S-1 1 ds1.htm FORM S-1 Form S-1
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As filed with the Securities and Exchange Commission on December 18, 2007.

Registration No. 333-            

 


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 


GLASSHOUSE TECHNOLOGIES, INC.

(Exact Name of Registrant as Specified in its Charter)

 


 

Delaware   7373   04-3561337
(State or Other Jurisdiction of Incorporation or Organization)   (Primary Standard Industrial Classification Code Number)  

(I.R.S. Employer

Identification Number)

200 Crossing Boulevard

Framingham, Massachusetts 01702

(508) 879-5729

(Address, including zip code and telephone number, including area code, of registrant’s principal executive offices)

Mark A. Shirman

Chairman of the Board of Directors, President and Chief Executive Officer

200 Crossing Boulevard

Framingham, Massachusetts 01702

(508) 879-5729

(Name, address, including zip code and telephone number, including area code, of agent for service)

 


Copies to:

 

Marc F. Dupré

Gunderson Dettmer Stough

Villeneuve Franklin & Hachigian, LLP

610 Lincoln Street

Waltham, Massachusetts 02451

Telephone: (781) 890-8800

Telecopy: (781) 622-1622

 

Keith F. Higgins

Ropes & Gray LLP

One International Place

Boston, Massachusetts 02110

Telephone: (617) 951-7000

Telecopy: (617) 951-7050

 


Approximate date of commencement of proposed sale to the public:    As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box.  ¨

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to be Registered

  Proposed Maximum
Aggregate Offering Price(1)(2)
  Amount of
Registration Fee

Common Stock, $0.001 par value

  $100,000,000   $3,070
 
 
(1) Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(o) under the Securities Act.
(2) Includes offering price of additional shares that the underwriters have the option to purchase, if any.

 


The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment that specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to such Section 8(a), may determine.

 



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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion. Dated             , 2008.

            Shares

LOGO

Common Stock

 


This is an initial public offering of shares of common stock of GlassHouse Technologies, Inc. All of the              shares of common stock are being sold by the company.

Prior to this offering, there has been no public market for the common stock. It is currently estimated that the initial public offering price per share will be between $             and $            . We intend to apply to have our common stock approved for quotation on the Nasdaq Global Market under the symbol “GLAS”.

 


See “ Risk Factors” on page 8 to read about factors you should consider before buying shares of the common stock.

 


Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 


 

     Per Share    Total

Initial public offering price

   $                 $             

Underwriting discount

   $      $  

Proceeds, before expenses, to GlassHouse

   $      $  

To the extent that the underwriters sell more than              shares of common stock, the underwriters have the option to purchase up to an additional              shares from GlassHouse at the initial public offering price less the underwriting discount.

The underwriters expect to deliver the shares against payment in New York, New York on                     , 2008.

Goldman, Sachs & Co.

JPMorgan

Banc of America Securities LLC

Thomas Weisel Partners LLC

 


Prospectus dated                     , 2008.


Table of Contents

LOGO

 

 


Table of Contents

TABLE OF CONTENTS

Prospectus

 

     Page

Prospectus Summary

   1

The Offering

   5

Summary Historical and Pro Forma Consolidated Financial and Other Data

   6

Risk Factors

   8

Special Note Regarding Forward-Looking Statements

   23

Use of Proceeds

   24

Dividend Policy

   25

Capitalization

   26

Dilution

   28

Selected Consolidated Financial Data

   29

Unaudited Pro Forma Combined Condensed Financial Information

   31

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   40

Business

   64

Management

   76

Transactions With Related Persons, Promoters and Certain Control Persons

   103

Principal Stockholders

   106

Description of Capital Stock

   110

Shares Eligible for Future Sale

   113

Underwriting

   116

Industry and Market Data

   120

Legal Matters

   120

Experts

   121

Where You Can Find More Information

   121

Index to Financial Statements

   F-1

 


Through and including                     , 2008 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This obligation is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

 


No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus. You must not rely on any unauthorized information or representations. This prospectus is an offer to sell only the shares offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date.


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PROSPECTUS SUMMARY

This summary highlights the most important features of this offering and the information contained elsewhere in this prospectus. This summary is not complete and does not contain all of the information that you should consider before investing in our common stock. You should read the entire prospectus carefully, especially the risks of investing in our common stock discussed under the heading “Risk Factors” and our consolidated financial statements and related notes included in this prospectus.

GlassHouse Technologies, Inc.

Overview

We are a leading provider of information technology (IT) consulting, technology integration and managed services that address inefficiencies and risks inherent in storage and data infrastructure. We deliver a differentiated, comprehensive set of IT services using our unique service delivery framework, TransomSM , which was developed over the course of thousands of customer engagements and consists of proprietary software tools, methodologies and domain expertise. We provide a demonstrable return on investment (ROI) to customers by:

 

  Ÿ  

Reducing the total cost of data infrastructure

 

  Ÿ  

Improving IT service levels to support business functions

 

  Ÿ  

Decreasing risk in both data recovery and regulatory areas

We are primarily focused on the following large and fast growing addressable markets:

 

 

Ÿ

 

Storage/Data Protection: These services help customers plan, integrate and manage their physical data storage and data protection technologies. According to Gartner, this market is predicted to grow from $24 billion in 2006 to $34 billion by 2011.G1

 

 

Ÿ

 

Virtualization: These services help customers plan, integrate and manage their virtualized environments. IDC forecasts that the consulting and systems integration segments of this market will grow from $1.2 billion in 2006 to $5.2 billion in 2011 at an average compound annual growth rate (CAGR) of 33%.I1

 

 

Ÿ

 

“Green” Data Centers: These services help customers plan, migrate and manage their data centers to reduce power needs, thereby decreasing the cost to operate their data centers. We believe this market will grow rapidly, as companies seek to reduce their energy costs. According to Gartner, “more than 70% of the world’s Global 1000 organizations will have to modify their data center facilities significantly during the next five years.”G2

Many of our customer engagements encompass delivery of services across these markets. For example, we help customers migrate their existing data centers to new facilities while simultaneously integrating virtualization technologies to increase the efficiency of their existing physical assets.

We utilize components of our TransomSM framework in the majority of our projects. We integrate these internally developed and enhanced software tools into customer environments, which has resulted in customers retaining us for long-term managed services arrangements.

 

 

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Since our inception in 2001, we have developed ongoing direct customer relationships and have gained access to additional customers through our indirect sales channels. We have cultivated strong consulting relationships with Fortune 1000 companies such as Biogen Idec and JPMorgan and have developed recurring managed services relationships with large and small organizations such as Bank of Tokyo and Footstar. In addition, we have built scaleable indirect sales channels through technology partners such as Hitachi Data Systems (HDS), Savvis and CA.

Our services revenues have grown substantially from $25.8 million in the nine months ending September 30, 2006, to $40.3 million for the same period in 2007, reflecting a total annual growth rate of 56%, including acquisitions, and an organic annual growth rate of 26%.

Industry Background

The markets in which we operate are highly dynamic, characterized by high growth driven by:

 

 

Ÿ

 

The strong demand for storage infrastructure and associated services to support the continuing growth in data stored for business operations, regulatory compliance and corporate governance purposes, which Enterprise Strategy Group (ESG) estimates will grow at a 58% CAGR among worldwide commercial and government markets between 2007 and 2012.E1

 

 

Ÿ

 

Potential data center disruptions, as Gartner predicts that, “By 2011, more than 70% of U.S. enterprise data centers will face tangible disruptions related to floor space, energy consumption and/or costs”G3

 

 

Ÿ

 

The market acceptance of virtualization software that allows for the significant improvement of utilization in server assets, as IDC estimates that “average server utilization is less than 10%”I2

The rapid evolution of these markets has created significant, interrelated challenges for IT managers, including:

 

  Ÿ  

Minimizing costs within constrained IT budgets

 

  Ÿ  

Managing risk efficiently and cost effectively

 

  Ÿ  

Improving IT service levels to support business functions

 

  Ÿ  

Selecting a vendor independent services provider with the breadth and depth of required capabilities

We believe that IT managers are looking for outside resources to bridge the gap between the skills available and the skills required to address these challenges. This creates a significant opportunity for an IT services company focused on the storage/data protection, virtualization and “green” data center sectors.

Our Solution

We help customers reduce costs, decrease risk and improve service levels to support business functions through TransomSM, a unique service delivery framework consisting of proprietary software tools, methodologies and domain expertise.

Our services are delivered through three key practices:

Consulting. This practice is focused on services that assist customers in developing strategies, architectures and business cases around data infrastructure.

 

 

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Technology Integration. This practice is focused on services that assist customers in the technical deployment, systems upgrades and integration of technologies in their data infrastructures.

Managed Services. This practice is focused on services that manage customers’ storage, data protection and database environments to specified service levels.

Our key, differentiating strengths include:

Intellectual Property (IP) and Tools-Based Services.    We provide tools-based services that facilitate scalability and efficiency for both us and our customers. The software tools improve efficiency and consistency in the delivery of our projects and also offer transparency to customers, assisting with future decision making.

Comprehensive Scope of Services.    We provide end-to-end IT solutions within our focused markets, from strategy through technology integration to managed services.

Domain Expertise.    Industry media recognition of GlassHouse in our focused markets reaffirms our domain expertise. Some of our consultants are widely recognized for their subject matter expertise and regularly contribute to various publications in our focused markets. For example, W. Curtis Preston, our Vice President of Data Protection, is the author of Backup & Recovery, published by O’Reilly Media. Our consultants also present at conferences worldwide and meet regularly with industry analysts to share knowledge and evaluate industry trends.

Vendor Independence.    Our focus on selling services, not products, to drive efficiency in customers’ IT infrastructure environments helps us develop “trusted advisor” relationships.

Our Growth Strategy

Our objective is to enhance our position as a leading IT infrastructure consulting and services firm to Fortune 1000 companies. Our strategy for achieving this objective includes the following elements:

Deepen and Grow Our Customer Base.    We expect to continue developing our existing customer base by expanding the scope of our current engagements and generating additional follow-on business in consulting, technology integration and managed services.

Broaden Managed Services Offerings.    We provide a range of managed services to remotely monitor, report and analyze and actively manage our customers’ IT infrastructure environments. We have evolved our managed services offerings to address our customers’ critical infrastructure activities such as backup, storage allocation, database and server support. Our managed services offerings provide us with a recurring revenue stream and enable us to maintain ongoing interaction with our customers beyond a single engagement.

Integrate Additional Capabilities into the TransomSM Framework.    We will continue to evolve the scope of our services to encompass a broader range of expertise. To meet IT infrastructure challenges observed in our customer base during the course of our engagements, we have developed new offerings in storage cost modeling and allocation services, backup monitoring and reporting services and server virtualization. In addition, we regularly monitor and assess emerging technologies to determine their viability in improving the performance, reliability and cost-effectiveness of our customers’ IT infrastructure environments. By maintaining close contact with our customers, we believe we will be able to anticipate and successfully meet their needs for new services.

 

 

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Pursue Strategic Acquisitions.    We intend to selectively evaluate and pursue strategic acquisitions that provide additional customer relationships, geographic coverage, intellectual property and domain expertise that enhance our TransomSM framework.

Leverage Indirect Sales Channels.    We have developed relationships with technology vendors who engage GlassHouse to integrate their products into their customers’ IT environments or provide customer support services. These indirect sales channel relationships provide us with access to additional enterprise customers to whom we can ultimately cross-sell a broad range of consulting, technology integration and managed services, often leading to the creation of new offerings. We plan to continue growing these indirect sales channel relationships.

Risks That We Face

You should carefully consider the risks described under “Risk Factors” and elsewhere in this prospectus. These risks could materially and adversely impact our business, financial condition, operating results and cash flow, which could cause the trading price of our common stock to decline and could result in a partial or total loss of your investment.

Our Corporate Information

We were incorporated in Delaware in 2001. Our principal executive offices are located at 200 Crossing Boulevard, Framingham, Massachusetts 01702 and our telephone number is (508) 879-5729. Our web site address is www.glasshouse.com. The information on, or that can be accessed through, our web site is not part of this prospectus.

 

 

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THE OFFERING

 

Total common stock offered by GlassHouse

  

             shares

Option to purchase additional shares offered to underwriters by GlassHouse   

             shares

Total common stock to be outstanding after this offering   

             shares

Use of proceeds

   We expect to use the net proceeds of this offering for working capital and general corporate purposes, and we intend to use a portion of the net proceeds to repay, from time to time, acquisition-related loans. See “Use of Proceeds.”

Risk factors

   You should read the “Risk Factors” section of this prospectus for a discussion of factors that you should consider carefully before deciding to invest in shares of our common stock.

Proposed Nasdaq Global Market symbol

  

GLAS

The number of shares of our common stock to be outstanding after the offering is based on 58,814,310 shares of common stock outstanding as of September 30, 2007, including the assumed conversion of 46,908,158 shares of preferred stock outstanding on September 30, 2007 into 46,908,158 shares of common stock in connection with the closing of this offering. Except where stated otherwise herein, the number of shares of common stock to be outstanding after this offering does not take into account:

 

  Ÿ  

10,504,393 shares issuable upon exercise of options outstanding as of September 30, 2007 at a weighted average exercise price of $0.67 per share;

 

  Ÿ  

478,740 shares reserved as of September 30, 2007 for future issuance under our stock-based compensation plans; and

 

  Ÿ  

4,655,045 shares issuable upon the exercise of warrants outstanding as of September 30, 2007 at a weighted average exercise price of $2.33 per share.

Unless otherwise indicated, the information we present in this prospectus assumes and reflects the following:

 

  Ÿ  

the automatic conversion of all outstanding shares of our preferred stock into shares of common stock upon the closing of this offering;

 

  Ÿ  

the filing of our amended and restated certificate of incorporation and the adoption of our amended and restated bylaws to be effective upon the closing of this offering;

 

  Ÿ  

no exercise by the underwriters of their option to purchase additional shares; and

 

  Ÿ  

a 1-for-             reverse split of our common stock to be effected prior to this offering.

 

 

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SUMMARY HISTORICAL AND PRO FORMA CONSOLIDATED FINANCIAL AND OTHER DATA

The tables below summarize our consolidated financial data. The following summary financial data should be read together with our consolidated financial statements and related notes, “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

   

Year Ended

December 31,

    Nine Months Ended
September 30,
    Pro Forma (1)  
    2004     2005     2006     2006     2007     Nine Months
Ended
September 30,
2007
 
                      (unaudited)     (unaudited)     (unaudited)  
    (in thousands, except per share data)  

Consolidated Statements of Operations Data:

           

Revenue

           

Service

  $ 16,411     $ 29,324     $ 35,184     $ 25,842     $ 40,270     $ 50,163  

Product

    12,930       16,353       2,624       2,641       376       1,865  
                                               

Total revenues

    29,341       45,677       37,808       28,483       40,646       52,028  

Cost of revenues:

           

Service

    14,619       25,671       27,381       20,299       29,684       37,666  

Product

    10,472       13,376       1,898       2,013       273       995  
                                               

Total cost of revenues

    25,091       39,047       29,279       22,312       29,957       38,661  

Gross profit

    4,250       6,630       8,529       6,171       10,689       13,367  

Research and development expenses

    —         —         —         —         96       155  

Selling and marketing expenses

    9,128       15,682       10,906       7,875       10,863       12,630  

General and administrative expenses

    4,046       8,840       7,058       5,274       5,703       7,460  

Amortization of intangible assets

    703       1,351       1,165       862       1,555       2,475  
                                               

Loss from operations

    (9,627 )     (19,243 )     (10,600 )     (7,840 )     (7,528 )     (9,353 )

Interest and other income (expense), net.

    (188 )     (2,248 )     393       44       (3,292 )     (3,986 )
                                               

Loss before income taxes and cumulative effect of change in accounting principle

    (9,815 )     (21,491 )     (10,207 )     (7,796 )     (10,820 )     (13,339 )

Provision for income taxes

    —         —         —         —         78       99  
                                               

Loss before cumulative effect of change in accounting principle.

    (9,815 )     (21,491 )     (10,207 )     (7,796 )     (10,898 )     (13,438 )

Cumulative effect of change in accounting principle

    —         —         558       558       —         —    
                                               

Net loss

  $ (9,815 )   $ (21,491 )   $ (9,649 )   $ (7,238 )   $ (10,898 )   $ (13,438 )
                                               

Net loss per share, basic and diluted

  $ (2.29 )   $ (4.62 )   $ (2.21 )   $ (1.68 )   $ (1.53 )   $ (1.23 )
                                               

Other unaudited financial data: EBITDA (3)

  $ (8,257 )   $ (18,466 )   $ (8,126 )   $ (6,173 )   $ (4,628 )   $ (4,713 )
                                               

 

 

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    As of September 30, 2007
        Actual         Pro Forma (1)     Pro Forma
as Adjusted (2)
    (unaudited)
    (in thousands)

Consolidated Balance Sheet Data:

     

Cash and cash equivalents.

  $ 11,482     $ 7,361    

Total assets

    62,911       67,316    

Total long term debt, including current portion.

    20,306       20,306    

Redeemable convertible preferred stock warrant liability

    5,105       5,105    

Total redeemable convertible preferred stock

    73,428       73,428    

Total stockholders’ deficit

    (61,756 )     (57,351 )  

(1) The pro forma column in the consolidated statements of operations data reflects the results of operations and pro forma adjustments related to our 2007 acquisitions as if they all took place on January 1, 2007. The pro forma column in the consolidated balance sheet data reflects the pro forma impact of our acquisition of DCMI Holdings as if it took place on September 30, 2007.

 

(2) The pro forma as adjusted column in the balance sheet data table above reflects the automatic conversion of all outstanding shares of the company’s preferred stock into an aggregate of 46,908,158 shares of common stock upon completion of this offering and our sale of              shares of common stock in this offering, at an assumed initial public offering price of $             per share (the mid-point of the price range set forth on the cover page of this prospectus) and after deducting estimated underwriting discounts and commissions and offering expenses payable by us.

 

(3) EBITDA represents net loss before deductions for interest, income taxes, the impact of warrant valuation and depreciation and amortization. EBITDA is a supplemental non-GAAP financial measure used by management and industry analysts to evaluate operations.

The following is a reconciliation of net loss to EBITDA (in thousands):

 

    

Year Ended

December 31,

   

Nine Months Ended

September 30,

    

Pro Forma

Nine Months Ended
September 30

 
     2004     2005     2006     2006     2007      2007  

EBITDA Calculation:

             

Net loss

   $ (9,815 )   $ (21,491 )   $ (9,649 )   $ (7,238 )   $ (10,898 )    $ (13,438 )

Non-cash impact of warrant valuation

     —         —         (1,013 )     (787 )     2,702        3,256  

Amortization of intangible assets

     703       1,351       1,165       862       1,574        2,721  

Interest expense

     267       690       643       427       1,460        2,148  

Depreciation

     588       984       728       563       456        501  

Tax Provision

     —         —         —         —         78        99  
                                                 

EBITDA

   $ (8,257 )   $ (18,466 )   $ (8,126 )   $ (6,173 )   $ (4,628 )    $ (4,713 )
                                                 

We believe that EBITDA is useful to investors as a measure of comparative operating performance, as it is less susceptible to variances in actual performance resulting from depreciation, amortization and other non-cash charges and more reflective of changes in pricing decisions, cost controls and other factors that affect operating performance. Management also uses EBITDA to develop incentive compensation plans and to measure operating performance. We are presenting EBITDA because we believe it is useful to investors as a way to measure our ability to incur and service debt, make capital expenditures and meet working capital requirements. EBITDA is not intended as an alternative to GAAP net loss as an indicator of our operating performance, or as an alternative to any other measure of performance in conformity with GAAP or as an alternative to cash flow from operating activities.

 

 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. Before investing in our common stock, you should carefully consider each of the following risk factors and all of the other information set forth in this prospectus.

Risks Related to Our Business and Industry

We have a history of losses and we may not achieve or sustain profitability in the future.

We have not yet achieved profitability for any fiscal year. We had a net loss of $9.6 million for 2006 and as of September 30, 2007, our accumulated deficit was $69.9 million. We expect to continue to incur losses, and we may not become profitable in the foreseeable future, if ever. We expect to make significant expenditures to develop our business. In addition, as a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. We will have to generate and sustain increased revenue to achieve profitability. Our revenue growth trends in prior periods may not be sustainable, and we may not generate sufficient revenue to achieve or maintain profitability. We may incur significant losses in the future for a number of reasons, including those discussed in other risk factors and factors that we cannot foresee.

We have a limited operating history and compete in rapidly evolving markets, which makes our future operating results difficult to predict.

We were incorporated in May 2001. We have a limited operating history in an industry characterized by rapid technological innovation, changing customer needs, evolving industry standards and frequent introductions of new products and services. Our success depends on our ability to implement data center services, IT infrastructure services and managed services that anticipate and respond to rapid and continuing changes in technology, industry developments and customer needs. As we encounter new customer requirements and increasing competitive pressures, we will likely be required to modify, enhance, reposition or introduce new solutions and service offerings. We may not be successful in doing so in a timely, cost-effective and appropriately responsive manner, or at all. Services, solutions and technologies offered by our current or future competitors may make our services and solutions uncompetitive or obsolete. All of these factors make it difficult to predict our future operating results, which may impair our ability to manage our business and our investors’ ability to assess our prospects.

We may experience quarterly fluctuations in our operating results due to a number of factors, which makes our future results difficult to predict and could cause our operating results to fall below expectations or our guidance.

Our operating results may fluctuate due to a variety of factors, many of which are outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful. You should not rely on our past results as an indication of our future performance. If our revenue or operating results fall below the expectations of investors or securities analysts, or below any guidance we may provide to the market, the price of our common stock could decline substantially.

In addition to other risk factors listed in this “Risk Factors” section, factors that may affect our quarterly operating results include:

 

  Ÿ  

fluctuations in demand for our data center services, IT infrastructure services and managed services

 

  Ÿ  

fluctuations in sales cycles and prices for our services and solutions

 

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  Ÿ  

reductions in customers’ budgets for IT purchases and delays in their purchasing cycles

 

  Ÿ  

the timing of recognizing revenue in any given quarter as a result of revenue recognition rules

 

  Ÿ  

our ability to develop, introduce and provide new services and solutions that meet customer requirements in a timely manner

 

  Ÿ  

our ability to hire additional technical and sales personnel and the length of time required for any such additional personnel to generate significant revenue

 

  Ÿ  

any significant changes in the competitive dynamics of our markets, including new entrants or substantial discounting of services or solutions

 

  Ÿ  

our ability to control costs, including our operating expenses

 

  Ÿ  

general economic conditions in our domestic and international markets

Our business could be materially and adversely affected as a result of the risks associated with our acquisitions.

As part of our business strategy, we have recently acquired and will continue seeking to acquire businesses that provide us with additional intellectual property, customer relationships, geographic coverage and domain expertise. We can provide no assurances that we will be able to find and identify desirable acquisition targets or that we will be successful in entering into a definitive agreement with any one target. In addition, even if we reach a definitive agreement with a target, there is no assurance that we will complete any future acquisition.

Our acquisitions have been and will be accompanied by risks commonly encountered in the acquisition of a business, which may include, among other things:

 

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the effect of the acquisition on our financial and strategic position and reputation

 

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the failure of an acquired business to further our strategies

 

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the failure of an acquisition to result in expected benefits, which may include benefits relating to enhanced revenues, technology, human resources, costs savings, operating efficiencies and other synergies

 

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the difficulty and cost of integrating the acquired businesses, including costs and delays in implementing common systems and procedures and costs and delays caused by communication difficulties

 

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the assumption of liabilities of the acquired business, including litigation-related liabilities

 

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the potential impairment of acquired assets, including goodwill

 

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the reduction of our cash available for operations and other uses, the increase in amortization expense related to identifiable assets acquired, potentially dilutive issuances of equity securities or the incurrence of debt

 

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the lack of experience in new markets, products or technologies or the initial dependence on unfamiliar distribution partners

 

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the diversion of our management’s attention from other business concerns

 

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the impairment of relationships with customers or suppliers of the acquired business or our customers

 

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  Ÿ  

the potential loss of key employees of the acquired company

 

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the potential incompatibility of business cultures

These factors could have a material adverse effect on our business, results of operations or financial condition. To the extent that we issue shares of our common stock or other rights to purchase our common stock in connection with any future acquisition, existing shareholders may experience dilution and our earnings per share may decrease.

In addition to the risks commonly encountered in the acquisition of a business as described above, we may also experience risks relating to the challenges and costs of closing a transaction. The risks described above may be exacerbated as a result of managing multiple acquisitions at the same time.

We have a large amount of goodwill as a result of our acquisitions. Our earnings will be harmed if we suffer an impairment of our goodwill.

As of September 30, 2007, on a pro forma basis assuming the acquisition of DCMI Holdings had taken place on September 30, 2007, we had goodwill of $11.2 million. Goodwill represents the excess of the amount we paid in our various acquisitions over the fair value of their net assets at the date of the acquisition. Under Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, we do not amortize acquired goodwill but instead we test it for impairment on an annual basis based upon a fair value approach. Testing for impairment of goodwill involves an estimation of the fair value of the net assets of our acquisitions and involves a high degree of judgment and subjectivity about the potential future cash flows that a particular acquisition is expected to generate. If an acquisition does not perform as we expect, the amount of any impairment could be significant and could have a material adverse effect on our reported financial results for the period in which the charge is taken and could result in a decrease in the market price of our common stock.

Our financial results would suffer if the market for IT services and solutions does not continue to grow.

Our services and solutions are designed to address the growing markets for (i) data center services (including migrations, consolidations and disaster recovery), (ii) IT infrastructure services (including storage and data protection services and the implementation of virtualization solutions) and (iii) managed services (including operational support and customer support). These markets are still emerging. A reduction in the demand for our services and solutions could be caused by, among other things, lack of customer acceptance, weakening economic conditions, competing technologies and services or decreases in corporate spending. Our future financial results would suffer if the market for our IT services and solutions does not continue to grow.

A prolonged economic downturn could materially harm our business.

Negative trends in the general economy, including trends resulting from actual or threatened military action by the United States, terrorist attacks on the United States and abroad and increased oil prices, could cause a decrease in corporate spending on IT services and solutions in general and negatively affect the rate of growth of our business. Any reduction in corporate confidence or corporate spending in general may adversely affect demand for our services and solutions.

 

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Our sales cycles can be long and unpredictable, and our sales efforts require considerable time and expense. As a result, our sales are difficult to predict and may vary substantially from quarter to quarter, which may cause our operating results to fluctuate significantly.

The timing of our revenue is difficult to predict. Our sales efforts involve educating our customers about the use and benefit of our services and solutions, including their technical capabilities and potential cost savings to an organization. Customers typically undertake a significant evaluation process that has in the past resulted in a lengthy sales cycle, which typically lasts several months, and may last a year or longer. We spend substantial time, effort and money on our sales efforts without any assurance that our efforts will produce any sales. In addition, customer purchases of our services and solutions are frequently subject to budget constraints, multiple approvals, and unplanned administrative, processing and other delays. If sales expected from a specific customer for a particular quarter are not realized in that quarter or at all, our results could fall short of public expectations and our business, operating results and financial condition could be materially adversely affected.

We may not be able to respond to rapid technological changes with new solutions and service offerings, which could have a material adverse effect on our sales and profitability.

The markets for our services and solutions are characterized by rapid technological changes, evolving customer needs, frequent new service, software and product introductions and changing industry standards. The introduction of third-party services and solutions embodying new technologies and the emergence of new industry standards could make our existing and future services and solutions obsolete and unmarketable. As a result, we may not be able to accurately predict the lifecycle of our services and solutions, and they may become obsolete before we receive the amount of revenues that we anticipate from them. If any of the foregoing events occurs, our ability to retain or increase our position in the relevant markets could be adversely affected.

To be successful, we need to develop and introduce new services and solutions on a timely and cost-effective basis that keep pace with technological developments and emerging industry standards and that address the increasingly sophisticated needs of our customers. We may experience difficulties that could delay or prevent the successful development, introduction and marketing of services and solutions that respond to technological changes or evolving industry standards or fail to develop services and solutions that adequately meet the requirements of the marketplace or achieve market acceptance. Our failure to develop and market such services and solutions on a timely basis, or at all, could have a material adverse effect on our sales and profitability.

We face intense competition that could prevent us from increasing our revenue or could reduce our gross profit margin.

The data center services, IT infrastructure services and managed services markets are competitive and, due in part to the forecasted growth rates in each market, we expect competition in all markets to intensify in the future. Other companies may introduce new services and solutions in the same markets we have entered or intend to enter. This competition could result in increased pricing pressure, reduced gross profit margins, increased sales and marketing expenses and failure to increase, or the loss of, market share.

Many of our current or potential competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, sales, marketing and other resources than we have. In addition, our competitors may be able to bundle services that we do not offer together with other products or services at a combined price that is more attractive than the prices we charge for our services. As competitive services are introduced or new competitors enter our

 

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markets, we expect increased pricing pressure which could have a negative impact on the gross margins for our services and solutions.

Within the data center services market, our principal competitors are IBM and HP. Within the IT infrastructure services market, our principal competitors are IBM, Accenture and EMC. Within the managed services market, IBM and CSC are our main competitors. Each competitor offers a comprehensive service offering within each market, has significantly greater financial resources than we do and may be able to offer their services at more attractive rates than we do. We also face competition in each market from smaller, regional players.

We expect increased competition from both established and emerging companies, including those located offshore, as our markets continue to develop and expand. We also expect that some of our competitors may make acquisitions or enter into partnerships or other strategic relationships with one another in order to offer more comprehensive product and service offerings than they are individually able to offer. We believe additional consolidation or partnerships are likely to occur in the future as companies attempt to strengthen or maintain their market positions in an evolving industry. The companies resulting from these consolidations or partnerships could significantly change the competitive landscape and adversely affect our ability to compete effectively.

We may lose money if we do not accurately estimate costs of fixed-price engagements.

A significant majority of our projects are based on fixed-price, fixed-time contracts, rather than contracts in which payment to us is determined on a time and materials basis. Our pricing on these projects is highly dependent on our internal forecasts and predictions about the projects and the marketplace, which might be based on limited data and could be inaccurate. There is a risk that we will underprice our contracts or fail to estimate accurately the costs of performing the work. Our failure to estimate accurately the resources and schedule required for a project, or our failure to complete our contractual obligations in a manner consistent with the project plan upon which our fixed-price, fixed-time contract was based, could make these projects less profitable or unprofitable and could have a material adverse effect on our overall profitability, business, financial condition and results of operations. We are increasingly entering into contracts for large projects that magnify this risk. We have been required to commit unanticipated additional resources to complete projects in the past, which has resulted in reduced profit margins. We will likely experience similar situations in the future.

Our financial results may be adversely impacted if we are unable to maintain favorable pricing and utilization rates as well as control our costs.

Our profitability is primarily based on three factors:

 

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the prices for our services

 

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the utilization rate of our IT professionals

 

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our costs

Our gross profit margin, and therefore our profitability, is dependent on the rates we are able to recover for our services. If we are not able to maintain favorable pricing for our services, our gross profit margin and profitability may suffer. The rates we are able to recover for our services are affected by a number of factors, including:

 

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our customers’ perceptions of our ability to add value through our services and solutions

 

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our competitors’ pricing policies

 

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  Ÿ  

our ability to estimate accurately, attain and sustain contract revenues, margins and cash flows over increasingly long contract periods

 

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the use by our competitors and our customers of off-shore resources to provide lower-cost service delivery capabilities

 

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the rate at which we are able to hire our service professionals

 

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general economic conditions, including the level of corporate spending

If we are not able to maintain an appropriate utilization rate for our professionals, our profit margin and profitability may suffer. Our utilization rates are affected by a number of factors, including:

 

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our ability to transition professionals from completed projects to new assignments and to hire and assimilate new employees

 

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our ability to forecast demand for our services and thereby maintain an appropriate headcount in each of our geographies and workforces

 

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our ability to manage attrition

 

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our need to devote time and resources to training, professional development and other non-chargeable activities

We expect our costs to increase as a public company, based in part on an increase in legal, accounting and other expenses that we did not incur as a private company. These increased costs, considered independently or in the context of any failure to maintain our pricing and utilization rates with respect to the services we provide, could have a material adverse effect on our overall profitability, business, financial condition and results of operations.

If we are unable to manage our growth effectively, our revenues and profits could be adversely affected.

We have recently expanded our operations significantly, increasing our total number of employees from approximately 200 at September 30, 2006 to over 425 at September 30, 2007, and acquiring five companies in diverse geographics. We anticipate that further significant expansion will be required. Our future operating results depend to a large extent on our ability to manage this expansion and growth successfully. Sustaining our growth will place significant demands on our management as well as on our administrative, operational and financial resources. For us to continue to manage our growth, we must continue to improve our operational, financial and management information systems and expand, motivate and manage our workforce as well as successfully integrate our acquisitions. If we are unable to manage our growth successfully without compromising our quality of service and our profit margins, or if new systems that we implement to assist in managing our growth do not produce the expected benefits, our revenues and profits could be adversely affected. Risks that we face in undertaking future expansion include: training new personnel to become productive and generate revenue; controlling expenses and investments in anticipation of expanded operations; implementing and enhancing our administrative infrastructure, systems and processes; addressing new markets; and expanding international operations. A failure to manage our growth effectively could materially and adversely affect our ability to market and sell our services and solutions.

If we are unable to further penetrate our existing markets, our business prospects may be limited.

We expect that our future success will depend, in part, upon our ability to further penetrate the existing markets for data center services, IT infrastructure services and managed services. To date, we

 

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have penetrated these markets in varying degrees. Part of our strategy for expanding our share of each market involves “cross-selling” our services in one market to our existing customers and partners in a different market. Our sales strategies may not be effective in further penetrating our existing markets and such failure could limit our business prospects and results of operations.

We rely on indirect sales channels to refer customers to us, and disruptions to, or our failure to develop and manage, our indirect sales channels would harm our business.

Our future success is dependent upon establishing and maintaining successful relationships with a large number of indirect sales channels. A significant portion of our revenue is generated by sales through our indirect sales channels and we expect indirect sales to continue to make up a significant portion of our total revenue in the future. In 2006, approximately 23% of our revenue was generated by sales through our indirect sales channels. Accordingly, our revenue depends in large part on the referral and effective sales and lead generation activities of these indirect sales channels.

Establishing and retaining qualified indirect sales channels and training them in our service offerings and solutions requires significant time and resources. In order to develop and expand our distribution channel, we must continue to scale and improve our processes and procedures that support our channel, including investment in systems and training. Those processes and procedures may become increasingly complex and difficult to manage as we grow our organization. Our contracts with these indirect sales channels do not typically prohibit them from offering products or services that compete with ours. Our competitors may provide incentives to existing and potential indirect sales channels to favor their services and solutions or to prevent or reduce sales of our services and solutions. Our indirect sales channels may choose not to offer our services and solutions exclusively or at all. Establishing relationships with indirect sales channels that have a history of selling our competitors’ services and solutions may also prove to be difficult. In addition, some of our indirect sales channels are also competitors. Our failure to establish and maintain successful relationships with indirect sales channels would seriously harm our business and operating results.

We partner with third parties on certain complex engagements in which our performance depends upon, and may be adversely impacted by, the performance of such third parties.

Our partners frequently engage us to perform discrete IT infrastructure services within the context of broader, sophisticated projects. If our partners fail to perform their portions of the projects in a timely or satisfactory manner, the relevant customer may elect to terminate the project or withhold payment until the services have been completed successfully. Additionally, we may lose revenues or realize lower profits if we incur additional costs due to delays or because we must assign additional personnel to complete the project. Furthermore, our relationships with our customers and our reputation generally may suffer harm as a result of our partners’ unsatisfactory performance.

If we fail to meet our service level obligations under our service level agreements, we would be subject to penalties and could lose customers.

We have service level agreements with many of our customers under which we guarantee specified levels of service availability. These arrangements involve the risk that we may not have adequately estimated the level of service we will in fact be able to provide. If we fail to meet our service level obligations under these agreements, we would be subject to penalties, which could result in higher than expected costs, decreased revenue and decreased operating margins. We could also lose customers.

 

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If we fail to offer high quality customer support and services, our business would suffer.

Once our solutions and methodologies are deployed within our customers’ IT infrastructure environments, our customers rely on our support services to resolve any related issues. A high level of customer support and service is important for the successful marketing and sale of our services and solutions. The importance of high quality customer support and service will be of increasing importance as we expand our managed services business. If we do not help our customers quickly resolve post-deployment issues and provide effective ongoing support, our ability to sell our solutions and methodologies to existing customers would suffer and our reputation with potential customers would be harmed. As we expand our sales, we will be required to hire and train additional support personnel. In addition, as we expand our operations internationally, our support organization will face additional challenges, including those associated with delivering support, training and documentation in languages other than English. If we fail to maintain high quality customer support or grow our support organization to match any future sales growth, our business will suffer.

Our services and solutions handle mission-critical data for our customers and are highly technical in nature. If customer data is lost or corrupted, our reputation and business could be harmed.

Our data center services and IT infrastructure services involve storing and replicating mission-critical data for our customers. The process of storing and replicating that data is highly technical and complex. If any data is lost or corrupted in connection with the use of our services and solutions, our reputation could be seriously harmed and market acceptance of our solutions and services could suffer. In addition, our solutions have contained, and may in the future contain, undetected errors, defects or security vulnerabilities. Some errors in our solutions may only be discovered after a solution has been in use by customers. Any errors, defects or security vulnerabilities discovered in our solutions after commercial release could result in loss of revenue, loss of customers, increased service and warranty cost and diversion of attention of our management and technical personnel, any of which could significantly harm our business. In addition, we could face claims for product liability, tort or breach of warranty. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and adversely affect the market’s perception of us and our service offerings.

Failures or interruptions of our services could materially harm our revenues, impair our ability to conduct our operations and damage relationships with our customers.

Our success depends in part on our ability to provide reliable data center, IT infrastructure and managed services to our customers. Our network operations are currently located in Durham, North Carolina, Weybridge, England and Havant, England and are susceptible to damage or interruption from human error, fire, flood, power loss, telecommunications failure, terrorist attacks and similar events. We could also experience failures or interruptions of our systems and services, or other problems in connection with our operations, as a result of: damage to or failure of our computer software or hardware or our connections; errors in the processing of data by our system; computer viruses or software defects; physical or electronic break-ins, sabotage, intentional acts of vandalism and similar events; increased capacity demands or changes in systems requirements of our customers; or errors by our employees or third-party service providers.

In addition, our business interruption insurance may be insufficient to compensate us for losses that may occur. Any interruptions in our storage and data center services could damage our reputation and substantially harm our business and results of operations.

 

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Our customers could unexpectedly terminate their contracts for our services.

Some of our contracts can be cancelled by the customer with limited advance notice and without significant monetary penalty. A customer’s termination of a contract for our services could result in a loss of expected revenues and additional expenses for staff that were allocated to that customer’s project. We could be required to maintain underutilized employees who were assigned to the terminated contract, thereby reducing the overall utilization rate of our professionals. The unexpected cancellation or significant reduction in the scope of any of our large projects, or customer termination of one or more recurring revenue contracts, could have a material adverse effect on our business, financial condition and results of operations.

We depend on a limited number of customers for a substantial portion of our revenue in any fiscal period and the loss of, or a significant shortfall in demand from, these customers could significantly harm our results of operations.

During any given fiscal period, a relatively small number of customers typically accounts for a significant percentage of our revenue. For example, in 2006, revenue generated by sales to our top 20 customers accounted for approximately 60% of our total revenue for the same period. In the past, the customers that comprised our top 20 customers have continually changed and we also have experienced significant fluctuations in individual customers’ usage of our services. In addition, our operating costs are relatively fixed in the near term. As a consequence, we may not be able to adjust our expenses in the short term to address the unanticipated loss of a large customer during any particular period. As such, we may experience significant, unanticipated fluctuations in our operating results which may cause us to not meet our expectations or those of stock market analysts, which could cause our stock price to decline.

Our methodologies and software solutions may infringe the intellectual property rights of third parties and may create liability for us as well as harm our reputation and customer relationships.

The methodologies and software solutions that we offer to customers may infringe upon the intellectual property rights of third parties and result in legal claims against our customers and us. These claims may damage our reputation, adversely impact our customer relationships and create liability for us. Moreover, although we generally agree in our customer contracts to indemnify customers for expenses or liabilities they incur as a result of third party intellectual property infringement claims associated with our services, the resolution of these claims, irrespective of whether a court determines that our methodologies and software solutions infringed another party’s intellectual property rights, may be time-consuming, disruptive to our business and extraordinarily costly. Finally, in connection with an intellectual property infringement dispute, we may be required to cease using or developing certain intellectual property that we offer to our customers. These circumstances could adversely affect our ability to generate revenue as well as require us to incur significant expense to develop alternative or modified services for our customers.

If we are unable to protect our intellectual property rights, our competitive position could be harmed or we could be required to incur significant expenses to enforce our rights.

Our success depends to a significant degree upon the protection of our proprietary technology rights, particularly the proprietary tools associated with our TransomSM framework. We rely on trade secret, copyright and trademark laws and confidentiality agreements with employees and third parties, all of which offer only limited protection. The steps we have taken to protect our intellectual property may not prevent misappropriation of our proprietary rights or the reverse engineering of our solutions.

 

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Additionally, our business often involves the development of services and solutions for specific customer engagements. While we generally retain ownership of these service methodologies and solutions, issues relating to the ownership of and rights to intellectual property developed in customer engagements can be complicated and there can be no assurance that disputes will not arise that affect our ability to continue to engage in the commercial use of such intellectual property. Legal standards relating to the validity, enforceability and scope of protection of intellectual property rights in other countries are uncertain and may afford little or no effective protection of our services, software, methodology and other proprietary rights. Consequently, we may be unable to prevent our services, software, methodology and other proprietary rights from being exploited abroad, which could require costly efforts to protect them. Policing the unauthorized use of our services, software, methodology and other proprietary rights is expensive, difficult and, in some cases, impossible. Litigation may be necessary in the future to enforce or defend our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Such litigation could result in substantial costs and diversion of management resources, either of which could harm our business. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property.

Furthermore, many of our current and potential competitors have the ability to dedicate substantially greater resources to developing and protecting their technology or intellectual property rights than we do. In addition, our attempts to protect our proprietary technology and intellectual property rights may be further limited due to the fact that our employees are attractive to other market participants and may leave GlassHouse with significant knowledge of our proprietary information. Consequently, others may develop services and methodologies that are similar or superior to our services and methodologies or design around our intellectual property.

If we do not attract and retain qualified professional staff, we may be unable to perform adequately our customer projects and could be limited in accepting new customer engagements.

Our business is labor intensive and our success depends on our ability to attract, retain, train and motivate highly skilled employees. The increase in demand for data center, IT infrastructure and managed services has further increased the need for employees with specialized skills or significant experience in these areas. We have been expanding our operations in all locations and these expansion efforts will be highly dependent on attracting a sufficient number of highly skilled people. We may not be successful in attracting enough employees to achieve our desired expansion or staffing plans. Furthermore, the industry turnover rates for these types of employees are high and we may not be successful in retaining, training or motivating the employees we attract. Any inability to attract, retain, train and motivate employees could impair our ability to manage adequately and complete existing projects and to accept new customer engagements. Such inability may also force us to increase our hiring of independent contractors, which may increase our costs and reduce our profitability on customer engagements. We must also devote substantial managerial and financial resources to monitoring and managing our workforce. Our future success will depend on our ability to manage the levels and related costs of our workforce.

If we are unable to expand our sales capabilities, we may not be able to generate increased revenues.

We must expand our sales force to generate increased revenue from new customers. We currently have a team of approximately 70 dedicated sales professionals. Our services and solutions require a sophisticated sales effort targeted at the senior management of our prospective customers. New hires will require training and will take time to achieve full productivity. We cannot be certain that

 

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new hires will become as productive as necessary or that we will be able to hire enough qualified individuals in the future. Failure to hire qualified sales personnel will preclude us from expanding our business and growing our revenue.

Our senior management is important to our customer relationships and the loss of one or more senior managers could have a negative impact on our business.

We believe that our success depends in part on the continued contributions of our president and chief executive officer, Mark Shirman, and other members of our senior management. We rely on our executive officers and senior management to generate business and execute our strategies successfully. In addition, the relationships and reputation that members of our management team have established and maintain with our customers contribute to our ability to operate a robust business. The loss of Mr. Shirman or any other members of senior management could impair our ability to identify and secure new customers, new engagements from existing customers and otherwise manage our business.

Our international sales and operations subject us to additional risks that may adversely affect our operating results.

In 2006 and the nine months ended September 30, 2007, we derived approximately 37% and 46% of our revenue, respectively, from customers outside the United States. We have facilities and sales personnel located in the United Kingdom, Israel and Turkey. We expect to continue to add personnel in additional countries. Our international operations subject us to a variety of risks, including:

 

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the difficulty of managing and staffing international offices and the increased travel, infrastructure and legal compliance costs associated with multiple international locations

 

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the management of our relationships with channel partners outside the United States, whose sales and lead generation activities are very important to our international operations

 

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difficulties in enforcing contracts and collecting accounts receivable, and longer payment cycles, especially in emerging markets

 

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tariffs and trade barriers and other regulatory or contractual limitations on our ability to sell or develop our products in certain foreign markets

 

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increased exposure to foreign currency exchange rate risk

 

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reduced protection for intellectual property rights in some countries

 

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political and economic instability

As we continue to expand our business internationally, our success will depend, in part, on our ability to anticipate and effectively manage these and other risks associated with our international operations. Our failure to manage any of these risks successfully could harm our international operations and reduce our international sales.

We may need additional capital in the future and it may not be available on acceptable terms.

We have historically relied on outside financing and cash flow from operations to fund our operations, capital expenditures and expansion. However, we may require additional capital in the future to fund our operations and acquisitions, finance investments in equipment or personnel, or respond to competitive pressures. We cannot assure you that additional financing will be available on terms acceptable to us. In addition, the terms of available financing may place limits on our financial

 

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and operational flexibility. If we are unable to obtain sufficient capital in the future, we may not be able to continue to meet customer demand for service quality, availability and competitive pricing. We also may be forced to reduce our operations or may not be able to expand or acquire complementary businesses or be able to develop new services or otherwise respond to changing business conditions or competitive pressures.

We will incur significant increased costs as a result of operating as a public company.

We have never operated as a public company. As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the Securities and Exchange Commission (SEC) and the Nasdaq Global Market impose various requirements on public companies, including requirements with respect to corporate governance practices. Our management and other personnel will need to devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly. For example, we expect these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantial costs to maintain the same or similar coverage. These rules and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers.

If we fail to establish and maintain proper and effective internal control over financial reporting, our operating results and our ability to operate our business could be harmed.

The Sarbanes-Oxley Act requires, among other things, that we establish and maintain effective internal control over financial reporting and disclosure controls and procedures. In particular, under the SEC’s current rules, beginning with the year ending December 31, 2009, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our independent registered public accounting firm will also be required to report on our internal control over financial reporting. Our testing and our auditor’s testing may reveal deficiencies in our internal control over financial reporting that are deemed to be material weaknesses and render our internal control over financial reporting ineffective. We expect to incur substantial accounting and auditing expense and to expend significant management time in complying with the requirements of Section 404. If we are not able to comply with the requirements of Section 404 in a timely manner, or if we or our independent registered public accounting firm identify deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to investigations or sanctions by the SEC, Nasdaq or other regulatory authorities. In addition, we could be required to expend significant management time and financial resources to correct any material weaknesses that may be identified or to respond to any regulatory investigations or proceedings.

Risks Related to this Offering

An active trading market for our common stock may not develop.

Prior to this offering, there has been no public market for our common stock. Although we anticipate that our common stock will be approved for listing on the Nasdaq Global Market, an active trading market for our shares may never develop or be sustained following this offering. The initial

 

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public offering price for our common stock will be determined by negotiation between the representatives of the underwriters and us. This initial public offering price may vary from the market price of our common stock after the offering. Investors may not be able to sell their common stock at or above the initial public offering price. In addition, an inactive market may impair our ability to raise capital by selling shares and may impair our ability to acquire other companies or technologies by using our shares as consideration, which, in turn, could materially adversely affect our business.

If securities or industry analysts do not publish research or reports or publish unfavorable research or reports about our business, our stock price and trading volume could decline.

The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us, our business, our market or our competitors. We do not currently have and may never obtain research coverage by securities and industry analysts. If no securities or industry analysts commence coverage of our company, the trading price for our stock could be negatively impacted. In the event we obtain securities or industry analyst coverage, if one or more of the analysts who covers us downgrades our stock, our stock price would likely decline. If one or more of these analysts ceases to cover us or fails to regularly publish reports on us, interest in our stock could decrease, which could cause our stock price or trading volume to decline.

The price of our common stock may be volatile and fluctuate substantially which could result in substantial losses for investors purchasing shares in this offering.

The initial public offering price for the shares of our common stock sold in this offering will be determined by negotiation between the representatives of the underwriters and us. This price may not reflect the market price of our common stock following this offering. In addition, the market price of our common stock is likely to be highly volatile and may fluctuate substantially due to the following factors (in addition to the other risk factors described in this section):

 

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Actual or anticipated fluctuations in our results of operations

 

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Variance in our financial performance from the expectations of market analysts

 

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Conditions and trends in the markets we serve

 

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Announcements of significant new services or solutions by us or our competitors

 

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The commencement or outcome of litigation

 

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Changes in market valuation or earnings of our competitors

 

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The trading volume of our common stock

 

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Changes in the estimation of the future size and growth rate of our markets

 

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Legislation or regulatory policies, practices or actions

 

  Ÿ  

General economic conditions

In addition, the stock market in general, and the Nasdaq Global Market and the market for technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of the particular companies affected. These broad market and industry factors may materially harm the market price irrespective of our operating performance. As a result of these factors, you might be unable to resell your shares at or above the initial public offering price after this offering. In addition, in the past, following periods of volatility in the overall market and the market price of a company’s securities, securities class action litigation has often been instituted against the affected company. This type of litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.

 

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We currently do not intend to pay dividends on our common stock and, consequently, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates.

We currently do not intend to declare or pay dividends on shares of our common stock in the foreseeable future. See “Dividend Policy” for more information. Consequently, your only opportunity to achieve a return on your investment in our company will be if the market price of our common stock appreciates and you sell your shares at a price above your cost. There is no guarantee that the price of our common stock will ever exceed the price that you pay.

A substantial number of shares of our common stock could be sold into the public market shortly after this offering, which could depress our stock price.

The market price of our common stock could decline as a result of sales by our existing stockholders of shares of common stock in the market after this offering or the perception that these sales could occur. Once a trading market develops for our common stock, many of our stockholders will have an opportunity to sell their stock for the first time. These factors could also make it difficult for us to raise additional capital by selling stock. Please see the section entitled “Shares Eligible for Future Sale” for more information regarding these factors.

As a new investor, you will incur immediate and substantial dilution as a result of this offering.

The initial public offering price of our common stock will be substantially higher than the pro forma as adjusted net tangible book value per share of our outstanding common stock. Accordingly, if you purchase shares of our common stock at the assumed initial public offering price (the midpoint of the range set forth on the cover page of this prospectus), you will incur immediate and substantial dilution of $             per share. If the holders of outstanding options or warrants exercise those options or warrants, you will suffer further dilution. See “Dilution” for more information.

Our management will have broad discretion over the use of the proceeds we receive in this offering and might not apply the proceeds in ways that increase the value of your investment.

Our management will have broad discretion to use the net proceeds from this offering and you will be relying on the judgment of our management regarding the application of these proceeds. They might not apply the net proceeds of this offering in ways that increase the value of your investment. We expect to use the net proceeds from this offering for general corporate purposes, including working capital, capital expenditures, acquisitions and further development of our services and solutions, and for debt repayment from time to time. We have not allocated these net proceeds for any specific purposes. Our management might not be able to yield any return on the investment and use of these net proceeds. You will not have the opportunity to influence our decisions on how to use the proceeds.

Existing stockholders significantly influence us and could delay or prevent an acquisition by a third party.

Upon completion of this offering, executive officers, key employees and directors and their affiliates will beneficially own, in the aggregate, approximately     % of our outstanding common stock. As a result, these stockholders will be able to exercise significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, which could have the effect of delaying or preventing a third party from acquiring control over us. For information regarding the ownership of our outstanding stock by our executive officers and directors and their affiliates, please see “Principal Stockholders.”

 

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Anti-takeover provisions in our certificate of incorporation and bylaws and in Delaware law could prevent or delay a change in control of our company.

We are a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. For more information, see “Description of Capital Stock—Anti-Takeover Effects of Provisions of Our Certificate of Incorporation, Bylaws and Delaware Law.” In addition, our amended and restated certificate of incorporation and bylaws may discourage, delay or prevent a change in our management or control over us that stockholders may consider favorable. Our amended and restated certificate of incorporation and bylaws, which will be in effect as of the closing of this offering:

 

  Ÿ  

Authorize the issuance of “blank check” preferred stock that could be issued by our board of directors to thwart a takeover attempt

 

  Ÿ  

Do not provide for cumulative voting in the election of directors, which would allow holders of less than a majority of the stock to elect some directors

 

  Ÿ  

Establish a classified board of directors, as a result of which the successors to the directors whose terms have expired will be elected to serve from the time of election and qualification until the third annual meeting following their election

 

  Ÿ  

Require that directors only be removed from office for cause

 

  Ÿ  

Provide that vacancies on the board of directors, including newly-created directorships, may be filled only by a majority vote of directors then in office

 

  Ÿ  

Limit who may call special meetings of stockholders

 

  Ÿ  

Prohibit stockholder action by written consent, requiring all actions to be taken at a meeting of the stockholders

 

  Ÿ  

Establish advance notice requirements for nominating candidates for election to the board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings

For information regarding these and other provisions, please see “Description of Capital Stock.”

Completion of this offering may limit our ability to use our net operating loss carryforwards.

As of December 31, 2006, we had substantial federal and state net operating loss carryforwards along with certain foreign net operating loss carryforwards. Under the provisions of the Internal Revenue Code, substantial changes in our ownership may limit the amount of our net operating loss carryforwards that can be utilized annually in the future to offset taxable income. We believe that, as a result of this offering, it is possible that a change in our ownership might be deemed to have occurred. If such a change in our ownership occurs, our ability to use our net operating loss carryforwards in any fiscal year will be significantly limited under these provisions.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements. All statements other than statements of historical fact contained in this prospectus, including statements regarding our future results of operations and financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. These statements involve known and unknown risks, uncertainties and other important factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.

In some cases, we identify forward-looking statements by terms such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar expressions. The forward-looking statements in this prospectus are only predictions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our business, financial condition and results of operations. These forward-looking statements speak only as of the date of this prospectus and are subject to a number of risks, uncertainties and assumptions described in the “Risk Factors” section and elsewhere in this prospectus. Because forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified, you should not rely on these forward-looking statements as predictions of future events. The events and circumstances reflected in our forward-looking statements may not occur and actual results could differ materially from those projected in our forward-looking statements. We undertake no obligation, and specifically decline any obligation, to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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USE OF PROCEEDS

We estimate that the net proceeds to us of the sale of the common stock that we are offering will be approximately $             million, assuming an initial public offering price of $             per share, which is the midpoint of the range listed on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses that we must pay. A $1.00 increase or decrease in the assumed initial public offering price of $             per share would increase or decrease the net proceeds to us from this offering by approximately $             million, assuming the number of shares offered by us, as set forth on the cover page of the prospectus, remains the same and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

We intend to use these net proceeds for working capital and other general corporate purposes, including the expansion of our current business through acquisitions of complementary or strategic businesses, products or technologies, the enhancement of our existing services and solutions and the hiring of additional personnel to increase our development, sales and marketing activities. We currently have no agreements or commitments for any specific acquisitions at this time. We also intend to use a portion of the net proceeds from this offering to repay, from time to time, acquisition-related loans from Lighthouse Capital Partners (Lighthouse) and from a syndicate of lenders led by BayStar Capital III Investment Fund, L.P. (BayStar). The table below sets forth the interest rate, maturity date and purposes for which we have used the borrowed monies:

 

Lender/Loan Amount

  

Interest Rate

  

Maturity Date

  

Use

Lighthouse/$6,000,000

  

7% per annum for year 1

Prime rate + 1.75% for years 2–4

   June 2008    Acquisition

Lighthouse/$3,000,000

  

7% per annum for year 1

Prime rate + 1.75% for years 2–4

  

December 2009 and

September 2010

   Acquisition

Lighthouse/$10,000,000

  

10% per annum from March 2007–August 2007

Prime rate + 1.75% from September 2007–August 2010

   August 2010    Acquisition

BayStar/$6,000,000

  

9.75% per annum

   August 2010    Acquisition

The amount and timing of our debt repayment will depend on numerous factors, including the cash used or generated in our operations and the cash on hand or used for acquisitions. As a result, we cannot estimate the amount of the net proceeds that will be used for debt repayment.

Pending use of proceeds from this offering, we intend to invest the proceeds in a variety of capital preservation investments, including short-term, investment-grade, interest-bearing instruments.

 

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DIVIDEND POLICY

We have never declared or paid any cash dividends on capital stock. We currently intend to retain all available funds and any future earnings for use in financing the growth of our business and do not anticipate paying any cash dividends after the offering and for the foreseeable future. Any future determination relating to dividend policy will be made at the discretion of our board of directors, subject to compliance with certain covenants under our loans, which restrict or limit our ability to declare or pay dividends, and will depend on our future earnings, financial condition, results of operations, capital requirements, general business conditions, future prospects, applicable Delaware law, which provides that dividends are only payable out of surplus or current net profits, and other factors that our board of directors may deem relevant.

 

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CAPITALIZATION

The following table sets forth the following information:

 

  Ÿ  

our actual capitalization, including our debt and warrant liability, as of September 30, 2007;

 

  Ÿ  

our pro forma capitalization after giving effect to the conversion, upon completion of this offering, of all outstanding shares of preferred stock into common stock and all outstanding warrants to purchase preferred stock into warrants to purchase common stock; and

 

  Ÿ  

our pro forma capitalization as adjusted to reflect the receipt of the estimated net proceeds from our sale of              shares of common stock in this offering, after deducting the underwriting discounts and commissions and estimated offering expenses, and the filing of an amended and restated certificate of incorporation after the closing of this offering.

 

    As of September 30, 2007
    (in thousands)
    Actual     Pro Forma     Pro Forma
As Adjusted

Preferred Stock Warrant liability

  $ 5,105     $ —       $ —  

Long-term debt, including current portion

    20,306       20,306       20,306

Capital leases, including current portion

    33       33       33

Series A Preferred Stock, $0.001 par value, 3,360,000 shares authorized, 3,360,000 shares issued and outstanding actual; 3,360,000 shares authorized, no shares outstanding pro forma and pro forma as adjusted

    2,253       —         —  

Series B Preferred Stock, $0.001 par value, 10,658,017 shares authorized, 10,623,402 shares issued and outstanding actual, 10,658,017 shares authorized, no shares outstanding pro forma and pro forma as adjusted

    9,971       —         —  

Series C Preferred Stock, $0.001 par value, 8,717,647 shares authorized, 8,364,707 shares issued and outstanding actual, 8,717,647 shares authorized, no shares outstanding pro forma and pro forma as adjusted

    8,844       —         —  

Series D Preferred Stock, $0.001 par value, 17,511,727 shares authorized, 15,626,305 shares issued and outstanding actual, 17,511,727 shares authorized, no shares outstanding pro forma and pro forma as adjusted

    41,166       —         —  

Series E Preferred Stock, $0.001 par value, 4,930,376 shares authorized, 4,493,245 shares issued and outstanding actual, 4,930,376 shares authorized, no shares outstanding pro forma and pro forma as adjusted

    11,194       —         —  
                     

Total redeemable convertible preferred stock

    73,428       —         —  

Stockholders’ (deficit) equity:

     

Series 1 Preferred Stock, $0.001 par value, 6,000,000 shares authorized, 4,440,499 shares issued and outstanding actual; 6,000,000 shares authorized, no shares outstanding pro forma and pro forma as adjusted

    370    



 
—         —  

Common Stock, $0.001 par value, 86,000,000 shares authorized, 12,356,152 shares issued and actual, 86,000,000 shares authorized, 58,814,310 shares issued pro forma and                      share outstanding pro forma as adjusted.

    13       59    

Additional paid-in capital

    7,435       86,290    

Treasury stock, at cost, 450,000 shares at September 30, 2007

    (1 )     (1 )  

Accumulated other comprehensive income (loss)

    338       338    

Accumulated deficit

    (69,911 )     (69,911 )  
                     

Total stockholders’ (deficit) equity

    (61,756 )     16,775    
                     

Total capitalization

  $ 37,116     $ 37,114    
                     

 

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This table excludes, as of September 30, 2007, the following:

 

  Ÿ  

10,504,393 shares issuable upon exercise of stock options outstanding at a weighted average exercise price of $0.67 per share;

 

  Ÿ  

478,740 shares of common stock available for future issuance under our stock-based compensation plans; and

 

  Ÿ  

4,655,045 shares of common stock issuable upon the exercise of outstanding warrants at a weighted average exercise price of $2.33 per share.

See “Management—Employee Benefit Plans,” and Note 12 of the notes to our consolidated financial statements for a description of our equity plans.

 

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DILUTION

Our pro forma net tangible book value as of September 30, 2007 was approximately $(2.6) million, or approximately $(0.05) per share. Pro forma net tangible book value per share represents the amount of total tangible assets minus our total liabilities, divided by 58,814,310 shares of common stock outstanding after giving effect to the conversion, upon completion of this offering, of all outstanding preferred stock into common stock and all outstanding warrants to purchase preferred stock into warrants to purchase common stock.

Net tangible book value dilution per share to new investors represents the difference between the amount per share paid by purchasers of shares of common stock in this offering and the net tangible book value per share of common stock immediately after completion of this offering. After giving effect to our sale of              shares of common stock in this offering at an assumed initial public offering price of $             per share, and after deducting the underwriting discounts and commissions and estimated offering expenses, the pro forma net tangible book value as of September 30, 2007 would have been approximately $             million or approximately $             per share. This represents an immediate increase in net tangible book value of $             per share to existing stockholders and an immediate dilution in net tangible book value of $             per share to purchasers of common stock in the offering, as illustrated in the following table:

 

Assumed initial public offering price per share

      $             

Pro forma net tangible book value per share before this offering

   $                

Increase per share attributable to new investors

   $                
         

Pro forma net tangible book value per share after this offering

      $             
         

Dilution per share to new investors

      $             
         

If the underwriters exercise their option to purchase additional shares of our common stock in full in this offering, the pro forma net tangible book value per share after the offering would be approximately $             per share, the increase in pro forma net tangible book value per share to existing stockholders would be approximately $             per share and the dilution to new investors purchasing shares in this offering would be approximately $             per share.

The table below presents on a pro forma basis as of September 30, 2007, after giving effect to the conversion of all outstanding shares of preferred stock into common stock upon completion of this offering and assuming there are no exercises of stock options or warrants outstanding on September 30, 2007 (as further described below), the differences between the existing stockholders and the purchasers of shares in the offering with respect to the number of shares purchased from us, the total consideration paid and the average price paid per share:

 

     Shares Purchased     Total Consideration     Average
Price
Per Share
     Number    Percent     Amount    Percent    

Existing stockholders

   58,814,310         %   $ 63,519,454         %   $ 1.08

New stockholders

            

Totals

           %      100.0 %  

As of September 30, 2007, there were options outstanding to purchase a total of 10,504,393 shares of stock at a weighted average exercise price of $0.67 per share, which will convert into the right to purchase 10,504,393 shares of common stock upon the completion of the offering. In addition, as of September 30, 2007, there were warrants outstanding to purchase 4,655,045 shares of stock at a weighted average exercise price of $2.33 per share, which will convert into the right to purchase 4,655,045 shares of common stock upon the completion of the offering. To the extent outstanding options or warrants are exercised, there will be further dilution to new investors. For a description of our equity plans, please see “Management—Employee Benefit Plans” and Note 12 of the notes to the consolidated financial statements.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

The following consolidated statements of operations data for fiscal years 2004, 2005 and 2006, and the consolidated balance sheet data for fiscal years 2005 and 2006 have been derived from our consolidated financial statements and related notes which have been audited by Ernst & Young LLP and are included elsewhere in this document. The consolidated statements of operations data for fiscal years 2002 and 2003, and the consolidated balance sheet data for fiscal years 2002 and 2003 and 2004 have been derived from our audited consolidated financial statements and related notes not included in this prospectus. The consolidated statements of operations data for the nine months ended September 30, 2007 and 2006 and the consolidated balance sheet data as of September 30, 2007 have been derived from our unaudited financial statements and related notes which are included elsewhere in this prospectus. In the opinion of management, the unaudited interim consolidated financial statements have been prepared on the same basis as the audited financial statements and include all adjustments necessary for the fair presentation of our financial position and results of operations for these periods. The following selected financial data should be read together with our financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

    Year Ended December 31,     Nine Months Ended
September 30,
 
    2002     2003     2004     2005     2006     2006     2007  
                                  (unaudited)     (unaudited)  
    (in thousands, except per share data)  

Consolidated Statements of Operations Data:

             

Revenues:

             

Service

  $ 1,412     $ 7,278     $ 16,411     $ 29,324     $ 35,184     $ 25,842     $ 40,270  

Product

    —         —         12,930       16,353       2,624       2,641       376  
                                                       

Total revenues

    1,412       7,278       29,341       45,677       37,808       28,483       40,646  

Cost of revenues:

             

Service

    2,346       5,735       14,619       25,671       27,381       20,299       29,684  

Product

    —         —         10,472       13,376       1,898       2,013       273  
                                                       

Total cost of revenues

    2,346       5,735       25,091       39,047       29,279       22,312       29,957  

Gross (loss) profit

    (934 )     1,543       4,250       6,630       8,529       6,171       10,689  

Research and development expenses

    —         —         —         —         —         —         96  

Selling and marketing expenses

    828       2,900       9,128       15,682       10,906       7,875       10,863  

General and administrative expenses

    680       2,248       4,046       8,840       7,058       5,274       5,703  

Amortization of intangible assets

    —         —         703       1,351       1,165       862       1,555  
                                                       

Loss from operations

    (2,442 )     (3,605 )     (9,627 )     (19,243 )     (10,600 )     (7,840 )     (7,528 )

Interest and other income (expense), net

    36       26       (188 )     (2,248 )     393       44       (3,292 )
                                                       

Loss before income taxes and cumulative effect of change in accounting principle

    (2,406 )     (3,579 )     (9,815 )     (21,491 )     (10,207 )     (7,796 )     (10,820 )

Provision for income taxes

    —         —         —         —         —         —         78  
                                                       

Loss before cumulative effect of change in accounting principle

    (2,406 )     (3,579 )     (9,815 )     (21,491 )     (10,207 )     (7,796 )     (10,898 )

Cumulative effect of change in accounting principle(1)

    —         —         —         —         558       558       —    
                                                       

Net loss

  $ (2,406 )   $ (3,579 )   $ (9,815 )   $ (21,491 )   $ (9,649 )   $ (7,238 )   $ (10,898 )

Dividends and accretion on preferred stock

   
(281
)
    (828 )     (1,129 )     (2,420 )     (3,482 )     (2,565 )     (3,120 )
                                                       

Net loss to common stockholders

  $ (2,687 )   $ (4,407 )   $ (10,944 )   $ (23,911 )   $ (13,131 )   $ (9,803 )   $ (14,018 )
                                                       

Net loss per share to common stockholders

  $ (0.66 )   $ (0.96 )   $ (2.29 )   $ (4.62 )   $ (2.21 )   $ (1.68 )   $ (1.53 )
                                                       

Weighted average number of shares outstanding (basic and diluted)

    4,093       4,584       4,769       5,170       5,955       5,834       9,189  
                                                       

 

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    As of December 31,     As of September 30,  
    2002     2003     2004     2005     2006     2006     2007  
                                  (unaudited)     (unaudited)  
    (in thousands)  

Consolidated Balance Sheet Data:

             

Cash and cash equivalents.

  $ 4,770     $ 8,072     $ 20,783     $ 4,948     $ 3,735     $ 3,023     $ 11,482  

Total assets

    5,479       11,288       37,529       18,756       18,072       16,132       62,911  

Total long-term debt, including current portion.

    80       123       5,832       4,898       5,695       6,158       20,306  

Redeemable convertible preferred stock warrant liability

    —         —         —         —         993       1,219       5,105  

Total redeemable convertible preferred stock

    8,631       16,540       37,560       43,924       54,680       48,792       73,428  

Total stockholders’ deficit

    (3,507 )     (7,913 )     (18,425 )     (41,279 )     (54,523 )     (51,108 )     (61,756 )

(1) The cumulative effect of change in accounting principle is due to the adoption of FSP 150-5, effective January 1, 2006 and represents a net gain from recording the estimated fair value of preferred stock warrants as of that date. The following table shows the impact had FSP 150-5 been adopted at the beginning of the periods presented:

 

      2002     2003     2004     2005  

Additional other income, net

   $ 10     $ 17     $ 28     $ 503  
                                

Adjusted net loss per share to common stockholders*

   $ (0.65 )   $ (0.96 )   $ (2.29 )   $ (4.53 )
                                
 
  * Represents the net loss per share to common shareholders adjusted for the impact of the additional income, net.

 

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UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL INFORMATION

On March 22, 2007, we acquired all of the outstanding capital stock of MBI Advanced Computer Systems Ltd. (MBI Israel) and MBI Veri Koruma Sistemleri Ticaret Limited Sirketi (MBI Turkey and, together with MBI Israel, the MBI Group), related companies which provide expertise in data protection of storage and servers. MBI Advanced Computer Systems Ltd. operates in Israel. MBI Veri Koruma Sistemleri Ticaret Limited Sirketi operates in Turkey. Total consideration for MBI Advanced Computer Systems Ltd. was approximately $8.1 million, consisting primarily of 1,788,798 shares of our common stock valued at $1.3 million, $6.5 million in cash, and transaction costs of approximately $240,000. Total consideration for MBI Turkey was approximately $346,000 consisting primarily of 61,683 shares of common stock valued at approximately $46,000 and $300,000 in cash.

On March 22, 2007, we acquired all of the outstanding capital stock of Integrity Systems Ltd. (Integrity), which provides expertise in data protection of storage, servers, and database environments. Integrity operates in Israel. Total consideration for Integrity was approximately $2.5 million, consisting primarily of 596,265 shares of common stock valued at approximately $447,000, $1.9 million in cash, and transaction costs of approximately $241,000. We refer to Integrity along with MBI Group collectively as the Israeli Group. We refer to the acquisition of the MBI Group and Integrity collectively as our Israeli acquisition.

On July 2, 2007, we acquired certain assets of Rapid Application Deployment, Inc. (RapidApp), which provides consulting support in the design and deployment of server virtualization and virtual infrastructure projects. Total consideration for RapidApp was approximately $10.6 million, consisting primarily of 2,344,300 shares of common stock valued at $4.5 million, $6.0 million in cash, and transaction costs of approximately $58,000. Within 45 days after June 30, 2008, we may be required to pay up to an additional $2.1 million in cash based on the achievement of certain revenue targets by the RapidApp business for the twelve month period following the acquisition.

On October 1, 2007, we acquired all of the outstanding capital stock of DCMI Holdings (DCMI), a UK-based provider of data center consolidation software. The total purchase price was approximately $8.5 million, consisting primarily of 2,148,942 shares of common stock valued at $4.4 million, $4.0 million in cash, and transaction costs of approximately $121,000. Within 45 days after September 30, 2008, we may be required to pay up to an additional $3.5 million in cash based on DCMI’s achievement of certain revenue targets for the twelve month period following the acquisition.

 

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We have allocated the preliminary estimated purchase price for each of these acquisitions to the net tangible and intangible assets, resulting in the excess of the purchase price over the net tangible and intangible assets being recorded as goodwill. The following represents a preliminary estimate of the purchase price (in thousands):

 

    Integrity   MBI - Israel   MBI - Turkey   Rapid
App
  DCMI   Total

Cash payment

  $ 1,850   $ 6,500   $ 300   $ 6,031   $ 4,000   $ 18,681

Fair value of GlassHouse Technologies stock issued(1)

    447     1,342     46     4,501     4,405     10,741

Transaction costs incurred

    241     240     —       58     121     660
                                   

Total Purchase Consideration

  $ 2,538   $ 8,082   $ 346   $ 10,590   $ 8,526   $ 30,082
                                   

(1) The fair value of our common stock was based on third party valuations at the dates of issuance. The per share fair values used by us were:

 

March 22, 2007

   $ 0.75

July 2, 2007

   $ 1.92

October 1, 2007

   $ 2.05

The following unaudited pro forma condensed combined financial statements have been prepared to give effect to our acquisitions of MBI Group, Integrity, RapidApp and DCMI, using the purchase method of accounting with the assumptions and adjustments described in the accompanying notes to the unaudited pro forma condensed combined financial statements. The unaudited pro forma condensed combined financial statements should be read in conjunction with the historical financial statements and the related notes of GlassHouse, MBI Group, Integrity, RapidApp and DCMI, whose audited financial statements are included in this prospectus.

The unaudited pro forma condensed combined balance sheet as of September 30, 2007 gives effect to the acquisition of DCMI as if it had occurred on September 30, 2007. The unaudited pro forma condensed combined statements of operations for the year ended December 31, 2006 and the nine months ended September 30, 2007 give effect to the acquisitions described above as if they had occurred on January 1, 2006 and January 1, 2007, respectively. MBI Group, Integrity and RapidApp operate on a calendar basis. DCMI operates on a March 31 year end. The unaudited pro forma condensed combined statement of operations for the year ended December 31, 2006 is based on audited historical results of operations of GlassHouse, MBI Group, Integrity and RapidApp and the unaudited historical results for the period from March 16, 2006 (inception) through December 31, 2006 of DCMI. The unaudited pro forma condensed combined statements of operations for the nine months ended September 30, 2007 is based on the unaudited historical results of GlassHouse, MBI Group, Integrity, RapidApp and DCMI. The unaudited pro forma condensed combined financial statements include all material pro forma adjustments necessary for their preparation, but do not assume any benefits from cost savings or synergies of operations of the combined company.

The unaudited pro forma condensed combined financial statements are not intended to represent or be indicative of the consolidated results of operations or financial condition of GlassHouse that would have been reported if the transactions had been consummated as of the beginning of the periods presented, nor are they necessarily indicative of the future operating results or financial position of the combined company.

 

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GLASSHOUSE TECHNOLOGIES, INC.

Unaudited Pro Forma Condensed Combined Balance Sheet

(in thousands, except share and per share amounts)

 

   

September 30,

2007

Consolidated

   

Pro forma

Adjustments

   

Pro forma

Balance
Sheet

 
     

Assets

     

Current assets:

     

Cash and cash equivalents.

  $ 11,482     $ (4,121 )(1)   $ 7,361  

Accounts receivable, net of allowance for doubtful accounts

    16,089         16,089  

Unbilled revenue

    4,131         4,131  

Prepaid expenses and other current assets

    5,175         5,175  
                       

Total current assets

    36,877       (4,121 )     32,756  

Property and equipment, net

    931         931  

Intangible assets, net

    12,458       4,286 (2)     16,744  

Goodwill

    7,005       4,240 (3)     11,245  

Restricted cash and cash equivalents

    16         16  

Other assets

    3,074         3,074  

Deferred cost

    2,550         2,550  
                       

Total assets

  $ 62,911     $ 4,405     $ 67,316  
                       

Liabilities, redeemable convertible preferred stock, and stockholders' deficit

     

Current liabilities

     

Current portion of long-term debt

  $ 7,401         7,401  

Accounts payable

    3,720         3,720  

Accrued expenses and other current liabilities

    8,163         8,163  

Deferred revenue

    7,823         7,823  
                 

Total current liabilities

    27,107         27,107  

Long-term debt, net of current portion

    12,905         12,905  

Long-term deferred revenues

    3,987         3,987  

Other long term liabilities

    982         982  

Redeemable convertible preferred stock warrant liability

    5,105         5,105  

Commitments and contingencies

     

Redeemable convertible preferred stock

     

Series A Preferred Stock, $.001 par value; 3,360,000 shares authorized, issued and outstanding at September 30, 2007 (liquidation preference of $2,252)

    2,253         2,253  

Series B Preferred Stock, $.001 par value; 10,658,017 shares authorized, 10,623,402 issued and outstanding at September 30, 2007 (liquidation preference of $9,767)

    9,971         9,971  

Series C Preferred Stock, $.001 par value; 8,717,647 shares authorized, 8,364,707 issued, and outstanding at September 30, 2007 (liquidation preference of $8,851)

    8,844         8,844  

Series D Preferred Stock, $.001 par value; 17,511,727 shares authorized at September 30, 2007, 15,626,305 shares issued and outstanding at September 30, 2007 (liquidation preference $42,623)

    41,166         41,166  

Series E Preferred Stock, $.001 par value; 4,930,376 shares authorized, 4,493,245 issued and outstanding at September 30, 2007 (liquidation preference $11,715)

    11,194         11,194  
                       

Total redeemable convertible preferred stock

    73,428       —         73,428  

Stockholders' deficit:

     

Series 1 convertible preferred stock, $0.001 par value—6,000,000 shares authorized; 4,440,499 shares issued and outstanding at September 30, 2007

    370         370  

Common stock, $.001 par value 86,000,000 shares authorized at September 30, 2007 12,356,152 shares issued and 14,700,452 issued at September 30, 2007 pro forma

    13       2 (4)     15  

Additional paid in capital

    7,435       4,403 (4)     11,838  

Treasury stock 450,000, at cost shares

    (1 )       (1 )

Accumulated other comprehensive income

    338         338  

Accumulated deficit

    (69,911 )       (69,911 )
                       

Total stockholders' deficit

    (61,756 )     4,405       (57,351 )
                       

Total liabilities, redeemable convertible preferred stock and stockholders' deficit

  $ 62,911     $ 4,405     $ 67,316  
                       

 

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GLASSHOUSE TECHNOLOGIES, INC.

Unaudited Pro Forma Condensed Combined Statements of Operations

(In thousands, except per share amounts)

 

    Year Ended December 31, 2006  

Pro forma

Adjustments

   

Pro forma

Combined

 
    GlassHouse     Integrity     MBI - Israel     MBI - Turkey   Rapid
App
    DCMI    

Revenues

               

Service

  $ 35,184     $ 6,658     $ 8,981     $ 1,417   $ 5,293     $ 809   $ (4,107 )(5)   $ 54,235  

Product

    2,624       1,418       513       —       1,744       261     —         6,560  
                                                           

Total revenues

    37,808       8,076       9,494       1,417     7,037       1,070     (4,107 )     60,795  

Cost of revenues

               

Service

    27,381       5,556       7,515       886     2,899       769     (2,606 )(6),(7),(8)     42,400  

Product

    1,898       451       408       —       1,601       39     —         4,397  
                                                           

Total cost of revenues

    29,279       6,007       7,923       886     4,500       808     (2,606 )     46,797  
                                                           

Gross profit

    8,529       2,069       1,571       531     2,537       262     (1,501 )     13,998  

Operating expenses:

               

Research and development expenses

    —         279       —         —       —         —       —         279  

Selling and marketing expenses

    10,906       818       1,203       134     1,137       58     12 (6)     14,268  

General and administrative expenses

    7,058       782       1,176       390     970       72     20 (6)     10,468  

Amortization of intangible assets

    1,165       —         —         —       —         —       2,400 (8)     3,565  
                                                           

Total operating expenses

    19,129       1,879       2,379       524     2,107       130     2,432       28,580  
                                                           

Income (loss) from operations

    (10,600 )     190       (808 )     7     430       132     (3,933 )     (14,582 )

Interest income (expense), net

    (643 )     (50 )     (77 )     2     (37 )     8     (1,805 )(9)     (2,602 )

Other income (expense), net

    1,036       (197 )     (110 )     12     (3 )     —       145 (10)     883  
                                                           

Income (loss) before income taxes and cumulative effect of change in accounting principle

    (10,207 )     (57 )     (995 )     21     390       140     (5,593 )     (16,301 )

Provision for income taxes

    —         101       —         6     —         45     —         152  
                                                           

Income (loss) before cumulative effect of change in accounting principles

    (10,207 )     (158 )     (995 )     15     390       95     (5,593 )     (16,453 )

Cumulative effect of change in accounting principles

    558       114       —         —       —         —       —         672  
                                                           

Net income (loss)

  $ (9,649 )   $ (44 )   $ (995 )   $ 15   $ 390     $ 95   $ (5,593 )   $ (15,781 )

Net (loss) income per share:

               

Dividends and accretion on preferred Stock

    (3,482 )               (182 )(11)     (3,664 )
                                                           

Net income (loss) to common stockholders

  $ (13,131 )   $ (44 )   $ (995 )   $ 15   $ 390     $ 95   $ (5,775 )   $ (19,445 )
                                                           

Net loss per share to common stockholder

  $ (2.21 )               $ (1.51 )
                           

Number of shares used in per share calculations:

               

Basic and diluted

    5,955                 6,940 (12)     12,895  
                                 

 

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GLASSHOUSE TECHNOLOGIES, INC.

Unaudited Pro Forma Condensed Combined Statements of Operations

(In thousands, except per share amounts)

 

    Nine Months Ended September 30, 2007    

Pro forma

Adjustments

   

Pro forma

Combined

 
    GlassHouse     Integrity     MBI - Israel     MBI - Turkey   Rapid
App
    DCMI      

Revenues

               

Service

  $ 40,270     $ 1,924     $ 2,794     $ 518   $ 2,235     $ 3,472     $ (1,050 )(5)   $ 50,163  

Product

    376       204       24       —       660       601       —         1,865  
                                                             

Total revenues

    40,646       2,128       2,818       518     2,895       4,073       (1,050 )     52,028  

Cost of revenues

               

Service

    29,684       1,747       2,223       356     1,244       3,086       (674 )(6),(7),(8)     37,666  

Product

    273       103       12       —       607       —         —         995  
                                                             

Total cost of revenues

    29,957       1,850       2,235       356     1,851       3,086       (674 )     38,661  
                                                             

Gross profit

    10,689       278       583       162     1,044       987       (376 )     13,367  

Operating expenses:

               

Research and development expenses

    96       59       —         —       —         —         —         155  

Selling and marketing expenses

    10,863       241       333       41     534       614       4 (6)     12,630  

General and administrative expenses

    5,703       622       299       36     417       378       5 (6)     7,460  

Amortization of intangible assets

    1,555       —         —         —       —         —         920 (8)     2,475  
                                                             

Total operating expenses

    18,217       922       632       77     951       992       929       22,720  
                                                             

Income (loss) from operations

    (7,528 )     (644 )     (49 )     85     93       (5 )     (1,305 )     (9,353 )

Interest income (expense), net

    (1,460 )     (10 )     26       —       (20 )     12       (636 )(9)     (2,088 )

Other income (expense), net

    (1,832 )     —         461       27     —         —         (554 )(10)     (1,898 )
                                                             

Income (loss) before income taxes and cumulative effect of change in accounting principle

    (10,820 )     (654 )     438       112     73       7       (2,495 )     (13,339 )

Provision/(benefit) for income taxes

    78       (41 )     —         28     7       27       —         99  
                                                             

Net income (loss)

    (10,898 )     (613 )     438       84     66       (20 )     (2,495 )     (13,438 )

Dividends and accretion on preferred stock

    (3,120 )     —         —         —       —         —         (243 )(11)     (3,363 )
                                                             

Net income (loss) to common stockholders

  $ (14,018 )   $ (613 )   $ 438     $ 84   $ 66     $ (20 )   $ (2,738 )   $ (16,801 )
                                                             

Net loss per share to common stockholders

  $ (1.53 )               $ (1.23 )
                           

Number of shares used in per share calculations:

               

Basic and diluted

    9,189                 4,429 (12)     13,618  
                                 

 

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Notes to Unaudited Pro Forma Condensed Combined Financial Information

Explanation of Adjustments to the Pro Forma Condensed Combined Financial Statements

 

(1) Cash consideration and expenses for the DCMI acquisition, closed October 1, 2007.

 

(2) Intangible assets associated with the DCMI acquisition, closed October 1, 2007.

 

(3) Goodwill associated with the DCMI acquisition, closed October 1, 2007.

 

(4) Common stock issued as consideration in the DCMI acquisition, closed October 1, 2007.

 

Shares issued

     2,148,942

Par value

   $ 0.001
      
     2,149

Total value of shares

     4,405,331
      

Additional paid in capital

   $ 4,403,182
      

 

(5) To record the impact of the fair valuing of deferred revenue at January 1, 2006 and 2007.

 

     Integrity     MBI - Israel     MBI - Turkey     Rapid
App
   DCMI    Total  
     (in thousands)  

For the twelve months ended December 31, 2006

   $ (398 )   $ (3,208 )   $ (501 )   $  —      $  —      $ (4,107 )
                                              

For the nine months ended September 30, 2007

   $ (54 )   $ (862 )   $ (134 )   $ —      $ —      $ (1,050 )
                                              

 

(6) To record stock compensation expense in accordance with the adoption of SFAS No. 123R related to options issued by Glasshouse to employees of acquired companies who continued to be employed by us subsequent to the merger. The break out of the expense by income statement category is as follows:

For the twelve months ended December 31, 2006

 

Statement of Operations Category

   Integrity    MBI - Israel    MBI - Turkey    Rapid
App
   DCMI    Total
     (in thousands)

Cost of revenues—service

   $ 7    $ 5    $ 1    $ 3    $  —      $ 16

Research and development

     —        —        —        —        —        —  

Sales and marketing

     4      4      —        4      —        12

General and administrative

     7      11      2      —        —        20
                                         

Total

   $ 18    $ 20    $ 3    $ 7    $  —      $ 48
                                         

For the nine months ended September 30, 2007

 

Statement of Operations Category

   Integrity    MBI - Israel    MBI - Turkey    Rapid
App
   DCMI    Total
     (in thousands)

Cost of revenues—service

   $ 2    $ 1    $ —      $ 2    $  —      $ 5

Research and development

     —        —        —        —        —        —  

Sales and marketing

     1      1      —        2      —        4

General and administrative

     3      2      —        —        —        5
                                         

Total

   $ 6    $ 4      —      $ 4    $ —      $ 14
                                         

 

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Table of Contents
(7) To record the impact of the fair valuing of deferred costs associated with deferred revenue.

 

     Integrity    MBI - Israel     MBI - Turkey     Rapid
App
   DCMI    Total  
     (in thousands)  

For the twelve months ended December 31, 2006

   $  —      $ (2,559 )   $ (400 )   $  —      $  —      $ (2,959 )
                                             

For the nine months ended September 31, 2007

   $  —      $ (784 )   $ (122 )   $  —      $  —      $ (906 )
                                             

 

(8) The pro forma expense of our acquired intangible assets for the twelve months ended December 31, 2006 and the nine months ended September 30, 2007 is as follows:

Amortization of the intangible assets recorded as part of the purchase price allocation in connection with the acquisitions. Intangible assets are amortized in accordance with SFAS 142 for purposes of these unaudited pro forma financial statements over the following number of years:

 

Developed product technology

   4-7   

Trademark / tradename portfolio

   5   

Customer relationships

   5-7   

For the twelve months ended December 31, 2006

 

     Integrity    MBI - Israel    MBI - Turkey    Rapid
App
   DCMI    Total  
     (in thousands)  

Developed product technology

   $ 49    $ —      $ —      $ —      $ 288    $ 337 *

Trademark / tradename portfolio

     —        —        —        105      —        105  

Customer relationships

     224      1,020      85      631      335      2,295  
                                           

Total

   $ 273    $ 1,020    $ 85    $ 736    $ 623    $ 2,737  
                                           

For the nine months ended September 30, 2007

 

     Integrity    MBI - Israel    MBI - Turkey    Rapid
App
   DCMI    Total  
     (in thousands)  

Developed product technology

   $ 11    $ —      $ —      $ —      $ 216    $ 227 *

Trademark / tradename portfolio

     —        —        —        52      —        52  

Customer relationships

     51      230      19      316      252      868  
                                           

Total

   $ 62    $ 230    $ 19    $ 368    $ 468    $ 1,147  
                                           
 
  * Included in cost of revenues

 

(9) To record the interest expense related to the debt issued to purchase our acquisitions. The expense by acquired company is as follows:

 

     Integrity    MBI - Israel    MBI - Turkey    Rapid
App
   DCMI    Total
     (in thousands)

For the twelve months ended December 31, 2006

   $ 258    $ 747    $ 37    $ 763    $  —      $ 1,805
                                         

For the nine months ended September 30, 2007

   $ 58    $ 188    $ 8    $ 382    $  —      $ 636
                                         

 

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(10) To record the income/(expense) from the change in fair value of the warrants issued in conjunction with the debt or equity issued to finance our acquisitions.

 

     Integrity     MBI - Israel     MBI - Turkey     Rapid
App
    DCMI    Total  
     (in thousands)  

For the twelve months ended December 31, 2006

   $ 20     $ 64     $ 3     $ 58     $ —      $ 145  
                                               

For the nine months ended September 30, 2007

   $ (30 )   $ (330 )   $ (4 )   $ (190 )   $ —      $ (554 )
                                               

 

(11) To record dividends and accretion for the preferred stock issued to fund our acquisition of DCMI.

 

(12) To record the impact of the issuance of our common stock as consideration in conjunction with the acquisitions.

 

     Integrity    MBI - Israel    MBI - Turkey    Rapid
App
   DCMI    Total
     (in thousands)

For the twelve months ended December 31, 2006

   596    1,789    62    2,344    2,149    6,940
                             

For the nine months ended September 30, 2007

   177    531    18    1,554    2,149    4,429
                             

 

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The estimated purchase price for the acquisitions has been allocated on a preliminary basis to the acquired net tangible and intangible assets based on their estimated fair values as follows (in thousands):

 

     Integrity     MBI - Israel     MBI - Turkey     Rapid
App
   DCMI    Total  

Cash and cash equivalents

   $ 23     $ 316     $ 353     $ —      $ —      $ 692  

Accounts receivable, net of allowance

     1,617       3,593       317       —        —        5,527  

Unbilled revenue

     556       —         —         —        —        556  

Inventory

       214       —         —           214  

Prepaid expenses and other current assets

     331       809       51       12      —        1,203  

Property and equipment, net

     104       148       12       65      —        329  

Other assets

     849       2,656       81       —        —        3,586  

Accounts payable

     (313 )     (3,314 )     (335 )     —        —        (3,962 )

Accrued expenses and other current liabilities

     (954 )     (871 )     (115 )     —        —        (1,940 )

Deferred revenue

     (111 )     (1,600 )     (500 )     —        —        (2,211 )

Debt

     (709 )     —         —         —        —        (709 )

Other long-term liabilities

     (843 )     (1,011 )     (96 )     —        —        (1,950 )
                                              

Net tangible assets acquired

     550       940       (232 )     77      —        1,335  

Excess of purchase price over net tangible assets acquired

     1,988       7,142       578       10,513      8,526      28,747  

Identified intangible assets:

              

Developed product technology

     196       —         —         —        2,013      2,209  

trademark / tradename portfolio

     —         —         —         523      —        523  

Customer relationships

     1,792       7,142       408       3,155      2,350      14,847  
                                              

Total fair value of identified intangibles

     1,988       7,142       408       3,678      4,363      17,579  
                                              

Goodwill

   $ —       $ —       $ 170     $ 6,835    $ 4,163    $ 11,168  
                                              

The above estimated purchase price allocation has been performed on a preliminary basis and is subject to change. The company expects to finalize the purchase price allocations during the fourth quarter of 2007, at which time any deferred tax liability on the difference between the book and tax basis of identified intangibles will be recorded under FAS 109.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Consolidated Financial Data” and our consolidated financial statements and related notes appearing elsewhere in this prospectus. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors. We discuss factors that we believe could cause or contribute to these differences below and elsewhere in this prospectus, including those set forth under “Risk Factors” and “Special Note Regarding Forward-Looking Statements.”

Overview

We are a leading provider of IT consulting, technology integration and managed services that address inefficiencies and risks inherent in storage and data infrastructure. Our services include server virtualization, data center migrations and consolidations, storage, operational recovery solutions, compliance and managed services. Our proprietary service delivery framework, TransomSM, combines our software tools, proprietary methodologies and domain expertise to execute services projects with the intent to transition customers to a recurring revenue relationship. Our customer base includes enterprise and small-to-midsized business (SMB) organizations across numerous industries and currently includes or has included 42 of the Fortune 100 companies. We provide a demonstrable ROI to our customers by:

 

  Ÿ  

Reducing the total cost of data infrastructure

 

  Ÿ  

Improving IT service levels to support business functions

 

  Ÿ  

Decreasing risk in both data recovery and regulatory areas

Founded in 2001, we initially focused on storage and data protection services. In response to customer demand, we expanded our breadth of services by offering complete lifecycle support from strategy to managed services. We achieved this expansion through a combination of organic growth and acquisitions. From our inception through 2005, we had four key acquisitions. These acquisitions accelerated our expansion into international markets, our tool development and our entrance into the managed services arena.

In 2007 we grew our revenue, capabilities, service offerings and international presence through additional strategic acquisitions. These acquisitions have added server virtualization, data center migration and additional managed services to our capabilities. In addition, these acquisitions expanded our presence in the United Kingdom and the United States, as well as facilitated expansion into Israel and Turkey to serve the Middle East markets.

Over the past two years we have identified several key trends that have contributed to our revenue and margin growth:

 

  Ÿ  

Increased growth in our managed services offerings

 

  Ÿ  

Our tools and IP becoming integrated into more of our projects

 

  Ÿ  

Growth in the size and scope of our projects

 

  Ÿ  

Higher revenues from large enterprise customers in the UK

 

  Ÿ  

Increased global accounts and cooperation

 

  Ÿ  

Increased volume of opportunities coming to us through indirect sales channels

 

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Revenues

 

    Year Ended December 31,     Year Ended December 31,     Nine Months Ended September 30,  
    2004   2005   $
Change
  %
Change
    2005   2006   $
Change
    %
Change
    2006   2007   $
Change
    %
Change
 
                                          (unaudited)   (unaudited)            
    (dollars in thousands)  
Revenues      

Services

  $ 16,411   $ 29,324   $ 12,913   79 %   $ 29,324   $ 35,184   $ 5,860     20 %   $ 25,842   $ 40,270   $ 14,428     56 %

Product

    12,930     16,353     3,423   26 %     16,353     2,624     (13,729 )   -84 %     2,641   $ 376     (2,265 )   -86 %
                                                                           

Total revenues

  $ 29,341   $ 45,677   $ 16,336   56 %   $ 45,677   $ 37,808   $ (7,869 )   -17 %   $ 28,483   $ 40,646   $ 12,163     43 %
                                                                           

We derive revenues from consulting services, managed service contracts, product sales and multi-element sales. Product sales consist of the resale of third party software and/or hardware. Multi-element sales include multiple services and products. We focus on generating service revenues. Product sales are not a part of the US or the UK business. Vendor independence is one of our key business differentiators. After we make an acquisition, part of the integration plan is to transition product sales out to a partner. Product sales in 2007 are a result of revenues from our Israeli acquisition. As a result of becoming part of GlassHouse, the Israeli Group has seen an increase in services work performed without any product resale component. The vast majority of our revenues is generated either through fixed fee engagements or managed services contracts. Included in our revenues are travel and entertainment expenses that are billable to our customers.

Service revenues increased 56% from the nine months ended September 30, 2006 to the nine months ended September 30, 2007. The growth was almost evenly split between organic growth and growth through acquisitions made in 2007. Our organic growth increased due to broader acceptance of our services within our customer base, an increase in our deal size and growth in our indirect channel relationships. In 2007, billing rates were increased. We built this increase into the fixed fee structure of our projects. We had no direct client that represented more than 10% of our revenues in this period.

Product revenues decreased 86% during this period reflecting the shift away from, and the planned outsourcing of, our product business in the UK in 2006.

Service revenues increased 20% from 2005 to 2006. All of this increase was from organic growth as we focused on improving efficiency of delivery and sales productivity. Product revenues decreased by 84% during this period, which reflects the shift away from our product business in the UK in 2006.

Service revenues grew 79% from 2004 to 2005. Of this increase, more than half was from organic growth. Our 2005 revenues included a complete 12 months of revenues from our UK operations compared to just four months in our 2004 revenues. Product revenues grew 26% in 2005 also reflecting a full 12 months of sales from our UK operations. Our UK operations were selling products at the time of their acquisition in 2004. The product sales grew marginally before being phased out of the UK operations in 2006.

Cost of revenues and gross profit

 

    Year Ended December 31,     Year Ended December 31,     Nine Months Ended September 30,  
    2004     2005     $
Change
  %
Change
    2005     2006     $
Change
    %
Change
    2006     2007     $
Change
    %
Change
 
                                                  (unaudited)     (unaudited)              
    (dollars in thousands)  
Gross profit      

Services

  $ 1,792     $ 3,653     $ 1,861   104 %   $ 3,653     $ 7,803     $ 4,150     114 %   $ 5,543     $ 10,586     $ 5,043     91 %

Product

    2,458       2,977       519   21 %     2,977       726       (2,251 )   -76 %     628       103       (525 )   -84 %
                                                                                       

Total gross profit

  $ 4,250     $ 6,630     $ 2,380   56 %   $ 6,630     $ 8,529     $ 1,899     29 %   $ 6,171     $ 10,689     $ 4,518     73 %
                                                                                       
Gross Margin      

Services

    11 %     12 %         12 %     22 %         21 %     26 %    

Product

    19 %     18 %         18 %     28 %         24 %     27 %    

Total gross margin

    14 %     15 %         15 %     23 %         22 %     26 %    

 

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Cost of revenues includes all costs related to the delivery of our services and consists primarily of salaries and benefits of our consultants, billable and non-billable travel and entertainment, third party contractors, third party products and services and facility related expenses. Our managed services business is performed onsite and offsite, but using customer-owned assets. Our investments in this area are primarily staff, our software tools and basic monitoring equipment.

We have experienced a steady improvement in our service margins since the beginning of 2006. This is a result of several key factors:

 

  Ÿ  

Winning and completing larger projects improves utilization by cutting down inefficiencies associated with starting and stopping many small projects

 

  Ÿ  

An increase in scale of managed services projects

 

  Ÿ  

Improved system controls increase accuracy of forecasting and allow us to more efficiently utilize resources

 

  Ÿ  

A maturation of our IP tools and software facilitates productivity and allows us to build out our labor pyramid to leverage our senior domain experts

Total gross profit increased 73% for the nine months ended September 30, 2007 over the nine months ended September 30, 2006. Gross profit from services increased 91% to 26% of service revenue during this period. Most of the increase is attributable to improved delivery efficiencies along with the rate increase. As our managed services revenues grew, we were generally able to add additional revenue without a corresponding increase in headcount.

From 2005 to 2006, total gross profit increased 29% and increased as a percentage of sales from 15% to 23%. Service gross profit increased 114% and increased as a percentage of sales from 12% to 22% during this period. This is due mostly to an increase in service revenues of 20% with a corresponding increase of only 7% in related costs of revenue. Higher utilization and efficiencies allowed us to make minimal headcount additions in 2006. In addition, higher margins were obtained in our managed services business through increased revenues without the need for additional hiring or associated costs.

From 2004 to 2005, total gross profit increased 56% mostly due to the contribution of our UK operations in 2004. Service gross profit grew 104% during the period; however, gross margin remained relatively flat, increasing from 11% in 2004 to 12% in 2005. In 2005, we made significant investments in our tools and methodologies. As a result, increases in services revenues and product revenues were offset by corresponding increases in costs that resulted in a small increase in the gross margin percentage. These investments, however, have allowed us to scale through the use of software tools and methodologies, while keeping our delivery quality high.

Operating expenses

 

    Year Ended December 31,     Year Ended December 31,     Nine Months Ended September 30,  
    2004   2005   $
Change
  %
Change
    2005   2006   $
Change
    %
Change
    2006   2007   $
Change
  %
Change
 
                                          (unaudited)   (unaudited)          
    (dollars in thousands)  

Operating expenses:

                       

Research and development expenses

  $ —     $ —     $ —     %   $ —     $ —     $ —       %   $ —     $ 96   $ 96   %

Selling and marketing expenses

    9,128     15,682     6,554   72 %     15,682     10,906     (4,776 )   -30 %     7,875     10,863     2,988   38 %

General and administrative expenses

    4,046     8,840     4,794   118 %     8,840     7,058     (1,782 )   -20 %     5,274     5,703     429   8 %

Amortization expense

    703     1,351     648   92 %     1,351     1,165     (186 )   -14 %     862     1,555     693   80 %
                                                                         

Total operating expenses

  $ 13,877   $ 25,873   $ 11,996   86 %   $ 25,873   $ 19,129   $ (6,744 )   -26 %   $ 14,011   $ 18,217   $ 4,206   30 %
                                                                         

 

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Research and development

Research and development expenses are attributable to our recent acquisition of Integrity Systems Ltd. and relate to the continued development of a software product, which is used in the delivery of our managed services. These expenses consist primarily of salaries and benefits of our development personnel and third party software and equipment. Our ongoing improvements and additions to our software toolset are primarily developed within the scope of our customers’ projects.

Selling and marketing

Selling and marketing expense consists primarily of salaries with related benefits, commissions and marketing expenses such as advertising, product literature and trade show costs.

Selling and marketing consist of three key components:

 

  Ÿ  

Direct Sales—regionally based sales representatives who call primarily on named accounts in their region

 

  Ÿ  

Indirect Sales—sales representatives who focus on creating indirect channel relationships for the company in specific geographies

 

  Ÿ  

Marketing—personnel who manage lead generation, collateral material development, and press and analyst relations

Sales commissions are paid regardless of whether the opportunity is closed directly or through an indirect sales channel. Sales representatives are encouraged to develop long-term relationships with our customers, and are compensated whether a sale is to a new customer or an existing customer.

For the nine months ended September 30, 2007, selling and marketing expenses increased 38% but decreased 1% as a percentage of revenues from 28% to 27% as compared to the nine months ended September 30, 2006. Most of this decrease can be attributed to efficiencies of an experienced sales force, increased quotas, performance management and being able to attract higher quality, experienced sales representatives. As our offerings have become more robust and project sizes have grown, sales representatives are becoming more productive with respect to the revenues they can produce.

From 2005 to 2006, selling and marketing expenses were reduced by 30% and dropped as a percentage of revenues from 34% to 29%. During 2005, we aggressively hired sales representatives in the UK and Europe. In late 2005, it was determined that the sales team was not effective because the UK market was immature at that time. We significantly decreased headcount in the UK and we aggressively phased out the product portion of the UK business. The result was a $4.8 million drop in sales costs in 2006.

From 2004 to 2005, selling and marketing expenses increased 72% and increased as a percentage of revenues from 31% to 34%. Part of the increase was due to a full year of sales and marketing expenses from our UK operations. In addition, we had aggressively built out our sales force during this period, particularly for the UK and European market. Increased salaries, commissions and related costs all contributed to this increase. Marketing spending was also increased to build brand awareness in the UK through marketing events and collateral.

General and administrative

General and administrative (G&A) expense includes the costs of financial, human resources, IT and administrative personnel, professional services, and corporate overhead.

 

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For the nine months ended September 30, 2007, G&A expenses increased 8% from the nine months ended September 30, 2006. As a percentage of revenues, G&A expenses decreased from 19% to 14% during this period. Most of the dollar increase was the result of additional expenses from the G&A departments of the companies we acquired in 2007. Additional expenses were for headcount needed to support finance, operational functions, revenue recognition and invoicing and control.

From 2005 to 2006, G&A expenses decreased 20%. In 2005, significant expenses were incurred in recruiting, facilities and related administrative functions as we made an aggressive sales effort primarily in the UK and Europe. In 2006, these costs were reduced as the headcount was reduced and sales offices were closed. As a percentage of revenues during this period, G&A expenses were flat at 19%. As a percentage of service revenues alone, G&A expenses actually declined from 30% to 20%.

From 2004 to 2005, G&A expenses increased 118%. As a percentage of revenues, G&A expenses increased from 14% to 19% during this period. Part of the increase was due to a full year of G&A expenses for our UK operations, including expenses relating to our investment in recruiting and facilities during this period as we made an aggressive sales effort in the UK and Europe.

Amortization expense

We have purchased intangible assets as part of our acquisitions. We have amortized these intangible assets over the estimated useful life of each such asset.

For the nine months ended September 30, 2007, amortization expense increased 80% from the nine months ended September 30, 2006 reflecting the impact of acquisitions made in 2007.

We made no acquisitions in 2006. Consequently, amortization expenses decreased by 14% in 2006 as certain intangible assets were fully amortized.

From 2004 through 2005, amortization expense increased by 92% reflecting our acquisition in the UK in 2005 and corresponding increase to our intangible assets.

Interest expense

Interest expense increased for the nine months ended September 30, 2007 by 242% from the nine months ended September 30, 2006. This increase was due to the additional $16 million of senior subordinated debt that was used to finance the acquisitions made in 2007.

From 2005 to 2006, interest expense decreased 7%. This decrease was due to lower principal amounts outstanding under our loans.

From 2004 to 2005, interest expense increased 158% as a result of a $6 million senior subordinated loan that was used to finance the acquisition of our UK operations in 2004. Interest expense in 2005 represents a full year of expense.

Other income and expense

Other income and expense consists of the impact of foreign currency exchange gains/losses, the net impact of changes in fair value of the preferred stock warrant liability, interest income and the receipts for services that are not considered to be our core business, such as speaking engagements and referral fees.

 

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Other income and expense decreased approximately $2.3 million in the nine months ended September 30, 2007 from the same period in 2006. The decrease is predominantly due to the expense related to the changes in fair value of the preferred stock warrant liability.

Other income and expense increased approximately $2.6 million in 2006 from approximately $1.6 million in net expense in 2005. The majority of this decrease was attributable to foreign currency exchange losses and due to the income related to the changes in fair value of the preferred stock warrant liability.

Other income and expense decreased $1.6 million in 2005 from approximately $79,000 in 2004. The majority of this decrease was attributable to foreign exchange gains/losses.

Provision for income taxes

We have incurred losses since inception and therefore do not pay significant income taxes, except in certain foreign jurisdictions where we are profitable. We have net operating loss carryforwards that may be available to offset future taxable income and expire at various dates through 2026. We have applied a full valuation allowance against the benefits of a deferred tax asset and have not recorded a provision for income taxes from 2004 through 2006. The provision for income taxes in 2007 represents income tax due on taxable income for the Israeli Group.

Cumulative effect of change in accounting principle

As of January 1, 2006, we adopted FASB Staff Position No. 150-5 (FSP 150-5), Issuer’s Accounting, and FASB Statement No. 150 for Freestanding Warrants and Other Similar Instruments on Shares that are Redeemable.

Under FSP 150-5, freestanding warrants to purchase our redeemable convertible preferred stock are liabilities that must be recorded at fair value. We recorded income of $558,000 for the cumulative effect of the change in accounting principle to reflect the change in the estimated fair value of the warrants between their issuance date and January 1, 2006, the date we adopted the new accounting standard. We recorded a loss of $2,702,000 related to the change in fair value for the nine months ended September 30, 2007 and recorded additional income of $455,000 related to the change in fair value for 2006.

 

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Quarterly Results of Operation

 

    (unaudited)        
    Quarter Ended in 2006     Quarter Ended in 2007  
    March 31     June 30     September 30     December 31     March 31     June 30     September 30  
    (in thousands, except per share data)  

Consolidated Statements of Operations Data:

 

           

Revenues:

             

Service

  $ 8,521     $ 8,625     $ 8,696     $ 9,342     $ 10,351     $ 13,527     $ 16,392  

Product

    1,982       557       85       —         —         111       265  
                                                       

Total revenues

    10,503       9,182       8,781       9,342       10,351       13,638       16,657  

Cost of revenues:

             

Service

    6,621       6,977       6,701       7,082       7,814       10,295       11,575  

Product

    1,428       390       80       —         11       169       93  
                                                       

Total cost of revenues

    8,049       7,367       6,781       7,082       7,825       10,464       11,668  

Gross profit.

    2,454       1,815       2,000       2,260       2,526       3,174       4,989  

Research and development expenses

    —         —         —         —         5       67       24  

Selling and marketing expenses

    2,828       2,547       2,500       3,031       2,966       3,478       4,419  

General and administrative expenses

    1,698       1,599       1,977       1,784       1,425       2,118       2,160  

Amortization of intangible assets

    292       266       304       303       279       611       665  
                                                       

Loss from operations

    (2,364 )     (2,597 )     (2,781 )     (2,858 )     (2,149 )     (3,100 )     (2,279 )

Interest and other income (expense), net.

    126       (259 )     177       349       (1,086 )     (1,767 )     (439 )
                                                       

Loss before income taxes and cumulative effect of change in accounting principle

    (2,238 )     (2,856 )     (2,604 )     (2,509 )     (3,235 )     (4,867 )     (2,718 )

Provision for (benefit from) income taxes

    —         —         —         —         —         —         78  
                                                       

Loss before cumulative effect of change in accounting principle

    (2,238 )     (2,856 )     (2,604 )     (2,509 )     (3,235 )     (4,867 )     (2,796 )

Cumulative effect of change in accounting principle

    558       —         —         —         —         —         —    
                                                       

Net loss

    (1,680 )     (2,856 )     (2,604 )     (2,509 )     (3,235 )     (4,867 )     (2,796 )

Dividends and accreditation on preferred stock

    (845 )     (859 )     (862 )     (916 )     (922 )     (1,056 )     (1,142 )
                                                       

Net loss to common shareholders

  $ (2,525 )   $ (3,715 )   $ (3,466 )   $ (3,425 )   $ (4,157 )   $ (5,923 )   $ (3,938 )
                                                       

Net loss per share to common stockholders

  $ (0.46 )   $ (0.63 )   $ (0.57 )   $ (0.54 )   $ (0.62 )   $ (0.65 )   $ (0.33 )
                                                       

Number of shares used in per share calculation

    5,533       5,876       6,093       6,311       6,679       9,068       11,770  
                                                       

Other financial data:

             

EBITDA(1)

  $ (1,680 )   $ (2,320 )   $ (2,075 )   $ (2,051 )   $ (1,472 )   $ (2,051 )   $ (1,105 )
                                                       
    Quarter Ended in 2006     Quarter Ended in 2007  
    March 31     June 30     September 30     December 31     March 31     June 30     September 30  
    (unaudited)  

Consolidated Statements of Operations Data:

 

           

Revenues

    100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %

Cost of revenues

    76.6       80.2       77.2       75.8       75.6       76.7       70.1  
                                                       

Gross profit.

    23.4       19.8       22.8       24.2       24.4       23.3       29.9  

Research and development expenses

    —         —         —         —         0.00       0.00       0.00  

Selling and marketing expenses

    26.9       27.7       28.5       32.4       28.7       25.5       26.5  

General and administrative expenses

    16.2       17.4       22.5       19.1       13.8       15.5       13.0  

Amortization of intangible assets

    2.8       2.9       3.5       3.2       2.7       4.5       4.0  
                                                       

Loss from operations

    (22.5 )     (28.3 )     (31.7 )     (30.6 )     (20.8 )     (22.7 )     (13.7 )

Interest and other income (expense), net.

    1.2       (2.8 )     2.0       3.7       (10.5 )     (13.0 )     (7.2 )

Loss before income taxes and cumulative effect of change in accounting principle

    (21.3 )     (31.1 )     (29.7 )     (26.9 )     (31.3 )     (35.7 )     (20.9 )

Provision for income taxes

    —         —         —         —         —         —         0.5  

Loss before cumulative effect of change in accounting principle

    (21.3 )     (31.1 )     (29.7 )     (26.9 )     (31.3 )     (35.7 )     (16.8 )

Cumulative effect of change in accounting principle

    5.3       —         —         —         —         —         —    
                                                       

Net loss

    (16.0 )%     (31.1 )%     (29.7 )%     (26.9 )%     (31.3 )%     (35.7 )%     (16.8 )%
                                                       

 

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(1) EBITDA represents net loss before deductions for interest, income taxes, the impact of warrant valuation and depreciation and amortization. EBITDA is a supplemental non-GAAP financial measure used by management and industry analysts to evaluate operations.

 

     The following is a reconciliation of net loss to EBITDA:

 

    Quarter Ended in 2006     Quarter Ended in 2007  
    March 31     June 30     September 30     December 31     March 31     June 30     September 30  
    (unaudited)  
    (in thousands)  

EBITDA Calculation:

             

Net loss

  $ (1,680 )   $ (2,856 )   $ (2,604 )   $ (2,509 )   $ (3,235 )   $ (4,867 )   $ (2,796 )

Provision for (benefit from) income taxes

    —         —         —         —         —         —         78  

Depreciation

    206       188       169       165       155       119       182  

Amortization of intangible assets

    292       266       304       303       279       623       672  

Non-cash impact of warrant valuation

    (636 )     (48 )     (103 )     (226 )     1,059       1,476       167  

Interest expense

    138       130       159       216       270       598       592  
                                                       

EBITDA

  $ (1,680 )   $ (2,320 )   $ (2,075 )   $ (2,051 )   $ (1,472 )   $ (2,051 )   $ (1,105 )
                                                       

We believe that EBITDA is useful to management and investors as a measure of comparative operating performance, as it is less susceptible to variances in actual performance resulting from depreciation, amortization and other non-cash charges and more reflective of changes in pricing decisions, cost controls and other factors that affect operating performance. Management also uses EBITDA to develop incentive compensation plans and to measure operating performance. We are presenting EBITDA because we believe it is useful to investors as a way to measure our ability to incur and service debt, make capital expenditures and meet working capital requirements. EBITDA is not intended as an alternative to GAAP net loss as an indicator of our operating performance, or as an alternative to any other measure of performance in conformity with GAAP or as an alternative to cash flow from operating activities.

 

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Liquidity and Capital Resources

Overview

Since our inception in 2001, we have primarily funded our operations through the issuance of an aggregate of $64.8 million in preferred stock and $25.6 million in borrowings under our loan and security agreements described below. We used these proceeds to fund our operations, invest in property and equipment and acquire other companies.

Cash Flows

The following table summarizes our cash flows for the years ended December 31, 2004, 2005 and 2006 and the nine months ended September 30, 2006 and 2007:

 

    

Year Ended

December 31,

   

Nine Months Ended

September 30,

(unaudited)

 
     2004     2005     2006     2006     2007  
     (dollars in thousands)  

Operating activities

   $ (10,317 )   $ (18,016 )   $ (11,072 )   $ (7,657 )   $ (9,066 )

Investing activities

     (3,045 )     (1,522 )     (258 )     4       (14,675 )

Financing activities

     26,206       2,900       10,100       5,784       31,687  

Cash Flows (Used in) Provided by Operating Activities

Cash used in operating activities primarily consist of net losses adjusted for certain non-cash items including depreciation and amortization, non-cash interest expense, stock-based compensation expenses, the non-cash change in warrant liabilities and the effect of changes in working capital and other activities.

Cash used in operating activities for 2006 was $11.1 million and consisted of a $9.6 million net loss and $2.5 million of cash used for working capital purposes and other activities. This was offset by $1.1 million of non-cash items, consisting primarily of depreciation and amortization, non-cash change in the warrant liability, non-cash stock based compensation expense and non-cash interest expense. Cash used for working capital purposes and other activities, consisted primarily of an increase in accounts receivable of $1.6 million, a decrease in accounts payable of $1.3 million and an aggregate increase in unbilled revenue, accrued expenses and other assets of $0.4 million offset by increases in deferred revenue $0.5 million and a decrease in prepaid expenses and other current assets of $0.3 million.

Cash used in operating activities for 2005 was $18.0 million and consisted of a $21.5 million net loss and working capital uses of $1.0 million. This was offset by $2.5 million of non-cash items. Non-cash items consisted primarily of $2.3 million of depreciation and amortization, and non-cash interest expense of $0.2 million. Cash used for working capital purposes and other activities, consisted primarily of a decrease in accounts payable of $1.7 million, an increase in unbilled revenue of $0.9 million and a decrease in prepaid expenses and other assets of $0.5 million offset by a decrease in accounts receivable of $1.9 million and increases in deferred revenue and accrued expenses of $0.7 million and $0.6 million, respectively.

During 2004, cash used in operating activities was $10.3 million and consisted of a $9.8 million net loss and $1.9 million of cash used for working capital purposes and other activities. This was offset by $1.4 million of non-cash items, consisting primarily of depreciation and amortization. Cash used for working capital purposes and other activities consisted primarily of increases in accounts receivable,

 

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unbilled revenue and prepaid expenses and other current assets of $0.9 million, $0.5 million and $0.1 million, respectively, and decreases in both accounts payable and deferred revenue of $0.2 million and $0.2 million respectively.

Cash used in operating activities for the nine months ended September 30, 2007 was $9.1 million and consisted of a $10.9 million net loss offset by $5.3 million of non-cash items including the change in the fair market value of the warrant liability of $2.7 million, amortization of intangibles assets of $1.6 million, non-cash stock based compensation expense of $0.1 million, non-cash interest of $0.4 million and $0.5 million of deprecation. Cash used for working capital purposes totaled $3.5 million and consisted primarily of a decrease in accounts payable of $4.3 million, and increases in accounts receivable, prepaid expenses and other current assets and other assets of $1.7 million, $3.0 million and $1.9 million respectively, while the unbilled revenue increase represented a $0.8 million use of cash. Working capital uses were offset by increases in deferred revenue of $5.9 million, other liabilities of $0.1 million and an increase in accrued expenses of $2.0 million contributed to the offset of the use of cash.

During the nine months ended September 30, 2006 cash used in operating activities was $7.7 million and consisted of a $7.2 million net loss offset by $0.8 million of non-cash items and working capital uses of $1.2 million. Cash used for working capital purposes and other activities, consisted primarily of an increase in unbilled revenue of $0.7 million, a decrease in accrued expenses and accounts payable of $0.9 million, offset by a increase in deferred revenue of $0.4 million and a decrease of $0.09 million prepaid expenses provided cash.

Investing Activities

Cash used in investing activities was $3.0 million, $1.5 million and $0.3 million for 2004, 2005 and 2006, respectively. For the nine months ended September 30, 2006, cash of $0.004 million was provided by investing activities while $14.7 million was used in investing activities during the nine months ended September 30, 2007. Our principal cash investments have related to acquisitions and the purchase of property and equipment.

During 2006, cash used in investing activities primarily consisted of $0.3 million of purchases of property and equipment to support our on-site consultants and infrastructure requirements offset by $0.1 million of decreases in restricted cash required to support our outstanding obligations under our loan and security agreements.

Cash used in investing activities during 2005 was $1.5 million which consisted of $1.0 million related primarily to the acquisition of PowerPM, $0.8 million for the purchase of property and equipment which were offset by a reduction of $0.2 million in restricted cash related to outstanding obligations under our loan and security agreements.

We used $3.0 million in cash related to investing activities during 2004. The acquisition of Source Enterprise Consulting Limited, Sagitta Performance Systems Limited and The Storage Group during 2004 used $1.1 million in cash. We invested in property and equipment of $1.5 million and were required to increase our restricted cash by $0.4 million to support our outstanding obligations under our loan and security agreements.

During the nine months ended September 30, 2007, cash used in investing activities consisted primarily of $14.5 million in cash used for the acquisitions of the Israeli Group and RapidApp, $0.3 million was used for the purchases of property and equipment to support our on-site consultants and infrastructure requirements offset by $0.1 million of decreases in restricted cash required to support our outstanding obligations under our loan and security agreements.

 

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Financing Activities

Cash flows provided by financing activities were $26.2 million, $2.9 million and $10.1 million for 2004, 2005 and 2006, respectively. For the nine months ended September 30, 2006 and 2007, cash flows provided by financing activities were $5.8 million and $31.7 million, respectively.

Equity Financing Activities

In December 2004, we raised net proceeds of $19.9 million through the sale of our Series D preferred stock. During 2005 we raised net proceeds of $3.9 million through the sale of additional Series D preferred stock. We raised net proceeds of $9.0 million through the sale of additional Series D preferred stock during 2006.

In April 2007 we raised net proceeds of $5.0 million through the sale of additional Series D preferred stock and in May and August of 2007 we raised approximately $11.4 million of net proceeds through the sale of Series E preferred stock.

Credit Facility Borrowings

In June 2004, we entered into a loan and security agreement (the 2004 Loan Agreement) with Lighthouse Capital Partners. The 2004 Loan Agreement allowed for borrowings of $6.0 million before June 2005. The 2004 Loan Agreement is secured by substantially all of our assets. Borrowings under the 2004 Loan Agreement bear interest at a fixed rate of 7.00% per annum and required interest only payments until June 30, 2005, followed by 36 consecutive monthly payments of principal and interest, payable monthly in advance. The interest rate during the repayment period is equal to the prime rate at the beginning of the repayment plus 1.75%. In addition, there will be a final non-principal balloon payment of $450,000, due at loan maturity.

In July 2006, we amended the 2004 Loan Agreement (Amendment #2) to allow for an additional $3.0 million in borrowings before December 31, 2006. Borrowings under Amendment #2 bear interest at a fixed rate of 7.00% per annum and required interest only payments until October 31, 2007, followed by 36 consecutive monthly payments of principal and interest, payable monthly in advance. The interest rate during the repayment period is equal to the prime rate at the beginning of the repayment period plus 1.75%. In addition, there will be a final non-principal balloon payment of $232,500, due at loan maturity.

In March 2007, in conjunction with the Israeli acquisition, we amended the 2004 Loan Agreement (Amendment #3) to allow for an additional $10.0 million in borrowings. Borrowings under Amendment #3 bear interest at a fixed rate of 10.00% per annum and required interest only payments until August 31, 2007, followed by 36 consecutive monthly payments of principal and interest, payable monthly in advance. The interest rate during the repayment period is equal to the prime rate at the beginning of the repayment period plus 1.75%. In addition, there will be a final non-principal balloon payment of $625,000, due at loan maturity.

In August 2007, we entered a new loan agreement with BayStar Capital III Investment Fund, L.P, Velocity Financial Group, Inc. and Leader Lending, LLC. The loan agreement allows for a total borrowing of $14.0 million in three separate borrowings. The first borrowing of $6.0 million was made in August 2007. The second borrowing of $4.0 million can be made between October 1, 2007 and December 31, 2007. The third and final borrowing of $4.0 million can be made between January 1, 2008 and March 31, 2008. The borrowings can be used for acquisitions and general working capital. Borrowings under the agreement bear interest at 9.75% per annum and require interest only payments for the lesser of a period of one year or until the next equity financing event, at which time 36 monthly payments of principal and interest are required. The notes issued pursuant to the loan agreement are convertible at the option of the lender upon the consummation of our next equity financing. There are no specific financial covenants related to the loan agreement.

 

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The 2004 Loan Agreement does not require us to meet financial ratios but does impose on us certain affirmative covenants (good standing and maintenance of collateral) and certain negative covenants (payment of dividends, restructuring and prohibited transactions).

In connection with entering into the 2004 Loan Agreement, we issued warrants to purchase 352,940 shares of our Series C preferred stock at $0.85 per share, subject to certain antidilution adjustments. The purchase rights represented by the warrants are exercisable immediately and have a term of seven years. The warrants have been valued at $208,528 using an option valuation model, assuming a weighted-average risk free rate of return of 3.9%, an expected life of seven years, 75% volatility and no dividends. We recorded the fair value of the warrants as an original issue discount on the debt. The value of the warrants is being amortized as interest expense through the maturity date of June 2008.

In connection with entering into Amendment #2, we issued warrants to purchase 61,683 shares of our Series D preferred stock at $2.4318 per share, subject to certain antidilution adjustments. The purchase rights represented by the warrants are exercisable immediately and have a term of seven years. The warrants have been valued at $104,264 using an option valuation model, assuming a weighted-average risk free rate of return of 3.826%, an expected life of seven years, 75% volatility and no dividends. We recorded the fair value of the warrants as an original issue discount on the debt. The value of the warrants is being amortized as interest expense through the maturity date of July 2013.

In connection with entering into Amendment #3, we issued additional warrants to purchase 261,124 shares of Series D preferred stock at an exercise price of $2.4318 per share. The warrants expire at the earlier of March 21, 2014, or two years after the effective date of an initial public offering or a merger as defined in the 2004 Loan Agreement. The purchase rights represented by the warrants are exercisable immediately and have a term of seven years. The warrants have been valued at $499,680 using an option valuation model, assuming a weighted-average risk free rate of return of 4.9%, an expected life of seven years, 50% volatility and no dividends. We recorded the fair value of the warrants as an original issue discount on the debt. The value of the warrants is being amortized as interest expense through the maturity date of August 2010.

In connection with the new loan agreement in August 2007, we issued warrants to purchase common stock to the lenders. The number of shares available to purchase under the warrants will be determined by dividing 450,000 by the exercise price, which will be equal to 80% of the per share price of the next equity financing event as defined in the loan agreement. In the event an equity financing event does not take place within 15 months of the agreement, the exercise price will be $2.5594 per share and 527,466 shares of common stock will be issuable under the warrants. The warrants expire six years from the date of issuance. The warrants have been valued at $482,048 using an option valuation model, assuming a weighted-average risk free rate of return of 4.25% an expected life of six years, 45% volatility and no dividends. We recorded the fair value of the warrants as an original issue discount on the debt. The value of the warrants is being amortized as interest expense through the maturity date of July 2011.

During the years 2004, 2005 and 2006 we made principal repayments of $100,000, $1.1 million and $2.1 million, respectively. For the nine months ended September 30, 2006 and 2007 we made principal repayments of $0 and $2.0 million, respectively.

Capital Lease

During 2005 we financed certain computer equipment under capital lease agreements in the amount of approximately $212,000. The agreements bear interest at 11.3% and 12.2% per annum with payments due quarterly in advance through August 2008 including termination payments.

 

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Contractual Obligations

Our principal commitments consist of obligations under leases for office space, computer equipment and furniture and fixtures. The following table summarizes our long-term contractual obligations as of September 30, 2007 (in thousands):

 

     Payments Due by Period   

4-5 years

  

More than

5 years

     Total   

1 year

   2-3 years      

Debt principal repayments

   $ 20,318    $ 7,789    $ 11,232    $ 1,297    $—    

Capital lease obligations

     33      33      —        —        —  

Operating lease obligations

     5,276      2,516      2,590      170      —  
                                  

Total

   $ 25,627    $ 10,338    $ 13,822    $ 1,467    $ —