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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 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 Number 0-26115
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INTERLIANT, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3978980
(State or other (I.R.S. Employer
jurisdiction of Identification No.)
incorporation or organization)
TWO MANHATTANVILLE ROAD
PURCHASE, NEW YORK 10577
(Address of principal executive offices, zip code)
(914) 640-9000
(Registrant's telephone number, Including Area Code)
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 Par Value Per Share
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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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this
Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based on the closing price of Common Stock on March 28, 2002 of
$0.26 as reported on the Nasdaq National Market, was approximately $5,002,000
million. Shares of Common Stock held by each officer and director and by each
person who owns 5% or more of the outstanding Common Stock have been excluded
in that such persons may be deemed to be affiliates. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.
As of March 28, 2002, approximately 53,672,000 shares of Common Stock, $.01
par value per share, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part of
Document Form 10-K
- -------- ---------
Portions of the Definitive Proxy Statement with respect to the Annual Meeting of Shareholders,
to be filed not later than 120 days after the close of the Registrant's fiscal year......... Part III
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TABLE OF CONTENTS
PART I
Item 1. Business............................................................................. 3
Item 2. Properties........................................................................... 21
Item 3. Legal Proceedings.................................................................... 21
Item 4. Submission of Matters to a Vote of Security Holders.................................. 22
PART II
Item 5. Market for the Company's Common Equity and Related Stockholder Matters............... 22
Item 6. Selected Consolidated Financial Data................................................. 25
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 26
Item 7A. Quantitative and Qualitative Disclosures about Market Risk........................... 37
Item 8. Financial Statements and Supplementary Data.......................................... 37
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. 64
PART III
Item 10. Directors and Executive Officers..................................................... 64
Item 11. Executive Compensation............................................................... 64
Item 12. Security Ownership of Certain Beneficial Owners and Management....................... 64
Item 13. Related Party Transactions........................................................... 64
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K...................... 65
Item 15 Signatures........................................................................... 67
Interliant is a registered trademark of Interliant, Inc. This Report on Form
10-K contains trademarks of other companies. These trademarks are the property
of their respective holders. All references to we, us, our, or Interliant in
this Report on Form 10-K means Interliant, Inc.
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PART I
THE STATEMENTS IN THIS REPORT ON FORM 10-K THAT ARE NOT DESCRIPTIONS OF
HISTORICAL FACTS MAY BE FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS REFLECT
MANAGEMENT'S CURRENT VIEWS, ARE BASED ON CERTAIN ASSUMPTIONS AND ARE SUBJECT TO
RISKS AND UNCERTAINTIES, INCLUDING, BUT NOT LIMITED TO, THE INFORMATION SET
FORTH UNDER THE CAPTION RISK FACTORS, AS WELL AS OTHER RISKS DETAILED HEREIN
AND IN OUR OTHER FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION, TO WHICH
YOU ARE REFERRED. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE CURRENTLY
ANTICIPATED AS A RESULT OF THE FOREGOING OR OTHER FACTORS.
We currently file reports, proxy statements and other information with the
SEC. Such reports, proxy statements and other information can be inspected and
copied at the public reference facilities maintained by the SEC at:
Room 1024 450 Fifth Suite 1400 Northwest 233 Broadway New York, NY
Street, N.W. Atrium Center 500 West 10279
Judiciary Plaza Madison Street Chicago,
Washington, D.C. 20549 Illinois 60661
Copies of material can be obtained at prescribed rates from the Public
Reference Section of the SEC at:
450 Fifth Street, N.W. Judiciary Plaza
Washington, D.C. 20549
The SEC maintains a World Wide Web site that contains reports, proxy and
information statements and other information regarding registrants that file
electronically with the SEC. The address of the site is http://www.sec.gov.
ITEM 1. BUSINESS
General
We are a provider of managed infrastructure solutions, encompassing
messaging, security, and hosting, plus an integrated set of professional
services products that differentiate and add customer value to these core
solutions. We sell to the large/enterprise market through our direct sales
force and to the small and medium-business market (SMB) through our INIT
Branded Solutions program, which allows companies to private label our
offerings. We provide companies of all sizes with cost-effective, secure
infrastructure and a focused suite of e-business solutions. Our customers face
significant challenges in doing business on the Internet due to its technical
complexity, their shortage of technical resources and/or specialized skills,
the time necessary to implement applications and the cost of implementation and
ongoing support. By providing outsourced solutions and services that combine
our infrastructure solutions with professional services expertise, we can
rapidly design, implement, deploy and effectively manage cost-effective
solutions for large and small enterprises alike.
We provide our customers integrated, high-level business value, from
development to implementation to maintenance, that allows them to maintain
critical business functions without maintaining an IT infrastructure and staff
that are not central to their core competencies. We focus on the critical
technologies necessary to support their business success--Internet, messaging,
security, applications, internal systems, network systems and infrastructure.
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Benefits
We provide the following advantages to our customers:
. Accelerated Implementation. Designing, implementing, and deploying
e-business applications in a timely manner is a complex task requiring
appropriate staff with the correct skill sets. Our hosting solutions
provide our customers with our preconfigured infrastructure and our
experienced team of consultants to rapidly implement their e-business
applications.
. Reduced Cost of Ownership. Our customers benefit from the capital and
labor investments that we have made to support hosting and other
Internet services. For customers to replicate our performance and
reliability, they would have to make significant expenditures for
hardware, software, data center facilities and connectivity, as well as
hiring and retaining skilled IT personnel. We believe that our hosting
solutions are significantly more cost-effective and reliable than
in-house solutions, both for businesses with low-end application
requirements as well as for those businesses whose Internet operations
are mission-critical and require sophisticated application support.
. Superior Expertise and Facilities. Our skilled, certified technology
and professional services staff receive ongoing training that we believe
provides them with advanced skill sets when compared to most in-house IT
personnel. We own and manage our own data centers and have in place
redundant systems and 24x7 support to keep customers critical Web sites
and applications up and running. In-house IT departments are our biggest
competitors, and we believe that we can surpass in-house expertise and
facilities, providing better-quality services and solutions that support
customers' mission-critical systems and applications.
. Robust Security. We provide and maintain platforms with security
technologies and processes in both our data centers and our hosted
platforms which leverage the design methodology and products that we
have deployed in Fortune 500 companies and major financial institutions
for many years. We are able to leverage a wide range of security
management architectures across our entire customer base. This allows us
to offer a suite of security services with price/performance ratios to
address the needs of each of our customer segments. Because of the
investment that we have made in infrastructure, systems and staff, in
most instances we are able to provide robust security services to
customers for a fraction of the cost of implementing and supporting
comparable systems themselves.
. Customer Service and Support. We are committed to providing value-added
customer service. Our customer services group can address technical
problems on a 24x7 basis. We have invested in and upgraded our internal
CRM (customer relationship management) system, including advanced
customer service software and call routing technology, to streamline the
customer service process. We also offer self-service customer reporting
product enhancements which allow access to site statistics such as disk
storage capacity and CPU utilization.
Services and Solutions
Our INIT Solutions Suite, offering operations support, systems and
applications management, and customer service and support, is comprised of the
following offerings: INIT Messaging, INIT Security, and INIT Hosting, plus
related professional services (INIT Services). Following is a description of
these solutions.
INIT MESSAGING. INIT Messaging helps customers identify and implement the
messaging and application strategy that best meets the needs of their business.
To support Interliant's end-to-end approach to messaging, we offer a
comprehensive set of products and services. We offer our customers migration
services from legacy mail systems, handling co-existence and integration
issues. For customers who choose to outsource their messaging infrastructure,
we can manage their system in our data centers or remotely manage it in their
own facility. Regardless of the location, we assume responsibility for the
management, monitoring, and support of the resulting mission-critical messaging
environment, ensuring a highly reliable solution with service level
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guarantees. Beyond messaging, we can create collaborative, Web-based
applications as well as manage existing applications so that organizations can
focus on their core business.
We offer a broad spectrum of e-mail, collaboration and knowledge management
solutions that allow a customer's widely distributed work force to collaborate
more effectively through shared software applications, intranets, extranets,
and messaging services for internal and external communication.
Messaging solutions include:
. Managed Messaging, a flexible management service to host or manage a
customer's mission-critical Lotus Domino, Microsoft Exchange, or
Openwave messaging infrastructure;
. Application Hosting for Domino, QuickPlace and Sametime, providing
state-of-the art hosting solutions that facilitate various types of
collaboration both within and outside the enterprise, with custom
application development services also available through INIT Services;
. INIT DealMaker, a hosted collaboration product specifically designed by
Interliant for companies in the venture capital business;
. INIT AppCare, a professional services offering that provides the
customer remote management of its Lotus Domino applications;
. INIT Mail Migration, a professional services offering that allows a
customer to take advantage of our deep knowledge, experience and proven
methodologies as they relate to migrations and implementations of
messaging platforms and infrastructures; and
. Strategic Services provided by INIT Services consultants, including a
messaging total cost of ownership review, messaging scorecard, and
collaboration strategy analysis.
INIT SECURITY. INIT Security is the single-source solution enabling
e-business acceleration to companies that do business of any kind on the
Internet. Our security solutions are based on firewall and virtual private
network (VPN) technologies, bundled with qualified security engineering as well
as monitoring and management services. INIT Security leverages security
products from industry leaders such as Check Point Software, Nokia, RSA
Security, Extreme Networks and other major vendors.
We offer comprehensive security planning for both existing networks and
those under design. Our consultants and engineers help design, build, and
deploy leading edge and secure networks for both internal and external
requirements.
Our INIT Security solutions and services include security policy
development; comprehensive planning for existing and future network and Web
initiatives; firewall design and implementation; VPN/remote access design;
vulnerability assessment services; authentication and encryption services;
managed firewall service: hosted, remote managed and remote monitored services;
and managed VPN services.
INIT HOSTING. INIT Hosting provides hosting infrastructure for
network-based applications, which allows our customers to store their
databases, applications or Web sites on equipment owned and maintained by us or
on their equipment located in our data centers, or on equipment at their
premises by means of remote access. We offer a comprehensive array of reliable,
secure hosting solutions to support virtually every Web requirement--from
startups to industrial-strength e-commerce sites.
Our INIT Branded Solutions program is the centerpiece of the INIT Hosting
division, providing organizations with the ability to leverage our hosting
infrastructure as a privately labeled or co-branded solution to their existing
customers.
We offer a comprehensive suite of solutions to meet the current and future
Web hosting needs of our customers. We provide shared and dedicated, as well as
co-located, hosting services.
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SHARED HOSTING. Our shared hosting solutions are available only through our
Branded Solutions program, partner referral or reseller programs. Our shared
hosting solutions provide customers with all the elements needed to establish a
basic presence on the Web at a reasonable cost, making it an economical
application for relatively simple or moderately accessed Web sites. This
entry-level service is known as shared hosting because the customer's Web site
has its own domain name and appears to exist on a stand-alone server, although
it is actually sharing the hardware it resides on with other customers. It
operates with the speed and efficiency of our high-speed network connections
and its location at our facility remains invisible to Web site visitors.
Customers are able to have their own Web site with a domain name at a fraction
of the cost of maintaining it themselves. Because customers do not need to
invest in costly network infrastructure, hardware or personnel to accommodate
future growth, we believe this application also maximizes the customers'
flexibility.
DEDICATED HOSTING. Dedicated servers owned and maintained by us provide
greater server and network resources to our customers, and more robust
e-commerce applications than shared hosting, and allow customers to configure
their hardware to optimize site performance. Customers receive a high level of
site security, maintenance and technical support without the prohibitive costs
of setting up and maintaining their own server and Internet backbone
connections. We support most leading Internet hardware and software system
vendor platforms, including Microsoft Windows NT, SQL and Windows 2000, Sun
Solaris, Red Hat Linux and Oracle Databases.
CO-LOCATED HOSTING. We provide co-located hosting services in each of our
primary data centers for customers with sophisticated, mission-critical
applications. This solution allows the customer to own and access their servers
on a 24x7 basis while having the option to delegate the day-to-day management
of their hardware to our IT specialists or to continue to manage it themselves.
In addition, co-located servers are housed in separate, limited-access space in
our data centers.
MANAGED HOSTING. We provide application infrastructure services to
implement Web-based mission critical databases or high-volume, transaction
intensive Web sites with a high degree of security, scalability and processing
power. Our managed hosting services reduce a company's IT staffing challenges
and infrastructure investment. Our expert technical staff provides 24x7
proactive management and maintenance so companies can focus on their core
business. Coupled with our professional services, our managed hosting solutions
can be designed, built, and managed for a scalable, enterprise-class
infrastructure and complex hosting environment. Our reporting tool allows
customers to access performance reporting that includes full system monitoring,
historic data and real-time alerts, and server statistics through a Web-enabled
portal.
INIT Services
Our INIT Services consultants focus on analyzing each business's unique
goals and requirements. We implement, enhance and support our hosted and
application solutions with professional services provided by our own
consultants. Our professional services include capabilities to create intranet,
extranet, and numerous application hosting solutions for our customers, as well
as network design and implementation, security implementation and back-end Web
development projects. In addition, we provide support for our customers'
enterprise networking needs. We address the complete spectrum of services,
including desktop and network server support, network architecture and design,
strategic technology planning and application development and implementation.
We scale our professional services to meet each client's individual needs.
Our professional services are a key part of our solution portfolio, enabling
us to provide our customers with end-to-end outsourced solutions and services.
In addition, we provide professional services for non-hosted solutions
including third party enterprise applications from Lotus, Microsoft and Oracle.
Our full portfolio of INIT Services includes:
. INIT Security--Our security consultants conduct enterprise-wide audits
to evaluate network security and follow through with comprehensive
security planning and implementation. We offer security
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support options ranging from enhanced phone support to firewall audits,
updates and on-site retainer contracts.
. INIT Systems--Interliant's Systems Consulting group provides design,
implementation, and support services for network design and
Internet/intranet connectivity. With more than 12 years of industry
independent experience, Interliant's systems consultants offer best
business practice in ongoing project support and staff augmentation
services, network design and implementation, and operating systems
migration (including Windows NT to Windows 2000 and Active Directory).
. Interliant's Oracle Consulting practice provides professional and
knowledgeable Oracle Application, Technical and DBA consultants to
governmental and commercial entities. Our implementation services
include business process analysis and re-engineering, project
management, application setup, conversion of legacy data, procedure
documentation, custom end-user training and post-implementation support.
. Interliant's Professional Services for Domino provide customers with
consultants having an understanding of overall IT strategy and the
ability and expertise to solve complex Lotus Notes/Domino infrastructure
issues. Our breadth of service includes Domino security audits,
migrating architectures from Domino R4 to R5, stability/performance
reviews, and recommendations for taking full advantage of the new
features and performance gains for Domino R5. We can also help with
network and platform issues, build new Web applications or maintain
existing systems.
. Interliant's Messaging professional services staff can review customers'
messaging needs and ensure a perfect fit with our messaging solutions.
For customers who are migrating or extending their Lotus Domino or
Microsoft Exchange messaging and prefer that the equipment reside at
their location, we can locate and remotely administer the pre-staged
servers on the customer's site. This lets the customer retain our
expertise in managing messaging servers, while gaining the performance
benefits associated with having the servers on their own LAN.
. Support/Service Options--Our professional services' comprehensive set of
support and maintenance options, include remote or on-site support,
24x7, and enhanced phone support, all designed to meet the needs of each
individual customer.
Customers
We have established a diversified customer base across our service
offerings. Our customer contracts generally range in duration from
month-to-month to three years. Our customers include end users representing a
variety of business types, from small and mid-sized businesses (SMB) to large
enterprises. We also sell our services to Web consulting firms, Internet
service providers, network integration companies, system integrators and other
Internet-related companies who resell them to their customers. In addition, our
customers include enterprises that brand and resell our INIT Solutions Suite to
their customer base through our INIT Branded Solutions program. We do not
believe that the loss of any one customer would materially adversely affect us.
Strategic Relationships
Our strategic relationships and partnerships with leading technology
companies allow us to provide a wide range of services to meet our customers'
needs. The following is a description of selected companies with whom we have a
strategic relationship:
Microsoft. We are a member of Microsoft's MCP Program as a Microsoft
Certified Application Provider. Under a Strategic Alliance Agreement entered
into with Microsoft in early 2000, we developed an Exchange 2000 managed
messaging product that we released in the second half of 2000. We are also
designated as a development and deployment partner for various Microsoft
products including the release of Windows 2000 and the next release of
Microsoft Exchange. As such, we are responsible for providing feedback on
Microsoft products in the advanced hosting and managed application markets
prior to release of those products and by
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doing so we have been able to provide services and gain expertise on these
products before the general market. In addition, under a Microsoft Application
Services Agreement that we entered into with Microsoft in March 2001, we may
provide customers with a rental license model for Microsoft software products.
IBM. We are a Premier Partner in the IBM Partnerworld Business Partner
Program for Service Providers, an IBM Service Provider for e-business, and the
first certified IBM Hosting Advantage partner. We work directly with IBM to
create co-marketing programs to increase demand generation.
Lotus Development. We are a leading partner of IBM's Lotus software
division. We are a Lotus Net Service Provider/Alliance Partner and a member of
the Lotus Partnership For Growth under which Lotus assists us in the growth and
development of our Lotus related business. We provide a variety of messaging
and hosting services for Internet, intranet and extranet applications operating
on Lotus Notes/Domino.
Cisco Systems. We are part of the Cisco Powered Network Program, a
certification awarded by Cisco in recognition of our world-class network
infrastructure design based on Cisco products. We have a strategic relationship
with Cisco Systems to provide comprehensive applications to our customers
utilizing Cisco Systems access and switching products. We are authorized to
distribute Cisco Systems products as part of our offering, both domestically
and on a multinational scale, at substantial discounts to the retail prices
generally available.
Oracle. We are an Oracle Certified Solution Provider (CSP) and an Oracle
Service Provider (OSP). In addition, we are a select partner within the Oracle
Service Industries Alliances Executive Exchange program. As a member of these
partner programs, we provide applications for customers based on the Oracle
e-business suite, in addition to Oracle database hosting.
Check Point Software. We are a Check Point Premier Value Added Solution
Provider (VASP), an Authorized Training Center (ATC), a Certified Support
Partner (CSP), and a Managed Service Provider (MSP). As a Premier Partner we
have attained the highest level of recognition within the Check Point partner
programs by demonstrating expertise and technical competency of Check Point
products, as well as a significant investment in their certified engineering
capability. We regularly participate with Check Point in co-marketing demand
generation activities.
Sprint. We entered into a 30-month agreement with Sprint in July 2001 to
provide Web-hosting services for Sprint's small business hosting initiative and
for its DellHost.com brand. At the same time, we reached an agreement with
Sprint to provide us with certain Internet protocol connectivity solutions and
other communication solutions.
Sales and Distribution
Our sales and marketing group sells our INIT Solutions Suite to our
customers through the following sales channels:
. direct sales, which sells INIT Messaging, INIT Security, INIT Hosting,
INIT Branded Solutions and INIT Services to large enterprises and other
businesses whose Internet operations are mission-critical;
. telesales, which acquires new customers through inbound calls generated
through traditional media and outbound telesales to pre-qualified
potential customers;
. Internet marketing programs, which drive potential customers to our Web
site or our telesales group. Customers can purchase Web-hosting
services, through our branded solutions program, on a 24x7 basis from
our Web site at www.interliant.com;
. indirect sales marketed under our INIT Partner programs. These programs
include INIT Referral (lead generation program), INIT ASP Host (designed
for ISVs and pure play ASPs), and INIT Alliances (solution partners and
equity partners). These distribution partners have established
relationships and
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cost-effective marketing reach with our prospective customer base as
well as sales teams capable of selling our solutions and services. These
indirect sales channels extend our market reach and assist in the
delivery of complete applications to meet customer needs; and
. our INIT Branded Solutions program, through which our enterprise
partners can provide our core solutions to their SMB customers under
their own brand or co-branded with us, which enables them to establish
new revenue streams.
Marketing
We market our INIT Solutions Suite through programs that generate lead
sources and increase awareness for our corporate and product brands. The
marketing techniques that provide the greatest success for us include
aggressive public relations, Interliant Seminars, direct response mail and
e-mail programs, and Web site marketing from our corporate Web site
www.interliant.com. All of these programs are enhanced through our channel
marketing initiatives with alliance partners. We are also engaged in the
following lead-generating activities:
. targeted cross-selling efforts that leverage the knowledge we have about
our current customers to offer them additional Interliant services;
. database-driven direct marketing programs that use prospect profiles and
specially crafted offers to generate leads and allow us to market our
services more cost-effectively by reaching the right contacts with the
right messages; and
. trade shows, customer events, newsletters, Webinars, and partner
roadshows that target our product areas.
Technology and Network Operations.
Hosting Platform. Although industry-standard Web servers are adequate for
basic Web hosting, we believe that efficiently managing large numbers of Web
sites and users on a single server or managing complex, Internet-based
applications requires significant technological innovations. We have developed
the proprietary INIT Host platform, a secure, reliable, high-performance and
scalable hosting platform, offered through our branded solutions program, that
we designed to provide a significant competitive advantage in the market. The
INIT Host platform architecture offers partners the ability to provide their
SMB customers with industry-leading technologies, including EMC Symmetrix
storage, Dell PowerEdge servers, Sun Enterprise servers, Openwave Internet
e-mail, Trellix site creation, Urchin Web statistics, and Miva e-commerce
solutions. Because we have made this expensive upfront investment in the INIT
Host platform, partners' initial and recurring costs are restricted to minimal
professional services fees plus reasonable recurring fees for the products
resold by the Partners. Partners can private label, co-brand or outsource all
or portions of the online interfaces such as the order page, control panel and
administrative tools and operational functions such as billing support,
customer care and technical support to Interliant. The design of the platform
also allows for new applications and products to easily be added as technology
and market standards change over time. We continue to look at ways to improve
our platform via formal programs such as the Microsoft Windows Reliability
Program and through internal programs that continually monitor feedback from
our customers and react to their needs. Our applications allow for servers to
be added while being monitored centrally, independent of where they are located.
Facilities and Operations. We have three primary data centers located in
Houston, Texas; Atlanta, Georgia; and Vienna, Virginia. In addition, we operate
a data center in London, England. We have network and server monitoring
infrastructures in all three of our primary data centers. In order to provide
our customers with high quality service, we have invested substantial resources
in building our network infrastructure. Our customer service representatives
and systems are located in or near our Atlanta and Houston data centers.
We have designed our network to minimize the effect of any interruptions.
Our high-speed network is designed to continue operating in case of software or
hardware failures. Our primary data centers feature separate
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fiber and power connections, primary and secondary network connections, backup
diesel generators, environmental control systems and uninterruptible power
supplies designed to provide on-site power for up to four weeks. Our data
centers in Atlanta and Houston also have separate redundant fiber. All our
internal systems receive nightly incremental and weekly full backups, and
customers in all of our data centers have the opportunity to purchase data
recovery services based on these backup for the servers that we provide for
their solution. We also provide remote access management and reporting tools.
Quality and security are paramount concerns for our customer base.
Consequently, we employ several security measures, including firewalls,
intrusion monitoring and site security monitoring, limited access electronic
card key measures and the physical separation of servers from administrative
workstations. We have also implemented monitoring systems to identify potential
sources of failure to limit downtime and notify our staff of potential and
actual problems. Although we have attempted to build redundancy into our
network and hosting facilities, our data centers are subject to various single
points of failure and a problem with one of our routers or switches could cause
an interruption in the services we provide to some of our customers.
Our Vienna, Virginia facility is a data center located within a mile of
MAE-East, the major East Coast data hub to the Internet, facilitating scalable
Internet connectivity and some of the most reliable network services available
in the country. This facility features equipment and design, including MGE
Uninterruptible Power Systems, multi-carrier connectivity, environmental
monitoring and conditioning and end-to-end physical security systems. We
believe these features ensure stable, reliable operation of applications.
Historically, our Houston data center housed our application hosting
operations and our Atlanta center housed our Web hosting operations. Each of
these centers, as well as our data center in Vienna, are capable of providing a
full range of hosting services for various applications and infrastructures. We
anticipate that, over time, the functional distinctions between our Houston,
Atlanta and Vienna data centers will diminish.
Our Enterprise Control Center (ECC) is responsible for monitoring our entire
network, server farm, security infrastructure and hosted applications on a 24x7
basis. We monitor each piece of equipment, including routers, switches,
firewalls and servers. The ECC also monitors all Internet and
telecommunications connections to ensure that they are functional and that
traffic is properly loaded. The design of the ECC enables systems
administrators and support staff to be promptly alerted to problems and we have
established procedures to alert appropriate staff for rapidly resolving any
technical problems that arise. The ECC is fully integrated into our customer
service facilities and systems, with integrated trouble ticketing, escalation
management and resolution. Our primary ECC is located in Atlanta, with backup
and redundant capabilities in each of our data centers to manage the specific
location in the event of a failure or disaster with our primary site.
Connectivity. We offer connectivity to our systems from virtually anywhere
in the world, enabling customers to deploy global applications. Customers can
access our data centers:
. via the Internet over Sprint's and Level (3) Communications' worldwide
networks;
. through X.25 connections provided by Worldcom;
. through dedicated lines at a bandwidth they specify;
. over Frame Relay through Sprint and Worldcom; or
. domestically via a toll-free number for either remote or Internet
protocol virtual private network (IPVPN) access.
We utilize multiple DS-3 connections to the Internet provisioned directly
off a SONET ring from our Houston data center. In addition, we currently
utilize multiple OC-12 sized circuits at our Atlanta facility and multiple OC-3
connections at our Vienna facility. Internally developed and commercially
available management and monitoring systems provide insight into the
performance of our entire network and alert us to potential problems and
security threats. In addition, there is a high level of consistency in our
security measures across all
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of our current hosting platforms. Bandwidth utilization management is done
through a hardware-based monitoring and data collection system that interfaces
with reporting and billing systems to provide our customers with timely
utilization statistics and monthly summaries.
By utilizing top-tier network connectivity providers and developing private
peering arrangements with other bandwidth providers, we are able to offer
highly available, resilient, redundant and high-speed connectivity between the
Internet and each of our data center facilities.
Agreements with certain of our connectivity providers, including Sprint and
Level (3) Communications, provide us with connectivity ranging in capacity from
T-1 to DS-3 to OC-3 to OC-12, which provides physical telecommunications
connections or "pipes" that are used to transport data and provide access to a
customer's resources. A larger pipe can carry a greater volume of data at a
greater speed. For example, a T-1 can carry 1.544 megabits per second; a DS-3
can carry 44.736 megabits per second, OC-3 carries 155 megabits per second and
an OC-12 can carry 622 megabits per second.
Customer Service
We have invested in advanced customer service software and call routing
technology to streamline the customer service process. Through our customer
service systems, customer service representatives can generally resolve any
issue in a timely manner via e-mail or our toll-free number. We also offer many
of our customers a self-service customer support alternative, which provides
site statistics such as disk storage capacity and bandwidth utilization.
Certain customer accounts also have access to dedicated support engineers who
are familiar with each unique configuration or requirement that a larger
customer may have.
A focused support team handles all the application hosting support
requirements via several mechanisms, including a facilitated discussion
database environment available over the Internet where customers, application
developers and support technicians can discuss pertinent issues and build a
relevant knowledge base. Our entire customer service operations are supported
by a company-wide CRM and trouble ticketing system with integrated escalation
management and SLA reporting and alarming. The system also includes an asset
management tracking application that enables a customer service representative
to view a customer's entire account, including past and recent interactions
with such customer. This database categorizes all reported problems so that if
a particular problem re-occurs, customer service representatives can view its
prior re-application and provide timely customer service.
Competition
The market we serve is highly competitive. Although barriers to entry and
continued growth are increasing, and consolidation of providers is expected to
continue, it is a market that is characterized by relative ease of entry. For
this reason, we expect that we will face additional competition from existing
competitors and new market entrants in the future.
Our current and potential competitors include:
. Web hosting and Internet services companies such as Digex, Divine,
Exodus (a Cable & Wireless company), Interland, NaviSite, NTT Verio,
Rackspace, and local and regional hosting providers;
. ASPs such as Corio, United Messaging, and USinternetworking;
. Internet professional services companies such as EDS, IBM Global
Services, Verisign and regional professional services organizations; and
. regional and local telecommunications companies, including the regional
Bell operating companies such as Qwest Communications, MCI/Worldcom, and
Verizon.
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Many of our competitors have substantially greater financial, technical and
marketing resources, larger customer bases, longer operating histories, greater
name recognition and more established relationships in the industry than we do.
As a result, certain of these competitors may be able to develop and expand
their network infrastructures and service offerings more rapidly, adapt to new
or emerging technologies and changes in customer requirements more quickly,
take advantage of acquisition and other opportunities more readily, devote
greater resources to the marketing and sale of their services and adopt more
aggressive pricing policies than we can. In addition, these competitors have
entered, and will likely continue, to enter into joint ventures or consortia to
provide additional services competitive with those provided by us.
Intellectual Property Rights
We rely on a combination of copyright, trademark, service mark, trade secret
laws and contractual restrictions to establish and protect certain proprietary
rights in our services. We have no patented technology that would preclude or
inhibit competitors from entering our market. The steps taken by us to protect
our intellectual property may not prove sufficient to prevent misappropriation
of our technology or to deter independent third-party development of similar
technologies. The laws of certain foreign countries may not protect our
services or intellectual property rights to the same extent as do the laws of
the United States. We also rely on certain technologies that we license from
third parties. These third-party technology licenses may not continue to be
available to us on commercially reasonable terms. The loss of the ability to
use such technology could require us to obtain the rights to use substitute
technology, which could be more expensive or offer lower quality or performance
and, therefore, have an adverse effect on our business.
To date, we have not been notified that our services infringe upon the
proprietary rights of third parties, but third parties could claim infringement
by us with respect to current or future services. From time to time, we are
notified that the content of one of our customer's sites infringes on a third
party's trademark or copyright. In response, we take steps pursuant to the
Digital Millennium Copyright Act to inform the customer of such claim and,
where appropriate, terminate a customer's service. We expect that participants
in our markets will be increasingly subject to infringement claims as the
number of services and competitors in our industry segment grows. Any such
claim, whether meritorious or not, could be time consuming, result in costly
litigation, cause service installation delays or require us to enter into
royalty or licensing agreements. Such royalty or licensing agreements might not
be available on terms acceptable to us or at all. As a result, any such claim
could have an adverse effect upon our business.
Government Regulation
We currently are not subject to direct federal, state or local government
regulation, other than regulations that apply to businesses generally. Only a
relatively small body of laws and regulations currently applies specifically to
hosting and e-commerce activities, or access to the Internet. Due to the
increasing popularity and use of the Internet, however, it is possible that
laws and regulations with respect to the Internet may be adopted at
international, federal, state and local levels, covering issues such as user
privacy, freedom of expression, pricing, characteristics and quality of
products and services, taxation, advertising, intellectual property rights,
information security and the convergence of traditional telecommunications
services with Internet communications. Although sections of the Communication
Decency Act of 1996 that, among other things, proposed to impose criminal
penalties on anyone distributing "indecent" material to minors over the
Internet were held to be unconstitutional by the U.S. Supreme Court, similar
laws may be proposed, adopted and upheld. The nature of future legislation and
the manner in which it may be interpreted and enforced cannot be fully
determined and, therefore, legislation similar to the Communications Decency
Act could subject us and/or our customers to potential liability, which in turn
could have a material adverse effect on our business, results of operations and
financial condition. The adoption of any such laws or regulations might
decrease the growth of the Internet, which in turn could decrease the demand
for our services, increase the cost of doing business or in some other manner
have an adverse effect on our business.
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We collect sales and other taxes in the states in which we have offices and
are required by law to do so. We currently do not collect sales or other taxes
with respect to the sale of services or products in all states and countries in
which we do not have offices and are not required by law to do so. One or more
jurisdictions have sought to impose sales or other tax obligations on companies
that engage in online commerce within their jurisdictions. A successful
assertion by one or more jurisdictions that we should collect sales or other
taxes on our products and services, or remit payment of sales or other taxes
for prior periods, could have an adverse effect on our business.
In addition, applicability to the Internet of existing laws governing issues
such as property ownership, copyright and other intellectual property issues,
taxation, libel, obscenity and personal privacy is uncertain. The vast majority
of such laws was adopted prior to the advent of the Internet and related
technologies and, as a result, does not contemplate or address the unique
issues of the Internet and related technologies. Changes to such laws intended
to address these issues could create uncertainty in the marketplace that could
reduce demand for our services, increase the cost of doing business as a result
of costs of litigation or increased service delivery costs or could in some
other manner have an adverse effect on our business.
Any new legislation or regulation, or the application of laws or regulations
from jurisdictions whose laws do not currently apply to our business, could
have an adverse effect on our business.
Employees
As of December 31, 2001 we had 716 employees, of which 94 were in sales,
distribution and marketing, 370 were IT professionals, including engineering,
technical and professional services, 125 were in customer care and 127 were in
finance and administration. None of our employees are represented by a labor
union and we believe that our employee relations are good. From January 1, 2002
to March 15, 2002, we reduced the number of employees by an additional 214
through the sale of assets, attrition and a reduction in force.
Risk Factors
In addition to the other information included in this Report on Form 10-K,
you should consider the following risk factors. This Report on Form 10-K
contains forward-looking statements covered by the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995. These forward-looking
statements involve risks and uncertainties that may affect our business and
prospects. Our results may differ significantly from the results discussed in
the forward-looking statements as a result of certain factors including those
listed below or discussed elsewhere in this Report and our other filings with
the Securities and Exchange Commission, to which you are referred.
We are a young and developing company with an evolving business model.
We have a history of significant losses and cash flow deficits which may
increase in the future.
Since our inception in December 1997, we have experienced operating losses
for each quarterly and annual period. We experienced net losses of
approximately $151.2 million in the year ended December 31, 2000 and
approximately $172.9 million in the year ended December 31, 2001. As of
December 31, 2001, we had an accumulated deficit of approximately $388.9
million. Our restructuring efforts in 2001 were designed to reduce expenses as
we focus on offering the solutions which we believe are most attractive to us,
and have led to decreases in our expenses during the quarters ended June 30,
2001, September 30, 2001 and December 31, 2001. However, there is no guarantee
that there will be future expense reductions as a result of these efforts.
We have experienced significant growth in revenues, primarily attributable
to acquisitions. The growth rate is not necessarily indicative of future
operating results. Our future results will depend primarily on internal growth
and to a lesser extent on acquisitions.
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We cannot give any assurance that we will ever achieve profitability on a
quarterly or annual basis, or, if we achieve profitability, that it will be
sustainable.
If the demand for our products and services and the use of the Internet does
not grow, we will need to raise additional funds in order to continue
operations beyond December 31, 2002.
From the latter half of the first quarter of 2001 through the end of 2001,
we experienced a decline in revenues and new sales orders. In addition, there
were negative economic developments and trends that have occurred since the
second half of the year 2000 in our industry sector, including reduced
corporate information technology spending, the failure of many internet-related
companies and sharply reduced sales forecasts. We generated negative cash flow
from operations during the years ended December 31, 2000 and December 31, 2001
of approximately $80.2 million and $50.7 million, respectively, and our capital
expenditures were approximately $39.4 million and $28.7 million, respectively.
As a result of these conditions, if we are unable to increase and sustain
anticipated growth in our revenues, we will need to obtain additional funding
through the sale of additional business divisions and/or assets, equity
financing or incurring additional debt in order to fund our operating needs and
meet our obligations beyond December 31, 2002. There can be no assurance that
any current or future discussions concerning such additional funding will
materialize. See the "Liquidity and Capital Resources" section of Management's
Discussion and Analysis of Financial Condition and Results of Operations
included in this Form 10-K.
If we raise additional funds, it could result in an increase in our interest
expense or dilution of the holdings of our stockholders.
We may need to raise additional funds through public or private debt or
equity financing. If funds are raised through the issuance of equity
securities, the percentage ownership of our then-current stockholders may be
reduced and such equity securities may have rights, preferences or privileges
senior to those of the holders of our shares of Common Stock. Also, the capital
markets recently have been unreceptive to new issues of Internet-related
securities, so our ability to raise funds in this manner is highly uncertain.
If additional funds are raised through the issuance of debt securities, such
securities may have certain rights, preferences and privileges senior to those
of the holders of our outstanding debt and equity securities and the terms of
such newly issued debt could impose restrictions on our operations.
Although we have reduced our debt from convertible notes, we still may not
be able to pay our debt and other obligations.
In the fourth quarter of 2001, as a result of our convertible debt
restructuring, we reduced the principal amount of our convertible debt by
approximately $120 million, thereby decreasing our ratio of debt to equity. We
also incurred $10.0 million of additional indebtedness in March 2002 in
connection with the investment by affiliates of Charterhouse Group
International, Inc. and Mobius Venture Capital of $10.0 million. Our other
indebtedness is principally comprised of notes payable and capital lease
obligations, other than approximately $600,000 in principal in convertible
notes issued as interest on our convertible notes. We may pay interest on our
convertible notes by issuing additional notes or by paying cash, at our option.
We may incur substantial additional indebtedness in the future. The level of
our indebtedness, among other things, could
. make it difficult for us to make payments on our outstanding
indebtedness;
. impair our ability to obtain additional financing in the future;
. reduce funds available to us for working capital, capital expenditures,
strategic acquisitions, research and development or other purposes;
. restrict our ability to introduce new products or exploit business
opportunities;
. limit our flexibility in planning for, or reacting to, changes in our
business; and
. make us more vulnerable in the event of a downturn in our business, and
to competitive pressures in the industry in which we operate.
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We cannot assure you that we will be able to pay interest and other amounts
due on our outstanding indebtedness as and when it becomes due and payable. If
our cash flow is inadequate to meet our obligations, we could face substantial
liquidity problems. If we are unable to generate sufficient cash flow or
otherwise obtain funds necessary to make required payments on our outstanding
indebtedness or our other obligations, we would be in default under the terms
thereof, which would permit the holders of our notes to accelerate the maturity
of the notes and could also cause defaults under any future indebtedness we may
incur. Any such default could have a material adverse effect on our business,
prospects, financial condition and operating results.
You may encounter volatility in the market price of our Common Stock.
The trading price of our Common Stock has been and is likely to continue to
be highly volatile. Our stock price could be subject to wide fluctuations in
response to factors such as the following:
. actual or anticipated variations in quarterly results of operations;
. the addition or loss of customers, vendors or strategic partners;
. our ability to hire and retain key personnel and other employees;
. announcements of technological innovations, new products or services by
us or our competitors;
. changes in financial estimates or recommendations by securities analysts;
. conditions or trends in the Internet and online commerce industries; and
. changes in the market valuations of other Internet or online service
companies.
In addition, the stock market in general, and the Nasdaq National Market and
the market for Internet and technology companies in particular, have
experienced extreme price and volume fluctuations that have often been
unrelated or disproportionate to the operating performance of these companies.
These broad market and industry factors may materially and adversely affect our
stock price, regardless of our operating performance. Consequently, holders of
our Common Stock may not be able to sell their shares of our Common Stock at a
price that is attractive to them.
Our existing principal stockholders, executive officers and directors
control Interliant and could delay or prevent a change in corporate control
that stockholders may believe will improve management and could depress our
stock price because purchasers cannot acquire a controlling interest.
As of December 31, 2001, our directors, executive officers and their
affiliates beneficially owned, in the aggregate, shares representing
approximately 82.3% of our Common Stock. As a result, these persons, acting
together, will be able to control all matters submitted to our stockholders for
approval and to control our management and affairs. This control could have the
effect of delaying or preventing a change of control that other stockholders
may believe would be beneficial to their interests. In addition, this control
could depress our stock price because purchasers will not be able to acquire a
controlling interest in Interliant.
Our stock price may be affected by the availability of shares for sale. The
future sale of large amounts of our stock, or the perception that such sales
could occur, could negatively affect our stock price.
The market price of our Common Stock could drop as a result of a large
number of shares of our Common Stock in the market. As of December 31, 2001,
there were approximately 51.9 million shares of Common Stock outstanding,
substantially all of which are eligible for sale in the public market, except
for 25.2 million shares held by Web Hosting Organization LLC and 3,379,283
shares held by SOFTBANK which are not currently eligible for sale. Holders of
approximately 35.7 million restricted shares have registration rights with
respect to such shares which, if exercised would permit the holders to sell
their shares freely in the public markets. Also, an aggregate of approximately
82.4 million shares of our Common Stock would be issuable upon conversion of all
15
of our convertible notes and the exercise of all of our warrants outstanding as
of December 31, 2001, which represents approximately 159% of our Common Stock
outstanding as of December 31, 2001. In addition, shares issuable upon exercise
of our outstanding options generally may be sold freely under our registration
statements on Form S-8.
Our operating results may fluctuate in the future. As a result,
period-to-period comparisons of our results of operations are not necessarily
meaningful and should not be relied upon as indications of future performance.
Our operating results may fluctuate in the future as a result of a variety
of factors, some of which are outside of our control. These factors include:
. our ability to divest certain previous acquisitions and streamline our
business into a group of core services;
. the demand for our services, pricing pressures in our market and changes
in the mix of products and services sold by us and our competitors;
. technological issues, including technical difficulties affecting the
Internet generally or our hosting operations in particular and increased
technological demands of our customers;
. the amount and timing of any significant restructuring, impairment, or
other charges resulting from or relating to our restructuring efforts;
. the amount and timing of our costs related to our marketing efforts and
service introductions by us or our reseller or referral partners; and
. economic conditions specific to the hosting and consulting industries.
Due to the factors described above, our operating results may not be
indicative of future operating results. In addition, our future operating
results for any particular period may differ materially from our expectations
or those of investors or security analysts. In this event, the market price of
our securities, including our Common Stock, would likely fall dramatically.
A significant portion of our assets consists of intangible assets, the
recoverability of which is not certain and the amortization of which will
increase losses or reduce earnings in the future.
In connection with acquisitions completed to date, approximately $202.9
million of the aggregate purchase price has been allocated to intangible assets
such as covenants not to compete, customer lists, trade names, assembled work
force and goodwill. However, in the twelve months ending December 31, 2001, we
recorded asset impairment charges related to the intangible assets amounting to
approximately $60.5 million of net book value. Our business could suffer if
changes in our industry or our inability to operate the business successfully
and produce positive cash flows from operations result in additional impairment
in the value of our remaining intangible assets and therefore necessitate a
write-off of all or part of these assets. Pursuant to recently enacted
accounting rules, certain intangible assets will not be subject to amortization
commencing in the year ending December 31, 2002. The impact of this change has
not been determined at this time.
If we do not respond effectively and on a timely basis to rapid
technological change, our business could suffer.
The Internet industry is characterized by rapidly changing technology,
industry standards, customer needs and competition, as well as by frequent new
product and service introductions. Our future success will depend, in part, on
our ability to accomplish all of the following in a timely and cost-effective
manner, all while continuing to develop our business model and roll-out of our
services:
. effectively use and integrate leading technologies;
. continue to develop our technical expertise;
16
. enhance our products and current networking services;
. develop new products and services that meet changing customer needs;
. advertise and market our products and services; and
. influence and respond to emerging industry standards and other changes.
We cannot assure you that we will successfully use or develop new
technologies, introduce new services or enhance our existing services on a
timely basis, or that new technologies or enhancements used or developed by us
will achieve market acceptance. Our pursuit of necessary technological advances
may require substantial time and expense.
We operate in an uncertain regulatory and legal environment which may make
it more difficult to defend ourselves against any claims brought against us.
We are not currently subject to direct regulation by the Federal
Communications Commission or any other governmental agency, other than
regulations applicable to business in general. While there are currently few
laws or regulations which specifically regulate Internet communications, laws
and regulations directly applicable to online commerce or Internet
communications are becoming more prevalent. There is much uncertainty regarding
the marketplace impact of these laws. In addition, various jurisdictions
already have enacted laws covering intellectual property, privacy, libel and
taxation that could affect our business by virtue of their impact on online
commerce. In the future, we may become subject to regulation by the FCC or
another regulatory agency. Further, the growth of the Internet, coupled with
publicity regarding Internet fraud, may lead to the enactment of more stringent
consumer protection laws. If we become subject to claims that we have violated
any laws, even if we successfully defend against these claims, our business
could suffer. Moreover, new laws that impose restrictions on our ability to
follow current business practices or increase our costs of doing business could
hurt our business.
If states and countries in which we do not currently collect sales or other
taxes mandate that we do so, our business could suffer.
We collect sales or other taxes with respect to the sale of products or
services in states and countries where we believe we are required to do so. We
currently do not collect sales and other taxes with respect to the sale of
products or services in all states and countries in which we do not have
offices and believe we are not required by law to do so. One or more
jurisdictions have sought to impose sales or other tax obligations on companies
that engage in online commerce within their jurisdictions. A successful
assertion by one or more jurisdictions that we should collect sales or other
taxes on our products and services, or remit payment of sales or other taxes
for prior periods, could have an adverse effect on our business.
We could face liability for information disseminated through our network.
It is possible that claims could be made against us in connection with the
nature and content of the materials disseminated through our networks. Several
private lawsuits are pending against other entities which seek to impose
liability upon online services companies and Internet service providers as a
result of the nature and content of materials disseminated over the Internet.
If any of these actions succeed, we might be required to respond by investing
substantial resources or discontinuing some of our product or service
offerings. The increased attention focused upon liability issues as a result of
these lawsuits and legislative proposals could impact the growth of Internet
use. Although we carry professional liability insurance, it may not be adequate
to compensate or may not cover us in the event we become liable for information
carried on or disseminated through our networks. Any costs not covered by
insurance incurred as a result of such liability or asserted liability could
adversely affect our business.
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We operate in an extremely competitive market and may not be able to compete
effectively.
Our current and prospective competitors are numerous. Many of our
competitors have substantially greater financial, technical and marketing
resources, larger customer bases, longer operating histories, greater name
recognition and more established relationships in the industry than we do. We
may not be able to compete effectively.
We depend on the skills of key personnel.
We depend on the continued service of our key personnel. Our key personnel
are critical to our success, and many of them would be difficult to replace.
Most of them are not bound by employment agreements, and competitors in our
industry may attempt to recruit them. We currently have agreements to retain
the services of certain members of our management team. These agreements do
not, however, as a practical matter, guarantee our retention of these persons.
The loss of the services of one or more of our key personnel could adversely
affect our business.
Our hosting solutions depend on software we obtain from third parties.
We obtain software products pursuant to agreements with vendors such as
Lotus and Microsoft and package them as part of our hosting solutions. The
agreements are typically for terms ranging from one to three years. We also
license additional technologies that we use in our business from other third
parties. If these agreements were terminated or not renewed, we might have to
discontinue products or services that are central to our business strategy or
delay their introduction unless we could find, license and package equivalent
technology. Our business strategy also depends on obtaining additional
software. We cannot be sure, however, that we will be able to obtain the new
and enhanced software we may need to keep our solutions competitive. If we
cannot obtain software and, as a result, must discontinue, delay or reduce the
availability of our solutions or other products and services, our business may
be adversely affected. In addition, we may become subject to infringement
actions based upon the technologies licensed from third parties. Any of these
claims, with or without merit, could subject us to costly litigation and divert
the attention of our technical and management personnel.
Our agreements with software vendors are not exclusive and may not provide
us with any competitive advantage.
None of our agreements for software and other technology are exclusive. Our
competitors may also license and utilize the same technology in competition
with us. We cannot be sure that the vendors of technology used in our products
will continue to support this technology in its current form. Nor can we be
sure that we will be able to adapt our own products to changes in this
technology. In addition, we cannot be sure that potential financial or other
difficulties of third party vendors will not have an adverse affect on the
technologies incorporated in our products, or that, if these technologies
become unavailable, we will be able to find suitable alternatives.
Disruption of our services due to accidental or intentional security
breaches may adversely impact our business.
A significant barrier to the growth of e-commerce and communications over
the Internet has been the need for secure transmission of confidential
information. Despite our design and implementation of a variety of network
security measures, unauthorized access, computer viruses, accidental or
intentional actions and other disruptions could occur. We may incur significant
costs to protect against the threat of security breaches or to alleviate
problems caused by such breaches. If someone were able to misappropriate our
users' personal or proprietary information or credit card information, we could
be subject to claims, litigation or other potential liabilities.
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We depend on our network infrastructure. If we do not have sufficient
network capacity, our ability to compete may be hurt.
Our success partly depends upon the capacity, scalability, reliability and
security of our network infrastructure, including the capacity leased from our
telecommunications network suppliers. We depend on these companies to provide
the capacity required to operate our business. For example, as our customers'
bandwidth usage increases, we will need to make additional investments in our
infrastructure to maintain adequate data transmission speeds, the availability
of which may be limited and the cost of which may be significant. Additional
network capacity may not be available from third-party suppliers as it is
needed by us. As a result, our network may not be able to achieve or maintain a
sufficiently high capacity of data transmission, especially if customers' usage
increases. Any failure on our part to achieve or maintain high-capacity data
transmission could significantly reduce our ability to compete and enhance our
services.
We could experience system failures and interruptions, which could result in
a decline in customer demand for our services.
To succeed, we must be able to operate our network infrastructure on a 24x7
basis without interruption. Our operations depend upon our ability to protect
our network infrastructure, equipment and customer files against damage. We
have experienced interruptions in service in the past. In addition, our data
centers are subject to various single points of failure. As a result, a problem
with one of our routers, switches or fiber paths or with another aspect of our
network could cause an interruption in the services we provide to some of our
customers. Any future interruptions could:
. require us to spend substantial amounts of money replacing existing
equipment or adding redundant facilities;
. damage our reputation for reliable service;
. cause existing end users, resellers and referral partners to cancel
their contracts;
. cause end users to seek damages for losses incurred; or
. make it more difficult for us to attract new end users, resellers and
referral partners.
We have entered into service level agreements with some of our customers and
we anticipate that we will offer service level agreements to a larger group of
customers in the future. In that case, we could incur significant liability to
our customers in connection with any system downtime and those obligations may
adversely affect our business.
Currency fluctuations and different standards, regulations and laws relating
to our international operations may adversely affect our business.
Approximately 10% of our revenue for the year ended December 31, 2000, and
7% for the year ended December 31, 2001, were to customers located outside the
United States, primarily in Europe, Asia and South America. Because our sales
overseas are denominated in U.S. dollars, currency fluctuations may inhibit us
from marketing our services to potential foreign customers or collecting for
services rendered to current foreign customers. Our international operations
expose us to additional risks including those such as managing operations
across disparate geographic areas and differences in privacy, censorship and
liability standards and regulations.
We may be liable for defects or errors in the solutions we develop.
Many of the solutions we develop are critical to the operations of our
clients' businesses. Any defects or errors in these solutions could result in:
. delayed or lost client revenues;
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. adverse customer reaction toward Interliant;
. negative publicity;
. additional expenditures to correct the problem; or
. claims against us.
Claims against us may not be adequately covered by insurance, may result in
significant losses and, even if defended successfully, may be costly and raise
our insurance costs.
We have a limited operating history and may not successfully implement our
business plan.
We have a limited operating history. We were incorporated in December 1997
and began offering Web hosting services in February 1998. Through December 31,
2001, we have completed 27 acquisitions. As a result of our limited operating
history and numerous acquisitions, our business model is still developing. In
April 2001, we announced a restructuring plan pursuant to which we sought to
narrow the focus of our service offerings. The execution of that restructuring
plan was completed in February 2002. Our business and prospects must be
considered in light of the risks frequently encountered by companies in their
early stages of development, particularly companies in the Internet services
market. Some of these risks relate to our ability to:
. obtain the benefits which our restructuring plan is designed to produce;
. implement our sales and marketing strategy to support our business and
build the Interliant brand;
. provide reliable and cost-effective services to our customers;
. continue to build our operations and accounting infrastructure to
accommodate additional customers;
. respond to technological developments and new products and services
offered by our competitors;
. develop and offer new products and services or differentiate such
products and services from those offered by our competitors;
. enter into strategic relationships with internet service providers,
software vendors and other strategic partners that further advance our
objective to become a full service managed infrastructure solutions
provider;
. build, maintain and expand distribution channels; and
. attract and retain qualified personnel.
We may not be successful in accomplishing these objectives. If we are not
successful, our business could be adversely affected.
Our rapid growth and expansion has and may continue to significantly strain
our resources.
From February 1998 through July 2000 we experienced rapid growth, primarily
due to acquisitions. This rapid growth has placed, and is likely to continue to
place, a significant strain on our operating and financial resources. Our
future performance will partly depend on our ability to manage our growth
effectively, which will require that we further develop our operating and
financial system capabilities and controls. We have invested and intend to
continue to invest significant amounts in billing, accounts receivable,
customer service and financial systems. Because in the past we employed a
strategy that included a high level of acquisition activity, we have operating
businesses that have not been integrated into our core systems and continue to
produce financial and other information from their existing systems. As a
result, our ability to record, process, summarize and report financial data
could be adversely affected.
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If the products and services we currently offer, and new products and
services we may offer in the future, are not accepted by the market or have
reliability or quality problems, our business may suffer.
If our current products and service offerings and other solutions and
enhanced Internet services that we may introduce in the future fail to gain
market acceptance, our business could be adversely affected. In addition, if
current solutions and enhanced Internet services have reliability, quality or
compatibility problems, market acceptance of these products and services could
be greatly hindered and our ability to attract new customers could be adversely
affected. We cannot offer any assurance that our solutions and services are
free from any reliability, quality or compatibility problems.
The growth of the market for our products and services may not materialize.
Our market is new and rapidly evolving. Whether the market for our products
and services will grow is uncertain. Our business would be adversely affected
if the market for our services does not grow or if businesses reduce or
discontinue outsourcing these services.
Our success depends in part on continued growth in the use of the Internet.
Our business would be adversely affected if Internet usage does not continue to
grow. Internet usage may be inhibited for a number of reasons, such as:
. security and privacy concerns;
. uncertainty of legal and regulatory issues concerning the use of the
Internet;
. inconsistent quality of service; and
. lack of availability of cost-effective, high-speed connectivity.
We depend on the growth and stability of the Internet infrastructure.
If the use of the Internet continues to grow rapidly, its infrastructure may
not be able to support the demands placed on it by such growth and its
performance or reliability may decline. In addition, Web sites have experienced
interruptions in their service as a result of outages and other delays
occurring throughout the Internet network infrastructure. If these outages or
delays occur frequently, use of the Internet as a commercial or business medium
could, in the future, grow more slowly or decline, which would adversely affect
our business.
ITEM 2. PROPERTIES
Our executive offices, which we lease, are located in Purchase, New York. We
also lease the facilities that house our data centers in Atlanta, Georgia,
Houston, Texas and Vienna, Virginia, as well as a data center in London,
England. We have other facilities in the Washington, D.C. and Boston
metropolitan areas. We believe these facilities are adequate for our current
and near term needs.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of business, we may be involved in legal proceedings
from time to time. As of the date hereof, there are no material legal
proceedings pending against us.
During September 2001, Cummings Properties, LLC initiated a summary
proceeding against Interliant Consulting and Professional Services, Inc., a
subsidiary of the Company (ICPS), in the District Court Department, Woburn
Division, in Woburn, Massachusetts. Cummings' action sought possession of the
office space rented by ICPS from Cummings at 12 Gill Street in Woburn, as well
as a judgment in the amount of $9.7 million for past due rent and liquidated
damages for all rent that would be due for the remainder of the lease term
pursuant to a rent acceleration clause in the lease. During October 2001, ICPS
filed an action against Cummings in the Superior Court Department of the
Middlesex County Trial Court of the Commonwealth of Massachusetts
21
seeking a declaration that the rent acceleration clause in the lease is invalid
and unenforceable under Massachusetts law, and seeking transfer of the Summary
Proceeding to the Superior Court.
In December 2001, Cummings and ICPS entered into a settlement agreement.
Under the terms of that agreement, Cummings deferred half of Interliant's
monthly rent for the period of November 1, 2001 through February 28, 2002. The
deferred amount plus interest and a deferral fee are to be paid during the
period of March 1, 2002 through February 1, 2003 (in addition to the regular
rent due for that period).
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A special meeting of the stockholders of Interliant, Inc. was held on
December 11, 2001 for the purposes listed below with the voting results
reflected thereafter:
1. To approve the issuance of shares of Interliant's Common Stock upon
conversion of 10% convertible senior notes of Interliant and upon
exercise of warrants which may be issued in exchange for Interliant's 7%
convertible subordinated notes, and in certain other events. The votes
were cast as follows: for: 32,486,317; against: 76,453; abstain: 9,073;
broker no-vote: 0.
2. To approve an amendment to Interliant's Certificate of Incorporation to
increase the number of authorized shares of Interliant's Common Stock
from 200 million shares to 250 million shares. The votes were cast as
follows: for: 32,347,231; against: 204,039; abstain: 20,573; broker
no-vote: 0.
3. To approve an amendment to Interliant's 1998 Stock Option Plan
increasing the number of shares of Common Stock available for grant
under such Plan and increasing the maximum number of shares of Common
Stock that may be subject to options granted to any optionee during any
one calendar year. The votes were cast as follows: for: 30,822,061;
against: 1,741,034; abstain: 8,748.
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market for Common Stock and Holders of Record
Our Common Stock commenced trading on the Nasdaq National Market under the
symbol INIT on July 8, 1999. The following table sets forth, for the periods
indicated, the intra-day high and low sales prices per share of Common Stock on
the Nasdaq National Market. Such prices reflect inter-dealer prices, without
retail mark-up, mark-down or commission and may not represent actual
transactions.
High Low
-------- -------
1999
Third Quarter (from July 8, 1999) $ 23.359 $10.500
Fourth Quarter................... $ 35.375 $ 9.250
2000
First Quarter.................... $ 54.930 $26.000
Second Quarter................... $ 28.812 $13.000
Third Quarter.................... $ 24.750 $ 7.469
Fourth Quarter................... $10.8125 $ 2.500
2001
First Quarter.................... $ 6.625 $ 1.188
Second Quarter................... $ 3.200 $ 0.350
Third Quarter.................... $ 0.780 $ 0.200
Fourth Quarter................... $ 0.860 $ 0.090
2002
First Quarter.................... $ 0.550 $ 0.200
22
The last reported sale price of our Common Stock on March 28, 2002 was
$0.26. As of March 28, 2002, there were approximately 210 stockholders of
record of our Common Stock. We believe that as of March 28, 2002 we had
approximately 12,500 beneficial owners of our Common Stock.
Dividends
We have never paid or declared cash dividends on our Common Stock. We
currently intend to retain all future earnings for our business and do not
anticipate paying cash dividends in the foreseeable future. Future dividends,
if any, will depend on, among other things: (1) our operating results, (2)
capital requirements and (3) restrictions in loan agreements.
Changes in Securities
In the year ended December 31, 2001, options to purchase 10,103 shares of
Common Stock were exercised at a weighted average exercise price of $0.58 per
share.
In the year ended December 31, 2001, 398,267 shares of Common Stock were
sold to our employees pursuant to the Employee Stock Purchase Plan at an
average price of $0.40 per share.
In January 2001, in connection with the attainment of certain earnout
targets as required under the agreement for the prior acquisition of Triumph
Technologies, Inc., we issued, as partial consideration, 102,041 shares of
Common Stock to certain stockholders of Triumph Technologies, Inc.
In February 2001, in connection with the attainment of certain earnout
targets as required under the agreement for the prior acquisition of The
Jacobson Consulting Group, Inc., we issued, as partial consideration, 547,920
shares of Common Stock to certain stockholders of The Jacobson Consulting
Group, Inc.
In April 2001, in connection with the attainment of certain earnout targets
as required under the agreement for the prior acquisition of Soft Link Holding
Corp., we issued, as partial consideration, 249,029 shares of Common Stock to
certain stockholders of Soft Link Holding Corp.
In May 2001, in connection with the attainment of certain earnout targets as
required under the agreement for the prior acquisition of Interliant Texas,
Inc. (formerly Interactive Software, Inc.), we issued, as partial
consideration, 151,831 shares of Common Stock to certain stockholders of
Interliant Texas, Inc.
In May 2001, in connection with the attainment of certain earnout targets as
required under the agreement for the prior acquisition of Milestone Services,
Inc., we issued, as partial consideration, 101,221 shares of Common Stock to
certain stockholders of Milestone Services, Inc.
In June 2001, pursuant to an amended consulting agreement for the services
of Bradley A. Feld, we issued 180,000 shares of Common Stock to Intensity
Ventures, Inc. in lieu of any other compensation thereunder for a period of
twelve months commencing June 1, 2001.
In June 2001, pursuant to an amended employment agreement with Leonard J.
Fassler, we issued 180,000 shares of Common Stock to Mr. Fassler in lieu of a
base salary thereunder as compensation for a period of twelve months commencing
June 1, 2001.
In June 2001, pursuant to an amended engagement letter with The Feld Group,
Inc., we issued 750,000 shares of Common Stock to The Feld Group, Inc. for past
services rendered.
In August 2001, in connection with the attainment of certain earnout targets
as required under the agreement for the prior acquisition of Interliant
Association Solutions, Inc. (formerly Knowledge Systems, Inc.), we issued, as
partial consideration, 424,406 shares of Common Stock to certain stockholders
of Interliant Association Solutions, Inc.
23
In August 2001, Interliant sold 190 Units consisting of convertible notes
and Common Stock for a total sales price of $19,000,000. Each Unit consisted of
$100,000 of 8% Convertible Subordinated Notes and 27,273 warrants for the
purchase of shares of Interliant's Common Stock. Initially, the notes had a
conversion price of $1.10 per share and the warrants had an exercise price of
$1.25 per share. In December 2001, the notes were amended to provide for a
conversion price of $1.00 per share and the warrants were amended to provide
for an exercise price of $0.60 per share. Interest on the notes is payable
quarterly by the issuance of additional notes carrying the same terms as the
original notes. The notes mature on June 30, 2003, and the warrants expire on
August 15, 2006.
In December 2001 Interliant completed an exchange of $164.2 million in
outstanding 7% Convertible Subordinated Notes issued February 2000. For each
$1,000 in notes exchanged, Interliant issued $270 principal amount of senior
notes convertible into 270 shares of Common Stock, warrants to purchase 67.5
shares of Common Stock at an exercise price of $0.60 per share and paid $70 in
cash. The notes have a conversion price of $1.00 per share and the warrants
have an exercise price of $0.60 per share. The interest on the notes is payable
semi-annually in cash or, at the option of Interliant, by the issuance of
additional notes carrying the same terms as the original senior notes. The
notes mature and the warrants expire on December 15, 2006.
We believe that the transactions described above were exempt from
registration under the Securities Act pursuant to Sections 3(a)(9) and 4(2) of
the Securities Act, Regulation D or Rule 144A promulgated thereunder, as
transactions by an issuer not involving a public offering, or pursuant to Rule
701 promulgated under Section 3(b) of the Securities Act, as transactions
pursuant to written compensatory benefit plans and contracts relating to
compensation. The recipients of securities in each of these transactions
represented that they were acquiring the securities for investment only and not
with a view to or for sale in connection with any distribution thereof and
appropriate legends were affixed to the securities certificates issued in such
transactions. All recipients had adequate access, through their relationships
with us, to information about us, or were given an adequate opportunity to
review information about us.
24
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA (In thousands, except per share
data)
The following selected consolidated financial data should be read in
conjunction with Interliant's Consolidated Financial Statements and Notes
thereto and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere in this Form 10-K. The statement of
operations for the period ended December 31, 1997, and the years ended December
31, 1998, 1999, 2000 and 2001, and the balance sheet data as of December 31,
1997, 1998, 1999, 2000 and 2001, are derived from the consolidated financial
statements of Interliant that have been audited by Ernst & Young LLP,
independent auditors, whose report with respect thereto is included elsewhere
in this Form 10-K. Results of operations for the period from inception to
December 31, 1997 and for the years ended December 31, 1998, 1999, 2000 and
2001 are not necessarily indicative of the results of operations for future
periods. Interliant's development and expansion activities, including
acquisitions, during the periods shown below may significantly affect the
comparability of this data from one period to another.
Period from
December 8,
Years ended 1997
December 31, (inception)
---------------------------------------- to December 31
2001 2000 1999 1998 1997
--------- --------- -------- -------- --------------
(In thousands, except per share data)
Statement of Operations Data:
Revenue............................................................ $ 117,257 $ 134,858 $ 47,114 $ 4,905 $
Costs and expenses:
Cost of revenue................................................. 79,008 95,259 27,514 3,236
Sales and marketing............................................. 29,713 38,358 17,236 2,555
General and administrative...................................... 60,142 55,660 27,076 6,016 156
Non-cash compensation........................................... (4,661) 15,106 1,986 833
Depreciation.................................................... 24,433 15,759 6,051 696 2
Amortization of intangibles..................................... 35,370 39,450 22,069 2,439
Restructuring charges........................................... 4,876 2,500
Impairment loss................................................. 126,736 --
--------- --------- -------- -------- ------
355,617 262,092 101,932 15,775 158
--------- --------- -------- -------- ------
Operating loss........................................................ (238,360) (127,234) (54,818) (10,870) (158)
Other income (expense), net........................................... 3,124 110
Interest income (expense), net........................................ (18,109) (5,247) 886 138
--------- --------- -------- -------- ------
Loss before minority interest, discontinued operations extraordinary
gain and cumulative effect of accounting change...................... (253,345) (132,371) (53,932) (10,732) (158)
Minority interest..................................................... 7,012 1,984
--------- --------- -------- -------- ------
Loss before discontinued operations, extraordinary gain and cumulative
effect of accounting change.......................................... (246,333) (130,387) (53,932) (10,732) (158)
Loss from discontinued operations..................................... (10,442) (19,622)
--------- --------- -------- -------- ------
Loss before extraordinary gain and cumulative effect of accounting
change............................................................... (256,775) (150,009) (53,932) (10,732) (158)
Extraordinary gain on debt refinancing................................ 83,896 --
--------- --------- -------- -------- ------
(Loss) before cumulative effect of accounting change.................. (172,879) (150,009) (53,932) (10,732) (158)
Cumulative effect of accounting change................................ -- (1,220)
--------- --------- -------- -------- ------
Net (loss)............................................................ $(172,879) $(151,229) $(53,932) $(10,732) $ (158)
========= ========= ======== ======== ======
Basic and diluted loss per share:
Loss before discontinued operations, extraordinary gain and
cumulative effect of accounting change............................ $ (4.86) $ (2.74) $ (1.50) $ (1.22) $(0.05)
Discontinued operations............................................ (0.21) (0.41)
Extraordinary gain on debt refinancing............................. 1.66
Cumulative effect of accounting change............................. (0.03)
--------- --------- -------- -------- ------
Net loss........................................................... $ (3.41) $ (3.18) $ (1.50) $ (1.22) $(0.05)
========= ========= ======== ======== ======
Weighted average shares outstanding--basic and diluted................ 50,648 47,548 35,838 8,799 3,000
========= ========= ======== ======== ======
25
Period from
December 8,
Years ended 1997
December 31, (inception)
--------------------------------------- to December 31
2001 2000 1999 1998 1997
-------- --------- -------- -------- --------------
(In thousands, except per share data)
Other Data:
EBITDA................................................ $(51,606) $ (54,419) $(24,712) $ (6,902) $ (156)
Statement of Cash Flows Data:
Net cash used for operating activities................ $(50,720) $ (80,159) $(24,152) $ (6,001) $ (59)
Net cash provided by (used for) investing activities.. 28,655 (115,703) (46,459) (17,919) (29)
Net cash provided by financing activities............. 747 195,495 91,406 29,821 1,000
Net capital activities................................ 28,717 39,406 12,084 4,322 29
Balance Sheet Data:
Cash, cash equivalents and short term investments..... $ 5,371 $ 79,911 $ 31,220 $ 6,813 $ 912
Working capital (deficiency).......................... (17,270) 62,298 26,886 3,755 4,815
Total assets............................................. 70,798 325,289 162,875 26,197 4,953
Debt and capital lease obligations, less current portion. 102,450 177,665 2,503
Total stockholders' equity (deficit)..................... (74,916) 87,278 137,575 21,693 4,842
- --------
(1) EBITDA represents earnings before net interest expense, income taxes,
depreciation and amortization, non-cash compensation expense, restructuring
charges, impairment loss, loss from discontinued operations, extraordinary
gain and other income (expense). EBITDA is presented because it is a widely
accepted financial indicator used by certain investors and analysts to
analyze and compare companies on the basis of operating performance and
because management believes that EBITDA is an additional meaningful measure
of performance and liquidity. EBITDA is not intended to represent cash
flows for the period, nor has it been presented as an alternative to
operating income (loss) as an indicator of operating performance and should
not be considered in isolation or as a substitute for measures of
performance prepared in accordance with generally accepted accounting
principles. The items excluded from the calculation of EBITDA are
significant components in understanding and assessing our financial
performance. Our computation of EBITDA may not be comparable to the
computation of similarly titled measures of other companies. EBITDA does
not represent funds available for discretionary uses.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
You should read the following description of our financial condition and
results of operations in conjunction with the Consolidated Financial Statements
and the Notes thereto included elsewhere in this report on Form 10-K. This
discussion contains forward-looking statements based upon current expectations
that involve risks and uncertainties.
Forward-Looking Statements And Associated Risks
This Form 10-K contains forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A
of the Securities Act of 1933, as amended. Certain forward-looking statements
relate to, among other things, future results of operations, profitability,
growth plans, sales, expense trends, capital requirements and general industry
and business conditions applicable to our business. Any statements contained
herein that are not statements of historical fact may be deemed to be
forward-looking statements. Our actual results and the timing of certain events
may differ significantly from the results discussed in the forward-looking
statements. These forward-looking statements are based largely upon our current
expectations and are subject to a number of risks and uncertainties. The words
"anticipate," "believe," "estimate" and similar expressions used herein are
generally intended to identify forward-looking statements. In addition to the
other risks described elsewhere in this report and in other filings by the
Company with the Securities and Exchange Commission, to which you are referred,
important factors to consider in evaluating such forward-looking statements
include but are not limited to: the uncertainty that demand for our services
will increase and
26
other competitive market factors; changes in our business strategy; an
inability to execute our strategy due to unanticipated changes in our business,
our industry or the economy in general; difficulties in the timely expansion of
our network and data centers or in the acquisition and integration of
businesses; difficulties in retaining and attracting new employees or
customers; difficulties in developing or deploying new services; risks
associated with rapidly changing technology; and various other factors that may
prevent us from competing successfully or profitably in existing or future
markets. In light of these risks and uncertainties, there can be no assurance
that the forward-looking statements contained herein will in fact be realized
and we assume no obligation to update this information.
Overview
We are a provider of managed infrastructure solutions, encompassing
messaging, security, and hosting, plus an integrated set of professional
services products that differentiate and add customer value to these core
solutions. The Company sells to the large/enterprise market through its direct
sales force and to the small and medium-business market (SMB) through its INIT
Branded Solutions program, which allows companies to private label our
offerings. The Company provides companies of all sizes with cost-effective,
secure infrastructure and a focused suite of e-business solutions.
We provide our customers integrated, high-level business value, from
development to implementation to maintenance, that allows them to maintain
critical business functions without maintaining an IT infrastructure and staff
that are not central to their core competencies. We focus on the critical
technologies necessary to support their business success - Internet, messaging,
security, applications, internal systems, network systems and infrastructure.
The accompanying financial statements have been prepared assuming we will
continue as a going concern. For the period from inception to December 31,
2001, we have incurred net losses and negative cash flows from operations, and
also have expended significant funds for capital expenditures (property and
equipment) and the acquisitions of businesses. As of December 31, 2001, we had
negative working capital of $17.3 million, including cash and cash equivalents
of $5.4 million.
We have grown our business by acquiring numerous operating companies
providing managed infrastructure solutions, Web hosting and professional
services solutions, for total consideration of approximately $216.2 million.
The purchase consideration for the acquisitions was in the form of cash, stock
or a combination of cash, stock and issuance of debt. The acquisitions have
been accounted for using the purchase method of accounting, which has resulted
in the recognition, as of December 31, 2001, of approximately $202.9 million of
intangible assets. During 2001, we recorded impairment charges for goodwill and
other intangibles of $60.5 million of net book value of such assets. As of
December 31, 2001, the net book value of goodwill and intangibles was $29.8
million. Recoverability of the remaining net book value of intangible assets is
dependent on our ability to successfully operate our businesses and generate
positive cash flows from operations. See notes 2 and 5 of Notes to Consolidated
Financial Statements in this report on Form 10-K and "Results of
Operations-Restructuring and Impairment Charges" set forth below.
Our principal sources of cash to fund the aforementioned activities were
from the sale of $152.3 million in Common and Preferred Stock in public and
private sales, the sale of $164.8 million of 7% Notes and the sale of units
(Units) comprising $19.0 million of 8% Convertible Subordinated Notes and
warrants to purchase shares of our Common Stock. As of December 31, 2001, we
had $5.4 million in cash and cash equivalents.
As of December 31, 2001, we had an accumulated deficit of $388.9 million.
The revenue and income potential of our business is unproven and our limited
operating history makes an evaluation of us and our prospects difficult. While
we have taken restructuring actions that we expect will result in reductions of
our overall cost structure, we anticipate the need to make continued
investments in connection with the following:
. Expanding our direct and channel sales initiatives;
27
. Funding of product development;
. Completing and equipping our data centers; and
. Implementing our billing, accounting, operations and customer service
systems.
We expect to continue to incur operating losses, including depreciation and
amortization expense, as well as negative operating cash flows for the
foreseeable future. We cannot be assured that we will ever achieve
profitability on a quarterly or annual basis, or, if achieved, that we will
sustain profitability.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in
the United States. The preparation of these financial statements requires us to
make estimates and judgments that affect the reported amount of assets and
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities at the date of our financial statements. Actual results may
differ from these estimates under different assumptions or conditions.
Critical accounting policies are defined as those that are reflective of
significant judgments and uncertainties, and potentially result in materially
different results under different assumptions and conditions. We believe that
our critical accounting policies are limited to revenue recognition, as
described below in "Results of Operations". For a detailed discussion on the
application of these and other accounting policies, see Note 2 in the Notes to
Consolidated Financial Statements.
Results Of Operations
Our reportable segments include managed infrastructure solutions, Web
hosting and professional services. Our current major lines of business included
in each of these segments are as follows:
Managed Infrastructure
Solutions Web Hosting Professional Services
--------- ------------------------- --------------------------
Managed Messaging Retail Web Hosting (a) Messaging
and Collaboration Services
Managed Hosting Security and Networking
Solutions
Managed Security Enterprise Resource
Planning (ERP)
Branded Web Hosting
(Private Label)
- --------
(a) Business was sold in October 2001
Our revenue streams consist of recurring service fees, and non-recurring
professional services and product sales. We sell managed infrastructure
solutions and Web hosting services for contractual periods generally ranging
from one month to three years. Web hosting arrangements generally are
cancelable by either party without penalty. Hosting revenues are recognized
ratably over the contractual period as services are performed. Incremental fees
for excess bandwidth usage and data storage are billed and recognized as
revenue in the period that customers utilize such services. Payments received
and billings made in advance of providing hosting services are deferred until
the services are provided.
Professional services revenues generally are recognized as the services are
rendered, provided that no significant obligations remain and collection of the
receivable is considered probable. Substantially all of our professional
services contracts call for billings on a time and materials basis. Some of our
contracts contain milestones and/or customer acceptance provisions. For these
contracts, revenue is recognized as milestones are performed and accepted by
the customer or when customer acceptance is attained.
28
Certain customer contracts contain multiple elements under which we sell a
combination of any of the following: managed infrastructure solutions and
professional services, computer equipment, software licenses and maintenance
services to customers. We have determined that objective evidence of fair value
exists for all elements and have recorded revenue for each of the elements as
follows: (1) revenue from the sale of computer equipment and software products
is recorded at the time of delivery; (2) revenue from service contracts is
recognized as the services are performed; and (3) maintenance revenue and
related costs are recognized ratably over the term of the maintenance agreement.
Under certain arrangements, we resell computer equipment and/or software and
maintenance purchased from various computer equipment and software vendors. We
are recording the revenue from these products and services on a gross basis
pursuant to EITF 99-19, Reporting Revenue Gross as a Principal versus Net as an
Agent. Under these arrangements, we determined that we are the primary obligor.
We present the end-user with a total solution from a selection of various
vendor products, set final prices and perform certain services. Additionally,
we have credit and back-end inventory risk.
In some circumstances we resell software, and in connection with such sales,
we apply the provisions of Statement of Position 97-2 ("SOP 97-2"), Software
Revenue Recognition, as amended by Statement of Position 98-4. Under SOP 97-2,
we recognize license revenue upon shipment of a product to the end-user if a
signed contract exists, the fee is fixed and determinable and collection of the
resulting receivable is probable. For contracts with multiple elements (e.g.,
software products, maintenance and other services), we allocate revenue to each
element of the contract based on vendor specific objective evidence of the
element's fair value.
Cost of revenues primarily consists of salaries and related expenses
associated with professional services and data center operations, data center
facilities costs, costs of hardware and software products sold to customers,
and data communications expenses, including one-time fees for circuit
installation and variable recurring circuit payments to network providers.
Monthly circuit charges vary based upon circuit type, distance and usage, as
well as the term of the contract with the carrier.
Sales and marketing expense consists of personnel costs associated with the
direct sales force, internal telesales, product development and product
marketing employees, as well as costs associated with marketing programs,
advertising, product literature, external telemarketing costs and corporate
marketing activities, including public relations.
General and administrative expense includes the cost of customer service
functions, finance and accounting, human resources, legal and executive
salaries, corporate overhead, acquisition integration costs and fees paid for
professional services.
Restructuring and impairment charges:
During the latter half of the first quarter of 2001, we experienced a
substantial decline in revenues and new sales orders. There were negative
economic developments and trends that occurred during this period in our
industry sector, including reduced corporate information technology spending,
the failure of many Internet-related companies, and sharply reduced sales
forecasts. All of these factors caused us to re-evaluate our business focus and
operating plans for the remainder of 2001 and beyond. Such decisions gave rise
to the following actions:
Based on a decision reached by our management and the Board of Directors in
late March 2001, on April 2, 2001 we announced a restructuring plan (the "April
Plan" or "Restructuring") to further streamline the business by narrowing our
services focus to a core set of offerings. The April Plan comprised workforce
reductions and the exit of certain non-core businesses. In conjunction with the
restructuring, we undertook a review of our long-lived assets pursuant to
Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,
and SEC Staff Accounting Bulletin No. 100, Restructuring and Impairment Charges
(SAB 100) to ascertain if these decisions and changed conditions caused an
impairment charge.
29
The April Plan was executed in two phases. Phase 1, which began on April 3,
2001, consisted of a workforce reduction of approximately 200 positions, and
resulted in a charge for the payment of severance and related costs of
approximately $1.7 million. This charge was recognized in the second quarter of
2001. We anticipate that the annualized cost savings from the Phase 1 workforce
reductions will range from $13.0 million to $15.0 million and we began
realizing savings during the latter part of the second quarter of 2001. The
amount of these savings could change if we need to further adjust our personnel
infrastructure to support ongoing operations.
Phase 2 of the April Plan included exiting, via sale, certain businesses
that we determined to be outside of the redefined scope of our service
offerings along with additional workforce reductions. In July 2001, we exited
the Managed Enterprise Resource Planning (ERP) and Customer Relationship
Management (CRM) product lines of our managed infrastructure solutions segment,
formerly known as reSOURCE PARTNER, Inc. (rSP), which had been a key component
of our scope of services prior to the April Plan. In August 2001, we exited the
remaining operations of rSP. The 2001 losses from discontinued operations of
$10.4 million include losses incurred prior to the measurement date of
approximately $6.5 million, and the estimated losses on disposal of $3.9
million. We have retained approximately $1.3 million of rSP assets, consisting
primarily of computer equipment and software. As of December 31, 2001, the net
liabilities of rSP totaled $0.9 million.
In July 2001, we announced a further business restructuring that included
additional workforce reductions of approximately 70 positions and a plan to
exit certain leased office facilities. We recognized a restructuring charge of
$3.0 million during the third quarter of 2001 for the qualifying costs. We
expect the annualized savings from this restructuring to be approximately $5.0
million.
In October 2001, we sold another of our non-core businesses, our shared and
unmanaged dedicated retail Web hosting business (see Note 5 of Notes to
Consolidated Financial Statements). We will continue to focus our strategy on
OEM, private label and referral partner Web hosting services through our
branded solutions offerings.
As part of the restructuring activities an impairment assessment was made at
the end of the first quarter of 2001 with respect to the long-lived assets
associated with the businesses planned to be sold or shut down. The assessment
indicated that, on a held for use basis, there was impairment evident in such
assets. Further, based on our assessment of internal and external facts and
circumstances to which the impairment was attributable, we concluded that the
impairment indicators arose in the latter half of the first quarter of 2001. In
connection therewith we recorded impairment charges aggregating $36.5 million.
Long-lived assets that are impaired consist of property and equipment,
identifiable intangible assets and related goodwill. For purposes of measuring
the impairment charge, fair value was determined based on a calculation of
discounted cash flows or net realizable value if known.
In connection with the disposition of our investment in Interliant Europe,
B.V. (Interliant Europe), we conducted an impairment assessment with respect to
the long-lived assets associated with Interliant Europe, and the assessment
indicated that there was impairment evident in such assets. The fair value of
the long-lived assets was determined based on the terms of the definitive
agreement that we executed in August 2001. Consequently, we recorded an
impairment charge of $4.7 million, to write-off the entire net book value of
property and equipment ($4.4 million), identifiable intangible assets ($0.2
million) and other long-term assets ($0.1 million) related to Interliant Europe.
We determined that there were potential impairment indicators present in our
core hosting and professional services businesses that arose during the third
quarter of 2001 as a result of the continued economic uncertainties in general,
certain weaknesses in our market and lack of revenue growth for the Company in
particular. Accordingly, we conducted an impairment assessment with respect to
long-lived assets associated with such businesses. Further, for businesses
previously identified for sale or disposition, we updated the fair value
determination based on more current pricing terms from recent negotiations with
prospective buyers. Based on
30
these assessments, we determined that there was impairment evident in the
assets associated with our core hosting businesses and the PeopleSoft ERP
professional services business. Consequently, we recorded impairment charges of
$85.5 million to write-off the net book value of certain of the fixed assets,
including software, used in those businesses ($51.4 million), other long term
assets ($1.4 million) and identifiable intangible assets and goodwill ($32.7
million) related to those businesses.
The following is a discussion of our results from continuing operations:
Years Ended December 31, 2001 and 2000
The following table sets forth in comparative format the historical results
of operations for 2001 and 2000.
Year Ended December 31,
--------------------------------------
2001 % of 2000 % of
Historical Revenues Historical Revenues
---------- -------- ---------- --------
(dollars in millions)
Service revenues............... $ 98.0 84% $ 103.3 77%
Product revenues............... 19.2 16% 31.6 23%
------- ---- ------- ---
Total revenues.............. 117.2 100% 134.9 100%
Costs and expenses:............
Cost of service revenues.... 63.7 54% 69.7 52%
Cost of product revenues.... 15.3 13% 25.6 19%
Sales and marketing......... 29.7 25% 38.3 28%
General and administrative.. 55.5 47% 70.7 52%
Depreciation................ 24.4 21% 15.8 12%
Amortization of intangibles. 35.4 30% 39.5 29%
Restructuring charge........ 4.9 4% 2.5
Impairment losses........... 126.7 108%
------- ---- ------- ---
355.6 303% 262.1 194%
------- ---- ------- ---
Operating loss................. $(238.4) -203% $(127.2) -94%
======= ==== ======= ===
Revenues
Revenues decreased $17.7 million, from $134.9 million in 2000 to $117.2
million in 2001. The decrease in revenues was due primarily to the lower
revenues from the professional services and Web hosting segments offset by
increased managed infrastructure solutions revenue as discussed below.
Managed infrastructure solutions revenues increased $5.0 million, from $25.0
million in 2000 to $30.0 million in 2001. This increase was due primarily to
the successful expansion of our OEM or private label hosting activities under
our branded solutions programs. Web hosting revenues decreased $7.1 million,
from $19.6 million in 2000 to $12.5 million in 2001, resulting primarily from
the sale of the retail Web hosting business in October 2001 as well as the
overall reduction in revenues as a result of the declining economy in 2001 and
reduced direct marketing expenditures in 2001. ASP professional services
revenues decreased $15.9 million, from $83.0 million in 2000 to $67.1 million
in 2001. This decrease was due primarily to lower sales of products ($12.4
million) and consulting ($16.5 million) revenues resulting from reduced
customer demand stemming from overall weaknesses in the economy and in the
Information Technology sector in particular, offset by the revenues included
for a full year from acquisitions completed during 2000 ($13.0 million).
Cost of Revenues
Cost of revenues decreased by $16.3 million, from $95.3 million in 2000 to
$79.0 million in 2001. This decrease was due primarily to the lower cost of
product sales as a result of lower revenue, reduced salaries and
31
related costs as a result of the restructuring activities in 2001, offset by
the increased costs related to the acquisitions consummated during 2000. In the
future, cost of revenues may fluctuate due to capacity utilization, the timing
of investments in data centers, changes in the mix of services, fluctuations in
bandwidth costs and increased levels of staffing to support anticipated revenue
growth.
Gross margin was 32.6% for 2001 as compared to 29.4% for 2000. The higher
gross margins are the result of an increase in the proportion of revenue from
hosting services as compared with ASP professional services and products, which
typically generate lower gross margins as compared with our hosting services.
Sales and Marketing
Sales and marketing expense decreased by $8.7 million, from $38.4 million in
2000 to $29.7 million in 2001. This decrease was attributable to lower
marketing expenditures, namely reductions in brand recognition programs and
lesser emphasis on direct marketing campaigns for the Web hosting segment, and
lower salaries and benefits associated with reductions in our sales headcount
stemming from our restructuring efforts, offset by increases from the sales and
marketing expenses of businesses acquired during 2000. We curtailed our brand
recognition programs and reduced emphasis on direct marketing campaigns for the
Web hosting segment.
General and Administrative
General and administrative expense (excluding non-cash compensation)
increased by $4.4 million, from $55.7 million in 2000 to $60.1 million in 2001.
This increase in general and administrative expense was attributable primarily
to the general and administrative expenses of businesses acquired during 2000
and increases in bad debt provisions stemming from overall weaknesses in the
economy and in the Information Technology sector in particular, offset by
expense decreases resulting from workforce reductions and improved cost
controls.
Non-cash compensation
Non-cash compensation expense decreased by $19.7 million, from $15.1 million
in 2000 to a credit of $4.6 million in 2001.
In January 2000, we issued options to purchase 1.5 million shares of Common
Stock at an average exercise price of $18.00 per share to our then-current CEO.
The average exercise price of the options was below the fair value of the
Common Stock as of the measurement date, which required the recognition of
approximately $30.0 million as compensation expense over the four-year vesting
period of the options on a graded vesting basis. In April 2001, said CEO
terminated his employment with us. In connection therewith, we recorded an
adjustment in the 2001 period to reverse compensation charges aggregating
approximately $8.4 million, which were recorded during 2000 and the quarter
ended March 31, 2001, to reflect the excess of the charge recognized on a
graded vesting basis over the value of the options that had ratably vested as
of the date of his termination.
During the year ended December 31, 2001, we recorded non-cash compensation
charges aggregating $1.3 million stemming from stock issuances to our
co-chairmen, and stock and warrant issuances and option grants to The Feld
Group, which is rendering executive-level service to us.
Restructuring Charge
As described in the "Results of Operations-Restructuring and Impairment
Charges" herein, we recorded restructuring charges of $5.2 million during the
year ended December 31, 2001. As of December 31, 2001, $3.1 million of the
restructuring reserve was utilized and 256 employees were terminated under the
plan. After the completion of this restructuring effort we expect to realize
annualized cost savings ranging from $18 million to $20 million. The foregoing
is a forward-looking statement and is based on our current business plan and
the assumptions on which it is based. Unanticipated changes in our assumptions
may cause these estimates to vary materially.
32
Depreciation
Depreciation expense increased by $8.6 million, from $15.8 million in 2000
to $24.4 million in 2001. The increase in depreciation expense was attributable
to the acquisitions consummated during 2000, and investments in network
software and equipment, furniture and office equipment, and leasehold
improvements during 2001 and the second half of 2000, offset by reductions in
depreciation for assets which were written down in connection with impairment
charges. The fixed asset additions were driven by the expansion of our data
centers and customer care facilities and customer-driven computer equipment and
software purchases to support revenue growth.
Amortization of Intangible Assets
Amortization expense decreased by $4.1 million, from $39.4 million in 2000
to $35.3 million in 2001. This decrease in amortization expense was
attributable primarily to the reduction in the carrying amounts of intangible
assets as a result of the impairment charges recorded in 2001, offset by
increases in amortization due to the acquisitions consummated during 2000.
Impairment Loss on Long-lived Assets
Impairment losses on long-lived assets were $126.7 million for the year
ended December 31, 2001. In conjunction with the events and circumstances
surrounding our April 2001 restructuring plan (see Notes 4 and 12 of Notes to
Consolidated Financial Statements), the plan to exit our European and ERP
People Soft consulting businesses and as we experienced weaknesses in our core
hosting business, we performed a series of reviews of our long-lived assets to
ascertain if such decisions and economic factors resulted in an impairment in
our long-lived assets pursuant to Statement of Financial Accounting Standards
No. (SFAS) 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of, and SEC Staff Accounting Bulletin No. 100
(SAB 100), Restructuring and Impairment Charges. See "Results of
Operations-Restructuring and Impairment Charges" herein.
Interest income (expense), net
Net interest expense increased by $12.9 million, from $5.2 million of net
interest expense in 2000 to $18.1 million of net interest expense in 2001.
Interest expense increased $6.7 million, from $13.2 million in 2000 to $19.9
million in 2001 as a result of the issuance of the 7% Convertible Subordinated
Notes in February 2001, the sale of $19.0 million of 8% Convertible
Subordinated Notes in August 2001 (including a charge of $3.3 million related
to the beneficial conversion feature of such notes) and capital lease
obligations to finance equipment and furniture purchases during 2001. Interest
income decreased $6.2 million, from $8.0 million in 2000 to $1.8 million in
2001. This decrease was due to the significant reduction in the amount of cash
available for short term investing in 2001.
33
Years Ended December 31, 2000 and 1999
The following table sets forth in comparative format the historical results
of operations for 2000 and 1999.
Year Ended December 31,
--------------------------------------
2000 % of 1999 % of
Historical Revenues Historical Revenues
---------- -------- ---------- --------
(dollars in millions)
Service revenues............... $ 103.3 77% $ 43.7 93%
Product revenues............... 31.6 23% 3.4 7%
------- --- ------ ----
Total revenues.............. 134.9 100% 47.1 100%
Costs and expenses:
Cost of service revenues.... 69.7 52% 24.8 53%
Cost of product revenues.... 25.6 19% 2.7 6%
Sales and marketing......... 38.3 28% 17.2 37%
General and administrative.. 70.7 52% 29.1 62%
Depreciation................ 15.8 12% 6.0 13%
Amortization of intangibles. 39.5 29% 22.1 47%
Restructuring charge........ 2.5 2%
------- --- ------ ----
262.1 194% 101.9 216%
------- --- ------ ----
Operating loss................. $(127.2) -94% $(54.8) -116%
======= === ====== ====
Revenues
Revenues increased $87.8 million, from $47.1 million in 1999 to $ 134.9
million in 2000. The increase in revenues was due primarily to the 15
acquisitions consummated during 2000 and 1999, and organic growth of
approximately 25%, which is calculated based on the increase in pro forma
revenues (giving effect to all acquisitions as if they occurred on January 1,
1999 and excluding revenue from operations discontinued in 2001) from $118.7
million in 1999 to $148.2 million in 2000.
Managed infrastructure solutions revenues increased $9.4 million, from $15.6
million in 1999 to $25.0 million in 2000. This increase was due primarily to
acquisitions completed during 2000 and 1999. Web hosting revenues increased
$2.7 million, from $16.9 million in 1999 to $19.6 million in 2000, resulting
from customer growth generated from increased marketing efforts. ASP
professional services revenues increased $71.5 million, from $11.5 million in
1999 to $83.0 million in 2000. This increase was due primarily to acquisitions
completed during 2000 and the second half of 1999.
Cost of Revenues
Cost of revenues increased by $67.8 million, from $27.5 million in 1999 to
$95.3 million in 2000. This increase was due primarily to the 15 acquisitions
consummated during 1999 and 2000, and increased costs, including but not
limited to additional data center facilities and personnel, to support revenue
growth. In the future, cost of revenues may fluctuate due to capacity
utilization, the timing of investments in data centers, changes in the mix of
services, fluctuations in bandwidth costs and increased levels of staffing to
support anticipated revenue growth.
Gross margin was 29% for 2000 as compared to 42% for 1999. The lower gross
margins are the result of an increase in the proportion of revenue from ASP
professional services and products, which typically generate lower gross
margins as compared with our hosting services. The increase in ASP professional
services and product revenue was primarily the result of the completion of six
acquisitions of such businesses since the second half of 1999.
Sales and Marketing
Sales and marketing expense increased by $21.2 million, from $17.2 million
in 1999 to $38.4 million in 2000. This increase was attributable in part to the
15 acquisitions consummated during 1999 and 2000.
34
Additionally, we continued the expansion of our direct sales force, increased
marketing efforts focusing on sales lead generation and brand promotion, and
developed reseller and referral partner channels. We expect sales and marketing
expenses to continue to be a substantial component of our cost structure in
future periods to support anticipated revenue growth.
General and Administrative
General and administrative expense increased by $41.7 million, from $29.1
million in 1999 to $70.8 million in 2000. This increase in general and
administrative expense was attributable to the 15 acquisitions consummated
during 1999 and 2000, non-cash compensation charges of $15.1 million primarily
related to the CEO Option Grant described below, increased investments in
internal systems and facilities, and increased staffing levels with respect to
the customer service, billing, accounting and human resources functions to
support revenue growth.
In February 2000, we issued options to purchase 1,500,000 shares of Common
Stock to our then Chief Executive Officer at exercise prices that were below
the market price of our Common Stock at the date of grant (CEO Option Grant).
Such options were not issued pursuant to our Stock Option Plan. In total, the
intrinsic value of these options approximated $30.0 million, and for the year
ended December 31, 2000, we charged $13.8 million to non-cash compensation
expense in connection with this arrangement.
Restructuring Charge
In September 2000, we announced a plan to accelerate our acquisition
integration program by consolidating geographically dispersed functions. The
plan included the elimination of approximately 300 jobs, the exit of certain
leased facilities and other related contractual arrangements, and the
termination of a software development project. The workforce reduction plan
included job eliminations in operations and information systems, customer care,
sales, marketing and business development, and finance and administration.
In connection therewith, we recorded a restructuring charge of $2.5 million
during the three months ended September 30, 2000. As of December 31, 2000, $1.5
million of the restructuring reserve was utilized and 112 employees were
terminated under the plan. Our execution of the plan was completed by December
31, 2001. As a result of this restructuring effort, we expect to realize
annualized cost savings ranging from $8.0 million to $12.0 million. The
foregoing is a forward-looking statement and is based on our current business
plan and the assumptions on which it is based. Unanticipated changes in our
assumptions may cause these estimates to vary materially.
Depreciation
Depreciation expense increased by $9.7 million, from $6.1 million in 1999 to
$15.8 million in 2000. The increase in depreciation expense was attributable to
the 15 acquisitions consummated during 1999 and 2000, and investments in
network software and equipment, furniture and office equipment, and leasehold
improvements during 2000 and the second half of 1999. The fixed asset additions
were driven by the expansion of our data centers and customer care facilities
and customer-driven computer equipment and software purchases to support
revenue growth.
Amortization of Intangible Assets
Amortization expense increased by $17.3 million, from $22.1 million in 1999
to $39.4 million in 2000. This increase in amortization expense was
attributable to the 15 acquisitions consummated during 1999 and 2000.
Interest income (expense), net
Net interest income (expense) decreased by $6.1 million, from $0.9 million
of net interest income in 1999 to $5.2 million of net interest expense in 2000.
Interest expense increased $12.7 million, from $0.5 million in 1999
35
to $13.2 million in 2000 as a result of the issuance of the 7% Convertible
Subordinated Notes in February 2000 ("7% Notes") and capital lease obligations
to finance equipment and furniture purchases during 2000. Interest income
increased $6.6 million, from $1.4 million in 1999 to $8.0 million in 2000. This
increase primarily was the result of income associated with investments of cash
proceeds from the issuance of debt and equity financings completed in 2000.
Liquidity and Capital Resources
We have financed our operations and acquisitions primarily from private
placements of debt and equity, and our initial public offering of Common Stock.
We had $5.4 million in cash, and cash equivalents at December 31, 2001. In
January and February, 2002 we sold two non-core business units for aggregate
cash proceeds of $3.7 million. On March 8, 2002 Charterhouse Equity Partners
III L.P. and Mobius Technology Ventures VI LP and its related funds (the
"Investors") purchased 100 units (the "Units"), with each Unit consisting of
$100,000 principal amount of our 10% Convertible Subordinated Notes and 100,000
warrants for the purchase of shares of our Common Stock for a total sales price
of $10.0 million.
In December 2001 we consummated an exchange of $164.2 million (99.6%) of our
then outstanding 7% Notes for new 10% Convertible Senior Notes ("10% Notes"),
cash and warrants. Under the terms of that transaction, we issued $270
principal amount of 10% Notes convertible into 270 shares of our Common Stock,
issued warrants to purchase 67.50 shares of our Common Stock at an exercise
price of $0.60 per share, and paid $70 in cash in exchange for each $1,000
principal amount of 7% Notes that were tendered in that transaction. The
exchange transaction has been accounted for pursuant to Statement of Financial
Accounting Standards (SFAS) No. 15, Accounting by Debtors and Creditors for
Troubled Debt Restructurings. Accordingly, upon closing, the difference between
the consideration issued and the present carrying value of the notes exchanged,
reduced by the gross interest costs from the issuance date to maturity ($27.9
million) and transaction costs on the 10% Notes issued, has been treated as an
extraordinary gain. Semi-annual interest payments on the 10% Notes may, at our
option, be made in cash or in the form of issuing additional 10% Notes thereby
reducing the cash requirements.
During the year ended December 31, 2001, cash used in operating activities
was $50.7 million. The net loss of $172.9 million included non-cash charges for
depreciation, amortization and other non-cash charges totaling $190.7 million
and non-cash income from debt refinancing totaling $83.9 million. Cash was
provided by decreases in accounts receivable and prepaid and other current
assets totaling $13.4 million and a net increase in operating liabilities of
$6.5 million.
During the year ended December 31, 2001, we added $34.3 million of network
software and equipment, furniture and office equipment and leasehold
improvements. Such fixed asset additions were primarily driven by our data
center and customer care facilities' expansion and customer-driven computer
equipment and software purchases to support revenue growth.
We have financed in excess of $30.5 million of computer equipment and
furniture from available lease facilities. There is no additional lease
financing currently available to us. We will continue to seek such financing
activities and obtain additional equipment financing in the future, although no
assurances can be given that additional financing will be available when needed.
In addition to funding ongoing operations and capital expenditures, our
principal commitments consist of non-cancelable operating leases and contingent
earnout payments to certain sellers of operating companies acquired by us.
We completed six acquisitions in 2000 (see Note 5 of Notes to Consolidated
Financial Statements for the year ended December 31, 2001, included in this
Form 10-K). The total cash consideration for these acquisitions, and contingent
earnout payments in connection with acquisitions completed prior to 2001, was
$27.8 million, net of acquired cash. If all targets for earnouts entered into
through December 31, 2001 are achieved in full, the maximum remaining cash
consideration due pursuant to these earnouts will be $2.1 million and $2.5
million in 2002 and 2003, respectively. In addition, certain of these
agreements provide for issuance of Common Stock in lieu of cash, at our option.
36
The Company is in active negotiations with a financial institution to obtain
a working capital financing facility which would allow it to finance up to $7.0
million of its accounts receivable (Accounts Receivable Financing). Based on
current receivable balances, the Accounts Receivable Financing, if and when
consummated, should provide approximately $3.2 to $3.5 million in immediate
cash availability. We believe that our existing cash, and cash equivalents as
of December 31, 2001, together with the aggregate of the sale in March 2002 of
$10.0 million of 10% Notes to the Investors, the $3.7 million proceeds from the
sale of businesses in the first quarter of 2002, the availability under the
anticipated Accounts Receivable Financing, and the receipt during 2002 of
contingent consideration from the sale of businesses in an amount of at least
$3.5 million, will provide sufficient funds to enable us to fund our operating
needs and meet our obligations through December 31, 2002. The foregoing is a
forward-looking statement and is based on our current business plan and the
assumptions on which it is based, including our ability to meet revenue
forecasts, close on and receive the funding anticipated under the Accounts
Receivable Financing, receive the anticipated amount of contingent
consideration described above, and continue to receive the cost savings and
cash generation benefits our restructuring plans were designed to produce. If
our plans change or one or more of our assumptions prove to be inaccurate, we
may be required to seek additional capital sooner than we currently anticipate
in order to continue operations and meet our obligations. One source of
additional capital the Company will consider is the sale of certain business
divisions and/or assets. We may also seek to raise additional capital to take
advantage of favorable conditions in the capital markets should they exist. It
is highly likely that after 2002, we will need additional funds to fund the
repayment of our debt (see Note 7 of Notes to Consolidated Financial
Statements). In order to fund the repayment of our existing debt obligations,
we will either have to increase revenues without a commensurate increase in
costs to generate sufficient cash from operations, refinance existing debt
obligations,raise additional cash through debt or equity financing, the sale of
certain business divisions and/or assets, or execute a combination thereof.We
cannot be assured, however, that if we need or seek additional capital that we
will be successful in obtaining it.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We have limited exposure to financial market risks, including changes in
interest rates. Substantially all of our indebtedness bears interest at a fixed
rate to maturity, which therefore minimizes our exposure to interest rate
fluctuations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors...................................................................... 38
Consolidated Balance Sheets as of December 31, 2001 and 2000........................................ 39
Consolidated Statements of Operations for the Years ended December 31, 2001, 2000 and 1999.......... 40
Consolidated Statements of Stockholders' Equity for the Years ended December 31, 2001, 2000 and 1999 41
Consolidated Statements of Cash Flows for the Years ended December 31, 2001, 2000 and 1999.......... 42
Notes to Consolidated Financial Statements.......................................................... 43
37
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
Interliant, Inc.
We have audited the accompanying consolidated balance sheets of Interliant,
Inc. (the "Company") as of December 31, 2001 and 2000, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 2001. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects the consolidated financial position of Interliant, Inc.
at December 31, 2001 and 2000, and the consolidated results of its operations
and its cash flows for each of the three years in period ended December 31,
2001, in conformity with accounting principles generally accepted in the United
States. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
As discussed in Note 2 to the financial statements, in 2000 the Company changed
its method of accounting for set-up fees to conform with Staff Accounting
Bulletin 101, Revenue Recognition.
/s/ Ernst & Young LLP
Stamford, Connecticut
February 14, 2002, except for Note 16
and the fifth and sixth paragraphs
of Note 1, as to which the date is April 16, 2002.
38
INTERLIANT, INC.
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
2001 2000
------------- -------------
Assets
Current assets:
Cash and cash equivalents.................................................. $ 5,371,102 $ 26,678,329
Restricted cash............................................................ 2,300,873 1,557,529
Short-term investments..................................................... -- 53,233,387
Accounts receivable, net of allowances of $1.7 million and $1.9 million at
December 31, 2001 and 2000, respectively................................. 12,299,067 27,354,652
Deferred costs............................................................. 1,914,695 --
Prepaid assets............................................................. 2,448,349 3,411,457
Other current assets....................................................... 1,287,620 4,986,251
------------- -------------
Total current assets................................................... 25,621,706 117,221,605
------------- -------------
Property and equipment, net................................................ 14,629,119 65,292,694
Intangibles, net........................................................... 29,850,529 97,105,740
Net assets of discontinued operations...................................... 0 37,568,004
Other assets............................................................... 696,880 8,101,395
------------- -------------
Total assets........................................................... $ 70,798,234 $ 325,289,438
============= =============
Liabilities and stockholders' (deficit) equity
Current liabilities:
Notes payable and current portion of long-term debt
and capital lease obligations............................................ $ 12,401,859 $ 11,789,385
Accounts payable........................................................... 6,785,500 9,539,967
Accrued expenses........................................................... 14,308,320 24,995,551
Deferred revenue........................................................... 6,307,120 7,556,306
Net liabilities of discontinued operations................................. 914,304 --
Restructuring reserve...................................................... 2,174,805 1,042,555
------------- -------------
Total current liabilities.............................................. 42,891,908 54,923,764
------------- -------------
Long-term debt and capital lease obligations, less current portion............ 102,449,875 177,664,647
Other long-term liabilities................................................... 372,115 195,961
Minority interest in subsidiary............................................... -- 5,227,593
Stockholders' (deficit) equity:
Preferred stock, $.01 par value; 1,000,000 shares authorized; 0 shares
issued and outstanding...................................................
Common stock, $.01 par value; 250,000,000 shares authorized;
51,891,036, and 48,796,218 shares issued and outstanding at
December 31, 2001 and 2000, respectively................................. 518,911 487,962
Additional paid-in capital................................................. 313,773,822 319,821,622
Deferred compensation...................................................... -- (16,336,488)
Accumulated deficit........................................................ (388,930,375) (216,051,382)
Accumulated other comprehensive loss....................................... (278,022) (644,241)
------------- -------------
Total stockholders' (deficit) equity................................... (74,915,664) 87,277,473
------------- -------------
Total liabilities and stockholders' (deficit) equity................... $ 70,798,234 $ 325,289,438
============= =============
See accompanying notes to consolidated financial statements.
39
INTERLIANT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31,
------------------------------------------
2001 2000 1999
------------- ------------- ------------
Revenues:
Service revenues......................................... $ 98,035,406 $ 103,255,827 $ 43,691,221
Product revenues......................................... 19,222,080 31,602,535 3,422,874
------------- ------------- ------------
Total Revenues....................................... 117,257,486 134,858,362 47,114,095
Costs and expenses:
Cost of service revenues................................. 63,656,013 69,674,005 24,767,708
Cost of product revenues................................. 15,352,107 25,584,561 2,746,002
Sales and marketing...................................... 29,713,353 38,357,833 17,236,121
General and administrative (exclusive of non-cash
compensation shown below).............................. 60,141,637 55,659,983 27,075,902
Non-cash compensation.................................... (4,660,586) 15,105,643 1,986,694
Depreciation............................................. 24,432,987 15,759,308 6,051,296
Amortization of intangibles.............................. 35,369,751 39,450,292 22,068,815
Restructuring charge..................................... 4,876,191 2,500,000
Impairment losses........................................ 126,736,480
------------- ------------- ------------
355,617,933 262,091,625 101,932,538
------------- ------------- ------------
Operating loss.............................................. (238,360,447) (127,233,263) (54,818,443)
Other income................................................ 3,124,029 109,856
Interest income (expense), net of $1,834,437 of interest
income in 2001............................................ (18,108,896) (5,247,488) 886,444
------------- ------------- ------------
Loss before minority interest, discontinued operations,
extraordinary gain, and cumulative effect of accounting
change.................................................... (253,345,314) (132,370,895) (53,931,999)
Minority interest........................................... 7,012,123 1,983,638
------------- ------------- ------------
Loss before discontinued operations, extraordinary gain, and
cumulative effect of accounting change.................... (246,333,191) (130,387,257) (53,931,999)
Discontinued operations..................................... (10,441,506) (19,622,316)
------------- ------------- ------------
Loss before extraordinary gain and cumulative effect of
accounting change......................................... (256,774,697) (150,009,573) (53,931,999)
Gain on debt refinancing.................................... 83,895,704
------------- ------------- ------------
Loss before cumulative effect of accounting change.......... (172,878,993) (150,009,573) (53,931,999)
Cumulative effect of accounting change...................... (1,219,712)
------------- ------------- ------------
Net loss.................................................... $(172,878,993) $(151,229,285) $(53,931,999)
============= ============= ============
Basic and diluted loss per share:
Loss before cumulative effect of accounting change....... $ (4.86) $ (2.74) $ (1.50)
Discontinued operations.................................. (0.21) (0.41)
Gain on debt restructuring............................... 1.66
Cumulative effect of accounting change................... (0.03)
------------- ------------- ------------
Net loss................................................. $ (3.41) $ (3.18) $ (1.50)
============= ============= ============
Weighted average shares outstanding--basic and diluted...... 50,647,723 47,547,721 35,837,523
============= ============= ============
See accompanying notes to consolidated financial statements.
40
INTERLIANT, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock
-------------------
Comprehensive Par Additional Deferred Accumulated
Income (Loss) Shares Value Paid-in Capital Compensation Deficit
------------- ---------- -------- --------------- ------------ -------------
Balance as of December 31, 1998................. 19,217,197 $192,172 $ 34,160,334 $ (1,769,429) $ (10,890,098)
Sales of common stock in private placements..... 6,600,000 66,000 10,934,000
Exercise of stock options and warrants.......... 1,524,491 15,244 5,671,875
Common stock issued and stock options granted in
connection with acquisitions................... 6,561,795 65,618 65,735,891
Conversion of preferred stock................... 2,647,658 26,477 12,973,524
Initial public offering of common stock, net of
offering costs................................. 8,050,000 80,500 72,446,504
Amortization of deferred compensation........... 1,769,429
Foreign currency translation adjustment......... $ 28,840
Net loss........................................ (53,931,999) (53,931,999)
------------- ---------- -------- ------------ ------------ -------------
Total comprehensive income (loss)............... (53,903,159)
Balance as of December 31, 1999................. 44,601,141 446,011 201,922,128 (64,822,097)
Sales of common stock in private placements..... 787,881 7,879 25,977,497
Exercise of stock options and warrants.......... 1,428,674 14,287 2,491,013
Common stock issued and stock options granted in
connection with acquisitions................... 1,978,522 19,785 57,988,853
Deferred compensatory stock options............. 31,442,131 (31,442,131)
Amortization of deferred compensation........... 15,105,643
Foreign currency translation adjustment......... (673,081)
Net loss........................................ (151,229,285) (151,229,285)
------------- ---------- -------- ------------ ------------ -------------
Total comprehensive income (loss)............... (151,902,366)
Balance as of December 31, 2000................. 48,796,218 487,962 319,821,622 (16,336,488) (216,051,382)
Exercise of stock options and warrants.......... 408,370 4,085 165,646
Common stock issued and stock options granted in
connection with acquisitions................... 1,576,448 15,764 3,389,777
Common stock issued............................. 1,110,000 11,100 1,327,200
Amortization of deferred compensation........... (22,335,374) 16,336,488
Convertible Notes issued........................ 3,251,485
Warrant value on 8% Subordinated Convertible
Notes.......................................... 3,942,394
Warrant value on 10% Senior notes............... 4,211,072
Foreign currency translation adjustment......... 366,219
Net loss........................................ (172,878,993) (172,878,993)
------------- ---------- -------- ------------ ------------ -------------
Total comprehensive income (loss)............... $(172,512,774)
=============
Balance as of December 31, 2001................. 51,891,036 $518,911 $313,773,822 -- $(388,930,375)
========== ======== ============ ============ =============
Accumulated Other Total
Comprehensive Stockholders'
(Loss) Income Equity
----------------- -------------
Balance as of December 31, 1998................. $ 21,692,979
Sales of common stock in private placements..... 11,000,000
Exercise of stock options and warrants.......... 5,687,119
Common stock issued and stock options granted in
connection with acquisitions................... 65,801,509
Conversion of preferred stock................... 13,000,001
Initial public offering of common stock, net of
offering costs................................. 72,527,004
Amortization of deferred compensation........... 1,769,429
Foreign currency translation adjustment......... $ 28,840 28,840
Net loss........................................ (53,931,999)
--------- -------------
Total comprehensive income (loss)...............
Balance as of December 31, 1999................. 28,840 137,574,882
Sales of common stock in private placements..... 25,985,376
Exercise of stock options and warrants.......... 2,505,300
Common stock issued and stock options granted in
connection with acquisitions................... 58,008,638
Deferred compensatory stock options.............
Amortization of deferred compensation........... 15,105,643
Foreign currency translation adjustment......... (673,081) (673,081)
Net loss........................................ (151,229,285)
--------- -------------
Total comprehensive income (loss)...............
Balance as of December 31, 2000................. (644,241) 87,277,473
Exercise of stock options and warrants.......... 169,731
Common stock issued and stock options granted in
connection with acquisitions................... 3,405,541
Common stock issued............................. 1,338,300
Amortization of deferred compensation........... (5,998,886)
Convertible Notes issued........................ 3,251,485
Warrant value on 8% Subordinated Convertible
Notes.......................................... 3,942,394
Warrant value on 10% Senior notes............... 4,211,072
Foreign currency translation adjustment......... 366,219 366,219
Net loss........................................ (172,878,993)
--------- -------------
Total comprehensive income (loss)...............
Balance as of December 31, 2001................. $(278,022) $ (74,915,664)
========= =============
See accompanying notes to consolidated financial statements.
41
INTERLIANT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
------------------------------------------
2001 2000 1999
------------- ------------- ------------
OPERATING ACTIVITIES..............................................................
Net loss........................................................................ $(172,878,993) $(151,229,285) $(53,931,999)
Adjustments to reconcile net loss to net cash used in operating activities:.....
Provision for uncollectible accounts........................................... 4,381,159 2,867,608 1,585,254
Depreciation and amortization.................................................. 59,802,738 64,912,871 28,120,111
Impairment..................................................................... 126,736,480
Beneficial conversion.......................................................... 3,251,485
Debt forgiveness............................................................... (1,187,230)
Discontinued operations........................................................ 3,503,426
Gain on 7% Convertible Subordinated Notes refinancing.......................... (83,895,704)
Gain on sale of Retail Web Hosting business.................................... (1,079,097)
Non-cash compensation, including amortization of deferred compensation......... (4,660,586) 15,105,643 1,986,694
Non-cash charges recorded in connection with restructuring..................... 43,833 392,567
Minority interest in earnings of subsidiary.................................... (7,012,123) (1,983,638)
Other non-cash items........................................................... 319,872 (135,403 129,957
Change in operating assets and liabilities:....................................
Restricted cash............................................................... (743,344) (545,757) (1,011,772)
Accounts receivable........................................................... 14,497,755 (13,076,518) (4,947,423)
Prepaid and other current assets.............................................. (333,839) (5,435,745) (1,873,117)
Other assets.................................................................. 2,079,407 503,334 (90,527)
Accounts payable.............................................................. (1,101,246) (3,535,857) 3,478,876
Accrued expenses.............................................................. 5,449,630 9,415,584 1,111,999
Deferred revenue.............................................................. 974,226 1,542,867 1,289,453
Restructuring reserve......................................................... 1,132,250 1,042,555
------------- ------------- ------------
Net cash used in operating activities....................................... (50,719,901) (80,159,174) (24,152,494)
------------- ------------- ------------
INVESTING ACTIVITIES..............................................................
Purchases of fixed assets....................................................... (28,717,370) (39,406,404) (12,084,072)
Payments issued in connection with non-compete agreements....................... (2,000,000)
Investment in long-term assets.................................................. (1,000,000) (952,969)
Purchases of short-term investments............................................. (19,509,794) (213,348,090) (3,612,229)
Sale of short-tem investments................................................... 72,743,181 163,726,932
Proceeds from sales of Retail Web Hosting business, net of costs................ 6,317,178
Acquisitions of businesses, net of cash acquired................................ (2,178,301) (25,675,249) (27,809,253)
------------- ------------- ------------
Net cash provided by (used in) investing activities......................... 28,654,894 (115,702,811) (46,458,523)
------------- ------------- ------------
FINANCING ACTIVITIES..............................................................
Proceeds from sale of common stock (includes Employee Stock Purchase Plan)...... 158,797 25,985,376 83,527,004
Proceeds from issuance of Series A redeemable convertible preferred stock....... 13,000,001
Proceeds from issuance of 7% Convertible Subordinated Notes..................... 164,825,000
Proceeds from exercise of options and warrants.................................. 10,933 2,505,300 5,469,854
Proceeds from issuance of debt and capital lease financing...................... 23,679,802 7,581,072 2,550,303
Payment in connection with debt restructuring................................... (11,496,940)
Repayment of debt and capital leases............................................ (11,605,817) (6,476,530) (13,141,466)
Minority investment in subsidiary............................................... 7,211,231
Offering costs.................................................................. (6,135,950)
------------- ------------- ------------
Net cash provided by financing activities................................... 746,775 195,495,499 91,405,696
------------- ------------- ------------
Effect of exchange rate changes on cash........................................... 11,005 (563,224)
Net increase (decrease) in cash and cash equivalents.............................. (21,307,227) (929,710) 20,794,679
Cash and cash equivalents at beginning of year.................................... 26,678,329 27,608,039 6,813,360
------------- ------------- ------------
Cash and cash equivalents at end of year.......................................... $ 5,371,102 $ 26,678,329 $ 27,608,039
============= ============= ============
SUPPLEMENTAL DISCLOSURES, INCLUDING NONCASH INVESTING AND.........................
FINANCING ACTIVITIES..............................................................
Cash paid for interest.......................................................... $ 8,593,683 $ 7,229,120 $ 468,408
Stock issued and options granted for acquisitions............................... $ 3,405,542 $ 58,008,638 $ 65,801,509
Stock issued for compensation agreements........................................ $ 1,338,300
Conversion of Series A redeemable convertible preferred stock into common stock. $ 13,000,001
Debt assumed or issued in acquisitions.......................................... $ 4,575,000 $ 1,262,341 $ 22,250,186
Equipment and furniture acquired under capital lease obligations................ $ 15,209,986 $ 16,998,652
See accompanying notes to consolidated financial statements.
42
INTERLIANT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Business
Interliant, Inc. (Nasdaq:INIT), (the Company), is a provider of managed
infrastructure solutions, encompassing messaging, security, and hosting, plus
an integrated set of professional services products that differentiate and add
customer value to these core solutions. The Company sells to the
large/enterprise market through its direct sales force and to the small and
medium-business market (SMB) through its INIT Branded Solutions program, which
allows companies to private label its offerings. The Company provides companies
of all sizes with cost-effective, secure infrastructure and a focused suite of
e-business solutions.
The Company was organized under the laws of the State of Delaware on
December 8, 1997. Web Hosting Organization LLC (WEB), a Delaware Limited
Liability Company, is the largest single shareholder, owning 49% of the
Company's issued and outstanding shares of common stock (Common Stock) as of
December 31, 2001. WEB's investors comprise Charterhouse Equity Partners III,
L.P. and Chef Nominees Limited (collectively, CEP Members), and WHO Management,
LLC (WHO).
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. For the period from inception to
December 31, 2001, the Company has incurred net losses and negative cash flows
from operations, and has also expended significant funds for capital
expenditures (property and equipment) and the acquisitions of businesses. As of
December 31, 2001 the Company had negative working capital of $17.3 million,
including cash and cash equivalents of $5.4 million. In April 2001, the Company
made a decision to sell certain businesses and assets, that it no longer
considered core to its ongoing business plans. The proceeds from such sales
have been and will continue to be used to fund the Company's ongoing operations
and restructuring efforts (see Notes 5 and 16).
The Company was in default on its 7% Convertible Subordinated Notes (7%
Notes) due to the failure to pay the interest due August 16, 2001 (see Note 7).
In December 2001 the Company exchanged $164.2 million (99.6%) of the 7% Notes
for new 10% Convertible Senior Notes, cash, and warrants to purchase the
Company's Common Stock which cured the default with respect to the notes
exchanged. In early 2002, the Company paid the interest due on the remaining 7%
Notes thereby eliminating the default. The exchange reduced the amount of
outstanding debt by approximately $120 million.
In January and February, 2002 the Company sold two non-core business units
for aggregate net cash proceeds of $3.7 million. On March 8, 2002 Charterhouse
Equity Partners III L.P., and Mobius Technology Ventures VI, LP (formerly
Softbank) and its related funds (the Investors) purchased $10.0 million of the
Company's 10% Convertible Senior Notes (see Note 16).
The Company is in active negotiations with a financial institution to obtain
a working capital financing facility which would allow it to finance up to $7.0
million of its accounts receivable (Accounts Receivable Financing). Based on
current receivable balances, the Accounts Receivable Financing, if and when
consummated, should provide approximately $3.2 to $3.5 million in immediate
cash availability. Based on the cash funds on hand at December 31, 2001,
combined with the cash received on the sale of the notes and businesses
referred to in the preceding paragraphs, and the cash availability under the
anticipated Accounts Receivable Financing, the Company believes it will have
sufficient cash to fund its operations and meet its obligations through
December 31, 2002. If the Accounts Receivable Financing is not consummated, the
Company will consider the sale of certain business divisions and/or assets to
generate additional cash to fund its operations and meet its obligations
through December 31, 2002. See the "Liquidity and Capital Resources" section of
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in this Form 10-K.
2. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and it's wholly and majority owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated.
43
Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity (at date of purchase) of three months or less to be cash
equivalents. Cash equivalents, which consist primarily of money market accounts
and commercial paper, are carried at cost, which approximates market value.
Short-term Investments
Short-term investments, consisting of commercial paper with maturities
ranging from three months to one year, are classified as available for sale and
are carried at cost, which approximates fair market value.
Fair Value of Financial Instruments
Carrying amounts of financial instruments held by the Company, which include
cash, cash equivalents, short-term investments, accounts receivable, accounts
payable and accrued expenses, approximate fair value due to their short
duration. The fair value of other long-term obligations approximates cost based
on borrowing rates for similar instruments.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to concentrations
of credit risk principally comprise cash, cash equivalents, short-term
investments, accounts receivable, accounts payable and debt obligations. As of
December 31, 2001, the Company's cash, and cash equivalents are deposited with
various domestic and foreign financial institutions. With respect to accounts
receivable, the Company's customer base is dispersed throughout North America.
The Company monitors customer payment history, generally does not require
collateral and establishes reserves for uncollectible accounts as warranted. In
addition to individual customers, the Company also provides services to
resellers, who, in turn, provide services to their own customers.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, and disclose contingent liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Property and Equipment
Property and equipment are stated at cost. Major additions and improvements
are capitalized, while replacements, maintenance and repairs that do not
improve or extend the life of the assets are charged to expense. Depreciation
and amortization has been provided using the straight-line method over the
estimated useful lives of the assets as follows:
Network software and equipment 2 to 3 years
Furniture and office equipment 3 to 7 years
Leasehold improvements........ Remaining lease term or useful
life, whichever is shorter
Intangible Assets
Intangible assets primarily consist of customer lists, covenants not to
compete, assembled workforce, trade names, and goodwill, all of which arose
from the acquisitions of hosting and related Internet professional services
companies. Such assets are being amortized on a straight-line basis over
periods ranging from one to five years (see Note 4).
44
Impairment of Long-Lived Assets
The Company continually reviews amortization periods and the carrying value
of long-lived assets, including property and equipment, and intangible assets
to determine whether or not there are any indications of reduction in useful
lives or impairments. With respect to intangible assets, including goodwill,
impairment indicators that would cause the Company to conduct an impairment
assessment include events such as significant losses of customers or acquired
workforce, or if operating results of acquired businesses continually failed to
meet management's performance expectations. If after conducting such an
assessment, indications of impairment are present in long-lived assets, the
estimated future undiscounted cash flows associated with the corresponding
assets would be compared to their carrying amounts to determine if a change in
useful life or a write-down to fair value is necessary.
Revenue Recognition
The Company's revenues are primarily derived from managed infrastructure
solutions, Web hosting and professional services.
The Company sells its managed infrastructure solutions and Web hosting
services for contractual periods generally ranging from one month to three
years. Web hosting arrangements generally are cancelable by either party
without penalty. Hosting revenues are recognized ratably over the contractual
period as services are performed. Incremental fees for excess bandwidth usage
and data storage are billed and recognized as revenue in the period that
customers utilize such services. Payments received and billings made in advance
of providing services are deferred until the services are provided.
In December 1999, the SEC issued Staff Accounting Bulletin 101, "Revenue
Recognition in Financial Statements" (SAB 101), which provides guidance related
to revenue recognition based on interpretations and practices followed by the
SEC.
The Company recorded a cumulative effect of change in accounting principle,
effective January 1, 2000, for revenue recognized in 1999 for set up fees
primarily associated with its Web hosting services. Prior to the adoption of
SAB 101, the Company recognized revenue from non-refundable set up fees charged
to customers upon completion of the set up services. Effective January 1, 2000,
such fees are being amortized over the longer of the contractual period or
expected life of the customer relationship (one year). For the year ended
December 31, 2000, the Company recorded a cumulative effect charge of $1.2
million to reflect the change in accounting principle.
Professional services revenues are recognized as the services are rendered,
provided that no significant obligations remain and collection of the
receivable is considered probable. Substantially all of the Company's
professional services contracts call for billings on a time and materials
basis. Some of the Company's contracts contain milestones and/or customer
acceptance provisions. For these contracts, revenue is recognized as milestones
are performed and accepted by the customer.
Certain of the Company's contracts contain multiple-elements under which the
Company sells a combination of any of the following: managed infrastructure
solutions and professional services, computer equipment, software licenses and
maintenance services to customers. The Company has determined that objective
evidence of fair value exists for all elements and has recorded revenue for
each of the elements as follows: (1) revenue from the sale of computer
equipment and software products is recorded at the time of delivery; (2)
revenue from service contracts is recognized as the services are performed; (3)
maintenance revenue and related costs are recognized ratably over the term of
the maintenance agreement. The Company is deferring and recognizing the cost of
the reseller hardware and software maintenance over the same term as the
maintenance revenue pursuant to SAB 101.
Under certain arrangements, the Company resells computer equipment and/or
software and maintenance purchased from various computer equipment and software
vendors. The Company is recording the revenue from
45
these products and services on a gross basis pursuant to EITF 99-19, Reporting
Revenue Gross as a Principal versus Net as an Agent. Under these arrangements,
the Company has determined that it is the primary obligor. The Company presents
the end-user with a total solution, provides the end-user with a choice from
various vendor products, sets final prices and performs certain services.
Additionally, the Company has credit and back-end inventory risk. As of
December 31, 2001, the Company had $0.9 million of computer hardware and
software inventory on hand.
In some circumstances, the Company resells software and in connection with
such sales applies the provisions of Statement of Position 97-2, ("SOP 97-2"),
Software Revenue Recognition, as amended. Under SOP 97-2, the Company
recognizes license revenue upon shipment of a product to the end-user if a
signed contract exists, the fee is fixed and determinable and collection of the
resulting receivable is probable. For contracts with multiple elements (e.g.,
software products, maintenance and other services), the Company allocates
revenue to each element of the contract based on vendor specific objective
evidence of the element's fair value.
Advertising Expenses
Advertising costs are expensed as incurred. Advertising expenses for the
year ended December 31, 2001, 2000 and 1999 were $0.5 million, $8.7 million and
$6.0 million, respectively.
Income Taxes
The Company accounts for income taxes using the liability method under which
deferred tax assets and liabilities are determined based on differences between
financial reporting and tax basis of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse.
Net Loss Per Share
Basic net loss per share is computed based on the weighted average number of
shares of Common Stock outstanding. Diluted loss per share does not differ from
basic loss per share since potential Common Stock to be issued upon exercise of
stock options, warrants and conversion of convertible notes are anti-dilutive
for the periods presented. As of December 31, 2001, 2000 and 1999, the number
of potentially dilutive shares of Common Stock were 2.6 million, 0.1 million
and 2.5 million shares, respectively, based on the number of outstanding stock
options, warrants and convertible securities as of that date.
Stock-Based Compensation
The Company accounts for its stock-based compensation plan using the
provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25). The Company has adopted the disclosure-only
provisions of Statement of Financial Accounting Standards ("SFAS") No. 123,
Accounting For Stock-Based Compensation (SFAS 123).
In March 2000, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation, an Interpretation of APB No. 25, which became effective beginning
July 1, 2000. The adoption of this new accounting standard did not have a
significant effect on the Company's financial position or results of operations.
Foreign Currency Translation
The financial statements of foreign subsidiaries have been translated into
U.S. dollars in accordance with SFAS No. 52, Foreign Currency Translation. The
functional currency of the Company's foreign operating units
46
is the local currency in the country that the entity operates. All balance
sheet accounts have been translated using the exchange rate in effect at the
balance sheet date. Statement of operations amounts have been translated using
the average exchange rate for the period. Adjustments resulting from such
translation have been reported separately as a component of other comprehensive
income in stockholders' equity. Gains and losses on foreign currency
transactions are recorded in the Statement of Operations.
Derivatives and Hedging Activities
In 2000, the Company adopted FASB No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended. To date, the Company has not
made use of the financial instruments covered by this Statement and therefore
there is no impact on its financial position or results of operations.
Goodwill and Other Intangible Assets
In June 2001, the FASB issued SFAS No. 141, Business Combinations, and SFAS
No. 142, Goodwill and Other Intangible Assets, effective for fiscal years
beginning after December 15, 2001. Under the new rules, goodwill and intangible
assets deemed to have indefinite lives will no longer be amortized but will be
subject to annual impairment tests in accordance with the Statements. Other
intangible assets will continue to be amortized over their useful lives.
The Company will apply the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of 2002. Application of the
non-amortization provisions of the Statement is expected to significantly
reduce the Company's net loss. During 2002, the Company will perform the first
of the required impairment tests of goodwill and indefinite lived intangible
assets as of January 1, 2002 and has not yet determined what the effect of
these tests will be on the earnings and financial position of the Company.
On August 1, 2001, the FASB issued SFAS No. 144, Accounting For Impairment
of Long-Lived Assets. The Company is required to adopt this pronouncement
beginning January 1, 2002. SFAS No. 144 prescribes the accounting for the
impairment of long-lived assets (excluding goodwill), and long-lived assets to
be disposed of by sale. SFAS No. 144 retains the requirement of SFAS No. 121 to
measure long-lived asset classified as held for sale at the lower of its
carrying value or fair market value less the cost to sell. Therefore,
discontinued operations are no longer measured on a net realizable basis, and
future operating results are no longer recognized before they occur.
Asset Impairment
In response to certain events and circumstances that transpired in the first
quarter of 2001 (see Note 4), pursuant to SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,
and SEC Staff Accounting Bulletin No. 100 (SAB 100), Restructuring and
Impairment Charges, the Company performed a review of its long-lived assets
because indicators of impairment to its long-lived assets existed. An
impairment assessment was made with respect to the long-lived assets associated
with businesses to be sold or shut down (see Note 2).
Discontinued Operations
Pursuant to Accounting Principles Board Opinion No. 30, Reporting the
Results of Operations--Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions, ("APB 30"), the Company's financial statements have been
reclassified to reflect the disposal of a major line of business included in
the Company's managed infrastructure solutions segment, its Managed Enterprise
Resource Planning (ERP) and Customer Relationship Management (CRM) hosting,
outsourcing and related hosting services business (see Note 11).
47
3. Property and Equipment
Property and equipment consist of the following:
December 31,
------------------------
2001 2000
------------ -----------
Network Software & Equipment........... $ 84,783,000 $66,389,000
Furniture Fixtures and Office Equipment 7,789,000 5,428,000
Leasehold Improvements................. 17,584,000 15,620,000
------------ -----------
110,156,000 87,437,000
Less Accumulated Depreciation.......... 44,148,000 22,144,000
Less Impairment, NBV................... 51,379,000 --
------------ -----------
$ 14,629,000 $65,293,000
============ ===========
Assets financed under capital leases were $15.2 million and $17.0 million in
2001 and 2000, respectively. Depreciation expense, including depreciation of
assets under capital leases and amortization of software and leasehold
improvements, amounted to $24.4 million, $15.8 million, and $6.1 million for
the years ended 2001, 2000 and 1999, respectively.
As discussed in Note 4, in connection with an impairment analysis of the
Company's long-lived assets, an impairment loss of $51.4 million was recorded
to write down the net book value of certain property used in the hosting
business.
4. Intangible Assets
The Company allocated the purchase price of acquired companies to
identifiable tangible assets and liabilities and intangible assets based on the
nature and the terms of the various purchase agreements and evaluation of the
acquired businesses. Covenants not to compete are amortized over periods not to
exceed the term of the respective agreement. Values are assigned to
identifiable intangible assets in accordance with Accounting Principles Board
Opinion No. 16 (APB 16), using the Company's estimate of the fair value of the
asset. Amounts not allocated to tangible assets and liabilities and
identifiable intangible assets have been recorded as goodwill.
Intangible assets consist of the following:
December 31,
------------------------- Amortization
2001 2000 Period
------------ ------------ ------------
Covenants not to compete..... $ 14,616,000 $ 23,575,000 1-5 Years
Customer lists............... 28,844,000 34,685,000 3 Years
Assembled Workforce.......... 9,979,000 11,277,000 3 Years
Trade Names.................. 6,842,000 6,789,000 3 Years
Goodwill..................... 76,054,000 84,472,000 5 Years
------------ ------------
136,335,000 160,798,000
Less accumulated amortization 73,306,000 63,692,000
Less Impairment NBV.......... 33,178,000 --
------------ ------------
$ 29,851,000 $ 97,106,000
============ ============
Amortization expense amounted to $35.4 million, $39.5 million and $22.1
million in 2001, 2000 and 1999, respectively.
48
Impairment of Long-Lived Assets
In response to certain events and circumstances that transpired in the first
quarter of 2001 (see Note 12--April 2001 Restructuring Charge), pursuant to
SFAS No.121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of, and SAB 100, Restructuring and Impairment
Charges, the Company performed a review of its long-lived assets because
indicators of impairment to its long-lived assets existed.
An impairment assessment was made with respect to the long-lived assets
associated with businesses to be sold or shut down. The assessment indicated
that, on a held for use basis, there was impairment evident in such assets.
Further, based on the Company's assessment of both internal and external facts
and circumstances to which the impairment was attributable, management
concluded that the impairment indicators arose in the latter half of the first
quarter of 2001. Consequently, the Company recorded impairment charges of $36.2
million and $0.4 million in the first and second quarters of 2001,
respectively. Long-lived assets that were impaired consist of property and
equipment ($8.6 million), identifiable intangible assets and related goodwill
($27.6 million), and other assets ($0.4 million). For purposes of measuring the
impairment charges, fair value was determined based on a calculation of
discounted cash flows.
During the second quarter of 2001, the Company approved a plan to exit
Interliant Europe, B.V., a 51%-majority owned subsidiary with operations in
continental Europe. An impairment assessment was made with respect to the
long-lived assets associated with Interliant Europe, and the assessment
indicated that there was impairment evident in such assets. The fair value of
the long-lived assets was determined based on a definitive agreement that was
executed in August 2001, whereby the Company sold its entire interest in
Interliant Europe for a nominal amount of proceeds (see Note 5). Consequently,
the Company recorded an impairment charge in the second quarter of 2001 of $4.7
million, to write-off the entire net book value of property and equipment
($4.4 million), identifiable intangible assets ($0.2 million) and other
long-term assets ($0.1 million) related to Interliant Europe.
During the third quarter of 2001, the Company determined that potential
impairment indicators were present in the core hosting and professional
services businesses. Such impairment indicators arose as a result of the
continued economic uncertainties in general, certain weaknesses in the
Company's market, and lack of revenue growth for the Company in particular.
Accordingly, an additional impairment assessment was conducted with respect to
long-lived assets associated with such businesses. Further, for businesses
previously identified for sale or disposition, the fair value determination was
updated based on more current pricing terms from recent negotiations with
prospective buyers. Based on these assessments, it was determined that there
was impairment evident in the assets associated with the Company's core hosting
businesses and the PeopleSoft ERP professional services business. Consequently,
impairment charges were recorded in the third and fourth quarters of 2001 of
$84.1 million to write down the net book value of certain of the fixed assets
including software used in those businesses ($51.4 million) and identifiable
intangible assets and goodwill ($32.7 million) related to those businesses. In
addition, during the third quarter of 2001, the Company recorded a charge of
approximately $1.4 million, included as part of impairment losses, to reflect
the permanent decline of the fair market value of restricted investments in
certain non-public companies and other current assets.
In connection with the above events and circumstances, management also has
re-evaluated the assigned lives used for depreciating and amortizing its
remaining long-lived assets and has concluded that the existing lives continue
to be appropriate.
5. Acquisitions and Dispositions
Since inception, the Company acquired 27 businesses at an aggregate cost
(including contingent consideration earned pursuant to the respective purchase
agreements) of $216.2 million, excluding assumed liabilities. Beginning in
2001, the Company sold five businesses including two sold in 2002. Each of the
49
acquisitions has been accounted for using the purchase method of accounting.
The operations of each of the acquired companies are included in the operating
results of the Company from their respective date of acquisition.
The following is a summary of acquisitions and dispositions
2001 Dispositions
In July 2001, the Company, through a subsidiary, sold all of the outstanding
capital stock of Interliant Managed Applications Solutions, Inc. (formerly
known as reSOURCE PARTNER, Inc. and herein referred to as rSP) to a subsidiary
of Interpath Communications, Inc. (Interpath) pursuant to the terms of a
purchase agreement (Purchase Agreement). The Purchase Agreement provides for
contingent consideration to be paid to the Company if Interpath renews or
retains certain customer contracts within specified periods after the closing
and if under those contracts, specified revenue targets are met during the
twelve-month period following July 20, 2001. The Purchase Agreement further
provides that additional contingent consideration will be paid to the Company
if new contracts are entered into by Interpath with certain prospective
customers within 180 days of July 20, 2001. The aggregate contingent
consideration payable under the Purchase Agreement may range as high as $3.5
million, however, there is no assurance that any contingent consideration will
be paid. Any contingent consideration payable shall be paid in cash and shall
be subject, in part, to an offset against any liability of the Company arising
under its indemnity obligations set forth in the Purchase Agreement. The
Company recorded the disposition as a discontinued operation during the second
quarter of 2001. The receipt of contingent consideration proceeds, if any, will
reduce the loss on disposal of discontinued operations (see Note 11).
In August 2001, the Company, through its subsidiary Interliant
International, Inc. (Interliant International), entered into definitive
agreements (Definitive Agreements) with @viso Limited (@viso) under which it
sold to @viso all of its 51% equity interest in Interliant Europe, B.V.
(Interliant Europe) for a nominal amount, plus an agreement which limits the
Company's liability at 1.8 million Euros (approximately US $1.5 million at
current exchange rates) for any additional funding which may be required by the
shareholders of Interliant Europe resulting from the dissolution and
liquidation of that company. The Definitive Agreements further provide that in
the event any funding from Interliant International is required in connection
with the liquidation of Interliant Europe, such funds would be loaned to
Interliant International under a lending facility from @viso, which facility
provides for interest on the borrowed amount at 12% per annum accruing until
maturity and repayment of all principal and interest at the second anniversary
of the completion of the funding. The Company has been preliminarily advised
that no additional funding will be required in connection with the dissolution
and liquidation of Interliant Europe.
In October 2001, the Company completed the sale of another of its non-core
businesses, its shared and unmanaged dedicated retail Website hosting business
(Retail Web hosting), to Interland, Inc. The Company received cash proceeds of
$6.6 million, consisting of an initial payment of $5.0 million for the
transferred customer accounts and $1.6 million for the sale of network
equipment and software used in connection with such customer accounts. Future
contingent payments related to the customer accounts will be dependent upon the
achievement of specified cash collection targets with respect to the
transferred customers, after transition of such accounts. Such contingent
payments are not reasonably determinable at this time.
2000 Acquisitions
In February 2000, the Company purchased all of the outstanding stock of Soft
Link, Inc. (Softlink), a provider of Enterprise Resource Planning (ERP)
solutions based on PeopleSoft software. The purchase price consisted of $18.1
million in cash and 0.5 million shares of the Company's Common Stock valued at
$9.7 million, including shares issued in connection with contingent
consideration provisions of the purchase agreement. The agreement, as amended,
also provides for contingent consideration of $0.5 million in Common Stock if
certain performance criteria are achieved in the year ended December 31, 2001.
Subsequent to December 31, 2001, the contingent consideration was paid and will
be recorded as a reduction to gain/loss on the sale of Softlink (see Note 16).
50
In February 2000, the Company purchased substantially all of the assets and
assumed certainliabilities of rSP, a provider of hosting services for
outsourced human resources and finance solutions primarily using PeopleSoft
software. The purchase price consisted of $2.5 million in cash and the issuance
of 1.0 million shares of Common Stock valued at $37.00 per share.
In May 2000, the Company, through its subsidiary Interliant International,
formed Interliant Europe. The shareholders of Interliant Europe are Interliant
International and @viso Limited (@viso) owning 51% and 49%, respectively, of
the outstanding stock of Interliant Europe. Interliant International's
investment in Interliant Europe of approximately $7.6 million was made with the
proceeds of a loan from @viso (see Note 7).
In May 2000, a subsidiary of Interliant Europe purchased certain data center
assets located in Paris, France from Cegetel Enterprises, SA. The purchase
price was approximately $1.9 million, of which $0.3 million was paid in cash at
closing and the balance in the form of a non-interest bearing note payable in
equal quarterly installments through February 2002. The entire purchase price
has been allocated to the acquired data center assets.
In June 2000, the Company purchased all of the outstanding stock of
Knowledge Systems, Inc., an ASP specializing in professional services and
hosting for associations. The purchase price consisted of $1.2 million in cash
(including $0.3 million in assumed seller debt) and 0.3 million shares of
Common Stock valued at $1.1 million including shares issued in connection with
contingent consideration provisions of the purchase agreement.
In July 2000, the Company purchased all of the outstanding stock of
Interactive Software, Inc. (ISI) and Milestone Services, Inc. (MSI), providers
of ERP software consulting and related solutions based on Oracle software. The
aggregate purchase price for ISI and MSI consisted of $4.4 million in cash, 0.6
million shares of Common Stock valued at $5.2 million and $3.8 million of
notes; the cash, Common Stock and notes include amounts earned pursuant to
contingent consideration provisions of the purchase agreements as amended.
1999 Acquisitions
During the year ended December 31, 1999, the Company acquired the assets of
three entities in the hosting business, the stock of four entities and assets
of one professional service company, and one other business. Total
consideration for these acquisitions, including payments of cash and issuance
of Common Stock in subsequent periods pursuant to contingent consideration
provisions of the respective purchase agreements was $44.3 million in cash,
including $18.1 million of debt assumed and subsequently paid, and 7.6 million
shares of Common Stock valued at $72.6 million.
51
6. Accrued Expenses
Accrued expenses consist of the following:
December 31,
---------------------
2001 2000
---------- ----------
Compensation and related costs.......................... 4,021,000 5,673,000
Communications costs.................................... 1,050,000 1,713,000
Marketing and advertising............................... 190,000 648,000
Amounts due to former owners under contingent...........
consideration arrangements.............................. -- 3,953,000
Amounts due to business partners for accounts receivable
collections on their behalf............................ 1,556,000 --
Hardware and software liabilities....................... 139,000 2,962,000
Professional Fees....................................... 3,106,000 1,931,000
Rent.................................................... 1,144,000 1,057,000
Interest................................................ 97,000 4,857,000
Other................................................... 3,005,000 2,202,000
---------- ----------
Total................................................ 14,308,000 24,996,000
========== ==========
7. Long-Term Debt and Capital Lease Obligations
Long-term debt and capital lease obligations consists of the following:
December 31,
-------------------------
2001 2000
------------ ------------
10% Convertible Senior Notes, due 2006.................... $ 39,955,000 $ --
Future interest to maturity on 10% Notes.................. 27,889,000 --
8% Convertible Subordinated Notes, due 2003............... 16,428,000 --
7% Convertible Subordinated Notes, due 2005............... 583,000 164,825,000
Capital lease obligations................................. 16,939,000 13,479,000
8% Note payable to @viso, due 2005........................ 7,872,000 7,434,000
Obligations related to the sale/leaseback of data center
equipment, approximate interest rate of 15%, payable
in monthly installments over 36 months................. 931,000 1,644,000
Notes payable to former owners of acquired businesses..... 4,253,000 643,000
Other debt................................................ 2,000 1,429,000
------------ ------------
114,852,000 189,454,000
Less amounts classified as current........................ 12,402,000 11,789,000
------------ ------------
$102,450,000 $177,665,000
============ ============
Maturities of long-term debt and capital lease obligations are as follows:
2002 $ 12,402,000
2003 22,527,000
2004 3,170,000
2005 8,909,000
2006 67,844,000
------------
$114,852,000
============
52
In February and March 2000, the Company sold $164.8 million of 7%
Convertible Subordinated Notes (7% Notes). The 7% Notes are convertible at the
option of the holder, at any time on or prior to maturity into Common Stock at
a conversion price of $53.10 per share, which is equal to a conversion rate of
18.8324 shares per $1,000 principal amount of the 7% Notes. Interest payments
began in August 2000, and are payable semi-annually. The 7% Notes mature on
February 16, 2005. Upon the occurrence of certain events the Company may redeem
the 7% Notes prior to maturity. In the third quarter of 2001, the Company
failed to pay the interest due causing an event of default. See below for
discussion of the restructuring of the debt.
On August 15, 2001, pursuant to a definitive agreement entered into on April
16, 2001 the Company sold to affiliates of Charterhouse Group International,
Inc. (Charterhouse) and SOFTBANK Technology Ventures VI, L.P. and its related
funds (Softbank) an aggregate of 190 units (Units), each Unit consisting of
$100,000 principal amount of 8% Convertible Subordinated Notes (8% Notes) and
27,273 warrants for the purchase of shares of Common Stock for a total sales
price of $19.0 million. The 8% Notes are convertible at the option of the
holder, at any time prior to maturity, into Common Stock at a conversion price
of $1.10 per share, subject to adjustment, which is equal to 90,909.09 shares
of Common Stock, per $100,000 principal amount of the 8% Notes. Interest
payments are payable on the last day of each calendar quarter by the issuance
of additional 8% Notes ($0.6 million as of December 31, 2001) The 8% Notes
mature on June 30, 2003. The warrants have an exercise price of $1.25 per share
and expire five years after issuance. The fair value of the warrants, which
were allocated to the total proceeds received was $3.9 million. Such amounts
are being charged to interest expense over the term of the 8% Notes commencing
August 2001. In addition, the 8% Notes contain a beneficial conversion feature
amounting to approximately $3.3 million, which was charged to interest expense
upon receipt of the proceeds. The unamortized value assigned to the warrants
($3.2 million) has been deducted from the face amount of the 8% Notes.
In December 2001 the Company exchanged $164.2 million (99.6%) of the 7%
Notes for new 10% Convertible Senior Notes (10% Notes), cash and warrants to
purchase the Company's Common Stock, ($270, $70 and 67.5 notes, cash, and
warrants, respectively for each $1,000 of 7% Notes exchanged). At the option of
the Company, semiannual interest payments can be made in the form of 10% Notes.
The 10% Notes are convertible into Common Stock at a conversion price of $1.00
per share. The warrants have an exercise price of $0.60 per share and expire
five years after issuance. This transaction cured the default with respect the
7% Notes exchanged. In early 2002, the Company paid the interest due on the
remaining 7% Notes thereby eliminating the default. The exchange transaction
has been accounted for pursuant to SFAS No. 15, Accounting by Debtors and
Creditors for Troubled Debt Restructurings. Accordingly, upon closing, the
difference between the consideration issued and the present carrying value of
the 7% Notes exchanged, reduced by the gross interest costs from the issuance
date to maturity ($27.9 million) and transaction costs on the 10% Notes issued,
has been treated as an extraordinary gain. SFAS No. 15 requires the accrual of
the entire amount of interest to be paid to maturity on the 10% Notes issued in
the exchange. The unamortized value assigned to the warrants ($4.4 million) has
been deducted from the face amount of the 10% Notes and the amortization is
being charged to interest expense.
In connection with 7% Note exchange transaction described above, the Company
has revised certain of the terms of the 8% Notes and related warrants. The
conversion price of the 8% Notes was reduced from $1.10 per share to $1.00 per
share and the exercise price of the related warrants was reduced from $1.25 per
share to $0.60 per share.
In connection with the Company's purchase of its equity interest in
Interliant Europe, @viso loaned the Company the amount required to purchase
said interest in May 2000 (approximately $7.6 million) evidenced by a note
bearing interest at 8% per annum which is payable in full at the earlier of a
sale of Interliant Europe's stock in an initial public offering or February
2005. The interest payable on the note may be added to the principal amount of
the note on each payment date at the option of the Company and the Company has
exercised such option at each interest payment date.
During the years ended December 31, 2001 and 2000, the Company financed
approximately $15.2 million and $17.0 million, respectively, of computer
equipment and furniture with various lenders under capital lease
53
arrangements, of which $4.7 million was financed under sale/leaseback
arrangements. The leases are payable in monthly installments over 24 to 36
months, with interest rates ranging from 7% to 17% per annum. During the fourth
quarter of 2001 and January 2002, the Company was successful in negotiating
restructured terms for most of the leases. As a result, the Company was able to
reduce the monthly payments, extend the payment period and in some cases reduce
the effective interest rate on the leases.
8. Stockholders' Equity
Preferred Stock
In May 1999, the Company's stockholders approved an amendment to the
Company's Charter to authorize the issuance of 1.0 million shares of
undesignated preferred stock with a par value of $0.01 per share.
Common Stock
In January and February 2000, the Company sold 0.8 million shares of Common
Stock in private placements for total gross proceeds of $27.5 million. In
connection with the sales, the Company issued warrants to purchase 0.2 million
shares of Common Stock at an average exercise price of $34.90 per share, which
approximated the market price at the date of issuance. The warrants expired
December 31, 2000.
During 2001, 2000 and 1999, approximately 1.6 million, 2.0 million and 6.6
million shares of Common Stock, respectively, were issued in connection with
acquisitions (see Note 5).
As of December 31, 2001, 98.9 million shares of Common Stock were reserved
for issuance upon exercise of stock options, warrants and conversion of all of
the convertible notes.
In July 1999, the Company sold 8.0 million shares of Common Stock, including
shares sold through the exercise of the underwriters' over-allotment option, in
an underwritten IPO for net proceeds of approximately $72.5 million.
In December 2001, the Company's stockholders approved an amendment to the
Company's Charter to increase the number of authorized shares of Common Stock
to 250.0 million.
In January 1999, pursuant to a Securities Purchase Agreement (the Purchase
Agreement), the Company sold to SOFTBANK Technology Ventures IV L.P. and one of
its affiliates, 2.6 million shares of its Series A Redeemable Convertible
Preferred (Series A Preferred) at a price of $4.91 per Series A Preferred share
and issued warrants to purchase 0.7 million shares of Common Stock at $6.67 per
share, for cash of $13.0 million. The warrants were exercised in April 1999 for
total proceeds of $5.0 million and the Series A Preferred was converted into an
equal number of shares of Common Stock in July 1999 upon the consummation of
the IPO.
On December 8, 1997, pursuant to a Stock Subscription Agreement dated
December 8, 1997 between the Company and WEB, WEB purchased 6.6 million shares
of Common Stock during 1999, and 18.6 million shares during the period December
8, 1997 (inception) to December 31, 1998, all at $1.67 per share.
Stock Option Plan
In February 1998, the Company adopted its 1998 Stock Option Plan (the Plan),
that is administered by the Compensation Committee of the Board of Directors
(the Committee). Under the terms of the Plan, as amended, the Committee may
grant stock options to directors, officers, employees and consultants of the
Company. The Plan permits the grant of incentive stock options (ISOs) and
nonqualified stock options (NSOs). In the year ended December 31, 2001, the
Company's stockholders approved amendments to the Plan which included (i) an
increase in the number shares available for grants of options under the plan to
17.6 million shares of Common
54
Stock, (ii) permission to grant options below fair market value, and (iii) an
increase of the maximum number of shares of Common Stock that may be subject to
options granted to any optionee during any one calendar year. The Plan provides
that stock options granted may not expire more than ten years from the date of
the grant. Options granted under the Plan generally will become exercisable
over a four-year period in equal annual installments unless the Committee
specifies a different vesting schedule. In the event of a change in control of
the Company, each option becomes immediately vested and exercisable, provided
that no written provision has been made, in connection with any such event, for
(1) the continuation of the Plan and/or the assumption of all outstanding
options by a successor corporation or (2) the substitution for such options
with new options covering the stock of a successor corporation. The Plan has a
term of ten years, subject to earlier termination or amendment by the
Committee, and all options under the Plan prior to its termination remain
outstanding until they have been exercised or terminated.
During the year ended December 31, 2001, no options were issued under the
Plan at less than fair market value.
The following table sets forth the Plan activity for the years ended December
31, 2001, 2000 and 1999:
2001 2000 1999
------------------------ ------------------------ -----------------------
Number of Price Number of Range Number of Price
Shares Range Shares Price Shares Range
---------- ------------ ---------- ------------ --------- ------------
Options outstanding, beginning of year 3,024,070 $0.13-$42.88 2,534,598 $0.13-$29.50 440,500 $ 1.67-$6.67
Options granted....................... 12,658,470 $0.24-$ 4.09 2,580,575 $5.28-$42.88 2,998,815 $0.13-$29.50
Options exercised..................... (10,103) $0.13-$ 1.67 (1,161,650) $0.13-$14.00 (768,867) $ 0.13-$6.67
Options terminated.................... (3,500,822) $0.13-$42.88 (929,453) $0.13-$42.88 (135,850) $1.67-$14.00
---------- ---------- ---------
Options outstanding, end of year...... 12,171,615 $0.13-$42.88 3,024,070 $0.13-$42.88 2,534,598 $0.13-$29.50
========== ========== =========
The weighted average exercise price of options granted under the Plan was
$3.28, $19.90 and $5.61 in 2001, 2000 and 1999, respectively. In connection
with certain acquisitions during 1999, the Company granted options to purchase
1,614,285 shares of Common Stock at prices ranging from $0.13 to $3.79 per
share in substitution for vested options. At December 31, 2001 and 2000, 1.7
million and 0.3 million options granted under the Plan, respectively were
vested and exercisable.
The following table summarizes information about stock options granted under
the Plan which were outstanding as of December 31, 2001:
Options Outstanding Options Exercisable
- ---------------------------------------------------------- ------------------------
Weighted-Average Weighted- Weighted-
Range of Number of Remaining Average Number of Average
Exercise Prices Options Contractual Life Exercise Price Options Exercise Price
- --------------- --------- ---------------- -------------- --------- --------------
$ 0.13-$ 0.57 4,492,683 9.7 years $ 0.39 254,569 $ 0.55
$ 1.00-$ 3.33 5,982,697 9.2 $ 1.52 816,194 $ 1.05
$ 4.00-$17.00 1,206,835 8.0 $12.18 455,176 $11.63
$19.25-$42.88 489,400 7.9 $29.51 184,428 $28.34
---------- --------- ---------
12,171,615 9.2 years $ 3.28 1,710,367 $ 6.73
========== --------- =========
Stock-Based Compensation
As discussed in Note 2, the Company applies APB 25 and related
interpretations in accounting for its stock option plan. During 2000 and 1999,
the vesting of options to purchase 31,750 and 40,250 shares of Common Stock was
accelerated in connection with termination arrangements, and as a result, the
Company charged approximately $0.7 million and $0.3 million, respectively, to
compensation expense.
As required under SFAS 123, the following pro forma net loss and net loss
per share presentations reflect the amortization of the option grant fair value
as expense. For purposes of this disclosure, the estimated fair value of the
options is amortized to expense over the options' vesting periods.
55
SFAS 123 pro forma information is as follows:
2001 2000 1999
------------- ------------- ------------
Pro forma net loss............................. $(188,373,000) $(160,539,000) $(55,093,000)
Pro forma net loss per share--basic and diluted $ (3.72) $ (3.38) $ (1.54)
The weighted average grant date fair value was $3.28, $17.96 and $10.85 for
stock options issued in 2001, 2000 and 1999, respectively, and the
weighted-average remaining contractual life for options outstanding as of
December 31, 2001 and 2000 is 9.2 and 8.6 years, respectively. Significant
assumptions used in determining this value include a risk free interest rate
and volatility of 4.29% and 2.72%, 6.5% and 1.26%, and 6.0% and 1.39%, in 2001,
2000 and 1999, respectively, an expected option life of five years, and a
dividend rate of zero.
The effects on pro forma disclosures of applying SFAS 123 are not likely to
be representative of the effects on pro forma disclosures in future years as
the period presented includes only four years of option grants under the Plan,
while 2001 includes four years, 2000 includes three years and 1999 includes two
years.
In May 2001, the Company amended its agreement with The Feld Group, Inc., a
Dallas, Texas based technology and management services firm (The Feld Group),
under which The Feld Group renders executive-level services to the Company.
Under the amended agreement (The Feld Group Agreement), Mr. Bruce Graham, a
member of The Feld Group is now rendering services as the Chief Executive
Officer and President of the Company. In connection therewith, as a
non-refundable and non-forfeitable sign-on bonus, the Company issued The Feld
Group 0.8 million shares of Common Stock, valued at $0.9 million, which was
recorded as a charge to non-cash compensation during the second quarter of 2001.
The Company also granted The Feld Group options to purchase 2.0 million
shares of Common Stock at an exercise price of $1.00 per share. Such options
were issued outside the Plan. The option shares will vest and become
exercisable, so long as The Feld Group Agreement remains in effect, in
forty-eight equal monthly installments based on the passage of time. In March
2002, The Feld Group options were amended to provide that the balance of the
2,000,000 options granted thereunder which are not vested as of March 7, 2002
(i.e., 1,625,000 option shares) shall become vested and exercisable in ten (10)
equal monthly installments based on the passage of time, on the last day of
each month commencing March 31, 2002 and continuing through and including
December 31, 2002. Pursuant to EITF 96-18, as the option shares vest, the
Company will record non-cash compensation charges based on the fair value of
the shares vesting during the period. Such non-cash compensation charges
totaled $0.1 million for the year ended December 31, 2001. Upon a change in
control of the Company, the option with respect to such number of shares equal
to the difference between 1,000,000 minus the then vested portion of the first
1,000,000 of the total option share grant, shall become fully and immediately
vested and exercisable. In addition, the balance of the option shall become
fully and immediately vested and exercisable upon the occurrence of both of the
following events: (1) a change in control of the Company, and (2) after such
change in control, The Feld Group's engagement by the Company, or the successor
entity resulting therefrom, is terminated by the Company or such successor or
The Feld Group terminates the engagement due to a significant adverse change in
its or Mr. Graham's level of responsibility, compensation or staffing
requirements, as directed by the Board of Directors of the Company or such
successor, which is not remedied within 30 days of written notice from The Feld
Group to such Board advising them of The Feld Group's intention to terminate
the engagement.
In January 2000, the Company issued options to purchase 1.5 million shares
of Common Stock at an average exercise price of $18.00 per share to its
then-current CEO. Such options were issued outside of the Plan. The average
exercise price of the options was below the fair value of the Common Stock as
of the measurement date, which would result in the recognition of approximately
$30.0 million as compensation expense over the four-year vesting period of the
options on a graded vesting basis. Due to the fact that the CEO terminated his
employment with the Company in April 2001, an adjustment was recorded during
the second quarter of 2001 to reverse compensation charges aggregating
approximately $8.4 million, which were expensed during 2000 and the quarter
ended March 31, 2001. The expense reversal reflects the excess of the charge
recognized on a graded
56
vesting basis over the value of the options that had ratably vested as of the
date of his termination. The entire 1.5 million share grant was canceled as of
July 2001 because the vested shares were not exercised within the requisite
three months of the employment termination.
Employee Stock Purchase Plan
Effective July 2000, the stockholders of the Company approved the adoption
of the 2000 Employee Stock Purchase Plan (ESPP), that provides for the sale of
up to 1.5 million shares of Common Stock to eligible participating employees of
the Company through periodic payroll deductions. The purchase price of the
shares is the lesser of 85 percent of the Common Stock's fair market value on
the first day of the purchase period or the last day of the purchase period for
each six-month purchase period. The ESPP qualifies as an "employee stock
purchase plan" under section 423 of the Internal Revenue Code of 1986, as
amended. During the year ended December 31, 2001, 0.4 million shares were
purchased by employees pursuant to the plan for total consideration of $0.2
million.
Accumulated Other Comprehensive Income
The Accumulated Other Comprehensive loss was $0.6 million as of December 31,
2000. During the year, in connection with the sale of Interliant Europe, a
foreign currency loss of $1.0 million was realized, offset by unrealized
translation losses of $0.6 million, for an Accumulated Other Comprehensive loss
balance of $0.3 million at December 31, 2001.
9. Income Taxes
As of December 31, 2001, the Company has federal and state net operating
loss carryforwards of approximately $225 million and foreign net operating loss
carryforwards of $15.3 million. The net operating loss carryforwards will
expire at various dates beginning in the years 2003 through 2020 if not
utilized.
Significant components of the Company's deferred tax assets and liabilities
for federal and state income taxes consist of the following at December 31,
2001 and 2000:
Year Ended December 31,
---------------------------
2001 2000
------------- ------------
Deferred tax assets and liabilities:
Net operating loss carryforwards..... $ 95,876,000 $ 60,792,000
SFAS No.142: Impairment.............. 19,983,000
Amortization of intangible assets.... 16,116,000 15,703,000
Non-cash compensation................ -- 5,483,000
SFAS No. 15 Interest Accrual......... 11,121,000
Other, net........................... 2,138,000 3,675,000
------------- ------------
Total deferred tax assets............... 145,234,000 85,653,000
Basis difference in acquired intangibles (2,905,000) (6,156,000)
------------- ------------
Total deferred tax assets, net.......... 142,329,000 79,497,000
Valuation allowance..................... (142,329,000) (79,497,000)
============= ============
Net..................................... $ -- $ --
============= ============
The Company believes that, based on a number of factors, the available
objective evidence creates sufficient uncertainty regarding the realization of
the deferred tax assets such that a full valuation allowance has been recorded.
The Company will continue to assess the realization of the deferred tax assets
based on actual and forecasted operating results. The valuation allowance
increased by $63 million from 2000 to 2001.
57
10. Operating Leases
The Company leases its data centers and certain office space under
noncancelable operating leases, which expire at various dates through April
2010. Some of the leases contain renewal options. Total rent expense for all
operating leases was approximately $11.0 million, $8.1 million and $3.4 million
for the years ended December 31, 2001, 2000 and 1999, respectively. In
connection with certain of the leases, the Company has given the landlords
standby letters of credit in the amount of approximately $1.8 million in lieu
of security deposits. Such letters of credit are backed by certificates of
deposit, which are restricted as to use, and are accordingly classified in the
Company's balance sheet as restricted cash as of December 31, 2001.
Future minimum lease commitments for noncancelable operating leases, net of
subleases, are as follows at December 31, 2001:
2002...... $ 8,917,000
2003...... 9,294,000
2004...... 9,676,000
2005...... 8,813,000
2006...... 5,438,000
Thereafter 7,672,000
-----------
$49,810,000
===========
11. Discontinued Operations
Pursuant to Accounting Principles Board Opinion No. 30, Reporting the
Results of Operations--Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions, (APB 30), the Company's financial statements have been
reclassified to reflect the disposal of a major line of business included in
the Company's managed infrastructure solutions segment, its Managed Enterprise
Resource Planning (ERP) and Customer Relationship Management (CRM) hosting,
outsourcing and related hosting services business, operated through rSP. Since
its acquisition in early 2000, rSP's business activities had been separately
operated (physically, operationally and for financial reporting purposes) as
one of the four separate major lines of business comprising the Company's
managed infrastructure solutions segment. The Company's ERP and CRM
professional services business line, which provides software consulting
services, has been and continues to be separately operated as a major line of
business in the ASP professional services segment, independent of rSP. In
addition, rSP's customer base represented a separate group of customers that is
no longer serviced by the Company. The Company did not retain the rSP employee
base, as its skill set (e.g., operations and sales personnel), in general, was
not sufficiently compatible with continuing business lines. Accordingly, the
revenues, costs and expenses, and assets and liabilities of rSP have been
segregated and reported in the accompanying condensed consolidated financial
statements as "Discontinued Operations."
Based on sales negotiations and other considerations, the measurement date
for such discontinued operations was determined to be May 31, 2001, the date at
which management was able to determine the method of disposal and,
consequently, was able to determine, with reasonable accuracy, the loss on such
disposal. In July 2001, the Company completed the sale of the ERP and CRM
hosting business of rSP (see Note 9). The Company disposed of the remaining
outsourcing operations of rSP during the third quarter of 2001, and retained
$1.3 million of assets, primarily consisting of computer equipment and
software. As of December 31, 2001, the net liabilities of rSP totaled $0.9
million, which includes estimated remaining liabilities associated with the
disposition. The 2001 losses from discontinued operations of $10.4 million
include an operating loss incurred prior to the measurement date of
approximately $6.5 million, and the loss on disposal of $3.9 million.
58
The summary unaudited results of the discontinued operations for the years
ended December 31, 2001 and 2000 are shown below.
December 31,
--------------------------
2001 2000
------------ ------------
Revenues......................................... $ 9,257,000 $ 23,212,000
Operating loss................................... $(10,442,000) $(19,622,000)
Summary balance sheet information with respect to the discontinued
operations as of December 31, 2001 and 2000 are shown below.
December 31, December 31,
2001 2000
------------ ------------
Current assets................................... $ 13,616,000
Property and equipment, net...................... 11,730,000
Intangibles, net................................. 29,284,000
Current liabilities.............................. $(914,000) (17,062,000)
--------- ------------
Net assets (liabilities)......................... $(914,000) $ 37,568,000
========= ============
12. Restructuring Charges
In September 2000, the Company announced a plan to accelerate its
acquisition integration program by consolidating certain geographically
dispersed functions. The plan included the elimination of approximately 300
jobs, the exit of certain leased facilities and other related contractual
arrangements, and the termination of a software development project. The plan
included a workforce reduction in operations and information systems, customer
care, sales, marketing and business development, and finance and
administration. The Company recorded a restructuring charge of $2.5 million
during the three months ended September 30, 2000. As of December 31, 2001 the
reserve was fully utilized and 112 positions were eliminated in 2000 and 26 in
2001. The following table summarizes the status of the restructuring reserve as
of December 31, 2001 and associated charges:
Total
September Severance Exit of
2000 and Related Leased Assets
Restructuring Costs Facilities Write-offs
------------- ----------- ---------- ----------
Total reserve charged to expense....... $ 2,500,000 $1,427,000 $ 684,000 $ 389,000
2000 Cash Charges Against Reserve...... (1,068,000) (596,000) (472,000)
2001 Cash Charges Against Reserve...... (671,000) (459,000) (212,000)
2000 Non-cash Charges Against Reserve.. (389,000) (389,000)
2001 Unused reserve credited to expense (372,000) (372,000)
----------- ---------- --------- ---------
Balance as of December 31, 2001........ $ -- $ -- $ -- $ --
=========== ========== ========= =========
April 2001 Restructuring Charge
Based on a decision reached by management and the Board of Directors in late
March 2001, the Company announced a restructuring plan on April 2, 2001 (April
Plan or restructuring) to further streamline the business by narrowing its
services focus to a core set of offerings. The April Plan comprises workforce
reductions and the exit of certain non-core businesses.
The April Plan, which began on April 3, 2001, consisted of a workforce
reduction of 186 positions. This action resulted in a charge for payment of
severance and related costs of approximately $1.7 million. The charge was
recognized during the second quarter of 2001 and was completed by the end of
2001 (see Note 5).
59
July 2001 Restructuring Charge
Based on a decision reached by management and the Board of Directors in July
2001, the Company announced a restructuring plan on July 31, 2001 (July Plan or
restructuring) designed to further reduce the ongoing operating expenses of the
Company in light of the continued uncertainties in the economy in general,
certain weaknesses in the market for IT outsourcing services, and lack of
recent revenue growth for the Company in particular.
The July Plan comprised workforce reductions of approximately 70 positions
and the exit of certain leased facilities. All 70 positions were eliminated as
of the end of 2001. The Company retained licensed real estate brokers to
actively market each of the identified leased facilities to be exited. To date,
no agreements have been made to exit or sublease any of the identified
facilities.
The following table summarizes the status of the July 2001 restructuring
reserve:
Total July 2001 Severance and Exit of Leased
Restructuring Related Costs Facilities
--------------- ------------- --------------
Reserve charged to expense in the 3rd quarter. $ 2,994,000 $ 581,000 $2,413,000
Reserve charged to expense in the 4th quarter. 584,000 65,000 519,000
----------- --------- ----------
Total reserve charged to expense.............. 3,578,000 646,000 2,932,000
2001 Cash Charges Against Reserve............. (1,359,000) (646,000) (713,000)
2001 Non-cash Charges Against Reserve......... (44,000) -- (44,000)
----------- --------- ----------
Balance as of December 31, 2001............... $ 2,175,000 $ -- $2,175,000
=========== ========= ==========
13. Related Party Transactions
Web Hosting Organization LLC (WEB), a Delaware Limited Liability Company, is
the largest single shareholder of the Company. WEB's investors comprise
Charterhouse Equity Partners III, L.P. and Chef Nominees Limited (collectively,
CEP Members), and WHO Management, LLC (WHO). The Company received consulting
services from Sage Equities, Inc. and Intensity Ventures, Inc., whose
principals are the co-chairmen of the Company and members of WHO, for the
purpose of providing strategic management oversight. In 2001, 2000 and 1999,
the principal of Sage Equities, Inc. was compensated as an employee of the
Company. For Intensity Ventures in the years ended December 31, 2001, 2000 and
1999, the Company incurred costs of $293,000 (of which $60,000 were consulting
services, $2,000 were expenses and $231,000 were non-cash compensation costs
incurred in the issuance of shares of Common Stock), $228,000 (of which $48,000
were expenses) and $338,000 (of which $141,000 were expenses), respectively.
Affiliates of Charterhouse Group International, Inc. (Charterhouse) and
Mobius Venture Capital (previously known as Softbank Venture Capital) purchased
8% Convertible Subordinated Notes and warrants for the purchase of Common Stock
for $19.0 million. Interliant incurred $315,000 and $255,000 of interest
expense in 2001 for Charterhouse and Mobius, respectively, in conjunction with
the subordinated debt. For the years ended December 31, 2001, 2000 and 1999,
Interliant generated $750,000, $1,051,000 and $312,000 of revenue,
respectively, from Mobius for security and Lotus Notes development and hosting
services. In connection with acquisition services, the Company paid transaction
fees of $361,000 for the year ended December 31, 1999 to Charterhouse.
The Feld Group, Inc., a Dallas, Texas based technology and management
services firm (The Feld Group), renders executive-level services to the
Company. Under the agreement Mr. Bruce Graham, a member of The Feld Group, acts
as a Director, Chief Executive Officer and President of the Company along with
at least one additional executive. For the Feld Group in 2001 and 2000,
Interliant incurred expenses of $2,778,000 (of which $1,320,000 were
professional service fees, $328,000 expenses and $1,130,000 non-cash
compensation for the issuance of Common Stock, warrants and options) and
$703,000 (of which $627,000 were professional service fees and $76,000
expenses), respectively.
Mr. Bruce Graham is a member of the board of directors of Contrado, Inc., an
enterprise software company that developed and installed software to automate
Interliant's equipment provisioning process. In 2001, Interliant
60
capitalized $229,000 of software development and installation fees it paid to
Contrado, Inc. and incurred $53,000 of software maintenance expenses with
Contrado, Inc.
In the fourth quarter of 2001, Mr. Stephen Maggs, at the time a member of
the Board of Directors, was retained to provide operational and strategic
management at Telephonetics, Inc., a wholly owned subsidiary of the Company.
During 2001, the Company incurred expenses of $16,000, including $10,000 for
professional services and $6,000 for expenses. Mr. Stephen Maggs resigned from
the Board of Directors effective January 31, 2002 at which time, a new company
he formed, purchased the assets of Telephonetics (see Note 16).
Vytek Wireless, Inc., a global integration company that provides wireless
data solutions, and the Company have three common board members.Vytek purchased
co-location hosting services from the Company, generating $37,000 of revenues
in 2001.
14. Employee Benefit Plan
In 1998, the Company instituted a 401(k) Plan for all employees who are age
19 or older and have been employed by the Company or by an acquired business
for at least one month. Participating employees may make contributions to the
401(k) Plan up to 15% of their eligible compensation. The 401(k) Plan provides
that the Company may make discretionary contributions to the 401(k) Plan on
behalf of participating employees. In 1999, the Company initiated a matching
contribution policy wherein it agreed to match the employee's contributions
100% up to 5% of the participating employee's eligible compensation. The total
amount contributed by the Company and charged to expense during 2001, 2000, and
1999 was $2.1 million, $2.4 million, and $0.6 million respectively. The Company
discontinued matching contributions in the second half of 2001.
15. Segment Reporting
Pursuant to FAS 131, the Company determined that it had three reportable
segments in 2001, Managed infrastructure solutions, Web Hosting and
Professional Services, but the Web Hosting segment was discontinued following
the October 26, 2001 sale of retail Web hosting assets to Interland, Inc.
The Company's management generally reviews the results of operations of each
segment exclusive of depreciation and amortization related to each segment.
Accordingly, such expenses are excluded from the segment operating income or
loss and are shown in the Other caption. In addition, all intangible assets and
corporate expenses of the Company are also included in the Other caption. The
Web Hosting segment was discontinued following the October 26, 2001 sale of
retail Web hosting assets to Interland, Inc.
61
Segment information as of and for the years ended December 31, 2001, 2000,
and 1999 for each of the segments is shown below.
December 31,
------------------------------------------
2001 2000 1999
------------- ------------- ------------
Revenues:
Managed infrastructure solutions. $ 29,968,000 $ 25,015,000 $ 15,639,000
Web Hosting...................... 12,487,000 19,550,000 16,892,000
Professional Services............ 67,146,000 82,992,000 11,493,000
Other............................ 7,656,000 7,301,000 3,090,000
------------- ------------- ------------
Total........................ $ 117,257,000 $ 134,858,000 $ 47,114,000
============= ============= ============
Operating Income (Loss):
Managed infrastructure solutions. $ (6,669,000) $ (11,232,000) $ (6,173,000)
Web Hosting...................... (15,006,000) (20,185,000) (17,302,000)
Professional Services............ (325,000) 5,883,000 755,000
Other............................ (216,360,000) (101,700,000) (32,098,000)
------------- ------------- ------------
Total........................ $(238,360,000) $(127,234,000) $(54,818,000)
============= ============= ============
Segment Assets:
Managed infrastructure solutions. $ 7,810,000 $ 37,124,000 $ 11,223,000
Web Hosting...................... -- 17,281,000 7,716,000
Professional Services............ 18,942,000 32,376,000 11,704,000
Other............................ 44,046,000 238,508,000 132,232,000
------------- ------------- ------------
Total........................ $ 70,798,000 $ 325,289,000 $162,875,000
============= ============= ============
For the years ended December 31, 2001, 2000 and 1999, approximately 7%, 10%
and 16%, respectively, of revenues were from sources outside the United States,
primarily from Europe, Latin America and Asia.
16. Subsequent Events
Equity Financing
On March 8, 2002, the Investors purchased an aggregate of $10.0 million of
the Company's 10% Notes and 10.0 million warrants to purchase the Company's
Common Stock at $0.30 per share. The 10% Notes are convertible into the
Company's Common Stock at $0.30 per share. The warrants are exercisable for 5
years. Interest on the 10% Notes may be paid in cash or the issuance of
additional 10% Notes at the Company's option. In addition, the Investors or
other persons acceptable to the Company, may purchase up to an additional $10.0
million of the 10% Notes and related warrants.
Sales of Businesses
In January 2002, the Company sold the assets of its subsidiary
Telephonetics, Inc. to a company formed by Stephen Maggs a founder and former
member of the Board of Directors of the Company. The total sales price was $1.6
million of which $0.6 million was in cash and the balance was in the form of
promissory notes and the assumption of debt. The notes are due $0.4 million in
2002 and $0.6 million in 2005.
In February 2002, the Company sold the assets of its subsidiary Softlink,
Inc. to a subsidiary of Springbow Solutions, Inc. The total sales price was
$4.2 million of which $3.1 million was paid in cash to the Company, $0.5
million was paid to a former owner of Softlink as part of the contingent
consideration provision of the original purchase agreement and $0.6 million is
being held in escrow.
62
17. Quarterly Information (unaudited)
The following tables set forth certain unaudited quarterly results of
operations of the Company for 2001 and 2000. The quarterly operating results
are not necessarily indicative of future results of operations.
Three Months Ended
-------------------------------------------------------
March 31, June 30, September 30, December 31,
2001 2001 2001 2001
------------ ------------ ------------- ------------
Revenues........................................ $ 35,123,000 $ 31,242,000 $ 28,263,000 $ 22,629,000
Gross Profit.................................... 11,333,000 10,768,000 8,806,000 7,342,000
Operating loss.................................. (75,280,000) (33,533,000) (114,210,000) (15,337,000)
Loss before minority interest, discontinued
operations, extraordinary gain, and cumulative
effect of accounting change................... (77,806,000) (37,793,000) (122,113,000) (15,633,000)
Loss before discontinued operations,
extraordinary gain, and cumulative effect of
accounting change............................. (76,183,000) (34,250,000) (120,267,000) (15,633,000)
Loss before extraordinary gain and cumulative
effect of accounting change................... (81,221,000) (38,432,000) (120,267,000) (16,855,000)
Loss before cumulative effect of accounting
change........................................ (81,221,000) (38,432,000) (120,267,000) 67,041,000
Net income (loss)............................... $(81,221,000) $(38,432,000) $(120,267,000) $ 67,041,000
Basic and diluted income (loss) per share:
Loss before cumulative effect of accounting
change..................................... $ (1.55) $ (0.69) $ (2.34) $ (0.28)
Discontinued operations...................... $ (0.10) $ (0.08) $ -- $ (0.02)
Gain on debt refinancing..................... $ -- $ -- $ -- $ 1.62
Cumulative effect of accounting change....... -- -- --
------------ ------------ ------------- ------------
Net income (loss)............................ $ (1.65) $ (0.77) $ (2.34) $ 1.30
============ ============ ============= ============
Three Months Ended
------------------------------------------------------
March 31, June 30, September 30, December 31,
2000 2000 2000 2000
------------ ------------ ------------- ------------
Revenues........................................ $ 25,005,000 $ 33,019,000 $ 39,299,000 $ 37,535,000
Gross Profit.................................... 7,919,000 9,164,000 11,734,000 10,783,000
Operating loss.................................. (25,248,000) (32,315,000) (35,805,000) (33,865,000)
Loss before minority interest, discontinued
operations, extraordinary gain, and cumulative
effect of accounting change................... (25,366,000) (33,467,000) (36,742,000) (36,796,000)
Loss before discontinued operations,
extraordinary gain, and cumulative effect of
accounting change............................. (25,366,000) (33,147,000) (35,661,000) (36,213,000)
Loss before extraordinary gain and cumulative
effect of accounting change................... (27,361,000) (38,926,000) (42,336,000) (41,387,000)
Loss before cumulative effect of accounting
change........................................ $(27,361,000) $(38,926,000) $(42,336,000) $(41,387,000)
Net Loss........................................ $(28,581,000) $(38,926,000) $(42,335,000) $(41,387,000)
Basic and diluted loss per share:
Loss before cumulative effect of accounting
change..................................... $ (0.55) $ (0.70) $ (0.74) $ (0.75)
Discontinued operations...................... $ (0.04) $ (0.12) $ (0.14) $ (0.11)
Gain on debt refinancing..................... $ -- $ -- $ -- $ --
Cumulative effect of accounting change....... (0.03) -- -- --
------------ ------------ ------------ ------------
Net loss..................................... $ (0.62) $ (0.82) $ (0.88) $ (0.85)
============ ============ ============ ============
63
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
Information with respect to directors and executive officers is included in
Interliant's Proxy Statement to be filed pursuant to Regulation 14A (the Proxy
Statement) under the captions Election of Directors and Executive Officers and
such information is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The section entitled Executive Compensation and the information set forth
under the caption Election of Directors-Director Compensation included in the
Proxy Statement are incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The Common Stock information in the section entitled Principal Shareholders
of the Proxy Statement is incorporated herein by reference.
ITEM 13. RELATED PARTY TRANSACTIONS
The section entitled Related Party Transactions of the Proxy Statement is
incorporated herein by reference.
64
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Item 14(a) 1. The information required by this item is included in Item 8 of
Part II of this 10K.
The following documents or the portions thereof indicated are filed as a
part of this Report in Item 8:
2. Financial Statement Schedules:
Schedule II Valuation and qualifying accounts for each of the three years in
the period ended December 31, 2001
All other schedules are omitted as the required information is inapplicable
or the information is presented in the Consolidated Financial Statements and
Notes thereto.
INTERLIANT, INC. AND CONSOLIDATED SUBSIDIARIES
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
Additions
-------------------
Balance at Charged Balance at
Beginning of Charged to to Other End of
Classification Period Expense accounts Deductions Period
-------------- ------------ ---------- -------- ---------- ----------
Year ended December 31, 2001 Allowance
for uncollectible accounts.......... $2,482,636 $4,381,159 -- $5,197,315 $1,666,480
Year ended December 31, 2000 Allowance
for uncollectible accounts.......... $1,378,000 $3,291,938 $280,049(1) $2,467,351 $2,482,636
Year ended December 31, 1999 Allowance
for uncollectible accounts.......... $ 320,000 $1,585,254 $507,078(1) $1,034,332 $1,378,000
- --------
(1) includes allowances of acquired companies
Item 14(b) Reports on Form 8-K
1. Form 8-K, dated October 25, 2001, whereby Interliant announced that it
had entered into a definitive agreement with a limited number of
then-current holders of Interliant's 7% Convertible Subordinated Notes
due 2005 ("Notes") for the purpose of restructuring $126.9 million in
principal out of $164.8 million in principal of those Notes.
2. Form 8-K, dated October 30, 2001, whereby Interliant announced the sale
of its shared and unmanaged dedicated retail Web hosting business to
Interland, Inc.
3. Form 8-K, Dated November 2, 2001, whereby Interliant announced that it
had entered into a Recapitalization and Exchange Agreement with a
limited number of then-current holders of 7% Convertible Subordinated
Notes due 2005 ("7% Notes") for the purpose of exchanging approximately
$126.8 million in principal of the 7% Notes for a cash payment and new
securities.
65
Item 14(c) EXHIBITS
The following is a list of exhibits filed as part of this Annual Report on
Form 10-K.
2.15 -- Recapitalization and Exchange Agreement between Interliant, Inc. and a limited number of current
holders representing a majority of the outstanding principal amount of the Company's 7% Convertible
Subordinated Notes due 2005.+
10.48 -- Amended Engagement Agreement, dated May 22, 2001, between The Feld Group, Inc. and Interliant,
Inc.*
10.49 -- Amendment to Employment Agreement, dated May 22, 2001, between Leonard J. Fassler and
Interliant, Inc.*
10.50 -- Amendment to Consulting Agreement, dated may 22, 2001, between Intensity Ventures, Inc. and
Interliant, Inc.*
10.51 -- Account Acquisition Agreement, dated October 26, 2001, between Interliant, Inc. and Interland, Inc.**
10.52 -- Securities Purchase Agreement, dated March 8, 2002, between Interliant and Charterhouse Equity
Partners, III, L.P., Mobius Technology Ventures VI L.P., Softbank U.S. Ventures Fund VI, L.P.,
Mobius Technology Ventures Advisors Fund VI, L.P. and Mobius Technology Ventures Side Fund
VI, L.P.***
10.53 -- Form of 10% Convertible Subordinated Note due February 28, 2005.***
10.54 -- Form of Common Stock Purchase Warrant.***
10.55 -- Registration Rights Agreement, dated as of March 8, 2002, among Interliant, Inc. and Charterhouse
Equity Partners III, L.P., CHUSA Equity Investors III, L.P., Charterhouse Equity III, L.P., Mobius
Technology Ventures VI L.P., Softbank U.S. Ventures Fund VI L.P., Mobius Technology Ventures
Advisors Fund VI L.P., and Mobius Technology Ventures Side Fund L.P.***
10.56 -- Letter Agreement between the Company and certain senior management employees dated March 8,
2002 regarding issuance of stock to such employees in exchange for a reduction in cash compensation
during the calendar year 2002.++
10.57 -- Second Amendment to Employment Agreement with Leonard J. Fassler dated March 15, 2002.++
10.58 -- Amendment dated March 7, 2002 to Nonqualified Stock Option Award Agreement dated May 22,
2001 between the Company and The Feld Group, Inc.++
21.1 -- List of Subsidiaries.++
23.1 -- Consent of Ernst & Young LLP with respect to the financial statements of Interliant, Inc. (formerly
known as Sage Networks, Inc.).++
- --------
* Previously filed as an exhibit to the Company's Quarterly Report on Form
10-Q for the Quarter Ended September 30, 2001, and incorporated by reference
herein.
** Previously filed as an exhibit to the Company's Quarterly Report on Form
10-Q for the Quarter Ended September 30, 2001, and incorporated by reference
herein.
*** Previously filed as an exhibit to Interliant's Current Report on Form 8-K
dated March 2, 2002, and incorporated herein by reference.
+ Previously filed as an exhibit to Interliant's Current Report on Form 8-K
dated October 19, 2001, and incorporated herein by reference.
++ Filed herewith.
66
ITEM 15. 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.
INTERLIANT, INC.
By: /S/ BRUCE GRAHAM
-----------------------------------
Bruce Graham
President and Chief Executive Officer
Dated: April 16, 2002
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities indicated and
on the dates indicated:
Signature Title Date
--------- ----- ----
/S/ LEONARD J. FASSLER Co-Chairman of the Board April 16, 2002
- -----------------------------
Leonard J. Fassler
/S/ BRADLEY A. FELD Co-Chairman of the Board April 16, 2002
- -----------------------------
Bradley A. Feld
/S/ BRUCE GRAHAM President, Chief Executive April 16, 2002
- ----------------------------- Officer, Director
Bruce Graham (Principal Executive
Officer)
/S/ FRANCIS J. ALFANO Chief Financial Officer April 16, 2002
- ----------------------------- (Principal Financial
Francis J. Alfano Officer)
/S/ HOWARD S. DIAMOND Director April 16, 2002
- -----------------------------
Howard S. Diamond
/S/ THOMAS C. DIRCKS Director April 16, 2002
- -----------------------------
Thomas C. Dircks
/S/ CHARLIE FELD Director April 16, 2002
- -----------------------------
Charlie Feld
/S/ JAY M. GATES Director April 16, 2002
- -----------------------------
Jay M. Gates
/S/ MERRIL M. HALPERN Director April 16, 2002
- -----------------------------
Merril M. Halpern
/S/ CHARLES R. LAX Director April 16, 2002
- -----------------------------
Charles R. Lax
/S/ DAVID M. WALKE Director April 16, 2002
- -----------------------------
David M. Walke
67