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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-K
(Mark One)
 
x
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended January 31, 2002
 
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: 000-32377
 
 
LOUDCLOUD, INC.
(Exact name of registrant as specified in its charter)
Delaware
  
94-3340178
(State or other jurisdiction of
incorporation or organization)
  
(I.R.S. Employer
Identification Number)
 
599 N. Mathilda Avenue, Sunnyvale, California 94085
(Address, including zip code, of Registrant’s principal executive offices)
 
(408) 744-7300
Registrant’s telephone number, including area code
 
 
Securities registered pursuant to Section 12(b) of the Act:
None
 
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.001 per share
 
 
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 statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x
 
The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing price of Common Stock on April 1, 2002, as reported by Nasdaq, was approximately $91.8 million. Shares of voting stock held by each officer and director and by each person who owns 5% or more of the outstanding voting stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
 
As of April 1, 2002, 76,322,947 shares of the registrant’s Common Stock were outstanding.
 
 

 
TABLE OF CONTENTS
 
           
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ITEM 1.
        
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ITEM 2.
        
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ITEM 4.
        
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ITEM 5.
        
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ITEM 6.
        
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ITEM 7.
        
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ITEM 7A.
        
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ITEM 8.
        
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ITEM 9.
        
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58
ITEM 10.
        
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ITEM 11.
        
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ITEM 12.
        
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ITEM 13.
        
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69
ITEM 14.
        
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i

 
PART I
 
ITEM 1.    BUSINESS
 
Cautionary Statement Regarding Forward-Looking Statements
 
This Annual Report on Form 10-K contains forward-looking statements. These statements relate to our, and in some cases our customers’ or partners’, future plans, objectives, expectations, intentions and financial performance and the assumptions that underlie these statements. These forward-looking statements include, but are not limited to, statements regarding the following:
 
 
•
 
anticipated market trends and uncertainties;
 
 
•
 
our intention to begin offering our Opsware automation technology in conjunction with our deployment and professional services to customers for use within their own data center facilities;
 
 
•
 
our offering of our Opsware automation technology as a stand alone product;
 
 
•
 
the closing of the acquisition of Frontera Corporation and our expectations regarding the amount of cash we expect to acquire in connection with the acquisition;
 
 
•
 
our expectations concerning our cost of revenues;
 
 
•
 
our expectations concerning our research and development expenses;
 
 
•
 
our expectations concerning our sales and marketing expenses;
 
 
•
 
our expectations concerning our general and administrative expenses;
 
 
•
 
our expectations concerning our stock-based compensation expense;
 
 
•
 
our anticipated capital expenditures and lease commitments;
 
 
•
 
the adequacy of our capital resources to fund our operations;
 
 
•
 
our expectations regarding our operating losses and negative cash flow;
 
 
•
 
our expectations regarding continuing customer concentration;
 
 
•
 
anticipated increases in customers and expansion of our service offerings and target markets;
 
 
•
 
our expectations regarding ongoing developments of our Opsware technology and other technical capabilities;
 
 
•
 
anticipated expansion in our direct and indirect sales organizations; and
 
 
•
 
anticipated continuation of expansion into foreign markets.
 
These statements involve known and unknown risks, uncertainties and other factors that may cause industry trends or our actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. These factors include those listed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” in this Annual Report on Form 10-K.
 
Although we believe that expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We will not update any of the forward-looking statements after the date of this Annual Report on Form 10-K to conform these statements to actual results or changes in our expectations, except as required by law. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Annual Report on Form 10-K.

1

 
Overview
 
We are a leading provider of managed Internet services for corporations and governmental agencies that operate mission-critical Internet applications. We deliver our services using our proprietary Opsware automation technology, which automates formerly manual tasks, such as provisioning and managing a customer’s Internet operations, thereby reducing the amount of manual intervention required. Our managed Internet services allow customers to outsource the deployment, configuration, hosting, management and support of their Internet applications and web sites in a cost-effective and highly flexible manner. Our services enable customers to increase or reduce their Internet operations capacity as business needs dictate, without having to undertake the difficulty and expense associated with building the required operations expertise in-house.
 
We are able to deploy operations capacity for our customers consistently across multiple locations and to maintain that infrastructure through a centralized network operations center. Among other things, our services enable our customers to: maintain a duplicate operations infrastructure in a separate location to protect against loss of service in the event of a localized disruption; quickly expand their Internet presence as business opportunities arise in new geographies; and efficiently incorporate new functionality or technologies into their existing Internet operations as technologies evolve. We believe that our Opsware automation technology enables us to deploy and service customers more efficiently and with a higher level of service quality than customers could otherwise do themselves.
 
Industry Background
 
The Internet is fundamentally changing the way businesses interact with their customers, partners and other businesses and has become an important medium for both commerce and communications. Businesses are now able to access and distribute a wide array of software services over the Internet, allowing them to, among other things, implement supply chain management solutions and migrate other operating functions on-line, market and sell products and services to customers and offer web-based customer self-service programs. As a result, businesses are substantially increasing their investments in Internet sites, services, software, network infrastructure, information technology personnel and hardware to leverage the reach and efficiency of the Internet.
 
Notwithstanding the increase in investments in Internet infrastructure, the complexity of successfully deploying and maintaining Internet operations continues to increase. The in-house expertise required to meet these challenges is significant and typically requires a host of technical specialists, including network administrators, systems administrators, database administrators, security experts, monitoring and management experts, project managers, software operations specialists, troubleshooting specialists and performance engineers. It is often difficult, time consuming and costly to hire and retain these experts. Even if businesses can effectively hire and retain these experts, deploying this talent to maintain a business’ Internet infrastructure is inefficient as it diverts these resources from enhancing a business’ core competencies.
 
As a result, businesses are increasingly seeking to outsource management of their Internet operations to providers that can increase performance, provide continuous operation of their Internet solutions and reduce operating expenses. To effectively manage the increasing complexity of Internet operations, we believe that customers require a reliable, secure, scalable and cost-effective solution that allows them to focus on their core competencies and provide greater functionality and flexibility than they could otherwise attain on their own. In addition, customers require the ability to increase or reduce their Internet applications capacity as business needs dictate and to deploy and maintain their Internet operations consistently across multiple locations via a centralized network operations center.
 
The Loudcloud Solution
 
We provide managed Internet services that address the challenges associated with deploying, maintaining and growing Internet operations for critical business functions. We provide customers with high levels of

2

reliability and the ability to efficiently grow their Internet operations, helping them to reduce the time it takes to build or expand their Internet initiatives. We serve as the single point of management for a customer’s Internet applications and offer a broad range of services that allow us to meet the customer’s expanding set of needs as its Internet applications become more complex. A key element of our service delivery is our Opsware automation technology, which automates formerly manual tasks associated with Internet operations, thereby reducing the amount of manual intervention required and increasing the quality and reliability of our services.
 
Service Offerings
 
Customers can purchase from us a variety of services that support a wide array of Internet applications, including databases, web and application software and servers, storage, security and data center space. We provide our services across both the Unix and Windows platforms in highly secure, highly available and redundant environments. At our network operations center, we monitor and report on the performance of each component of the customer’s Internet operations that is managed by us through our centralized monitoring platform. In addition, through the myLoudcloud portal, our customers can access a variety of reports and services to view information and monitor the performance of the infrastructure we provide them. We provide our services in exchange for recurring monthly fees, enabling our customers to predictably budget costs for Internet managed services. These fees are typically contracted as part of one, two or three-year agreements that provide for service-level guarantees.
 
We offer the following services:
 
Managed Server and Network Services.    Our Managed Server and Network services provide the basic components upon which a customer builds its site. We provide procurement, setup, testing, monitoring and troubleshooting of a wide range of best-of-breed server and network devices. We manage and test all deployed devices for reliability, scalability, security, and manageability.
 
Our Managed Server services provide customers with monitoring and management services for the hardware and operating system. In addition, we provide end-to-end management of a customer’s network infrastructure to deliver secure, reliable network connectivity. Our Managed Network services include firewall and load balancing solutions designed to maximize site performance and protection. We also offer secure remote access solutions, enabling customers to transmit sensitive data securely over a virtual private network or point-to-point connection.
 
Managed Application and Database Services.    Our Managed Application and Database services provide a dedicated, scalable and secure foundation for a customer’s Internet operations. Our Web Server Management services maintain the availability of inbound and outbound Internet-based requests to and from a customer’s web site. Our Application Server Management services provide a dedicated, scalable and secure application server environment, which evaluates business rules and serves dynamic web content to the end users of a customer’s web site. We also offer customers Database Server Management services, which provide the environment through which transactions requested by the end user are processed, data maintained in the database is served and transaction history is stored.
 
We monitor each of these environments on a 24x7 basis, including searching for security and functional patch updates, filtering them for relevance and applying the patches in a consistent and reliable way. We also offer customers load balancing functionality, which is a means of balancing traffic and information processing requests across multiple hardware servers.
 
An additional component of our Application and Database Management services is our Application Provisioning services. These services leverage our Opsware automation technology to provide consistent installation of applications and the ability to quickly restore these applications in the case of a failure.

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Managed Storage and Backup Services.    We provide a flexible, multi-tiered, storage offering to cost-effectively deliver storage solutions that meet businesses availability and performance requirements. In addition, we offer customers a robust backup and recovery solution to protect against the loss of mission-critical data through technical errors, security breaches or hardware failures.
 
Managed Security Services.    Our suite of security services helps protect customers against Internet threats. While critical security components are applied to every server we deploy, our Managed Security Services enable customers to tailor an advanced defense to fit their business needs. Available services include digital certificate management, intrusion detection analysis, vulnerability analysis, 24x7 monitoring, network-based intrusion detection and secure mail.
 
Managed Service Options.    Our Managed Service Options are modular services that provide customers the flexibility to tailor our services to their specific managed service requirements. We offer the following Managed Service Options:
 
Reporting Services.    We provide reporting services to help customers analyze their web sites from an end user’s perspective. Available services include:
 
 
•
 
Web Log Analysis Service.    Our Web Log Analysis service provides reports on a broad range of metrics—from a list of the most-accessed pages to more sophisticated analyses of end-user search behavior. We support and manage the analysis application, maintain the timeliness and accuracy of the reports and can customize reports based on customer preferences.
 
 
•
 
Keynote Perspective Service.    The Keynote Perspective service provides quantitative analysis regarding the perception of a customer’s web site by its end users and the site’s performance relative to the web sites of its competitors. This service uses the Keynote Perspective Service.
 
 
•
 
Mercury Interactive ActiveWatch Service.    The ActiveWatch Service allows our customers to continuously measure the time it takes to perform important transactions, such as logging in, ordering an item or initiating a stock trade. By simulating the end-user experience, this service can help customers make decisions on where to focus their web site optimization efforts. This service uses Mercury Interactive’s Topaz software.
 
Monitoring Services.    Our Monitoring Service provides monitoring for customer-defined events and includes a customer-specified, pre-defined response for each event.
 
Performance Services.    We provide a suite of services that can enhance web site performance by improving the speed with which end users can access the site. Performance services include Akamai FreeFlow, Akamai FreeFlow Streaming, secure socket layer acceleration and caching.
 
Disaster Recovery Services.    Our Disaster Recovery services enable companies to continue operating their Internet business through catastrophic events and to return to normalcy as rapidly as possible. We provide three Disaster Recovery service options that suit a customer’s unique budget and service requirements. Each of the services provides customers with the geographical redundancy necessary for a disaster recovery plan:
 
 
•
 
Disaster Recovery Select.    This option permits customers to determine which applications are needed to provide business continuity in the event of a disaster. We then provide complete disaster recovery for the specified applications only.
 
 
•
 
Disaster Recovery Distributed.    This option allows customers to split their web sites into two geographically distinct locations using existing hardware. For example, customers can opt to place the staging and production environments in two different locations. In the event of a disaster, we will then convert the staging environment to a live production environment for the customer’s use.
 
 
•
 
Disaster Recovery Complete.    In this option, we provide a complete replica of the customer’s primary site in another geographic location. In the event of a disaster, we can fail over to the disaster recovery site in 4 hours or fewer.

4

 
Deployment and Launch Services.    In addition to the ongoing maintenance of a customer’s Internet operations, we also provide Deployment and Launch services to migrate and deploy customers to our infrastructure environment.
 
Planning and Design.    During this phase in the deployment process, our technical team works with the customer to understand the technical site requirements and generate a project plan and a final site architecture diagram.
 
Build.    During the build phase, our technical team deploys and provisions all network, hardware, and storage systems required for the customer configuration. In addition, using our Opsware automation technology, we install, configure and integrate key system software, including the operating system, web server, application server and database, to base-level configurations.
 
Site Integration.    During the site integration phase, we integrate the customer’s software code, content, configuration and database into the operational environment.
 
Test and Go-live.    Immediately prior to taking the customer’s Internet site live, we perform comprehensive system testing. Tests include customer site testing, high availability (HA) and system failover, stability testing, security testing, monitoring configuration verification, and troubleshooting documentation verification.
 
We also offer a variety of professional services including architectural design and assessment and platform and systems consultation. We have recently announced our intention to begin offering our Opsware automation technology in conjunction with our deployment and professional services to customers for use within their own data center facilities. In addition, we may offer our Opsware automation technology as a stand alone product in the future.
 
Technology and Infrastructure
 
Central to the delivery of our managed services is our Opsware automation technology. This technology consists of software and systems that automate the many tasks required to configure, deploy, maintain and scale web sites. Our Opsware technology requires no modifications to existing customer code and provides the following functionality:
 
Deployment.    We designed our Opsware technology to automate the deployment and configuration of our customers’ Internet environments. For example, our Opsware technology can automatically and remotely configure servers as needed by a particular customer. Our Opsware technology also consistently configures the various components of the operational environment to ensure, for example, that a customer’s networking devices are configured appropriately to interact with the hardware running in the environment. We believe that this functionality allows us to configure equipment in less time and with more consistent quality than if the process were done manually. In addition, our Opsware technology permits us to deliver our services in multiple locations, without having to maintain a full operations presence in each location.
 
Scaling.    Our Opsware technology maintains a central repository of data pertaining to the operations of our customer environments. Because our Opsware technology maintains this customer-specific data, whenever a customer requires additional capacity in the environment, our Opsware technology can automatically deploy new servers and configure them to the specifications of the customer’s existing environment. This functionality, in conjunction with our procurement process and vendor relationships, enables us to offer our customers the ability to deploy the capacity that their environment requires and adjust capacity as their needs change.
 
Advanced configuration management.    We have built into our Opsware technology advanced configuration management functionality designed to enhance the consistency and reliability of our services. For example, our

5

Opsware technology maintains a repository of customer data and operations configurations, as well as their cross-system dependencies, to enable us to re-provision a customer in a new environment in the event of a failure in the customer’s existing location. This same functionality also allows us to roll back a customer’s operational environment to a previous version in the event that a change to the operational environment—for example, introducing a new version of application server software or updating new customer code—adversely affects the performance of the environment.
 
Ongoing monitoring and maintenance.    Using our Opsware technology, we provide comprehensive monitoring and maintenance of our customers’ environments, from the network layer through the application layer. The metrics that our Opsware technology monitors are designed to maintain and verify the integrity and quality of the infrastructure and customer data and to proactively detect performance problems. In addition, the technology assists us in preventing, detecting, responding to and auditing security breaches. We have designed our Opsware technology to extend the scope of monitoring capabilities beyond those generally provided by standard monitoring tools. We provide a comprehensive, uniform approach to monitoring across multiple levels of the Internet infrastructure to help identify performance bottlenecks and detect and diagnose failures. In addition, through the myLoudcloud portal, our customers can access a variety of reports and services to view information and monitor the performance of the infrastructure we provide them.
 
Operational Environment
 
We provide our services to the majority of our customers through third-party data centers located in the San Francisco Bay Area, the New York metropolitan area and the United Kingdom. We provision bandwidth services directly through our third-party data center providers and through third-party bandwidth providers. We build out the core operational environment in each of our third-party data center locations to include a robust and highly available operational core—which includes switches, routers, firewalls and a storage area network. In addition, we build out individual customer compartments that include fully dedicated equipment required to support a particular customer’s operational needs. The operational environment also includes the hardware and storage equipment required to extend the capabilities of our Opsware technology to the customers we support in the particular third-party data center. We are also able to provide our Opsware technology, deployment and professional services within the customer’s own data center facilities.
 
Each of our third-party data center locations is continuously monitored from our Network Operations Center, or NOC, which is located at our corporate headquarters in Sunnyvale, California. We maintain continuous, twenty-four hour staffing of our NOC with our professional support representatives who are trained in network diagnostics, server diagnostics and engineering. The NOC is designed to monitor and maintain the stability, performance and security of our customers’ operations environments.
 
We provide a comprehensive, multi-level security infrastructure to help our customers protect their sites against security breaches. Our multi-level approach to security avoids dependencies on a single point of failure that, if breached, could leave the entire site vulnerable. Our approach provides additional levels of protection that an attacker must penetrate before inflicting significant damage to a customer’s business. Our use of individual customer compartments further protects a customer from exposure to security breaches in another customer’s compartment. In addition to various security prevention tactics, we also employ a number of detection, auditing and response and repair mechanisms designed to ensure that security problems are quickly detected and remedied.
 
Customers
 
Our customers include a variety of businesses and governmental agencies that have deployed mission-critical Internet sites. Currently, our representative customers include: Adidas, Blockbuster, Boeing-Autometric, Cablevision, Consignia (UK Post Office), E-envoy, Fandango, Fannie Mae, Ford Motor Company, Freddie Mac, Fusura, Juniper Financial, Knight Ridder, Kontiki, News Corporation, Univision Online and USA Today.

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Industry Relationships
 
We have developed a variety of relationships with a number of leading technology companies. Among others, we have established relationships with the following third parties:
 
Enterprise Software and Hardware Vendors.    We have entered into marketing or lead referral relationships with several enterprise software vendors, including Akamai, BEA, IBM, Microsoft, Oracle and Sun Microsystems. In addition, for the particular technology products that our research organization has certified are appropriate to deploy in our customer environments, we have incorporated into our service offerings products from the vendors mentioned above, as well as from Alteon WebSystems, Art Technology Group, Cacheflow, Cisco, Compaq, EMC, Epicentric, Hewlett-Packard, Sun Microsystems’ iPlanet, Keynote Systems, Mercury Interactive, Micromuse, Netegrity, Network Appliance, Veritas and Vignette. We develop our Opsware technology to automatically provision, maintain and scale the technology we support.
 
Data Center Providers.    We have contractual arrangements with AT&T, Equinix and Qwest Communications. We utilize the facilities of our data center providers to deploy our customers. In addition, we have also entered into a reseller agreement with Qwest whereby we have trained members of the Qwest sales force to directly sell our managed services, while we remain the sole operations provider responsible for the delivery of the services. For most of our data center relationships, we are able to procure data center space for additional customers on an as-needed or just-in-time basis.
 
Engineering and Research
 
Our engineering organization designs and develops services that we offer to our customers and services that we use internally to streamline customer deployment and support. Our research organization investigates and tests products from multiple software and hardware vendors to determine whether they have the appropriate levels of scalability, reliability and security to be incorporated into our service offerings. Key to the engineering organization’s development of a new service offering is its ability to implement the provisioning, configuration, monitoring and maintenance of the new service into our technology. Our engineering organization is also responsible for the continuous extension of our technology’s capabilities.
 
Sales and Marketing
 
We sell and market our services in the United States and Europe primarily through a direct sales force and indirectly through our sales and marketing channels. We have a European sales office in the United Kingdom and sales representatives located in Germany. We are selectively expanding our number of direct sales representatives to enhance our geographic coverage.
 
We focus our marketing efforts on increasing brand recognition, market awareness and lead generation. We will continue to invest in building our brand recognition in the United States and internationally through public relations programs, interactions with industry analysts and trade shows.
 
Competition
 
The market for managed services is rapidly evolving and highly competitive. We expect competition to persist and intensify in the future. In addition to in-house solutions, our primary current and prospective competitors include: providers of co-location or web site hosting and related services and providers of Internet systems integration or professional services.
 
Many of our competitors have longer operating histories, significantly greater financial, technical, and other resources, or greater name recognition than we do. Our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements. Competition could seriously harm our ability to

7

sell additional services on terms favorable to us. Competitive pressures could cause us to lose market share or to reduce the price of our services, either of which could harm our business, financial condition and operating results.
 
We believe that the principal competitive factors in our market include: quality and reliability of services offered; scope of supported applications and technology platforms; scalability of the operational environment supported; price; extent to which the services offered provide a complete solution to a potential customer’s operations requirements; engineering and technical expertise and development of automation software; rapid deployment of services; and quality of customer service and support. Although we believe our services compete favorably with respect to each of these factors, the market for our services is new and rapidly evolving. We may not be able to maintain our competitive position against current and potential competitors, especially those with greater resources.
 
Intellectual Property
 
We rely on a combination of patent, trademark, trade secret, copyright and other laws and contractual restrictions to protect the proprietary aspects of our services. These legal provisions afford only limited protection. We have no issued patents. It is difficult to monitor unauthorized use of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States, and our competitors may independently develop technology similar to ours. We will continue to assess appropriate occasions for seeking intellectual property protections for those aspects of our technology that we believe constitute innovations providing significant competitive advantages.
 
We routinely require our employees, customers and potential business partners to enter into confidentiality and nondisclosure agreements before we disclose any sensitive aspects of our services, technology or business plans to them. In addition, we require employees to agree to assign to us any proprietary information, inventions or other intellectual property they generate while employed by us. Despite our efforts to protect our proprietary rights through confidentiality and license agreements, unauthorized parties may attempt to copy or otherwise obtain and use our services or technology. These precautions may not prevent misappropriation or infringement of our intellectual property.
 
Employees
 
As of April 1, 2002, we had 380 full-time employees. Our future success will depend upon our ability to attract, integrate, retain and motivate highly qualified technical and management personnel, for whom competition can be intense. None of our employees is covered by a collective bargaining agreement. We believe our relations with our employees are good.
 
Corporate Information
 
We were incorporated in September 1999 as a Delaware corporation.

8

 
ITEM 2.    PROPERTIES
 
Our corporate headquarters are located in Sunnyvale, California, where we occupy approximately 75,000 square feet under a lease expiring in 2010. In addition, we are currently under obligation for leased space terminating between 2002 and 2005 that totals 150,000 square feet. Of the 150,000 square feet, approximately 92,000 square feet is subleased and 58,000 square feet is currently available and unoccupied. We also lease a facility consisting of approximately 22,000 square feet in Virginia. This lease expires in 2005. We have numerous operating leases and licenses for third-party data center space and field sales offices. We believe that our facilities are adequate to meet current requirements and that additional space will be available as needed to accommodate any expansion of operations.
 
ITEM 3.    LEGAL PROCEEDINGS
 
We are currently a defendant in multiple lawsuits filed beginning in August 2001 claiming that we, certain of our officers, directors and the underwriters of our initial public offering violated federal securities laws by providing materially false and misleading information in our prospectus. These lawsuits, which are pending in the U.S. District Courts for the Southern District of New York and the Northern District of California, are being brought as a class action on behalf of all purchasers of our common stock from March 8, 2001 to May 1, 2001, and seek damages in unspecified amounts. We strongly deny these allegations and will defend ourselves vigorously; however, litigation is inherently uncertain and there can be no assurance that we will not be materially affected. In addition, we anticipate that we will incur associated litigation expenses in connection with these lawsuits.
 
ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
None.

9

 
PART II
 
ITEM 5.
 
MARKET FOR REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
 
Market for Our Common Stock
 
Our common stock is listed on the Nasdaq National Market under the symbol “LDCL.” The following table sets forth, for the periods indicated, the high and low sales prices per share of our common stock as reported by the Nasdaq National Market since our initial public offering of common stock at $6.00 per share on March 9, 2001. Prior to this time there was no public market for our stock.
 
Fiscal year ending January 31, 2002:
   
High
     
Low
First Quarter (from March 9, 2001)
   
$6.56
     
$3.88
Second Quarter
   
$7.00
     
$1.28
Third Quarter
   
$2.81
     
$1.12
Fourth Quarter
   
$4.98
     
$2.00
 
We have never paid cash dividends and do not plan to do so in the foreseeable future. According to the records of our transfer agent, at April 1, 2002, there were approximately 499 stockholders of record of our common stock.
 
Recent Sales of Unregistered Securities
 
We did not sell any unregistered securities during the fiscal quarter ended January 31, 2002.

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ITEM 6.    SELECTED CONSOLIDATED FINANCIAL DATA
 
The selected consolidated financial data below should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. The selected consolidated statement of operations data for the years ended January 31, 2002 and 2001 and for the period from inception (September 9, 1999) to January 31, 2000 and the selected consolidated balance sheet data as of January 31, 2002 and 2001 are derived from the audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected consolidated balance sheet data as of January 31, 2000 was derived from the audited Consolidated Balance Sheet included with the Annual Report on Form 10-K filed on April 25, 2001. Historical results are not necessarily indicative of results that may be expected for future periods.
 
    
Year Ended January 31,
       
Period from Inception
(September 9, 1999)
to January 31, 2000
  
    
2002
     
2001
       
    
(in thousands, except per share amounts)
  
Consolidated Statements of Operations Data:
                             
Net revenue
   
$
56,012
 
   
$
15,486
 
     
$
—  
 
Restructuring costs
   
 
31,471
 
   
 
—  
 
     
 
—  
 
Amortization of deferred stock compensation
   
 
42,666
 
   
 
71,725
 
     
 
2,208
 
Loss from operations
   
 
(207,334
)
   
 
(164,806
)
     
 
(5,131
)
Net loss
   
 
(210,675
)
   
 
(166,420
)
     
 
(4,981
)
Series C convertible preferred stock deemed non-cash dividend
   
 
—  
 
   
 
(67,530
)
     
 
—  
 
Net loss applicable to common stockholders
   
 
(210,675
)
   
 
(233,950
)
     
 
(4,981
)
Basic and diluted net loss per share applicable to common stockholders
   
$
(3.45
)
   
$
(165.57
)
     
$
(1,815.23
)
 
 
    
As of January 31,
    
2002
   
2001
   
2000
    
(in thousands)
Consolidated Balance Sheet Data:
                     
Cash, cash equivalents, short-term investments and restricted cash
   
$
115,638
   
$
80,422
   
$
20,479
Working capital
   
 
48,928
   
 
19,643
   
 
16,088
Total assets
   
 
174,297
   
 
148,212
   
 
25,763
Long-term obligations and senior discount notes, net of current portion
   
 
56,657
   
 
43,063
   
 
—  
Stockholders’ equity
   
$
57,476
   
$
58,591
   
$
20,690

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ITEM 7.
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion should be read together with the consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause future results to differ materially from those projected in the forward-looking statements include, but are not limited to, those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in “Risk Factors.” See “Business—Cautionary Statements Regarding Forward-Looking Statements.”
 
The following discussion 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 amounts of assets, liabilities, revenues and expenses, and related disclosure of contingencies. On an on-going basis, we evaluate our estimates, including those related to customer downtime credits and incentives, allowance for doubtful accounts, impairment of investments and property, plant, and equipment, restructuring, long-term service contracts and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
 
Overview
 
We are a leading provider of managed Internet services for corporations and government agencies that operate mission-critical Internet applications. We deliver our services using our proprietary Opsware automation technology, which automates formerly manual tasks, such as provisioning and managing a customer’s Internet operations, thereby reducing the amount of manual intervention required. Our managed Internet services allow customers to outsource the deployment, configuration, hosting, management and support of their Internet applications and web sites in a cost-effective and highly flexible manner. Our services enable customers to increase or reduce their Internet operations capacity as business needs dictate, without having to undertake the difficulty and expense associated with building the required operations expertise in-house.
 
We were founded in September 1999. From inception through January 2000, we developed our initial service offerings, hired employees and began to market our services. We deployed our first customer in February 2000. Our customers purchase our services through customer service agreements, which generally have terms of one to three years. Our agreements are generally renewed automatically for periods ranging from three months to one year, unless terminated prior to the expiration of the initial term. We generally recognize revenue related to these agreements ratably over the period the managed services are provided to the respective customers.
 
From time to time, we may disclose our bookings for a particular quarter. Bookings over a particular period represent the prospective contract value of agreements entered into during a period from new and existing customers and other agreements for services initiated during the period. In addition, bookings typically does not take into account any decreases in contracts previously booked. The extent to which revenue is generated from bookings depends on a number of factors such as customer churn, service credits in case of outages, deployment timing, contract renegotiation, early termination and, in certain cases, further specification of projects by our customers. In addition, our customer agreements are subject to standard termination provisions, including breach or insolvency by either party to the agreement. Finally, customers’ ability to pay the contractually agreed upon amounts could become limited in the future based on their operating results, in which case we would not ultimately recognize revenue related to those customers. Also, from time to time, we may disclose information related to customer churn, which means the loss of revenue from both contract terminations and reductions in the size of contracts. The amount of revenue we ultimately realize under these agreements may be less than the

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prospective contract value of these agreements and cannot be derived from bookings. Although we disclose bookings from time to time, we will not update any such disclosures after the date upon which they are made to conform such disclosures to actual results or changes, except as required by law.
 
Cost of revenue consists primarily of payments on rental equipment, salaries and related personnel expenses of our employees who provide services to our customers, leases of data center space in third-party facilities, customer support services, including network monitoring and support, and depreciation and amortization of capitalized equipment and software.
 
Research and development expenses consist primarily of salaries and related personnel expenses and depreciation and amortization of purchased equipment and software. Sales and marketing expenses consist primarily of salaries, commissions and related personnel expenses, as well as advertising, trade shows and promotional expenses. General and administrative expenses consist primarily of salaries and benefits of our administrative personnel and fees for outside professional services. We intend to continue to invest in research and development and new technologies to develop new services and further advance our offerings.
 
In February 2001, we entered into a marketing alliance agreement with Accenture. Accenture is entitled to receive marketing assistance fees and has been issued a warrant to purchase up to 250,000 shares of our common stock. Warrants issued to Accenture vest contingently. A specified number of warrants fully vest and become immediately exercisable and non-forfeitable upon the signing of a contract between us and a new customer referred to us by Accenture. The warrants can be earned through the termination of the agreement in February 2004, and vested warrants expire on February 28, 2006. We will record the fair value of each warrant as it vests using the Black-Scholes pricing model. A significant factor in the Black-Scholes pricing model will be the fair value of our stock when the warrants vest compared to the exercise price. The exercise price is $6.00. The fair value of the warrants that vest upon the signing of a customer’s contract will be amortized into operating expenses (marketing expenses) over the life of the contract between the customer and us. To date, no warrants have vested. In addition, upon the signing of a contract between us and a customer referred from Accenture, Accenture is entitled to receive marketing assistance fees, payable monthly, based on a percentage of amounts payable to us under the contract. The marketing assistance fees will be recognized monthly by us based on the fees due Accenture. To date, no marketing assistance fees have been paid. We believe that the sales and marketing alliance agreement could result in significant stock-based compensation. Accenture stock-based and cash compensation will be disclosed on a separate line in operating expenses (marketing expenses).
 
In May 2001, we announced a restructuring program to improve utilization of our existing technology and infrastructure. This restructuring program included a worldwide workforce reduction, consolidation of the resulting excess facilities and a provision for excess and obsolete property and equipment. As a result of the restructuring program, we recorded restructuring costs of $30.2 million classified as operating expenses.
 
In September 2001, we announced an organizational realignment intended to increase operational efficiencies, reduce costs and reduce our cash needs. This organizational realignment included hiring in some key areas and the elimination of some positions. As a result of the organization realignment, we recorded restructuring costs of $1.3 million which were included in operating expenses.
 
In February 2002, we entered into an agreement to acquire Frontera Corporation, a privately held managed services provider located in southern California, for consideration consisting solely of our common stock. The acquisition is valued at approximately $12 million to $13 million. The closing of the acquisition is expected to occur in the second quarter of fiscal 2003 and is subject to customary closing conditions, including Frontera stockholder approval and regulatory approvals. If the acquisition closes, we expect to acquire approximately $10 million of cash.

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Results of Operations
 
The following table sets forth consolidated statements of operations data for the fiscal years ended January 31, 2002 and 2001 and for the period from inception (September 9, 1999) to January 31, 2000. This information has been derived from our audited consolidated financial statements. This information should be read together with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. The operating results for any period are not necessarily indicative of the operating results for any future period.
 
    
Year Ended January 31,
       
Period from Inception
(September 9, 1999)
to January 31, 2000
  
    
2002
     
2001
       
    
(in thousands, except per share amounts)
  
Consolidated Statements of Operations Data:
                             
Net revenue
   
$
56,012
 
   
$
15,486
 
     
$
—  
 
Costs and expenses:
                             
Cost of revenue*
   
 
109,676
 
   
 
58,083
 
     
 
—  
 
Research and development*
   
 
21,033
 
   
 
17,867
 
     
 
1,453
 
Sales and marketing*
   
 
39,560
 
   
 
20,561
 
     
 
710
 
General and administrative*
   
 
18,940
 
   
 
12,056
 
     
 
760
 
Restructuring costs
   
 
31,471
 
   
 
—  
 
     
 
—  
 
Amortization of deferred stock compensation
   
 
42,666
 
   
 
71,725
 
     
 
2,208
 
    
  
    
Total costs and expenses
   
 
263,346