
assurance that sufficient additional financing will be available on acceptable
terms or at all.
The Company is also taking actions to improve operating results. During
January, February and April 2001, the Company eliminated 61 positions
company-wide. In addition, the Company is continuing to evaluate all aspects of
its operations with a view to reducing operating losses. Alternatives under
consideration include: the elimination or sale of certain operations; the
curtailment of further expenditures for expansion of the ASP
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FUTURELINK CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
THREE MONTHS ENDED MARCH 31, 2001 AND 2000
(UNAUDITED)
business and infrastructure until such time as this service becomes more readily
accepted by the market; a sale of a portion of assets; and further staff and
overhead reductions.
Accordingly, the Company's continued existence is dependent upon its
ability to obtain additional financing, align costs with revenue, and ultimately
achieve and maintain profitable operations.
These matters raise substantial doubt about the Company's ability to
continue as a going concern. The accompanying consolidated financial statements
do not include any adjustments, including those related to the carrying value
and classification of recorded assets or the amounts and classification of
liabilities, that might become necessary when the outcome of the aforementioned
uncertainties are known.
NOTE 2. ACQUISITIONS
MicroLAN Systems, Inc.
On February 29, 2000, the Company acquired MicroLAN Systems, Inc. doing
business as Madison Technology Group, Madison Consulting Resources, Inc. and
Madison Consulting Resources NJ, Inc. The companies were acquired for total
consideration of $57.5 million, consisting of $6.5 million cash, a note payable
in the amount of $7.3 million that was paid in July 2000 and 1,975,170 shares of
common stock valued at $43.7 million. The acquisition was accounted for by the
purchase method of accounting. In connection therewith, $12.4 million of the
purchase price was allocated to assembled workforce and is being amortized over
three years, and $45.2 million of the excess purchase price over the estimated
fair value of net assets acquired was allocated to goodwill.
Vertical Software, Inc.
On January 31, 2000, the Company acquired Vertical Software, Inc. ("VSI"),
a U.S. mid-Atlantic regional provider of system integration and information
technology services for total consideration of $27.6 million consisting of $8.1
million cash and 1,026,316 common shares of the Company's common stock valued at
$19.5 million. The acquisition was accounted for by the purchase method of
accounting, and the excess purchase price of $26.7 million over the estimated
fair value of net assets acquired was allocated to goodwill.
The following pro forma results of operations give effect to the
acquisition of the above companies as if the transactions had occurred January
1, 2000 (dollars in thousands):
THREE MONTHS ENDED
MARCH 31, 2000
------------------
(UNAUDITED)
Revenue............................................ $ 27,131
Net loss........................................... (23,810)
Loss per share..................................... $ (0.43)
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FUTURELINK CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
THREE MONTHS ENDED MARCH 31, 2001 AND 2000
(UNAUDITED)
NOTE 3. GOODWILL AND OTHER INTANGIBLES
Goodwill and other intangible assets are comprised of the following at
March 31, 2001 and December 31, 2000 (in thousands):
MARCH 31, DECEMBER 31,
2001 2000
--------- ------------
Goodwill..................................... $117,018 $117,018
Assembled workforce.......................... 15,166 15,166
-------- --------
Total........................................ 132,184 132,184
Less accumulated amortization................ (68,811) (63,802)
-------- --------
Goodwill and other intangibles............... $ 63,373 $ 68,382
======== ========
NOTE 4. LINES OF CREDIT
In November 2000, the Company entered into a loan and security agreement
with a financial institution for a revolving credit facility of up to $25
million, which was reduced to $15 million pursuant to an April 2001 amendment to
the agreement. The actual amount that the Company is permitted to borrow at any
given time varies based upon a percentage of the Company's U.S. and Canadian
eligible accounts receivable. The Company typically borrows at or near its
capacity under the facility. The maximum amount the Company may borrow against
its Canadian subsidiary's accounts receivable is $2 million. Before it may
borrow against its Canadian subsidiary accounts receivable, however, the Company
first must meet certain conditions of the lender, which the Company is
attempting to satisfy. The credit facility is secured by substantially all of
the assets of the Company and its subsidiaries and by guarantees and a pledge of
a percentage of the shares of those subsidiaries, has an expiration date of
November 30, 2001 and bears interest at prime plus 2% per year. The Company's
weighted average interest rate for the three months ended March 31, 2001 was
9.6%. When it entered into the facility, the Company issued to the financial
institution warrants to purchase up to 100,000 shares of common stock at an
exercise price of $8.40 per share with a term of ten years. These warrants were
valued at $170,000 on the date of grant based on the Black Scholes pricing
model. Such amount was recorded as deferred financing costs and is being
amortized over the term of the loan and security agreement to interest expense.
The additional interest expense for the period ended March 31, 2001 was
approximately $5,000.
Before April 2001, the financial institution providing our $15 million
credit facility waived violations by us of the financial covenant in the loan
agreement requiring us to maintain specified levels of tangible net worth. In
the April 2001 amendment to the credit facility, the tangible net worth covenant
was amended to lower the amount of tangible net worth required under the
agreement. The credit facility prohibits the Company from paying dividends in
cash or other property (other than common stock), except, under certain
circumstances, for cash dividends up to $360,000 in any fiscal quarter to
holders of the Company's Series A Preferred Stock. In addition, because the
Company's aggregate cash balance has fallen below $10 million, the financial
institution sweeps all collections on the Company's receivables into its account
and applies all such collections to reduce borrowings on the facility. This
mechanism has imposed limitations on the Company's ability to manage its cash
disbursements and fund ongoing operations.
A subsidiary of the Company also has a revolving credit facility of up to
$1.7 million with the same financial institution. This facility has the same
terms as the $15 million credit facility. Amounts borrowed under this facility
reduce the available amounts under the $15 million facility. Accordingly, the
maximum amount the Company can borrow under both of these revolving credit
facilities is $15 million.
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FUTURELINK CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
THREE MONTHS ENDED MARCH 31, 2001 AND 2000
(UNAUDITED)
NOTE 5. CAPITAL LEASE OBLIGATIONS
Capital lease obligations consist of the following at March 31, 2001 and
December 31, 2000 (in thousands):
MARCH 31, DECEMBER 31,
2001 2000
--------- ------------
Capital lease obligations, net of original issue
discount of $536 and $599, respectively............ $ 21,334 $22,353
Less current portion................................. (10,901) (8,116)
-------- -------
Long-term portion.................................... $ 10,433 $14,237
======== =======
Capital lease obligations are for the lease of computer hardware and
related infrastructure costs. Aggregate monthly payments are based upon 36 to 60
month amortization periods, including interest implicit in the lease at rates
ranging from 4.3% to 20% per annum. Certain of the leases also contain renewal
and bargain purchase options. The Company also issued to the lessors warrants
valued at $833,000 to acquire 72,599 shares of common stock with exercise prices
ranging from $4.00 to $24.38 per share. The value of such warrants has been
reflected as a discount to the related capital lease obligation and is being
amortized to interest expense over the term of the leases.
NOTE 6. STOCKHOLDERS' EQUITY
On March 8, 2001, 770,057 shares of common stock were issued to the
Futurelink 401(k) plan resulting in a charge of approximately $223,000.
During the quarter ended March 31, 2001, the Company amortized an aggregate
of $163,000 of deferred compensation.
On February 11 and February 29, 2000, warrant holders exercised their
rights to acquire 2,401,041 shares of common stock at an effective price of
$7.50 per share for aggregate net proceeds to the Company of $18.0 million. The
warrants had an adjusted (for anti-dilution) exercise price of $8.40 per share
and the holders of these warrants effectively paid $7.50 per share after
adjustment for a warrant exercise fee of $0.90 for each warrant exercised.
On March 30, 2000 certain note holders of convertible debt converted
$200,000 of debt into 189,160 shares of common stock.
The Company recorded approximately $1.1 million in deferred compensation
for the quarter ended March 31, 2000, for the difference between the exercise
price of certain of the Company's stock options granted under the Plan and the
fair market value of the underlying common stock. Such amount has been presented
as a reduction to stockholders' equity and is being amortized ratably over the
vesting period of the applicable options. The Company amortized an aggregate of
$300,000 of deferred compensation during the first quarter of 2000.
During the three months ended March 31, 2000, 545,766 shares of common
stock were issued to employees who exercised their stock options, resulting in
$1.0 million in cash.
NOTE 7. CONTINGENCIES
During the three month period ended March 31, 2001, no new material legal
proceedings were filed against the Company, and there were no material
developments in any previously reported legal proceedings.
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FUTURELINK CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
THREE MONTHS ENDED MARCH 31, 2001 AND 2000
(UNAUDITED)
NOTE 8. SUBSEQUENT EVENT
On April 20, 2001, the Company issued to Pequot Private Equity Fund II,
L.P. ("Pequot"), a secured subordinated convertible promissory note (the "Bridge
Note") in the aggregate principal amount of $5 million. Under the terms of this
Bridge Note, $3.5 million was advanced to the Company by Pequot on April 23,
2001, and, subject to the Company's satisfaction of certain representations and
warranties and covenants, an additional $1.5 million will be advanced pursuant
to the terms of the Bridge Note on the earlier of (a) the closing of the next
round of equity or convertible debt financing in which the Company receives
aggregate gross proceeds of at least $5 million (the "Third-party Financing")
and (b) May 31, 2001. In addition, the Company granted Pequot, its affiliates
and JDS Capital Management, Inc. and its affiliates the right to invest in a
Third-party Financing, if any, up to an additional $2.5 million. The Bridge Note
is convertible at the option of the holder into units consisting of senior
subordinated convertible promissory notes and warrants to purchase shares of the
Company's common stock. The convertible notes are, in turn, convertible into
shares of either common stock of the Company or shares of a new series of
preferred stock which will be convertible into common stock of the Company.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We deliver information technology, or IT, solutions for customers who
choose to outsource or augment all or part of their IT needs. In conjunction
with our strategic partners, we enable the deployment, management, support and
maintenance of software applications from our data centers or at the customers'
data center location.
Our professional services group provides expertise in server-based
computing, information security, data communications management, technical
staffing and other related services. We also purchase and resell hardware and
software as part of our services. These sales of hardware and software in
connection with the delivery of professional services comprise a substantial
portion of our revenue. Together with our strategic partners worldwide, we are
also an application service provider, or ASP, that delivers access to software
applications to our customers. Our customers, who pay a monthly fee for this
service, connect to our facilities through the Internet, dedicated
telecommunications lines or by wireless connection.
We are recognized as the largest integrator in North America of
server-based computing systems using Citrix software, one of the leading
technologies for delivering software applications from remote locations. We
typically install Citrix software along with Windows NT Terminal Server(TM)
software from Microsoft Corporation. Our customers have included Cisco Systems,
The Walt Disney Company, Allied Signal, General Motors, Ford Motor Company, Bank
of America, Apple Computer and Delta Airlines. We are continuing to emphasize
our core competencies in professional services while simultaneously growing our
ASP services.
RESULTS OF OPERATIONS
Our three acquisitions that occurred in early-to mid 2000, had a material
impact on our financial statements for the quarter ended March 31, 2001.
Accordingly, current financial statements may not be directly comparable to our
historical financial statements.
Revenue
The components of our revenue for the three months ended March 31, 2001 and
2000 were as follows (in millions):
MARCH 31, MARCH 31,
2001 2000
--------- ---------
Hardware and software.......................... $23.3 $17.3
Service delivery............................... 12.4 5.3
----- -----
Total................................ $35.7 $22.6
===== =====
Revenue for the three months ended March 31, 2001 consisted of $12.4
million of service delivery revenue, of which $10.5 million related to services
provided by consultants in our professional services group and $1.9 million
related to our ASP offerings. Our professional services group also purchases and
resells hardware and software to our customers for a profit, which accounted for
$23.3 million of revenue for the three months ended March 31, 2001. Revenue for
the three months ended March 31, 2000 consisted of $5.3 million of service
delivery revenue, of which $4.8 million related to services provided by
consultants in our professional services group and $0.5 million related to our
ASP offerings. The professional services group also sold hardware and software
to our customers totaling $17.3 million of revenue for the quarter ended March
31, 2000. The increase in revenue for the three months ended March 31, 2001 was
due primarily to our three acquisitions which occurred in early 2000 and, to a
lesser extent, to the re-allocation of resources, particularly personnel from
our ASP business to our professional services business.
Cost of Goods Sold
Cost of goods sold reflects costs of hardware and software purchased for
resale to customers. Cost of goods sold for the three months ended March 31,
2001 was $18.7 million, or 80% of related hardware and
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software sales. The increase in cost of goods sold as compared to the prior
period was commensurate with the corresponding increase in revenue.
Our cost of goods sold for the three months ended March 31, 2000 was $14.1
million, or 81% of related hardware and software sales.
Cost of Service Delivery
Our cost of service delivery for the three months ended March 31, 2001 was
$7.7 million, or 62% of service delivery revenue. Our cost of service delivery
reflects payroll and benefit costs for our consultants who support the
professional services group and payroll, benefit and operational costs related
to testing and operating our data center and installing and supporting software
applications related to our ASP services. Cost of service delivery as a
percentage of service delivery revenue declined in the quarter ended March 31,
2001 partly as a result of reductions in staff in the Company's ASP operations.
Our cost of service delivery for the three months ended March 31, 2000 was
$3.7 million, or 69% of service delivery revenue.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses include payroll, sales
commissions, advertising, and marketing expenses to secure customers and to
develop business partnerships, as well as facilities and communications costs,
insurance, legal and travel costs incurred in the normal course of conducting
business. Selling, general and administrative expenses for the three months
ended March 31, 2001 increased $1.2 million or 9% to $15.6 million, from $14.4
million in the comparable period in 2000. The increase in such costs resulted
primarily from additional costs for our financing and marketing activities and
the additional selling, general and administrative costs of the subsidiaries
that we acquired during 2000.
Our selling, general and administrative expenses for the three months ended
March 31, 2000 were $14.4 million.
Depreciation and Amortization of Goodwill and Other Intangible Assets
Our depreciation and amortization costs for the three months ended March
31, 2001 and 2000 are comprised of the following (in thousands):
THREE MONTHS
ENDED
MARCH 31,
-----------------
2001 2000
------ -------
Goodwill amortization............................. $5,009 $11,783
Depreciation and other amortization............... 3,117 1,494
------ -------
$8,126 $13,277
====== =======
Amortization of goodwill for the three months ended March 31, 2001 relates
to the acquisitions made during 1999 and 2000. Our depreciation and other
amortization expense for the three months ended March 31, 2001 includes
depreciation on the expansion of our Irvine and Canadian data centers, software
user licenses, and office and leasehold improvements, and amortization of our
assembled workforce. Amortization of goodwill for the three months ended March
31, 2001 declined $6.8 million or 57% as compared to the prior period due to the
$170 million impairment charge and corresponding write down of goodwill that
occurred in the fourth quarter of 2000. Depreciation and other amortization
increased $1.6 million for the quarter ended March 31, 2001 as compared to the
prior year as a result of acquisitions in 2000, the expansion of our data
centers and increased software user licenses.
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Interest Expense
Interest expense increased approximately $0.6 million for the three months
ended March 31, 2001 as compared to the same period last year as a result of a
$10.5 million increase in outstanding lines of credit at March 31, 2001 from the
approximately $1.0 million in outstanding lines of credit we had at March 31,
2000. Our interest expense of $1 million for the three months ended March 31,
2001 primarily relates to interest on lines of credit and capital lease
obligations outstanding during the three months.
Our interest expense of $0.4 million for the three months ended March 31,
2000 is composed of non-cash charges related to, among other factors,
amortization of deferred financing fees and debt discount, and interest on bank
indebtedness and lines of credit, capital lease obligations and convertible debt
outstanding during the three month period.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2001, cash and cash equivalents were $3.1 million, compared
to $14.2 million as of December 31, 2000. Our principal uses of cash during the
three months ended March 31, 2001 were for the expansion of our overall
business, funding of ongoing operations, net payments of approximately $4
million for accounts payable and accrued expenses, $1 million in repayment of
capital leases and $0.4 million of investment in property and equipment. Our
principal source of liquidity to fund ongoing operations for the three months
ended March 31, 2001 was borrowings under our various capital leases and senior
credit facility. We anticipate that funding ongoing operations will continue to
be our principal use of cash in the fiscal year ending December 31, 2001.
Operating Activities
Cash used by operating activities for the three months ended March 31, 2001
was $10.3 million, attributable primarily to the funding of ongoing operations.
Investing Activities
Net cash used in investing activities for the three months ended March 31,
2001 was $0.4 million relating to investments in property and equipment.
Financing Activities
Net cash used in financing activities for the three months ended March 31,
2001 was $24,000. Our principal financing activities for the quarter were the
repayment of capital lease obligations and borrowings under our existing lines
of credit.
In November 2000, we entered into a loan and security agreement with a
financial institution relating to a revolving credit facility. In April 2001,
the agreement was amended to limit maximum borrowings under the facility from
$25 million to $15 million. The actual amount that we are permitted to borrow at
any given time varies based upon a percentage of our eligible U.S. and Canadian
accounts receivable as described in the loan and security agreement. Typically,
we borrow at or near our capacity under the facility. In addition, there are
limits as to how much we can borrow against various categories of accounts
receivable. For example, the maximum we can borrow against our Canadian
subsidiary accounts receivable is $2 million. Before we may borrow against our
Canadian subsidiary accounts receivable, however, we first must meet certain
conditions of the lender, which we are attempting to satisfy. The percentage of
our accounts receivable against which we can borrow may be reduced if the amount
of bad debt write-offs, advertising allowances, credits or similar reductions of
our accounts receivable exceed 5% of the applicable category of accounts
receivable used for purposes of determining the maximum borrowing amount. If at
any time the amount we owe under the credit facility exceeds the borrowing
limits under the facility, we may immediately be required to repay in cash the
amount of such excess. The credit facility is secured by substantially all of
our assets, the receivables and other assets of certain of our subsidiaries, and
by guarantees and a pledge of a percentage of the shares of those subsidiaries.
The April 2001 amendment to the credit facility accelerated the maturity date of
the facility to
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November 30, 2001. We can terminate the facility at any time upon 30 days prior
notice. The credit facility bears interest at prime plus 2% per annum; however
at no time will the interest rate charged by the lender be less than 8% per
annum. The credit facility contains certain financial and other covenants and
restrictions, including the maintenance of minimum levels of tangible net worth,
revenue and EBITDA measured as of the end of each month, limitations on capital
expenditures and the incurrence of indebtedness and restrictions on the payment
of dividends. Before April 2001, the financial institution providing our $15
million credit facility waived violations by us of the financial covenant in the
loan agreement requiring us to maintain specified levels of tangible net worth.
In the April 2001 amendment to the credit facility, the tangible net worth
covenant was amended to lower the amount of tangible net worth required under
the agreement. The amendment also requires that we raise at least $5 million in
additional debt or equity financing by May 31, 2001 and another $5 million by
June 30, 2001.
The terms of the facility also require us to follow cash management
procedures. Specifically, we are required to, and have, established and maintain
cash management bank accounts in the lender's name, into which our collections
on accounts receivable are deposited. Because the Company's aggregate cash
balance has fallen below $10 million, the financial institution sweeps all
collections of the Company's receivables into its account. As a result, all such
collections reduce borrowings on the facility. This mechanism has limited our
ability to manage our cash disbursements and fund ongoing operations. Our
capacity to borrow fluctuates daily based on that day's level of eligible
accounts receivables and the level of outstanding borrowings.
In December 2000, certain of our UK subsidiaries entered into a loan
agreement with the same financial institution relating to a revolving credit
facility. In April 2001, we amended this facility to limit the maximum amount we
can borrow under the facility to $1.7 million. Any amount we borrow under the UK
facility will reduce the available amount we can borrow under our $15 million
credit facility. Accordingly, the maximum amount that can be borrowed under both
of these credit facilities is $15 million. The UK credit facility is secured by
substantially all of the assets of our UK subsidiaries and by guarantees by us
and certain of our subsidiaries. The terms of the UK credit facility are
substantially the same as the $15 million credit facility.
As of March 31, 2001, we had borrowed $11.5 million under the credit
facility, which includes borrowings of $1.6 million under the UK credit
facility.
MATERIAL CHANGES IN FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
At the present time, we are not generating sufficient revenue to cover our
expenses. Our independent auditors have modified their December 31, 2000 report
included in the Company's Annual Report on Form 10-KSB to include a going
concern uncertainty paragraph. This paragraph indicates that there is
substantial doubt about our ability to continue as a going concern. As noted
above, because our aggregate cash balances are below $10 million, all of our
receivables are being swept into our lender's account and our capacity to borrow
fluctuates daily based on that day's level of eligible accounts receivable and
the level of outstanding borrowings. This mechanism has imposed limitations on
our ability to manage our cash disbursements and fund ongoing operations. We
have been working with various creditors to restructure the terms of our
obligations under capital lease and other agreements, some of which are in
default. We cannot provide assurances that we will be successful in
restructuring these agreements.
As a result of our current financial condition, our ability to continue as
a going concern is dependent on our ability to obtain additional financing,
align costs with revenue and ultimately achieve and maintain profitable
operations. In October 2000, we initiated a plan to reduce our operating losses
by integrating our recently acquired companies and achieving more efficient
operations. Accordingly, we closed 6 branch offices and eliminated an aggregate
of 75 positions company-wide through a combination of reduction in force and
attrition. During January, February and April 2001, we eliminated an additional
61 positions company-wide. We are continuing to evaluate all aspects of our
operations for opportunities to further reduce our operating losses. Such
actions may include (i) the elimination of certain operations, (ii) the
restructure of certain capital lease and other agreements, (iii) further staff
and overhead reductions, (iv) a sale of a portion of our assets and (v) the
curtailment of further expansion of our ASP business and infrastructure until
such time as
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our ASP product becomes more readily accepted by the market. We are also
refocusing our efforts to improve the margins in our professional services
group.
Further, we are in the process of seeking additional capital through the
issuance of debt and/or equity securities. On April 20, 2001, we issued to
Pequot Private Equity Fund II, L.P. ("Pequot"), a secured subordinated
convertible promissory note (the "Bridge Note") in the aggregate principal
amount of $5 million. Under the terms of this Bridge Note, $3.5 million was
advanced to us by Pequot on April 23, 2001, and, subject to our satisfaction of
certain representations and warranties and covenants, an additional $1.5 million
will be advanced pursuant to the terms of the Bridge Note on the earlier of (a)
the closing of the next round of equity or convertible debt financing in which
we receive aggregate gross proceeds of at least $5 million (the "Third Party
Financing") and (b) May 31, 2001. In addition, we granted Pequot, its affiliates
and JDS Capital Management, Inc. and its affiliates the right to invest in a
Third-Party Financing, if any, up to an additional $2.5 million. The Bridge Note
is convertible at the option of the holder into units consisting of senior
subordinated convertible promissory notes and warrants to purchase shares of our
common stock. The convertible notes are, in turn, convertible into shares of
either our common stock or shares of a new series of our preferred stock which
will be convertible into our common stock. When fully funded, the Bridge Note
will satisfy the first $5 million debt or equity obligation required by the
April 2001 amendment to our senior credit facility.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to foreign currency fluctuations through our operations in
Canada and the United Kingdom. For the quarter ended March 31, 2001,
approximately 20% of our consolidated revenue was from our Canadian subsidiary
and approximately 19% of our revenue was from our UK subsidiary and as of March
31, 2001 approximately 19% of our receivables were from our Canadian subsidiary
and approximately 18% of our receivables were from our UK subsidiary. We do not
enter into forward exchange contracts or any derivative financial investments
for trading purposes. Thus, we do not currently hedge our foreign currency
exposure.
FORWARD-LOOKING STATEMENTS
A number of the matters and subject areas discussed in this Form 10-Q are
forward-looking in nature. The discussion of such matters and subject areas is
qualified by the inherent risks and uncertainties surrounding future
expectations generally, and also may differ materially from our actual future
experience involving any one or more of such matters and subject areas. We wish
to caution readers that all statements other than statements of historical facts
included in this Quarterly Report on Form 10-Q regarding our financial position
and business strategy may constitute forward-looking statements. All of these
forward-looking statements are based on estimates and assumptions made by our
management, which although believed to be reasonable, are inherently uncertain.
Therefore, undue reliance should not be placed on such estimates and statements.
No assurance can be given that any of such estimates or statements will be
realized and actual results may differ materially from those contemplated by
such forward-looking statements. Factors that may cause such differences
include: (i) our inability to obtain new financing of debt or equity capital by
June 30, 2001 to meet the conditions of our amended senior credit facility and
to otherwise meet our working capital requirements; (ii) our inability to
restructure capital lease and other agreements with creditors, (iii) our
inability to modify, restructure or replace our debt facilities in such a manner
for us to continue as a going concern; (iv) a material default in one or more of
our credit agreements which is not waived or rectified in a manner which would
allow us to continue as a going concern; (v) our inability to successfully
restructure our operations to reduce operating losses; and (vi) changes in
general economic conditions in the markets in which we may compete. We have
attempted to identify, in context, certain of the factors that we currently
believe may cause actual future experience and results to differ from our
current expectations regarding the relevant matter or subject area. In addition
to the items specifically discussed in the foregoing, our results of operations
are subject to the risks and uncertainties described under the heading "Factors
That May Affect Future Results" contained herein; however, the operations and
results of our business also may be subject to the effect of other risks and
uncertainties. Such risks and uncertainties include, but are not limited to,
items
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described from time to time in our filings with the Securities and Exchange
Commission. We assume no obligation to update the forward-looking information to
reflect actual results or changes in the facts affecting such forward-looking
information.
FACTORS THAT MAY AFFECT FUTURE RESULTS
WE HAVE A HISTORY OF SUBSTANTIAL LOSSES AND NEGATIVE CASH FLOWS. WE EXPECT THESE
LOSSES AND NEGATIVE CASH FLOWS TO CONTINUE IN THE FUTURE. IF WE ARE UNABLE TO
GENERATE SUFFICIENT REVENUE FROM OUR OPERATIONS OR RAISE SUFFICIENT ADDITIONAL
CAPITAL, WE MAY NOT BE ABLE TO CONTINUE TO OPERATE OUR BUSINESS, AND YOU MAY
LOSE YOUR INVESTMENT.
We have experienced net losses and negative cash flows and our net losses
and our negative cash flows will continue for the foreseeable future. Unless we
increase our revenues and reduce costs or are able to obtain sufficient
additional capital, we may not be able to operate profitably in the future or
generate positive cash flows. If we cannot operate profitably or generate
positive cash flows, we may continue to have trouble meeting our obligations to
our vendors and lessors of equipment, we may fail to comply with covenants in
capital lease agreements and our senior credit facility, we may be unable to
continue to operate our business, and you may lose your investment.
IN ORDER TO EXECUTE OUR BUSINESS PLAN, WE WILL NEED TO RAISE ADDITIONAL CAPITAL.
IF WE ARE UNABLE TO RAISE SUFFICIENT ADDITIONAL CAPITAL, WE WILL NOT BE ABLE TO
ACHIEVE OUR BUSINESS PLAN AND YOU COULD LOSE YOUR INVESTMENT.
We need to raise additional funds through public or private debt or equity
financings to be able to fully execute our business plan. Any additional capital
raised through the sale of equity may dilute your ownership interest. We may not
be able to raise sufficient additional funds on favorable terms, or at all. If
we are unable to obtain sufficient additional funds, we will be unable to
execute our business plan and you could lose your investment.
OUR COMMON STOCK MAY BE DELISTED FROM THE NASDAQ NATIONAL MARKET. IF IT IS
DELISTED, THE MARKET PRICE OF THE COMMON STOCK COULD DECLINE POTENTIALLY TO ZERO
AND YOU COULD LOSE YOUR INVESTMENT.
We have received a notice from Nasdaq that our common stock has failed to
maintain the required minimum bid price of $1.00 over a period of 30 consecutive
trading days. As a result, Nasdaq has provided us with 90 calendar days, or
until June 25, 2001, to regain compliance with this requirement or be delisted
from trading on the Nasdaq National Market. In addition, Nasdaq may decide to
delist our common stock at an earlier time based upon our financial condition.
Although we have taken steps to maintain our listing, we can give no assurances
that our securities will not be delisted from trading by Nasdaq. If we lose our
Nasdaq National Market status, our common stock would most likely trade in the
over-the-counter market, which is viewed by most investors as a less desirable
and less liquid marketplace. In that event, trading in shares of our common
stock would likely decrease substantially or cease altogether, and the market
price of the common stock would likely decline further, potentially to zero.
IF ALL OR A SUBSTANTIAL PORTION OF THE SHARES OF OUR COMMON STOCK OFFERED FOR
SALE BY THE PROSPECTUS RELATED TO THE REGISTRATION STATEMENT WHICH WAS DECLARED
EFFECTIVE IN FEBRUARY 2001 ARE SOLD IN A SHORT PERIOD OF TIME, OUR STOCK PRICE
MAY BE ADVERSELY AFFECTED. OUR STOCK PRICE MAY ALSO BE ADVERSELY AFFECTED BY THE
PERCEPTION THAT SUCH SALES COULD OCCUR.
The shares of common stock offered for sale by the prospectus related to
the registration statement that was declared effective in February 2001
represent a majority of our outstanding common stock. We cannot control when the
selling stockholders will sell their shares. If all or a substantial portion of
the shares of common stock offered for sale by that prospectus are sold in a
short period of time, the common stock available for sale may exceed the demand
and the stock price may be adversely affected. In addition, the mere perception
that such sales could occur may depress the price of our common stock.
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RECENT REDUCTIONS IN FORCE AND THE DEPRESSED MARKET VALUE OF OUR COMMON STOCK
MAY MAKE IT DIFFICULT FOR US TO RETAIN OUR KEY EMPLOYEES. IF WE ARE UNABLE TO
RETAIN OUR KEY EMPLOYEES AT ALL LEVELS OF OUR BUSINESS, WE WILL NOT BE ABLE TO
GROW OUR BUSINESS AND ACHIEVE OUR BUSINESS PLAN. IF WE FAIL TO ACHIEVE OUR
BUSINESS PLAN WE WILL NOT BE ABLE TO CONTINUE TO OPERATE OUR BUSINESS AND YOU
MAY LOSE YOUR INVESTMENT.
We recently completed the third reduction in force in a seven-month period
and we may need to make additional reductions to reduce our operating losses. In
addition, the price of our common stock has dropped significantly in the last
twelve months. The combination of these events may have an adverse effect on the
morale of our key employees. Our success depends in significant part on the
continued services of our key employees. Losing one or more of our key personnel
will seriously impair our ability or could cause us to fail to successfully
implement our business plan. This will have a material adverse effect on our
business, results of operations and financial condition, and you may lose your
investment.
WE OPERATE IN AN INDUSTRY WHERE IT IS DIFFICULT TO ATTRACT AND RETAIN QUALIFIED
PERSONNEL. IF WE ARE UNABLE TO ATTRACT AND RETAIN QUALIFIED PERSONNEL, OUR
OPERATIONS WOULD SUFFER AND WE COULD LOSE OUR CUSTOMERS OR FAIL TO ATTRACT NEW
CUSTOMERS.
Our business is labor-intensive, and our success depends in large part upon
our ability to attract, develop, motivate and retain highly skilled personnel.
We believe that we will need to hire additional qualified personnel. Some of
these individuals are in great demand and are likely to remain a limited
resource for the foreseeable future. We may not be able to engage the services
of such personnel or retain our current personnel. If we do not succeed in
attracting new, qualified personnel or successfully retaining our current
personnel, our business will suffer.
OUR INTERNAL ACCOUNTING AND FINANCIAL CONTROLS HAVE WEAKNESSES. IF WE ARE UNABLE
TO RECRUIT AND RETAIN QUALIFIED ACCOUNTING AND FINANCIAL STAFF, WE MAY CONTINUE
TO EXPERIENCE WEAKNESSES IN THESE MANAGEMENT SYSTEMS AND OUR BUSINESS, RESULTS
OF OPERATIONS AND FINANCIAL CONDITION COULD BE MATERIALLY ADVERSELY AFFECTED.
When auditing our consolidated financial statements for the years ended
December 31, 2000 and 1999, our independent auditors reported to us conditions
they believed to be material weaknesses in our system of internal accounting and
financial controls related to the financial statement close process and the
reconciliation and analysis of general ledger account balances. We have begun to
address these concerns by hiring a new Chief Financial Officer and other staff.
We have identified and continue to take measures to improve our system of
internal controls, implement more rigorous internal accounting policies,
procedures and controls, and conduct accounting systems training. However, the
success of these measures will depend in large part upon our having qualified
accounting and financial staff to implement them. We have lost several key
personnel in our accounting and finance departments in recent months. If we are
unable to recruit and retain additional qualified accounting and financial
staff, we may be not be successful in correcting the noted deficiencies. If we
are unable to establish and maintain effective internal accounting and financial
controls, we will not be able to timely and accurately account for and monitor
the operations of our business and we, therefore, may not be able to properly
execute our business plan, which could materially adversely affect our business,
results of operations and financial condition.
OUR PAST FINANCIAL RESULTS MAY NOT BE REPRESENTATIVE OF OUR FUTURE FINANCIAL
RESULTS AND THEREFORE INVESTORS WILL HAVE DIFFICULTY EVALUATING US AND OUR
PROSPECTS.
We have grown our business rapidly through acquisitions closed in the
fourth quarter of 1999 and during 2000. Because we have grown through
acquisitions, our financial results cover periods when we did not control or
manage our subsidiaries and may not be indicative of our future financial
results. Investors will have difficulty evaluating us and therefore our stock
price may be adversely affected as well as our ability to raise money in the
future.
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THE ASP MARKET HAS NOT DEVELOPED AS WE ANTICIPATED AND WE MAY NOT BE ABLE TO
BENEFIT FROM THE ASP MARKET WHEN, AND IF, THE ASP MARKET DEVELOPS.
To date, most of our revenue has come from our professional services group.
We introduced our ASP services in March 1999, and it still does not account for
a significant portion of our revenues. The market for ASP services has grown
more slowly than we anticipated. Accordingly, for the near term, we will focus
on the services provided by our professional services group while continuing to
position ourselves to take advantage of the ASP services market when, and if, it
develops. The market for ASP services is evolving. Future demand for these
services and the timing of when such future demand may occur is highly
uncertain. We believe that many of our potential customers are not fully aware
of the benefits of ASP services. We must educate potential customers regarding
these benefits and of our ability to provide complete and reliable services. The
market for ASP services may never become viable or grow further. If the market
for our ASP services does not grow or grows more slowly than we currently
anticipate, our business, financial condition and operating results will be
materially adversely affected. If the market for our ASP services does grow as
we originally anticipated, it is uncertain whether we will have the financial
resources and the personnel necessary to benefit from such growth.
IF THE ASP MARKET DEVELOPS, WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY WITH NEW
ENTRANTS INTO THE ASP MARKET.
To the extent that the ASP market develops and begins to grow, we believe
established companies in complementary industries, such as telecommunications,
consulting services and computer networking, could be future competitors. We may
not be able to compete successfully against either current or future
competitors. Increased competition could result in significant price erosion,
reduced revenue, lower margins or loss of market share, any of which would
significantly harm our business. Furthermore, larger companies in other related
industries, such as the telecommunications industry, may apply their significant
resources, including their distribution channels existing infrastructure,
personnel, other resources, and brand name recognition, to capture significant
market share.
WE ARE SUSCEPTIBLE TO FLUCTUATIONS IN THE ECONOMY. IF OUR CLIENTS REDUCE CAPITAL
EXPENDITURES RELATING TO INFORMATION TECHNOLOGY IN RESPONSE TO SLOWDOWNS IN
THEIR BUSINESSES DUE TO A GENERAL SLOWING OF THE ECONOMY, OUR BUSINESS COULD BE
ADVERSELY AFFECTED.
Demand for our professional services and ASP services will be affected by
the general health of the domestic and international economies. Some of our
clients may reduce capital expenditures relating to information technology if
they suffer slowdowns in their businesses due to a general slowing of the
economy. This reduction in capital spending may require some of our clients to
delay or cancel information technology projects that we have been engaged to
manage or on which our personnel may have been staffed. Fluctuations in the
general economy which adversely impact the capital expenditure or other budgets
of our clients may adversely affect our business.
OUR INDUSTRY IS CHARACTERIZED BY RAPIDLY CHANGING TECHNOLOGY WITH CONTINUOUS
IMPROVEMENTS IN BOTH COMPUTER HARDWARE AND SOFTWARE. IF WE DO NOT RESPOND
EFFECTIVELY AND ON A TIMELY BASIS TO RAPID TECHNOLOGICAL CHANGE IN OUR INDUSTRY,
WE WILL NOT BE ABLE TO EFFECTIVELY SELL OUR SERVICES AND OUR SALES WILL
MATERIALLY DECLINE.
We must continually buy or lease new computer hardware and license new
computer software systems to effectively compete in our industry. In addition,
our software delivery applications must be able to support changes in the
underlying software applications that are delivered to our customers. The rapid
development of new technologies increases the risk that current or new
competitors could develop products or services that would reduce the
competitiveness of our products or services. We rely on software providers to
produce software applications that keep pace with our customers' demands.
We may not successfully develop or adopt new technologies, introduce new
services or enhance our existing services on a timely basis and new
technologies, new services or enhancements we use or develop may
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never achieve market acceptance. If we fail to address these developments, we
will lose sales to our competitors and our business, operating results and
financial condition will be materially adversely affected.
WE RELY ON SOFTWARE APPLICATION AND SOFTWARE SYSTEMS INTEGRATION COMPANIES TO
REFER MANY OF OUR CLIENTS TO US. ANY FAILURE BY THESE THIRD PARTIES TO PROVIDE
US WITH THESE REFERRALS WILL CAUSE OUR SALES TO MATERIALLY DECLINE.
We rely on referrals from software application and technology integrators
for a portion of our business. These software application and technology
integrators refer their customers to us because we can provide an array of
services which complement the products and services they offer. However, these
software application and technology integrators may stop or substantially
diminish referring business to us or they may decide to cooperate with our
competitors and thereby adversely impact or eliminate the amount of referrals
made to us. If these third-party referrals cease or materially decline, our
sales will materially decline and our business, results of operations and
financial condition will be materially adversely affected.
WE MUST LICENSE THE SOFTWARE APPLICATIONS WE PROVIDE TO OUR CUSTOMERS FROM THIRD
PARTIES. IF WE CANNOT OBTAIN THESE SOFTWARE APPLICATIONS WE WILL NOT BE ABLE TO
OFFER ASP SERVICES RELATED TO SUCH SOFTWARE APPLICATIONS.
We depend on third-party software manufacturers agreeing to allow their
software applications to be hosted or run at our data centers and provided to
our customers. We have entered into non-exclusive agreements with Microsoft,
Onyx, Great Plains, SalesLogix and others that allow us to host some of their
software applications at our data centers or re-license their software
applications to our customers. Under most of these agreements, the software
manufacturer can terminate its relationship with us for any reason by giving us
as little as 30 days notice. In these instances, the software manufacturer is
not liable to us or our customers for any damages resulting from termination. If
our relationships with these software manufacturers are terminated or if these
or other software manufacturers do not allow our customers to obtain a license
to operate the software application on our data centers, our business, operating
results and financial condition could be materially adversely affected.
IF WE ARE UNABLE TO OBTAIN CITRIX OR MICROSOFT PRODUCTS, AS WELL AS OTHER KEY
HARDWARE COMPONENTS AND SOFTWARE APPLICATIONS FROM OTHER VENDORS, WE WOULD BE
UNABLE TO DELIVER OUR SERVICES, AND UNTIL WE REPLACE THESE PRODUCTS, OUR
BUSINESS WOULD BE MATERIALLY ADVERSELY AFFECTED.
We depend on third-party suppliers to provide us with key hardware
components and software applications for our infrastructure and with sufficient
communications lines to allow our customers to access their software
applications. Some components or applications are only available from limited
sources. Citrix Systems, Inc. and Microsoft Corporation are our key suppliers of
software that we utilize to connect our customers to software applications.
Although there are other competing software applications on the market, we
believe that Citrix software, deployed with Windows NT Terminal Server software
from Microsoft, is currently best suited to serve this function. If we are
unable to obtain these products or services such as telecommunications services
from other vendors, in a timely manner, at an acceptable cost or at all, we
would be unable to deliver our services. Unless we replace these products, our
business, results from operations and financial condition could be materially
adversely affected.
IF THE SOFTWARE WE UTILIZE CONTAINS DEFECTS, OUR CUSTOMERS' SERVICE COULD BE
DISRUPTED AND THEIR DATA COULD BE LOST. THIS COULD RESULT IN OUR INCURRING
LIABILITY AND LOSING CUSTOMERS FOR OUR SERVICES, WHICH WOULD HAVE A MATERIAL
ADVERSE EFFECT ON OUR OPERATIONS.
Our service offerings depend on complex software which may contain defects,
particularly when first introduced or when new versions are released. Although
we test software applications prior to deployment, we may not discover software
defects that affect our new or current services or enhancements until after they
are deployed. These defects could cause service interruptions or data loss which
could damage our reputation or increase our service costs, cause us to lose
revenue, delay market acceptance or divert our development resources. Any
software modifications we perform as part of our integration services could
cause problems in
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application delivery. Also, because we offer a one-source solution to our
customers, they are likely to hold us accountable for any problems associated
with their software, even if the problem results from software defects the
manufacturer causes. Typically, software manufacturers disclaim liability for
any damages suffered as a result of software defects or provide only limited
warranties. As a result, we may have no recourse against the providers of
defective software applications.
A MATERIAL PART OF OUR GROWTH STRATEGY IS BASED UPON EXPANDING OUR OPERATIONS
INTERNATIONALLY WHICH INVOLVES ADDITIONAL RISKS. IF WE ARE UNABLE TO ADAPT OUR
BUSINESS TO MINIMIZE THESE RISKS, WE MAY INCUR SIGNIFICANT LOSSES WHICH COULD
HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.
We anticipated that Canadian and European sales will account for a
significant amount of our future revenue. There are inherent risks in doing
business internationally such as different telecommunications access fees,
different technology standards, different liability standards, less protective
intellectual property laws, changes in political conditions, changes in
regulatory requirements, increased expenses due to tariffs and other trade
barriers, fluctuations in currency exchange rates, restrictions on currency
transfers, potentially adverse tax consequences, and difficulties in managing or
overseeing foreign operations. Any of these risks could have a material adverse
effect on our business operations.
IF ONE OR MORE OF OUR DATA CENTERS ARE DISRUPTED, WE COULD LOSE OUR CUSTOMERS
AND FAIL TO ATTRACT NEW CUSTOMERS, WHICH COULD MATERIALLY ADVERSELY AFFECT OUR
BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
Our ASP services strategy depends on the consistent performance of our
three North American data centers located in Lake Forest, California; Leonia,
New Jersey and Calgary, Canada, which we plan to consolidate; and our data
center in Newbury, United Kingdom. We offer back-up storage of data for
customers that elect this service. Although our current data centers all have
back-up generators and other safety systems, all are vulnerable to interruption
from fire, earthquake, flood, extended power loss, telecommunications failure,
break-ins and other events beyond our control. If a data center is damaged, a
customer storing its data on that data center may lose its data if it is not
backed up. If one of our data centers was damaged, the loss of data may affect a
significant portion of our customers. We have experienced periodic systems
disruptions in the past and anticipate that such disruptions will occur in the
future. In the event that we experience significant disruptions that affect one
or more of our data centers, we could lose customers and fail to attract new
customers, and our business, results of operations and financial condition would
be materially adversely affected.
BREACHES OF OUR SECURITY COULD DISRUPT THE OPERATION OF OUR DATA CENTERS AND
JEOPARDIZE OUR SECURE TRANSMISSION OF CONFIDENTIAL INFORMATION. THESE BREACHES
COULD CAUSE OUR CUSTOMERS TO LOSE CONFIDENCE IN OUR SERVICES AND CANCEL THEIR
CONTRACTS WITH US OR PROSPECTIVE CUSTOMERS NOT TO PURCHASE OUR SERVICES.
The growth of our business depends upon our ability to securely transmit
confidential information to and from our data centers or the servers of our
customers. Despite our design and implementation of a variety of delivery
systems and security measures, unauthorized access, computer viruses and
accidental or intentional disturbances could occur. We may need to devote
substantial capital and resources to protect against these threats or to remedy
any problems that these threats create. The occurrence of any of these events
could cause us to lose customers and expose us to liability, all of which could
have a material adverse effect on us.
OUR ASP SERVICE CONTRACTS GUARANTEE CERTAIN SERVICE LEVELS. IF WE DO NOT MEET
SUCH SERVICE LEVELS, WE MAY BE REQUIRED TO GIVE OUR CUSTOMERS CREDIT FOR FREE
SERVICE AND OUR CUSTOMERS MAY BE ENTITLED TO CANCEL THEIR ASP SERVICE CONTRACTS,
WHICH COULD MATERIALLY ADVERSELY AFFECT OUR BUSINESS.
Our ASP service contracts contain service level guarantees which obligate
us to provide our hosted applications at a guaranteed level of performance. To
the extent we fail to meet those service levels, we may be obligated to provide
our customers credit for free service. If we continue to fail to meet these
service levels, our ASP customers may have the right to cancel their contracts
with us. These credits or cancellations will cost us
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money, damage our reputation with our customers and prospective customers and
could materially adversely affect our business, results of operations and
financial condition.
MANY COMPANIES USE THE NAME "FUTURELINK." INTELLECTUAL PROPERTY INFRINGEMENT
CLAIMS AGAINST US FOR THE USE OF THE "FUTURELINK" NAME, EVEN IF WITHOUT MERIT,
COULD BE EXPENSIVE TO DEFEND AND DIVERT MANAGEMENT'S ATTENTION FROM OUR
BUSINESS. IF A CLAIM TO STOP US FROM USING OUR NAME IS SUCCESSFUL, WE WILL HAVE
TO EITHER BUY THE RIGHT TO USE OUR NAME OR CHANGE OUR NAME, WHICH IN EITHER CASE
MAY BE EXPENSIVE.
We are aware that other companies have claimed prior use of the name
"FutureLink" for products or services similar to our own. We are in the process
of investigating the rights, if any, others may have to the name. In addition,
we are attempting to register "FutureLink" as a service mark in the United
States. However, we may not be able to obtain proprietary rights to the use of
this name. We will incur expenses if called to defend our use of the
"FutureLink" name. Any litigation, even if without merit, may be time consuming
and expensive to defend. It also could divert management's attention and
resources and require us to enter into costly royalty or licensing agreements.
In addition, if any company in our industry is able to establish a use of the
"FutureLink" name that is prior to our use, we could be liable for damages and
could be forced to stop using the name unless we are able to buy the right to
use the name. If we are unable to buy the right to use our name after we lose an
infringement claim, we would have to change our name, which may require us to
spend money to build new brand recognition and incur other costs. Third parties
may assert other infringement claims against us. Any of these events could have
a material adverse effect on our business, financial condition and results of
operations.
WE ARE A TECHNOLOGY COMPANY. HOWEVER, OUR PREVIOUS BUSINESS ACTIVITIES INCLUDED
NATURAL RESOURCE MINING AND EXPLORATION. AS A RESULT WE MAY BE EXPOSED TO
UNKNOWN ENVIRONMENTAL LIABILITY THAT COULD REQUIRE US TO EXPEND OUR FINANCIAL
RESOURCES AND MATERIALLY ADVERSELY AFFECT OUR FINANCIAL CONDITION.
We merged with a publicly-traded company that prior to 1992 was engaged in
the natural resource exploration and development business, including mining and
oil and gas. The mining, mineral processing and oil and gas industries are
subject to extensive governmental regulations for the protection of the
environment, including regulations relating to air and water quality, site
reclamation, solid and hazardous waste handling and disposal and the promotion
of occupational safety. We could be held responsible for any liabilities
relating to our previous involvement in mining or oil and gas exploration and
development, which liabilities would result in our spending our cash resources
and could have a material adverse effect on our business, financial condition
and results of operations.
PART II
OTHER INFORMATION
ITEM 5. OTHER INFORMATION
On May 15, 2001, we issued a press release, a copy of which is attached
hereto as Exhibit 99.1 and is incorporated herein by reference.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
The exhibits listed below are hereby filed with the U.S. Securities and
Exchange Commission (the "Commission") as part of this Report.
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.1 Third Amendment to the Company's Second Amended and Restated
Stock Option Plan
99.1 Press Release dated May 15, 2000 by registrant
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(b) REPORTS ON FORM 8-K.
On February 9, 2001, we filed a Current Report on Form 8-K reporting (i)
the resignations of Glen C. Holmes as our President and Chief Operating Officer,
Philip R. Ladouceur as our Chief Executive Officer, Richard M. White as our
Senior Vice President, Administration and Raghu N. Kilambi as our Chief
Financial Officer, Executive Vice President and a director, (ii) the
appointments of Howard E. Taylor as our President and Chief Executive Officer,
Richard M. White as our Chief Financial Officer and Executive Vice President,
and Marshall S. Geller as a director, (iii) the relocation of our headquarters
to Lake Forest, California, (iv) the indemnification claim that Cameron Chell,
our former Chief Executive Officer, filed against us in the lawsuit filed
against us and Mr. Chell by Michael Chan, a former employee, (v) our efforts to
realign our business and cut our costs, and (vi) the terms of our credit
facility with Foothill Capital Corporation.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FUTURELINK CORP.
Date: May 15, 2001 By: /s/ HOWARD E. TAYLOR
------------------------------------
Howard E. Taylor
President & Chief Executive Officer
By: /s/ EUGENE L. FROELICH
----------------------------------
Eugene L. Froelich
Executive Vice President &
Chief Financial Officer
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EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
10.1 Third Amendment to the Company's Second Amended and Restated
Stock Option Plan
99.1 Press Release dated May 15, 2000 by registrant
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