In the third quarter of 2000, CenterSpan began development of a peer-to-peer file sharing and search network utilizing digital rights management technology, which is code-named C-star. In December 2000, CenterSpan purchased certain assets of Scour, Inc. (“Scour”) as approved by the U.S. Bankruptcy Court. Prior to its bankruptcy, Scour developed Internet information location tools and provided other online services. Its search and peer-to-peer file sharing application, Scour Exchange, facilitated the search and exchange of digital audio, video and image files over the Internet. CenterSpan began beta testing of the new Scour™, which incorporates its C-star technology, in March 2001. The new Scour™ is a secure and legal digital distribution channel that integrates peer-to-peer technology with digital rights management support. Scour™ is available by pointing a user’s browser to the Scour.com website.
CenterSpan is pursuing three revenue opportunities utilizing the C-star technology. CenterSpan is pursuing a tiered subscription revenue model for access to music and video files through Scour™ and also expects to receive revenue from advertising placements in Scour™. CenterSpan also expects to derive revenue by providing the C-star peer-to-peer digital distribution channel to third parties as a service on a transaction basis.
Included in the research and engineering amounts for the quarter and six month period ended June 30, 2000 is $1.3 million related to the value of a warrant issued to Intel in exchange for the ability to sublicense its Launch & Connect technology. This technology is no longer being utilized, nor is CenterSpan attempting to sublicense the technology.
CenterSpan anticipates incurring levels of research and engineering expense in each of the remaining quarters of 2001 similar to the level incurred in the quarter ended June 30, 2001, except for the $580,000 impairment of technology, as it launches its paid subscription service for Scour Exchange™. CenterSpan had 26 employees in research and engineering functions at both June 30, 2001 and December 31, 2000.
Selling, General and Administrative
Selling, general and administrative expenses consist of salaries and related expenses for personnel engaged in direct sales, partner development, consultant fees, advertising, promotional materials, executive, legal, accounting and administrative personnel, professional services and general corporate expenses. Selling, general and administrative expenses increased to $3.3 million and $5.8 million, respectively, in the three and six month periods ended June 30, 2001 from $1.5 million and $2.6 million, respectively, in the comparable periods of 2000. The increase in the first six months of 2001 is primarily due to $1,289,000 of amortization expense in the first half of 2001 related to the purchase of certain intangible assets of Scour, Inc. in the fourth quarter of 2000, $646,000 related to the establishment of our Digital Media and Entertainment Group, which is responsible for building long-term business relationships with content providers, $360,000 related to additional infrastructure costs for C-star, $387,000 related to value of non-employee stock options issued in exchange for services, and $450,000 in increased salaries and public relations expense. CenterSpan anticipates incurring levels of general and administrative expenses in each of the remaining quarters of 2001 similar to the level incurred in the quarter ended June 30, 2001, and decreased costs for marketing expense in the third quarter of 2001, increasing in the fourth quarter of 2001 as it promotes and launches its paid subscription version of Scour ™. At June 30, 2001, CenterSpan had 32 employees in selling, general and administrative functions compared to 27 at December 31, 2000.
Interest Income
Interest income decreased to $138,000 and $279,000, respectively, in the three and six month periods ended June 30, 2001 from $260,000 and $495,000, respectively, in the comparable periods of 2000, as a result of higher cash balances in the first half of 2000, which resulted primarily from private placements of debt and equity securities during 1999 and the sale of the Company’s hardware business in October 1999 for $15.0 million. CenterSpan’s cash balances increased during the first half of 2001 as a result of the sale of Common Stock to an individual investor for proceeds of $5.0 million late in the fourth quarter of 2000 and of $5.0 million in the first quarter of 2001 and the sale of 569,177 shares of Common Stock to nine investors for total proceeds of $6.4 million in the second quarter of 2001, which will result in interest income until utilized.
Interest Expense
CenterSpan incurred interest expense of $26,000 in the second quarter of 2001 as a result of the purchase of certain information systems software utilizing a capital lease in the amount of $675,000.
Gain from Disposal of Discontinued Operations
The gain from disposal of discontinued operations of $604,000 in the first half of 2001 resulted from the release of $2.4 million of restricted cash from escrow and final settlement with Guillemot. CenterSpan received approximately $1.4 million of the restricted cash after all required payments were made to Guillemot. See Note 5.
Provision for Income Taxes
A valuation allowance has been recorded for the full amount of deferred tax assets due to the uncertainty regarding the utilization of the net operating loss and credit carryforwards.
Liquidity and Capital Resources
CenterSpan has financed its activities since the disposition of its hardware business in October 1999 primarily with a combination of proceeds from the sale of its hardware business and proceeds from the sale of equity securities. At June 30, 2001, CenterSpan had $11.4 million of working capital and a current ratio of 7.9 to 1.0. Included in working capital is $491,000 of restricted cash related to deposits for certain contracts, a majority of which is scheduled to be released April 1, 2002.
In March 2001, CenterSpan and Guillemot entered into a settlement agreement and mutual release under which CenterSpan received approximately $1.4 million of restricted cash from escrow. Guillemot received approximately $1.0 million, including amounts collected on their behalf and purchase price adjustments called for in the asset purchase contract. See Note 5.
In February 2001, CenterSpan sold 714,286 shares of its Common Stock to an accredited investor for $7.00 per share for total proceeds of $5.0 million. In conjunction with this issuance, the Company issued warrants exercisable for an aggregate of 85,000 shares of the Company’s Common Stock to five designees of the investor’s financial consultant. The warrants are immediately exercisable at a price of $9.063 per share and expire in December 2005. The fair value of the warrants was determined to be $563,000 using the Black Scholes methodology.
In June 2001, CenterSpan sold 569,177 shares of its Common Stock to nine accredited investors for $11.21 per share (the 30-day trailing volume weighted average price of the Company’s Common Stock) for proceeds to the Company of $6.4 million. In conjunction with this issuance, warrants covering an aggregate of 598,214 shares of the Company’s Common Stock were issued to the investors and certain finders at an exercise price of $18.68 per share. The warrants are immediately exercisable and expire in June 2003. The warrants were valued using the Black-Scholes model using the following assumptions: expected dividends, 0%; risk-free interest rate, 4.4%; volatility, 90%; and expected life, 3 years. The relative fair value of the warrants was $2,001,000.
Cash increased $4.5 million in the first half of 2001 primarily as a result of proceeds from issuance of Common Stock of $11.7 million, offset in part by $6.4 million used in operations and $638,000 used for the purchase of property and equipment.
CenterSpan currently anticipates that it will continue to utilize cash in operations at current levels for the remainder of 2001 as it decreases spending on the Scour beta, offset by increased research and engineering and marketing expenses for the launch of the paid subscription version of Scour ™ and increased expenditures related to the development of new distribution channels.
Accrued liabilities decreased $1.8 million to $761,000 at June 30, 2001 from $2.6 million at December 31, 2000 primarily due to the final settlement with Guillemot in connection with the release of restricted cash from escrow. See Note 5.
During the second quarter of 2001, CenterSpan entered into a one-year capital lease obligation for $675,000 for the purchase of certain information systems software for the C-star platform, which supports Scour. As of June 30, 2001, CenterSpan owed $520,000 on this obligation.
CenterSpan spent $1,313,000 on capital expenditures in the first six months of 2001, including the $675,000 financed with a capital lease, primarily for engineering and information systems equipment and software. CenterSpan anticipates spending $1.0 million on capital expenditures during the remainder of 2001 primarily for additional server hardware and software, data warehousing software tools and billing and financial clearing software.
We believe that our current cash and cash equivalent balances, together with cash anticipated to be generated from operations and anticipated financing arrangements, will satisfy our projected working capital and capital expenditure requirements through at least the next 12 months. However, we may be required to finance any additional requirements through additional equity, debt financings, or credit facilities. We may not be able to obtain additional financings or credit facilities, or if these funds are available, they may not be
available on satisfactory terms.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
None.
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
In May 2001, Ingram Micro, Inc. filed a lawsuit, case number 01-CV-715-JO, in the U.S. District Court for Oregon relating to a dispute regarding Ingram’s ability to return Company merchandise for which it acted as a distributor in 1999. The amount of the claim is approximately $450,000 plus pre-judgment interest. The Company intends to vigorously defend this claim.
Item 2. Changes in Securities and Use of Proceeds
In June 2001, CenterSpan sold 569,177 shares of its Common Stock to Peter R. Kellogg, four separate AIG SoundShore funds, Baltic Securities Limited, Sawtooth Partners, LP, Steelhead Investments Ltd. and Strong River Investments Inc., all accredited investors, at a price of $11.21 per share (the 30-day trailing volume weighted average price of the Company’s Common Stock) for total proceeds of $6.4 million. On June 30, 2001, Mr. Kellogg held a total of 2,119,222 shares, or 24.6%, of our outstanding Common Stock and Sawtooth Partners, LP held a total of 873,982 shares, or 10.1%, of our outstanding Common Stock. The proceeds from this stock sale are being used to fund current operations.
In connection with this issuance, CenterSpan also issued warrants to the investors to purchase a total of 569,177 shares of its Common Stock. In addition, warrants to purchase 21,008 and 8,029 shares of its Common Stock, respectively, were issued to Lucas Capital and one individual as a finders fee. The warrants have an exercise price of $18.68, are immediately exercisable and expire June 20, 2003.
Each purchaser of Common Stock and each recipient of warrants represented to CenterSpan that he, she or it is an accredited investor and each of them received all SEC filings made by CenterSpan since January 1, 2001.
The offer and sale of the shares and the warrants involved no general solicitation or general advertising by or on behalf of CenterSpan and were made in reliance upon the exemptions from registration provided by Section 4(2) of the Securities Act and Regulation D, Rule 506 of the Securities Act.
CenterSpan has agreed to use reasonable efforts to file a registration statement under the Securities Act, prior to August 20, 2001, with respect to the shares and warrants issued in June 2001. The Company also anticipates including in the registration statement other shares issued in prior private placements. Upon registration, the shares will be freely tradable under the Securities Act. Sales in the public market of a significant number of CenterSpan’s shares could cause a decline in the market value of CenterSpan's Common Stock.
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of the shareholders of the Company was held on May 15, 2001, at which the following actions were taken:
| 1. | The shareholders elected the three Class A nominees for director to the Board of Directors of the Company for three-year terms. The three directors elected, along with the voting results are as follows: |
| | |
| | Name | No. of Shares
Voting For | | No. of Shares
Withheld Voting | |
|
| |
| |
| | David Billstrom | 7,605,711 | | 26,245 | |
| | Jerome J. Meyer | 7,609,211 | | 22,745 | |
| | G. Gerald Pratt | 7,608,111 | | 23,845 | |
| 2. | The shareholders approved the appointment of KPMG LLP, independent accountants, as auditors of the Company for the year ending December 31, 2001. |
No. of Shares
Voting For | | No. of Shares
Voting Against | | No. of Shares
Abstaining | | No. of Broker
Non-Votes |
| |
| |
| |
|
| 7,610,247 | | 15,650 | | 6,059 | | - |
Item 6. Exhibits and Reports on Form 8–K
(a) Exhibits
The exhibits filed as a part of this report are listed below and this list is intended to constitute the exhibit index.
Exhibit No.
| | 10.1 | Settlement Agreement and Mutual Release dated March 27, 2001 between CenterSpan Communications Corporation and Guillemot Corporation, S.A. Incorporated by reference from the Company’s Form 10-Q for the quarter ended March 31, 2001. |
| | | |
| | 10.2 | Form of Unit Purchase Agreement dated June 20, 2001. (1) |
| | | |
| | 10.3 | Form of Common Stock Purchase Warrant Agreement dated June 20, 2001. (1) |
| | | |
| | 10.4 | License Agreement dated April 12, 2001 and Term License Lease Schedule between Oracle Corporation and CenterSpan Communications Corporation. |
| | (1) | A Schedule attached to this exhibit identifies all other documents not required to be filed as exhibits because such other documents are substantially identical to this exhibit. The schedule also sets forth material details by which the omitted documents differ from this exhibit. |
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended June 30, 2001.
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.
| Date: August 13, 2001 | CENTERSPAN COMMUNICATIONS CORPORATION |
| | |
| | By:/s/MARK B. CONAN |
| |
|
| | Mark B. Conan |
| | Vice President, Finance and Administration and |
| | Chief Financial Officer |
| | (Principal Financial and Accounting Officer) |
