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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
FOR THE QUARTERLY PERIOD ENDED 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: 000-27787
DIGITAL IMPACT, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3286913
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
177 BOVET ROAD
SAN MATEO, CALIFORNIA 94402
(Address of principal executive offices)
TELEPHONE NUMBER (650) 356-3400
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days:
Yes [X] No [ ]
As of February 9, 2002, there were approximately 29,122,000 shares of the
Registrant's Common Stock outstanding.
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DIGITAL IMPACT, INC.
INDEX
PART I. FINANCIAL INFORMATION Page No.
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
Condensed Consolidated Statements of Operations for the
three and nine months ended December 31, 2001 and 2000............3
Condensed Consolidated Balance Sheets as of
December 31, 2001 and March 31, 2001..............................4
Condensed Consolidated Statements of Cash Flows for the
nine months ended December 31, 2001 and 2000......................6
Notes to Condensed Consolidated Financial Statements...............7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS........................................11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........19
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.................................................20
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.........................20
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K..................................21
SIGNATURES........................................................22
2
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DIGITAL IMPACT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
Three months ended Nine months ended
December 31, December 31,
-------------------- --------------------
2001 2000 2001 2000
--------- -------- -------- --------
Revenues $ 10,329 $ 12,156 $ 28,755 $ 30,001
Cost of revenues 4,840 5,326 13,612 13,193
-------- -------- -------- --------
Gross margin 5,489 6,830 15,143 16,808
Operating expenses:
Research and development 2,493 4,934 9,216 12,800
Sales and marketing 3,576 4,935 12,480 13,085
General and administrative 1,948 3,111 6,566 8,178
Stock-based compensation 278 595 2,428 4,353
Amortization of goodwill and
purchased intangibles 375 2,411 1,125 4,018
Write-off of acquired in-process
research and development and
fixed assets -- -- -- 4,563
-------- -------- -------- --------
Total operating expenses 8,670 15,986 31,815 46,997
-------- -------- -------- --------
Loss from operations (3,181) (9,156) (16,672) (30,189)
Other income and (expense) (26) 664 299 2,500
-------- -------- -------- --------
Net loss $ (3,207) $ (8,492) $(16,373) $(27,689)
======== ======== ======== ========
Net loss per common share -- basic
and diluted $ (0.11) $ (0.34) $ (0.59) $ (1.17)
======== ======== ======== ========
Shares used in net loss per common
share calculation -- basic and diluted 28,340 25,080 27,650 23,760
======== ======== ======== ========
The accompanying notes are an integral part of
these unaudited condensed consolidated
financial statements.
3
DIGITAL IMPACT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
December 31, March 31,
2001 2001
------------ ---------
ASSETS
Current assets:
Cash and cash equivalents $ 26,319 $ 35,038
Accounts receivable, net 9,096 12,899
Prepaid expenses and other current assets 1,313 551
--------- ---------
Total current assets 36,728 48,488
--------- ---------
Property and equipment, net 11,127 13,100
Restricted cash 1,932 1,847
Intangible assets 3,396 5,005
Other assets 494 579
--------- ---------
Total assets $ 53,677 $ 69,019
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,706 $ 4,557
Deferred revenues 1,670 1,050
Accrued payroll 1,599 2,342
Accrued liabilities 915 1,087
Current portion of capital lease obligations 699 862
Current portion of long term debt 1,808 913
--------- ---------
Total current liabilities 10,397 10,811
--------- ---------
Capital lease obligations, less current portion 123 524
Long term debt, less current portion 1,326 2,129
--------- ---------
Total liabilities 11,846 13,464
--------- ---------
Stockholders' equity:
Common Stock 28 28
Additional paid-in capital 142,177 141,822
Accumulated other comprehensive loss (34) (34)
Unearned stock-based compensation (1,843) (4,387)
Accumulated deficit (98,100) (81,727)
4
Less treasury stock at cost $ (397) (147)
========= =========
Total stockholders' equity 41,831 55,555
--------- ---------
Total liabilities and stockholders' equity $ 53,677 $ 69,019
========= =========
The accompanying notes are an integral part of
these unaudited condensed consolidated
financial statements.
5
DIGITAL IMPACT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine months ended
December 31,
--------------------
2001 2000
-------- --------
Cash flows from operating activities
Net loss $(16,373) $(27,689)
Adjustments to reconcile net loss to net cash used in
operating activities:
Write-off of acquired in-process research and
development and fixed assets -- 4,563
Depreciation and amortization 6,119 7,262
Provision for (recovery of) bad debts (67) 1,100
Amortization of unearned stock-based compensation 2,428 4,353
Unrealized loss on cash and cash equivalents -- (19)
Changes in operating assets and liabilities:
Accounts receivable 3,870 (10,508)
Prepaid expenses and other current assets (762) (231)
Other assets 85 (130)
Accounts payable (851) 2,132
Accrued liabilities and deferred revenue (295) 2,116
-------- --------
Net cash used in operating activities (5,846) (17,051)
-------- --------
Cash flows from investing activities
Acquisition of property and equipment (1,444) (8,469)
Cash acquired from acquisition -- 264
Restricted cash (85) (1,739)
-------- --------
Net cash used in investing activities (1,529) (9,944)
-------- --------
Cash flows from financing activities
Principal payments on long-term debt (1,565) (505)
Proceeds from exercise of common stock options and
warrants, net of treasury stock repurchases 221 1,438
-------- --------
Net cash (used in) provided by financing activities (1,344) 933
-------- --------
Net decrease in cash and cash equivalents (8,719) (26,062)
Cash and cash equivalents at beginning of period 35,038 68,073
-------- --------
Cash and cash equivalents at end of period $ 26,319 $ 42,011
======== ========
Supplemental noncash information:
Fair value of net assets acquired (excluding transaction
costs) $ -- $ 31,145
Assets acquired under capital leases $ 1,093 $ 140
Unearned stock-based compensation $ (148) $ (1,706)
The accompanying notes are an integral part of
these unaudited condensed consolidated
financial statements.
6
DIGITAL IMPACT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. THE COMPANY
Digital Impact, Inc. ("Digital Impact" or the "Company") is one of the premier
providers of online direct marketing solutions for enterprises. The Company was
incorporated in California in October 1997 and reincorporated in Delaware in
October 1999. Digital Impact's solutions -- Strategy, Customer Acquisition and
Customer Marketing -- enable corporations to create and deliver marketing
programs that drive revenue, influence behavior and deepen customer
relationships. Digital Impact solutions provide deeper customer insight and
powerful program execution through a combination of hosted web applications,
messaging technology infrastructure and professional services.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation and liquidity
The accompanying interim consolidated financial statements are unaudited, but in
the opinion of management, contain all the adjustments (consisting of those of a
normal, recurring nature) considered necessary to present fairly the financial
position, results of operations and cash flows for the periods presented in
conformity with generally accepted accounting principles applicable to interim
periods. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted under the Securities and Exchange
Commission's ("SEC") rules and regulations. Results of operations are not
necessarily indicative of the results expected for the full fiscal year or any
other future period.
The accompanying interim condensed consolidated financial statements should be
read in conjunction with the audited financial statements and the notes thereto
included in Digital Impact's Annual Report on Form 10-K for the fiscal year
ended March 31, 2001.
The Company has incurred recurring losses from operations and has an accumulated
deficit of approximately $98.1 million as of December 31, 2001. The Company has
incurred substantial losses and negative cash flows from operations since
inception. For the nine months ended December 31, 2001, the Company incurred a
loss from operations of approximately $16.7 million and negative cash flows from
operations of approximately $5.8 million.
The Company believes it has sufficient cash and cash equivalents to fund
operations for at least the next twelve months.
Principles of Consolidation
The accompanying interim consolidated financial statements include the accounts
of Digital Impact, Inc. and its wholly owned subsidiaries. All significant
intercompany transactions and balances have been eliminated on consolidation.
Comprehensive income
Comprehensive income is defined as the change in equity of a business enterprise
during a period from transactions and other events and circumstances from
non-owner
7
sources. Other comprehensive loss, a component of stockholders' equity, recorded
by the Company for the nine months ended December 31, 2001 was attributable to
an unrealized loss on cash equivalents. The Company did not have any additional
transactions that were required to be reported in other comprehensive income
during the nine months ended December 31, 2001.
Concentration of credit risk and other risks and uncertainties
Financial instruments subjecting the Company to concentration of credit risk
consist primarily of cash and cash equivalents and trade accounts receivable.
The Company's cash and cash equivalents are maintained at a major U.S. financial
institution. Deposits in this institution may exceed the amount of insurance
provided on such deposits.
The Company's customers are primarily concentrated in the United States. The
Company performs ongoing credit evaluations and establishes an allowance for
doubtful accounts based upon factors surrounding the credit risk of customers,
historical trends and other information.
NOTE 3. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 133, or SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS 133 establishes new
standards of accounting and reporting for derivative instruments and hedging
activities. SFAS 133 requires that all derivatives be recognized at fair value
in the statement of financial position, and that the corresponding gains or
losses be reported either in the statement of operations or as a component of
comprehensive income, depending on the type of hedging relationship that exists.
SFAS 133 is effective for fiscal years beginning after June 15, 2000. The
Company does not currently hold derivative instruments or engage in hedging
activities and hence the implementation of SFAS 133 did not have a material
impact upon the financial statements of the Company.
In July 2001, the Financial Accounting Standards Board issued SFAS No. 141
"Business Combinations," which established financial accounting and reporting
for business combinations and superseded APB Opinion No. 16, Business
Combinations, and FASB Statement No. 38, Accounting for Preacquisition
Contingencies of Purchased Enterprises. It requires that all business
combinations in the scope of this Statement are to be accounted for using one
method, the purchase method. The provisions of this Statement apply to all
business combinations initiated after June 30, 2001.
In July 2001, the Financial Accounting Standards Board issued SFAS No. 142
"Goodwill and Other Intangible Assets," which established financial accounting
and reporting for acquired goodwill and other intangible assets and supersedes
APB Opinion No. 17, Intangible Assets. It addresses how intangible assets that
are acquired individually or with a group of other assets (but not those
acquired in a business combination) should be accounted for in financial
statements upon their acquisition and after they have been initially recognized
in the financial statements. The provisions of this Statement are effective
starting with fiscal years beginning after December 15, 2001. Early adoption is
permitted for entities with fiscal years beginning after March 15, 2001,
provided that the first interim financial statements have not previously been
issued. Accordingly, the Company has elected not to early adopt SFAS No. 142
beginning with the first quarter of fiscal 2002. Upon adoption of FAS 142, the
Company will reclassify the amount relating to assembled workforce (currently
$1.4 million) from intangible assets to goodwill and will no longer amortize
goodwill.
On October 3, 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets." SFAS No. 144 supercedes SFAS No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." SFAS No. 144 applies to all long-lived assets (including
discontinued operations) and consequently amends APB Opinion No. 30, "Reporting
the Results of Operations, Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." SFAS No. 144 develops one accounting model for long-lived assets
that are to be disposed of by sale. SFAS No. 144 requires that long-lived assets
that are to be disposed of by sale be measured at the lower of book value or
fair value less cost to sell.
8
Additionally SFAS No. 144 expands the scope of discontinued operations to
include all components of an entity with operations that (1) can be
distinguished from the rest of the entity and (2) will be eliminated from the
ongoing operations of the entity in a disposal transaction. SFAS No. 144 is
effective for the Company for all financial statements issued in 2002. The
adoption of SFAS No. 144 is not expected to have a material impact on the
Company's financial statements.
NOTE 4. NET LOSS PER SHARE
Basic net loss per share is computed using the weighted-average number of
outstanding shares of common stock, excluding common stock subject to
repurchase. Diluted net loss per share is computed using the weighted-average
number of outstanding shares of common stock and, when dilutive, potential
common shares from options and warrants to purchase common stock and common
stock subject to repurchase using the treasury stock method. The following table
presents the calculation of basic and diluted net loss per share (in thousands,
except per share amounts):
Three months ended Nine months ended
December 31, December 31,
-------------------- --------------------
2001 2000 2001 2000
-------- -------- -------- --------
Numerator:
Net loss $ (3,207) $ (8,492) $(16,373) $(27,689)
======== ======== ======== ========
Denominator:
Weighted average common shares
outstanding 28,430 26,790 28,100 25,810
Weighted average unvested
common shares subject to
repurchase (90) (1,710) (450) (2,050)
-------- -------- -------- --------
Denominator for basic and 28,340 25,080 27,650 23,760
diluted calculation
======== ======== ======== ========
Net loss per common share -- basic
and diluted $ (0.11) $ (0.34) $ (0.59) $ (1.17)
======== ======== ======== ========
The following warrants, outstanding stock options, and shares subject to
repurchase by the company have been excluded from the calculation of diluted net
loss per common share because all such securities are antidilutive for all
periods presented (in thousands):
December 31,
---------------------------
2001 2000
------------ -----------
Options 9,005 8,028
Shares subject to repurchase 838 1,715
Warrants -- 3
NOTE 5. STOCK-BASED COMPENSATION
During the nine months ended December 31, 2001, the Company reduced unearned
stock-based compensation, a component of stockholders' equity, by approximately
$2.6 million. This reduction was the result of amortization of stock-based
compensation of approximately $2.4 million and a reduction of approximately $1.8
million related primarily to stock option forfeitures and the revaluation of
options granted to consultants, offset by the recording of approximately $1.6
million of deferred compensation related to the issuance of restricted stock in
exchange for the
9
cancellation of options. Unearned stock-based compensation is amortized to
expense over the period during which the options and restricted stock vest,
generally three to four years, in accordance with FASB Interpretation No. 28.
In May 2001, the Company issued approximately 797,500 shares of restricted stock
with a fair value of $1.17 per share in exchange for the cancellation of
approximately 737,500 options. The restricted stock was issued with a purchase
price of $0.001 with one sixth of the stock vesting on the grant date and the
remainder vesting over three years. As a result of the restricted stock grant,
the Company recognized approximately $186,000 and $828,000 of compensation
expense in the three and nine months ended December 31, 2001. The remainder of
the unearned stock-based compensation will be recognized over the period which
the restricted stock vests in accordance with FASB Interpretation No. 28.
In December 2001, the Company issued approximately 375,000 restricted stock
units with a fair value of $0.73 per underlying share to an executive officer in
exchange for the cancellation of 375,000 options. Approximately 140,000
restricted stock units were vested on the grant date, with the remaining units
vesting quarterly through February 2004. As a result of the award, the Company
recognized approximately $140,000 of compensation expense in the three months
ended December 31, 2001. The remainder of the stock-based compensation will be
recognized over the period in which the restricted stock units vest in
accordance with FASB Interpretation No. 28.
NOTE 6. RESTRUCTURING CHARGES
In September 2001, management took additional steps to further increase
operational efficiencies and to bring costs in line with revenues. These
measures included the involuntary termination of approximately 30 employees,
approximately 10% of the Company's workforce. As a result, Digital Impact
recorded a charge of approximately $100,000 to operations for the quarter ended
September 30, 2001. As of September 30, 2001, all of the $100,000 charge had
been paid.
In January 2002, management took certain actions to reduce employee headcount in
the sales and marketing, development and administrative organizations. These
measures included the involuntary termination of approximately 25 employees.
Since the workforce reduction plans were finalized and initiated after the close
of the current fiscal quarter, no charges to operations were recognized in the
quarter ending December 31, 2001. As a result, charges of approximately $100,000
will be realized in the fourth fiscal quarter ending March 31, 2002.
NOTE 7. CONTINGENCIES
In June 2001, a series of putative securities class actions were filed in United
States District Court for the Southern District of New York against certain
investment bank underwriters for the Company's initial public offering ("IPO"),
the Company, and various of the Company's officers and directors. The
complaints, which have been consolidated under the caption Stein v. Digital
Impact, Inc., et al., Civil Action No. 01-CV-4942, allege undisclosed and
improper practices by the underwriters concerning the allocation of the
Company's IPO shares, in violation of the federal securities laws, and seeks
unspecified damages on behalf of persons who purchased the Company's stock
during the period from November 22, 1999 and December 6, 2000. Other actions
have been filed making similar allegations regarding the IPOs of more than 300
other companies. All of these lawsuits have been coordinated for pretrial
purposes as In re Initial Public Offering Securities Litigation, Civil Action
No. 21-MC-92. The Company believes it has meritorious defenses to the claims
against it and will defend itself vigorously. In the opinion of management,
after consultation with legal counsel and based on currently available
information, the ultimate disposition of these matters is not expected to have a
material adverse effect on our business, financial condition or results of
operations, and hence no amounts have been accrued for these cases.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
You should read the following discussion of our financial condition and results
of operations in conjunction with our financial statements and related notes.
This discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results may differ materially from those anticipated
in these forward-looking statements as a result of factors including those
discussed in "Certain Factors Which May Impact Future Operating Results,"
starting on page 16, as well as factors set forth in Digital Impact's Annual
Report on Form 10-K for the fiscal year ended March 31, 2001. Any
forward-looking statements speak only as of the date such statements are made.
OVERVIEW
Digital Impact, Inc. is one of the premier providers of online direct marketing
solutions for enterprises. We were incorporated in California in October 1997
and reincorporated in Delaware in October 1999. Digital Impact's solutions --
Strategy, Customer Acquisition and Customer Marketing -- enable corporations to
create and deliver marketing programs that drive revenue, influence behavior and
deepen customer relationships. Digital Impact solutions provide deeper customer
insight and powerful program execution through a combination of hosted web
applications, messaging technology infrastructure and professional services.
In July 2000, we acquired MineShare, Inc. ("MineShare"), a customer intelligence
and analysis software company based in Santa Monica, California. The transaction
was accounted for using the purchase method of accounting.
Digital Impact generates revenues from the sale of solutions that enable
businesses to proactively communicate with their customers online. Historically,
these solutions have primarily consisted of the design and execution of online
direct marketing campaigns, the development and execution of customer
acquisition programs, and additional services delivered by our professional
services organization. In accordance with Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements," revenue is recognized when online
direct marketing campaigns are delivered, provided that there are no remaining
significant obligations and collection of the resulting receivable is reasonably
assured. Customer set-up fees related to service initiation are deferred and
recognized ratably over the term of the customer's master service agreement.
Revenue generated from our acquisition services group, which assists clients in
growing their email lists through the use of third party list rentals, is
recognized when the campaigns are delivered, provided there are no significant
remaining obligations and the collection of receivables is reasonably assured.
The cost of renting the list is passed through to our clients and hence is
offset against the corresponding revenue. Revenue generated from our
professional services is recognized as the services are provided.
Cost of revenues consists primarily of expenses relating to the delivery of
online direct marketing services, including personnel costs, primarily
consisting of our production services and operations staff, the amortization of
equipment, purchased and licensed technology, and data center expenses.
Our operating expenses are classified into three general categories: research
and development, sales and marketing, and general and administrative. We
classify all charges to these operating expense categories based on the nature
of the expenditures. Although each category includes expenses that are unique to
the category, some expenditures, such as compensation, employee benefits,
recruiting costs, equipment costs, travel and entertainment costs, facilities
costs and third-party professional service fees, occur in each of these
categories.
We allocate the total cost for information services and facilities to each
functional area that uses the information services and facilities based on its
relative headcount. These allocated charges include rent and other
facility-related costs, communication charges and depreciation expense for
furniture and equipment.
Total operating expenses also include non-cash expenses related to stock-based
compensation and amortization of goodwill and purchased intangibles.
As of December 31, 2001 we had 293 full-time employees. In April and September
2001 we realigned our organization with a workforce reduction of approximately
60
11
and 30 employees, respectively, in order to streamline operations, reduce costs
and bring our staffing structure in line with current economic conditions. As a
result, costs associated with the April workforce reduction, including severance
and other employee-related costs, were accrued in the balance sheet for the
fiscal year ended March 31, 2001. Expenses related to the September work force
reduction, including severance and other employee expenses, were expensed in the
quarter ended September 30, 2001. In January 2002 management reduced the
staffing level for the sales, development and administrative organizations. This
involved the involuntary termination of approximately 25 employees. Expenses
related to payments for severance were not accrued in the quarter ended December
31, 2001. Expense related to the workforce reduction will be realized in the
fiscal quarter ending March 31, 2002.
RESULTS OF OPERATIONS
The following table sets forth selected data for the periods indicated as a
percentage of total revenues. These operating results are not necessarily
indicative of results for any future periods.
Three months ended Nine months ended
December 31, December 31,
-------------------- --------------------
2001 2000 2001 2000
-------- --------- -------- ---------
Net revenue 100% 100% 100% 100%
Cost of revenue 47% 44% 47% 44%
-------- --------- -------- ---------
Gross margin 53% 56% 53% 56%
Operating expenses:
Research and development 24% 41% 32% 43%
Sales and marketing 35% 41% 43% 44%
General and administrative 19% 25% 23% 27%
Stock-based compensation 3% 5% 8% 15%
Amortization of goodwill and
purchased intangibles 4% 20% 4% 13%
Nonrecurring charges -- -- -- 15%
-------- --------- -------- ---------
Total operating expenses 85% 132% 110% 157%
Loss from operations (32%) (76%) (57%) (101%)
======== ========= ======== =========
Interest income, net 0% 5% 1% 8%
-------- --------- -------- ---------
Net loss (32%) (71%) (56%) (93%)
======== ========= ======== =========
Three Months Ended December 31, 2001 and 2000
Revenues. Total revenues decreased 16% to $10.3 million for the three months
ended December 31, 2001 from $12.2 million for the three months ended December
31, 2000. The decrease was primarily due to a decline in clients, particularly
dot-com companies, and a decrease in spending from certain continuing clients
from December 2000 to December 2001. These decreases were partially offset by
revenue from new large clients, and the expansion of our core service offerings.
Cost of Revenues. Total cost of revenues decreased 9% to $4.8 million for the
three months ended December 31,2001 from $5.3 million for the three months ended
December 31, 2000. Gross margins declined to 53% for the quarter ended December
31, 2001 from 56% for the quarter ended December 31, 2000, largely due to
continued investments in our data center infrastructure and the resulting excess
capacity that when spread over our revenue base resulted in lower margins.
Margins were favorably impacted by lower consulting costs as we moved towards
meeting operating needs with internal personnel.
Research and Development. Research and development expenses consist primarily of
personnel related costs, outside contractor costs, and software and hardware
maintenance costs. To date, all research and development costs have been
expensed as incurred. Research and development expenses declined by 49% to $2.5
million for the quarter ended December 31, 2001 from $4.9 million for the
quarter ended December 31, 2000. The decline is primarily a result of a decrease
in personnel costs of approximately $1.1 million, largely related to the
reduction in engineering staff related to our realignment initiatives and
related overhead, and an $800,000 reduction in outside consulting expenses
achieved by utilizing internal resources.
12
Sales and Marketing. Sales and marketing expenses consist of personnel and
related costs of our direct sales force and marketing staff and marketing
expenses for trade shows, advertisements, promotional activities and media
events. Sales and marketing expenses decreased 27% to $3.6 million for the three
months ended December 31, 2001 from $4.9 million for the three months ended
December 31, 2000. The decrease was primarily due to a decline in personnel
costs of approximately $500,000 related to our realignment initiatives and a
$550,000 decline in travel, entertainment and program expenses.
General and Administrative. General and administrative expenses consist
primarily of personnel and related costs for general corporate operations,
including information technology services, finance, accounting, human resources,
facilities and legal. General and administrative expenses declined by 39% to
$1.9 million for the three months ended December 31, 2001 from $3.1 million for
the three months ended December 31, 2000. The overall decrease was primarily the
result of a reduction in personnel costs of approximately $450,000 related to a
decline in headcount, and a decline in bad debt expense of $400,000 due to lower
loss experience from our current client base.
Stock-based Compensation. In connection with the granting of stock options and
restricted stock to our employees and the assumption of options related to the
acquisition of MineShare, we recorded unearned stock based compensation totaling
approximately $18.5 million, net of forfeitures, from inception through December
31, 2001. This amount represents the total difference between the exercise
prices of the stock options or the purchase price of restricted stock and the
deemed fair market value of the underlying common stock for accounting purposes
on the date granted. This amount is included as a component of stockholders'
equity and is being amortized on an accelerated basis by charges to operations
over the vesting period, consistent with the methods described in FASB
Interpretation No. 28.
Stock-based compensation, a noncash expense, decreased 53% to $278,000 for the
three months ended December 31, 2001 from $595,000 for the three months ended
December 31, 2000. Unearned stock based compensation is recognized over the
vesting period, generally three to four years.
Amortization of Goodwill and Purchased Intangibles. During the quarter ended
December 31, 2001, we recorded amortization of goodwill and purchased
intangibles of $375,000. The goodwill and purchased intangibles relate to the
July 31, 2000 acquisition of MineShare and are being amortized over three years.
Other Income and (expense). Other income and (expense) decreased to ($26,000)
for the quarter ended December 31, 2001 from $664,000 for the quarter ended
December 31, 2000. The decrease is largely due to lower average cash and cash
equivalents balances resulting from the use of cash to fund current operations,
and lower prevailing interest rates.
Nine Months Ended December 31, 2001 and 2000
Revenues. Total revenues decreased 4% to $28.8 million for the nine months ended
December 31, 2001 from $30.0 million for the nine months ended December 31,
2000. The decrease was primarily due to a decline in total clients from December
2000 to December 2001 and a slight decline in the volume of email messages
delivered, partially offset by higher revenue from certain continuing clients
and expansion of our core service offerings.
Cost of Revenues. Total cost of revenues increased 3% to $13.6 million for the
nine months ended December 31, 2001 from $13.2 million for the nine months ended
December 31, 2000. The increase was primarily due to higher costs of campaign
creation and delivery associated with supporting a higher volume of campaigns,
and the expansion of our data center infrastructure. Gross margins declined to
53% for the nine months ended December 31, 2001 from 56% for the nine months
ended December 31, 2000, largely due to investments in our data center
infrastructure, resulting in excess capacity that when spread over our revenue
base resulted in lower margins.
Research and Development. Research and development expenses consist primarily of
personnel and related costs, outside contractor costs, and software and hardware
maintenance costs. To date, all research and development costs have been
expensed as incurred. Research and development expenses declined by 28% to $9.2
million for
13
the nine months ended December 31, 2001 from $12.8 million for the nine months
ended December 31, 2000. The decline is primarily a result of a decrease in
personnel costs of approximately $2.0 million, largely related to the decrease
in engineering staff associated with our realignment initiatives, and a $2.2
million reduction in outside consulting expenses related to continuing efforts
to meet development needs with internal resources. This was partially offset by
a $322,000 increase in amortized tangible purchased technology expense related
to our MineShare acquisition and a $100,000 increase in allocated corporate
overhead and depreciation.
Sales and Marketing. Sales and marketing expenses consist of personnel and
related costs primarily for our direct sales force and marketing staff, as well
as marketing programs, which include trade shows, advertisements, promotional
activities and media events. Sales and marketing expenses decreased 5% to $12.5
million for the nine months ended December 31, 2001 from $13.1 million for the
nine months ended December 31, 2000. The decrease was primarily due to a decline
in personnel costs of approximately $700,000 related to our realignment
initiatives, partially offset by an increase in marketing costs of $169,000.
General and Administrative. General and administrative expenses consist
primarily of personnel and related costs for general corporate purposes,
including information services, finance, accounting, human resources, facilities
and legal. General and administrative expenses declined by 20% to $6.6 million
for the nine months ended December 31, 2001 from $8.2 million for the nine
months ended December 31, 2000. The decrease was primarily the result of a
decrease in personnel costs related to a reduction in headcount and a reduction
in bad debt expense.
Stock-based Compensation. In connection with the granting of stock options to
our employees and the assumption of options related to the acquisition of
MineShare, we recorded unearned stock based compensation totaling approximately
$18.5 million, net of forfeitures, from inception through December 31, 2001.
This amount represents the total difference between the exercise prices of the
stock options or the purchase price of restricted stock and the deemed fair
market value of the underlying common stock for accounting purposes on the date
these stock options were granted. This amount is included as a component of
stockholders' equity and is being amortized on an accelerated basis by charges
to operations over the vesting period of the options, consistent with the
methods described in FASB Interpretation No. 28.
Stock-based compensation, a noncash expense, decreased 45% to $2.4 for the nine
months ended December 31, 2001 from $4.4 million for the nine months ended
December 31, 2000. Unearned stock based compensation is recognized over the
vesting period, generally four years.
Amortization of Goodwill and Purchased Intangibles. During the nine months ended
December 31, 2001, we recorded amortization of goodwill and purchased
intangibles of $1.1 million. The goodwill and purchased intangibles relate to
the July 31, 2000 acquisition of MineShare and are being amortized over three
years.
Write-off of In-process Research and Development and fixed assets. Nonrecurring
charges recorded during the nine months ended December 31, 2000 ($4.6 million)
consisted primarily of the write-off of purchased in-process research and
development and fixed assets associated with the acquisition of MineShare. The
in-process research and development acquired as part of the MineShare
acquisition has been incorporated into the Company's product offering.
Other Income and (expense). Other income and (expense) decreased to $299,000 for
the nine months ended December 31, 2001 from $2.5 million for the nine months
ended December 31, 2000. The decrease is largely due to lower average cash and
cash equivalents balances resulting from the use of cash to fund current
operations and lower prevailing interest rates.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was $5.8 million for the nine months ended
December 31, 2001, which was due primarily to a net loss of $16.4 million, a
decline of $851,000 in accounts payable and an increase in prepaid expenses and
other current assets of $762,000. This was partially offset by noncash charges
for amortization of stock-based compensation ($2.4 million) and depreciation and
amortization ($6.1 million), as well as a decrease of $3.9 million in accounts
receivable related to collection efforts and tighter credit standards. Net cash
used in operating activities for the nine months ended December 31, 2000 was
$17.1 million, which was due primarily to a net loss of $27.7 million and an
increase in accounts receivable of $10.5 million related to higher sales during
the period. This was partially offset by non-cash charges including the
write-off of in-process research and development associated with the MineShare
acquisition ($4.4 million), amortization of stock-based compensation ($4.4
million), and depreciation and amortization ($7.3 million).
14
Our investing activities used $1.5 million during the nine months ended
December 31, 2001, which was attributable primarily to the acquisition of
property and equipment related to investments in our data center infrastructure.
Cash used in investing activities for the nine months ended December 31, 2000
was $9.9 million, attributable primarily to the acquisition of property and
equipment related to significant investments in our data center infrastructure
and purchases for new office furniture and equipment for our increased staff.
Financing activities used $1.3 million during the nine months ended December 31,
2001, which was attributable primarily to principal payments on long-term debt
of $1.5 million, partially offset by proceeds from the exercise of stock options
and the purchase of shares through our employee stock purchase plan. During the
nine months ended December 31, 2000, cash provided by financing activities was
$933,000, consisting primarily of the proceeds from the exercise of stock
options and the purchase of shares through our employee stock purchase plan.
This was offset by principal payments on our long-term debt.
At December 31, 2001, we had $26.3 million in cash and cash equivalents. Amounts
borrowed under a leasing line of credit totaled approximately $413,000 at
December 31, 2001 and bear interest at rates of between 6.2% and 10.1%. We had
$386,000 outstanding under an equipment leasing line, which is secured by the
leased assets and bears interest at a rate of 9.5%. We had $470,000 outstanding
under an additional equipment leasing line, which is secured by the leased
assets and bears interest at a rate of 9.74%. We also had $2.4 million
outstanding under a term loan. The loan bears interest at the three-year
Treasury rate plus 950 basis points (13.09% as of December 31, 2001) and is
secured by the leased assets. Our MineShare subsidiary had approximately $40,000
outstanding under a $50,000 revolving line of credit that bears interest at
prime plus 3% (7.75% as of December 31, 2001). We have an equipment loan
facility with a maximum borrowing limit of $800,000, which is secured by the
equipment of our MineShare subsidiary and bears interest at a rate of 10%. As of
December 31, 2001, approximately $205,000 was outstanding under this facility.
We have a second equipment loan facility with a borrowing limit of $1,000,000,
which is secured by the equipment of our MineShare subsidiary, and bears
interest at a rate of 10%. As of December 31, 2001, approximately $32,000 was
outstanding under this facility. As of December 31, 2001 no amount is available
under either of the equipment leasing lines secured by the assets of our
MineShare subsidiary.
Our other principal commitments at December 31, 2001 consisted of obligations
under operating leases for facilities and our pledge of $1.9 million of cash as
collateral for an outstanding letter of credit. For additional information, see
the financial statements. We believe that our existing cash and cash equivalents
will be sufficient to satisfy our currently anticipated cash requirements for at
least the next twelve months.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 133, or SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS 133 establishes new
standards of accounting and reporting for derivative instruments and hedging
activities. SFAS 133 requires that all derivatives be recognized at fair value
in the statement of financial position, and that the corresponding gains or
losses be reported either in the statement of operations or as a component of
comprehensive income, depending on the type of hedging relationship that exists.
SFAS 133, as amended, is effective for fiscal years beginning after June 15,
2000. The Company does not currently hold derivative instruments or engage in
hedging activities and hence SFAS 133 did not have a material impact upon the
financial statements of the Company.
In July 2001, the Financial Accounting Standards Board issued SFAS No. 141
"Business Combinations," which establishes financial accounting and reporting
for business combinations and supersedes APB Opinion No. 16, Business
Combinations, and FASB Statement No. 38, Accounting for Preacquisition
Contingencies of Purchased Enterprises. It requires that all business
combinations in the scope of this Statement are to be accounted for using one
method, the purchase method. The provisions of this Statement apply to all
business combinations initiated after June 30, 2001.
In July 2001, the Financial Accounting Standards Board issued SFAS No. 142
"Goodwill and Other Intangible Assets," which establishes financial accounting
and reporting for acquired goodwill and other intangible assets and supersedes
APB Opinion No. 17, Intangible Assets. It addresses how intangible assets that
are acquired individually or with a group of other assets (but not those
acquired in a business combination) should be accounted for in financial
statements upon their acquisition, and after they have been initially recognized
in the financial statements. The provisions of this Statement are effective
starting with fiscal
15
years beginning after December 15, 2001. Early adoption is permitted for
entities with fiscal years beginning after March 15, 2001, provided that the
first interim financial statements have not previously been issued. Accordingly,
the Company has elected not to early adopt SFAS No.142 beginning with the first
quarter of fiscal 2002. Upon adoption of FAS 142, the Company will reclassify
the amount relating to assembled workforce (currently $1.4 million) from
intangible assets to goodwill and will no longer amortize goodwill.
On October 3, 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets." SFAS No. 144 supercedes SFAS No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." SFAS No. 144 applies to all long-lived assets (including
discontinued operations) and consequently amends APB Opinion No. 30, "Reporting
the Results of Operations, Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." SFAS No. 144 develops one accounting model for long-lived assets
that are to be disposed of by sale. SFAS No. 144 requires that long-lived assets
that are to be disposed of by sale be measured at the lower of book value or
fair value less cost to sell. Additionally SFAS No. 144 expands the scope of
discontinued operations to include all components of an entity with operations
that (1) can be distinguished from the rest of the entity and (2) will be
eliminated from the ongoing operations of the entity in a disposal transaction.
SFAS No. 144 is effective for the Company for all financial statements issued in
2002. The adoption of SFAS No. 144 is not expected to have a material impact on
the Company's financial statements.
CERTAIN FACTORS WHICH MAY IMPACT FUTURE OPERATING RESULTS
Our future operating results may vary substantially from period to period due to
a number of factors, many of which are beyond our control. The following
discussion highlights some of these factors and the possible impact of these
factors on future results of operations. If any of the following factors
actually occur, our business, financial condition or results of operations could
be harmed. In that case, the price of our common stock could decline, and
investors could experience losses on their investment.
BECAUSE OF OUR LIMITED OPERATING HISTORY AND THE EMERGING NATURE OF THE ONLINE
DIRECT MARKETING INDUSTRY, ANY PREDICTIONS ABOUT OUR FUTURE REVENUES AND
EXPENSES MAY NOT BE AS ACCURATE AS THEY WOULD BE IF WE HAD A LONGER BUSINESS
HISTORY, AND WE CANNOT DETERMINE TRENDS THAT MAY AFFECT OUR BUSINESS.
We were incorporated in October 1997 in California and reincorporated in
Delaware in October 1999. Our limited operating history makes financial
forecasting and evaluation of our business difficult. Since we have limited
financial data, any predictions about our future revenues and expenses may not
be as accurate as they would be if we had a longer business history. Because of
the emerging nature of the online direct marketing industry, we cannot determine
trends that may emerge in our market or affect our business. The revenue and
income potential of the online direct marketing industry, and our business, are
unproven.
OUR OPERATING RESULTS HAVE VARIED SIGNIFICANTLY IN THE PAST AND ARE LIKELY TO
VARY SIGNIFICANTLY FROM PERIOD TO PERIOD, AND OUR STOCK PRICE MAY DECLINE IF WE
FAIL TO MEET THE EXPECTATIONS OF ANALYSTS AND INVESTORS.
Our operating results have varied significantly in the past and are likely to
vary significantly from period to period. As a result, our operating results are
difficult to predict and may not meet the expectations of securities analysts or
investors. If this occurs, the price of our common stock would likely decline.
SEASONAL TRENDS MAY CAUSE OUR QUARTERLY OPERATING RESULTS TO FLUCTUATE, WHICH
MAY ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK.
The traditional direct marketing industry has typically generated lower revenues
during the summer months and higher revenues during the calendar year-end
months. Because we do experience these effects, analysts and investors may not
be able to predict our quarterly or annual operating results. If we fail to meet
expectations of analysts and investors, our stock price could decline.
IF BUSINESSES AND CONSUMERS FAIL TO ACCEPT ONLINE DIRECT MARKETING AS A MEANS TO
ATTRACT NEW CUSTOMERS, DEMAND FOR OUR SERVICES MAY NOT DEVELOP AND THE PRICE OF
OUR
16
STOCK COULD DECLINE.
The market for online direct marketing services is relatively new and rapidly
evolving, and our business may be harmed if sufficient demand for our services
does not develop. Our current and planned services are very different from the
traditional methods that many of our clients have historically used to attract
new customers and maintain customer relationships.
THE LOSS OF A MAJOR CLIENT COULD RESULT IN LOWER THAN EXPECTED REVENUES.
The loss of a major client could harm our business. While only one client
accounted for more than 10% of our revenues for the quarter ended December 31,
2001, the loss of a major client could have a material adverse effect on our
business and results of operations. Additionally, some Internet-based businesses
have recently been experiencing financial problems. While the majority of our
clients are not Internet-based businesses, the loss of a number of these clients
could have a material adverse effect on our business and our results of
operations.
THE ONLINE DIRECT MARKETING INDUSTRY IS HIGHLY COMPETITIVE, AND IF WE ARE UNABLE
TO COMPETE EFFECTIVELY, THE DEMAND FOR, OR THE PRICES OF, OUR SERVICES MAY
DECLINE.
The market for online direct marketing is highly competitive, rapidly evolving
and experiencing rapid technological change. Intense competition may result in
price reductions, reduced sales, gross margins and operating margins, and loss
of market share. Our principal competitors include providers of online direct
marketing solutions such as DoubleClick, , Responsys, Cheetahmail, CMGI's
Yesmail (through its recent acquisition of Post Communications), eDialog and
Clickaction, as well as the in-house information technology departments of our
existing and prospective clients.
In addition, we expect competition to persist and intensify in the future, which
could harm our ability to increase sales and maintain our prices. In the future,
we may experience competition from Internet service providers, advertising and
direct marketing agencies and other large established businesses. possessing
large, existing customer bases, substantial financial resources and established
distribution channels and could develop, market or resell a number of online
direct marketing solutions. These potential competitors may also choose to
enter, or have already entered, the market for online direct marketing by
acquiring one of our existing competitors or by forming strategic alliances with
a competitor.
Many of these potential competitors have broad distribution channels and they
may bundle competing products or services. As a result of future competition,
the demand for our services could substantially decline. Any of these
occurrences could harm our ability to compete effectively.
IF WE DO NOT ATTRACT AND RETAIN ADDITIONAL HIGHLY-SKILLED PERSONNEL, WE MAY BE
UNABLE TO EXECUTE OUR BUSINESS STRATEGY.
Our business depends on the continued technological innovation of our core
services and our ability to provide comprehensive online direct marketing
expertise. Our main offices are located in the San Francisco Bay Area, where
competition for personnel with Internet-related technology and marketing skills
is intense. If we fail to identify, attract, retain and motivate these highly
skilled personnel, we may be unable to successfully introduce new services or
otherwise implement our business strategy. As a public company we face greater
difficulty attracting and retaining personnel than we did as a private company.
WE RELY ON THE SERVICES OF OUR FOUNDERS AND OTHER KEY PERSONNEL, WHOSE KNOWLEDGE
OF OUR BUSINESS AND TECHNICAL EXPERTISE WOULD BE EXTREMELY DIFFICULT TO REPLACE.
Our future success depends to a significant degree on the skills, experience and
efforts of our senior management. In particular, we depend upon the continued
services of our co-founders William Park, our Chief Executive Officer, and
Gerardo Capiel, our Chief Technology Officer, whose vision for our company,
knowledge of our business and technical expertise would be extremely difficult
to replace. In addition, we have not obtained life insurance benefiting Digital
Impact covering any of our key employees. If any of our key employees left or
was seriously injured and unable to work and we were unable to find a qualified
replacement, the level of services we are able to provide could decline or we
could be otherwise unable to execute our business strategy.
17
IF THE DELIVERY OF OUR EMAIL MESSAGES IS LIMITED OR BLOCKED, THEN OUR CLIENTS
MAY DISCONTINUE THEIR USE OF OUR SERVICES.
Our business model relies on our ability to deliver emails over the Internet
through Internet service providers and to recipients in major corporations. In
particular, a significant percentage of our emails are sent to recipients who
use America Online. We do not have, and we are not required to have, an
agreement with America Online to deliver emails to their customers. America
Online uses a proprietary set of technologies to handle and deliver email and
the value of our services will be reduced if we are unable to provide emails
compatible with these technologies. In addition, America Online and other
Internet service providers are able to block unwanted messages to their users.
If these companies limit or halt the delivery of our emails, or if we fail to
deliver emails in such a way as to be compatible with these companies' email
handling technologies, then our clients may discontinue their use of our
services.
OUR FACILITIES AND SYSTEMS ARE VULNERABLE TO NATURAL DISASTERS AND OTHER
UNEXPECTED EVENTS, AND ANY OF THESE EVENTS COULD RESULT IN AN INTERRUPTION OF
OUR ABILITY TO EXECUTE OUR CLIENTS' ONLINE DIRECT MARKETING CAMPAIGNS.
We depend on the efficient and uninterrupted operations of our data center and
hardware systems. Our data center and hardware systems are located in Northern
California, an area susceptible to earthquakes. Our data center and hardware
systems are also vulnerable to damage from fire, floods, power loss,
telecommunications failures, and similar events. If any of these events results
in damage to our data center or systems, we may be unable to execute our
clients' online direct marketing campaigns until the damage is repaired, and may
accordingly lose clients and revenues. In addition, we may incur substantial
costs in repairing any damage.
OUR DATA CENTER IS LOCATED AT FACILITIES PROVIDED BY A THIRD PARTY, AND IF THIS
PARTY IS UNABLE TO ADEQUATELY PROTECT OUR DATA CENTER, OUR REPUTATION MAY BE
HARMED AND WE MAY LOSE CLIENTS.
Our data center, which is critical to our ongoing operations, is located at
facilities provided by a third party. Our operations depend on this party's
ability to protect our data center from damage or interruption from human error,
break-ins, sabotage, computer viruses, intentional acts of vandalism and similar
events. If this party is unable to adequately protect our data center and
information is lost or our ability to deliver our services is interrupted, our
reputation may be harmed and we may lose clients.
IF WE ARE UNABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY, THIRD PARTIES
COULD USE OUR INTELLECTUAL PROPERTY WITHOUT OUR CONSENT.
Our ability to successfully compete is substantially dependent upon our
internally developed technology and intellectual property, which we protect
through a combination of copyright, trade secret and trademark law, and
contractual obligations. We have no issued patents and have two U.S. patent
applications pending. We have several registered U.S. trademarks and have
several more applications pending in the U.S., Europe and Japan. We may not be
able to adequately protect our proprietary rights. Unauthorized parties may
attempt to obtain and use our proprietary information. Policing unauthorized use
of our proprietary information is difficult, and we cannot be certain that the
steps we have taken will prevent misappropriation, particularly in foreign
countries where the laws may not protect our proprietary rights as fully as in
the United States.
IF WE ARE UNABLE TO SAFEGUARD THE CONFIDENTIAL INFORMATION IN OUR DATA
WAREHOUSE, OUR REPUTATION MAY BE HARMED AND WE MAY BE EXPOSED TO LIABILITY.
We currently store confidential customer information in a secure data warehouse.
We cannot be certain, however, that we will be able to prevent unauthorized
individuals from gaining access to this data warehouse. If any compromise or
breach of security were to occur, it could harm our reputation and expose us to
possible liability. Any unauthorized access to our servers could result in the
misappropriation of confidential customer information or cause interruptions in
our services. It is also possible that one of our employees could attempt to
misuse confidential customer information, exposing us to liability. In addition,
our
18
reputation may be harmed if we lose customer information maintained in our
data warehouse due to systems interruptions or other reasons.
ACTIVITIES OF OUR CLIENTS COULD DAMAGE OUR REPUTATION OR GIVE RISE TO LEGAL
CLAIMS AGAINST US.
Our clients' promotion of their products and services may not comply with
federal, state and local laws, including but not limited to laws and regulations
surrounding the Internet. We cannot predict whether our role in facilitating
these marketing activities would expose us to liability under these laws. Any
claims made against us could be costly and time-consuming to defend. If we are
exposed to this kind of liability, we could be required to pay substantial fines
or penalties, redesign our business methods, discontinue some of our services or
otherwise expend resources to avoid liability.
Our services involve the transmission of information through the Internet. Our
services could be used to transmit harmful applications, negative messages,
unauthorized reproduction of copyrighted material, inaccurate data or computer
viruses to end-users in the course of delivery. Any transmission of this kind
could damage our reputation or could give rise to legal claims against us. We
could spend a significant amount of time and money defending against these legal
claims.
NEW REGULATION OF, AND UNCERTAINTIES REGARDING THE APPLICATION OF EXISTING LAWS
AND REGULATIONS TO, ONLINE DIRECT MARKETING AND THE INTERNET COULD PROHIBIT,
LIMIT OR INCREASE THE COST OF OUR BUSINESS.
Legislation has been enacted in several states regulating the sending of
unsolicited commercial email. We cannot assure you that existing or future
legislation regarding commercial email will not harm our business. The federal
government, foreign governments and several other states are considering, or
have considered, similar legislation. These provisions generally limit or
prohibit both the transmission of unsolicited commercial emails and the use of
forged or fraudulent routing and header information. Some states, including
California, require that unsolicited emails include opt-out instructions and
that senders of these emails honor any opt-out requests.
Our business could be negatively impacted by new laws or regulations applicable
to online direct marketing or the Internet, the application of existing laws and
regulations to online direct marketing or the Internet or the application of new
laws and regulations to our business as we expand into new jurisdictions. There
is a growing body of laws and regulations applicable to access to or commerce on
the Internet. Moreover, the applicability to the Internet of existing laws is
uncertain and may take years to resolve. Due to the increasing popularity and
use of the Internet, it is likely that additional laws and regulations will be
adopted covering issues such as privacy, pricing, content, copyrights,
distribution, taxation, antitrust, characteristics and quality of services and
consumer protection. The adoption of any additional laws or regulations may
impair the growth of the Internet or online direct marketing, which could, in
turn, decrease the demand for our services and prohibit, limit or increase the
cost of our doing business.
INTERNET-RELATED STOCK PRICES ARE ESPECIALLY VOLATILE AND THIS VOLATILITY MAY
DEPRESS OUR STOCK PRICE.
The stock market and specifically the stock prices of Internet-related companies
have been very volatile. Because we are an Internet-related company, we expect
our stock price to be similarly volatile. As a result of this volatility, the
market price of our common stock could significantly decrease. This volatility
is often not related to our operating performance and may accordingly reduce the
price of our common stock without regard to our operating performance.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For the period from our inception through December 31, 2001, we provided our
services to clients primarily in the United States. As a result, our financial
results have not been directly affected by factors such as changes in foreign
currency exchange rates or weak economic conditions in foreign markets. The
majority of our sales are currently denominated in U.S. dollars. During the
quarter ended June 30, 2000, we established a subsidiary in the United Kingdom
which has had minimal operations to date. As the operations of this subsidiary
19
expand, our future operating results could be directly impacted by changes in
foreign currency exchange rates or economic conditions in this region.
Our exposure to market risk for changes in interest rates relates primarily to
the increase or decrease in the amount of interest income we can earn on our
investment portfolio and on the increase or decrease in the amount of interest
expense we must pay on our outstanding debt instruments. The risk associated
with fluctuating interest expense is limited, however, to the exposure related
to those debt instruments and credit facilities which are tied to market rates.
We do not plan to use derivative financial instruments in our investment
portfolio. We plan to ensure the safety and preservation of our invested
principal funds by limiting default risk, market risk and reinvestment risk. We
plan to mitigate default risk by investing in high-credit quality securities.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In June 2001, a series of putative securities class actions were filed in United
States District Court for the Southern District of New York against certain
investment bank underwriters for the Company's initial public offering ("IPO"),
the Company, and various of the Company's officers and directors. The
complaints, which have been consolidated under the caption Stein v. Digital
Impact, Inc., et al., Civil Action No. 01-CV-4942, allege undisclosed and
improper practices by the underwriters concerning the allocation of the
Company's IPO shares, in violation of the federal securities laws, and seeks
unspecified damages on behalf of persons who purchased the Company's stock
during the period from November 22, 1999 and December 6, 2000. Other actions
have been filed making similar allegations regarding the IPOs of more than 300
other companies. All of these lawsuits have been coordinated for pretrial
purposes as In re Initial Public Offering Securities Litigation, Civil Action
No. 21-MC-92. The Company believes it has meritorious defenses to the claims
against it and will defend itself vigorously. In the opinion of management,
after consultation with legal counsel and based on currently available
information, the ultimate disposition of these matters is not expected to have a
material adverse effect on our business, financial condition or results of
operations, and hence no amounts have been accrued for these cases.
ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS
In November 1999, we completed our initial public offering of 5,175,000 shares
of our common stock, which included 675,000 shares in connection with the
exercise of the underwriters' overallotment option, at $15 per share. The
managing underwriters in the offering were Credit Suisse First Boston; Hambrecht
& Quist; Donaldson, Lufkin & Jenrette; and U.S. Bancorp Piper Jaffray. The sale
of our shares of common stock in the offering was registered under the
Securities Act of 1933, as amended, on a Registration Statement on Form S-1
(Reg. No. 333-87299) that was declared effective by the Securities and Exchange
Commission on November 22, 1999. The aggregate offering amount including the
overallotment exercise was approximately $77.6 million. We incurred expenses of
approximately $6.8 million, of which approximately $5.4 million represented
underwriting discounts and commissions and approximately $1.4 million
represented other expenses related to the offering.
Currently, we have placed the remaining net proceeds (approximately $26.3
million) from the offering in short-term, interest bearing, investment grade
securities. During the nine months ended December 31, 2001, we used
approximately $8.7 million of the net proceeds to fund our general operations.
We expect to use the remaining offering net proceeds for working capital and
general corporate purposes, including continued investment in the development of
our current and future online direct marketing services, the expansion of our
sales and marketing activities, and investment in our infrastructure.
Additionally, we may use a portion of the net proceeds to acquire or invest in
complementary products, technologies, or businesses.
20
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits Description
-------- -----------
10.1 Employment agreement by and between Registrant and
Kevin Johnson
Reports on Form 8-K
None
21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: February 13, 2002
DIGITAL IMPACT, INC.
(Registrant)
/S/ WILLIAM PARK
-------------------------------------------
William Park
President, Chief Executive Officer and
Chairman of the Board of Directors
(Principal Executive Officer)
/S/ DAVID OPPENHEIMER
-------------------------------------------
David Oppenheimer
Sr. Vice President, Chief Financial Officer
and Treasurer (Principal Financial and
Accounting Officer)
22
EXHIBIT INDEX
Exhibits Description
-------- -----------
10.1 Employment agreement by and between Registrant and
Kevin Johnson
23