UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER 0-26707
NETWORK COMMERCE INC.
(Exact name of registrant as specified in its charter)
WASHINGTON 91-1628103
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
411 1ST AVENUE SOUTH
SUITE 200 NORTH
SEATTLE, WA 98104
(Address of principal executive offices)
(206) 223-1996
(Registrant's telephone number, including area code)
SHOPNOW.COM INC.
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes X No
--- ---
As of August 9, 2000, there were 59,110,686 shares outstanding of the
Registrant's common stock.
1
NETWORK COMMERCE INC.
FORM 10-Q
INDEX
PAGE
PART I FINANCIAL INFORMATION
ITEM 1: Financial Statements
Consolidated Balance Sheets as of June 30, 2000
and December 31, 1999.............................................................. 4
Consolidated Statements of Operations for the three- and six-month
periods ended June 30, 2000 and 1999............................................... 5
Consolidated Statements of Cash Flows for the six-month
periods ended June 30, 2000 and 1999............................................... 6
Notes to Interim Consolidated Financial Statements.................................... 7
ITEM 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations................................................ 14
ITEM 3: Quantitative and Qualitative Disclosures about Market Risk............................ 30
PART II OTHER INFORMATION
ITEM 1: Legal Proceedings..................................................................... 31
ITEM 2: Changes in Securities and Use of Proceeds............................................. 31
ITEM 3: Defaults Upon Senior Securities....................................................... 31
ITEM 4: Submission of Matters to a Vote of Security Holders................................... 31
ITEM 5: Other Information..................................................................... 32
ITEM 6: Exhibits and Reports on Form 8-K...................................................... 32
SIGNATURES ...................................................................................... 33
EXHIBITS ...................................................................................... 34
2
PART I. FINANCIAL INFORMATION
ITEM 1.
3
NETWORK COMMERCE INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
===============================
June 30, December 31,
2000 1999
-------------- ---------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents .................................................... $ 8,205 $ 10,660
Short-term investments ....................................................... 76,682 52,172
Investments in marketable equity securities .................................. 7,750 30,884
Accounts receivable, net ..................................................... 16,694 6,591
Unbilled services ............................................................ 2,915 2,102
Prepaid expenses and other ................................................... 10,935 5,559
------------ ---------------
Total current assets .................................................... 123,181 107,968
Property and equipment, net ....................................................... 28,528 19,385
Goodwill, net ..................................................................... 65,745 23,860
Other intangible assets, net ...................................................... 166,904 104,713
Other assets, net ................................................................. 35,019 18,248
------------ ---------------
Total assets ............................................................ $ 419,377 $ 274,174
============ ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................................. $ 15,382 $ 8,330
Accrued liabilities .......................................................... 9,836 8,778
Current portion of notes and leases payable .................................. 7,460 8,565
Customer deposits ............................................................ 1,684 2,194
Deferred revenue ............................................................. 6,831 5,786
------------ ---------------
Total current liabilities ............................................... 41,193 33,653
Notes and leases payable and line of credit, less current portion ................. 7,029 5,409
Put warrant liability ............................................................. -- 1,388
Deferred tax liabilities .......................................................... 13,697 4,511
------------ ---------------
Total liabilities ....................................................... 61,919 44,961
------------ ---------------
Commitments
Shareholders' equity:
Convertible preferred stock, $0.001 par value: authorized shares - 5,000,000;
none issued and outstanding .............................................. -- --
Common stock, $0.001 par value: authorized shares - 200,000,000; issued
and outstanding shares - 59,034,677 at June 30, 2000 and 42,923,035 at
December 31, 1999 ....................................................... 525,820 325,502
Common stock warrants ........................................................ 8,091 8,260
Deferred compensation ........................................................ (7,612) (6,713)
Accumulated other comprehensive (loss) income ................................ (15,680) 7,470
Accumulated deficit .......................................................... (153,161) (105,306)
------------ ---------------
Total shareholders' equity .............................................. 357,458 229,213
------------ ---------------
Total liabilities and shareholders' equity .............................. $ 419,377 $ 274,174
============ ===============
The accompanying notes are an integral part of
these consolidated balance sheets.
4
NETWORK COMMERCE INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
=============================================================
For the Three Month For the Six Month
Period Ended June 30, Period Ended June 30,
---------------------------- ----------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
Revenues .......................................... $ 26,921 $ 8,414 $ 45,603 $ 15,982
Cost of revenues .................................. 12,839 7,543 23,232 14,683
------------ ------------ ------------ ------------
Gross profit ................................. 14,082 871 22,371 1,299
------------ ------------ ------------ ------------
Operating expenses:
Sales and marketing .......................... 24,032 12,807 46,132 18,279
General and administrative ................... 3,361 1,520 6,594 2,480
Research and development ..................... 5,195 1,334 9,410 2,934
Amortization of intangible assets ............ 18,300 1,081 31,792 1,639
Stock-based compensation ..................... 1,286 1,823 3,142 1,956
------------ ------------ ------------ ------------
Total operating expenses ................ 52,174 18,565 97,070 27,288
------------ ------------ ------------ ------------
Loss from operations .................... (38,092) (17,694) (74,699) (25,989)
------------ ------------ ------------ ------------
Nonoperating income (expense):
Gain on sale of marketable equity securities . 293 -- 1,379 --
Interest income (expense), net ............... 1,082 (260) 1,915 (245)
------------ ------------ ------------ ------------
Total nonoperating income, net .......... 1,375 (260) 3,294 (245)
------------ ------------ ------------ ------------
Net loss before income tax benefit ...... (36,717) (17,954) (71,405) (26,234)
Income tax benefit ................................ 11,634 -- 23,550 --
------------ ------------ ------------ ------------
Net loss ................................ $ (25,083) $ (17,954) $ (47,855) $ (26,234)
============ ============ ============ ============
Basic and diluted net loss per share .............. $ (0.45) $ (3.67) $ (0.86) $ (5.50)
============ ============ ============ ============
Weighted average shares outstanding used to
compute basic and diluted net loss per share . 56,221,302 4,890,250 55,487,522 4,768,405
============ ============ ============ ============
Pro forma basic and diluted net loss per share .... $ (0.80) $ (1.32)
============ ============
Weighted average shares outstanding used to compute
pro forma basic and diluted net loss per share 22,538,696 19,868,479
============ ============
The accompanying notes are an integral part of these
unaudited interim consolidated statements.
5
NETWORK COMMERCE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
======================
For the Six Month
Period Ended June 30,
----------------------
2000 1999
--------- ---------
Operating activities:
Net loss ....................................................................... $ (47,855) $ (26,234)
Adjustments to reconcile net loss to net cash used in operating activities-
Depreciation and amortization ............................................... 36,910 2,707
Deferred income tax benefit ................................................. (23,550) --
Non-cash consideration received ............................................. (2,141) --
Amortization of deferred compensation ....................................... 3,142 1,356
Operating expenses paid in stock and warrants ............................... -- 1,214
Changes in operating assets and liabilities, excluding effects of
acquired businesses-
Accounts receivable, net ............................................... (9,799) (756)
Prepaid expenses and other assets ...................................... (4,978) (1,220)
Unbilled services and customer deposits ................................ (1,573) 249
Accounts payable and accrued liabilities ............................... 5,110 4,164
Deferred revenue ....................................................... 1,004 (300)
--------- ---------
Net cash used in operating activities .................................. (43,730) (18,820)
--------- ---------
Investing activities:
Purchases of short-term investments ............................................ (109,317) (54)
Sales of short-term investments ................................................ 84,871 --
Sales of marketable equity securities .......................................... 103 --
Purchases of property and equipment ............................................ (12,846) (5,262)
Investments in equity and debt securities and other assets ..................... (14,327) (784)
Acquisition of businesses, net of cash acquired of $392 in 2000 and $640 in 1999 (17,691) (3,950)
--------- ---------
Net cash used in investing activities .................................. (69,207) (10,050)
--------- ---------
Financing activities:
Borrowings on line of credit, net of loan fees paid ............................ 6,011 999
Payments on line of credit ..................................................... -- (238)
Proceeds from debt financing ................................................... -- 10,632
Payments on long-term debt ..................................................... (5,953) (579)
Proceeds from sales of preferred stock ......................................... -- 14,400
Proceeds from sale of common stock ............................................. 110,424 77
--------- ---------
Net cash provided by financing activities .............................. 110,482 25,291
--------- ---------
Net increase (decrease) in cash and cash equivalents ................................. (2,455) (3,579)
Cash and cash equivalents at beginning of period ..................................... 10,660 9,820
--------- ---------
Cash and cash equivalents at end of period ........................................... $ 8,205 $ 6,241
========= =========
Supplementary disclosure of cash flow information:
Cash paid during the period for interest ....................................... $ 799 $ 185
========= =========
Cash paid during the period for income taxes ................................... $ -- $ --
========= =========
Non-cash investing and financing activities:
Common stock, options and warrants issued and liabilities assumed
as part of business and technology acquisitions ........................ $ 118,255 $ 11,560
========= =========
The accompanying notes are an integral part of
these unaudited interim consolidated statements.
6
NETWORK COMMERCE INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. ORGANIZATION AND BACKGROUND:
THE COMPANY
Network Commerce Inc. (the Company), a Washington corporation, provides
end-to-end technology and services that enable businesses, merchants, Internet
sites and wireless networks to engage in e-commerce. The Company's end-to-end
commerce solution consists of proprietary e-commerce technology platforms,
mobile commerce technology, commerce network systems, proprietary transaction
processing technology, hosting and professional services. The Company maintains
an on-line marketplace, referred to as the Network Commerce Consumer Network,
which aggregates merchants and shoppers over a distributed network of web sites.
The Company also maintains a business-to-business portal and marketplace, known
as the Network Commerce Business Network, which is designed to enable businesses
to engage in online transactions with other businesses. On May 17, 2000, the
Company changed its name from ShopNow.com Inc. to Network Commerce Inc.
The Company is subject to the risks and challenges associated with other
companies at a similar stage of development, including dependence on key
management personnel, successful development and marketing of its products and
services, the continued acceptance of the Internet as a medium for electronic
commerce, competition from substitute products and services from companies with
greater financial, technical, management and marketing resources and risks
associated with recent acquisitions. Further, during the period required to
develop commercially viable products, services and sources of revenues, the
Company may require additional funds that may not be readily available.
PUBLIC OFFERINGS
On October 4, 1999, the Company closed its initial public offering (IPO) of
7,250,000 shares of common stock at $12.00 per share, for proceeds net of
underwriters' fees and commissions of $80.9 million. At closing, all of the
Company's issued and outstanding shares of convertible preferred stock were
converted into shares of common stock on a one-for-one basis. On November 2,
1999, the underwriters of the IPO exercised their over-allotment option and sold
an additional 1,087,500 shares at $12.00 per share, for proceeds net of
underwriters' fees and commissions of $12.1 million. The combined net proceeds
to the Company, less additional offering costs of approximately $1.9 million,
were $91.1 million. In addition, a $1.0 million promissory note in connection
with the Company's acquisition of GO Software, Inc. (GO) and a $4.0 million
bridge loan with a financial institution plus accrued interest were repaid.
On February 18, 2000, the Company closed a supplemental public offering (SPO) of
7,913,607 shares of common stock at $14.50 per share, for proceeds net of
underwriters' fees and commissions of $108.7 million. Offering costs incurred by
the Company relating to the SPO were approximately $700,000.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
UNAUDITED INTERIM FINANCIAL DATA
The interim consolidated financial statements are unaudited and have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. These consolidated financial statements should be read in
conjunction with the audited consolidated financial statements and notes thereto
included in the Company's December 31, 1999 Form 10-K as filed with the
Securities and Exchange Commission on February 10, 2000. The financial
information included herein reflects all adjustments (consisting only of normal
recurring adjustments) which are, in the opinion of
7
management, necessary for a fair presentation of the results for interim
periods. The results of operations for the three- and six-month periods ended
June 30, 2000 and 1999 are not necessarily indicative of the results to be
expected for the full year.
PRINCIPLES OF CONSOLIDATION
The Company's consolidated financial statements include 100% of the assets,
liabilities and results of operations of all subsidiaries in which the Company
has a controlling ownership interest of greater than 50%. Equity investments in
which the Company holds less than a 20% ownership interest are recorded at cost
and are included in other assets, net in the accompanying consolidated balance
sheets. All significant intercompany transactions and balances have been
eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
REVENUE RECOGNITION
The Company derives substantially all of its revenues from the Network Commerce
Consumer Network, the Network Commerce Business Network and from providing
services to businesses.
Revenues from the Network Commerce Consumer Network, which is a network of
proprietary and affiliated web sites including www.shopnow.com and licensed
affiliate sites, the BottomDollar Network (including www.bottomdollar.com and
licensed affiliate sites), www.speedyclick.com and www.chaseshop.com are
generated primarily from the sale of on-line e-mail marketing and registrations,
leads and orders, banner advertising and merchandising to merchants. Revenues
from these agreements are recognized as the media are delivered to the merchants
over the term of the agreements, which typically range from one to four months.
Where billings exceed revenues earned on these agreements, the amounts are
included in the accompanying consolidated balance sheets as deferred revenue. In
certain circumstances, such as with ChaseShop (www.chaseshop.com), the Company
offers products directly to shoppers. In these instances where the Company acts
as merchant-of-record, the Company records as revenue the full sales price of
the product sold and records the full cost of the product to the Company as cost
of revenues, upon shipment of the product. Revenues generated from the Company's
ceased BuySoftware.com business are included in the accompanying June 30, 1999
interim consolidated statements of operations, as management did not cease
operations of BuySoftware.com until June 1999.
Revenues from the Network Commerce Business Network, which is a network of
proprietary and affiliated web sites, including www.b2bnow.com,
www.freemerchant.com and www.ubarter.com, are derived primarily from providing
services, transaction processing, advertising and technology licensing to
businesses. Since the acquisition of Ubarter.com on June 2, 2000 (see Note 4),
the Company also recognizes revenues from transaction fees earned from member
businesses that transact over the Ubarter exchange system as well as from
products sold by Ubarter.com to other member merchants of the Ubarter exchange
system. Revenues from services are generated principally through development
fees, hosting fees and sales and marketing services. These services can be
purchased as a complete end-to-end suite of services or separately. The Company
recognizes revenues from development of custom applications and online stores
and marketing projects on a percentage of completion basis over the period of
development or the period of the marketing project. These projects generally
range from two to five months. Hosting contracts typically have a term of one
year, with fees charged and earned on a monthly basis. The Company bears full
credit risk with respect to these sales. Anticipated losses on these contracts
are recorded when identified. To date, losses have not been significant.
Contract costs include all direct labor, material, subcontract and other direct
project costs and certain indirect costs related to contract performance.
Changes in job performance, job conditions and estimated profitability,
including those arising from contract penalty provisions and final contract
settlements that may result in revision to costs and income, are recognized in
the period in which the revisions are determined. Unbilled services typically
represent amounts earned under the Company's contracts not billed due to timing
or contract terms, which usually consider passage of time, achievement of
certain milestones or
8
completion of the project. Where billings exceed revenues earned on
contracts, the amounts are included in the accompanying consolidated balance
sheets as customer deposits, as the amounts typically relate to ancillary
services, whereby the Company is acting in an agency capacity. Fee revenue from
ancillary services provided by the services division is recognized upon
completion of the related job by the applicable third party vendor.
Revenues are also generated from fees paid to the Company by businesses and
merchants that license the Company's transaction processing and fraud prevention
technologies and on-line payment gateways, as well as other e-commerce enabling
technologies. Revenues include licensing fees, per-transaction fees and in
certain cases monthly hosting and maintenance fees, which are recognized in the
period earned. Revenues generated from technology licensing are recognized in
accordance with Statement of Position 97-2, "Software Revenue Recognition."
Where billings exceed revenues earned on these contracts, the amounts are
included in the accompanying consolidated balance sheets as deferred revenue.
Businesses and merchants that utilize the Company's payment processing
technologies act as the merchant-of-record and bear the full credit risk on
those sales of goods and services. Revenues from b2bNow.com are generated
primarily from the sales of advertising and merchandising products and services
similar to those sold on the Network Commerce Consumer Network.
INCOME TAXES
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
The Company's income tax benefit of $11.6 million and $23.6 million recognized
for the three- and six-month periods ended June 30, 2000, respectively, are the
result of changes in the Company's deferred tax accounts, which have principally
been created as a result of the Company's recent business acquisitions and from
the Company's generation of net operating losses.
PRO FORMA NET LOSS PER SHARE
Pro forma basic and diluted net loss per share is computed based on the weighted
average number of shares of common stock outstanding, giving effect to the
conversion of all outstanding convertible preferred stock that automatically
converted to common stock upon the closing of the Company's IPO discussed in
Note 1, using the if-converted method from the original issuance date. Both
diluted net loss per share and pro forma diluted net loss per share exclude the
impact of stock options and warrant exercises as the effect of their inclusion
would be antidilutive.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements," to provide guidance on the recognition, presentation and disclosure
of revenues in financial statements. The Company believes its revenue
recognition practices are in conformity with the guidelines prescribed in SAB
No. 101.
In March 2000, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 44 (FIN 44), "Accounting for Certain Transactions Involving
Stock Compensation." FIN 44 clarifies certain issues relating to the application
of Accounting Principles Board Opinion No. 25 and related interpretations, which
are the authoritative pronouncements the Company uses to account for its
stock-based compensation transactions. FIN 44 is effective July 1, 2000, however
certain conclusions reached in FIN 44 are applicable for transactions
consummated after either December 15, 1998 or January 12, 2000. The Company does
not believe that the adoption of FIN 44 will have a material effect on the
Company's financial position or results of operations.
RECLASSIFICATIONS
Certain information reported in previous periods has been reclassified to
conform to the current period presentation.
9
NOTE 3. COMPREHENSIVE LOSS:
The following table represents the Company's comprehensive loss for the three-
and six-month periods ended June 30, 2000 and 1999:
======================= =========================
For the Three Month For the Six Month
Period Ended June 30, Period Ended June 30,
------------------------ ------------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
(in thousands) (in thousands)
Net loss before income tax benefit ............................ $ (36,717) $ (17,954) $ (71,405) $ (26,234)
---------- ---------- ---------- ----------
Other comprehensive loss, before taxes:
Unrealized loss on marketable equity securities .......... (12,108) (4,508) (21,984) (4,508)
Reclassification adjustment for gains included in net loss (80) -- (1,166) --
---------- ---------- ---------- ----------
Total other comprehensive loss ........................... (12,188) (4,508) (23,150) (4,508)
---------- ---------- ---------- ----------
Comprehensive loss before income tax benefit .................. $ (48,905) $ (22,462) $ (94,555) $ (30,742)
========== ========== ========== ==========
NOTE 4. ACQUISITIONS:
In June 1999, the Company acquired GO Software, Inc. (GO). GO develops and
markets transaction processing software for personal computers that can function
on a stand-alone basis or can interface with core corporate accounting systems.
The Company paid GO $4.7 million in cash, issued a $1.0 million promissory note
bearing interest at 10%, and issued 1,123,751 shares of common stock, valued at
$8.54 per share, for a total purchase price of $15.4 million. The acquisition
was accounted for using the purchase method of accounting. Of the excess
purchase price of approximately $14.4 million, $13.8 million was allocated to
acquired technology and $556,000 was allocated to goodwill, which are both being
amortized over a three-year life. The note bore interest at 10% and was repaid
in full upon completion of the Company's IPO.
Also in June 1999, the Company acquired CardSecure, Inc. (CardSecure) for a
purchase price of approximately $3.5 million. CardSecure is a developer of
e-commerce enabled Web sites. The acquisition was accounted for using the
purchase method of accounting. The excess purchase price of approximately $3.5
million was allocated to acquired technology and is being amortized over a
three-year life.
On November 12, 1999, the Company acquired SpeedyClick, Corp. (SpeedyClick), a
California corporation, for $55.6 million of cash, common stock and common stock
options. SpeedyClick, a privately held company, maintains an Internet web site
that focuses on entertainment, commerce and interactivity. Upon effectiveness of
the acquisition, a total of 3,799,237 shares of common stock valued at $13.31
per share were issued to the owners of SpeedyClick. Options to purchase
SpeedyClick common stock were assumed by the Company and converted into 157,527
options to purchase the Company's common stock. The Company also paid cash
consideration of $3.0 million to the owners of SpeedyClick. The Company
accounted for this transaction as a purchase. Of the $55.6 million in
consideration paid, approximately $27.9 was allocated to proprietary concepts,
$14.7 million to customer lists and $13.0 million to goodwill. These intangible
assets are being amortized over a three-year life.
On December 3, 1999, the Company acquired Cortix, Inc. (Cortix), an Arizona
corporation doing business as 20-20Consumer.com, for $14.4 million of cash and
common stock. Cortix, a privately held company, is an operator of comparison
shopping services including online reviews and ratings for commerce-oriented
businesses, merchants and products. Upon effectiveness of the acquisition,
711,435 shares of common stock valued at $18.81 per share were issued to the
owners of Cortix. The Company also paid cash consideration of $1.0 million to
the owners of Cortix. The Company accounted for this transaction as a purchase.
Of the $14.4 million in consideration paid, approximately $11.3 million was
allocated to acquired technology, $1.6 million to customer lists and $1.3
million to goodwill. These intangible assets are being amortized over a
three-year life.
On December 17, 1999, the Company acquired WebCentric Inc., (WebCentric) a
Kansas corporation doing business as bottomdollar.com, for $40.2 million of
common stock, common stock options and approximately $1.4 million of cash.
WebCentric, a privately held company, develops e-commerce integration technology
and applications, including a comparison shopping engine that allows consumers
to search and compare the products and services of
10
several leading Internet merchants. Upon effectiveness of the acquisition, a
total of 2,161,904 shares of common stock valued at $16.89 per share were issued
to the owners of WebCentric. In addition, the Company issued replacement stock
options to purchase an aggregate of 121,544 shares of the Company's common stock
to certain employees and owners of WebCentric. The Company accounted for this
transaction as a purchase. Of the $40.2 million in consideration paid,
approximately $31.8 million was allocated to acquired technology, $3.3 million
to customer lists and $4.6 million to goodwill. These intangible assets are
being amortized over a three-year life.
On January 13, 2000, the Company, through its wholly owned subsidiary 3037952
Nova Scotia Company, a Nova Scotia Company, acquired Pronet Enterprises Ltd.
(Pronet), a Canadian company, for approximately $12.8 million, of which $3.2
million was paid in cash, $2.2 million in non-cash deferred tax liabilities
assumed and $7.4 million in common stock and common stock options issued to
Pronet shareholders. Pronet, a privately held company, operates a
business-to-business portal and marketplace that aggregates businesses that seek
to transact with one another. Upon effectiveness of the acquisition, a total of
162,508 shares of common stock, valued at $17.60 per share, were issued to the
shareholders Pronet. In addition, the Company issued options to purchase 351,666
shares of common stock to the two principals of Pronet. The Company accounted
for this transaction as a purchase. Of the $12.8 million in consideration paid,
approximately $6.3 million was allocated to acquired technology, $2.7 million to
customer lists and $3.8 million to goodwill. These intangible assets are being
amortized over a three-year life.
On January 18, 2000, the Company acquired AXC Corporation, (AXC) a Washington
corporation, for approximately $17.9 million, of which $2.2 million was paid in
cash, $4.1 million in non-cash deferred tax liabilities assumed and $11.6
million in common stock and common stock options issued to AXC shareholders.
AXC, a privately held company, provides e-commerce consulting services to
businesses. Upon effectiveness of the acquisition, a total of 540,296 shares of
common stock valued at $17.60 per share were issued to the owners of AXC. In
addition, the Company issued replacement stock options to purchase an aggregate
of 72,089 shares of the Company's common stock to certain employees and owners
of AXC. The Company accounted for this transaction as a purchase. Of the $17.9
million in consideration paid, approximately $7.2 million was allocated to
assembled workforce, $4.9 million to customer lists, $5.0 million to goodwill
and $800,000 to working capital. The intangible assets acquired are being
amortized over a three-year life.
On April 11, 2000, the Company acquired Freemerchant.com, Inc. (Freemerchant), a
Delaware corporation, for approximately $38.1 million, of which $2.0 million was
paid in cash, $10.0 million in non-cash deferred tax liabilities assumed, $0.5
million of debt assumed and $25.6 million in common stock and common stock
options issued to Freemerchant shareholders. Freemerchant, a privately held
company, has developed on-line store-builder technology for small- to
medium-sized merchants that seek a low-cost entry point to e-commerce, as well
as providing hosting services to those merchants. Upon effectiveness of the
acquisition, a total of 2,573,723 shares of common stock, valued at $8.80 per
share, were issued to the shareholders of Freemerchant. In addition, the Company
issued options to purchase 293,596 shares of common stock to certain
Freemerchant shareholders and employees. The Company accounted for this
transaction as a purchase. Of the $38.1 million in consideration paid,
approximately $23.0 million was allocated to acquired technology, $4.1 million
to assembled workforce and $11.0 million to goodwill. All intangible assets are
expected to be amortized over a three-year estimated useful life.
On June 2, 2000, the Company effected its acquisition of Ubarter.com Inc
(Ubarter), a Nevada corporation, pursuant to an agreement and plan of merger
dated January 20, 2000, for approximately $61.7 million, of which $875,000 was
paid in cash, $11.4 million in non-cash deferred tax liabilities assumed,
$978,000 of net liabilities assumed, $7.6 million in the cancellation of debt
between Ubarter and the Company, and $40.8 million in common stock and common
stock warrants issued to Ubarter shareholders and creditors. Ubarter, a publicly
traded company, is a business-to-business e-commerce enterprise which utilizes
the Ubarter Dollar as payment for products and services by its member businesses
over its proprietary barter exchange system. Upon effectiveness of the
acquisition, a total of 2,682,871 shares of common stock were issued to the
shareholders and creditors of Ubarter. In addition, the Company issued warrants
to purchase 51,842 shares of common stock to certain Ubarter shareholders,
employees and creditors. The Company accounted for this transaction as a
purchase. Of the $61.7 million in consideration paid, approximately $7.5 million
was allocated to acquired technology, $2.5 million to assembled workforce, $25.1
million to proprietary concept, $2.5 million to customer lists, and $24.0
million to goodwill. All intangible assets have a three-year estimated useful
life.
11
UNAUDITED PRO FORMA COMBINED RESULTS
The following summarizes the unaudited pro forma results of the Company's
operations for the six-month periods ended June 30, 2000 and 1999 as if the GO,
CardSecure, SpeedyClick, Cortix, WebCentric, Pronet, AXC, Freemerchant and
Ubarter transactions occurred as of January 1, 1999. The pro forma results are
presented for the purposes of additional analysis only and do not purport to
present the results of operations that would have occurred for the periods
presented or that may occur in the future.
======================
For the Six Month
Period Ended June 30,
----------------------
2000 1999
--------- ---------
(in thousands, except
share amounts)
Revenues ........................... $ 50,102 $ 21,500
Net loss before taxes .............. (119,448) (72,116)
Net loss per share before taxes .... (2.13) (3.83)
5. INVESTMENTS IN MARKETABLE EQUITY SECURITIES:
At June 30, 2000, the Company held 476,410 shares of 24/7 Media and 45,124
shares of FreeShop.com Inc., both of which are publicly traded companies subject
to the reporting requirements of the Securities and Exchange Commission. The
Company classifies these investments as available for sale and are stated at
fair value in accordance with Statement of Financial Accounting Standards No.
115, "Accounting for Certain Investments in Debt and Equity Securities." This
statement specifies that available for sale securities are reported at fair
value with changes in unrealized gains and losses recorded directly to
shareholders' equity, which are reflected in accumulated other comprehensive
income (loss) in the accompanying consolidated balance sheets. Fair value is
based on quoted market prices.
6. DEBT OBLIGATIONS:
In March 1999, the Company entered into a loan and security agreement with a
financial institution for a term loan and line of credit. In May 1999, the
agreement was amended and restated to allow the Company to borrow up to $8.5
million at any one time, consisting of a $3.5 million term loan (term loan), a
$4.0 million bridge loan (bridge loan) and a line of credit of up to $2.5
million ($1.0 million until the bridge loan is repaid). The line of credit bears
interest at the financial institution's base rate plus 2% and was amended in
January 2000 to expire on June 30, 2001. The outstanding credit line balance was
$0 as of June 30, 2000. The term loan bears interest at 12%, is secured by
substantially all assets of the Company and matures in March 2002. The term loan
balance was $2.5 million as of June 30, 2000. The bridge loan bore interest at
12% and was repaid in October 1999, as discussed in Note 1.
On May 19, 2000, the Company entered into credit agreement with a commercial
bank, with a maximum commitment amount of $15.0 million to finance the purchase
of equipment, software and tenant improvements. The credit agreement is secured
by substantially all of the Company's assets and had an outstanding balance of
$6.1 million at June 30, 2000. The outstanding commitments bear interest at an
annual rate equal to the prime lending rate plus one and one-half percent.
Outstanding commitments under the agreement are required to be repaid under
specific schedules, with all commitments to be repaid no later than November 18,
2003. The credit agreement requires the Company to maintain certain financial
ratios and places limitations on certain financing and investing activities. The
credit agreement also contains other customary conditions and events of default
that, in the event of noncompliance by the Company, would prevent any further
borrowings and would generally require the repayment of any outstanding
commitments under the credit agreement.
12
7. SEGMENT INFORMATION:
The following table represents the Company's segment information for the three-
and six-month periods ended June 30, 2000 and 1999:
=========================================================
For the Three Month For the Six Month
Period Ended June 30, Period Ended June 30,
--------------------------- ---------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
(in thousands)
Revenues from unaffiliated customers:
Consumer Network .............................. $ 15,691 $ 1,539 $ 26,329 $ 1,883
Business Network .............................. 5,811 -- 9,154 --
Services ...................................... 5,419 2,446 10,120 4,176
BuySoftware.com ............................... -- 4,429 -- 9,923
------------ ------------ ------------ ------------
Total revenues from unaffiliated customers 26,921 8,414 45,603 15,982
------------ ------------ ------------ ------------
Cost of revenues:
Consumer Network .............................. 8,574 721 15,736 1,024
Business Network .............................. 1,305 -- 1,424 --
Services ...................................... 2,960 1,517 6,072 2,469
BuySoftware.com ............................... -- 5,305 -- 11,190
------------ ------------ ------------ ------------
Total cost of revenues ................... 12,839 7,543 23,232 14,683
------------ ------------ ------------ ------------
Gross profit ............................. $ 14,082 $ 871 $ 22,371 $ 1,299
============ ============ ============ ============
The Company does not track assets by operating segments. Consequently is it not
practicable to show assets by operating segments.
8. RELATED PARTY TRANSACTIONS:
During the six-month period ended June 30, 2000, the Company purchased
approximately $1.8 million in marketing and advertising services from 24/7
Media, a significant shareholder of the Company. Also during the same period
ended June 30, 2000, the Company recognized approximately $1.3 million in
licensing revenues from PrivaSeek, Inc., in which the Company also owns a
minority interest.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The matters discussed in this report contain forward-looking statements that
involve known and unknown risks and uncertainties, such as statements of our
plans, objectives, expectations and intentions. Words such as "may," "could,"
"would," "expect," "anticipate," "intend," "plan," "believe," "estimate," and
variations of such words and similar expressions are intended to identify such
forward-looking statements. You should not place undue reliance on these
forward-looking statements, which are based on our current expectations and
projections about future events, are not guarantees of future performance, are
subject to risks, uncertainties and assumptions (including those described
below) and apply only as of the date of this report. Our actual results could
differ materially from those anticipated in the forward-looking statements.
Factors that could cause or contribute to such differences include, but are not
limited to, those discussed below in "Additional Factors That May Affect Future
Results" as well as those discussed in this section and elsewhere in this
report, and the risks discussed in the "Risk Factors" section included in our
December 31, 1999 10-K filed on February 10, 2000 with the Securities and
Exchange Commission.
OVERVIEW
We provide end-to-end technology and services that enable businesses, merchants,
Internet sites and wireless networks to engage in e-commerce. Our end-to-end
commerce solution consists of proprietary e-commerce technology platforms,
mobile commerce technology, commerce network systems, proprietary transaction
processing technology, hosting and professional services. We maintain an on-line
marketplace, referred to as the Network Commerce Consumer Network, which
aggregates merchants and shoppers over a distributed network of web sites. We
also maintain a business-to-business portal and marketplace, known as the
Network Commerce Business Network, which is designed to enable businesses to
engage in online transactions with other businesses.
We were incorporated in January 1994 and initially operated as a computer
services company. In 1996, we began to change the focus of our business to
conducting commerce over the Internet. In May 1997, we launched BuySoftware.com,
an online computer products store. During 1998, we completed three acquisitions,
including the acquisition of Media Assets, Inc., a direct marketing company,
launched ShopNow.com and began offering merchants e-commerce enabling products
and services. In April 1999, we changed our name from TechWave Inc. to
ShopNow.com Inc. In June 1999, we ceased operation of BuySoftware.com because we
determined it was inconsistent with our evolving strategy. In May 2000, we
changed our name to Network Commerce Inc. We consummated two acquisitions in the
second quarter of 1999, three in the fourth quarter of 1999, two in the first
quarter of 2000 and two in the second quarter of 2000.
We derive substantially all of our revenues from the Network Commerce Consumer
Network, the Network Commerce Business Network and from providing services to
businesses.
Revenues from the Network Commerce Consumer Network, which is a network of
proprietary and affiliated web sites including www.shopnow.com and licensed
affiliates, the BottomDollar Network (including www.bottomdollar.com and
licensed affiliate sites), www.speedyclick.com and www.chaseshop.com are
generated primarily from the sale of on-line e-mail marketing and registrations,
leads and orders, banner advertising and merchandising to merchants. Revenues
from these agreements are recognized as the media are delivered to the merchants
over the term of the agreements, which typically range from one to four months.
In certain circumstances, such as with ChaseShop (www.chaseshop.com), we offer
products directly to shoppers. In these instances where we act as
merchant-of-record, we record as revenue the full sales price of the product
sold and record the full cost of the product to us as cost of revenues, upon
shipment of the product. Revenues generated from our ceased BuySoftware.com
business are included in our June 30, 1999 operations, as management did not
cease operations of BuySoftware.com until June 1999.
Revenues from the Network Commerce Business Network, which is a network of
proprietary and affiliated web sites, including www.b2bnow.com,
www.freemerchant.com and www.ubarter.com, are derived primarily from providing
services, transaction processing, advertising and technology licensing to
businesses. Since the acquisition of Ubarter.com on June 2, 2000, we also
generate revenues from transaction fees earned from member businesses that
transact over the Ubarter exchange system as well as from products sold by
Ubarter.com to other member merchants of the Ubarter exchange system. Revenues
from services are generated principally through development fees, hosting fees
and sales and marketing services. These services can be purchased as a complete
end-to-end suite
14
of services or separately. We recognize revenues from development of custom
applications and online stores and marketing projects on a percentage of
completion basis over the period of development or the period of the marketing
project. These projects generally range from two to five months. Hosting
contracts typically have a term of one year, with fees charged and earned on a
monthly basis. We bear full credit risk with respect to these sales. Contract
costs include all direct labor, material, subcontract and other direct project
costs and certain indirect costs related to contract performance.
Revenues are also generated from fees paid to us by businesses and merchants
that license our transaction processing and fraud prevention technologies and
on-line payment gateways, as well as other e-commerce enabling technologies.
Revenues include licensing fees, per-transaction fees and in certain cases
monthly hosting and maintenance fees, which are recognized in the period earned.
Revenues generated from technology licensing are recognized in accordance with
Statement of Position 97-2, "Software Revenue Recognition." Businesses and
merchants that utilize our payment processing technologies act as the
merchant-of-record and bear the full credit risk on those sales of goods and
services. Revenues from b2bNow.com are generated primarily from the sales of
advertising and merchandising products and services similar to those sold on the
Network Commerce Consumer Network.
Cost of revenues generated from the Network Commerce Consumer Network include
the portion of our Internet telecommunications connections that are directly
attributable to traffic on the Network Commerce Consumer Network and the direct
labor costs incurred in maintaining and enhancing our network infrastructure. In
order to fulfill our obligations under our registrations, lead and order
delivery advertising programs, we occasionally purchase consumer traffic from
third party networks by placing on their web sites advertisements that, when
clicked on by a visitor, send the visitor to the Network Commerce Consumer
Network. Any shopping traffic that we purchase from a third party that is used
to fulfill these obligations is included as cost of revenues. Cost of revenues
on the products that we sell as merchant-of-record includes the cost of the
product, credit card fees and shipping costs. Cost of revenues generated from
providing services includes all direct labor costs incurred in connection with
the provision of services, as well as fees charged by third-party vendors that
have directly contributed to the design, development and implementation of our
services. Cost of revenues generated from licensing e-commerce-enabling
technologies and from our proprietary business-to-business portal consists
primarily of telecommunications costs and direct labor costs incurred in
maintaining and enhancing our network infrastructure.
FINANCIAL DATA
The following table presents selected operating data for the Network Commerce
Consumer and Business Networks. This information should be read in conjunction
with the other information presented in Management's Discussion and Analysis of
Financial Condition and Results of Operations. The operating data presented
below for any quarter are not necessarily indicative of data for any future
period.
===================================
June 30, March 31, December 31,
2000 2000 1999
-------- --------- ------------
Number of premier merchants listed on the Network Commerce Consumer
Network (1) .................................................. 125 97 68
Average revenue per premier merchant per month ..................... $ 71,736 $ 47,504 $ 34,991
Number of businesses listed on the Network Commerce Business Network
(2) .......................................................... 899,000 610,000 --
Number of businesses utilizing our technology platforms ............ 115,000 19,700 18,300
(1) Premier merchants include those merchants that contribute greater than
$10,000 of revenue per month to the Network Commerce Consumer Network.
(2) Represents the number of businesses listed in the Network Commerce Business
Network directory as of the last day of the applicable quarter. The Network
Commerce Business Network launched in January 2000.
15
RESULTS OF OPERATIONS
REVENUES. Total revenues for the three- and six-month periods ended June 30,
2000 were $26.9 million and $45.6 million, respectively. Revenues for the
comparable periods in 1999 were $8.4 million and $16.0 million, respectively.
The increase was due primarily to the expansion of our networks and increased
demand for our services. We continued to experience growth in our business and
merchant listings, consumer traffic and affiliate and syndication shopping
sites, which resulted in increased fees from licensing, transaction processing,
business services, online direct marketing and advertising, exclusive of
BuySoftware.com. The BuySoftware.com portion of revenues for the six-month
period ended June 30, 1999 was $9.9 million.
COST OF REVENUES. The cost of revenues for the three- and six-month periods
ended June 30, 2000 were $12.8 million and $23.2 million, respectively. Total
costs of revenues for the comparable periods in 1999 were $7.5 million and $14.7
million, respectively. The increase in our cost of revenues was directly
attributable to the increase in revenues during the same period from the Network
Commerce Consumer Network and the Network Commerce Business Network. The
BuySoftware.com portion of cost of revenues for the six-month period ended June
30, 1999 was $11.2 million.
GROSS PROFIT. Gross profit for the three- and six-month periods ended June 30,
2000 were $14.1 million and $22.4 million, respectively. Gross profit for the
comparable periods in 1999 were $871,000 and $1.3 million, respectively. As a
percent of revenues, our gross profits were 52.3% and 49.1%, respectively,
compared to 10.4% and 8.1% for the comparable periods in 1999. This increase in
gross profit percentage was due primarily to the increase in higher-margin
revenues during 2000, while decreasing our concentration of revenues from
product sales to shoppers, which historically has contributed only flat or
negative gross profits. While we expect to continue to increase our gross
profits both in absolute dollars and as a percentage of revenues, we do not
expect that the rate of growth achieved historically will continue.
SALES AND MARKETING. Sales and marketing expenses consist primarily of costs
associated with marketing programs such as advertising and public relations, as
well as salaries and commissions. Sales and marketing expenses for the three-
and six-month periods ended June 30, 2000 were $24.0 million and $46.1 million,
respectively. Sales and marketing expenses for the comparable periods in 1999
were $12.8 million and $18.3 million, respectively. The increase was due
primarily to increased spending as a result of our expansion of the Network
Commerce Consumer Network and our launch and expansion of the Network Commerce
Business Network, both of which resulted in additional personnel and nationwide
television, print, radio and on-line advertisements. We anticipate continued
growth in our sales and marketing expenses during the remainder of 2000.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of salaries and other personnel-related costs for executive,
financial, human resources, information services and other administrative
personnel, as well as legal, accounting and insurance costs. General and
administrative expenses for the three- and six-month periods ended June 30, 2000
were $3.4 million and $6.6 million, respectively. General and administrative
expenses for the comparable periods in 1999 were $1.5 million and $2.5 million,
respectively. The increase was due primarily to an increase in personnel from
internal growth and acquisitions. We anticipate continued growth in our general
and administrative expenses during the remainder of 2000.
RESEARCH AND DEVELOPMENT. Research and development expenses consist primarily of
salaries and related costs associated with the development of new products and
services, the enhancement of existing products and services, and the performance
of quality assurance and documentation activities. Research and development
expenses for the three- and six-month periods ended June 30, 2000 were $5.2
million and $9.4 million, respectively. Research and development costs for the
comparable periods in 1999 were $1.3 million and $2.9 million, respectively. The
increase was due primarily to the development and enhancement of our technology
platform, as well as to an increase in technology personnel. These employees
focus on developing our technology platform as well as building the overall
infrastructure that supports the Network Commerce Consumer Network and the
Network Commerce Business Network. We anticipate continued growth in our
research and development expenses during the remainder of 2000.
AMORTIZATION OF INTANGIBLE ASSETS. Amortization of intangible assets resulting
from acquisitions is primarily related to the amortization of customer lists,
domain names, acquired technology, proprietary concepts, assembled workforce and
goodwill. Amortization of intangible assets expense for the three- and six-month
periods ended June 30, 2000 was $18.3 million and $31.8 million, respectively.
Amortization of intangible assets for the comparable periods in 1999
16
was $1.1 million and $1.6 million, respectively. This increase was due primarily
to the increase in intangible assets and related amortization expenses from
business acquisitions completed during the last quarter of 1999 and the first
half 2000, including the acquisitions of SpeedyClick, Corp., Cortix, Inc.,
WebCentric, Inc., Pronet Enterprises Ltd., AXC Corporation, Freemerchant.com
Inc. and Ubarter.com Inc. Intangible assets acquired in business combinations
are amortized over a three-year period.
STOCK-BASED COMPENSATION. Stock-based compensation expense is related to the
amortization of deferred compensation resulting from stock option grants to
employees with an option exercise price below the estimated fair market value of
our common stock as of the date of grant. Stock-based compensation expense for
the three- and six-month periods ended June 30, 2000 was $1.3 million and $3.1
million. Stock-based compensation in comparable periods for 1999 was $1.8
million and $2.0 million. The amount of deferred compensation resulting from
these grants are generally amortized over a one- to three-year vesting period.
GAIN ON SALE OF MARKETABLE EQUITY SECURITIES. Gain on sale of marketable equity
securities for the three- and six-month periods ended June 30, 2000 was $293,000
and $1.4 million, respectively. We did not liquidate any of our marketable
equity securities during the three- or six-month periods ended June 30, 1999.
INTEREST INCOME, NET. Interest income, net consists primarily of the combination
of interest income earned on our cash and cash equivalents and short-term
investments as well as interest expense incurred on our outstanding debt
obligations. Interest income, net for the three- and six-month periods ended
June 30, 2000 was $1.1 million and $1.9 million, respectively. Interest expense,
net for the comparable periods in 1999 was $260,000 and $245,000, respectively.
Interest income, net increased due to the increase in our cash and cash
equivalents and short-term investments realized from completion of our initial
and supplemental public offerings of common stock.
INCOME TAX BENEFIT. The income tax benefit resulted principally from reductions
of deferred tax liabilities created as a result of business combinations. Income
tax benefit for the three- and six-month periods ended June 30, 2000 was $11.6
million and $23.6 million, respectively. We did not realize any income tax
benefits during the three- or six-month periods ended June 30, 1999. If we
continue to consummate additional business combinations that result in the
recognition of deferred taxes, we may incur additional tax deferred tax
benefits. We have not paid nor have we received refunds for federal income taxes
and we do not expect to pay income taxes or receive income tax refunds in the
foreseeable future.
NET LOSS. Net loss for the three- and six-month periods ended June 30, 2000 was
$25.1 million and $47.9 million, respectively. Net loss for the comparable
periods in 1999 was $18.0 and $26.2 million, respectively. This increase was due
primarily to an increase in our operating expenses, most significantly sales and
marketing expenses and amortization of intangible assets, partially offset by
our increase in gross profit and income tax benefit during the same periods. We
expect to incur additional net losses in 2000.
NET OPERATING LOSS CARRYFORWARDS
As of June 30, 2000, we had net operating loss carryforwards of approximately
$119.7 million. If not used, the net operating loss carryforwards will expire at
various dates beginning in 2012. The Tax Reform Act of 1986 imposes restrictions
on the use of net operating losses and tax credits in the event that there has
been an ownership change, as defined, of a corporation since the periods in
which the net operating losses were incurred. Our ability to use net operating
losses incurred prior to July 1999 is limited to approximately $14.3 million per
year due to sales of Series D and Series E convertible preferred stock to third
parties in April 1998 and the sale of Series I convertible preferred stock to
Chase Manhattan Bank in July 1999, which resulted in ownership changes. Our
deferred tax assets are recognizable only to the extent that they are offset by
deferred tax liabilities. To the extend that our deferred tax assets exceed our
deferred tax liabilities in the future, valuation allowances may be recorded
against our deferred tax assets. In concluding that valuation allowances may be
required, management considers such factors as our history of operating losses,
potential future losses and the nature of our deferred tax assets.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have experienced net losses and negative cash flows from
operations. As of June 30, 2000, we had an accumulated deficit of $153.2
million. We have financed our activities largely through issuances of common
stock and preferred stock, from the issuance of short- and long-term obligations
and from capital leasing transactions for
17
certain of our fixed asset purchases. Through June 30, 2000, our aggregate net
proceeds have been $271.9 million from issuing equity securities and $27.8
million from issuing debt securities. As of June 30, 2000, we had $84.9 million
in cash, cash equivalents and short-term investments.
Net cash used in operating activities was $43.7 million for the six-month period
ended June 30, 2000, compared to $18.8 million for the same period in 1999. The
increase was due primarily to the increase in our net loss for the six-month
period ended June 30, 2000 of $47.9 million compared to $26.2 million for the
same period ended 1999, the increase in depreciation and amortization of $36.9
million for the six month period ended June 30, 2000 compared to $2.7 million in
the comparable period in 1999, and the deferred income tax benefit of $23.6 in
the six month period ended June 30, 2000 compared to none in the comparable
period in 1999.
Net cash used in investing activities was $69.2 million for the six-month period
ended June 30, 2000, compared to $10.1 million for the same period in 1999. The
increase was due primarily to the net increase in purchases of short-term
investments of $24.4 million for the six-month period ended June 30, 2000,
compared to $54,000 for the same period in 1999, the increase in purchases of
property and equipment of $12.8 million for the six-month period ended June 30,
2000, compared to $5.3 million for the same period in 1999, the increase in
investments in equity securities and other assets of $14.3 million for the
six-month period ended June 30, 2000, compared to $784,000 for the same period
in 1999, and the increase in acquisition of businesses of $17.7 million for the
six-month period ended June 30, 2000, compared to $4.0 for the same period in
1999.
Net cash provided by financing activities was $110.5 million for the six-month
period ended June 30, 2000, compared to $25.3 million for the same period in
1999. The increase was due primarily to the closing of our public offering on
February 18, 2000 of 7,913,607 shares of common stock at $14.50 per share, which
resulted in proceeds to us net of underwriters' fees and commissions of $108.7
million. Offering costs incurred by the Company were approximately $700,000.
In March 1999, we entered into a loan and security agreement with a financial
institution for a term loan and line of credit. In May 1999, the agreement was
amended and restated to allow us to borrow up to $8.5 million at any one time,
consisting of a $3.5 million term loan (term loan), a $4.0 million bridge loan
(bridge loan) and a line of credit of up to $2.5 million ($1.0 million until the
bridge loan is repaid). The line of credit bears interest at the financial
institution's base rate plus 2% and was amended in January 2000 to expire on
June 30, 2001. The outstanding credit line balance was $0 as of June 30, 2000.
The term loan bears interest at 12%, is secured by substantially all of our
assets and matures in March 2002. The term loan balance was $2.5 million as of
June 30, 2000. The bridge loan bore interest at 12% and was repaid in October
1999 after the closing of our initial public offering.
On May 19, 2000, we entered into credit agreement with a commercial bank, with a
maximum commitment amount of $15.0 million to finance the purchase of equipment,
software and tenant improvements. The credit agreement is secured by
substantially all of our assets and had an outstanding balance of $6.1 million
at June 30, 2000. The outstanding commitments bear interest at an annual rate
equal to the prime lending rate plus one and one-half percent. Outstanding
commitments under the agreement are required to be repaid under specific
schedules, with all commitments to be repaid no later than November 18, 2003.
The credit agreement requires us to maintain certain financial ratios and places
limitations on certain financing and investing activities. The credit agreement
also contains other customary conditions and events of default that, in the
event of noncompliance by us, would prevent any further borrowings and would
generally require the repayment of any outstanding commitments under the credit
agreement.
Our capital requirements depend on numerous factors, including the rate of
expansion of the Network Commerce Consumer Network and the Network Commerce
Business Network, the investments we make in our technology platforms and in
future technologies, the number of acquisitions that are completed and the
composition of the consideration paid between cash, debt and stock, and the
resources we devote to expansion of our sales, marketing and branding efforts.
We have also entered into agreements with Chase Manhattan Bank and 24/7 Media
that require us to make aggregate advertising and marketing expenditures of
approximately $5.0 million in 2000, decreasing annually to $250,000 in 2002. We
believe that existing cash balances and cash generated from operations, together
with the net proceeds from our public offerings and the future sale of
marketable equity securities will be sufficient to meet our anticipated cash
needs for working capital and capital expenditures through the next 18 months.
After that time, we may be required to raise additional financing. We cannot be
sure that the assumed levels of revenues and expenses underlying our anticipated
cash needs will prove to be accurate. The sale of additional equity or
convertible debt
18
securities could result in additional dilution to our shareholders. We cannot be
sure that financing will be available in amounts or on terms acceptable to us,
or even available at all.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin (SAB) No. 101, "REVENUE RECOGNITION IN FINANCIAL
STATEMENTS," to provide guidance on the recognition, presentation and disclosure
of revenues in financial statements. We believe our revenue recognition
practices are in conformity with the guidelines prescribed in SAB No. 101.
In March 2000, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 44 (FIN 44), "Accounting for Certain Transactions Involving
Stock Compensation." FIN 44 clarifies certain issues relating to the application
of Accounting Principles Board Opinion No. 25 and related interpretations, which
are the authoritative pronouncements we use to account for our stock-based
compensation transactions. FIN 44 is effective July 1, 2000, however certain
conclusions reached in FIN 44 are applicable for transactions consummated after
either December 15, 1998 or January 12, 2000. We do not believe that the
adoption of FIN 44 will have a material effect on our financial position or
results of operations.
SEASONALITY
We believe that our advertising and merchandising revenues on the Network
Commerce Consumer Network and the Network Commerce Business Network are subject
to seasonality changes as retail transactions and advertising sales in
traditional media, such as television and radio, generally are lower in the
first and third calendar quarters of each year. In addition, Internet usage
typically declines during the summer and certain holiday periods. If our market
makes the transition from an emerging to a more developed market, seasonal and
cyclical patterns may develop in our industry and in the usage of, and
transactions on, our web sites and those of our merchants. Seasonal and cyclical
patterns in online transactions and advertising would affect our revenues. Those
patterns may also develop on our web sites. Given the early stage of the
development of the Internet and our company, however, we cannot predict to what
extent, if at all, our operations will prove to be seasonal.
IMPACT OF THE YEAR 2000 COMPUTER PROBLEM
Prior to January 1, 2000, we devoted substantial resources in an effort to
ensure that our proprietary software, the third-party software on which we rely,
and the underlying systems and protocols did not contain errors associated with
Year 2000 date functions. Since January 1, 2000, we have not experienced any
disruption as a result of Year 2000 problems.
19
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW AND THE OTHER
INFORMATION IN THIS QUARTERLY REPORT. WHILE WE HAVE ATTEMPTED TO IDENTIFY ALL
RISKS THAT ARE MATERIAL TO OUR BUSINESS, ADDITIONAL RISKS THAT WE HAVE NOT YET
IDENTIFIED OR THAT WE CURRENTLY THINK ARE IMMATERIAL MAY ALSO IMPAIR OUR
BUSINESS OPERATIONS. THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE DUE TO
ANY OF THESE RISKS. IN ASSESSING THESE RISKS, YOU SHOULD ALSO REFER TO THE OTHER
INFORMATION IN THIS QUARTERLY REPORT, INCLUDING THE CONSOLIDATED FINANCIAL
STATEMENTS AND RELATED NOTES AND THE RISKS DISCUSSED IN THE "RISK FACTORS"
SECTION INCLUDED IN OUR DECEMBER 31, 1999 10-K FILED ON FEBRUARY 10, 2000 WITH
THE SECURITIES AND EXCHANGE COMMISSION.
RISKS RELATED TO OUR BUSINESS
OUR RAPID GROWTH AND EVOLUTION MAY MAKE IT DIFFICULT TO EVALUATE OUR BUSINESS
AND PROSPECTS
We were incorporated in January 1994 and operated initially as a computer
services company. In 1996, we began to change the focus of our business to
conducting commerce over the Internet. In August 1998, we launched our first
online marketplace, ShopNow.com. In recent months, particularly with the launch
of the Network Commerce Business Network, we have increasingly focused on
developing and providing products and services to enable businesses to conduct
online commerce. The recent shifts in our business focus may make it difficult
for you to evaluate our business and prospects. You should also consider the
risks, expenses and difficulties that we may encounter as a young company in a
rapidly evolving market.
WE HAVE A HISTORY OF LOSSES AND WE EXPECT FUTURE LOSSES
We incurred net losses of $47.9 million for the six-month period ended June 30,
2000 and $26.2 million for the six-month period ended June 30, 1999. At June 30,
2000, we had an accumulated deficit of $153.2 million. We have historically
invested heavily in sales and marketing, technology infrastructure and research
and development and expect to continue to do so in the future. As a result, we
must generate significant revenues to achieve and maintain profitability. We
expect that our sales and marketing expenses, research and development expenses
and general and administrative expenses will continue to increase in absolute
dollars and may increase as a percentage of revenues. In addition, we may incur
substantial expenses in connection with future acquisitions.
OUR FUTURE REVENUES ARE UNPREDICTABLE AND WE EXPECT OUR OPERATING RESULTS TO
FLUCTUATE FROM PERIOD TO PERIOD
Our business model has only been applied to the Internet since the mid-1990's
and continues to evolve. Therefore we have limited experience in planning the
financial needs and operating expenses of our business. It is difficult for us
to accurately forecast our revenues in any given period. We may not be able to
sustain our recent revenue growth rates or obtain sufficient revenues to achieve
profitability. If our revenues in a particular period fall short of our
expectations, we will likely be unable to quickly adjust our spending in order
to compensate for that revenue shortfall.
Our operating results are likely to fluctuate substantially from period to
period as a result of a number of factors, such as:
- declines in the number of businesses and merchants to which we provide
our products and services;
- the amount and timing of operating costs and expenditures relating to
expansion of our operations; and
- the mix of products and services that we sell.
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In addition, factors beyond our control may also cause our operating results to
fluctuate, such as:
- the announcement or introduction of new or enhanced products or
services by our competitors; and
- the pricing policies of our competitors.
Period-to-period comparisons of our operating results are not a good indicator
of our future performance. It is likely that our operating results in some
quarters may not meet the expectations of stock market analysts and investors
and this could cause our stock price to decline.
OUR BUSINESS MODEL IS UNPROVEN AND CHANGING
Our business model consists of providing businesses and merchants with
e-commerce enabling solutions. We have limited experience as a company and,
additionally, the Internet, on which our business model relies, is still
unproven as a business medium. Accordingly, our business model may not be
successful, and we may need to change it. Our ability to generate sufficient
revenues to achieve profitability will depend, in large part, on our ability to
successfully market our e-commerce products and services to businesses and
merchants that may not be convinced of the need for an online presence or may be
reluctant to rely upon third parties to develop and manage their e-commerce
offerings and marketing efforts.
OUR FUTURE GROWTH WILL DEPEND ON OUR ABILITY TO MAKE AND SUCCESSFULLY INTEGRATE
ADDITIONAL ACQUISITIONS
Our success depends on our ability to continually enhance and expand our
e-commerce enabling products and services and our online marketplaces in
response to changing technologies, customer demands and competitive pressures.
Consequently, we have acquired complementary technologies or businesses in the
past, and intend to do so in the future. If we are unable to identify suitable
acquisition targets, or if we are unable to successfully complete acquisitions
and successfully integrate the acquired businesses, technologies and personnel,
our ability to increase product and service offerings will be reduced. This
could cause us to lose business to our competitors, and our operating results
could suffer.
ACQUISITIONS INVOLVE A NUMBER OF RISKS
We actively seek to identify and acquire companies with attributes complementary
to our e-commerce products and services. Since December 31, 1999, we have
acquired four companies.
Acquisitions that we make may involve numerous risks, including:
- diverting management's attention from other business concerns;
- being unable to maintain uniform standards, controls, procedures and
policies;
- entering markets in which we have no direct prior experience;
- improperly evaluating new services and technologies or otherwise being
unable to fully exploit the anticipated opportunity; and
- being unable to successfully integrate the acquired businesses,
technologies and other assets.
If we are unable to accurately assess any newly acquired businesses or
technologies, our business could suffer. For example, in June 1998 we acquired
e-Warehouse and CyberTrust. These companies had developed payment processing
technologies that we planned to utilize as part of our e-commerce products and
services. However, we are not currently utilizing the acquired technologies, and
we have determined that the technologies have no other use or value to us.
Because we are not using the acquired technologies, we wrote off substantially
all of the $5.4 million aggregate purchase price for e-Warehouse and CyberTrust
in 1998. Future acquisitions may involve the assumption
21
of obligations or large one-time write-offs and amortization expenses related to
goodwill and other intangible assets. Any of the factors listed above would
adversely affect our results of operations.
In addition, in order to finance any future acquisition, we may need to raise
additional funds through public or private financings. In this event, we could
be forced to obtain equity or debt financing on terms that are not favorable to
us and that may result in dilution to our shareholders.
OUR SUCCESS DEPENDS UPON ACHIEVING ADEQUATE MARKET SHARE TO INCREASE OUR
REVENUES AND BECOME PROFITABLE
Our success depends upon achieving significant market penetration and acceptance
of our e-commerce enabling products and services. We have only recently begun to
expand our business-to-business initiatives designed to enable businesses to
maximize their e-commerce opportunities, and our online marketplaces have
achieved only limited market acceptance to date. We may not currently have
adequate market share to successfully execute our business plan. If we are
unable to reach and retain substantial numbers of businesses, merchants and
shoppers, our business model may not be sustainable.
To successfully market and sell our e-commerce enabling products and services we
must:
- become recognized as a leading provider of end-to-end enabling
solutions;
- enhance existing products and services;
- add new products and services;
- complete projects on time;
- increase the number of businesses and merchants using our e-commerce
products and services and online marketplaces; and
- continue to increase the attractiveness of the Network Commerce
Consumer Network to shoppers.
IF WE DO NOT INCREASE BRAND AWARENESS OUR SALES MAY SUFFER
Due in part to the emerging nature of the markets for e-commerce enabling
products and services and online marketplaces, together with the substantial
resources available to many of our competitors, our opportunity to achieve and
maintain a significant market share may be limited. Developing and maintaining
awareness of the ShopNow.com, b2bNow.com, Freemerchant.com, SpeedyClick.com,
Ubarter.com and BottomDollar brand names is critical in achieving widespread
acceptance of our e-commerce enabling products and services and our online
marketplaces. We launched the Network Commerce Consumer Network in August 1998
and we have only recently begun to expand our business-to-business initiatives
designed to enable businesses to maximize their e-commerce opportunities. The
importance of brand recognition will increase as competition in our markets
increases. Successfully promoting and positioning our brands will depend largely
on the effectiveness of our marketing and sales efforts and our ability to
develop reliable and useful products and services at competitive prices. If our
planned marketing and sales efforts are ineffective, we may need to increase our
financial commitment to creating and maintaining brand awareness among
businesses, merchants and shoppers, which could divert financial and management
resources from other aspects of our business, or cause our operating expenses to
increase disproportionately to our revenues. This could cause our business and
operating results to suffer.
WE FACE SIGNIFICANT COMPETITION
The market for e-commerce enabling products and services and online marketplaces
is highly competitive, and we expect competition to intensify in the future.
Barriers to entry are not significant. Our failure to compete effectively could
result in the following:
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- fewer businesses and merchants relying upon our enabling solutions;
- the obsolescence of the technology underlying our products and
services;
- fewer businesses and merchants listed in our directories;
- a decrease in shopper traffic on our web sites; and
- a reduction in the prices of or profits on our products and services.
The number of companies providing e-commerce enabling products and services is
large and increasing at a rapid rate. We expect that additional companies which
to date have not had a substantial commercial presence on the Internet or in our
markets will offer competing products and services. Although we believe no one
company currently offers a range of e-commerce enabling solutions as
comprehensive as our suite of products and services, companies such as
InfoSpace, Go2Net, Yahoo! and Cybersource offer alternatives to one or more of
our products and services.
Many of our competitors and potential competitors have substantial competitive
advantages as compared to us, including:
- larger customer or user bases;
- the ability to offer a wider array of e-commerce products and
solutions;
- greater name recognition and larger marketing budgets and resources;
- substantially greater financial, technical and other resources;
- the ability to offer additional content and other personalization
features; and
- larger production and technical staffs.
These advantages may enable our competitors to adapt more quickly to new
technologies and customer needs, devote greater resources to the promotion or
sale of their products and services, initiate or withstand substantial price
competition, take advantage of acquisition or other opportunities more readily
or develop and expand their product and service offerings more quickly.
In addition, as the use of the Internet and online products and services
increases, larger well-established and well-financed entities may continue to
acquire, invest in or form joint ventures with providers of e-commerce enabling
solutions, and existing providers may continue to consolidate. Providers of
Internet browsers and other Internet products and services who are affiliated
with providers of web directories and information services that compete with our
products and services may more tightly integrate these affiliated offerings into
their browsers or other products or services. Any of these trends would increase
the competition we face.
IF WE FAIL TO MAINTAIN OUR STRATEGIC BUSINESS RELATIONSHIPS AND ENTER INTO NEW
RELATIONSHIPS OUR BUSINESS WILL SUFFER
An important element of our strategy involves entering into business
relationships with other companies. Our success is dependent on maintaining our
current contractual relationships and developing new strategic relationships.
These contractual relationships typically involve joint marketing, licensing or
promotional arrangements. For example, we have entered into a licensing and
co-marketing agreement with Chase Manhattan Bank, a cross promotion agreement
with 24/7 Media and a software license agreement with HNC Software. Although
these relationships are an important factor in our strategy because they enable
us to enhance our product and service offerings, the parties with which we
contract may not view their relationships with us as significant to their own
businesses. To date, we have not derived material revenue from these
relationships, and some of these
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relationships impose substantial obligations on us. It is not certain that the
benefits to us will outweigh our obligations. For example, our relationship with
24/7 Media requires us to refer to them any business that would benefit from the
advertising services offered by 24/7 Media and makes 24/7 Media the only third
party authorized to sell advertising on our web site. Several of our significant
business arrangements do not establish minimum performance requirements but
instead rely on contractual best efforts obligations of the parties with which
we contract. In addition, either party with little notice may terminate most of
these relationships. Accordingly, in order to maintain our strategic business
relationships we will need to meet our partners' specific business objectives,
including incremental revenue, brand awareness and implementation of specific
e-commerce applications. If our strategic business relationships are
discontinued for any reason, or if we are unsuccessful in entering into new
relationships in the future, our business and results of operations may be
harmed.
IF WE FAIL TO EFFECTIVELY MANAGE THE RAPID GROWTH OF OUR OPERATIONS OUR BUSINESS
WILL SUFFER
Our ability to successfully offer e-commerce enabling products and services and
implement our business plan in a rapidly evolving market requires an effective
planning and management process. We are increasing the scope of our operations
domestically and internationally, and we have recently increased our headcount
substantially. From December 31, 1997 to June 30, 2000, our total number of
employees increased from less than 50 to approximately 620. This growth has
placed and will continue to place a significant strain on our management
systems, infrastructure and resources. We will need to continue to improve our
financial and managerial controls and reporting systems and procedures, and will
need to continue to expand, train and manage our workforce worldwide.
Furthermore, we expect that we will be required to manage an increasing number
of relationships with various customers and other third parties. Any failure to
expand any of the foregoing areas efficiently and effectively could cause our
business to suffer.
WE DEPEND ON OUR KEY MANAGEMENT PERSONNEL FOR SUCCESSFUL OPERATION OF OUR
BUSINESS
Our success depends on the skills, experience and performance of our senior
management and other key personnel. Our key personnel include Dwayne Walker, our
Chairman and Chief Executive Officer, Joe Arciniega, our President and Chief
Operating Officer, Alan Koslow, our Chief Financial Officer, and Dr. Ganapathy
Krishnan, our Chief Technology Officer. Each of these officers, other than Dr.
Krishnan, has an employment agreement with Network Commerce Inc. Many of our
executive officers have joined us within the past three years. If we do not
quickly and efficiently integrate these new personnel into our management and
culture, our business could suffer. Our business could also suffer if we do not
retain our key personnel.
WE MUST HIRE ADDITIONAL PERSONNEL TO EXPAND OUR OPERATIONS
Our future success depends on our ability to identify, hire, train, retain and
motivate highly skilled executive, technical, managerial, sales and marketing,
business development and administrative personnel. We intend to hire a
significant number of personnel during the next year, and as of June 30, 2000 we
had openings for 62 job positions. Competition for qualified personnel is
intense, particularly in the technology and Internet markets. If we fail to
successfully attract and retain a sufficient number of qualified executive,
technical, managerial, sales and marketing, business development and
administrative personnel, our ability to manage and expand our business could
suffer.
OUR ABILITY TO DEVELOP AND INTEGRATE E-COMMERCE TECHNOLOGIES IS SUBJECT TO
UNCERTAINTIES
We have limited experience delivering our e-commerce products and services and
operating online marketplaces. In order to remain competitive, we must regularly
upgrade our e-commerce products and services to incorporate current technology,
which requires us to integrate complex computer hardware and software
components. If we do not successfully integrate these components, the quality
and performance of our online offerings may be reduced. In addition, the ability
of our online marketplaces to accommodate an increasing number of businesses,
merchants and shoppers would suffer. While these technologies are generally
commercially available, we may be required to expend considerable time and money
in order to successfully integrate them into our products and services and this
may cause our business to suffer. We must also maintain an adequate testing and
technical support infrastructure to ensure the successful introduction of
products and services.
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OUR COMPUTER SYSTEMS MAY BE VULNERABLE TO SYSTEM FAILURES
Our success depends on the performance, reliability and availability of the
technology supporting our e-commerce products and services and our online
marketplaces. Our revenues depend, in large part, on the number of businesses
and merchants that use our products and services and the number of shoppers that
access the Network Commerce Consumer Network. This depends, in part, upon our
actual and perceived reliability and performance. Any inability to provide our
products and services or any slowdown or stoppage of our online marketplaces
could cause us to lose clients and therefore lose revenue. Substantially all of
our computer and communications hardware is located at leased and third-party
facilities in Seattle, Washington and Sterling, Virginia. Our systems and
operations are vulnerable to damage or interruption from fire, flood, power
loss, telecommunications failure, break-in, earthquake and similar events.
Because we presently do not have fully redundant systems or a formal disaster
recovery plan, a systems failure could adversely affect our business. Our
computer systems are vulnerable to computer viruses, physical or electronic
break-ins and similar disruptions, which may lead to interruptions, delays, loss
of data or inability to process online transactions for our clients. We may be
required to expend considerable time and money to correct any system failure. If
we are unable to fix a problem that arises, we may lose clients or be unable to
conduct our business at all.
OUR BUSINESS MAY BE HARMED BY DEFECTS IN OUR SOFTWARE AND SYSTEMS
We have developed custom software for our network servers and have licensed
additional software from third parties. This software may contain undetected
errors or defects. Although we have not suffered significant harm from any
errors or defects to date, we may discover significant errors or defects in the
future that we may be unable to fix in a timely or cost-effective manner.
WE WILL NEED TO EXPAND AND UPGRADE OUR SYSTEMS IN ORDER TO MAINTAIN CUSTOMER
SATISFACTION
We must expand and upgrade our technology, transaction processing systems and
network infrastructure if the number of businesses and merchants using our
e-commerce products and services and online marketplaces, or the volume of
traffic on our web sites or our clients' web sites, increases substantially. We
could experience periodic capacity constraints, which may cause unanticipated
system disruptions, slower response times and lower levels of customer service.
We may be unable to accurately project the rate or timing of increases, if any,
in the use of our products or services or our web sites or when we must expand
and upgrade our systems and infrastructure to accommodate these increases in a
timely manner. Any inability to do so could harm our business.
OUR INTERNATIONAL OPERATIONS INVOLVE RISKS
We are subject to risks specific to Internet-based companies in foreign markets.
These risks include:
- delays in the development of the Internet as a commerce medium in
international markets;
- restrictions on the export of encryption technology; and
- increased risk of piracy and limits on our ability to enforce our
intellectual property rights.
WE MAY REQUIRE ADDITIONAL FUNDING TO SUCCESSFULLY OPERATE AND GROW OUR BUSINESS
Although we believe that our cash reserves and cash flows from operations will
be adequate to fund our operations for at least the next twelve months, these
resources may be inadequate. Consequently, we may require additional funds
during or after this period. Additional financing may not be available on
favorable terms or at all. If we raise additional funds by selling stock, the
percentage ownership of our then current shareholders will be reduced. If we
cannot raise adequate funds to satisfy our capital requirements, we may have to
limit our operations significantly. Our future capital requirements depend upon
many factors, including, but not limited to:
25
- the rate at which we expand our sales and marketing operations and our
product and service offerings;
- the extent to which we develop and upgrade our technology and data
network infrastructure; and
- the occurrence, timing, size and success of acquisitions.
WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY AND PROPRIETARY
RIGHTS
We regard our intellectual property rights as critical to our success, and we
rely on trademark and copyright law, trade secret protection and confidentiality
and license agreements with our employees, customers and others to protect our
proprietary rights. Despite our precautions, unauthorized third parties might
copy portions of our software or reverse engineer and use information that we
regard as proprietary. We currently have five patents pending in the United
States Patent and Trademark Office covering different aspects of our product
architecture and technology. However, we do not currently own any issued patents
and there is no assurance that any pending patent application will result in an
issued patent, or that any future patent will not be challenged, invalidated or
circumvented, or that the rights granted under any patent will provide us with a
competitive advantage. The laws of some countries do not protect proprietary
rights to the same extent as do the laws of the United States, and our means of
protecting our proprietary rights abroad may not be adequate. Any
misappropriation of our proprietary information by third parties could adversely
affect our business by enabling third parties to compete more effectively with
us.
OUR TECHNOLOGY MAY INFRINGE THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS
Although we have not received notice of any alleged infringement by us, we
cannot be certain that our technology does not infringe issued patents or other
intellectual property rights of others. In addition, because patent applications
in the United States are not publicly disclosed until the patent is issued,
applications may have been filed which relate to our software. We may be subject
to legal proceedings and claims from time to time in the ordinary course of our
business, including claims of alleged infringement of the trademarks and other
intellectual property rights of third parties. Intellectual property litigation
is expensive and time-consuming, and could divert our management's attention
away from running our business.
IF THE SECURITY PROVIDED BY OUR E-COMMERCE SERVICES IS BREACHED WE MAY BE LIABLE
TO OUR CLIENTS AND OUR REPUTATION COULD BE HARMED
A fundamental requirement for e-commerce is the secure transmission of
confidential information of businesses, merchants and shoppers over the
Internet. Among the e-commerce services we offer to merchants are security
features such as:
- secure online payment services;
- secure order processing services; and
- fraud prevention and management services.
Third parties may attempt to breach the security provided by our e-commerce
products and services or the security of our clients' internal systems. If they
are successful, they could obtain confidential information about businesses and
shoppers using our online marketplaces, including their passwords, financial
account information, credit card numbers or other personal information. We may
be liable to our clients or to shoppers for any breach in security. Even if we
are not held liable, a security breach could harm our reputation, and the mere
perception of security risks, whether or not valid, could inhibit market
acceptance of our products and services. We may be required to expend
significant capital and other resources to license additional encryption or
other technologies to protect against security breaches or to alleviate problems
caused by these breaches. In addition, our clients might decide to stop using
our e-commerce products and services if their customers experience security
breaches.
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RISKS RELATED TO OUR INDUSTRY
OUR SUCCESS DEPENDS ON CONTINUED INCREASES IN THE USE OF THE INTERNET AS A
COMMERCIAL MEDIUM
We depend on the growing use and acceptance of the Internet by businesses,
merchants and shoppers as a medium of commerce. Rapid growth in the use of and
interest in the Internet and online products and services is a recent
development. No one can be certain that acceptance and use of the Internet and
online products and services will continue to develop or that a sufficiently
broad base of businesses, merchants and shoppers will adopt and continue to use
the Internet and online products and services as a medium of commerce.
The Internet may fail as a commercial marketplace for a number of reasons,
including potentially inadequate development of the necessary network
infrastructure or delayed development of enabling technologies, including
security technology and performance improvements. For example, if technologies
such as software that stops advertising from appearing on a web user's computer
screen gain wide acceptance, the attractiveness of the Internet to advertisers
would be diminished, which could harm our business.
RAPID TECHNOLOGICAL CHANGE COULD NEGATIVELY AFFECT OUR BUSINESS
Rapidly changing technology, evolving industry standards, evolving customer
demands and frequent new product and service introductions characterize the
market for e-commerce products and services and online marketplaces. Our future
success will depend in significant part on our ability to improve the
performance, content and reliability of our products and services in response to
both the evolving demands of the market and competitive product and service
offerings. Our efforts in these areas may not be successful. If a large number
of our clients adopt new Internet technologies or standards, we may need to
incur substantial expenditures modifying or adapting our e-commerce products and
services to remain compatible with their systems.
WE RELY ON THE INTERNET INFRASTRUCTURE PROVIDED BY OTHERS TO OPERATE OUR
BUSINESS
Our success depends in large part on other companies maintaining the Internet
infrastructure. In particular, we rely on other companies to maintain a reliable
network backbone that provides adequate speed, data capacity and security and to
develop products that enable reliable Internet access and service. If the
Internet continues to experience significant growth in the number of users,
frequency of use and amount of data transmitted, the Internet infrastructure of
thousands of computers communicating via telephone lines, coaxial cable and
other telecommunications systems may be unable to support the demands placed on
it, and the Internet's performance or reliability may suffer as a result of this
continued growth. If the performance or reliability of the Internet suffers,
Internet users could have difficulty obtaining access to the Internet. In
addition, data transmitted over the Internet, including information and graphics
contained on web pages, could reach Internet users much more slowly. This could
result in frustration of Internet users, which could decrease online traffic and
cause advertisers to reduce their Internet expenditures.
FUTURE GOVERNMENTAL REGULATION AND PRIVACY CONCERNS COULD ADVERSELY AFFECT OUR
BUSINESS
We are not currently subject to direct regulation by any government agency,
other than regulations applicable to businesses generally, and there are
currently few laws or regulations directly applicable to access to or commerce
on the Internet. However, due to the increasing popularity and use of the
Internet, a number of legislative and regulatory proposals are under
consideration by federal, state, local and foreign governmental organizations,
and it is possible that a number of laws or regulations may be adopted with
respect to the Internet relating to issues such as user privacy, taxation,
infringement, pricing, quality of products and services and intellectual
property ownership. The adoption of any laws or regulations that have the effect
of imposing additional costs, liabilities or restrictions relating to the use of
the Internet by businesses or consumers could decrease the growth in the use of
the Internet, which could in turn decrease the demand for our products and
services, decrease traffic on our online marketplaces, increase our cost of
doing business, or otherwise have a material adverse effect on our business.
Moreover, the applicability to the Internet of existing laws governing issues
such as property ownership, copyright, trademark, trade secret, obscenity, libel
and personal privacy is uncertain and developing. Any new legislation or
regulation, or application or interpretation of existing laws, could have a
material adverse effect on our business.
27
The Federal Communications Commission is currently reviewing its regulatory
positions on the privacy protection given to data transmissions over
telecommunications networks and could seek to impose some form of
telecommunications carrier regulation on telecommunications functions of
information services. State public utility commissions generally have declined
to regulate information services, although the public service commissions of
some states continue to review potential regulation of such services. Future
regulation or regulatory changes regarding data privacy could have an adverse
effect on our business by requiring us to incur substantial additional expenses
in order to comply with this type of regulation.
A number of proposals have been made at the federal, state and local level that
would impose additional taxes on the sale of goods and services over the
Internet and certain states have taken measures to tax Internet-related
activities. Foreign countries also may tax Internet transactions. The taxation
of Internet-related activities could have the effect of imposing additional
costs on companies, such as Network Commerce Inc., that conduct business over
the Internet. This, in turn, could lead to increased prices for products and
services, which could result in decreased demand for our solutions.
WE COULD FACE LIABILITY FOR MATERIAL TRANSMITTED OVER THE INTERNET BY OTHERS
Because material may be downloaded from web sites hosted by us and subsequently
distributed to others, there is a potential that claims will be made against us
for negligence, copyright or trademark infringement or other theories based on
the nature and content of this material. Negligence and product liability claims
also potentially may be made against us due to our role in facilitating the
purchase of some products, for example firearms. Although we carry general
liability insurance, our insurance may not cover claims of these types, or may
not be adequate to indemnify us against this type of liability. Any imposition
of liability, and in particular liability that is not covered by our insurance
or is in excess of our insurance coverage, could have a material adverse effect
on our reputation and our operating results, or could result in the imposition
of criminal penalties on us.
WE DO NOT CURRENTLY COLLECT SALES TAX FROM ALL TRANSACTIONS
We do not currently collect sales or other similar taxes on products sold by us
and delivered into states other than Washington, California, Georgia, Arizona,
Kansas, New York, Tennessee and Kentucky. However, one or more states or foreign
countries may seek to impose sales tax collection obligations on out-of-state or
foreign companies engaging in e-commerce. In addition, any new operation in
states outside the states for which we currently collect sales tax could subject
shipments into these states to state or foreign sales taxes. A successful
assertion by one or more states or any foreign country that we should collect
sales or other similar taxes on the sale of merchandise or services could result
in liability for penalties as well as substantially higher expenses incurred by
our business.
RISKS RELATED TO AN INVESTMENT IN OUR STOCK
PROVISIONS OF OUR CHARTER DOCUMENTS AND WASHINGTON LAW COULD DISCOURAGE OUR
ACQUISITION BY A THIRD PARTY
Specific provisions of our articles of incorporation and bylaws and Washington
law could make it more difficult for a third party to acquire us, even if doing
so would be beneficial to our shareholders.
Our articles of incorporation and bylaws establish a classified board of
directors, eliminate the ability of shareholders to call special meetings,
eliminate cumulative voting for directors and establish procedures for advance
notification of shareholder proposals. The presence of a classified board and
the elimination of cumulative voting may make it more difficult for an acquirer
to replace our board of directors. Further, the elimination of cumulative voting
substantially reduces the ability of minority shareholders to obtain
representation on the board of directors.
Our board of directors has the authority to issue up to 5,000,000 shares of
preferred stock and to determine the price, rights, preferences, privileges and
restrictions, including voting rights, of those shares without any further vote
or action by our shareholders. The issuance of preferred stock could have the
effect of delaying, deferring or preventing a change of control of Network
Commerce Inc. and may adversely affect the market price of the common stock and
the voting and other rights of the holders of common stock.
Washington law imposes restrictions on some transactions between a corporation
and significant shareholders. Chapter 23B.19 of the Washington Business
Corporation Act prohibits a target corporation, with some exceptions,
28
from engaging in particular significant business transactions with an acquiring
person, which is defined as a person or group of persons that beneficially owns
10% or more of the voting securities of the target corporation, for a period of
five years after the acquisition, unless the transaction or acquisition of
shares is approved by a majority of the members of the target corporation's
board of directors prior to the acquisition. Prohibited transactions include,
among other things:
- a merger or consolidation with, disposition of assets to, or issuance
or redemption of stock to or from the acquiring person;
- termination of 5% or more of the employees of the target corporation;
or
- allowing the acquiring person to receive any disproportionate benefit
as a shareholder.
A corporation may not opt out of this statute. This provision may have the
effect of delaying, deterring or preventing a change in control of Network
Commerce Inc.
The foregoing provisions of our charter documents and Washington law could have
the effect of making it more difficult or more expensive for a third party to
acquire, or could discourage a third party from attempting to acquire, control
of Network Commerce Inc. These provisions may therefore have the effect of
limiting the price that investors might be willing to pay in the future for our
common stock.
OUR STOCK PRICE MAY BE VOLATILE
The stock market in general, and the stock prices of Internet-related companies
in particular, have recently experienced extreme volatility, which has often
been unrelated to the operating performance of any particular company or
companies. Our stock price could be subject to wide fluctuations in response to
factors such as the following:
- actual or anticipated variations in quarterly results of operations;
- the addition or loss of merchants and shopper traffic;
- announcements of technological innovations, new products or services
by us or our competitors;
- changes in financial estimates or recommendations by securities
analysts;
- conditions or trends in the Internet, e-commerce and marketing
industries;
- changes in the market valuations of other Internet or online service
or software companies;
- our announcements of significant acquisitions, strategic
relationships, joint ventures or capital commitments;
- additions or departures of key personnel;
- sales of our common stock;
- general market conditions; and
- other events or factors, many of which are beyond our control.
These broad market and industry factors may materially and adversely affect our
stock price, regardless of our operating performance. The trading prices of the
stocks of many technology companies are at or near historical highs and reflect
price to earnings ratios substantially above historical levels. These trading
prices and price-to-earnings ratios may not be sustained.
29
In the past, securities class action litigation has often been brought against
companies following periods of volatility in their stock prices. We may in the
future be the target of similar litigation. Securities litigation could result
in substantial costs and divert our management's time and resources, which could
cause our business to suffer.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We currently have instruments sensitive to market risk relating to exposure to
changing interest rates and market prices. We do not enter into financial
instruments for trading or speculative purposes and do not currently utilize
derivative financial instruments. Our operations are conducted primarily in the
United States and as such are not subject to material foreign currency exchange
rate risk.
The fair value of our investment portfolio or related income would not be
significantly impacted by either a 100 basis point increase or decrease in
interest rates due mainly to the short-term nature of the major portion of our
investment portfolio. All of the potential changes noted above are based on
sensitivity analyses performed on our investment portfolio balances as of June
30, 2000.
30
PART II. OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
None.
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
Between April 1, 2000 and June 30, 2000, we issued and sold unregistered
securities as set forth below:
- On April 11, 2000, pursuant to an Agreement and Plan of Merger among
Network Commerce Inc., Venice Acquisition, Inc., Freemerchant.com,
Inc. and Serge Wilson, the principal stockholder of Freemerchant.com,
we acquired all of the equity securities of Freemerchant.com for
approximately $2.0 million in cash, the issuance of 2,573,723 shares
of common stock at $8.80 per share and the issuance of options to
purchase 293,596 shares of common stock to certain employees of
Freemerchant.com.
- On May 19, 2000, in connection with the consummation of a credit
agreement, we issued a term note for a $15 million or such lesser
amount outstanding at any one time. As of June 30, 2000, the principal
amount of the note was $6.1 million. The term note bears interest at
an annual rate equal to the prime lending rate plus one and one-half
percent. Principal and interest under the term note are required to be
repaid under specific schedules, with all commitments to be repaid no
later than November 18, 2003.
- On May 19, 2000, in connection with the execution of a credit
agreement, we issued warrants to purchase 105,820 shares of common
stock to Imperial Bank at an exercise price of $5.67 per share.
- Effective as of June 2, 2000, in connection with the consummation of
our acquisition of Ubarter.com, we issued 38,995 shares of common
stock to Astra Ventures LLC at a per share price of $17.31.
- On July 4, 2000, in connection with the consummation of our
acquisition of Ubarter.com, we issued 50,000 shares of common stock to
Commonwealth Associates L.P. at a per share price of $5.38.
No underwriters were engaged in connection with these issuances and sales. These
securities were issued in transactions exempt from registration under the
Securities Act of 1933 in reliance upon Section 4(2) of the Securities Act and
Regulation D promulgated thereunder. Between April 1, 2000 and June 30, 2000, we
issued 1,193,260 shares of common stock in conjunction with the exercise of
options granted under our stock option plans. The options granted under the
stock option plan were issued to our officers, employees and consultants at
exercise prices ranging from $0.00 to $13.11. No options were granted outside of
our stock option plans. These securities were issued in transactions exempt from
registration under the Securities Act of 1933 in reliance upon Rule 701
promulgated under the Securities Act of 1933. Where Rule 701 was not available,
the securities were issued in transactions exempt from registration under the
Securities Act of 1933 in reliance upon Section 4(2) of the Securities Act of
1933.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY SHAREHOLDERS
The Company's annual meeting of stockholders was held on May 22, 2000.
The following nominees were elected as directors, each to hold office until his
or her successor is elected and qualified, by the vote set forth below:
31
NOMINEE FOR WITHHELD
Jacob I. Friesel................................... 32,572,895 1,743,009
Mark C. McClure.................................... 32,456,391 1,859,513
Mark H. Terbeek.................................... 32,456,391 1,859,513
Eytan J. Lombroso.................................. 32,570,600 1,745,304
The proposal to approve an amendment to the Company's Amended and Restated 1996
Combined Incentive and Nonqualified Stock Option Plan to increase the number of
reserved shares from 8,000,000 shares to 10,500,000 shares and to qualify it for
exemption under Section 162(m) of the Internal Revenue Code was approved by the
vote set forth below:
FOR AGAINST ABSTAIN
--- ------- -------
28,333,898 5,921,142 60,864
ITEM 5: OTHER INFORMATION
Effective August 1, 2000, the Company changed its transfer agent and
registrar of its common stock from Continental Stock Transfer and Trust to
Wells Fargo Shareowner Services, a division of Wells Fargo Bank Minnesota,
N.A. The address of Wells Fargo Shareowner Services is 161 North Concord
Exchange Street; South St. Paul, Minn., 55075-1139. Representatives of Wells
Fargo may be contacted at 877/840-0492; fax 651/450-4033.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3.1 Amended and Restated Articles of Incorporation of the registrant, as
amended.
4.1 Credit Agreement, dated as of May 19, 2000, among Network Commerce
Inc., the financial institutions named on the signature pages thereof,
and Imperial Bank, as agent for such financial institutions.
4.2 Form of Warrant, dated as of May 19, 2000, issued to Imperial Bank.
10.1 Amended and Restated 1996 Combined Incentive and Nonqualified Stock
Option Plan.
10.2 Amended and Restated 1999 Nonofficer Employee Stock Option Plan.
10.3 Offer of Amended Employment, dated as of May 15, 2000, for Joe E.
Arciniega, Jr., as amended.
10.4 Offer of Amended Employment, dated as of May 15, 2000, for Alan D.
Koslow, as amended.
27.1 Financial Data Schedule.
(b) Reports on Form 8-K
On May 22, 2000, we filed a Form 8-K, dated to announce that our corporate
name had been changed from ShopNow.com Inc. to Network Commerce Inc.
On June 16, 2000, we filed a Form 8-K, dated June 2, 2000, to announce the
effectiveness of our acquisition of Ubarter.com Inc., pursuant to an
Agreement and Plan of Merger dated as of January 20, 2000, as amended,
among Network Commerce, Shamu Acquisition, Inc. and Ubarter.com.
32
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NETWORK COMMERCE INC.
Date: August 14, 2000
By: /s/ Dwayne M. Walker
-------------------------------------
Dwayne M. Walker
Chief Executive Officer
By: /s/ Alan D. Koslow
-------------------------------------
Alan D. Koslow
Chief Financial Officer
33