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 March 31, 2001
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
March 31, 2001: 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 March 31, 2001 (unaudited) and at June
30, 2000.............................................................3
Unaudited Condensed Consolidated Statements of Operations for the three months
and the nine months ended March 31, 2001 and March 31, 2000
......................................................................4
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months
ended March 31, 2001 and March 31, 2000..............................5
Unaudited Consolidated Statement of Stockholders' Deficit for the nine months
ended March 31, 2001..................................................6
Notes to Unaudited Condensed Consolidated Financial Statements.............7
2
NETGATEWAY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, June 30,
2001 2000
(Unaudited)
------------------------- -------------------------
Assets
Cash $ 11,986 $ 2,607,491
Trade receivable, net 2,901,485 2,383,544
Related party trade receivables - 2,519
Unbilled receivables - 12,293
Inventories 32,449 98,372
Prepaid expenses 1,045,712 395,074
Other current assets 1,320,476 726,648
------------------------- -------------------------
Total current assets 5,312,108 6,225,941
Property and equipment, net 1,424,477 3,026,487
Intangible assets, net 608,584 2,167,024
Other assets 114,803 889,948
------------------------- -------------------------
Total Assets $ 7,459,972 $ 12,309,400
========================= =========================
Liabilities and Stockholders' Deficit
Accounts payable $ 4,708,716 $ 2,839,727
Bank overdraft 360,211 330,307
Accrued wages and benefits 1,151,551 1,454,819
Accrued liabilities 1,757,559 1,311,859
Current portion of capital lease obligations 73,022 87,897
Notes payable 355,779 102,326
Current portion of deferred revenue 10,295,326 14,943,860
Debenture payable 2,546,199 -
------------------------- -------------------------
Total current liabilities 21,248,363 21,070,795
Deferred revenue, net of current portion 735,540 1,023,292
Convertible long term notes 89,293 0
Other liabilities 417,412 449,785
Capital lease obligations, net of current portion 34,743 47,379
------------------------- -------------------------
Total Liabilities 22,525,351 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 March 31, 2001 and June 30, 2000
respectively 21,695 21,649
Additional paid-in capital 61,117,628 58,012,244
Deferred compensation (181,897) (724,994)
Accumulated other comprehensive loss (4,902) (4,267)
Accumulated deficit (76,373,062) (68,080,932)
------------------------- -------------------------
Total stockholders' deficit (15,420,538) (10,776,300)
------------------------- -------------------------
Total Liabilities and Stockholders' Deficit $ 7,459,972 $ 12,309,400
========================= =========================
See Notes to Consolidated Financial Statements
3
NETGATEWAY, INC.
Unaudited Condensed Consolidated Statements of Operation for the
Three Months and Nine Months Ended March 31, 2001 and March 31, 2000
Three Months Ended Nine Months Ended
------------------------------------- ---------------------------------------
March 31, March 31, March 31, March 31,
2001 2000 2001 2000
--------------- ----------------- ------------------ ----------------
Revenue $ 7,886,385 $ 6,587,123 $ 29,491,885 $ 15,959,379
Cost of revenue 2,133,371 1,562,557 6,550,790 2,943,944
--------------- ----------------- ------------------ ----------------
Gross profit 5,753,014 5,024,566 22,941,095 13,015,435
Product development - 1,926,324 1,657,337 4,217,599
Selling and marketing 3,569,952 7,572,941 17,260,782 18,282,040
General and administrative 500,397 2,829,610 10,227,134 19,484,047
Depreciation and amortization 229,135 345,743 1,050,908 743,812
--------------- ----------------- ------------------ ----------------
Total operating expenses 4,299,484 12,674,618 30,196,161 42,727,498
Income (loss) from continuing operations before
items shown below 1,453,530 (7,650,052) (7,255,066) (29,712,063)
Other income (expense) (1,157) (29,130) 173,727 (24,968)
Interest expense (241,373) 128,199 (1,289,280) (4,645,140)
--------------- ----------------- ------------------ ----------------
Total other expenses (242,530) 99,069 (1,115,553) (4,670,108)
--------------- ----------------- ------------------ ----------------
Net income (loss) from continuing operations 1,211,000 (7,550,983) (8,370,619) (34,382,171)
Discontinued Operations:
(Loss) from operations, less applicable tax
expense (benefit) of $0 (1,128) (196,666) (285,780) (1,028,289)
Gain / on disposal, less applicable tax
expense (benefit) of $0 363,656 - 363,656 -
--------------- ----------------- ------------------ ----------------
Net income (loss) $ 1,573,528 $(7,747,649) $ (8,292,743) $(35,410,460)
=============== ================= ================== ================
Basic earnings (loss) per share:
Income (loss) from continuing operations $ 0.06 $ (0.48) $ (0.39) $ (1.96)
Income (loss) from discontinued operations 0.02 (0.01) 0.01 (0.06)
--------------- ----------------- ------------------ ----------------
Net income (loss) $ 0.08 $ (0.49) $ (0.38) $ (2.02)
=============== ================= ================== ================
Diluted earnings (loss) per share:
Income (loss) from continuing operations $ 0.06 $ (0.48) $ (0.39) $ (1.96)
Income (loss) from discontinued operations 0.02 (0.01) 0.01 (0.06)
--------------- ----------------- ------------------ ----------------
Net Income (loss) $ 0.08 $ (0.49) $ (0.38) $ (2.02)
=============== ================= ================== ================
Weighted average shares outstanding:
Basic 21,694,791 15,755,087 21,693,674 17,512,838
Diluted 22,076,955 15,755,087 21,693,674 17,512,838
See Notes to Consolidated Financial Statements
4
NETGATEWAY, INC
Unaudited Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended March 31, 2001 and March 31, 2000
Nine Months Ended
---------------------------------------------
March 31, March 31,
2001 2000
--------------------- ---------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income (loss) from continuing operations $ (8,370,619) $ (34,382,171)
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation and amortization 1,050,908 735,741
Bad debt expense 1,360,911 -
Loss on disposal of fixed assets and intangibles 1,922,397 -
Amortization of deferred compensation 275,552 493,147
Interest expense from beneficial conversion feature 973,293 -
Common stock issued for services 7,000 3,402,313
Stock issued in exchange for cancellation of options - 8,400,000
Warrants and options issued for services - 172,853
Amortization of debt issue costs 151,853 585,592
Amortization of debt discount 142,424 4,022,550
Changes in assets and liabilities:
Trade receivables and unbilled receivables (2,009,802) (3,119,713)
Prepaid offering costs - (190,309)
Inventories 29,576 (26,216)
Other assets (223,988) 330,582
Deferred revenue (4,463,412) 6,208,281
Accounts payable and accrued expenses 2,696,755 1,794,977
--------------------- ---------------------
Net cash (used in) continuing operating activities (6,457,152) (11,572,373)
Net cash (used in) discontinued operations (474,360) (170,412)
--------------------- ---------------------
Net cash (used in) operating activities (6,931,512) (11,742,785)
--------------------- ---------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of subsidiary 300,000 -
Cash received in acquisition - 16,905
Repayment of notes receivable - (420,000)
(Purchase) disposal of equipment (49,987) (2,338,845)
--------------------- ---------------------
Net cash provided by (used in) investing activities $ 250,013 $ (2,741,940)
--------------------- ---------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds for issuance of stock - 25,177,885
Proceeds from exercise of options and warrants 2,250 1,173,028
Repayment of notes (206,001) (6,173,531)
Repayment of note to related party (110,000) (1,799)
Cash paid for debt issue costs (270,025) (104,178)
Bank borrowing 29,904 240,973
Proceeds from issuance of notes payable 1,830,500 2,026,901
Proceeds from issuance of long term debenture 2,500,000 -
Proceeds from issuance of long term debt 310,000 -
--------------------- ---------------------
Net cash provided by financing activities $ 4,086,628 $ 22,339,279
--------------------- ---------------------
NET INCREASE (DECREASE) IN CASH (2,594,871) 7,854,554
CASH AT THE BEGINNING OF THE PERIOD 2,607,491 967,672
Effect of exchange rate changes on cash balances (634) (798)
--------------------- ---------------------
CASH AT THE END OF THE PERIOD $ 11,986 $ 8,821,428
===================== =====================
Supplemental disclosures of non-cash transactions:
Interest expense from beneficial conversion feature 884,000 -
Common stock issued for services 7,000 -
Warrants issued for debt issuance 371,000 -
Supplemental disclosure of cash flow information;
Interest paid 61,012 -
See Notes to Consolidated Financial Statements
5
NETGATEWAY, INC.
Consolidated Statement of Stockholders' Deficit
Additional
Common Stock 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 - - - 275,552
Forfeiture of stock options - - (93,129) 93,129
Beneficial conversion feature on convertible debenture - - 884,000 -
Warrants issued for convertible debentures - - 371,000 -
Repricing of warrants issued for convertible debentures - - 9,008 -
Warrants issued for restructuring of debenture - - 129,927 -
Forfeiture of deferred compensation - - (174,416) 174,416
Debt discount on convertible note warrants 1,054,368
Beneficial conversion feature on convertible note 776,132
Net loss - - - -
Foreign currency translation adjustment - - - -
Comprehensive loss
-------------- -------------- ------------------ --------------------
Balance March 31, 2001 21,694,791 $ 21,695 $ 61,117,628 $ (181,897)
============== ============== ================== ====================
See Notes to Consolidated Financial Statements
6a
NETGATEWAY, INC.
Consolidated Statement of Stockholders' Deficit
(continued from previous page)
Accumulated
Other Total
Accumulated Comprehensive Shareholders'
Deficit loss Deficit
------------------- -------------------- ------------------
Balance June 30, 2000 $ (68,080,932) $ (4,267) $ (10,776,300)
Exchange for Stores On Line stock - - 139,290
Stock options exercised - - 2,250
Shares issued for services - - 7,000
Amortization of deferred compensation - - 275,552
Forfeiture of stock options - - 0
Beneficial conversion feature on convertible debenture - - 884,000
Warrants issued for convertible debentures - - 371,000
Repricing of warrants issued for convertible debentures - - 9,008
Warrants issued for restructuring of debenture - - 129,927
Forfeiture of deferred compensation - - 0
Debt discount on convertible note warrants 1,054,368
Beneficial conversion feature on convertible note 776,132
Net loss (8,292,743) - (8,292,743)
Foreign currency translation adjustment 613 (635) (22)
------------------
Comprehensive loss (8,292,765)
------------------- -------------------- ------------------
Balance March 31, 2001 $ (76,373,062) $ (4,902) $ (15,420,538)
=================== ==================== ==================
See Notes to Consolidated Financial Statements
6b
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 on
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 at March 31, 2001 and for the three and nine months
ended March 31, 2001 and 2000, is unaudited, but includes all adjustments
(consisting only of normal recurring adjustments) which in the opinion of
management, are necessary to state fairly the financial information set forth
therein in accordance with generally accepted accounting principles. The interim
results are not necessarily indicative of results to be expected for the full
fiscal year period. Certain information and footnote disclosures have been
omitted pursuant to rules and regulations published by the Securities and
Exchange Commission ("SEC"), although the Company believes that the disclosures
are adequate to make the information presented not misleading. These financial
statements should be read in conjunction with the audited financial statements
for the year ended June 30, 2000 included in the Company's Annual Report on Form
10-K filed with 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 conjunction 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.............................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 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. This twenty-four
month period represents the twelve months in which a customer can activate a web
site and twelve months of free hosting upon activation. Revenue from web site
hosting rights that expire is recognized at the time of expiration. 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. SFAS No. 131 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 operated under two principal business segments
(Internet services and multimedia products). The primary business segment
(internet services) is 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. A secondary business segment
(multimedia services) has been 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. This second segment was sold on January 11, 2001 and accordingly
is reported as discontinued operations in the accompanying consolidated
statements of operations. As a result, the Company now operates in one business
segment.
(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 the average of the exchange rates in effect during the period. 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 nine months ended March 31, 2001 and March 31,
2000.
(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. 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.
There were 5,111,752 options and 5,541,896 warrants to purchase shares
of common stock that were outstanding as of March 31, 2001, of which 382,164
were included in the computation of diluted earnings per share for the quarter
ending March 31, 2001. There were 4,010,348 options and 1,380,603 warrants to
purchase shares of common stock that were outstanding as of March 31, 2000 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.
(p) Discontinued Operations
APB Opinion No. 30 states that discontinued operations refers
to the operations of a segment of a business that has been sold,
abandoned, spun off, or otherwise disposed of or, although still
operating, is the subject of a formal plan for disposal. In accordance
with APB Opinion No. 30, the results of continuing operations are
reported separately from discontinued operations and any gain or loss
from disposal of a segment is reported in conjunction with the related
results of discontinued operations.
(q) Issuance of Common Stock of Subsidiary
The difference between the proceeds received for the sale of
the Company's subsidiary and the carrying amount of the Company's
investment sold is reflected as a gain in the consolidated statements
of income.
(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 no 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) 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 value of the beneficial conversion
feature on the $2.5 million that has been drawn down was recorded as additional
paid in capital and interest expense of $884,000 for the quarter ended September
30, 2000, as the convertible debentures were immediately exerciseable.
In connection with the securities purchase agreement, the Company
issued to King William a warrant to purchase 231,000 shares of the Company's
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
additional paid in capital and debt discount and is amortized over the life of
the debt. The remaining balance is accounted for as debt issuance costs included
in other assets and is amortized over the life of the debt.
Effective as of January 25, 2001, the Company reached an agreement with
King William LLC to restructure the debenture. As of the date of the
Restructuring Agreement the Company was in breach and/or violation of the
Purchase Agreement, the Debenture, the King William Warrant Agreement, the
Registration Rights Agreements and the Equity Agreement. However, 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.
Under the terms of the Restructuring Agreement the agreements were terminated
effective as of the date of the Restructuring Agreement and no termination
payment or additional warrants were issued in connection therewith.
Under the terms of the Restructuring and Amendment Agreement the second
tranche of the debenture will not be available to the Company. The Company
agreed to repay the full amount of the Debenture plus a 15% premium ($375,000)
with respect to the original principal amount in ten payments. As of the date of
the Restructuring and Amendment Agreement the current principal amount including
accrued and unpaid interest was $2,972,781. Additionally, the Company has
allowed King William to retain the right to convert any or all portions 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 the Company 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. The incremental
fair value of the repricing of the warrants and the issuance of the new warrants
was $9,009 and $129,927, respectively. These costs were classified on the
balance sheet as debt restructuring costs and are being amortized over the life
of the debt. The initial payment of $250,000, as called for by the Restructuring
and Amendment Agreement, was made during the first week of February. A second
payment to be paid on February 28,2001 was not made.
In May 2001 King William elected to convert $200,000 of the principal
and accrued and unpaid interest of the debenture (Conversion Amount) into
800,000 shares of Common Stock of the Company, at a conversion price of $.25 per
share. The Conversion Amount was credited toward the payment of $250,000 due on
February 28, 2001, with the balance plus interest accrued to be paid on March
10, 2002. In addition, in May 2001, the Company entered into a Waiver Agreement
with King William, LLC to amend certain of the terms of the Restructuring
Agreement and to waive certain existing defaults under the Restructuring and
Amendment Agreement. The waiver agreement amended the Restructuring Agreement
payment schedule to postpone the remaining April 2001 payment of $247,278 to
February 2001 and the May 2001 payment of $247,278 to March 2002. As of the date
of the Waiver Agreement King William has withdrawn and waived all defaults and
violations.
At the present time there is no cash available to the Company under
these agreements.
(5) Convertible Long Term Notes Payable
In January 2001, the Company issued long term Convertible Promissory Notes
("Notes") in a private placement offering totaling $1,830,500. The Notes mature
on July 1, 2004 and interest accrues at the rate of eight percent (8%) per
annum. The Note is convertible prior to the Maturity Date at the option of the
Holder any time after July 1, 2001, or by the Company at any time after July 1,
2001 upon certain conditions as detailed in the Convertible Promissory Notes.
The Note is convertible into shares of common stock of the Corporation by
dividing the Note balance on the date of conversion by $.25, subject to
Conversion Price Adjustments as defined in the agreement. The relative fair
value of this Beneficial Conversion Feature of the notes has been calculated to
be $1,317,960 and has been recorded as debt discount on the balance sheet, and
is amortized over the life of the Notes.
In connection with the sale of the Notes, the Company issued a warrant to
purchase a share of the Company's common stock at an exercise price of $.50 per
share for every two shares of Common Stock into which the Note is originally
convertible. The Company issued a total of 3,661,000 warrants in connection with
the sale of the Notes, with a date of expiration not to exceed sixty calendar
days following the commencement date of the warrants. The relative fair value of
the warrants has been determined to be $512,540 and has been recorded as debt
discount on the balance sheet and is amortized over the life of the Notes.
The debt discounts of $1,319,760 and $512,540 for the beneficial conversion
feature and the warrants, respectively, are netted against the $1,830,500
balance of the Notes on the Balance Sheet and will be amortized over the life of
the notes. As of March 31, 2001, amortization of the debt discount and the
balance of the note was $89,293.
(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. In addition, 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 September 30, 2000.
During the three-month periods ending December 31, 2000 and March 31,
2001 the Company did not issue shares of common stock.
(7) Discontinued Operations
On January 11, 2001, the Company sold IMI, Inc., dba Impact Media, a
wholly-owned subsidiary, for $1,631,589 including $1,331,589 owed to the Company
by IMI, Inc. at the time of the sale, to Capistrano Capital, LLC. The Company
received from Capistrano Capital, LLC. a cash payment of $300,000. Since the
Company has yet to receive required payments on the Note, and IMI, Inc. has not
been successful in obtaining additional financing, the Company has reserved the
entire $1,331,589 note balance at March 31, 2001.
Operating results for the three months and nine months ended March 31, 2001
include the operating activity for the first eleven days up to and including
January 11, 2001. Certain information with respect to discontinued operations is
summarized as follows:
Three Months Ended Nine Months Ended
--------------------------------------- -----------------------------------------
March 31 March 31 March 31 March 31
2001 2000 2001 2000
------------------- ------------------- -------------------- --------------------
Revenue $ 100,098 $ 1,058,684 $1,116,863 $4,416,755
Cost of revenue 69,298 950,020 703,831 4,633,632
------------------- ------------------- -------------------- --------------------
Gross profit 30,800 108,664 413,032 (216,877)
Total operating expenses 32,181 305,330 698,580 811,412
------------------- ------------------- -------------------- --------------------
Income (loss) from discontinuted operations
before other item shown below (1,381) (196,666) (285,548) (1,028,289)
Other income / (expense) 253 - (232) -
------------------- ------------------- -------------------- --------------------
Net income (loss) from discontinued operations $ (1,128) $ (196,666) $ (285,780) $(1,028,289)
=================== =================== ==================== ====================
8) Subsequent Events
On April 4, 2001 the Company sold an additional $296,000 in convertible 8% notes
to investors. The notes mature on April 4, 2004 and the holder can convert at
any time after six months at a rate of $.25 per share for unregistered common
stock, or the Company may convert at any time after six months 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 were used to pay down debt
and support operations.
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
Netgateway, Inc. has in the past been operating with large losses as
discussed in its Quarterly report for the quarter ending December 31, 2000 and
pervious filings. Our liquidity was severely strained to the point where as of
the start of the fiscal quarter it was not possible to continue operations
without significant changes.
As a result, 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 John J. 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 board
thereafter consisted of three members, Donald L. Danks, John J. Poelman and
Shelly Singhal.
Netgateway, Inc. then implemented a restructuring process in order to
keep the Company solvent. The Business to Business Solutions division (B2B) and
the Cable Commerce division were reduced to a maintenance staff supporting
existing customers and all other employees were laid off. IMI, Inc., also known
as Impact Media, a wholly owned subsidiary of the Company was sold. Surplus
equipment was sold. The Company entered into an agreement with a third party to
negotiate a compromise payment schedule with non-essential vendors for less than
the full amount owed. Key management employees also agreed to voluntarily reduce
their salaries.
The Company then concentrated on the core business of the Galaxy Mall
Division, an eServices company, to generate sufficient revenues to enable
continued operations. Approximately $1.8 million was raised through the private
placement of convertible notes to support the Galaxy operations and deal with
the heavy debt load. The following discussion of the results of operations will
further expand upon the effects of these changes.
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
Nine months period ended March 31, 2001 and the third fiscal quarter
ended March 31, 2001 compared to the nine months period ended March 31, 2000 and
the third fiscal quarter ended March 31, 2000.
Revenue
Revenues for the nine months period ended March 31, 2001 increased to
$29,491,885 from $15,959,379 in the comparable period of the prior fiscal year,
an increase of 85%. Revenues for the January to March 2001 quarter, our third
fiscal quarter, increased to $7,886,385 from $6,587,123 in the comparable period
of the prior fiscal year, an increase of 20%. Revenues for the relevant periods
are 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. Formerly we reported product
sales which came from our subsidiary, IMI, Inc. On January 11, 2001 we sold IMI
for $1,631,589, including $1,331,589 owed to the Company by IMI at the time of
the sale, to an unrelated third party. The Company received a cash payment of
$300,000 from the third party. Accordingly IMI operations from this and prior
periods are now reported as discontinued operations in the accompanying
consolidated statement of operations.
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 268 workshops for the current fiscal year to
date from 191 in the nine month period ended March 31, 2000. For the quarter the
workshops held were 80 in 2001 compared to 67 in 2000.
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. During the period from January to March 2001, we
recognized $5,564,815 in revenue from sales made prior to December 31, 2000 and
deferred revenue from the current quarter's sales of $1,354,212 to future
periods. The net change increased revenues for the quarter by $4,210,603. The
similar net change increase for the nine month period ending March 31, 2001 is
$7,202,175.
The beneficial deferred revenue impact will comtinue for only a short
period of time. The Company anticipates that it will continue to recognize a
beneficial impact from the recognition of deferred revenues in amounts similar
to those recorded in the third fiscal quarter during the next two and possibly
three quarters. Thereafter the amount of revenue recognized from earlier
quarters is anticipated to be approximately equal to that deferred into future
periods. If the Company enjoys a rapid growth rate it is possible that during
any one quarter the amount of revenue deferred into future periods will exceed
that recognized during the same quarter from sales in prior periods.
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 nine month period ended March 31, 2001 increased to
$22,941,095 from $13,015,435 in the comparable prior period. For the current
fiscal quarter gross profit increased to $5,753,014 from $5,024,566 in the same
quarter of fiscal year 2000. 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 decreased for the nine months period ended
March 31, 2001 to 78% of revenue from 82% of revenue for the nine month period
ended March 31, 2000. For the current quarter gross margin percentages decreased
to 73% from 76% in the comparable period of 2000. The decrease in the gross
profit as a percentage of revenue is due to an increase in the cost of
conducting the Internet training workshops and the cost to program the customer
storefronts relative to the increase in revenue.
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 nine month period
ended March 31, 2001 decreased to $1,657,337 from $4,217,599 in the comparable
period of the prior fiscal year. Product development expenses for the three
month period ended March 31, 2001 decreased to an immaterial amount from
$1,926,325 in the comparable prior period. Most of the development expenses for
the Internet Commerce Center (ICC), our core technology platform, were incurred
prior to December 2000. The basic development of the ICC as redefined by the
Company is completed.
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 nine month period ended March 31, 2001 and the third fiscal quarter
decreased to $17,260,782 and $3,569,953 from $18,282,040 and $7,572,941 in the
comparable prior periods respectively. The decrease in selling and marketing
expenses is primarily attributable to the discontinuance of any sales or
marketing activity in the B2B and the Cable Commerce divisions after December
31, 2000. This decrease was partially offset by expenses associated with the
increased number of Internet training workshops conducted. Selling and marketing
expenses as a percentage of sales decreased for the nine months period ended
March 31, 2001 and the third fiscal quarter to 59% and 45% from 115% and $115%
in the comparable prior periods respectively.
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 nine month period ended March 31, 2001 and the third fiscal quarter
decreased to $10,227,134 and $500,397 from $19,484,047 and $2,829,610 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 to Orem, Utah from Long Beach, California, the
resignation of senior management personnel that were not replaced, a reduction
in the salaries of retained management personnel and cutbacks in administrative
workers associated with the discontinuance of the B2B and Cable Commerce
divisions. During the nine months period ended March 31, 2000 there were legal,
accounting and other costs associated with the merger between Galaxy
Enterprises, Inc. and Netgateway, Inc. that were not incurred in the March 31,
2001 period.
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.
Depreciation and Amortization
Depreciation and amortization expenses consist of a systematic charge
to operations for the cost of long term equipment and a write down of the
goodwill associated with the purchase of other businesses. Depreciation and
amortization expenses for the nine month period ended March 31, 2001 increased
to $1,050,908 from $743,812 in the comparable prior period. This increase was
due to the purchase of additional equipment and software. For the three month
period ended March 31, 2001 this expense decreased to $229,135 from $345,743 in
the comparable prior period. The decrease was due to the disposal of excess
equipment which came about because of the reduction in personnel described
earlier.
Interest Expense
Interest expense for the nine month period ended March 31, 2001
decreased to $1,289,280 from $4,645,140 in the comparable prior period. Interest
expense in the current nine month period consists primarily of a one-time
recording of $884,000 relating to the fair value of the beneficial conversion
feature of an 8% convertible debenture to King William, LLC, the amortization of
the discount relating to the beneficial conversion feature and the warrants
issued that are associated with the sale by the Company of convertible notes in
January 2001 of $89,292 and the actual interest accrued on the debenture and
notes. (See Liquidity and Capital Resources) The interest expense for the nine
months period ended March 31, 2000 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
due to a change of control under Section 382 of the Internal Revenue Code of
1986, as amended.
Liquidity and Capital Resources
Cash
At March 31, 2001, we had $11,986 cash on hand, a decrease of
$2,595,505 from June 30, 2000.
Net cash used in operating activities was $8,252,920 for the nine
months period ended March 31, 2001. Net cash used in operations was primarily
attributable to $8,370,619 in net losses partially offset by non-cash charges.
These non-cash charges include recording $973,293 interest expense as the fair
value of the beneficial conversion feature of a convertible debenture issued to
King William, LLC and convertible notes sold to investors. These debentures and
notes also gave rise to an amortization of debt issuance costs and debt discount
of $294,277. There was also $1,050,909 as depreciation and amortization, and
$1,922,397 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 $2,696,755 in accounts payable and
accrued expenses while a decrease in liabilities included $4,463,412 in deferred
revenue. Accounts payable increased due to the inability of the Company to pay
its vendors and other obligations due to the operating losses and the lack of
sufficient equity and debt financing. Deferred revenue decreased due to a change
in the business model (see Results of Operations - Revenue) which allowed the
Company to recognize more of its revenue in the current period.
Net cash provided by investing activities was $250,013 for the nine
months period ended March 31, 2001. During January 2001 the Company sold a
wholly owned subsidiary, IMI, Inc., for $1,631,589, including $1,331,589 owed to
the Company by IMI at the time of the sale. The Company received a cash payment
of $300,000. The amounts due from IMI, Inc. have been fully reserved. Also
during the period the company sold surplus equipment for cash. The equipment was
available for sale as a result of the Netgateway, Inc. down-sizing.
Net cash provided by financing activities for the nine months period
ended March 31, 2001 was $4,086,628. The Company sold a $2,500,000 convertible
debenture to King William, LLC and sold $1,830,500 in convertible notes to
investors.
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 further 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, 2001, we consummated a private placement of convertible
promissory notes for a total value of $1,830,500 million at 8% interest. The
note matures on July 1, 2004 and the holder can convert at any time after six
months at a rate of $.25 per share for unregistered common stock or the Company
may convert at any time after six months 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 were used to pay down debt and support
operations.
On April 4, 2001 the Company sold an additional $296,000 in convertible 8% notes
to investors. The notes mature on April 4, 2004 and the holder can convert at
any time after six months at a rate of $.25 per share for unregistered common
stock or the Company may convert at any time after six months 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 were used to pay down debt
and support operations.
Accounts Receivable
Accounts receivable, net of allowance for doubtful accounts, was
$2,901,485 at March 31, 2001 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
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 March 31, 2001,
we had over $2.1 million of these installment contracts, of which, based on
underwriting criteria historically used by this third party, approximately
$860,000 would be eligible for purchase on a discounted basis. We have recently
entered into arrangements with other financial institutions who have purchased a
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.
An additional payment of $250,000 was due on February 28, 2001 and
another payment of $247,278.99 was due on April 10, 2001. Neither of these
payments was made. On May 9, 2001 the Company and King William signed a waiver
agreement which allowed King William to convert $188,630 principal balance of
the note and $11,370 of accrued interest into 800,000 shares of Netgateway, Inc.
stock. This is equivalent to $.25 per share for the stock. The $200,000 was
credited toward the payment due February 28, 2001 and the balance of $50,000 is
required to be paid on March 10, 2002. The payment due April 10, 2001 is
required to be paid January 10, 2002 and the payment due May 10, 2001 is
required to be paid February 10, 2002. King William waived its right to make
further conversions on account of the failure of the Company to make its April
and May 2000 payments.
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.
Accounts Payable
Accounts payable at March 31, 2001 totaled $4,708,716 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 payroll with respect to a portion of its
employees in one of its business units in December 2000. On February 9, 2001 the
missed payroll was paid to all employees except for 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. As of April 23, 2001 settlements have been made
with vendors who are due approximately $2.5 million to be paid a compromised
amount of $428,043. Approximately $250,000 of the compromised amount has been
paid.
The cash required to settle the remaining compromised claims will have
to be raised by the Company selling equity or debt securities. There can be no
assurance that the balance of 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 March 31, 2000 totaled $11,030,866 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 future periods.
Stockholders' Deficit
Total stockholders' deficit increased to a deficit of $15,420,538
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 nine month period ending
March 31, 2001. (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 $64,257 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, have used the equipment and are unable to
pay the plaintiff due to a lack of working capital. The matter was settled on
April 19, 2001.
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. Complete Business Solutions, Inc. has
changed their name to COVANSYS. 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. On March 27, 2001 we entered into a settlement and mutual
release agreement with COVANSYS in which, provided the Company makes a payment
of $160,000 by April 23, 2001, both sides will release the other from all
existing claims. The payment was made on April 23, 2001.
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 January 1, 2001 and
March 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 January 31, 2001 the Company sold convertible notes in the aggregate
principal amount of $1,830,500 to 63 investors. The notes are due on July 1,
2004 and carry an interest rate of 8%. The notes are convertible into common
stock of the Company at any time after July 1, 2001 by the holder at a
conversion price of $.25 per share. The notes are convertible into common stock
of the Company after July 1, 2001 by Netgateway, Inc. if after July 1, 2001 the
stock trades at or above $.75 for twenty consecutive trading days, at a
conversion price of $.25 per share. The holders of the notes were also given
warrants to purchase an additional share of the Company's common stock for every
two shares of common stock into which the note was originally convertible at an
exercise price of $.50 per share. These warrants expired on April 1, 2001 and
none were exercised.
On January 25, 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 agreement with King William.
On May 9, 2001 the Company and King William signed a waiver agreement
which allowed King William to convert $188,630 principal balance of the note and
$11,370 of accrued interest into 800,000 shares of Netgateway, Inc. stock. This
is equivalent to $.25 per share for the stock. The $200,000 was credited toward
the payment due February 28, 2001 and the balance of $50,000 is required to be
paid on March 10, 2002. The payment due April 10, 2001 is required to be paid
January 10, 2002 and the payment due May 10, 2001 is required to be paid
February 10, 2002.
King William waived its right to make further conversions on account of these
payment defaults.
On January 5, 2001, the Company issued to a consultant of the Company
warrants to purchase 150,000 shares of the Company's common stock at an exercise
price of $0.30 per share, which warrants are exercisable for a period of five
years, in connection with the termination of such consultant's agreement with
the Company.
In addition, on January 5, 2001, the Company issued to another
consultant of the Company warrants to purchase 100,000 shares of the Company's
common stock at an exercise price of $0.30 per share, which warrants are
exercisable for a period of five years, in connection with such consultant's
development of the curriculum for the Company's training workshops.
The Company believes that light of the sophisticated nature of each of
the acquirers, registration of the securities under the Securities Act was not
required and that the sale of its securities to the respective acquirers did not
constitute the sale of an unregistered security in violation of the federal
securities laws and regulations by reason of the exemption provided under
Section 4(2) of the Securities Act, and the rules and regulations promulgated
thereunder.
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.
10.86 Settlement Agreement and Mutual Release, dated March 27, 2001,
by and between CONVANSYS, Inc. and Netgateway, Inc.
10.87 Form of Convertible Promissory Note
10.88 Form of Note Purchase Agreement
10.89 Form of Note Purchase Agreement with warrants
10.90 Form of Common Stock Purchase Warrant
10.91 Restructuring and Amendment Agreement, dated January 25, 2001,
by and between Netgateway, Inc. and King
William, LLC
10.92 Waiver Agreement, dated May 9, 2001, by and between
Netgateway, Inc. and King William, LLC
10.93 Letter Agreement, dated January 10, 2001, by and between
Netgateway, Inc. and Keith Freadhoff
10.94 Letter Agreement, dated January 10, 2001, by and between
Netgateway, Inc. and Donald M. Corliss
10.95 Letter Agreement, dated January 10, 2001, by and between
Netgateway, Inc. and Jill Glashow Padwa
(b) Reports on Form 8-K
(i) Form 8-K, Item 5, filed on January 8, 2001, with
respect to press release describing appointment of
new chief executive officer and directors.
(ii) Form 8-K, Item 5, filed on January 11, 2001, with
respect to the sale of IMI, Inc., a Netgateway, Inc.
Subsidiary.
(iii) Form 8-K, Item 5, filed on January 12, 2001, with
respect to a termination in certifying accountants.
(iv) Form 8-K, Item 5, filed on February 8, 2001, with
respect to a change in certifying accountants from
KPMG to Grant Thornton.
(v) Form 8-K, Item 5, filed on April 4, 2001, with
respect to a change in certifying accountants from
Grant Thornton to Richard A. Eisner & Company.
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: May 15, 2001 /s/ Donald Danks
------------------------
Name: Donald Danks
Chief Executive Officer
Date: May 15, 2001 /s/ Frank C. Heyman
------------------------
Name: Frank C. Heyman
Title: Chief Financial Officer