UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended December 31,1999.
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:________
Netgateway, Inc.
---------------------------
(Exact name of registrant as specified in its charter)
Delaware 87-0591719
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
300 Oceangate, 5th Floor, Long Beach, California 90802
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(Address of principal executive offices) (Zip Code)
(562)308-0010
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(Registrant's telephone number, including area code)
----------------------------
(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_____
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Indicate by check mark whether the registrant has filed all
documents and reports required to be filed by Sections 12, 13 or 15(d) of the
Securities Exchange Act of 1934 subsequent to the distribution of securities
under a plan confirmed by a court.
Yes_____ No_____
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date: 16,954,464 shares of
common stock as of February 11, 2000
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When we refer in this Form 10Q to "Netgateway," "the Company," "we,"
"our," and "us," we mean Netgateway, Inc., a Delaware corporation, together with
our subsidiaries and their respective predecessors.
- --------------------------------------------------------------------------------
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS. (UNAUDITED)
Condensed Consolidated Balance Sheets at December 31, 1999 and at June 30, 1999...............F-1
Condensed Consolidated Statements of Operations for the three and six months ended
December 31, 1999 and 1998....................................................................F-2
Condensed Consolidated Statements of Cash Flows for the six months ended December 31, 1999
and 1998......................................................................................F-3
Condensed Consolidated Statements of Changes in Shareholders' Equity..........................F-4
Notes to the Condensed Consolidated Financial Statements..................................... F-5
NETGATEWAY, INC. AND SUBSIDIARY
Condensed Consolidated Balance Sheets
December 31, 1999 and June 30, 1999
December 31, June 30,
1999 1999
-------------- ----------
(Unaudited)
Assets
Current assets:
Cash $ 13,119,848 569,472
Accounts receivable less allowance for doubtful accounts of $600
and $3,000 at December 31, 1999 and June 30, 1999, respectively 464,375 44,198
Unbilled receivables 307,678 --
Note receivable from officer (note 4) -- 30,000
Debt issue costs -- 336,288
Prepaid offering costs -- 325,887
Prepaid advertising 300,000 --
Prepaid expenses and other current assets 659,151 73,481
------------ -----------
Total current assets 14,851,052 1,379,326
Property and equipment, net 1,598,683 496,536
Intangible assets, net 1,403,248 1,562,635
Other assets 27,284 19,853
------------ -----------
$ 17,880,267 3,458,350
============ ===========
Liabilities and Shareholders' Equity
Current liabilities:
Current portion of notes payable (note 5) $ -- 1,496,000
Convertible debentures (note 5) -- 200,000
Accounts payable 1,161,453 278,723
Accrued wages and benefits 759,403 278,741
Accrued interest 3,708 44,301
Accrued liabilities 646,990 543,632
Deferred revenue 36,392 67,694
Accrued contract losses -- 302,543
Current portion of notes payable to related parties -- 1,799
------------ -----------
Total current liabilities 2,607,946 3,213,433
Shareholders' equity (note 8):
Common stock, par value $.001 per share. Authorized
40,000,000 shares; issued and outstanding 16,956,778 and
9,912,304 at December 31, 1999 and June 30, 1999, respectively 16,957 9,913
Additional paid-in capital 54,291,536 15,639,160
Deferred compensation (505,909) (52,919)
Accumulated other comprehensive loss (4,160) (3,598)
Accumulated deficit (38,526,103) (15,347,639)
------------ -----------
Total shareholders' equity 15,272,321 244,917
Commitments and subsequent events (note 7)
------------- ----------
Total liabilities and shareholders' equity $ 17,880,267 3,458,350
============= ==========
See accompanying notes to unaudited condensed consolidated financial statements.
F-1
NETGATEWAY, INC. AND SUBSIDIARY
Unaudited Condensed Consolidated Statements of Operations
Three months Three months Six months Six months
ended ended ended ended
December 31, December 31, December 31, December 31,
1999 1998 1999 1998
-------------- ------------ ------------ ------------
Service revenue (note 3) $ 924,921 18,614 1,172,681 80,184
Operating expenses:
Depreciation and amortization 181,208 24,355 313,913 47,380
Selling, general and administrative 16,550,141 3,532,170 19,269,200 5,287,318
------------- --------- ---------- ---------
Total operating expenses 16,731,349 3,556,525 19,583,113 5,334,698
------------- --------- ---------- ---------
Loss from operations (15,806,428) (3,537,911) (18,410,432) (5,254,514)
Loss on sale of equity securities -- -- -- 54,729
Interest (income) expense, net 3,738,220 15,110 4,768,032 (17,970)
------------- --------- ---------- ---------
Net loss before extraordinary item (19,544,648) (3,553,021) (23,178,464) (5,291,273)
============= ========= ========== =========
Extraordinary gain on debt extinguishment -- 1,653,233 -- 1,653,233
============= ========= ========== =========
Net loss $ (19,544,648) (1,899,788) (23,178,464) (3,638,040)
============= ========= ========== =========
Basic and diluted extraordinary
gain per share $ -- 0.19 -- 0.20
============= ========= ========== =========
Basic and diluted loss per share $ (1.44) (0.22) (1.96) (0.43)
============= ========= ========== =========
Weighted average common shares outstanding -
basic and diluted 13,606,846 8,667,252 11,819,559 8,453,939
============= ========= ========== =========
See accompanying notes to unaudited condensed consolidated financial statements.
F-2
NET GATEWAY, INC. AND SUBSIDIARY
Unaudited Condensed Consolidated Statements of Cash Flows
Six months Six months
ended ended
December 31, December 31,
1999 1998
------------- ------------
Cash flows from operating activities:
Net loss $ (23,178,464) (3,638,040)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 313,913 47,380
Common stock issued for services 3,389,400 725,000
Loss on sale of equity securities -- 54,729
Amortization of deferred compensation 230,533 76,760
Gain on extinguishment of debt -- (1,653,232)
Stock compensation paid by shareholders -- 400,000
Stock issued in exchange for cancellation of options 8,400,000 --
Amortization of debt issue costs 585,592 --
Amortization of debt discount 4,022,550 35,488
Options and warrants issued for services 172,853 1,596,191
Provision for doubtful accounts -- 10,886
Write-off of note receivable -- 800,000
Changes in assets and liabilities:
Accounts receivable (420,177) (4,931)
Unbilled receivables (307,678) --
Other assets (266,464) 28,386
Accounts payable and accrued expenses 1,145,846 477,344
------------- ----------
Net cash used in operating activities (5,912,096) (1,044,039)
------------- ----------
Cash flows from investing activities:
Loan for notes receivable -- (800,000)
Repayment of notes receivable 30,000 50,000
Purchase of equity securities -- (100,733)
Proceeds from sale of equity securities -- 46,004
Purchase of property and equipment (1,256,673) (33,768)
------------- ----------
Net cash used in investing activities (1,226,673) (838,497)
------------- ----------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 25,314,234 1,932,800
Proceeds from exercise of warrants -- 231,000
Repayment of notes payable (6,633,500) --
Proceeds from issuance of notes payable and
convertible debentures 1,114,950 195,000
Cash paid for debt issue costs (104,178) --
Repayment of notes payable to related parties (1,799) (730,630)
------------- ----------
Net cash provided by financing activities 19,689,707 1,628,170
------------- ----------
Net increase in cash 12,550,938 (254,366)
Cash at beginning of period 569,472 254,597
Effect of exchange rate changes on cash balances (562) --
------------- ----------
Cash at end of period $ 13,119,848 231
============= ==========
Supplemental schedule of noncash activities:
Conversion of debt to common stock $ 200,000 --
Common stock issued for prepaid advertising 300,000 --
Capital contributed upon extinguishment of debt -- 200,000
Warrants issued to settle an obligation 53,534 --
Warrants issued for debt issue costs 145,876 --
============= ==========
See accompanying notes to unaudited condensed consolidated financial statements.
F-3
NETGATEWAY INC. AND SUBSDIARY
Unaudited Condensed Consolidated Statement of Changes in Shareholders' Equity
Common stock
-------------------------- Additional Deferred Comprehensive
Shares Amount paid-in capital Compensation Loss
------------ ---------- --------------------------------------------------------
Balance at June 30, 1999 9,912,304 $ 9,913 15,639,160 (52,919)
Common stock issued for prepaid advertising 50,000 50 299,950 -- --
Common stock issued for services 502,400 502 3,388,898 -- --
Warrants issued for services -- -- 53,534 -- --
Sale of common stock for cash, net 4,155,350 4,156 25,455,584 -- --
Shares issued for debenture conversion 80,000 80 199,920 -- --
Options granted for services -- -- 172,853 -- --
Stock option compensation -- -- 683,523 (683,523) --
Amortization of deferred compensation -- -- -- 230,533 --
Exercise of warrants 370 -- 370 -- --
Cashless exercise of options and warrants 969,810 969 (969) -- --
Shares issued for cancellation of options 1,200,000 1,200 8,398,800 -- --
Shares issued upon conversion of subsidiary
common stock 86,544 87 (87) -- --
Comprehensive loss:
Net loss -- -- -- -- (23,178,464)
Foreign currency translation adjustment -- -- -- -- (562)
------------
(23,179,026)
============
Total comprehensive loss
---------- ------- ------------ ---------
Balance at December 31, 1999 16,956,778 $16,957 54,291,536 (505,909)
========== ======= ============ =========
Accumulated
Other Total
Accumulated Comprehensive shareholders'
Deficit Loss equity
-------------------------------------------------
Balance at June 30, 1999 (15,347,639) (3,598) 244,917
Common stock issued for prepaid advertising -- -- 300,000
Common stock issued for services -- -- 3,389,400
Warrants issued for services -- -- 53,534
Sale of common stock for cash, net -- -- 25,459,740
Shares issued for debenture conversion -- -- 200,000
Options granted for services -- -- 172,853
Stock option compensation -- -- --
Amortization of deferred compensation -- -- 230,533
Exercise of warrants -- -- 370
Cashless exercise of options and warrants -- -- --
Shares issued for cancellation of options -- -- 8,400,000
Shares issued upon conversion of subsidiary
common stock -- -- --
Comprehensive loss:
Net loss (23,178,464) -- (23,178,464)
Foreign currency translation adjustment -- (562) (562)
Total comprehensive loss
------------ ------- ------------
Balance at December 31, 1999 (38,526,103) (4,160) 15,272,321
============ ======= ============
See accompanying notes to unaudited condensed consolidated financial statements.
F-4
NETGATEWAY, INC. AND SUBSIDIARY
Unaudited Notes to Condensed Consolidated Financial Statements
(1) Description of Business
Netgateway, Inc. and subsidiary ("Netgateway" to the "Company"), was formed
on March 4, 1998 as a Nevada corporation. Netgateway is an internet commerce
and connectivity company which provides turn-key solutions designed to
enable companies of any size to extend their business to the internet for a
wide variety of purposes, including the advertising and sale of products or
services by retailers and the conduct of commercial transactions between
business enterprises.
Prior to October 1, 1999, the Company was a development stage enterprise as
defined in Statement of Financial Accounting Standards ("SFAS") No. 7.
Planned principal operations commenced and began producing significant
revenue on October 1, 1999, and accordingly, Netgateway is no longer
considered a development stage company.
(2) Summary of Significant Accounting Policies
(a) Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
(b) Revenue Recognition
Revenues from the design and development of internet web sites and
related consulting projects are recognized using the
percentage-of-completion method. Unbilled receivables represent time
and costs incurred on projects in progress in excess of amounts billed,
and are recorded as assets. Deferred revenue represents amounts billed
in excess of costs incurred, and is recorded as a liability. To the
extent costs incurred and anticipated costs to complete projects in
progress exceed anticipated billings, a loss is recognized in the
period such determination is made for the excess.
(c) Business Segments and Related Information
Statement No. 131, "Disclosures about Segments of an Enterprise and
Related Information" (SFAS No. 131) establishes standards for the way
public business enterprises are to report information about operating
segments in annual financial statements and requires enterprises to
report selected information about operating segments in interim
F-5
NETGATEWAY, INC. AND SUBSIDIARY
Unaudited Notes to Condensed Consolidated Financial Statements (Continued)
financial reports issued to shareholders. It also establishes standards
for related disclosure about products and services, geographic areas
and major customers. It replaces the "industry segment" concept of SFAS
No. 14, "Financial Reporting for Segments of a Business Enterprise,"
with a "management approach" concept as the basis for identifying
reportable segments. The Company has only one operating segment. The
Company formed its wholly-owned Canadian subsidiary, StoresOnline.com,
Ltd., in January 1999. Prior to that time, the Company only had
operations in the United States. All revenues during the three and six
months ended December 31, 1999 and 1998 were generated in the United
States. Substantially all of the Company's long-lived assets were
located in the United States at December 31, 1999.
(d) Investment Securities
The Company accounts for investment securities in accordance with
Financial Accounting Standards Board Statement No. 115, "Accounting for
Certain Investments in Debt and Equity Securities" (SFAS 115). SFAS 115
requires investments to be classified based on management's intent in
one of the three categories: held-to-maturity securities,
available-for-sale securities and trading securities. Held-to-maturity
securities are recorded at amortized cost. Available-for-sale
securities are recorded at fair value with unrealized gains and losses
reported as a separate component of shareholders' equity and
comprehensive income (loss). Trading securities are recorded at market
value with unrealized gains and losses reported in operations. The
Company's investment securities have been classified as
available-for-sale.
(e) Foreign Currency Translation
The financial statements of the Company's Canadian subsidiary,
StoresOnline.com, Ltd. have been translated into U.S. dollars from its
functional currency in the accompanying consolidated financial
statements in accordance with Statement of Financial Accounting
Standards No. 52, "Foreign Currency Translation." Balance sheet
accounts of StoresOnline.com, Ltd. are translated at period-end
exchange rates while income and expenses are translated at actual
exchange rates on the date of the transaction. Translation gains or
losses that related to StoresOnline.com, Ltd.'s net assets are shown as
a separate component of shareholders' equity and comprehensive income
(loss). There were no gains or losses resulting from realized foreign
currency transactions (transactions denominated in a currency other
than the entities' functional currency) during the three and six months
ended December 31, 1999 and 1998.
F-6
NETGATEWAY, INC. AND SUBSIDIARY
Unaudited Notes to Condensed Consolidated Financial Statements (Continued)
(f) Loss Per Share
Basic earnings (loss) per share is computed by dividing net income
(loss) available to common shareholders by the weighted average number
of common shares outstanding during the period in accordance with SFAS
No. 128 "Earnings Per Share". Diluted earnings (loss) per share
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common
stock or resulted in the issuance of common stock that then shared in
the earnings of the entity. Diluted earnings (loss) per share is
computed similarly to fully diluted earnings (loss) per share pursuant
to Accounting Principles Board (APB) Opinion No. 15. There were
2,654,873 options and 1,366,375 warrants to purchase shares of common
stock that were outstanding during the three and six months ended
December 31, 1999 which were not included in the computation of diluted
loss per share because the impact would have been antidilutive. There
were 2,575,936 options and 1,150,000 warrants to purchase shares of
common stock that were outstanding during the three and six months
ended December 31, 1998 which were not included in the computation of
diluted loss per share because the impact would have been antidilutive.
(g) Costs of Start-Up Activities
Pursuant to AICPA Statement of Position No. 98-5, "Reporting on the
Costs of Start-Up Activities," the Company expenses all the costs of
start-up activities as incurred.
(h) Use of Estimates
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities and the
disclosure of contingent assets and liabilities at the balance sheet
date and the reporting of revenues and expenses during the reporting
periods to prepare these financial statements in conformity with
generally accepted accounting principles. Actual results could differ
from those estimates.
(i) Reclassifications
Certain amounts have been reclassified to conform with current year
presentation.
(3) Change in Method of Accounting for Revenue
Effective October 1, 1999, the Company changed its method of accounting for
revenue from the completed contract method to the percentage-of-completion
method. The Company believes the percentage of completion method more accurately
reflects the current earnings process under the Company's contracts. The
percentage of completion method is preferable according to Statement of Position
F-7
NETGATEWAY, INC. AND SUBSIDIARY
Unaudited Notes to Condensed Consolidated Financial Statements (Continued)
81-1, Accounting for Performance of Construction-Type and Certain
Production-Type Contracts, issued by the American Institute of Certified Public
Accountants. The new method has been applied retroactively by restating the
Company's consolidated financial statements for prior periods in accordance with
Accounting Principles Board Opinion No. 20.
The impact of the accounting change was a decrease in net loss and loss per
share as follows:
Net Loss Loss per Share
------------ ---------------
Three months ended December 31, 1999 $ 549,272 .04
Six months ended December 31, 1999 584,298 .05
Three months ended December 31, 1998 -- --
Six months ended December 31, 1998 -- --
(4) Notes Receivable and Notes Receivable from Officer
During the period March 4, 1998 (inception) through June 30, 1998, the Company
issued a $50,000 note receivable to a customer which was repaid during the six
months ended December 31, 1998. In July 1998 and August 1998, the Company
advanced $800,000 to an entity with which the Company was in merger discussions.
Certain Company officers and directors were minor shareholders of the potential
merger entity. The merger was not consummated and the advance was deemed
uncollectible and written-off during the three months ended September 30, 1998.
During June 1999, the Company issued its chief executive officer, Keith
Freadhoff, a non-interest bearing $30,000 note receivable. The note was repaid
in July 1999.
(5) Notes Payable and Convertible Debentures
In August and September 1999, the Company obtained bridge financing whereby 12%
senior notes payable and 357,850 shares of common stock were issued generating
proceeds of $2,744,290, net of $803,612 of issuance costs. The senior notes
payable are due the earlier of April 30, 2000 or upon the close of a public sale
of the Company's common stock. The Company also granted 149,375 warrants to
purchase an equivalent number of shares of common stock at an exercise price of
$10 per share as additional issuance costs. The warrants are exercisable for a
period of four years commencing May 18, 2000. The fair value of the warrants on
the dates of issuance was estimated to be $469,402 using the Black-Scholes
option-pricing model with the following assumptions: dividend yield of 0%;
risk-free interest rate of 5%; volatility of 100% and an expected life of 2
years. The net proceeds from the bridge financing were allocated to the senior
notes payable and common stock based on their relative fair values. Accordingly,
$957,450 was recorded as notes payable, $2,035,140 as equity, net of $555,313 of
stock issuance costs, and $248,299 as debt issuance costs.
F-8
NETGATEWAY, INC. AND SUBSIDIARY
Unaudited Notes to Condensed Consolidated Financial Statements (Continued)
In September 1999, the Company issued a 12% senior note payable of $500,000 and
50,000 shares of common stock valued at $350,000 stock, the proceeds of which
were received in October 1999. The note is due the earlier of April 30, 2000 or
upon the close of a public sale of the Company's common stock. In October 1999,
the Company issued a 12% senior note payable of $25,000 and 2,500 shares of
common stock valued at $17,500 generating net proceeds of $22,500. The note is
due the earlier of April 30, 2000 or upon the close of a public sale of the
Company's common stock. The Company also granted 1,250 warrants valued at
$3,349. The net proceeds were allocated to the senior notes payable and common
stock based on their relative fair value.
In November 1999, the Company repaid all of the $6,633,500 12% senior notes
payable. Upon repayment of the senior notes, the remaining debt discount balance
of $3,253,469 was recognized as interest expense.
In October and November 1999, $200,000 of convertible debentures were converted
into 80,000 shares of common stock.
(6) Shareholders' Equity
In July 1999, the Board of Directors adopted the 1999 Stock Option Plan for
Non-Executives. An aggregate of 2,000,000 shares were reserved for issuance
under the Plan. During the six months ended December 31, 1999, the Company
granted 1,119,682 options under the Plan at exercise prices ranging from $3.50
to $12.50 per share. The Company also granted 285,714 options under the 1998
Executive Plan during the six months ended December 31, 1999 at exercise prices
ranging from $3.50 to $8.18 per share. The Company also granted 123,916 options
under the 1998 Employee Stock Option Plan during the six months ended December
31, 1999 at exercise prices ranging from $3.50 to $4.19 per share.
In July 1999, the Company entered into a Cable Reseller and Mall agreement with
MediaOne of Colorado, Inc. (MediaOne) whereby the Company also issued to
MediaOne 50,000 shares of common stock and warrants to purchase 200,000 shares
of common stock. The exercise price of the warrants is dependent upon the market
price of the Company's common stock on the date that the warrants are earned
under certain performance criteria. As of December 31, 1999, the performance
criteria had not been met.
During the six months ended December 31, 1999, the Company issued 502,400 shares
of common stock valued at $3,389,400 for services, of which 500,000 shares were
issued to the CEO of the Company.
In October, the Company issued 969,810 shares of common stock upon the cashless
exercise of warrants, 100 shares of common stock upon the exercise of warrants
for $100, 1,200,000 shares of common stock valued at $8,400,000 to three
executives upon the cancellation of 1,980,000 options, and 8,000 shares of
common stock upon the conversion of $20,000 of convertible debentures. In
November 1999, the Company issued 270 shares of common stock upon the exercise
of warrants for $270.
F-9
NETGATEWAY, INC. AND SUBSIDIARY
Unaudited Notes to Condensed Consolidated Financial Statements (Continued)
In November and December 1999, the Company sold 3,795,000 shares of common stock
in a public offering generating net proceeds of $23,057,844. The Company also
granted 190,250 warrants as stock issuance costs.
In December 1999, the Company issued 86,544 shares of common stock upon the
conversion of common stock of its Storesonline.com subsidiary.
(7) Subsequent Events
In December 1999, the Company signed a letter of intent to acquire Galaxy
Enterprises, Inc. ("Galaxy Enterprises"). Under the terms of the letter of
intent, we will acquire Galaxy Enterprises in an all-stock merger by issuing to
Galaxy Enterprises's stockholders approximately 5 million shares of Netgateway
with a value of approximately $50 million. Among other things, Galaxy
Enterprises, through its subsidiary Galaxy Mall, Inc., engages in the business
of selling electronic home pages, or "storefronts" on its Internet shopping
mall, and hosts those storefront sites on its Internet server. Galaxy
Enterprises also conducts Internet training seminars throughout the United
States for its customers and for others interestd in extending their businesses
to the Internet.
In connection with the proposed merger, on January 7, 2000, the Company advanced
$300,000 in bridge financing to Galaxy Enterprises for working capital purposes
and for the payment of certain professional fees incurred by Galaxy Enterprises
in connection with the merger. On February 4, 2000, the Company advanced an
additional $150,000 to Galaxy Enterprises for working capital purposes and for
the payment of certain professional fees incurred by Galaxy Enterprises in
connection with the merger. Each loan is secured by a pledge of Galaxy
Enterprises common stock from John J. Poelman, the chief executive officer and
largest shareholder of Galaxy Enterprises. The notes bear interest at 9.5% and
are due and payable on the earlier of April 30, 2000 or the consummation date of
the acquisition.
F-10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following "Management's Discussion and Analysis of Financial Condition and
Results of Operations" includes "forward-looking statements" within the meaning
of the Private Securities Litigation Reform Act of 1995. This Act provides a
"safe harbor" for forward-looking statements to encourage companies to provide
prospective information about themselves so long as they identify these
statements as forward-looking and provide meaningful cautionary statements
identifying important factors that could cause actual results to differ from the
projected results. All statements other than statements of historical fact that
we make in this Form 10Q are forward looking. In particular, statements herein
regarding our future results of operations or financial position are
forward-looking statements. Forward-looking statements reflecting our current
expectations are inherently uncertain. Our actual results may differ
significantly from our expectations. Factors that may cause such differences
include, but are not limited to, those discussed under the heading "Risk
Factors" in our Registration Statement on Form S-1, as filed with the Securities
and Exchange Commission (the "SEC") on June 1, 1999, amended by Amendment No. 1
filed with the SEC on July 21, 1999, amended by Amendment No. 2 filed with the
SEC on October 14, 1999, amended by Amendment No. 3 filed with the SEC on
November 12, 1999 and amended by Amendment No. 4 filed with the SEC on November
17, 1999 (Registration No. 333-79571), and elsewhere in this report. This
Management's Discussion and Analysis of Financial Condition and Results of
Operations should be read in conjunction with our financial statements and the
related notes included elsewhere herein.
General
We provide turn-key electronic commerce services designed to enable clients to
extend their business to the Internet to conduct commercial transactions between
business enterprises. The hub of our electronic commerce solution is our
proprietary Internet Commerce Center "ICC", which consists of the hardware,
proprietary and licensed software, and the related technical services necessary
for our clients to transact electronic commerce, known in our industry as
eCommerce. We also design and build custom interfaces, or spokes, to connect
business clients to the ICC. Our ICC provides our clients a continuum of
increasingly sophisticated and technologically complex solutions, ranging from a
simple internet storefront advertising their products and taking orders through
e-mail to a highly complex system of private websites, known as extranets. These
extranets are accessible only by clients and selected outsiders, such as our
customers, suppliers, and vendors, to interact and transact business-to-business
electronic commerce.
Prior to October 1, 1999, we were a development stage enterprise as defined in
Statement of Financial Accounting Standards ("SFAS") No. 7. Planned principal
operations commenced and began producing significant revenue on October 1, 1999,
and accordingly, we are no longer considered a development stage company.
Effective October 1, 1999, we changed our method of accounting for revenue from
the completed contract method to the percentage-of-completion method. We believe
that the percentage of completion method more accurately reflects the current
earnings process under the Company's contracts. The percentage of completion
method is preferable according to Statement of Position 81-1, Accounting for
Performance of Construction-Type and Certain Production-Type Contracts, issued
by the American Institute of Certified Public Accountants. The new method has
been applied retroactively by restating our consolidated financial statements
for prior periods in accordance with Accounting Principles Board Opinion No. 20.
Results of Operations
Revenue
Service revenue includes revenues related to web site development and the design
of electronic storefronts, internet-based shopping mall development and design,
and transaction processing. Service revenues for the three and six month periods
ended December 31, 1999 increased to $924,921 and $1,172,681, respectively, from
$18,614 and $80,184 in the comparable prior periods. The growth in service
revenues was attributable primarily to the addition of several new customers to
our ICC. In addition, our average price for system development has increased as
the scope and technical requirements of our customers utilizing the ICC has
increased.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist of payroll and related
expenses for executive, sales, marketing, accounting and administrative
personnel, recruiting, professional fees, research and development and other
general corporate expenses. Selling, general and administrative expenses for the
three and six month periods ended December 31, 1999 increased to $16,550,141 and
$19,269,200, respectively, from $3,532,170 and $5,287,318 in the comparable
prior periods. The increase in selling, general and administrative expenses is
attributable primarily to non-cash compensation from common stock issued to
executives during the three months ended December 31,1999 valued at $11,775,000.
The increases in selling, general and administrative expenses are also
attributable to increased payroll-related and other infrastructure costs as we
expand and incur additional costs related to the growth of our business.
Interest (Income) Expense, Net
Interest expense consists primarily of amortization of debt issuance costs and
debt discount and interest in connection with our $1,000,000 of Secured
Convertible Debentures due December 31,1999 (the "Convertible Debentures"), and
$6,633,500 of our Series A 12% Senior Notes (the "Senior Notes"). The Senior
Notes were issued in connection with our May through October 1999 bridge
financing private placements (the "Bridge Financing"). Interest (income)
expense, net for the three and six month periods ended December 31, 1999,
increased to $3,738,220 and $4,768,032, respectively, from $15,110 and $(17,970)
in the comparable prior periods. The increase in interest expense is
attributable primarily to the amortization of promissory note discounts incurred
in conjunction with the Bridge Financing. The amortization of the debt discount
aggregated $3,587,853 and $4,356,934 during the three and six-month periods
ended December 31, 1999, respectively. All of the Convertible Debentures were
converted into common stock as of December 31, 1999. The Senior Notes were
repaid in full in November 1999.
Income Taxes
We have not generated any taxable income to date and therefore have not paid any
federal income taxes since our inception. Utilization of our net operating loss
carry forwards, which begin to expire in 2013, may be subject to certain
limitations under Section 382 of the Internal Revenue Code of 1986, as amended.
Liquidity and Capital Resources
At December 31, 1999, the Company had $13,119,848 in cash on hand, an increase
of $12,550,376 from June 30, 1999.
Net cash used in operating activities was $5,577,712 for the six-month period
ended December 31, 1999. Net cash used in operations was primarily attributable
to $23,178,464 in net losses and increases in assets, partially offset by
non-cash charges as well as increases in accounts payable and accrued expenses.
Increases in assets included $420,177 in accounts receivable and $307,678 in
unbilled receivables resulting from the growth in revenues. Non-cash charges
include $3,389,000 for common stock issued for services, $8,400,000 for stock
issued for cancellation of options and $4,022,550 from the amortization of debt
discount. Accounts payable and accrued expenses increased $1,145,846 and
resulted primarily from the accrual of mid-year bonuses to our employees and
balances owed on capital expenditures.
Net cash used in investing activities was $1,226,673 for the six months ended
December 31, 1999 and consisted primarily of purchases of property and equipment
for the upgrade of our technological infrastructure.
Net cash provided by financing activities of $19,355,323 for the six-month
period ended December 31, 1999 resulted primarily from $1,114,950 in proceeds
from the issuance of Senior Notes and $25,314,234 in proceeds from the issuance
of common stock in connection with our secondary offering, which we completed in
November and December 1999. These proceeds were partially offset by $6,633,500
used to repay the Bridge Financing loans in their entirety.
We believe that our existing capital resources are adequate to meet its cash
requirements for at least the next ten months. We anticipate that we will incur
additional capital expenditures spending during the third and fourth quarters of
our fiscal year to continue upgrading the technological infrastructure.
Recent Events
In December 1999, the Company signed a letter of intent to acquire Galaxy
Enterprises, Inc. ("Galaxy Enterprises"). Under the terms of the letter of
intent, we will acquire Galaxy Enterprises in an all-stock merger by issuing to
Galaxy Enterprise's stockholders approximately 5 million shares of Netgateway
with a value of approximately $50 million. Among other things, Galaxy
Enterprises, through its subsidiary, Galaxy Mall, Inc., engages in the business
of selling electronic home pages, or "storefronts" on its Internet shopping
mall, and hosts those storefront sites on its Internet server. Galaxy
Enterprises also conducts Internet training seminars throughout the United
States for its customers and for others interested in extending their businesses
to the Internet.
In connection with the proposed merger, on January 7, 2000, the Company advanced
$300,000 in bridge financing to Galaxy Enterprises for working capital purposes
and for the payment of certain professional fees incurred by Galaxy Enterprises
in connection with the merger. On February 4, 2000, the Company advanced an
additional $150,000 to Galaxy Enterprises for working capital purposes and for
the payment of certain professional fees incurred by Galaxy Enterprises in
connection with the merger. Each loan is secured by a pledge of Galaxy
Enterprises common stock from John J. Poelman, the chief executive officer and
largest shareholder of Galaxy Enterprises.
In December 1999, the Company reached an agreement with Leading Technologies
Inc.,d/b/a Mall of Minority America.com, Inc. to develop, manage, and service
Leading Technologies Inc.'s Internet-based shopping mall and client extranet.
In January 2000, the Company reached an agreement with Intermedia Partners
Southeast, an affiliate of AT&T Media Services, to launch a local electronic
shopping portal in Nashville, Tennessee. Pursuant to this agreement, the Company
will design and develop an Internet-based shopping mall, to be branded with the
Intermedia's name, brand and image, and will offer its storefront building and
maintenance services to Intermedia's subscribers. The Company will also be
responsible for marketing support, including development of mall content,
training of Intermedia's sales people, development of Intermedia's branded
collateral material and periodic distribution and updating of advertising spots
to promote online shopping mall and storebuilding services.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISK
None.
PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
The proceeds from the offering of 3,795,000 shares of our common stock
have been used to repay $6,633,500 of indebtedness incurred in
connection with our May through September 1999 private placements of
Series A 12% Senior Notes due 2000. Additionally approximately $830,000
was used to upgrade our technological infrastructure. The remainder of
the proceeds is being used to fund operations and continue to develop
the infrastructure necessary to support the growth of our business. As
of December 31, 1999 we had $13,119,848 of the proceeds from the
offering.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
The documents required to be filed as exhibits to this report under
Item 601 of Regulation S-K are listed in the Exhibit Index included elsewhere in
this report, which list is incorporated herein by reference.
(b) Reports on Form 8-K
None.
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.
NETGATEWAY, INC.
Date: February 14, 2000 /s/ Roy W. Camblin
----------------------------------
Name: Roy W. Camblin III
Title: Chief Executive Officer
Date: February 14, 2000 /s/ Donald M. Corliss Jr.
----------------------------------
Name: Donald M. Corliss Jr.
Title: President
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.1 Letter of Intent, dated December 12, 1999 between Galaxy Enterprises, Inc., a Nevada corporation
and the Company
10.2R Electronic Commerce Services Agreement, dated as of December 1, 1999, between Netgateway and
Leading Technologies, Inc. d/b/a Mall of Minority America.com, Inc.
10.3R Cable Reseller and Mall Agreement, dated as of December 9, 1999, among Netgateway,
StoresOnline.com, Inc. and Intermedia Partners Southeast
10.4 Pledge Agreement, dated as of January 7, 2000, between John J. Poelman and the Company
10.5 Promissory Note in the principal amount of $300,000, dated January 7, 2000 issued to the Company
10.6 Pledge Agreement, dated as of February 4, 2000, between John J. Poelman and the Company
10.7 Promissory Note in the principal amount of $150,000, dated February 4, 2000 issued to the Company
10.8 Employment Agreement, dated as of December 15, 1999, between Jill Padwa and the Company
18.1 Letter dated February 9, 2000 from KPMG LLP
Please note that certain confidential technical and commercial information has
been redacted from some of the exhibits attached to this Form 10-Q in order to
preserve the confidentiality of such information. All of the confidential
information which has been redacted is on file with the Securities and Exchange
Commission and may be obtained in accordance with the Freedom of Information
Act. Exhibits to this Form 10-Q which have had confidential information redacted
are indicated as follows on the exhibit list above: "R" Within the exhibits to
this Form 10-Q, redacted material is indicated by the following sign where such
redacted text would have appeared in the relevant exhibit: "[**REDACTED**]"