10-Q/A 1 s2000q3.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q/A (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the period ended September 30, 2000 ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-13865 RARE MEDIUM GROUP, INC. ---------- (Exact name of registrant as specified in its charter) Delaware 23-2368845 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 565 Fifth Avenue, 29th Floor New York, New York 10017 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (212) 883-6940 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No __________ --------- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Number of shares outstanding of the issuer's common stock, as of June 22, 2001 Common Stock, par value $.01 per share 63,668,987 -------------------------------------- ----------- Class Number of shares outstanding INDEX EXPLANATORY PARAGRAPH Part I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements Consolidated Balance Sheets as of September 30, 2000 (Unaudited) and December 31, 1999 Unaudited Consolidated Statements of Operations Three and nine months ended September 30, 2000 and 1999 Unaudited Consolidated Statements of Cash Flows Nine months ended September 30, 2000 and 1999 Notes to Unaudited Consolidated Financial Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk Part II. OTHER INFORMATION Item 1. Legal Proceedings Item 2. Changes in Securities and Use of Proceeds Item 3. Defaults Upon Senior Securities Item 4. Submission of Matters to a Vote of Security Holders Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K SIGNATURES EXPLANATORY PARAGRAPH On June 26, 2001, Rare Medium Group, Inc. announced that it would restate its financial results for the fiscal year ended December 31, 2000 and for the fiscal quarters ended March 31, 2001 and September 30, 2000 to reflect the recognition of approximately $3.7 million of revenue in the first quarter of 2001 which was originally recognized in 2000, of which approximately $0.5 million was recognized in the third quarter. Rare Medium performed services for a client in the year ended December 31, 2000, during which time a definitive professional services agreement was being negotiated. The definitive professional services agreement, which was signed during the first week of January 2001, established fees for past and future services, including fees of $3.7 million which were recognized as revenue during the year ended December 31, 2000. The professional services agreement also provided that the fees would be contingent upon the closing of a financing by the client, which would include an investment by Rare Medium. A stock purchase agreement, dated as of December 29, 2000, to make the investment was entered into by several investors, including Rare Medium, but the investment transaction did not close until the first week of January 2001, following which time Rare Medium was paid for substantially all of the services relating to the $3.7 million in fees. After re-examining this transaction, Rare Medium has concluded that the revenue in question should have been recognized in the first quarter of 2001. This amended Form 10-Q/A includes the restated financial statements and does not update information contained in Rare Medium's previously filed Form 10-Q unless otherwise indicated.
RARE MEDIUM GROUP, INC. CONSOLIDATED BALANCE SHEETS (In thousands except share data) September 30, December 31, 2000 1999 ---------------- -------------- (Unaudited and Restated - See Note 3) ASSETS Current assets: Cash and cash equivalents $ 173,029 $ 28,540 Accounts receivable, net 23,301 12,601 Work in process 5,623 3,171 Notes receivable - 1,100 Prepaid expenses and other current assets 6,862 2,508 ---------------- -------------- Total current assets 208,815 47,920 Property, plant and equipment, net 26,279 12,100 Investments in affiliates 56,307 26,467 Goodwill and intangibles, net 60,182 72,552 Other assets 4,020 1,384 ---------------- -------------- Total assets $ 355,603 $ 160,423 ================ ============== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 4,218 $ 7,097 Accrued liabilities 13,988 5,759 Deferred revenue 5,282 3,044 Current portion of note payable - related parties - 997 Current portion of notes payable 168 579 ---------------- -------------- Total current liabilities 23,656 17,476 Notes payable 155 - Note payable - related parties - 997 Other noncurrent liabilities 4,321 735 ---------------- -------------- Total liabilities 28,132 19,208 ---------------- -------------- Series A Convertible Preferred Stock, $.01 par value, net of unamortized discount of $51,262 44,723 36,224 ---------------- -------------- Stockholders' equity: Preferred stock, $.01 par value, authorized 10,000,000 shares, issued 959,849 shares as Series A Convertible Preferred Stock at September 30, 2000 and 907,820 shares at December 31, 1999 - - Common stock, $.01 par value, authorized 200,000,000 shares, issued and outstanding 63,648,965 shares at September 30, 2000 and 42,893,357 shares at December 31, 1999 636 429 Additional paid-in capital 529,260 252,075 Accumulated other comprehensive income 2,953 937 Note receivable from shareholder - (231) Accumulated deficit (249,930) (148,048) Treasury stock, at cost, 66,227 shares (171) (171) ---------------- -------------- Total stockholders' equity 282,748 104,991 ---------------- -------------- Total liabilities and stockholders' equity $ 355,603 $ 160,423 ================ ============== See accompanying notes to unaudited consolidated financial statements.
RARE MEDIUM GROUP, INC. UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands except share data) Three Months Ended September 30, Nine Months Ended September 30, 2000 1999 2000 1999 ---- ---- ---- ---- (Restated - (Restated - See Note 3) See Note 3) Revenues $ 28,876 $ 11,337 $ 80,399 $ 19,081 Cost of revenues 17,799 5,983 47,524 10,371 ----------- ----------- ----------- ----------- Gross profit 11,077 5,354 32,875 8,710 Expenses: Sales and marketing expense 6,387 1,293 15,560 2,404 General and administrative expense 25,368 8,861 66,619 17,132 Depreciation and amortization 13,455 6,807 35,469 16,971 ----------- ----------- ----------- ----------- Total expenses 45,210 16,961 117,648 36,507 ----------- ----------- ----------- ----------- Loss from operations (34,133) (11,607) (84,773) (27,797) Interest income (expense), net 3,015 762 7,587 (1,441) Equity interest in net loss of investments (1,861) - (4,424) - Other expense (192) - (454) - ----------- ----------- ----------- ----------- Net loss (33,171) (10,845) (82,064) (29,238) Deemed dividend attributable to issuance of convertible preferred stock - - - (29,879) Cumulative dividends and accretion of convertible preferred stock to liquidation value (2,975) (3,471) (19,818) (4,663) ----------- ----------- ----------- ----------- Net loss attributable to common stockholders $ (36,146) $ (14,316) $ (101,882) $ (63,780) =========== =========== =========== =========== Basic and diluted loss per share $ (0.65) $ (0.37) $ (2.03) $ (1.81) ============ =========== ============ ============ Basic weighted average common shares outstanding 55,419,834 38,723,657 50,108,149 35,320,850 =========== =========== =========== =========== See accompanying notes to unaudited consolidated financial statements.
RARE MEDIUM GROUP, INC. UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Nine months ended September 30, 2000 1999 ---- ---- (Restated - See Note 3) Cash flows from operating activities: Net loss $ (82,064) $ (29,238) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 35,469 16,971 Equity interest in net loss of investments 4,424 - Non-cash interest - 2,359 Changes in assets and liabilities, net of acquisitions: Accounts receivable (15,536) (3,948) Work in process (2,452) (2,873) Prepaid expenses and other assets (5,652) (1,774) Deferred revenue 2,238 297 Accounts payable and accrued and other liabilities 6,771 2,315 ------------- ------------ Net cash used in operating activities (56,802) (15,891) ------------- ------------ Cash flows from investing activities: Cash paid for investments in affiliates (26,592) (14,551) Purchases of property, plant and equipment, net (19,154) (4,305) Decrease in notes receivable 1,000 - Cash acquired (paid) in acquisitions, net of acquisition costs 46 (1,258) ------------- ------------ Net cash used in investing activities (44,700) (20,114) ------------- ------------ Cash flows from financing activities: Proceeds from issuance of convertible debenture - 6,000 Proceeds from issuance of convertible preferred stock, net of costs - 82,998 Proceeds from issuance of common stock, net of costs 241,355 - Repayments of borrowings, net (832) (1,625) Proceeds from issuance of stock in connection with exercise of warrants and options 5,468 7,088 ------------- ------------ Net cash provided by financing activities 245,991 94,461 ------------- ------------ Net increase in cash and cash equivalents 144,489 58,456 Cash and cash equivalents, beginning of period 28,540 918 ------------- ------------ Cash and cash equivalents, end of period $ 173,029 $ 59,374 ============= ============ See accompanying notes to unaudited consolidated financial statements.
RARE MEDIUM GROUP, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (1) Description of the business Rare Medium Group, Inc. (the "Company") conducts its operations primarily through its subsidiaries, which are organized as two related lines of business: the Internet services business and the investment business. The Company is headquartered in New York with offices throughout the United States and in the United Kingdom, Australia, Singapore and Canada. The Company's Internet services business is a provider of Internet solutions, offering Fortune 1000 companies and others its services to develop e-commerce Internet strategies, improve business processes and develop marketing communications, branding strategies and interactive content using Internet-based technologies and solutions. Through its incubator investment strategy, the Company invests in and develops, manages and operates companies in selected Internet-focused markets. The Company also makes venture investments by making strategic equity investments in companies with Internet-focused business models. (2) Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared by the Company in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the accompanying consolidated financial statements contain all adjustments, consisting only of those of a normal recurring nature, necessary for a fair presentation of the Company's financial position, results of operations and cash flows at the dates and for the periods indicated. While the Company believes that the disclosures presented are adequate to make the information not misleading, these consolidated financial statements should be read in conjunction with the audited financial statements and related notes for the year ended December 31, 1999 which are contained in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission (the "SEC"). The results for the three and nine month periods ended September 30, 2000 are not necessarily indicative of the results to be expected for the full year. Certain prior year amounts in the consolidated financial statements have been reclassified to conform with the current year's presentation. (3) Restatement On June 26, 2001, the Company announced that it would restate its financial results for the fiscal year ended December 31, 2000 and for the fiscal quarters ended March 31, 2001 and September 30, 2000 to reflect the recognition of approximately $3.7 million of revenue in the first quarter of 2001 which was originally recognized in 2000, of which approximately $0.5 million was recognized in the third quarter. The Company performed services for a client in the year ended December 31, 2000, during which time a definitive professional services agreement was being negotiated. The definitive professional services agreement, which was signed during the first week of January 2001, established fees for past and future services, including fees of $3.7 million which were recognized as revenue during the year ended December 31, 2000. The professional services agreement also provided that the fees would be contingent upon the closing of a financing by the client, which would include an investment by the Company. A stock purchase agreement, dated as of December 29, 2000, to make the investment was entered into by several investors, including the Company, but the investment transaction did not close until the first week of January 2001, following which time the Company was paid for substantially all of the services relating to the $3.7 million in fees. After re-examining this transaction, the Company has concluded that the revenue in question should have been recognized in the first quarter of 2001. As a result of the restatement, net accounts receivable as of September 30, 2000 decreased approximately $1.0 million and work in process as of September 30, 2000 increased $0.5 million. The effect on the results of operations is as follows (in thousands, except per share data):
Three Months Ended September 30, 2000 Nine Months Ended September 30, 2000 ------------------------------------- -------------------------------------- As Reported As Restated As Reported As Restated ----------------- ---------------- ---------------- --------------- (Unaudited) (Unaudited) Revenues $29,420 $28,876 $80,943 $80,399 Loss from operations (33,589) (34,133) (84,229) (84,773) Net loss (32,627) (33,171) (81,520) (82,064) Basic and diluted loss per share (0.64) (0.65) (2.02) (2.03)
RARE MEDIUM GROUP, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (4) Investments in Affiliates The following is a summary of the carrying values of the investments held by the Company (in thousands): September 30, 2000 December 31, 1999 ---------------------- ---------------------- Cost investments $ 44,611 $ 20,876 Marketable securities 11,130 2,060 Equity investments 566 3,531 ---------------------- ---------------------- $ 56,307 $ 26,467 ====================== ======================
Net unrealized appreciation for marketable securities amounted to $3.0 million and $0.9 million at September 30, 2000 and December 31, 1999, respectively. (5) Segment Information The Company's operations have been classified into two primary operating segments: the Internet services business and the investment business. Presented below is summarized unaudited financial information for each segment (in thousands):
Three month period ended Nine month period ended September 30, September 30, September 30, September 30, 2000 1999 2000 1999 ---------------- ---------------- ---------------- ---------------- (Restated) (Restated) Revenues: Internet services $ 33,215 $ 11,846 $ 86,730 $ 19,850 Investment 2,410 230 5,726 442 Internet services provided to investments (6,749) (739) (12,057) (1,211) ---------------- ---------------- ---------------- ---------------- $ 28,876 $ 11,337 $ 80,399 $ 19,081 ================ ================ ================ ================ Loss before interest, taxes, depreciation and amortization: Internet services (318) (988) (6,077) (2,703) Investment and corporate (20,360) (3,812) (43,227) (8,123) ---------------- ---------------- ---------------- ---------------- $ (20,678) $ (4,800) $ (49,304) $ (10,826) ================ ================ ================ ================ Depreciation and amortization (13,455) (6,807) (35,469) (16,971) Interest income (expense), net 3,015 762 7,587 (1,441) Equity interest in net loss on investments (1,861) - (4,424) - Other expense (192) - (454) - ---------------- ---------------- ---------------- ---------------- Net loss $ (33,171) $ (10,845) $ (82,064) $ (29,238) ================ ================ ================ ================ Total assets: As of As of December September 30, 2000 31, 1999 ------------------ -------------- Internet services $ 59,529 $ 31,047 Investment and corporate 296,074 129,376 ---------------- ---------------- $ 355,603 $ 160,423 ================ ================
RARE MEDIUM GROUP, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (6) Equity Transactions On January 14, 2000, the Company sold 2,500,000 shares of its common stock for gross proceeds of $70.1 million (net proceeds of $65.7 million) in a private transaction to a group of mutual funds managed by Putnam Investments and Franklin Resources, Inc. On April 18, 2000, the Company filed a registration statement with the SEC to register the resale of such shares as required by the purchase agreement executed in connection with such private transaction. On March 29, 2000, the Company sold 3,000,000 shares of common stock for gross proceeds of $186 million (net proceeds of $175.6 million) in a public offering underwritten by Credit Suisse First Boston Corporation, Deutsche Bank Securities Inc. and FleetBoston Robertson Stephens Inc. In August 2000, the holders of the Company's Series 1-A warrants executed a cashless exercise of all such warrants at a price of $0.01 per share and received a total of 12,709,499 shares of common stock. (7) Employee Stock Options In August 2000, the Board of Directors approved a plan that allowed employee holders of stock options with exercise prices at or above $30 per share to exchange either all or 50% of their existing stock options for an agreement by the Company to issue new options. The exercise price of the new options will be based on the fair market value of the underlying common stock on March 12, 2001, the date of issuance of the new options. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act") that involve risks and uncertainties, including statements regarding our capital needs, business strategy, expectations and intentions. We urge you to consider that statements which use the terms "believe," "do not believe," anticipate," "expect," "plan," "estimate," "intend," and similar expressions are intended to identify forward-looking statements. These statements reflect our current views with respect to future events and because our business is subject to numerous risks, uncertainties and risk factors, our actual results could differ materially from those anticipated in the forward-looking statements, including those set forth below under this "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this report. Actual results will most likely differ from those reflected in these statements, and the differences could be substantial. We disclaim any obligation to publicly update these statements, or disclose any difference between our actual results and those reflected in these statements. The information constitutes forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The following discussion has been amended to reflect the impact of the restatement of our financial statements for the three months ended September 30, 2000 as discussed in Note 3 to the unaudited consolidated financial statements included elsewhere herein. OVERVIEW We are an Internet-focused company that: o provides Internet professional services to companies; o invests in and develops, manages and operates companies in selected Internet-focused market segments; and o takes strategic equity positions in companies that we believe possess superior Internet-focused business models. Our end-to-end Internet professional services offering encompasses the entire Internet services spectrum, ranging from strategic and creative consulting to applications development, implementation and hosting. Our strategic approach is to align these service offerings and expertise with our customers' industries. This vertical market approach allows us to provide more sophisticated strategic solutions. Our customers include AT&T, Dr. Drew, Epson, Forbes, Microsoft, Nestle, NextJet, Ritz Carlton, Weider, Paine Webber, Sun International, Furniture Brands, Wyndham Hotels, Corporate Express, Red Herring, Providence Health Systems, Cablevision and Body Shop. We also invest in and internally develop, manage and operate companies in selected Internet-focused market segments. In addition, we make minority investments in independently managed companies, in which we co-invest with well-known financial and industry partners such as Brentwood Associates, Compaq Computer Corp., Constellation Ventures, GE Capital Corp., Hicks, Muse, Tate & Furst, Institutional Venture Partners, Intel, Mayfield Partners, MCI Worldcom, New Enterprise Associates and Omnicom. Our investment business is currently focused on Internet companies engaged in the business-to-business e-commerce, Internet enabling tools, broadband and next generation communications sectors. The carrying value of our investment in these businesses at September 30, 2000 amounted to $70.2 million of which $56.3 million is reflected in our balance sheet as "investments in affiliates" and of which $13.9 million is included in "goodwill and intangibles" for our incubators that are accounted as consolidated subsidiaries. Our operating results are primarily driven by our Internet services business. We evaluate the performance of this business as a separate segment. Revenue and loss before interest, taxes, depreciation and amortization are used to measure and evaluate our financial results and make relative comparisons to other entities that operate within the Internet services industry. Our Internet service business revenue, including revenue from services provided to our consolidated subsidiaries, increased to $33.2 million for the three month period ended September 30, 2000 from $30.0 million for the three month period ended June 30, 2000. This 11% increase in revenue from the second quarter of 2000 was achieved through organic growth. Loss before interest, taxes, depreciation and amortization decreased to $0.3 million for the three month period ended September 30, 2000 from $2.5 million for the three month period ended June 30, 2000. Many of our Internet service contracts are currently on a fixed price basis, rather than a time and materials basis. We recognize revenues from fixed price contracts based on our estimate of the percentage of each project completed in a reporting period. To the extent our estimates are inaccurate, the revenues and operating profits, if any, we report for periods during which we are working on a project may not accurately reflect the final results of the project and we would be required to make adjustments to such estimates in a subsequent period. Our Internet services clients generally retain us on a project by project basis, rather than entering into long-term contracts. As a result, a client may or may not engage us for further services once a project is completed. Establishment and development of relationships with additional companies and other corporate users of information technology and securing repeat engagements with existing clients are important components of our success. Cost of revenues includes salaries, payroll taxes and related benefits and other direct costs associated with the generation of revenues. Sales and marketing expense represents the actual costs associated with our marketing and advertising. General and administrative expense includes facilities costs, recruiting, training, finance, legal, and other corporate costs as well as salaries and related employee benefits for those employees that support such functions. We have an equity participation plan that allows our Compensation Committee to incentivize our employees by allocating to them up to 20% of any profit we might recognize when and if our investments in portfolio and incubator companies become liquid, subject to vesting and other requirements. Upon a liquidation event, we will recognize a compensation charge for that portion of the profit on the investment that is allocated to the employees. We will have the right to pay such amount to the employees either in cash, shares of our common stock, or a combination thereof. Three Months Ended September 30, 2000 Compared to Three Months Ended September 30, 1999 REVENUES Revenues for the three months ended September 30, 2000 increased to $28.9 million from $11.3 million for the three months ended September 30, 1999, an increase of $17.6 million. This increase reflects increases in both the number and relative size of client engagements, which has been facilitated by increases in our billable employees substantially as a result of our aggressive hiring strategy and, to a lesser extent, acquisitions. All of the acquired Internet services businesses' operations have been integrated into our existing operations. Our incubator companies generated revenues totaling $2.4 million in the third quarter ended September 30, 2000, compared to $0.2 million in the third quarter ended September 30, 1999. COST OF REVENUES Cost of revenues for the three months ended September 30, 2000 increased to $17.8 million from $6.0 million for the three months ended September 30, 1999, an increase of $11.8 million. This increase is due primarily to a substantial increase in additional personnel in our Internet services business. We expect cost of revenues to increase on an absolute dollar basis as we hire additional personnel and incur additional costs related to the anticipated growth of our Internet services business. Costs of sales as a percentage of revenue related to our services business amounted to 50.5% for the three month period ended September 30, 2000. The increase in cost of revenues also reflects $1.4 million of costs related to our incubator businesses. SALES AND MARKETING EXPENSE Sales and marketing expense for the three months ended September 30, 2000 increased to $6.4 million from $1.3 million for the three months ended September 30, 1999, an increase of $5.1 million. This increase is primarily the result of the continued national marketing program to build the "Rare Medium" brand and the marketing with respect to our incubator companies. We expect sales and marketing expenses to increase as we continue to build brand awareness. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expense for the three months ended September 30, 2000 increased to $25.4 million from $8.9 million for the three months ended September 30, 1999, an increase of $16.5 million. This increase is a result of the cost of infrastructure needed to support the significant growth in revenue and our continued expansion into new markets. The increase in general and administrative expense also relates to the costs associated with required resources with respect to our venture/incubator strategy. DEPRECIATION AND AMORTIZATION EXPENSE Depreciation and amortization expense substantially consists of the amortization of intangible assets. Depreciation and amortization expense for the three months ended September 30, 2000 increased to $13.5 million from $6.8 million for the three months ended September 30, 1999, an increase of $6.7 million. This increase resulted primarily from our acquisitions during 1999. We anticipate that expenses related to the amortization of intangible assets will increase in future periods where we may make additional strategic acquisitions. INTEREST INCOME, NET Interest income, net for the three months ended September 30, 2000 is mainly comprised of the interest earned on the proceeds received from the sale of our common stock during the first quarter of 2000 as described below in "Liquidity and Capital Resources." NET LOSS For the three months ended September 30, 2000, we recorded a net loss of $33.2 million. Excluding $13.5 million in amortization and depreciation, the net loss was $19.7 million. This loss was primarily due to the factors described above in "Cost of Revenues," "General and Administrative Expense" and "Sales and Marketing Expense." Included in net loss attributable to common shareholders of $36.1 million was $3.0 million of non-cash deemed dividends and accretion related to the issuance of our Series A convertible preferred stock. Dividends were accrued related to the pay-in-kind dividends payable quarterly on Series A convertible preferred stock, and to the accretion of the carrying amount of the Series A convertible preferred stock up to its face redemption amount over 13 years. Nine Months Ended September 30, 2000 Compared to Nine Months Ended September 30, 1999 REVENUES Revenues for the nine months ended September 30, 2000 increased to $80.4 million from $19.1 million for the nine months ended September 30, 1999, an increase of $61.3 million. This increase reflects increases in both the number and relative size of client engagements which has been facilitated by the increase in our billable employees as a result of acquisitions and our aggressive hiring strategy. All of the acquired Internet services businesses' operations have been integrated into our existing operations. Our incubator companies generated revenues totaling $5.7 million in the nine months ended September 30, 2000, compared to $0.4 million in the nine months ended September 30, 1999. COST OF REVENUES Cost of revenues for the nine months ended September 30, 2000 increased to $47.5 million from $10.4 million for the nine months ended September 30, 1999, an increase of $37.1 million. This increase is due primarily to a substantial increase in additional personnel in our Internet services business. We expect cost of revenues to increase on an absolute dollar basis as we hire additional personnel and incur additional costs related to the anticipated growth of our Internet services business. Costs of sales as a percentage of revenue related to our services business amounted to 50.1% for the nine month period ended September 30, 2000. The increase in cost of revenues also reflects $4.5 million of costs related to our incubator businesses. SALES AND MARKETING EXPENSE Sales and marketing expense for the nine months ended September 30, 2000 increased to $15.6 million from $ 2.4 million for the nine months ended September 30, 1999, an increase of $13.2 million. This increase is primarily the result of our continued national marketing program to build the "Rare Medium" brand and the marketing with respect to our incubator companies. We expect sales and marketing expenses to increase as we continue to build our brand awareness. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expense for the nine months ended September 30, 2000 increased to $66.6 million from $17.1 million for the nine months ended September 30, 1999, an increase of $49.5 million. This increase is a result of the infrastructure needed to support our significant growth in revenue and our continued expansion into new markets. The increase in general and administrative expense also relates to the costs associated with required resources with respect to our venture/incubator strategy. DEPRECIATION AND AMORTIZATION EXPENSE Depreciation and amortization expense substantially consists of the amortization of intangible assets. Depreciation and amortization expense for the nine months ended September 30, 2000 increased to $35.5 million from $17.0 million for the nine months ended September 30, 1999, an increase of $18.5 million. This increase resulted primarily from our acquisitions during 1999. We anticipate that expenses related to the amortization of intangible assets will increase in future periods where we may make additional strategic acquisitions. INTEREST INCOME, NET Interest income, net for the nine months ended September 30, 2000 is mainly comprised of the interest earned on the proceeds received from the sale of our common stock during the period as described below in "Liquidity and Capital Resources." NET LOSS For the nine months ended September 30, 2000, we recorded a net loss of $82.1 million. Excluding $35.5 million in amortization and depreciation, our net loss was $46.6 million. This loss was primarily due to the factors described in "Cost of Revenues," "General and Administrative Expense" and "Sales and Marketing Expense." Included in net loss attributable to common shareholders of $101.9 million was $19.8 million of non-cash deemed dividends and accretion related to the issuance of our Series A convertible preferred stock. Dividends were accrued related to the pay-in-kind dividends payable quarterly on the Series A convertible preferred stock, and to the accretion of the carrying amount of the Series A convertible preferred stock up to its face redemption amount over 13 years. LIQUIDITY AND CAPITAL RESOURCES We had $173.0 million in cash and cash equivalents at September 30, 2000. This amount is substantially a result of the proceeds received from (1) the issuance of 2,500,000 shares of our common stock on January 14, 2000, for gross proceeds of $70.1 million (net proceeds of $65.7 million) in a private transaction to a group of mutual funds managed by Putnam Investments and Franklin Resources, Inc.; and (2) the issuance of 3,000,000 shares of our common stock on March 29, 2000 for gross proceeds of $186.0 million (net proceeds of $175.6 million) in an underwritten public offering. Cash used in operating activities was $56.8 million for the nine months ended September 30, 2000 and resulted primarily from the net loss of $82.1 million, offset by non-cash charges of $39.9 million (which consists of depreciation, amortization, and equity interest in net loss on investments) and increased by changes in working capital. Cash used in investing activities was $44.7 million for the nine months ended September 30, 2000, which primarily consists of venture investments of $26.6 million, and capital expenditures of $19.2 million. Capital expenditures have generally been comprised of purchases of computer hardware and software, as well as leasehold improvements related to leased facilities. YEAR 2000 ISSUE We and our subsidiaries have not experienced any material problems with network infrastructure, software, hardware and computer systems relating to the inability to recognize appropriate dates related to the Year 2000. We and our subsidiaries are also not aware of any material Year 2000 problems with customers, suppliers or vendors. Accordingly, we and our subsidiaries do not anticipate incurring future material expenses or experiencing any material operational disruptions as a result of any Year 2000 issues. RECENTLY ISSUED ACCOUNTING STANDARDS In March 2000, the Financial Accounting Standards Board issued Interpretation No. 44, "Accounting For Certain Transactions Involving Stock Compensation" ("FIN No. 44") which provides guidance for applying APB Opinion No. 25, "Accounting For Stock Issued to Employees." With certain exceptions, FIN No. 44 applies prospectively to new awards, exchanges of awards in a business combination, modifications to outstanding awards and changes in grantee status on or after July 1, 2000. The implementation of FIN No. 44 did not have a significant effect on our results of operations. In December 1999, the SEC issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB No. 101") which summarizes certain of the SEC staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. We will be required to adopt the accounting provisions of SAB No. 101, no later than the fourth quarter of 2000. We do not believe that the implementation of SAB No. 101 will have a significant effect on our results of operations. In June 1998, the Financial Accounting Standards Board issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 establishes accounting and reporting standards for derivative instruments, including derivative instruments embedded in other contracts and hedging activities. In June 1999, SFAS No. 137 was issued which delayed the effective date of SFAS No. 133 to January 1, 2001. In June 2000, the Financial Accounting Standards Board issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities, an Amendment of FASB Statement No. 133" which intended to simplify the accounting for derivatives under SFAS 133 and is effective upon adoption of SFAS 133. Our management has not yet determined the impact of adopting SFAS 133 as amended. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We believe that our market risk exposures associated with our outstanding debt is immaterial as our fixed rate and variable rate debt obligations are not material. PART II. OTHER INFORMATION Item 1. Legal Proceedings Currently, we are not a party to any pending material legal proceedings. Item 2. Changes in Securities. None Item 3. Defaults Upon Senior Securities Not applicable Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) The following index sets forth those exhibits filed pursuant to Item 601 of Regulation S-X: EXHIBIT NUMBER DESCRIPTION ------- ----------- 3.1 -- Restated Certificate of Incorporation of Rare Medium Group, Inc., which was filed as Exhibit 3.1 to the Company's Form 10-K for the year ended December 31, 1999, and is hereby incorporated herein by reference. 3.2 -- Amended and Restated By-Laws of Rare Medium Group, Inc., which was filed as Exhibit 3.2 to the Company's Form 10-K for the year ended December 31, 1999, and is hereby incorporated herein by reference. 10.1 -- Form of Purchase Agreement, dated January 14, 2000, between the Company and each of the purchasers in the private placement of the Company's Common Stock on January 14, 2000, which was filed as Exhibit 4.1 to the Company's Form S-3 (Reg. No. 333-95829) and is hereby incorporated herein by reference. 10.2 -- Form of Underwriting Agreement by and among the Company and Credit Suisse First Boston Corporation, Deutsche Bank Securities Inc. and FleetBoston Robertson Stephens Inc. which was filed as Exhibit 1.1 to the Company's Registration Statement on Form S-3 (Reg. No. 333-95829) and is hereby incorporated herein by reference. SIGNATURES PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED. Date: June 25, 2001 By: /s/ GLENN S. MEYERS ----------------------- Glenn S. Meyers Chief Executive Officer Date: June 25, 2001 By: /s/ CRAIG C. CHESSER ------------------------ Craig C. Chesser Vice President Finance and Treasurer (Principal Financial Officer) Date: June 25, 2001 By: /s/ MICHAEL A. HULTBERG ------------------------- Michael A. Hultberg Vice President and Controller (Principal Accounting Officer) EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION ------- ----------- 3.1 -- Restated Certificate of Incorporation of Rare Medium Group, Inc., which was filed as Exhibit 3.1 to the Company's Form 10-K for the year ended December 31, 1999, and is hereby incorporated herein by reference. 3.2 -- Amended and Restated By-Laws of Rare Medium Group, Inc., which was filed as Exhibit 3.2 to the Company's Form 10-K for the year ended December 31, 1999, and is hereby incorporated herein by reference. 10.1 -- Form of Purchase Agreement, dated January 14, 2000, between the Company and each of the purchasers in the private placement of the Company's Common Stock on January 14, 2000, which was filed as Exhibit 4.1 to the Company's Form S-3 (Reg. No. 333-95829) and is hereby incorporated herein by reference. 10.2 -- Form of Underwriting Agreement by and among the Company and Credit Suisse First Boston Corporation, Deutsche Bank Securities Inc. and FleetBoston Robertson Stephens Inc. which was filed as Exhibit 1.1 to the Company's Registration Statement on Form S-3 (Reg. No. 333-95829) and is hereby incorporated herein by reference.