---

UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





---




FORM 10-K/A


(Mark One)





|x |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ------------------------------------------------------------------------------------




For the fiscal year ended January 31, 2002





OR





| ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------




For the transition period from
 to





Commission file number: 000-32377





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LOUDCLOUD, INC.


(Exact name of registrant as
specified in its charter)


Delaware

94-3340178(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification
Number)





599 N. Mathilda Avenue, Sunnyvale, California 94085


(Address, including zip code, of Registrants principal executive offices)





(408) 744-7300


Registrants telephone number, including area code





---




Securities registered pursuant to Section 12(b) of the Act:


None





Securities
registered pursuant to Section 12(g) of the Act:


Common Stock, par value $0.001 per share





---




Indicate by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days.     YES x     NO  ̈





Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and
will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x





The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing price of Common Stock on April 1, 2002, as reported by Nasdaq, was approximately $91.8 million. Shares of voting stock held by each officer and director and by each person who owns 5% or more of the outstanding
voting stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.





As of April 1, 2002, 76,322,947 shares of the registrants Common Stock were outstanding.





---




---



---




ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA





I
NDEX TO CONSOLIDATED FINANCIAL STATEMENTS





PageReport of Ernst & Young LLP, Independent Auditors

1Consolidated Balance Sheets

2Consolidated Statements of Operations

3Consolidated Statements of Stockholders Equity

4Consolidated Statements of Cash Flows

6Notes to Consolidated Financial Statements

7






---

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS





The Board of Directors and Stockholders of Loudcloud,
Inc.





We have audited the accompanying consolidated balance sheets of Loudcloud, Inc. as of January 31, 2002 and
2001, and the related consolidated statements of operations, stockholders equity, and cash flows for the years ended January 31, 2002 and 2001 and for the period from September 9, 1999 (inception) through January 31, 2000. Our audits also
included the financial statement schedule listed in the Index at Item 14(a). These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our
audits.





We conducted our audits in accordance with auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statements presentation. We believe that our audits
provide a reasonable basis for our opinion.





In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Loudcloud, Inc. at January 31, 2002 and 2001, and the consolidated results of its operations, and its cash flows for the years ended January 31, 2002 and 2001 and the period
from September 9, 1999 (inception) through January 31, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.





The accompanying financial statements have been prepared assuming Loudcloud, Inc. will continue as a going concern. As more fully described in Note 13, Loudcloud, Inc. paid $42 million in cash as part of the consideration to
repurchase their 13% Senior Discount Notes, which significantly reduces their funds available for operations. In addition, the funds available for Loudclouds operations do not take into consideration the estimated net proceeds of $61.5
million, subject to purchase price adjustments, from the Electronic Data Systems Corporation transaction and estimated cash received from the Frontera transaction of $9.0 million, as these transactions may not close. These conditions raise
substantial doubt about the Companys ability to continue as a going concern. Managements plans in regard to these matters are also described in Note 13. The financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.





/s/    ERNST & YOUNG LLP





San Jose, California


February 26, 2002, except


for the
last four paragraphs


of Note 13, as to which the


date is June 14, 2002




1




---




LOUDCLOUD, INC.





CONSOLIDATED BALANCE SHEETS


(in thousands, except par value per share)





January 31,2002


2001ASSETSCurrent assets:Cash and cash equivalents

$
91,415


$
43,438Short-term investments


3,288



10,244Accounts receivable, net of allowance for doubtful accounts of $915 and $851 at January 31, 2002 and 2001,
respectively


11,303



7,558Prepaids and other current assets


3,086



4,961Total current assets


109,092



66,201Property and equipment, net


43,090



53,280Restricted cash


20,935



26,740Other assets


1,180



1,991Total assets

$
174,297


$
148,212LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
3,598


$
14,147Accrued compensation


5,659



3,275Accrued data center facilities costs


7,252



5,000Other accrued liabilities


8,319



8,473Deferred revenue


16,234



13,759Accrued restructuring costs


17,081



Capital lease obligations, current portion


2,021



1,904Total current liabilities


60,164



46,558Capital lease obligations, net of current portion


168



912Senior discount notes


50,536



42,151Deferred revenue


5,953



Commitments and contingenciesStockholders equity:Preferred stock, $0.001 par value, 15,000 shares authorized at January 31, 2002, no shares issued or
outstanding






Convertible preferred stock, $0.001 par value, issuable in series; none and 27,500 shares authorized at January 31,
2002 and 2001, respectively; none and 26,386 shares issued and outstanding at January 31, 2002 and 2001, respectively






26Common stock, $0.001 par value, 200,000 and 75,000 shares authorized at January 31, 2002 and 2001, respectively;
75,894 and 20,878 shares issued and outstanding at January 31, 2002 and 2001, respectively


76



21Additional paid-in capital


534,590



393,127Notes receivable from stockholders


(3,022
)


(5,793
)Deferred stock compensation


(24,539
)


(89,909
)Accumulated deficit


(449,606
)


(238,931
)Accumulated other comprehensive income (loss)


(23
)


50Total stockholders equity


57,476



58,591Total liabilities and stockholders equity

$
174,297


$
148,212





See accompanying notes.




2




---




LOUDCLOUD, INC.





CONSOLIDATED STATEMENTS OF OPERATIONS


(in thousands, except per share amounts)





Year Ended January 31,


Period from Inception (September 9, 1999) to January 31, 20002002


2001Net revenue

$
56,012


$
15,486


$
Costs and expenses:Cost of revenue*


109,676



58,083



Research and development*


21,033



17,867



1,453Sales and marketing*


39,560



20,561



710General and administrative*


18,940



12,056



760Restructuring costs


31,471







Amortization of deferred stock compensation


42,666



71,725



2,208Total costs and expenses


263,346



180,292



5,131Loss from operations


(207,334
)


(164,806
)


(5,131
)Interest and other income


5,606



5,431



150Interest and other expense


(8,947
)


(7,045
)


Net loss


(210,675
)


(166,420
)


(4,981
)Series C convertible preferred stock deemed non-cash dividend






(67,530
)


Net loss applicable to common stockholders

$
(210,675
)

$
(233,950
)

$
(4,981
)Basic and diluted net loss per share applicable to common stockholders

$
(3.45
)

$
(165.57
)

$
(1,815.23
)Shares used in computing basic and diluted net loss per share applicable to common stockholders


61,089



1,413



3* Excludes amortization of deferred stock compensation of the
following:Cost of revenue

$
13,046


$
20,062


$
Research and development


8,537



12,746



1,224Sales and marketing


8,830



21,026



361General and administrative


12,253



17,891



623Total amortization of deferred stock compensation

$
42,666


$
71,725


$
2,208





See accompanying notes.




3




---




LOUDCLOUD, INC.





CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY


(in thousands)





Convertible Preferred
Stock

Common Stock

Additional Paid-In Capital


Notes Receivable from Stockholders


Deferred Stock Compensation


Accumulated Deficit


Accumulated Other Comprehensive

Total StockholdersShares


Amount

Shares

Amount





Income

EquityBalance at inception (September 9, 1999)




$




$


$



$



$



$



$


$
Issuance of common stock for cash in October 1999







11,375


11


11


















22Issuance of Series A convertible preferred stock (less issuance costs of $29) in November 1999

6,880



7







2,211


















2,218Issuance of Series B convertible preferred stock (less issuance costs of $21) in November 1999 and January
2000

12,492



12







20,967


















20,979Issuance of warrant in conjunction with building lease in January 2000













5


















5Exercise of options to purchase common stock by a consultant







89





4


















4Exercise of options to purchase common stock for cash and notes







4,612


5


404



(181
)













228Deferred stock compensation













17,181







(17,181
)


Amortization of deferred stock compensation





















2,215










2,215Net loss and comprehensive loss

























(4,981
)





(4,981
)Balance at January 31, 2000

19,372



19

16,076


16


40,783



(181
)


(14,966
)


(4,981
)





20,690Issuance of warrants in conjunction with senior discount notes in February 2000













9,827


















9,827Issuance of Series C convertible preferred stock (less issuance costs of $140) in June 2000

7,034



7







119,852


















119,859Deemed non-cash dividend on Series C convertible preferred stock













67,530











(67,530
)





Conversion of Series A convertible preferred stock to commonstock

(20
)




20
























Issuance of common stock to consultants







20
























Exercise of options to purchase common stock for cash and notes, net of repurchases







4,762


5


5,958



(5,680
)













283Repayment of note receivable

















68














68Deferred stock compensation













150,764







(150,764
)









Amortization of deferred stock compensation





















74,234










74,234Reversal related to unamortized portion of deferred stock compensation related to terminated employees













(1,587
)






1,587










Components of comprehensive loss:Net loss

























(166,420
)





(166,420
)Unrealized gain on short term investments





























50


50Total comprehensive loss
































(166,370
)




4




---




LOUDCLOUD, INC.





CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY(Continued)


(in
thousands)





Convertible Preferred
Stock


Common Stock


Additional Paid-In Capital


Notes Receivable from Stockholders


Deferred Stock Compensation


Accumulated Deficit


Accumulated Other Comprehensive


Total Stockholders EquityShares


Amount


Shares


Amount






IncomeBalance at January 31, 2001

26,386


$
26


20,878


$
21


$
393,127


$
(5,793
)

$
(89,909
)

$
(238,931
)

$
50


$
58,591Conversion of convertible preferred stock to common stock in connection with the initial public offering

(26,386
)


(26
)

26,386



26























Issuance of common stock in connection with the initial public offering (less issuance costs of $14,961) in March
2001








28,750



29



157,510



















157,539Issuance of common stock in a private placement in March 2001








877



1



4,999



















5,000Exercise of stock options by employees, net of repurchases








(2,693
)


(3
)


(2,431
)


2,085















(349
)Issuance of common stock in connection with the Employee Stock Purchase Program








539



1



1,180



















1,181Exercise of common stock warrants








1,157



1



30



















31Repayment of note receivable




















686















686Amortization of deferred stock compensation
























42,666











42,666Charge for accelerated vesting of options to terminated employees
















2,879



















2,879Reversal related to unamortized portion of deferred stock compensation related to terminated employees
















(22,704
)






22,704











Components of comprehensive loss:Net loss




























(210,675
)






(210,675
)Translation adjustment
































(58
)


(58
)Unrealized loss on short-term investments
































(15
)


(15
)Total comprehensive loss




































(210,748
)Balance at January 31, 2002








75,894


$
76


$
534,590


$
(3,022
)

$
(24,539
)

$
(449,606
)

$
(23
)

$
57,476








See accompanying notes.




5




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LOUDCLOUD, INC.





CONSOLIDATED STATEMENTS OF CASH FLOWS


(in thousands)





Year Ended January 31,


Period from Inception (September 9, 1999) to January 31,2002


2001


2000Operating activities:Net loss

$
(210,675
)

$
(166,420
)

$
(4,981
)Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Depreciation and amortization


26,943



12,807



78Accretion on notes payable


6,420



5,953



Amortization of warrants related to senior discount notes


1,965



889



Charges related to stock awards to consultants and lessor






2,604



12Amortization of deferred stock compensation


42,666



71,725



2,208Non-cash restructuring charges


2,879







Changes in operating assets and liabilities:Accounts receivable


(3,745
)


(7,375
)


(183
)Prepaids, other current assets and other assets


2,686



(6,054
)


(898
)Accounts payable


(10,549
)


12,016



2,131Accrued compensation


2,384



3,139



136Accrued data center facilities costs


2,252



4,562



438Other accrued liabilities


(154
)


6,414



2,059Deferred revenue


8,428



13,450



309Accrued restructuring costs


17,081







Net cash (used in) provided by operating activities


(111,419
)


(46,290
)


1,309Investing activities:Capital expenditures


(14,105
)


(56,476
)


(4,281
)Purchases of short-term investments


(3,288
)


(16,720
)


Maturities and sales of short-term investments


10,244



6,476



Increase (decrease) in restricted cash


5,805



(26,740
)


Net cash used in investing activities


(1,344
)


(93,460
)


(4,281
)Financing activities:Proceeds from issuance of preferred stock, net of issuance costs






119,859



23,197Proceeds from issuance of common stock, net of repurchases


163,329



283



254Proceeds from issuance of senior discount notes






45,137



Principal payments on capital lease obligations


(3,275
)


(2,638
)


Proceeds from repayment of notes receivable


686



68



Net cash provided by financing activities


160,740



162,709



23,451Net increase in cash and cash equivalents


47,977



22,959



20,479Cash and cash equivalents at beginning of period


43,438



20,479



Cash and cash equivalents at end of period

$
91,415


$
43,438


$
20,479Supplemental schedule of noncash investing and financing activities:Issuance of warrants in conjunction with senior discount notes

$



$
9,827


$
Issuance of common stock in exchange for notes receivable






5,680



181Equipment purchased under capital lease


2,648



5,408



Series C preferred stock deemed, non-cash dividend






67,530



Conversion of Series A convertible preferred stock to common stock






40



Supplemental disclosures:Cash paid for interest


476



75









See accompanying notes.




6




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LOUDCLOUD, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS







1.    Summary of the Company and Significant Accounting Policies





Nature of Operations





Loudcloud, Inc. (Loudcloud, the Company, We or Our), was incorporated as VCellar, Inc. on September 9, 1999 in the state of
Delaware. The Company is a leading managed services provider, offering a complete solution to enterprise customers for outsourcing global Internet operations. Loudcloud deploys, manages, secures, scales, and monitors e-business systems using its
unique Opsware technology, which automates functions otherwise performed manually, delivering higher quality, cost savings, and increased flexibility. The Company manages its systems via a worldwide network of data centers and Loudcloud Operations
Centers located in the United States and Europe.





Basis of Presentation





The consolidated financial statements include accounts of the Company and its wholly owned subsidiary. The Company has sales offices
throughout the United States and Europe. All significant intercompany balances have been eliminated. Through January 31, 2000, the Companys activities primarily consisted of establishing its offices, conducting research and development,
recruiting management and technical personnel, and obtaining financing. Accordingly, the Company was considered to be in the development stage through January 31, 2000. In February 2000, the Company deployed services for its first customer and
therefore emerged from the development stage. See Note 13.





Use of Estimates and Reclassifications





The preparation of consolidated financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that materially affect the amounts reported in the consolidated financial statements. Actual results could differ from these estimates. In addition, certain amounts that were
previously reported have been reclassified to conform to the current period presentation. The methods, estimates and judgments the Company uses in applying its most critical accounting policies have a significant impact on the results it reports in
its financial statements. The U.S. Securities and Exchange Commission has defined the most critical accounting policies as the ones that are most important to the portrayal of the Companys financial condition and results, and require the
Company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, the Companys most critical accounting policies include: revenue
recognition, allowance for doubtful accounts, property and equipment, impairment of long-lived assets and restructuring.





Cash, Cash Equivalents and Short-term Investments





The Company considers all highly liquid
investments with maturity from the date of purchase of three months or less to be cash equivalents and investments with maturity from the date of purchase of more than three months, but less than twelve months, to be short-term investments. All cash
equivalents and short-term investments are classified as available-for-sale. The cost of securities sold is based upon the specific identification method.





Concentrations of Credit Risk and Significant Customers





Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash, cash equivalents, short-term investments, restricted cash and accounts receivable. The




7




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LOUDCLOUD, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




Company places all of its cash equivalents, short-term investments and restricted cash with high-credit quality issuers. Carrying amounts of financial instruments held by the Company, which
include cash equivalents, short-term investments, restricted cash, accounts receivable, accounts payable and accrued expenses, approximate fair value due to their short duration. The Company performs ongoing credit evaluations of its customers,
generally requires customers to prepay services and maintains reserves for potential losses.





For the year ended
January 31, 2002, customers Nike and Atriax accounted for 13% and 12% of the Companys net revenue, respectively. On April 5, 2002, Atriax announced that it would cease operations within a short period of time. As a result, the Company does not
expect to derive any revenue from Atriax beyond the first quarter of fiscal 2003. All receivable amounts owed by Atriax as of January 31, 2002 have been subsequently collected. For the year ended January 31, 2001, customers Nike and Rational
Software accounted for 23% and 14% of the Companys net revenues, respectively. As of January 31, 2002, customers Atriax, Consignia and Office of the e-Envoy, accounted for 12%, 13% and 10% of the Companys accounts receivable balance,
respectively. As of January 31, 2001, customer Nike accounted for 24% of the Companys accounts receivable balance.





Property and Equipment





Property and equipment are stated at cost, net of accumulated
depreciation and amortization. Property and equipment are depreciated or amortized on a straight-line basis over the estimated useful lives of the assets ranging from approximately two to five years or the applicable lease term, if shorter.





Revenue Recognition





The Company generates revenue from the sale of Internet infrastructure services. These services incorporate the hardware, software and networking infrastructure and the
provisioning, maintenance and scaling expertise required to support Internet operations. The Company recognizes revenue ratably over the managed services contract period as services are fulfilled, provided the Company has evidence of an agreement,
the price of the services is fixed or determinable, all contracted services are being delivered and payment is reasonably assured. When obligations remain after services are delivered, revenue is only recognized after such obligations are fulfilled.
In addition to the sale of Internet infrastructure services, the Company generates revenue from short-term professional service agreements. Revenue from professional services is recognized as work is completed and accepted by the customer.





Some of the Companys customers are obligated to pay incremental fees once the Company has fulfilled its
readiness obligations by preparing the Internet infrastructure if those customers are not ready to launch the site. The incremental fees begin a defined period of time after the operational date and end on the launch date. The managed service period
begins on the launch of the site, and thus the length of time or fees charged between the operational date and launch date typically do not affect the fees charged during the managed service period. The Company recognizes revenue between the
operational date and launch date, as it represents a separate and distinct earnings process, provided it has evidence of an agreement, the price is fixed or determinable, the Company has fulfilled its obligations and collectibility is reasonably
assured.





The Company records bandwidth billings on a gross basis on the indicators in Emerging Issue Task Force
No. 99-19 Recording Revenue Gross as a Principal versus Net as an Agent. The Company is the primary obligor as the Companys customer service agreements identify the Company as the party responsible for the fulfillment of bandwidth services to
the Companys customers. The Company selects the bandwidth providers from numerous potential suppliers. The Company has inventory risk for bandwidth capacity as the Company forecasts,




8




---



LOUDCLOUD, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




then purchases, total bandwidth capacity for a certain period of time, in order to secure bandwidth capacity, which may be in excess of total actual customer demand during that period of time.
The fact that bandwidth capacity is not specifically designated to a particular customer does not mitigate the inventory risk, since the Company forecasts and purchases total bandwidth capacity for a future period of time. The Company has credit
risk, as it is responsible for collecting the sales price from a customer, but must pay the amount owed the bandwidth suppliers after the suppliers perform, regardless of whether the sales price is fully collected.





The Company generally guarantees 100% scheduled uptime to its customers on a monthly basis. The Company reduces revenue for credits given
for estimated unscheduled downtime on a monthly basis. Amounts billed and/or cash received in excess of revenue recognized are included as deferred revenue in the accompanying balance sheets.





Accounting for Stock-Based Compensation





The Company grants stock options and stock purchase rights for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. As permitted under the Financial Accounting
Standards Board (FASB) Statement of Financial Accounting Standards No. 123 (FAS 123), Accounting for Stock-Based Compensation, the Company accounts for stock option grants and stock purchase rights to employees and directors in
accordance with Accounting Principles Board Opinion No. 25 (APB Opinion No. 25), Accounting for Stock Issued to Employees, and, accordingly, recognizes no compensation expense for stock option grants or stock purchase rights with an
exercise price equal to the fair value of the shares at the date of grant.





Impairment of Long-Lived Assets





The Company continually reviews the carrying value of long-lived assets, including property and equipment to
determine whether there are any indications of impairment losses. Recoverability of long-lived assets is measured by a comparison of the carrying amount of an asset to estimated future net cash flows generated by the asset. If such assets are
considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.





Advertising Expenses





All
advertising costs are expensed as incurred. Advertising costs were $2.3 million and $629,000 for the years ended January 31, 2002 and 2001, respectively, and were not material for the period from inception (September 9, 1999) to January 31, 2000.





Research and Development Costs





Costs of software developed internally by the Company for use in its operations are accounted for under the American Institute of Certified Public Accountants
Statement of Position (SOP) 98-1, Accounting for the Costs of Corporate Software Developed or Obtained for Internal Use. Under SOP 98-1, the Company expenses costs of research, including pre-development efforts prior to establishing technological
feasibility, and costs incurred for training and maintenance. Software development costs are capitalized when technological feasibility has been established, it is probable that the project will be completed and the software will be used as
intended. Costs incurred during the application development stage were insignificant, and accordingly no costs related to internal use software have been capitalized through January 31, 2002.




9




---



LOUDCLOUD, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







Other research and development costs were also expensed as incurred.
Research and development costs expensed were $21.0 million and $17.9 million for the years ended January 31, 2002 and 2001, respectively, and were $1.5 million for the period from inception (September 9, 1999) to January 31, 2000.





Segment Information





The Company has adopted Statement of Financial Accounting Standards No. 131, Disclosure about Segments of an Enterprise and Related Information, which requires companies to report selected information
about operating segments, as well as enterprise-wide disclosures about products, services, geographical areas and major customers. Operating segments are determined based on the way management organizes its business for making operating decisions
and assessing performance. The Company has only one operating segment, Internet infrastructure services. Revenue recognized outside of the United States has been less than 10% for each of the years ending January 31, 2002 and 2001. There were no
sales in the period from inception (September 9, 1999) to January 31, 2000.





Comprehensive Loss





Under FAS 130, the Company is required to display comprehensive income (loss) and its components as part of
the financial statements. Other comprehensive income (loss) includes certain changes in equity, foreign currency translation adjustments and unrealized gains/losses on available-for-sale securities that are excluded from net loss.





Income Taxes





The Company accounts for income taxes using the liability method under which deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets
and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets if it is more likely
than not that those assets will not be realized.





Recently Issued Accounting Standards





In June 2001, the FASB issued Statements of Financial Accounting Standards No. 141 (SFAS 141), Business
Combinations, and No. 142 (SFAS 142), Goodwill and Other Intangible Assets. SFAS 141 supersedes APB Opinion No. 16, Business Combinations, and eliminates the pooling-of-interests method of accounting for business
combinations, thus requiring that all business combinations be accounted for using the purchase method. The requirements of SFAS 141 apply to all business combinations initiated after June 30, 2001. SFAS 142 supersedes APB Opinion No. 17,
Intangible Assets, and provides that goodwill and other intangible assets that have an indefinite useful life will no longer be amortized. However, these assets must be reviewed at least annually for impairment. SFAS 142 applies to all
business combinations completed after June 30, 2001. The Company did not enter into any business combinations prior to January 31, 2002. The Company will adopt SFAS 141 and 142 effective as of February 1, 2002 and does not expect that the
adoption will have a material impact on its consolidated financial statements.





In October 2001, the FASB issued
SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which applies to financial statements issued for fiscal years beginning after December 15, 2001. SFAS 144 supersedes FASB Statement 121, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and portions of APB Opinion 30, Reporting the Results of Operations.




10




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LOUDCLOUD, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




SFAS 144 provides a single accounting model for long-lived assets we expect to dispose of and significantly changes the criteria for classifying an asset as held-for-sale. This classification is
important because held-for-sale assets are not depreciated and are stated at the lower of fair value or carrying amount. SFAS 144 also requires expected future operating losses from discontinued operations to be displayed in the period(s) in which
the losses are actually incurred, rather than when the amount of the loss is estimated, as presently required. The Company will adopt SFAS 144 effective February 1, 2002 and does not expect that the adoption will have a material impact on its
consolidated financial statements.





In November 2001, the Emerging Issues Task Force (EITF) released
Issue No. 01-09, Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendors Product, which applies to annual or interim financial statement periods beginning after December 15, 2001. The release
provides that cash consideration (including sales incentives) that we give to our customers or resellers should be accounted for as a reduction of revenue unless we receive a benefit that is identifiable and that can be reasonably estimated. The
Company will adopt this new release effective February 1, 2002 and does not expect that the adoption of EITF Issue No. 01-09 will have a material impact on its total net revenue.





2.    Significant Customer Agreement





In August 2001, the Company entered into two agreements with Qwest Communications Corporation (Qwest), which included an Ethernet Co-location and Internet Access Service Agreement (Co-location Agreement) and a
Reseller Agreement. The term of each of the agreements is five years from the effective date of the contracts. Under the Co-location Agreement the Company received a non-refundable prepayment of $7.5 million in consideration for providing
services in connection with the provisioning and maintaining of three of Qwests data centers and the migration of the Companys operations into the three data centers. The entire amount is included in deferred revenue and will be
recognized as revenue ratably over the period services are provided, commencing upon the deployment of Qwests first signed customer at each data center.





Additionally the Co-location Agreement provides that the Company pays rates and charges for space, power and bandwidth. During the first 12 months of the Co-location Agreement, Qwest will provide a
reimbursement to the Company for a portion of those costs. Consistent with the Companys past accounting for these types of charges the amount, net of the cost reimbursement, will be recorded as a cost of revenue.





Pursuant to the Reseller Agreement, the Company provides its managed services to customers that execute customer service agreements with
Qwest. In addition, pursuant to the Reseller Agreement, the Company receives a percentage of the monthly fees billed to those customers that have executed customer services agreements with Qwest where the Company shall provide its managed services.
The Company will record fees received under this agreement on a net basis based on the indicators in Emerging Issue Task Force 99-19, Recording Revenue Gross as a Principal versus Net as an Agent. The Company is not the primary obligor as the
customer service agreements identify Qwest as the party responsible for the fulfillment of bandwidth services. The Company does not have credit risk as Qwest is responsible for collecting the sales price from a customer and the Company receives
their fee under the Reseller Agreement regardless of whether the sales price is fully collected. The Companys fee received under the Reseller Agreement is a fixed percentage of a customer service agreement. As of January 31, 2002, revenue
earned for customers signed pursuant to the Reseller Agreement has been insignificant.




11




---



LOUDCLOUD, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







3.    Financial Instruments





The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:





The following is a summary of securities as of January 31, 2002 and 2001 (in thousands):





January 31, 2002Amortized Cost

Unrealized Gain

Unrealized Loss


Estimated Fair ValueCash and money market funds

$
112,350

$



$ 


$
112,350U.S. Government Agencies


3,303


3


18



3,288$
115,653

$
3

$
18


$
115,638Reported as:Cash and cash equivalents

$
91,415

$


$



$
91,415Short-term marketable securities


3,303


3


18



3,288Restricted cash


20,935









20,935$
115,653

$
3

$
18


$
115,638January 31, 2001Amortized Cost

Unrealized Gain

Unrealized Loss


Estimated Fair ValueCash and money market funds

$
20,467

$


$



$
20,467Commercial paper


33,165


52


(2
)


33,215Certificates of deposit


26,740









26,740$
80,372

$
52

$
(2
)

$
80,422Reported as:Cash and cash equivalents

$
43,440

$


$
(2
)

$
43,438Short-term marketable securities


10,192


52






10,244Restricted cash


26,740









26,740$
80,372

$
52

$
(2
)

$
80,422





The approximately $3.3 million and $33.2 million of
available-for-sale debt securities as of January 31, 2002 and 2001, respectively, have a contractual maturity of one year or less.





4.    Property and Equipment





Property and equipment consist of the
following:





January 31, 2002


January 31, 2001(in thousands)Computer and other related equipment

$
45,829


$
43,538Office equipment, leasehold improvements, furniture, and fixtures


10,894



6,698Software


26,195



15,92982,918



66,165Less accumulated depreciation and amortization


(39,828
)


(12,885
)Property and equipment, net

$
43,090


$
53,280




12




---



LOUDCLOUD, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







Depreciation and amortization expense amounted to $26.9 million and
$12.9 million for the years ended January 31, 2002 and 2001, respectively. As of January 31, 2002 and 2001 property and equipment acquired under capital leases totaled $2.6 million and $5.4 million, respectively, and had related accumulated
amortization of $2.7 million and $575,000, respectively. Additionally, the Company has available $6.3 million of equipment lease facilities from its vendors as of January 31, 2002.





5.    Senior Discount Notes





On
February 9, 2000, the Company issued 66,000 units at a per unit price of $683.89 of 13% Senior Discount Notes (the Notes) for an aggregate amount of $45.1 million to Morgan Stanley & Co., Inc. The Notes are due in February 2005. In connection
with the issuance of these Notes, the Company also issued detachable warrants to purchase an aggregate 1.2 million shares of common stock at an exercise price of $0.02 per share. Of the $45.1 million in gross proceeds, $9.8 million was allocated to
additional paid-in capital for the deemed fair value of the warrants and recorded as a discount to the Notes. The discount on the Notes is being amortized to interest expense, using the effective interest method, over the life of the Notes.





At the time of issuance the Notes were sold at a substantial discount from their principal amount at maturity of
$66.0 million. Prior to August 15, 2003, no cash interest payments are required; instead, interest will accrete during this period to the aggregate principal amount at maturity. From and after February 15, 2003, the Notes will bear interest at a
rate of 13% per annum payable in cash each February 15 and August 15. The Notes are redeemable at the option of the Company, in whole or in part, at any time, at the redemption prices set forth in the indenture agreement relating to the Notes, plus
accrued and unpaid interest, if any, to the date of redemption.





The indenture relating to the Notes contains
certain covenants that, among other things, limit the ability of the Company and its Restricted Subsidiaries (as defined in the indenture relating to the Notes) to incur indebtedness, pay dividends, prepay subordinated indebtedness, repurchase
capital stock, make certain investments, create liens, engage in transactions with stockholders and affiliates, sell assets, and engage in mergers and consolidations. However, these limitations are subject to a number of important qualifications and
exceptions.





6.    Commitments





Rent expense was $10.0 million and $5.1 million for the years ended January 31, 2002 and 2001, respectively, and $95,000 for the period from inception (September 9, 1999)
to January 31, 2000. The Company leases approximately 75,000 square feet in Sunnyvale, California for its corporate headquarters. The Company issued a letter of credit in connection with this lease, which requires the Company to hold on deposit
approximately $2.8 million of restricted cash with the issuer of the letter of credit. In October 2000, the Company agreed to lease approximately 150,000 square feet for general corporate purposes in Sunnyvale, California. The related cost of these
leases is approximately $872,000 per month, net of the proceeds received from the subleases. As of January 31, 2002, the Company has subleased approximately 92,000 square feet of the 150,000 square feet and is seeking to sublease the remaining
58,000 square feet. The Company issued a letter of credit of approximately $23.2 million to the lessor in association with these leases in November 2000. This letter of credit is secured by approximately $23.2 million of restricted cash, which is
subject to a phased release through June 2003. These amounts are shown as restricted cash, as of January 31, 2002, on the accompanying balance sheet. These leases expire between 2003 and 2005.





In October 2000, the Company agreed to lease 22,000 square feet for general corporate purposes in Chantilly, Virginia. The related cost of this lease is approximately
$43,000 per month. The lease expires in December 2005. The Company commenced occupancy in March 2001.




13




---



LOUDCLOUD, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







We lease data center space from third parties. A number of data
center providers have recently encountered financial difficulties, and the industry has experienced consolidation. Some data center providers require us to enter into contracts for data center space in advance of customer commitments, and to the
extent that we are unable to grow our customer base at the rate that we anticipate in the geographic areas in which we have contracted for space, our operating results will suffer.





Future payments under all noncancelable leases entered into as of January 31, 2002 are as follows:





Years ending January 31,

Capital Leases

Operating Leases(in thousands)2003

$
2,140

$
30,8062004


188


9,0282005





5,2062006





4,7832007





2,668Thereafter





8,894Total minimum payments


2,328

$
61,385Less amount representing interest


139Present value of minimum payments


2,189Less current portion


2,021Long-term portion

$
168





Future payments under operating leases are shown net of
approximately $4.3 million due from noncancelable subleases as of January 31, 2002.





7.    Restructuring Costs





In May 2001, the Company announced a restructuring program to improve utilization of its existing technology
and infrastructure. This restructuring program included a worldwide workforce reduction of approximately 122 employees, consolidation of the resulting excess facilities and an accrual for excess and obsolete equipment. As a result of the
restructuring program, the Company recorded restructuring costs of $30.2 million classified as operating expenses in the quarter ended July 31, 2001. Included in the $30.2 million was a noncash charge of $2.9 million related to accelerating the
vesting of options for certain employees.





A summary of the May 2001 restructuring charges is outlined as follows
(in millions):





Total Charge

Noncash Charges


Cash Payments


Restructuring Liabilities at January 31, 2002Workforce reduction

$
5.4

$
(2.9
)

$
(2.4
)

$
0.1Consolidation of excess facilities


20.6






(5.9
)


14.7Disposal of property and equipment


4.2






(2.1
)


2.1Total

$
30.2

$
(2.9
)

$
(10.4
)

$
16.9





In September 2001, the Company announced an organizational
realignment to increase overall effectiveness and operational efficiencies. The organizational realignment included hiring in key areas, such as direct sales




14




---



LOUDCLOUD, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




representatives and specific technology positions, and the elimination of some other positions. Approximately 66 employees were affected as a result of the reorganizational alignment. As a
result of the organizational realignment, the Company recorded a reorganization charge of $1.3 million relating to elimination of some positions, which was classified as an operating expense. All of the costs associated with the September 2001
organizational realignment were workforce related. As of January 31, 2002, the Company had made cash payments related to the September 2001 reorganization charge of $1.1 million.





8.    Stockholders Equity





Initial Public Offering





In March 2001, the Company received approximately $163 million in
net cash proceeds from the sale of approximately 28.75 million shares of the Companys common stock in an initial public offering and approximately 877,000 shares of the Companys common stock in a private placement to Compaq. On
March 1, 2001, the Company had entered into an agreement with Compaq under which the Company agreed to sell Compaq $5 million worth of the Companys common stock at a per share price equal to 95% of the Companys per share
initial public offering price of $6.00. The 5% discount on this issuance will be amortized into cost of revenue over three years. In connection with the Companys initial public offering, each outstanding share of the Companys preferred
stock was converted into one share of the Companys common stock.





Stock Split





In February 2001, the holders of a majority of our outstanding stock approved by written consent a reverse stock split of our
outstanding common stock and preferred stock pursuant to which every two shares of common stock was combined and exchanged into one share of common stock and every two shares of preferred stock was combined and exchanged into one share of preferred
stock. All share and per share information included in these financial statements has been adjusted to reflect this reverse stock split.





Preferred Stock





All outstanding preferred stock converted to common stock upon
completion of the initial public offering in March 2001. The Company is authorized to provide for the issuance of up to 15 million shares of undesignated preferred stock, none of which has been issued as of January 31, 2002.





Common Stock





In October 1999, the Company sold at fair market value 11.4 million shares of common stock to founders for cash. The common stock shares vest 25% on the first anniversary of the issuance date with the balance vesting ratably
over the remaining period of three years as specified in the purchase agreements. All unvested shares purchased by the founders are subject to repurchase by the Company at the original cost if the founders employment is terminated. As of
January 31, 2002, 4.7 million shares were subject to repurchase. The sale of common stock to founders at fair market value was accounted for as an increase in equity. The measurement date of the founders stock is not changed solely by the provision
that termination of employment reduces the number of shares of stock that may be issued.





Amended and Restated
Certificate of Incorporation





In March 2001, the Company amended the Certificate of Incorporation to increase
the authorized common stock to 200 million shares.




15




---



LOUDCLOUD, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







Stock Option Plans





In September 1999, the Board of Directors adopted the 1999 Stock Plan (the 1999 Plan). Under the 1999 Plan, options or stock
purchase rights may be granted for common stock, pursuant to actions by the Board of Directors, to eligible participants. A total of 9.6 million shares have been reserved under the 1999 Plan. Options and stock purchase rights vest over a period of
time as determined by the Board of Directors, generally four years. The term of the 1999 Plan is ten years.





In
August 2000, the Board of Directors adopted the 2000 Stock Plan (the 2000 Plan). Under the 2000 Plan options or stock purchase rights may be granted for common stock, pursuant to actions by the Board of Directors, to eligible
participants. A total of 8.0 million shares were reserved under the 2000 Plan. Options, which are granted as either incentive stock options or nonstatutory stock options, and stock purchase rights are exercisable within the times or upon the events
determined by the Board of Directors as specified in each option agreement. Options and stock purchase rights vest over a period of time as determined by the Board of Directors, generally four years. The term of the 2000 Plan is ten years.





In September 2000, the Board of Directors approved the 2000 Incentive Stock Plan. The plan provides for the grant
of incentive stock options to the Companys employees and nonstatutory stock options and stock purchase rights to our employees, directors and consultants. A total of 12.5 million shares of our common stock plus any unissued but reserved shares
under the 1999 Stock Plan and the 2000 Stock Plan as of the effective date of the initial public offering and any shares returned to such plans shall be reserved for issuance under the 2000 Incentive Stock Plan. The shares may be authorized, but
unissued, or reacquired common stock.





The number of shares reserved for issuance under the Companys 2000
Incentive Stock Plan will increase annually on the first day of the Companys fiscal year beginning in 2003 by an amount equal to the lesser of (i) 8% of the outstanding shares of the Companys common stock on the first day of the
year; provided, however, such percentage shall decrease to 6% of the outstanding shares of the Companys common stock beginning on the first day of the fiscal year beginning in 2007, (ii) 9.0 million shares or (iii) a lesser amount as the
Companys Board of Directors may determine.





The Director Option Program is part of the Companys 2000
Incentive Stock Plan and provides for the periodic grant of nonstatutory stock options to the Companys non-employee directors.





2000 Employee Stock Purchase Plan





In September 2000, the Board of Directors
approved the 2000 Employee Stock Purchase Plan. A total of 1.5 million shares of the Companys common stock will be made available for sale under the Purchase Plan. In addition, the Purchase Plan provides for annual increases in the number
of shares available for issuance under the Purchase Plan on the first day of the Companys fiscal year beginning in 2003 in an amount equal to the lesser of (i) 5.0 million shares, (ii) 2% of the outstanding shares of the Companys common
stock on that date, or (iii) a lesser amount determined by the Companys Board of Directors. The Companys Board of Directors or a committee of its Board administers the plan.





The Purchase Plan contains consecutive, overlapping 24-month offering periods. Each offering period includes four six-month purchase periods.





The price of common stock is 85% of the lower of the fair market value of the Companys common stock at the beginning of an offering
period or after a purchase period ends. If the fair market value at the end of a purchase period is less than the fair market value at the beginning of the offering period, participants will be




16




---



LOUDCLOUD, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




withdrawn from the current offering period following their purchase of shares on the purchase date and will be re-enrolled in the immediately following offering period. The Company issued 538,524
shares under the Purchase Plan as of January 31, 2002. At January 31, 2002, the Company had 961,476 shares reserved for future issuance.





Series C convertible preferred stock dividend





In June
2000, the Company issued 7.0 million shares of Series C convertible preferred stock for a total purchase price of $120 million. The difference between the deemed fair value of these shares at the issuance date and the actual issuance price has been
accounted for as a non-cash deemed dividend totaling $67.5 million in the year ended January 31, 2001.





Warrants





In January 2000, the Company issued a warrant to purchase 5,000 shares of Series
B convertible preferred stock with an exercise price of $1.68 per share in connection with the leasing of its new office space. The warrant was exercised in March 2001 when the Company successfully completed its IPO. The Company recorded
amortization of the warrant of $5,300 during the year ended January 31, 2000.





In February 2000, in connection
with the issuance of the Notes, the Company issued detachable warrants to purchase an aggregate of 1.2 million shares of common stock at an exercise price of $0.02 per share. The warrants expire in February 2010. The deemed fair value of the
warrants of $9.8 million was estimated at the date of issuance using the Black-Scholes pricing model with the following assumptions: deemed fair market value of the common stock of $10.80 on the day of issuance, risk free interest rate of 6.0%,
contractual life of the warrants of ten years, volatility of 70%, and a dividend rate of zero. The amount represents a discount to the face value of the notes and is being amortized to interest expense, using the effective interest method, over the
life of the Notes. These warrants were exercised in full during October 2001.





In February 2001, the Company
entered into a marketing alliance agreement with Accenture. Accenture is entitled to receive marketing assistance fees and has been issued a warrant to purchase up to 250,000 shares of the Companys common stock. Warrants issued to Accenture
vest contingently. A specified number of warrants fully vest and become immediately exercisable and non-forfeitable upon the signing of a contract between Loudcloud and a new customer referred to the Company by Accenture. The warrants can be earned
through the termination of the agreement in February 2004, and vested warrants expire on February 28, 2006. The Company will record the fair value of each warrant as it vests using the Black-Scholes pricing model. A significant factor in the
Black-Scholes pricing model will be the fair value of our stock when the warrants vest compared to the exercise price. The exercise price is $6.00. The fair value of the warrants that vest upon the signing of a customers contract will be
amortized into operating expenses (marketing expenses) over the life of the contract between the customer and Loudcloud. To date, no warrants have vested. In addition, upon the signing of a contract between Loudcloud and a customer referred from
Accenture, Accenture is entitled to receive marketing assistance fees, payable monthly, based on a percentage of amounts payable to us under the contract. The marketing assistance fees will be recognized monthly by us based on the fees due
Accenture. We believe that the sales and marketing alliance agreement could result in significant stock-based compensation. Accenture stock-based and cash compensation will be disclosed on a separate line in operating expenses (marketing expenses).





Notes Receivable from Stockholders





The Company has notes receivable outstanding of $3.0 million from employees as of January 31, 2002, issued to finance the purchase of shares of common and the convertible
preferred stock of the Company. The




17




---



LOUDCLOUD, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




notes are full recourse notes that bear interest at a rate of approximately 6% per annum with principal and interest due four years from the original issuance date. The notes were issued from
inception (September 9, 1999) to August 2000.





Options to Consultants





As of January 31, 2002, the Company had granted stock purchase rights and options for 122,033 shares of common stock to consultants of
which 3,600 remain subject to repurchase at a weighted average exercise price of $1.2967 per share. These options were granted in exchange for consulting services to be rendered and vest over a period of three to four years. These options were
exercised by the consultants, but are subject to repurchase.





The unvested shares held by consultants have been
and will be marked-to-market using the estimate of fair value at the end of each accounting period pursuant to the FASBs Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for
Acquiring or in Conjunction with Selling Goods, or Services.





Stock-Based Compensation





Under the Companys stock option plans, options or stock purchase rights may be granted for common stock, pursuant to
actions by the Board of Directors, to eligible participants. Options or stock purchase rights granted are either incentive stock options or nonstatutory stock options and are exercisable within the times or upon the events determined by the Board of
Directors as specified in each agreement. Options and stock purchase rights vest over a period of time as determined by the Board of Directors, generally four years. Options and stock purchase rights generally vest with respect to 25% of the shares
one year after the option or stock purchase right grant date and the remainder ratably over the following three years.




18




---



LOUDCLOUD,INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







The following table summarizes all stock option plan activity:





Options and Stock Purchase RightsOutstandingShares Available


Shares


Weighted Average Exercise PriceShares Authorized

8,512,500





$
Granted

(4,701,053
)

4,701,053



0.09Exercised




(4,701,053
)


0.09Balance at January 31, 2000

3,811,447






Shares Authorized

8,103,737






Granted

(9,277,665
)

9,277,665



5.34Exercised




(5,026,313
)


1.20Repurchases

264,670


Cancellations

105,475


(105,475
)


9.96Balance at January 31, 2001

3,007,664


4,145,877



10.23Shares Authorized

13,500,000






Granted

(12,438,066
)

12,438,066



3.37Exercised




(19,170
)


4.62Repurchases

2,714,177






0.82Cancellations

2,366,885


(2,366,885
)


8.27Balance at January 31, 2002

9,150,660


14,197,888



4.55Exercisable at end of period




1,421,839


$
7.74





The following table summarizes significant ranges of outstanding
and exercisable options at January 31, 2002:





Options Outstanding

Options ExercisableRanges ofExercise Prices

Number of Shares

Weighted Average Remaining Contractual Life

Weighted Average Exercise Price

Number of Shares

Weighted Average Exercise Price$1.46$1.46

2,881,018

9.63

$
1.46

6,817

$
1.461.85  3.60

3,949,930

9.22


2.57

715,689


3.133.68  3.68

3,152,658

9.84


3.68

69,915


3.684.00  8.00

2,990,076

9.11


6.05

207,920


7.4613.0018.00

1,224,206

8.79


16.80

421,498


16.4714,197,888

9.38

$
4.55

1,421,839

$
7.74





There were 7.3 million unvested shares of common stock subject to
repurchase as of January 31, 2002. Common stock is subject to repurchase upon termination of the stock purchase right holders employment. Such shares are subject to repurchase at their original issuance prices.





As discussed in Note 1, the Company applies APB 25 and related interpretations in accounting for the Companys option plans. Through
January 31, 2001, the Company recorded $168.0 million in deferred compensation for stock purchase rights and stock options to purchase common stock granted at exercise prices deemed to be below the fair value of common stock. Compensation expense of
$42.7 and $71.7 million was




19




---



LOUDCLOUD, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




recognized using the graded vesting method for the years ended January 31, 2002 and 2001, respectively. In addition, the Company reversed $22.7 million from deferred compensation related to
employees that were terminated during fiscal 2002. The Companys policy is to use the graded vesting method for recognizing compensation cost for fixed awards with pro rata vesting. The Company amortizes the deferred stock-based compensation on
the graded vesting method over the vesting periods of the applicable stock purchase rights and stock options, generally four years. The graded vesting method provides for vesting of portions of the overall awards at interim dates and results in
greater vesting in earlier years than the straight-line method.





As required under SFAS 123, the following pro
forma net loss and net loss per share presentations reflect the amortization of the fair value of the stock purchase rights grants and stock options as expense. For purposes of this disclosure, the estimated fair value of the stock purchase rights
and stock options is amortized to expense over the stock purchase rights and options vesting periods. The fair value of stock purchase rights and options granted during all periods was estimated at the date of the option grant using the
Black-Scholes option pricing model with the following assumptions:





Year Ended January 31,


Inception (September 9, 19992002


2001


to January 31, 2000)Risk-free interest yield

6.0
%

6.0
%

6.0
%Expected life (years)

4.0


4.0


4.0Volatility

157
%

70
%

70
%Dividend yield

0
%

0
%

0
%





The weighted average grant date fair value was $3.37, $3.88 and
$0.02 for stock purchase rights and stock options granted in the years ended January 31, 2002, 2001 and for the period from inception (September 9, 1999) to January 31, 2000, respectively.





The Companys consolidated pro forma information follows for the years ended January 31, 2002 and 2001 and for the period from inception (September 9, 1999) to January
31, 2000:





Year Ended January 31,


Inception (September 9, 19992002


2001


to January 31, 2000)(in thousands, except per share amounts)As reported consolidated net loss applicable to common stockholders

$
(210,675
)

$
(233,950
)

$
(4,981
)Consolidated pro forma net loss applicable to common stockholders


(220,360
)


(239,100
)


(4,997
)As reported consolidated net loss per share applicable to common stockholdersbasic and diluted


(3.45
)


(165.57
)


(1,815.23
)Consolidated pro forma net loss per share applicable to common stockholdersbasic and diluted


(3.61
)


(169.21
)


(1,821.06
)





The effects on pro forma disclosures of applying SFAS 123 are not
likely to be representative of the effects on pro forma disclosures in future years.




20




---



LOUDCLOUD, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







9.    Income Taxes





There is no provision for income taxes because the Company has incurred net operating losses. Deferred income taxes reflect the net tax
effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Companys deferred tax assets are as follows:





January 31,2002


2001(in thousands)Net operating loss carryforwards

$
64,000


$
26,055Deferred revenue


8,000



5,000Non-deductible reserves and accruals


10,500



5,900Other


2,100



1,545Total deferred tax assets


84,600



38,500Valuation allowance


(84,600
)


(38,500
)Net deferred tax assets

$



$






Realization of deferred tax assets is dependent upon future
earnings, if any, the timing and amount of which are uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance. The valuation allowance increased by approximately $46.1 million and $37.3 million during the
years ended January 31, 2002 and 2001, respectively.





As of January 31, 2002, the Company had net operating loss
carryforwards for federal income tax purposes of approximately $171 million, which expire in the years 2020 through 2022, and federal research and development tax credits of approximately $400,000, which expire in the years 2020 through 2022. In
addition, the Company had state net operating loss carryforwards of approximately $100 million, which expire in the years 2010 through 2012, and state research and development credits of approximately $350,000, which do not expire.





Utilization of the Companys net operating loss and tax credit carryforwards may be subject to a substantial annual
limitation due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such an annual limitation may result in the expiration of the net operating loss and tax credit carryforwards before utilization.





10.    Net Loss Per Share





The Company follows the provisions of Statement of Financial Accounting Standards No. 128, Earnings Per Share. Basic and diluted net loss per share is computed by dividing
the consolidated net loss by the weighted average number of common shares outstanding during the period less outstanding nonvested shares.




21




---



LOUDCLOUD, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







Outstanding nonvested shares are not included in the computation of
basic consolidated net loss per share until the time-based vesting restrictions have lapsed.





Year Ended January 31,


Inception(September 9, 1999)2002


2001


to January 31, 2000(in thousands, except per share amounts)Consolidated net loss applicable to commonstockholders (numerator)

$
(210,675
)

$
(233,950
)

$
(4,981
)Shares used in computing historical basic and diluted consolidated net loss per share applicable to common stockholders
(denominator):Weighted average common shares outstanding


73,805



19,006



10,348Less weighted average shares subject to repurchase


(12,716
)


(17,593
)


(10,345
)Denominator for basic and diluted consolidated net loss per share


61,089



1,413



3Historical basic and diluted consolidated net loss per shareapplicable to common stockholders

$
(3.45
)

$
(165.57
)

$
(1,815.23
)





The Company has excluded the impact of all convertible preferred
stock, shares of common stock subject to repurchase, warrants for convertible preferred stock and common stock from the calculation of historical diluted consolidated net loss per common share because all such securities are antidilutive for all
periods presented. The total number of shares excluded from the calculations of historical diluted consolidated net loss per share was 7.6 million, 43.2 million and 35.4 million for the years ended January 31, 2002, 2001 and for the period from
inception (September 9, 1999) to January 31, 2000, respectively.





11.    Legal Proceedings





The Company is currently a defendant in multiple lawsuits filed beginning in August 2001 claiming that it, certain of its
officers, directors and the underwriters of its initial public offering violated federal securities laws by providing materially false and misleading information in its prospectus. These lawsuits, which are pending in the U.S. District Courts for
the Southern District of New York and the Northern District of California, are being brought as a class action on behalf of all purchasers of the Companys common stock from March 8, 2001 to May 1, 2001, and seek damages in unspecified amounts.
The Company strongly denies these allegations and will defend itself vigorously; however, litigation is inherently uncertain and there can be no assurance that the Company will not be materially affected. In addition, the Company anticipates that it
will incur associated litigation expenses in connection with these lawsuits.




22




---



LOUDCLOUD, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







12.    Quarterly Results (Unaudited)





The table below sets forth selected unaudited financial data for each quarter of the last two years.





First Quarter


Second Quarter


Third Quarter


Fourth Quarter(in thousands, except per share amounts)Year ended January 31, 2002Net revenue

$
11,662


$
14,088


$
14,316


$
15,946Restructuring charges






30,162



1,309



Amortization of deferred stock compensation


16,900



10,282



8,174



7,310Loss from operations


(59,688
)


(75,789
)


(39,718
)


(32,139
)Net loss


(60,313
)


(75,987
)


(40,722
)


(33,653
)Basic and diluted net loss per share applicable to common stockholders

$
(1.25
)

$
(1.19
)

$
(0.62
)

$
(0.51
)Year ended January 31, 2001Net revenue

$
86


$
1,855


$
4,613


$
8,932Amortization of deferred stock compensation


5,846



18,518



26,714



20,647Loss from operations


(13,793
)


(34,403
)


(58,529
)


(58,081
)Net loss


(14,601
)


(34,842
)


(58,164
)


(58,813
)Series C convertible preferred stock deemednon-cash dividend






(67,530)







Net loss applicable to common stockholders


(14,601
)


(102,372
)


(58,164
)


(58,813
)Basic and diluted net loss per share applicableto common stockholders

$
(1,175.98
)

$
(2,647.32
)

$
(58.93
)

$
(12.83
)





Basic and diluted net losses per share are computed independently
for each of the quarters presented. Therefore, the sum of the quarters may not be equal to the full year net loss per share amounts.





13.    Subsequent Events





2000 Employee Stock Purchase Plan





In February 2002, an additional 1.5 million shares were added to the available shares for issuance under the
Employee Stock Purchase Plan pursuant to the annual increase provisions of the Purchase Plan.





Frontera
Acquisition





In February 2002,the Company entered into an agreement to acquire Frontera Corporation, a
privately held managed services provider located in southern California, for consideration consisting solely of the Companys common stock. The acquisition is valued at approximately $8 million to $9 million. Management believes that the
Company will receive approximately $9.0 million of cash if the Frontera transaction closes. The closing of the acquisition is expected to occur in the second quarter of fiscal 2003 and is subject to customary closing conditions, including Frontera
stockholder approval and regulatory approvals.





Repurchase of 13% Senior Discount Notes due 2005





On June 14, 2002, the Company repurchased their 13% Senior Discount Notes due 2005 for $42.0 million in cash
and the issuance of approximately 2.0 million shares of the Companys common stock valued at $3.0 million.





Electronic Data Systems Corporation





On June 14, 2002, the Company
entered into an agreement to sell all of the assets, plus the assumption of certain liabilities relating to its managed service business to Electronic Data Systems Corporation (EDS) for estimated net proceeds of $61.5 million, subject to purchase
price adjustments depending on the occurrence of certain events, plus the assumption of certain liabilities. EDS and the Company also entered into a three-year license agreement whereby EDS will license from the Company for a fee Opsware Automation
Technologies, subject to a minimum commitment by EDS of $52 million. The license is limited to use of Opsware by EDS to manage its internal operations and to provide managed services to its customers. The license is non-transferable and all
rights, title and interest in Opsware remain with the Company. The Company must develop specified features and functionality under the license agreement.





The approval of the sale of the managed services business requires the vote of holders of a majority of Loudclouds outstanding common stock and various other customary conditions to closing. In
addition, the asset purchase agreement maybe terminated in certain circumstances.





Going Concern





The accompanying financial statements have been prepared assuming the Company will continue as a going
concern. As discussed above the Company paid $42 million in cash as part of the consideration to repurchase their 13% Senior Discount Notes due 2005 in June 2002, which significantly reduces their funds available for operations. In addition, the
funds available for Loudclouds operations do no take into consideration the estimated net proceeds of $61.5 million, subject to a purchase price adjustment, from the EDS transaction and estimated cash received from the Frontera transaction of
$9.0 million, as these transactions may not close. These conditions raise substantial doubt about the Companys ability to continue as a going concern, if the preceding transactions do not close. Management believes that upon the closing of the
EDS transaction, the Frontera acquisition and the restructuring of its operations which will be required to develop, market and sell Opsware software, the Company will have sufficient funds for the operation of the Software Business. The financial
statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.





|ITEM 9. |  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|------- |  | ------------------------------------------------------------------------------------




None.




23




---

PART IV





ITEM 14.    EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K





| | (a) |  | 1.    Consolidated Financial Statements.
| | --- |  | ----------------------------------------




See Index to Consolidated Financial Statements at Item 8 on page 1 of this Annual Report on Form 10-K.





| | 2.    Financial |  | Statement Schedules.
| | --------------- |  | --------------------




The following consolidated financial statement schedules of Loudcloud, Inc. are filed as part of this Annual Report on Form 10-K and should be read in conjunction with the Financial Statements:





Schedule

PageIIValuation and Qualifying Accounts

**





Schedules not listed above have been omitted because they are not
applicable or are not required or the information required to be set forth therein is included in the Consolidated Financial Statements or notes thereto.





| | 3. |  | Exhibits:
| | -- |  | ---------




The following exhibits are filed as part of, or incorporated by reference into, this Report on Form 10-K:





Exhibit Number

Description3.1*

Amended and Restated Certificate of Incorporation of the Registrant.3.2**

Bylaws of the Registrant.10.1*+

Registrants 1999 Stock Plan.10.2*+

Registrants 2000 Stock Plan.10.3*+

Registrants 2000 Incentive Stock Plan.10.4**+

Registrants Employee Stock Purchase Plan.10.5*+

Form of Directors and Officers Indemnification Agreement.10.6*

Investor Rights Agreement, dated June 23, 2000, by and among the Registrant and the parties who are signatories
thereto.10.7*

Indenture, dated February 9, 2000, by and among the Registrant and the parties who are signatories thereto.10.8*

Notes Registration Rights Agreement, dated February 9, 2000, by and among the Registrant and the parties who are
signatories thereto.10.9*+

Promissory Note dated June 22, 2000, by and among the Registrant and Roderick M. Sherwood III.10.10*+

Promissory Note dated August 24, 2000, by and among the Registrant and Roderick M. Sherwood III.10.11**+

Promissory Note dated May 9, 2000 by and among the Registrant and James T. Dimitriou.10.12*

Lease Agreement between the Registrant and Sequoia Del Rey, dated January 31, 2000.10.13*

Lease between the Registrant and Maude Avenue Land Corporation, dated October 17, 2000.23.1

Consent of Ernst & Young LLP, Independent Auditors.24.1**

Power of Attorney.




24




---

---

|* |  | Incorporated by reference from our registration statement on Form S-1, registration number 333-46606, declared effective by the Securities and Exchange
Commission on March 8, 2001.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|** |  | Previously Filed.
|-- |  | -----------------

|+ |  | Contract, plan or arrangement with management.
|- |  | ----------------------------------------------




| | (b) |  | Reports on Form 8-K.
| | --- |  | --------------------




We did not file any reports on Form 8-K during the fiscal year ended January 31, 2002.





| | (c) |  | Exhibits.
| | --- |  | ---------




See Item 14(a) above.





| | (d) |  | Financial Statements and Schedules.
| | --- |  | -----------------------------------




See Item 14(a) above.




25




---




SIGNATURES





Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Sunnyvale, State of California, on the  19th day of
June 2002.





LOUDCLOUD, INC.By:

/s/     BENJAMIN A.
HOROWITZ*Benjamin A. Horowitz President, Chief Executive Officer and Director





POWER OF ATTORNEY





Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the
registrant on June 19th, 2002 in the capacities indicated:





Signature

Title/s/    BENJAMIN A. HOROWITZ*
Benjamin A. Horowitz

President, Chief Executive Officer and Director (Principal Executive Officer)/s/    RODERICK M. SHERWOOD
III* Roderick M. Sherwood III

Chief Financial Officer (Principal Financial and Accounting Officer)/s/    MARC L. ANDREESSEN* Marc L. Andreessen

Chairman of the Board of Directors/s/     WILLIAM V. CAMPBELL*
William V. Campbell

Director/s/    MICHAEL S. OVITZ* Michael S. Ovitz

Director/s/    ANDREW S. RACHLEFF* Andrew S. Rachleff

Director


*By:

/s/    JORDAN J.
BRESLOWJordan J. Breslow Attorney-in-fact




26




---

EXHIBIT INDEX





Exhibit Number


Description3.1
*

Amended and Restated Certificate of Incorporation of the Registrant.3.2
**

Bylaws of the Registrant.10.1
*+

Registrants 1999 Stock Plan.10.2
*+

Registrants 2000 Stock Plan.10.3
*+

Registrants 2000 Incentive Stock Plan.10.4
**+

Registrants Employee Stock Purchase Plan.10.5
*+

Form of Directors and Officers Indemnification Agreement.10.6
*

Investor Rights Agreement, dated June 23, 2000, by and among the Registrant and the parties who are signatories
thereto.10.7
*

Indenture, dated February 9, 2000, by and among the Registrant and the parties who are signatories
thereto.10.8
*

Notes Registration Rights Agreement, dated February 9, 2000, by and among the Registrant and the parties who are
signatories thereto.10.9
*+

Promissory Note dated June 22, 2000, by and among the Registrant and Roderick M. Sherwood III.10.10
*+

Promissory Note dated August 24, 2000, by and among the Registrant and Roderick M. Sherwood III.10.11
**+

Promissory Note dated May 9, 2000, by and among the Registrant and James T. Dimitriou.10.12
*

Lease Agreement between the Registrant and Sequoia Del Rey, dated January 31, 2000.10.13
*

Lease between the Registrant and Maude Avenue Land Corporation, dated October 17, 2000.23.1


Consent of Ernst & Young LLP, Independent Auditors.24.1
**

Power of Attorney.


---

|* |  | Incorporated by reference from our registration statement on Form S-1, registration number 333-46606, declared effective by the Securities and Exchange
Commission on March 8, 2001.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|** |  | Previously filed.
|-- |  | -----------------

|+ |  | Contract, plan or arrangement with management.
|- |  | ----------------------------------------------