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, 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 000-27941
NETGATEWAY, INC.
---------------
(Exact name of registrant as specified in its charter)
Delaware 87-0591719
-------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
754 E. Technology Avenue
Orem, Utah 84097
---------- -----
(Address of Principal Executive Offices) (Zip Code)
(801) 227-0004
--------------
(Registrant's telephone number, including area code)
Not Applicable
---------------
(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 proceeding 12 months and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
The number of shares outstanding of the registrant's common stock as of
December 31, 2000: 21,694,791
When we refer in this Form 10-Q 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.
Condensed Consolidated Balance Sheets at December 31, 2000 (unaudited) and at
June 30, 2000..........................................................3
Unaudited Condensed Consolidated Statements of Operations for the six months
ended December 31, 2000 and December 31, 1999 .........................4
Unaudited Condensed Consolidated Statements of Cash Flows for the six months
ended December 31, 2000 and December 31, 1999..........................5
Unaudited Consolidated Statement of Stockholders' Deficit .....................7
Notes to the Unaudited Condensed Consolidated Financial Statements ............9
NETGATEWAY, INC.
Condensed Consolidated Balance Sheets
December 31 June 30,
2000 2000
(Unaudited)
----------------------- -----------------------
Assets
Cash $ 39,706 $ 2,607,491
Trade receivable, net 4,356,561 2,383,544
Related party trade receivables 0 2,519
Unbilled receivables 18,386 12,293
Inventories 83,076 98,372
Prepaid expenses 120,783 395,074
Other current assets 428,156 726,648
----------------------- -----------------------
Total current assets 5,046,668 6,225,941
Property and equipment, net 1,840,574 3,026,487
Intangible assets, net 872,504 2,167,024
Other assets 1,510,977 889,948
----------------------- -----------------------
Total Assets $ 9,270,723 $ 12,309,400
======================= =======================
Liabilities and Stockholders' Deficit
Accounts payable $ 4,843,804 $ 2,839,727
Bank overdraft 820,527 330,307
Accrued wages and benefits 1,453,982 1,454,819
Accrued liabilities 2,231,393 1,311,859
Capital leases 87,897 87,897
Current portion of notes payable 408,535 102,326
Current portion of deferred revenue 14,614,743 14,943,860
Convertible debenture 2,276,972 -
----------------------- -----------------------
Total current liabilities $ 26,737,853 $ 21,070,795
Deferred revenue, net of current portion 988,276 1,023,292
Other liabilities 125,625 449,785
Capital leases 47,379 47,379
----------------------- -----------------------
Total Liabilities $ 27,899,133 $ 22,591,251
----------------------- -----------------------
Minority interest 355,159 494,449
Stockholders' deficit:
Preferred stock, par value $.001 per share. Authorized
5,000,000 Shares; issued and outstanding 0 shares - -
Common stock, par value $.001 per shares. Authorized
250,000,000; issued and outstanding 21,694,791 and
21,648,732 at December 31, 2000 and June 30, 2000
respectively 21,695 21,649
Additional paid-in capital 59,247,103 58,012,244
Deferred compensation (300,805) (724,994)
Accumulated other comprehensive loss (4,972) (4,267)
Accumulated deficit (77,946,590) (68,080,932)
----------------------- -----------------------
Total stockholders' deficit $ (18,983,569) $ (10,776,300)
----------------------- -----------------------
Total Liabilities and Stockholders' Deficit $ 9,270,723 $ 12,309,400
======================= =======================
NETGATEWAY, INC.
Unaudited Condensed Consolidated Statements of Operation for the
Three Months and Six Months Ended December 31, 2000 and December 31, 1999
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
December 31, December 31, December 31, December 31,
2000 1999 2000 1999
------------------- ------------------ ------------------- -------------------
Service revenue $ 14,179,643 $ 4,671,502 $ 21,605,501 $ 8,614,011
Product sales 491,861 2,794,147 1,016,765 4,116,315
------------------- ------------------ ------------------- -------------------
Total revenue 14,671,504 7,465,649 22,622,266 12,730,326
Cost of service revenue 2,227,512 1,087,258 4,417,419 3,459,637
Cost of product sales 300,642 475,007 634,534 1,605,363
------------------- ------------------ ------------------- -------------------
Gross profit 12,143,350 5,903,384 17,570,313 7,665,326
Product development 443,013 1,834,939 1,657,337 1,834,939
Selling and marketing 6,976,100 6,222,539 13,926,647 11,327,199
General and administrative 5,560,729 16,327,862 7,808,934 16,987,856
Depreciation and amortization 420,763 230,185 840,090 408,967
Bad debt expense 1,809,138 - 2,130,985 -
------------------- ------------------ ------------------- -------------------
Total operating expenses 15,209,743 24,615,525 26,363,993 30,558,961
Loss from Operations (3,066,393) (18,712,141) (8,793,680) (22,893,635)
Other income (expense) (16,462) 10,196 (24,198) 4,289
Interest expense (103,380) (3,742,342) (1,048,392) (4,773,958)
------------------- ------------------ ------------------- -------------------
Total other expenses (119,842) (3,732,147) (1,072,591) (4,769,669)
------------------- ------------------ ------------------- -------------------
Net loss $ (3,186,236) $ (22,444,288) $ (9,866,271) $ (27,663,304)
=================== ================== =================== ===================
Basic and diluted loss per share (0.15) (1.27) (0.45) (1.76)
=================== ================== =================== ===================
Basic and diluted weighted
average shares outstanding 21,691,464 17,628,962 21,693,127 15,744,396
NETGATEWAY, INC.
Unaudited Condensed Consolidated Statements of Cash Flows
For the Six Months Ended December 31, 2000 and December 31, 1999
Six Months Ended Six Months Ended
December 31 December 31
2000 1999
---------------------- -------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (9,866,271) $ (27,663,304)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 840,090 408,967
Bad debt expense 2,130,985 -
Loss on disposal of fixed assets and intangibles 1,727,013
Amortization of deferred compensation 255,555 251,533
Interest expense from beneficial conversion feature 884,000 -
Common stock issued for services 7,000 3,389,400
Stock issued in exchange for cancellation of options - 8,400,000
Warrants and options issued for services - 172,853
Amortization of debt issue costs 40,168 585,592.00
Amortization of debt discount 27,805 4,022,550.00
Changes in assets and liabilities:
Trade receivables and unbilled receivables (3,760,538) (2,273,353)
Prepaid offering costs - (132,548)
Inventory 15,296 (44,937)
Other assets (79,082) 263,768
Deferred revenue (364,133) 3,690,870
Accounts payable and accrued expenses 2,596,365 2,284,075
---------------------- -------------------------
Net cash flows used in operating activities (5,545,747) (6,644,534)
---------------------- -------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Cash received in acquisition 16,905
Repayment of notes receivable 30,000
Purchase of equipment (49,987) (1,305,490)
---------------------- -------------------------
Net cash used in investing activities (49,987) (1,258,585)
---------------------- -------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds for issuance of stock - 25,164,985
Proceeds from exercise of options and warrants 2,250 -
Repayment of notes (53,791) (6,555,943)
Repayment of note to a related party (1,799)
Cash paid for debt issue costs (270,025) (104,178)
Bank borrowing 540,220 169,606
Proceeds from issuance of notes payable 1,576,901
Proceeds from issuance of long term debenture 2,500,000 0
Proceeds from issuance of long term debt 310,000
---------------------- -------------------------
Net cash flows from financing activities 3,028,654 20,249,572
---------------------- -------------------------
NET INCREASE (DECREASE) IN CASH (2,567,080) 12,346,453
CASH AT THE BEGINNING OF THE PERIOD 2,607,491 906,698
Effect of exchange rate changes on cash balances (705) (562)
---------------------- -------------------------
CASH AT THE END OF THE PERIOD $ 39,706 $ 13,252,589
====================== =========================
Supplemental disclosures of non-cash transactions:
Conversion of debt to common stock 200,000
Interest expense from beneficial conversion feature 884,000 -
Common stock issued for services 7,000 -
Common stock issued for prepaid advertising 300,000
Warrants issued to settle an obligation 53,534
Warrants issued for debt issuance 371,000 145,876
Supplemental disclosure of cash flow information;
Interest paid 61,012 -
NETGATEWAY, INC.
Consolidated Statement of Stockholders' Deficit
Common Stock Additional
--------------------------------------- Paid-in Deferred
Shares Amount Capital Compensation
--------------------- ----------------- ----------------- --------------------
Balance June 30, 2000 21,648,732 $ 21,649 $ 58,012,244 $ (724,994)
Exchange for Stores On Line stock 37,144 $ 37 $ 139,253 $ -
Stock Options Exercised 1,915 $ 2 $ 2,248 $ -
Shares issued for services 7,000 $ 7 $ 6,993 $ -
Amortization of deferred
compensation - $ - $ - $ 159,959
Forfeture of stock options - $ - $ (93,130) $ 93,129 $
Beneficial Conversion Feature on debt - $ - $ 884,000 $ -
Warrants issued for convertible debentures - $ - $ 371,000 $ -
Foreign currency translation
adjustment - $ - $ - $ -
Amortization of deferred
compensation - $ - $ $ - $ 95,597
Forfeture of deferred compensation - $ - $ (75,505) $ 75,505
Net Loss - $ - $ - $ -
Foreign currency translation
adjustment - $ - $ - $ -
Comprehensive Loss
--------------------- ----------------- --------------------------------------------
Balance December 31, 2000 21,694,791 $ 21,695 $ 59,247,103 $ (300,805)
===================== ================= =================== ==========================
(CONTINUED)
CONTINUED)
Accumulated
Other Total
Balance June 30, 2000 Accumulated Comprehensive Shareholders'
Deficit loss Deficit
--------------- ----------------- ---------------------
Exchange for Stores On Line stock $ (68,080,932) $ (4,267) $ (10,776,300)
Stock Options Exercised $ - $ - $ 139,290
Shares issued for services $ - $ - $ 2,250
Amortization of deferred
compensation
$ - $ - $ 7,000
Forfeture of stock options $ - $ - $ 159,959
Beneficial Conversion Feature on debt $ - $ - $ (1)
Warrants issued for convertible debentures $ - $ - $ 884,000
Foreign currency translation
adjustment
$ - $ - $ 371,000
Amortization of deferred
compensation $ (118) $ 608 $ (726)
$ - $ - $ 95,597
Forfeture of deferred compensation
Net Loss $ - $ - $ -
Foreign currency translation
adjustment
$ 9,866,271 $ - $ (9,866,271)
$ 731 $ (97) 633
Comprehensive Loss
Balance December 31, 2000 ----------------
(9,865,637)
---------------- -------------------- -----------------
$ (77,946,590) $ (4,972) $ (18,983,569)
================ =================== ================
NETGATEWAY, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(1) Description of Business
Netgateway, Inc. and subsidiaries ("Netgateway" or the "Company"), was
formed on March 4, 1998 as a Nevada corporation. Netgateway provides eCommerce
services designed to enable clients to extend their business to the Internet
quickly and effectively, with minimal investment. Netgateway develops, hosts,
licenses, and supports a wide range of built-to-order business-to-business,
business-to-consumer and business-to-employee applications, including enterprise
portal, e-retail, e-procurement and e-marketplace solutions. In addition,
Netgateway engages in the business of selling electronic home pages, or
"storefronts" on its Internet shopping mall, and hosts those storefront sites as
its Internet server. Netgateway also conducts Internet training seminars
throughout the United States for its customers and for others interested in
extending their businesses to the internet.
(2) Summary of Significant Accounting Policies
(a)......Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. The Company's acquisition of Galaxy
Enterprises on June 26, 2000 was accounted for under the pooling-of-interest
method and accordingly all periods prior to the acquisition have been restated
to include the accounts and results of operations of Galaxy Enterprises for all
periods presented. All Galaxy common stock and common stock option information
has been adjusted to reflect the exchange ratio. All significant intercompany
balances and transactions have been eliminated in consolidation.
(b)......The information furnished is unaudited and reflects all
adjustments that, in the opinion of management, are necessary to provide a fair
statement and should be read in conjunction with the financial statements
included in the Company's Annual Report on Form 10-K for the year ended June 30,
2000 as filed with the Securities and Exchange Commission (the "SEC").
(c)......Inventories
Inventories are stated at the lower of cost (first-in, first-out) or
market. Inventory consists mainly of products provided in conjuction with the
Internet training workshops.
(d)......Property and Equipment
Property and equipment are stated at cost. Depreciation expense is
computed principally on the straight-line method in amounts sufficient to write
off the cost of depreciable assets over their estimated useful lives ranging
from 3 to 5 years. The cost of leasehold improvements is being depreciated using
the straight-line method over the shorter of the estimated useful life of the
asset or the terms of the related leases. Depreciable lives by asset group are
as follows:
Computer and office equipment ...................3 to 5 years
Furniture and fixtures...........................4 years
Computer software................................3 years
Leasehold improvements...........................4 years (term of lease)
Normal maintenance and repair items are charged to costs and expenses
as incurred. The cost and accumulated depreciation of property and equipment
sold or otherwise retired are removed from the accounts and gain or loss on
disposition is reflected in net income in the period of disposition.
(e)......Intangible Assets
Intangible assets are amortized on a straight-line basis over their
estimated useful lives as follows:
Acquired technology.......................5 to 7 years
Goodwill..................................10 years
(f)......Impairment of Long-Lived Assets and Long-Lived Assets to be
Disposed Of
The Company reviews long-lived assets and certain identifiable
intangibles for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to future undiscounted operating cash flows expected to be generated by
the asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets. Assets to be disposed of are reported at
the lower of the carrying amount or fair value less costs to sell.
(g) Financial Instruments
The carrying values of cash, accounts receivable, notes receivable,
accounts payable, accrued liabilities, capital leases, current portion of notes
payable and convertible debenture approximated fair value due to the short
maturity of those instruments. All financial instruments are held for purposes
other than trading.
(h) Income Taxes
Income taxes are accounted for under the asset and liability method.
The asset and liability method recognizes deferred income taxes for the tax
consequences of "temporary differences" by applying enacted statutory tax rates
applicable to future years to differences between the financial statement
carrying amounts and the tax bases of existing assets and liabilities. The
effect on deferred taxes of a change in tax rates is recognized in income in the
period that includes the enactment date.
Deferred tax assets are to be recognized for temporary differences that
will result in deductible amounts in future years and for tax carryforwards if,
in the opinion of management, it is more likely than not that the deferred tax
assets will be realized.
(i) Accounting for Stock Options
The Company applies the intrinsic value-based method of accounting
prescribed by Accounting Principles Board (APB) Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations, in accounting for its
fixed plan employee stock options. As such, compensation expense would be
recorded on the date of grant only if the current market price of the underlying
stock exceeded the exercise price. Compensation expense related to stock options
granted to non-employees is accounted for under Statement of Financial
Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation,"
whereby compensation expense is recognized over the vesting period based on the
fair value of the options on the date of grant.
(j) .....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.
Revenue from Internet training workshops (which entitle the customer to
attend the workshop, activate Web sites and receive customer Web site hosting)
is deferred and recognized over a twenty-four month period which represents the
twelve months in which a customer can activate a web site plus twelve months of
free hosting upon activation. Revenue from web site hosting rights that expire
is recognized at the point of expiration. Revenue from manufactured multimedia
products is recognized when products are shipped. Revenues from the "Complete
Store-Builder Packet", banner advertising and mentor services are recognized
when delivered.
(k) .....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 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 two principal business
segments (Internet services and multimedia products). The first is primarily
engaged in the business of providing its customers the ability to (i) acquire a
presence on the internet and (ii) to advertise and sell their products or
services on the Internet. The second is primarily engaged in providing
assistance in the design, manufacture and marketing of multimedia brochure kits,
shaped compact discs and similar products and services intended to facilitate
conducting business over the Internet. Management evaluates segment performance
based on the contributions to earnings of the respective segment. Substantially
all the Company's business operations are in the United States.
(l) .....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 six months ended December 31, 2000 and 1999.
(m) .....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
3,816,042 options and 1,553,160 warrants to purchase shares of common stock that
were outstanding during the three months ended December 31, 2000 and 3,275,540
options and 1,755,666 warrants to purchase shares of common stock that were
outstanding during the three months ended December 31, 1999 which were not
included in the computation of diluted loss per share because the impact would
have been antidilutive.
(n) .....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.
(o) .....Reclassifications
Certain amounts have been reclassified to conform to current year
presentation.
(3) Liquidity
The accompanying financial statements have been prepared on the basis
that the Company will continue as a going concern, which contemplates the
realization of assets and satisfaction of liabilities in the normal course of
business. The Company has generated significant losses. The Company has relied
upon private placements of its stock and issuance of debt to generate funds to
meet its operating needs and plans to continue pursuing financing in this manner
during the next year. However, there are not assurances that such financing will
be available when and as needed to satisfy current obligations. As such,
substantial doubt exists as to whether the Company will continue as a going
concern.
(4) 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
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.
(5) Notes Payable and Convertible Debentures
In July 2000, the Company entered into a securities purchase agreement with King
William, LLC. Under the terms of the agreement, the Company issued to King
William an 8% convertible debenture due July 31, 2003 in the principal amount of
$4.5 million. The debenture was convertible into the number of shares of our
common stock at the lower of $1.79 or a conversion rate of 80% of the average
market price of the common stock during any three non-consecutive trading days
during the 20 trading days prior to conversion. The purchase price for the
debenture was payable in two tranches. The first tranche of $2.5 million was
paid at the closing in July 2000. The second tranche of $2.0 million may be
drawn down by the Company three business days after the satisfaction by the
Company of certain conditions, including that there be on file an effective
registration statement covering the shares issuable upon conversion of the
debenture and certification by the Company of its ability to honor a conversion
of the entire balance of the debenture and an exercise of all related warrants
without violating the capitalization regulations of the principal exchange on
which the shares of our common stock are then listed. Effective as of January
25, 2001, we reached an agreement with King William LLC to restructure this
debenture. Under the terms of the agreement no second tranche of the debenture
will be available and the note is scheduled to be repaid in installments with a
15% prepayment premium over the remainder of calendar year 2001. Additionally,
Netgateway has allowed King William to retain the right to convert any or all
portion of the outstanding debt to equity, but only after the stock has traded
at or above $3.00 for twenty consecutive trading days or if Netgateway does not
make a required payment of principal. Warrants already earned by King William
were repriced at $.25 per share and King William was issued a warrant for an
additional 269,000 shares of common stock at $.25 per share. During the first
week of February, 2001 the initial payment of $250,000 as called for by the
agreement was made. As of the date of the Restructuring Agreement the Company
was in default under the Convertible Debenture but pursuant to the terms of the
Restructuring Agreement the holder of the Convertible Debenture has waived all
of these defaults as of the date of the Restructuring Agreement.
The value of the beneficial conversion feature on the $2.5 million that
has been drawn down on the $4.5 million principal amount as of September 30,
2000, is recorded as capital and interest expense of $884,000 for the quarter
ended September 30, 2000, as the convertible debentures are immediately
exerciseable.
In connection with the securities purchase agreement, the Company
issued to King William a warrant to purchase 231,000 shares of common stock. In
connection with the issuance of the debenture, the Company also issued to Roth
Capital Partners, Inc., a warrant to purchase 90,000 shares of common stock and
to Carbon Mesa Partners, LLC, a warrant to purchase 10,000 shares of common
stock. Each of the warrants is exercisable for five years from the date of
issue, at an exercise price of $1.625 per share and with cashless exercise and
piggyback registration rights. The fair value of the warrants has been
determined to equal $371,000. Of the $371,000, $259,000 is accounted as capital
and debt discount and is amortized over the life of the debt. The remaining
balance is accounted for debt issuance costs under other assets and is amortized
over the life of the debt.
In August 2000, the Company entered into a private equity credit
agreement with King William, LLC. Under the terms of the agreement, the Company
has the right to issue and sell to King William up to $10 million of our common
stock at 87.5% of the market price at the time of sale, subject to certain
conditions and adjustments. In addition, for each 10,000 shares of common stock
that the Company issues and sells to King William, the Company will issue a
warrant to King William to purchase 1,500 shares of the Company common stock at
an exercise price equal to 125% of the market price of the common stock as of
the put date and exercisable for a period of five years from the put date,
together with cashless exercise and piggy back registration rights. Under the
terms of the Restructuring Agreement this agreement was terminated effective as
of the date of the Restructuring Agreement and no termination payment or
additional warrants were issued in connection therewith.
At the present time there is no cash available to the Company under
these agreements.
(6) Shareholders' Equity
During the three-month period ending September 30, 2000, the Company
issued 37,144 shares of common stock upon the exchange of common stock of its
StoresOnline.com, Ltd. Subsidiary, pursuant to the terms of the original
issuance of StoresOnline.com Ltd.'s common stock.
During the three-month period ending September 30, 2000, the Company
issued 1,915 shares upon the exercise of employee options and issued 7,000
shares of common stock pursuant to employment contracts.
During the three-month period ending December 31, 2000, the Company did
not issue shares of common stock.
(7) Segment Information
The Company has two principal business segments (Internet services and
multimedia products). The first is primarily engaged in the business of
providing its customers the ability to (i) acquire a presence on the Internet
and (ii) to advertise and sell their products or services on the Internet. The
second is primarily engaged in providing assistance in the design, manufacture
and marketing of multimedia brochure kits, shaped compact discs and similar
products and services intended to facilitate conducting business over the
Internet. Management evaluates segment performance based on the contributions to
earnings of the respective segment. Management has not included information
relative to Interest Income, Interest Expense or Income Taxes, because we do not
evaluate these items in our decisions relative to allocation of resources to the
segments of the Company. An analysis and reconciliation of the Company's
business segment information to the respective information in the consolidated
financial statements is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2000 1999 2000 1999
---------- ---------- ---------- ----------
Service revenue:
Internet services $ 14,179,643 $ 4,671,502 $ 21,605,500 $ 8,614,011
Multimedia services 491,861 2,794,147 1,016,765 4,116,315
---------------- ------------------- ------------------- --------------
Total consolidated revenue $ 14,671,504 $ 7,465,649 $ 22,622,265 $ 12,730,326
================ =================== =================== ==============
(Loss) income from operations:
Internet services $ (2,874,936) $ (18,557,621) $ (8,509,513) $ (22,623,992)
Multimedia services (191,457) (154,520) (284,167) (269,643)
---------------- ------------------- ------------------- ---------------
$ (3,066,393) $ (18,712,141) $ (8,793,680) $ (22,893,635)
================ =================== =================== ===============
Net (loss) income:
Internet services $ (2,993,876) $ (22,289,358) $ (9,581,444) $ (27,389,847)
Multimedia services (192,360) (154,930) (284,827) (273,457)
---------------- ------------------- ------------------- ---------------
$ (3,186,236) $ (22,444,288) $ (9,866,271) $ (27,663,304)
================ =================== =================== ================
Depreciation and amortization:
Internet services $ 411,605 $ 225,297 $ 821,774 $ 398,509
Multimedia services 9,158 4,888 18,316 10,458
---------------- ------------------- ------------------- ---------------
$ 420,763 $ 230,185 $ 840,090 $ 408,967
================ =================== =================== ===============
Capital expenditures:
Internet services $ 11,963 $ 1,054,765 $ 97,917 $ 1,337,731
Multimedia services - 22,684 - 22,684
--------------- ------------------- ------------------- --------------
$ 11,963 $ 1,077,449 $ 97,917 $ 1,360,415
=============== =================== =================== ==============
Assets:
Internet services $ 8,510,458 $ 19,956,236 $ 8,510,458 $ 19,956,236
Multimedia services 760,265 880,485 760,265 880,485
---------------- ------------------- ------------------- --------------
Total consolidated assets $ 9,270,723 $ 20,836,721 $ 9,270,723 $ 20,836,721
================ =================== =================== ===============
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL Condition And Results
Of Operations
This management's discussion and analysis of financial condition and
results of operations and other portions of this Quarterly Report on Form 10-Q
contain forward-looking information that involves risks and uncertainties. Our
actual results could differ materially from those anticipated by this
forward-looking information. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed below and in or
referred to in the Annual Report on Form 10-K for the year ended June 30, 2000,
filed on September 22, 2000, under the heading Information Regarding
Forward-Looking statements. This management's discussion and analysis of
financial condition and results of operations should be read in conjunction with
our financial statements and related notes included elsewhere in this quarterly
report on Form 10-Q.
General
As part of our ordinary cash flow management and in order to generate
liquidity, we have in the past sold on a discounted basis a portion of the
installment contracts generated by our Galaxy Mall Internet training business to
a third party financial institution for cash. Because this financing source has
been engaged in its own recapitalization it has been, since early September, no
longer able to purchase our installment contracts at historical levels. This
third party has informed us that due to further delays in its recapitalization,
it cannot commit to a date by which it will be able to purchase the accumulated
unpurchased installment contracts and resume purchasing newly created
installment contracts at historical rates. As of December 31, 2000, we had over
$4.7 million of these installment contracts, of which, based on underwriting
criteria historically used by this third party, approximately $2.4 million would
be eligible for purchase on a discounted basis. We have entered into
arrangements with other financial institutions who have purchased a small
portion of this portfolio of installment contracts but to date these financial
institutions have not purchased installment contracts at rates adequate to
provide us with sufficient liquidity and some of them have applied stricter
underwriting criteria than the financial institution we have worked with in the
past. As a result, we are seeking to develop relationships with other potential
purchasers of these installment contracts. In the interim, our inability to sell
our installment contracts has had a material negative impact on our near-term
liquidity and cash position. (See Liquidity and Capital Resources below).
Effective October 1, 1999, we changed our method of accounting for
revenue to the percentage-of-completion method. We believe that the
percentage-of-completion method more accurately reflects the current earnings
process under our 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 Principals Board Opinion No. 20.
On June 26, 2000, we completed the merger of Galaxy Enterprises, Inc.
into a wholly owned subsidiary of Netgateway, Inc. The merger was accounted for
on a pooling-of-interests basis. Accordingly, our historical consolidated
financial statements and the discussion and analysis of financial condition and
results of operations for the prior periods have been restated to include the
operations of Galaxy Enterprises, Inc. as if it had been combined with our
company at the beginning of the first period presented.
Fluctuations in Quarterly Results and Seasonality
In view of the rapidly evolving nature of our business and its limited
operating history, we believe that period-to-period comparisons of our operating
results, including our gross profit and operating expenses as a percentage of
net sales, are not necessarily meaningful and should not be relied upon as an
indication of future performance.
While we cannot say with certainty the degree to which we experience
seasonality in our business because of our limited operating history, our
experience to date indicates that we experience lower sales from our Galaxy Mall
business during our first and second fiscal quarters. We believe this to be
attributable to summer vacations and the Thanksgiving and Christmas holiday
seasons.
Results of Operations
Six month period ended December 31, 2000 and the second fiscal quarter ended
December 31, 2000 compared to the six month period ended December 31, 1999 and
the second fiscal quarter ended December 31, 1999.
Revenue
Total revenues for the six months period ended December 31, 2000
increased to $22,622,266 from $12,730,326 in the comparable period of the prior
fiscal year, an increase of 78%. Total revenues for the October to December,
2000 quarter (second fiscal quarter) increased to $14,671,504 from $7,465,649 in
the comparable period of the prior fiscal year, an increase of 97%. Total
revenues for the relevant periods are comprised of service revenues and product
sales.
Service revenues include revenues from the design and development of
Internet Web sites and related consulting projects, revenues from our Internet
training workshops (including attendance at the workshop, rights to activate Web
sites and hosting), sales of banner advertising, mentoring and transaction
processing. Service revenues for the six months ended December 31, 2000
increased to $21,605,501 from $8,614,011 for the comparable, period of the prior
year, an increase of 151%. Service revenues for the second fiscal quarter
increased to $14,179,643 from $4,671,502 for the comparable period of the prior
year, an increase of 204%.
The increase can be attributed to two major factors. There was an
increase in the number of Internet training workshops conducted during the
periods. The number increased to 188 workshops for the current fiscal year to
date from 124 in the six months period ended December 31, 1999. For the quarter
the workshops held were 93 in 2000 compared to 66 in 1999.
The second factor contributing to the increased revenue was a change in
the business model for our Galaxy Mall Internet workshop training business.
Effective October 1, 2000, the product delivered at the Internet training
workshop is a "Complete Store-Building Packet" which contains a CD- ROM that
includes the necessary computer software and instructions to allow the customer
to construct its storefront without any additional services being supplied by
us. If additional assistance is required, we will provide it for a fee and
charge the customer after the services are rendered. The customer may host the
storefront with us, or any other provider of Internet hosting services. Should
the customer elect to prepay the Company for hosting, the revenue will be
recognized as the service is rendered. Under this new model, we now recognize
most of the revenue generated at our Internet workshops at the time of sale.
Revenues and earnings are anticipated to be enhanced in future periods since the
amount of revenue deferred from each Internet workshop sale will be greatly
reduced and the revenue from prior period sales will continue to be recognized
during this and future periods over the next seven quarters. During the period
from October to December 2000, we recognized $5,570,939 in revenue from sales
made prior to October 1, 2000 and deferred revenue from the current quarter's
sales of $2,579,376 to future periods. The net change of $2,991,572 increased
revenues for the six months period ending December 31, 2000 and the currant
fiscal quarter by that same amount.
Product sales, relating to the sale of our multimedia products, for the
six months period ended December 31, 2000 decreased to $1,016,675 from
$4,116,315 in the comparable prior period. Product sales for the second fiscal
quarter decreased to $491,861 from $2,794,147 in the comparable prior period.
Product sales were lower because the six month period ended December 31, 1999
included two large non-recurring orders that accounted for approximately
$2,000,000 of that period's product revenues.
The multimedia products are designed, manufactured and marketed by a
wholly owned subsidiary of the Company, IMI, Inc. On January 11, 2001
Netgateway, Inc. sold its subsidiary to an unrelated third party for a cash down
payment of $300,000 and a ten year note having a principle balance of
approximately $1.3 million.
Gross Profit
Gross profit is calculated as revenue less the cost of sales, which
consists of the cost to conduct Internet training workshops, to program customer
storefronts, customer support expenses and the cost of tangible products sold.
Gross profit for the six months period ended December 31, 2000 increased to
$17,570,313 from $7,665,326 in the comparable prior period. For the current
fiscal quarter gross profit increased to $12,143,350 from $5,903,384 in the same
quarter of 1999. The increase in gross profit primarily reflects the increased
sales volume of services provided through our Internet training workshops and
the effect on revenues from the sale of the "Complete Store-Building Packet" as
explained above.
Gross margin percentages increased for the six months period ended
December 31, 2000 to 78% of revenue from 60% of revenue in 1999. For the current
quarter gross margin percentages increased to 83% from 79% in the comparable
period of 1999. The increase in the gross profit as a percentage of revenue is
due to the increase in the service revenues and the decrease in product sales
since the contribution to profits from the service segment is much greater than
the product segment.
Product Development
Product development expenses consist primarily of payroll and related
expenses for development, editorial, creative and systems personnel as well as
outside contractors. Product development expenses for the six months period
ended December 31, 2000 decreased to $1,657,337 from $1,834,939 in the
comparable prior period. The majority of development expenses for the Internet
Commerce Center (ICC), our core technology platform, were incurred in the third
and fourth quarters of the fiscal year ended June 30, 2000. These expenses in
the quarters ending June 30 and March 31, 2000 were $2,358,399 and $2,342,665,
respectively. The approximately $.4 million spent on product development during
the current quarter and the approximately $1.2 million spent in the July to
September 2000 quarter represent a decrease from the prior two quarters and the
product development expenditures should continue to decline as the basic
development of the ICC is completed. Beginning in October 2000 there were
reductions in personnel working on the development of the ICC. The total number
of person from this area leaving the company through January 31, 2001 were 33.
Enhancements to our technology, including the ICC, will be made as
technology and business opportunities present themselves, but our business model
currently contemplates that in most cases we will seek to pass these costs to
our customers. Other product development projects currently in progress are a
Web-builder packet and a shopping mall development tool. We intend to expense
these costs as incurred. Additional development projects will be undertaken as
the needs are identified.
Selling and Marketing
Selling and marketing expenses consist of payroll and related expenses
for sales and marketing and the cost of advertising, promotional and public
relations expenditures and related expenses for personnel engaged in sales and
marketing activities. We also contract with telemarketing companies and
commissions earned by them are also included. Selling and marketing expenses for
the six months period ended December 31, 2000 and the second fiscal quarter
increased to $13,926,647 and $6,976,100 from $11,327,199 and $6,222,539 in the
comparable prior periods respectively. The increase in selling and marketing
expenses is primarily attributable to infrastructure costs as we expanded and
incurred additional costs related to the growth of our business, including
expenses associated with the increased number of Internet training workshops
conducted. Selling and marketing expenses did not increase as rapidly as revenue
growth. These expenses as a percentage of sales decreased for the six months
period ended December 31, 2000 and the second fiscal quarter to 62% and 48% from
89% and $83% in the comparable prior periods respectively
Beginning in December 2000 there were reductions in personnel selling
B2B solutions to larger corporate customers and in the cable commerce division
which markets services to television cable companies. The total number of
selling and marketing personnel leaving the company through January 31, 2001
were 26.
General and Administrative
General and administrative expenses consist of payroll and related
expenses for executive, accounting and administrative personnel, professional
fees and other general corporate expenses. General and administrative expenses
for the six months period ended December 31, 2000 and the second fiscal quarter
decreased to $7,808,934 and $5,560,729 from $16,987,856 and $16,327,862 in the
comparable prior periods respectively. This decrease is primarily attributable
to the decrease in payroll and related expenses that resulted from the
relocation of our headquarters and a reduction in costs and expenses associated
with obtaining equity capital.
During the quarter ended September 30, 2000, we implemented our
previously announced consolidation strategy to relocate our headquarter
operation from Long Beach, California to Orem, Utah. Orem has been the
headquarters of our Galaxy Mall, Inc. subsidiary since 1997. The relocation was
intended to realize significant improvements in operations and savings in
general and administrative expenses. The cost structure is lower in Orem due to
lower prevailing wage rates in the local labor market, as well as lower costs
for facilities, outside professional services and other costs of operations.
Beginning in October 2000 there were reductions in personnel in
accounting, the in-house legal department, and general administrative positions.
The total number of administrative personnel leaving the company through January
31, 2001 were 15.
Included in general and administrative expenses for the six months
period ended December 31, 2000, were several one time charges that are not
expected to recur. Principally these were related to our relocation to Orem and
the merger with Galaxy Enterprises, Inc. These included:
Relocation $385,000
Merger related 165,000
-------
Total $550,000
Bad Debt Expense
Bad debt expense for the six months period ended December 31, 2000 and
the current fiscal quarter were $2,130,985 and $1,809,138 respectively. There
was no identified similar expense in the comparable prior periods. $675,000 of
bad debt expense was included in general and administrative expenses during the
six months period ending December 31, 1999. Management believes bad debts
expense should be reported on a separate line item in the statement of
operations. The expense is primarily due to the establishment of a provision for
doubtful accounts that relates to the installment contracts the Company accepts
as payment for the products and services sold at its Internet training
workshops. We accept installment contract payments from all customers without
regard to their credit history, if they are willing to make a down payment of
from 5% to 10%. As a result we establish a 50% reserve for doubtful accounts to
provide for future expected losses. The additional costs associated with
assisting these customers to complete their electronic store fronts and host
them on our Galaxy Mall after the sale is made at the workshop is small. If they
fail to honor their commitment to us we discontinue hosting of their storefront.
Accepting this method of payment has increased the number of workshop attendees
who purchase our products and services.
Interest (Income) Expense, Net
Interest expense for the six months period ended December 31, 2000
decreased to $1,048,392 from $4,773,958 in the comparable prior period. Interest
expense in the current period consists primarily of a one-time recording of
$884,000 as the fair value of the beneficial conversion feature of an 8%
convertible debenture to King William, LLC and the actual interest accrued on
the debenture. (See Liquidity and Capital Resources) The interest expense for
the six months period ended December 31,1999 was primarily attributable to
various debt instruments that have been repaid.
Income Taxes
We have not generated any taxable income to date and, therefore, we
have not paid any federal income taxes. The use of our net operating loss carry
forwards, which begin to expire in 2006, may be subject to certain limitations
under Section 382 of the Internal Revenue Code of 1986, as amended.
Liquidity and Capital Resources
Cash
At December 31, 2000, we had $39,706 in cash on hand, a decrease of
$2,567,785 from June 30, 2000.
Net cash used in operating activities was $5,545,747 for the six months
period ended December 31, 2,000. Net cash used in operations was primarily
attributable to $9,866,271 in net losses and increases in assets, partially
offset by non-cash charges. Increases in assets during the six months period
ended December 31, 2000 included $3,760,538 in accounts receivable resulting
from the growth in revenues and the failure of a financial institution to
purchase installment contracts from the Company that were generated from our
Internet training workshops in historical quantities. Non-cash charges include
recording a $884,000 interest expense as the fair value of the beneficial
conversion feature of a convertible debenture issued to King William, LLC. (See
Liquidity and Capital Resources), $840,090 as depreciation and amortization,
$2,130,985 as bad debt expense and 1,727,013 to write off fixed and intangible
assets.
The write off of fixed assets resulted from an inventory being taken at
the time of the relocation from Long Beach, California to Orem, Utah. Some of
the assets on the books could not be found and others were determined to be of
no value to the Company and were scraped. The write off of intangibles resulted
from the determination that the acquired technology relative to Stores On Line,
Inc., a subsidiary of the Company, was no longer being used and had no resale
value.
Increases in liabilities included $2,596,364 in accounts payable and
accrued expenses.
Net cash used in investing activities was $49,987 for the six months
period ended December 31, 2000, and consisted of purchases of property and
equipment. Equipment purchases were less than in prior periods and are
anticipated to remain low for the next several quarters.
Net cash provided by financing activities of $3,028,654 for the six
months period ended December 31, 2000, was primarily from $2,500,000 in proceeds
from the issuance of a convertible debenture as more fully described elsewhere
in this filing and loans from a bank and a related party.
As a result of our inability to sell the installment contracts
generated by our Galaxy Mall Internet workshop training business in accordance
with past practices and due to operating losses, we do not have sufficient cash
from operating activities to meet our immediate working capital and cash
requirements. Because this additional capital is not currently available under
our arrangements with King William LLC (See Arrangements with King William LLC
below) we have sought and will continue to seek such capital through public or
private sales of our equity and debt securities. There can be no assurance that
additional financing will be available on acceptable terms, if at all. If
adequate funds are not available, we may be required to delay, reduce the scope
of, or eliminate one or more of our business lines or obtain funds through
arrangements with collaborative partners or others that may require us to
relinquish rights to all or part of the intellectual property of the Internet
Commerce Center or control of one or more of our businesses.
In January and February, 2001, we consummated a private placement of
convertible promissory notes for a total value of approximately $1.8 million at
8% interest. The note holder can convert at any time after six months at a rate
$.25 per share of unregistered common stock or the company may convert at any
time after six month if for a period of twenty consecutive trading days the
average of the closing bid and ask prices per share of our common stock is or
exceeds $.75 as reported on Nasdaq's OTC Bulletin Board Service. The proceeds
from the notes are to be used to pay down debt.
Accounts Receivable
Accounts receivable, net of allowance for doubtful accounts, was
$4,356,561 at December 31, 2000 compared to $2,383,544 at the prior fiscal
year's end, June 30, 2000. This increase is principally the result of an
increase in service revenue through our Internet training workshops. A
relatively constant and significant portion of these revenues have been made on
an installment contract basis. We have in the past sold on a discounted basis a
portion of these installment contracts to a third party financial institution
for cash. Because this financing source has been engaged in its own
recapitalization it has been, since early September, no longer able to purchase
our installment contracts at historical levels. This third party has informed us
that due to further delays in its recapitalization, it cannot commit to a date
by which it will be able to purchase the accumulated unpurchased installment
contracts and resume purchasing newly created installment contracts at
historical rates. As of December 31, 2000, we had over $4.7 million of these
installment contracts, of which, based on underwriting criteria historically
used by this third party, approximately $2.4 million would be eligible for
purchase on a discounted basis. We have recently entered into arrangements with
other financial institutions who have purchased a small portion of this
portfolio of installment contracts but to date these financial institutions have
not purchased installment contracts at rates adequate to provide us with
sufficient liquidity and some of them have applied stricter underwriting
criteria than the financial institution we have worked with in the past. As a
result, we are seeking to develop relationships with other potential purchasers
of these installment contracts. In the interim, our inability to sell our
installment contracts has had a material negative impact on our near-term
liquidity and cash position.
Delisting of Common Stock
In letters dated September 26, 2000 we were advised by The Nasdaq Stock
Market, Inc. that we no longer met the criteria for continued listing on the
Nasdaq National Market.
On January 10, 2001 our common stock was delisted from the Nasdaq
National Market, and our stock began to trade on the National Association of
Securities Dealers OTC Electronic Bulletin Board.
The delisting of our common stock may have an adverse impact on the
market price and liquidity of our securities and could adversely affect our
ability to attract additional investors. This would likely have a material
adverse effect on our liquidity because sales of additional shares of our common
stock is currently the principal potential source of additional funds required
to operate our businesses. (See Arrangements with King William, LLC below).
Arrangements with King William, LLC
In July 2000, the Company entered into a securities purchase agreement
with King William, LLC. Under the terms of the agreement, the Company issued to
King William an 8% convertible debenture due July 31, 2003 in the principal
amount of $4.5 million. The debenture was convertible into the number of shares
of our common stock at the lower of $1.79 or a conversion rate of 80% of the
average market price of the common stock during any three non-consecutive
trading days during the 20 trading days prior to conversion. The purchase price
for the debenture was payable in two tranches. The first tranche of $2.5 million
was paid at the closing in July 2000. The second tranche of $2.0 million may be
drawn down by the Company three business days after the satisfaction by the
Company of certain conditions, including that there be on file an effective
registration statement covering the shares issuable upon conversion of the
debenture and certification by the Company of its ability to honor a conversion
of the entire balance of the debenture and an exercise of all related warrants
without violating the capitalization regulations of the principal exchange on
which the shares of our common stock are then listed. Effective as of January
25, 2001, we reached an agreement with King William LLC to restructure this
debenture. Under the terms of the agreement no second tranche of the debenture
will be available and the note is scheduled to be repaid in installments with a
15% prepayment premium over the remainder of calendar year 2001. Additionally,
Netgateway has allowed King William to retain the right to convert any or all
portion of the outstanding debt to equity, but only after the stock has traded
at or above $3.00 for twenty consecutive trading days or if Netgateway does not
make a required payment of principal. Warrants already earned by King William
were repriced at $.25 per share and King William was issued a warrant for an
additional 269,000 shares of common stock at $.25 per share. During the first
week of February, 2001 the initial payment of $250,000 as called for by the
agreement was made. As of the date of the Restructuring Agreement the Company
was in default under the Convertible Debenture but pursuant to the terms of the
Restructuring Agreement the holder of the Convertible Debenture has waived all
of these defaults as of the date of the Restructuring Agreement.
The value of the beneficial conversion feature on the $2.5 million that
has been drawn down on the $4.5 million principal amount as of September 30,
2000, is recorded as capital and interest expense of $884,000 for the quarter
ended September 30, 2000, as the convertible debentures are immediately
exerciseable.
In connection with the securities purchase agreement, the Company
issued to King William a warrant to purchase 231,000 shares of common stock. In
connection with the issuance of the debenture, the Company also issued to Roth
Capital Partners, Inc., a warrant to purchase 90,000 shares of common stock and
to Carbon Mesa Partners, LLC, a warrant to purchase 10,000 shares of common
stock. Each of the warrants is exercisable for five years from the date of
issue, at an exercise price of $1.625 per share and with cashless exercise and
piggyback registration rights. The fair value of the warrants has been
determined to equal $371,000. Of the $371,000, $259,000 is accounted as capital
and debt discount and is amortized over the life of the debt. The remaining
balance is accounted for debt issuance costs under other assets and is amortized
over the life of the debt.
In August 2000, the Company entered into a private equity credit
agreement with King William, LLC. Under the terms of the agreement, the Company
has the right to issue and sell to King William up to $10 million of our common
stock at 87.5% of the market price at the time of sale, subject to certain
conditions and adjustments. In addition, for each 10,000 shares of common stock
that the Company issues and sells to King William, the Company will issue a
warrant to King William to purchase 1,500 shares of the Company common stock at
an exercise price equal to 125% of the market price of the common stock as of
the put date and exercisable for a period of five years from the put date,
together with cashless exercise and piggy back registration rights. Under the
terms of the Restructuring Agreement this agreement was terminated effective as
of the date of the Restructuring Agreement and no termination payment or
additional warrants were issued in connection therewith.
At the present time there is no cash available to the Company under
these agreements.
Accounts Payable
Accounts payable at December 31, 2000 totaled $4,843,804 as compared to
$2,839,727 at June 30, 2000. Our business operations are dependent on the
ongoing willingness of our suppliers and service providers to extend their
payment terms until we resolve our current liquidity problems. A number of
suppliers and service providers now require payment in advance or on delivery
and the Company did not meet a recent payroll with respect to a portion of its
employees in one of its business units. On February 9, 2001 the missed payroll
was made up to all employees except eight present and former officers of the
Company.
No assurance can be made that our suppliers will continue to extend
their payment terms or that they will continue to supply us with the materials
and services required to operate the business or on terms that are acceptable to
us or that we will resolve our current liquidity problems. Any interruption in
our business operations or the imposition of more restrictive payment terms for
payments to additional suppliers and service providers would have a further
negative impact on our liquidity.
On January 25, 2001 we engaged an unrelated third party to attempt to
settle a portion of our accounts payable and accrued liability obligations. They
have begun contacting selected vendors to offer an immediate settlement for less
than the face value of the obligations. Approximately $3.2 million of
obligations were turned over. The cash required to settle these compromised
claims will have to be raised by the Company selling equity or debt securities.
There can be no assurance that our creditors will be willing to compromise their
claims or that the Company will be able to raise sufficient additional cash to
settle the claims that may be agreed to by our vendors and creditors.
Deferred Revenue
Deferred revenue at December 31, 2000 totaled $15,603,019 as compared
to $15,967,152 at June 30, 2000. The deferred revenue will be recognized as the
services are rendered or when the time period in which customers have the right
to receive the services expires. The decrease from the prior fiscal year end is
the result of a change in our products offered at our Internet training
workshops.
We have changed the business model for our Galaxy Mall Internet
workshop training business and now, effective October 1, 2000, the product
delivered at the Internet training workshop is a "Complete Store-Building
Packet" which contains a CD- ROM that includes the necessary computer software
and instructions to allow the customer to construct its storefront without any
additional services being supplied by us. If additional assistance is required,
we will provide it for a fee and charge the customer after the services are
rendered. The customer may host the storefront with us, or any other provider of
Internet hosting services. Should the customer elect to prepay the Company for
hosting, the revenue will be recognized as the service is rendered.
Under this new model, we now recognize most of the revenue generated at
our Internet workshops at the time of sale. Revenues and earnings are
anticipated to be enhanced in future periods since the amount of revenue
deferred from each Internet workshop sale will be greatly reduced and the
revenue from prior period sales will continue to be recognized during this and
future periods over the next seven quarters.
Stockholders' Deficit
Total Stockholders' Deficit increased to a deficit of $18,983,569
during the current fiscal year from a deficit of $10,776,300 at June 30, 2000.
This was mainly the result of the Net Loss for the six months period ending
December 31, 2000. (See the Statement of Stockholders' Deficit in the financial
statements.)
Financing Arrangements.
We accept payment for the sales made at our Galaxy Mall Internet
training workshops by cash, credit card, installment contract or a third party
leasing option. As part of our cash flow management and in order to generate
liquidity, we have sold on a discounted basis a portion of the installment
contracts generated by our Galaxy Mall subsidiary to a third party for cash.
Because this financing source has been engaged in its own recapitalization,
beginning in early September, it was no longer able to purchase installment
contracts at historical levels. (See Liquidity and Capital Resources - Accounts
Receivable for further information).
On September 13, 2000, we retained the services of National Financial
Communications Corp. ("NFCC") for a six-month period as a nonexclusive advisor
in connection with our investor relations, in consideration for which we paid
$10,000 and gave a commitment to issue the consultant 250,000 shares of common
stock. In October 2000, the Company was notified by NFCC that it was unwilling
to perform its obligations under its retainer agreement unless the consideration
were substantially increased. This agreement has since been terminated.
On October 18, 2000, we entered into a letter agreement with Glendale Capital
LLC to provide investor relations services to the Company. As consideration for
its services, Glendale Capital LLC was issued warrants exercisable for 500,000
shares of Company common stock with an exercise price of $1.00 per share. The
agreement with Glendale Capital has been terminated.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISK
None.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On January 31, 2001 we were served with a Summons and Complaint by
Applied Computer Solutions, a California Corporation, in the Fourth District
Court, State of Utah, Case Number 010400400. The complaint asks for judgment in
the amount of $64,256.54 plus interest and attorney's fees because of breach of
contract, unjust enrichment and other causes of action. We purchased two
computer systems from the plaintiff, has used the equipment and is unable to pay
the plaintiff due to a lack of working capital. We will attempt to settle the
action before trial. There is no assurance that we will be able to make full
payment or that the plaintiff will agree to settle the complaint.
On January 10, 2001, we were served with a Summons and Complaint by
Freevest, LC, in the Fourth District Court, State of Utah. No case number was
shown on the complaint. The complaint asks for judgment in the amount of
$51,678.63 plus interest and attorney's fees because of breach of contract,
unjust enrichment and other causes of action. We leased space in a building
owned by plaintiff in American Fork, Utah. When we vacated the building in
September 2000, it was subleased by Promo.com, a Utah limited liability company.
During December 2000 Promo.com vacated the leased premises without warning.
Promo.com has not paid us the rent due under the sublease, and we are unable to
pay the plaintiff due to a lack of working capital. We will attempt to settle
the action before trial. There is no assurance that we will be able to make full
payment or that the plaintiff will agree to settle the complaint.
On January 26, 2001, we were served with a Demand for Arbitration by
Complete Business Solutions, Inc. (Claimant) in the Southfield, Michigan office
of the American Arbitration Association. The demand seeks "The balance due and
owing claimant for services rendered, the exact amount of which is currently
unknown because all services have not yet been billed, but is approximately $1
Million". We dispute the claim. Claimant was engaged by us to write the
specifications and produce the Internet Commerce Center (ICC), our core
technology platform used to provide services to our customers. Claimant was not
able to deliver a useful working platform and as a result we were obliged to
complete the project with our own employees. We will attempt to settle the
action before arbitration. There is no assurance that we will be able to settle
the complaint without arbitration and the arbitration procedure is costly in
both executive time and legal expenses. It is not possible to estimate the
future cost to us to dispute this claim.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Recent Sales of Unregistered Securities
Set forth below in chronological order is information regarding the numbers of
shares of common stock sold by us, the number of options issued by us, and the
principal amount of debt instruments issued by us between October 1, 2000 and
December 31, 2001, the consideration received by us for such shares, options and
debt instruments and information relating to the section of the Securities Act
or rule of the Securities and Exchange Commission under which exemption from
registration was claimed. None of these securities was registered under the
Securities Act. Except as otherwise indicated, no sales of securities involved
the use of an underwriters and no commissions were paid in connection with the
sale of any securities.
On February 5, 2001, the Company reached an agreement with King
William, LLC to restructure the approximately $2.5 million convertible debenture
held by King William. Under the terms of the agreement the note is scheduled to
be repaid in installments with a 15% prepayment premium over the remainder of
calendar year 2001. Additionally, Netgateway has allowed King William to retain
the right to convert any or all of the outstanding debt to equity, but only
after the stock has traded at or above $3.00 for twenty consecutive trading days
or if Netgateway does not make a required payment of principal. Warrants already
earned by King William were repriced at $.25 per share and King William was
issued a warrant for an additional 269,000 shares of common stock at $.25 per
share. No additional payment will be made or warrants issued in connection with
the termination of the Private Equity Line.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Please refer to Management's Discussion and Analysis contained in Item
2 of this quarterly report.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
At a Board meeting on November 19, 2000 the Company appointed Keith
Freadhoff as Chief Executive Officer and appointed John J. Poelman, Robert E.
Ciri and Shelly Singhall as directors replacing Roy C. Camblin, III who had
resigned as Chief Executive Officer and as a Director and John Dillon and Joseph
Roebuck who had resigned as Directors.
Subsequently, at a Board meeting on January 3, 2001 the Company
appointed Donald L. Danks as a director and at a Board meeting on January 5,
2001, the Company appointed Donald L. Danks as Chairman and Chief Executive
Officer of the Company and Jay Poelman as President and Chief Operating Officer.
The Board also accepted the resignations of Chairman, Chief Executive Officer
and Director, Keith D. Freadhoff; Chief Operating Officer and Director, Don
Corliss, as well as Directors Scott Bebee and Robert Ciri.
The Company has engaged BlueStone Capital, LLP, as its financial
advisor to explore strategic alternatives. BlueStone Capital is an investment
bank that focuses on emerging growth and middle market companies. BlueStone is
known for providing a broad range of corporate finance, research, syndicate
sales and trading services to its clients and will assist the Company in
exploring strategic business alternatives to drive shareholder value in
connection with the Company's development and implementation of strategic and
financial programs.
Pursuant to the terms of the agreement, BlueStone Capital will provide
the Company with financial advisory services and assist the Company in
identifying financial opportunities. In exchange, BlueStone Capital received
warrants to purchase 500,000 shares of the common stock of the Company that can
be exercised at the Company's market price at the time of conversion and is to
receive $7,500 during each month of the engagement. Shelly Singhal, a director
of the Company, is a managing director of BlueStone Capital.
On January 15, 2001, the Company reached an agreement to terminate the
BlueStone Capital, LLP engagement and Bluestone agreed to forego any early
termination penalty and has returned to the company half of the warrants
previously issued. Mr. Singhal is still a Director of the Company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
10.85 Restructuring Agreement, dated as of January 25, 2001, by
and between Netgateway, Inc. and King William, LLC
(b) Reports on Form 8-K
(i) Form 8-K, Item 5, filed on November 21, 2000, with respect to
press release describing appointment of new chief executive
officer and directors.
(ii) Form 8-K, Item 5, filed on December 19, 2000, with respect to
press release describing grant of hearing before the NASDAQ to
appeal delisting decision.
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 13, 2001 /s/ Donald Danks
Name: Donald Danks
Chief Executive Officer
Date: February 13, 2001 /s/ Frank C. Heyman
Name: Frank C. Heyman
Title: Chief Financial Officer
RESTRUCTURING AND AMENDMENT AGREEMENT
Restructuring and Amendment Agreement (this "Agreement") dated as of
January 25, 2001 by and between Netgateway, Inc., a Delaware corporation
("Netgateway") and King William, LLC, a Cayman Islands Limited Liability Company
("King William").
Whereas the parties have entered into (i) a Securities Purchase
Agreement (the "Purchase Agreement") dated July 31, 2000 pursuant to which
Netgateway issued to King William its 8% Convertible Debenture Due July 31, 2003
with an original principal amount of up to $4.5 million and an actual principal
amount of $2.5 million (the "Debenture") and warrants (the "King William
Warrants") pursuant to a Common Stock Purchase Warrant (the "King William
Warrant Agreement") dated as of July 31, 2000 to acquire a total of 231,000
shares of the common stock, par value $.001 per share of Netgateway (the "Common
Stock"), (ii) a Registration Rights Agreement dated July 31, 2000 (the
"Debenture Registration Rights Agreement"), (iii) a Private Equity Credit
Agreement dated August 2, 2000 (the "Equity Agreement") and (iv) a Registration
Rights Agreement dated August 2, 2000 (the "Equity Registration Rights
Agreement"; and together with the Debenture Registration Rights Agreement, the
"Registration Rights Agreements");
Whereas on September 7, 2000 Netgateway filed a registration statement
(the "Registration Statement") on Form S-1 as contemplated by the Registration
Rights Agreements which registration has not become effective;
Whereas effective with the opening of business on January 10, 2001 the
Common Stock was delisted from the NASDAQ National Market System and the Common
Stock is currently listed on the NASDAQ Bulletin Board;
Whereas no securities have been issued under the Equity Line; and
Whereas, the parties wish to amend certain of the terms of the
Debenture and the Registration Rights Agreements and to terminate the Equity
Agreement.
Now therefore, in consideration of the foregoing premises and of the
mutual covenants and agreements contained herein and other good and valuable
consideration, the sufficiency of which is hereby acknowledged, the parties
agree as follows.
1. Repayment of Debenture. Netgateway agrees to repay the full amount
(including interest accrued to date thereon) of the Debenture plus a 15% premium
with respect to the original principal amount (the "Current Principal Amount")
in ten payments. As of the date of this Agreement the Current Principal Amount
is $2,972,789.90. An initial payment in the amount of $250,000 (the "Initial
Payment") shall be made within five business days of the date this Agreement is
executed. A second payment in the amount of $250,000 shall be made on or before
February 28, 2001. The remainder of the Current Principal Amount shall be paid
in ten equal payments of $247,278.99 beginning on April 10, 2001 and on the
tenth day of each successive month except that the tenth payment shall be made
on the same date as the ninth payment. Each such payment shall be made with
interest accrued through the date of payment at a rate of 8% per annum.
2. Waiver of Defaults. Netgateway is in breach and/or violation of and
may be declared to be in default under certain of the terms and provisions of
each of the Purchase Agreement, the Debenture, the King William Warrant
Agreement, the Registration Rights Agreements and the Equity Agreement. King
William hereby waives all such defaults and violations, whether known or unknown
existing on the date of this Agreement; provided, however, that, nothing
contained herein shall be construed to limit, impair or otherwise affect any
rights of King William with respect of any future non-compliance with any
covenant, term or provision of any such agreement. Section 15(k) of the
Debenture is amended to refer to "an exchange, the NASDAQ Bulletin Board or
another Principal Market" rather than "an exchange or the Nasdaq National Market
System."
3. Conversion of Debenture. The Notice of Conversion previously
delivered to Netgateway by King William is hereby rescinded and retracted. King
William further agrees that it will not issued any future conversion notice to
Netgateway unless either the Market Price of the Common Stock has been in excess
of $3.00 per share for at least 20 consecutive trading days (for example in
connection with a transaction that will result in a sale of Common Stock by King
William pursuant to Rule 144 in which case the resulting reduced principal
balance shall be deemed allocated so as to reduce each remaining principal
payment on the Debenture under Section 1 of this Agreement equally) or
Netgateway shall have failed to make any of the Required Principal Payments when
due and such payment shall remain unpaid after five days written notice from
King William (a "Special Default"). Any such conversion shall be at a Conversion
Rate (as defined in the Debenture) equal to the lesser of 80% of the Current
Market Price (as defined in the Debenture) and $1.79 and in connection with any
such conversion the portion of the principal amount of the Debenture which is
being converted which is attributable to the 15% premium added pursuant Section
1 of this Agreement shall be ignored and shall not be converted but instead
shall constitute a permanent deduction from and reduction to the principal
amount of the Debenture. The foregoing limitations on conversion are in addition
to, and not in substitution for, the limitations on conversion set out in the
Purchase Agreement and the Debenture.
4. Other Modifications to Purchase Agreement. No "Second Tranche" (as
defined in the Purchase Agreement) shall be available to Netgateway and no
additional amounts shall be advanced pursuant to the Purchase Agreement.
Compliance with Section 4(g) of the Purchase Agreement (including as referred to
in the Debenture) is hereby waived so long as Donald Danks or another person
approved by King William (such approval not to be unreasonably withheld or
delayed) is Chief Executive Officer of Netgateway and, in the event of a
termination of such waiver, securities issued after the date of termination of
such waiver based on options, warrants, conversion or exchange rights or other
agreements entered into prior to such termination shall not constitute a breach
thereof.
5. Registration Rights Agreements. Netgateway may withdraw the
Registration Statement. All Late Filing Penalties and Late Effective Penalties
accrued to date are hereby waived. If there shall be a Special Default the Late
Filing Penalties and the Late Effective Penalties waived under the prior
sentence shall be added back to the principal amount of the Debenture. The
Debenture Registration Rights Agreement is hereby amended (i) to provide that
the Required Filing Date for such agreement shall be thirty days following the
date of a Special Default, if any, and the Required Effective Date for such
agreement shall be 90 calendar days after the Required Filing Date and (ii) to
amend Section 3(i) to refer to "the NASDAQ Bulletin Board or a Primary Market"
rather than "the NASDAQ National Market System." Netgateway agrees to comply
with the provisions of the Registration Rights Agreements as so amended.
6. Termination of Equity Agreement. The Equity Agreement and the Equity
Registration Rights Agreement are each hereby terminated by mutual agreement and
neither Netgateway nor King William shall make any payments or issue any
warrants in connection therewith, nor shall either party have any future
liability or obligation to the other thereunder. Netgateway agrees that if it
elects to engage in a future transaction of the specific type contemplated by
the Equity Line at any time prior to December 31, 2001 then prior to entering
into such arrangement it will first discuss with King William the proposed terms
and conditions thereof with a view to affording King William an opportunity to
provide such financing.
7. Warrants. The exercise price of the King William Warrants is hereby
reduced to $.25 per share. Netgateway agrees to issue warrants to purchase an
additional 269,000 shares of Common Stock at an exercise price of $.25 per share
with a five year exercise period beginning on the date of this Agreement and
otherwise on the same terms and conditions as the King William Warrants.
8. Implementation. If the Initial Payment is not made within five
business days of the date of this Agreement then this Agreement shall be deemed
rescinded and shall be void and of no effect and no party shall have any
liability to the other hereunder except that Section 5, other than the second
sentence thereof, shall remain in effect but the Required Filing Date referred
to in Clause (i) thereof shall be the thirtieth day after the date King William
requests that such filing be made.
9. Release. Netgateway hereby releases King William and all of its
direct and indirect partners, officers, directors, employees, affiliates(both
persons and entities, agents, representatives, servants, trustees,
beneficiaries, predecessors in interest, successors in interest, assigns,
nominees and insurers from any and all claims it may have against King William
arising out of the conduct of King William through the date of this Agreement
with respect to the Purchase Agreement, the Equity Agreement and the
transactions completed pursuant thereto. Netgateway, Inc. acknowledges that it
is familiar with Section 1542 of the Civil Code of the State of California which
provides as follows:
"A general release does not extend to claims which the
creditor does not know or suspect to exist in his favor at the
time of executing the release, which if known by him must have
materially affected his settlement with the debtor."
Netgateway hereby waives any and all rights and benefits that it now has or in
the future may have under Section 1542 of the Civil Code (and under the
comparable provisions of any other applicable law) and agrees and acknowledges
that this Agreement contains a full and final release applying to unknown and
unanticipated claims, injuries or damages arising out of the subject matter
hereof, as well as to those now known or disclosed. Netgateway represents,
warrants and covenants that it has not, and at the time this release becomes
effective will not have, sold, assigned, transferred or otherwise conveyed to
any other person or entity all or any portion of its rights, claims, demands,
actions or causes of action herein released.
10. Miscellaneous. Terms used herein but not defined herein shall have
the meanings assigned to them in the Purchase Agreement and the Debenture. King
William represents and warrants that it holds all right, title and interest in
and to the entire principal amount of the Debenture and all of the King William
Warrants. This Agreement shall be binding on all future holders of the Debenture
and of the King William Warrants and a new debenture reflecting the terms of
this Agreement shall be provided to King William in exchange for the current
Debenture held by it. This Agreement shall be governed by and construed in
accordance with the laws of the state of California.
IN WITNESS WHEREOF the parties hereto have executed this Agreement as
of the date first above written.
Netgateway, Inc. King William, L.L.C.
By: /s/ Donald Danks By: /s/ Illegible
Name: Donald Danks Name: Navigator Management Ltd.
Title: CEO / Chairman Title: Director