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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[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 0-30905
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 No.)
225 Wyman Street,
Waltham, Massachusetts 02451
(Address of Principal
Executive Offices) (Zip Code)
Registrant's Telephone Number, including area code: (781) 622-6700
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
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 the registrant's knowledge, in definitive proxy or information
statement 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 Common Stock held by non-affiliates
of the registrant was approximately $446,558,137 as of January 31, 2002. The
number of shares outstanding of the registrant's class of Common Stock as of
March 8, 2002 was 98,154,915 shares.
DOCUMENTS INCORPORATED BY REFERENCE.
Certain information is incorporated into Part III of this report on Form
10-K by reference to the Proxy Statement for the registrant's 2002 Annual
Meeting of Stockholders to be held on May 15, 2002.
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StorageNetworks, Inc.
Annual Report on Form 10-K
For the Fiscal Year Ended December 31, 2001
TABLE OF CONTENTS
PART I
Item 1. Business.............................................................................. 1
Item 2. Properties............................................................................ 7
Item 3. Legal Proceedings..................................................................... 7
Item 4. Submission of Matters to a Vote of Security Holders................................... 7
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................. 8
Item 6. Selected Financial Data............................................................... 9
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. 10
Item 7A. Quantitative and Qualitative Disclosures about Market Risk........................... 24
Item 8. Financial Statements.................................................................. 25
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.. 41
PART III
Item 10. Directors and Executive Officers of the Registrant................................... 41
Item 11. Executive Compensation............................................................... 43
Item 12. Security Ownership of Certain Beneficial Owners and Management....................... 43
Item 13. Certain Relationships and Related Transactions....................................... 43
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................... 43
Signatures....................................................................................... 44
PART I
Item 1. Business.
OVERVIEW
StorageNetworks, Inc. and its subsidiaries ("StorageNetworks" or "we") is a
provider of data storage management software and services. We provide data
storage management services and enterprise storage resource management software
to enable our customers to deliver cost-effective solutions to store, manage,
and protect information. StorageNetworks was founded in late 1998 to offer
services designed to provide customers with efficient and cost-effective data
storage. Today, 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. Through our professional services, we design and implement
networked storage infrastructures for our customers, and through our managed
services, we manage our customers' data storage environments.
Our revenues for the year ended December 31, 2001 were $123.6 million. Our
managed storage services segment accounted for $113.5 million, or 92%, of our
total revenues, and our professional services segment accounted for $10.1
million, or 8%, of our total revenues. The relative contributions of each of
our segments to our total revenues in 2001 may not be indicative of future
periods, however, as we shift the focus of our sales and marketing efforts to
selling software and professional services to large enterprise organizations.
For example, we expect to decrease sales and marketing of our managed storage
services. For more financial information about our business segments and
customers, long-lived assets, and geographic information about our revenues,
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and note 10 to our consolidated financial statements included in
this Annual Report on Form 10-K.
In order to deliver our managed storage services more efficiently and
cost-effectively, we have developed proprietary software-our STORos operating
system-to monitor and manage our own and our customers' complex, multi-vendor
networked storage environments. We utilize this software in the delivery of our
managed storage services to reduce complexity and cost and to increase
efficiency. Beginning in the second half of 2002, we plan to offer our STORos
operating system directly to customers as a stand-alone enterprise storage
resource management software application (together with professional services).
We market our software and services primarily to large enterprise
organizations, network service providers and systems integrators.
The StorageNetworks Solution
Today, many large enterprise organizations are experiencing rapid growth in
the volume of data that they must store and protect. Our goal is to offer
customers software and services that improve the performance of their storage
environments and reduce the costs associated with managing complex storage
environments. We believe that our software and services help customers achieve
the following benefits:
Improved service levels. We are focused on reducing the complexities
associated with data storage and offer enterprise storage management software
and services that are designed to increase the control that customers have over
their storage environments. Our interoperability lab tests storage technologies
from various vendors for interoperability and quality assurance. We use
documented practices and repeatable processes for storage configuration and
management to help ensure that our customers' storage environments can provide
consistent performance and high levels of data availability. Our software and
services are designed to enable our customers to gain control over and improve
the performance of their storage infrastructure, and to improve the
availability and recoverability of data.
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Reduce storage management costs. We are also focused on lowering the costs
associated with data storage management. We offer software and services that
are designed to help customers optimize the utilization of their storage assets
and resources, quickly deploy networked storage infrastructures, and improve
management and control of the storage environment. We believe that these
increased efficiencies help to reduce the costs of managing a complex
multi-vendor environment.
StorageNetworks Software
We have developed storage management software to manage both our and our
customers' complex, multi-vendor storage environments. We currently utilize
these applications, outlined below, which include our STORos operating system,
our Virtual Storage Portal software, and our STORvision software, in delivering
our managed storage services. Our STORos operating system integrates and
centralizes the management of the various elements of a multi-vendor networked
storage environment, our Virtual Storage Portal allows us and our customers to
monitor the performance of their storage environments, and our STORvision
software allows us to provide efficient and scalable managed services. We
expect to have a stand-alone enterprise storage resource management solution,
version 5.0 of our STORos operating system, available for customers in the
second half of 2002.
STORos operating system Our STORos operating system is designed to
facilitate the collection and processing of
information about storage infrastructures. We
currently use the STORos operating system in
delivering our managed storage services to
customers. The STORos operating system is an open
platform that enables storage and data management
applications to interoperate. The STORos operating
system also integrates storage infrastructure
management information with existing
decision-support applications and management
frameworks through the STOR-API, our application
programming interface. The STOR-API integrates
information collected from our STORos software,
our Virtual Storage Portal software and our
STORvision software into our customers' existing
management frameworks, such as enterprise ticket
and billing applications. As described below, we
expect to have version 5.0 of the STORos operating
system available as a stand-alone product in the
second half of 2002, which will be available
directly to customers for purchase along with
related professional services.
Virtual Storage Portal
software Our Virtual Storage Portal, or VSP, software is a
storage management application that enables us and
our enterprise and service provider customers to
analyze and monitor data storage infrastructures.
This software application has been developed to
provide customers with a single tool that provides
storage resource management functionality for
multi-vendor storage environments. The VSP
software collects and reports current and
historical statistics about storage availability,
usage, capacity, performance and charge-backs.
STORvision software Our STORvision software is command and control
software that we currently utilize in providing
our managed storage services. The STORvision
software is designed to provide efficient and
scalable management of enterprise storage
resources. Enterprise and service provider
customers who license version 5.0 of our STORos
operating system, which we expect to have
available in the second half of 2002, will be able
to use the STORvision software to automate labor-
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intensive tasks surrounding storage process
management, including storage procurement,
capacity planning and forecasting and the
administration of event, problem and change
management tasks.
STORos software version 5.0 In the second half of 2002, we expect to have
version 5.0 of our STORos software available.
Version 5.0 of the STORos software will be a
productized version of the STORos and Virtual
Storage Portal software that we currently use in
the delivery of our managed services. Version 5.0
and subsequent releases of the STORos software
will be enterprise storage resource management
applications designed to manage the multi-vendor
components of enterprise customers' and service
providers' storage environments. We expect that
STORos version 5.0 and subsequent releases will
support various storage architectures, including
storage area networks, network attached storage,
and backup and restore environments. Version 5.0
of the STORos software will be designed to report
business information and statistics to help
customers more efficiently manage their storage
environments.
StorageNetworks Services
We currently provide both managed data storage services and professional
services to our customers at their data centers, both onsite at the customers'
facilities or in a third-party hosting center. Historically, we have offered a
suite of managed data storage services that are designed to provide businesses
with reliable and secure data storage that can be readily expanded to meet
their critical data storage needs. We use our proprietary software in
delivering these managed services. We also offer a range of professional
services, in which we advise our customers on the design, implementation,
migration and ongoing management of their data storage environments. As
discussed herein, we are shifting the focus of our sales and marketing efforts
to selling software and professional services. The following discussion of our
managed storage services has been included due to the fact that a majority of
our historical revenues derived from these services and our belief that a
majority of our revenues for the immediate future will be derived from such
services.
Managed Storage Services
Our suite of managed data storage services has been designed to enable
customers to achieve higher levels of data availability, optimize utilization
rates, and improve recovery rates, and include our STORbackup, STORmanage,
STORfusion and PACS services. We are currently providing these services to
enterprise customers, to customers whose data centers are located in
third-party hosting centers, and to service providers who resell storage
services to their customers. We, and our STORfusion customers, utilize our
STORos operating system, STORvision software and Virtual Storage Portal
software in the delivery of managed storage services. Our managed storage
service customers benefit from the interoperability testing and evaluation of
storage technologies performed in our STORlabs testing center and receive
monitoring and management through our Customer Support Center. Typically, our
managed data storage services are purchased by our end-user customers through
service level agreements or other contracts that guarantee our services will
meet or exceed specific performance criteria, including data and storage
availability, successful performance of back-ups and overall infrastructure and
data security.
STORbackup and STORmanage Services for Enterprise Customers
Our current managed data storage services for enterprise customers include
our STORbackup services and our STORmanage services. These services offer the
following features:
STORbackup Services Our STORbackup services are designed to help
enterprise organizations minimize the risk of data
loss by offering dependable data
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backup, recovery and business continuity services.
With these services, we copy a customer's data
onto magnetic tape media, which is then archived
and stored in accordance with the customer's
instructions. We can also provide these customers
with services to restore data in the event of a
file or data corruption event.
STORmanage Services Our STORmanage services are software-based
services that are primary data storage management
and monitoring services designed to help customers
monitor and manage their existing storage
environments. Our STORmanage services can support
primary disk, tape back-up and restore and remote
site data replication. To deliver these services,
we integrate our proprietary software applications
with the customer's existing storage
infrastructure, which can include components from
multiple vendors. The STORmanage services are
designed to enable the customer to become a
service provider to its own internal business
units.
STORfusion Services and Software for Service Provider Customers
We market our STORfusion managed data storage services to service provider
customers, including system integrators, telecommunications companies and
network service providers, who in turn provide data storage services to their
own customers. STORfusion services provide our customers with access to a
combination of our proprietary software, training, marketing, processes and
expertise, and can be customized to meet the specific needs of different
customers. STORfusion services are designed to enable our customers to
efficiently and cost-effectively deliver managed data storage services to their
own customers.
PACS Managed Services
Our PACS services, which stands for Protection, Availability, Continuity,
Scalability and Security of data, have historically been offered primarily to
customers whose data centers are located at third-party hosting facilities,
although we also provide PACS services to enterprise customers. With our PACS
services, we own and manage the storage infrastructure, including all hardware,
software and networking equipment. Our PACS services include primary data
management (both storage area networks and network attached storage
environments), back-up, recovery and business continuity services. These
services include:
BackPACS Services Our BackPACS services are managed services that
copy customers' data onto magnetic tape media,
which is then archived and stored. These
services provide detailed restore procedures in
the event of a file restoration or data
corruption event.
DataPACS and NetPACS Services Our DataPACS and NetPACS services are primary
data storage services based on storage area
network or network attached storage
architectures. As part of these services, we can
also provide our customers with point-in-time
copies of their data. Rather than being directly
attached to the storage devices, customers'
servers are connected to one or more file
servers by a separate local area network.
Professional Services
Our STORconsulting professional services are designed to help enterprise
organizations design their primary data storage systems and optimize their
existing data storage infrastructures. Our storage experts have experience in
helping customers design or evaluate their current storage environment, migrate
to a networked storage environment and implement effective data protection,
recovery and business continuity strategies. Our STORconsulting experts also
have experience with a wide range of storage technologies from various vendors.
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Our STORconsulting group continues to build its expertise by collecting
technical information and identifying storage inefficiencies within
multi-vendor storage environments. We offer strategy, implementation and design
services in the following areas:
Storage strategy services Through our storage strategy consulting services,
we assess a customer's current storage
infrastructure, evaluate the customer's storage
management processes and recommend ways for the
customer to improve performance of its storage
infrastructure and improve levels of data
availability. We also offer backup and restore
strategy services that assist customers with the
implementation of backup and restore solutions
designed to help reduce the risk of data loss,
improve backup success rates, and minimize
recovery time in the event of data loss.
Implementation services With our implementation consulting services, we
enable organizations to migrate from a direct
attached storage architecture to a networked
storage environment, either a storage area network
environment or a networked attached storage
environment.
Design services Through our design services, we assist customers
with the design of storage area networks and
network attached storage systems, as well as
backup processes, based on the customer's required
levels of data availability and redundancy and
system performance.
Sales and Marketing
We market our software and services primarily through our direct sales
force. Our direct sales team targets large enterprises and service providers
that want to improve the performance and management of their multi-vendor data
storage environments. We also market our software and services indirectly
through our STORfusion customers, who market storage services to their own
existing and prospective customers. Our marketing goal is to develop sales
opportunities by increasing enterprise customers' and service providers'
awareness of the value proposition of storage management software and services,
the StorageNetworks brand and the brand of our STORos operating system. Our
direct sales force is based primarily in the United States, with additional
personnel located in London, England and Japan.
Research and Development
Our software development group is focused on developing new features and
functionalities for our storage management software that we use in delivering
our managed services to our customers. Our software development group is also
responsible for converting version 5.0 of our STORos operating system, which we
currently use in the delivery of managed services, into a stand-alone
enterprise storage resource management application that we expect to be able to
deliver to customers in the second half of 2002. Our engineering group
maintains our STORlabs testing center, which tests interoperability, provides
quality assurance, performs distance transmission analysis and evaluates
emerging technologies. Our STORlabs center serves as a controlled, secure
environment for reviewing storage technologies and evaluating technologies for
integration into our software applications. Our engineering group also creates
and maintains product engineering guides and field implementation guides that
are designed to assure guaranteed performance levels and that detail processes
and other information for storage configuration and management. We and our
STORfusion customers use, and we expect that our software customers will use,
these guides in the delivery of managed storage services.
Operations
Our operations group consists of our Customer Support Center and our field
operations group. The Customer Support Center remotely monitors events in our
customers' storage environments and manages our
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responses to customer requests. Our field operations team manages the delivery
and deployment of our managed storage services in customers' data centers,
including the implementation and ongoing management of storage
environments.
Competition
The storage software and services markets are highly competitive, and the
market for enterprise storage resource management software, which we consider
to be the primary market for version 5.0 of our STORos operating system, is
also highly competitive. We expect that we will continue to face competition
from traditional storage hardware and software vendors as well as start-up
storage software vendors. We believe that the principal competitive factors
affecting these markets include:
. Development of a single software layer that can manage a heterogeneous
storage environment;
. Development of proprietary storage management applications;
. The ability to provide software and services to support multi-vendor
storage environments;
. Customer acceptance of a stand-alone enterprise storage resource
management software package;
. Ability to market and sell a stand-alone enterprise storage resource
management software package;
. Engineering and technical expertise;
. Brand recognition;
. A proven-track record with enterprise customers and service providers;
. Ability to attract and retain skilled professionals;
. Quality of customer service and support; and
. Financial resources.
Our current primary competitors are storage hardware, storage software and
service vendors such as EMC, BMC Software, Computer Associates, VERITAS
Software, IBM, Hitachi Data Systems, Sun Microsystems and other announced
entrants to the storage management market.
Intellectual Property
We rely on a combination of trademark, trade secret and copyright laws and
contractual restrictions to protect the proprietary aspects of our software,
services and other technology. These legal protections afford only limited
protection. We have no significant issued patents and have filed only a limited
number of patent applications with the United States Patent and Trademark
Office with respect to our data storage software, services and technology. We
seek to limit disclosure of our intellectual property by requiring employees,
consultants and business associates with access to our proprietary information
to execute confidentiality agreements with us and by restricting access to our
proprietary information. Due to rapid technological change, we believe that
factors such as the expertise and technological and creative skills of our
personnel, new software products and services, and enhancements to our existing
software and services are more important to establishing and maintaining our
proprietary technology position than the various available legal protections.
Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy aspects of our software and services or to obtain and use
information that we regard as proprietary. 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 and could have a material adverse effect on our business, operating
results and financial condition. There can be no assurance that our means of
protecting our proprietary
6
rights will be adequate or that our competitors will not independently develop
similar information or technology. Any failure by us to adequately protect our
intellectual property could have a material adverse effect on our business,
operating results and financial condition.
Employees
As of December 31, 2001, we had a total of 396 full-time employees. Our
success will depend on our ability to attract, retain and motivate highly
qualified technical and management personnel, for whom competition is intense.
Our employees are not represented by any collective bargaining representative.
We believe our relations with our employees are good.
Item 2. Properties.
Our headquarters are located in Waltham, Massachusetts, where we have
entered into a lease for approximately 117,000 square feet of office space. The
lease for this space terminates on March 31, 2011. As of December 31, 2001, we
also leased approximately 145,000 square feet of additional office space. We
are actively utilizing approximately 37% of this additional office space, we
sublet 34%, and the balance is vacant. We also have numerous operating leases
and licenses for our S-POP data centers in locations in the United States and
abroad.
Item 3. 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 purported 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. 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 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted to a vote of our stockholders, through the
solicitation of proxies or otherwise, during the fourth quarter of 2001.
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PART II
Item 5. Market For Registrant's Common Equity and Related Stockholder Matters.
(a) Market Price of and Dividends of the Company's Common Stock and Related
Stockholder Matters
Our common stock is listed on the Nasdaq National Market under the symbol
"STOR." Public trading of our common stock commenced on June 30, 2000. Prior to
that, there was no public market for our common stock. The following table sets
forth, for the periods indicated, the high and low intraday sales prices per
share of our common stock.
High Low
-------- -------
Year Ended December 31, 2001:
First Quarter................. $ 33.625 $ 8.50
Second Quarter................ $ 23.54 $ 7.00
Third Quarter................. $ 17.86 $ 3.65
Fourth Quarter................ $ 8.10 $ 3.75
Year Ended December 31, 2000:
Second Quarter (June 30, 2000) $ 102.00 $ 90.00
Third Quarter................. $ 154.25 $79.125
Fourth Quarter................ $106.625 $ 16.50
As of March 8, 2002, there were 432 holders of record of our common stock,
as shown in the records of our transfer agent.
We have never declared or paid any cash dividends on our capital stock. We
presently intend to retain future earnings, if any, to finance the expansion of
our business and do not expect to pay any cash dividends in the foreseeable
future. Payment of future cash dividends, if any, will be at the discretion of
our board of directors after taking into account various factors, including our
financial condition, operating results, current and anticipated cash needs and
plans for expansion.
(b) Recent Sales of Unregistered Securities
In December 2001, we issued 27,618 shares of our common stock to a leasing
company upon the cashless exercise of a warrant originally issued in October
1999, which resulted in no cash proceeds to us. These shares were issued in
reliance upon exemptions from registration set forth in Section 4(2) of the
Securities Act, or regulations promulgated thereunder, relating to sales by an
issuer not involving any public offering. No underwriters or placement agents
were involved in the foregoing issuance.
(c) Use of Proceeds from Sales of Registered Securities
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 December 31, 2001, we have spent
approximately $64.1 million of the $258.6 million of net proceeds from the IPO
for capital lease payments and approximately $21.8 million of the proceeds from
the IPO for operating expenses.
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Item 6. Selected Financial Data.
You should read the selected financial data set forth below along with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and the related notes
included elsewhere in this Annual Report on Form 10-K. We have derived the
consolidated statement of operations data for 1998, 1999, 2000 and 2001, and
the consolidated balance sheet data as of December 31, 1998, 1999, 2000 and
2001 from our audited consolidated financial statements.
Consolidated Statement of Operations Data:
Period from
October 5, 1998
(commencement
of operations) to Year ended Year ended Year ended
December 31, December 31, December 31, December 31,
1998 1999 2000 2001
----------------- ------------ ------------ ------------
(in thousands, except per share data)
REVENUES:
Managed storage service revenues....................... $ -- $ 720 $ 30,733 $ 113,496
Professional service revenues.......................... -- 3,203 17,485 10,129
Equipment revenues..................................... -- 2,335 -- --
------- -------- --------- ---------
Total revenues..................................... -- 6,258 48,218 123,625
COSTS AND EXPENSES:
Cost of managed storage service revenues............... 101 8,400 72,961 120,232
Cost of professional service revenues.................. 9 5,343 18,928 6,982
Cost of equipment revenues............................. -- 2,111 -- --
Sales and marketing.................................... 39 7,304 53,986 56,695
General and administrative............................. 231 5,558 17,882 24,712
Research and development............................... -- 1,133 11,872 21,964
Amortization of deferred stock
compensation(1)...................................... -- 1,301 5,061 3,866
Impairment charge and other related costs.............. -- -- -- 114,449
------- -------- --------- ---------
Total costs and expenses.................................. 380 31,150 180,690 348,900
------- -------- --------- ---------
Loss from operations...................................... (380) (24,892) (132,472) (225,275)
Interest income........................................... 11 1,371 15,120 15,144
Interest expense.......................................... -- (393) (7,513) (14,682)
Other income (expense).................................... -- -- -- (160)
------- -------- --------- ---------
Net loss.................................................. $ (369) $(23,914) $(124,865) $(224,973)
======= ======== ========= =========
Net loss per share -- basic and diluted................... $ (0.02) $ (0.98) $ (2.12) $ (2.33)
Weighted average common shares outstanding................ 24,400 24,407 58,888 96,698
(1)Amortization of deferred stock compensation consists of
the following:
Cost of managed storage service revenues.................. $ -- $ 71 $ 495 $ 510
Cost of professional service revenues..................... -- 229 488 199
Sales and marketing....................................... -- 603 1,653 1,118
General and administrative................................ -- 251 579 398
Research and development.................................. -- 147 1,846 1,641
------- -------- --------- ---------
$ -- $ 1,301 $ 5,061 $ 3,866
======= ======== ========= =========
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Consolidated Balance Sheet Data:
As of December 31,
--------------------------------
1998 1999 2000 2001
------ ------- -------- --------
(in thousands)
Cash, cash equivalents and investments......... $8,280 $34,815 $389,628 $258,749
Working capital................................ 8,085 25,053 338,123 147,943
Total assets................................... 9,672 67,259 602,613 384,741
Capital lease obligations, less current portion -- 15,822 94,050 60,512
Total stockholders' equity..................... 8,668 37,009 439,128 220,218
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
You should read the following discussion and analysis together with our
consolidated financial statements and the related notes and the other financial
information appearing elsewhere in this Annual Report on Form 10-K. The
following discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those
anticipated in such forward-looking statements due to various factors,
including, but not limited to, our critical accounting policies and those
factors set forth below under "Factors Affecting Future Operating Results" and
elsewhere in this Annual Report on Form 10-K.
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.
Our managed storage services 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. We
opened our first S-POP data center in Houston in May 1999. Through December 31,
2001, we operated 49 S-POP data centers in the metropolitan areas of Atlanta,
Austin, Boston, Chicago, Dallas, Detroit, Houston, Los Angeles, New York, San
Francisco, Seattle, Washington, D.C., Amsterdam, Frankfurt and London.
In 2001, we identified a significant opportunity to provide our software and
services to service providers in order to enable them to manage their storage
infrastructure and provide new value to their customers. As a result, we
developed and began marketing our 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 operating system
as a stand-alone product, along with weakening demand for storage services by
customers inside 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 and focused on developing and enhancing our software and
services that enterprise customers, telecommunications companies and system
integrators were demanding.
In the future, we expect to focus on selling solutions that deliver high
value to customers, including our software-based offering, STORfusion. We are
in the process of commercializing our STORos operating system as a stand-alone
software application, to 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.
10
Since our inception, we have incurred significant losses and negative
operating cash flows. As of December 31, 2001, we had an accumulated deficit of
$374.3 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 is unproven, and our limited operating history makes an evaluation
of our company difficult. 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.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of
operations is 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 assets and liabilities,
revenues and expenses, and other financial information. Actual results may
differ significantly from these estimates under different assumptions and
conditions.
In December 2001, the SEC requested that all registrants disclose their
"critical accounting policies" in the discussion and analysis of their
financial condition and results of operations. The SEC indicated that a
"critical accounting policy" is one which is both important to the portrayal of
the company's financial condition and results and requires management's most
difficult, subjective and complex judgments, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain.
Our significant accounting policies are described in note 2 to our
consolidated financial statements. Not all of these significant accounting
policies, however, require management to make difficult, complex or subjective
judgments or estimates. We believe that our accounting policies relating to
revenue recognition, impairment of long-lived assets, allowance for doubtful
accounts, and provision for income taxes described below fit the definition of
"critical accounting policies."
Revenues
Revenues consist of (i) fees from customer use of our managed storage
services, which include PACS storage services, STORmanage storage services, and
STORfusion storage services, (ii) professional services fees, and (iii)
proceeds from data storage equipment sales to customers. 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 our 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.
Our 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 service 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. We determine the percentage
of completion of our contracts by comparing costs incurred to date to total
estimated costs. Contract costs include all direct labor and expenses related
to the contract performance.
11
Equipment sales are recognized when the equipment is delivered to the
customer or placed into service.
Impairment of Long-Lived Assets
We continually review the carrying value of long-lived assets, including
property and equipment to determine whether there are any indications of
impairment losses. Recoverability of long-lived assets is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets.
During 2001, we conducted an impairment review of long-lived assets,
primarily storage hardware assets used in delivering our fully managed storage
services within our traditional S-POP data centers.
We calculated the expected net undiscounted cash flows of each S-POP data
center to determine which group of assets was impaired. For those assets where
impairment was present, a loss was recognized for the difference between the
asset carrying values and fair market values. We determined fair market value
based on multiple quotes from third party data storage equipment resellers. In
conducting the impairment review, we separated assets in production (assets to
be held and used) from idle assets (assets to be disposed of).
Allowance for Doubtful Accounts
We evaluate the collectibility of our accounts receivable based on specific
identification of uncollectible accounts. In circumstances where we are aware
of a customer's inability to meet its financial obligations to us
(e.g., bankruptcy filings and substantial downgrading of credit scores), we
record a specific reserve for bad debts against amounts due, to reduce the net
recognized receivable to the amount we reasonably believe will be collected. If
circumstances change (e.g., higher than expected defaults or an unexpected
material adverse change in a major customer's ability to meet its financial
obligations to us), our estimates of the recoverability of amounts due to us
could be reduced by a material amount.
Provision for Income Taxes
We incurred a net taxable loss in 1999, 2000 and 2001, and therefore did not
record a provision for income taxes in these periods. As of December 31, 2001,
we had a federal and state net operating loss and tax credit carryforwards of
$266.1 million, which may be used, subject to limitations, to offset future
state and federal taxable income through 2003 and 2021, respectively. We have
recorded a valuation allowance against the entire net operating loss and tax
credit carryforwards because we are uncertain that we will be able to realize
the benefit of the carryforwards before they expire.
Results of Operations
Years ended December 31, 1999 and 2000
Revenues
Revenues increased from $6.3 million in 1999 to $48.2 million in 2000.
Managed storage service revenues increased from $720,000 in 1999 to $30.7
million in 2000. The increase resulted primarily from the increase in the
number of customers in 2000. We had 21 customers under contract to receive our
managed storage services at December 31, 1999, and over 170 customers at the
end of 2000. Professional service revenues increased from $3.2 million in 1999
to $17.5 million in 2000. The increase resulted primarily from the increase in
the number of professional service engagements in 2000. In 2000, we performed
professional service engagements for customers of EMC Corporation and Compaq
Computer Corp. that accounted for approximately 14% and 12%, respectively, of
our total consolidated revenues. Approximately 37% of our revenues in 1999 were
represented by data storage equipment sales. During 2000, we had no data
storage equipment sales. The relative contributions of
12
each of our segments to our total revenues in 2001 may not be indicative of
future periods, however, as we shift the focus of our sales and marketing
efforts to selling software and professional services to large enterprise
organizations and service providers.
Cost of Revenues
Cost of managed storage service revenues increased from $8.4 million in 1999
to $73.0 million in 2000. The opening of 35 additional S-POP data centers in
2000 and the operation of 35, 37, 42 and 51 S-POP data centers during each
consecutive quarter of 2000 caused the increase. We had 16 active S-POP data
centers at the end of 1999. Accordingly, costs incurred in the operation of an
S-POP data center, such as depreciation of capital equipment, personnel costs,
networking costs and facility costs were all higher in 2000.
Cost of professional service revenues increased from $5.3 million in 1999 to
$18.9 million in 2000. The increase was caused by an increase in the number of
professional services personnel in 2000. Costs of equipment revenues were $2.1
million in 1999. Since we did not sell equipment in 2000, we did not incur the
associated costs.
Sales and Marketing
Sales and marketing expenses increased from $7.3 million in 1999 to $54.0
million in 2000. The increase was caused primarily by an increase in the number
of sales and marketing personnel and an increase in promotional and advertising
activities in 2000. In addition, higher direct sales-related compensation
expenses, such as commissions and bonuses, were incurred in 2000.
General and Administrative
General and administrative expenses increased from $5.6 million in 1999 to
$17.9 million in 2000. The increase was caused by an increase in the number of
general and administrative personnel in 2000, as well as increased information
technology and facilities costs incurred as a result of our growth in 2000. In
addition, we incurred higher consulting and professional fees in 2000 as a
result of our transition to a public company.
Research and Development
Research and development expenses increased from $1.1 million in 1999 to
$11.9 million in 2000. The increase was caused primarily by an increase in the
number of technology and engineering personnel in 2000, as well as higher costs
incurred in connection with technology and research activities, such as
equipment and depreciation.
Amortization of Deferred Stock Compensation
Amortization of deferred stock compensation increased from $1.3 million in
1999 to $5.1 million in 2000. In 2000, we incurred a full year of amortization
of deferred stock compensation for stock options granted with exercise prices
deemed to be less than the fair value of common stock at the dates of grant.
Interest Income
Interest income increased from $1.4 million in 1999 to $15.1 million in
2000. The increase resulted from our higher average cash and investment
balances during 2000 as a result of our equity financings.
Interest Expense
Interest expense increased from $393,000 in 1999 to $7.5 million in 2000.
The increase resulted from higher capital lease obligations under which
interest expense was incurred in 2000.
13
Years ended December 31, 2000 and 2001
Revenues
Revenues increased from $48.2 million in 2000 to $123.6 million in 2001.
Managed storage service revenues increased from $30.7 million in 2000 to
$113.5 million in 2001. The increase resulted from more capacity under
management. Our customer base in 2001 consisted of companies for whom we
managed larger volumes of data, primarily with our back-up services.
Accordingly, our average annualized revenue per customer increased each quarter
in 2001. One managed storage service customer, Merrill Lynch, accounted for
approximately 10% of our total consolidated revenues for the year ended
December 31, 2001. Approximately 10% of our total consolidated revenues earned
in the year ended December 31, 2001 were recognized from fees paid for
non-recurring customer contract renegotiations.
In addition, in 2001, our new managed storage service customer base
consisted of a higher ratio of large enterprise customers to Internet-related
companies than in 2000. The capacity under management in hosting service
provider S-POP data centers declined in the second half of 2001 as a result of
the weakening economy and related decline in demand for services within the
data centers of hosting service providers. We anticipate that due to our focus
on selling our software and related services, we may encounter longer sales
cycles and will incur lower average selling prices per unit. Although we
believe that potential profit from these sales is greater than that from our
fully managed storage service offerings, we expect that the size of each sale
will generally be smaller. Therefore, in 2002, we anticipate that revenues from
managed storage services may decrease on a quarterly basis, which may be
partially offset by an increase in revenues from sales and licensing of our
software and related services.
Professional service revenues decreased from $17.5 million in 2000 to $10.1
million in 2001. The decrease resulted primarily from the decrease in the
number of professional service engagements in 2001. In 2000, we performed
subcontracted professional service engagements for customers of EMC Corporation
and Compaq Computer Corp. that accounted for approximately 14% and 12%,
respectively, of our total consolidated revenues. In the second half of 2001,
we focused our professional service organization on delivering higher scale and
increased value-added services, and we performed fewer sub-contracting
engagements. As a result, we performed fewer overall professional service
engagements and our professional service revenues declined. We expect to
continue performing direct professional service engagements that are both
strategic and provide higher value to the customer. However, these engagements
are not as frequent as those that we had performed under various subcontracting
agreements with hardware vendors. As such, we do not anticipate immediate
growth in revenues from professional services in 2002.
During 2000 and 2001, we had no data storage equipment sales.
Cost of Revenues
Cost of managed storage service revenues increased from $73.0 million in
2000 to $120.2 million in 2001.
The increase resulted primarily from higher depreciation and equipment
maintenance expense related to equipment used in 2001. We had more capacity
under management in 2001 than we did in 2000 and needed to procure more data
storage capital equipment to satisfy this increase. However, our gross margins
from providing managed storage services increased from (137%) in 2000 to (6%)
in 2001. We achieved this improvement through greater efficiencies from the
equipment deployed and personnel required to manage the 2001 storage capacity.
Our STORos operating system allowed our delivery of managed storage services to
scale as capacity under management increased. As a result of an impairment
recorded in the quarter ended December 31, 2001 (see "Impairment Charge and
Other Related Costs" below), the Company recognized a charge of $79.0 million
to write-down certain managed storage services assets to fair market value. As
a result, the Company expects its
14
depreciation expense to decline in 2002. In addition, we recorded charges
related to long-term fiber contracts and other S-POP data center related
charges, such as unutilized floor space, that will also reduce the cost of
managed storage services in the future.
Cost of professional service revenues decreased from $18.9 million in 2000
to $7.0 million in 2001. The decrease was caused by a decrease in the number of
professional services personnel in 2001. Our professional service organization
was scaled down in the second half of 2001 as a result of our performing fewer
subcontracting engagements. Subcontracting engagements required us to maintain
a large group of consultants due to the unpredictability of the timing and
volume of these engagements at any point in time. As a result of a smaller,
more focused professional services group, we were able to increase gross
margins from professional services from (8%) in 2000 to 31% in 2001.
Since we did not sell equipment in 2000 and 2001, we did not incur the
associated costs.
Sales and Marketing
Sales and marketing expenses increased from $54.0 million in 2000 to $56.7
million in 2001. The increase was caused primarily by an increase in the number
of sales and marketing personnel in the first half of 2001. Also, because
revenues increased during 2001, we incurred higher direct sales-related
compensation expenses, such as commissions and fees paid to resellers.
General and Administrative
General and administrative expenses increased from $17.9 million in 2000 to
$24.7 million in 2001. The increase was primarily caused by higher salary and
related costs in 2001 as a result of more general and administrative personnel
in the first half of 2001. In addition, we incurred higher insurance costs,
professional service fees, and legal costs in 2001, our first full year as a
public company, than in 2000. Finally, we incurred higher facilities and
related costs in 2001 as we established a new corporate headquarters.
Research and Development
Research and development expenses increased from $11.9 million in 2000 to
$22.0 million in 2001. The increase was caused primarily by higher salary and
related costs in 2001 as a result of more research and development personnel in
2001, specifically within software development. We also incurred higher
consulting costs in 2001 as we initiated software development projects relating
to the enhancement of our STORos operating system. Consulting costs were
significant in the first half of 2001, and were reduced in the second half as
we continued to add full-time software development personnel. Depreciation of
fixed assets, equipment and maintenance costs all increased in 2001 as we
procured equipment used in our development, interoperability and quality
assurance activities.
Amortization of Deferred Stock Compensation
Amortization of deferred stock compensation decreased from $5.1 million in
2000 to $3.9 million in 2001. The decrease in 2001 resulted from the
termination of certain compensatory stock options as a result of employee
terminations before such options vested.
Impairment Charge and Other Related Costs
In 2001, we recorded asset impairment charges of $79.0 million, or ($0.82)
per share, and other one-time charges of $35.4 million, or ($0.37) per share.
As discussed above, during 2001, demand for services in third party data
centers weakened. In addition, we recognized that there was limited demand for
fully managed primary data services from enterprise customers.
15
During the quarter ended December 31, 2001, general economic conditions
remained difficult and hosting service providers continued to experience
significant financial difficulties. As a result, we focused our sales and
marketing efforts on selling software and services to large enterprise
organizations. This focus triggered an impairment review of long-lived assets,
primarily storage hardware assets used in delivering our fully managed storage
services, within our S-POP data centers that are located within third-party
hosting centers.
We calculated the expected net undiscounted cash flows of each S-POP data
center to determine which group of assets was impaired. For those assets where
impairment was present, a loss was recognized for the difference between the
asset carrying values and fair market values. We determined fair market value
based on multiple quotes from third party data storage equipment resellers. In
conducting the impairment review, we separated assets in production (assets to
be held and used) from idle assets (assets to be disposed of). Assets to be
held and used and assets to be disposed of accounted for $55.4 million and
$23.6 million, respectively, of the total $79.0 million asset impairment charge.
In addition, as a result of our new focus on selling software and services
to large enterprise organizations, we determined that certain assets and future
obligations no longer matched the needs of our current enterprise customers or
the future direction of the business. Therefore, we recognized a one-time
charge of $35.4 million related to the following items: fiber related assets
and obligations ($12.4 million), the permanent impairment of strategic
investments of privately-held companies with businesses complementary to our
fully managed primary storage services ($12.1 million), future commitments for
office and S-POP data center floor space ($6.6 million), future commitments for
assets related to fully managed primary storage services ($3.0 million) and
employee termination costs and other charges ($1.3 million). During the year
ended December 31, 2001, we paid $184,000 related to these charges, and had
$18.9 million remaining in accrued expenses.
Interest Income
Interest income remained unchanged at $15.1 million for 2000 and 2001. A
larger average cash and investment balance, offset by lower overall money
market and commercial paper interest rates in 2001, caused interest income to
remain unchanged.
Interest Expense
Interest expense increased from $7.5 million in 2000 to $14.7 million in
2001. The increase resulted from higher capital lease obligations throughout
the year under which interest expense was incurred in 2001.
Liquidity and Capital Resources
At December 31, 2001, we had cash and cash equivalents, including
temporarily restricted cash equivalents, of $216.0 million, investments of
$72.9 million and working capital of $147.9 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.
We have entered into a number of operating leases for our facilities, which
expire from 2002 through 2011. We also lease certain data center infrastructure
and equipment under capital leases. The following table sets forth information
with respect to our long-term obligations payable in cash as of December 31,
2001 (in thousands):
16
Payments Due by Period
----------------------
Contractual Obligations Less than 1 year 1-3 years 4-5 years After 5 years Total
----------------------- ---------------- --------- --------- ------------- --------
Long-term debt........................ $ -- $ -- $ -- $ -- $ --
Capital lease obligations............. 54,740 65,024 -- -- 119,764
Operating leases...................... 11,600 22,723 8,536 13,647 56,506
------- ------- ------ ------- --------
Total contractual cash obligations. $66,340 $87,747 $8,536 $13,647 $176,270
======= ======= ====== ======= ========
Net cash used in operating activities totaled $16.0 million in 1999, $90.4
million in 2000 and $48.4 million in 2001. Our use of cash in 1999 and 2000 was
primarily attributable to the operating loss generated by our investment in the
growth of our business, which included an increase in personnel from nine at
the end of 1998 to 276 as of December 31, 1999, to 581 as of December 31, 2000,
offset by non-cash charges such as depreciation and amortization and increases
in accounts payable and accrued expenses. Our use of cash in 2001 was also
primarily attributable to the operating loss generated during the year.
Although our operating loss in 2001 was greater than our operating loss in
2000, our operating cash used was significantly less because our operating loss
included $114.3 million in asset impairment and other charges that were not
represented by cash. Also, depreciation of fixed assets represented a larger
percentage of our operating loss in 2001. Finally, we reduced discretionary
operating costs, mainly within cost of managed storage services and sales and
marketing expenses, during the second half of 2001 while at the same time
maintaining a consistent accounts receivable days sales outstanding. However,
$18.9 million of the $114.4 million asset impairment and other charges is
represented by accrued expenses which will result in a use of cash in future
periods.
Net cash used in investing activities totaled $42.5 million in 1999, $108.1
million in 2000 and $8.6 million in 2001. Our cash used in investing activities
in 1999, 2000 and 2001 resulted primarily from our purchase of short-term
investments offset by maturities of such investments, the purchase of
restricted cash equivalents in order to secure certain lease facilities, as
well as additional procurement of capital equipment, principally equipment
related to our managed storage services. In addition, in 2000, we made
strategic investments in the preferred stock of private companies. We did not
make significant strategic investments in the preferred stock of private
companies in 2001. Our use of cash in 2001 was primarily attributable to the
procurement of capital equipment used in the delivery of our managed storage
services. In addition, we redeemed more investments, which we used for
operating purposes, than we purchased in 2001. As a result, our total use of
cash from investing activities decreased in 2001.
Net cash provided by financing activities totaled $50.2 million in 1999 and
$503.7 million in 2000. In 2001, our net cash used in financing activities
totaled $62.7 million. In 1999 we raised $51.0 million from the sale of
convertible preferred stock. In 2000, we raised $143.0 million from the sale of
convertible preferred stock, $259.9 million from our initial public offering
and $116.8 million from our follow-on public offering completed in November
2000. Our use of cash from financing activities in 2001 primarily related to
the payment of capital lease obligations. In the quarter ended December 31,
2001, we paid $27.1 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 additional early lease
terminations.
We believe that our current cash, cash equivalents and short-term
investments will be sufficient to meet our anticipated cash needs for working
capital, lease terminations and capital expenditures for at least the next
twelve months. However, we may need to raise additional funds to finance the
expansion of our business with regard to new products or services or the
acquisition of complementary businesses or technologies. In the event that
additional financing is required, we may not be able to raise it on terms
acceptable to us, if at all.
Recent Accounting Pronouncement
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets and for Long-Lived Assets-
17
to Be Disposed Of" (SFAS 144). SFAS 144, which is effective for all quarters in
fiscal years beginning after December 15, 2001, establishes accounting and
reporting standards for recognizing and measuring the impairment of long-lived
assets. We do not expect the adoption of this standard to have a significant
impact on our consolidated financial statements.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
(SFAS 142), and Statement of Financial Accounting Standards No. 141, "Business
Combinations" (SFAS 141). SFAS 142, which is effective for all quarters in
fiscal years beginning after December 15, 2001, supercedes APB Opinion No. 17,
"Intangible Assets"; however, it carries forward without reconsideration the
provisions in APB 17 related to internally developed intangible assets. SFAS
141, which is effective for all quarters in fiscal years beginning after June
30, 2001, supercedes APB Opinion No. 16, "Business Combinations", and amends or
supercedes a number of interpretations of APB No. 16. We do not expect the
adoption of these standards to have a significant impact on our consolidated
financial statements.
Factors Affecting Future Operating Results
This Annual Report on Form 10-K contains forward-looking statements that
involve substantial risks and uncertainties. You can identify these statements
by forward-looking words such as "anticipate," "expect," "intend," "may,"
"should," "will," and "would" or similar words. You should read statements that
contain these words carefully because they discuss our future expectations,
contain projections of our future results of operations or of our financial
position or other "forward-looking" information. 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. The factors listed below, as well as any cautionary language elsewhere
in this Form 10-K, 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 may not successfully produce and sell our enterprise storage resource
management software
Historically, our managed storage services have generated the majority of
our revenues. 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 and to
decrease our sales and marketing of our managed storage services. We are also
in the process of preparing our existing software, which we currently use in
providing our services, for licensing and delivery to customers as a
stand-alone product.
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, and 92% of
our revenues in 2001 from these services. None of our revenues in 2001 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 resource 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.
18
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 and $225.0 million
in 2001. As of December 31, 2001, we had an accumulated deficit of $374.3
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 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 of
investors
The market for technology stock has been extremely volatile. The following
factors could cause the market price of our common stock in the public market
to fluctuate significantly:
. the addition or departure of key personnel;
. variations in our quarterly operating results;
. 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;
. changes in earnings estimates by analysts;
. our sales of common stock or other securities in the future;
. changes in market valuations of technology companies; and
. 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, services 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
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 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 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
19
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, and our business, operating results and financial
condition could be adversely affected.
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:
. The sales cycle is typically lengthy, generally lasting six to twelve
months, and varies substantially from transaction to transaction;
. Enterprise license transactions often include multiple elements such as
product licenses and service and support;
. Recognition of revenue from enterprise license transactions may vary
from transaction to transaction;
. They typically involve significant technical evaluation and commitment
of resources; and
. 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
new technologies that affect key operations.
Many of the large organizations that we target as customers have lowered
their rate of spending on enterprise software. 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.
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.
20
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.
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 resource 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:
. Product error;
. design flaws;
. human error;
. physical or electronic security breaches;
. fire, earthquake, flood and other disasters;
. power loss; and
. 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 could result in lack of performance, service interruptions,
significant damage to equipment or loss or unavailability of customer data,
which 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 continue to grow, our costs will increase, and our
reputation will be damaged if we are not able to deliver our products and
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
21
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 services, and cause us to receive lower
fees than expected and incur unforeseen costs to remedy our shortfalls.
Quarterly and annual operating results and revenue 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 revenue, profitability or
cash flow in the future and could cause serious harm to our business. These
factors include:
. Our success at marketing and selling our software and services, and
customers' reactions to our new software products;
. success in expanding and adapting our sales and marketing programs;
. financial condition of our customers and customers' demand for and
implementation of our products and services;
. length of sales cycle;
. general economic conditions;
. price and product competition;
. ability to introduce new or enhanced products and services;
. market acceptance of our or our competitors' new products and services;
. ability to control costs;
. new hardware and software technologies;
. size and timing of licensing and services transactions;
. ability to retain qualified personnel;
. changes in pricing policies;
. quality control of our products and services;
. acquisition costs or other non-recurring charges in connection with the
acquisition of companies, products or technologies;
. acts of terrorism and acts of war;
. temporary shortages or interruptions in supply of storage hardware and
software; and
. 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.
22
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 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
As we grow our business, we may need additional financing. We cannot be sure
that we will be able to secure additional financing on acceptable terms.
Additionally, holders of any future debt instruments may have rights senior to
those of the holders of our common stock, and any future issuance of common
stock would result in dilution of existing stockholders' equity interests.
23
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 36% of our revenues recognized in 2001 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.
Item 7.A. Quantitative and Qualitative 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 could become 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.
24
Item 8. Financial Statements
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors...................................................................... 26
Consolidated balance sheets at December 31, 2000 and 2001........................................... 27
Consolidated statements of operations for the years ended December 31, 1999, 2000 and 2001.......... 28
Consolidated statements of stockholders' equity for the years ended December 31, 1999, 2000 and 2001 29
Consolidated statements of cash flows for the years ended December 31, 1999, 2000 and 2001.......... 30
Notes to consolidated financial statements.......................................................... 31
25
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
StorageNetworks, Inc.
We have audited the accompanying consolidated balance sheets of
StorageNetworks, Inc. (the Company) as of December 31, 2000 and 2001, 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
StorageNetworks, Inc. at December 31, 2000 and 2001, and the consolidated
results of their operations and their cash flows for each of the three years in
the 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.
/s/ Ernst & Young LLP
Boston, Massachusetts
January 28, 2002
26
StorageNetworks, Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
December 31,
--------------------
2000 2001
--------- ---------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents......................................................... $ 304,861 $ 185,834
Short-term investments............................................................ 84,767 42,978
Accounts receivable, net of allowance for doubtful accounts of $307 and $2,161 at
December 31, 2000 and 2001...................................................... 7,886 13,735
Prepaid expenses and other current assets......................................... 10,044 9,407
--------- ---------
Total current assets.......................................................... 407,558 251,954
Property and equipment, net....................................................... 135,867 67,074
Restricted cash equivalents....................................................... 32,133 30,158
Rights to use fiber optic capacity................................................ 7,595 --
Cost method investments........................................................... 11,083 --
Non-current investments........................................................... -- 29,937
Other assets...................................................................... 8,377 5,618
--------- ---------
Total assets.................................................................. $ 602,613 $ 384,741
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.................................................................. $ 3,746 $ 3,821
Accrued expenses.................................................................. 23,134 50,259
Deferred revenue.................................................................. 5,938 5,868
Capital lease obligations......................................................... 36,617 44,063
--------- ---------
Total current liabilities..................................................... 69,435 104,011
Capital lease obligations, less current portion...................................... 94,050 60,512
Commitments and contingencies........................................................
STOCKHOLDERS' EQUITY:
Common stock, par value $.01; 600,000,000 shares authorized; 95,362,730 and
97,810,286 shares issued and outstanding at December 31, 2000 and 2001
respectively.................................................................... 954 978
Less treasury stock, at cost, 25,000 shares....................................... -- (200)
Additional paid-in capital........................................................ 601,649 597,938
Deferred stock compensation....................................................... (13,754) (4,638)
Accumulated other comprehensive income............................................ (406) 428
Accumulated deficit............................................................... (149,315) (374,288)
--------- ---------
Total stockholders' equity.................................................... 439,128 220,218
--------- ---------
Total liabilities and stockholders' equity.................................... $ 602,613 $ 384,741
========= =========
See accompanying notes to consolidated financial statements.
27
StorageNetworks, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Year ended December 31,
------------------------------
1999 2000 2001
-------- --------- ---------
REVENUES:
Managed storage service revenues..................................... $ 720 $ 30,733 $ 113,496
Professional service revenues........................................ 3,203 17,485 10,129
Equipment revenues................................................... 2,335 -- --
-------- --------- ---------
Total revenues................................................... 6,258 48,218 123,625
COSTS AND EXPENSES:
Cost of managed storage service revenues............................. 8,400 72,961 120,232
Cost of professional service revenues................................ 5,343 18,928 6,982
Cost of equipment revenues........................................... 2,111 -- --
Sales and marketing.................................................. 7,304 53,986 56,695
General and administrative........................................... 5,558 17,882 24,712
Research and development............................................. 1,133 11,872 21,964
Amortization of deferred stock compensation*......................... 1,301 5,061 3,866
Impairment charge and other related costs............................ -- -- 114,449
-------- --------- ---------
Total costs and expenses......................................... 31,150 180,690 348,900
-------- --------- ---------
Loss from operations.................................................... (24,892) (132,472) (225,275)
Interest income......................................................... 1,371 15,120 15,144
Interest expense........................................................ (393) (7,513) (14,682)
Other income (expense).................................................. -- -- (160)
-------- --------- ---------
Net loss......................................................... $(23,914) $(124,865) $(224,973)
======== ========= =========
Net loss per share -- basic and diluted................................. $ (0.98) $ (2.12) $ (2.33)
Weighted average common shares outstanding.............................. 24,407 58,888 96,698
* Amortization of deferred stock compensation consists of the following:
Cost of managed storage service revenues................................ $ 71 $ 495 $ 510
Cost of professional service revenues................................... 229 488 199
Sales and marketing..................................................... 603 1,653 1,118
General and administrative.............................................. 251 579 398
Research and development................................................ 147 1,846 1,641
-------- --------- ---------
$ 1,301 $ 5,061 $ 3,866
======== ========= =========
See accompanying notes to consolidated financial statements.
28
StorageNetworks, Inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
Series A Series C Series D
Common Preferred Series B Preferred Preferred
Stock Stock Preferred Stock Stock Stock
------------ -------------- -------------- ------------ ------------
Par Par Par Par Par
Shares Value Shares Value Shares Value Shares Value Shares Value
------ ----- ------ ------ ------- ----- ------ ----- ------ -----
BALANCE AT DECEMBER 31, 1998............... 24,400 $244 4,500 $ 45
Issuance of Series A preferred stock......... 500 5
Issuance of Series B preferred stock, net.... 10,163 $ 102
Issuance of common stock in connection with
exercise of stock options................... 132 1
Deferred stock compensation expense..........
Amortization of deferred stock compensation..
Cancellation of compensatory stock options...
Net loss.....................................
------ ---- ------ ------ ------- ----- ------ ---- ------ ----
BALANCE AT DECEMBER 31, 1999............... 24,532 245 5,000 50 10,163 102
Issuance of Series C preferred stock......... 6,013 $ 60
Issuance of Series D preferred stock......... 1,758 $ 18
Issuance of Series D preferred stock warrants
Issuance of common stock in connection with
the initial public offering, net............ 64,459 645 (5,000) (50) (10,163) (102) (6,013) (60) (1,758) (18)
Issuance of common stock in connection with
the secondary offering, net................. 3,600 36
Issuance of common stock in connection with
exercise of stock options................... 1,984 20
Issuance of common stock in connection with
exercise of warrants........................ 788 8
Deferred stock compensation expense..........
Amortization of deferred stock compensation..
Cancellation of compensatory stock options...
Net loss.....................................
Translation adjustment.......................
------ ---- ------ ------ ------- ----- ------ ---- ------ ----
BALANCE AT DECEMBER 31, 2000............... 95,363 954 -- -- -- -- -- -- -- --
Issuance of common stock in connection with
exercise of stock options................... 2,420 24
Issuce of common stock in connection with
exercise of warrants........................ 28 --
Purchase of treasury stock...................
Amortization of deferred stock compensation..
Cancellation of compensatory stock options...
Offering costs...............................
Net loss.....................................
Translation adjustment.......................
------ ---- ------ ------ ------- ----- ------ ---- ------ ----
BALANCE AT DECEMBER 31, 2001............... 97,811 $978 -- $ -- -- $ -- -- $-- -- $ --
====== ==== ====== ====== ======= ===== ====== ==== ====== ====
Treasury
Stock Accumulated
------------ Other Total
Par Deferred Comp. Accumulated Stockholder's
Shares Value APIC Compensation Income Deficit Equity -
------ ----- -------- ------------ ----------- ----------- -------------
BALANCE AT DECEMBER 31, 1998............... $ 9,992 $ (1,077) $ (536) $ 8,668
Issuance of Series A preferred stock......... 995 1,000
Issuance of Series B preferred stock, net.... 49,849 49,951
Issuance of common stock in connection with
exercise of stock options................... 3 4
Deferred stock compensation expense.......... 20,806 (20,806) --
Amortization of deferred stock compensation.. 1,300 1,300
Cancellation of compensatory stock options... (703) 703 --
Net loss..................................... (23,914) (23,914)
-- ----- -------- -------- ----- --------- ---------
BALANCE AT DECEMBER 31, 1999............... 80,942 (19,880) (24,450) 37,009
Issuance of Series C preferred stock......... 102,940 103,000
Issuance of Series D preferred stock......... 39,982 40,000
Issuance of Series D preferred stock warrants 3,546 3,546
Issuance of common stock in connection with
the initial public offering, net............ 258,141 258,556
Issuance of common stock in connection with
the secondary offering, net................. 115,886 115,922
Issuance of common stock in connection with
exercise of stock options................... 1,285 1,305
Issuance of common stock in connection with
exercise of warrants........................ (8) --
Deferred stock compensation expense.......... 580 (580) --
Amortization of deferred stock compensation.. 5,061 5,061
Cancellation of compensatory stock options... (1,645) 1,645 --
Net loss..................................... (124,865) (124,865)
Translation adjustment....................... $(406) (406)
-- ----- -------- -------- ----- --------- ---------
BALANCE AT DECEMBER 31, 2000............... -- -- 601,649 (13,754) (406) (149,315) 439,128
Issuance of common stock in connection with
exercise of stock options................... 2,190 2,214
Issuce of common stock in connection with
exercise of warrants........................ -- --
Purchase of treasury stock................... 25 $(200) (200)
Amortization of deferred stock compensation.. 3,866 3,866
Cancellation of compensatory stock options... (5,250) 5,250 --
Offering costs............................... (651) (651)
Net loss..................................... (224,973) (224,973)
Translation adjustment....................... 834 834
-- ----- -------- -------- ----- --------- ---------
BALANCE AT DECEMBER 31, 2001............... 25 $(200) $597,938 $ (4,638) $ 428 $(374,288) $ 220,218
== ===== ======== ======== ===== ========= =========
See accompanying notes to consolidated financial statements.
29
StorageNetworks, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year ended December 31,
------------------------------
1999 2000 2001
-------- --------- ---------
OPERATING ACTIVITIES:
Net loss................................................................................. $(23,914) $(124,865) $(224,973)
Adjustments to reconcile net loss to net cash used in operating activities:
Impairment charges and other related costs............................................. -- -- 114,265
Depreciation and amortization.......................................................... 1,796 23,988 53,739
Amortization of deferred stock compensation............................................ 1,301 5,061 3,866
Issuance of stock warrants............................................................. -- 3,546 --
Other non-cash charges................................................................. -- -- 156
Changes in operating assets and liabilities:...........................................
Accounts receivable.................................................................. (2,626) (4,719) (5,663)
Inventory............................................................................ 201 -- --
Prepaid expenses and other current assets............................................ (1,432) (8,545) (116)
Other assets......................................................................... (317) (7,660) 2,351
Accounts payable..................................................................... 3,094 652 83
Accrued expenses..................................................................... 5,575 17,052 8,146
Deferred revenue..................................................................... 313 5,128 (303)
-------- --------- ---------
Net cash used in operating activities............................................. (16,009) (90,362) (48,449)
INVESTING ACTIVITIES:
Net purchases of property and equipment................................................ (7,292) (15,254) (21,276)
Purchases of investments............................................................... (49,676) (292,161) (207,090)
Proceeds from maturities of investments................................................ 14,874 242,196 219,786
Purchases of cost method investments................................................... -- (11,083) (2,000)
(Purchase) redemption of restricted cash equivalents................................... (359) (31,774) 1,975
-------- --------- ---------
Net cash used in investing activities.................................................. (42,453) (108,076) (8,605)
FINANCING ACTIVITIES:....................................................................
Proceeds from issuance of common stock................................................. -- 376,673 --
Proceeds from exercise of stock options................................................ 4 1,305 2,214
Proceeds from issuance of preferred stock.............................................. 51,000 143,000 --
Acquisition of treasury stock.......................................................... -- -- (200)
Offering costs......................................................................... (49) (2,195) (651)
Payments of capital lease obligations.................................................. (760) (15,091) (64,083)
-------- --------- ---------
Net cash provided by (used in) financing activities.................................... 50,195 503,692 (62,720)
-------- --------- ---------
Net increase (decrease) in cash and cash equivalents................................... (8,267) 305,254 (119,774)
Effect of exchange rates on cash and cash equivalents.................................. -- (406) 747
Cash and cash equivalents at beginning of year......................................... 8,280 13 304,861
-------- --------- ---------
Cash and cash equivalents at end of year............................................... $ 13 $ 304,861 $ 185,834
======== ========= =========
Supplemental disclosure of cash flow information:
Cash paid during the year for interest................................................. $ 393 $ 6,808 $ 15,387
======== ========= =========
Supplemental disclosures of non-cash financing activity:
Capital lease obligations incurred in connection with the purchase of property and
equipment............................................................................. $ 20,124 $ 118,629 $ 45,028
======== ========= =========
Capital lease obligations incurred in connection with the purchase of rights to use fiber
optic capacity.......................................................................... $ 900 $ 6,865 $ 2,398
======== ========= =========
See accompanying notes to consolidated financial statements.
30
StorageNetworks, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001
1. Business
StorageNetworks, Inc. (the "Company") is a leading provider of data storage
management services and developer of data storage management software. The
Company provides both managed storage services, which includes its PACS storage
services, STORmanage storage services, and STORfusion storage services, as well
as professional services, to its customers. The Company's proprietary software
and data storage management services enable its customers to deliver
cost-effective solutions to store, manage and protect information. The
Company's professional services assist customers in assessing their data
storage needs and designing appropriate data storage systems.
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent liabilities at the date of the consolidated financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
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, (ii) professional services fees, and
(iii) proceeds from data storage equipment sales to customers. 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.
Equipment sales are recognized when the equipment is delivered to the
customer or placed into service.
31
StorageNetworks, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Cash Equivalents
Cash equivalents consist of highly liquid investments with maturities of 90
days or less at the time of purchase. As of December 31, 2000 and 2001, cash
equivalents consisted principally of money market funds.
Restricted Cash Equivalents
Restricted cash equivalents represent amounts that are restricted as to
their use in accordance with financing and leasing arrangements.
Investments
The Company classifies its short and long-term investments as held to
maturity in accordance with Statement of Financial Accounting Standards No. 115
"Accounting for Investments in Debt and Equity Securities." Such investments
are carried at amortized cost, which approximates market value. The Company
reviews investments on a quarterly basis for reductions in market value that
are other than temporary. When such reductions occur, the cost of the
investment is adjusted to its fair value.
Cost method investments represent a less than 20% ownership share in the
preferred stock of privately held companies.
Concentrations of Credit Risk
Carrying amounts of financial instruments held by the Company, which include
cash equivalents, accounts receivable, accounts payable and accrued expenses,
approximate fair value due to their short duration. Financial instruments that
potentially expose the Company to a concentration of credit risk principally
consist of cash and cash equivalents, investments and accounts receivable.
The Company's customer base is primarily composed of businesses throughout
the United States. The Company performs ongoing credit evaluations of its
customers and maintains reserves for potential losses. One managed storage
service customer accounted for 10% of the Company's consolidated total revenues
for the year ended December 31, 2001. Revenues earned from two professional
services customers for which the Company had sub-contracting agreements
accounted for 14% and 12%, respectively, of the Company's consolidated total
revenues for the year ended December 31, 2000. One of those professional
services customers accounted for approximately 40% of the Company's
consolidated total revenues for the year ended December 31, 1999.
Property and Equipment
Property and equipment are stated at cost and depreciated on a straight-line
basis over their respective estimated useful lives, which are generally three
to four years. Equipment recorded under capital leases and leasehold
improvements are depreciated using the straight-line method over the shorter of
the respective lease term or estimated useful life of the asset.
Research and Development Costs
Research and development costs are expensed as incurred and include costs to
develop, enhance and manage the Company's proprietary technology.
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 bases 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.
32
StorageNetworks, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock-Based Compensation
The Company accounts for its stock-based compensation plans utilizing the
provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB 25"). The Company has adopted the disclosure
provisions only of Statement of Financial Accounting Standards No. 123,
"Accounting For Stock-Based Compensation" ("SFAS 123").
Impairment of Long-Lived Assets
The Company continually reviews the carrying value of long-lived assets,
including property and equipment, to determine whether there are any
indications of impairment losses. Recoverability of long-lived assets is
measured by a comparison of the carrying amount of an asset to future net cash
flows expected to be generated by the asset. If such assets are considered to
be impaired, the impairment to be recognized is measured by the amount by which
the carrying amount of the assets exceeds the fair value of the assets.
Software Development Costs
Under Statement of Financial Accounting Standards No. 86 "Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed," certain
software development costs incurred subsequent to the establishment of
technological feasibility are capitalized and amortized over the estimated
lives of the related products. Technological feasibility is established upon
completion of a working model, which is typically demonstrated by initial beta
shipment. As of December 31, 2001 all software development costs have been
charged to research and development expense in the accompanying consolidated
statements of operations.
Advertising Expenses
All advertising costs are expensed as incurred. Advertising costs were not
material for the year ended December 31, 1999. The Company incurred $5.6
million and $1.2 million in advertising costs during the years ended December
31, 2000 and 2001.
Foreign Currency Translation
The financial statements of foreign subsidiaries have been translated into
U.S. dollars in accordance with FASB Statement No. 52, "Foreign Currency
Translation". All balance sheet accounts have been translated using the
exchange rates in effect at the balance sheet date. Statements of operations
amounts have been translated using the average exchange rate for the year. The
gains and losses resulting from the changes in exchange rates have been
reported in other comprehensive income.
Net Loss Per Share
Basic net loss per share is computed by dividing the net loss for the period
by the weighted average number of shares of common stock outstanding during the
period. Diluted loss per share does not differ from basic loss per share since
potential common shares to be issued upon the exercise of stock options and the
conversion of preferred stock are anti-dilutive for the periods presented.
Segment Information
The Company has adopted Statement of Financial Accounting Standards No. 131,
"Disclosure about Segments of an Enterprise and Related Information" ("SFAS
131"), which requires companies to report selected information about operating
segments, as well as enterprise-wide disclosures about products, services,
geographical areas and major customers. Operating segments are determined based
on the way management organizes its business for making operating decisions and
assessing performance.
33
StorageNetworks, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. Investments
Investments consist of the following (in thousands):
December 31, 2000
---------------------------------------
Gross Gross Estimated
Unrealized Unrealized Fair
Cost Gains Losses Value
------- ---------- ---------- ---------
U.S. government securities due within one year.......... $42,500 $-- $-- $42,500
Corporate notes due within one year..................... 42,267 -- -- 42,267
------- --- --- -------
Total debt securities included in short-term investments $84,767 $-- $-- $84,767
======= === === =======
December 31, 2001
---------------------------------------
Gross Gross Estimated
Unrealized Unrealized Fair
Cost Gains Losses Value
------- ---------- ---------- ---------
U.S. government securities due within one year........... $31,058 $-- $-- $31,058
Corporate notes due within one year...................... 11,920 -- -- 11,920
------- --- ---- -------
Total debt securities included in short-term investments. $42,978 $-- $-- $42,978
======= === ==== =======
U.S. government securities due within two years.......... 19,133 -- -- 19,133
Corporate notes due within two years..................... 10,804 -- -- 10,804
------- --- ---- -------
Total debt securities included in non-current investments $29,937 $-- $-- $29,937
======= === ==== =======
4. Property and Equipment
Property and equipment consist of the following (in thousands):
2000 2001
-------- --------
Managed storage service equipment................ $151,163 $ 60,011
Furniture, fixtures, computer equipment and other 7,843 9,778
Leasehold improvements........................... 2,377 9,845
-------- --------
161,383 79,634
Less accumulated depreciation.................... (25,516) (12,560)
-------- --------
$135,867 $ 67,074
======== ========
Depreciation expense amounted to $1.7 million, $23.8 million and $53.1
million in 1999, 2000 and 2001, respectively.
Included in the December 31, 2000 and 2001 amounts above are property and
equipment under capital leases with an adjusted cost basis of $126.4 million
and $40.9 million and accumulated depreciation of $20.9 million and $7.9
million, respectively.
34
StorageNetworks, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. Accrued Expenses
Accrued expenses consist of the following (in thousands):
2000 2001
------- -------
Accrued bonuses.............. $ 9,316 $ 7,345
Accrued restructuring charges -- 18,903
Accrued other................ 13,818 24,011
------- -------
$23,134 $50,259
======= =======
6. Stockholders' Equity
Common Stock
The Company has authorized 600,000,000 shares of common stock, $.01 par
value. The voting, dividend and liquidation rights of the holders of common
stock are subject to, and qualified by, the rights of the holders of preferred
stock. The holders of common stock are entitled to one vote for each share
held. The Board of Directors (the "Board") may declare dividends subject to
preferential dividend rights of any outstanding preferred stock. Holders of
common stock are entitled to receive all assets available for distribution on
the dissolution or liquidation of the Company, subject to any preferential
rights of any outstanding preferred stock.
Initial Public Offering
In July 2000, the Company completed its initial public offering ("IPO") in
which it sold 10,350,000 shares of common stock at a price to the public of
$27.00 per share. The net proceeds of the IPO after deducting underwriting
discounts were $258.6 million. Upon the closing of the IPO, all of the
Company's then outstanding convertible preferred stock automatically converted
into an aggregate of 54,109,118 shares of common stock.
Preferred Stock
The Company's amended and restated certificate of incorporation authorizes
the issuance of 5,000,000 shares of preferred stock. The Board has discretion
to determine the rights, preferences, privileges and restrictions, including
voting rights, dividend rights, conversion rights, redemption privileges and
liquidation preferences of each series of preferred stock.
Stock Option Plans
The Company has adopted the StorageNetworks, Inc. Amended and Restated 1998
Stock Incentive Plan, the 2000 Stock Plan and the 2000 Non-Employee Director
Option Plan (collectively, the "Stock Plans"), which are administered by the
Board. Under the terms of the Stock Plans, the Board may grant stock awards to
officers, employees and consultants of the Company. The Stock Plans permit the
grant of incentive stock options and nonqualified stock options. As of December
31, 2001, the Company has reserved 21,818,601 shares of common stock for
issuance under the Stock Plans. Incentive stock options may not be granted at
less than 100% of the fair market value of the common stock on the date of the
grant and may not expire more than ten years from the date of the grant. Stock
options granted under the Stock Plans generally will become exercisable over a
four-year period unless the Board specifies a different vesting schedule. The
Stock Plans have a term of ten years, subject to earlier termination or
amendment by the Board, and options outstanding under the Stock Plans prior to
its termination remain outstanding after such termination.
35
StorageNetworks, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
2000 Employee Stock Purchase Plan
The 2000 Employee Stock Purchase Plan (the "2000 Stock Purchase Plan") was
adopted by the Board and approved by our Stockholders in March 2000. The 2000
Stock Purchase Plan authorizes the issuance of up to a total of 10,000,000
shares of common stock to the Company's participating employees.
The following table presents the activity of the Stock Plans for the periods
ended December 31, 1999, 2000 and 2001:
1999 2000 2001
-------------------- -------------------- --------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- -------- ---------- -------- ---------- --------
Outstanding options at beginning of
year............................. 2,266,000 $0.03 9,126,000 $ 0.73 9,969,030 $10.07
Granted............................ 9,664,000 0.70 3,665,650 27.34 12,088,161 7.76
Exercised.......................... (131,500) 0.03 (1,984,337) 0.66 (2,419,938) 0.71
Cancelled.......................... (2,672,500) 0.04 (838,283) 6.06 (7,225,070) 11.04
---------- ----- ---------- ------ ---------- ------
Outstanding options at end of year. 9,126,000 $0.73 9,969,030 $10.07 12,412,183 $ 9.07
========== ===== ========== ====== ========== ======
Exercisable at end of year......... 43,000 $0.34 1,035,213 $ 2.13 1,901,458 $11.69
========== ===== ========== ====== ========== ======
Available for grant at end of year. 1,662,500 10,835,133 9,406,418
========== ========== ==========
The following table summarizes information about the Company's stock options
at December 31, 2001:
Stock Options Outstanding Stock Options Exercisable
-------------------------------- -------------------------
Weighted Weighted Weighted
Average Average Average
Number Contractual Exercise Number Exercise
Outstanding Life (yrs) Price Exercisable Price
----------- ----------- -------- ----------- --------
9,909,897 8.2 $ 4.50 1,308,302 $ 3.99
1,936,411 7.8 18.39 432,900 17.46
42,500 7.9 25.07 10,624 25.07
444,875 8.5 55.00 121,496 55.00
67,750 8.5 84.50 23,403 84.50
8,750 4.8 102.80 2,733 102.80
2,000 8.5 115.13 2,000 115.13
---------- ---------
12,412,183 8.2 $ 9.07 1,901,458 $ 11.69
========== =========
Stock-Based Compensation
As discussed in Note 2, the Company applies APB 25 and related
interpretations in accounting for its Stock Plans. For the years ended December
31, 1999, and 2000, the Company recorded $20.8 million and $580,000 in deferred
compensation for options to purchase common stock granted at exercise prices
determined to be below the fair value of common stock. Compensation expense of
$1.3 million, $5.1 million and $3.9 million was recognized during the years
ended December 31, 1999, 2000 and 2001. 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
36
StorageNetworks, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
over the options' vesting periods. The Company's pro forma information follows
for the year ended December 31, 1999, 2000 and 2001 (in thousands, except per
share amounts):
1999 2000 2001
-------- --------- ---------
Pro forma net loss............................... $(23,816) $(140,111) $(253,635)
Pro forma net loss per share -- basic and diluted $ (0.98) $ (2.38) $ (2.62)
The fair value of each option is estimated on the grant date using the
Black-Scholes option-pricing model with the following assumptions:
1999 2000 2001
Stock Options: ----- ------ -----
Expected term (years)......................... 4.0 3.7 4.8
Risk-free interest rate (%)................... 5.5 6.2 4.3
Expected volatility (%)....................... -- 147 136
Dividend yield (%)............................ 0 0 0
Weighted average fair value of options granted $2.61 $22.69 $6.82
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 periods presented include only one, two and three years of option grants
under the Stock Plans.
Stock Warrants
At December 31, 2001, there were warrants outstanding to purchase 80,000
shares of common stock with an exercise price of $22.75 per share. The warrants
expired on March 1, 2002.
On February 29, 2000, the Company issued warrants to three customers to
purchase 810,000 shares of preferred stock, that converted to warrants to
purchase 810,000 shares of common stock upon the completion of the Company's
IPO in July 2000, at $22.75 per share. The fair value of the warrants was
determined to be $3.5 million and was calculated using the Black-Scholes option
pricing model with the following assumptions: volatility--95%, dividends--none,
expected life-- 1/4/ year, risk-free interest rate--5.5%. All of the warrants
were immediately exercisable. Warrants with a fair value of $1.9 million issued
to customers with non-cancelable managed services contracts have been deferred
and will be amortized over the contract term and had a balance of $788,000 at
December 31, 2001. The remaining warrants with a fair value of $1.7 million are
included in sales and marketing expenses for the year ended December 31, 2000. /
7. Income Taxes
As of December 31, 2001, the Company had federal and state net operating
loss carryforwards of approximately $266.1 million. The net operating loss
carryforwards will expire at various dates beginning in the years 2003 through
2021 if not utilized.
37
StorageNetworks, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Significant components of the Company's deferred tax assets and liabilities
for federal and state income taxes consist of the following at December 31 (in
thousands):
1999 2000 2001
------- -------- ---------
Deferred tax assets:
Net operating loss and tax credit carryforwards. $10,203 $ 63,100 $ 108,825
Restructuring charges........................... -- -- 45,226
Other........................................... 459 1,710 1,774
------- -------- ---------
10,662 64,810 155,825
Deferred tax liabilities:
Depreciation.................................... 1,497 5,866 5,280
------- -------- ---------
9,165 58,944 150,545
Valuation allowance............................. (9,165) (58,944) (150,545)
------- -------- ---------
Net deferred tax asset...................... $ -- $ -- $ --
======= ======== =========
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.
8. Impairment Charge and Other Related Costs
In 2001, the Company recorded an asset impairment charge of $79.0 million,
or ($0.82) per share and other one-time charges of $35.4 million, or ($0.37)
per share.
During 2001, demand for services in third party data centers weakened. In
addition, the Company recognized that there was limited demand for fully
managed primary data services from enterprise customers. During the fourth
quarter of 2001, general economic conditions remained difficult and hosting
service providers continued to experience significant financial difficulties.
As a result, the Company focused its sales and marketing efforts on selling
software and services to large enterprise organizations. This focus triggered
an impairment review of long-lived assets, primarily storage hardware assets
used in delivering the Company's fully managed storage services, within the
Company's traditional S-POP data centers.
The Company calculated the expected net undiscounted cash flows of each
S-POP data center to determine which group of assets was impaired. For those
assets where impairment was present, a loss was recognized for the difference
between the asset carrying values and fair market values. The Company
determined fair market value based on multiple quotes from third party data
storage equipment resellers. In conducting the impairment review, the Company
separated assets in production (assets to be held and used) from idle assets
(assets to be disposed of). Assets to be held used and assets to be disposed of
accounted for $55.4 million and $23.6 million, respectively, of the total $79.0
million asset impairment charge.
In addition, as a result of the Company's new focus toward selling software
and services to large enterprise organizations, the Company determined that
certain assets and future obligations no longer matched the needs of the
Company's current enterprise customers or the future direction of the business.
Therefore, the Company recognized a one-time charge of $35.4 million related to
the following items: fiber related assets and obligations ($12.4 million)
(which includes the Company's estimated obligation to Metromedia Fiber Network
("MFN") under its Fiber Optic Network Leased Fiber Agreement with MFN), the
permanent impairment of strategic
38
StorageNetworks, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
investments of privately-held companies with businesses complementary to the
Company's fully managed primary storage services ($12.1 million), future
commitments for office and S-POP data center floor space ($6.6 million), future
commitments for assets related to fully managed primary storage services ($3.0
million) and employee termination costs and other charges ($1.3 million).
At December 31, 2001, the Company has $18.9 million remaining in accruals
for costs related to future obligations for the following items: fiber related
obligations ($9.0 million), future commitments for office and S-POP data center
floor space ($6.6 million), future commitments for assets related to fully
managed primary storage services ($3.0 million) and employee termination costs
and other charges ($300,000).
9. Commitments and Contingencies
Leases
The Company has entered into a number of operating leases for its
facilities. The leases expire from 2002 through 2011. The Company also leases
certain data center infrastructure and equipment under capital leases. Certain
of these capital leases were entered into as sales-leaseback transactions. No
gain or loss was recorded in any such transaction due to the short holding
period from the time the assets were purchased until the time of the
sale-leaseback. Future minimum lease payments as of December 31, 2001 are as
follows:
Capital Operating
Leases Leases
-------- ---------
(in thousands)
Year ending December 31,
2002.................................................... $ 54,740 $11,600
2003.................................................... 46,632 9,749
2004.................................................... 17,424 7,801
2005.................................................... 968 5,173
2006.................................................... -- 4,294
Thereafter.............................................. -- 17,889
-------- -------
Total minimum lease payments............................... 119,764 $56,506
=======
Less amounts representing imputed interest................. 15,189
--------
Present value of minimum lease payments.................... 104,575
Less current portion....................................... 44,063
--------
Capital lease obligations, less current portion..... $ 60,512
========
The Company's rent expense was approximately $2.4 million, $19.6 million and
$25.3 million for the years ended December 31, 1999, 2000 and 2001,
respectively. Future minimum rentals to be received under noncancelable
subleases totaled $3.3 million at December 31, 2001.
Litigation
In July 2001, the Company initiated an action against 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 the Company's Fiber Optic Network Leased Fiber Agreement with
MFN. MFN also initiated an action in New York, New York alleging that the
Company has breached such agreement. While the outcome of these matters is not
currently determinable, the Company believes that the result will not have a
material adverse effect on the result of its operations or its financial
position.
39
StorageNetworks, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In August, 2001, a purported class action lawsuit was filed in the United
States District Court for the Southern District of New York against the Company
and several of its officers or directors as well as against the underwriters of
the Company's initial public offering of common stock in June, 2000. The
complaint, which seeks unspecified damages, was filed allegedly on behalf of
persons who purchased the Company's 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 the Company, the underwriters and the other named
defendants made material false and misleading statements in the prospectus that
was part of the registration statement on Form S-1 that was filed in connection
with the Company's 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 inceased prices. Although the Company believes that these claims are
without merit and intends to defend vigorously against such claims, it is not
presently able to reasonably estimate potential losses, if any, related to this
matter.
In addition, the Company is subject to various claims and proceedings in the
ordinary course of business. Based on information currently available, the
Company believes that none of such current claims or proceedings, individually
or in the aggregate, will materially harm our financial condition or results of
operations.
10. 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 0%, 2% and 10% for the years ended December
31, 1999, 2000 and 2001, respectively. The percentage of professional services
revenues derived from international operations totaled 0%, 4% and 1% for the
years ended December 31, 1999, 2000 and 2001, respectively.
Total assets for the Company's managed storage services totaled $136.2
million and $79.7 million at December 31, 2000 and 2001, respectively. Total
assets pertaining to the Company's professional services were $3.3 million and
$1.2 million at December 31, 2000 and 2001, respectively. Long-lived assets
located internationally were not material in any period.
11. Employee Benefit Plan
In January 2000, the Company established a savings plan that is designed to
be qualified under Section 401(k) of the Internal Revenue Code (The "401(k)
Plan"). Eligible employees are permitted to contribute to the 401(k) Plan
through payroll deductions within statutory and plan limits. The Company made
no contributions to the 401(k) Plan in 2000 or 2001.
12. Related Party Transaction
In August 2000, pursuant to a secured promissory note, the company loaned
$1.2 million to an executive officer for the purchase of a principal residence
in connection with the executive officer's relocation to the Company's
corporate headquarters. The note was secured by a mortgage on the property, had
a term of four years and an interest rate of 6.62%. The note was included in
other assets on the Company's balance sheet at December 31, 2000. The note was
paid in full in 2001.
40
13. Selected Quarterly Results of Operations (unaudited)
First Second Third Fourth Fiscal
Quarter Quarter Quarter Quarter Year
-------- -------- -------- --------- ---------
FISCAL 2001
Total net revenue............................ $ 27,105 $ 33,402 $ 31,540 $ 31,578 $ 123,625
Gross margin (deficit)....................... (5,788) (985) 1,024 2,160 (3,589)
Net loss..................................... (32,863) (32,202) (26,996) (132,912) (224,973)
Net loss per share -- Basic and diluted...... $ (0.34) $ (0.33) $ (0.28) $ (1.36) $ (2.33)
Number of shares used in computing per share
amounts -- basic and diluted............... 95,842 96,449 96,723 97,440 96,698
FISCAL 2000
Total net revenue............................ $ 4,620 $ 8,038 $ 14,320 $ 21,240 $ 48,218
Gross margin (deficit)....................... (11,291) (12,813) (12,583) (6,984) (43,671)
Net loss..................................... (27,016) (31,317) (33,492) (33,040) (124,865)
Net loss per share -- Basic and diluted...... $ (1.09) $ (1.20) $ (0.37) $ (0.36) $ (2.12)
Number of shares used in computing per share
amounts -- basic and diluted............... 24,765 26,126 90,890 93,038 58,888
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.
None.
PART III
Item 10. Directors and Executive Officers of the Registrant.
Except as set forth below, the information required by this item is
incorporated by reference to the information under the captions "Election of
Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the
definitive proxy statement filed with the Securities and Exchange Commission
with respect to our 2002 Annual Meeting of Stockholders (the "Proxy Statement")
to be held on May 15, 2002.
Our executive officers and directors, and their ages and positions as of
March 15, 2002, are as follows:
Name Age Position
- ---- --- --------
Peter W. Bell............ 37 Chairman of the Board, Chief Executive Officer,
President and Director
William D. Miller........ 41 Executive Vice President, Chief Technical Officer
and Director
Paul C. Flanagan......... 37 Executive Vice President, Chief Financial Officer,
Treasurer and Secretary
Jeffrey P. Keohane....... 39 Executive Vice President of Worldwide Sales
Robert E. Davoli (1)(2).. 53 Director
Stephen J. Gaal (1)(2)... 57 Director
Michael D. Lambert (1)(2) 55 Director
- --------
(1) Member of the Compensation Committee
(2) Member of the Audit Committee
41
Set forth below is certain information regarding the professional experience
for each of the above-named persons.
Peter W. Bell co-founded StorageNetworks and has served as our Chief
Executive Officer and President and as a director since October, 1998 and as
our Chairman of the Board since January, 2000. From July, 1997 to July, 1998,
Mr. Bell served as the Vice President of Worldwide Sales at Andataco, Inc., an
integrator of storage technology products. From July, 1996 to July, 1997, Mr.
Bell served as the Executive Vice President of Sales, Services and Marketing at
NetXchange, a provider of internet telephony software. Between November, 1986
and June, 1996, Mr. Bell held a variety of management positions in marketing,
operations and sales at EMC Corporation, a vendor of storage hardware, software
and services, including Director of Sales, Open Storage Group.
William D. Miller co-founded StorageNetworks and has served as our Executive
Vice President and Chief Technical Officer and as a director since October,
1998. From 1994 to 1998, Mr. Miller managed strategic accounts for Andataco,
Inc., an integrator of storage technology products.
Paul C. Flanagan has served as our Executive Vice President since April,
2000, and as our Chief Financial Officer since March, 1999. From May, 1997 to
February, 1999, Mr. Flanagan served as Vice President of Finance for Lasertron,
Inc., a manufacturer of fiber optic components for telecommunications. From
December, 1995 to May, 1997, Mr. Flanagan served as Vice President of Finance
and Administration for Vitol Gas and Electric, LLC, an energy commodity trading
company. From September, 1986 to December, 1995, Mr. Flanagan was employed by
Ernst & Young LLP, a public accounting firm.
Jeffrey P. Keohane has served as our Executive Vice President of Worldwide
Sales since February, 2002. From March, 2001 to February, 2002, Mr. Keohane
served as our Executive Vice President of Business Operations. From February,
1993 to March, 2001, Mr. Keohane held various positions at Comdisco, Inc., a
global technology services provider, including Senior Vice President, and was
also President of Comdisco Technology Services, where he was responsible for
managing its continuity services, storage services, web services and networks
services lines of business. Previous to that position, Mr. Keohane was
responsible for Comdisco's enterprise systems leasing and trading business.
Robert E. Davoli has served as a director of StorageNetworks since December,
1998, as a member of the Compensation Committee since August, 1999, and as a
member of the Audit Committee since January, 2002. Mr. Davoli has been a
general partner of Sigma Partners, a venture capital firm, since 1995. Prior to
his association with Sigma Partners, he was President and Chief Executive
Officer of Epoch Systems, a vendor of client-server data management software
products. Mr. Davoli also serves on the board of directors of Internet Security
Systems, Inc., Vignette Corporation, and Versata, Inc.
Stephen J. Gaal has served as a director of StorageNetworks since October,
1998, as a member of the Compensation Committee since August, 1999, and as a
member of the Audit Committee since March 2000. Mr. Gaal, a private investor,
was the founder and Managing Director of Gaal & Company, Inc. from 1997 to
early 2002, which provided advisory services to emerging technology companies
in the areas of business and financial strategy and planning. Between 1987 and
1996, Mr. Gaal held the positions of Principal, Partner, and Managing Director
of TA Associates, a venture capital and private equity firm.
Michael D. Lambert has served as a director of StorageNetworks since
January, 2000, as a member of the Compensation Committee since March, 2000, and
as a member of the Audit Committee since December, 2000. Mr. Lambert is Senior
Vice President of the Enterprise Systems Group of Dell Computer Corporation, a
direct provider of computer systems and services. In this position, his
responsibilities include the development and delivery of Internet-related
consulting and hosting services, and the oversight of engineering, product
marketing and manufacturing of servers, storage and related products. From 1993
to 1996, Mr. Lambert held the position of Vice President of Sales and
Marketing, North America, for Compaq Computer Corporation, a developer and
manufacturer of computer hardware, software and services.
42
Item 11. Executive Compensation.
The information required by this item in incorporated by reference from the
information under the captions "Election of Directors--Compensation of
Directors," "Executive Compensation," "Compensation Committee Report on
Executive Compensation" and "Compensation Committee Interlocks and Insider
Participation" in the Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this item is incorporated by reference from the
information under the caption "Stock Ownership of Certain Beneficial Owners and
Management" in the Proxy Statement.
Item 13. Certain Relationships and Related Transactions.
The information required by this item is incorporated by reference from the
information under the caption "Certain Relationships and Related Party
Transactions" in the Proxy Statement.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) The following documents are included in this Annual Report on Form 10-K.
1. Financial Statements (see Item 8--Financial Statements and
Supplementary Data included in this Annual Report on Form 10-K).
2. The schedule listed below and the Report of Independent Auditors are
filed as part of this Annual Report on Form 10-K:
Page
No.
----
Schedule II--Valuation and Qualifying Accounts S-1
All other schedules are omitted as the information required is inapplicable
or the information is presented in the consolidated financial statements and
related notes thereto.
3. Exhibits
The exhibits filed as part of this Annual Report on Form 10-K are listed
in the Exhibit Index immediately preceding the exhibits and are incorporated
herein.
(b) No current reports on Form 8-K were filed by the Company during the
fourth quarter of the year ended December 31, 2001.
The following registered trademarks and trademarks or servicemarks of
StorageNetworks are mentioned in this Annual Report on Form 10-K:
StorageNetworks, PACS, DataPACS, NetPACS, BackPACS, STORmanage, STORos,
STORvision, Virtual Storage Portal, VSP, S-POP and STORfusion.
43
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.
STORAGENETWORKS, INC.
/S/ PETER W. BELL
By_________________________________
Peter W. Bell
President and Chief Executive Officer
Date: March 19, 2002
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ PETER W. BELL President, Chief Executive
- ----------------------------- Officer and Director
Peter W. Bell (Principal Executive
Officer) March 19, 2002
/s/ WILLIAM D. MILLER Executive Vice President,
- ----------------------------- Chief Technical Officer and
William D. Miller Director March 19, 2002
/s/ PAUL C. FLANAGAN Executive Vice President,
- ----------------------------- Chief Financial Officer,
Paul C. Flanagan Treasurer and Secretary
(Principal Financial and
Accounting Officer) March 19, 2002
/s/ ROBERT E. DAVOLI
- -----------------------------
Robert E. Davoli Director March 19, 2002
/s/ STEPHEN J. GAAL
- -----------------------------
Stephen J. Gaal Director March 19, 2002
/s/ MICHAEL D. LAMBERT
- -----------------------------
Michael D. Lambert Director March 19, 2002
44
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
3.1* Amended and Restated Certificate of Incorporation of StorageNetworks, Inc.
3.2** Amended and Restated By-Laws of StorageNetworks, Inc., as amended to date.
4.1* Specimen common stock certificate.
10.1*# Amended and Restated 1998 Stock Incentive Plan, as amended to date.
10.2*# 2000 Stock Plan.
10.3*# 2000 Non-employee Director Option Plan.
10.4* Master Lease Agreement between StorageNetworks, Inc. and Dell Financial Services dated
June 15, 1999.
10.5* Third Amended and Restated Stockholder Rights Agreement dated as of February 29, 2000
among StorageNetworks, Inc. and certain stockholders of StorageNetworks, Inc. named therein.
10.6+* Fiber Optic Network Agreement with Metromedia Fiber Network Services Inc. dated October 8,
1999.
10.7*# Employment Agreement with Paul Flanagan dated March 15, 1999.
10.8***# Form of Contingent Compensation Payment Agreement for each of Peter W. Bell, William D.
Miller and Paul C. Flanagan
10.9***# Amendment to Incentive Stock Option Agreements between StorageNetworks, Inc. and Paul C.
Flanagan
10.10 Statement re: per share earnings (This exhibit has been omitted because the information is shown
in the financial statements or notes thereto).
10.11*# 2000 Employee Stock Purchase Plan
10.12+* Agreement for Professional Services between StorageNetworks, Inc. and Dell Marketing L.P.
dated April 27, 2000.
10.13++** Hobbs Brook Office Park Lease between StorageNetworks, Inc. and 275 Wyman Street Trust
dated July 31, 2000.
21.1 List of Subsidiaries.
23.1 Consent of Ernst & Young LLP.
- --------
* Incorporated by reference to StorageNetworks, Inc.'s Registration Statement
on Form S-1 filed on March 1, 2000 (Registration No. 333-31430).
** Incorporated by reference to StorageNetworks, Inc.'s Registration Statement
on Form S-1 filed on October 24, 2000 (Registration No. 333-48530).
*** Incorporated by reference to StorageNetworks, Inc.'s Quarterly Report on
Form 10-Q filed on November 13, 2001.
+ Confidential treatment has been granted for certain portions of this Exhibit
pursuant to Rule 406 promulgated under the Securities Act of 1933, as
amended.
++ Confidential treatment has been granted for certain portions of this Exhibit
pursuant to Rule 24(b) promulgated under the Securities Exchange Act of
1934, as amended.
# Management contract or compensatory plan or arrangement.
45
SCHEDULE II
STORAGENETWORKS, INC.
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Balance at Charged to Deductions Balance at
Beginning Costs and from End of
Description of Period Expenses Other Reserves Period
- ----------- ---------- ---------- ----- ---------- ----------
YEAR ENDED DECEMBER 31, 2001............................
Reserves and allowances deducted from asset
accounts:
Allowance for doubtful accounts. . . . . . . . . . .. $307 1,971 0 117 $2,161
YEAR ENDED DECEMBER 31, 2000............................
Reserves and allowances deducted from asset
accounts:
Allowance for doubtful accounts. . . . . . . . . . .. $ 76 263 0 32 $ 307
YEAR ENDED DECEMBER 31, 1999............................
Reserves and allowances deducted from asset
accounts:
Allowance for doubtful accounts. . . . . . . . . . .. $ 0 76 0 0 $ 76
S-1