UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED 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 0-26707
NETWORK COMMERCE INC.
(Exact name of registrant as specified in its charter)
WASHINGTON 91-1628103
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
411 1st AVENUE SOUTH
SUITE 200 NORTH
SEATTLE, WA 98104
(Address of principal executive offices)
(206) 223-1996
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No __
As of May 4, 2001, there were 77,027,788 shares outstanding of the Registrant's
common stock.
Network Commerce Inc.
Form 10-Q
Index
PAGE
PART I FINANCIAL INFORMATION
ITEM 1: Financial Statements
Consolidated Balance Sheets as of March 31, 2001
and December 31, 2000.............................................................. 4
Consolidated Statements of Operations for the three-month
periods ended March 31, 2001 and 2000 ............................................. 5
Consolidated Statements of Cash Flows for the three-month
periods ended March 31, 2001 and 2000.............................................. 6
Notes to Condensed Financial Statements............................................... 7
ITEM 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations................................................ 18
ITEM 3: Quantitative and Qualitative Disclosures about Market Risk............................ 39
PART II OTHER INFORMATION
ITEM 1: Legal Proceedings..................................................................... 40
ITEM 2: Changes in Securities and Use of Proceeds............................................. 40
ITEM 3: Defaults Upon Senior Securities....................................................... 40
ITEM 4: Submission of Matters to a Vote of Security Holders................................... 40
ITEM 5: Other Information..................................................................... 40
ITEM 6: Exhibits and Reports on Form 8-K...................................................... 41
SIGNATURES ...................................................................................... 42
EXHIBITS ...................................................................................... 43
2
PART I. FINANCIAL INFORMATION
ITEM 1.
3
Network Commerce Inc.
Condensed Consolidated Balance Sheets
(in thousands)
March 31, December 31,
2001 2000
------------ -----------
ASSETS
Current assets:
Cash and cash equivalents $ 6,907 $ 11,715
Restricted cash 13,730 16,599
Short-term investments 5,627 21,592
Accounts receivable, less allowance for bad debts of $2,260 and $1,195. 4,953 18,111
Notes receivable from employees - 2,900
Prepaid expenses and other current assets 9,720 13,341
------------ -----------
Total current assets 40,937 84,258
Property and equipment, net 14,901 22,580
Goodwill and intangible assets, net 18,712 135,628
Cost-basis investments 11,425 29,481
Other assets, net 2,155 5,773
------------ -----------
Total assets $ 88,130 $ 277,720
============ ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 14,160 $ 18,933
Accrued liabilities and other liabilities 12,594 21,502
Current portion of notes and leases payable 25,260 24,797
Deferred revenues 10,590 11,338
------------ -----------
Total current liabilities 62,604 76,570
Notes and leases payable and line of credit, less current portion 1,094 1,741
Non-current liability 1,300 -
Deferred revenues 2,734 3,703
------------ -----------
Total liabilities 67,732 82,014
------------ -----------
Commitments
Shareholders' equity:
Convertible preferred stock, $0.001 par value: authorized shares - 5,000,000;
none issued and outstanding - -
Common stock, $0.001 par value: authorized shares - 200,000,000; issued
and outstanding shares - 78,253,578 at March 31, 2001 and 78,222,569
at December 31, 2000 554,463 555,175
Subscriptions receivable (63) (2,421)
Common stock warrants 18,172 18,172
Deferred compensation (7,151) (7,758)
Accumulated other comprehensive loss (82) (130)
Accumulated deficit (544,941) (367,332)
------------ -----------
Total shareholders' equity 20,398 195,706
------------ -----------
Total liabilities and shareholders' equity $ 88,130 $ 277,720
============ ===========
The accompanying notes are an integral part of these condensed consolidated
balance sheets.
4
Network Commerce Inc.
Condensed Consolidated Statements of Operations
(in thousands, except share amounts)
For the Three Months Ended
March 31,
----------------------------
2001 2000
---------- ----------
Revenues $ 10,108 $ 18,682
Cost of revenues 2,316 10,393
---------- ----------
Gross profit 7,792 8,289
---------- ----------
Operating expenses:
Sales and marketing 17,291 22,100
Research and development 5,268 4,215
General and administrative 4,283 3,234
Amortization of intangible assets 18,297 13,492
Stock-based compensation 260 1,856
Restructuring and other impairment charges 70,988 -
Impairment of certain long-lived assets 43,136 -
Unusual item - settlement of claim 4,559 -
---------- ----------
Total operating expenses 164,082 44,897
---------- ----------
Loss from operations (156,290) (36,608)
---------- ----------
Nonoperating (expense) income:
(Loss) gain on sale of marketable equity securities (150) 1,086
Interest income 557 1,295
Interest expense (2,882) (441)
Other (24) (20)
Impairment of cost-basis investments (18,820) -
---------- ----------
Total nonoperating (expense) income, net (21,319) 1,920
---------- ----------
Net loss before income tax benefit (177,609) (34,688)
Income tax benefit - 11,916
---------- ----------
Net loss $ (177,609) $ (22,772)
========== ==========
Basic and diluted net loss per share $ (2.45) $ (0.48)
========== ==========
Weighted average shares outstanding used to
compute basic and diluted net loss per share 72,458,451 47,581,471
========== ==========
The accompanying notes are an integral part of these condensed consolidated
statements.
5
Network Commerce Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
For the three months ended
March 31,
----------------------------
2001 2000
----------- -----------
Operating activities:
Net loss $ (177,609) $ (22,772)
Adjustments to reconcile net loss to net cash used in operating activities-
Depreciation and amortization 21,235 15,806
Accretion of promissory note payable 2,074 -
Provision for bad debts 2,627 -
Amortization of deferred compensation 260 1,856
Restructuring and impairment charges 70,988 -
Impairment of certain ling-lived assets 43,136 -
Impairment of marketable equity securities and investments 18,820 -
Unusual item - settlement of claim 4,559 -
Realized loss from sale of marketable equity securities 150 -
Deferred income tax benefit - (11,916)
Changes in operating assets and liabilities, excluding effects of acquired businesses-
Accounts receivable 8,730 (4,179)
Prepaid expenses and other current assets (260) (7,764)
Other assets (283) -
Accounts payable and accrued liabilities (16,825) 4,038
Deferred revenue 706 3,231
----------- -----------
Net cash used in operating activities (21,692) (21,700)
----------- -----------
Investing activities:
Purchases of short-term investments - (104,768)
Sales of short-term investments 32,694 49,703
Proceeds from sale of investments 148 29
Purchases of property and equipment (35) (6,483)
Investments in equity and debt securities and other assets (2) (10,531)
Acquisition of businesses, net of cash acquired of $ - in 2001 and $259 in 2000 - (5,826)
----------- -----------
Net cash provided by (used in) investing activities 32,805 (77,876)
----------- -----------
Financing activities:
Payments on line of credit (1,041) -
Payments on long-term debt (1,157) (3,038)
Proceeds from sale of common stock and exercise of stock options 4 109,347
Proceeds from collection of subscription receivable 3 -
----------- -----------
Net cash (used in) provided by financing activities (2,191) 106,309
----------- -----------
Net increase in cash and cash equivalents 8,922 6,733
Cash and cash equivalents at beginning of period 11,715 10,660
----------- -----------
Cash and cash equivalents at end of period $ 20,617 $ 17,393
=========== ===========
Supplementary disclosure of cash flow information:
Cash paid during the period for interest $ 427 $ 390
=========== ===========
Cash paid during the period for income taxes $ - $ -
=========== ===========
Non-cash investing and financing activities:
Common stock, options and warrants issued and liabilities assumed
as part of business and technology acquisitions $ - $ 18,992
=========== ===========
Assets acquired under capital leases $ 160 $ -
=========== ===========
The accompanying notes are an integral part of these condensed consolidated
statements.
6
Network Commerce Inc.
Notes To Condensed Consolidated Financial Statements
(unaudited)
Note 1. Organization and Background:
The Company
Network Commerce Inc. (the Company), a Washington corporation, is a technology
infrastructure and services company. The Company provides a technology and
services platform solution that includes domain registration, hosting services,
commerce services, business services and one-to-one marketing services. The
Company's headquarters are located in Seattle, Washington. Through December 31,
2000, the Company operated two commerce networks, known as the Network Commerce
Consumer Network, which aggregated merchants and shoppers over a distributed
network of Web sites, and the Network Commerce Business Network, which was
designed to enable businesses to engage in online activities and transactions
with other businesses. In January 2001, the Company restructured these groups
into the Network Commerce Portal Services and the Network Commerce
Infrastructure and Technology (IT) groups. The Portal Services group includes
one-to-one marketing services and various online marketplaces focused on gaming
and entertainment. The Network Commerce IT group includes domain name
registration, technology and licensing and other business services. As a result
of this restructuring, certain of the Company's previous business units and
offerings were shut down. Further restructuring efforts in March 2001, resulted
in the shutdown of SpeedyClick.com and the sale of Ubarter Canada, components of
the Portal Services group. The Company's current focus is its IT group and its
one-to one marketing business.
The Company is subject to the risks and challenges associated with other
companies at a similar stage of development, including dependence on key
management personnel, on successful development and marketing of its products
and services, and the continued acceptance of the Internet. Additional risks
include competition from substitute products and services from companies with
greater financial, technical, management and marketing resources and risks
associated with recent acquisitions and closures of business units. Further,
during the period required to develop commercially viable products, services and
sources of revenues, the Company may require additional funds that may or may
not be readily available.
Going Concern
The Company's condensed consolidated financial statements for the three months
ended March 31, 2001 have been prepared on a going concern basis, which
contemplates the realization of assets and the settlement of liabilities in the
normal course of business. The Company has incurred net losses of $177.6 million
for the three-month period ended March 31, 2001 and has accumulated deficits of
$544.9 million as of March 31, 2001. The Company has continuously incurred net
losses from operations and, as of March 31, 2001, has working capital deficit of
$21.6 million. The Company is out of compliance with certain debt covenants.
These factors raise substantial doubt about the Company's ability to continue as
a going concern. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
The Company believes that its cash reserves and cash flows from operations will
be adequate to fund its operations through June 2001. Consequently, the Company
will require substantial additional funds to continue to operate its business
beyond that period. Many companies in the Internet industry have experienced
difficulty raising additional financing in recent months. Additional financing
may not be available to the Company on favorable terms or at all. Even if
additional financing is available, the Company may be required to obtain the
consent of its existing lenders, which the Company may not be able to obtain. If
additional financing is not available, the Company may need to dramatically
change its business plan, sell or merge its business, or face bankruptcy. In
addition, the issuance of equity or equity-related securities will dilute the
ownership interest of existing stockholders and the issuance of debt securities
could increase the risk or perceived risk of the Company.
7
The Company's plans to mitigate the risk of this uncertainty include, but are
not limited to, one or more of the following:
exploring strategic alternatives, which may include a merger, asset sale,
or another comparable transaction;
raising additional capital to fund continuing operations by private
placements of equity and/or debt securities; and
forming a joint venture with a strategic partner or partners to provide
additional capital resources to fund operations.
Additional cost-cutting measures could include additional lay-offs and/or the
closure of certain business units and facilities.
Public Offerings
On October 4, 1999, the Company closed its initial public offering (IPO) of
7,250,000 shares of common stock at $12.00 per share, for proceeds net of
underwriters' fees and commissions of $80.9 million. At closing, all of the
Company's issued and outstanding shares of convertible preferred stock were
converted into shares of common stock on a one-for-one basis. On November 2,
1999, the underwriters of the IPO exercised their over-allotment option and sold
an additional 1,087,500 shares at $12.00 per share, for proceeds net of
underwriters' fees and commissions of $12.1 million. The combined net proceeds
to the Company, less additional offering costs of approximately $1.9 million,
were $91.1 million. In addition, a $1.0 million promissory note in connection
with the Company's acquisition of GO Software, Inc. (GO) and a $4.0 million
bridge loan with a financial institution plus accrued interest were repaid.
On February 18, 2000, the Company closed a supplemental public offering (SPO) of
7,913,607 shares of common stock at $14.50 per share, for proceeds net of
underwriters' fees and commissions of $108.7 million. Offering costs incurred by
the Company relating to the SPO were approximately $700,000.
Note 2. Summary of Significant Accounting Policies:
Unaudited Interim Financial Data
The condensed consolidated financial statements are unaudited and have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. These condensed consolidated financial statements should be read in
conjunction with the audited consolidated financial statements and notes thereto
included in the Company's December 31, 2000 Form 10-K as filed with the
Securities and Exchange Commission on April 17, 2001. The financial information
included herein reflects all adjustments (consisting only of normal recurring
adjustments), which are, in the opinion of management, necessary for a fair
presentation of the results for interim periods. The results of operations for
the three-month periods ended March 31, 2001 and 2000 are not necessarily
indicative of the results to be expected for the full year.
Principles of Consolidation
The Company's condensed consolidated financial statements include 100% of the
assets, liabilities and results of operations of all subsidiaries in which the
Company has a controlling ownership interest of greater than 50%. Equity
investments in which the Company holds less than a 20% ownership interest and
does not exercise significant influence are recorded at cost and are included in
cost-basis investments in the accompanying condensed consolidated balance
sheets. All significant intercompany transactions and balances have been
eliminated.
8
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Revenue Recognition
Through December 31, 2000, the Company derived substantially all of its revenues
from the Network Commerce Consumer Network, the Network Commerce Business
Network and from providing services to businesses.
Revenues from the Network Commerce Consumer Network, which was a network of
proprietary and affiliated Web sites including www.shopnow.com and licensed
affiliates, the BottomDollar Network (including www.bottomdollar.com and
licensed affiliates) and www.speedyclick.com were generated primarily from the
sale of online marketing services, leads and orders, advertising and
merchandising. Revenues from these agreements were recognized as the media or
services were delivered to the merchants over the term of the agreements, which
typically ranged from one to twelve months. Where billings exceed revenues
earned on these agreements, the amounts are included in the accompanying
consolidated balance sheets as deferred revenue. The Company bears the full
credit risk with respect to these sales. In certain circumstances, such as with
the www.chaseshop.com portal, the Company offered products directly to shoppers.
In these instances where the Company acted as merchant-of-record, the Company
records as revenue the full sales price of the product sold and records the full
cost of the product to the Company as cost of revenues, upon shipment of the
product. Shipping charges billed to the customer are included in revenues, and
the costs incurred by the Company to ship the product to the customer are
included in cost of sales.
Revenues from the Network Commerce Business Network, which is a network of
proprietary and affiliated Web sites, including www.registrars.com,
www.b2bnow.com, www.freemerchant.com, www.ehost.com and www.ubarter.com, are
derived primarily from providing domain registration, web-enablement services,
commerce-enablement services, transaction processing, advertising, hosting
services and technology licensing to businesses. Revenues from registrars.com
are derived from the sale of domain name registration fees, which are typically
paid in full at the time of the sale and are recognized over the registration
term, which typically range from one to three years. Unearned revenues are
classified as either current or long-term deferred revenues depending on the
future recognition of those revenues. Revenues from b2bNow.com are generated
primarily from the sale of advertising and merchandising products and services
similar to those sold on the Network Commerce Consumer Network. Revenues from
Ubarter.com are generated from transaction fees earned from member businesses
that transact over the Ubarter exchange system as well as from products sold by
Ubarter.com to other member merchants of the Ubarter exchange system. Revenues
from services are generated principally through development fees, domain
registration fees, hosting fees and sales and marketing services. These services
can be purchased as a complete end-to-end suite of services or separately. The
Company recognizes revenues from the development of custom applications and
online stores and marketing projects on a percentage of completion basis over
the period of development or the period of the marketing project. These projects
generally range from two to twelve months. Hosting contracts typically have a
term of one year, with fees charged and earned on a monthly basis. The Company
bears full credit risk with respect to these sales. Anticipated losses on these
contracts are recorded when identified. To date, losses have not been
significant. Contract costs include all direct labor, material, subcontract and
other direct project costs and certain indirect costs related to contract
performance. Changes in job performance, job conditions and estimated
profitability, including those arising from contract penalty provisions and
final contract settlements that may result in revision to costs and income, are
recognized in the period in which the revisions are determined. Unbilled
services typically represent amounts earned under the Company's contracts not
billed due to timing or contract terms, which usually consider passage of time,
achievement of certain milestones or completion of the project. Where billings
exceed revenues earned on contracts, the amounts are included in the
accompanying consolidated balance sheets as customer deposits, as the amounts
typically relate to ancillary services, whereby the Company is acting in an
agency capacity. Fee revenue from ancillary services provided by the services
division is recognized upon completion of the related job by the applicable
third party vendor.
Revenues are also generated from fees paid to the Company by businesses and
merchants who license the Company's technology; transaction processing, fraud
prevention, and online payment gateways, as well as other e-commerce enabling
technologies. Revenues include licensing fees, per-transaction fees and in
certain cases monthly hosting and maintenance fees, which are recognized in the
period earned. Revenues generated from technology
9
licensing are recognized in accordance with Statement of Position 97-2,
"Software Revenue Recognition." Where billings exceed revenues earned on these
contracts, the amounts are included in the accompanying consolidated balance
sheets as deferred revenue. Businesses and merchants who utilize the Company's
payment processing technologies act as the merchant-of-record and bear the full
credit risk on those sales of goods and services.
The Company recognizes revenues from barter transactions when earned. The
Company values the barter transactions based on the value of the consideration
received from the customer or from the value of the services provided to the
customer, whichever is more readily determinable.
The Company recognizes revenues from sale of online marketing services, leads
and orders, advertising and merchandising and receives equity in the customer.
The Company values the equity received from these transactions as cost-basis
investments based on the value of the consideration received from the customer
or from the value of the services provided to the customer, whichever is more
readily determinable. The Company monitors these cost-basis investments for
impairment. When cost-basis investments are deemed to be permanently impaired,
the difference between cost and market value is charged to operations. There can
be no assurance that our investments in these early-stage technology companies
will be realized.
Cash, Restricted Cash and Cash Equivalents
For the purposes of consolidated statements of cash flows, the Company considers
investment instruments with an original maturity of three months or less to be
cash equivalents. Cash equivalents are comprised of investments in money market
funds, government mortgage-backed bonds, and highly rated corporate securities.
Approximately $13.7 million and $16.6 million of cash as of March 31, 2001 and
December 31, 2000, respectively, is characterized as restricted in order to
secure certain facilities leasing and debt obligations under letters of credit
and another security arrangement. The Company's restricted cash and cash
equivalents are stated at cost, which approximates fair market value.
Short-Term Investments and Marketable Equity Securities
The Company classifies these securities as available-for-sale and they are
stated at fair value in accordance with Statement of Financial Accounting
Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." This statement specifies that available-for-sale securities are
reported at fair value with changes in unrealized gains and losses recorded
directly to shareholders' equity, which are also reflected in accumulated other
comprehensive loss in the accompanying consolidated statement of changes in
shareholders' equity and comprehensive loss. Fair value is based on quoted
market prices. The Company's short-term investments consist of corporate notes
and bonds, commercial paper, municipal notes and bonds, auction preferreds and
US government securities and are stated at cost, which approximates fair value
as of March 31, 2001. Marketable equity securities consist solely of investments
in the common stock of publicly traded companies and are recorded at fair value.
Realized gains and losses from the sale of available-for-sale securities are
determined on a specific identification basis. Dividend and interest income are
recognized as earned. Any changes in market values that are considered other
than temporary are recorded as realized gains or losses in current operations.
Stock Compensation
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation", and instead applies Accounting
Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations (see Recent Accounting Pronouncements
below). Accordingly, compensation cost for stock options is measured as the
excess, if any, of the market price of the Company's common stock over the stock
option exercise price at the date of grant. Options and warrants issued to
non-employees are accounted for using the fair value method of accounting as
prescribed by SFAS No. 123.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying
10
amounts of existing assets and liabilities and their respective tax bases and
operating loss and tax credit carryforwards. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized as income in the period that includes the enactment date.
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards that require derivative instruments (including certain
derivative instruments embedded in other contracts) to be recorded at fair
value. The statement requires that changes in the derivative's fair value be
recognized currently in operations unless specific hedge accounting criteria are
met. Special accounting for qualifying hedges allows a derivative's gains and
losses to offset related results on the hedged item in the statements of
operations, and requires that a company must formally document, designate, and
assess the effectiveness of transactions that are subject to hedge accounting.
Pursuant to SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB No. 133 - an Amendment to
FASB Statement No. 133," the effective date of SFAS No. 133 has been deferred
until fiscal years beginning after January 15, 2000. SFAS No. 133 cannot be
applied retroactively. SFAS No. 133 must be applied to (a) derivative
instruments and (b) certain derivative instruments embedded in hybrid contracts
that were issued, acquired, or substantively modified after December 31, 1998
(and, at a company's election, before January 1, 1999). The Company impact of
adopting SFAS No. 133 is not material on the financial statements. However, the
statement could increase volatility in the consolidated statements of operations
and in other comprehensive loss.
Reclassifications
Certain information reported in previous periods has been reclassified to
conform to the current period presentation.
Note 3. Acquisitions:
In June 1999, the Company acquired GO Software, Inc. (GO). GO develops and
markets transaction processing software for personal computers that can function
on a stand-alone basis or can interface with core corporate accounting systems.
The Company paid GO $4.7 million in cash, issued a $1.0 million promissory note
bearing interest at 10%, and issued 1,123,751 shares of common stock, valued at
$8.54 per share, for a total purchase price of $15.4 million. The acquisition
was accounted for using the purchase method of accounting. Of the excess
purchase price of approximately $14.4 million, $13.8 million was allocated to
acquired technology and $556,000 was allocated to goodwill, which are both being
amortized over a three-year life. The note bore interest at 10% and was repaid
in full upon completion of the Company's initial public offering completed in
September 1999. In March 2001, the Company recognized an impairment charge of
$1.8 million to write-down the carrying value to the approximate net realizable
value. On May 14, 2001, pursuant to an Agreement and Plan of Merger and Exchange
of Stock dated as of May 11, 2001, the Company completed the sale of GO to
Return on Investment Corporation ("ROI") through its wholly-owned subsidiary for
$1.0 million in cash and $3.0 million in ROI common stock. As part of the merger
transaction, ROI is required to file with the Securities Exchange Commission a
registration statement to effect a registration of the common stock delivered to
Network Commerce.
Also in June 1999, the Company acquired CardSecure, Inc. (CardSecure) for a
purchase price of approximately $3.5 million. CardSecure is a developer of
e-commerce enabled Web sites. The acquisition was accounted for using the
purchase method of accounting. The excess purchase price of approximately $3.5
million was allocated to acquired technology and is being amortized over a
three-year life.
On November 12, 1999, the Company acquired SpeedyClick, Corp. (SpeedyClick), a
California corporation, for $55.6 million of cash, common stock and common stock
options. SpeedyClick, a privately held company, maintained an Internet Web site
that focused on entertainment and interactivity. Upon effectiveness of the
acquisition, a total of 3,799,237 shares of common stock valued at $13.31 per
share were issued to the owners of SpeedyClick. Options to purchase SpeedyClick
common stock were assumed by the Company and converted into 157,527 options to
purchase the Company's common stock. The Company also paid cash consideration of
$3.0 million to the owners of SpeedyClick. The Company accounted for this
transaction as a purchase. Of the $55.6 million in consideration paid,
approximately $27.9 million was allocated to proprietary concepts, $14.7 million
to customer lists and $13.0 million to goodwill. These intangible assets were
being amortized over a three-year life.
11
However, in March 2001, the Company decided to shut down the operations and
wrote-off the remaining intangible assets of $37.2 million.
On December 3, 1999, the Company acquired Cortix, Inc. (Cortix), an Arizona
corporation doing business as 20-20Consumer.com, for $14.4 million of cash and
common stock. Cortix, a privately held company, provided comparison shopping
services including online reviews and ratings for commerce-oriented businesses,
merchants and products. Upon effectiveness of the acquisition, 711,435 shares of
common stock valued at $18.81 per share were issued to the owners of Cortix. The
Company also paid cash consideration of $1.0 million to the owners of Cortix.
The Company accounted for this transaction as a purchase. Of the $14.4 million
in consideration paid, approximately $11.3 million was allocated to acquired
technology, $1.6 million to customer lists and $1.3 million to goodwill. These
intangible assets were being amortized over a three-year life. However, in
December 2000, the Company decided to shut down the operations and wrote-off the
remaining intangible assets of $9.1 million.
On December 17, 1999, the Company acquired WebCentric Inc., (WebCentric) a
Kansas corporation doing business as bottomdollar.com, for $40.2 million of
common stock, common stock options and approximately $1.4 million of cash.
WebCentric, a privately held company, developed e-commerce integration
technology and applications, including a comparison shopping engine that allowed
consumers to search and compare the products and services of several leading
Internet merchants. Upon effectiveness of the acquisition, a total of 2,161,904
shares of common stock valued at $16.89 per share were issued to the owners of
WebCentric. In addition, the Company issued replacement stock options to
purchase an aggregate of 121,544 shares of the Company's common stock to certain
employees and owners of WebCentric. The Company accounted for this transaction
as a purchase. Of the $40.2 million in consideration paid, approximately $31.8
million was allocated to acquired technology, $3.3 million to customer lists and
$4.6 million to goodwill. These intangible assets were being amortized over a
three-year life. However, in December 2000, the Company decided to shut down the
operations and wrote-off the remaining intangible assets of $24.3 million.
On January 13, 2000, the Company, through its wholly owned subsidiary 3037952
Nova Scotia Company, a Nova Scotia Company, acquired Pronet Enterprises Ltd.
(Pronet), a Canadian company, for approximately $12.8 million, of which $3.2
million was paid in cash, $2.2 million in non-cash deferred tax liabilities
assumed and $7.4 million in common stock and common stock options issued to
Pronet shareholders. Pronet, a privately held company, operates a
business-to-business portal and marketplace that aggregates businesses that seek
to transact with one another. Upon effectiveness of the acquisition, a total of
162,508 shares of common stock, valued at $17.60 per share, were issued to the
shareholders of Pronet. In addition, the Company issued options to purchase
351,666 shares of common stock to the two principals of Pronet. The Company
accounted for this transaction as a purchase. Of the $12.8 million in
consideration paid, approximately $6.3 million was allocated to acquired
technology, $2.7 million to customer lists and $3.8 million to goodwill. These
intangible assets are being amortized over a three-year life. In January 2001,
management revised its estimated useful life for these assets and will be
amortizing the remaining carrying value of Pronet (approximately $9.1 million as
of December 31, 2000) over the first six months of 2001.
On January 18, 2000, the Company acquired AXC Corporation (AXC), a Washington
corporation, for approximately $17.9 million, of which $2.2 million was paid in
cash, $4.1 million in non-cash deferred tax liabilities assumed and $11.6
million in common stock and common stock options issued to AXC shareholders.
AXC, a privately held company, provided e-commerce consulting services to
businesses. Upon effectiveness of the acquisition, a total of 540,296 shares of
common stock valued at $17.60 per share were issued to the owners of AXC. In
addition, the Company issued replacement stock options to purchase an aggregate
of 72,089 shares of the Company's common stock to certain employees and owners
of AXC. The Company accounted for this transaction as a purchase. Of the $17.9
million in consideration paid, approximately $7.2 million was allocated to
assembled workforce, $4.9 million to customer lists, $5.0 million to goodwill
and $800,000 to working capital. These intangible assets were being amortized
over a three-year life. However, in December 2000, the Company decided to shut
down the operations and wrote-off the remaining intangible assets of $14.2
million.
On April 11, 2000, the Company acquired FreeMerchant.com, Inc. (FreeMerchant), a
Delaware corporation, for approximately $38.1 million, of which $2.0 million was
paid in cash, $10.0 million in non-cash deferred tax liabilities assumed,
$500,000 of debt assumed and $25.6 million in common stock and common stock
options issued to FreeMerchant shareholders. FreeMerchant, a privately held
company, has developed online store-builder technology for small- to
medium-sized merchants that seek a low-cost point of entry to e-commerce and
provides
12
hosting services to those merchants. Upon effectiveness of the acquisition, a
total of 2,573,723 shares of common stock, valued at $8.80 per share, were
issued to the shareholders of FreeMerchant. In addition, the Company issued
options to purchase 293,596 shares of common stock to certain FreeMerchant
shareholders and employees. The Company accounted for this transaction as a
purchase. Of the $38.1 million in consideration paid, approximately $23.0
million was allocated to acquired technology, $4.1 million to assembled
workforce and $11.0 million to goodwill. These intangible assets are being
amortized over a three-year life. In March 2001, the Company recognized an
impairment charge of $22.4 million to write-down the carrying value to the
approximate net realizable value.
On June 2, 2000, the Company effected its acquisition of Ubarter.com Inc
(Ubarter), a Nevada corporation, pursuant to an agreement and plan of merger
dated January 20, 2000, for approximately $61.7 million, of which $875,000 was
paid in cash, $11.4 million in non-cash deferred tax liabilities assumed,
$978,000 in net liabilities assumed, $7.6 million in the cancellation of debt
between Ubarter and the Company, and $40.8 million in common stock and common
stock warrants issued to Ubarter shareholders and creditors. Ubarter, a publicly
traded company, is a business-to-business e-commerce enterprise, which utilizes
the Ubarter Dollar as payment for products and services by its member businesses
over its proprietary barter exchange system. Upon effectiveness of the
acquisition, a total of 2,682,871 shares of common stock valued at approximately
$15.10 per share were issued to the shareholders and creditors of Ubarter. In
addition, the Company issued warrants to purchase 51,842 shares of common stock
to certain Ubarter shareholders, employees and creditors. The Company accounted
for this transaction as a purchase. Of the $61.7 million in consideration paid,
approximately $7.5 million was allocated to acquired technology, $2.5 million to
assembled workforce, $25.1 million to proprietary concept, $2.5 million to
customer lists, and $24.0 million to goodwill. These intangible assets are being
amortized over a three-year life. Early in the fourth quarter 2000, the Company
launched a new user interface and back-end management system for the Ubarter.com
merchant exchange, and executed various marketing efforts to promote the new
system. These efforts did not stimulate growth in the Ubarter economy as
expected, which led to a revision in the Company's original forecasts and
projections for Ubarter. These revised forecasts indicated that future expected
cash flows from this business unit were less than the carrying value of its
intangible assets, thus triggering an impairment event in December 2000. At that
time, the carrying value of Ubarter's intangible assets including goodwill was
$51.6 million. Based on recent comparable sales of other barter exchange
systems, we determined the fair value of Ubarter.com to be approximately $5
million. As a result, the Company recognized an impairment charge of $46.6
million in December 2000. In February 2001, the Company sold the Canadian-based
operations of Ubarter and recognized a loss of $2.3 million. In March 2001, the
Company recognized an impairment charge of $4.2 million to write-down the
remaining carrying value to the approximate net realizable value.
On August 24, 2000, the Company acquired Ivebeengood.com, d.b.a. UberWorks
(UberWorks), a wholly owned subsidiary of Trilogy, Inc. (Trilogy), for
approximately $22.8 million, of which $2.4 million was accrued as non-cash
deferred compensation, $5.9 million in non-cash deferred tax liabilities assumed
and $14.5 million in common stock and common stock options issued to UberWorks
shareholders and employees. UberWorks was a developer of multi-merchant
e-commerce purchasing tools and universal shopping cart technology. Upon
effectiveness of the acquisition, a total of 2,601,562 shares of common stock
valued at approximately $6.13 per share were issued to shareholders of
UberWorks, of which 423,253 are being held back by the Company to be
subsequently released based on time vesting and on certain performance criteria
yet to be achieved (these shares have been excluded from determining the
Company's weighted average shares outstanding used to calculate basic and
diluted earnings per share). The maximum term of the retention is three years
from the effective date of the acquisition. In addition, the Company issued a
warrant to Trilogy, with a strike price of $0.000001 per share, to purchase
additional shares of the Company's common stock if on the one-year anniversary
date of the acquisition, the shares currently held by Trilogy (the Trilogy
Shares) are not worth at least $13.1 million. The maximum number of additional
shares that Trilogy can purchase under the terms of the warrant is 2.6 million.
To the extent that the Trilogy Shares have a fair market value that exceeds
$13.1 million on the one-year anniversary date, the warrant is cancelled and
Trilogy must forfeit the number of Trilogy Shares that would be required to
bring their fair value down to $13.1 million, limited to a maximum of 1.3
million shares to be forfeited under this scenario. The Company also issued
options to purchase 248,162 shares of common stock to certain UberWorks
employees. The Company accounted for this transaction as a purchase. Of the
$22.8 million of consideration paid, approximately $12.3 million was allocated
to acquired technology, $2.4 million to deferred compensation, $726,000 to
assembled workforce and $7.3 million to goodwill. These intangible assets were
being amortized over a three-year life. However, in March 2001, the Company
decided to abandon the technology and wrote-off the remaining intangible assets
of $16.6 million.
13
On December 8, 2000, the Company acquired ePackets.Net, Inc. (ePackets) for
approximately $270,000 consisting of $150,000 in cash, $37,000 in common stock
and common stock options and $83,000 in net liabilities assumed. ePackets
provided permission-based one-to-one email solutions. In connection with this
acquisition, the Company issued to the shareholders of ePackets a total of
33,324 shares of common stock. The Company accounted for this transaction as a
purchase. The consideration paid was allocated to acquired technology and was
being amortized over a three-year life. However, in March 2001, the Company
decided to shut down the operations and wrote-off the remaining intangible
assets of $255,000.
On December 22, 2000, the Company acquired Internet Domain Registrars
Corporation ("IDR"), for approximately $23.6 million, consisting of $750,000 in
cash, $6.1 million in non-cash deferred tax liabilities assumed, $5.7 million in
common stock and $11.1 million in net liabilities assumed. IDR is a domain name
infrastructure company, which owns and operates the www.registrars.com Web site.
In connection with this acquisition, the Company issued to the shareholders of
IDR a total of 7,650,000 shares of common stock, of which 1,000,000 were placed
in escrow for indemnification purposes. In addition, 3,281,000 shares were
issued and placed in escrow to be released to the former shareholders and
certain employees of IDR upon the achievement of established future revenue
targets over an eighteen month period, and 219,000 shares were issued to
employees of IDR who continued to be employed by IDR after the acquisition.
Finally, 600,000 shares of common stock was issued at the closing to certain
other persons in connection with the settlement of potential claims against IDR
and as consideration of services rendered to IDR in connection with the
acquisition. The closing price of the Company's common stock on December 22,
2000 was $0.69 per share. The Company accounted for this transaction as a
purchase. Of the $23.6 million of consideration paid, approximately $10.5
million was allocated to proprietary concept, $874,000 to domain name, $3.5
million to customer lists, $874,000 to assembled workforce and $7.8 million to
goodwill. These intangible assets are being amortized over a three-year life. In
March 2001, the Company recognized an impairment charge of $17.6 million to
write-down the remaining carrying value to the approximate net realizable value.
Note 4. Restructuring and Impairment Charges:
Impairment of Certain Long-Lived Assets
During the first quarter 2001, the Company determined that the carrying value of
the intangible assets for the GO, FreeMerchant and IDR business units, which
were being considered for sale was in excess of anticipated sales values. As a
result, the Company recognized impairment charges of approximately $43.1
million.
Restructurings and related impairments
During the first quarter of 2001, the Company continued its restructuring
efforts, that commenced in December 2000, including the shutdown of SpeedyClick,
the sale of Ubarter Canada, which resulted in a loss of approximately $2.3
million, and the lay off of 245 employees, which resulted in severance and
related payroll charges of approximately $580,000 and approximately $68.1
million of restructuring charges.
Impairment of cost-basis investments
During the first quarter of 2001, the Company determined that certain of its
cost-basis investments were permanently impaired relative to their historical
values. As a result, the Company recognized an impairment charge of $18.8
million, which is included as a component of nonoperating income (expense) in
the accompanying March 31, 2001 consolidated statements of operations. Permanent
impairments in the Company's cost-basis investments were determined by examining
the operations of each company, and when possible, by reviewing recent
private-placement valuations for comparable companies and by obtaining
professional business valuations.
Note 5. Unusual Item:
In April 2001, the Company settled potential claims held by Mr. Dwayne Walker,
the Company's Chairman and Chief Executive Officer, against the Company arising
from the withdrawal of Mr. Walker's shares of the Company's common stock from
the Company's secondary public offering completed in February 2000. The terms of
the settlement are set forth in a letter agreement dated as of April 5, 2001
between the Company and Mr. Walker.
14
The settlement provides that the Company will purchase 262,000 shares of its
common stock from Mr. Walker in exchange for the tender of a $3.8 million note
payable from the Company (Company Note). In connection with the settlement, the
Company agreed to consolidate all of Mr. Walker's outstanding promissory notes
to the Company, executed by him since September 28, 1999, which totaled $4.5
million as of December 31, 2000 and were recorded in Notes receivables from
employees and Subscriptions receivable. Principal and interest, at 7% per year,
are due on March 31, 2011. Following the Company's purchase of the 262,000
shares, Mr. Walker may endorse the Company Note to the Company in partial
satisfaction of the new loan. In addition, Mr. Walker agreed to transfer up to
1,171,158 shares of Company stock to the Company as additional payment of the
loan. The Company agreed to reduce the balance of the loan by the fair market
value of the 1,171,158 shares on the date of the transfer. To the extent Mr.
Walker's outstanding promissory note has not been completely repaid by the above
actions, the Company will immediately extinguish any remaining obligation Mr.
Walker may owe under the promissory note plus any applicable withholding. As a
result of the settlement, the Company recognized a $4.5 million dollar expense
in the first quarter of 2001. Mr. Walker also agreed to take on additional
responsibities as President.
Note 6. Deferred Revenues:
Unearned revenues related to domain registrations represent the unexpired term
of registration fees, net of the referral commissions paid to affiliates and
referral partners, and are recognized ratably over the term of the registration.
Revenues from marketing and professional fees are recognized when services are
delivered, and licensing fees are recognized over the term of agreement.
Note 7. Debt Obligations:
In March 1999, the Company entered into a loan and security agreement with a
financial institution for a term loan and line of credit. In May 1999, the
agreement was amended and restated to allow the Company to borrow up to $8.5
million at any one time, consisting of a $3.5 million term loan (term loan), a
$4.0 million bridge loan (bridge loan) and a line of credit of up to $2.5
million. The term loan had an outstanding balance of $1.4 million at March 31,
2001 and bears interest at 12%, is secured by a letter of credit and matures in
March 2002. In conjunction with the agreement, the Company issued warrants to
acquire 72,000 shares of common stock at an exercise price of $6.25 per share.
The warrants are exercisable immediately and expire in March 2006. In May 1999,
the Company issued to the financial institution additional warrants to acquire
70,000 shares of common stock at an exercise price of $7.00 per share. The
warrants are exercisable immediately and expire in June 2006.
On May 19, 2000, the Company entered into a credit agreement with a commercial
bank, with a maximum commitment amount of $15.0 million to finance the purchase
of equipment, software and tenant improvements. The credit agreement is secured
by substantially all of the Company's assets and had an outstanding balance of
$9.1 million at March 31, 2001. The outstanding commitments bear interest at an
annual rate equal to the prime lending rate plus one and one-half percent.
Outstanding commitments under the agreement are required to be repaid under
specific schedules, with all commitments to be repaid no later than November 18,
2003. The credit agreement requires the Company to maintain certain financial
ratios and places limitations on certain financing and investing activities. The
credit agreement also contains other customary conditions and events of default
that, in the event of noncompliance by the Company, would prevent any further
borrowings and would generally require the repayment of any outstanding
commitments under the credit agreement.
On September 29, 2000, the Company sold $20.0 million of convertible notes and
warrants to a private institution. The notes have a one-year term and bear
interest at an annual rate of six percent. On October 26, 2000, the Company
filed a registration statement on Form S-3 with the SEC, which was declared
effective on December 4, 2000. Also, the Company issued warrants to purchase
4,050,633 shares of common stock to the private institution at an exercise price
of $10.37 per share. The warrants are immediately exercisable and expire in five
years. These warrants were valued at $9.4 million and were recorded as common
stock warrants in the accompanying December 31, 2000 consolidated balance
sheets. The notes were valued at $10.6 million. Immediately after the effective
date, $5.0 million of the notes were converted into common stock. As of March
31, 2001, the notes were valued at $11.5 million. The terms of the notes provide
for conversion to common stock at a conversion price of $1.68 per share. Under
the terms of the agreement, the notes can be called by the holder if the Company
were to be delisted from the NASDAQ stock exchange.
15
Note 8. Segment Information:
The Company's segment information for each of the three months ended March 31,
2001 and 2000, and the year ended December 31, 2000 as follows (in thousands):
Year ended
Three months ended March 31, December 31,
------------------------------- ---------------
2001 2000 2000
-------------- -------------- ---------------
Revenues:
Continuing operations $ 6,571 $ 1,604 $ 11,806
Operations closed in 2001 3,537 17,078 94,315
-------------- -------------- ---------------
10,108 18,682 106,121
-------------- -------------- ---------------
Cost of revenues:
Continuing operations 1,583 39 2,924
Operations closed in 2001 733 10,354 56,375
-------------- -------------- ---------------
2,316 10,393 59,299
-------------- -------------- ---------------
Gross Profit:
Continuing operations 4,988 1,565 8,882
Operations closed in 2001 2,804 6,724 37,940
-------------- -------------- ---------------
$ 7,792 $ 8,289 $ 46,822
============== ============== ===============
Note 9. Subsequent Events
Option Repricing and Exchange Program
In April 2001, the Company repriced options to purchase 4,530,792 shares issued
in December 2000 from a price of $0.78 to a price of $0.09. This repricing will
result in variable accounting treatment for these stock options. Variable
accounting treatment will result in unpredictable stock-based compensation
dependent on fluctuations in quoted prices for the Company's common stock.
In April 2001, the Company offered a voluntary stock option exchange program to
its employees. The plan allows employees, if they so choose, to exchange three
options for one option priced at $0.09 per share. The vesting period will be
quarterly over the next four quarters. This exercise price change will result in
variable accounting treatment for these stock options. Variable accounting
treatment will result in unpredictable stock-based compensation dependent on
fluctuations in quoted prices for the Company's common stock.
Debt Obligations
On April 2, 2001, the Company repaid its obligation under the credit agreement
with a commercial bank, which had a balance of $9.1 million as of March 31,
2001. The obligation was repaid with the cash that was restricted for this
purpose.
On April 3, 2001, the Company received a notice of default from the holders of
the $20 million of convertible notes for an alleged violation of certain
provisions of the convertible notes relating to the breach of certain negative
financial covenants contained in the our credit agreement for $15.0 million with
a commercial bank and the breach by the Company of certain material terms of the
Securities Purchase Agreement dated as of September 28, 2000. The notice of
default demanded that the Company redeem the convertible notes on or before
April 9, 2001 for an amount equal to $17.25 million, which amount represents
115% of the aggregate principal amount of the remaining convertible notes. The
Company responded to the notice of default on April 4, 2001 and denied that an
event of default occurred. If the Company were to be in default of the
convertible notes and if the default is not cured, or waived by the holder of
the convertible notes, and we are required to redeem the amounts outstanding
under the convertible notes, the holder could seek remedies against us, which
may include penalty rates of interest, immediate repayment of the debt and the
filing of an involuntary petition in bankruptcy. In addition, the Company may
have no alternative but to file a petition in bankruptcy.
During May 2001, the holders of the above mentioned convertible notes converted
$2.5 million of the notes into common stock.
Also, during May 2001, a lessor filed a Writ of Attachment on our bank account
in the amount of $600,000. The Company is defending this matter.
On May 10, 2001, the Company repaid its obligation under the loan and security
agreement with a financial institution, which had a balance of $1.4 million as
of March 31, 2001. The obligation was repaid with the cash that was restricted
for this purpose.
16
Related Party Transactions
In April 2001, the Company settled potential claims held by Mr. Dwayne Walker,
the Company's Chairman and Chief Executive Officer, against the Company arising
from the withdrawal of Mr. Walker's shares of the Company's common stock from
the Company's secondary public offering completed in February 2000. The terms of
the settlement are set forth in a letter agreement dated as of April 5, 2001
between the Company and Mr. Walker.
The settlement provides that the Company will purchase 262,000 shares of its
common stock from Mr. Walker in exchange for the tender of a $3.8 million note
payable from the Company (Company Note). In connection with the settlement, the
Company agreed to consolidate all of Mr. Walker's outstanding promissory notes
to the Company, executed by him since September 28, 1999, which totaled $4.5
million as of December 31, 2000 and were recorded in Notes receivables from
employees and Subscriptions receivable. Principal and interest, at 7% per year,
are due on March 31, 2011. Following the Company's purchase of the 262,000
shares, Mr. Walker may endorse the Company Note to the Company in partial
satisfaction of the new loan. In addition, Mr. Walker agreed to transfer up to
1,171,158 shares of Company stock to the Company as additional payment of the
loan. The Company agreed to reduce the balance of the loan by the fair market
value of the 1,171,158 shares on the date of the transfer. To the extent Mr.
Walker's outstanding promissory note has not been completely repaid by the above
actions, the Company will immediately extinguish any remaining obligation Mr.
Walker may owe under the promissory note, plus any applicable withholding. As a
result of the settlement, the Company recognized a $4.5 million dollar expense
in the first quarter of 2001. Mr. Walker also agreed to take on additional
responsibities as President.
Litigation
On October 6, 2000, Mall.com, Inc. filed suit against the Company in the
District Court of Travis County, Texas which was removed by the Company to the
United States District Court for the Western District of Texas. The suit was
based on a contract between Mall.com, Inc. and IveBeenGood.com, Inc. which the
Company acquired on August 24, 2000. The suit alleged that IveBeenGood.com, Inc.
breached the contract, breached a warranty given to Mall.com, Inc. and committed
fraud and negligent misrepresentation. The claims asserted by Mall.com, Inc.
were acquired by Mall Acquisition Corp. On May 7, 2001, the Company, Mall.com,
Inc. and Mall Acquisition Corp. entered into a Compromise and Settlement
Agreement and Mutual General Release. Pursuant to the settlement agreement, the
Company paid Mall Acquisition Corp. the sum of $67,500, and Mall.com, Inc. and
Mall Acquisition Corp. assigned to the Company any claims they may have against
Trilogy, Inc., a former shareholder of IveBeenGood.com, Inc. The parties also
agreed to approve a final judgment of dismissal that will refer to the
Compromise and Settlement Agreement.
On December 20, 2000, an action was initiated in Los Angeles Superior Court
styled Futurist Entertainment, Inc. v. Network Commerce, Inc., Jackie Sutphin,
SpeedyClick.com, Case No. BC242139. In the complaint plaintiff alleges, among
other things, breach of contract and business torts against defendants relating
to a Development and Website Agreement ("Development Agreement") between
Futurist Entertainment, Inc. and Network Commerce dated February 25, 2000. The
website was to serve as the official website for the Jackson 5's upcoming album
and world tour. Plaintiff alleges damages "in an amount yet to be ascertained,
but in no event less than $4,400,000." The Company is mounting a vigorous legal
defense, and on April 5, 2001, the Company filed an answer and cross-complaint
against S. Jackie Jackson and Futurist Entertainment, Inc. In the answer, the
Company contends, among other things, that Futurist and Jackson thwarted the
Company's ability to perform under the Development Agreement. In the
cross-complaint, the Company alleges, among other things, securities fraud,
fraud, unfair competition, gross negligence and breach of fiduciary duty by both
Futurist and Jackson. Additionally, the Company alleges damages "in an amount
presently unknown but in excess of $10 million." Jackson and Futurist have yet
to respond to the Cross-Complaint or pending discovery. The Company holds an
investment in the common stock of Futurist Entertainment, Inc.
On May 10, 2001, a shareholder filed a lawsuit in the United States District
Court in Seattle, Washington against the Company and its chairman and chief
executive officer alleging violations of Sections 11 and 12(a)(2) of the
Securities Act of 1933 and Sections 10(b), 15 and 20(a) of the Securities
Exchange Act of 1934. The lawsuit is styled Jan Sherman, on behalf of herself
and all others similarly situated, v. Dwayne M. Walker and Network Commerce
Inc., Case Number: C01-0675. The lawsuit seeks unspecified damages and
certification of a class consisting of purchasers of the Company's common stock
during the period from September 28, 1999 through April 16, 2001. The Company is
investigating the allegations and intends to vigorously defend this action.
Nevertheless, an unfavorable resolution of this lawsuit could have a material
adverse effect on the Company in one or more future periods.
On May 14, 2001, pursuant to an Agreement and Plan of Merger and Exchange of
Stock dated as of May 11, 2001, the Company completed the sale of GO to Return
on Investment Corporation ("ROI") through its wholly-owned subsidiary for $1.0
million in cash and $3.0 million in ROI common stock. As part of the merger
transaction, ROI is required to file with the Securities Exchange Commission a
registration statement to effect a registration of the common stock delivered to
Network Commerce.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The matters discussed in this report contain forward-looking statements that
involve known and unknown risks and uncertainties, such as statements of our
plans, objectives, expectations and intentions. Words such as "may," "could,"
"would," "expect," "anticipate," "intend," "plan," "believe," "estimate," and
variations of such words and similar expressions are intended to identify such
forward-looking statements. You should not place undue reliance on these
forward-looking statements, which are based on our current expectations and
projections about future events, are not guarantees of future performance, are
subject to risks, uncertainties and assumptions (including those described
below) and apply only as of the date of this report. Our actual results could
differ materially from those anticipated in the forward-looking statements.
Factors that could cause or contribute to such differences include, but are not
limited to, those discussed below in "Additional Factors That May Affect Future
Results" as well as those discussed in this section and elsewhere in this
report, and the risks discussed in the "Risk Factors" section included in our
December 31, 2000 10-K filed on April 17, 2001 with the Securities and Exchange
Commission, as amended by Form 10-K/A on April 30, 2001.
Overview
We are a technology infrastructure and services company that offers a
comprehensive technology and services platform solution, including domain
registration, hosting services, e-commerce services and online marketplaces. Our
technology and services platform operates across our core infrastructure, which
includes four data centers, more than 500 servers, and operates at a bandwidth
in excess of 400 megabits per second. Through December 31, 2000, we operated two
commerce networks and an eBusiness Services division. The Network Commerce
Consumer Network aggregated merchants and shoppers over a distributed network of
Web sites, and the Network Commerce Business Network enabled businesses to
engage in online activities and transactions with other businesses. The
eBusiness services division provided consulting, custom commerce solutions, and
integrated marketing services for businesses conducting commerce online. In
January 2001, we restructured these groups into the Network Commerce Portal
Services and the Network Commerce Infrastructure and Technology ("IT") groups
and we shutdown the eBusiness Services division. The Portal Services group
includes one-to-one marketing services and various online marketplaces focused
on gaming and entertainment. The Network Commerce IT group includes domain name
registration, hosting, commerce service, technology and licensing and other
business services. As a result of this restructuring, we recognized
approximately $64.9 million in restructuring and impairment charges for the year
ended December 31, 2000. During the first quarter of 2001, our further
restructuring efforts included the shut down of certain business units,
including SpeedyClick, the sale of Ubarter Canada, and the lay off of 245
employees. As a result of this further restructuring, we recognized
approximately $114.1 million of restructuring and impairment charges, in the
three-months ended March 31, 2001.
We believe that our cash reserves and cash flows from operations will be
adequate to fund our operations through June 2001. Consequently, we will require
substantial additional funds to continue to operate our business beyond that
period. Many companies in the Internet industry have experienced difficulty
raising additional financing in recent months. Additional financing may not be
available to us on favorable terms or at all. Even if additional financing is
available, we may be required to obtain the consent of our existing lenders,
which we may not be able to obtain. If additional financing is not available, we
may need to dramatically change our business plan, sell or merge our business,
or face bankruptcy. In addition, the issuance of equity or equity-related
securities will dilute the ownership interest of existing stockholders and the
issuance of debt securities could increase the risk or perceived risk of our
company.
Our condensed consolidated financial statements for the quarter ended March 31,
2001 were prepared on a going concern basis, which contemplates the realization
of assets and the settlement of liabilities in the normal course of business. We
have incurred net losses of $177.6 million for the three-months ended March 31,
2001 and have accumulated deficits of $544.9 million as of March 31, 2001. The
Company has continuously incurred net loss from operations and as of March 31,
2001 has working capital deficit of $21.7 million. These factors raise
substantial doubt about our ability to continue as a going concern. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty. Our plans to mitigate the risk of
this uncertainty include, but are not limited to, the following:
18
exploring strategic alternatives, which may include a merger, asset sale,
or another comparable transaction;
raising additional capital to fund continuing operations by private
placements of equity and/or debt securities; and
forming a joint venture with a strategic partner or partners to provide
additional capital resources to fund operations.
Additional cost-cutting measures could include additional lay-offs and/or the
closure of certain business units and facilities.
We were incorporated in January 1994 and initially operated as a computer
services company. In 1996, we began to change the focus of our business to
conducting commerce over the Internet. In May 1997, we launched the
BuySoftware.com Network, a network of online sites that sold computer products.
During 1998, we completed three acquisitions, including the acquisition of Media
Assets, Inc., a direct marketing company, we launched ShopNow.com and we began
offering merchants e-commerce enabling products and services. In April 1999, we
changed our name from TechWave Inc. to ShopNow.com Inc. In June 1999, we ceased
operation of the BuySoftware.com Network because we determined it was
inconsistent with our evolving strategy. In May 2000, we changed our name to
Network Commerce Inc. We consummated five acquisitions during 1999 and seven
additional acquisitions during 2000. During the fourth quarter of 2000, we
announced the lay off of 209 employees through staff reductions and from the
closure of Media Assets, Inc., AXC Corporation, Cortix, Inc. and WebCentric,
Inc. In addition, we initiated a restructuring plan to lower costs and improve
profitability by shutdown of certain other business units, including ShopNow.com
in January 2001, and SpeedyClick.com in March 2001, these restructuring efforts
included the lay off of 145 and 100 employees, respectively.
Through December 31, 2000, we have derived substantially all of our revenues
from the Network Commerce Consumer Network, the Network Commerce Business
Network and from providing services to businesses.
Revenues from the Network Commerce Consumer Network, which was a network of
proprietary and affiliated Web sites including www.shopnow.com and licensed
affiliates, the BottomDollar Network (including www.bottomdollar.com and
licensed affiliates) and www.speedyclick.com were generated primarily from the
sale of online marketing services, leads and orders, advertising and
merchandising. Revenues from these agreements were recognized as the media or
services were delivered to the merchants over the term of the agreements, which
typically ranged from one to twelve months. We bore the full credit risk with
respect to these sales. In certain circumstances, such as with the
www.chaseshop.com portal, we offered products directly to shoppers. In these
instances where we acted as merchant-of-record, we recorded as revenue the full
sales price of the product sold and recorded the full cost of the product to us
as cost of revenues; upon shipment of the product. Shipping charges billed to
the customer were included in revenues, and the costs incurred by us to ship the
product to the customer were included in cost of sales. In January 2001, to
improve margins and to lower costs, we discontinued offering products directly
to online shoppers. In March 2001, the Network Commerce Consumer Network was
shutdown to further reduce costs.
Revenues from the Network Commerce Business Network, which is a network of
proprietary and affiliated Web sites, including www.registrars.com,
www.b2bnow.com, www.freemerchant.com, www.domainzero.com, www.ehost.com and
www.ubarter.com, are derived primarily from providing domain registration,
web-enablement services, commerce-enablement services, transaction processing,
advertising and technology licensing to businesses. Revenues from registrars.com
are derived from the sale of domain name registration fees, which are typically
paid in full at the time of the sale and are recognized over the registration
term, which typically ranges from one to three years. Revenues from b2bNow.com
are generated primarily from the sale of advertising and merchandising products
and services similar to those sold on the Network Commerce Consumer Network.
Revenues from Ubarter.com are generated from transaction fees earned from member
businesses that transact over the Ubarter exchange system as well as from
products sold by Ubarter.com to other member merchants of the Ubarter exchange
system. Revenues from services are generated principally through development
fees, domain registration fees, hosting fees and sales and marketing services.
These services can be purchased as a complete end-to-end suite of services or
separately. We recognize revenues from the development of custom applications
and online stores and marketing projects on a percentage of completion basis
over the period of development or the period of the marketing project. These
projects generally range from two to twelve months. Hosting contracts typically
have a term of one year, with fees charged and earned on a monthly basis. We
bear the full credit risk with respect to these sales. Contract costs include
all direct labor, material, subcontract and other direct project costs and
certain indirect costs related to contract performance.
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Revenues are also generated from fees paid to us by businesses and merchants who
license our technology; transaction processing, fraud prevention, and online
payment gateways, as well as other e-commerce enabling technologies. Revenues
include service fees, licensing fees, per-transaction fees and in certain cases
monthly hosting and maintenance fees, which are recognized in the period earned.
Revenues generated from technology licensing are recognized in accordance with
Statement of Position 97-2, "Software Revenue Recognition." Businesses and
merchants who utilize our payment processing technologies act as the
merchant-of-record and bear the full credit risk on those sales of goods and
services.
We recognize revenues from barter transactions when earned, and value barter
transactions based on the value of the consideration received from the customer
or from the value of the services provided to the customer, whichever is more
readily determinable. During the first quarter of 2001, we recognized
approximately $1.4 million in revenues on such transactions.
We recognize revenues from sale of online marketing services, leads and orders,
advertising and merchandising in which we receive equity in our customer. We
value the equity received from these transactions as cost-basis investments
based on the value of the consideration received from the customer or from the
value of the services provided to the customer, whichever is more readily
determinable. We monitor these cost-basis investments for impairment. When
cost-basis investments are deemed to be permanently impaired, the difference
between cost and market value is charged to operations. There can be no
assurance that our investments in these early-stage technology companies will be
realized. During the first quarter of 2001, we recognized approximately $205,000
in revenues on such equity transactions.
Cost of revenues generated from the Network Commerce Consumer Network include
the portion of our Internet telecommunications connections that are directly
attributable to traffic on the Network Commerce Consumer Network and the direct
labor costs incurred in maintaining and enhancing our network infrastructure. In
order to fulfill our obligations under our registrations, lead and order
delivery advertising programs, we occasionally purchase consumer traffic from
third party networks by placing on their Web sites advertisements that, when
clicked on by a visitor, send the visitor to the Network Commerce Consumer
Network. Any shopping traffic that we purchase from a third party that is used
to fulfill these obligations is included as cost of revenues. Cost of revenues
on the products that we sell as merchant-of-record includes the cost of the
product, credit card fees and shipping costs. Cost of revenues generated from
providing services includes all direct labor costs incurred in connection with
the provision of services, as well as fees charged by third-party vendors that
have directly contributed to the design, development and implementation of our
services. Cost of revenues generated from licensing e-commerce enabling
technologies and from our proprietary business-to-business portal consists
primarily of telecommunications costs and direct labor costs incurred in
maintaining and enhancing our network infrastructure.
Acquisitions
In June 1999, we acquired GO Software, Inc. ("GO"). GO develops and markets
transaction processing software for personal computers that can function on a
stand-alone basis or can interface with core corporate accounting systems. We
paid GO shareholders $4.7 million in cash, issued a $1.0 million promissory note
bearing interest at 10%, and issued 1,123,751 shares of common stock, valued at
$8.54 per share, for a total purchase price of $15.4 million. The acquisition
was accounted for using the purchase method of accounting. Of the excess
purchase price of approximately $14.4 million, $13.8 million was allocated to
acquired technology and $556,000 was allocated to goodwill, which are both being
amortized over a three-year life. The note bore interest at 10% and was repaid
in full upon completion of our initial public offering completed in September
1999. In March 2001, we recognized an impairment charge of $1.8 million to
write-down the carrying value to the approximate net realizable value. On May
14, 2001, pursuant to an Agreement and Plan of Merger and Exchange of Stock
dated as of May 11, 2001, the Company completed the sale of GO to Return on
Investment Corporation ("ROI") through its wholly-owned subsidiary for $1.0
million in cash and $3.0 million in ROI common stock. As part of the merger
transaction, ROI is required to file with the Securities Exchange Commission a
registration statement to effect a registration of the common stock delivered to
Network Commerce.
Also in June 1999, we acquired CardSecure, Inc. ("CardSecure") for a purchase
price of approximately $3.5 million. CardSecure is a developer of e-commerce
enabled Web sites. The acquisition was accounted for using the purchase method
of accounting. The excess purchase price of approximately $3.5 million was
allocated to acquired technology and is being amortized over a three-year life.
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On November 12, 1999, we acquired SpeedyClick, Corp. ("SpeedyClick"), a
California corporation, for $55.6 million of cash, common stock and common stock
options. SpeedyClick, a privately held company, maintained an Internet Web site
that focused on entertainment and interactivity. In connection with this
acquisition, we issued to the shareholders of SpeedyClick 3,799,237 shares of
common stock valued at $13.31 per share. Options to purchase SpeedyClick common
stock were assumed by us and converted into 157,527 options to purchase our
common stock. We also paid cash consideration of $3.0 million to the owners of
SpeedyClick. We accounted for this transaction as a purchase. Of the $55.6
million in consideration paid, approximately $27.9 million was allocated to
proprietary concepts, $14.7 million to customer lists and $13.0 million to
goodwill. These intangible assets were being amortized over a three-year life.
However, in March 2001, we decided to shut down the operations and wrote-off the
remaining intangible assets of $37.2 million.
On December 3, 1999, we acquired Cortix, Inc. ("Cortix"), an Arizona corporation
doing business as 20-20Consumer.com, for $14.4 million of cash and common stock.
Cortix, a privately held company, provided comparison shopping services
including online reviews and ratings for commerce-oriented businesses, merchants
and products. In connection with this acquisition, we issued to the shareholders
of Cortix 711,435 shares of common stock valued at $18.81 per share together
with cash consideration of $1.0 million. We accounted for this transaction as a
purchase. Of the $14.4 million in consideration paid, approximately $11.3
million was allocated to acquired technology, $1.6 million to customer lists and
$1.3 million to goodwill. These intangible assets were being amortized over a
three-year life. However, in December 2000, we decided to shut down the
operations and wrote-off the remaining intangible assets of $9.1 million.
On December 17, 1999, we acquired WebCentric Inc. ("WebCentric"), a Kansas
corporation doing business as bottomdollar.com, for $41.6 million of cash,
common stock, and common stock options. WebCentric, a privately held company,
developed e-commerce integration technology and applications, including a
comparison shopping engine that allowed consumers to search and compare the
products and services of several leading Internet merchants. In connection with
this acquisition, we issued to the shareholders of WebCentric 2,161,904 shares
of common stock valued at $16.89 per share together with approximately $1.4
million of cash. In addition, we issued replacement stock options to purchase an
aggregate of 121,544 shares of our common stock to certain employees and owners
of WebCentric. We accounted for this transaction as a purchase. Of the $40.2
million in consideration paid, approximately $31.8 million was allocated to
acquired technology, $3.3 million to customer lists and $4.6 million to
goodwill. These intangible assets were being amortized over a three-year life.
However, in December 2000, we decided to shut down the operations and wrote-off
the remaining intangible assets of $24.3 million.
On January 13, 2000, through a wholly owned Nova Scotia company, we acquired
Pronet Enterprises Ltd. ("Pronet"), a Canadian company, for approximately $12.8
million, consisting of $3.2 million in cash, $2.2 million in non-cash deferred
tax liabilities assumed and $7.4 million in common stock and common stock
options issued to Pronet shareholders. Pronet, a privately held company,
operates a business-to-business portal and marketplace that aggregates
businesses that seek to transact with one another. In connection with this
acquisition, we issued to the shareholders of Pronet 162,508 shares of common
stock, valued at $17.60 per share. In addition, we issued options to purchase
351,666 shares of common stock to the two principal shareholders of Pronet. We
accounted for this transaction as a purchase. Of the $12.8 million in
consideration paid, approximately $6.3 million was allocated to acquired
technology, $2.7 million to customer lists and $3.8 million to goodwill. These
intangible assets are being amortized over a three-year life. In January 2001,
we revised our estimated useful life for these assets and will be amortizing the
remaining carrying value of Pronet (approximately $9.1 million as of December
31, 2000) over the first six months of 2001.
On January 18, 2000, we acquired AXC Corporation ("AXC"), a Washington
corporation, for approximately $17.9 million, consisting of $2.2 million in
cash, $4.1 million in non-cash deferred tax liabilities assumed and $11.6
million in common stock and common stock options issued to AXC shareholders.
AXC, a privately held company, provided e-commerce consulting services to
businesses. In connection with this acquisition, we issued to the shareholders
of AXC 540,296 shares of common stock valued at $17.60 per. In addition, we
issued replacement stock options to purchase an aggregate of 72,089 shares of
our common stock to certain employees and owners of AXC. We accounted for this
transaction as a purchase. Of the $17.9 million in consideration paid,
approximately $7.2 million was allocated to assembled workforce, $4.9 million to
customer lists, $5.0 million to goodwill and $800,000 to working capital. These
intangible assets were being amortized over a three-year life.
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However, in December 2000, we decided to shut down the operations and wrote-off
the remaining intangible assets of $14.2 million.
On April 11, 2000, we acquired FreeMerchant.com, Inc. ("FreeMerchant"), a
Delaware corporation, for approximately $38.1 million, consisting of $2.0
million in cash, $10.0 million in non-cash deferred tax liabilities assumed,
$500,000 of debt assumed and $25.6 million in common stock and common stock
options issued to FreeMerchant stockholders. FreeMerchant, a privately held
company, has developed online store-builder technology for small- to
medium-sized merchants who seek a low-cost entry point to e-commerce, and
provides hosting services to those merchants. In connection with this
acquisition, we issued to the shareholders of FreeMerchant 2,573,723 shares of
common stock, valued at $8.80 per share. In addition, we issued options to
purchase 293,596 shares of common stock to certain FreeMerchant stockholders and
employees. We accounted for this transaction as a purchase. Of the $38.1 million
in consideration paid, approximately $23.0 million was allocated to acquired
technology, $4.1 million to assembled workforce and $11.0 million to goodwill.
These intangible assets are being amortized over a three-year life. In March
2001, we recognized an impairment charge of $22.4 million to write-down the
carrying value to the approximate net realizable value.
On June 2, 2000, we acquired Ubarter.com Inc ("Ubarter"), a Nevada corporation,
pursuant to an agreement and plan of merger dated January 20, 2000, for
approximately $61.7 million, consisting of $875,000 in cash, $11.4 million in
non-cash deferred tax liabilities assumed, $978,000 of net liabilities assumed,
$7.6 million in the cancellation of debt between Ubarter and us, and $40.8
million in common stock and common stock warrants issued to Ubarter stockholders
and creditors. Ubarter, a publicly traded company, is a business-to-business
e-commerce enterprise, which utilizes the Ubarter Dollar as payment for products
and services by its member businesses over its proprietary barter exchange
system. In connection with this acquisition, we issued to the stockholders and
creditors of Ubarter a total of 2,682,871 shares of common stock valued at
approximately $15.10 per share. In addition, we issued warrants to purchase
51,842 shares of common stock to certain Ubarter stockholders, employees and
creditors. We accounted for this transaction as a purchase. Of the $61.7 million
in consideration paid, approximately $7.5 million was allocated to acquired
technology, $2.5 million to assembled workforce, $25.1 million to proprietary
concept, $2.5 million to customer lists, and $24.0 million to goodwill. These
intangible assets are being amortized over a three-year life. Early in the
fourth quarter 2000, we launched a new user interface and back-end management
system for the Ubarter.com merchant exchange, and executed various marketing
efforts to promote the new system. These efforts did not stimulate growth in the
Ubarter economy as expected, which led to a revision in our original forecasts
and projections for Ubarter. These revised forecasts indicated that future
expected cash flows from this business unit were less than the carrying value of
its intangible assets, thus triggering an impairment event in December 2000. At
that time, the carrying value of Ubarter's intangible assets including goodwill
was $51.6 million. Based on recent comparable sales of other barter exchange
systems, we determined the fair value of Ubarter.com to be approximately $5
million. As a result, we recognized an impairment charge of $46.6 million in
December 2000. In February 2001, the Company sold the Canadian-based operations
of Ubarter and recognized a loss of $2.3 million. In March 2001, we recognized
an impairment charge of $4.2 million to write-down the carrying value to the
approximate net realizable value.
On August 24, 2000, we acquired Ivebeengood.com, d.b.a. UberWorks ("UberWorks"),
a wholly owned subsidiary of Trilogy, Inc. ("Trilogy"), for approximately $22.8
million, consisting of $2.4 million accrued as non-cash deferred compensation,
$5.9 million in non-cash deferred tax liabilities assumed and $14.5 million in
common stock and common stock options issued to Trilogy and UberWorks employees.
UberWorks was a developer of multi-merchant e-commerce purchasing tools and
universal shopping cart technology. In connection with this acquisition, we
issued to the shareholders of UberWorks a total of 2,601,562 shares of common
stock valued at approximately $6.13 per share. Of the total, 913,459 are being
held back by us to be subsequently released based on time vesting and on certain
performance criteria yet to be achieved. In addition, we issued a warrant to
Trilogy, with a strike price of $0.000001 per share, to purchase additional
shares of our common stock if on the one-year anniversary date of the
acquisition; the shares issued to Trilogy are not worth at least $13.1 million.
The maximum number of additional shares that Trilogy can purchase under the
terms of the warrant is 2.6 million. To the extent that the shares have a fair
market value that exceeds $13.1 million on the one-year anniversary date, the
warrant is cancelled and Trilogy must forfeit the number of shares that would be
required to bring their fair value down to $13.1 million, limited to a maximum
of 1.3 million shares. We also issued options to purchase 248,162 shares of
common stock to certain UberWorks employees. We accounted for this transaction
as a purchase. Of the $22.8 million of consideration paid, approximately $12.3
million was allocated to acquired technology, $2.4 million to deferred
compensation, $726,000
22
to assembled workforce and $7.3 million to goodwill. These intangible assets
were being amortized over a three-year life. However, in March 2001, we decided
to abandon the technology wrote-off the remaining intangible assets of
approximately $16.6 million.
On December 8, 2000, we acquired ePackets.Net, Inc. ("ePackets") for
approximately $270,000, consisting of $150,000 in cash, $37,000 in common stock
and common stock options and $83,000 in net liabilities assumed. ePackets
provided permission-based one-to-one email solutions. In connection with this
acquisition, we issued to the shareholders of ePackets a total of 33,324 shares
of common stock. We accounted for this transaction as a purchase. The
consideration paid was allocated to acquired technology and was being amortized
over a three-year life. However, in March 2001, we decided to shut down the
operations and wrote-off the remaining intangible assets of $255,000.
On December 22, 2000, we acquired Internet Domain Registrars Corporation
("IDR"), for approximately $23.6 million, consisting of $750,000 in cash, $6.1
million in non-cash deferred tax liabilities assumed, $5.7 million in common
stock and $11.1 million in net liabilities assumed. IDR is a domain name
infrastructure company, which owns and operates the www.registrars.com Web site.
In connection with this acquisition, we issued to the shareholders of IDR a
total of 7,650,000 shares of common stock, of which 1,000,000 were placed in
escrow for indemnification purposes. In addition, 3,281,000 shares were issued
and placed in escrow to be released to the former shareholders and certain
employees of IDR upon the achievement of established future revenue targets over
an eighteen month period, and 219,000 shares were issued to employees of IDR who
continued to be employed by IDR after the acquisition. Finally, 600,000 shares
of our common stock were issued at the closing to certain other persons in
connection with the settlement of potential claims against IDR and as
consideration of services rendered to IDR in connection with the acquisition.
The closing price of our common stock on December 22, 2000 was $0.69 per share.
We accounted for this transaction as a purchase. Of the $23.6 million of
consideration paid, approximately $10.5 million was allocated to proprietary
concept, $874,000 to domain name, $3.5 million to customer lists, $874,000 to
assembled workforce and $7.8 million to goodwill. These intangible assets are
being amortized over a three-year life. In March 2001, we recognized an
impairment charge of $17.6 million to write-down the remaining carrying value to
the approximate net realizable value.
Results of Operations
Revenues. Total revenues for the three-month period ended March 31, 2001 were
$10.1 million compared to $18.7 million for the comparable period in 2000. The
decrease was due primarily to the shutdown of ShopNow.com, the elimination of
product sales, and the sale of Ubarter Canada. Revenue during the first quarter
from continuing business units was $6.6 million compared to $1.6 million during
the comparable period in 2000. Internet Domain Registrars, acquired on December
22, 2000, provided revenues of $3.1 million in the first quarter.
Cost of Revenues. The cost of revenues for the three-month period ended March
31, 2001, were $2.3 million compared to $10.4 million for the comparable period
in 2000. The decrease in our cost of revenues was directly attributable to the
decrease in revenues during the same period and due to the shutdown of
ShopNow.com, the elimination of product sales, and the sale of Ubarter Canada,
which were all low profit margin operations.
Gross Profit. Gross profit for the three-month period ended March 31, 2001, was
$7.8 million compared to $8.3 million for the comparable period in 2000. As a
percent of revenues, our gross margins were 77.1% compared to 44.4% for the
comparable period in 2000. This increase in gross profit percentage was due
primarily to the shutdown of ShopNow.com, the elimination of product sales, and
the sale of Ubarter Canada, which were all low profit margin operations.
Sales and Marketing. Sales and marketing expenses consist primarily of costs
associated with marketing programs such as advertising and public relations, as
well as salaries and commissions. Sales and marketing expenses for the
three-month period ended March 31, 2001 were $17.3 million compared to $22.1
million of the comparable period in 2000. The decrease was due primarily to
elimination of nationwide television, radio and print advertising during the
first quarter 2001, as well as we no longer purchased traffic for our Consumer
Network.
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General and Administrative. General and administrative expenses consist
primarily of salaries and other personnel-related costs for executive,
financial, human resources, information services and other administrative
personnel, as well as legal, accounting and insurance costs. General and
administrative expenses for the three-month periods ended March 31, 2001 were
$4.3 million compared to $3.2 million for the comparable period in 2000. The
increase was due primarily to an increase in personnel and related costs.
Research and Development. Research and development expenses consist primarily of
salaries and related costs associated with the development of new products and
services, the enhancement of existing products and services, and the performance
of quality assurance and documentation activities. Research and development
expenses for the three-month period ended March 31, 2001 were $5.3 million
compared to $4.2 million for the comparable period in 2000.
Amortization of Intangible Assets. Amortization of intangible assets resulting
from acquisitions is primarily related to the amortization of customer lists,
domain names, acquired technology, proprietary concepts, assembled workforce and
goodwill. Amortization of intangible assets expense for the three-month period
ended March 31, 2001 was $18.3 million compared to $13.5 million for the
comparable period in 2000. This increase was due primarily to the increase in
intangible assets and related amortization expenses from business acquisitions
completed during 2000 described above. Intangible assets acquired in business
combinations are amortized over a three-year period.
Stock-Based Compensation. Stock-based compensation expense is related to the
amortization of deferred compensation resulting from stock option grants to
employees with an option exercise price below the estimated fair market value of
our common stock as of the date of grant. Stock-based compensation expense for
the three-month period ended March 31, 2001 was $260,000 compared to $1.9
million for the comparable period in 2000. The amount of deferred compensation
resulting from these grants is generally amortized over a one- to three-year
vesting period. As of March 31, 2001, we have recognized $7.1 million of
deferred compensation to be amortized over future periods
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Restructuring and other impairment charges. Restructuring and impairment charge
consists primarily of $57.6 million of write-off of impaired goodwill and
intangible assets, $12.8 million of tenant improvements, fixed assets, software
and supporting technologies and infrastructure related to previously acquired
businesses that were shut down, and $580,000 relating to severance and related
benefits for terminated employees. There was no such charge for the comparable
period last year.
Impairment of certain long-lived assets. As part of the restructuring, we
determined that goodwill and intangibles assets associated with acquired
businesses had a carrying value in excess of the potential sales value of the
business units. As a result, we recognized an impairment charge of $43.1
million.
Unusual item - settlement of claim. In April 2001, the Company settled potential
claims held by Mr. Dwayne Walker, the Company's Chairman and Chief Executive
Officer, against the Company arising from the withdrawal of Mr. Walker's shares
of the Company's common stock from the Company's secondary public offering
completed in February 2000. There were not such settlements in the comparable
period of 2000.
(Loss) gain on sale of investments. Loss on sale of marketable equity securities
for the three-month period ended March 31, 2001 was $150,000 compared to $1.1
million gain for the comparable period in 2000.
Interest Income. Interest income is earned on our cash and cash equivalents and
short-term investments. Interest income for the three-month period ended March
31, 2001 was $557,000 compared to interest income of $1.3 million for the
comparable period in 2000.
Interest Expense. Interest expense is incurred on our outstanding debt
obligations and the accretion of convertible promissory note. Interest expense
for the three-month period ended March 31, 2001 was $2.9 million compared to
$441,000 for the comparable period in 2000. Interest expense increased for the
three-month period ended March 31, 2000 due to the accretion of the convertible
promissory note.
Impairment of Cost-Basis Investments. During the first quarter of 2001, we
determined that certain of our cost-basis investments were permanently impaired
to between 50% and 100% of their historical values. As a result, we recognized
an impairment charge of $18.8 million during the three-month period ended March
31, 2001. There were no such charges for the comparable period in 2000.
Income Tax Benefit. The income tax benefit resulted principally from reductions
of deferred tax liabilities created as a result of business combinations. There
was no income tax benefit for the three-month period ended March 31, 2001
compared to $11.9 million for the comparable period in 2000. If we continue to
consummate additional business combinations that result in the recognition of
deferred taxes, we may experience additional deferred tax benefits. We have not
paid nor have we received refunds for federal income taxes and we do not expect
to pay income taxes or receive income tax refunds in the foreseeable future.
Net Loss. Net loss for the three-month period ended March 31, 2001 was $177.6
million compared to $22.8 million for the comparable period in 2000. This
increase was due primarily to impairment charges related to cost-basis
investments and intangible assets and restructuring charges related to closure
of business units. We expect to incur additional net losses in 2001.
Liquidity and Capital Resources
Since inception, we have experienced net losses and negative cash flows from
operations. As of March 31, 2001, we had an accumulated deficit of $544.9
million. We have financed our activities largely through issuances of common
stock and preferred stock, from the issuance of short- and long-term obligations
and from capital leasing transactions for certain of our fixed asset purchases.
Through March 31, 2001, our aggregate net proceeds have been $272.1 million from
issuing equity securities and $52.3 million from issuing debt securities. As of
March 31, 2001, we had $26.3 million in cash, cash equivalents and short-term
investments, of which $13.7 million of such amounts is characterized as
restricted cash to secure our obligations under certain letters of credit.
Net cash used in operating activities was $21.7 million for the three-month
period ended March 31, 2001, compared to $21.7 million for the same period in
2000.
25
Net cash provided by investing activities was $32.8 million for the three-month
period ended March 31, 2001, compared to net cash used in investing activities
of $77.9 million for the same period in 2000. The change was due primarily to no
purchases of short-term investments in the three-month period ended March 31,
2001, compared to the purchases of $104.8 million for the same period in 2000,
the decrease in the sales of short-term investments for the three-month period
ended March 31, 2001 of $32.7 million, compared to $49.7 million for the same
period in 2000, the decrease in purchases of property and equipment of $35,000
for the three-month period ended March 31, 2001, compared to $6.5 million for
the same period in 2000, the decrease in investments in equity and debt
securities and other assets of $2,000 for the three-month period ended March 31,
2001, compared to $10.5 million for the same period in 2000, and the decrease in
acquisition of businesses of nil for the three-month period ended March 31,
2001, compared to $5.8 million for the same period in 2000.
Net cash used in financing activities was $2.2 million for the three-month
period ended March 31, 2001, compared to cash provided by financing activities
of $106.3 million for the same period in 2000. The change was due primarily to
the closing of our public offering on February 18, 2000 of 7,913,607 shares of
common stock at $14.50 per share, which resulted in proceeds to us net of
underwriters' fees and commissions of $108.7 million.
In March 1999, we entered into a loan and security agreement with a financial
institution for a term loan and line of credit. In May 1999, the agreement was
amended and restated to allow us to borrow up to $8.5 million at any one time,
consisting of a $3.5 million term loan (the "term loan"), a $4.0 million bridge
loan (the "bridge loan") and a line of credit of up to $2.5 million. The term
loan bears interest at 12%, is secured by a letter of credit and matures in
March 2002. The term loan balance was $1.4 million as of March 31, 2001. The
outstanding credit line and bridge loan balances were both $0 as of March 31,
2001.
On May 19, 2000, we entered into a credit agreement with a commercial bank, with
a maximum commitment amount of $15.0 million to finance the purchase of
equipment, software and tenant improvements. The credit agreement is secured by
substantially all of our assets and had an outstanding balance of $9.1 million
at March 31, 2001. The outstanding commitments bear interest at an annual rate
equal to the prime lending rate plus one and one-half percent. Outstanding
commitments under the agreement are required to be repaid under specific
schedules, with all commitments to be repaid no later than November 18, 2003.
The credit agreement requires us to maintain certain financial ratios and places
limitations on certain financing and investing activities. The credit agreement
also contains other customary conditions and events of default that, in the
event of noncompliance by us, would prevent any further borrowings and would
generally require the repayment of any outstanding commitments under the credit
agreement. On April 2, 2001, we repaid the obligation under this credit
agreement, which had a balance of $9.1 million as of March 31, 2001. The
obligation was repaid with the cash that was restricted for this purpose.
On September 29, 2000, we sold $20.0 million of convertible notes and warrants
to Capital Ventures International ("CVI"), a private institution. The notes have
a one-year term and bear interest at an annual rate of six percent. The original
conversion price for the notes was 95% of the average closing bid price of our
common stock during a 20-day trading period prior to the conversion date (which
automatically occurs upon the effectiveness of a registration statement filed
with the Securities and Exchange Commission), subject to a maximum conversion
price of the lower of our common stock's closing bid price the day prior to
closing or $7.50 per share. On October 26, 2000, we filed a registration
statement on Form S-3 with the Securities and Exchange Commission, which was
declared effective on December 4, 2000. Also at closing, we issued warrants to
purchase 4,050,633 shares of our common stock to the private institution at an
exercise price of $10.37 per share. The warrants are immediately exercisable and
expire five years from closing. Immediately after the effective date, $5.0
million of the notes were converted into common stock. The terms of the notes
were also amended such that the conversion price was set at $1.68 per share. The
delisting of our common stock from the Nasdaq National Market is an event of
default under the terms of the notes. Upon default, we are obligated to repay
part of the purchase price of the notes and to make penalty payments to CVI.
On April 3, 2001, we received a notice of default from CVI for an alleged
violation of certain provisions of Article VI of the Convertible Notes relating
to the breach of certain negative financial covenants contained in the Company's
Credit Agreement with Imperial Bank and the breach by the Company of certain
material terms of the Securities Purchase Agreement dated as of September 28,
2000. The notice of default demanded that the Company redeem the Convertible
Notes on or before April 9, 2001 for an amount equal to $17.25 million, which
amount represents 115% of the aggregate principal amount of the remaining
Convertible Notes. Management responded to
26
the notice of default on April 4, 2001 and denied that an event of default
occurred under the Notes. If the Company were to be in default of the
Convertible Notes and if the default is not cured, or waived by the holder of
the Convertible Notes, and the Company is required to redeem the amounts
outstanding under the Convertible Notes, the holder could seek remedies against
us, which may include penalty rates of interest, immediate repayment of the debt
and the filing of an involuntary petition in bankruptcy. In addition, the
Company may have no alternative but to file a petition in bankruptcy. If we
become insolvent or enter into a liquidation proceeding, after payment to our
creditors there is likely to be insufficient assets remaining for any
distribution to shareholders.
Our future capital requirements depend on numerous factors, including, but not
limited to:
the magnitude of our future losses;
asset sales, if any;
any future restructuring; and;
the resources we devote to expansion of our sales, marketing, technology
development and branding efforts.
We believe that our cash reserves and cash flows from operations will be
adequate to fund our operations through June 2001. Consequently, we will require
substantial additional funds to continue to operate our business beyond that
period. Many companies in the Internet industry have experienced difficulty
raising additional financing in recent months. Additional financing may not be
available to us on favorable terms or at all. Even if additional financing is
available, we may be required to obtain the consent of our existing lenders,
which we may not be able to obtain. If additional financing is not available to
us we may need to dramatically change our business plan, sell or merge our
business, or face bankruptcy. In addition, our issuance of equity or
equity-related securities will dilute the ownership interest of existing
stockholders and our issuance of debt securities could increase the risk or
perceived risk of our Company. Our future capital requirements depend upon many
factors, including, but not limited to:
the level of revenues in 2001, which we expect to decline from 2000 levels;
the rate at which we are able to reduce expense levels;
the extent to which we develop and upgrade our technology and data network
infrastructure;
the occurrence, timing, size and success of any asset dispositions in which
we may engage; and
the scope and success of our restructuring efforts, including reductions in
our workforce.
Our plans for financing may include, but are not limited to, the following:
engaging a financial advisor to explore strategic alternatives, which may
include a merger, asset sale, or another comparable transaction;
raising additional capital to fund continuing operations by private
placements of equity and/or debt securities; and
forming a joint venture with a strategic partner or partners to provide
additional capital resources to fund operations.
Recent Accounting Pronouncements
In June 1998, the FASB issued Statement of Financial Accounting Standards (SFAS)
No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
No. 133 establishes accounting and reporting standards that require derivative
instruments (including certain derivative instruments embedded in other
contracts) be recorded at fair value. The statement requires that changes in the
derivative's fair value be recognized currently in operations unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the statements of operations, and requires that a company must formally
document, designate, and assess the effectiveness of transactions that are
subject to hedge accounting. Pursuant to SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB No. 133 - an Amendment to FASB Statement No. 133," the effective date of
SFAS No. 133
27
has been deferred until fiscal years beginning after January 15, 2000. SFAS No.
133 cannot be applied retroactively. SFAS No. 133 must be applied to (a)
derivative instruments and (b) certain derivative instruments embedded in hybrid
contracts that were issued, acquired, or substantively modified after December
31, 1998 (and, at a company's election, before January 1, 1999). The impact of
adopting SFAS No. 133 is not material on our financial statements. However, the
statement could increase volatility in our consolidated statements of operations
and other comprehensive income.
28
Additional Factors That May Affect Future Results
You should carefully consider the risks described below and the other
information in this quarterly report. While we have attempted to identify the
primary known risks that are material to our business, additional risks that we
have not yet identified or that we currently think are immaterial may also
impair our business operations. The trading price of our common stock could
decline due to any of these risks. In assessing these risks, you should also
refer to the other information in this quarterly report, including the
consolidated financial statements and related notes and the risks discussed in
the "Factors Affecting Our Operating Results, Business and Stock Price" section
included in our December 31, 2001 10-K filed on April 17, 2000 with the
Securities and Exchange Commission, as amended by Form 10-K/A filed on April 30,
2001.
WE WILL NEED ADDITIONAL FINANCING AND WE HAVE RECEIVED A "GOING CONCERN" OPINION
FROM OUR ACCOUNTANTS
We believe that our cash reserves and cash flows from operations will be
adequate to fund our operations through June 2001. Consequently, we will require
substantial additional funds to continue our business beyond that period. Many
companies in the Internet industry have experienced difficulty raising
additional financing in recent months. Additional financing may not be available
to us on favorable terms or at all. Even if additional financing is available,
we may be required to obtain the consent of our existing lenders, which we may
not be able to obtain. If additional financing is not available to us we may
need to dramatically change our business plan, sell or merge our business, or
face bankruptcy. In addition, our issuance of equity or equity-related
securities will dilute the ownership interest of existing stockholders and our
issuance of debt securities could increase the risk or perceived risk of our
Company.
Our inability to secure additional financing would have a material adverse
effect on whether we would be able to successfully implement our proposed
business plan and our ability to continue as a going concern. Our independent
accountants have issued a "going concern" opinion in their report to our
financial statements for the year ended December 31, 2000, citing recurring
operating losses, reduced working capital and violation of debt covenants.
Accordingly, those conditions raise substantial doubt about our ability to
continue as a going concern.
FAILURE TO RESTRUCTURE OUR PAYMENTS TO OUR CREDITORS COULD RESULT IN OUR
BANKRUPTCY
We are receiving increasing pressure for payments from trade creditors and are
seeking to restructure the payment terms; however, there is no assurance that we
will be able to do this. If we are unable to reach agreement with certain trade
creditors regarding the restructuring of payment terms, our creditors may seek
to file a petition in bankruptcy against us, or we may need to seek protection
of the bankruptcy court. Even if we are successful in restructuring our
obligations, we will need additional capital to avoid bankruptcy.
IF WE FAIL TO REMAIN IN COMPLIANCE WITH TERMS OF OUR CONVERTIBLE NOTES OUR
ABILITY TO CONTINUE AS A GOING CONCERN WILL BE CHALLENGED
On September 28, 2000, in connection with the closing of a private placement, we
issued convertible promissory notes in the aggregate principal amount of $20.0
million (the "Convertible Notes") to Capital Ventures International ("CVI"). In
connection with the private placement, we also issued to CVI warrants to
purchase up to 4,050,633 shares of our common stock at an exercise price of
$10.375 per share. The warrants have a term of 5 years. The Convertible Notes
bear interest of 6%, compounded annually. As of December 31, 2000, the principal
amount of the Convertible Notes was $15.0 million.
On April 3, 2001, we received a notice of default from CVI for an alleged
violation of certain covenants of the Convertible Notes and the Securities
Purchase Agreement relating thereto. The notice of default demanded that we
redeem the Convertible Notes on or before April 9, 2001 for an amount equal to
$17.25 million. We responded to the notice of default on April 4, 2001 and
denied that an event of default occurred under the Notes. If we are found to be
in default of the Convertible Notes and if the default is not cured, or waived
by the holder of the Convertible Notes, and we are required to redeem the
amounts outstanding under the Convertible Notes, the holder could seek remedies
against us, which may include penalty rates of interest, immediate repayment of
the debt and the filing of an involuntary petition in bankruptcy. In addition,
we may have no alternative but to file a petition in bankruptcy.
29
If we become insolvent or enter into a liquidation proceeding, after payment to
our creditors, there is likely to be insufficient assets remaining for any
distribution to shareholders.
OUR CONTINUED NASDAQ NATIONAL MARKET LISTING IS NOT ASSURED, WHICH COULD MAKE IT
MORE DIFFICULT TO RAISE CAPITAL AND WHICH COULD RESULT IN A DEFAULT UNDER OUR
CONVERTIBLE NOTES
Our common stock is presently listed on the Nasdaq National Market. In order to
maintain such listing, we must continue to satisfy on-going listing
requirements, some of which we currently do not satisfy. Potential events that
could lead to our delisting from the Nasdaq National Market include:
failure to maintain a minimum bid price for the common stock of either
$1.00 per share or $5.00 per share, depending on, among other things,
whether or not tangible net assets for the company are greater than or less
than $4 million;
failure to maintain an audit committee which comports to the independence
and other standards of the Nasdaq and the SEC;
failure to maintain a board with an adequate number of independent members;
and
failure to timely hold annual meetings of stockholders and comply with
other corporate governance requirements.
Our common stock has been trading below the $1 minimum bid requirement, which
could lead to Nasdaq's initiation of delisting procedures at any time.
Furthermore, as of April 17, 2001, we have only two independent directors, both
of whom are members of the audit committee. Our failure to maintain a sufficient
number of independent directors on the board of directors to satisfy Nasdaq's
audit committee requirements could also lead to Nasdaq's initiation of delisting
procedures.
If we lose our Nasdaq National Market status, our common stock would trade
either on the Nasdaq Small Cap market or in the over-the-counter market, both of
which are viewed by most investors as less desirable, less liquid marketplaces.
Among other things, our common stock would then constitute "penny stock," which
would place increased regulatory burden upon brokers, making them less likely to
make a market in the stock. Loss of our Nasdaq National Market status could make
it more difficult for us to raise capital or complete acquisitions and would
also complicate compliance with state blue sky laws. Loss of our Nasdaq National
Market status would also be deemed an event of default under our Convertible
Notes.
Several of our board members have resigned. Our board currently has two
independent members and one management member. There can be no assurances that
there will not be additional resignations or that suitable replacement board
members can be found.
WE HAVE A HISTORY OF LOSSES
We incurred net losses of $24.7 million for the year ended December 31, 1998,
$75.9 million for the year ended December 31, 1999, $262.0 million for the year
ended December 31, 2000 and $177.6 million for the three-months ended March 31,
2001. At March 31, 2001, we had an accumulated deficit of $544.9 million. We
have historically invested heavily in sales and marketing, technology
infrastructure and research and development. As a result, we must generate
significant revenues to achieve and maintain profitability. There can be no
assurance that we will ever become profitable on an annual basis. We expect that
our sales and marketing research and development and general and administrative
expenses will decrease in absolute dollars but may increase as a percentage of
revenues.
Many of our cost-basis investments in early-stage technology companies have
uncertain futures primarily related to the general decline in the technology
companies and many of our acquisitions are losing money. If our cost-basis
investments and acquisitions are not successful, we will incur additional losses
from asset impairment charges, lease and employee terminations and other
restructuring costs. See subsequent events.
30
OUR FUTURE REVENUES ARE UNPREDICTABLE AND WE EXPECT OUR OPERATING RESULTS TO
FLUCTUATE FROM PERIOD TO PERIOD
Our business model has been applied to the Internet only since the mid-1990's
and continues to evolve. Therefore, we have limited experience in planning the
financial needs and operating expenses of our business. It is difficult for us
to accurately forecast our revenues in any given period. We do not expect to be
able to sustain our recent revenue growth rates and may not obtain sufficient
revenues to achieve profitability or become cash flow positive. If our revenues
in a particular period fall short of our expectations, we will likely be unable
to quickly adjust our spending in order to compensate for that revenue
shortfall.
Our operating results are likely to fluctuate substantially from period to
period as a result of a number of factors, such as:
declines in the number of businesses and merchants to which we provide our
products and services;
the amount and timing of operating costs and expenditures relating to
expansion of our operations; and
the mix of products and services that we sell.
In addition, factors beyond our control may also cause our operating results to
fluctuate, such as:
the announcement or introduction of new or enhanced products or services by
our competitors;
registration services related to the introduction of new top level domains;
a decrease in the growth of Internet usage; and
the pricing policies of our competitors.
Period-to-period comparisons of our operating results are not a good indicator
of our future performance, particularly in light of recent changes in our
business focus. It is likely that our operating results in some quarters may not
meet the expectations of stock market analysts and investors and this could
cause our stock price to decline.
OUR RAPID GROWTH AND EVOLUTION MAY MAKE IT DIFFICULT TO EVALUATE OUR BUSINESS
AND PROSPECTS
Network Commerce was incorporated in January 1994 and operated initially as a
computer services company. In 1996, we began to change the focus of our business
to conducting commerce over the Internet. In August 1998, we launched our first
online marketplace, ShopNow.com. In January 2001, we announced plans to
discontinue the ShopNow.com marketplace. In March 2001, we announced plans to
discontinue our gaming and entertainment site, SpeedyClick.com. In recent
months, we have increasingly focused on developing and providing technology
infrastructure and domain registration services and operating portal sites. Due
to the recent shifts in our business focus, our historical results are likely
not indicative of our future performance and you may have difficulty evaluating
our business and prospects.
OUR BUSINESS MODEL IS UNPROVEN AND CHANGING
We provide technology infrastructure and services and operate portal sites. We
have limited experience as a company, particularly with these businesses.
Additionally, the Internet, on which our business model relies, is still
unproven as a business medium. Accordingly, our business model may not be
successful, and we may need to change it. Our ability to generate sufficient
revenues to achieve profitability or become cash flow positive will depend, in
large part, on our ability to successfully market our technology infrastructure
services and portal sites to businesses and consumers.
IF WE FAIL TO EFFECTIVELY MANAGE THE RAPID CHANGE OF OUR OPERATIONS OUR BUSINESS
WILL SUFFER
Our ability to successfully offer our products and services and implement our
business plan in a rapidly evolving market requires an effective planning and
management process. We are diversifying and changing the scope of our
operations. While our operations have been changing, we have reduced our overall
number of employees from 620 in October 2000 to 220 in May 2001. These changes
in our business
31
plan and reduction in personnel have placed, and will continue to place, a
significant strain on our management systems, infrastructure and resources.
Simultaneously, the reduction in our workforce may make it more difficult to
execute and implement our business plan. We will need to continue to improve our
financial and managerial controls and reporting systems and procedures, and will
need to continue to train and manage our workforce worldwide. Furthermore, we
expect that we will be required to manage an increasing number of relationships
with various customers and other third parties. Any failure to adapt to any of
the foregoing areas efficiently and effectively could cause our business to
suffer.
ANY FUTURE GROWTH MAY DEPEND ON OUR ABILITY TO MAKE AND SUCCESSFULLY INTEGRATE
ADDITIONAL ACQUISITIONS
Our success depends on our ability to continually enhance and expand our
e-commerce enabling products and services and domain registration and hosting
services in response to changing technologies, customer demands and competitive
pressures. Consequently, we have acquired complementary technologies or
businesses in the past, and intend to do so in the future. If we are unable to
identify suitable acquisition targets, or if we are unable to successfully
complete acquisitions and successfully integrate the acquired businesses,
technologies and personnel, our ability to increase and enhance product and
service offerings will be negatively impacted. This could cause us to lose
business to our competitors and our operating results could suffer.
ACQUISITIONS INVOLVE A NUMBER OF RISKS
We have actively sought to identify and acquire companies with attributes
complementary to our products and services. Since January 1, 1999, we have
acquired twelve companies. Acquisitions that we make may involve numerous risks,
including:
failure to conduct an adequate investigation of the financial, business or
operational condition of companies we acquire;
diverting management's attention from other business concerns;
being unable to maintain uniform standards, controls, procedures and
policies;
entering markets in which we have no direct prior experience;
improperly evaluating new services and technologies or otherwise being
unable to fully exploit the anticipated opportunity; and
being unable to successfully integrate the acquired businesses,
technologies, other assets and personnel.
If we are unable to accurately assess any newly acquired businesses or
technologies, our business could suffer. For example, in August 2000 we acquired
Ubarter for approximately $61.7 million. Ubarter had developed a multi-merchant
e-commerce purchasing tool and universal shopping cart technology. Early in the
fourth quarter 2000, we launched a new user interface and back-end management
system for the Ubarter.com merchant exchange, and executed various marketing
efforts to promote the new system. These efforts did not stimulate growth in the
Ubarter economy as expected, which led to a revision of the original forecasts
and projections for Ubarter. These revised forecasts indicated that future
expected cash flows from this business unit were less than the carrying value of
its intangible assets, thus triggering an impairment event in December 2000. At
that time, the carrying value of Ubarter's intangible assets, including
goodwill, was $51.6 million. Based on recent comparable sales of other barter
exchange systems, management determined the fair value of Ubarter.com to be
approximately $5.0 million. As a result, the Company recognized an impairment
charge of $46.6 million in 2000. We have also had to write off in 2000
substantially all the purchase price for our acquisitions of AXC, WebCentric and
Cortix. In June 1998 we acquired e-Warehouse and CyberTrust. These companies had
developed payment processing technologies that we planned to utilize as part of
our e-commerce products and services. However, we are not currently utilizing
the acquired technologies, and we have determined that the technologies have no
other use or value to us. Because we are not using the acquired technologies, we
wrote off substantially all of the $5.4 million aggregate purchase price for
e-Warehouse and CyberTrust in 1998. Additionally, in the first quarter of 2001,
we incurred write-offs due to further restructuring. Future acquisitions may
involve the assumption of obligations or large one-time write-offs and
amortization expenses related to goodwill and other intangible assets. Any of
the factors listed above would adversely affect our results of operations.
32
In addition, in order to finance any future acquisition, we may need to raise
additional funds through public or private financings. In this event, we could
be forced to obtain equity or debt financing on terms that are not favorable to
us and that may result in dilution to our shareholders.
OUR SUCCESS DEPENDS UPON ACHIEVING ADEQUATE MARKET SHARE TO INCREASE OUR
REVENUES AND BECOME PROFITABLE
Our success depends upon achieving significant market penetration and acceptance
of our products and services. We have only recently begun to expand our
technology infrastructure services. We may not currently have adequate market
share to successfully execute our business plan. If we are unable to reach and
retain substantial numbers of businesses, merchants and shoppers, our business
model may not be sustainable.
To successfully market and sell our products and services we must: o become
recognized as a leading provider of technology infrastructure and services;
enhance existing products and services;
add new products and services and increase awareness of these products and
services;
complete projects on time;
increase the number of businesses and merchants using our e-commerce
products and services and online marketplaces; and
continue to increase the attractiveness of the Registrars.com and
Freemerchant.com Web sites to businesses and other users.
WE FACE SIGNIFICANT COMPETITION
The market for our products and services is highly competitive, and we expect
competition to intensify in the future. Barriers to entry are not significant.
Our failure to compete effectively could result in the following:
fewer businesses and merchants relying upon our enabling solutions or using
our technology infrastructure products and services;
the obsolescence of the technology underlying our products and services;
a decrease in traffic on our Web sites; and
a reduction in the prices of or profits on our products and services.
The number of companies providing technology infrastructure services, portal
sites and e-commerce enabling products and services is large and increasing at a
rapid rate. We expect that additional companies, which to date have not had a
substantial commercial presence on the Internet or in our markets, will offer
competing products and services. Companies such as InfoSpace Inc., Yahoo! Inc.,
Register.com and Network Solutions offer alternatives to one or more of our
products and services.
Many of our competitors and potential competitors have substantial competitive
advantages as compared to us, including:
larger customer or user bases;
the ability to offer a wider array of technology infrastructure products
and solutions;
greater name recognition and larger marketing budgets and resources;
substantially greater financial, technical and other resources;
the ability to offer additional content and other personalization features;
and
larger production and technical staffs.
33
These advantages may enable our competitors to adapt more quickly to new
technologies and customer needs, devote greater resources to the promotion or
sale of their products and services, initiate or withstand substantial price
competition, take advantage of acquisition or other opportunities more readily,
or develop and expand their product and service offerings more quickly.
In addition, as the use of the Internet and online products and services
increases, larger well-established and well-financed entities may continue to
acquire, invest in or form joint ventures with providers of e-commerce enabling
solutions, and existing providers may continue to consolidate. Providers of
Internet browsers and other Internet products and services who are affiliated
with providers of Web directories and information services that compete with our
products and services may more tightly integrate these affiliated offerings into
their browsers or other products or services. Any of these trends would increase
the competition we face.
WE CANNOT PREDICT WITH ANY CERTAINTY THE EFFECT THAT NEW GOVERNMENTAL AND
REGULATORY POLICIES, OR INDUSTRY REACTIONS TO THOSE POLICIES, WILL HAVE ON OUR
DOMAIN REGISTRATION BUSINESS
Before April 1999, the domain name registration system for the .com, .net and
.org domains was managed by Network Solutions pursuant to a cooperative
agreement with the U.S. government. In November 1998, the Department of Commerce
recognized the Internet Corporation for Assigned Names and Numbers, commonly
known as ICANN, to oversee key aspects of the Internet domain name registration
system. We cannot predict with any certainty that future measures adopted by the
Department of Commerce or ICANN will benefit us or that they will not materially
harm our business, financial condition and results of operations. In addition,
we continue to face the following risks:
the U.S. government may, for any reason, reassess its decision to introduce
competition into, or ICANN's role in overseeing, the domain name
registration market;
the Internet community may become dissatisfied with ICANN and refuse to
recognize its authority or support its policies, which could create
instability in the domain name registration system; and
ICANN may revoke or fail to renew our accreditation, or attempt to impose
additional fees on registrars if it fails to obtain funding sufficient to
run its operations.
OUR BUSINESS WILL SUFFER IF WE FAIL TO MAINTAIN OUR STRATEGIC BUSINESS
RELATIONSHIPS OR ARE UNABLE TO ENTER INTO NEW RELATIONSHIPS
An important element of our strategy involves entering into business
relationships with other companies. Our success is dependent on maintaining our
current contractual relationships and developing new strategic relationships.
These contractual relationships typically involve joint marketing, licensing or
promotional arrangements. For example, we have entered into a Registrar
Accreditation Agreement with ICANN, a Registrar License and Agreement with
Network Solutions, Inc., a licensing and co-marketing agreement with Chase
Manhattan Bank, and a marketing agreement with About.com, Inc. Although these
relationships are an important factor in our strategy because they enable us to
enhance our product and service offerings, the parties with which we contract
may not view their relationships with us as significant to their own businesses.
Most of these relationships may be terminated by either party with little
notice. Accordingly, in order to maintain our strategic business relationships
with some of these partners we will need to meet our partners' specific business
objectives, which may include incremental revenue, brand awareness and
implementation of specific e-commerce applications. If our strategic business
relationships are discontinued for any reason, or if we are unsuccessful in
entering into new relationships in the future, our business and results of
operations may be harmed.
WE MAY NOT DERIVE SUBSTANTIAL BENEFITS FROM OUR STRATEGIC RELATIONSHIPS
To date, we have not derived material revenue from these relationships, and some
of these relationships impose substantial obligations on us. It is not certain
that the benefits to us will outweigh our obligations. Several of our
significant business arrangements do not establish minimum performance
requirements but instead rely on contractual best efforts obligations of the
parties with which we contract.
34
WE DEPEND ON OUR KEY PERSONNEL FOR SUCCESSFUL OPERATION OF OUR BUSINESS
Our success depends on the skills, experience and performance of our senior
management and other key personnel. Our key personnel include Dwayne Walker, our
Chairman and Chief Executive Officer, Randy Cerf, our Executive Vice President
and Chief Financial Officer, Ganapathy Krishnan, Ph.D., Executive Vice President
and Chief Technology Officer, Anne-Marie Savage, Executive Vice President,
One-to-One Marketing, Jennifer Rogers, Senior Vice President, Commerce Group,
Sanjay Arnad, Chief Information Officer, Stephen D. Smith, Vice President of
Finance and Tony Abruzzio, General Manager of Go Software, Inc. All key
personnel listed above have employment agreements with Network Commerce. Many of
our executive officers have joined us within the past three years. If we do not
quickly and efficiently integrate these new personnel into our management and
culture, our business could suffer. If we fail to successfully attract and
retain a sufficient number of qualified executive, technical, managerial, sales
and marketing, business development and administrative personnel, our ability to
manage and expand our business could suffer. Our current financial situation may
make it more difficult to retain kay employees.
OUR ABILITY TO DEVELOP AND INTEGRATE INFRASTRUCTURE TECHNOLOGIES IS SUBJECT TO
UNCERTAINTIES
We have limited experience delivering our technology infrastructure products and
services. In order to remain competitive, we must regularly upgrade our
technology infrastructure products and services to incorporate current
technology, which requires us to integrate complex computer hardware and
software components. If we do not successfully integrate these components, the
quality and performance of our online offerings may be reduced. While these
technologies are generally commercially available, we may be required to expend
considerable time and money in order to successfully integrate them into our
products and services and this may cause our business to suffer. We must also
maintain an adequate testing and technical support infrastructure to ensure the
successful introduction of products and services.
OUR COMPUTER SYSTEMS MAY BE VULNERABLE TO SYSTEM FAILURES
Our success depends on the performance, reliability and availability of the
technology supporting our products and services. Our revenues depend, in large
part, on the number of businesses and consumers that use our products and
services. This depends, in part, upon our actual and perceived reliability and
performance. Any inability to provide our products and services could cause us
to lose customers and therefore lose revenue. Substantially all of our computer
and communications hardware is located at leased and third-party facilities in
Seattle, Washington. Our systems and operations are vulnerable to damage or
interruption from fire, flood, power loss, telecommunications failure, break-in,
earthquake and similar events. In addition, due to the ongoing power shortages
in California, the Pacific Northwest may experience power shortages or outages.
These power shortages or outages could cause disruptions to our operations,
which in turn may result in a material decrease in our revenues and earnings and
have a material adverse affect on our operating results. Because we presently do
not have fully redundant systems or a formal disaster recovery plan, a systems
failure could adversely affect our business. In addition, our computer systems
are vulnerable to computer viruses, physical or electronic break-ins and similar
disruptions, which may lead to interruptions, delays, loss of data or inability
to process online transactions for our clients. We may be required to expend
considerable time and money to correct any system failure. If we are unable to
fix a problem that arises, we may lose customers or be unable to conduct our
business at all.
OUR BUSINESS MAY BE HARMED BY DEFECTS IN OUR SOFTWARE AND SYSTEMS
We have developed custom software for our network servers and have licensed
additional software from third parties. This software may contain undetected
errors or defects. We may be unable to fix defects in a timely or cost-effective
manner.
WE WILL NEED TO EXPAND AND UPGRADE OUR SYSTEMS IN ORDER TO MAINTAIN CUSTOMER
SATISFACTION
We must expand and upgrade our technology, transaction processing systems and
network infrastructure if the number of businesses and merchants using our
e-commerce products and services and online marketplaces, or the volume of
traffic on our Web sites or our clients' Web sites, increases substantially. We
could experience periodic capacity constraints, which may cause unanticipated
system disruptions, slower response times and lower levels of customer service.
We may be unable to accurately project the rate or timing of increases, if any,
in the use of our products or services or our Web sites, or when we must expand
and upgrade our systems and infrastructure to accommodate these increases in a
timely manner. Any inability to do so could harm our business.
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OUR INTERNATIONAL OPERATIONS INVOLVE RISKS
We are subject to risks specific to Internet-based companies in foreign markets.
These risks include:
delays in the development of the Internet as a commerce medium in
international markets;
restrictions on the export of encryption technology; and
increased risk of piracy and limits on our ability to enforce our
intellectual property rights.
In addition, we have been developing business opportunities in Canada and Asia.
We may be unable to develop sufficient relationships in Canada or Asia to take
advantage of business opportunities there. In recent periods, the Asia Pacific
and Canadian economies have experienced weakness. If these economies continue to
exhibit weakness, our efforts to develop business opportunities in these areas
and our ability to grow these markets could be impaired. In addition, the
failure to succeed in these markets could impair our ability to enter other
international markets.
WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY AND PROPRIETARY
RIGHTS
We regard our intellectual property rights as critical to our success, and we
rely on trademark and copyright law, trade secret protection and confidentiality
and license agreements with our employees, customers and others to protect our
proprietary rights. Despite our precautions, unauthorized third parties might
copy portions of or reverse engineer our software and use information that we
regard as proprietary. We currently have been granted two patents and have six
patent applications pending in the United States Patent and Trademark Office
covering different aspects of our product architecture and technology. However,
there is no assurance that any pending patent application will result in an
issued patent, or that our existing patents or any future patent will not be
challenged, invalidated or circumvented, or that the rights granted under any
patent will provide us with a competitive advantage. The laws of some countries
do not protect proprietary rights to the same extent as do the laws of the
United States, and our means of protecting our proprietary rights abroad may not
be adequate. Any misappropriation of our proprietary information by third
parties could adversely affect our business by enabling third parties to compete
more effectively with us.
OUR TECHNOLOGY MAY INFRINGE THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS
We cannot be certain that our technology does not infringe issued patents or
other intellectual property rights of others. In addition, because patent
applications in the United States are not publicly disclosed until the patent is
issued, applications may have been filed which relate to our software. We may be
subject to legal proceedings and claims from time to time in the ordinary course
of our business, including claims of alleged infringement of the trademarks and
other intellectual property rights of third parties. Intellectual property
litigation is expensive and time-consuming, and could divert our management's
attention away from running our business.
IF THE SECURITY PROVIDED BY OUR E-COMMERCE SERVICES IS BREACHED, WE MAY BE
LIABLE TO OUR CLIENTS AND OUR REPUTATION COULD BE HARMED
A fundamental requirement for e-commerce is the secure transmission of
confidential information of businesses, merchants and shoppers over the
Internet. Among the e-commerce services we offer to merchants are security
features such as:
secure online payment services;
secure order processing services; and
fraud prevention and management services.
Third parties may attempt to breach the security provided by our e-commerce
products and services or the security of our clients' internal systems. If they
are successful, they could obtain confidential information about businesses and
shoppers using our online marketplaces, including their passwords, financial
account information, credit card
36
numbers or other personal information. We may be liable to our clients or to
shoppers for any breach in security. Even if we are not held liable, a security
breach could harm our reputation, and the mere perception of security risks,
valid or not, could inhibit market acceptance of our products and services. We
may be required to expend significant capital and other resources to license
additional encryption or other technologies to protect against security breaches
or to alleviate problems caused by these breaches. In addition, our clients
might decide to stop using our e-commerce products and services if their
customers experience security breaches.
Risks Related to Our Industry
WE ARE VULNERABLE TO DOWNTURNS EXPERIENCED BY OTHER INTERNET COMPANIES OR THE
INTERNET INDUSTRY IN GENERAL
We derive a significant portion of our revenue from strategic marketing and
advertising relationships with other Internet companies and we own equity in a
number of Internet companies. At the current time, some of these companies are
having difficulty generating operating cash flow or raising capital, or are
anticipating such difficulties, and are electing to scale back the resources
they devote to advertising, including on our network. Other companies in the
Internet industry have depleted their available capital and have ceased
operations or filed for bankruptcy protection or may be expected to do so.
Difficulties such as these may affect our ability to collect revenues or
advances against revenues from our existing partners or advertisers as such
amounts become due and may impair the value of the equity we hold in certain of
our partners. If the current environment for Internet companies does not
improve, our business and financial results may suffer.
OUR SUCCESS DEPENDS ON CONTINUED INCREASES IN THE USE OF THE INTERNET AS A
COMMERCIAL MEDIUM
We depend on the growing use and acceptance of the Internet by businesses,
merchants and shoppers as a medium of commerce. Rapid growth in the use of and
interest in the Internet and online products and services is a recent
development. No one can be certain that acceptance and use of the Internet and
online products and services will continue to develop or that a sufficiently
broad base of businesses, merchants and shoppers will adopt and continue to use
the Internet and online products and services as a medium of commerce.
The Internet may fail as a commercial marketplace for a number of reasons,
including potentially inadequate development of the necessary network
infrastructure or delayed development of enabling technologies, including
security technology and performance improvements. For example, if technologies
such as software that stops advertising from appearing on a Web user's computer
screen gain wide acceptance, the attractiveness of the Internet to advertisers
would be diminished, which could harm our business.
RAPID TECHNOLOGICAL CHANGE COULD NEGATIVELY AFFECT OUR BUSINESS
Rapidly changing technology, evolving industry standards, evolving customer
demands and frequent new product and service introductions characterize the
market for our products and services. Our future success will depend in
significant part on our ability to improve the performance, content and
reliability of our products and services in response to both the evolving
demands of the market and competitive product and service offerings. Our efforts
in these areas may not be successful. If a large number of our clients adopt new
Internet technologies or standards, we may incur substantial expenditures
modifying or adapting our products and services to remain compatible with their
systems.
WE RELY ON THE INTERNET INFRASTRUCTURE PROVIDED BY OTHERS TO OPERATE OUR
BUSINESS
Our success depends in large part on other companies maintaining the Internet
infrastructure. In particular, we rely on other companies to maintain a reliable
network backbone that provides adequate speed, data capacity and security and to
develop products that enable reliable Internet access and service. If the
Internet continues to experience significant growth in the number of users,
frequency of use and amount of data transmitted, the Internet infrastructure of
thousands of computers communicating via telephone lines, coaxial cable and
other telecommunications systems may be unable to support the demands placed on
it, and the Internet's performance or reliability may suffer as a result of this
continued growth. If the performance or reliability of the Internet suffers,
Internet users could have difficulty obtaining access to the Internet. In
addition, data transmitted over the Internet,
37
including information and graphics contained on Web pages, could reach Internet
users much more slowly. This could result in frustration of Internet users,
which could decrease online traffic and cause advertisers to reduce their
Internet expenditures.
FUTURE GOVERNMENTAL REGULATION AND PRIVACY CONCERNS COULD ADVERSELY AFFECT OUR
BUSINESS
We are not currently subject to direct regulation by any government agency,
other than regulations applicable to businesses generally, and there are
currently few laws or regulations directly applicable to access to or commerce
on the Internet. However, due to the increasing popularity and use of the
Internet, a number of legislative and regulatory proposals are under
consideration by federal, state, local and foreign governmental organizations,
and it is possible that a number of laws or regulations may be adopted with
respect to the Internet relating to issues such as user privacy, taxation,
infringement, pricing, quality of products and services and intellectual
property ownership. The adoption of any laws or regulations that have the effect
of imposing additional costs, liabilities or restrictions relating to the use of
the Internet by businesses or consumers could decrease growth in the use of the
Internet, which could in turn decrease demand for our products and services,
decrease traffic on our online marketplaces, increase our cost of doing
business, or otherwise have a material adverse effect on our business. Moreover,
the applicability to the Internet of existing laws governing issues such as
property ownership, copyright, trademark, trade secret, obscenity, libel and
personal privacy is uncertain and developing. Any new legislation or regulation,
or new application or interpretation of existing laws, could have a material
adverse effect on our business.
The Federal Communications Commission is currently reviewing its regulatory
positions on the privacy protection given to data transmissions over
telecommunications networks and could seek to impose some form of
telecommunications carrier regulation on telecommunications functions of
information services. State public utility commissions generally have declined
to regulate information services, although the public service commissions of
some states continue to review potential regulation of such services. Future
regulation or regulatory changes regarding data privacy could have an adverse
effect on our business by requiring us to incur substantial additional expenses
in order to comply with this type of regulation.
A number of proposals have been made at the federal, state and local level that
would impose additional taxes on the sale of goods and services over the
Internet and certain states have taken measures to tax Internet-related
activities. Foreign countries also may tax Internet transactions. The taxation
of Internet-related activities could have the effect of imposing additional
costs on companies, such as Network Commerce, that conduct business over the
Internet. This, in turn, could lead to increased prices for products and
services, which could result in decreased demand for our solutions.
WE COULD FACE LIABILITY FOR MATERIAL TRANSMITTED OVER THE INTERNET BY OTHERS
Because material may be downloaded from Web sites hosted by us and subsequently
distributed to others, there is a potential that claims will be made against us
for negligence, copyright or trademark infringement or other theories based on
the nature and content of this material. Negligence and product liability claims
also potentially may be made against us due to our role in facilitating the
purchase of some products, for example firearms. Although we carry general
liability insurance, our insurance may not cover claims of these types, or may
not be adequate to indemnify us against this type of liability. Any imposition
of liability, and in particular liability that is not covered by our insurance
or is in excess of our insurance coverage, could have a material adverse effect
on our reputation and our operating results, or could result in the imposition
of criminal penalties on us.
WE DO NOT CURRENTLY COLLECT SALES TAX FROM ALL TRANSACTIONS
We do not currently collect sales or other similar taxes on products sold by us
and delivered into states other than Washington, California, Georgia, and New
York. However, one or more states or foreign countries may seek to impose sales,
value added or other tax collection obligations on out-of-state or foreign
companies engaging in e-commerce. In addition, any new operation in states
outside of those for which we currently collect sales tax could subject
shipments into these states to state or foreign sales taxes. A successful
assertion by one or more states or any foreign country that we should collect
sales, value added or other similar taxes on the sale of merchandise or services
could result in liability for penalties as well as substantially higher expenses
incurred by our business.
38
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We currently have instruments sensitive to market risk relating to exposure to
changing interest rates and market prices. We do not enter into financial
instruments for trading or speculative purposes and do not currently utilize
derivative financial instruments. Our operations are conducted primarily in the
United States and as such are not subject to material foreign currency exchange
rate risk.
The fair value of our investment portfolio or related income would not be
significantly impacted by either a 100 basis point increase or decrease in
interest rates due mainly to the short-term nature of the major portion of our
investment portfolio. All of the potential changes noted above are based on
sensitivity analyses performed on our investment portfolio balances as of March
31, 2001.
39
PART II. OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
On October 6, 2000, Mall.com, Inc. filed suit against the Company in the
District Court of Travis County, Texas which was removed by the Company to the
United States District Court for the Western District of Texas. The suit was
based on a contract between Mall.com, Inc. and IveBeenGood.com, Inc. which the
Company acquired on August 24, 2000. The suit alleged that IveBeenGood.com, Inc.
breached the contract, breached a warranty given to Mall.com, Inc. and committed
fraud and negligent misrepresentation. The claims asserted by Mall.com, Inc.
were acquired by Mall Acquisition Corp. On May 7, 2001, the Company, Mall.com,
Inc. and Mall Acquisition Corp. entered into a Compromise and Settlement
Agreement and Mutual General Release. Pursuant to the settlement agreement, the
Company paid Mall Acquisition Corp. the sum of $67,500, and Mall.com, Inc. and
Mall Acquisition Corp. assigned to the Company any claims they may have against
Trilogy, Inc., a former shareholder of IveBeenGood.com, Inc. The parties also
agreed to approve a final judgment of dismissal that will refer to the
Compromise and Settlement Agreement.
On May 10, 2001, a shareholder filed a lawsuit in the United States District
Court in Seattle, Washington against the Company and its chairman and chief
executive officer alleging violations of Sections 11 and 12(a)(2) of the
Securities Act of 1933 and Sections 10(b), 15 and 20(a) of the Securities
Exchange Act of 1934. The lawsuit is styled Jan Sherman, on behalf of herself
and all others similarly situated, v. Dwayne M. Walker and Network Commerce
Inc., Case Number: C01-0675. The lawsuit seeks unspecified damages and
certification of a class consisting of purchasers of the Company's common stock
during the period from September 28, 1999 through April 16, 2001. The Company is
investigating the allegations and intends to vigorously defend this action.
Nevertheless, an unfavorable resolution of this lawsuit could have a material
adverse effect on the Company in one or more future periods.
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
Between January 1, 2001 and March 31, 2001, we did not issue or sell
unregistered securities.
Between January 1, 2001 and March 31, 2001, we issued 642,636 shares of common
stock in conjunction with the exercise of options granted under our stock option
plans. The options granted under the stock option plan were issued to our
officers, employees and consultants at exercise prices ranging from $1.20 to
$0.09. No options were granted outside of our stock option plans. These
securities were issued in transactions exempt from registration under the
Securities Act of 1933 in reliance upon Rule 701 promulgated under the
Securities Act of 1933. Where Rule 701 was not available, the securities were
issued in transactions exempt from registration under the Securities Act of 1933
in reliance upon Section 4(2) of the Securities Act of 1933.]
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY SHAREHOLDERS
None.
ITEM 5: OTHER INFORMATION
None.
40
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Number Description
3.1*** Amended and Restated Articles of Incorporation of the registrant.
3.2*** Amended and Restated Bylaws of the registrant.
4.1*** Second Amended and Restated Registration Rights Agreement dated as of November 30, 1998
4.2*** Amendment No. 1 to Second Amended and Restated Registration Rights Agreement dated as of June 15, 1999.
4.3*** Amendment No. 2 to Second Amended and Restated Registration Rights Agreement dated as of June 16, 1999.
10.1* Amendment to Employment Agreement of Dr. Ganapathy Krishman dated February 28, 2001.
10.2* Amendment to Employement Agreement of Joe Arciniega dated March 6, 2001.
10.3* Amended and Restated Offer of Employment for Randy Cerf dated March 19, 2001.
10.4* First Amendment to Credit Agreement and Limited Waiver dated January 23, 2001.
10.5* Second Amendment to Credit Agreement dated March 22, 2001.
10.7*** Amended and Restated 1999 Employee Stock Purchase Plan and form of agreement thereunder.
10.8*** Amended and Restated 1996 Combined Incentive and Nonqualified Stock Option Plan and form of agreements thereunder.
10.10*** Employment Agreement effective as of July 1, 1999, between Dwayne M. Walker and the registrant.
10.11** Promissory Note, dated May 26, 2000 from Dwayne Walker to registrant.
10.12** Promissory Note, dated June 1, 2000 from Dwayne Walker to registrant.
10.13** Promissory Note, dated September 19, 2000 from Dwayne Walker to registrant.
10.14** Promissory Note, dated October 25, 2000 from Dwayne Walker to registrant.
10.15** Promissory Note, dated November 16, 2000 from Dwayne Walker to registrant.
- ----------
* Filed herewith
** Incorporated by reference to the Annual Report filed on Form 10-K on April 17, 2001, as
amended by Form 10-K/A filed on April 30, 2001.
*** Incorporated by reference to the Registration Statement on Form S-1
(No. 333-80981) filed by the registrant on September 28, 1999, as
amended.
(b) Reports on Form 8-K
FORM 8-K dated January 4, 2001
FORM 8-K dated January 24, 2001
FORM 8-K dated February 2, 2001
FORM 8-K dated April 4, 2001
41
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NETWORK COMMERCE INC.
Date: May 15, 2001
By: /s/ Dwayne M. Walker
-----------------------------------
Dwayne M. Walker
Chief Executive Officer
By: /s/ Randy Cerf
------------------------------------
Randy Cerf
Chief Financial Officer
42