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 JUNE 30, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
Commission File Number 0-26707
NETWORK COMMERCE INC.
(Exact name of registrant as specified in its charter)
WASHINGTON 91-1628103
(State or other jurisdiction of (IRS Employer
incorporation or organization) 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 July 26, 2002, there were 5,893,110 shares outstanding of the Registrant's
common stock.
Network Commerce Inc.
Form 10-Q
Index
PAGE
PART I FINANCIAL INFORMATION
ITEM 1: Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2002
and December 31, 2001.............................................................. 3
Condensed Consolidated Statements of Operations for the three- and six-month
periods ended June 30, 2002 and 2001 .............................................. 4
Condensed Consolidated Statements of Cash Flows for the six-month
periods ended June 30, 2002 and 2001............................................... 5
Notes to Interim Condensed Consolidated Financial Statements.......................... 6
ITEM 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations................................................ 14
ITEM 3: Quantitative and Qualitative Disclosures about Market Risk............................ 35
PART II OTHER INFORMATION
ITEM 1: Legal Proceedings..................................................................... 36
ITEM 2: Changes in Securities and Use of Proceeds............................................. 36
ITEM 3: Defaults Upon Senior Securities....................................................... 36
ITEM 4: Submission of Matters to a Vote of Security Holders................................... 36
ITEM 5: Other Information..................................................................... 36
ITEM 6: Exhibits and Reports on Form 8-K...................................................... 36
SIGNATURES ...................................................................................... 37
2
PART I. FINANCIAL INFORMATION
ITEM 1.
Network Commerce Inc.
Condensed Consolidated Balance Sheets
(in thousands, except share amounts)
(unaudited)
June 30, December 31,
---------- -----------
2002 2001
---------- -----------
ASSETS
Current assets:
Cash and cash equivalents .................................................... $ 1,456 $ 1,879
Restricted cash .............................................................. 57 164
Short-term investments ....................................................... 50 5
Marketable equity securities ................................................. 15 2,547
Accounts receivable, net of allowance for bad debts of $1,292 and $1,468 .... 557 1,366
Prepaid expenses and other current assets .................................... 1,121 1,275
--------- ---------
Total current assets .................................................... 3,256 7,236
Property and equipment, net ..................................................... 1,215 1,705
Other intangible assets, net .................................................... 8 168
Cost-basis investments .......................................................... 645 720
Other assets, net ............................................................... 616 561
--------- ---------
Total assets ............................................................ $ 5,740 $ 10,390
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................................. $ 1,464 $ 2,200
Accrued liabilities .......................................................... 2,525 2,860
Current portion of notes and leases payable .................................. 1,744 723
Deferred revenues ............................................................ 859 750
--------- ---------
Total current liabilities ............................................... 6,592 6,533
Notes and leases payable, less current portion .................................. 173 1,630
Deferred revenues ............................................................... 275 155
--------- ---------
Total liabilities ....................................................... 7,040 8,318
--------- ---------
Commitments and contingencies (Note 13)
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 - 5,893,110 at June 30, 2002 and 5,878,030
at December 31, 2001 .................................................... 556,537 556,574
Subscriptions receivable...................................................... (41) (41)
Common stock warrants ........................................................ 18,248 18,248
Deferred compensation ........................................................ (1,927) (3,193)
Accumulated other comprehensive loss ......................................... (15) (85)
Accumulated deficit .......................................................... (574,102) (569,431)
--------- ---------
Total shareholders' equity .............................................. (1,300) 2,072
--------- ---------
Total liabilities and shareholders' equity .............................. $ 5,740 $ 10,390
========= =========
The accompanying notes are an integral part of these condensed consolidated
balance sheets.
3
Network Commerce Inc.
Condensed Consolidated Statements of Operations
(in thousands, except share amounts)
(unaudited)
For the Three Months Ended For the Six Months Ended
June 30, June 30,
----------------------------- ------------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Revenues ......................................... $ 1,675 $ 6,280 $ 3,293 $ 16,388
Cost of revenues ................................. 517 1,932 1,023 4,248
----------- ----------- ----------- -----------
Gross profit ................................ 1,158 4,348 2,270 12,140
----------- ----------- ----------- -----------
Operating expenses:
Sales and marketing ......................... 1,340 6,788 3,001 24,079
Research and development .................... 203 2,126 632 7,394
General and administrative .................. 1,254 2,874 2,557 7,157
Amortization of intangible assets ........... 64 5,042 160 23,339
Stock-based compensation .................... 659 1,007 1,228 1,267
Restructuring and other impairment charges .. -- (8,915) -- 62,073
Impairment of certain long-lived assets ..... -- -- -- 43,136
Unusual item - settlement of claim .......... -- -- -- 4,559
----------- ----------- ----------- -----------
Total operating expenses ............... 3,520 8,922 7,578 173,004
----------- ----------- ----------- -----------
Loss from operations ................... (2,362) (4,574) (5,308) (160,864)
----------- ----------- ----------- -----------
Nonoperating income (expense):
Loss on sale of investments ................. (196) -- (584) (150)
Interest income ............................. 22 66 28 623
Interest expense ............................ (49) (2,658) (105) (5,540)
Other ....................................... 211 (15) 808 (39)
Impairment of cost-basis investments ........ -- -- (75) (18,820)
----------- ----------- ----------- -----------
Total nonoperating income (expense), net (12) (2,607) 72 (23,926)
----------- ----------- ----------- -----------
Loss before extraordinary gains ........ (2,374) (7,181) (5,236) (184,790)
Extraordinary gains .............................. 304 8,974 565 8,974
----------- ----------- ----------- -----------
Net income (loss)....................... $ (2,070) $ 1,793 $ (4,671) $ (175,816)
=========== =========== =========== ===========
Basic income (loss) per share:
Loss before extraordinary gains .................. $ (0.42) $ (1.45) $ (0.94) $ (37.63)
Extraordinary gains .............................. 0.05 1.81 0.10 1.83
----------- ----------- ----------- -----------
Basic income (loss) per share..................... $ (0.37) $ 0.36 $ (0.84) $ (35.80)
=========== =========== =========== ===========
Weighted average shares outstanding used to
compute basic income (loss) per share........ 5,560,760 4,937,404 5,558,463 4,910,967
=========== =========== =========== ===========
The accompanying notes are an integral part of these condensed consolidated
balance sheets.
4
Network Commerce Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
For the Six Months Ended
June 30,
--------------------------
2002 2001
---------- ----------
Operating activities:
Net loss .................................................................. $ (4,671) $(175,816)
Adjustments to reconcile net loss to net cash used in operating activities-
Depreciation and amortization .......................................... 712 28,285
Accretion of promissory note payable ................................... 59 4,296
Provision for bad debts ................................................ 66 2,282
Amortization of deferred compensation .................................. 1,228 1,267
Restructuring and impairment charges ................................... -- 67,238
Impairment of certain long-lived assets ................................ -- 43,136
Impairment of investments .............................................. 75 18,820
Extraordinary gains .................................................... (565) (8,974)
Unusual item - settlement of claim ..................................... -- 4,559
Realized loss from sale of marketable equity securities ................ 584 150
Changes in operating assets and liabilities -
Accounts receivable ............................................... 742 11,591
Prepaid expenses and other current assets ......................... 154 1,494
Other assets ...................................................... (45) (85)
Accounts payable and accrued liabilities .......................... (506) (24,175)
Deferred revenue .................................................. 229 (2,126)
--------- ---------
Net cash used in operating activities ........................................... (1,938) (28,058)
--------- ---------
Investing activities:
Sales of short-term investments ........................................... 62 35,567
Proceeds from sale of investments ......................................... 2,018 848
Purchases of property and equipment ....................................... (62) (35)
Investments in other assets ............................................... -- (3)
--------- ---------
Net cash provided by investing activities ....................................... 2,018 36,377
--------- ---------
Financing activities:
Payments on line of credit ................................................ -- (10,147)
Payments on long-term debt ................................................ (505) (3,918)
Proceeds from sale of common stock and exercise of stock options .......... 2 5
Proceeds from collection of subscription receivable ....................... -- 3
--------- ---------
Net cash used in financing activities ........................................... (503) (14,057)
--------- ---------
Net decrease in cash and cash equivalents ....................................... (423) (5,738)
Cash and cash equivalents at beginning of period ................................ 1,879 11,715
--------- ---------
Cash and cash equivalents at end of period ...................................... $ 1,456 $ 5,977
========= =========
Supplementary disclosure of cash flow information:
Cash paid during the period for interest .................................. $ 46 $ 644
========= =========
Cash paid during the period for income taxes .............................. $ 91 $ --
========= =========
Non-cash investing and financing activities:
Assets acquired under capital leases ................................... $ -- $ 160
========= =========
The accompanying notes are an integral part of these condensed consolidated
balance sheets.
5
Network Commerce Inc.
Notes To Condensed Consolidated Financial Statements
(unaudited)
Note 1. Organization and Background:
The Company
Network Commerce Inc. (the Company), a Washington corporation, is a technology
infrastructure and online services company. The Company provides technology and
online business services solutions through its two operating groups, NCI Hosting
and NCI Marketing. Currently, NCI Hosting includes domain registration, hosting
and other online business services, and NCI Marketing includes online database
marketing services. Additionally, the Company is pursuing licenses of certain
software patents. The Company's headquarters are located in Seattle, Washington.
The Company established NCI Hosting and NCI Marketing in January 2001 out of a
restructuring of the Company's two then-existing commerce networks, known as the
Network Commerce Consumer Network, which aggregated businesses and shoppers over
a distributed network of Web sites, and the Network Commerce Business Network,
which enabled businesses to engage in online activities and transactions with
other businesses. The Company also previously operated an eBusiness Services
division, which provided consulting, custom commerce solutions, and integrated
marketing services for businesses conducting commerce online, and which was
shutdown in January 2001 as part of the restructuring process. In addition, as a
result of the restructuring efforts in 2001, certain of the Company's previous
business units and offerings were shut down or sold, including SpeedyClick.com,
GO Software, Ubarter, Internet Domain Registrars and FreeMerchant.com.
The Company is subject to similar risks and challenges associated with other
companies at a similar stage of development, including dependence on key
management personnel, on successful development and marketing of its products
and services and the continued acceptance of the Internet. Additional risks
include competition from substitute products and services from companies with
greater financial, technical, management and marketing resources and risks
associated with recent restructuring activities. 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.
Going Concern
The Company's condensed consolidated financial statements for the six months
ended June 30, 2002 have been prepared on a going concern basis, which
contemplates the realization of assets and the settlement of liabilities in the
normal course of business. The Company has incurred a net loss of $4.7 million
for the six-month period ended June 30, 2002 and has accumulated deficits of
$574.1 million as of June 30, 2002. The Company has continuously incurred net
losses from operations and as of June 30, 2002 had a working capital deficit of
$3.3 million. These factors raise substantial doubt about the Company's ability
to continue as a going concern. The condensed consolidated financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.
The Company believes that its cash reserves and cash flows from operations may
be adequate to fund its operations through December 2002. Consequently, the
Company will require substantial additional funds to continue to operate its
business beyond that period. Many companies in the Internet industry have
experienced difficulty raising additional financing in recent months. Additional
financing may not be available to the Company on favorable terms or at all. Even
if additional financing is available, the Company may be required to obtain the
consent of its existing lenders, shareholders, or the party from whom the
Company secured the equity credit line, which the Company may not be able to
obtain. If additional financing is not available, the Company may need to
dramatically change its business plan, shut down or reduce business units or
production lines, sell or merge its business, or face bankruptcy. In addition,
the issuance of equity or equity-related securities will dilute the ownership
interest of existing shareholders and the issuance of debt securities could
increase the risk or perceived risk of the Company.
6
The Company's plans to mitigate the risk of this uncertainty may include, but
are not limited to, one or more of the following:
o exploring strategic alternatives, which may include a merger, asset sale,
the shut down of assets or divisions, joint ventures or another comparable
transaction;
o raising additional capital to fund continuing operations by private
placements of equity and/or debt securities or through the establishment of
other funding facilities;
o forming a joint venture with a strategic partner or partners to provide
additional capital resources to fund operations; and
o loans from management or employees, salary deferrals or other cost cutting
mechanisms.
Additional cost-cutting measures could include additional lay-offs and/or the
closure of certain business units and facilities.
Note 2. Summary of Significant Accounting Policies:
Unaudited Interim Financial Data
The condensed consolidated financial statements are unaudited and have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission (SEC). 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 condensed consolidated financial statements should be read in
conjunction with the audited consolidated financial statements and notes thereto
included in the Company's December 31, 2001 Form 10-K as filed with the SEC on
April 1, 2002. 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 six-month periods
ended June 30, 2002 and 2001 are not necessarily indicative of the results to be
expected for the full year.
Principles of Consolidation
The Company's condensed 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. Equity investments in which the
Company holds less than a 20% ownership interest and does not exercise
significant influence are recorded at cost and are included in cost-basis
investments in the accompanying condensed consolidated balance sheets. The
Company monitors these cost-basis investments for impairment. When cost-basis
investments are deemed to be permanently impaired, the difference between cost
and market value is charged to operations. 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.
Revenue Recognition
Since restructuring in January 2001, the Company derives revenues primarily from
the sale of online database marketing services within NCI Marketing and domain
registration, hosting and other online business services within NCI Hosting.
Revenues from online database marketing services are recognized as the services
are delivered to the businesses over the term of the agreement, which typically
range from one to three months. Revenues from domain
7
registrations are recognized over the registration term, which typically range
from one to three years. Revenues from hosting and online business services are
recognized over the term of the agreements, which are generally twelve months.
Unearned revenues are classified as either current or long-term deferred
revenues depending on the future recognition of those revenues.
Revenues are also generated from fees paid to the Company by businesses that
licensed the Company's technology and patents: transaction processing, fraud
prevention, and online payment system, as well as other e-commerce enabling
technologies. Revenues may include licensing fees, per-transaction fees and, in
certain cases, monthly hosting and maintenance fees, which were recognized in
the period earned. Revenues generated from technology licensing were recognized
in accordance with American Institute of Certified Public Accountants, Statement
of Position 97-2, "Software Revenue Recognition."
The Company recognized revenues from barter transactions when earned. The
Company valued 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 was more readily determinable. The Company recognized
approximately $0 and $1.4 million in revenues on such transactions during the
six-months ended June 30, 2002 and 2001, respectively.
The Company recognized revenues from the sale of online database marketing
services, leads and orders, advertising and merchandising in which the Company
received equity in the customer. The Company valued the equity received from
these transactions as cost-basis investments based on the value of the
consideration received from the customer or from the value of the services
provided to the customer, whichever was more readily determinable. The Company
monitors these cost-basis investments for impairment. When cost-basis
investments are deemed to be permanently impaired, the difference between cost
and market value is charged to operations. There can be no assurance that the
Company's investments in these early-stage technology companies will be
realized. The Company recognized approximately $0 and $205,000 in revenues on
such equity transactions during the six-month period ended June 30, 2002 and
2001, respectively.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations."
SFAS No. 141 establishes accounting and reporting standards for business
combinations to use the purchase method. The effective date of SFAS No. 141 is
June 30, 2001. All acquisitions by the Company have been accounted for using the
purchase method. There have been no business combinations since June 30, 2001.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 142 establishes accounting and reporting standards for
acquired goodwill and other intangible assets. The statement eliminates the
amortization of goodwill over its estimated useful life. Rather, goodwill will
be subject to at least an annual assessment for impairment by applying a
fair-value-based test. SFAS No. 142 is effective for fiscal years beginning
after December 14, 2001. The Company adopted SFAS No. 142 on January 1, 2002 and
the impact was immaterial.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS No. 144 establishes accounting and
reporting standards for the impairment or disposal of long-lived assets and
supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of." The Company adopted SFAS No. 144 on
January 1, 2002 and the impact was immaterial.
Reclassifications and Reverse Stock Split Adjustments
Certain information reported in previous periods has been reclassified to
conform to the current period presentation. Effective June 18, 2001, the Company
initiated a 1-for-15 reverse split of the Company's outstanding common stock.
All common stock shares and per share amounts have been adjusted to reflect the
reverse split.
8
Note 3. Acquisitions and Dispositions:
All acquisitions have been accounted for using the purchase method of
accounting.
In June 1999, the Company acquired GO Software, Inc. ("GO"). GO develops and
markets transaction processing software. In May 2001, the Company completed the
sale of GO to Return on Investment Corporation ("ROI") for $1.0 million in cash
and $3.0 million in ROI common stock.
Also in June 1999, the Company acquired CardSecure, Inc. ("CardSecure") for a
purchase price of approximately $3.5 million. CardSecure is a developer of
e-commerce enabled Web sites. The excess purchase price of approximately $3.5
million was allocated to acquired technology and was amortized over the
three-year period ending May 2002.
In November 1999, the Company acquired SpeedyClick, Corp. ("SpeedyClick"), a
California corporation that maintained an Internet Web site that focused on
entertainment and interactivity. In March 2001, the Company shut down the
operations and wrote-off the remaining intangible assets.
In January 2000, the Company acquired Pronet Enterprises Ltd. ("Pronet"), a
Canadian company, that operated a business-to-business portal and marketplace
that aggregates businesses that seek to transact with one another. In January
2001, the Company revised its estimated useful life for these assets and
amortized the remaining carrying value of Pronet over the first six months of
2001.
In April 2000, the Company acquired FreeMerchant.com, Inc. ("FreeMerchant"), a
Delaware corporation, that developed online store-builder technology and
provides hosting services to those businesses. In December 2001, the Company
sold substantially all of the assets of FreeMerchant.
In June 2000, the Company acquired Ubarter.com Inc. ("Ubarter"), a
business-to-business e-commerce enterprise, which utilizes its proprietary
barter exchange system. In February 2001, the Company sold the Canadian-based
operations of Ubarter and in June 2001, the Company sold the US-based
operations.
In August 2000, the Company acquired Ivebeengood.com, d.b.a. UberWorks, a
developer of multi-merchant e-commerce purchasing tools and universal shopping
cart technology. In March 2001, the Company abandoned the technology and
wrote-off the remaining intangible assets.
In December 2000, the Company acquired ePackets.Net, Inc., a provider of
permission-based one-to-one email solutions. In March 2001, the Company shut
down the operations and wrote-off the remaining intangible assets.
In December 2000, the Company acquired Internet Domain Registrars Corporation
("IDR"), a domain name infrastructure company. In June 2001, the Company sold
substantially all of the assets and liabilities of IDR.
Note 4. Restructuring, Impairment and Extraordinary Gains:
Restructurings and related impairments
During the first quarter 2001, the Company continued its restructuring efforts,
which commenced in fourth quarter 2000. The restructuring included the shutdown
of SpeedyClick, the sale of Ubarter Canada, which resulted in a loss of
approximately $2.3 million, the lay off of 245 employees, which resulted in
severance and related payroll charges of $580,000 and the write-off of impaired
goodwill and intangible assets of $55.2 million, and of tenant improvements,
fixed assets, software and supporting technologies and infrastructure related to
businesses that were shut down of $13.0 million.
During the second quarter 2001, the Company further restructured its operations
by selling Ubarter USA, IDR and GO for total proceeds of $6.0 million cash and
$3.0 million of marketable equity securities, which were subject to lockup until
November 2001. The Company recorded a gain in the second quarter of $5.8 million
related to these sales. The
9
gains on these sales in the second quarter resulted from the fact that the
Company wrote down these business units by $23.6 million in first quarter 2001,
based on the best available evidence of fair market value. On an aggregate
basis, for the six months ended June 30, 2001, the Company recognized losses
totaling $17.8 million on the sale of these business units.
Impairment of Certain Long-Lived Assets
During the first quarter 2001, the Company determined that goodwill and
intangible assets associated with acquired businesses had a carrying value in
excess of the discounted cash flow expected to be received from the business
units. As a result, the Company recognized an impairment charge of $43.1
million.
Impairment of cost-basis investments
During the first quarter 2002, the Company determined that certain of its
cost-basis investments were permanently impaired relative to their historical
values. As a result, the Company recognized an impairment charge of $75,000,
which is included as a component of nonoperating (expense) income in the
accompanying June 30, 2002 condensed consolidated statements of operations.
Permanent impairments in the Company's cost-basis investments were determined by
examining the operations of each company, and when possible, by reviewing recent
private-placement valuations for comparable companies and by obtaining
professional business valuations. During the first quarter 2001, the Company
recognized an impairment charge of $18.8 million.
Extraordinary gains
The Company has negotiated with various creditors to settle liabilities for less
than the recorded invoices. These settlements resulted in an extraordinary gain
of approximately $565,000 and $9.0 million for the six months ended June 30,
2002 and 2001, respectively.
Note 5. Unusual Item:
During the first quarter 2001, the Company recorded a charge resulting from a
settlement of potential claims held by Mr. Dwayne Walker, the Company's
Chairman, and then Chief Executive Officer and President, against the Company
arising from the withdrawal of Mr. Walker's shares of the Company's common stock
from the Company's secondary public offering completed in February 2000.
Note 6. Marketable Equity Securities:
In February 2002, the Company sold 700,000 shares of ROI at $2.50 per share and
recognized a loss of $371,000 on the sale. During the second quarter 2002, the
Company returned 3,333 shares to ROI in payment of certain expenses and sold the
remaining 130,000 shares of ROI at $1.85 per share, recognizing a loss of
$156,000 on the sale. Realized gains and losses from the sale of
available-for-sale securities are determined on a specific identification basis.
Dividend and interest income are recognized as earned. Any changes in market
values that are considered other than temporary are recorded as realized gains
or losses in current operations.
Note 7. Deferred Revenues:
Unearned revenues related to domain registrations represent the unexpired term
of registration fees and are recognized ratably over the term of the
registration. Revenues from online database marketing services are recognized
when services are delivered, and licensing fees are recognized over the term of
agreement.
Note 8. Debt Obligations:
In September 2000, the Company sold $20.0 million of convertible notes and
warrants to Capital Ventures International ("CVI") pursuant to a securities
purchase agreement. The notes had a one-year term. In April 2001, the Company
received a notice of default from CVI for an alleged violation of certain
covenants. CVI filed suit against the
10
Company in May 2001 in the United States District Court for the Southern
District of New York under Civil Action No. 01CV-4390.
In July 2001, the Company entered into a settlement agreement with CVI with
respect to certain claims arising out of the securities purchase agreement. As a
result, convertible notes with a face value of $11 million and all warrants were
retired. The Company paid $2.2 million and delivered a $1.5 million non-interest
bearing convertible promissory note, which is due January 2003 and is
convertible, at any time at the option of CVI, into common stock at an exercise
price of $2.00 per share. CVI agreed that, upon payment of the $2.2 million and
delivery of the promissory note, the Company satisfied all of past, present and
future obligations to CVI under the securities purchase agreement and all
related documents other than the Registration Rights Agreement. However, CVI did
not release its claim against the Company, certain current and former officers
and directors for the alleged security violations and for fraudulent inducement.
The Company is vigorously defending against these claims. Nevertheless, an
unfavorable resolution of these claims could have a material adverse effect on
the Company in one or more future periods.
Note 9. Income Taxes:
The Company is subject to tax laws of the United States, various state and local
jurisdictions within the United States and in foreign jurisdictions. The Company
has recorded no provision for taxes in any of these jurisdictions, however the
Company may be subject to claims by these taxing jurisdictions, which would be
material to the financial position of the Company. The Company believes it has
reasonable and defendable positions in all of its taxing jurisdictions and would
vigorously defend itself against any such claim.
Note 10. Equity Financing:
In July 2001, the Company entered into an agreement with Cody Holdings Inc.
(Investor) to provide the Company with up to $18 million in equity financing
(Equity Line). Under the terms of the agreement, the Company will have the
right, but not the obligation during the 18-month term of the agreement, to
obtain equity financing through the issuance of common stock to the Investor in
a series of periodic draw downs at a discount to the market price at the time of
sale to the Investor. The maximum available amount for draw down each period is
determined using a formula that utilizes a weighted average stock price and
stock volume over a sixty-day period. The shares of common stock may be sold to
the Investor during this period at times and in amounts, subject to certain
minimum and maximum volumes, determined at the discretion of the Company. If the
Company chooses to draw down on the Equity Line, it will use the proceeds of the
financing for general corporate purposes. In October 2001, the Company completed
a draw down of $25,000. Based on the Company's stock price and average trading
volume as of June 30, 2002, it would be unable to make a draw down.
11
Note 11. Segment Information:
The Company's segment information for each of the six-months ended June 30, 2002
and 2001, as follows (in thousands):
Six Months Ended June 30,
---------------------------------
2002 2001
--------------- ---------------
Revenues:
Continuing operations:
NCI Marketing $ 1,887 $ 2,047
NCI Hosting 1,331 397
Other 75 -
--------------- ---------------
3,293 2,444
Operations shutdown or sold during 2001 - 13,944
--------------- ---------------
3,293 16,388
--------------- ---------------
Cost of revenues:
Continuing operations:
NCI Marketing 594 53
NCI Hosting 372 114
Other - -
--------------- ---------------
966 167
Operations shutdown or sold during 2001 57 4,081
--------------- ---------------
1,023 4,248
--------------- ---------------
Gross Profit:
Continuing operations:
NCI Marketing 1,293 1,994
NCI Hosting 959 283
Other 75 -
--------------- ---------------
2,327 2,277
Operations shutdown or sold during 2001 (57) 9,863
--------------- ---------------
$ 2,270 $ 12,140
=============== ===============
Note 12. Option Repricing and Grants:
In June 2002, the Company repriced 2,139,686 options to purchase shares to a
price of $0.10. This repricing will result in variable accounting treatment for
these stock options. Variable accounting treatment will result in unpredictable
stock-based compensation dependent on fluctuations in quoted prices for the
Company's common stock.
In June 2002, the Company granted 4,595,000 stock options with an exercise price
of $0.05 to its employees. The options vest ratably from April 2002 through
December 2002. The stock options covered under this grant will result in
variable accounting treatment. Variable accounting treatment will result in
unpredictable stock-based compensation charges dependent on fluctuations in
quoted prices for the Company's common stock.
Note 13. Litigation:
The Company and Mr. Walker, the Company's chairman of the board, were named as
defendants in multiple putative class actions pending in the United States
District Court for the Western District of Washington in Seattle. Those actions
are Jan Sherman, et al v. Dwayne M. Walker and Network Commerce Inc., C01-0675L
(filed May 10, 2001); Joseph Carreiro v. Network Commerce, Inc. and Dwayne M.
Walker, C01-0767L (filed May 25, 2001); Steven Leong v. Network Commerce, Inc.
and Dwayne M. Walker, C01-0770L (filed May 25, 2001); Alan Danse,
12
et al. v. Dwayne M. Walker and Network Commerce, Inc., C01-852L (filed June 7,
2001); James Lindsay v. Dwayne M. Walker and Network Commerce, Inc., C01-0918R
(filed June 20, 2001); and Kelly Christianson v. Dwayne M. Walker and Network
Commerce, Inc., C01-1063L (filed July 11, 2001). The judge in the class actions,
the Honorable Robert Lasnik, entered an order consolidating the class actions.
On September 26, 2001, prior to the date the consolidated complaint was due in
the consolidated class actions, certain of the plaintiffs filed another putative
class action in the United States District Court for the Western District of
Washington in Seattle, titled Jan Sherman; James Michaelson; and Jason Elkin v.
Dwayne M. Walker; Network Commerce Inc.; Jacob I. Friesel; Alan D. Koslow; David
M. Lonsdale; Bret R. Maxwell; Mark C. McClure; John R. Snedegar; Mark H.
Terbeek; Dain Rauscher Inc.; U.S. Bancorp Piper Jaffray; SoundView Technology
Group, Inc.; J.P. Morgan Chase & Co.; CIBC World Markets Corp.; and PaineWebber
Inc., C01-0675L. This last action was filed under the consolidated cause number
for the other consolidated class actions pending in Seattle. On November 13,
2001, plaintiffs filed the Court-ordered consolidated complaint. The
consolidated complaint named as defendants all the institutions (including the
Company) named in the prior complaints, but named only Mr. Walker as an
individual defendant, and not the other individual defendants named in the
September 26, 2001 complaint. The consolidated complaint purports to allege
claims on behalf of all persons who purchased the Company's common stock during
the period that begins on September 28, 1999 and ends on April 16, 2001. The
consolidated complaint alleges violations of the federal securities laws based
on alleged misrepresentations and omissions made by defendants to the market.
The suits seek unspecified damages. On January 28, 2002, the Company and Mr.
Walker filed a motion to dismiss the consolidated class action complaint for
failure to state a claim on which legal relief can be granted. Oral argument on
this motion is scheduled for September 4, 2002. The Company and Mr. Walker
intend to vigorously defend the suits, but unfavorable resolution of these suits
could have a material adverse effect on the Company in one or more future
periods.
On May 22, 2001, Capital Ventures International ("CVI") filed suit against the
Company and Mr. Walker, the Company's chairman of the board and other past and
current members of the Company's board of directors alleging, among other
things, a breach of the securities purchase agreement dated September 28, 2000
entered into between CVI and Network Commerce Inc., fraudulent inducement and
violations of certain federal securities laws. The lawsuit seeks unspecified
damages and rescission. On July 25, 2001, the Company entered into a settlement
agreement with CVI with respect to certain claims arising out of the securities
purchase agreement. As a result the Company paid $2.2 million and delivered a
$1.5 million promissory note. CVI agreed that, upon the payment of the $2.2
million and delivery of the settlement note, the Company satisfied all of its
past, present and future obligations to CVI under the securities purchase
agreement and all documents related to such agreement other than the
Registration Rights Agreement dated September 28, 2000. Notwithstanding the
settlement, CVI did not release its claim against the Company, certain current
and former officers and directors for the alleged security violations and for
fraudulent inducement.
The Company cannot predict the outcome of the litigation matters described above
or the extent to which the costs of defense and any settlement or award will be
covered by the Company's insurance policies. The Company is vigorously defending
against these claims. However, an adverse determination on one or more of these
matters could result in a material adverse effect on the Company's financial
condition and results of operations.
From time to time the Company has been named in other claims arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial position, results of operations or liquidity.
Note 14. Subsequent Events:
Effective July 12, 2002, Dwayne Walker resigned as Chief Executive Officer and
President. Dwayne Walker will continue as Chairman of the Board. N. Scott
Dickson was appointed as acting Chief Executive Officer.
13
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 "Factors That May Affect Our Operating
Results, Business and Stock Price" and elsewhere in this report, and the risks
discussed in our December 31, 2001 Form 10-K filed on April 1, 2002 with the
Securities and Exchange Commission.
Overview
Established in 1994, we are a technology infrastructure and online services
company that offers technology and online business services through our two
operating groups, NCI Hosting and NCI Marketing. NCI Hosting includes domain
registration, hosting and other online business services, and NCI Marketing
includes online database marketing services. Additionally, we are pursuing
licenses of certain of our software patents. We are headquartered in Seattle,
Washington.
We established NCI Hosting and NCI Marketing in January 2001 out of a
restructuring of our two then-existing commerce networks, known as the Network
Commerce Consumer Network, which aggregated businesses and shoppers over a
distributed network of Web sites, and the Network Commerce Business Network,
which enabled businesses to engage in online activities and transactions with
other businesses. We also previously operated an eBusiness Services division
that provided consulting, custom commerce solutions, and integrated marketing
services for businesses conducting commerce online, which we shutdown in January
2001 as part of the restructuring. In addition, as a result of the restructuring
efforts in 2001, certain of our previous business units and offerings were sold
or shut down, including SpeedyClick.com, GO Software, Ubarter, Internet Domain
Registrars and FreeMerchant.com.
Our condensed consolidated financial statements for the six months ended June
30, 2002 have been prepared on a going concern basis, which contemplates the
realization of assets and the settlement of liabilities in the normal course of
business. We have incurred a net loss of $4.7 million for the six months ended
June 30, 2002 and have accumulated deficits of $574.1 million as of June 30,
2002. The Company has continuously incurred net losses from operations and as of
June 30, 2002 has a working capital deficit of $3.3 million. These factors raise
substantial doubt about our ability to continue as a going concern.
As reflected on our balance sheet, our current liabilities exceed our current
assets. Although we believe that our cash reserves and cash flows from
operations may be adequate to fund our operations through December 2002, we will
require substantial additional funds to continue to operate the business beyond
that period, see "Liquidity and Capital Resources" below.
Effective July 12, 2002, Dwayne Walker resigned as Chief Executive Officer and
President. Dwayne Walker will continue as Chairman of the Board. N. Scott
Dickson was appointed as acting Chief Executive Officer.
Critical Accounting Policies And Estimates
Our critical accounting policies and estimates are as follows:
14
Revenue recognition. Since restructuring in January 2001, we derive our revenues
primarily from the sale of online database marketing services within our NCI
Marketing group and domain registration, hosting and other online business
services within our NCI Hosting group. Revenues from online database marketing
services are recognized as the services are delivered over the term of the
agreement, which typically ranges from one to three months. Revenues from domain
registrations are recognized over the registration term, which typically range
from one to three years. Revenues from hosting and online business services are
recognized over the term of the agreements, which are generally twelve months.
Unearned revenues are classified as either current or long-term deferred
revenues depending on the future recognition of those revenues.
Revenues were also generated from fees paid to us by businesses that licensed
our technology and patents; transaction processing, fraud prevention, and online
payment business system, as well as other e-commerce enabling technologies.
Revenues included licensing fees, per-transaction fees and, in certain cases,
monthly hosting and maintenance fees, which were recognized in the period
earned. Revenues generated from technology licensing were recognized in
accordance with American Institute of Certified Public Accountants, Statement of
Position 97-2, "Software Revenue Recognition."
We recognized revenues from barter transactions when earned. We valued 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
was more readily determinable. We recognized approximately $0 and $1.4 million
in revenues on such transactions during the six-month periods ended June 30,
2002 and 2001, respectively.
We recognized revenues from the sale of online database marketing services,
leads and orders, advertising and merchandising in which we received equity in
the customer. We valued the equity received from these transactions as
cost-basis investments based on the value of the consideration received from the
customer or from the value of the services provided to the customer, whichever
was more readily determinable. We monitor these cost-basis investments for
impairment. When cost-basis investments are deemed to be permanently impaired,
the difference between cost and market value is charged to operations. There can
be no assurance that our investments in these early-stage technology companies
will be realized. We recognized approximately $0 and $205,000 in revenues on
such equity transactions during the six-month periods ended June 30, 2002 and
2001, respectively. Many of these investments were written down in 2001.
Impairment of cost-basis investments. We periodically evaluate whether any
permanent declines in the fair value of our cost-basis investments has occurred.
Significant judgments and estimates must be made to assess whether a permanent
decline in fair value of investments has occurred and to estimate the fair value
of investments in privately held companies. We determined permanent impairment
in privately held companies by examining the business results and prospects of
each company, and when possible by reviewing recent private-placement valuations
for comparable companies and by obtaining professional business valuations. We
recognized permanent impairments of cost-basis investments of $75,000 and $18.8
million in the six-month periods ended June 30, 2002 and 2001, respectively.
Impairment of long-lived assets and goodwill. We assess the impairment of
long-lived assets and goodwill whenever events or changes in circumstances
indicate that the carrying value may not be recoverable. Factors we consider
important which could trigger an impairment review include the following: poor
economic performance relative to expected historical or projected future
operating results; significant negative industry, economic or company specific
trends; and changes in the manner of our use of the assets or the plans for our
business. Where we determine that the carrying value of long-lived assets or
goodwill may not be recoverable based upon the existence of one or more of the
above indicators of impairment, we measure impairment based on a comparison of
the carrying amount of an asset to discounted cash flows expected to be
generated by the asset. If such analysis indicates assets are impaired, an
impairment is recognized equal to the amount by which the carrying amount of the
assets exceeds the discounted cash flows expected to be received. We recognized
impairments of long-lived assets and goodwill of $0 and $43.1 million in the
six-month periods ended June 30, 2002 and 2001, respectively.
Restructuring and related impairments. As part of our restructuring efforts in
2001, we made significant estimates in determining the appropriate amount of
loss that resulted from the shutdown of business units. The loss included
15
write-off of impaired goodwill, intangible assets, tenant improvements, fixed
assets, software and supporting technologies and infrastructure. We recognized
restructuring and related impairments of $0 and $62.1 million in the six-month
periods ended June 30, 2002 and 2001, respectively.
Results of Operations
Overview. In light of the recent instability within the technology and Internet
infrastructure sectors and our current position within those sectors, we lack
visibility to our future revenues and related costs of revenues. Our best
estimate for 2002, is that our revenues, cost of revenues and operating expenses
will be less than our 2001 levels. We expect that our sales and marketing,
research and development and general and administrative expenses will decrease
in absolute dollars from 2001 to 2002 but may increase as a percentage of
revenues.
Revenues. Total revenues for the three- and six-month periods ended June 30,
2002 were $1.7 million and $3.3 million compared to $6.3 million and $16.4
million for the comparable periods in 2001. The decrease in revenue was due
primarily to the shutdown of ShopNow.com and SpeedyClick.com during first
quarter 2001, the elimination of product sales and the sale of Ubarter, Internet
Domain Registrars, GO Software and Free Merchant during 2001. In addition,
revenues for first quarter 2001 included $1.4 million in barter transactions and
$205,000 in revenues on equity transactions (See "Note 2. Summary of Significant
Accounting Policies: Revenue Recognition"), for which no such revenues were
recognized in the first and second quarters of 2002 or second quarter 2001.
However, revenues from continuing operations (which excludes results from the
businesses and divisions shut down or sold during 2001) were $1.7 million and
$3.3 million for the three- and six-month periods ended June 30, 2002 compared
to $1.2 million and $2.4 million for the comparable periods in 2001.
Cost of Revenues. The cost of revenues for the three- and six-month periods
ended June 30, 2002 was $517,000 and $1.0 million compared to $1.9 million and
$4.2 million for the comparable periods in 2001. The decrease in cost of
revenues was directly attributable to the decrease in revenues during the same
period and due to the shutdown of ShopNow.com and SpeedyClick.com during first
quarter 2001, and the sale of Ubarter, Internet Domain Registrars, GO Software
and Free Merchant during 2001. However, cost of revenues from continuing
operations were $519,000 and $967,000 for the three- and six-month periods ended
June 30, 2002 compared to $40,000 and $167,000 for the comparable periods in
2001.
Gross Profit. Gross profit for the three- and six-month periods ended June 30,
2002, was $1.2 million and $2.3 million compared to $4.3 million and $12.1
million for the comparable periods in 2001.
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 six-month periods ended June 30, 2002 were $1.3 million and $3.0 million
compared to $6.8 million and $24.1 million for the comparable periods in 2001.
The decrease was due primarily to a decrease in sales and marketing personnel
resulting from the restructuring in early 2001 and related costs. We anticipate
that sales and marketing expenses will be less for future periods in 2002 when
compared to comparable periods in 2001.
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 six-month periods ended June 30, 2002 were $203,000
and $632,000 compared to $2.1 million and $7.4 million for the comparable
periods in 2001. The decrease was primarily due to a decrease in personnel and
related costs and to a decreased emphasis on development activities. We
anticipate that research and development expenses will be less for future
periods in 2002 when compared to comparable periods in 2001.
General and Administrative. General and administrative expenses consist
primarily of salaries and other personnel-related costs, including benefits, 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 six-month periods ended
June 30, 2002 were $1.3 million and $2.6 million compared to $2.9 million and
$7.2 million for the comparable periods in 2001. The decrease was primarily due
to a decrease in personnel and related
16
costs, including benefits, offset by an increase in legal fees. During second
quarter 2002 we reduced the accrual for self insurance by $300,000 due to the
reduction in employees during the last twelve months and the decrease in
estimated outstanding claims. We currently have approximately 50 employees,
compared to approximately 110 at the end of the second quarter 2001. We are in
the process of evaluating and implementing cost-saving measures in an effort to
further reduce our general and administrative expense. With respect to our legal
expenses for defense of the litigation proceedings currently pending, as of May
2001 we had accrued our full deductible of $350,000 under our insurance
policies. We anticipate that general and administrative expenses will be less
for future periods in 2002 when compared to comparable periods in 2001.
Amortization of Intangible Assets. Amortization of intangible assets resulting
from our acquisitions primarily relate 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 six-month
periods ended June 30, 2002 was $64,000 and $160,000 compared to $5.0 million
and $23.3 million for the comparable periods in 2001. This decrease was due
primarily to the decrease in intangible assets and related amortization expenses
from the sale of businesses and the write-down of intangible assets. Intangible
assets acquired in business combinations were being amortized over a three-year
period, which were fully amortized as of May 2002.
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. The amount of deferred compensation
resulting from these grants is generally amortized over a one to three-year
vesting period. Additionally, in April and July 2001, we offered two voluntary
stock option exchange programs to our employees. Under the programs, the
employees, if they so chose, could exchange a certain number of highly priced
options for one option priced at the then fair market value. In June 2002, we
initiated a stock option exchange program in which 2,139,686 options were
exchanged for options priced at $0.10 per share. These stock option repricing
and voluntary stock option exchange programs resulted in variable accounting
treatment for the new priced stock options. Additionally, certain stock option
grants made within six months of the re-pricing and voluntary exchange programs
resulted in variable accounting treatment for those options. Also, in June 2002,
4,595,000 stock options were granted to employees at $0.05 per share, which
resulted in variable accounting treatment. Variable accounting treatment can
result in unpredictable stock-based compensation dependent on fluctuations in
quoted prices for our common stock. Stock-based compensation expense for the
three- and six-month periods ended June 30, 2002 was $659,000 and $1.2 million
compared to $1.0 million and $1.3 million for the comparable periods in 2001. As
of June 30, 2002, we had $1.9 million of deferred compensation to be amortized
over future periods.
Restructuring and Other Impairment Charges. We had no restructuring charges in
the three- and six-month periods ended June 30, 2002 compared to a gain of $8.9
million and a charge of approximately $62.1 million in the three- and six-month
periods ended June 30, 2001. During the first quarter 2001, we continued our
restructuring efforts, which commenced in fourth quarter 2000, and included the
shutdown of SpeedyClick, the sale of Ubarter Canada and the lay off of 245
employees. The restructuring charges in first quarter 2001 consisted primarily
of severance and related payroll charges of $580,000, the write-off of impaired
goodwill and intangible assets of $55.2 million, and of tenant improvements,
fixed assets, software and supporting technologies and infrastructure related to
businesses that were shut down of $13.1 million. During the second quarter 2001,
we further restructured our operations by selling Ubarter USA, IDR and GO for
total proceeds of $6.0 million cash and $3.0 million of marketable equity
securities which were subject to lockup until November 2001. We recorded a gain
in second quarter 2001 of $5.8 million related to these sales. The gains on
these sales in the second quarter resulted from the fact that we wrote down
these business units by $23.6 million in first quarter 2001, based on the best
available evidence of fair market value. On an aggregate basis, for the six
months ended June 30, 2001, we recognized losses totaling $17.8 million on the
sale of these business units. Additionally, we recognized gains totaling $1.3
million, primarily from revising estimates on unused operating leases and
adjustment of other liabilities related to businesses previously shut down in
first quarter 2001. If we are unable to obtain additional financing during 2002
to fund operations, we may be required to undertake further restructuring
efforts and incur additional restructuring charges. See "Liquidity and Capital
Resources" below.
Impairment of Certain Long-Lived Assets. As part of the restructuring in 2001,
we determined that goodwill and intangible assets associated with acquired
businesses had a carrying value in excess of the discounted cash flow
17
receipts of the business units. As a result, we recognized an impairment charge
of $43.1 million during the three-month period ended March 31, 2001. We had no
such impairment charges in second quarter 2001 or in the first six months of
fiscal 2002. If we are unable to obtain additional financing in fiscal 2002 to
fund operations, we may be required to take further charges for impairment of
assets. See "Liquidity and Capital Resources" below.
Unusual Item - Settlement of Claim. During the first quarter 2001, we recorded a
charge resulting from a settlement of potential claims held by Dwayne Walker,
the Company's Chairman, and then Chief Executive Officer and President against
us arising from the withdrawal of Mr. Walker's shares of our common stock from
our secondary public offering completed in February 2000.
Loss on Sale of Investments. Gain or loss on sale of investments occurs when we
sell certain of our investments in marketable equity securities and/or our
cost-basis investments for cash proceeds in excess or below our cost-basis in
these investments at the time of sale. Loss on sale of investments for the
three- and six-month periods ended June 30, 2002 was $196,000 and $584,000
compared to $0 and $150,000 in the comparable periods in 2001.
Interest Income. Interest income is earned on our cash and cash equivalents and
short-term investments. Interest income for the three- and six-month periods
ended June 30, 2002 was $22,000 and $28,000 compared to $66,000 and $623,000 in
the comparable periods in 2001. Interest income decreased due to a decrease in
our cash and cash equivalents and short-term investments. We expect that
interest income will be less in 2002 compared to comparable periods in 2001 due
to the decreased cash and investment balances.
Interest Expense. Interest expense is incurred on our outstanding debt
obligations and the accretion of our convertible promissory note. Interest
expense for the three- and six-month periods ended June 30, 2002 was $49,000 and
$105,000 compared to $2.7 million and $5.5 million for the comparable periods in
2001. Interest expense decreased due to reduced outstanding debt obligations. We
expect that interest expense will be less in 2002 compared to comparable periods
in 2001 due to reduced outstanding debt obligations as compared to 2001.
Other Nonoperating Income (Expense). Other non-operating income for the three-
and six-month periods ended June 30, 2002 was $211,000 and $808,000 compared to
an expense of $15,000 and $39,000 for the comparable periods in 2001. The
increase between the periods was primarily due to a gain of $824,000 from the
sale of FreeMerchant, which sale occurred in December 2001 but which gain was
recognized in the first and second quarters of 2002.
Impairment of Cost-Basis Investments. We determined that certain of our
cost-basis investments were permanently impaired based on our analysis of
changes in investees business operations and prospects. As a result, we
recognized an impairment charge of $0 and $75,000 during the three- and
six-month periods ended June 30, 2002 compared to a charge of $0 and $18.8
million in the comparable periods in 2001.
Extraordinary Gains. We have negotiated with various creditors to settle
liabilities for less than the recorded invoices. These settlements resulted in
gains of approximately $304,000 and $565,000 for the three- and six-month
periods ended June 30, 2002 and $9.0 million for each of the comparable periods
in 2001.
Net Income (Loss). Net loss for the three- and six-month periods ended June 30,
2002 was $2.1 million and $4.7 million compared to net gain of $1.8 million and
net loss of $175.8 million for the comparable periods in 2001. The net loss in
the three- and six-month periods ended June 30, 2002 was due primarily to
operating expenses. The net income in the three-months ended June 30, 2001 was
due primarily to extraordinary gains associated with settlements with various
creditors and net gains on the sale of three business units that had been
written down in the three-month period ended March 31, 2001, and the loss for
the six-month period ended June 30, 2001 was due primarily to impairment charges
related to cost-basis investments and intangible assets and restructuring
charges related to closure of business units.
Liquidity and Capital Resources
Since inception, we have experienced net losses and negative cash flows from
operations. For the six months ended June 30, 2002, we used net cash of $1.9
million in operating activities and funded the shortfall in cash flow needed
18
for operations primarily through the sale of investments. As reflected on our
balance sheet, our current liabilities exceed our current assets, and as those
liabilities come due, we will need to increase our cash flow to fund those
obligations. In addition, a promissory note in the amount of $1.5 million that
we issued to CVI in July 2001 matures in January 2003. If we are unable to
increase cash flow from operations, we will need to seek additional financing or
take other drastic action. Set forth at the end of this section is a more
detailed description of steps we may take to obtain any necessary financing. As
of June 30, 2002, we had an accumulated deficit of $574.1 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 June 30,
2002, our aggregate net proceeds have been $272.2 million from issuing equity
securities and $52.4 million from issuing debt securities.
As of June 30, 2002, we had $1.6 million in cash, cash equivalents and
short-term investments compared to approximately $2.0 million as of December 31,
2001, of which $57,000 of such amounts is characterized as restricted cash to
secure our obligation under a certain letter of credit. As of June 30, 2002, we
had $15,000 in marketable equity securities, compared to $2.5 million in
marketable equity securities as of December 31, 2001. The decrease in our cash
position is primarily attributable to losses from operations and payments on our
debt obligations during the first six months of 2002, offset by the sale of a
substantial portion of our marketable equity securities portfolio.
Net cash used in operating activities was $1.9 million for the six-month period
ended June 30, 2002, compared to $28.1 million for the same period in 2001. The
decrease was due primarily to the decrease in our net loss for the six-month
period ended June 30, 2002 of $4.7 million compared to $175.8 million for the
same period in 2001. The change in the amount of cash used in operations during
the comparable six-month periods was also significantly impacted by a decrease
in depreciation and amortization of $712,000 in the six months of 2002 (compared
to $28.3 million for the same period in 2001), by $0 in impairment and
restructuring charges in the six months of 2002 (compared to $67.2 million in
the same period in 2001), by $0 in impairment of long-lived assets in the six
months of 2002 (compared to $43.1 million for the same period in 2001) and by a
decrease in the impairment of investments of $75,000 in the six months of 2002
(compared to $18.8 million for the same period in 2001).
Net cash provided by investing activities was $2.0 million for the six-month
period ended June 30, 2002, compared to $36.4 million for the same period in
2001. Amounts from investing activities for the first six months of 2002
consisted of $2.0 million in proceeds from sales of investments and $62,000 from
sales of short-term investments, partially offset by $62,000 in purchases of
certain equipment. In contrast, amounts for the first six months of 2001
consisted primarily of $35.6 million from sales of short-term investments and
$848,000 in proceeds from sales of investments.
Net cash used in financing activities was $503,000 for the six-month period
ended June 30, 2002 (consisting primarily of $505,000 for repayment of long-term
debt obligations), compared to $14.1 million for the same period in 2001
(consisting primarily of $10.1 million for repayment of a line of credit, $1.8
million for repayment of a credit agreement and 2.1 million for repayment of
long-term debt obligations). Neither of these credit facilities are available to
us.
In September 2000, we sold $20.0 million of convertible notes and warrants to
CVI, a private institution, pursuant to a securities purchase agreement. The
notes had a one-year term. In April 2001, we received a notice of default from
CVI for an alleged violation of certain covenants. Subsequently, in July 2001,
we restructured the convertible notes with CVI, with a face value of $11 million
and all warrants, with a payment of $2.2 million and issuance of a $1.5 million
non-interest bearing convertible promissory note, which is due January 2003 and
is convertible, at any time at the option of CVI, into common stock at an
exercise price of $2.00 per share. CVI did not release its claim against us,
certain current and former officers and directors for the alleged security
violations and for fraudulent inducement. We are vigorously defending against
these claims. Nevertheless, an unfavorable resolution of these claims could have
a material adverse effect on us in one or more future periods.
In July 2001, we entered into an agreement with Cody Holdings Inc. to provide us
with up to $18 million in equity financing ("Equity Line"). Under the terms of
the agreement, we have the right, but not the obligation during the 18-month
term of the Agreement, to obtain equity financing from Cody Holdings through
draw downs under this Equity Line, and the issuance of common stock to Cody
Holdings at a discount to the market price at the time of the
19
draw down. The shares of common stock may be sold to Cody Holdings during this
period at times and in amounts, subject to certain minimum and maximum volumes,
determined at our discretion. The agreement restricts our ability to make draw
downs based on a formula calculated on our stock trading volume and stock price.
Accordingly, if our stock price and trading volume fall below established
levels, we will not be able to draw down funds from the Equity Line. During the
first six months of 2002, our stock price ranged from a high of $0.18 to a low
of $0.08 per share and our average daily trading volume was 12,400 shares. Based
on these numbers, we are currently unable to draw down any funds from the Equity
Line. If we are able to and choose to draw down on the Equity Line, we will use
the proceeds of the financing for general corporate purposes. In October 2001,
we completed a draw down of $25,000. Until and unless our average trading volume
and our stock price increase, we will be unable to draw upon this Equity Line.
There are no assurances that we will be able to make a draw down on this Equity
Line during 2002.
We believe that our cash reserves and cash flows from operations may be adequate
to fund our operations through December 2002. Consequently, we will require
substantial additional funds to continue to operate our business beyond that
period. Many companies in the Internet industry have experienced difficulty
raising additional financing in recent months. Additional financing may not be
available to us on favorable terms or at all. Even if additional financing is
available, we may be required to obtain the consent of our existing lenders,
shareholders or the party from whom we secured our equity line of credit, which
we may not be able to obtain. If additional financing is not available, we may
need to change our business plan, sell or merge our business, or file a petition
in bankruptcy. In addition, our issuance of equity or equity-related securities
will dilute the ownership interest of existing shareholders and our issuance of
debt securities could increase the risk or perceived risk of our company.
Our future capital requirements depend upon many factors, including, but not
limited to:
o the level of revenues in 2002;
o the rate at which we are able to reduce expense levels;
o the rate at which our overall losses improve or deteriorate;
o the extent to which we develop and upgrade our technology and data network
infrastructure;
o the occurrence, timing, size and success of any asset dispositions in which
we may engage;
o the shut down or other disposition of one or more divisions or assets;
o the scope and success of our prior and any future restructuring efforts,
including reductions in our workforce;
o the scope of any reduction of our business activities;
o the scope and degree of market recovery and performance;
o the scope and degree of acceptance of our products and services by our
target customers; and
o other business and economic factors that may occur from time to time.
Our plans for financing may include, but are not limited to, the following:
o exploring strategic alternatives, which may include a merger, asset sales,
the shut down of assets or divisions, joint ventures or another comparable
transaction;
o raising additional capital to fund continuing operations by private
placements of equity and/or debt securities or through the establishment of
other funding facilities;
20
o forming a joint venture with a strategic partner or partners to provide
additional capital resources to fund operations; and
o loans from management or employees, salary deferrals or other cost cutting
measures.
Additional cost-cutting measures could include additional lay-offs and/or the
closure of additional business units and facilities. The results of any of these
measures could materially affect our business, results of operations and
financial position. Currently, we do not have any commitment for any of the
foregoing. Absent any such restructuring or financial transaction that provides
significant additional funding to the Company, our ability to continue business
as a going concern beyond the fourth quarter of fiscal 2002 will be severely
challenged.
21
FACTORS THAT MAY AFFECT OUR OPERATING RESULTS, BUSINESS AND STOCK PRICE
You should carefully consider the risks described below and the other
information in this quarterly report. While we have attempted to identify the
primary known 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. Our business may be adversely affected, and 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 Condensed Consolidated Financial Statements and
related Notes and the risks discussed in the "Factors Affecting Our Operating
Results, Business and Stock Price" section included in our December 31, 2001
Form 10-K filed on April 1, 2002 with the Securities and Exchange Commission.
RISKS RELATED TO OUR BUSINESS
OUR FUTURE CAPITAL REQUIREMENTS ARE LIKELY TO BE SUBSTANTIAL AND WE MAY NOT BE
ABLE TO OBTAIN FINANCING ON FAVORABLE TERMS, IF AT ALL, AND WE HAVE RECEIVED A
"GOING CONCERN" OPINION FROM OUR ACCOUNTANTS.
Our future capital requirements depend upon many factors, including, but not
limited to:
o the level of revenues in 2002;
o the rate at which we are able to reduce expense levels;
o the rate at which our overall losses improve or deteriorate;
o the extent to which we develop and upgrade our technology and data network
infrastructure;
o the occurrence, timing, size and success of any asset dispositions in which
we may engage;
o the shut down or other disposition of one or more divisions or assets;
o the scope and success of our prior and any restructuring efforts, including
reductions in our workforce;
o the scope of any reduction of our business activities;
o the scope and degree of market recovery and performance;
o the scope and degree of acceptance of our products and services by our
target customers; and
o other business and economic factors that may occur from time to time.
We believe that our cash reserves and cash flows from operations may be adequate
to fund our present operations through December 2002. However, we will require
substantial additional funds in the future. Our plans, which may or may not
occur, for financing may include, but are not limited to, the following:
o exploring strategic alternatives, which may include a merger, asset sale,
the shut down of assets or divisions, joint ventures or another comparable
transaction;
o raising additional capital to fund continuing operations by private
placements of equity and/or debt securities or through the establishment of
other funding facilities;
o forming a joint venture with a strategic partner or partners to provide
additional capital resources to fund operations; and
o loans from management or employees, salary deferrals or other cost cutting
mechanisms.
We secured an $18 million equity line of credit, under which we have the right,
but not the obligation, during the 18-month term of the agreement to obtain
equity financing through the issuance of common stock in a series of periodic
draw downs at a discount to the market price at the time of sale. The amount, if
any, of capital draw down from this
22
equity line may not be adequate to fund our operation. Furthermore, we may not
have adequate trading volume or stock price to draw down from our equity line.
Through June 30, 2002, we have only drawn $25,000 from the $18 million equity
line. As of June 30, 2002, our stock price and trading volume of our common
shares had fallen below the established minimum levels at which we can initiate
a draw down.
While we attempt to secure financing, many companies in the Internet industry,
including us, have experienced difficulty raising additional financing over the
last 18 months. Additional financing may not be available to us on favorable
terms or at all. Even if additional financing is available, we may be required
to obtain the consent of our existing lenders, shareholders or the party from
whom we secured our equity line of credit, which we may not be able to obtain.
If additional financing is not available to us we may need to dramatically
change our business plan, sell or merge our business, close business units, sell
assets or face bankruptcy. In addition, our issuance of equity or equity-related
securities will dilute the ownership interest of existing shareholders and our
issuance of debt securities could increase the risk or perceived risk of our
Company.
Our inability to secure additional financing would have a material adverse
effect on whether we would be able to successfully implement our proposed
business plan and our ability to continue as a going concern. Our independent
accountants have issued a "going concern" opinion in their report to our
financial statements for the year ended December 31, 2001, citing recurring
operating losses and reduced working capital. Accordingly, those conditions
raise substantial doubt about our ability to continue as a going concern.
FAILURE TO RESTRUCTURE PAYMENTS TO OUR CREDITORS COULD RESULT IN OUR BANKRUPTCY.
We are receiving pressure for payments from trade creditors and are seeking to
restructure the payment terms; however, there is no assurance that we will be
able to do this. As reflected on our balance sheet, our current liabilities
exceed our current assets. If we are unable to reach agreement with certain
trade creditors, long-term debt holders and our real estate landlord regarding
the restructuring of payment terms, our creditors may seek to file a petition in
bankruptcy against us, or we may need to seek protection of the bankruptcy
court. Even if we are successful in restructuring our obligations, we may need
additional capital to avoid bankruptcy. If we file for bankruptcy protection,
there can be no assurances that we can or will emerge from bankruptcy as a going
concern.
WE HAVE A HISTORY OF LOSSES.
We have incurred significant losses since our inception. As of June 30, 2002, we
had an accumulated deficit of $574.1 million. We have historically invested
heavily in sales and marketing, technology infrastructure and research and
development. As a result, we must generate significant revenues to achieve
profitability. There can be no assurance that we will ever become profitable on
a quarterly or an annual basis. We expect that our sales and marketing, research
and development and general and administrative expenses will decrease in
absolute dollars from 2001 to 2002 but may increase as a percentage of revenues.
OUR BUSINESS MODEL IS UNPROVEN AND CHANGING.
We provide technology infrastructure and online business services. We have
limited experience as a company, particularly with these businesses.
Additionally, the Internet, on which our business model relies, is still
unproven as a business medium and has experienced significant industry slow down
during the last year. Also, our disposition and closure of several business
units during 2001 resulted in significant changes to our business model.
Accordingly, our business model may not be successful, and we may need to change
it again. Our ability to generate sufficient revenues to achieve profitability
or become cash flow positive will depend, in large part, on our ability to
successfully market our technology infrastructure and online business services
and our ability to restructure our debts.
23
OUR FUTURE REVENUES ARE UNPREDICTABLE AND WE EXPECT OUR OPERATING RESULTS TO
FLUCTUATE FROM PERIOD TO PERIOD.
Our business model has been applied to the Internet only 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. 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:
o declines in the number of businesses to which we provide our products and
services;
o the amount and timing of operating costs and expenditures relating to our
operations;
o the mix of products and services that we sell;
o the shutting down or paring back one or more business units or product
lines; and
o the ability to maintain our telecommunications infrastructure.
In addition, factors beyond our control may also cause our operating results to
fluctuate, such as:
o the announcement or introduction of new or enhanced products or services by
our competitors;
o the failure or lack of access to our telecommunications infrastructure or
technical staff;
o registration services related to the introduction of new top level domains;
o a decrease in the growth of Internet usage; and
o the pricing policies of our competitors.
Period-to-period comparisons of our operating results are not a good indicator
of our future performance, particularly in light of changes in our business
focus.
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 products and online business services. 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 customers, our business model may not be
sustainable.
To successfully market and sell our products and online business services we
must:
o become recognized as a leading provider of technology infrastructure and
online business services;
o enhance existing products and services;
o add new products and services and increase awareness of these products and
services;
o complete projects on time;
o increase the number of businesses using our products and online business
services;
o continue to increase the attractiveness of our Web site and services; and
24
o retain key business, technical, customer service and financial personnel.
WE FACE SIGNIFICANT COMPETITION.
The market for our products and services 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:
o fewer businesses using our technology infrastructure products and services;
o the obsolescence of the technology underlying our products and services;
and
o a reduction in the prices of or profits on our products and services.
The number of companies providing technology infrastructure services, hosting
services and marketing services is large and increasing at a rapid rate. Many of
our competitors and potential competitors have substantial competitive
advantages as compared to us, including:
o larger customer or user bases;
o the ability to offer a wider array of technology infrastructure products
and solutions;
o greater name recognition and larger marketing budgets and resources;
o substantially greater financial, technical and other resources;
o the ability to offer additional content and other personalization features;
and
o 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 EFFECTIVELY MANAGE THE RAPID CHANGE OF OUR OPERATIONS OUR BUSINESS
WILL SUFFER.
Our ability to successfully offer our products and services and implement our
business plan in a rapidly evolving market requires an effective planning and
management process. We are changing the scope of our operations. In recent
months, we have focused on developing and providing technology infrastructure
and online business services. Due to the shift in our business focus, our
historical results are likely not indicative of our future performance and you
may have difficulty evaluating our business and prospects. While our operations
have been changing, we have reduced our overall number of employees from 620 in
January 2001 to 50 as of June 30, 2002. These changes in our business plan and
reduction in personnel have placed, and will continue to place, a significant
strain on our management systems, infrastructure and resources. Simultaneously,
the reduction in our workforce or future reductions in workforce may make it
more difficult to execute and implement our business plan. We will need to
continue to monitor our financial and managerial controls and reporting systems
and procedures, and will need to
25
continue to train and manage our workforce. Any failure to adapt to any of the
foregoing areas or other areas efficiently and effectively could cause our
business to suffer.
WE TRADE ON THE OVER THE COUNTER MARKET, WHICH COULD MAKE IT MORE DIFFICULT FOR
US TO RAISE CAPITAL.
Our common stock is presently listed on the over the counter market. Our common
stock has been delisted from the Nasdaq National Market effective as of August
29, 2001. The over the counter market is viewed by most investors as a less
desirable and less liquid marketplace than the Nasdaq markets. Our common stock
constitutes "penny stock," which places increased regulatory burden upon
brokers, making them less likely to make a market in our stock. The loss of our
Nasdaq status will make it more difficult for us to raise capital or complete
acquisitions and also complicate compliance with state blue sky laws.
OUR COMMON STOCK PURCHASE AGREEMENT WITH CODY HOLDINGS AND THE ISSUANCE OF
SHARES TO CODY HOLDINGS UNDER THAT AGREEMENT MAY CAUSE SIGNIFICANT DILUTION TO
OUR SHAREHOLDERS AND MAY HAVE AN ADVERSE IMPACT ON THE MARKET PRICE OF OUR
COMMON STOCK.
The resale by Cody Holdings of the common stock that it purchases from us will
increase the number of our publicly traded shares, which could depress the
market price of our common stock. Moreover, as all the shares we sell to Cody
Holdings will be available for immediate resale, the mere prospect of our sales
to Cody Holdings could depress the market price for our common stock. The shares
of our common stock issuable to Cody Holdings under the equity line facility
will be sold at a 10% discount to the volume-weighted average daily price of our
common stock during the applicable drawdown period and the proceeds paid to us
upon each drawdown will be net of a 6% placement fee to our placement agent, GKN
Securities Corp., and an escrow agent fee of $1,000. If we were to require Cody
Holdings to purchase our common stock at a time when our stock price is low, our
existing common shareholders will experience substantial dilution. The issuance
of shares to Cody Holdings will therefore dilute the equity interest of existing
shareholders and could result in a change in control of the Company and have an
adverse effect on the market price of our common stock. Also, if we draw down
funds under our equity line facility at a time or times when our share price is
relatively low, it would result in a significant issuance of stock by us, and a
change in control of the Company could be effected.
The perceived risk of dilution may cause our shareholders to sell their shares,
which would contribute to a downward movement in the stock price of our common
stock. Moreover, the perceived risk of dilution and the resulting downward
pressure on our stock price could encourage investors to engage in short sales
of our common stock. By increasing the number of shares offered for sale,
material amounts of short selling could further contribute to progressive price
declines in our common stock.
WE MAY BE UNABLE TO ACCESS ALL OR PART OF OUR EQUITY LINE FACILITY.
The maximum draw down amount every 22 trading days is the lesser of $2,000,000
or 6% of the weighted average price of our stock for the 60-day period prior to
the draw down multiplied by the total trading volume for that 60 day period. If
our stock price and trading volume fall below established levels, then we will
not be able to draw down additional funds pursuant to the equity line facility
with Cody Holdings. During the first six months of 2002, our stock price ranged
from a high of $0.18 to a low of $0.08 per share and our average daily trading
volume was 12,400 shares. Based on our stock price and average trading volume,
as of June 30, 2002, we are unable to make a draw down. In addition, business
and economic conditions may not make it feasible to draw down pursuant to this
facility. Furthermore, if we are unable to keep a registration statement
effective for those shares of common stock subject to the equity line, or if we
experience a material adverse change to our business that is not cured within 30
days, the common stock purchase agreement may terminate, or we may not be able
to draw down any funds.
26
WE ARE SUBJECT TO CERTAIN LIMITATIONS ON THE DRAW DOWNS WE CAN EXERCISE UNDER
OUR EQUITY LINE OF CREDIT.
We may exercise draw downs under our equity line of credit at our sole
discretion subject to certain limitations. We are permitted to exercise one draw
down in the twenty-two day period from the date of our notice (indicating that
we intend to exercise a draw down). We also have limitations as to the dollar
amount we can draw down under the equity line of credit as follows:
o the minimum amount is $100,000;
o the maximum amount is the lesser amount of (i) $2,000,000 and (ii) 6% of
the EQY weighted average price field (as reported on Bloomberg Financial
L.P. using the BLPH function) for our common stock for the 60 calendar days
immediately prior to the first day of the draw down period (during which
the price per share is being determined); and
o if the maximum amount is less than the minimum amount, the minimum amount
that can be drawn down cannot be less than $50,000.
OUR BUSINESS MAY BE SERIOUSLY HARMED BY LITIGATION ALLEGING VIOLATIONS OF LOCAL,
STATE OR FEDERAL SECURITIES LAWS.
Some of our current and former officers and directors, and some of the
underwriters of our initial public offering of common stock in September 1999
are defendants in pending class action lawsuits that allege violations of
federal securities laws in connection with our initial and secondary public
offerings. Class action litigation is often expensive and time-consuming, and
the outcome of such litigation is often uncertain. Such lawsuits, regardless of
their outcome, may cause us to incur significant expenses and divert the
attention of our management and key personnel from our business operations. In
addition, such lawsuits may result in the payment by us of substantial damages
and the rescission of the sale of shares in the initial public offering, and may
otherwise seriously harm our business. See "Legal Proceedings." We are also
party to numerous other lawsuits and legal matters in which we may be harmed or
may receive benefit.
WE CANNOT PREDICT WITH ANY CERTAINTY THE EFFECT THAT NEW GOVERNMENT AND
REGULATORY POLICIES, OR INDUSTRY REACTIONS TO THESE POLICIES, WILL HAVE ON OUR
DOMAIN REGISTRATION BUSINESS.
Before April 1999, the domain name registration system for the .com, .net and
..org domains was managed by Network Solutions pursuant to a cooperative
agreement with the U.S. government. In November 1998, the Department of Commerce
recognized the Internet Corporation for Assigned Names and Numbers, commonly
known as ICANN, to oversee key aspects of the Internet domain name registration
system. We cannot predict with any certainty that future measures adopted by the
Department of Commerce or ICANN will benefit us or that they will not materially
harm our business, financial condition and results of operations. In addition,
we continue to face the following risks:
o the U.S. government may, for any reason, reassess its decision to introduce
competition into, or ICANN's role in overseeing, the domain name
registration market;
o the Internet community may become dissatisfied with ICANN and refuse to
recognize its authority or support its policies, which could create
instability in the domain name registration system; and
o ICANN may fail to approve our accreditation, or attempt to impose
additional fees on registrars if it fails to obtain funding sufficient to
run its operations.
27
OUR BUSINESS WILL SUFFER IF WE FAIL TO MAINTAIN OUR STRATEGIC BUSINESS
RELATIONSHIPS OR ARE UNABLE TO ENTER INTO NEW RELATIONSHIPS.
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. 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. Most of these relationships may
be terminated by either party with little notice. Accordingly, in order to
maintain our strategic business relationships with some of these partners we
will need to meet our partners' specific business objectives, which may include
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.
WE MAY NOT DERIVE SUBSTANTIAL BENEFITS FROM OUR STRATEGIC RELATIONSHIPS.
To date, we have not derived material revenue from our strategic relationships,
and some of these relationships impose substantial obligations on us. It is not
certain that the benefits to us will outweigh our obligations. 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.
WE DEPEND ON OUR KEY PERSONNEL FOR SUCCESSFUL OPERATION OF OUR BUSINESS.
Our success depends on the skills, experience and performance of our senior
management and other key personnel, specifically including N. Scott Dickson, our
acting-Chief Executive Officer, Chief Financial Officer and Secretary,
Anne-Marie K. Savage, our Executive Vice President and Joseph Shatara, our Vice
President and other senior managers and the members of our board of directors.
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 current financial situation may make it more difficult to attract
and retain key employees. In addition, recently effective July 12, 2002, Dwayne
Walker resigned as our Chief Executive Officer and President. Although Mr.
Walker will continue as Chairman of the Board, we cannot evaluate the impact
that his resignation as an officer of the Company may have on us, our business,
our prospects or our employees.
28
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 June
30, 2002.
29
PART II. OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
Reference is made to "Item 3. Legal Proceedings" in the Company's Annual Report
on Form 10-K for the year ended December 31, 2001. Through August 1, 2002, the
date of this report, there have been no material developments with respect to
any of the legal proceedings previously disclosed.
From time to time we are and expect to continue to be, subject to legal
proceedings and claims in the ordinary course of business. If the Company
suffers an adverse judgment in any such legal proceeding or if we incur
significant expenses to defend against such proceedings, it will likely have a
material adverse effect on our results of operations and financial condition;
and could affect our ability to continue business on as a going concern.
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY SHAREHOLDERS
None.
ITEM 5: OTHER INFORMATION
Effective July 12, 2002, Dwayne Walker resigned as Chief Executive Officer and
President. Dwayne Walker will continue as Chairman of the Board. N. Scott
Dickson was appointed as acting Chief Executive Officer.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Number Description
99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
We filed a Form 8-K on April 11, 2002 to report a change in our independent
auditors from Arthur Andersen LLP to Moss Adams LLP, effective as of April 4,
2002. We filed an amended report on Form 8-K/A on April 16, 2002.
30
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 on August 14, 2002.
NETWORK COMMERCE INC.
By: /s/ N. Scott Dickson
--------------------------------------------
N. Scott Dickson
Chief Executive Officer and
Chief Financial Officer
31
EXHIBIT INDEX
Number Description
99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.