UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark one)
X Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 1999.
OR
Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
Commission File Number:
000-24643
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DIGITAL RIVER, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 41-1901640
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9625 WEST 76TH STREET, SUITE 150
EDEN PRAIRIE, MINNESOTA 55344
(address of principal executive offices)
(952) 253-1234
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock $0.01 par value
-----------------------------
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 filing requirements
for the past 90 days.
Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [X].
The aggregate market value of the Common Stock of the registrant held by
non-affiliates as of March 10, 2000 was $567,031,025.
The number of shares of Common Stock outstanding at March 10, 2000 was
21,756,025 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Certain sections of the Registrant's definitive Proxy Statement for the 2000
Annual Meeting of Stockholders are incorporated by reference in Part III of this
Form 10-K to the extent stated herein.
PART I
ITEM 1. BUSINESS.
OVERVIEW
Digital River is a leading provider of comprehensive electronic commerce
outsourcing solutions. The Company is an application service provider that
enables its clients to access its proprietary electronic commerce system over
the Internet. The Company has developed a technology platform that allows it to
provide a suite of electronic commerce services, including Web commerce
development and hosting, transaction processing, fraud screening, digital
delivery, integration to physical fulfillment and customer service. The Company
also provides analytical marketing and merchandising services to assist clients
in increasing Web page view traffic to, and sales through, their Web commerce
systems. Digital River provides an outsourcing solution that allows its clients
to promote their own brands while leveraging Digital River's investment in
infrastructure and technology. As of March 1, 2000, the Company had processed
over 2.7 million cumulative transactions and had contracts with over 6,000
clients, primarily software publishers and online retailers. In January 2000,
the Company announced that it had created the Software and Digital Services
Group to serve the software and digital products market, and the E-Business
Services Group to serve manufacturers, distributors and retailers outside of the
software industry. The Company's clients include 3M Company, Autodesk Inc.,
CompUSA Inc., Adolph Coors Co., Egghead.com, Inc., Fujitsu Ltd., Sega of
America Inc., ScanSoft Inc. and Symantec Corp.
Digital River's proprietary commerce network server, or CNS, technology
serves as the platform for the Company's solutions. The CNS incorporates custom
software applications that enable Web store authoring, electronic software
delivery, fraud prevention, export control, merchandising programs and online
registration, and features a database of more than 100,000 software and digital
products. Using its CNS platform, the Company creates Web commerce systems for
its clients that replicate the look and feel of each client's Web site.
End-users enter the client site and are then seamlessly transferred to the
Company's CNS. End-users can then browse for products and make purchases online,
and once purchases are made, the Company either delivers the products digitally
to the end-user through the Internet or communicates the order through its
integration into a number of third party fulfillment agencies for physical
fulfillment. The Company also provides transaction processing services and
collects and maintains critical information about end-users. This information
can later be used by the Company's clients to facilitate add-on or upgrade sales
and for other direct marketing purposes. The Company actively manages direct
marketing campaigns for its clients, and also delivers purchase information and
Web store traffic statistics to its clients through online reporting.
INDUSTRY BACKGROUND
GROWTH OF THE INTERNET AND ELECTRONIC COMMERCE. The Internet has emerged as
a significant global communications medium, enabling millions of people to share
information and conduct business electronically. A number of factors have
contributed to the growth of the Internet and its commercial use, including: (i)
the large and growing installed base of personal computers in homes and
businesses; (ii) improvements in network infrastructure and bandwidth; (iii)
easier and cheaper access to the Internet; (iv) increased awareness of the
Internet among consumer and business users; and (v) the rapidly expanding
availability of online content and commerce that increases the value to users of
being connected to the Internet.
The increasing functionality, accessibility and overall usage of the
Internet have made it an attractive commercial medium. Online businesses can
interact directly with end-users, both businesses and consumers, and can
frequently adjust their featured selections, shopping interfaces and pricing.
The ability to reach and serve a large and global group of end-users
electronically from a central location and the potential for personalized
low-cost customer interaction provide additional economic benefits for online
businesses. Unlike traditional retail channels, online businesses do not have
the burdensome costs of managing and maintaining a significant physical retail
store infrastructure or the continuous printing and mailing costs of catalog
marketing. Because of these advantages, online businesses have the potential to
build large, global customer bases quickly and to achieve superior economic
returns over the long term. An increasingly broad base of products is being sold
successfully online, including computers, travel services, brokerage services,
automobiles and music, as well as software products.
2.
ADVANTAGES OF OUTSOURCING ELECTRONIC COMMERCE. According to a Gartner Group
study, the initial investment in an electronic commerce site that is
functionally equivalent to most industry participants is $1.0 million to $5.0
million and requires an average of five months to implement. A market
differentiating electronic commerce solution requires an expenditure of $5.0 to
$20.0 million. According to the same study, the cost to build an electronic
commerce solution is expected to increase by 25% in each of the next two years.
Additionally, to maintain a scaleable, best of breed commerce solution,
businesses must continue to invest in technology, infrastructure and personnel
of electronic commerce management.
There are a number of advantages to outsourcing electronic commerce,
including: (i) avoiding the large, upfront investment required to purchase and
implement software applications and computer hardware; (ii) a shorter time to
market with an electronic commerce solution; (iii) the opportunity to shift the
ongoing financial and technology risk to a proven service provider; and (iv)
allowing businesses to focus on their specific core competency. Because of these
advantages, the Company believes that an increasing number of businesses will
outsource their electronic commerce needs.
OPPORTUNITY FOR ELECTRONIC COMMERCE OUTSOURCING. The Company believes that
the market for electronic commerce outsourcing in the software and digital
products market as well as among manufacturers, distributors and retailers will
continue to grow rapidly. However, unlike established physical distribution
channels, there is currently no established, comprehensive electronic
distribution source for businesses. The Company believes that providing an
integrated service offering of Web commerce development and hosting, transaction
processing, fraud screening, digital delivery, integration to physical
fulfillment and customer service is complex and requires upfront and ongoing
investments in secure, reliable and scaleable systems. Accordingly, the Company
believes that a substantial market opportunity exists for a comprehensive,
cost-effective, outsourced electronic commerce solution for software publishers
and online retailers as well as for manufacturers, distributors and retailers.
THE DIGITAL RIVER SOLUTION
The Company has developed a technology platform that enables it to provide
a comprehensive suite of electronic commerce services to its clients. The
Company also leverages its merchandising expertise to increase traffic and sales
for its clients. Rather than maintaining its own branded Web store, Digital
River provides an outsourcing solution for Web commerce development and hosting,
transaction processing, digital delivery and merchandising services that enables
its clients to promote their own brands while leveraging Digital River's
investment in infrastructure. In addition, this approach enables Digital River
to leverage its clients' brand investments and the traffic at its clients' sites
to maximize the number of transactions completed through Digital River.
BENEFITS TO CLIENTS. The Company's electronic commerce solution enables its
clients to leverage Digital River's investment in technology, personnel and
infrastructure to provide a business-to-business or business-to-consumer
electronic commerce solution. This provides the client with a cost-effective,
proven solution that allows the clients to focus on their core competency.
Clients have the ability to offer the complete library of their products
directly to end-users from their Web commerce systems, and for software
publishers, through the Company's network of online retailers. This benefit is
particularly significant for smaller software publishers who have limited market
access through traditional distribution methods. The Company's solution also
provides a channel for underdistributed products permitting clients to offer
online their complete product catalog. In addition, through its 100% end-user
registration and data warehousing, Digital River provides clients with valuable
end-user information that can facilitate targeted marketing, upgrade
notification and sophisticated merchandising strategies. Finally, by exploiting
the distribution relationships Digital River has developed with a large network
of online retailers, software publishers can reduce or eliminate the need for
multiple retailer relationships, thereby lowering administrative costs and
reducing the number of master copies of their software in existence for
distribution.
Additionally online retailers can use Digital River's robust CNS technology
to sell software products online without having to build and maintain their own
electronic commerce infrastructure. Digital River enables online retailers to
offer their end-users access to virtually all of Digital River's inventory of
software products without the burden of developing and maintaining relationships
with hundreds of software publishers. Like software publishers, online retailers
enjoy the cost savings from online fulfillment and the database marketing
benefits offered by Digital River. Online retailers can effectively outsource
electronic commerce functionality while building their own brands online. Online
retailers also eliminate the cost and risk associated with carrying inventory
and the risk of inventory
3.
obsolescence. In addition, niche market and high traffic Web sites can become
online retailers at minimal cost using the Company's solution.
BENEFITS TO END-USERS. Digital River's solution emphasizes convenience by
allowing end-users, both business and consumer, to purchase products online
twenty-four hours a day, seven days a week, or 24x7, from their home or office.
End-users are not required to make a trip to the store, can act immediately on a
purchase impulse and can locate products that are difficult to find. Because
Digital River has a global reach, it can deliver an extremely broad selection to
end-users in rural, international or other locations that cannot support retail
stores. Software and digital products purchased online can either be quickly and
conveniently downloaded and installed through digital delivery or delivered
physically. Using the Company's sophisticated search engine technology,
end-users visiting retailers' online Web stores can access virtually all of
Digital River's inventory of products. End-users also benefit from the
protection of Digital River's archiving service, through which the Company
guarantees replacement of software in the event of accidental destruction
through computer error or malfunction and from Digital River's 24x7 customer
service provided on behalf of its clients.
STRATEGY
The Company's objective is to become a global leader in comprehensive
electronic commerce outsourcing solutions to software publishers and online
retailers through its Software and Digital Services Group as well as to
manufacturers, distributors and retailers through its E-Business Services Group.
The Company intends to achieve its objective through the following key
strategies:
SOFTWARE AND DIGITAL SERVICES GROUP: DEVELOP AND EXPAND RELATIONSHIPS WITH
SOFTWARE PUBLISHERS AND ONLINE RETAILERS. The Company plans to continue to build
its inventory of software products through additional contractual relationships
with software publishers. As of March 1, 2000, the Company had signed contracts
with more than 4,700 software publishers, representing more than 100,000
software products and 4,400 Web stores. The Company believes that its ability to
develop Web hosting relationships with its software publisher clients increases
its reach to end-users and provides the basis for a long-term relationship with
its software publisher clients. The Company further believes that the large
number of software products offered by the Company from its software publisher
clients will be critical to the Company's ability to deliver a compelling
inventory of products to online retailer clients.
Additionally, the Company believes that by increasing the number of points
of entry to its CNS, Digital River will increase the number of transactions over
its network. Accordingly, in addition to expanding and developing relationships
with software publishers, the Company seeks to expand aggressively its network
of online retailer clients. Online retailer clients include traditional
store-based and mail order retailers with a Web presence, online retailers
dedicated to online commerce, as well as high traffic or niche Web site
operators desiring to add electronic commerce functionality. The Company had
contracts with more than 1,300 online retailers as of March 1, 2000. The
Company's model enables it to leverage its clients' marketing resources to
direct traffic to its software trade network.
E-BUSINESS SERVICES GROUP: DEVELOP AND EXPAND RELATIONSHIPS WITH
MANUFACTURERS, DISTRIBUTORS AND RETAILERS. In late 1998, the Company began
exploring electronic commerce outsourcing opportunities outside of the software
industry. During 1999, sales and marketing personnel were hired to develop
contractual relationship to sell the Company's electronic commerce outsourcing
services to manufacturers, distributors and retailers. As of March 1, 2000, the
Company had 22 contracts to provide commerce services such as Web commerce
development and hosting, transaction processing and fraud screening, customer
service, integration into third party physical fulfillment and merchandising and
analytical marketing services. The Company believes that its ability to provide
a proven, cost efficient electronic commerce solution, which can typically be
implemented in a one to eight week time frame, provides the basis for a
long-term relationship with these clients. The Company further believes that
additional electronic commerce outsourcing opportunities may develop as the
relationships with existing clients expand.
PROVIDE CLIENTS VALUE-ADDED SERVICES. The Company believes its growing data
warehouse of end-user purchasing information provides it with a powerful tool to
assist clients with value-added services, such as targeted advertising,
promotions and direct response merchandising. The Company offers merchandising
and analytical
4.
marketing programs, customer support and communications programs, advertising
placement services, Web commerce system design services, a returns management
module and fraud screening services. The Company intends to continue to expand
its programs and believes that these programs help build stronger partnerships
with its clients, while enabling its clients to increase their Web site sales.
MAINTAIN TECHNOLOGY LEADERSHIP. The Company believes that its CNS
technology has given it a competitive advantage in the market for outsourcing
solutions. The Company will continue to invest in and enhance its CNS technology
in order to increase redundancy, reliability and bandwidth, to expand services
and to reduce costs. By leveraging its fixed-cost infrastructure, Digital River
will improve its ability to provide low cost, high value services to its clients
while utilizing the latest technology.
SERVICES
The Company provides a broad range of services to its clients, including
Web commerce hosting, digital delivery and physical fulfillment services,
transaction processing and fraud screening, customer service and merchandising
and analytical marketing services.
WEB COMMERCE HOSTING. The Company hosts Web commerce activities for all of
its online retailer clients, its E-Business clients and for those software
publisher clients that choose this option. The Company's outsourcing solution is
mission-critical for many of its clients. Therefore, the Company has a data
center that is designed to provide its clients with the performance they require
for continuous Web commerce operations. The data center features redundant, high
speed connections to the Internet, 24x7 security and monitoring, back-up
generators and dedicated power.
Digital River can quickly and efficiently create a Web commerce system for
its clients, which can be accessed easily by clicking on a "buy button" on a
client's existing Web site. The end-user is then transferred to a Web commerce
system hosted on Digital River's CNS, which replicates the look and feel of the
client Web site. The end-user can then shop for products and make purchases
online. By replicating the look and feel of its clients' Web sites, Digital
River supports clients in conducting electronic commerce under their own brands.
Digital River's solution allows clients to choose either digital or, when
available, physical delivery. The transaction information is captured and added
to Digital River's data warehouse. The Company's ability to retrieve and
manipulate this information creates a powerful data mining tool, which can be
used for targeted merchandising to end-users through emails, banner
presentations and special offers.
DIGITAL AND PHYSICAL FULFILLMENT SERVICES. The Company offers clients
access to its electronic software delivery capabilities to permit delivery of
digital products to an end-user's computer via the Internet. Digital delivery
eliminates many of the costs that exist in the physical distribution chain, such
as manufacturing, packaging, shipping, warehousing and inventory carrying and
handling costs. Delivery is fulfilled when a copy is made from the master on the
Company's CNS and is then securely downloaded to the end-user via the Internet.
Digital River's digital distribution model not only reduces costs, thereby
increasing margins available to software publishers and online retailers, but
also solves the shelf space problem constraining product availability and sales.
While most software publishers use the Company's Web hosting services, certain
software publishers use only the Company's digital delivery services, which
provide them with online distribution through the Company's extensive network of
online retailers.
In addition to fulfillment through electronic software delivery, the
Company offers clients physical distribution services. The Company has
contracted with a third party fulfillment agency that maintains an inventory of
physical software products, generally on consignment from the Digital River
clients that select this option, for shipment to end-users. The Company also
communicates orders through its integration into many third party fulfillment
agencies for physical fulfillment for its clients. The Company believes physical
fulfillment services are important to its ability to provide a comprehensive
electronic commerce outsourcing solution.
TRANSACTION PROCESSING AND FRAUD SCREENING. The Company processes
transactions, primarily via credit card, generated by end-users ordering
products through the Company's CNS. The Company obtains customer and payment
information required to process transactions. The fraud screening component of
the CNS uses both rules based and heuristic scoring methods to make a
determination regarding the validity of the order, end-user and
5.
payment information. As the end-user is entering the order, over 580 data
reviews are processed real time. Depending on the contractual agreement, the
Company either offers the use of its proprietary fraud screening to clients to
either significantly reduce the number of fraudulent transactions or to
completely shift the risk of fraud to Digital River. When a credit card
transaction is completed and approved, and the ordered product has been
delivered, the Company processes the order for payment.
CUSTOMER SERVICE. The Company offers both telephone and email customer
support for products sold through its CNS on behalf of its clients. The Company
will provide end-user assistance on order and delivery questions on a 24x7
basis. The Company has invested and continues to invest heavily in technology
and infrastructure to provide fast, efficient responses to customer inquiries.
The Company also provides archiving service to the end-users that purchase
digital products.
MERCHANDISING AND ANALYTICAL MARKETING SERVICES. The Company offers a range
of merchandising and analytical marketing services to its clients to help them
drive additional traffic to their Web stores. Clients are provided with detailed
reports of transactions on their Web stores, as well as marketing information
related to end-user visits to their Web stores. The CNS captures Web page
visits, banner and pricing information and other data that can be used by the
software publishers and online retailers to analyze their Web stores'
performance.
The Company also offers advanced merchandising services to assist clients
in increasing response rates for their marketing efforts. These services include
email campaigns for special promotions, upgrade notification programs and the
presentation of complementary products, bundled products or other programs
designed to increase average order size based on a targeted end-user profile.
The Company participates in co-op dollar and market development fund programs
with its clients and buys selected banner placements in bulk to support clients'
promotional campaigns. In addition, Digital River tests and analyzes
merchandising techniques, such as promotional pricing and banner advertising,
based on information gathered in the CNS data warehouse.
CLIENTS
Within the Software and Digital Services Group, the Company distributes
software products through a network of software publishers and online retailers.
Online retailer clients include traditional store-based and direct mail
retailers with a Web presence, online retailers dedicated to online commerce, as
well as high traffic or niche Web site operators desiring to add electronic
commerce functionality. In a typical online retailer contract, the Company is
responsible for: (i) a payment to the online retailer based on a percentage of
net sales of software products that the Company distributes through the online
retailer's Web site; (ii) the processing of payments made by end-users; (iii)
the delivery of the software products to end-users; (iv) the payment of
applicable credit card transaction fees; (v) the collection, payment and returns
filing of applicable sales taxes; and (vi) the distribution of a report to the
online retailer detailing related sales activity processed by the Company. The
Company also expects to support traditional physical retailers in developing
their online stores for the sale of software products online. While most
software publishers use the Company's Web hosting services, certain software
publishers use only the Company's "channel services" whereby the software
publishers are provided with digital and physical fulfillment capability through
the Company's extensive network of online retailers. In a typical software
publisher contract, the Company is responsible for: (i) the maintenance of
master copies of software products in a secure format for distribution to
end-users; (ii) a payment to the software publisher for the cost of software
products that the Company distributes through either a retailers' Web site or
through the publisher's host Web site; (iii) the processing of payments made by
end-users; (iv) the delivery of software products to end-users; (v) the payment
of applicable credit card transaction fees; (vi) the collection, payment and
returns filing of applicable sales taxes; and (vii) the distribution of a report
to the software publisher detailing related sales activity processed by the
Company.
As of March 1, 2000, the Company had more than 4,700 contracts with
software publishers and more than 1,300 contracts with online retailers. The
Company's Software and Digital Services Group clients include:
SOFTWARE PUBLISHERS ONLINE RETAILERS
- ------------------------------ -------------------------------
WEB HOSTING AND CHANNEL SERVICES
Adaptec, Inc. CompUSA Inc.
6.
Autodesk Inc. Cyberian Outpost, Inc.
JASC Software, Inc. Egghead.com, Inc.
ScanSoft, Inc. Micro Warehouse, Inc.
Multiple Zones International, Inc.
Quixtar, Inc.
CHANNEL SERVICES ONLY Staples.com
Lotus Development Corporation US WEST, Inc.
Network Associates, Inc.
QUALCOMM Incorporated
Symantec Corp.
Within the E-Business Services Group, the Company provides a variety of
electronic commerce services to clients outside of the software industry,
primarily manufacturers, distributors and retailers. These services allow the
client to perform electronic commerce on a business-to-business or
business-to-consumer basis. In a typical E-Business Services contract, the
Company is responsible for: (i) Web commerce system design, hosting and
integration into the client's management system; (ii) the processing of payments
made by end-users; (iii) the communication of orders to the client or the
clients third party fulfillment agency for delivery of the product to end-users;
(iv) the fraud screening and processing of the applicable credit card
transaction to the client's credit card processor; (v) customer service; and
(vi) the distribution of a report to the client detailing related sales activity
processed by the Company.
As of March 1, 2000, the Company had 22 contracts with clients in the
E-Business Services Group, including:
E-BUSINESS SERVICES
-----------------------------
3M Company
Adolph Coors Co.
Fujitsu Ltd.
Sega of America Inc.
The United States Golf Association
Uproar Inc.
SALES AND MARKETING
The Company markets its services directly to clients and prospective
clients. The Company does not operate its own Web store because of its strategy
to serve as a neutral provider of electronic commerce outsourcing solutions.
Generally, the Company's direct marketing to end-users focuses on supporting the
marketing and promotional efforts of its clients in driving traffic to their Web
stores. This direct marketing effort leverages the Company's extensive data
warehouse, which enables the Company to create and quickly implement marketing
programs targeted at specific end-user segments. By providing consistent quality
service, branding client order pages with its name and logo, billing credit card
transactions under the Digital River name and engaging in brand positioning,
advertising and promotion, the Company believes it has established the Digital
River brand as a trusted name for
7.
electronic software delivery and electronic commerce outsourcing solutions among
current and prospective clients and end-users.
The Company's sales and marketing organization is divided into two groups:
the Software and Digital Services Group and the E-Business Services Group. The
Software and Digital Services Group focuses on software and digital content
publishers and online retailers of all sizes, including traditional physical
retailers, with significant online revenue potential. These sales are typically
complex in nature and involve a lengthy sales cycle. Contracts with larger
clients often involve certain incentives, principally pricing concessions. The
Company makes decisions with respect to contract incentives on a case by case
basis. The E-Business Services Group focuses on manufacturers, distributors and
retailers, generally with total annual revenues of $500 million or more. These
sales are complex in nature and involve a lengthy sales cycle. Both the Software
and Digital Services Group and the E-Business Services Group serve existing
clients and provide them with merchandising and database marketing assistance
designed to increase revenues. As of March 1, 2000, the Company had 114
employees engaged in sales and marketing.
The Company currently markets its services to clients via direct marketing,
print advertising, trade show participation and other media events. The Company
plans to increase its expenditures on direct marketing, seminars and print
advertising, primarily directed at potential E-Business Services clients. In
addition, the Company operates a sales office in the United Kingdom.
TECHNOLOGY
Digital River delivers its electronic commerce outsourcing solution using
its proprietary CNS technology, which enables the sale and distribution of
products via the Internet.
ARCHITECTURE. The Company's scaleable CNS is designed to handle tens of
thousands of different Web commerce systems and millions of products. The CNS
consists of a pool of network servers and a proprietary software application
that serves dynamic Web pages using an Oracle database. The Company's CNS was
designed to scale to support growth by adding CPUs, memory, disk drives and
bandwidth without substantial changes to the application. The CNS software code
is written in modular layers, enabling the Company to quickly adapt in response
to industry changes, including bandwidth opportunities, payment processing
changes, international requirements for taxes and export screening, new
technologies such as Java, XML, DHTML, VRML, SET, banking procedures and
encryption technologies. The CNS product search system allows end-users to
search for items across millions of potential products and thousands of
categories specific to various product specifications, while maintaining a fast
page response that is acceptable to the end-user. The Company uses sophisticated
database indexing coupled with a dynamic cache system to provide flexibility and
speed. These caches help increase the overall speed of each page and facilitate
complex searches across the Company's entire inventory of software products. The
CNS is also been designed to index, retrieve and manipulate all transactions
that flow through the system, including detailed commerce transaction and
end-user interaction data. This enables the Company to create proprietary market
profiles of each end-user and groups of end-users that can be used to create
merchandising campaigns. The Company's CNS is also used for internal purposes,
including reporting and maintenance for fraud detection and prevention, physical
shipping, return authorizations, back order processing and full transaction
auditing and reporting capabilities for all commerce functions.
WEB COMMERCE SYSTEM MAINTENANCE. Clients' Web commerce systems are built
and maintained using the CNS centralized management system. Global changes that
affect all Web commerce systems or groups of Web commerce systems can be made as
easily as changes to an individual Web commerce system. Client Web commerce
systems typically include a main store and may optionally include several "focus
stores" and "channel sites" to which highly targeted traffic may be routed.
Clients may also link specific locations on their Web stores to detailed product
or category areas of the stores in order to better target their end-users'
interests.
SECURITY. Digital River's security systems address access to internal
systems and illegal access to commerce data via the Internet. Internally,
log-ins and passwords are maintained for all systems, with additional log-ins,
passwords and IP access control granted on an individual basis to only the
required commerce areas the person is responsible for. Firewalls prevent
unauthorized access from outside. The Company relies on certain encryption and
authentication technology licensed from third parties to provide secure
transmission of confidential information, such as end-user credit card numbers.
Unix, Oracle and Web server security additionally restrict access from the
8.
outside to the appropriate transaction data. The CNS security system is designed
not to interfere with the end-user experience. Product wrappers, clearing-house
processing and additional password mechanisms that negatively impact digital
delivery performance are not needed. The CNS security system does not allow
direct access to the clients' products and ensures that an end-user requests
digital delivery through a valid page and has purchased the product.
DATA CENTER OPERATIONS. Continuous data center operations are crucial to
the Company's success. All transaction data is backed up periodically and all
inventory data is archived and kept in fireproof storage facilities. The
Company's network software constantly monitors clients' Web commerce systems and
internal system functions and notifies systems engineers if any unexpected
conditions arise. The Company currently leases seven T1 lines and 4 DS3 lines
from multiple vendors and maintains a policy of adding additional lines if more
than 50% of its bandwidth capacity is utilized. Accordingly, if one line fails
the other lines are able to assume the capacity of the failed line. The
Company's data center is located in a single location at the Company's main
facilities in Eden Prairie, Minnesota. In the event of electrical power failure,
the Company has a back-up power supply system. The Company has also installed a
FM-200 automatic fire suppression system in the data center. The data center
currently incorporates redundant systems consisting of additional servers and
arrays. The Company currently has no automatic switchover in the case of
equipment or software failure, although it has plans to implement further
redundancy in the future.
PRODUCT DEVELOPMENT
Digital River's product development strategy is to enhance the technology
and features of its CNS. To this end, the Company has numerous development
projects in process, including Internet optimization tools, end-user profiling
and collaboration technologies and online interactive customer service. Product
development and operations expenses, which include customer service, data center
operations and telecommunications infrastructure, were $1.5 million, $5.4
million and $16.1 million in 1997, 1998 and 1999, respectively. As of March 1,
2000, the Company employed 91 persons in product development.
To remain competitive, the Company must continue to enhance and improve the
responsiveness, functionality and features of the CNS and the underlying network
infrastructure. The Internet and the online commerce industry are characterized
by rapid technological change, changes in user and client requirements and
preferences, frequent new product and service introductions embodying new
technologies and the emergence of new industry standards and practices that
could render the Company's existing CNS proprietary technology and systems
obsolete. The Company's success will depend, in part, on its ability to both
license and internally develop leading technologies useful in its business,
enhance its existing services, develop new services and technology that address
the increasingly sophisticated and varied needs of its clients, and respond to
technological advances and emerging industry standards and practices on a
cost-effective and timely basis. The development of the CNS technology and other
proprietary technology entails significant technical and business risks. The
Company may be unable to use new technologies effectively or adapt its
proprietary technology and transaction-processing systems to customer
requirements or emerging industry standards. If the Company is unable, for
technical, legal, financial or other reasons, to adapt in a timely manner to
changing market conditions, client requirements or emerging industry standards,
its business could be harmed.
COMPETITION
The electronic commerce market is new, rapidly evolving and intensely
competitive, and the Company expects competition to intensify in the future,
particularly in the area of electronic commerce outsourcing both for digital and
software products as well as for industries outside of the software market. The
Company currently competes directly with other providers of electronic commerce
solutions, including CyberSource Corporation, Preview Systems, Inc.,
ReleaseNow.com Corporation and ShopNow.com, Inc. The Company also competes
indirectly with software companies, system integrators and application service
providers that offer tools and services for electronic commerce, including
companies that provide a broad range of Internet and server solutions such as
Microsoft Corporation and Netscape Communications Corporation. The Company also
competes indirectly with a large number of companies that provide tools and
services enabling one or more of the transaction processing functions of
electronic commerce, including transaction control, data security, customer
interaction and database marketing, such as BroadVision, Inc., Open Market,
Inc., CommerceOne, Inc., IBM Global Services, Scient Corp., US Web/CKS
9.
Corporation, US Internetworking, Corio, Inc. and Qwest Communications
International Inc. In addition to direct competition with other transaction
processing providers and enablers and indirect competition with other providers
of electronic commerce software and systems, the Company competes with companies
that sell and distribute software products via the Internet, including
Amazon.com, Inc., beyond.com Corporation, Ingram Micro Inc. and Tech Data
Corporation. The Company also competes with companies such as AltaVista Company,
a subsidiary of CMGI, America Online, Inc., Excite@Home, Go.com, Lycos, Inc. and
Yahoo! Inc., which specialize in electronic commerce or derive a substantial
portion of their revenues from electronic commerce and may themselves offer, or
provide means for others to offer, software products.
The Company believes that the principal competitive factors in its market
are breadth of services and software product offerings, software publisher and
online retailer relationships, brand recognition, system reliability and
capacity, price, customer service, speed and accessibility and ease of use,
convenience and speed of fulfillment. The online retailers and the other
companies listed above may compete directly with the Company by adopting a
similar business model. Moreover, while some of these companies are also clients
or potential clients of the Company, they may compete with the Company's
electronic commerce outsourcing solution to the extent that they develop
electronic commerce systems or acquire such systems from other software vendors
or service providers.
Many of the Company's current and potential competitors have longer
operating histories, larger customer bases, greater brand recognition and
significantly greater financial, marketing and other resources than the Company.
In addition, larger, well-established and well-financed entities may acquire,
invest in or form joint ventures with online competitors as the use of the
Internet and other online services increases. In addition, new technologies and
the expansion of existing technologies, such as price comparison programs that
select specific titles from a variety of Web sites, may direct end-users to
online retailers that compete with the Company, which would increase competitive
pressures on the Company. Increased competition may result in reduced operating
margins, as well as a loss of market share. Further, as a strategic response to
changes in the competitive environment, the Company may from time to time make
certain pricing, service or marketing decisions or acquisitions that could harm
its business. The Company may be unable to compete successfully against current
and future competitors, and any inability to do so could harm the Company's
business.
INTELLECTUAL PROPERTY
The Company regards trademarks, copyrights, trade secrets and other
intellectual property as critical to its success, and relies on trademark, trade
secret protection and confidentiality and license agreements with its employees,
clients, partners and others to protect its proprietary rights. The Company
seeks to protect its proprietary position by, among other methods, filing United
States and foreign patent applications related to its proprietary technology,
inventions and improvements that are important to the development of its
business. Proprietary rights relating to the Company's technologies will be
protected from unauthorized use by third parties only to the extent they are
covered by valid and enforceable patents or are effectively maintained as trade
secrets.
The Company currently has four United States patents issued and nine U.S.
and two foreign patents pending in a number of areas of electronic commerce. The
laws of certain foreign countries do not protect the Company's intellectual
property rights to the same extent as do the laws of the United States. The
patent position of high technology companies involves complex legal and factual
questions and, therefore, their validity and enforceability cannot be predicted
with certainty. The Company's patents may be challenged, invalidated, held
unenforceable or circumvented, and the rights granted thereunder may not provide
proprietary protection or competitive advantages to the Company against
competitors with similar technology. Furthermore, others may independently
develop similar technologies or duplicate any technology developed by the
Company. The Company has three registered trademarks, including "Digital River,"
and seven trademark registrations pending. Effective trademark and trade secret
protection may not be available in every country in which the Company's products
and services are made available online. The steps taken by the Company to
protect its proprietary rights may be inadequate and third parties may infringe
or misappropriate the Company's trade secrets, trademarks, trade dress and
similar proprietary rights. Any significant failure by the Company to protect
its intellectual property could harm on the Company's business. In addition,
litigation may be necessary in the future to enforce the Company's intellectual
property rights, to protect the Company's trade secrets or to determine the
validity and scope of the proprietary rights of others. Litigation could result
in substantial costs and diversion of management and technical resources, which
could harm the Company's business.
10.
In addition, other parties may assert infringement claims against the
Company. From time to time, the Company may receive notice of claims of
infringement of other parties' proprietary rights. The defense of any claims,
whether these claims are with or without merit, could be time-consuming, result
in costly litigation and diversion of technical and management personnel, cause
product shipment delays or require the Company to develop non-infringing
technology or enter into royalty or licensing agreements. Royalty or licensing
agreements, if required, may be unavailable on terms acceptable to the Company
or at all. In the event of a successful claim of infringement against the
Company and the failure or inability of the Company to develop non-infringing
technology or license the infringed or similar technology on a timely basis, the
Company's business could be harmed.
EMPLOYEES
As of March 1, 2000 the Company employed 317 people, including 28 in
administration, 175 in product development and operations and 114 in sales and
marketing. The Company also employs independent contractors and other temporary
employees. None of the Company's employees is represented by a labor union, and
the Company considers its employee relations to be good. Competition for
qualified personnel in the Company's industry is intense, particularly among
software development and other technical staff. The Company believes that its
future success will depend in part on its continued ability to attract, hire and
retain qualified personnel.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information regarding the Company's
executive officers as of December 31, 1999:
NAME AGE POSITION
Joel A. Ronning 43 Chief Executive Officer
Perry W. Steiner 34 President
Robert E. Strawman 40 Chief Financial Officer and Treasurer
Jay A. Kerutis 40 Executive Vice President, Software and Digital
Commerce Services Division
Kelly J. Wical 43 Chief Technology Officer
Draper M. Jaffray 36 Vice President of Business Development
Gregory R.L. Smith 33 Vice President of Finance and Secretary
Mr. Ronning founded the Company in February 1994 and has been Chief
Executive Officer and a director of the Company since that time. From February
1994 to July 1998, Mr. Ronning was also President of the Company. From May 1995
to December 1999, Mr. Ronning served as Chairman of the Board of Directors of
Tech Squared Inc., a direct catalog marketer of software and hardware products.
From May 1995 to July 1998, Mr. Ronning served as Chief Executive Officer, Chief
Financial Officer and Secretary of Tech Squared. From May 1995 to August 1996,
Mr. Ronning also served as President of Tech Squared. Mr. Ronning founded
MacUSA, Inc., a wholly-owned subsidiary of Tech Squared, and served as a
director of MacUSA from April 1990 to December 1999. From April 1990 to July
1998, Mr. Ronning also served as the Chief Executive Officer of MacUSA. Mr.
Ronning also serves as a director of the Software Publishers Association and
JASC, Inc.
Mr. Steiner joined the Company in July 1998 as President and has
served as a director of the Company since April 1998. From January 1997 to July
1998, Mr. Steiner served as Vice President of Wasserstein Perella & Co., Inc.,
an investment banking firm, and as Vice President of Wasserstein Perella
Ventures, Inc., the general partner of Wasserstein Adelson Ventures, L.P., a
venture capital fund. From June 1993 to December 1996, Mr. Steiner was a
principal of TCW Capital, a group of leveraged buyout funds managed by Trust
Company of the West. Mr. Steiner serves as a director of LapLink.com, Inc. and
was a director of Tech Squared from December 1998 to June 1999.
Mr. Strawman joined the Company in April 1998 as Chief Financial
Officer and Treasurer. From September 1995 to April 1998, Mr. Strawman served as
Director of Finance and Vice President of Finance for Caribou Coffee Company,
Inc., a gourmet coffee retailer. From 1989 to 1995, Mr. Strawman held various
financial positions at Software Etc. Stores, Inc., a specialty retailer of
software, most recently as Chief Financial Officer.
Mr. Kerutis jointed the Company in February 1999 as Vice President of
Sales and has been Executive Vice President, Software and Digital Commerce
Services Division since January 2000. From March 1997 to February 1999, Mr.
Kerutis was Vice President - Retail Channel for Merisel Americas, Inc. From
April 1995 to March 1997, Mr. Kerutis was Vice President - Sales and Marketing
for New Media Corporation. From October 1993 to April 1995, Mr. Kerutis served
as Director - Sales for Merisel Americas, Inc.
11.
Mr. Wical joined the Company in April 1997 as Chief Technology
Officer. From 1992 to April 1997, Mr. Wical was Director of Development and
Chief Scientist/Architect of the ConText Server Division of Oracle Corporation.
From 1987 to 1992, Mr. Wical was co-founder and Vice President of Research and
Development for Artificial Linguistics, Inc., a developer of text management
software.
Mr. Jaffray joined the Company in December 1996 as Vice President of
Business Development. From January 1996 to December 1996, Mr. Jaffray was a
partner in The Firm, a computer products manufacturers representative. From 1991
to 1995, Mr. Jaffray served as Director of Sales for Tech Squared.
Mr. Smith joined the Company as Controller in June 1997 and has served
as Vice President of Finance since June 1999. Since December 1997, Mr. Smith has
also served as Secretary. From November 1995 to June 1997, Mr. Smith was
Manager, External Reporting and Investor Relations at Secure Computing
Corporation, a developer of network and Internet security products. From June
1988 to November 1995, Mr. Smith held various positions with Ernst & Young LLP.
RISK FACTORS
In addition to the other information provided in this report, the
following risk factors should be considered carefully in evaluating the Company
and our business.
BECAUSE WE HAVE A LIMITED OPERATING HISTORY, WE ARE ENCOUNTERING NUMEROUS RISKS
THAT WE MAY FAIL TO SUCCESSFULLY ADDRESS
We have a limited operating history. We were incorporated in February
1994 and conducted our first online sale through a client's Web store in August
1996. Our business and prospects must be considered in light of the risks
encountered by companies in their early stages of development, particularly
companies in new and rapidly evolving markets such as electronic commerce. Some
of these risks relate to our ability to:
- maintain or develop relationships with software and online
retailers;
- maintain or develop relationships with E-Business clients and
prospects;
- execute our business and marketing strategy;
- continue to develop and upgrade our technology and
transaction-processing systems;
- provide superior customer service and order fulfillment;
- respond to competitive developments; and
- retain and motivate qualified personnel.
We may not be successful in addressing these risks, and if we are not
successful, our business will suffer. Our current and future expense levels are
based largely on our planned operations and our estimates of future sales. It is
difficult, however, for us to accurately forecast future sales, because our
business is still new and our market is still developing. We may be unable to
adjust spending in a timely manner to compensate for any unexpected revenue
shortfall. As a result, any significant shortfall in sales would immediately
harm our business. As a result of our rapidly evolving business and our limited
operating history, we believe that period-to-period comparisons of our operating
results are not necessarily meaningful and investors should not rely upon our
historical results as an indication of future performance.
WE HAVE A HISTORY OF LOSSES AND WE EXPECT OUR LOSSES TO CONTINUE FOR THE
FORESEEABLE FUTURE
We have incurred significant losses since we were formed. As of
December 31, 1999, we had an accumulated deficit of approximately $45.8 million.
We intend to continue to expend significant financial and management resources
on the development of additional services, sales and marketing, improved
technology and expanded operations. For example, we have invested over $15
million to improve our technology infrastructure so that we can offer our
clients comprehensive e-commerce outsourcing solutions. As a result of these
expenditures, we expect operating losses and negative cash flows to continue for
the foreseeable future. In addition, we anticipate our operating losses may
increase from current levels. Our sales may not increase or even continue at
their current level, and we may not be profitable or generate cash from
operations in future periods.
OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE SIGNIFICANTLY
12.
Our quarterly and annual operating results are likely to fluctuate
significantly in the future due to a variety of factors, many of which are
outside our control. Some of these factors include:
our ability to attract and retain software publishers and online
retailers as clients;
our ability to attract and retain E-Business clients;
the introduction of new Web sites, Web stores, services or products by
us or by others;
price competition and margin erosion;
the rate at which the online market for the purchase of software
products continues to emerge;
our ability to continue to upgrade and develop our systems and
infrastructure to meet emerging market needs and remain competitive in
our service offerings;
termination of any account that represents a significant portion of
our sales;
technical difficulties or system downtime;
our ability to attract new personnel as needed as our business grows;
our ability to increase the proportion of sales from online retailers,
which sales generally carry higher gross margins;
the failure of Internet bandwidth to increase over time or any
increase in the cost of Internet bandwidth; and
U.S. and foreign regulations relating to our business.
We also may offer favorable economic terms to certain software
publishers and online retailers in order to attract or retain their business,
which would reduce our gross margins. Due to these factors, our annual or
quarterly operating results may not meet the expectations of securities analysts
and investors. If this happens, the trading price of the common stock would
likely significantly decline.
A LOSS OF ANY CLIENT THAT ACCOUNTS FOR A LARGE PORTION OF OUR SALES
COULD CAUSE OUR REVENUES TO DECLINE
Sales initiated through the Web stores of three software publisher
clients collectively accounted for approximately 25% of our sales in 1998 and
approximately 20% of our sales in 1999. Contracts with these clients are
generally short term in nature. If any one of these contracts is not renewed or
otherwise ends, our revenues could decline and our business could be harmed.
OUR SALES CYCLE IS LENGTHY
We market our services directly to software publishers, online
retailers and E-Business prospects. These relationships are typically complex
and take time to finalize. Due to operating procedures in many large
organizations, a significant amount of time may pass between selection of our
products and services by key decision makers and the signing of a contract. As a
result, the period between the initial sales call and the signing of a contract
with significant sales potential typically ranges from six to twelve months, can
be longer and is difficult to predict. Delays in signing contracts with these
potential clients could harm our business.
THERE ARE A NUMBER OF RISKS ASSOCIATED WITH ELECTRONIC SOFTWARE DELIVERY, OR
ESD, INCLUDING THE MARKET'S POTENTIAL FAILURE TO ACCEPT ESD
Our success will depend in large part on growth in end-user acceptance
of ESD as a method of distributing software products. ESD is a relatively new
method of distributing software products and the growth and market acceptance of
ESD is highly uncertain and subject to a number of risks. Factors that will
influence market acceptance of ESD include:
- the availability of sufficient bandwidth to enable purchasers to
rapidly download software products;
- the cost of time-based Internet access;
13.
- the number of software products that are available for purchase
through ESD as compared to those available through physical
delivery; and
- the level of end-user comfort with the process of downloading
software via the Internet, including the ease of use and lack of
concern about transaction security.
If ESD does not achieve widespread market acceptance, our business
will be harmed. Even if ESD achieves widespread acceptance, we cannot be certain
that we will overcome the substantial existing and future technical challenges
associated with electronically delivering software reliably and consistently on
a long-term basis. Our failure to do so would harm our business.
WE ARE DEPENDENT ON THE CONTINUED GROWTH OF ELECTRONIC COMMERCE AND DEVELOPMENT
OF THE INTERNET INFRASTRUCTURE
We depend on the growing use and acceptance of the Internet as an
effective medium of commerce by end-users. Rapid growth in the use of and
interest in the Internet and other online services is a recent development. The
acceptance and use of the Internet and other online services may not continue to
develop and a sufficiently broad base of consumers may not adopt, and continue
to use, the Internet and other online services as a medium of commerce. We rely
on purchasers who have historically used traditional means of commerce to
purchase goods or transact business. If we are to be successful, these
purchasers must accept and use the Internet as a means of purchasing goods and
services and exchanging information and we cannot predict the rate at which
these purchasers will do so.
The Internet may fail as a commercial marketplace for a number of
reasons, including potentially inadequate development of the necessary network
infrastructure or delayed development of enabling technologies and performance
improvements. If the number of Internet users or their use of Internet resources
continues to grow, it may overwhelm the existing Internet infrastructure. Delays
in the development or adoption of new standards and protocols required to handle
increased levels of Internet activity or increased governmental regulation could
also have a similar effect. In addition, growth in Internet usage that is not
matched by comparable growth in the infrastructure supporting Internet usage
could result in slower response times or impair usage of the Internet.
WE ARE DEPENDENT ON SOFTWARE PUBLISHERS
We are heavily dependent upon the software publishers that supply us
with software, and the availability of this software is unpredictable. Our
contracts with our software publisher clients are generally one year in
duration, with an automatic renewal provision for additional one-year periods,
unless we are provided with a written notice at least 90 days before the end of
the contract. As is common in our industry, we have no long-term or exclusive
contracts or arrangements with any software publishers that guarantee the
availability of software products. We cannot be certain that the software
publishers that currently supply software to us will continue to do so or that
we will be able to establish new relationships with software publishers. If we
cannot develop and maintain satisfactory relationships with software publishers
on acceptable commercial terms, if we are unable to obtain sufficient quantities
of software, if the quality of service provided by these software publishers
falls below a satisfactory standard or if software returned to us exceeds our
clients' expectations, our business could be harmed.
WE ARE DEPENDENT ON ONLINE RETAILERS
Our strategy is dependent upon increasing our sales of software
products through online retailers. We have historically generated substantially
all of our sales from the sale of software to end-users that were initiated
through the Web stores of our software publisher clients. In 1999, less than 8%
of our sales were generated through the Web stores of our online retailer
clients. We may not successfully establish relationships with additional online
retailers and our current relationships may not continue. If we are unable to
expand our relationships with online retailers, we will likely be unable to
continue to grow our business and establish meaningful market share.
WE ARE DEPENDENT ON E-BUSINESS CLIENTS
Our strategy is also dependent upon increasing fee and service
revenues from E-Business clients. Sales related to E-Business clients were less
than 3% in 1999. We may not succeed in establishing and maintaining
relationships with sufficient numbers of E-Business clients to support our
investments in technology and infrastructure. If we are unable to attract and
retain these clients, our business will suffer.
WE MAY BE UNABLE TO SUCCESSFULLY IMPLEMENT OUR DEVELOPMENT AND ACQUISITION
STRATEGY
To extend our e-commerce outsourcing capabilities, we have developed,
and intend to continue developing, our e-Business services. We have also
acquired, and intend to continue acquiring, companies that provide
14.
outsourcing services to shareware publishers. These business initiatives require
a significant expenditure of management time and sales, marketing and product
development funds. These expenditures may disrupt our ongoing business, distract
management and make it difficult to maintain standards, controls and procedures.
If we make acquisitions outside of our core business, assimilating the acquired
technology, services or products into our operations could be difficult. If we
are unable to successfully implement our new business initiatives, we will not
generate a profitable return on our investment and we will be unable to gain
meaningful market share. If a significant number of clients of the acquired
companies cease doing business with us, our business will suffer.
SYSTEM FAILURES COULD REDUCE THE ATTRACTIVENESS OF OUR PRODUCT AND SERVICE
OFFERINGS
We provide commerce, marketing and delivery services to our clients
and end-users through our CNS transaction-processing and client management
systems. These systems also maintain an electronic inventory of products and
gather consumer marketing information. The satisfactory performance, reliability
and availability of the CNS and the underlying network infrastructure are
critical to our operations, our level of customer service, and our reputation
and ability to attract and retain clients. Our systems and operations are
vulnerable to damage or interruption from:
- fire, flood and other natural disasters; and
- power loss, telecommunications failure, break-ins and similar
events.
We presently have no offsite back-up facilities and do not carry
sufficient business interruption insurance to fully compensate us for losses
that may occur. Despite the use of network security devices, our servers are
vulnerable to computer viruses, physical or electronic break-ins and similar
disruptions, which could lead to interruptions, delays, loss of data or the
inability to accept and fulfill end-user orders. Any systems interruption that
impairs our ability to accept and fill customer orders reduces the
attractiveness of our product and service offerings to clients and end-users,
which could harm our business.
FAILURE TO DEVELOP OUR TECHNOLOGY TO ACCOMMODATE INCREASED CNS TRAFFIC COULD
REDUCE DEMAND FOR OUR SERVICES
We have experienced periodic interruptions, affecting all or a portion
of our systems, which we believe will continue to occur from time to time. We
periodically enhance and expand our technology and transaction-processing
systems, and network infrastructure and other technologies to accommodate
increases in the volume of traffic on the CNS. We may be unable to improve and
increase the capacity of our network infrastructure. We may be unable to
anticipate increases, if any, in the use of the CNS or to expand and upgrade its
systems and infrastructure to accommodate such increases. Our inability to add
software and hardware or to develop and upgrade existing technology,
transaction-processing systems or network infrastructure to handle increased
traffic on the CNS may cause unanticipated system disruptions, slower response
times and poor customer service, including problems filling customer orders, any
of which could harm our business. In addition, additional network capacity may
not be available from third-party suppliers when we need it. Our network and our
suppliers' networks may be unable to maintain an acceptable data transmission
capability, especially if demands on the CNS increase. Our failure to maintain
an acceptable data transmission capability could significantly reduce demand for
our services, which would impair our business.
SECURITY BREACHES COULD HINDER OUR ABILITY TO SECURELY TRANSMIT CONFIDENTIAL
INFORMATION
A significant barrier to electronic commerce and communications is the
secure transmission of confidential information over public networks. We rely on
encryption and authentication technology licensed from third parties to provide
the security and authentication necessary for secure transmission of
confidential information, such as customer credit card numbers. A party who
circumvents our security measures could misappropriate proprietary information
or interrupt our operations. Any compromise or elimination of our security could
harm our business.
We may be required to expend significant capital and other resources
to protect against security breaches or to address problems caused by breaches.
Concerns over the security of the Internet and other online transactions and the
privacy of users may also inhibit the growth of the Internet and other online
services generally, and the Web in particular, especially as a means of
conducting commercial transactions. To the extent that our activities or those
of third-party contractors involve the storage and transmission of proprietary
information, such as credit card numbers, security breaches could damage our
reputation and expose us to a risk of loss or litigation and possible liability.
Our security measures may not prevent security breaches and failure to prevent
security breaches could cause our business to suffer.
CURRENT AND POTENTIAL COMPETITORS COULD REDUCE OUR OPERATING MARGINS AND MARKET
SHARE
15.
The electronic commerce market is new, rapidly evolving and intensely
competitive. We expect competition to intensify in the future, particularly in
the area of electronic sale and distribution of software products. We currently
compete directly with other providers of electronic commerce solutions,
including CyberSource Corporation, Preview Systems, Inc., ReleaseNow.com
Corporation and ShopNow.com, Inc. We compete indirectly with software companies,
system integrators and application service providers that offer tools and
services for electronic commerce, including companies that provide a broad range
of Internet and server solutions such as Microsoft Corporation and Netscape
Communications Corporation. We also compete indirectly with a large number of
companies that provide tools and services enabling one or more of the
transaction processing functions of electronic commerce, such as transaction
control, data security, customer interaction and database marketing, such as
BroadVision, Open Market, CommerceOne, IBM Global Services, Scient, US Web/CKS,
US Internetworking, Corio and Qwest. In addition to direct competition with
other transaction processing providers and enablers and indirect competition
with other providers of electronic commerce software and systems, we compete
with companies that sell and distribute software products via the Internet,
including Amazon.com, Inc., beyond.com Corporation, Ingram Micro Inc. and Tech
Data Corporation. We also compete with companies such as AltaVista, a subsidiary
of CMGI, America Online, Inc., Excite, Inc., Infoseek Corporation, Lycos, Inc.
and Yahoo! Inc., which specialize in electronic commerce or derive a substantial
portion of their revenues from electronic commerce and may themselves offer, or
provide means for others to offer, software products.
We believe that the principal competitive factors in our market
include:
- breadth of service and product offerings;
- software and shareware publisher and online retailer
relationships;
- brand recognition;
- system reliability and capacity;
- price;
- customer service;
- speed, accessibility and ease of use;
- speed to market;
- scaleability;
- convenience; and
- speed of fulfillment.
The online retailers and the other companies listed above may compete
directly with us by adopting a similar business model. Moreover, while some of
these companies are also clients or potential clients of ours, they may compete
with our electronic commerce outsourcing solution if they develop electronic
commerce systems or acquire such systems from other software and shareware
vendors or service providers.
Many of our current and potential competitors have longer operating
histories, larger customer bases, greater brand recognition and significantly
greater financial, marketing and other resources than we do. In addition,
larger, well-established and well-financed entities may acquire, invest in or
form joint ventures with online competitors as the use of the Internet and other
online services increases. New technologies and the expansion of existing
technologies, such as price comparison programs that select specific titles from
a variety of Web sites, may direct end-users to online retailers that compete
with us, which would increase competitive pressures on us. Increased competition
may result in reduced operating margins, as well as a loss of market share.
Further, in response to changes in the competitive environment, we may from time
to time make pricing, service or marketing decisions or acquisitions that could
harm our business. We may be unable to compete successfully against current and
future competitors, and any inability to do so could harm our business.
WE MUST KEEP PACE WITH RAPID TECHNOLOGICAL CHANGE IN ORDER TO SUCCEED
To remain competitive, we must continue to enhance and improve the
responsiveness, functionality and features of the CNS and the underlying network
infrastructure. The Internet and the electronic commerce industry are
characterized by rapid technological change, changes in user requirements and
preferences, frequent new product and service introductions embodying new
technologies and the emergence of new industry standards and
16.
practices that could render our technology and systems obsolete. Our success
will depend, in part, on our ability to both license and internally develop
leading technologies to enhance our existing services, develop new products,
services and technologies that address the increasingly sophisticated and varied
needs of our clients, and respond to technological advances and emerging
industry standards and practices on a cost-effective and timely basis. The
development of the CNS technology and other proprietary technology involves
significant technical and business risks. We may fail to use new technologies
effectively or adapt our proprietary technology and systems to customer
requirements or emerging industry standards. If we are unable to adapt to
changing market conditions, client requirements or emerging industry standards,
our business could be harmed.
WE MUST EFFECTIVELY MANAGE OUR RAPID GROWTH IN ORDER TO SUCCEED
We have rapidly and significantly expanded our operations and
anticipate that further significant expansion will be required to address
potential growth in our client base and market opportunities. In 1999, we
increased our number of employees from 116 to 278. This expansion is placing a
significant strain on our managerial, operational and financial resources. Our
new employees include a number of key managerial, technical and operations
personnel who we have not yet fully integrated. We recently acquired three
shareware businesses that required us to integrate two new offices and a number
of new employees. We expect to add additional key personnel in the near future,
including direct sales, marketing and technical personnel. To manage the
expected growth of our operations and personnel, we will be required to:
- improve existing and implement new operational, financial and
management controls, reporting systems and procedures;
- install new management information systems; and
- train, motivate and manage our employees.
We may not be able to install management information and control
systems in an efficient and timely manner, and our current or planned personnel,
systems, procedures and controls may not be adequate to support our future
operations. In addition, we may not be able to hire, train, retain, motivate and
manage required personnel or to successfully identify, manage and exploit
existing and potential market opportunities. If we are unable to manage growth
effectively, our business will be harmed.
OUR CHIEF EXECUTIVE OFFICER IS CRITICAL TO OUR BUSINESS AND HE MAY NOT REMAIN
WITH US IN THE FUTURE
Our future success significantly depends on the continued services and
performance of our senior management, particularly Joel A. Ronning, our Chief
Executive Officer. Our performance also depends on our ability to retain and
motivate our other executive officers and key employees. The loss of the
services of any of our executive officers or other key employees could harm our
business. We have long-term employment agreements only with Mr. Ronning and
Perry W. Steiner, our President. See "Management--Employee Agreements." Our
future success also depends on our ability to identify, attract, hire, train,
retain and motivate other highly skilled technical, managerial, operations,
merchandising, sales and marketing and customer service personnel. Competition
for personnel is intense, and we may be unable to successfully attract,
assimilate or retain sufficiently qualified personnel. The failure to retain and
attract the necessary personnel could harm our business.
PROTECTING OUR INTELLECTUAL PROPERTY IS CRITICAL TO OUR SUCCESS
Trademarks, patents, copyrights, trade secrets and other intellectual
property are critical to our success, and we rely on trademark, trade secret
protection and confidentiality and license agreements with our employees,
clients, partners and others to protect our proprietary rights. We seek to
protect our proprietary position by, among other methods, filing United States
and foreign patent applications related to our proprietary technology,
inventions and improvements that are important to the development of our
business. We currently have four United States patents issued and nine U.S. and
two foreign patents pending in a number of areas of electronic commerce.
Proprietary rights relating to our technologies will be protected from
unauthorized use by third parties only to the extent that they are covered by
valid and enforceable patents or copyrights or are effectively maintained as
trade secrets. The laws of some foreign countries do not protect our
intellectual property rights to the same extent as do the laws of the United
States. The patent position of high technology companies involves complex legal
and factual questions and, therefore, we cannot predict their validity and
enforceability with certainty. Even if issued, our patent applications may be
challenged, invalidated, held unenforceable or circumvented. Further, rights
granted under future patents may not provide us with proprietary protection or
competitive advantages against competitors with similar technology. Others may
independently develop similar technologies or duplicate technologies developed
by us.
We have three registered trademarks, including "Digital River," and
seven trademark registrations pending. Effective trademark and trade secret
protection may not be available in every country in which our products and
17.
services are made available online. The steps we have taken to protect our
proprietary rights may be inadequate, and third parties may infringe or
misappropriate our trade secrets, trademarks, trade dress and similar
proprietary rights. In addition, others may independently develop substantially
equivalent intellectual property. Any significant failure to protect our
intellectual property in a meaningful manner could harm our business. In
addition, litigation may be necessary in the future to enforce our intellectual
property rights, to protect our trade secrets or to determine the validity and
scope of the proprietary rights of others. Litigation could result in
substantial costs and diversion of management and technical resources, which
could harm our business.
CLAIMS OF INFRINGEMENT OF OTHER PARTIES' INTELLECTUAL PROPERTY RIGHTS COULD
REQUIRE US TO EXPEND SIGNIFICANT RESOURCES
From time to time we may receive notice of claims of infringement of
other parties' proprietary rights. Any future assertions or prosecutions of
claims like these could require us to expend significant financial and
managerial resources. Defending any claim, whether valid or not, could be
time-consuming, result in costly litigation and diversion of technical and
management personnel, cause product shipment delays or require us to develop
non-infringing technology or enter into royalty or licensing agreements. Royalty
or licensing agreements, if required, may be unavailable on terms acceptable to
us, or at all. If a third party succeeds in any infringement action against us
and we fail or are unable to develop non-infringing technology or license the
infringed or similar technology on a timely basis, our business could be harmed.
CLAIMS AGAINST US RELATED TO THE SOFTWARE PRODUCTS THAT WE DELIVER
ELECTRONICALLY COULD ALSO REQUIRE US TO EXPEND SIGNIFICANT RESOURCES
Claims may be made against us for negligence, copyright or trademark
infringement or other theories based on the nature and content of software
products that are delivered electronically and subsequently distributed to
others. Although we carry general liability insurance, our insurance may not
cover potential claims of this type or may not be adequate to cover all costs
incurred in defense of potential claims or to indemnify us for all liability
that may be imposed. Any costs or imposition of liability that is not covered by
insurance or in excess of insurance coverage could harm our business.
WE MAY NEED TO RAISE ADDITIONAL CAPITAL TO ACHIEVE OUR BUSINESS OBJECTIVES
We require substantial working capital to fund our business. We have
had significant operating losses and negative cash flow from operations since
inception and expect to continue to do so for the foreseeable future. We believe
that our existing capital resources will be sufficient to meet our capital
requirements for at least the next 12 months. However, our capital requirements
depend on several factors, including the rate of market acceptance of our
products, the ability to expand our client base, the growth of sales and
marketing and other factors. If capital requirements vary materially from those
currently planned, we may require additional financing sooner than anticipated.
If additional funds are raised through the issuance of equity securities, the
percentage ownership of our stockholders will be reduced, stockholders may
experience additional dilution, or these equity securities may have rights,
preferences or privileges senior to those of the holders of our common stock.
Additional financing may not be available when needed on terms favorable to us
or at all. If adequate funds are not available or are not available on
acceptable terms, we may be unable to develop or enhance our services, take
advantage of future opportunities or respond to competitive pressures, which
could harm our business.
CHANGES IN GOVERNMENT REGULATION COULD LIMIT OUR INTERNET ACTIVITIES OR RESULT
IN ADDITIONAL COSTS OF DOING BUSINESS OVER THE INTERNET
We are not currently subject to direct regulation by any domestic or
foreign governmental agency, other than regulations applicable to businesses
generally, export control laws and laws or regulations directly applicable to
electronic commerce. However, due to the increasing popularity and use of the
Internet, it is possible that a number of laws and regulations may be adopted
with respect to the Internet covering issues such as:
- user privacy;
- pricing;
- content;
- copyrights;
- distribution; and
- characteristics and quality of products and services.
18.
Furthermore, the growth and development of the market for electronic
commerce may prompt calls for more stringent consumer protection laws that may
impose additional burdens on those companies conducting business online. The
adoption of additional laws or regulations may decrease the growth of the
Internet or other online services, which could, in turn, decrease the demand for
our products and services and increase our cost of doing business, or otherwise
harm our business.
The applicability of existing laws governing issues such as property
ownership, copyrights, encryption and other intellectual property issues,
taxation, libel, export or import matters, obscenity and personal privacy to the
Internet is uncertain. The vast majority of these laws were adopted prior to the
advent of the Internet and related technologies. As a result, they do not
contemplate or address the unique issues of the Internet and related
technologies. Changes to the laws intended to address these issues, including
some recently proposed changes, could create uncertainty in the Internet
marketplace. Uncertainty could reduce demand for our services or increase the
cost of doing business due to increased costs of litigation or increased service
delivery costs.
In addition, as our services are available over the Internet in
multiple states and foreign countries, these jurisdictions may claim that we are
required to qualify to do business as a foreign corporation in each state or
foreign country. We are qualified to do business only in Connecticut, Minnesota
and Washington. Failure to qualify as a foreign corporation in a jurisdiction
where we are required to do so could subject us to taxes and penalties and could
result in our inability to enforce contracts in these jurisdictions. New
legislation or regulation, the application of laws and regulations from
jurisdictions whose laws do not currently apply to our business, or the
application of existing laws and regulations to the Internet and other
electronic services could harm our business.
WE MAY NOT SUCCEED IN DEVELOPING A SUCCESSFUL INTERNATIONAL PRESENCE
Although we sell software products and services to end-users outside
the United States, we might not succeed in expanding our international presence.
Conducting business outside of the United States is subject to certain risks,
including:
- changes in regulatory requirements and tariffs;
- reduced protection of intellectual property rights;
- difficulties in distribution;
- the burden of complying with a variety of foreign laws; and
- political or economic constraints on international trade or
instability.
In addition, some software exports from the United States are subject
to export restrictions as a result of the encryption technology in the software
and we may become liable to the extent we violate these restrictions. We may be
unable to market, sell and distribute our products and services in local markets
and we cannot be certain that one or more of these factors will not harm our
future international operations, and consequently, our business.
NEW OBLIGATIONS TO COLLECT OR PAY SALES TAX COULD HARM OUR BUSINESS
We do not currently collect sales, use or other similar taxes with
respect to ESD or shipments of software products into states other than
Connecticut, Minnesota and Washington. However, one or more local, state or
foreign jurisdictions may seek to impose sales or use tax collection obligations
on out-of-state companies like ours that engage in electronic commerce. Any new
operation in states outside Connecticut, Minnesota and Washington could subject
shipments into those states to state sales or use taxes under current or future
laws. In addition, any failure by an E-Business client to collect obligatory
sales or use taxes could cause the relevant jurisdiction to attempt imposing
that obligation on us. A successful assertion by one or more states or any
foreign country that we should collect sales, use or other taxes on the sale of
merchandise through ESD or E-Business or shipments of software could harm our
business.
OUR STOCK PRICE IS LIKELY TO BE HIGHLY VOLATILE DUE TO BROAD MARKET AND INDUSTRY
FACTORS BEYOND OUR CONTROL
The trading price of our common stock has been and is likely to
continue to be highly volatile and could be subject to wide fluctuations in
response to factors such as:
- actual or anticipated variations in quarterly operating results;
- announcements of technological innovations;
19.
- new products or services that we or our competitors offer;
- changes in financial estimates by securities analysts;
- conditions or trends in the Internet and online commerce
industries;
- changes in the economic performance and/or market valuations of
other Internet, online service industries;
- changes in the economic performance and/or market valuations of
other Internet, online service or retail companies;
- our announcements of significant acquisitions, strategic
partnerships, joint ventures or capital commitments;
- additions or departures of key personnel;
- sales of common stock; and
- other events or factors, many of which are beyond our control.
In addition, the stock market in general, and the Nasdaq National
Market and the market for Internet-related and technology companies in
particular, has experienced extreme price and volume fluctuations that have
often been unrelated or disproportionate to the operating performance of these
companies. The trading prices of many technology companies' stocks are at or
near historical highs and these trading prices and multiples are substantially
above historical levels. These trading prices and multiples may not be
sustained. These broad market and industry factors may cause the market price of
our common stock to decline, regardless of our actual operating performance. In
the past, following periods of volatility in the market price of a company's
securities, securities class-action litigation has often been instituted against
that company. Litigation, if instituted, could result in substantial costs and a
diversion of management's attention and resources, which would harm our
business.
PROVISIONS OF OUR CHARTER DOCUMENTS, OTHER AGREEMENTS AND DELAWARE LAW MAY
INHIBIT POTENTIAL ACQUISITION BIDS FOR US
Certain provisions of our Amended and Restated Certificate of
Incorporation, Bylaws, other agreements and Delaware law could make it more
difficult for a third party to acquire us, even if a change in control would be
beneficial to our stockholders.
YEAR 2000 PROBLEMS WITH OUR INTERNAL SYSTEMS AND THIRD-PARTY SYSTEMS OF
SUPPLIERS COULD CREATE SIGNIFICANT POTENTIAL LIABILITY FOR US AND REQUIRE US TO
EXPEND SUBSTANTIAL MANAGEMENT AND FINANCIAL RESOURCES
Many installed computer systems and software products were programmed
to accept only two digits in the date code field. As of January 1, 2000, it
became necessary for these code fields to accept four digit entries to
distinguish years beginning with "19" from those beginning with "20."
Like many other companies, Year 2000 computer issues create risks for
us. If our internal management information systems and external electronic
commerce information systems do not correctly recognize the process date
information beyond the year 1999, there could be an adverse impact on our
operations. To address potential Year 2000 issues with our internal and external
systems, we have evaluated these systems. We believe we have completed all
activities to evaluate and remediate year 2000 problems. We have also worked
with key suppliers of products and services to determine that their operations
and products are Year 2000 compliant. The failure of a major supplier to become
Year 2000 Compliant on a timely basis, or a conversion that is incompatible with
our systems could harm our business. In addition, our business may be harmed if
our end-users are unable to use their credit cards due to the Year 2000 issues
that are not rectified by their credit card vendors.
We have a contingency plan for handling year 2000 problems that were
not detected and corrected prior to their occurrence, and we are continuing to
assess any exposure areas in order to determine what additional steps are
advisable. We are prepared to use backup systems and have developed other
alternative contingency plans for other critical functions where computer
systems are essential. To date, we have not experienced any material year 2000
problems. However, if all of our potential year 2000 problems were not properly
identified or if adequate assessment and remediation are not timely effected
with respect to any year 2000 problems, our business could be harmed. Moreover,
any year 2000 compliance problems facing our suppliers or vendors could also
harm our business.
20.
ITEM 2. PROPERTIES.
The Company currently leases approximately 55,000 square feet of
office and warehouse space in two facilities in Eden Prairie, Minnesota. Both
agreements expire on July 31, 2003. The Company also leases on a month to month
basis approximately approximately 900 square feet of office space in suburban
London that houses its European sales office. In addition, the Company leases on
a short term basis offices in Cheshire, Connecticut and Issaquah, Washington
with space of 1,700 and 800 square feet, respectively. The Company believes that
its facilities will be adequate to accommodate the Company's needs for the
foreseeable future.
ITEM 3. LEGAL PROCEEDINGS.
From time to time, the Company may be involved in litigation relating
to claims arising out of its ordinary course of business. The Company presently
is not subject to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is traded on the Nasdaq National Market
under the symbol "DRIV." Public trading of the Common Stock commenced on August
11, 1998. Prior to that, there was no public market for the Common Stock. The
following table sets forth, for the periods indicated, the high and low sale
price per share of the Common Stock on the Nasdaq National Market.
1998 HIGH LOW
Third Quarter (from August 11, 1998) $ 13.25 $ 5.00
Fourth Quarter $ 44.00 $ 5.63
1999
First Quarter $ 61.38 $ 27.44
Second Quarter $ 51.38 $ 19.56
Third Quarter $ 36.13 $ 18.25
Fourth Quarter $ 43.63 $ 19.63
2000
First Quarter (through March 10, 2000) $ 37.38 $ 23.81
As of March 10, 2000 there were approximately 332 holders of record of
the Company's Common Stock. On March 10, 2000, the last sale price reported on
the Nasdaq National Market System for the Company's Common Stock was $31.38 per
share.
The Company has never declared or paid any cash dividends on its
capital stock. The Company intends to retain any future earnings to support
operations and to finance the growth and development of the Company's business
and does not anticipate paying cash dividends for the foreseeable future.
Since January 1, 1999, the Company has sold and issued the following
unregistered securities:
In February 1999, the Company granted to Linda Ireland, a vice
president of the Company, outside of its equity incentive plans, options
representing an aggregate of 61,296 shares of the Company's Common Stock at an
exercise price of $29.1875 per share. Ms. Ireland left the Company in October
1999 prior to exercising any portion of this option and the option was cancelled
in full.
From January 5, 1999 to September 3, 1999, warrants were exercised
to purchase 55,734 shares of Common Stock with a weighted average exercise
price of $2.50.
In April 1999, pursuant to an Agreement and Plan of Merger by and
among the Company, Maagnum Internet Group, Inc., a Connecticut corporation
("Maagnum"), and Cyrus Maaghul, the sole shareholder of Maagnum, Maagnum merged
with and into the Company (the "Merger"). At the effective time of the Merger,
21.
Mr. Maaghul's shares of Maagnum common stock converted into the right to receive
from the Company cash and 88,809 shares of Common Stock of the Company and up to
an additional 320,161 shares of Common Stock that may be earned by Mr. Maaghul
upon the achievement of certain business goals over the 24-month period
following the closing date of the Merger. In addition, pursuant to a Stock
Purchase Agreement dated April 1, 1999 by and between the Company and Meiman
Kentjana, a key employee of Maagnum, in consideration for Mr. Kentjana's
agreement to waive certain rights with respect to Maagnum, the Company issued to
Mr. Kentjana on the closing date of the Merger 22,841 shares of Common Stock and
gave him the right to receive up to an additional 192,374 shares of Common Stock
that may be earned by Mr. Kentjana upon the achievement of certain business
goals over the 24-month period following the closing date of the Merger.
In the quarter ended September 30, 1999, Messrs. Maaghul and Kentjana
of Maagnum collectively received earn-out payments in the form of 48,095 shares
of Common Stock valued at $1,046,000.
Also in April 1999, pursuant to an Asset Purchase Agreement by and
among the Company, Public Software Library Ltd., a Texas limited partnership
("Seller"), and the partners of Seller, the Company purchased substantially all
of the assets and assumed certain liabilities of Seller in exchange for an
aggregate of 161,842 shares of Common Stock of the Company.
In June 1999, pursuant to an Agreement and Plan of Merger and
Reorganization by and among the Company, Universal Commerce, Incorporated, a
Delaware corporation ("RegNow"), and certain stockholders of RegNow (the
"Stockholders"), RegNow merged with and into the Company (the "RegNow Merger").
At the effective time of the RegNow Merger, the Stockholders received from the
Company cash and 306,884 shares of Common Stock of the Company. In addition, the
Stockholders may receive additional shares of Common Stock upon the achievement
of certain revenue goals over the 12-month period following the closing date of
the RegNow Merger.
In October 1999, pursuant to an Asset Purchase Agreement by and among
the Company, Walnut Creek CDROM, Inc. ("Walnut Creek"), and the sole shareholder
of Walnut Creek, the Company purchased certain assets of Walnut Creek in
exchange for cash and 143,885 shares of Common Stock of the Company.
The sales and issuances of the unregistered securities in the
transactions described above were deemed to be exempt from registration under
the Act in reliance upon Section 4(2) of the Act, Regulation D promulgated
thereunder, Regulation S promulgated thereunder, or Rule 701 promulgated under
Section 3(b) of the Act, as transactions by an issuer not involving any public
offering or transactions pursuant to compensatory benefit plans and contracts
relating to compensation as provided under Rule 701. The recipients of
securities in each such transaction represented their intentions to acquire the
securities for investment only and not with a view to or for sale in connection
with any distribution thereof and appropriate legends were affixed to the
securities issued in such transactions. All recipients had adequate access,
through their relationship with the Company, to information about the Company.
There were no underwritten offerings employed in connection with the
sales and issuances of the unregistered Securities in any of the transactions
set forth above.
22.
ITEM 6. SELECTED FINANCIAL DATA.
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------
1999 1998 1997 1996 1995
------------ -------------- ------------- ------------- ----------
(in thousands, except per share data)
STATEMENT OF OPERATIONS DATA:
Sales...................................... $ 75,050 $ 20,911 $ 2,472 $ 111 $ -
Cost of sales.............................. 61,012 17,487 2,052 95 -
------------ -------------- ------------- ------------- ----------
Gross profit............................. 14,038 3,424 420 16 -
Operating expenses:
Sales and marketing...................... 17,636 9,514 1,501 68 3
Product development and operations 16,145 5,432 1,528 230 130
General and administrative............... 4,172 3,171 929 415 32
Amortization of goodwill and acquisition
related costs............................ 6,886 - - - -
----------- --------------- ------------- ------------- ----------
Total operating expenses............... 44,839 18,117 3,958 713 165
----------- --------------- ------------- ------------- ----------
Loss from operations....................... (30,801) (14,693) (3,538) (697) (165)
Interest income.......................... 3,148 895 53 8 22
----------- --------------- ------------- ------------- ----------
Net loss................................... $ (27,653) $ (13,798) $ (3,485) $ (689) $ (143)
=========== =============== ============= ============= ==========
Basic and diluted net loss per share (1)... $ (1.36) $ (1.01) $ (0.46) $ (0.13) $ (0.03)
=========== =============== ============= ============= ==========
Shares used in per share computation (1)... 20,312 13,691 7,514 5,333 5,333
DECEMBER 31,
-----------------------------------------------------------------------
1999 1998 1997 1996 1995
----------- -------------- ------------ ------------ ----------
(in thousands, except per share data)
BALANCE SHEET DATA:
Cash and cash equivalents $ 15,120 $ 63,503 $ 2,126 $ 800 $ 487
Short-term investments..................... 24,387 10,894 - - -
Working capital (deficit) 28,777 70,563 1,244 (451) 478
Total assets............................... 87,142 80,328 3,405 1,202 635
Accumulated deficit........................ (45,776) (18,123) (4,325) (840) (152)
Total stockholders' equity (deficit)....... 73,077 74,587 2,329 (58) 627
- ----------------
(1) See Note 1 of Notes to Consolidated Financial Statements for an
explanation of the method employed to determine the number of shares used to
compute per share amounts.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION
WITH "SELECTED FINANCIAL DATA" AND THE COMPANY'S FINANCIAL STATEMENTS AND NOTES
THERETO INCLUDED ELSEWHERE IN THIS REPORT. EXCEPT FOR THE HISTORICAL INFORMATION
CONTAINED HEREIN, THE DISCUSSION IN THIS REPORT CONTAINS CERTAIN FORWARD-LOOKING
STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES, SUCH AS STATEMENTS OF THE
COMPANY'S PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS. THESE FORWARD-LOOKING
STATEMENTS ARE BASED ON THE CURRENT EXPECTATIONS OF THE COMPANY, AND THE COMPANY
ASSUMES NO OBLIGATION TO UPDATE THIS INFORMATION. THE CAUTIONARY STATEMENTS MADE
IN THIS REPORT SHOULD BE READ AS BEING APPLICABLE TO ALL RELATED FORWARD-LOOKING
STATEMENTS WHEREVER THEY APPEAR IN THIS REPORT. THE COMPANY'S ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THOSE DISCUSSED HERE.
OVERVIEW
The Company is a leading provider of comprehensive electronic commerce
outsourcing solutions. The Company was incorporated in February 1994 and
commenced offering products for sale through its clients' Web stores in August
1996. From inception through August 1996, the Company had no sales, and its
activities related primarily to the development of its Commerce Network Server
("CNS") technology related to electronic commerce. In 1996, the Company began to
focus its business development efforts on the software industry, building its
inventory of
23.
software products through contracts with software publishers. In 1997, the
Company began to develop software distribution relationships through contracts
with online retailers. In the second quarter of 1999 the Company added
approximately 3,000 software publisher clients through its acquisition of three
electronic commerce outsourcing providers to the shareware publishing industry,
Maagnum Internet Group, Public Software Library and Universal Commerce,
Incorporated. As of December 31, 1999, the Company had approximately 4,800
software publisher clients and 1,300 online retailer clients that it serves
under its Software and Digital Services Group. In late 1998, the Company began
to offer it's comprehensive electronic commerce outsourcing services in the form
of a transaction fee-based e-commerce service to clients outside of the software
industry. As of December 31, 1999, the Company had contracts with 22 clients
that it serves under its E-Business Services Group.
The Company derives its revenue primarily from sales of third-party
software. The Company has contractual relationships with its software publisher
and online retailer clients which obligate the Company to pay to the client a
specified percentage of each sale. Revenues from the sale of software products,
net of estimated returns, are recognized upon either delivery through electronic
software delivery ("ESD") or shipment of the physical product to the end-user.
The amount payable to the software publisher or online retailer is reported as
cost of sales. The Company bears full credit risk with respect to substantially
all sales. In late 1998, the Company began formally offering e-commerce service
for products other than third-party software, under its E-Business Services
Group. The Company derives its revenue from development fees, transaction
processing and hosting fees as well as service fees. Most E-Business revenue is
recognized as services are performed, with the exception of annual fees and
certain integration fees which are recognized evenly over the term of the
contract. The Company generated less than 3% of its 1999 revenue from E-Business
Services. There can be no assurance that the Company will derive any significant
revenue from this service.
The Company has a limited operating history upon which investors may
evaluate its business and prospects. Since inception, the Company has incurred
significant losses, and as of December 31, 1999, had an accumulated deficit of
approximately $45.8 million. The Company intends to expend significant financial
and management resources on the development of additional services, sales and
marketing, technology and operations to support larger-scale operations and
greater service offerings. As a result, the Company expects to incur additional
losses and continued negative cash flow from operations for the foreseeable
future, and such losses are anticipated to increase significantly from current
levels. There can be no assurance that the Company's sales will increase or even
continue at their current level or that the Company will achieve or maintain
profitability or generate cash from operations in future periods. The Company's
prospects must be considered in light of the risks, expenses and difficulties
frequently encountered by companies in their early stage of development,
particularly companies in new and rapidly evolving markets such as electronic
commerce. To address these risks, the Company must, among other things, maintain
existing and develop new relationships with software publishers, online
retailers and E-Business clients, implement and successfully execute its
business and marketing strategy, continue to develop and upgrade its technology
and transaction-processing systems, provide superior customer service and order
fulfillment, respond to competitive developments, and attract, retain and
motivate qualified personnel. There can be no assurance that the Company will be
successful in addressing such risks, and the failure to do so would have a
material adverse effect on the Company's business, financial condition and
results of operations. The Company's current and future expense levels are based
largely on its planned operations and estimates of future sales. Sales and
operating results generally depend on the volume and timing of orders received,
which are difficult to forecast. The Company may be unable to adjust spending in
a timely manner to compensate for any unexpected revenue shortfall. Accordingly,
any significant shortfall in sales would have an immediate adverse effect on the
Company's business, financial condition and results of operations. In view of
the rapidly evolving nature of the Company's business and its limited operating
history, the Company is unable to accurately forecast its sales and believes
that period-to-period comparisons of its operating results are not necessarily
meaningful and should not be relied upon as an indication of future performance.
24.
RESULTS OF OPERATIONS
The following table sets forth certain items from the Company's
consolidated condensed statements of operations as a percentage of total
revenues for the years indicated.
------------------------------------------
1999 1998 1997
-------------- -------------- ----------
Sales 100.0% 100.0% 100.0%
Cost of sales 81.3 83.6 83.0
-------------- -------------- ----------
Gross profit 18.7 16.4 17.0
-------------- -------------- ----------
Operating expenses:
Sales and marketing 23.5 45.5 60.7
Product development and operations 21.5 26.0 61.8
General and administrative 5.6 15.2 37.6
Amortization of goodwill and other acquisition
related costs 9.1 - -
-------------- -------------- ----------
Total operating expenses 59.7 86.7 160.1
-------------- -------------- ----------
Loss from operations (41.0) (70.3) (143.1)
-------------- -------------- ----------
Interest income, net 4.2 4.3 2.1
-------------- -------------- ----------
Net loss (36.8)% (66.0)% (141.0)%
============== ============== ==========
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
SALES. The Company derives its revenue primarily from sales of
third-party software. The Company recognizes revenue from the sale of
software products upon delivery through ESD or shipment of the physical
product to the end-user. The majority of sales are comprised of the gross
selling price of the software sold by the Company, net of estimated returns,
plus any outbound shipping and handling charges, as well as gross revenue
generated by certain merchandising activities. For these type of sales, the
Company bears credit and delivery risk with respect to the sale. For sales
where the Company does not bear the risk of credit, the Company records a net
service fee. Additionally, the Company realizes development fees, transaction
processing and hosting fees, and service fees from its E-Business Services
clients. The E-Business Services revenue represented less than 3% of the
total Company revenue in 1999. The Company's sales increased to $75.1 million
in 1999 from $20.9 million in 1998 and $2.5 million in 1997. The sales
increases in 1999 and 1998 were a result of significant growth in the number
of the Company's clients, the increasing market acceptance of ESD and
merchandising activities implemented which increased the average sales
generated by the Company's software publisher clients. The 1999 sales growth
was also a function of the acquisitions of the three shareware outsourcing
companies during 1999. International sales represented approximately 22%, 24%
and 31% of sales in the years ended December 31, 1999, 1998 and 1997,
respectively.
GROSS PROFIT. Cost of sales consists primarily of the amount payable to the
software publishers and online retailers for product sold to the end-user and
outbound and inbound shipping and distribution costs for physical product. Cost
of sales for services provided to E-Business clients consists of the labor and
direct costs of providing e-commerce services to the client. Cost of sales
increased to $61.0 million from $17.5 million and $2.1 million in 1999, 1998 and
1997, respectively, reflecting the Company's growth in sales. During 1999, 1998
and 1997, the Company's gross profit margins were 18.7%, 16.4% and 17.0%,
respectively. The gross profit margin increased in 1999 as compared to 1998
primarily due to the increased number of processed fee-based transactions as
well as cost efficiencies implemented in the physical distribution process and
the termination of certain low-margin client contracts. The gross profit margin
declined in 1998 as compared to 1997 primarily as a result of the addition of
certain lower margin software publishers in the second half of 1997 and the
higher cost impact of a greater proportion of sales in 1998 involving physical
shipments. In each of the years ended December 31, 1999, 1998 and 1997, less
than 3% of the Company's revenue was generated from the high-margin E-Business
services. The
25.
Company expects that an increasing percentage of its revenue will be generated
from E-Business services. The Company also believes that Internet commerce and
related services will become more competitive in the near future. Accordingly,
the Company may reduce or alter its pricing structure and policies in the future
and any change could reduce gross margins.
SALES AND MARKETING. Sales and marketing expense consists primarily of
personnel and related expenses, advertising and promotional expenses, credit
card chargebacks and bad debt expense, and credit card transaction fees. Sales
and marketing expense increased to $17.6 million from $9.5 million and $1.5
million in 1999, 1998 and 1997, respectively, resulting from additional sales
and marketing personnel and related expenses, increased advertising and
promotional expense, increased bad debt expense and increased credit card
transaction fees due to the increased sales. The primary components of the
increase in 1999 from 1998 were an increase in wages, benefits and consulting
fees of $4.3 million and an increase in credit card chargebacks, bad debt
expense and credit card transaction fees of $3.0 million. As a percentage of
sales, sales and marketing expense decreased to 23.5% in 1999 from 45.5% in
1998, primarily reflecting the Company's increased sales volume. The primary
components of the increase in 1998 from 1997 were an increase in advertising and
marketing expenditures of $3.2 million and an increase in wages and benefits of
$1.5 million. As a percentage of sales, sales and marketing expense decreased to
45.5% in 1998 from 60.7% in 1997, primarily reflecting the Company's increased
sales volume. The Company expects that sales and marketing expense will continue
to increase in absolute dollars as the Company continues to build its sales and
marketing infrastructure and to develop marketing programs.
PRODUCT DEVELOPMENT AND OPERATIONS. Product development and operations
expense consists primarily of personnel and related expenses and consulting
associated with developing, enhancing and maintaining the Company's CNS and
related facilities, internal systems and telecommunications infrastructure as
well as customer service and phone order functions. Product development and
operations expense increased to $16.1 million from $5.4 million and $1.5 million
in 1999, 1998 and 1997, respectively. The increase was primarily related to
increased personnel and consulting costs related to developing, enhancing and
maintaining the Company's CNS, customer service and related facilities on a 24
hour a day, seven day per week basis. The primary components of the increase in
1999 from 1998 were an increase in wages, benefits and temporary employee costs
of $3.7 million and an increase in consulting costs of $4.4 million. As a
percentage of sales, product development and operations expense decreased to
21.5% in 1999 from 26.0% in 1998, primarily reflecting the Company's increased
sales volume. The primary components of the increase in 1998 from 1997 were an
increase in consulting costs of $1.4 million and an increase in wages and
benefits of $1.2 million. As a percentage of sales, sales and marketing expense
decreased to 26.0% in 1998 from 61.8% in 1997, primarily reflecting the
Company's increased sales volume. The Company believes that continued investment
in product development and operations is critical to attaining its strategic
objectives and, and as a result, expects product development and operations
expenses will continue to increase in absolute dollars.
GENERAL AND ADMINISTRATIVE. General and administrative expense consists
principally of executive, accounting and administrative personnel and related
expenses, including deferred compensation expense, professional fees, and
investor relations expenses. General and administrative expense increased to
$4.2 million from $3.2 million and $929,000 in 1999, 1998 and 1997,
respectively, primarily due to increased personnel related expense and
professional fees and investor relations cost associated with being a public
company. The primary components of the increase in 1999 from 1998 were an
increase in wages and benefits of $204,000 and an increase in professional fees
of $535,000. As a percentage of sales, general and administrative expense
decreased to 5.6% in 1999 from 15.2% in 1998, primarily reflecting the Company's
increased sales volume. The primary components of the increase in 1998 from 1997
were an increase in deferred compensation expense of $1.2 million and an
increase in wages and benefits of $346,000. As a percentage of sales, general
and administrative expense decreased to 15.2% in 1998 from 37.6% in 1997,
primarily reflecting the Company's increased sales volume. The Company expects
general and administrative expense to increase in absolute dollars in the
future, particularly as the Company continues to build infrastructure to support
growth and incurs costs associated with being a public company. As a percentage
of sales, these expenses are expected to decrease as sales increase.
INTEREST INCOME. Interest income consists of earnings on the Company's
cash, cash equivalents and short-term investments. Interest income increased to
$3.1 million from $895,000 and $53,000 in 1999, 1998 and 1997, respectively,
resulting from changes in average cash and cash equivalent balances. The Company
expects interest income to decrease in the future as cash is used to fund
operations and is used for investments in infrastructure.
INCOME TAXES. The Company paid no income taxes in 1999, 1998 and 1997. The
Company has incurred a net loss for each period since inception. As of December
31, 1999, the Company had approximately $56.3 million of net operating loss
carryforwards for federal income tax purposes, which expire beginning in 2009.
Due to the uncertainty of future profitability, a valuation allowance equal to
the deferred tax asset has been recorded. Certain changes in ownership that
resulted from the sales of Common and Preferred Stock will limit the future
annual realization of the tax net operating loss carryforwards to a specified
percentage under Section 382 of the Internal Revenue Code.
26.
LIQUIDITY AND CAPITAL RESOURCES
In August 1998, the Company completed its initial public offering in which
the Company sold 3,000,000 shares of Common Stock. Net proceeds to the Company
were $22.7 million after expenses. In December 1998, the Company completed a
follow-on public offering in which the Company sold 2,200,000 shares of Common
Stock. Net proceeds to the Company were $48.1 million after expenses. Prior to
the Company's initial public offering and follow-on offering, the Company
financed its operations primarily through the private placement of equity
securities, which yielded an aggregate of $19.3 million of net proceeds.
Net cash used in operating activities in 1999, 1998 and 1997 was $13.6
million, $9.0 million and $2.6 million, respectively. Net cash used for
operating activities in each of these periods was primarily the result of net
losses, offset in part by goodwill amortization and earn-out charges, increases
in accounts payable and increases in depreciation and amortization.
Net cash used in investing activities in 1999, 1998 and 1997 was $37.5
million, $14.5 million and $984,000, respectively. Net cash used in investing
activities in each of these periods was primarily the result of the purchases of
property and equipment and the purchase of investments in 1999 and 1998.
Additionally, $4.1 million of cash was used for cash paid for acquisition, net
of cash received. The property and equipment purchased consisted primarily of
computer hardware and software.
Net cash provided by financing activities in 1999, 1998 and 1997 was $2.7
million, $84.9 million and $4.9 million, respectively. The cash provided by
financing activities was the result of proceeds from the sales of the Company's
Common Stock in 1998 and 1997, the sale of the Company's Series A Preferred
Stock in April 1998 and the exercise of options and warrants in 1999 and 1998.
As of December 31, 1999 the Company had approximately $15.1 million of cash
and cash equivalents, $24.4 million of short-term investments and $14.8 million
of long-term investments. The Company's principal commitments consisted of
obligations outstanding under operating leases. Although the Company has no
material commitments for capital expenditures, it anticipates an increase in the
rate of capital expenditures consistent with its anticipated growth in
operations, infrastructure and personnel. The Company anticipates that it will
expend approximately $22.0 million over the next 24 months on capital
expenditures based on the Company's current anticipated growth rate. The Company
further anticipates that it will expend approximately $30.0 million over the
next 24 months on product development based on the Company's current anticipated
growth rate in operations. The Company may also use cash to acquire or license
technology, products or businesses related to the Company's current business.
The Company also anticipates that it will continue to experience significant
growth in its operating expenses for the foreseeable future and that its
operating expenses will be a material use of the Company's cash resources.
The Company believes that existing sources of liquidity will provide
adequate cash to fund its operations for at least the next 18 months, although
the Company may seek to raise additional capital during that period. The sale of
additional equity or convertible debt securities could result in additional
dilution to the Company's stockholders. There can be no assurances that
financing will be available in amounts or on terms acceptable to the Company, if
at all.
YEAR 2000 COMPLIANCE
Prior to January 1, 2000, there was a great deal of concern regarding the
ability for computers to accurately recognize and process dates due to the
century change. Most reports to date indicate that computer systems are
functioning normally and compliance and remediation work leading up to Year 2000
was effective in preventing problems. The Company has not experienced any
material Year 2000 difficulties or disruptions and does not expect to over the
course of time. However, the Company will continue to monitor the potential for
disruptions throughout the year and has in place techniques that can be used in
case of a failure to allow the Company to continue to process commerce activity.
Should a significant disruption occur due to a future Year 2000 problem, it will
likely have a material adverse effect on the Company.
The Company's cost to analyze the Year 2000 issue was under $25,000 and the
ongoing costs are expected to be minor. Additionally, the Company did not defer
any development or information technology spending because of Year 2000, other
than for a period of three weeks around the year change.
ITEM 7a. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK.
The Company does not enter into financial instruments for trading or
speculative purposes and does not currently utilize derivative financial
instruments. The operations of the Company are conducted primarily in the
27.
United States and as such are not subject to material foreign currency exchange
rate risk. The Company has no long-term debt.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Company's Financial Statements and Notes thereto appear beginning
at page F-1 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
ANDFINANCIAL DISCLOSURE.
None.
PART III
Certain information required in Part III of this Report is
incorporated by reference to the Company's Proxy Statement in connection with
the Company's 2000 Annual Meeting to be filed in accordance with Regulation 14A
under the Securities Exchange Act of 1934, as amended.
ITEM 10. Directors and Executive Officers of the Registrant.
(a) Identification of Directors:
The information concerning the Company's directors and nominees is
incorporated by reference to the Company's Proxy Statement in connection with
the Company's 2000 Annual Meeting to be in accordance with Regulation 14A under
the Securities Exchange Act of 1934, as amended.
(b) Identification of Executive Officers:
Please refer to the section entitled "Executive Officers" in part I,
Item 1 hereof.
(c) Compliance with Section 16(a) of the Exchange Act:
Based solely upon a review of Forms 3 and 4 and amendments
thereto furnished to the Company pursuant to Rule 16a-3(e) during the
1999 fiscal year and Form 5 and amendments thereto furnished to the
Company with respect to fiscal year 1999, no director, officer, or
beneficial owner of more than 10 percent of any class of equity
security of the Company has failed to file on a timely basis, as
disclosed by the above forms, reports required by Section 16(a) of the
Securities Exchange Act of 1934, as amended during the 1999 fiscal
year.
ITEM 11. EXECUTIVE COMPENSATION.
The information required in Item 11 of Part III of this report is
incorporated by reference to the Company's Proxy Statement in connection with
the Registrant's 2000 Annual Meeting to be filed in accordance with
Regulation14A under the Securities Exchange Act of 1934, as amended.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required in Item 12 of Part III of this report is
incorporated by reference to the Company's Proxy Statement in connection with
the Registrant's 2000 Annual Meeting to be filed in accordance with
Regulation14A under the Securities Exchange Act of 1934, as amended.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required in Item 13 of Part III of this Report is
incorporated by reference to the Company's Proxy Statement in connection with
the Registrant's 2000 Annual Meeting to be filed in accordance with
Regulation 14A under the Securities Exchange Act of 1934, as amended.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this report:
28.
(1) Index to Consolidated Financial Statements and Report of
Independent Public Accountants.
The consolidated financial statements required by this item are submitted
in a separate section beginning on page F-1 of this report.
PAGE
Report of Independent Public Accountants F-1
Consolidated Balance Sheets F-2
Consolidated Statements of Operations F-3
Consolidated Statements of Stockholders' Equity (Deficit) F-4
Consolidated Statements of Cash Flows F-5
Notes to Consolidated Financial Statements F-6
(2) Financial Statement Schedules.
Schedules not listed above have been omitted because the
information required to be set forth therein is not applicable or is
included in the financial statements or notes thereto.
(3) Exhibits
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT
3.1(1) Amended and Restated Certificate of Incorporation of the Registrant, as currently in effect.
3.2(1) Bylaws of the Registrant, as currently in effect.
4.1(1) Specimen Stock Certificate.
10.1(1) Form of Indemnity Agreement between Registrant and each of its directors and executive officers.
10.2(1) 1998 Stock Option Plan.
10.3(1) Distributor Agreement dated April 23, 1997 by and between Corel Corporation and the Registrant.
10.4(1) Employment and Non-Competition Agreement effective May 25, 1998 by and between Joel A. Ronning and the Registrant.
10.5(1) Fujitsu Modification Agreement dated December 11, 1997 by and between Joel A. Ronning, the Registrant, Fujitsu
Limited and MacUSA, Inc.
10.6(1) Heads of Agreement for International Agreement dated February 25, 1998 by and between Christopher J. Sharples,
David A. Taylor and the Registrant.
10.7(1) Stock Subscription Warrant for Shares of Common Stock dated February 26, 1998 by and between Christopher Sharples
and Registrant.
10.8(1) Termination of Lease Letter dated April 30, 1998 by and between Tech Squared, Inc. and Registrant.
10.9(1) Services Agreement dated July 30, 1998 by and between Tech Squared, Inc. and Registrant.
10.10(1) Stock Option Agreement dated December 28, 1995 by and between Joel A. Ronning and MacUSA, Inc.
10.11(1) Form of Registration Rights Agreement by and between Wasserstein Adelson Ventures, L.P., certain other investors
and Registrant.
29.
10.12(1) Form of Conditional Warrant to Purchase Common Stock dated April 22, 1998 by and between Wasserstein Adelson
Ventures, L.P. and Registrant.
10.13(1) Form of Warrant to Purchase Common Stock by and between certain investors and Registrant.
10.14 (1) Form of Registration Rights Agreement by and between certain investors and Registrant.
10.15(1) Consent to Assignment and Assumption of Lease dated April 22, 1998 by and between CSM Investors, Inc., IntraNet
Integration Group, Inc. and Registrant.
10.16(1) Employment Agreement effective July 30, 1998 by and between Perry W. Steiner and the Registrant.
10.17 Assignment of Lease dated April 21, 1998 by and between Intranet Integration Group, Inc. and Registrant.
10.18 Lease Agreement dated January 18, 2000 between Property Reserve, Inc. and Registrant.
21.1(1) Subsidiaries of Digital River, Inc.
23.1 Consent of Independent Public Accountants.
24.1 Power of Attorney. Reference is made to the signature page.
27.1 Financial Data Schedule
- ----------------------------
+ Confidential treatment has previously been granted for portions of this
exhibit.
(1) Incorporated by reference to the indicated exhibit in the Company's
Registration Statement on Form S-1 (File No. 333-56787), declared
effective on August 11, 1998.
(b) The Registrant filed no reports on Form 8-K in the fourth quarter
of 1999.
(c) See Exhibits listed under Item 14(a)(3).
(d) The financial statement schedules required by this item are listed
under 14(a)(2).
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report on Form 10-K to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Eden Prairie, State of Minnesota, on the 30th day of March 2000.
DIGITAL RIVER, INC.
By: /s/ JOEL A. RONNING
Joel A. Ronning
CHIEF EXECUTIVE OFFICER AND DIRECTOR
POWER OF ATTORNEY
KNOW ALL THESE PERSONS BY THESE PRESENTS, that each person whose
signature appears below constitutes and appoints Joel A. Ronning and Robert E.
Strawman and each of them, jointly and severally, his attorneys-in-fact, each
with full power of substitution, for him in any and all capacities, to sign any
and all amendments to this Form 10-K, and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that each said
attorneys-in-fact or his substitute or substitutes, may do or cause to be done
by virtue hereof.
30.
Pursuant to the requirements of the Securities Exchange Act of 1934,this
Form 10-K has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
SIGNATURE TITLE DATE
/s/ JOEL A. RONNING Chief Executive Officer and Director March 30, 2000
(Principal Executive Officer)
- --------------------------------
Joel A. Ronning
/s/ ROBERT E. STRAWMAN Chief Financial Officer and Treasurer March 30, 2000
(Principal Financial and Accounting
- -------------------------------- Officer)
Robert E. Strawman
/s/ PERRY W. STEINER President and Director March 30, 2000
- --------------------------------
Perry W. Steiner
/s/ WILLIAM LANSING Director March 30, 2000
- --------------------------------
William Lansing
/s/ THOMAS F. MADISON Director March 30, 2000
- --------------------------------
Thomas F. Madison
/s/ J. PAUL THORIN Director March 30, 2000
- --------------------------------
J. Paul Thorin
/s/ CHRISTOPHER J. SHARPLES Director March 30, 2000
- --------------------------------
Christopher J. Sharples
/s/ TIMOTHY C. CHOATE Director March 30, 2000
- --------------------------------
Timothy C. Choate
31.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Digital River, Inc.:
We have audited the accompanying consolidated balance sheets of Digital
River, Inc. and Subsidiary as of December 31, 1999 and 1998, and the related
consolidated statements of operations, stockholders' equity and cash flows
for each of the three years in the period ended December 31, 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Digital River, Inc. and
Subsidiary as of December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1999, in conformity with accounting principles generally
accepted in the United States.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota,
January 26, 2000
F-1
DIGITAL RIVER, INC.
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31
(IN THOUSANDS, EXCEPT SHARE DATA)
1999 1998
-------- --------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $15,120 $63,503
Short-term investments 24,387 10,894
Accounts receivable, net allowance of $593 and $129 2,455 1,487
Prepaid expenses and other 880 420
------- -------
Total current assets 42,842 76,304
------- -------
PROPERTY AND EQUIPMENT:
Property and equipment 8,993 4,539
Less- Accumulated depreciation (1,714) (625)
------- ------
Net property and equipment 7,279 3,914
LONG-TERM INVESTMENTS 14,832 -
GOODWILL, net of accumulated 22,050 -
amortization of $5,560
OTHER ASSETS 139 110
------- -------
Total assets $87,142 $80,328
------- -------
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $11,020 $3,880
Accrued payroll 1,909 807
Other accrued liabilities 1,136 1,054
------- -------
Total current liabilities 14,065 5,741
------- -------
COMMITMENTS AND CONTINGENCIES (Note 4)
STOCKHOLDERS' EQUITY:
Preferred Stock, $.01 par value, 5,000,000 shares
authorized; no shares issued or outstanding - -
Common stock, $.01 par value, 45,000,000 shares
authorized; 20,699,244 and 19,544,791 shares issued and
outstanding 207 195
Additional paid-in capital 119,445 93,883
Deferred compensation (637) (1,368)
Accumulated other comprehensive income (loss) (162) -
Accumulated deficit (45,776) (18,123)
------- -------
Total stockholders' equity 73,077 74,587
------- -------
Total liabilities and stockholders' equity $87,142 $80,328
------- -------
------- -------
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
DIGITAL RIVER, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1999 1998 1997
--------- -------- --------
SALES $ 75,050 $ 20,911 $ 2,472
COST OF SALES 61,012 17,487 2,052
-------- ------- -------
Gross profit 14,038 3,424 420
OPERATING EXPENSES:
Sales and marketing 17,636 9,514 1,501
Product development and operations 16,145 5,432 1,528
General and administrative 4,172 3,171 929
Amortization of goodwill and acquisition 6,886 - -
related costs (note 2)
-------- ------- -------
Total operating expenses 44,839 18,117 3,958
-------- ------- -------
LOSS FROM OPERATIONS (30,801) (14,693) (3,538)
INTEREST INCOME 3,148 895 53
-------- ------- -------
Net loss $(27,653) $(13,798) $(3,485)
-------- ------- -------
-------- ------- -------
BASIC AND DILUTED NET LOSS PER SHARE $ (1.36) $ (1.01) $ (0.46)
-------- ------- -------
-------- ------- -------
BASIC AND DILUTED WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING 20,312 13,691 7,514
-------- ------- -------
-------- ------- -------
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
DIGITAL RIVER, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
Accumulated
Common Stock Additional Deferred Other
--------------- Paid-In Compen- Comprehensive
Shares Amount Capital sation Income
------ ------ ------- ------ -------------
BALANCE, December 31, 1996 5,333 $ 53 $ 729 $ - $ -
Convertible debentures exchanged for
common stock 1,018 10 987 - -
Sales of common stock 2,831 28 4,746 - -
Common stock issued in Fujitsu
agreement 60 1 100 - -
Net loss - - - - -
------- ----- ------- ------ -
BALANCE, December 31, 1997 9,242 92 6,562 - -
-
Sales of common stock 8,679 87 80,581 - -
Sales of preferred stock
subsequently converted to
common stock 1,000 10 2,815 - -
Exercise of options and warrants 624 6 1,346 - -
Deferred compensation related to
stock options and warrants - - 2,579 (2,579) -
Deferred compensation expense - - - 1,211 -
Net loss - - - - -
------- ----- ------- ------ -
BALANCE, December 31, 1998 19,545 195 93,883 (1,368) -
Common stock issued for
acquisitions and earn-out
arrangements 777 8 22,801 - -
Net common stock exchanged
in Tech Squared transition
(Note 2) (350) (3) 235 - -
Exercise of options and warrants 727 7 2,416 - -
Stock options granted for services - - 110 - -
Deferred compensation expense - - - 731 -
Unrealized loss on investments - - - - (162)
Net loss - - - - -
------- ----- -------- ------ -----------
BALANCE, December 31, 1999 20,699 $207 $119,445 $ (637) $ (162)
======= ===== ======== ====== ===========
Total
Stockholder's Comprehensive
Accumulated Equity Income
Deficit (Deficit) (Loss)
------- ----------- -------------
BALANCE, December 31, 1996 $ (840) $ (58) $ -
Convertible debentures exchanged for
common stock - 997 -
Sales of common stock - 4,774 -
Common stock issued in Fujitsu
agreement - 101 -
Net loss (3,485) (3,485) (3,485)
------- ------- -------
BALANCE, December 31, 1997 (4,325) 2,329 $(3,485)
=======
Sales of common stock - 80,668 -
Sales of preferred stock
subsequently converted to
common stock - 2,825 -
Exercise of options and warrants - 1,352 -
Deferred compensation related to
stock options and warrants - - -
Deferred compensation expense - 1,211 -
Net loss (13,798) (13,798) (13,798)
-------- ------- --------
BALANCE, December 31, 1998 (18,123) 74,587 $(13,798)
========
Common stock issued for
acquisitions and earn-out
arrangements - 22,809 -
Net common stock exchanged
in Tech Squared transition
(Note 2) - 232 -
Exercise of options and warrants - 2,423 -
Stock options granted for services - 110 -
Deferred compensation expense - 731 -
Unrealized loss on investments - (162) (162)
Net loss (27,653) (27,653) (27,653)
-------- -------- --------
BALANCE, December 31, 1999 $(45,776) $ 73,077 $(27,615)
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
DIGITAL RIVER, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31
(IN THOUSANDS)
1999 1998 1997
----------- ------------ -----------
OPERATING ACTIVITIES:
Net loss $ (27,653) $ (13,798) $ (3,485)
Adjustments to reconcile net loss to net cash used in operating
activities:
Goodwill amortization and earn-out charges 6,606 - -
Depreciation and amortization 1,552 604 195
Deferred compensation expense 731 1,211 -
Common stock and options issued for services 110 - 101
Change in operating assets and liabilities:
Accounts receivable and prepaid expenses (1,226) (1,713) (184)
Accounts payable 5,122 3,160 607
Accrued payroll and other accrued liabilities 1,184 1,505 206
---------- ---------- ---------
Net cash used in operating activities (13,574) (9,031) (2,560)
---------- ---------- ---------
INVESTING ACTIVITIES:
Purchases of short-term investments (106,467) (15,894) -
Proceeds from sales of investments 78,000 5,000 -
Cash paid for acquisitions, net of cash received (4,077) - -
Purchases of equipment (4,783) (3,531) (920)
Patent acquisition costs (117) (62) (64)
---------- ---------- ---------
Net cash used in investing activities (37,464) (14,487) (984)
---------- ---------- ---------
FINANCING ACTIVITIES:
Sales of preferred and common stock - 83,543 4,774
Exercise of options and warrants 2,423 1,352 -
Other 232 - 96
---------- ---------- ---------
Net cash provided by financing activities 2,655 84,895 4,870
---------- ---------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (48,383) 61,377 1,326
CASH AND CASH EQUIVALENTS, beginning of year 63,503 2,126 800
---------- ---------- ----------
CASH AND CASH EQUIVALENTS, end of year $ 15,120 $ 63,503 $ 2,126
---------- ---------- ----------
---------- ---------- ----------
NONCASH INVESTING AND FINANCING ACTIVITIES:
Convertible debentures exchanged for common stock, net of direct
costs $ - $ - $ 998
---------- ---------- ----------
---------- ---------- ----------
Preferred stock converted to common stock $ - $ 2,825 $ -
---------- ---------- ----------
---------- ---------- ----------
Common stock issued in acquisitions $ 21,713 $ - $ -
---------- ---------- ----------
---------- ---------- ----------
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
DIGITAL RIVER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 and 1998
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Digital River, Inc., a Delaware corporation, and its wholly owned
subsidiaries (collectively, the Company) provide a suite of electronic
commerce services to its clients, including web store development and
hosting, transaction processing, electronic software delivery, fraud
screening, customer service and analytical marketing. Through contractual
relationships with software publishers and online retailers, the Company
offers software products for sale via the Internet. Beginning in late 1998,
the Company also began to offer electronic commerce services to companies
outside of the software vertical market.
The Company was incorporated in 1994 and conducted its first online sale
through a client's Web store in August 1996. The Company has experienced
significant losses of $45.8 million since inception and has experienced
significant negative cash flows from operations. The Company anticipates it
will continue to have net losses and negative cash flows from operations for
the foreseeable future and that such losses are anticipated to increase
significantly from current levels.
The Company's prospects must be considered in light of the risks frequently
encountered by companies in their early stage of development, particularly
companies in new and rapidly evolving markets such as electronic commerce. To
address these risks, the Company must, among others things, maintain existing
and develop new relationships with independent software publishers, online
retailers and other companies outside of the software market, maintain and
increase its client base, implement and successfully execute its business and
marketing strategy, continue to develop and upgrade its technology and
transaction-processing systems, provide superior customer service and order
fulfillment, respond to competitive developments, and attract, retain and
motivate qualified personnel. There can be no assurances that the Company
will be successful in addressing such risks, and the failure to do so could
have a material adverse effect on the Company's business, financial condition
and results of operations.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Digital River,
Inc. and its wholly owned subsidiaries. All intercompany balances and
transactions have been eliminated in consolidation.
CASH AND CASH EQUIVALENTS
The Company considers all short-term, highly liquid investments, primarily
high grade commercial paper and money market accounts, that are readily
convertible into known amounts of cash and that have original maturities of
three months or less, to be cash equivalents.
INVESTMENTS
F-6
Investments held by the Company are classified as available for sale
securities and are carried at their market value with cumulative unrealized
gains or losses recorded as a component of accumulated other comprehensive
income (loss) within stockholders' equity.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost and is being depreciated under the
straight-line method using lives of three to seven years. Impairment losses
are recorded on long-lived assets in operations when indicators of impairment
are present and the undiscounted cash flows estimated to be generated by
those assets are less than the assets' carrying amount. Impairment losses are
measured by comparing the fair value of assets, as determined by discounting
the future cash flows at a market rate of interest, to their carrying amount.
GOODWILL
Goodwill has been recorded as a result of certain acquisitions made by the
Company and is being amortized under the straight-line method using a life of
three years.
PATENTS
The costs of developing patents are amortized over a three-year period
utilizing the straight-line method of amortization once the patent
application is filed. Patents are included in other assets on the
accompanying consolidated balance sheets, net of accumulated amortization of
$262,000 and $174,000 as of December 31, 1999 and 1998, respectively.
REVENUE RECOGNITION
The Company derives its revenue primarily from sales of third-party software.
The Company has contractual relationships with its software publisher and
online retailer clients which obligate the Company to pay to the client a
specified percentage of each sale. For the majority of sales, the Company
takes title to the merchandise, is at risk of loss for collecting all sales
proceeds, is responsible for delivery of the merchandise and takes returns
from customers. The Company records the full sales amount as revenue upon
verification of credit card authorization and either electronic delivery or
physical shipment of the merchandise. The amount payable to the software
publisher or online retailer is reported as cost of sales. The Company bears
full credit risk with respect to these sales. In certain cases, the Company
does not take title to merchandise or bear credit risk on a sale, in which
case the Company records a net service fee amount as revenue. Sales to
foreign customers accounted for 22%, 24% and 31% of sales for the years ended
December 31, 1999, 1998 and 1997, respectively. One client accounted for 18%
of sales for the year ended December 31, 1997. No clients accounted for more
than 10% of sales in the years ended December 31, 1999 and 1998.
ADVERTISING COSTS
F-7
The costs of advertising are charged to sales and marketing expense as
incurred. For the years ended December 31, 1999, 1998 and 1997, the Company
incurred advertising expense of $2,442,000, $2,569,000 and $292,000,
respectively.
PRODUCT DEVELOPMENT
Costs associated with the development of new products and services are
charged to operations as incurred. Those costs totaled $7,464,000, $3,392,000
and $1,393,000, for the three years ended December 31, 1999, 1998 and 1997,
respectively.
NET LOSS PER SHARE
Basic loss per common share is computed by dividing net loss by the weighted
average number of shares of common stock outstanding during the year. The
computation of diluted earnings per common share is similar to the
computation of basic loss per common share, except that the denominator is
increased for the assumed conversion of convertible securities and the
exercise of dilutive options using the treasury stock method. The weighted
average shares used in computing basic and diluted loss per share were the
same for the three years ended December 31, 1999, 1998 and 1997. Options,
warrants and the Series A Preferred Stock totaling 3,898,313, 2,883,059 and
1,056,642 for the three years ended December 31, 1999, 1998 and 1997,
respectively, were excluded from the computation of earnings per share as
their effect is antidilutive.
USE OF ESTIMATES
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and 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.
Ultimate results could differ from those estimates.
SEGMENTS
The Company adopted the provisions of Statement of Financial Accounting
Standards (SFAS) No. 131, "Disclosures about Segments of an Enterprise and
Related Information," in 1998. The Company has determined that it does not
have any separately reportable business segments as of December 31, 1999.
RECENT ACCOUNTING PRONOUNCEMENTS
The Company will be required to adopt SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," in fiscal year 2001. The
Company does not currently engage in any derivative or hedging activities and
therefore expects there will be no impact to the financial statements upon
adoption of this standard.
2. ACQUISITIONS AND PURCHASES OF ASSETS:
F-8
In 1999, the Company acquired or purchased the assets of Maagnum Internet
Group ("Maagnum"), Public Software Library Ltd., Universal Commerce,
Incorporated ("RegNow"), and Walnut Creek CDROM, Inc. for an aggregate $4.5
million in cash and 724,261 shares of common stock. In addition the former
shareholders of Maagnum and RegNow have earn-out arrangements which allow
them to receive up to approximately 900,000 additional shares of common stock
and $2 million in cash upon attaining certain business goals for a period of
12 to 24 months following the close of each respective acquisition.
Former Maagnum shareholders collectively received earn-out payments of 48,095
shares of common stock valued at $1,046,000 in 1999. The Company charged
such amount to compensation expense and this is included as amortization of
goodwill and acquisition related costs in the accompanying Consolidated
Statements of Operations. This amount would have increased general and
administrative expense had it been reported outside of that caption.
Each of the above transactions was accounted for using the purchase method.
The purchase price in each transaction was allocated substantially to
goodwill and other intangibles, which are being amortized over three years.
If any earn-out payments, as listed above, are earned, they will be
recognized as compensation expense in the period in which the required
milestones are achieved.
The following unaudited pro forma condensed results of operations for the
year ended December 31, 1999 and 1998 have been prepared as if each of the
above four transactions had occurred on January 1, 1998:
Year Ended December 31, 1999 1998
- -------------------------------------------------------------
Sales $ 79,092,000 $ 28,611,000
Loss from operations (34,366,000) (23,563,000)
Net loss (31,319,000) (22,943,000)
Basic and diluted loss
per share (1.50) (1.59)
This financial information does not purport to represent results that would
actually have been obtained if the transactions had been in effect on January 1,
1998 or any future results that may in fact be realized.
In December 1999, the Company completed its acquisition of certain assets of
Tech Squared Inc., whereby the Company purchased Tech Squared assets
consisting of 3.0 million shares of the Company's common stock and $1.2
million of cash in exchange for 2.65 million shares of the Company's common
stock. The impact of this transaction was to reduce common stock outstanding
by 350,000 shares and is presented on the accompanying Consolidated Statement
of Stockholders' Equity net of expenses incurred in conjunction with the
transaction.
3. INCOME TAXES:
F-9
Deferred tax assets and liabilities are determined based on the difference
between the financial statement and tax bases of assets and liabilities using
currently enacted tax rates. No income taxes were paid in any of the years
presented.
As of December 31, 1999, the Company had net operating loss carryforwards of
approximately $56,300,000. Included in this amount is approximately
$19,100,000 of deductions resulting from disqualifying dispositions of stock
options. When these deductions are realized for financial statement purposes
they will not result in a reduction in income tax expenses, rather the
benefit will be recorded as additional paid-in-capital. These income tax net
operating loss carryforwards expire beginning in the year 2009. Because of
the uncertainty of future realization, a valuation allowance equal to the
deferred tax asset has been recorded.
The components of deferred income taxes are as follows:
1999 1998
Net operating loss carryforwards $ 19,704,000 $ 6,739,000
Nondeductible reserves and accruals 252,000 71,000
Depreciation and amortization 459,000 (35,000)
Valuation allowance (20,415,000) (6,775,000)
-----------------------------------
$ - $ -
Ownership changes resulting from the issuance of additional equity will limit
future annual realization of the tax net operating loss carryforwards to a
specified percentage of the value of the Company under Section 382 of the
Internal Revenue Code.
LEASE COMMITMENTS
The Company leases its main facility. Total rent expense, including common
area maintenance charges, recognized under this lease was $378,000 and
$172,000 for the years ended December 31, 1999 and 1998, respectively.
Subsequent to year end, the Company entered into an additional lease
agreement for a second facility. The minimum annual rents under these leases
at December 31, 1999 are as follows:
Years ending December 31:
2000 $ 440,000
2001 440,000
2002 440,000
2003 257,000
----------
$1,577,000
F-10
5. STOCKHOLDERS' EQUITY:
COMMON STOCK SALES
In August 1998, the Company completed its initial public offering in which
the Company sold 3,000,000 shares of common stock at an offering price of
$8.50 per share. Net proceeds to the Company after underwriting and other
offering expenses was $22.7 million.
In December 1998, the Company completed a secondary offering in which the
Company sold 2,200,000 shares of common stock at $23.50 per share. Net
proceeds to the Company after underwriting and other offering expenses were
$48.1 million. The proceeds from the offerings have been or will be used for
general corporate purposes, including continued investment in product
development, expansion of sales and marketing activities and working capital.
PREFERRED STOCK
During April 1998, the Company sold 1,500,000 shares of its $.01 par value
Series A Preferred Stock in a private placement transaction. Net proceeds to
the Company totaled $2,825,000. The preferred stock was converted to common
stock on a 2-for-3 basis in conjunction with the closing of the Company's
initial public offering of common stock in August 1998.
CONVERTIBLE DEBENTURES
During 1996 the Company issued convertible debentures totaling $998,000.
These debentures were converted to common stock in February 1997 at a
conversion rate of $1.13 per share.
WARRANTS
Warrants to purchase 371,086 shares of common stock issued principally in
conjunction with sales of common stock at an exercise price of $3.00 per
share were outstanding as of December 31, 1999. The warrants expire at
various dates between February and August 2003.
6. STOCK OPTIONS:
The Company's 1998 Stock Option Plan (the SOP) was adopted by the Board of
Directors in June 1998 as an amendment and restatement of the Amended and
Restated 1995 Stock Option Plan. The SOP provides for the granting of stock
options to purchase up to 3,283,333 shares of common stock. Options granted
to employees under the plan expire no later than ten years after the date of
grant. The exercise price must be at least 100% of the fair market value of
the shares at the date of grant for incentive options. The SOP covers both
incentive and nonstatutory stock options. Incentive stock options
F-11
granted to employees who immediately before such grant owned stock directly
or indirectly representing more than 10% of the voting power of all the stock
of the Company, expire no later than five years from the grant date unless
the option exercise price is at least 110% of the fair market value of the
stock.
In 1999, the Company's Board of Directors adopted the 1999 Non-Officer Stock
Option Plan (the NOP). The NOP provides for the granting of stock options to
purchase up to 1,300,000 shares of common stock and has terms similar to
those of the SOP.
In addition to shares granted under the SOP and NOP, during 1998 the Company
has granted options to purchase 605,882 shares of common stock at an exercise
price of $8.50 per share to certain members of management outside of both
plans.
A summary of change in outstanding options under the SOP and NOP is as follows:
Options Outstanding Weighted Average $/Share
-----------------------------------------------
Balance,
December 31, 1996 338,665 $0.60
Grants 496,817 1.66
Cancelled (42,672) 1.69
-----------------------------------------------
Balance,
December 31, 1997 792,810 1.20
Grants 1,389,570 8.93
Exercised 220,350) 1.63
Cancelled (91,673) 5.10
-----------------------------------------------
Balance,
December 31, 1998 1,870,357 6.70
Grants 2,131,636 21.51
Exercised (601,172) 2.76
Cancelled (308,035) 24.83
-----------------------------------------------
Balance,
December 31, 1999 3,092,786 16.50
A summary of information about stock options outstanding at December 31, 1999
is as follows:
Options Outstanding Options Exercisable
- ----------------------------------------------------- ---------------------------
Weighted
Exercise Number Avg. Life Number Weighted
Price Outstanding Remaining Exercisable Avg. Price
- ----- ----------- --------- ----------- ----------
$0.38-1.69 225,309 7 years 68,770 $ 1.04
F-12
3.00 478,950 8 years 31,104 3.00
7.25-12.50 641,086 8.5 years 329,002 8.68
19.50-24.81 1,874,682 9.5 years 221,533 20.79
26.88-31.13 307,200 9 years - -
----------- --------- --------- ------- ------
$0.38- 31.13 3,527,227 9 years 650,409 $11.73
The Company recorded deferred compensation for the difference between the
grant price and the deemed fair value of the Company's common stock on
options to purchase 454,468 shares at exercise prices of $3.00 to $7.50
during May and June 1998. In addition, the Company recognized $110,000 in
expense during 1999 related to options granted for consulting services.
The Company has elected to apply the disclosure-only provisions of SFAS No.
123, "Accounting for Stock-Based Compensation." Accordingly, the Company
accounts for stock-based compensation using the intrinsic value method
prescribed in Accounting Principles Board Opinion (APB) No. 25, "Accounting
for Stock Issued to Employees," and related interpretations. Compensation
cost for stock options is measured as the excess, if any, of the fair value
of the Company's common stock at the date of grant over the stock option
exercise price. Had compensation costs for these plans been determined
consistent with SFAS No. 123, the Company's net loss would have been adjusted
to the following pro forma amounts:
1999 1998 1997
Net loss:
As reported $(27,653,000) $(13,798,000) $(3,485,000)
Pro forma (35,204,000) (15,037,000) (3,565,000)
Basic and diluted loss per share:
As reported (1.36) (1.01) (0.46)
Pro forma (1.73) (1.10) (0.47)
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions used: risk-free interest rates of 6%, 5.5% and 6%; no expected
dividends; expected lives of five years; and a volatility factor of 1.1, 1.3
and 1.1 in 1999, 1998 and 1997, respectively. The weighted average fair value
of the options granted in 1999, 1998 and 1997 was $17.21, $8.36 and $1.04,
respectively.
7. RELATED-PARTY TRANSACTIONS:
Prior to the acquisition by the Company of certain assets of Tech Squared,
Inc. as further described in Note 2, the Company's CEO owned 43% of Tech
Squared Inc. where he spent a portion of his time working as Tech Squared's
Chairman. The Company paid to Tech Squared a total of $254,000, $453,000 and
$168,000 in 1999, 1998 and 1997, respectively for rent, fulfillment fees and
other direct expenses.
F-13
In February 1998, two stockholders, one of which is a director for the
Company, entered into an agreement with the Company whereby the stockholders
will help establish and oversee the international operations for the Company
for a term of three years. As consideration, the stockholders each received
warrants to purchase 100,000 shares of common stock, at $3.00 per share.
Deferred compensation has been reflected for the estimated fair value of the
services and is being recognized over the term of the agreement.
In connection with an investment in the Company in 1994, Fujitsu Limited
(Fujitsu) obtained certain rights with respect to the Company's common stock
and the operations of the Company's business. In December 1997, in exchange
for the issuance of 60,000 shares of the Company's common stock, Fujitsu
agreed to relinquish most rights under the agreement. In 1997, the Company
recorded a charge to expense for the fair value of the Common shares issued
totaling $101,250.
F-14