Network Commerce 10Q 2000 Q3 Quarterly report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

/x/	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000

/ /	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 0-26707

NETWORK COMMERCE INC.
(Exact name of registrant as specified in its charter)

WASHINGTON
(State or other jurisdiction of
incorporation or organization)

91-1628103
(IRS Employer
Identification Number)

411 1st AVENUE SOUTH
SUITE 200 NORTH
SEATTLE, WA 98104
(Address of principal executive offices)

(206) 223-1996
(Registrant's telephone number, including area code)

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

As of November 9, 2000, there were 62,183,852 shares outstanding of the Registrant's common stock.

Network Commerce Inc.
Form 10-Q

Index

		PAGE
PART I	FINANCIAL INFORMATION
ITEM 1:	Financial Statements
	Consolidated Balance Sheets as of September 30, 2000 and December 31, 1999	3
	Consolidated Statements of Operations for the three- and nine-month periods ended September 30, 2000 and 1999	4
	Consolidated Statements of Cash Flows for the nine-month periods ended September 30, 2000 and 1999	5
	Notes to Interim Consolidated Financial Statements	6
ITEM 2:	Management's Discussion and Analysis of Financial Condition and Results of Operations	16
ITEM 3:	Quantitative and Qualitative Disclosures about Market Risk	37
PART II	OTHER INFORMATION
ITEM 1:	Legal Proceedings	38
ITEM 2:	Changes in Securities and Use of Proceeds	38
ITEM 3:	Defaults Upon Senior Securities	39
ITEM 4:	Submission of Matters to a Vote of Security Holders	39
ITEM 5:	Other Information	39
ITEM 6:	Exhibits and Reports on Form 8-K	39
SIGNATURES		40
EXHIBITS

PART I. FINANCIAL INFORMATION

ITEM 1.

Network Commerce Inc.

Consolidated Balance Sheets

(in thousands, except share amounts)

			September 30, 2000			December 31, 1999
			(unaudited)
ASSETS
Current assets:
	Cash and cash equivalents		$	16,967		$	10,660
	Short-term investments			70,138			52,172
	Investments in marketable equity securities			5,537			30,884
	Accounts receivable, net			20,814			6,591
	Unbilled services			4,307			2,102
	Prepaid expenses and other			8,913			5,559

		Total current assets		126,676			107,968
Property and equipment, net				31,855			19,385
Goodwill, net				67,071			23,860
Other intangible assets, net				163,959			104,713
Other assets, net				32,710			18,248

		Total assets	$	422,271		$	274,174

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
	Accounts payable		$	19,333		$	8,330
	Accrued liabilities			9,682			8,778
	Current portion of notes and leases payable			9,890			8,565
	Customer deposits			3,491			2,194
	Deferred revenue			5,827			5,786

		Total current liabilities		48,223			33,653
Notes and leases payable and line of credit, less current portion				18,183			5,409
Put warrant liability				—			1,388
Deferred tax liabilities				3,892			4,511

		Total liabilities		70,298			44,961

Commitments
Shareholders' equity:
	Convertible preferred stock, $0.001 par value: authorized shares—5,000,000; none issued and outstanding			—			—
	Common stock, $0.001 par value: authorized shares—200,000,000; issued and outstanding shares—62,041,462 at September 30, 2000 and 42,923,035 at December 31, 1999			543,683			325,502
	Common stock warrants			18,073			8,260
	Deferred compensation			(9,347	)		(6,713	)
	Accumulated other comprehensive (loss) income			(18,641	)		7,470
	Accumulated deficit			(181,795	)		(105,306	)

		Total shareholders' equity		351,973			229,213

		Total liabilities and shareholders' equity	$	422,271		$	274,174

The accompanying notes are an integral part of these consolidated balance sheets.

Network Commerce Inc.

Consolidated Statements of Operations

(in thousands, except share amounts)
(unaudited)

			For the Three Month Period Ended September 30,						For the Nine Month Period Ended September 30,
			2000			1999			2000			1999
Revenues			$	33,443		$	7,555		$	79,046		$	23,537

Cost of revenues				15,191			4,811			38,424			19,494
Cost of revenues—unusual item (Note 9)				5,320			—			5,320			—

		Total cost of revenues		20,511			4,811			43,744			19,494

		Gross profit		12,932			2,744			35,302			4,043

Operating expenses:
	Sales and marketing			24,114			15,265			70,246			33,545
	General and administrative			3,489			3,012			10,083			5,493
	Research and development			6,660			2,433			16,070			5,367
	Amortization of intangible assets			23,842			2,096			55,634			3,734
	Stock-based compensation			1,484			592			4,626			2,547

		Total operating expenses		59,589			23,398			156,659			50,686

		Loss from operations		(46,657	)		(20,654	)		(121,357	)		(46,643	)

Nonoperating income (expense):
	Gain on sale of marketable equity securities			4,163			—			5,542			—
	Interest income (expense), net			666			(360	)		2,582			(605	)
	Impairment of cost-basis investments (Note 9)			(2,486	)		—			(2,486	)		—

		Total nonoperating income (expense), net		2,343			(360	)		5,638			(605	)

		Net loss before income tax benefit		(44,314	)		(21,014	)		(115,719	)		(47,248	)
Income tax benefit				15,680			—			39,230			—

		Net loss	$	(28,634	)	$	(21,014	)	$	(76,489	)	$	(47,248	)

Basic and diluted net loss per share			$	(0.48	)	$	(3.42	)	$	(1.36	)	$	(9.03	)

Weighted average shares outstanding used to compute basic and diluted net loss per share				60,063,876			6,139,867			56,395,640			5,230,394

The accompanying notes are an integral part of these unaudited interim consolidated statements.

Network Commerce Inc.

Consolidated Statements of Cash Flows

(in thousands)
(unaudited)

				For the Nine Month Period Ended September 30,
				2000			1999
Operating activities:
	Net loss			$	(76,489	)	$	(47,248	)
	Adjustments to reconcile net loss to net cash used in operating activities—
		Depreciation and amortization			63,743			6,364
		Cost of revenues—unusual item			5,320			—
		Deferred income tax benefit			(39,230	)		—
		Non-cash consideration received			(5,213	)		—
		Amortization of deferred compensation			4,626			1,947
		Impairment of cost-basis investments			2,486			—
		Realized gain from sale of marketable equity securities			(5,542	)		—
		Operating expenses paid in stock and warrants			—			1,354
		Changes in operating assets and liabilities, excluding effects of acquired businesses—
			Accounts receivable, net		(14,921	)		(5,627	)
			Prepaid expenses and other assets		(7,405	)		(3,290	)
			Unbilled services and customer deposits		(1,158	)		4,190
			Accounts payable and accrued liabilities		8,907			8,351
			Deferred revenue		(1,105	)		5,383

			Net cash used in operating activities		(65,981	)		(28,576	)

Investing activities:
	Purchases of short-term investments				(130,785	)		(23,630	)
	Sales of short-term investments				112,883			15,111
	Proceeds from sale of investments				9,243			—
	Purchases of property and equipment				(18,232	)		(9,533	)
	Investments in equity and debt securities and other assets				(14,954	)		(642	)
	Acquisition of businesses, net of cash acquired of $392 in 2000 and $640 in 1999				(18,051	)		(3,951	)

			Net cash used in investing activities		(59,896	)		(22,645	)

Financing activities:
	Borrowings on line of credit, net of loan fees paid				9,095			1,000
	Payments on line of credit				—			(238	)
	Proceeds from debt financing				20,000			10,706
	Payments on long-term debt				(7,502	)		(1,613	)
	Proceeds from sales of preferred stock				—			33,429
	Proceeds from sale of common stock				110,591			1,030

			Net cash provided by financing activities		132,184			44,314

Net increase (decrease) in cash and cash equivalents					6,307			(6,907	)
Cash and cash equivalents at beginning of period					10,660			9,820

Cash and cash equivalents at end of period				$	16,967		$	2,913

Supplementary disclosure of cash flow information:
	Cash paid during the period for interest			$	1,236		$	911

	Cash paid during the period for income taxes			$	—		$	—

	Non-cash investing and financing activities:
		Common stock, options and warrants issued and liabilities assumed as part of business and technology acquisitions		$	138,642		$	11,560

The accompanying notes are an integral part of these unaudited interim consolidated statements.

Network Commerce Inc.

Notes To Interim Consolidated Financial Statements

(unaudited)

Note 1. Organization and Background:

The Company

Network Commerce Inc. (the Company), a Washington corporation, is a global technology infrastructure and services company. The Company provides a comprehensive technology and services platform including domain registration, hosting services, e-commerce services, wireless technology and online marketplaces. The Company operates two commerce networks, known as the Network Commerce Consumer Network, which aggregates merchants and shoppers over a distributed network of web sites, and the Network Commerce Business Network, which is designed to enable businesses to engage in online activities and transactions with other businesses. The Company's headquarters are located in Seattle, Washington.

The Company is subject to the risks and challenges associated with other companies at a similar stage of development, including dependence on key management personnel, successful development and marketing of its products and services, the continued acceptance of the Internet, competition from substitute products and services from companies with greater financial, technical, management and marketing resources and risks associated with recent acquisitions. Further, during the period required to develop commercially viable products, services and sources of revenues, the Company may require additional funds that may or may not be readily available.

Public Offerings

On October 4, 1999, the Company closed its initial public offering (IPO) of 7,250,000 shares of common stock at $12.00 per share, for proceeds net of underwriters' fees and commissions of $80.9 million. At closing, all of the Company's issued and outstanding shares of convertible preferred stock were converted into shares of common stock on a one-for-one basis. On November 2, 1999, the underwriters of the IPO exercised their over-allotment option and sold an additional 1,087,500 shares at $12.00 per share, for proceeds net of underwriters' fees and commissions of $12.1 million. The combined net proceeds to the Company, less additional offering costs of approximately $1.9 million, were $91.1 million. In addition, a $1.0 million promissory note in connection with the Company's acquisition of GO Software, Inc. (GO) and a $4.0 million bridge loan with a financial institution plus accrued interest were repaid.

On February 18, 2000, the Company closed a supplemental public offering (SPO) of 7,913,607 shares of common stock at $14.50 per share, for proceeds net of underwriters' fees and commissions of $108.7 million. Offering costs incurred by the Company relating to the SPO were approximately $700,000.

Note 2. Summary of Significant Accounting Policies:

Unaudited Interim Financial Data

The interim consolidated financial statements are unaudited and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's December 31, 1999 Form 10-K as filed with

the Securities and Exchange Commission on February 10, 2000. The financial information included herein reflects all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the results for interim periods. The results of operations for the three- and nine-month periods ended September 30, 2000 and 1999 are not necessarily indicative of the results to be expected for the full year.

Principles of Consolidation

The Company's consolidated financial statements include 100% of the assets, liabilities and results of operations of all subsidiaries in which the Company has a controlling ownership interest of greater than 50%. Equity investments in which the Company holds less than a 20% ownership interest are recorded at cost and are included in other assets, net in the accompanying consolidated balance sheets. All significant intercompany transactions and balances have been eliminated.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash, Cash Equivalents and Short-Term Investments

For the purposes of consolidated statements of cash flows, the Company considers investment instruments with an original maturity of three months or less to be cash equivalents. Cash equivalents are comprised of investments in money market funds, government mortgage backed bonds and highly rated corporate securities. The Company's short-term investments consist of corporate notes and bonds, commercial paper, municipal notes and bonds, auction preferreds and US government securities. The Company's cash equivalents and short-term investments are stated at cost, which approximates fair market value. The Company's short-term investments also include restricted cash of $8.1 million as of September 30, 2000.

Revenue Recognition

The Company derives substantially all of its revenues from the Network Commerce Consumer Network, the Network Commerce Business Network and from providing services to businesses.

Revenues from the Network Commerce Consumer Network, which is a network of proprietary and affiliated web sites includingwww.shopnow.com and licensed affiliates, the BottomDollar Network (includingwww.bottomdollar.com and licensed affiliates) andwww.speedyclick.com are generated primarily from the sale of on-line marketing services, leads and orders, advertising and merchandising. Revenues from these agreements are recognized as the media or services are delivered to the merchants over the term of the agreements, which typically range from one to twelve months. Where billings exceed revenues earned on these agreements, the amounts are included in the accompanying consolidated balance sheets as deferred revenue. The Company bears the full credit risk with respect to

these sales. In certain circumstances, such as with thewww.chaseshop.com portal, the Company offers products directly to shoppers. In these instances where the Company acts as merchant-of-record, the Company records as revenue the full sales price of the product sold and records the full cost of the product to the Company as cost of revenues, upon shipment of the product. Shipping charges billed to the customer are included in revenues, and the costs incurred by the Company to ship the product to the customer are included in cost of sales.

Revenues from the Network Commerce Business Network, which is a network of proprietary and affiliated web sites, includingwww.b2bnow.com,www.freemerchant.com,www.domainzero.com andwww.ubarter.com, are derived primarily from providing web-enablement services, commerce-enablement services, transaction processing, advertising and technology licensing to businesses. Revenues from b2bNow.com are generated primarily from the sales of advertising and merchandising products and services similar to those sold on the Network Commerce Consumer Network. Revenues from Ubarter.com are generated from transaction fees earned from member businesses that transact over the Ubarter exchange system as well as from products sold by Ubarter.com to other member merchants of the Ubarter exchange system. Revenues from services are generated principally through development fees, domain registration fees, hosting fees and sales and marketing services. These services can be purchased as a complete end-to-end suite of services or separately. The Company recognizes revenues from the development of custom applications and online stores and marketing projects on a percentage of completion basis over the period of development or the period of the marketing project. These projects generally range from two to twelve months. Hosting contracts typically have a term of one year, with fees charged and earned on a monthly basis. The Company bears full credit risk with respect to these sales. Anticipated losses on these contracts are recorded when identified. To date, losses have not been significant. Contract costs include all direct labor, material, subcontract and other direct project costs and certain indirect costs related to contract performance. Changes in job performance, job conditions and estimated profitability, including those arising from contract penalty provisions and final contract settlements that may result in revision to costs and income, are recognized in the period in which the revisions are determined. Unbilled services typically represent amounts earned under the Company's contracts not billed due to timing or contract terms, which usually consider passage of time, achievement of certain milestones or completion of the project. Where billings exceed revenues earned on contracts, the amounts are included in the accompanying consolidated balance sheets as customer deposits, as the amounts typically relate to ancillary services, whereby the Company is acting in an agency capacity. Fee revenue from ancillary services provided by the services division is recognized upon completion of the related job by the applicable third party vendor.

Revenues are also generated from fees paid to the Company by businesses and merchants that license the Company's technology, transaction processing and fraud prevention technologies and on-line payment gateways, as well as other e-commerce enabling technologies. Revenues include licensing fees, per-transaction fees and in certain cases monthly hosting and maintenance fees, which are recognized in the period earned. Revenues generated from technology licensing are recognized in accordance with Statement of Position 97-2, "Software Revenue Recognition." Where billings exceed revenues earned on these contracts, the amounts are included in the accompanying consolidated balance sheets as deferred revenue. Businesses and merchants that utilize the Company's payment processing technologies act as the merchant-of-record and bear the full credit risk on those sales of goods and services.

The Company recognizes revenues from barter transactions when earned. The Company values the barter transactions based on the value of the consideration received from the customer or from the value of the services provided to the customer, whichever is more readily determinable. Revenues generated from barter transactions have historically not been significant.

Revenues generated from the Company's ceased BuySoftware.com business are included in the accompanying nine-month period ended September 30, 1999 interim consolidated statements of operations, as management did not cease operations of BuySoftware.com until June 1999.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company's income tax benefit of $15.7 million and $39.2 million recognized for the three- and nine-month periods ended September 30, 2000, respectively, are the result of changes in the Company's deferred tax accounts, which have principally been created as a result of the Company's recent business acquisitions and from the Company's generation of net operating losses.

Recent Accounting Pronouncements

In December 1999, the Securities and Exchange Commission released Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements," to provide guidance on the recognition, presentation and disclosure of revenues in financial statements. The Company believes its revenue recognition practices are in conformity with the guidelines prescribed in SAB No. 101.

In March 2000, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 44 (FIN 44), "Accounting for Certain Transactions Involving Stock Compensation." FIN 44 clarifies certain issues relating to the application of Accounting Principles Board Opinion No. 25 and related interpretations, which are the authoritative pronouncements the Company uses to account for its stock-based compensation transactions. FIN 44 is effective July 1, 2000, however certain conclusions reached in FIN 44 are applicable for transactions consummated after either December 15, 1998 or January 12, 2000. The adoption of FIN 44 did not have a material effect on the Company's financial position or results of operations.

In September 2000, the Emerging Issues Task Force of the FASB reached a consensus on Issue No. 00-10, "Accounting for Shipping and Handling Fees and Costs" to provide guidance on the classification of shipping and handling fees and costs in financial statements. This consensus is consistent with the Company's historical accounting policies described above and has no impact on the Company's financial position or results of operations.

In June 1998, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting

and reporting standards that require derivative instruments (including certain derivative instruments embedded in other contracts) be recorded at fair value. The statement requires that changes in the derivative's fair value be recognized currently in operations unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the statements of operations, and requires that a company must formally document, designate, and assess the effectiveness of transactions that are subject to hedge accounting. Pursuant to SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities—Deferral of the Effective Date of FASB No. 133—an Amendment to FASB Statement No. 133," the effective date of SFAS No. 133 has been deferred until fiscal years beginning after January 15, 2000. SFAS No. 133 cannot be applied retroactively. SFAS No. 133 must be applied to (a) derivative instruments and (b) certain derivative instruments embedded in hybrid contracts that were issued, acquired, or substantively modified after December 31, 1998 (and, at a company's election, before January 1, 1999). The Company has not yet quantified the impacts of adopting SFAS No. 133 on the financial statements and has not determined the timing or method of adopting SFAS No. 133. However, the statement could increase volatility in the consolidated statements of operations and in other comprehensive loss.

Reclassifications

Certain information reported in previous periods has been reclassified to conform to the current period presentation.

Note 3. Comprehensive Loss:

The following table represents the Company's comprehensive loss for the three- and nine-month periods ended September 30, 2000 and 1999:

		For the Three Month Period Ended September 30,						For the Nine Month Period Ended September 30,
		2000			1999			2000			1999
		(in thousands)
Net loss before income tax benefit		$	(44,314	)	$	(21,014	)	$	(115,719	)	$	(47,248	)

Other comprehensive (loss) income, before taxes:
	Unrealized (loss) gain on marketable equity securities		(2,491	)		1,746			(24,475	)		(2,762	)
	Reclassification adjustment for gains included in net loss		(470	)		—			(1,636	)		—

	Total other comprehensive (loss) income		(2,961	)		1,746			(26,111	)		(2,762	)

Comprehensive loss before income tax benefit		$	(47,275	)	$	(19,268	)	$	(141,830	)	$	(50,010	)

Note 4. Acquisitions:

On January 13, 2000, the Company, through its wholly owned subsidiary 3037952 Nova Scotia Company, a Nova Scotia Company, acquired Pronet Enterprises Ltd. (Pronet), a Canadian company, for approximately $12.8 million, of which $3.2 million was paid in cash, $2.2 million in non-cash

deferred tax liabilities assumed and $7.4 million in common stock and common stock options issued to Pronet shareholders. Pronet, a privately held company, operates a business-to-business portal and marketplace that aggregates businesses that seek to transact with one another. Upon effectiveness of the acquisition, a total of 162,508 shares of common stock, valued at $17.60 per share, were issued to the shareholders of Pronet. In addition, the Company issued options to purchase 351,666 shares of common stock to the two principals of Pronet. The Company accounted for this transaction as a purchase. Of the $12.8 million in consideration paid, approximately $6.3 million was allocated to acquired technology, $2.7 million to customer lists and $3.8 million to goodwill. These intangible assets are being amortized over a three-year life.

On January 18, 2000, the Company acquired AXC Corporation (AXC), a Washington corporation, for approximately $17.9 million, of which $2.2 million was paid in cash, $4.1 million in non-cash deferred tax liabilities assumed and $11.6 million in common stock and common stock options issued to AXC shareholders. AXC, a privately held company, provides e-commerce consulting services to businesses. Upon effectiveness of the acquisition, a total of 540,296 shares of common stock valued at $17.60 per share were issued to the owners of AXC. In addition, the Company issued replacement stock options to purchase an aggregate of 72,089 shares of the Company's common stock to certain employees and owners of AXC. The Company accounted for this transaction as a purchase. Of the $17.9 million in consideration paid, approximately $7.2 million was allocated to assembled workforce, $4.9 million to customer lists, $5.0 million to goodwill and $800,000 to working capital. These intangible assets are being amortized over a three-year life.

On April 11, 2000, the Company acquired Freemerchant.com, Inc. (Freemerchant), a Delaware corporation, for approximately $38.1 million, of which $2.0 million was paid in cash, $10.0 million in non-cash deferred tax liabilities assumed, $0.5 million of debt assumed and $25.6 million in common stock and common stock options issued to Freemerchant shareholders. Freemerchant, a privately held company, has developed on-line store-builder technology for small- to medium-sized merchants that seek a low-cost entry point to e-commerce, as well as providing hosting services to those merchants. Upon effectiveness of the acquisition, a total of 2,573,723 shares of common stock, valued at $8.80 per share, were issued to the shareholders of Freemerchant. In addition, the Company issued options to purchase 293,596 shares of common stock to certain Freemerchant shareholders and employees. The Company accounted for this transaction as a purchase. Of the $38.1 million in consideration paid, approximately $23.0 million was allocated to acquired technology, $4.1 million to assembled workforce and $11.0 million to goodwill. These intangible assets are being amortized over a three-year life.

On June 2, 2000, the Company effected its acquisition of Ubarter.com Inc (Ubarter), a Nevada corporation, pursuant to an agreement and plan of merger dated January 20, 2000, for approximately $61.7 million, of which $875,000 was paid in cash, $11.4 million in non-cash deferred tax liabilities assumed, $978,000 of net liabilities assumed, $7.6 million in the cancellation of debt between Ubarter and the Company, and $40.8 million in common stock and common stock warrants issued to Ubarter shareholders and creditors. Ubarter, a publicly traded company, is a business-to-business e-commerce enterprise which utilizes the Ubarter Dollar as payment for products and services by its member businesses over its proprietary barter exchange system. Upon effectiveness of the acquisition, a total of 2,682,871 shares of common stock valued at approximately $15.10 per share were issued to the shareholders and creditors of Ubarter. In addition, the Company issued warrants to purchase 51,842

shares of common stock to certain Ubarter shareholders, employees and creditors. The Company accounted for this transaction as a purchase. Of the $61.7 million in consideration paid, approximately $7.5 million was allocated to acquired technology, $2.5 million to assembled workforce, $25.1 million to proprietary concept, $2.5 million to customer lists, and $24.0 million to goodwill. These intangible assets are being amortized over a three-year life.

On August 24, 2000, the Company effected its acquisition of Ivebeengood.com, d.b.a. UberWorks (UberWorks), a wholly owned subsidiary of Trilogy, Inc. (Trilogy), for approximately $22.8 million, of which $2.4 million was accrued as non-cash deferred compensation, $5.9 million in non-cash deferred tax liabilities assumed and $14.5 million in common stock and common stock options issued to UberWorks shareholders and employees. UberWorks is a developer of multi-merchant e-commerce purchasing tools and universal shopping cart technology. Upon effectiveness of the acquisition, a total of 2,601,562 shares of common stock valued at approximately $6.13 per share were issued to shareholders of UberWorks, of which 423,253 are being held back by the Company to be subsequently released based on time vesting and on certain performance criteria yet to be achieved. The maximum term of the retention is three years from the effective date of the acquisition. In addition, the Company issued a warrant to Trilogy, with a strike price of $0.000001 per share, to purchase additional shares of the Company's common stock if on the one-year anniversary date of the acquisition, the shares currently held by Trilogy (the Trilogy Shares) are not worth at least $13.1 million. The maximum number of additional shares that Trilogy can purchase under the terms of the warrant is 2.6 million. To the extent that the Trilogy Shares have a fair market value that exceeds $13.1 million on the one-year anniversary date, the warrant is cancelled and Trilogy must forfeit the number of Trilogy Shares that would be required to bring their fair value down to $13.1 million, limited to a maximum of 1.3 million shares to be forfeited under this scenario. The Company also issued options to purchase 248,162 shares of common stock to certain UberWorks employees. The Company accounted for this transaction as a purchase. Of the $22.8 million of consideration paid, approximately $12.3 million was allocated to acquired technology, $2.4 million to deferred compensation, $726,000 to assembled workforce and $7.3 million to goodwill. These intangible assets are being amortized over a three-year life. Deferred compensation will be amortized over the three-year term of the option agreements, subject to certain accelerated vesting criteria.

Unaudited Pro Forma Combined Results

The following summarizes the unaudited pro forma results of the Company's operations for the nine-month periods ended September 30, 2000 and 1999 as if the transactions described above as well as acquisitions effected during 1999 had occurred as of January 1, 1999. The pro forma results are

presented for the purposes of additional analysis only and do not purport to present the results of operations that would have occurred for the periods presented or that may occur in the future.

	For the Nine Month Period Ended September 30,
	2000			1999
	(in thousands, except share amounts)
Revenues	$	80,842		$	33,092
Net loss before taxes		(141,870	)		(124,432	)
Net loss per share before taxes		(2.40	)		(5.80	)

5. Investments in Marketable Equity Securities:

At September 30, 2000, the Company held equity investments in certain publicly traded companies with a fair value of $5.5 million. The Company classifies these investments as available for sale and they are stated at fair value in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." This statement specifies that available for sale securities are reported at fair value with changes in unrealized gains and losses recorded directly to shareholders' equity, which are reflected in accumulated other comprehensive income (loss) in the accompanying consolidated balance sheets. Fair value is based on quoted market prices.

6. Debt Obligations:

In March 1999, the Company entered into a loan and security agreement with a financial institution for a term loan and line of credit. In May 1999, the agreement was amended and restated to allow the Company to borrow up to $8.5 million at any one time, consisting of a $3.5 million term loan (term loan), a $4.0 million bridge loan (bridge loan) and a line of credit of up to $2.5 million. The term loan bears interest at 12%, is secured by a letter of credit and matures in March 2002. The term loan balance was $2.1 million as of September 30, 2000. The outstanding credit line and bridge loan balances were both $0 as of September 30, 2000.

On May 19, 2000, the Company entered into a credit agreement with a commercial bank, with a maximum commitment amount of $15.0 million to finance the purchase of equipment, software and tenant improvements. The credit agreement is secured by substantially all of the Company's assets and had an outstanding balance of $9.2 million at September 30, 2000. The outstanding commitments bear interest at an annual rate equal to the prime lending rate plus one and one-half percent. Outstanding commitments under the agreement are required to be repaid under specific schedules, with all commitments to be repaid no later than November 18, 2003. The credit agreement requires the Company to maintain certain financial ratios and places limitations on certain financing and investing activities. The credit agreement also contains other customary conditions and events of default that, in the event of noncompliance by the Company, would prevent any further borrowings and would generally require the repayment of any outstanding commitments under the credit agreement. The Company was in compliance with these covenants as of September 30, 2000.

On September 29, 2000 (Closing), the Company sold $20 million of convertible notes (Notes) and warrants to a private institution. The Notes have a one-year term and bear interest at an annual rate of six percent. The conversion price for the Notes are 95% of the average closing bid price of the Company's common stock during a 20-day trading period prior to the conversion date (which automatically occurs upon the effectiveness of a registration statement filed with the Securities and Exchange Commission), subject to a maximum conversion price of the lower of the Company's common stock closing bid price the day prior to Closing or $7.50 per share. On October 26, 2000, the Company filed a registration statement on Form S-3 with the Securities and Exchange Commission, which under the terms of the Notes agreement, must be declared effective within 90 days of Closing. Delays in the effectiveness of the registration statement could result in a reduction of the conversion price and/or cash penalties to the Company. Also at Closing, the Company issued warrants to purchase 4,050,633 shares of the Company's common stock to the private institution at an exercise price of $10.37 per share. The warrants are immediately exercisable and expire five years from Closing. These warrants were valued at $9.4 million and were recorded as common stock warrants in the accompanying September 30, 2000 consolidated balance sheet. The Notes were valued at $10.6 million and are classified as a component of long-term notes and leases payable in the accompanying September 30, 2000 consolidated balance sheet as it is management's intent to convert these Notes into shares of common stock under the terms of the Notes agreement.

7. Segment Information:

The following table represents the Company's segment information for the three- and nine-month periods ended September 30, 2000 and 1999:

			For the Three Month Period Ended September 30,				For the Nine Month Period Ended September 30,
			2000		1999		2000		1999
			(in thousands)
Revenues from unaffiliated customers:
	Consumer Network		$	22,033	$	4,366	$	48,362	$	6,249
	Business Network			6,598		—		15,752		—
	Services			4,812		3,189		14,932		7,365
	BuySoftware.com			—		—		—		9,923

		Total revenues from unaffiliated customers		33,443		7,555		79,046		23,537

Cost of revenues:
	Consumer Network			10,659		2,561		26,395		3,584
	Consumer Network—unusual item			5,320		—		5,320		—
	Business Network			2,076		—		3,500		—
	Services			2,456		2,250		8,529		4,720
	BuySoftware.com			—		—		—		11,190

		Total cost of revenues		20,511		4,811		43,744		19,494

		Gross profit	$	12,932	$	2,744	$	35,302	$	4,043

The Company does not track assets by operating segments. Consequently is it not practicable to show assets by operating segments.

8. Related Party Transactions:

During the nine-month period ended September 30, 2000, the Company purchased approximately $2.8 million in marketing and advertising services and recognized approximately $1.0 million of marketing revenues from 24/7 Media, a significant shareholder of the Company. During the same period ended September 30, 2000, the Company recognized approximately $2.0 million in licensing revenues from Persona Inc. (formerly PrivaSeek, Inc.), in which the Company owns a minority interest. Also during the same time period, the Company recognized approximately $3.9 million in marketing and registrations revenues and paid approximately $1.0 million in site licensing fees to PlanetofMusic.com, Inc., in which the Company owns a minority interest.

9. Impairment of Cost-Basis Investments and Unusual Item:

During the third quarter of 2000, management determined that certain of its cost-basis investments were permanently impaired to between 20% and 100% of their historical values. As a result, the Company recognized an impairment charge of $2.4 million, which is shown as a component of nonoperating income (expense) in the accompanying consolidated statement of operations for the three- and nine-month periods ended September 30, 2000.

During the first quarter of 2000, the Company paid Inktomi Corp. (Inktomi) a $6.1 million prepaid fee to be a non-exclusive distributor of Inktomi's shopping engine technologies. This fee allows the Company to sell up to 100 occurrences to Inktomi's shopping engine during a 12-month period subsequent to the first quarter 2000. Through September 30, 2000, the Company had recognized approximately $400,000 in revenues from this distribution agreement. Based on this sales history, management determined that the Company would not recover the remaining value of the prepaid fee before the 12-month period expires. As a result, the Company charged $5.3 million to cost of revenues—unusual item during the third quarter 2000 in order to write down this prepaid asset to its net realizable value, which was deemed to be approximately $300,000 as of September 30, 2000.

10. Subsequent Event:

On October 6, 2000, Mall.com, Inc. filed suit against the Company. The suit is based on a contract between Mall.com and IveBeenGood.com, which the Company acquired in August 2000. The suit alleges that IveBeenGood.com breached a contract with Mall.com, breached a warranty given to Mall.com and committed fraud and negligent misrepresentation. Mall.com seeks return of cash and stock paid by Mall.com, attorneys' fees and costs, $1 million in direct damages, $15 million in compensatory damages and $32 million in punitive damages. Management intends to vigorously defend the Company's position.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The matters discussed in this report contain forward-looking statements that involve known and unknown risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. Words such as "may," "could," "would," "expect," "anticipate," "intend," "plan," "believe," "estimate," and variations of such words and similar expressions are intended to identify such forward-looking statements. You should not place undue reliance on these forward-looking statements, which are based on our current expectations and projections about future events, are not guarantees of future performance, are subject to risks, uncertainties and assumptions (including those described below) and apply only as of the date of this report. Our actual results could differ materially from those anticipated in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below in "Additional Factors That May Affect Future Results" as well as those discussed in this section and elsewhere in this report, and the risks discussed in the "Risk Factors" section included in our December 31, 1999 10-K filed on February 10, 2000 with the Securities and Exchange Commission.

Overview

We are a global technology infrastructure and services company that offers a comprehensive technology and services platform solution, including domain registration, hosting services, e-commerce services, wireless technology and online marketplaces. Our technology and services platform operates across our core infrastructure, which includes four data centers, over 500 servers, and operates at a bandwidth of 400 megabits per second. The Company operates two commerce networks, known as the Network Commerce Consumer Network, which aggregates merchants and shoppers over a distributed network of web sites, and the Network Commerce Business Network, which is designed to enable businesses to engage in online activities and transactions with other businesses. These two networks combined include more than one million businesses and merchants in more than 230 countries worldwide.

We were incorporated in January 1994 and initially operated as a computer services company. In 1996, we began to change the focus of our business to conducting commerce over the Internet. In May 1997, we launched the BuySoftware.com Network, a network of online sites that sold computer products. During 1998, we completed three acquisitions, including the acquisition of Media Assets, Inc., a direct marketing company, launched ShopNow.com and began offering merchants e-commerce enabling products and services. In April 1999, we changed our name from TechWave Inc. to ShopNow.com Inc. In June 1999, we ceased operation of the BuySoftware.com Network because we determined it was inconsistent with our evolving strategy. In May 2000, we changed our name to Network Commerce Inc. We consummated five acquisitions during 1999 and five additional acquisitions through the third quarter of 2000.

We derive substantially all of our revenues from the Network Commerce Consumer Network, the Network Commerce Business Network and from providing services to businesses.

Revenues from the Network Commerce Consumer Network, which is a network of proprietary and affiliated web sites includingwww.shopnow.com and licensed affiliates, the BottomDollar Network (includingwww.bottomdollar.com and licensed affiliates) andwww.speedyclick.com are generated primarily from the sale of on-line marketing services, leads and orders, advertising and merchandising. Revenues from these agreements are recognized as the media or services are delivered to the merchants over the term of the agreements, which typically range from one to twelve months. We bear the full credit risk with respect to these sales. In certain circumstances, such as with thewww.chaseshop.com portal, we offer products directly to shoppers. In these instances where we act as merchant-of-record, we record as revenue the full sales price of the product sold and record the full

cost of the product to us as cost of revenues, upon shipment of the product. Shipping charges billed to the customer are included in revenues, and the costs incurred by us to ship the product to the customer are included in cost of sales.

Revenues are also generated from fees paid to us by businesses and merchants that license our technology, transaction processing and fraud prevention technologies and on-line payment gateways, as well as other e-commerce enabling technologies. Revenues include licensing fees, per-transaction fees and in certain cases monthly hosting and maintenance fees, which are recognized in the period earned. Revenues generated from technology licensing are recognized in accordance with Statement of Position 97-2, "Software Revenue Recognition." Businesses and merchants that utilize our payment processing technologies act as the merchant-of-record and bear the full credit risk on those sales of goods and services.

We recognize revenues from barter transactions when earned, and value barter transactions based on the value of the consideration received from the customer or from the value of the services provided to the customer, whichever is more readily determinable. Revenues generated from barter transactions have historically not been significant.

Cost of revenues generated from the Network Commerce Consumer Network include the portion of our Internet telecommunications connections that are directly attributable to traffic on the Network Commerce Consumer Network and the direct labor costs incurred in maintaining and enhancing our network infrastructure. In order to fulfill our obligations under our registrations, lead and order delivery advertising programs, we occasionally purchase consumer traffic from third party networks by placing on their web sites advertisements that, when clicked on by a visitor, send the visitor to the Network Commerce Consumer Network. Any shopping traffic that we purchase from a third party that is used to fulfill these obligations is included as cost of revenues. Cost of revenues on the products that we sell as merchant-of-record includes the cost of the product, credit card fees and shipping costs. Cost of revenues generated from providing services includes all direct labor costs incurred in connection with the provision of services, as well as fees charged by third-party vendors that have directly contributed to the design, development and implementation of our services. Cost of revenues generated from licensing e-commerce-enabling technologies and from our proprietary business-to-business portal consists primarily of telecommunications costs and direct labor costs incurred in maintaining and enhancing our network infrastructure.

During the first quarter of 2000, we paid Inktomi Corp. (Inktomi) a $6.1 million prepaid fee to be a non-exclusive distributor of certain of Inktomi's shopping engine technologies. This fee allows us to sell up to 100 occurrences to Inktomi's shopping engine during a 12-month period subsequent to the first quarter 2000. Through September 30, 2000, we had recognized approximately $400,000 in revenues from this distribution agreement. Based on this sales history, we determined that we would not recover the remaining value of the prepaid fee before the 12-month period expires. As a result, we charged $5.3 million to cost of revenues—unusual item during the third quarter 2000 in order to write down this prepaid asset to its net realizable value, which was deemed to be approximately $300,000 as of September 30, 2000.

At September 30, 2000, we held marketable equity securities with a fair market value of $5.5 million and a cost basis of $24.1 million, resulting in an unrealized holding loss of $18.6 million. This represents a $26.1 million decrease from the $7.5 million unrealized holding gain recognized as of December 31, 1999. The 476,410 shares of 24/7 Media comprise the majority of our marketable equity securities held as of September 30, 2000 and as of December 31, 1999.

Financial Data

The following table presents selected operating data for the Network Commerce Consumer and Business Networks. This information should be read in conjunction with the other information presented in Management's Discussion and Analysis of Financial Condition and Results of Operations. The operating data presented below for any quarter are not necessarily indicative of data for any future period.

	Sept. 30, 2000		June 30, 2000		March 31, 2000
Number of premier merchants listed on the Network Commerce Consumer Network(1)		118		125		97
Average quarterly revenue per premier merchant	$	122,831	$	71,736	$	47,504
Number of businesses listed on the Network Commerce Business Network(2)		1,025,000		899,000		610,000
Number of businesses utilizing our technology platforms		232,000		115,000		19,700

(1): Premier merchants include those merchants that contribute greater than $10,000 of revenue per month to the Network Commerce Consumer Network.
(2): Represents the number of businesses listed in the Network Commerce Business Network directory as of the last day of the applicable quarter. The Network Commerce Business Network launched in January 2000.

Acquisitions

In June 1999, we acquired GO Software, Inc. (GO). GO develops and markets transaction processing software for personal computers that can function on a stand-alone basis or can interface with core corporate accounting systems. We paid GO $4.7 million in cash, issued a $1.0 million promissory note bearing interest at 10%, and issued 1,123,751 shares of common stock, valued at $8.54 per share, for a total purchase price of $15.4 million. The acquisition was accounted for using the purchase method of accounting. Of the excess purchase price of approximately $14.4 million, $13.8 million was allocated to acquired technology and $556,000 was allocated to goodwill, which are both being amortized over a three-year life. The note bore interest at 10% and was repaid in full upon completion of our initial public offering completed in September 1999. Also in June 1999, we acquired CardSecure, Inc. (CardSecure) for a purchase price of approximately $3.5 million. CardSecure is a developer of e-commerce enabled Web sites. The acquisition was accounted for using the purchase

method of accounting. The excess purchase price of approximately $3.5 million was allocated to acquired technology and is being amortized over a three-year life.

On November 12, 1999, we acquired SpeedyClick, Corp. (SpeedyClick), a California corporation, for $55.6 million of cash, common stock and common stock options. SpeedyClick, a privately held company, maintains an Internet web site that focuses on entertainment, commerce and interactivity. Upon effectiveness of the acquisition, a total of 3,799,237 shares of common stock valued at $13.31 per share were issued to the owners of SpeedyClick. Options to purchase SpeedyClick common stock were assumed by us and converted into 157,527 options to purchase our common stock. We also paid cash consideration of $3.0 million to the owners of SpeedyClick. We accounted for this transaction as a purchase. Of the $55.6 million in consideration paid, approximately $27.9 was allocated to proprietary concepts, $14.7 million to customer lists and $13.0 million to goodwill. These intangible assets are being amortized over a three-year life.

On December 3, 1999, we acquired Cortix, Inc. (Cortix), an Arizona corporation doing business as 20-20Consumer.com, for $14.4 million of cash and common stock. Cortix, a privately held company, is an operator of comparison shopping services including online reviews and ratings for commerce-oriented businesses, merchants and products. Upon effectiveness of the acquisition, 711,435 shares of common stock valued at $18.81 per share were issued to the owners of Cortix. We also paid cash consideration of $1.0 million to the owners of Cortix. We accounted for this transaction as a purchase. Of the $14.4 million in consideration paid, approximately $11.3 million was allocated to acquired technology, $1.6 million to customer lists and $1.3 million to goodwill. These intangible assets are being amortized over a three-year life.

On December 17, 1999, we acquired WebCentric Inc., (WebCentric) a Kansas corporation doing business as bottomdollar.com, for $40.2 million of common stock, common stock options and approximately $1.4 million of cash. WebCentric, a privately held company, develops e-commerce integration technology and applications, including a comparison shopping engine that allows consumers to search and compare the products and services of several leading Internet merchants. Upon effectiveness of the acquisition, a total of 2,161,904 shares of common stock valued at $16.89 per share were issued to the owners of WebCentric. In addition, we issued replacement stock options to purchase an aggregate of 121,544 shares of our common stock to certain employees and owners of WebCentric. We accounted for this transaction as a purchase. Of the $40.2 million in consideration paid, approximately $31.8 million was allocated to acquired technology, $3.3 million to customer lists and $4.6 million to goodwill. These intangible assets are being amortized over a three-year life.

On January 13, 2000, through a wholly owned Nova Scotia Company, we acquired Pronet Enterprises Ltd. (Pronet), a Canadian company, for approximately $12.8 million, of which $3.2 million was paid in cash, $2.2 million in non-cash deferred tax liabilities assumed and $7.4 million in common stock and common stock options issued to Pronet shareholders. Pronet, a privately held company, operates a business-to-business portal and marketplace that aggregates businesses that seek to transact with one another. Upon effectiveness of the acquisition, a total of 162,508 shares of common stock, valued at $17.60 per share, were issued to the shareholders of Pronet. In addition, we issued options to purchase 351,666 shares of common stock to the two principals of Pronet. We accounted for this transaction as a purchase. Of the $12.8 million in consideration paid, approximately $6.3 million was allocated to acquired technology, $2.7 million to customer lists and $3.8 million to goodwill. These intangible assets are being amortized over a three-year life.

On January 18, 2000, we acquired AXC Corporation (AXC), a Washington corporation, for approximately $17.9 million, of which $2.2 million was paid in cash, $4.1 million in non-cash deferred tax liabilities assumed and $11.6 million in common stock and common stock options issued to AXC shareholders. AXC, a privately held company, provides e-commerce consulting services to businesses. Upon effectiveness of the acquisition, a total of 540,296 shares of common stock valued at $17.60 per

share were issued to the owners of AXC. In addition, we issued replacement stock options to purchase an aggregate of 72,089 shares of our common stock to certain employees and owners of AXC. We accounted for this transaction as a purchase. Of the $17.9 million in consideration paid, approximately $7.2 million was allocated to assembled workforce, $4.9 million to customer lists, $5.0 million to goodwill and $800,000 to working capital. These intangible assets are being amortized over a three-year life.

On April 11, 2000, we acquired Freemerchant.com, Inc. (Freemerchant), a Delaware corporation, for approximately $38.1 million, of which $2.0 million was paid in cash, $10.0 million in non-cash deferred tax liabilities assumed, $500,000 of debt assumed and $25.6 million in common stock and common stock options issued to Freemerchant shareholders. Freemerchant, a privately held company, has developed on-line store-builder technology for small- to medium-sized merchants that seek a low-cost entry point to e-commerce, as well as providing hosting services to those merchants. Upon effectiveness of the acquisition, a total of 2,573,723 shares of common stock, valued at $8.80 per share, were issued to the shareholders of Freemerchant. In addition, we issued options to purchase 293,596 shares of common stock to certain Freemerchant shareholders and employees. We accounted for this transaction as a purchase. Of the $38.1 million in consideration paid, approximately $23.0 million was allocated to acquired technology, $4.1 million to assembled workforce and $11.0 million to goodwill. These intangible assets are being amortized over a three-year life.

On June 2, 2000, we acquired Ubarter.com Inc (Ubarter), a Nevada corporation, pursuant to an agreement and plan of merger dated January 20, 2000, for approximately $61.7 million, of which $875,000 was paid in cash, $11.4 million in non-cash deferred tax liabilities assumed, $978,000 of net liabilities assumed, $7.6 million in the cancellation of debt between Ubarter and us, and $40.8 million in common stock and common stock warrants issued to Ubarter shareholders and creditors. Ubarter, which was a publicly traded company, is a business-to-business e-commerce enterprise which utilizes the Ubarter Dollar as payment for products and services by its member businesses over its proprietary barter exchange system. Upon effectiveness of the acquisition, a total of 2,682,871 shares of common stock valued at approximately $15.10 per share were issued to the shareholders and creditors of Ubarter. In addition, we issued warrants to purchase 51,842 shares of common stock to certain Ubarter shareholders, employees and creditors. We accounted for this transaction as a purchase. Of the $61.7 million in consideration paid, approximately $7.5 million was allocated to acquired technology, $2.5 million to assembled workforce, $25.1 million to proprietary concept, $2.5 million to customer lists, and $24.0 million to goodwill. These intangible assets are being amortized over a three-year life.

On August 24, 2000, we acquired Ivebeengood.com, d.b.a. UberWorks (UberWorks), a wholly owned subsidiary of Trilogy, Inc. (Trilogy), for approximately $22.8 million, of which $2.4 million was accrued as non-cash deferred compensation, $5.9 million in non-cash deferred tax liabilities assumed and $14.5 million in common stock and common stock options issued to UberWorks shareholders and employees. UberWorks is a developer of multi-merchant e-commerce purchasing tools and universal shopping cart technology. Upon effectiveness of the acquisition, a total of 2,601,562 shares of common stock valued at approximately $6.13 per share were issued to shareholders of UberWorks, of which 423,253 are being held back by us to be subsequently released based on time vesting and on certain performance criteria yet to be achieved. The maximum term of the retention is three years from the effective date of the acquisition. In addition, we issued a warrant to Trilogy, with a strike price of $0.000001 per share, to purchase additional shares of our common stock if on the one-year anniversary date of the acquisition, the shares currently held by Trilogy (the Trilogy Shares) are not worth at least $13.1 million. The maximum number of additional shares that Trilogy can purchase under the terms of the warrant is 2.6 million. To the extent that the Trilogy Shares have a fair market value that exceeds $13.1 million on the one-year anniversary date, the warrant is cancelled and Trilogy must forfeit the number of Trilogy Shares that would be required to bring their fair value down to $13.1 million, limited to a maximum of 1.3 million shares to be forfeited under this scenario. We also issued options to

purchase 248,162 shares of common stock to certain UberWorks employees. We accounted for this transaction as a purchase. Of the $22.8 million of consideration paid, approximately $12.3 million was allocated to acquired technology, $2.4 million to deferred compensation, $726,000 to assembled workforce and $7.3 million to goodwill. These intangible assets are being amortized over a three-year life. Deferred compensation will be amortized over the three-year term of the option agreements, subject to certain accelerated vesting criteria.

Results of Operations

Revenues. Total revenues for the three- and nine-month periods ended September 30, 2000 were $33.4 million and $79.0 million, respectively. Revenues for the comparable periods in 1999 were $7.6 million and $23.5 million, respectively. The increase was due primarily to the expansion of our networks and increased demand for our services. We continued to experience growth in our business and merchant listings, consumer traffic and affiliate and syndication shopping sites, which resulted in increased fees from licensing, transaction processing, business services, online direct marketing and advertising, exclusive of BuySoftware.com. The BuySoftware.com portion of revenues for the nine-month period ended September 30, 1999 was $9.9 million.

Cost of Revenues. The cost of revenues for the three- and nine-month periods ended September 30, 2000, before the unusual item of $5.3 million recognized during the third quarter 2000, were $15.2 million and $38.4 million, respectively. Total cost of revenues for the comparable periods in 1999 were $4.8 million and $19.5 million, respectively. The increase in our cost of revenues was directly attributable to the increase in revenues during the same period from the Network Commerce Consumer Network and the Network Commerce Business Network. The BuySoftware.com portion of cost of revenues for the nine-month period ended September 30, 1999 was $11.2 million.

Gross Profit. Gross profit for the three- and nine-month periods ended September 30, 2000, before the unusual item recognized during the third quarter 2000, was $18.3 million and $40.6 million, respectively. Gross profit for the comparable periods in 1999 were $2.7 and $4.0 million, respectively. As a percent of revenues, our gross margins before the unusual item were 54.6% and 51.4%, respectively, compared to 36.3% and 17.2% for the comparable periods in 1999. This increase in gross profit percentage was due primarily to the increase in higher-margin revenues during 2000, while decreasing our concentration of revenues from product sales to shoppers, which historically has contributed only flat or negative gross profits. Gross margins for the three- and nine-month periods ended September 30, 2000 inclusive of the $5.3 million unusual item described above were 38.7% and 44.7%, respectively. While we expect to continue to increase our gross profits both in absolute dollars and as a percentage of revenues, we do not expect that the rate of growth achieved historically will continue.

Sales and Marketing. Sales and marketing expenses consist primarily of costs associated with marketing programs such as advertising and public relations, as well as salaries and commissions. Sales and marketing expenses for the three- and nine-month periods ended September 30, 2000 were $24.1 million and $70.2 million, respectively. Sales and marketing expenses for the comparable periods in 1999 were $15.3 million and $33.5 million, respectively. The increase was due primarily to increased spending as a result of our expansion of the Network Commerce Consumer Network and our launch and expansion of the Network Commerce Business Network, both of which resulted in additional personnel and nationwide television, print, radio and on-line advertisements. We anticipate continued growth in our sales and marketing expenses during the remainder of 2000.

General and Administrative. General and administrative expenses consist primarily of salaries and other personnel-related costs for executive, financial, human resources, information services and other administrative personnel, as well as legal, accounting and insurance costs. General and administrative expenses for the three- and nine-month periods ended September 30, 2000 were $3.5 million and

$10.1 million, respectively. General and administrative expenses for the comparable periods in 1999 were $3.0 million and $5.5 million, respectively. The increase was due primarily to an increase in personnel from internal growth and acquisitions. We anticipate continued growth in our general and administrative expenses during the remainder of 2000.

Research and Development. Research and development expenses consist primarily of salaries and related costs associated with the development of new products and services, the enhancement of existing products and services, and the performance of quality assurance and documentation activities. Research and development expenses for the three- and nine-month periods ended September 30, 2000 were $6.7 million and $16.1 million, respectively. Research and development costs for the comparable periods in 1999 were $2.4 million and $5.4 million, respectively. The increase was due primarily to the development and enhancement of our technology platform, as well as to an increase in technology personnel. These employees focus on developing our technology platform as well as building the overall infrastructure that supports the Network Commerce Consumer Network and the Network Commerce Business Network. We anticipate continued growth in our research and development expenses during the remainder of 2000.

Amortization of Intangible Assets. Amortization of intangible assets resulting from acquisitions is primarily related to the amortization of customer lists, domain names, acquired technology, proprietary concepts, assembled workforce and goodwill. Amortization of intangible assets expense for the three-and nine-month periods ended September 30, 2000 was $23.8 million and $55.6 million, respectively. Amortization of intangible assets for the comparable periods in 1999 was $2.1 million and $3.7 million, respectively. This increase was due primarily to the increase in intangible assets and related amortization expenses from business acquisitions completed during 1999 and 2000 described above. Intangible assets acquired in business combinations are amortized over a three-year period.

Stock-Based Compensation. Stock-based compensation expense is related to the amortization of deferred compensation resulting from stock option grants to employees with an option exercise price below the estimated fair market value of our common stock as of the date of grant. Stock-based compensation expense for the three- and nine-month periods ended September 30, 2000 was $1.5 million and $4.6 million. Stock-based compensation in comparable periods for 1999 was $592,000 and $2.5 million. The amount of deferred compensation resulting from these grants is generally amortized over a one- to three-year vesting period. As of September 30, 2000, we have recognized $9.4 million of deferred compensation to be amortized over future periods at approximately $783,000 per quarter for the next twelve quarters.

Gain on Sale of Marketable Equity Securities. Gain on sale of marketable equity securities for the three-and nine-month periods ended September 30, 2000 was $4.2 and $5.5 million, respectively. We did not liquidate any of our marketable equity securities during the three- or nine-month periods ended September 30, 1999.

Interest Income (Expense), Net. Interest income (expense), net consists primarily of the combination of interest income earned on our cash and cash equivalents and short-term investments as well as interest expense incurred on our outstanding debt obligations. Interest income, net for the three- and nine-month periods ended September 30, 2000 was $666,000 and $2.6 million, respectively. Interest expense, net for the comparable periods in 1999 was $360,000 and $605,000, respectively. Interest income, net increased for the nine-month period ended September 30, 2000 due to the increase in our cash and cash equivalents and short-term investments realized from completion of our initial and supplemental public offerings of common stock.

Impairment of Cost-Basis Investments. During the third quarter of 2000, we determined that certain of our cost-basis investments were permanently impaired to between 20% and 100% of their historical values. As a result, we recognized an impairment charge of $2.4 million during the three-

month period ended September 30, 2000. There were no such charges earlier in 2000 or for the comparable periods in 1999.

Income Tax Benefit. The income tax benefit resulted principally from reductions of deferred tax liabilities created as a result of business combinations. Income tax benefit for the three- and nine-month periods ended September 30, 2000 was $15.7 million and $39.2 million, respectively. We did not realize any income tax benefits during the three- or nine-month periods ended September 30, 1999. If we continue to consummate additional business combinations that result in the recognition of deferred taxes, we may incur additional tax deferred tax benefits. We have not paid nor have we received refunds for federal income taxes and we do not expect to pay income taxes or receive income tax refunds in the foreseeable future.

Net Loss. Net loss for the three- and nine-month periods ended September 30, 2000 was $28.6 million and $76.5 million, respectively. Net loss for the comparable periods in 1999 was $21.0 and $47.2 million, respectively. This increase was due primarily to an increase in our operating expenses, most significantly sales and marketing expenses and amortization of intangible assets, partially offset by our increase in gross profit and income tax benefit during the same periods. We expect to incur additional net losses in 2000.

Net Operating Loss Carryforwards

As of September 30, 2000, we had net operating loss carryforwards of approximately $136.4 million. If not used, the net operating loss carryforwards will expire at various dates beginning in 2012. The Tax Reform Act of 1986 imposes restrictions on the use of net operating losses and tax credits in the event that there has been an ownership change, as defined, of a corporation since the periods in which the net operating losses were incurred. Our ability to use net operating losses incurred prior to July 1999 is limited to approximately $14.3 million per year due to sales of Series D and Series E convertible preferred stock to third parties in April 1998 and the sale of Series I convertible preferred stock to Chase Manhattan Bank in July 1999, which resulted in ownership changes. Our deferred tax assets are recognizable only to the extent that they are offset by deferred tax liabilities. To the extent that our deferred tax assets exceed our deferred tax liabilities in the future, valuation allowances may be recorded against our deferred tax assets. In concluding that valuation allowances may be required, management considers such factors as our history of operating losses, potential future losses and the nature of our deferred tax assets.

Liquidity and Capital Resources

Since inception, we have experienced net losses and negative cash flows from operations. As of September 30, 2000, we had an accumulated deficit of $181.8 million. We have financed our activities largely through issuances of common stock and preferred stock, from the issuance of short- and long-term obligations and from capital leasing transactions for certain of our fixed asset purchases. Through September 30, 2000, our aggregate net proceeds have been $272.0 million from issuing equity securities and $50.9 million from issuing debt securities. As of September 30, 2000, we had $87.1 million in cash, cash equivalents and short-term investments, of which $8.1 million of such amounts is characterized as restricted cash to secure our obligations under certain letters of credit.

Net cash used in operating activities was $66.0 million for the nine-month period ended September 30, 2000, compared to $28.6 million for the same period in 1999. The increase was due primarily to the increase in our net loss for the nine-month period ended September 30, 2000 of $76.5 million compared to $47.2 million for the same period ended 1999, the increase in depreciation and amortization of $63.7 million for the nine-month period ended September 30, 2000 compared to $6.4 million in the comparable period in 1999, and the deferred income tax benefit of $39.2 in the nine-month period ended September 30, 2000 compared to none in the comparable period in 1999.

Net cash used in investing activities was $59.9 million for the nine-month period ended September 30, 2000, compared to $22.6 million for the same period in 1999. The increase was due primarily to the net increase in purchases of short-term investments of $17.9 million for the nine-month period ended September 30, 2000, compared to $8.5 for the same period in 1999, the increase in purchases of property and equipment of $18.2 million for the nine-month period ended September 30, 2000, compared to $9.5 million for the same period in 1999, the increase in investments in equity and debt securities and other assets of $15.0 million for the nine-month period ended September 30, 2000, compared to $642,000 for the same period in 1999, and the increase in acquisition of businesses of $18.1 million for the nine-month period ended September 30, 2000, compared to $4.0 million for the same period in 1999.

Net cash provided by financing activities was $132.2 million for the nine-month period ended September 30, 2000, compared to $44.3 million for the same period in 1999. The increase was due primarily to the closing of our public offering on February 18, 2000 of 7,913,607 shares of common stock at $14.50 per share, which resulted in proceeds to us net of underwriters' fees and commissions of $108.7 million. Offering costs incurred were approximately $700,000.

In March 1999, we entered into a loan and security agreement with a financial institution for a term loan and line of credit. In May 1999, the agreement was amended and restated to allow us to borrow up to $8.5 million at any one time, consisting of a $3.5 million term loan (term loan), a $4.0 million bridge loan (bridge loan) and a line of credit of up to $2.5 million. The term loan bears interest at 12%, is secured by a letter of credit and matures in March 2002. The term loan balance was $2.1 million as of September 30, 2000. The outstanding credit line and bridge loan balances were both $0 as of September 30, 2000.

On May 19, 2000, we entered into a credit agreement with a commercial bank, with a maximum commitment amount of $15.0 million to finance the purchase of equipment, software and tenant improvements. The credit agreement is secured by substantially all of our assets and had an outstanding balance of $9.2 million at September 30, 2000. The outstanding commitments bear interest at an annual rate equal to the prime lending rate plus one and one-half percent. Outstanding commitments under the agreement are required to be repaid under specific schedules, with all commitments to be repaid no later than November 18, 2003. The credit agreement requires us to maintain certain financial ratios and places limitations on certain financing and investing activities. The credit agreement also contains other customary conditions and events of default that, in the event of noncompliance by us, would prevent any further borrowings and would generally require the repayment of any outstanding commitments under the credit agreement. We were in compliance with these covenants as of September 30, 2000.

On September 29, 2000 (Closing), we sold $20 million of convertible notes (Notes) and warrants to a private institution. The Notes have a one-year term and bear interest at an annual rate of six percent. The conversion price for the Notes are 95% of the average closing bid price of our common stock during a 20-day trading period prior to the conversion date (which automatically occurs upon the effectiveness of a registration statement filed with the Securities and Exchange Commission), subject to a maximum conversion price of the lower of our common stock's closing bid price the day prior to Closing or $7.50 per share. On October 26, 2000, we filed a registration statement on Form S-3 with the Securities and Exchange Commission, which under the terms of the Notes agreement, must be declared effective within 90 days of Closing. Delays in the effectiveness of the registration statement could result in a reduction of the conversion price and/or cash penalties to us. Also at Closing, we issued warrants to purchase 4,050,633 shares of our common stock to the private institution at an exercise price of $10.37 per share. The warrants are immediately exercisable and expire five years from Closing.

Our capital requirements depend on numerous factors, including the rate of expansion of the Network Commerce Consumer Network and the Network Commerce Business Network, the

investments we make in our technology platforms and in future technologies, the number of acquisitions that are completed and the composition of the consideration paid between cash, debt and stock, and the resources we devote to expansion of our sales, marketing and branding efforts. We have also entered into an agreement with 24/7 Media that requires us to make aggregate advertising and marketing expenditures of approximately $1.0 million in 2001, decreasing to $250,000 in 2002. We believe that existing cash balances and cash generated from operations, together with the net proceeds from our public offerings and the future sale of marketable equity securities will be sufficient to meet our anticipated cash needs for working capital and capital expenditures through the next 12 months. After that time, we may be required to raise additional financing. We cannot be sure that the assumed levels of revenues and expenses underlying our anticipated cash needs will prove to be accurate. The sale of additional equity or convertible debt securities could result in additional dilution to our shareholders. We cannot be sure that financing will be available in amounts or on terms acceptable to us or even available at all.

Recent Accounting Pronouncements

In December 1999, the Securities and Exchange Commission released Staff Accounting Bulletin (SAB) No. 101,"Revenue Recognition in Financial Statements," to provide guidance on the recognition, presentation and disclosure of revenues in financial statements. We believe our revenue recognition practices are in conformity with the guidelines prescribed in SAB No. 101.

In March 2000, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 44 (FIN 44), "Accounting for Certain Transactions Involving Stock Compensation." FIN 44 clarifies certain issues relating to the application of Accounting Principles Board Opinion No. 25 and related interpretations, which are the authoritative pronouncements we use to account for our stock-based compensation transactions. FIN 44 is effective July 1, 2000, however certain conclusions reached in FIN 44 are applicable for transactions consummated after either December 15, 1998 or January 12, 2000. The adoption of FIN 44 did not have a material effect on our financial position or results of operations.

In September 2000, the Emerging Issues Task Force of the FASB reached a consensus on Issue No. 00-10, "Accounting for Shipping and Handling Fees and Costs" to provide guidance on the classification of shipping and handling fees and costs in financial statements. This consensus is consistent with our historical accounting policies and has no impact on our financial position or results of operations.

In June 1998, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards that require derivative instruments (including certain derivative instruments embedded in other contracts) be recorded at fair value. The statement requires that changes in the derivative's fair value be recognized currently in operations unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the statements of operations, and requires that a company must formally document, designate, and assess the effectiveness of transactions that are subject to hedge accounting. Pursuant to SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities—Deferral of the Effective Date of FASB No. 133—an Amendment to FASB Statement No. 133," the effective date of SFAS No. 133 has been deferred until fiscal years beginning after January 15, 2000. SFAS No. 133 cannot be applied retroactively. SFAS No. 133 must be applied to (a) derivative instruments and (b) certain derivative instruments embedded in hybrid contracts that were issued, acquired, or substantively modified after December 31, 1998 (and, at a company's election, before January 1, 1999). We have not yet quantified the impact of adopting SFAS No. 133 on the financial statements and have not determined the timing or method of adopting SFAS No. 133. However, adoption of the statement could increase volatility in our consolidated statements of operations and other comprehensive income.

Seasonality

We believe that our advertising and merchandising revenues on the Network Commerce Consumer Network and the Network Commerce Business Network are subject to seasonality changes as retail transactions and advertising sales in traditional media, such as television and radio, generally are lower in the first and third calendar quarters of each year. In addition, Internet usage typically declines during the summer and certain holiday periods. If our market makes the transition from an emerging to a more developed market, seasonal and cyclical patterns may develop in our industry and in the usage of, and transactions on, our web sites and those of our merchants. Seasonal and cyclical patterns in online transactions and advertising would affect our revenues. Those patterns may also develop on our web sites. Given the early stage of the development of the Internet and our company, however, we cannot predict to what extent, if at all, our operations will prove to be seasonal.

Impact of the Year 2000 Computer Problem

Prior to January 1, 2000, we devoted substantial resources in an effort to ensure that our proprietary software, the third-party software on which we rely, and the underlying systems and protocols did not contain errors associated with Year 2000 date functions. Since January 1, 2000, we have not experienced any disruption as a result of Year 2000 problems.

Additional Factors That May Affect Future Results

You should carefully consider the risks described below and the other information in this quarterly report. While we have attempted to identify all risks that are material to our business, additional risks that we have not yet identified or that we currently think are immaterial may also impair our business operations. The trading price of our common stock could decline due to any of these risks. In assessing these risks, you should also refer to the other information in this quarterly report, including the consolidated financial statements and related notes and the risks discussed in the "Risk Factors" section included in our December 31, 1999 10-K filed on February 10, 2000 with the Securities and Exchange Commission.

RISKS RELATED TO OUR BUSINESS

Our rapid growth and evolution may make it difficult to evaluate our business and prospects

We were incorporated in January 1994 and operated initially as a computer services company. In 1996, we began to change the focus of our business to conducting commerce over the Internet. In August 1998, we launched our first online marketplace, ShopNow.com. In recent months, particularly with acquisitions of Freemerchant.com and Ubarter.com and the launch of b2bNow.com, our business-to-business marketplace, we have increasingly focused on developing and providing products and services to enable businesses to conduct online commerce. The recent shifts in our business focus may make it difficult for you to evaluate our business and prospects. When making your investment decision, you should also consider the risks, expenses and difficulties that we may encounter as a young company in a rapidly evolving market.

We have a history of losses and we expect future losses

We incurred net losses of $76.5 million for the nine-month period ended September 30, 2000 and $47.2 million for the nine-month period ended September 30, 1999. At September 30, 2000, we had an accumulated deficit of $181.8 million. We have historically invested heavily in sales and marketing, technology infrastructure and research and development and expect to continue to do so in the future. As a result, we must generate significant revenues to achieve and maintain profitability. We expect that our sales and marketing expenses, research and development expenses and general and administrative expenses will continue to increase in absolute dollars and may increase as a percentage of revenues. In addition, we may incur substantial expenses in connection with future acquisitions.

Our future revenues are unpredictable and we expect our operating results to fluctuate from period to period

Our business model has only been applied to the Internet since the mid-1990's and continues to evolve. Therefore we have limited experience in planning the financial needs and operating expenses of our business. It is difficult for us to accurately forecast our revenues in any given period. We may not be able to sustain our recent revenue growth rates or obtain sufficient revenues to achieve profitability. If our revenues in a particular period fall short of our expectations, we will likely be unable to quickly adjust our spending in order to compensate for that revenue shortfall.

Our operating results are likely to fluctuate substantially from period to period as a result of a number of factors, such as:

•: declines in the number of businesses and merchants to which we provide our products and services;
•: the amount and timing of operating costs and expenditures relating to expansion of our operations; and
•: the mix of products and services that we sell.

In addition, factors beyond our control may also cause our operating results to fluctuate, such as:

•: the announcement or introduction of new or enhanced products or services by our competitors; and
•: the pricing policies of our competitors.

Period-to-period comparisons of our operating results are not a good indicator of our future performance. It is likely that our operating results in some quarters may not meet the expectations of stock market analysts and investors and this could cause our stock price to decline.

Our business model is unproven and changing

Our business model consists of providing businesses and merchants with e-commerce enabling solutions. We have limited experience as a company and, additionally, the Internet, on which our business model relies, is still unproven as a business medium. Accordingly, our business model may not be successful, and we may need to change it. Our ability to generate sufficient revenues to achieve profitability will depend, in large part, on our ability to successfully market our e-commerce products and services to businesses and merchants that may not be convinced of the need for an online presence or may be reluctant to rely upon third parties to develop and manage their e-commerce offerings and marketing efforts.

Our future growth will depend on our ability to make and successfully integrate additional acquisitions

Our success depends on our ability to continually enhance and expand our e-commerce enabling products and services and our online marketplaces in response to changing technologies, customer demands and competitive pressures. Consequently, we have acquired complementary technologies or businesses in the past, and intend to do so in the future. If we are unable to identify suitable acquisition targets, or if we are unable to successfully complete acquisitions and successfully integrate the acquired businesses, technologies and personnel, our ability to increase product and service offerings will be reduced. This could cause us to lose business to our competitors, and our operating results could suffer.

Acquisitions involve a number of risks

We actively seek to identify and acquire companies with attributes complementary to our e-commerce products and services. Since January 1, 2000, we have acquired five companies. Acquisitions that we make may involve numerous risks, including:

•: diverting management's attention from other business concerns;
•: being unable to maintain uniform standards, controls, procedures and policies;
•: entering markets in which we have no direct prior experience;
•: improperly evaluating new services and technologies or otherwise being unable to fully exploit the anticipated opportunity; and
•: being unable to successfully integrate the acquired businesses, technologies and other assets.

If we are unable to accurately assess any newly acquired businesses or technologies, our business could suffer. For example, in June 1998 we acquired e-Warehouse and CyberTrust. These companies had developed payment processing technologies that we planned to utilize as part of our e-commerce products and services. However, we are not currently utilizing the acquired technologies, and we have determined that the technologies have no other use or value to us. Because we are not using the acquired technologies, we wrote off substantially all of the $5.4 million aggregate purchase price for e-Warehouse and CyberTrust in 1998. Future acquisitions may involve the assumption of obligations or large one-time write-offs and amortization expenses related to goodwill and other intangible assets. Any of the factors listed above would adversely affect our results of operations.

In addition, in order to finance any future acquisition, we may need to raise additional funds through public or private financings. In this event, we could be forced to obtain equity or debt financing on terms that are not favorable to us and that may result in dilution to our shareholders.

Our success depends upon achieving adequate market share to increase our revenues and become profitable

Our success depends upon achieving significant market penetration and acceptance of our e-commerce enabling products and services. We have only recently begun to expand our business-to-business initiatives designed to enable businesses to maximize their e-commerce opportunities, and our online marketplaces have achieved only limited market acceptance to date. We may not currently have adequate market share to successfully execute our business plan. If we are unable to reach and retain substantial numbers of businesses, merchants and shoppers, our business model may not be sustainable.

To successfully market and sell our e-commerce enabling products and services we must:

•: become recognized as a leading provider of end-to-end enabling solutions;
•: enhance existing products and services;
•: add new products and services;
•: complete projects on time;
•: increase the number of businesses and merchants using our e-commerce products and services and online marketplaces;
•: continue to increase the attractiveness of the ShopNow marketplace to shoppers; and
•: continue to increase the attractiveness of the b2bNow.com, Freemerchant.com and Ubarter.com Web sites to businesses and other users.

If we do not increase brand awareness our sales may suffer

Due in part to the emerging nature of the markets for e-commerce enabling products and services and online marketplaces, together with the substantial resources available to many of our competitors, our opportunity to achieve and maintain a significant market share may be limited. Developing and maintaining awareness of the ShopNow.com and b2bNow.com brand names is critical in achieving widespread acceptance of our e-commerce enabling products and services and our online marketplaces. We launched the ShopNow marketplace in August 1998 and we have only recently begun to expand our business-to-business initiatives designed to enable businesses to maximize their e-commerce opportunities. The importance of brand recognition will increase as competition in our markets increases. Successfully promoting and positioning our brands will depend largely on the effectiveness of our marketing and sales efforts and our ability to develop reliable and useful products and services at competitive prices. If our planned marketing and sales efforts are ineffective, we may need to increase our financial commitment to creating and maintaining brand awareness among businesses, merchants and shoppers, which could divert financial and management resources from other aspects of our business, or cause our operating expenses to increase disproportionately to our revenues. This could cause our business and operating results to suffer.

We face significant competition

The market for e-commerce enabling products and services and online marketplaces is highly competitive, and we expect competition to intensify in the future. Barriers to entry are not significant. Our failure to compete effectively could result in the following:

•: fewer businesses and merchants relying upon our enabling solutions;
•: the obsolescence of the technology underlying our products and services;
•: fewer businesses and merchants listed in our directories;
•: a decrease in shopper traffic on our web sites; and
•: a reduction in the prices of, or profits on, our products and services.

The number of companies providing e-commerce enabling products and services is large and increasing at a rapid rate. We expect that additional companies, which to date have not had a substantial commercial presence on the Internet or in our markets, will offer competing products and services. Although we believe no one company currently offers a range of e-commerce enabling solutions as comprehensive as our suite of products and services, companies such as InfoSpace, Yahoo! and Cybersource offer alternatives to one or more of our products and services.

Many of our competitors and potential competitors have substantial competitive advantages as compared to us, including:

•: larger customer or user bases;
•: the ability to offer a wider array of e-commerce products and solutions;
•: greater name recognition and larger marketing budgets and resources;
•: substantially greater financial, technical and other resources;
•: the ability to offer additional content and other personalization features; and
•: larger production and technical staffs.

These advantages may enable our competitors to adapt more quickly to new technologies and customer needs, devote greater resources to the promotion or sale of their products and services,

initiate or withstand substantial price competition, take advantage of acquisition or other opportunities more readily or develop and expand their product and service offerings more quickly.

In addition, as the use of the Internet and online products and services increases, larger well-established and well-financed entities may continue to acquire, invest in or form joint ventures with providers of e-commerce enabling solutions, and existing providers may continue to consolidate. Providers of Internet browsers and other Internet products and services who are affiliated with providers of web directories and information services that compete with our products and services may more tightly integrate these affiliated offerings into their browsers or other products or services. Any of these trends would increase the competition we face.

If we fail to maintain our strategic business relationships and enter into new relationships our business will suffer

An important element of our strategy involves entering into business relationships with other companies. Our success is dependent on maintaining our current contractual relationships and developing new strategic relationships. These contractual relationships typically involve joint marketing, licensing or promotional arrangements. For example, we have entered into a licensing agreement with Chase Manhattan Bank, a cross promotion agreement with 24/7 Media and a software license agreement with HNC Software. Although these relationships are an important factor in our strategy because they enable us to enhance our product and service offerings, the parties with which we contract may not view their relationships with us as significant to their own businesses. To date, we have not derived material revenue from these relationships, and some of these relationships impose substantial obligations on us. It is not certain that the benefits to us will outweigh our obligations. For example, our relationship with 24/7 Media requires us to refer to them any business that would benefit from the advertising services offered by 24/7 Media and makes 24/7 Media the only third party authorized to sell advertising on our web site. Several of our significant business arrangements do not establish minimum performance requirements but instead rely on contractual best efforts obligations of the parties with which we contract. In addition, most of these relationships may be terminated by either party with little notice. Accordingly, in order to maintain our strategic business relationships we will need to meet our partners' specific business objectives, including incremental revenue, brand awareness and implementation of specific e-commerce applications. If our strategic business relationships are discontinued for any reason, or if we are unsuccessful in entering into new relationships in the future, our business and results of operations may be harmed.

If we fail to effectively manage the rapid growth of our operations our business will suffer

Our ability to successfully offer e-commerce enabling products and services and implement our business plan in a rapidly evolving market requires an effective planning and management process. We are increasing the scope of our operations domestically and internationally, and we have increased our headcount substantially. From December 31, 1997 to October 5, 2000, our total number of employees increased from less than 50 to 594. This growth has placed and will continue to place a significant strain on our management systems, infrastructure and resources. We will need to continue to improve our financial and managerial controls and reporting systems and procedures, and will need to continue to expand, train and manage our workforce worldwide. Furthermore, we expect that we will be required to manage an increasing number of relationships with various customers and other third parties. Any failure to expand any of the foregoing areas efficiently and effectively could cause our business to suffer.

We depend on our key management personnel for successful operation of our business

Our success depends on the skills, experience and performance of our senior management and other key personnel. Our key personnel include Dwayne Walker, our Chairman and Chief Executive

Officer, Joe Arciniega, our President and Chief Operating Officer, Alan Koslow, our Chief Financial Officer, and Dr. Ganapathy Krishnan, our Chief Technology Officer. Messrs. Walker, Koslow and Arciniega and Dr. Krishnan have employment agreements with Network Commerce. Many of our executive officers have joined us within the past three years. If we do not quickly and efficiently integrate these new personnel into our management and culture, our business could suffer. Our business could also suffer if we do not retain our key personnel.

We must hire additional personnel to expand our operations

On October 5, 2000, we announced that we reduced our work force by 68 people. After the staff reductions, we now employ 594 people. Notwithstanding our reduction in the work force, we expect personnel numbers to increase in certain areas of our business in the fourth quarter of 2000, including without limitation our international and wireless divisions. As of October 31, 2000 we had openings for 35 positions. Our future success depends on our ability to identify, hire, train, retain and motivate highly skilled executive, technical, managerial, sales and marketing, business development and administrative personnel. Competition for qualified personnel is intense, particularly in the technology and Internet markets. If we fail to successfully attract and retain a sufficient number of qualified executive, technical, managerial, sales and marketing, business development and administrative personnel, our ability to manage and expand our business could suffer.

Our ability to develop and integrate e-commerce technologies is subject to uncertainties

We have limited experience delivering our e-commerce products and services and operating online marketplaces. In order to remain competitive, we must regularly upgrade our e-commerce products and services to incorporate current technology, which requires us to integrate complex computer hardware and software components. If we do not successfully integrate these components, the quality and performance of our online offerings may be reduced. In addition, the ability of our online marketplaces to accommodate an increasing number of businesses, merchants and shoppers would suffer. While these technologies are generally commercially available, we may be required to expend considerable time and money in order to successfully integrate them into our products and services and this may cause our business to suffer. We must also maintain an adequate testing and technical support infrastructure to ensure the successful introduction of products and services.

Our computer systems may be vulnerable to system failures

Our success depends on the performance, reliability and availability of the technology supporting our e-commerce products and services and our online marketplaces. Our revenues depend, in large part, on the number of businesses and merchants that use our products and services and the number of shoppers that access the ShopNow marketplace. This depends, in part, upon our actual and perceived reliability and performance. Any inability to provide our products and services or any slowdown or stoppage of our online marketplaces could cause us to lose clients and therefore lose revenue. Substantially all of our computer and communications hardware is located at leased and third-party facilities in Seattle, Washington and Sterling, Virginia. Our systems and operations are vulnerable to damage or interruption from fire, flood, power loss, telecommunications failure, break-in, earthquake and similar events. Because we presently do not have fully redundant systems or a formal disaster recovery plan, a systems failure could adversely affect our business. Our computer systems are vulnerable to computer viruses, physical or electronic break-ins and similar disruptions, which may lead to interruptions, delays, loss of data or inability to process online transactions for our clients. We may be required to expend considerable time and money to correct any system failure. If we are unable to fix a problem that arises, we may lose clients or be unable to conduct our business at all.

Our business may be harmed by defects in our software and systems

We have developed custom software for our network servers and have licensed additional software from third parties. This software may contain undetected errors or defects. Although we have not suffered significant harm from any errors or defects to date, we may discover significant errors or defects in the future that we may be unable to fix in a timely or cost-effective manner.

We will need to expand and upgrade our systems in order to maintain customer satisfaction

We must expand and upgrade our technology, transaction processing systems and network infrastructure if the number of businesses and merchants using our e-commerce products and services and online marketplaces, or the volume of traffic on our web sites or our clients' web sites, increases substantially. We could experience periodic capacity constraints, which may cause unanticipated system disruptions, slower response times and lower levels of customer service. We may be unable to accurately project the rate or timing of increases, if any, in the use of our products or services or our web sites or when we must expand and upgrade our systems and infrastructure to accommodate these increases in a timely manner. Any inability to do so could harm our business.

Our international operations involve risks

We are subject to risks specific to Internet-based companies in foreign markets. These risks include:

•: delays in the development of the Internet as a commerce medium in international markets;
•: restrictions on the export of encryption technology; and
•: increased risk of piracy and limits on our ability to enforce our intellectual property rights.

In addition, we have been developing business opportunities in Japan during the first half of 2000 and more recently, in the United Kingdom. We may be unable to develop sufficient relationships in Japan or the United Kingdom to take advantage of business opportunities there. In recent periods, the Japanese economy has experienced weakness. If the Japanese economy continues to exhibit weakness, our efforts to develop business opportunities in Japan and our ability to grow in that market could be impaired. In addition, the failure to succeed in the Japanese market could impair our ability to enter other international markets.

We may require additional funding to successfully operate and grow our business

Although we believe that our cash reserves and cash flows from operations will be adequate to fund our operations for at least the next twelve months, these resources may be inadequate. Consequently, we may require additional funds during or after this period. Additional financing may not be available on favorable terms or at all. If we raise additional funds by selling stock, the percentage ownership of our then current shareholders will be reduced. If we cannot raise adequate funds to satisfy our capital requirements, we may have to limit our operations significantly. Our future capital requirements depend upon many factors, including, but not limited to:

•: the rate at which we expand our sales and marketing operations and our product and service offerings;
•: the extent to which we develop and upgrade our technology and data network infrastructure; and
•: the occurrence, timing, size and success of acquisitions.

We may be unable to adequately protect our intellectual property and proprietary rights

We regard our intellectual property rights as critical to our success, and we rely on trademark and copyright law, trade secret protection and confidentiality and license agreements with our employees, customers and others to protect our proprietary rights. Despite our precautions, unauthorized third parties might copy portions of our software or reverse engineer and use information that we regard as proprietary. We currently have five patents pending in the United States Patent and Trademark Office covering different aspects of our product architecture and technology. However, we do not currently own any issued patents and there is no assurance that any pending patent application will result in an issued patent, or that any future patent will not be challenged, invalidated or circumvented, or that the rights granted under any patent will provide us with a competitive advantage. The laws of some countries do not protect proprietary rights to the same extent as do the laws of the United States, and our means of protecting our proprietary rights abroad may not be adequate. Any misappropriation of our proprietary information by third parties could adversely affect our business by enabling third parties to compete more effectively with us.

Our technology may infringe the intellectual property rights of others

Although we have not received notice of any alleged infringement by us, we cannot be certain that our technology does not infringe issued patents or other intellectual property rights of others. In addition, because patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed which relate to our software. We may be subject to legal proceedings and claims from time to time in the ordinary course of our business, including claims of alleged infringement of the trademarks and other intellectual property rights of third parties. Intellectual property litigation is expensive and time-consuming, and could divert our management's attention away from running our business.

If the security provided by our e-commerce services is breached we may be liable to our clients and our reputation could be harmed

A fundamental requirement for e-commerce is the secure transmission of confidential information of businesses, merchants and shoppers over the Internet. Among the e-commerce services we offer to merchants are security features such as:

•: secure online payment services;
•: secure order processing services; and
•: fraud prevention and management services.

Third parties may attempt to breach the security provided by our e-commerce products and services or the security of our clients' internal systems. If they are successful, they could obtain confidential information about businesses and shoppers using our online marketplaces, including their passwords, financial account information, credit card numbers or other personal information. We may be liable to our clients or to shoppers for any breach in security. Even if we are not held liable, a security breach could harm our reputation, and the mere perception of security risks, whether or not valid, could inhibit market acceptance of our products and services. We may be required to expend significant capital and other resources to license additional encryption or other technologies to protect against security breaches or to alleviate problems caused by these breaches. In addition, our clients might decide to stop using our e-commerce products and services if their customers experience security breaches.

RISKS RELATED TO OUR INDUSTRY

Our success depends on continued increases in the use of the Internet as a commercial medium

We depend on the growing use and acceptance of the Internet by businesses, merchants and shoppers as a medium of commerce. Rapid growth in the use of and interest in the Internet and online products and services is a recent development. No one can be certain that acceptance and use of the Internet and online products and services will continue to develop or that a sufficiently broad base of businesses, merchants and shoppers will adopt and continue to use the Internet and online products and services as a medium of commerce.

The Internet may fail as a commercial marketplace for a number of reasons, including potentially inadequate development of the necessary network infrastructure or delayed development of enabling technologies, including security technology and performance improvements. For example, if technologies such as software that stops advertising from appearing on a web user's computer screen gain wide acceptance, the attractiveness of the Internet to advertisers would be diminished, which could harm our business.

Rapid technological change could negatively affect our business

Rapidly changing technology, evolving industry standards, evolving customer demands and frequent new product and service introductions characterize the market for e-commerce products and services and online marketplaces. Our future success will depend in significant part on our ability to improve the performance, content and reliability of our products and services in response to both the evolving demands of the market and competitive product and service offerings. Our efforts in these areas may not be successful. If a large number of our clients adopt new Internet technologies or standards, we may need to incur substantial expenditures modifying or adapting our e-commerce products and services to remain compatible with their systems.

We rely on the Internet infrastructure provided by others to operate our business

Our success depends in large part on other companies maintaining the Internet infrastructure. In particular, we rely on other companies to maintain a reliable network backbone that provides adequate speed, data capacity and security and to develop products that enable reliable Internet access and service. If the Internet continues to experience significant growth in the number of users, frequency of use and amount of data transmitted, the Internet infrastructure of thousands of computers communicating via telephone lines, coaxial cable and other telecommunications systems may be unable to support the demands placed on it, and the Internet's performance or reliability may suffer as a result of this continued growth. If the performance or reliability of the Internet suffers, Internet users could have difficulty obtaining access to the Internet. In addition, data transmitted over the Internet, including information and graphics contained on web pages, could reach Internet users much more slowly. This could result in frustration of Internet users, which could decrease online traffic and cause advertisers to reduce their Internet expenditures.

Future governmental regulation and privacy concerns could adversely affect our business

We are not currently subject to direct regulation by any government agency, other than regulations applicable to businesses generally, and there are currently few laws or regulations directly applicable to access to or commerce on the Internet. However, due to the increasing popularity and use of the Internet, a number of legislative and regulatory proposals are under consideration by federal, state, local and foreign governmental organizations, and it is possible that a number of laws or regulations may be adopted with respect to the Internet relating to issues such as user privacy, taxation, infringement, pricing, quality of products and services and intellectual property ownership. The adoption of any laws or regulations that have the effect of imposing additional costs, liabilities or

restrictions relating to the use of the Internet by businesses or consumers could decrease the growth in the use of the Internet, which could in turn decrease the demand for our products and services, decrease traffic on our online marketplaces, increase our cost of doing business, or otherwise have a material adverse effect on our business. Moreover, the applicability to the Internet of existing laws governing issues such as property ownership, copyright, trademark, trade secret, obscenity, libel and personal privacy is uncertain and developing. Any new legislation or regulation, or application or interpretation of existing laws, could have a material adverse effect on our business.

The Federal Communications Commission is currently reviewing its regulatory positions on the privacy protection given to data transmissions over telecommunications networks and could seek to impose some form of telecommunications carrier regulation on telecommunications functions of information services. State public utility commissions generally have declined to regulate information services, although the public service commissions of some states continue to review potential regulation of such services. Future regulation or regulatory changes regarding data privacy could have an adverse effect on our business by requiring us to incur substantial additional expenses in order to comply with this type of regulation.

A number of proposals have been made at the federal, state and local level that would impose additional taxes on the sale of goods and services over the Internet and certain states have taken measures to tax Internet-related activities. Foreign countries also may tax Internet transactions. The taxation of Internet-related activities could have the effect of imposing additional costs on companies, such as Network Commerce, that conduct business over the Internet. This, in turn, could lead to increased prices for products and services, which could result in decreased demand for our solutions.

We could face liability for material transmitted over the Internet by others

Because material may be downloaded from web sites hosted by us and subsequently distributed to others, there is a potential that claims will be made against us for negligence, copyright or trademark infringement or other theories based on the nature and content of this material. Negligence and product liability claims also potentially may be made against us due to our role in facilitating the purchase of some products, for example firearms. Although we carry general liability insurance, our insurance may not cover claims of these types, or may not be adequate to indemnify us against this type of liability. Any imposition of liability, and in particular liability that is not covered by our insurance or is in excess of our insurance coverage, could have a material adverse effect on our reputation and our operating results, or could result in the imposition of criminal penalties on us.

We do not currently collect sales tax from all transactions

We do not currently collect sales or other similar taxes on products sold by us and delivered into states other than Washington, California, Georgia, Arizona, Texas, Tennessee and Kentucky. However, one or more states or foreign countries may seek to impose sales tax collection obligations on out-of-state or foreign companies engaging in e-commerce. In addition, any new operation in states outside the states for which we currently collect sales tax could subject shipments into these states to state or foreign sales taxes. A successful assertion by one or more states or any foreign country that we should collect sales or other similar taxes on the sale of merchandise or services could result in liability for penalties as well as substantially higher expenses incurred by our business.

RISKS RELATED TO AN INVESTMENT IN OUR STOCK

Provisions of our charter documents and Washington law could discourage our acquisition by a third party

Specific provisions of our articles of incorporation and bylaws and Washington law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our shareholders.

Our articles of incorporation and bylaws establish a classified board of directors, eliminate the ability of shareholders to call special meetings, eliminate cumulative voting for directors and establish procedures for advance notification of shareholder proposals. The presence of a classified board and the elimination of cumulative voting may make it more difficult for an acquirer to replace our board of directors. Further, the elimination of cumulative voting substantially reduces the ability of minority shareholders to obtain representation on the board of directors.

Our board of directors has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by our shareholders. The issuance of preferred stock could have the effect of delaying, deferring or preventing a change of control of Network Commerce Inc. and may adversely affect the market price of the common stock and the voting and other rights of the holders of common stock.

Washington law imposes restrictions on some transactions between a corporation and significant shareholders. Chapter 23B.19 of the Washington Business Corporation Act prohibits a target corporation, with some exceptions, from engaging in particular significant business transactions with an acquiring person, which is defined as a person or group of persons that beneficially owns 10% or more of the voting securities of the target corporation, for a period of five years after the acquisition, unless the transaction or acquisition of shares is approved by a majority of the members of the target corporation's board of directors prior to the acquisition. Prohibited transactions include, among other things:

•: a merger or consolidation with, disposition of assets to, or issuance or redemption of stock to or from the acquiring person;
•: termination of 5% or more of the employees of the target corporation; or
•: allowing the acquiring person to receive any disproportionate benefit as a shareholder.

A corporation may not opt out of this statute. This provision may have the effect of delaying, deterring or preventing a change in control of Network Commerce Inc.

The foregoing provisions of our charter documents and Washington law could have the effect of making it more difficult or more expensive for a third party to acquire, or could discourage a third party from attempting to acquire, control of Network Commerce Inc. These provisions may therefore have the effect of limiting the price that investors might be willing to pay in the future for our common stock.

Our stock price may be volatile

The stock market in general, and the stock prices of Internet-related companies in particular, have recently experienced extreme volatility, which has often been unrelated to the operating performance of any particular company or companies. Our stock price could be subject to wide fluctuations in response to factors such as the following:

•: actual or anticipated variations in quarterly results of operations;
•: the addition or loss of merchants and shopper traffic;
•: announcements of technological innovations, new products or services by us or our competitors;
•: changes in financial estimates or recommendations by securities analysts;
•: conditions or trends in the Internet, e-commerce and marketing industries;
•: changes in the market valuations of other Internet or online service or software companies;

•: our announcements of significant acquisitions, strategic relationships, joint ventures or capital commitments;
•: additions or departures of key personnel;
•: sales of our common stock;
•: general market conditions; and
•: other events or factors, many of which are beyond our control.

These broad market and industry factors may materially and adversely affect our stock price, regardless of our operating performance. The trading prices of the stocks of many technology companies are at or near historical lows and reflect price to earnings ratios substantially different from recent levels where these stocks were trading at all-time highs. These trading prices and price-to-earnings ratios may continue to be volatile.

In the past, securities class action litigation has often been brought against companies following periods of volatility in their stock prices. We may in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert our management's time and resources, which could cause our business to suffer.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We currently have instruments sensitive to market risk relating to exposure to changing interest rates and market prices. We do not enter into financial instruments for trading or speculative purposes and do not currently utilize derivative financial instruments. Our operations are conducted primarily in the United States and as such are not subject to material foreign currency exchange rate risk.

The fair value of our investment portfolio or related income would not be significantly impacted by either a 100 basis point increase or decrease in interest rates due mainly to the short-term nature of the major portion of our investment portfolio. All of the potential changes noted above are based on sensitivity analyses performed on our investment portfolio balances as of September 30, 2000.

PART II. OTHER INFORMATION

ITEM 1: LEGAL PROCEEDINGS

On October 6, 2000, Mall.com, Inc. filed suit against us in Texas State District Court of Travis County. The suit is based on a contract between Mall.com and IveBeenGood.com, which we acquired in August 2000. The suit alleges that IveBeenGood.com breached a contract with Mall.com, breached a warranty given to Mall.com and committed fraud and negligent misrepresentation. Mall.com seeks return of cash and stock paid by Mall.com, attorneys' fees and costs, $1 million in direct damages, $15 million in compensatory damages and $32 million in punitive damages. We first received a copy of the complaint on October 30, 2000, and are evaluating the claims made and our counterclaims. We intend to vigorously defend our position.

ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS

Between July 1, 2000 and September 30, 2000, we issued and sold unregistered securities as set forth below:

•: On August 24, 2000, the Company acquired Ivebeengood.com, d/b/a UberWorks ("UberWorks"), a wholly owned subsidiary of Trilogy, Inc. ("Trilogy"), for approximately $22.8 million, of which $2.4 million was accrued as non-cash deferred compensation, $5.9 million in non-cash deferred tax liabilities assumed and $14.5 million in common stock and common stock options issued to UberWorks shareholders and employees. Upon effectiveness of the acquisition, a total of 2,601,562 shares of common stock valued at approximately $6.13 per share were issued to shareholders of UberWorks, of which 423,253 are being held by the Company to be released based on time vesting and on certain performance criteria yet to be achieved. The maximum term of the retention is 3 years from the effective date of the acquisition. In addition, the Company issued a warrant to Trilogy, with a strike price of $0.000001 per share, to purchase additional shares of the Company's common stock if on the one-year anniversary date of the acquisition, the shares currently held by Trilogy (the "Trilogy Shares") are not worth at least $13.1 million. The maximum number of additional shares that Trilogy can purchase under the terms of the warrant are 2.6 million. To the extent that the Trilogy Shares have a fair market value that exceeds $13.1 million on the one-year anniversary date, the warrant is cancelled and Trilogy must forfeit the number of Trilogy Shares that would be required to bring the fair value of the Trilogy Shares down to $13.1 million, limited to a maximum of 1.1 million shares to be forfeited under this scenario. The Company also issued options to purchase 248,162 shares of common stock to certain UberWorks employees.
•: On September 28, 2000, in connection with the closing of a private placement, we issued convertible promissory notes in the aggregate principal amount of $20 million to Capital Ventures International ("CVI"). In connection with the private placement, we also issued to CVI warrants to purchase up to 4,050,633 shares of our common stock at an exercise price of $10.375 per share. The warrants have a term of 5 years. The promissory notes bear interest of 6%, compounded annually. The principal amount of the notes plus accrued and unpaid interest automatically convert into shares of our common stock upon the effectiveness of the registration statement filed with the Securities Exchange Commission on October 26, 2000, covering the resale of the shares issuable upon the conversion of the promissory notes and upon the exercise of the warrants, subject to the limitation that the notes will not convert to the extent that the right to effect such conversion would result in CVI beneficially owning more than 4.99% of our outstanding shares. If the limitation applies, then the rest of the notes will convert one year following the effectiveness of the registration statement. If the registration statement is not declared effective by the first anniversary of the date of issuance, then the outstanding principal and interest under the notes will become due and payable. The conversion price is initially $7.50

and upon the effective date of the registration statement will be reduced (if lower) to 95% of the average closing bid price of our common stock during the 20 trading days immediately prior to the effective date of the registration statement but in no event greater than the closing bid price on the last trading day immediately prior to the effective date of the registration statement.

No underwriters were engaged in connection with these issuances and sales. These securities were issued in transactions exempt from registration under the Securities Act of 1933 in reliance upon Section 4(2) of the Securities Act and Regulation D promulgated thereunder. Between July 1, 2000 and September 30, 2000, we issued 393,575 shares of common stock in conjunction with the exercise of options granted under our stock option plans. The options granted under the stock option plan were issued to our officers, employees and consultants at exercise prices ranging from $1.20 to $16.68. No options were granted outside of our stock option plans. These securities were issued in transactions exempt from registration under the Securities Act of 1933 in reliance upon Rule 701 promulgated under the Securities Act of 1933. Where Rule 701 was not available, the securities were issued in transactions exempt from registration under the Securities Act of 1933 in reliance upon Section 4(2) of the Securities Act of 1933.

ITEM 3: DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY SHAREHOLDERS

None.

ITEM 5: OTHER INFORMATION

None.

ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K

(a)

Exhibits

27.1: Financial Data Schedule.

(b): Reports on Form 8-K

On October 4, 2000, we filed a Form 8-K to announce the closing of a private placement whereby we issued convertible promissory notes in the aggregate principal amount of $20 million, together with warrants to purchase up to 4,050,633 shares of our common stock, to Capital Ventures International.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	NETWORK COMMERCE INC.
Date: November 13, 2000	By:	/s/ DWAYNE M. WALKER Dwayne M. Walker Chief Executive Officer
	By:	/s/ ALAN D. KOSLOW Alan D. Koslow Chief Financial Officer

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Index
PART I. FINANCIAL INFORMATION

ITEM 1.

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 SHAREHOLDERS

ITEM 5: OTHER INFORMATION

ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K

SIGNATURES

Positive
Negative
Uncertain
Constraining
Legalese
Litigious
Readability	8th grade Avg

Network Commerce (NWKCE) Inactive 10-Q2000 Q3 Quarterly report

Content analysis

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