SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002.
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
Commission file number: 0-30905
STORAGENETWORKS, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-3436145
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification Number)
225 Wyman Street
Waltham, MA 02451
(781) 434-6700
(Address, Including Zip Code, and Telephone Number, Including Area Code,
of Registrant's Principal Executive Offices)
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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 |_|
The number of shares outstanding of the registrant's Common Stock as of
May 3, 2002: 98,522,638 shares.
StorageNetworks, Inc.
Form 10-Q
For the Quarterly Period Ended March 31, 2002
Table of Contents
Page
PART I. Financial Information
Item 1. Condensed Consolidated Financial Statements (Unaudited) 1
Condensed Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 1
Condensed Consolidated Statements of Operations for the three months 2
ended March 31, 2001 and 2002
Condensed Consolidated Statements of Cash Flows for the three months 3
ended March 31, 2001 and 2002
Notes to Condensed Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results 5
of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk 15
PART II. Other Information
Item 1. Legal Proceedings 15
Item 2. Changes in Securities and Use of Proceeds 15
Item 6. Exhibits and Reports on Form 8-K 15
Signatures 16
PART I--FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
StorageNetworks, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
December 31, March 31,
2001 2002
(Note 1) (Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 185,834 $ 164,579
Short-term investments 42,978 53,264
Accounts receivable, net 13,735 9,699
Prepaid expenses and other current assets 9,407 8,354
--------- ---------
Total current assets 251,954 235,896
Property and equipment, net 67,074 62,118
Non-current investments 29,937 26,139
Restricted cash equivalents 30,158 29,558
Other assets 5,618 4,652
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Total assets $ 384,741 $ 358,363
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LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 3,821 $ 5,885
Accrued expenses 50,259 42,208
Deferred revenue 5,868 2,274
Capital lease obligations 44,063 43,693
--------- ---------
Total current liabilities 104,011 94,060
Capital lease obligations, less current portion 60,512 47,638
STOCKHOLDERS' EQUITY:
Common stock 978 985
Treasury stock (200) (200)
Additional paid-in capital 597,938 597,595
Deferred stock compensation (4,638) (2,522)
Accumulated other comprehensive income 428 489
Accumulated deficit (374,288) (379,682)
--------- ---------
Total stockholders' equity 220,218 216,665
--------- ---------
Total liabilities and stockholders' equity $ 384,741 $ 358,363
--------- ---------
See notes to condensed consolidated financial statements.
1
StorageNetworks, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share data)
Three Months Ended
March 31,
2001 2002
-------- -------
REVENUES:
Managed storage services revenues $ 23,049 $30,639
Professional services revenues 4,056 987
-------- -------
Total revenues 27,105 31,626
COSTS AND EXPENSES:
Cost of managed storage services revenues, excluding deferred stock compensation
amortization amounts 30,110 20,597
Cost of professional services revenues, excluding deferred stock compensation
amortization amounts 2,783 645
Sales and marketing, excluding deferred stock compensation amortization amounts 18,400 6,051
General and administrative, excluding deferred stock compensation amortization amounts 5,503 3,002
Research and development, excluding deferred stock compensation amortization amounts 4,356 4,466
Amortization of deferred stock compensation* 1,194 462
-------- -------
Total costs and expenses 62,346 35,223
Loss from operations (35,241) (3,597)
Interest income 5,433 1,520
Interest expense (3,055) (3,317)
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Net loss $(32,863) $(5,394)
-------- -------
Net loss per share--basic and diluted $ (0.34) $ (0.05)
Weighted average common shares outstanding 95,842 98,099
*Amortization of deferred stock compensation consists of the following:
Cost of managed storage services revenues $ 205 $ 80
Cost of professional services revenues 52 39
Sales and marketing 405 165
General and administrative 101 95
Research and development 431 83
-------- -------
$ 1,194 $ 462
See notes to condensed consolidated financial statements.
2
StorageNetworks, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
Three Months Ended
March 31,
2001 2002
-------- --------
Net cash used in operating activities $(20,048) $ (642)
INVESTING ACTIVITIES:
Purchases of property and equipment (15,460) (2,973)
Purchases of marketable investments (98,209) (37,123)
Proceeds from maturities of marketable investments 64,856 30,635
Purchase of restricted cash equivalents (683) 600
Purchases of long term investments (2,000) --
-------- --------
Net cash used in investing activities (51,496) (8,861)
FINANCING ACTIVITIES:
Proceeds from exercise of stock options 702 1,318
Acquisition of treasury stock (200) --
Payments of capital lease obligations (9,686) (13,227)
-------- --------
Net cash used in financing activities (9,184) (11,909)
-------- --------
Net decrease in cash and cash equivalents (80,728) (21,412)
Effect of exchange rate changes on cash 636 157
Cash and cash equivalents at beginning of period 304,861 185,834
-------- --------
Cash and cash equivalents at end of period $224,769 $164,579
-------- --------
See notes to condensed consolidated financial statements.
3
StorageNetworks, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of
StorageNetworks, Inc. (the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been included.
Operating results for the three-month period ended March 31, 2002 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2002.
The balance sheet at December 31, 2001 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and footnotes thereto for
the year ended December 31, 2001 included in the Company's annual report on Form
10-K filed with the Securities and Exchange Commission on March 26, 2002.
2. Revenue Recognition
Revenues consist of (i) fees from customer use of the Company's managed
storage services, which include PACS storage services, STORmanage storage
services, and STORfusion storage services and (ii) professional services fees.
Revenues are recognized in accordance with the guidance of Staff Accounting
Bulletin No. 101 "Revenue Recognition in Financial Statements," when all of the
following conditions are met: persuasive evidence of an agreement exists,
delivery has occurred or services have been rendered, the sales price is fixed
or determinable and collection is reasonably assured.
Revenues from the Company's PACS and STORmanage storage services primarily
include monthly service fees charged on a per usage basis and are recognized as
the managed storage services are provided.
The Company's STORfusion services include fees for launch and enablement
services and monthly service fees. Revenues from launch and enablement services
are recognized ratably over the period the services are provided. Monthly
service fees are charged on a per usage basis and are recognized as the managed
storage services are provided.
Revenues from professional services engagements are recognized as the
services are provided. Revenues on fixed-price contracts are recognized using
the percentage of completion method of accounting and are adjusted monthly for
the cumulative impact of any revision in estimates. The Company determines the
percentage of completion of its contracts by comparing costs incurred to date to
total estimated costs. Contract costs include all direct labor and expenses
related to the contract performance.
3. Property and Equipment
Property and equipment consist of the following (in thousands):
December 31, March 31,
2001 2002
------------ ---------
Managed storage service equipment $ 60,011 $ 64,009
Furniture, fixtures, computer and other equipment 9,778 7,176
Leasehold improvements 9,845 9,845
-------- --------
79,634 81,030
Less accumulated depreciation and amortization (12,560) (18,912)
-------- --------
$ 67,074 $ 62,118
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4. Impairment Charge and Other Related Costs
In 2001, the Company recorded an asset impairment charge of $79.0 million
and other one-time charges of $35.4 million.
At March 31, 2002, the Company had $14.4 million remaining in accrued
expenses relating to theses charges, consisting of the following (in thousands):
December 31, 2001 Activity March 31, 2002
----------------- -------- --------------
Fiber related obligations $ 9,048 $ (419) $ 8,629
Future commitments for office and S-POP
floor space 6,581 (1,310) 5,271
Future commitments for assets related to fully
managed primary storage services 3,030 (2,668) 362
Employee termination costs and other charges
244 (75) 169
------- ------- -------
Total $18,903 $(4,472) $14,431
======= ======== =======
5. Segment Information
The Company considers its managed storage services and its professional
services as reportable segments under the aggregation criteria of SFAS No. 131.
The revenues and related cost of revenues for each reportable segment are
reported separately in the accompanying consolidated statements of operations.
The percentage of managed storage services revenues derived from
international operations totaled 5% and 3% for the three months ended March 31,
2001 and 2002, respectively. The percentage of professional services revenues
derived from international operations totaled 14% and 18% for the three months
ended March 31, 2001 and 2002, respectively.
Total assets for the Company's managed storage services were $79.7 million
and $54.9 million at December 31, 2001 and March 31, 2002, respectively. Total
assets for the Company's professional services were $1.2 million and $1.0
million at December 31, 2001 and March 31, 2002, respectively.
6. Comprehensive Loss
Total comprehensive loss was not materially different from net loss for the
three months ended March 31, 2001 and 2002.
7. Subsequent Event
In April, 2002, the Company executed a cost reduction program. The Company
reduced its headcount by approximately 80 employees primarily in its delivery,
sales and support organizations. As a result, the Company recognized a charge
for severance and other associated costs of approximately $300,000, which will
be taken in the second quarter of 2002 in the normal course.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Our management's discussion and analysis of financial condition and results
of operations contain forward-looking statements and are subject to important
factors that could cause StorageNetworks, Inc.'s ("we", "our" or
"StorageNetworks") future results to differ materially from those indicated by
such forward-looking statements. These factors include, without limitation,
those set forth below under the caption "Certain Factors That May Affect Future
Operating Results".
Overview
We are a provider of data storage management software and services. We
operate in two business segments, managed storage services and professional
services, and provide these services to our customers at their data centers,
both onsite at the customers' facilities or in a third-party hosting center. We
manage our customers' data storage environments through our managed storage
services, which include PACS, STORbackup, STORmanage, and STORfusion storage
services. Our STORconsulting professional services are designed to help
enterprise organizations design their primary data storage systems and optimize
their existing data storage infrastructures.
Since our inception in 1998, we have provided our managed storage services
to our customers in our Storage Point of Presence, or S-POP, data centers. An
S-POP data center can be located either within a customer's own on-site data
center, or within a data center operated by a hosting service provider. As of
March 31, 2002, we operated 42 S-POP data centers in the
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metropolitan areas of Atlanta, Austin, Boston, Chicago, Dallas, Detroit,
Houston, Los Angeles, New York, San Francisco, Seattle, Washington, D.C.,
Frankfurt and London. During the three months ended March 31, 2002, we ceased
operating seven S-POP data centers located within hosting service providers due
to weakening demand, and we continued to generate an increasing percentage of
our managed service revenues from on-site enterprise services.
In 2001, we identified a significant opportunity to provide our software
and services to service providers, including system integrators,
telecommunications companies and network service providers, in order to enable
them to manage their storage infrastructure and cost-effectively deliver managed
storage services to their own customers. As a result, we developed and
began marketing our software-based STORfusion offering. Due to increased
interest in our software and services from large enterprise organizations, our
addition of STORfusion customers, and interest in our STORos software as a
stand-alone product, along with weakening demand for storage services through
hosting service provider data centers, we shifted our focus to marketing to
large enterprise customers and STORfusion customers and on the development and
commercialization of our software. Therefore, we scaled back the sales and
marketing activities for our fully managed PACS primary storage service
offerings, which have historically been offered primarily to customers whose
data centers are located at third-party hosting facilities, and focused on
developing and enhancing our software and services that enterprise customers and
service providers were demanding.
Our managed storage services include software-based and related services,
primary data services, and backup and restore services. During the three months
ended March 31, 2002, the percentage of our managed storage services revenues
from software-based and related services, including our STORfusion and
STORmanage services, continued to increase, while the percentage of our managed
storage services revenues from primary data services continued to decrease. We
began offering our software-based and related services in May 2001 and derived
6% of our managed storage services revenues in the second quarter of 2001, 12%
in the third quarter of 2001, 17% in the fourth quarter of 2001 and 23% in
the three months ended March 31, 2002 from these services. In contrast, we
derived 63% of our managed storage services revenues from primary data services
in the second quarter of 2001, 55% in the third quarter of 2001, 45% in the
fourth quarter of 2001 and 40% in the three months ended March 31, 2002 from
these services. We derived between 30% to 37% of our managed storage services
revenues from backup and restore services during 2001, and 37% of our revenues
in the three months ended March 31, 2002 were derived from these services.
During the three months ended March 31, 2002, the percentage of our total
revenues derived from enterprise customers also continued to increase. We
derived 58% of our revenues in the first quarter of 2001, 58% in the second
quarter of 2001, 68% in the third quarter of 2001, 76% in the fourth quarter of
2001 and 82% in the three months ended March 31, 2002 from these customers.
In the future, we expect to focus on selling solutions that deliver high
value to customers, including our software-based STORfusion offering. We are in
the process of commercializing our STORos software as a stand-alone software
platform. From this platform, we will make available for sale our enterprise
storage resource management software applications. This software, combined with
our professional service capabilities, will enable customers to use our
solutions in managing their own storage infrastructures more efficiently and
effectively. We expect to begin selling our software directly to customers
during the second half of 2002.
Since our inception, we have incurred significant losses and negative
operating cash flows, including a net loss of $5.4 million during the three
months ended March 31, 2002. As of March 31, 2002, we had an accumulated deficit
of $379.7 million. We have not achieved profitability on a quarterly or an
annual basis. We believe that we will continue to incur losses on a quarterly
and annual basis for the foreseeable future. The revenue and income potential of
our business in general, and of our stand-alone software in particular, is
unproven, and our limited operating history makes an evaluation of our company
difficult. In light of the evolving nature of our business, products, services
and customer base, we believe that you should not rely on the period-to-period
comparison of our operating results to predict our future performance. You must
consider our prospects in light of the risks, expenses and difficulties
encountered by new companies in rapidly evolving industries. We may not be
successful in addressing these risks and difficulties.
See the discussion under the caption "Critical Accounting Policies" in
Item 7 of Part II of our Report on From 10-K for the year ended December 31,
2001, for a discussion of our critical accounting policies, to which there were
no material changes in the quarter ended March 31, 2002.
Results of Operations
Three months ended March 31, 2001 and 2002
Revenues
Total revenues for the three months ended March 31, 2002 were $31.6
million, compared to $27.1 million in the same period in 2001.
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Revenues from managed storage services for the three months ended March 31,
2002 were $30.6 million, compared to $23.0 million in the same period in 2001.
The increase in managed storage services revenues resulted from more capacity
under management in the 2002 period. In the 2002 period, our customer base
consisted of companies for whom we managed larger volumes of data. Accordingly,
our average annualized revenue per customer was higher in the 2002 period.
Approximately 10% of our total consolidated revenues earned in the quarter ended
March 31, 2002 were recognized from fees paid for non-recurring customer
contract renegotiations.
Revenues from professional services were $1.0 million for the three months
ended March 31, 2002, compared to $4.1 million in the same period in 2001. The
decrease in professional services revenues resulted from a decrease in the
number of professional services engagements in the 2002 period. In the 2001
period, we primarily performed subcontracted professional service engagements.
In the 2002 period, we delivered higher scale and increased value-added services
compared to the 2001 period, although we performed fewer sub-contracting
engagements. As a result, we performed fewer overall professional service
engagements and our professional service revenues declined.
Cost of Revenues
Cost of managed storage services revenues in the three months ended March
31, 2002 were $20.6 million, compared to $30.1 million in the same period in
2001. The decrease resulted primarily from lower depreciation and equipment
maintenance expense related to equipment used to deliver our services in the
three months ended March 31, 2002. Although we had more capacity under
management in the 2002 period, our cost basis for the infrastructure used in the
delivery of our services was lower in the 2002 period as a result of an asset
impairment charge recognized in the fourth quarter of 2001. In addition, in the
2002 period we had fewer personnel inside S-POP data centers delivering our
services because we further utilized our software to centrally manage our
customer's data. Finally, we had fewer S-POP data centers located inside hosting
service providers in the 2002 period. Accordingly, we incurred lower floor space
costs in the 2002 period.
Cost of professional services revenues in the three months ended March 31,
2002 were $645,000, compared to $2.8 million in the same period in 2001. The
decrease was caused by a reduction in the number of professional services
personnel in the 2002 period as a result of fewer professional services
engagements.
Sales and Marketing
Sales and marketing expenses in the three months ended March 31, 2002 were
$6.1 million, compared to $18.4 million in the same period in 2001. The decrease
was caused primarily by a decrease in the number of sales and marketing
personnel in the three months ended March 31, 2002. In addition, lower sales
commissions and fees paid to third parties, such as hosting service providers,
who resell or market our services to customers, were incurred in the 2002 period
because more of our revenues were derived from services within a customer's own
on-site data center.
General and Administrative
General and administrative expenses in the three months ended March 31,
2002 were $3.0 million, compared to $5.5 million in the same period in 2001. The
decrease was caused by a decrease in the number of general and administrative
personnel, as well as a decrease in professional fees, legal costs, and
recruiting fees, in the 2002 period. Also, we recovered $1.5 million of bad debt
expense in the 2002 period which represented an estimate of uncollectible
accounts receivable recorded during the third quarter of 2001 as a result of the
Chapter 11 filing by Exodus Communications.
Research and Development
Research and development expenses in the three months ended March 31, 2002
were $4.5 million, compared to $4.4 million in the same period in 2001. The
increase was caused by an increase in the number of software development and
engineering personnel and higher costs incurred in connection with technology
and research activities, such as depreciation and equipment costs, partially
offset by lower third party development costs in the 2002 period.
Amortization of Deferred Stock Compensation
Amortization of deferred stock compensation in the three months ended March
31, 2002 was $462,000, compared to $1.2 million in the same period in 2001. The
decrease in the 2002 period resulted from the termination of certain
compensatory stock options as a result of employee terminations before such
options vested.
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Interest Income
Interest income in the three months ended March 31, 2002 was $1.5 million,
compared to $5.4 million in the same period in 2001. The decrease was caused by
lower average cash and investment balances and lower average interest rates
during the 2002 period.
Interest Expense
Interest expense in the three months ended March 31, 2002 was $3.3 million,
compared to $3.1 million in the same period in 2001. The increase resulted from
higher capital lease obligations, under which interest expense is incurred, in
the 2002 period.
Liquidity and Capital Resources
At March 31, 2002, we had cash and cash equivalents, including temporarily
restricted cash equivalents, of $194.1 million; investments of $79.4 million;
and working capital of $141.8 million.
As a result of our initiatives to develop version 5.0 of our STORos
software as a stand-alone product and to focus our sales and marketing efforts
on large enterprise organizations, we have eliminated strategic investments in
privately-held companies with businesses complementary to our fully managed
primary storage services, reduced future commitments for office and S-POP data
center floor space and reduced headcount. We expect, however, that cash
expenditures relating to research and development, including expenditures for
software development, will continue to increase.
Net cash used in operating activities totaled $642,000 in the three months
ended March 31, 2002, and $20.0 million in the same period in 2001. Our use of
cash in the 2001 and 2002 periods was primarily attributable to our operating
loss, partially offset by non-cash charges such as depreciation and amortization
and increases in accounts payable and accrued expenses. Our use of operating
cash in the 2002 period was lower than the 2001 period because our revenues
increased, and we reduced discretionary operating costs, mainly within cost of
managed storage services and sales and marketing expenses, while at the same
time maintaining a consistent accounts receivable days sales outstanding.
Net cash used in investing activities totaled $8.9 million in the three
months ended March 31, 2002, and $51.5 million in the same period in 2001. Our
cash used in investing activities in the 2001 period resulted primarily from the
procurement of capital equipment to be used in our S-POP data centers, and the
purchase of marketable investments, partially offset by maturities of such
investments. Our cash used in investing activities in the 2002 period resulted
primarily of the purchase of marketable investments partially offset by the
maturities of such marketable investments.
Net cash used in financing activities totaled $11.9 million in the three
months ended March 31, 2002, and $9.2 million in the same period in 2001. The
cash used in financing activities in the three months ended March 31, 2002 and
2001 primarily reflects the payment of capital lease obligations. In the 2002
period, we paid $3.6 million to retire certain equipment lease obligations
associated with storage assets before the end of their terms. We did this to
have more flexibility with these assets and because we were paying a fixed
imputed interest rate that far exceeded our return on our cash. We plan to spend
at least $50 million in 2002 in connection with early lease terminations.
We believe, based on our current operating plan, plus anticipated interest
income and anticipated revenues from our services, that our current cash and
marketable investment position will be sufficient to meet our anticipated cash
needs for working capital and capital expenditures for at least the next twelve
months. However, if our existing resources are insufficient to satisfy our
liquidity
8
requirements due to slower than anticipated services revenues or otherwise, we
may need to raise additional funds to develop new products or services or
acquire complementary businesses or technologies or if we chose to more rapidly
expand our business. In the event that additional financing is required, we may
need to sell additional equity or debt securities or seek additional financing
through other arrangements. The sale of additional equity or debt securities may
result in dilution to our stockholders, and we cannot be certain that additional
public or private financing will be available in amounts or on terms acceptable
to us, if at all. If we are unable to obtain this additional financing, we may
be required to delay, reduce the scope of, or eliminate one or more of our
planned research, development and commercialization activities, which could harm
our financial condition and operating results.
Certain Factors that May Affect Future Operating Results
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of the federal securities laws. For this purpose, any
statement that is not a statement of historical fact should be considered a
forward-looking statement. We often use words such as "anticipate," "expect,"
"intend," "may," "should," "will," and "would" or similar words to help identify
forward-looking statements. You should read statements that contain these words
carefully because they discuss our future expectations and contain projections
of our future results of operations or of our financial position or other
"forward-looking" information that involve substantial risks and uncertainties.
We believe that it is important to communicate our future expectations to
our stockholders. However, there may be events in the future that we are not
able to accurately predict or control. There are a number of important factors
that could cause our actual results to differ materially from those indicated or
implied by forward-looking statements. The factors described below, as well as
any cautionary language elsewhere in this Form 10-Q, provide examples of risks,
uncertainties and events that may cause our actual results to differ materially
from the expectations indicated by forward-looking statements. We disclaim any
intention or obligation to update or revise any forward-looking statements,
whether as a result of new information, future events, or otherwise.
We may not successfully produce and sell our enterprise storage resource
management software
Historically, our managed storage services have generated the majority, and
an increasing percentage, of our revenues, including 97% of our revenues in the
three months ended March 31, 2002. In January, 2002, we announced our intention
to transition our business to focus on providing storage management software and
services that meet the needs of large enterprise organizations and service
providers. We are in the process of preparing our existing software, which we
currently use in providing our services, for licensing and delivery to customers
as stand-alone products.
To be successful, this transition will require the successful development of
new, independent versions of our software products. These versions may not be
available on schedule, or at all, and may not be accepted by customers. This
transition will also require changes in many aspects of our operations,
including a modification of the function of our engineering department, our
revenue recognition policies, our revenue forecasting, our profitability
metrics, how we contract with our customers, how we provide support to our
customers, how we market and sell our products and services, how we train our
sales force, how we utilize third party sales channels, and how we compensate
our sales force. If this transition is not successful, our business, operating
results and financial condition will be materially and adversely affected.
We have a limited operating history
Due to the changing nature of our business, our limited operating history
and the emerging nature of our markets, products and services, it is difficult
to evaluate our business and prospects. We commenced operations in October,
1998. We began offering our managed data storage services in May, 1999 and
derived 12% of our revenues in 1999, 64% of our revenues in 2000, 92% of our
revenues in 2001 and 97% of our revenues in the first quarter of 2002 from these
services. None of our revenues in 2001 or in the first quarter of 2002 was
derived from the direct licensing of software products. The enterprise storage
resource management software and services markets are relatively new, highly
competitive, and may not continue to grow or be sustainable. Potential customers
may choose to purchase enterprise storage management software and services from
a competitor or may choose to develop the software or services themselves. It is
possible that our software and services may never achieve significant market
acceptance. If these markets do not mature, or develop more slowly than we
expect, our business, results of operations and financial condition will be
seriously harmed.
We have incurred losses in each quarter since our inception. We experienced
net losses of $23.9 million in 1999, $124.9 million in 2000, $225.0 million in
2001 and $5.4 million in the first quarter of 2002. As of March 31, 2002, we had
an accumulated deficit of $379.7 million. We cannot be certain that our revenues
will grow or that we will generate sufficient revenues to achieve profitability.
We believe that we will continue to incur losses on a quarterly and annual basis
for the foreseeable future. We will need to generate higher revenues in order to
achieve and maintain profitability. If our revenues do not
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grow or grow more slowly, or if our operating or capital expenses increase more
than we expect or cannot be further reduced in the event of lower revenues, our
business will be materially and adversely affected.
Our stock price has been volatile and could result in substantial losses for
investors
The market for technology stocks has been extremely volatile. The following
factors could cause the market price of our common stock in the public market to
fluctuate significantly:
o the addition or departure of key personnel;
o variations in our quarterly operating results;
o announcements by us or our competitors of the gain or loss of
significant contracts, new products or service offerings or
enhancements, mergers, acquisitions, joint ventures or capital
commitments;
o changes in earnings estimates by analysts;
o our inability to realize forecasted results of operations for a
particular period;
o our sales of common stock or other securities in the future;
o changes in market valuations of technology companies; and
o fluctuations in stock market prices and volumes.
Our market is highly competitive, and our competition includes established
storage hardware and software vendors and service providers against whom we
may not be able to compete successfully
The market in which we operate is highly competitive and is marked by rapid
and substantial technological change, the emergence of new competitive
companies, products and services, changing customer needs and evolving technical
standards. To remain competitive, we must develop new products and services and
continue to enhance our existing products and services. We may be unsuccessful
in our attempts to forecast customer preferences or customer demand accurately,
or develop new products or services or new releases or versions that meet the
needs of customers. In addition, the introduction of new products and services,
or new versions of existing products, may not meet with customer acceptance or
may be delayed. We currently face competition from hardware and software vendors
whose products compete with our software products and who also provide
consulting and related services that compete with our services. Many of these
vendors have longer operating histories, greater name recognition and
substantially greater financial, technical and marketing resources than we have.
Many of these vendors also have more extensive customer bases, broader customer
relationships and broader industry alliances than us, including relationships
with many of our current and potential customers. We also face competition from
other providers of storage services and may face competition from new entrants
to the data storage management market.
Increased competition from any of these sources could result in a loss of
customers and market share. Our current and future competitors could introduce
products and services with superior features and functionality, and could bundle
their services and software with other products in order to compete.
Additionally, price competition, particularly from competitors with greater
resources, could require us to reduce the prices for our services and software.
Any of these results could seriously harm our business and financial condition.
We might experience significant defects in our software products
In the past, we have utilized our software to manage the delivery of our
services to our customers. However, we have never sold our software to customers
as independent products, and we may not be successful in developing our software
as independent products. Software products frequently contain errors or
failures, especially when first introduced or when new versions are released. We
might experience significant errors or failures in our products, or they might
not work with other hardware or software as expected, which could delay the
development or release of new products or new versions of products, or which
could adversely affect market acceptance or our products. Our products can be
used to manage data critical to organizations. If we were to experience
significant delays in the release of new products or new versions of products,
or if customers were dissatisfied with product functionality or performance, we
could lose revenue or be subject to liability for service or warranty costs and
claims. Our insurance may not, or may not be sufficient to, cover us against
liability claims or may not continue to be available to us. Liability claims
could also require us to spend significant time and money in litigation. As a
result, any of these claims, whether or not successful, could seriously damage
our reputation and harm our business, operating results and financial condition.
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Certain software is licensed from third parties
Some of our products contain software licensed from third parties. Some of
these licenses may not be available to us in the future or on terms that are
acceptable or allow our products to remain competitive. Our inability to use any
of this third party software could result in shipment delays, delays in the
development of future products or enhancements of existing products, or other
disruptions in our business, which could materially and adversely affect our
business, financial condition and operating results.
We rely on enterprise transactions
We market our services and intend to market our products to large
enterprise customers. However, we may not successfully be able to market and
sell our software or services to such customers. Such failure could seriously
harm our business, operating results and financial condition. Our operating
results are sensitive to the timing of such orders. Such orders are difficult to
manage and predict, because:
o The sales cycle is typically lengthy, generally lasting six to twelve
months, and varies substantially from transaction to transaction;
o Enterprise license transactions often include multiple elements such
as product licenses and service and support;
o Recognition of revenue from enterprise license transactions may vary
from transaction to transaction;
o They typically involve significant technical evaluation and commitment
of resources; and
o Customers' internal procedures frequently cause delays in orders. Such
internal procedures include approval of capital expenditures,
implementation of new technologies within their networks, and testing
of new technologies that affect key operations.
Many of the large organizations that we target as customers have lowered
their rate of spending on information technology, including data storage
products and services, as a result of recent unfavorable economic and market
conditions. If economic and market conditions do not improve, our business,
results of operations or financial condition could be materially adversely
affected. In addition, due to the large size of enterprise transactions, if
orders forecasted for a specific transaction for a particular quarter are not
realized in that quarter, our operating results for that quarter may be
seriously harmed.
We may rely on indirect sales channels
As we develop and market our software products, we may rely on
distributors, systems integrators, other software makers, and hardware vendors
for the marketing and distribution of our products. Agreements with such
resellers may not be exclusive and may be terminable by either party without
cause. These resellers might also market products that are competitive with
ours. The development of business relationships with resellers will require a
significant amount of resources. Any failure of these reseller arrangements, or
any failure to develop such reseller arrangements, could have a materially
adverse effect on our business, financial conditions and operating results.
A class action lawsuit has been filed against us, and additional suits may be
filed, which may result in litigation that is costly to defend and the outcome
of which may harm our business
We and several of our officers are named as defendants in a purported class
action complaint that has been filed on behalf of certain persons who purchased
our common stock between June 30, 2000 and December 6, 2000. This complaint
alleges violations of the Securities Act of 1933 and the Securities Exchange Act
of 1934, each as amended. This complaint primarily alleges that there was
undisclosed compensation received by our underwriters from purchasers of our
common stock in connection with our initial public offering and secondary
offering.
We can provide no assurance as to the outcome of this matter. Any
conclusion of this matter in a manner adverse to us could have a material
adverse affect on our financial position and results of operation. In addition,
the costs to us of defending any litigation or other proceeding, even if
resolved in our favor, could be substantial. We may also be subject to other
class action litigation in the future. Any such litigation could also
substantially divert the attention of our management and our resources in
general and could have a materially adverse effect on our business and results
of operations.
Our growth strategy will be unsuccessful if we are unable to develop and
protect our proprietary technology
A key component of our growth strategy is to further develop our
proprietary software. Our continued expansion and development of our operations
will depend on, among other things, our ability to produce software that can be
sold as products independent of our services, as well as to develop new
products.
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We rely on a combination of copyright, trademark and trade secret laws and
restrictions on disclosure to protect our intellectual property rights. We do
not have any significant issued patents and have filed only a limited number of
patent applications with respect to our data storage software and services. We
cannot be certain that our current patent applications or any future application
will be granted, that any future patent will not be challenged, invalidated or
circumvented, or that rights granted under any patent issued to us will afford
us a competitive advantage. Our intellectual property may be subject to even
greater risk in foreign jurisdictions. The laws of many countries do not protect
proprietary rights to the same extent as the laws of the United States.
Litigation may be necessary in the future to enforce our intellectual
property rights, to protect our trade secrets, to determine the validity and
scope of the proprietary rights of others or to defend against claims of
infringement. Any such litigation could result in substantial costs and
diversion of resources. There can be no assurance that our means of protecting
our proprietary rights will be adequate or that our competitors will not
independently develop similar information or technology. Our inability to
continue to expand our services or to develop and adequately protect our
proprietary technology would have a material adverse effect on our business and
financial condition and our ability to compete effectively.
Any failure of our products and services could lead to significant costs,
service disruptions and data loss, which could reduce our revenues and harm
our business and reputation
To be successful, we must provide our customers with secure, efficient and
reliable enterprise storage management software and managed data storage
services. To meet these customer requirements, we must protect our software and
services against failure caused by occurrences such as:
o product error;
o design flaws;
o human error;
o physical or electronic security breaches;
o fire, earthquake, flood and other disasters;
o power loss; and
o sabotage, vandalism and terrorism.
The failure of our software to operate as we warrant, or the occurrence of
a natural disaster or other unanticipated problem at one or more of our S-POP
data centers that results in lack of performance, service interruptions,
significant damage to equipment or loss or unavailability of customer data,
could adversely affect our reputation, our ability to attract new customers and
the value of our stock. We may also be subject to legal actions by our
customers. Any significant product errors or design flaws or any widespread loss
of services would slow the adoption of our products and services and cause
damage to our reputation, which would seriously harm our business.
Our revenues will not grow, our costs will increase, and our reputation will
be damaged if we are not able to deliver our services in accordance with our
contracts with our customers
Because our services contracts provide customers credits against a portion
of their monthly service fees if our managed data storage services do not
achieve specified performance levels of data availability, successfully
completed back-ups and data security, we will lose revenues and may experience a
decrease in customer satisfaction if our services and software do not perform as
we expect. Our failure to satisfy our customers could damage our reputation,
significantly reduce demand for our products and services, and cause us to
receive lower fees than expected and incur unforeseen costs to remedy our
shortfalls.
Quarterly and annual operating results and revenues are subject to
fluctuations caused by many factors, which may cause our stock price to
decline and could cause long-term harm to our business
Quarterly and annual results of operations are affected by a number of
factors, which in turn could adversely affect our revenues, profitability or
cash flow in the future and could cause serious harm to our business. These
factors include:
o Our success at marketing and selling our software and services, and
customers' reactions to our new software products;
o success in expanding and adapting our sales and marketing programs;
o financial condition of our customers and customers' demand for and
implementation of our products and services;
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o length of sales cycle;
o general economic conditions;
o price and product competition;
o ability to develop, manufacture, introduce and support new or enhanced
products and services;
o market acceptance of our or our competitors' new products and
services;
o ability to control costs;
o new hardware and software technologies;
o size and timing of licensing and services transactions;
o ability to retain qualified personnel;
o changes in pricing policies;
o quality control of our products and services;
o acquisition costs or other non-recurring charges in connection with
the acquisition of companies, products or technologies;
o acts of terrorism and acts of war;
o temporary shortages or interruptions in supply of storage hardware and
software; and
o natural disasters in the geographic markets in which we operate.
If any of our business relationships with hosting service providers,
hardware and software vendors and other service providers and suppliers
terminate or do not develop, our revenues could be adversely affected
We have formed business relationships, both formally and informally, with
various hosting service providers, hardware and software vendors and other
service providers and suppliers for joint marketing and sales activities. We may
also need to develop relationships with third party hardware and software
vendors to sell our software products. If we are unable to develop or maintain
such relationships, our potential future software revenues could be adversely
affected.
For example, Exodus Communications, Inc. ("Exodus"), with whom we had a
joint marketing and services agreement, filed a voluntary petition for
protection under Chapter 11 of the United States Bankruptcy Code on September
26, 2001. Under the terms of our agreement with Exodus, we provide services to
customers inside Exodus data centers, and Exodus generally invoices the
customers for these services. On February 1, 2002, Exodus completed the sale of
a substantial part of its business to Cable & Wireless plc (and Digital Island,
Inc., a wholly-owned subsidiary of Cable & Wireless). As part of this
acquisition, Cable & Wireless has assumed the joint marketing and services
agreement, and we intend to continue to provide services to customers under that
agreement. The closing of the acquisition by Cable & Wireless also triggered
Exodus' obligation to pay us for pre-bankruptcy petition services that had
previously been unpaid as a result of Exodus' bankruptcy filing, and we have
received such payment in full.
As a result of the change of ownership from Exodus to Cable & Wireless,
some of these customers may move their business to data center hosting companies
with whom we do not have a relationship. In addition, these customers may
otherwise cease using our services, and Cable & Wireless may otherwise not
fulfill its obligations under our agreement with Exodus, including the failure
of certain Exodus subsidiaries to fulfill obligations under the agreement. If
our relationship with Cable & Wireless is terminated, or if we are otherwise
unable to collect revenue from Cable & Wireless, its subsidiaries, or from these
customers, our business and results of operations would be substantially harmed.
Our software and services may become obsolete if we do not respond rapidly
to technological and market changes
The data storage software and managed data storage services markets are and
will continue to be characterized by rapid technological change and frequent new
product and service introductions. We may be unable to respond quickly or
effectively to these developments. If competitors introduce products, services
or technologies that are better than ours or that gain greater market
acceptance, or if new industry standards emerge, our software and services may
become obsolete, which would materially
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harm our business and results of operations. In developing our software and
services, we have made, and will continue to make, assumptions about the
standards that our customers and competitors may adopt. If the standards adopted
are different from those that we may now or in the future promote or support,
market acceptance of our software and services may be significantly reduced or
delayed, and our business will be harmed. In addition, the introduction of
products or services incorporating new technologies and the emergence of new
industry standards could render our existing products and services obsolete. The
development of new or enhanced products and services is a complex and uncertain
process that requires the accurate anticipation of technological and market
trends.
We currently plan to introduce and market several potential new products in
the next twelve months. Some of our competitors currently offer certain of these
potential new products or products similar to these potential new products. Such
potential new products are subject to significant technical risks. We may fail
to introduce such potential new products on a timely basis or at all. If
potential new products are delayed or do not achieve market acceptance, our
business, operating results and financial condition would be seriously harmed.
We may experience design, marketing and other difficulties that could delay
or prevent the development, introduction or marketing of new services or
enhancements to our existing services. Our failure to anticipate and meet
changing customer requirements could materially adversely affect our business,
results of operations and financial condition.
We may not be able to obtain additional financing necessary to grow our
business
We may need to raise additional funds in the future, for example, to
develop new technologies, support our expansion, respond to competitive
pressures, acquire complementary businesses or technologies or respond to
unanticipated situations. We may try to raise additional funds through public or
private financings, strategic relationships or other arrangements. Our ability
to obtain debt or equity funding will depend on a number of factors, including
market conditions, our operating performance and investor interest. We cannot be
sure that we will be able to secure additional financing on acceptable terms or
at all. If adequate funds are not available, we may be required to revise our
business plan to reduce expenditures, including reducing our product development
efforts, curtailing our growth strategies or foregoing acquisitions. If we
succeed in raising additional funds through the issuance of equity or
convertible securities, the issuance could result in substantial dilution to
existing stockholders. If we raise additional funds through the issuance of debt
securities or preferred stock, these new securities would have rights,
preferences and privileges senior to those of the holders of our common stock.
In addition, the terms of these securities could impose restrictions on our
operations.
Our revenues could decline if our customers do not renew our services or if
the rates we charge for services are reduced
We provide our managed data storage services through service level
agreements with our customers. We have little historical information with which
to forecast future demand for our services from our existing customer base after
existing contracts expire. If our customers elect not to renew our services, our
revenues will be reduced and our business and financial results may suffer. As
the data storage hardware, software and services market continues to experience
increased competition and price pressure, we will continue to experience
pressure to decrease the fees for our services, which could adversely affect our
revenues and our gross margin.
A portion of our current customers are Internet-based businesses that may
not pay us for our services on a timely basis and that may not succeed over
the long term
Approximately 18% of our revenues recognized in the first quarter of 2002
were derived from customers that are Internet-based businesses, and a portion of
our future managed storage services revenues will be derived from this customer
base. The unproven business models of some of these customers make their
continued financial viability uncertain. Given the short operating history and
emerging nature of many of these businesses, some of our customers have
encountered financial difficulties and failed to pay for our services or
substantially delayed payment and there is a risk that more of these customers
will encounter similar difficulties. The failure of any of our customers to pay
our fees on a timely basis or to continue to purchase our services in accordance
with their contractual commitments could adversely affect our revenue collection
periods, revenues and other financial results.
Provisions of our charter documents may have anti-takeover effects that
could prevent a change in control even if the change in control would be
beneficial to our stockholders
Provisions of our amended and restated certificate of incorporation,
by-laws, and Delaware law could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our stockholders. For
example, our Board of Directors is staggered in three classes, so that only a
portion of the directors may be replaced at any annual meeting. Our by-laws
limit the persons authorized to call special meetings of stockholders and
require advance notice for stockholders to submit proposals for consideration at
stockholder meetings. Additionally, our certificate of incorporation permits our
Board of Directors to authorize the issuance of preferred stock without
stockholder approval that could have the effect not only of delaying or
preventing an acquisition, but also of adversely affecting the price of our
common stock.
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Item 3. Qualitative and Quantitative Disclosures About Market Risk
Nearly all of our revenues to date have been denominated in U.S. dollars
and are primarily from customers located in the United States. Although we have
S-POP data centers and sales offices located outside the United States, revenues
from international customers to date have not been significant. We incur costs
for our overseas offices in the local currency of those offices for staffing,
rent, telecommunications and other services. As a result, our operating results
are subject to fluctuations based upon changes in the exchange rates of those
currencies in relation to the U.S. dollar. Although currency fluctuations are
currently not a material risk to our operating results, we will continue to
monitor our exposure to currency fluctuations and, when appropriate, use
financial hedging techniques to minimize the effect of these fluctuations in the
future. We do not currently utilize any derivative financial instruments or
derivative commodity instruments.
Our interest income is sensitive to changes in the general level of U.S.
interest rates. We typically do not attempt to reduce or eliminate our market
risk on our investments because substantially all of our investments are in
fixed-rate, short-term securities. The fair value of our investment portfolio or
related income would not be significantly impacted by either a 100 basis point
increase or decrease in interest rates due to the fixed-rate, short-term nature
of our investment portfolio.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In July, 2001 we initiated an action against Metromedia Fiber Network
("MFN") in Middlesex (Massachusetts) Superior Court. This action seeks
compensatory, punitive and declaratory relief, alleging, among other things,
misrepresentation, fraudulent inducement and breach of contract due to MFN's
failure to possess or to deliver fiber optic capacity in accordance with
representations made by MFN and as specified under our Fiber Optic Network
Leased Fiber Agreement with MFN. MFN also initiated an action in New York, New
York alleging that we have breached such agreement. While the outcome of these
matters is not currently determinable, we believe that the result will not have
a material adverse effect on the results of our operations or our financial
position, although we can make no assurances in this regard.
In August, 2001, a purposed class action lawsuit was filed in the United
States District Court for the Southern District of New York against us and
several of our officers as well as against the underwriters of our initial
public offering of common stock in June, 2000. The complaint, which seeks
unspecified damages, was filed allegedly on behalf of persons who purchased our
common stock between June 30, 2000 and December 6, 2000. The complaint alleges
violations of the Securities Act of 1933 and the Securities Exchange Act of
1934, each as amended, primarily based on allegations that StorageNetworks, the
underwriters and the other named defendants made material false and misleading
statements concerning fees paid by purchasers of our common stock to the
underwriters in the prospectus that was part of the registration statement on
Form S-1 that was filed in connection with our initial public offering. The
allegations in the complaint are generally related to the alleged receipt of
excessive and undisclosed commissions by the underwriters and alleged prohibited
after-market transactions by the underwriters. The complaint alleges that the
underwriters obtained excessive commissions and inflated transactions fees from
their customers, and allegedly entered into agreements with their customers
pursuant to which the customers, in return for being allocated shares in the
initial public offering, agreed to purchase additional shares on the open market
at specified increased prices. In April, 2002, the complaint was amended to add
allegations, substantially similar to those described above, concerning our
secondary public offering of stock. Although we believe that these claims are
without merit and intend to defend ourselves vigorously against such claims, we
are not presently able to reasonably estimate potential losses, if any, related
to this matter.
In addition, we are subject to various claims and proceedings in the
ordinary course of business. Based on information currently available, we
believe that none of such current claims or proceedings, individually or in the
aggregate, will materially harm our financial condition or results of
operations, although we can make no assurances in this regard.
Item 2. Changes in Securities and Use of Proceeds
In our initial public offering, we sold 10,350,000 shares of our common
stock in an initial public offering at a price of $27.00 per share, less
underwriting discounts and commissions, pursuant to a Registration Statement on
Form S-1 (Registration No. 333-31430) that was declared effective by the
Securities and Exchange Commission on June 29, 2000. In addition to expenses
incurred in connection with the IPO and previously disclosed in our Forms 10-Q
for the quarters ended June 30, 2000 and September 30, 2000, from the effective
date of the registration statement through March 31, 2002, we have spent
approximately $77.3 million of the $258.6 million of net proceeds from the IPO
for capital lease payments, approximately $21.1 million of the proceeds from the
IPO for operating expenses, and approximately $3.0 million for property and
equipment.
Item 6. Exhibits and Reports on Form 8-K
(b) Reports on Form 8-K.
None.
The following registered trademarks, trademarks or servicemarks of
StorageNetworks are mentioned in this Quarterly Report on Form 10-Q:
StorageNetworks, PACS, STORmanage, STORos, S-POP and STORfusion.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: May 9, 2002
STORAGENETWORKS, INC.
/s/ Paul C. Flanagan
--------------------
Paul C. Flanagan
Executive Vice President, Chief Operating Officer,
Chief Financial Officer, Treasurer and Secretary
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