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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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Amendment No. 1
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 1999
Commission File Number: 0-25427
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NETOBJECTS, INC.
(Exact name of Registrant as specified in its charter)
Delaware 94-3233791
State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
301 Galveston Drive, Redwood City, California 94063
(Address of Principal Executive Offices) (Zip Code)
(650) 482-3200
(Registrant's Telephone Number, Including Area Code)
None
Securities registered pursuant to Section 12(b) of the Act
Common Stock, par value $0.01
Securities registered pursuant to Section 12(g) of the Act
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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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated herein by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
As of September 30, 1999, the aggregate market value of voting stock held by
non-affiliates of the Registrant, based upon the closing sales price for the
Registrant's Common Stock, as reported on the Nasdaq National Market, was
approximately $45.7 million Shares of Common Stock held by each officer and
director and by each person who owns 5% or more of the outstanding Common Stock
have been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for any other purpose.
As of November 30, 1999, Registrant had outstanding 26,979,369 shares of Common
Stock, $.01 par value.
DOCUMENTS INCORPORATED BY REFERENCE
The following documents (or parts thereof) are incorporated by reference into
the following parts of this Form 10-K: Certain information required in Part III
of this Form 10-K is incorporated from the registrant's Proxy Statement for its
Annual meeting of Stockholders.
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TABLE OF CONTENTS
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Part I
Page
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Item 1. Business.................................................................................... 1
Item 2. Properties.................................................................................. 17
Item 3. Legal Proceedings........................................................................... 17
Item 4. Submission of Matters to a Vote of Security Holders......................................... 17
Part II
Item 5. Market for Registrants Common Equity and Related Stockholder Matters........................ 17
Item 6. Selected Financial Data..................................................................... 19
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....... 20
Item 7A. Qualitative and Quantitative Disclosures about Market Risk.................................. 26
Item 8. Financial Statements and Supplementary Data................................................. 26
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........ 26
Part III
Item 10. Directors and Executive Officers of Registrant.............................................. 27
Item 11. Executive Compensation...................................................................... 27
Item 12. Security Ownership of Certain Beneficial Owners and Management.............................. 27
Item 13. Certain Relationships and Related Transactions.............................................. 27
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................ 28
Signatures.................................................................................. 30
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This Form 10-K contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. Any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, the words "believes," "anticipates," "plans," "expects," and similar
expressions are intended to identify forward-looking statements. These
forward-looking statements include, without limitation, statements about the
market opportunity for website building software and services, our strategy,
competition and expected expense levels, and the adequacy of our available cash
resources. Our actual results could differ materially from those expressed or
implied by these forward-looking statements as a result of various factors,
including the risk factors described in Risk Factors and elsewhere in this
report. We undertake no obligation to update publicly any forward-looking
statements for any reason, even if new information becomes available or other
events occur in the future.
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Item 1. Business
Our Company
We are a leading provider of software, solutions, and services that
enable small businesses to build, deploy, maintain websites, and conduct online
e-business, and enable large enterprises to effectively create and manage
corporate intranets. Our e-business solutions address the growing challenges
faced by businesses in capturing the explosive growth of the Internet as an
online business medium to publish content, run web applications, and manage
their e-business operations.
In 1996, we pioneered the website building product category with the
introduction of our award-winning flagship product, NetObjects Fusion.
NetObjects Fusion is an easy-to-use desktop software application for building
small business websites with an intuitive, visual interface that helps automate
and integrate many site-building functions. Since 1996, we have continued to
enhance and expand NetObjects Fusion, incorporating a wide range of support for
web browsers, database software and web servers. In September 1998, we
introduced NetObjects Authoring Server Suite 3.0, a client-server application
for the corporate intranet market. In addition, to complement our enterprise
solutions, we began offering professional services to our business customers to
better serve their website planning, building and maintenance needs.
We have also built popular online resources, including NetObjects.com,
and eFuse.com, that target communities of business users and provide sources of
information, product, and services for building websites.
In October 1999, we acquired Sitematic Corporation, an Application
Service Provider (ASP), that offered on-line website building capabilities for
small businesses. In December 1999, we combined our online resources and
launched GoBizGo.com, a web application services site where small businesses can
find the solutions and services needed to build a successful web presence.
As part of our strategy to provide complete e-business solutions, we
have formed technology relationships with other Internet companies. We have
worked with many of these companies to extend their products to integrate with
NetObjects Fusion and NetObjects Authoring Server, such as Allaire ColdFusion,
iCat Commerce Online, Lotus Domino, Beatnik audio software, IBM HotMedia, and
IBM WebSphere, and we have built extensions for the Microsoft ASP Site Server.
These extensions provide us with broader platform connectivity and
interoperability. We offer online solutions with key online service providers,
including website hoster's such as Concentric Network, One and One, Verio, and
Strato AG, and banner exchange providers such as SmartAge and BeFree. We also
have product bundling agreements with leading software companies, such as IBM,
Lotus Development Corporation, and Novell, Inc. that help us to create greater
brand recognition and awareness. Further, we have entered into a joint agreement
with Sun Microsystems to offer the Netobjects Authoring Server on the Sun
Solaris platform.
We have established a premier Internet brand and estimate that over 1.5
million copies of NetObjects Fusion have been licensed to date. Traffic to our
websites has grown steadily, and currently averages over 100,000 visitors per
month. New visitors provided approximately half of the traffic to our website in
1999. We think the increasing number of visitors to our websites reflects the
broad distribution of our products and the growing strength of our brand.
On May 7, 1999, we completed an initial public offering of our common
stock, raising about $65.0 million, after underwriters' fees and other expenses,
through the sale of six million shares of common stock. On October 4, 1999, we
acquired all the outstanding stock of Sitematic Corporation for approximately
two million shares of NetObjects common stock and $1.5 million in cash.
Following the acquisition of Sitematic, we reorganized our business into two
divisions: The Small Business and Online division, which offers small firms
website solutions and online application services; and the Enterprise division,
which offers corporate intranet solutions and services for large enterprises.
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Industry Overview
Growth of the Web
In fewer than five years, the World Wide Web (WWW) has emerged as a
universal, rapidly growing online business medium enabling millions of users
worldwide to share information, conduct e-commerce, and access business
applications. According to International Data Corp. (IDC), by the end of 2002,
the number of web users worldwide will grow to an estimated 399 million and
worldwide Internet commerce will grow to an estimated $733 billion. The
explosive growth of the web as an online business medium has been fueled by a
number of factors, including an increased awareness by businesses of the
revenue, cost and performance benefits from using the web to conduct business,
and the large and growing number of web users.
In addition, we believe the growth will accelerate as an increasing
number of web users attract more businesses to build or enhance their online
websites, which in turn attracts more users. IDC reports that the number of web
site addresses, or URL's, will grow to 3.2 billion in 2000.
As developing or enhancing a web presence and building an e-business
becomes increasingly important to businesses, business websites are becoming
more complex. As the web's importance has grown, businesses have applied
advances in Internet technology to convert business websites from static
"billboards" to sophisticated e-business websites where businesses can interact
and transact with customers, employees, suppliers, and distributors. E-business
sites may contain hundreds of pages, embed audio and video content and provide
access to data, or "e-publishing", provide online commerce, or "e-commerce"
capabilities, and run web applications, or "e-applications" such as interactive
forms. E-business websites are rapidly becoming a strategic necessity for many
companies as they discover how conducting business online can enhance revenues,
reduce costs, and improve performance.
Growth of Corporate Intranets
The growth of the web as a global communications medium is also driving
large-scale corporate enterprises to enhance communication, collaboration, and
productivity by building corporate intranets consisting of numerous internal web
sites. These intranets bring together corporate information and applications
that help facilitate communication and information sharing within an
organization. Intranets can also streamline business processes such as customer
service, sales and marketing, and human resources, thereby reducing costs or
improving performance through automation or self-service. According to a recent
report, Zona Research estimates that two-thirds of intranet sites are being
developed through team-based web site building, and corporate intranets
represent the greatest business opportunity for providers of Internet and
intranet-related software technologies and products.
The Business WebSite Opportunity
Although it has become relatively easy to access the web, it can be
difficult and expensive to build an effective web presence. The challenges of
building a successful Internet or intranet website require solutions that
address planning, design, building and deployment, as well as website promotion
and maintenance after the website is placed online. Companies are often also
faced with a difficult "make or buy" decision, either to build a website by
using in-house resources or third-party service providers, or to develop a web
site with available "off-the-shelf" applications. Key factors influencing their
choice of solutions include ease and flexibility for building, reduced time and
cost for construction, and greater flexibility at a lower cost for maintaining
and enhancing their website presence. In addition, the web utilizes multiple
standards and platforms, including different web browsers, databases and web
servers, which increase the complexity of building a site that operates in
multiple environments.
The first generation of website building products was technically
difficult to use and generally required the programming expertise of a limited
number of highly skilled users such as HTML programmers or highly skilled
designers. Although third-party service providers and in-house programmers can
provide technical coding, these resources can be expensive and may not provide
the flexibility required to develop and maintain dynamic, evolving websites. In
addition, third-party and in-house solutions often have excluded key business
users from the website building and maintenance process, rather than enabling a
truly collaborative site building development process that includes content
contributions from users. The second generation of products and online services
that facilitated website building targeted consumers with personal "home page"
building tools and casual desktop users with the ability to publish simple,
static information and did not target the business user.
Our opportunity to provide website solutions in todays environment lie
in multiple areas. We believe that the majority of small businesses have not yet
strategically embraced the Internet. Those that have a web presence often need
to enhance their websites with new functionality such as e-commerce or
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marketing applications, or otherwise improve their website features and
promotion. Businesses with more sophisticated website requirements, but without
access to programmers, require an easy-to-use, capability-rich, and open
solution. In-house programmers or third-party service providers can address
technical design and programming requirements, but often at a much higher cost
than a packaged application and with less flexibility in building and
maintaining their websites. In addition, large enterprises have a variety of
departments and need solutions that allow effective collaboration in developing,
deploying, and maintaining their intranet websites.
The NetObjects Solution
Small businesses require easy-to-use integrated solutions that enable
them to build or enhance their websites quickly and efficiently, add key
functions such as e-commerce or web applications, and work with a variety of
industry standards and platforms. Our award-winning application, NetObjects
Fusion, now shipping as version 5.0, addresses these needs. NetObjects Fusion
has an intuitive, visual interface that integrates and helps automate many site
creation functions, including site layout and design, page building, and content
management. In addition, NetObjects Fusion 5.0 includes a feature to easily link
the newly created website to a web hosting service.
For small businesses that wish to start with a simple e-commerce
presence, GoBizGo.com offers online site building capabilities using templates,
web hosting, and other application services needed to make these firms fully
e-commerce enabled. GoBizGo.com also provides information for building,
maintaining, and promoting websites, and an online site development community
for small businesses.
Large-scale corporate enterprises and departments require an integrated
solution that enables them to manage the entire web production process. They
also need products that integrate with disparate corporate systems and platforms
in order to leverage existing legacy systems, databases, and content. In
addition, teams that develop corporate web applications have requirements
distinctly different from those of individuals who develop external websites.
They need a solution that supports creativity and collaboration, while allowing
an administrator to assert control over the site-building process. Our
Enterprise division provides an award-winning software package, NetObjects
Authoring Server Suite, for corporations that are developing enterprise web
applications as well as the services necessary to manage a seamless
implementation of this software. In addition, we offer software components that
provide integration with products from other technology companies, including
Allaire Corporation, IBM, Lotus, and Microsoft Corporation that provide
additional web applications, database publishing, and e-commerce capabilities
for the NetObjects Authoring Server Suite.
To facilitate the implementation of NetObjects Authoring Server Suite,
we provide our customers with the training and consulting services that large
enterprises typically need to design, build, deploy, maintain their websites,
and integrate their websites with existing corporate applications. We provide
these services through our own professional services organization and through
relationships with third-party service providers.
NetObjects Strategy
Our strategy is to establish ourselves as a complete e-business
solutions provider for small businesses and a leading developer of corporate
intranets for large enterprises, by leveraging our position as a leading
provider and brand for website building software. As more companies seek
solutions for capturing the explosive growth of the web as an online business
medium, we believe our e-business software and services provide an ideal
starting point. NetObjects Fusion, NetObjects Authoring Server Suite, and
GoBizGo.com online position us to aggregate broader solutions, including third
party hosting, software and components, site content, e-commerce using
third-party transactional software, and other web applications and services. Key
elements of our strategy include:
Brand Recognition and Broad Customer Base. As a pioneer of the website
building product category, and as the recipient of many industry awards, we
believe that we have established a premier Internet brand in the market for
website building products and services. We estimate that over 1.5 million copies
of NetObjects Fusion have been licensed to date. Our customer base and the
active online communities of builders who use our products help sustain and
promote our brand by participating in our website forums and bulletin boards and
by providing feedback on pre-release versions of our software. Over 60,000 links
exist from other websites to NetObjects.com, including the websites of
complementary products and services providers. Our strong brand recognition and
growing customer base are significant assets for attracting new customers, as
well as for enhancing our ability to develop relationships with other leading
software and service solution providers.
Strategic Relationships. We will continue to form strategic
relationships that enhance our product and service offerings and help expand our
market presence. Our current strategic relationships include:
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o product bundling and distribution arrangements with companies such as
Allaire, IBM, Lotus and Novell to combine NetObjects Fusion with
popular business software;
o arrangements with companies such as Deluxe Business Forms, ThemeWare
Corporation, US West Communications Services, Inc, OfficeMax, Inc, Sir
Speedy International, and Tickets.com, Inc to distribute GoBizgo.com
services to their small business customers;
o technology relationships to integrate our products with web application
servers from Allaire, Lotus, IBM, Microsoft, PeopleSoft, and Sun
Microsystems, and e-commerce software from Breakthrough Software, PDG
Software, iCat, and to create components in Java that provide our
products with additional functions for building web applications and
conducting e-commerce; and
o online solutions that combine our products with online service
providers such as Concentric Network, T-Online, Verio and Zip2 by
offering our products as part of their online services, for hosting and
promoting e-business sites, which enhance our products and solutions,
as well as complement our sales, marketing, and distribution reach.
These relationships greatly enhance our brand recognition and provide a
short-term source of revenues. Our strategic relationship with IBM has provided
us with other sales and marketing benefits, including access to IBM and Lotus
sales and distribution channels, co-marketing and co-promotion benefits, and
credibility in the marketplace.
Technological Leadership and Open Architecture. NetObjects Fusion and
NetObjects Authoring Server are based on proprietary technology that provides an
intuitive, visual building environment that allows for significant productivity
gains compared to web page coding products that require manual programming of
each page. Our products are Windows-based and allow users to automatically
generate HTML code by using words and graphics without programming. In addition,
NetObjects Authoring Server offers a collaborative website building environment
for teams of builders while providing centralized control over the site building
effort. We have an open architecture that:
o supports all major Internet protocols;
o is publishable on major web browsers, such as Netscape Navigator and
Microsoft Internet Explorer; and
o allows other website solutions providers to integrate their products
with our products using components implemented in the Java language.
By maintaining these advantages, we believe our products will continue
to be recognized as open platforms for easy integration with their other OEM
products and services.
Platforms of Choice for e-Business Solutions Aggregation. As businesses
face the increasingly complex and numerous challenges of establishing a
successful e-business presence, we believe they will seek aggregated solutions
to address their needs, from building and hosting their websites to maintaining
and promoting them. We believe that other website solutions providers have
compelling incentives to use NetObjects Fusion, NetObjects Authoring Server and
GoBizGo.com as platforms for aggregating their e-business solutions. Other
solutions providers can benefit from our strong brand to reach a growing
business customer base through our products, services and websites. In turn, we
can offer more complete solutions by leveraging our strategic relationships to
include e-commerce services, database access, banner exchange, content, web
applications and other online services from other website solutions providers.
Products and Services
We provide solutions for two broad categories of customers: NetObjects
Fusion and GoBizGo.com services for small businesses; and NetObjects Authoring
Server and professional services for the large enterprise intranet market.
Small Business and Online Services
NetObjects Fusion is an easy-to-use desktop application designed
specifically for small businesses. NetObjects Fusion offers a range of
publishing and e-commerce capabilities to simplify website building and enhance
the productivity of both novice and experienced website builders. NetObjects
Fusion is available in nine languages in addition to English, including German,
French, Spanish, Chinese, and Japanese. The multi-language versions of
NetObjects Fusion, developed through our relationship with IBM, gives us an
opportunity to enter international markets for website building software, which
have seen limited development to date.
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NetObjects Fusion 5.0 provides six views that facilitate the process of site
building:
o Online view provides a wide variety of online e-services and content
that has direct and immediate value to building a successful website.
The integrated browser enables the user to add new service to their
website all from within the NetObjects Fusion application.
o Site view lets the author visually plan and organize the pages on the
website. NetObjects Fusion automatically creates and maintains the
navigation buttons and links based on how the author lays out the
website.
o Page view lets the author create pages visually. A wide range of
content can be incorporated on the page, including text, graphics,
video, audio, applets, and other components.
o Styles view lets the author create a consistent, attractive visual
style for the site. Over 150 site styles are available, and authors can
customize or create their own styles.
o Assets view serves as a content manager to make it easy to find and
replace assets throughout the site.
o Publish view lets the author publish all or portions of the site as
standard HTML pages to the server of choice.
GoBizGo.com, offers small businesses the website services they need to
become e-business participants. These services include website building
software, e-mail list management for communicating to customers, domain name and
search engine registration, auction export, content, and advice to implement an
e-business plan, and web hosting services.
Enterprise and Professional Services
The currrent family of NetObjects Authoring Server Suite products,
consist of the NetObjects Authoring Server Suite 2000, NetObjects Authoring
Server Connectors and NetObjects Authoring Server for IBM WebSphere. NetObjects
Authoring Server currently runs only on Windows NT, but supports a variety of
web browsers, databases, and web servers. The Authoring Server Suite consists of
four modules:
Authoring Server. Authoring Server is the "server"-side control center
of NetObjects Authoring Server and contains an internal database which stores
the information about assets, site pages, site structure, link information and
user profiles for multiple websites. It also controls the number of concurrent
users that can access the system. Authoring Server works in conjunction with any
web server.
Authoring Server Administrator. Authoring Server Administrator is used
to create sites and enable the formation of teams, assign team members with
editing and publishing privileges and monitor workflow. The product is designed
to provide control of the website building process, without imposing a specific
workflow on team members.
TeamFusion Client. TeamFusion Client provides the "client"-side
software of the client-server application and includes all of NetObjects
Fusion's features.
Content Contributor Client. Content Contributor Client enables any
business user to submit content directly into templates created on completed
websites or websites under construction, regardless of their web authoring
skills, and without compromising the website's integrity. Users can add, modify
and delete text easily and without considering website design. NetObjects
Authoring Server automatically formats the content contributed as a web page
when the website is published.
In addition, we offer NetObjects Authoring Server Connector for
Microsoft FrontPage, which enables Microsoft FrontPage and FrontPage 2000 users
to collaborate with team members using NetObjects Authoring Server. NetObjects
Authoring Server Connector for Business Documents allows Microsoft Office 2000,
Lotus SmartSuite, and Corel WordPerfect users to convert office productivity
documents to web-ready format (HTML), and integrates these pages within a
collaborative authoring environment for publishing to a website.
NetObjects' Authoring Server's built-in workflow, publishing and site
management capabilities provide a comprehensive end-to-end web development and
management solution that can significantly streamline and enhance internal
communications. The new review/approval workflow publishing system of NetObjects
Authoring Server 2000 creates an efficient and enforceable process between
content contributors and content publishers that facilitates collaboration among
members with different roles and skill sets. Other new features include: instant
messaging, automated task scheduling, versioning, change control, site
histories, cross-site linking, cross-site shared assets, and mirror publishing.
These features provide increased control, security, ease-of-use, and
performance.
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We believe that providing a high level of customer service and
technical support is necessary to achieve rapid product implementation, which,
in turn, is essential to customer satisfaction and license sales growth. We
provide consulting and implementation services to our customers deploying the
NetObjects Authoring Server Suite. We provide these services through our own
professional services organization and, through relationships with third-party
service providers. We also offer support and training services to our customers,
including telephone and online support. Internationally, with our technical
assistance, our distributors provide telephone support to their customers.
Customers
We market and sell our products to a wide range of customers located in
the U.S. and in over 30 other countries. We believe that approximately 60% of
our customers have been small businesses and approximately 40% have been large
enterprises, including Fortune 1000 companies or departments within these
enterprises. Approximately one-third of our small business customers are
third-party service providers that build websites for other companies.
Sales, Marketing, and Distribution
We sell our products and services to our customers using a combination
of indirect distribution channels, our direct enterprise sales force, our online
distribution channel and strategic relationships, and we market our products and
services using a broad range of activities to generate demand and build brand
awareness. As of September 30, 1999, 51 of our employees, or approximately
one-third of our work force, were engaged in sales and marketing activities.
Indirect Distribution Channels
Our indirect distribution channels include domestic and international
distributors, retail vendors, value-added resellers and other technology
companies with whom we have strategic relationships. We have 15 non-exclusive
distributors worldwide including Ingram Micro, Tech Data and Digital River in
North America; Softline, Internet 2000, and Unipalm in Europe.
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Direct Enterprise Sales Force
Our direct enterprise sales force focuses on sales to larger corporate
customers worldwide. The enterprise sales force is comprised of field
representatives and inside sales representatives. The field representatives
market and sell our products and services to corporate customers that the inside
sales representatives have identified as sales prospects through leads generated
from inquiries on our websites, downloads of our trial products and other direct
marketing efforts.
Online Distribution Channel
Our eSiteStore.com website allows users to download and purchase our
products as well as numerous third-party add-ons. In addition, several
third-party e-commerce and distribution sites, including buydirect.com,
beyond.com and download.com, make our products available for sale online. The
online distribution channel provides us with a low-cost, globally accessible,
24-hour a day sales channel.
Strategic Relationships
We have a number of significant ongoing strategic relationships with
other technology companies pursuant to which our products are incorporated into,
or bundled with, the third party's products. We believe that these strategic
relationships significantly enhance our brand recognition and awareness of our
products and services and also provide a source of revenues. Our strategic
relationships include:
IBM/Lotus. Lotus markets, bundles and sells a version of NetObjects
Fusion with Designer for Domino Application Studio under an agreement that
expires on December 31, 1999. IBM markets, bundles and sells NetObjects Fusion
with its WebSphere Studio product. In addition, our products are offered for
sale through a variety of IBM and Lotus channels including "Passport Advantage,"
the worldwide direct purchasing option for Lotus and IBM branded software and
the Lotus Business Partner program, which allows 18,000 program members access
to our products at discounted prices globally. At September 30, 1999, IBM owned
a majority of our outstanding common stock.
Novell. Novell bundles a version of NetObjects Fusion with its NetWare
for Small Business product offering on a worldwide basis. Under the terms of
this agreement, the contract is automatically renewed each September 30, unless
terminated by one of the parties with written notice. This agreement was renewed
on September 30, 1999 for an additional year. Novell also offers end-user
training for NetObjects Fusion at over 100 Novell certified training centers
worldwide. Novell is a NetObjects stockholder.
Marketing Activities
Since our inception, we have invested a substantial percentage of our
annual revenues in a broad range of marketing activities to generate demand,
gain corporate brand identity, establish the site building product category and
educate the market about our products and services. These activities have
included advertising, including both print and online, direct marketing,
including direct mail, newsletters and e-mail, public relations, seminars for
potential customers, participation in trade shows, as well as conferences and
website promotion. Our marketing programs are aimed at informing our customers
of the capabilities and benefits of our products and services, increasing brand
awareness, stimulating demand across all market segments and encouraging
independent software developers to develop products and web applications that
are compatible with our products and technology. We also have had many
co-marketing and distribution arrangements with well-known companies such as
AT&T, Cisco Systems, Compaq Computer, Inc., Concentric Networks, Microsoft,
Netscape, Verio, Office Max, Deluxe Forms, ADP, Tickets.com, Sir Speedy, Strato
AG, One and One, Vobis AG, and PeopleSoft that have allowed us to identify our
NetObjects Fusion brand with their brands.
Competition
The market for software and services for the Internet and intranets is
relatively new, constantly evolving and intensely competitive. We expect
competition to intensify in the future. Many of our current and potential
competitors have longer operating histories, greater name recognition and
significantly greater financial, technical and marketing resources. We compete
for small business customers with web content software makers like Adobe
Systems, Inc., Macromedia, Inc., and Microsoft. In the online web hosting and
services market, we compete with providers like Verio, Bigstep, Icat, and Yahoo
store. We compete in the Internet application development and services market
for enterprise customers with companies such as Interwoven, Inc., and Vignette
Corporation.
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Moreover, Microsoft's FrontPage, a website building software product,
has a dominant market share. Microsoft has introduced FrontPage 2000, in one
version of Microsoft's Office product suite, which dominates the market for
desktop business application software. We believe that NetObjects Fusion and
NetObjects Authoring Server contain features that significantly differentiate
them from FrontPage 2000, but widespread distribution of Office with FrontPage
2000, and the vast number of computer users familiar with Microsoft desktop
application software products, give Microsoft a substantial competitive
advantage over us.
Competitive factors in our market segments include:
o the manner in which the software is distributed with other products;
o quality and reliability;
o features for creating, editing, and developing websites;
o pricing;
o ease of use and interactive user features;
o scalability and cost per user; and
o compatibility with the user's existing computer systems.
To expand our user base and further enhance the user experience, we
must continue to innovate and improve the performance of our products. We
anticipate that consolidation will continue in the website building products
industry and related industries such as computer software, media and
communications. Consequently, our competitors may be acquired by, receive
investments from or enter into other commercial relationships with larger,
well-established and well-financed companies. There can be no assurance that we
can establish or sustain a leadership position in our market segments.
We believe that additional competitors may enter the market with
competing products as the size and visibility of the market opportunity
increases. Increased competition could result in additional pricing pressures,
reduced margins or the failure of our products to achieve or maintain market
acceptance, any of which could harm our business and cause our revenues and
stock price to fall. Many of our current and potential competitors such as
Microsoft, Adobe and Macromedia have longer operating histories and
substantially greater financial, technical, marketing and other resources than
us and therefore may be able to respond more quickly to new or changing
opportunities, technologies, standards or customer requirements. Many of these
competitors also have broader and more established distribution channels that
may be used to deliver competing products directly to customers through product
bundling or other means. For example, Microsoft enjoys significant distribution
advantages over us, including the vast number of computer users familiar with
Microsoft desktop application software products. If our competitors bundle
competing products with their products, the demand for our products might be
substantially reduced and our ability to distribute our products successfully
would be substantially diminished. Moreover, Microsoft's dominance in desktop
business application software enables it to vary the pricing for its software
sold as part of a suite. As a result of Microsoft's and other competitors'
bundling arrangements, we may need to reduce our prices for our products to keep
them competitive.
New technologies and the enhancement of existing technologies will
likely increase the competitive pressures on us. Competing technologies or the
emergence of new industry standards could adversely affect our competitive
position or render our products or technologies noncompetitive or obsolete.
There is no assurance that we will compete effectively with current or
future competitors or that competitive pressures will not harm our business and
cause our revenues and stock price to fall.
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Technology and Development
We devote substantial resources to the development of innovative
products for the market for website building software and services. During the
fiscal year ended September 30, 1999, respectively, we invested approximately
42% of our total revenues on research and development activities. NetObjects
Fusion and NetObjects Authoring Server are among the earliest and most
recognized entrants in the emerging market for website building software. We
believe that we have been able to leverage our understanding of the market and
technology opportunity as well as our staff and software development processes
to build robust, open solutions for customers. We intend to continue to use
these core strengths to introduce innovative products and product enhancements
for building, deploying and maintaining business websites. We intend to continue
to devote substantial resources to research and development for at least the
next several years.
Our technology provides the following product advantages:
Open Architecture
Our products are built upon a flexible object-oriented architecture,
which has been instrumental in the rapid development of our products. The
architecture provides such significant benefits as:
o separating the visual display of information from its storage;
o supporting multiple databases;
o supporting major Internet protocols;
o allowing any HTML page editor to be used with our products;
o extending our products using components built using the Java language;
and
o allowing access to powerful applications over the Internet via a
browser.
We intend to continue to invest in further development of this
architecture to build and integrate new products and technologies.
Control and Collaboration
Intranet websites are evolving from simple publishing pages coordinated
by a single webmaster to multi-contributor strategic business platforms that
integrate business processes and deploy mission-critical applications.
Enterprise groups that build these intranet websites face the conflicting needs
of maintaining control and encouraging collaboration. NetObjects Authoring
Server provides the performance needed to support concurrent, collaborating
users across an enterprise-wide deployment with several underlying technologies
such as a Java-based content contributor, an integrated asset manager and remote
systems administrator.
In addition to our products, product enhancements and core proprietary
technology, we have a highly-skilled engineering workforce that includes several
seasoned software industry veterans. As of September 30, 1999, we had 58
employees, or approximately one-third of our workforce, engaged in research and
development activities. Our original key technologists are still NetObjects
employees, and they continue to play an integral role in defining and leading
our technology vision and strategy. We intend to hire additional software
engineers to further our research and development efforts. If we are unable to
hire and retain the required number of skilled engineers, our business will be
harmed, our revenues could decline and our stock price may fall.
Intellectual Property
Our success depends in part on our ability to protect our proprietary
software and other intellectual property. To protect our proprietary rights, we
rely generally on patent, copyright, trademark and trade secret laws,
confidentiality agreements with employees and third parties, license agreements
with consultants, vendors and customers and "shrink-wrap" license agreements.
Despite these protections, a third party could, without authorization, copy or
otherwise obtain and use our products, or develop similar products. There can be
no assurance that our agreements will not be breached, that we will have
adequate remedies for any breach or that our trade secrets will not otherwise
become known or independently developed by competitors.
We currently have several pending patents relating to our product
architecture and technology and have licensed two utility patents from Rae
Technology, a predecessor to our business that is controlled and majority owned
by our CEO. There can be no assurance that any pending or future patent
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application will be granted, that any existing or future patent will not be
challenged, invalidated or circumvented or that the rights granted under any
patent that has issued or may issue will provide competitive advantages to us.
If a blocking patent has issued or issues in the future, we would need to obtain
a license or design around the patent. Except for patents licensed from Rae
Technology, which we have rights to acquire, there can be no assurance that we
would be able to obtain a license on acceptable terms, if at all, or to design
around the patent.
We pursue the registration of some of our trademarks and service marks
in the United States and in other countries, although we have not secured
registration of all of our marks. Many of our current and potential competitors
dedicate substantially greater resources to protection and enforcement of
intellectual property rights. We are also aware of other companies that use
"Fusion" in their marks alone or in combination with other words, such as
Allaire's ColdFusion, and we do not expect to be able to prevent third party
uses of the word "Fusion" for competing goods and services. We have agreed with
Allaire that neither party will use the word "Fusion" to describe products in
the absence of appropriate brand identification, such as "NetObjects Fusion."
The laws of some foreign countries do not protect our proprietary
rights to the same extent as do the laws of the United States, and effective
patent, copyright, trademark and trade secret protection may not be available in
these jurisdictions. We license some of our proprietary rights to third parties,
and there can be no assurance that these licensees will abide by compliance and
quality control guidelines with respect to our proprietary rights.
Employees
As of September 30, 1999, we had 158 full-time employees and 18
part-time employees. None of our employees are subject to a collective
bargaining agreement, and we believe that our relations with our employees are
good. We believe that our future success will depend in part on our continued
ability to attract, integrate, retain and motivate highly qualified sales,
technical, professional services and managerial personnel, and upon the
continued service of our current personnel. We also use independent contractors
to supplement our work force. None of our personnel is bound by an employment
agreement that prevents the person from terminating his or her relationship with
the Company at any time for any reason. Competition for qualified personnel is
intense. There can be no assurance that we will be successful in attracting,
integrating, retaining and motivating a sufficient number of qualified personnel
to conduct our business in the future.
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Risk Factors
NetObjects believes that its results of operations in any annual or
quarterly period may be impacted adversely by a number of factors, including
those set forth below. Readers of this report should consider these and other
ordinary business risk factors in evaluating the business, financial condition,
results of operations and prospects of NetObjects.
We have a history of substantial losses and expect substantial losses in the
future.
We were incorporated in November 1995 and first recognized revenues in
October 1996. As of September 30, 1999, we had an accumulated deficit of
approximately $73.6 million. We expect to sustain significant losses for the
foreseeable future, which could harm our business and decrease the market price
of our stock.
To achieve and sustain profitability, we must, among other things,
increase substantially our revenues from our two principal products, NetObjects
Fusion and NetObjects Authoring Server, and substantially increase our revenues
from professional and online services.
Our relationship with IBM has changed substantially over time. While IBM
controls us, it is under no obligation to continue any business relationships
with us, and IBM is allowed to compete with us or act in a manner which is
disadvantageous to us.
Although we have contracts with IBM to bundle our products with their
offerings, we have no commitments for future revenues from IBM. Revenues from
IBM have represented a substantial portion of our total revenues, representing
approximately 29% and 36% of our total revenues for the years ended September
30, 1999 and 1998, respectively. Lotus also currently markets, bundles and sells
our products and has created foreign language, or "localized," versions of our
software, for which IBM pays us reduced royalties on products that it sells
outside the U.S. Lotus's obligation to create localized versions of our software
expires on December 31, 1999. After that date, we may need to incur substantial
additional expense to obtain localized versions of new products or product
upgrades from Lotus or other vendors if necessary to satisfy the requirements of
key customers like IBM, Lotus and Novell.
We have a number of license and reseller agreements or arrangements
with IBM, many of which are subject to the terms of our 10-year license
agreement that expires in April 2007. We have no revenue commitments from IBM or
Lotus. Although we expect to continue licensing our products to IBM and Lotus as
original equipment manufacturer, or OEM, resellers, we believe that revenues
from IBM will comprise a substantially lower percentage of our total revenues in
the future than they have during the fiscal year ended September 30, 1999.
We have business conflicts with IBM. IBM has chosen in the past and is free in
the future to promote and bundle competitors' products over our products.
Although we have been dependent on IBM, and IBM has provided substantial support
to us, IBM makes independent business and product decisions that present
conflicts with our business objectives.
IBM controls us and is free to sell its interest in us. As of November 30, 1999,
IBM owned approximately 47% of our common stock and held warrants which, if
exercised, would increase its ownership to approximately 53% of our outstanding
voting securities. As our largest stockholder, with three representatives on our
board of directors, IBM has substantial influence over our direction and
management, may be able to prevent or cause a change in control of us and could
take other actions that might be favorable to IBM and potentially harmful to us.
IBM can act in ways that may be disadvantageous to us, such as competing with
us, investing in our competitors and taking advantage of corporate
opportunities. IBM is contractually or otherwise free to act in ways that may
harm our business. Our restated certificate of incorporation contains provisions
expressly acknowledging that:
o IBM retains "freedom of action" to conduct its business and pursue
other business opportunities, even in competition with us;
o IBM has no obligation to refrain from investing in our competitors,
doing business with our customers or hiring away our key personnel;
o no director appointed by IBM is prohibited from taking actions or from
voting on any action because of any actual or apparent conflict of
interest between that director and us; and
o These provisions materially limit the liability of IBM and its
affiliates, including IBM's representatives on our board of directors
and Lotus, from conduct and actions taken by IBM or its affiliates,
even if the conduct or actions are beneficial to IBM and harmful to us.
Furthermore:
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o IBM is eligible to sell its stock subject to applicable securities
laws, contractual arrangements with our underwriters and the terms of a
registration rights agreement. IBM may transfer some or all of its
stock, including to our competitors. Such a transfer could result in a
transfer of IBM's interest in us, which could cause our revenues to
decrease and our stock price to fall; and
o IBM is under no obligation to inform us of any corporate opportunity
and is free to avail itself of any opportunity or to transfer the
opportunity to a third party.
Any of IBM's rights could give rise to conflicts of interests, and we
cannot be certain that any conflicts would be resolved in our favor. Any of the
risks arising from our relationship with IBM could harm our business and cause
our stock price to fall.
IBM could obtain and use our source code if we default on our
obligations under license agreements with IBM. Although our license agreements
with IBM contain restrictions on IBM's use and transfer of our software and
intellectual property, these restrictions are subject to exceptions. Under a
software license agreement with IBM, we have placed our key source code in
escrow for IBM's benefit. In the event of our default under the contract, IBM
will have access rights to this source code and will be free to use it to
maintain our products and create derivative works for the benefit of IBM and its
customers.
Our licensing arrangements with IBM are not exclusive, and IBM is free
to enter into similar arrangements with our competitors. All of our licensing
arrangements with IBM are non-exclusive. IBM has the right to cease promoting
and distributing our software at any time. IBM may license its name, logo and
technology to, or invest in, other website building companies, and it may more
actively promote the services of our competitors.
We have many established competitors, including Microsoft, and may be unable to
compete effectively against them.
The market for website building software and services for the Internet
and corporate intranets is relatively new, constantly evolving and intensely
competitive. We expect competition to intensify in the future. Many of our
current and potential competitors have longer operating histories, greater name
recognition and significantly greater financial, technical and marketing
resources, and we may be unable to compete effectively against them. We compete
for small business customers with web content software makers like Adobe,
Macromedia, and Microsoft. In the online web hosting and services market, we
compete with providers like Verio, Bigstep, Icat, and Yahoo store. We compete in
the Internet application development and services market segment for enterprise
customers with companies such as Interwoven, and Vignette. Microsoft's
FrontPage, a website building software product, has a dominant market share.
Microsoft bundles FrontPage 2000 in several versions of the Office 2000 product
suite that dominates the market for desktop business application software.
We may not be able to accurately forecast revenue and adjust spending.
Because our business is evolving rapidly and we have a very limited
operating history, we have little experience in forecasting our revenues. Our
expense levels are based in part on our expectations of future revenues, and to
a large extent those expenses are fixed, particularly in the short-term. We
cannot be certain that our revenue expectations will be accurate or that we will
be able to adjust spending in a timely manner to compensate for any unexpected
revenue shortfall.
Our quarterly operating results will probably fluctuate.
We believe that period-to-period comparisons of our financial results
are not necessarily meaningful, and you should not rely upon them as an
indication of our future performance. Going forward, our revenues from IBM, if
any, are likely to become more variable. The promptness with which sales data,
used for recognizing product royalties, are reported to us from third parties,
including IBM, may cause quarterly results to be more volatile.
We allow product returns and provide price protection to some purchasers and
resellers of our products and our allowances for product returns may be
inadequate.
We have stock-balancing programs for our software products that under
specified circumstances allow for the return of software by resellers. These
programs also provide for price protection for our software for some of our
direct and indirect channel resellers that, under specified conditions, entitle
the reseller to a credit if we reduce our price to similar channel resellers.
There can be no assurance that actual returns or price protection will not
exceed our estimates, and our estimation policy may cause significant quarterly
fluctuations.
Most of our revenues have been derived from sales of a single product, and a
decline in demand or the sale price of that product would harm our business and
cause our stock price to fall.
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About 60% of our revenues from software license fees in fiscal year
1999 were derived from versions of one of our products, NetObjects Fusion, and
we expect that this single product will continue to account for the majority of
our total revenues in the near-term. To remain competitive, software products
typically require frequent updates that add new features. There can be no
assurance that we will succeed in creating and selling updated or new versions
of NetObjects Fusion. A decline in demand for, or in the average selling price
of, NetObjects Fusion, whether as a result of new product introductions or price
competition from competitors, technological change or otherwise, would hurt our
business or cause our stock price to fall.
Our future financial performance depends substantially on market acceptance and
growth of NetObjects Authoring Server, Professional Services and Online
services.
We increasingly depend on NetObjects Authoring Server Suite to provide
us with revenues. We depend on increasing revenues from NetObjects Authoring
Server, and we may not receive these revenues for the following reasons:
o the success of NetObjects Authoring Server will depend on the rapid
emergence of a market for large-scale enterprise website and intranet
building products and services;
o information services departments of large enterprises may choose to
create and maintain their web and intranet sites internally or may use
third-party professional developers to create and maintain their sites;
o NetObjects Authoring Server may not meet customer performance needs or
be free of significant software defects or bugs;
o NetObjects Authoring Server will have a longer sales cycle than
NetObjects Fusion due to higher pricing and different marketing and
distribution characteristics;
o We depend heavily on bundling arrangements with third parties to sell
our products, and we currently do not have any arrangements for
bundling NetObjects Authoring Server Suite, and;
o we may not be able to recruit and retain the additional sales personnel
needed to effectively market NetObjects Authoring Server.
Our professional services business, through which we provide training
and other support for our products, may not generate sufficient revenues. We
cannot be certain that our professional services business will generate
significant revenues or achieve profitability. We believe that software license
fees growth will depend on our ability to provide our customers with these
services and to educate third-party resellers about how to use our products. We
currently outsource much of our customers' services needs, but we plan to
increase the number of our services personnel to meet the needs of our
customers. Competition for qualified services personnel is intense, and we
cannot be certain that we can attract or retain a sufficient number of highly
qualified services personnel to meet our business needs.
Our online services are new and have not yet received a broad customer
acceptance. Since inception, we have invested resources to create and enhance
our online services, which we believe support and add to market acceptance of
our products. With the Sitematic acquisition, providing online services to
enable small businesses to conduct e-commerce has become an integral part of our
business growth strategy. Including the pre-acquisition period during which
Sitematic provided these services, they have been offered to customers for less
than 12 months. Together with our distribution partners, we must attract a
substantial number of small business subscribers for these services for our
online business to succeed. We may fail to attract these new customers which
would hurt our business and could cause our stock price to fall.
We may not be able to expand our distribution channels or sales force.
We need to maintain our third-party distribution channel because our
direct sales to third parties would be insufficient to support our operating
base. While we derive some of our revenues from selling our products directly to
third parties, most of our revenues are derived from the sale of our products
through third-party distributors and resellers. There can be no assurance that
third parties will be willing or able to carry our products in the future. If
third parties were to reduce or cease carrying our products, our direct sales to
third parties would be insufficient to support our operating expense base.
We need to maintain and establish new bundling arrangements because we
may be less successful at selling our products on a stand-alone basis. We
believe that products that are not sold in a "suite" containing software
products
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or components that perform different functions are less likely to be
commercially successful. For example, NetObjects Fusion 4.0 includes software
products or components from different vendors such as Allaire Corporation, IBM,
iCat, Lotus and NetStudio. IBM also bundles our products with some of its
software products, such as the bundling of NetObjects Fusion with WebSphere
Studio and NetObjects Fusion with Lotus Designer Studio. NetObjects Fusion is
also bundled with Novell's NetWare for Small Business. We cannot be assured of
maintaining or obtaining suitable product or component bundling arrangements
with third parties. Failure to maintain and expand our distribution channels or
conclude suitable software product bundling arrangements could hurt our
business, cause our revenues to decrease and our stock price to fall.
Our products may contain defects that could subject us to liability in excess of
insurance limitations.
Our software products are complex and may contain undetected errors or
result in system failures. Despite extensive testing, errors could occur in any
of our current or future product offerings after commencement of commercial
shipments. Any errors could result in loss of or delay in revenues, loss of
market share, failure to achieve market acceptance, diversion of development
resources, injury to our reputation or damage to our efforts to build brand
awareness. We cannot be certain that the contractual limitations of liability
will be enforceable, or that our insurance coverage will continue to be
available on reasonable terms or will be available in amounts to cover one or
more large claims, or that the insurer will not disclaim coverage as to any
future claim. The successful assertion of one or more large claims that exceed
available insurance coverage or changes in our insurance policies, including
premium increases or the imposition of large deductible or co-insurance
requirements, could cause our revenues to decrease and our stock price to fall.
If we fail to respond adequately to rapid technological changes, our existing
products and services will become obsolete or unmarketable.
The market for our products is marked by rapid technological change,
which leads to frequent new product introductions and enhancements, uncertain
product life cycles, changes in customer demands and evolving industry
standards. New website building products and services based on new technologies
or new industry standards could render our existing products obsolete and
unmarketable. We believe that to succeed, we must enhance our current products
and develop new products on a timely basis to keep pace with technological
developments and to satisfy the increasingly sophisticated requirements of our
customers.
Our product and software development efforts are inherently difficult to manage
and keep on schedule, so development delays may increase our costs.
On occasion, we have experienced development delays and related cost
overruns, which to date have not materially affected our business, and we cannot
be certain that we will not encounter these problems in the future. Any delays
in developing and releasing enhanced or new products could cause our revenues to
decrease. In addition, we cannot be certain that we will successfully develop
and market new products or product enhancements that respond to technological
change, evolving industry standards or customer requirements, or that any
product innovations will achieve the market penetration or price stability
necessary for profitability.
The loss of our key personnel, or failure to hire additional personnel, could
harm our business because we would lose experienced personnel and new skilled
personnel are in short supply and command high salaries.
We depend on the continued service of our key personnel, and we expect
that we will need to hire additional personnel in all areas. The competition for
personnel throughout our industry is intense, particularly in the San Francisco
Bay Area, where our headquarters are located. We have experienced difficulties
in attracting new personnel, and all of our personnel, including our management,
may terminate their employment at any time for any reason. Currently, we are
dependent upon the services of Samir Arora, our President, Chief Executive
Officer, Chairman of the Board and one of our founders. The loss of Mr. Arora's
services would materially impede the operation and growth of our business at
this time. We do not maintain key person life insurance for any of our
personnel. Furthermore, our failure to attract new personnel or retain and
motivate our current personnel could hurt our business.
A third party could be prevented from acquiring your shares of stock at a
premium to the market price because of our anti-takeover provisions.
As of November 30, 1999, IBM owned approximately 47% of our outstanding
stock. That ownership interest and provisions of our restated certificate of
incorporation, bylaws, a voting agreement between us and IBM and Delaware law
could make it more difficult for a third party to acquire us, even if a change
in control would result in the purchase of your shares of common stock at a
premium to the market price.
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If we fail to adequately protect our intellectual property rights or face a
claim of intellectual property infringement by a third party, we could lose our
intellectual property rights or be liable for significant damages.
Trademarks and other proprietary rights are important to our success
and our competitive position. We seek to protect our trademarks and other
proprietary rights, but our actions may be inadequate to prevent
misappropriation or infringement of our technology, trademarks and other
proprietary rights or to prevent others from claiming violations of their
trademarks and other proprietary rights. Although we have obtained federal
registration of the trademark NetObjects Fusion, we know that other businesses
use the word "Fusion" in their marks alone or in combination with other works.
We do not believe that we will be able to prevent others from using the word
"Fusion" for competing goods and services. For example, Allaire markets its
application development and server software for web development, including
applications for e-commerce, under the federally registered trademark
"ColdFusion." Under an agreement with Allaire Corporation, we have agreed that
neither company will identify its products and services with the single word
"Fusion," unless otherwise agreed as in the case of our co-bundled product
"Fusion2Fusion." Business customers may confuse our products and services with
similarly named brands, which could dilute our brand names or limit our ability
to build market share. To license many of our products, we rely in part on
"shrink-wrap" and "clickwrap" licenses that are not signed by the end user and,
therefore may be unenforceable under the laws of certain jurisdictions. In
addition, we may license content from third parties. We could become subject to
infringement actions based upon these third-party licenses, and we could be
required to obtain licenses from other third parties to continue offering our
products.
We cannot be certain that we will be able to avoid significant
expenditures to protect our intellectual property rights, to defend against
third-party infringement or other claims or to license content from third
parties alleging that our products infringe their intellectual property rights.
Incurring significant expenditures to protect our intellectual property rights
or to defend against claims or to license content could decrease our revenues
and cause our stock price to fall.
Because we are no longer a majority-owned subsidiary of IBM, we no
longer enjoy cross-licensing protection that we received as an IBM subsidiary.
We may face material litigation risk associated with patent infringement claims
that IBM's patent cross-licensees could not assert against us while we were an
IBM subsidiary. In addition, we may be unable to assert patent claims of our own
against an IBM cross-licensee, which may remain free of liability for claims
under the terms of the applicable IBM cross-license agreement.
Our international operations continue to expand and may not be successful.
International sales represented approximately 23% of our total revenues
in the fiscal year ended September 30, 1999. We intend to expand the scope of
our international operations and currently have a subsidiary in the United
Kingdom. Our continued growth and profitability will require continued expansion
of our international operations, particularly in Europe.
Our international operations are, and any expanded international
operations will be, subject to a variety of risks associated with conducting
business internationally that could materially adversely affect our business,
including the following:
o difficulties in staffing and managing international operations;
o lower gross margins than in the United States;
o slower adoption of the Internet;
o longer payment cycles;
o fluctuations in currency exchange rates;
o seasonal reductions in business activity during the summer months in
Europe and other parts of the world;
o recessionary environments in foreign economies; and
o increases in tariffs, duties, price controls or other restrictions on
foreign currencies or trade barriers imposed by foreign countries.
Furthermore, the laws of foreign countries may provide little or no
protection of our intellectual property rights.
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We may be unable to manage our rapid growth.
We have expanded our operations rapidly since inception, and we intend
to continue to expand them in the foreseeable future. This rapid growth places a
significant demand on our managerial and operational resources. To manage growth
effectively, we must:
o implement and improve our operational systems, procedures and controls
on a timely basis;
o expand, train and manage our workforce and, in particular, our sales
and marketing and support organizations in light of our recent decision
to offer online and professional services;
o implement and manage new distribution channels to penetrate different
and broader markets, including the market for intranet software
products; and
o manage an increasing number of complex relationships with customers,
co-marketers and other third parties.
We cannot be certain that our systems, procedures or controls will be
adequate to support our current or future operations or that our management will
be able to manage the expansion and still achieve the rapid execution necessary
to exploit fully the market for our products and services. Failure to manage our
growth effectively could harm our business.
If Internet and intranet usage does not continue to grow, we will not be
successful.
Sales of our products and services depend in large part on the
emergence of the Internet as a viable commercial marketplace with a strong and
reliable infrastructure and on the growth of corporate intranets. Critical
issues concerning use of the Internet and intranets, including security,
reliability, cost, ease of use and quality of service, remain unresolved and may
inhibit the growth of, and the degree to which business is conducted over, the
Internet and intranets. Failure of the Internet and intranets to develop into
viable commercial mediums would harm our business and cause our revenues to
decrease and our stock price to fall.
Year 2000 problems may disrupt our internal operations.
We have completed an assessment of our Year 2000 readiness and have
developed contingency plans. We have contacted our third-party vendors,
licensors and providers of software, hardware and services regarding their Year
2000 readiness. Our inability to correct a significant Year 2000 problem, if one
exists, could result in an interruption in, or a failure of, certain of our
normal business activities and operations. Furthermore, because NetObjects
Fusion and NetObjects Authoring Server may interact with external databases for
purposes of data storage, the ability of applications integrated with a website
built using NetObjects Fusion or NetObjects Authoring Server to comply with Year
2000 requirements is largely dependent on whether the databases underlying the
application are Year 2000 ready. If NetObjects Fusion or NetObjects Authoring
Server is connected to a database that is not Year 2000 ready, a web application
created or developed for a website using NetObjects Fusion or NetObjects
Authoring Server could work incorrectly and could result in unanticipated
expenses to address problems or claims raised by customers that we cannot
presently foresee. Any significant Year 2000 problem in our internal systems or
in our products could require us to incur significant unanticipated expenses to
remedy these problems and could divert management's time and attention, either
of which could harm our business or increase our losses, and cause our stock
price to fall.
Due to our small size, limited operations and the difficulty of hiring personnel
in our industry, any future acquisitions could strain our managerial,
operational and financial resources.
In the future we may make additional acquisitions of, or large
investments in, businesses that offer products, services and technologies that
we believe would help us better provide e-business website and intranet site
building software and services to businesses. Any future acquisitions or
investments would present risks such as difficulty in combining the technology,
operations or workforce of the acquired business with our own, disruption of our
ongoing businesses and difficulty in realizing the anticipated financial or
strategic benefits of the transaction.
To make these acquisitions or large investments we might use cash,
common stock or a combination of cash and common stock. If we use common stock,
these acquisitions could further dilute existing stockholders. Amortization of
goodwill or other intangible assets resulting from acquisitions could materially
impair our operating results and financial condition. Furthermore, there can be
no assurance that we would be able to obtain acquisition financing, or that any
acquisition, if consummated, would be smoothly integrated into our business. If
we make
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acquisitions or large investments and are unable to surmount these risks, our
business could be harmed, our revenues could decrease and our stock price could
fall.
We may become subject to burdensome government regulation and legal
uncertainties in areas including network security, encryption and privacy, among
others, because we conduct electronic commerce and provide information and
services over the Internet.
We are not currently subject to direct regulation by any governmental
agency, other than laws and regulations generally applicable to businesses,
although specific U.S. export controls and import controls of other countries,
including controls on the use of encryption technologies, may apply to our
products. Due to the increasing popularity and use of the Internet, it is
possible that a number of laws and regulations may be adopted in the United
States and abroad with particular applicability to the Internet. It is possible
that governments will enact legislation that may apply to us in areas such as
network security, encryption, the use of key escrow, data and privacy
protection, electronic authentication or "digital" signatures, illegal and
harmful content, access charges and retransmission activities. Moreover, the
applicability to the Internet of existing laws governing issues such as property
ownership, content, taxation, defamation and personal privacy is uncertain. Any
new legislation or regulation or governmental enforcement of existing
regulations may limit the growth of the Internet, increase our cost of doing
business or increase our legal exposure, any of which could cause our revenues
to decrease and our stock price to fall.
A governmental body could impose sales and other taxes on the sale of our
products, license of our technology or provision of services, which would harm
our financial condition.
We currently do not collect sales or similar taxes with respect to the
sale of products, license of technology or provision of services in states and
countries other than states in which we have offices. In October 1998, the
Internet Tax Freedom Act, or ITFA, was signed into law. Among other things, the
ITFA imposes a three-year moratorium on discriminatory taxes on e-commerce.
Nonetheless, foreign countries, or, following the moratorium, one or more
states, may seek to impose sales or other tax obligations on companies that
engage in online commerce within their jurisdictions. A successful assertion by
one or more states or any foreign country that we should collect sales or other
taxes on the sale of products, license of technology or provision of services or
remit payment of sales or other taxes for prior periods, could hurt our
business.
Our stock price might have wide fluctuations, and Internet-related stocks have
been particularly volatile.
The market price of our common stock is likely to be highly volatile
and could be subject to wide fluctuations. Recently, the stock market has
experienced significant price and volume fluctuations and the market prices of
securities of technology companies, particularly Internet-related companies,
have been highly volatile. Market fluctuations, as well as general political and
economic conditions, such as recession or interest rate or currency rate
fluctuations, could adversely affect the market price of our common stock.
Item 2. Properties
Our executive offices are located in Redwood City, California, in an
office building in which, as of September 30, 1999, we lease an aggregate of
approximately 26,000 square feet. The lease agreement terminates on November 2,
2002. We lease three office suites for our sales and marketing personnel in a
facility in Bucks, United Kingdom under a lease that expired November 23, 1999.
We currently occupy this facility on a month-to-month basis. We lease an office
facility in Germany under a lease that expires May 31, 2001.
Item 3. Legal Proceedings
From time to time, we are subject to legal proceedings and claims in
the ordinary course of business, including claims of alleged infringement of
third-party trademarks and other intellectual property rights by us and our
licensees. These claims, even if not meritorious, could result in the
expenditure of significant financial and managerial resources. We are not aware
of any legal proceedings or claims that we believe would harm our business or
cause our revenues or stock price to fall.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Our common stock is quoted on the Nasdaq National Market under the
symbol "NETO". We completed an initial public offering of our common stock on
May 7, 1999, offering 6,000,000 shares at $12
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per share. Since the IPO, we have invested approximately $1.6 million in the
Sitematic acquisition. We have used approximately $5.6 million to provide
working capital to maintain our business operations. The remainder of the
original net proceeds of $40.1 million, approximately $32.9 million, were
invested in cash, cash equivalents or short term investments at this time at
September 30, 1999.
The following table sets forth the range of high and low closing sales
prices for each period indicated.
Quarter ending High Low
June 30, 1999 $13.00 $6.75
September 30, 1999 10.438 5.156
We had 257 stockholders of record as of November 30, 1999. We have not
declared or paid any cash dividends on its common stock and presently intends to
retain its future earnings, if any, to fund the development and growth of our
business and, therefore, do not anticipate paying any cash dividends in the
foreseeable future.
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<PAGE>
Item 6. Selected Financial Data
<TABLE>
The selected historical consolidated financial data presented below are
derived from our consolidated financial statements. The selected consolidated
financial data set forth below is qualified in its entirety by, and should be
read in conjunction with, "Management's Discussion and Analysis of Financial
Condition and Results of Operations," our consolidated financial statements, the
related notes and other financial information included herein.
<CAPTION>
Statement of Operations Data
Year Ended September 30, Inception (11/21/95) to
1999 1998 1997 September 30, 1996
------------ ------------ ------------ -----------------------
(In thousands, except share and per share data)
Revenues:
<S> <C> <C> <C> <C>
Software license fees $ 13,566 $ 9,703 $ 7,392 $ --
Service revenues 2,178 -- -- --
Software license fees from IBM 3,689 2,700 175 --
Service revenues from IBM 2,782 2,867 -- --
------------ ------------ ------------ -----------------------
Total revenues 22,215 15,270 7,567 --
------------ ------------ ------------ -----------------------
Cost of revenues:
Software license fees 1,817 2,531 772 --
Service revenues 2,295 -- -- --
Service revenues from IBM 2,113 2,562 -- --
------------ ------------ ------------ -----------------------
Total cost of revenues 6,225 5,093 772 --
------------ ------------ ------------ -----------------------
Gross profit 15,990 10,177 6,795 --
------------ ------------ ------------ -----------------------
Total operating expenses 33,031 31,147 24,359 6,741
------------ ------------ ------------ -----------------------
Operating income (loss) (17,041) (20,970) (17,564) (6,741)
------------ ------------ ------------ -----------------------
Interest income (expense) (715) (1,194) (234) 46
Accretion of discount on debt (1,653) -- -- --
Interest charge on beneficial conversion
feature of convertible debt (7,457) -- -- --
------------ ------------ ------------ -----------------------
Income (loss) before income taxes (26,866) (22,164) (17,798) (6,695)
------------ ------------ ------------ -----------------------
income taxes 44 60 1 --
------------ ------------ ------------ -----------------------
Net income (loss) (26,910) (22,224) (17,799) (6,695)
============ ============ ============ =======================
Basic and diluted asset income (loss) per share $ (2.40) $ (12.26) $ (10.45) $ (4.10)
============ ============ ============ =======================
Shares used to calculate basic and diluted net
income (loss) per share 11,215,118 1,812,484 1,702,726 1,634,000
============ ============ ============ =======================
September 30,
---------------------------------------------------------
Balance Sheet Data 1999 1998 1997 1996
-------- -------- -------- ---------
(In thousands)
Cash and cash equivalents $ 32,954 $ 459 $ 303 $ 1,090
Working capital (deficit) 34,022 (30,229) (10,116) (1,749)
Short-term borrowings from IBM and IBM Credit Corp. -- 20,666 -- --
Long-term obligations, less current portion 54 336 633 173
Total assets 42,709 5,145 4,605 2,129
Accumulated deficit 73,628 (46,718) (24,494) (6,695)
Stockholders' equity (deficit) 36,172 (28,925) (8,913) (1,357)
</TABLE>
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<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Management's Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with the accompanying
consolidated financial statements and notes included in this report. This
discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those expressed
or implied by these forward-looking statements as a result of various factors,
including the risk factors described in Risk Factors and elsewhere in this
report.
Overview
We provide both online and software solutions that enable small
businesses to build, deploy and maintain Internet websites and applications to
conduct e-business; and enable large enterprises to create corporate intranets.
For fiscal 1999, our revenues were derived principally from license fees from
our software products and, to a lesser extent, fees for a range of services
complementing these products. Subsequent to Sept. 30, 1999, we created two
operating divisions. Our Small Business and Online division licenses NetObjects
Fusion and offers online services to small business customers. We derived no
revenues from online services during fiscal year 1999. Our Enterprise division
licenses NetObjects Fusion(TM) and NetObjects Authoring Server(TM) and in fiscal
year 1999, began providing training, consulting and design services to large
enterprise customers for creating corporate intranets.
We recognize revenues from software license fees upon delivery of our
software products to our customers, net of allowances for estimated returns and
price protection, as long as we have no significant obligations remaining and we
believe that collection of the resulting receivable is probable. We provide most
of our distributors of software products with rights of return and record an
allowance for estimated future returns based upon our historical experiences
with product returns by those distributors. Software license fees earned from
products bundled with OEM resellers, including IBM, are generally recognized
upon the OEM resellers shipping the bundled products to their customers. We
recognize service revenues as services are rendered, or, if applicable, using
the percentage-of-completion method. We defer recognition of maintenance
revenues, paid primarily for support and upgrades, upon receipt of payment and
recognize the related revenues ratably over the term of the contract, which
typically is 12 months. These payments generally are made in advance and are
nonrefundable.
We earn revenues from software license fees through direct licenses to
enterprises, through strategic relationships such as our relationships with IBM
and Lotus and through our indirect distribution channel. Professional services
and maintenance are typically sold through our direct sales organization. Most
of our software license fees to date have come from licenses to our indirect
distribution channel and OEM resellers. We expect our revenues from license fees
derived from our direct, or enterprise, sales channel to increase as a
percentage of our total revenues as our direct sales organization grows in size.
We derive our international revenues primarily through our indirect distribution
channel.
As a result of our recent acquisition of Sitematic Corporation, we have
begun offering online subscription services, which will represent an increasing
percentage of our revenue. We anticipate that revenues derived from sales of our
products by resellers will decrease as a percentage of our total revenues. We
anticipate that revenues derived from our direct sales will continue to increase
as a percentage of our total revenues.
In April 1997, IBM acquired approximately 80% of our outstanding stock
from existing investors. Under the terms of a 10-year license agreement with
IBM, we granted IBM rights to market and sell some of our products to its
customers for 10 years in exchange for nonrefundable cash prepayments totaling
$10.5 million between April 1997 and December 31, 1998. We requested and
received the full amount of these prepayments between April and December 1997.
These prepayments were reflected as deferred revenues from IBM on our balance
sheet. By June 1999, IBM had sold sufficient quantities of licenses, and
purchased services from NetObjects to fully utilize this $10.5 million
prepayment. In the three months ended December 31, 1997, IBM began reselling our
products, and in the three months ended March 31, 1998, we began providing
services to IBM to make our products compatible with
20
<PAGE>
and to integrate them with IBM's WebSphere products. This services contract with
IBM expired on February 28, 1999. Due, inpart, to the expiration of this
contract, our total revenues from IBM were substantially lower during the second
half of fiscal year 1999 compared to the first six months of the year when they
represented 45.1% of total revenues. We anticipate that total revenues from IBM
during fiscal year 2000 will decrease substantially as a percentage of revenues
from the 29% of total revenues they requested in fiscal year 1999.
We have incurred substantial net losses in each fiscal period since our
inception and, as of September 30, 1999, had an accumulated deficit of $73.6
million. Such net losses and accumulated deficit resulted primarily from the
significant costs incurred in the development of our products, establishing
brand identity, marketing organization, domestic and international sales
channels, and general and administrative infrastructure. We intend to increase
our expenditures in all of these areas, particularly for research and
development and sales and marketing.
Our future operating results must be considered in light of our limited
operating history and the risks, expenses and difficulties frequently
encountered by companies in early stages of development, particularly companies
in rapidly evolving markets such as the market for website building software
and services. In order to be successful financially, we will need to achieve the
following:
o Increase substantially our revenues from our two principal products,
NetObjects Fusion and NetObjects Authoring Server;
o Continue to develop successfully new versions of our products;
o Continue to be a leading provider of e-business software for building
websites and corporate intranet sites;
o Respond quickly and effectively to competitive, market, and
technological developments;
o Expand our professional services business;
o Expand our online services business;
o Control expenses;
o Continue to attract, train, and retain qualified personnel in the
competitive software industry; and
o Maintain existing relationships and establish new relationships with
leading internet hardware and software companies.
There can be no assurance that we will achieve or sustain
profitability. Moreover, we may be unable to adjust spending in a timely manner
to compensate for any unexpected revenue shortfall. Accordingly, any significant
shortfall of revenues in relation to expectations would cause significant
declines in operating results.
Due to the foregoing factors, we believe that period to period
comparisons of historical operating results should not be relied upon as an
indication of future performance. Also, operating results may fall below our
expectations or the expectations of securities analysts or investors in some
future quarter and our stock price may decline substantially.
Results of Operations
Years ended September 30, 1999 and 1998
Revenues. Total revenues increased to $22.2 million for the year ended
September 30, 1999 from $15.3 million for the year ended September 30, 1998. The
increase was attributable to additional license fees for NetObjects Fusion, the
introduction of NetObjects Authoring Server, and related services. Our software
license revenues were $17.3 million and $12.4 million for the years ended
September 30, 1999 and 1998, respectively. Software license revenue from IBM was
$3.7 million and $2.7 million, respectively, for the two fiscal years.
For the fiscal year ended September 30, 1999 services revenues were
approximately $5.0 million, compared to $2.9 million for the year ended
September 30, 1998. Of these amounts, $2.8 million represented services provided
to IBM in fiscal 1999. The remaining $2.2 million in fiscal 1999 was derived
from our newly formed professional services group.
International sales of software licenses grew steadily over the same
period, increasing to $4.5 million in fiscal 1999 from $2.5 million in fiscal
1998. Increased international sales resulted primarily from increased licenses
of NetObjects Fusion through our distributors in Europe. Total international
revenues, which include the sale of software licenses and services, were 23% and
16% of total revenues for the fiscal years ended September 30, 1999 and 1998,
respectively.
Revenues from IBM were 29% and 36% of total revenues for the fiscal
years ended September 30, 1999, and 1998, respectively. Service revenue from IBM
declined slightly with the expiration of the WebSphere contract. IBM license
fees increased by 37% over the entire period, primarily during the first half of
the year.
Cost of Revenues. The cost of software license fees was approximately
$1.8 million and $2.5 million for the years ended September 30, 1999 and 1998,
respectively, representing approximately 8% and 17%, respectively, of total
revenues. The improvement in percentage terms from fiscal 1998 to fiscal 1999
resulted primarily from better inventory management, more favorable freight
contract terms, and a better sales channel mix.
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<PAGE>
The cost of service for our new professional services group was $2.3
million, with a gross margin of (-5%). The loss reflected our initial startup
costs for this business in its first year of operation.
Cost of revenues from the sale of services to IBM and affiliates was
approximately $2.1 million and $2.6 million for the years ended September 30,
1999 and 1998, respectively.
Overall our gross margin improved from 67% for the year ended September
30, 1998 to 72% for the year ended September 30, 1999.
Research and Development. Our research and development expenses were
approximately $9.4 million and $10.2 million for the years ended September 30,
1999 and 1998, respectively, which was 42% and 67% respectively, of total
revenues. The decrease in percentage terms occurred as revenues grew at a faster
rate than expenses. The savings were achieved through reductions in contractor
costs and selective staffing reductions.
Sales and Marketing. Our sales and marketing expenses were
approximately $18.8 million and $17.1 million for the years ended September 30,
1999 and 1998, respectively, representing approximately 85% and 112%
respectively, of total revenues. The increased expenses in fiscal 1999 resulted
primarily from growth in the number of sales personnel, increased sales
commissions and costs related to the continued development and implementation of
our branding and marketing campaigns. The decrease in percentage terms occurred
as revenues grew at a faster rate than expenses.
General and Administrative. Our general and administrative expenses
were approximately $4.3 million and $3.6 million for the years ended September
30, 1999 and 1998, respectively, representing approximately 19% and 23%
respectively, of total revenues. The decrease in percentage terms occurred as
revenues grew at a faster rate than expenses. The increase in expenses in fiscal
1999 resulted primarily from hiring additional personnel and related personnel
expenses, as well as increased professional fees needed to operate a public
company.
Interest expense. Interest expense was $0.7 million and $1.0 million
for the years ended September 30, 1999 and 1998, respectively. In fiscal 1999,
we recorded a charge to earnings of $9.1 million, compared to $200,000 in fiscal
1998. Of this amount, approximately $7.5 million was recognized in connection
with the "in-the-money" convertible notes totaling $10.9 million that we issued
to IBM and Perseus Capital LLC during October 1998, and was recorded as interest
expense in accordance with EITF Topic D-60 for the fiscal year ended September
30, 1999. The remaining $1.6 million charge recorded during fiscal 1999 was an
accretion of discount resulting from Series E-2 and Series F warrants issued in
connection with loans obtained from IBM, IBM Credit Corp, and Perseus Capital
LLC in fiscal 1999. The value of the attached warrants, and the resulting
interest expense was determined using a Black-Scholes option pricing model. We
recorded $200,000 in charges during fiscal 1998.
Years ended September 30, 1998 and 1997
Revenues. Our total revenues increased to approximately $15.3 million
from $7.6 million for the fiscal years ended September 30, 1998 and 1997,
respectively. The increase was due primarily to growing market acceptance of our
products and $2.9 million of WebSphere services revenues. None of the increase
was due to product price increases, although we introduced NetObjects TeamFusion
in 1998, which had a higher sales price than our previous products. In August
1997, we reduced the price of NetObjects Fusion from a suggested retail price of
$495 to $295, and provided credits for unsold inventory to many of our
distributors and other resellers, thereby reducing revenues from software
license fees for the three months ended September 30, 1997 to a lower amount
than in the preceding quarter. Although the price reduction of NetObjects Fusion
resulted in reduced revenues during the three months ended September 30, 1997,
the increased sales volume in subsequent periods more than offset this price
reduction.
Our international revenues were approximately 16% and 15% of total
revenues for the fiscal years ended September 30, 1998 and 1997, respectively.
The increase in international revenues was due in part to the expansion of the
indirect sales channel in Europe as well as the initiation of our master
distributor agreement with Mitsubishi, which also invested in us in November
1998, to manufacture and sell our products in Japan. We have not been exposed to
significant foreign currency translation and transaction exposure from our
operations in fiscal 1998 and 1997.
Our revenues from IBM were approximately 36% and 2% of total revenues
for the fiscal years ended September 30, 1998 and 1997, respectively. The
increased revenues from IBM were generated primarily from our product bundles
with Lotus Designer for Domino and our provision of WebSphere services beginning
in March 1998.
22
<PAGE>
Under our original agreement with IBM with respect to IBM's WebSphere
offerings, we were obligated to deliver modified versions of NetObjects Fusion,
NetObjects ScriptBuilder and NetObjects Authoring Server. We anticipated that
all three products would be bundled with IBM's WebSphere product offerings. In
that event, the agreement provided for IBM to pay us license fees for each of
the listed products with a minimum total amount committed to us. Most of the
license fees would have been due for NetObjects Authoring Server, which is our
highest priced product. In October 1998, however, IBM purchased all rights to
Build IT from Wallop, Inc., and decided to bundle that product instead of
NetObjects Authoring Server. We therefore amended our IBM license agreement to
provide for revenues from charges for our services based on the amount of our
costs and expenses instead of the minimum total amount of license fees. As a
result of the agreement and IBM's decision not to bundle NetObjects Authoring
Server, we expect to earn less revenues from our WebSphere agreement with IBM
than we had expected to earn and will need to find other revenue sources.
Cost of revenues. Our cost of software license fees was approximately
$2.5 million and $772,000 for the fiscal years ended September 30, 1998 and
1997, respectively, representing approximately 26% and 10% respectively, of
total revenues from sources other than IBM. Approximately $1 million of the
increase can be attributed to increased production and freight costs partially
driven by volume increases in 1998 over 1997. In addition, royalty costs grew by
approximately $300,000 due to our increased bundling of third party components
and products within NetObjects Fusion and NetObjects TeamFusion. Finally,
approximately $400,000 of the increase was due to write-offs of product
inventory made obsolete by new product releases. Cost of IBM service revenues
consists solely of the costs of providing WebSphere services.
Research and development. Our research and development expenses were
approximately $10.2 million and $8.4 million for the fiscal years ended
September 30, 1998 and 1997, respectively, and 67% and 111% respectively, of
total revenues. The increase in fiscal 1998 resulted primarily from increases in
internal development personnel and independent contractor expenses. The decrease
in percentage terms occurred as revenues grew at a faster rate than expenses.
Sales and marketing. Our sales and marketing expenses were
approximately $17.1 million and $12.2 million for the fiscal years ended
September 30, 1998 and 1997, respectively, representing approximately 112% and
161% respectively, of total revenues. Approximately $2.9 million of the increase
resulted from salary and associated overhead expense increases for additional
personnel. Most of the remaining $2.1 million represented additional spending in
marketing communications to increase market awareness of the NetObjects brand
and products. The decrease in percentage terms occurred as revenues grew at a
faster rate than expenses.
General and administrative. Our general and administrative expenses
were approximately $3.6 million and $3.8 million for the fiscal years ended
September 30, 1998 and 1997, respectively, representing approximately 23% and
50% respectively, of total revenues. Total general and administrative expenses
were higher in fiscal year 1997 than in fiscal year 1998 principally because of
costs incurred in connection with IBM's acquisition of approximately 80% of our
stock in fiscal 1997, including approximately $300,000 in professional fees. The
decrease in percentage terms occurred as revenues grew at a faster rate than
expenses.
Stock-based compensation. We amortized approximately $227,000 of the
total deferred stock-based compensation in fiscal year 1998.
Interest expense. Our interest expense consisted primarily of interest
on our borrowings and increased to approximately $1.2 million from $234,000 for
the fiscal years ended September 30, 1998 and 1997, respectively, as we
increased our borrowings during fiscal year 1998. Fiscal year 1998 interest
expense included $201,000 for the Series F preferred stock warrants issued to
IBM Credit Corp.
Liquidity and Capital Resources
In May 1999, we sold 6,000,000 shares of common stock at $12 per share
in our IPO. Proceeds from the offering were approximately $65.6 million after
deducting the underwriting discount and offering expenses. Prior to our initial
public offering (IPO), we funded our operations primarily through a combination
of private placements of equity securities and borrowings, which yielded an
aggregate of $59.9 million of net proceeds from inception in November 1995
through April 1999. IBM and Perseus Capital LLC provided approximately $15.5
million of this financing, and another $19.0 million was provided by IBM Credit
Corp. in the form of a secured credit facility between December 1997 and May
1999. In addition, we received cash prepayments from IBM of approximately $10.5
million from April 1997 to December 1997, which were recorded as deferred
revenues from IBM on our balance sheet. These deferred revenues offset revenues
from licenses of our products by IBM from January 1998 through April 1999. We
paid interest to IBM on the amounts of prepayments that we received in advance
of the scheduled prepayment period set forth in our license agreement with IBM.
23
<PAGE>
Our $19 million credit facility with IBM Credit Corp., initially
obtained in December 1997, was repaid out of the proceeds of the initial public
offering and was then terminated. Our $10.9 million Convertible Note and Warrant
Purchase Agreement with IBM and Perseus was converted into 2,141,713 shares of
common stock at the time of our initial public offering. A $2.0 million loan
obtained in February 1999, a $1.4 million loan obtained in March 1999, and a
$2.0 million loan obtained in April 1999, all from IBM, were repaid from the
proceeds of our IPO.
At September 30, 1999, we had cash or cash equivalents of $23.6
million, and short-term investments of $9.3 million, an increase of $32.5
million from September 30, 1998. Net cash used in operating activities was $10.8
million, $19.0 million and $25.9 million for the years ended September 30, 1997,
1998 and 1999, respectively. For the year ended September 30, 1997, the outflow
of cash from operating activities was partially offset by an increase in
deferred revenue attributable to a prepayment by IBM for goods and services. For
the year ended September 30, 1998, an operating loss was partially offset by an
increase in accounts payable. For the year ended September 30, 1999, cash used
in operating activities was primarily attributable to a net loss of $26.9
million, a nonrecurring interest charge on convertible debt obtained from IBM
and Perseus of $7.5 million, a $3.8 million increase in accounts receivable, a
$1.9 million decrease in accounts payable and a $4.3 million decrease in
deferred revenue. The decrease in deferred revenue was due primarily to the
recognition of deferred revenues from license and service fee prepayments by
IBM.
Net cash used in investing activities was $1.0 million, $0.8 million
and $2.2 million for the years ended September 30, 1997, 1998 and 1999,
respectively. For the years ended September 30, 1997 and 1998, the principal
investing activity was the purchase of property and equipment. The increase for
the year ended September 30, 1999 was attributable to expenditures for new
leasehold improvements as the Company moved from smaller facilities to its
current location and to operating loans provided to Sitematic Corporation in
August 1999.
Net cash provided by financing activities was approximately $11.0
million, $20.0 million and $60.0 million for the years ended September 30, 1997,
1998 and 1999, respectively. For the year ended September 30, 1997, the major
financing activity was the issuance of Series E preferred stock and the exercise
of Series B, C and E warrants. For the year ended September 30, 1998, repayments
of about $2.1 million in notes to IBM offset $21 million in proceeds from
short-term notes, principally from IBM and IBM Credit Corp. For the year ended
September 30, 1999, we received $12.9 million in proceeds of convertible debt
from IBM and Perseus, $3.4 million in short-term notes from IBM, $5.3 million in
proceeds from the issuance of preferred stock, and $65.6 million in net proceeds
from our IPO of which we used approximately $26.7 million to repay short-term
notes, convertible debt, and credit facilities to IBM and IBM Credit Corp.
We anticipate moderate growth in our operating expenses for the
foreseeable future to execute our business plan, particularly in sales and
marketing expenses and to a lesser extent research and development and general
and administrative expenses. As a result, we expect our operating expenses, as
well as planned capital expenditures, to continue to constitute a material use
of our cash resources. In addition, we may require cash resources to fund
acquisitions or investments in complementary businesses, technologies or product
lines. We believe that our current cash, cash equivalents, and short-term
investments will be sufficient to meet our anticipated cash requirements for
working capital and capital expenditures through September 30, 2000. Thereafter,
if cash generated from operations is insufficient to satisfy our liquidity
requirements, we may seek to sell additional equity or debt securities, or
obtain additional credit facilities.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards 133 (SFAS 133), Accounting for
Derivative Instruments and Hedging Activities, which establishes accounting and
reporting standards for derivative instruments and hedging activities. SFAS 133
is effective as of the beginning of the first quarter of the fiscal year
beginning after June 16, 2000. The Company is determining the effect of SFAS 133
on the financial statements.
In February 1998, the Accounting Standards Executive Committee (AcSEC)
issued Statement of Position (SOP) 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. SOP 98-1 provides guidelines to
assist management in determining when software products developed or purchased
for internal use should be expensed or capitalized. We do not expect SOP 98-1 to
have a material effect on our financial condition or results of operations.
Recent Developments
In November 1999, the board of directors approved an increase of
3,100,000 shares under the Amended and Restated 1997 Stock Option Plan, as
options to purchase all 4,500,000 shares previously authorized under the plan
had been granted and were outstanding prior to November. One million of the
additional authorized shares have been approved for grants to existing
employees. The compensation committee of the board of directors also approved
the issuance of new options to purchase a total of 1,400,000 shares to existing
executives. All of these options are subject to stockholder approval prior to
exercise, and the recent option grants
24
<PAGE>
generally vest monthly based upon continued employment over the next 24 months.
These actions are intended to keep us competitive in the tight labor market
currently faced by all Silicon Valley e-commerce companies.
Year 2000 Readiness
Many existing software programs are coded to accept only two digit
entries in their date fields. As a result, these programs are unable to
distinguish whether "00" means the year 1900 or the year 2000, which could
result in system failures or miscalculations causing disruptions to operations.
Although we believe that our products are Year 2000 ready, because NetObjects
Fusion and NetObjects Authoring Server may interact with external databases for
purposes of data storage, the ability of applications integrated with a website
built using NetObjects Fusion or NetObjects Authoring Server to comply with Year
2000 requirements is largely dependent on whether any databases underlying the
application are Year 2000 ready. If NetObjects Fusion or NetObjects Authoring
Server is connected to a database that is not Year 2000 ready, a web application
created or developed for a website built using NetObjects Fusion or NetObjects
Authoring Server could work incorrectly and could result in unanticipated
expenses to address problems or claims raised by customers that we cannot
presently foresee. Furthermore, Year 2000 issues may affect the purchasing
patterns of customers or potential customers as businesses expend significant
resources to correct their current systems for Year 2000 readiness.
State of Readiness. We have completed an assessment of Year 2000
requirements for our products and our internal systems. To ensure that our
products are compliant, we have completed quality assurance testing of
NetObjects Fusion and NetObjects Authoring Server. To ensure that the software
that we use is compliant, we have upgraded our internal financial systems, our
telecommunications systems, and our office productivity software, among others.
To ensure that the hardware that we use is compliant, we have upgraded our
servers and other internal hardware systems. To protect the integrity of the
data that is critical to our business, we have prepared back-up copies of that
data. To prepare for unanticipated Year 2000 problems from third parties that
could have an impact on our business, we have developed certain contingency
plans.
Separately, we have begun an evaluation of Year 2000 preparations by
Sitematic Corporation, which we acquired in October 1999. The costs of bringing
Sitematic's systems into compliance are not expected to have a material impact
on our business.
Costs. To date, our costs to identify, evaluate and fix Year 2000
compliance issues have been approximately $400,000. Most of our expenses have
related to the indirect operating costs associated with time spent by employees
in the evaluation process, upgrading internal software and hardware systems, and
Year 2000 compliance matters generally.
Risks. We are not currently aware of any significant Year 2000
compliance problems relating to our software for our product offerings or our
information technology or non-information technology systems that would harm our
business or results of operations, without taking into account our efforts to
avoid or fix these problems. There can be no assurance that we will not discover
Year 2000 compliance problems in our software for our product offerings that
will require substantial revisions or replacements. In addition, there can be no
assurance that third-party software, hardware or services incorporated into our
material information technology and non-information technology systems will not
need to be revised or replaced, which could be time-consuming and expensive. Our
inability to fix our software for our product offerings or to fix or replace
third-party software or hardware on a timely basis could result in lost
revenues, increased operating costs and other business interruptions, any of
which could harm our business, cause our revenues to decrease and our stock
price to fall. Because the Company has less control over the efforts of third
parties to correct their Year 2000 deficiencies, we believe that the greatest
risk to the Company's operations will come from utilities and telecommunications
suppliers.
Contingency Plan. We have developed contingency plans in the event that
unanticipated external system failures occur after January 1, 2000. We are
assessing the vulnerability of third parties to Year 2000 problems and the
extent to which delivery of services from these third parties would disrupt our
business.
Reasonably likely worst case scenario. A reasonably likely worst-case
scenario would include the failure of our products to operate properly, causing
customers' systems and/or operations to fail or be disrupted. Our inability to
correct a significant Year 2000 problem, if one develops, could result in an
interruption in, or a failure of, certain of our normal business activities or
operations. In addition, a significant Year 2000 problem concerning NetObjects
Fusion and NetObjects Authoring Server could cause our customers to seek
alternate providers of website building software or services. Any material Year
2000 problem could require us to incur significant unanticipated expenses to
remedy and could divert our management's time and attention, either of which
could harm our business, cause our revenues to decrease and our stock price to
fall.
25
<PAGE>
Item 7A. Qualitative and Quantitative Disclosures About Market Risk
Our exposure to market risks for changes in interest rates relates
primarily to investments in debt securities issued by U.S. government agencies
and corporate debt securities. We place our investments with high quality credit
issuers and, by policy, limits the amount of the credit exposure to any one
issuer. We manage interest rate risk by limiting investments to debt securities
of relatively short maturities. In addition, we maintain sufficient cash and
cash equivalents so that it can hold investments to maturity.
At September 30, 1999, we had short-term investments with an amortized
cost of approximately $9.3 million, consisting of high-grade commercial paper
issued by US companies, with maturities that extend from 90 to 180 days. We have
classified these debt securities as held-to-maturity.
Our general policy is to limit the risk of principal loss and ensure
the safety of invested funds by limiting market and credit risk. All highly
liquid investments with a maturity of three months or less at the date of
purchase are considered to be cash equivalents; investments with maturities
greater than three months are considered to be short-term investments. Effective
October 1, 1999, we have implemented an investment policy that limits purchases
of debt securities to maturities of three months or less.
To date, we have not purchased or sold forward contracts to hedge
foreign currency exposure, since the relative amounts of international revenue
generated by the Company have not been large enough to make hedging
cost-effective.
Item 8. Financial Statements and Supplementary Data
Reference is made to the financial statements listed under the heading
"(a)(1) Consolidated Financial Statements" of Item 14 hereof, which financial
statements are incorporated herein by reference in response to this Item 8.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Ernst & Young LLP was previously our principal accountant. On October
29, 1997, Ernst & Young LLP was dismissed as our principal accountant and KPMG
LLP was engaged to audit our consolidated financial statements. The board of
directors approved the appointment of KPMG LLP as our principal accountants.
In connection with the audit for the period from November 21, 1995, our
inception, through September 30, 1996, and the subsequent interim period through
October 29, 1997, there were no disagreements with Ernst & Young LLP on any
matter of accounting principles or practices, financial statement disclosure, or
auditing scope or procedures, which disagreements if not resolved to their
satisfaction would have caused them to make reference in connection with their
opinion on the subject matter of the disagreement.
26
<PAGE>
Part III
Item 10. Directors and Executive Officers of the Registrant
The response to this item is incorporated by reference from the
Sections titled "Management" and "Section 16(A) Beneficial Ownership Reporting
Compliance" in the Registrant's Proxy Statement for its 2000 Annual Meeting of
Shareholders.
Item 11. Executive Compensation
The response to this item is incorporated by reference from the Section
titled "Executive Compensation", but not from the Sections titled "Executive
Compensation - Performance Graph" and "Executive Compensation - Report on
Executive Compensation by the Compensation and Management Development Committee
of the Board of Directors", in the Registrant's Proxy Statement for its 2000
Annual Meeting of Shareholders.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The response to this item is incorporated by reference from the Section
titled "Share Ownership" in the Registrant's Proxy Statement for its 2000 Annual
Meeting of Shareholders.
Item 13. Certain Relationships and Related Transactions
The response to this item is incorporated by reference from the Section
titled "Certain Relationships and Related Transactions" in the Registrant's
Proxy Statement for its 2000 Annual Meeting of Shareholders.
27
<PAGE>
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) Consolidated Financial Statements
See pages 31 through 49 of this Annual Report on Form 10-K.
(a)(2) Financial Statement Schedules
<TABLE>
Accounts Receivable Reserve
<CAPTION>
BALANCE AT ADDITIONS
---------- ---------
BEGINNING OF CHARGED TO BALANCE AT
------------ ---------- ----------
PERIOD EXPENSE DEDUCTIONS END OF PERIOD
------ ------- ---------- -------------
<S> <C> <C> <C> <C>
Year ended September 30, 1997 - 1,850 (1,094) 756
Year ended December 31, 1998 756 4,691 (3,183) 2,263
Year ended December 31, 1998 2,263 1,698 (3,053) 908
</TABLE>
All other financial statement schedules required by Item 14(a) (2) have
been omitted because they are inapplicable or because the required information
has been included in the consolidated financial statements or notes thereto.
<PAGE>
(a)(3) Exhibits
The following Exhibits are incorporated herein by reference or are
filed with this report as indicated below.
Index to Exhibits
Number Description
- ------ -----------
3.1.1+ Restated Certificate of Incorporation of the Registrant
3.2.1+ Form of Amended and Restated Bylaws of the Registrant
4.1+ Specimen stock certificate
4.3+ Form of Series E Preferred Stock Warrant
4.4+ Form of Series E-2 Preferred Stock Warrant
4.5+ Form of Series F Preferred Stock Warrant
9.1+ Voting Agreement between NetObjects, Inc. and International Business
Machines Corporation
10.1.1+ NetObjects, Inc. Amended and Restated 1997 Stock Option
10.1.2+ Form of Stock Option Agreement under the 1997 Stock Option Plan
10.1.3+ Form of Restricted Stock Purchase Agreement under the 1997 Stock
Option Plan
10.1.4+ Form of Restricted Stock Transfer Agreement under the 1997 Stock
Option Plan
10.1.5 Form of Executive Stock Option Agreement
10.2+ NetObjects, Inc. 1997 Special Stock Option Plan
10.3.1+ Amended 1999 Employee Stock Purchase Plan
10.4+ IBM Software License Agreement (NetObjects License Agreement #L97063)
by and between NetObjects and IBM dated as of March 18, 1997
10.4.1+ Amendment Number 1 to NetObjects License Agreement L97063 dated as of
April 30, 1997
10.4.2+ Second Amendment to NetObjects License Agreement L97063 dated as of
October 7, 1997
10.4.3+ Third Amendment to NetObjects License Agreement L97063 dated as of
December 16, 1997
10.4.4+ Fourth Amendment to NetObjects License Agreement L97063 dated as of
April 27, 1998
10.4.5+ Fifth Amendment to NetObjects License Agreement L97063 dated as of
January 14, 1999
10.4.6+ Amendment No. 6 to NetObjects License Agreement L97063 dated as of
September 18, 1998
10.4.7+ Seventh Amendment to NetObjects License Agreement L97063 effective
January 15, 1999
10.4.8+ Eighth Amendment to NetObjects License Agreement L97063 dated
September 18, 1998
10.4.9+ Amendment No. 9 to NetObjects License Agreement effective January 21,
1999
10.4.10+ Amendment No. 10 to NetObjects License Agreement dated as of February
4, 1999
10.4.11+ Letter Agreement modifying NetObjects License Agreement L97063 dated
as of February 6, 1998
28
<PAGE>
10.4.12+ Letter Agreement modifying NetObjects License Agreement L97063 dated
as of June 30, 1998
10.4.13+ Letter Agreement modifying NetObjects License Agreement L97063 dated
as of January 14, 1999
10.4.14+ Letter Agreement modifying NetObjects License Agreement L97063 dated
as of March 25, 1999
10.5+ IBM Patent License Agreement by and between NetObjects and IBM dated
as of April 10, 1997
10.6+ Lease Agreement by and between NetObjects and Metropolitan Life
Insurance Company dated July 24, 1998
10.7+ Lease Agreement by and between NetObjects Limited and HQ Executive
Offices (UK) LTD dated February 15, 1999
10.10+ Technology Transfer Agreement between Rae Technology, Inc. and
NetObjects, Inc. dated February 2, 1996
10.10.1+ Amendment to Technology Transfer Agreement by and between Rae
Technology and NetObjects dated as of March 18, 1997
10.11+ Patent Transfer and License Agreement by and between Rae Technology
LLC and NetObjects, Inc. dated as of April 10, 1997, as amended
10.12+ Technology License Agreement by and between NetObjects and Clement Mok
Designs dated as of December 21, 1995
10.13*+ Distribution Agreement by and between Ingram Micro, Inc. and
NetObjects, Inc. dated March 6, 1997
10.14*+ Commercial Application Partner Agreement by and between Sybase, Inc.
and NetObjects, Inc. dated June 30, 1997
10.15*+ Master Distributor Agreement by and between Mitsubishi Corporation and
NetObjects, Inc. dated September 30, 1997
10.16*+ Standard Inbound License Agreement by and between NetObjects and
Novell effective September 30, 1998
10.16.1*+ Amendment to Standard Inbound License Agreement by and between
NetObjects and Novell effective April 2, 1999
10.17+ Build-It License Agreement dated as of February 2, 1999
10.18+ IBM Trademark License Agreement dated as of January 19, 1999
10.19+ Letter Agreement by and between NetObjects and John Sculley dated
February 3, 1999
10.20+ Sun Microsystems, Inc. Porting Agreement by and between Sun
Microsystems, Inc. and NetObjects dated as of March 26, 1999
10.21+ Employment Agreement between Russell F. Surmanek and NetObjects dated
as of April 5, 1999
10.22+ Distribution Agreement by and between Lotus Development Corporation
and NetObjects dated as of April 21, 1999
16.1+ Letter from Ernst & Young LLP dated February 5, 1999 regarding change
in certifying accountant
21.1 Subsidiaries of the Registrant
23.1 Consent of KPMG LLP
23.2 Consent of KPMG LLP
24.1 Power of attorney (included on the signature page, p. 33 of this Form
10-K)
27.1 Financial Data Schedule
99.1 Sitematic Corporation Financial Statements
- -------
+ Incorporated by reference to the same -numbered exhibit to our Registration
Statement on Form S-1, as amended, originally filed February 5, 1999,
declared effective May 7 1999 (Commission File No. 333-71893).
* Portions of these exhibits have been omitted and filed separately with the
Commission pursuant to a request for confidential treatment under Rule 406.
29
<PAGE>
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this amendment to be signed
on its behalf by the undersigned, thereunto duly authorized, on the 20th day of
December, 1999.
/s/ Samir Arora
--------------------------------------------
Samir Arora
Chairman of the Board, Chief Executive Officer,
and President (principal executive officer)
/s/ Russell Surmanek
--------------------------------------------
Russell Surmanek
Executive Vice President, Finance & Operations,
and Chief Financial Officer (principal financial officer)
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Samir Arora and Russell R. Surmanek, and each of
them, his true and lawful attorneys-in-fact, each with full power of
substitution, for him in any and all capacities, to sign any amendments to this
report on Form 10-K and to file the same, with exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
hereby ratifying and confirming all that each of said attorneys-in-fact or their
substitue or substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this amendment has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
/s/ Samir Arora
- --------------------------- Chairman of the Board, December 20, 1999
Samir Arora Chief Executive Officer,
and President
/s/ Russell F. Surmanek
- --------------------------- Executive Vice President, December 20, 1999
Russell F. Surmanek Finance & Operations, and
Chief Financial Officer
/s/ Robert G. Anderegg
- --------------------------- Director December 20, 1999
Robert G. Anderegg
/s/ Lee A. Dayton
- --------------------------- Director December 20, 1999
Lee A. Dayton
/s/ John Sculley
- --------------------------- Director December 20, 1999
John Sculley
/s/ Christopher M. Stone
- --------------------------- Director December 20, 1999
Christopher M. Stone
/s/ Michael D. Zisman
- --------------------------- Director December 20, 1999
Michael D. Zisman
30
<PAGE>
Index to Consolidated Financial Statements
Report of KPMG LLP, Independent Auditors.....................................32
Consolidated Balance Sheets as of September 30, 1999
and 1998...........................................................33
Consolidated Statement of Operations and comprehensive loss for the
years ended September 30, 1999, 1998, and 1997......................34
Consolidated Statements of Stockholders' Equity (Deficit) for
the years ended September 30, 1999, 1998 and 1997...................35
Consolidated Statements of Cash Flows for the years
ended September 30, 1999, 1998, and 1997............................36
Notes to Consolidated Financial Statements...................................37
31
<PAGE>
Independent Auditors' Report
The Board of Directors
NetObjects, Inc.:
We have audited the accompanying consolidated balance sheets of
NetObjects, Inc. and subsidiary (the Company), a majority owned subsidiary of
IBM Corporation, as of September 30, 1999 and 1998, and the related consolidated
statements of operations and comprehensive loss, stockholders' equity (deficit),
and cash flows for each of the years in the three-year period ended September
30, 1999 and Financial Statement Schedule appearing under Item 14 of Form 10-K.
In connection with our audits of the consolidated financial statements, we have
also audited the related financial statement schedule identified in Item 14 --
Exhibits, Financial Statement Schedules and Reports on Form 8-K. These
consolidated financial statements and related financial statement schedule are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements and related financial
statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
NetObjects, Inc. and subsidiary, a majority owned subsidiary of IBM Corporation,
as of September 30, 1999 and 1998, and the results of their operations and
comprehensive loss and their cash flows for each of the years in the three-year
period ended September 30, 1999, in conformity with generally accepted
accounting principles. Also in our opinion, the related financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
KPMG LLP
Mountain View, California
November 5, 1999
32
<PAGE>
<TABLE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A Majority Owned Subsidiary of IBM Corporation)
Consolidated Balance Sheets
(In thousands, except share and per share data)
<CAPTION>
September 30,
--------------------------
1999 1998
--------- ---------
Assets
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 23,623 $ 459
Short-term investments 9,331 --
Accounts receivable, net of allowances of $908 and $2,263
as of September 30, 1999 and 1998, respectively 6,065 2,292
Prepaid expenses and other current assets 1,486 754
--------- ---------
Total current assets 40,505 3,505
Property and equipment, net 2,204 1,640
--------- ---------
Total assets $ 42,709 $ 5,145
========= =========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 2,489 $ 4,723
Notes payable to IBM and IBM Credit -- 20,666
Accrued compensation 1,068 1,690
Other accrued liabilities 1,657 1,066
Deferred revenue from IBM -- 5,121
Other deferred revenue 988 169
Current portion of capital lease obligations 281 299
--------- ---------
Total current liabilities 6,483 33,734
--------- ---------
Capital lease obligations, less current portion 54 336
========= =========
Stockholders Equity (Deficit):
Convertible preferred stock, $0.01 par value, 0 and 15,783,333 shares
authorized as of September 30, 1999 and 1998, respectively. 0 and
11,576,937 shares issued and outstanding as of September 30, 1999 and 1998, respectively -- 109
Preferred stock, $0.01 par value, 6,000,000 and 0 shares authorized as of September 30,
1999 and 1998, respectively. 0 shares issued and outstanding as of September 30, 1999
and 1998
Common stock, $0.01 par value; 60,000,000 and 28,333,333 shares authorized as of
September 30, 1999 and 1998, respectively. 24,755,960 and 2,001,186 shares issued
and outstanding as of September 30, 1999 and 1998, respectively 248 20
Additional paid in capital 110,810 18,318
Notes receivable from stockholders (23) (113)
Accumulated other comprehensive income (losses) (30) --
Deferred stock-based compensation (1,205) (541)
Accumulated deficit (73,628) (46,718)
--------- ---------
Total stockholders equity (deficit) 36,172 (28,925)
--------- ---------
Total liabilities and stockholders equity (deficit) $ 42,709 $ 5,145
========= =========
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
33
<PAGE>
<TABLE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A Majority Owned Subsidiary of IBM)
Consolidated Statement of Operations and Comprehensive Loss
(In thousands, except share and per share data)
<CAPTION>
Year Ended September 30,
---------------------------------------------------------
1999 1998 1997
------------ ------------ ------------
Revenues:
<S> <C> <C> <C>
Software license fees $ 13,566 $ 9,703 $ 7,392
Service revenues 2,178 --
Software license fees from IBM 3,689 2,700 175
Service revenues from IBM 2,782 2,867 --
------------ ------------ ------------
Total revenues 22,215 15,270 7,567
------------ ------------ ------------
Cost of revenues:
Software licensefees 1,817 2,531 772
Service revenues 2,295 --
Service revenues from IBM 2,113 2,562 --
------------ ------------ ------------
Total cost of revenues 6,225 5,093 772
Gross profit 15,990 10,177 6,795
------------ ------------ ------------
Operating expenses:
Sales and marketing 18,800 17,114 12,161
Research and development 9,358 10,231 8,436
General and administrative 4,314 3,575 3,762
Stock-based compensation 559 227 --
------------ ------------ ------------
Total operating expenses 33,031 31,147 24,359
------------ ------------ ------------
Operating income (loss) (17,041) (20,970) (17,564)
Interest income (expense) (715) (1,194) (234)
Accretion of discount on debt (1,653) -- --
Interest on beneficial conversion feature of
convertible debt (7,457) -- --
------------ ------------ ------------
Income (loss) before income taxes (26,866) (22,164) (17,798)
------------ ------------ ------------
Income taxes 44 60 1
------------ ------------ ------------
Net income (loss) (26,910) (22,224) (17,799)
Translation adjustment (30) --
Comprehensive loss $ (26,940) $ (22,224) $ (17,799)
============ ============ ============
Basic and diluted net income (loss) per share $ (2.40) $ (12.26) $ (10.45)
============ ============ ============
Shares used to calculate basic and diluted net
income (loss) per share 11,215,118 1,812,484 1,702,726
============ ============ ============
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
34
<PAGE>
<TABLE>
NETOBJECTS INC.
AND SUBSIDIARY
(A Majority Owned Subsidiary of IBM)
Consolidated Statements of Stockholders' Equity
Three Years Ended September 30, 1999
(In thousands)
CAPTION>
Preferred Stock
-------------------------------------------------------------------------------------------
Series A Series B Series C Series E Series F
--------------- --------------- --------------- --------------- ---------------
Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at September 30, 1996 1,833 4,467 45
Exercise of stock options
Issuance of common stock
Repurchase of restricted stock
Warrants exercised 27 4,821 48 23
Issuance of Series E and F warrants
Conversion of Series A, B, and C
preferred stock to Series E
preferred stock (1,181) (4,494) (45) (4,821) (48) 10,495 105
Issuance of Series E preferred stock 225 2
Net loss
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Balance at September 30, 1997 652 10,743 107
Exercise of stock options
Issuance of common stock
Repurchase of restricted stock
Warrants to purchase Series F
preferred stock
Issuance of Series E preferred stock 182 2
Repayment of shareholder
notes receivable
Deferred compensation related
to stock option grants
Amortization of stock-based
compensation
Net loss
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Balance at September 30, 1998 652 10,925 109
Exercise of stock options
Issuance of common stock,
non-employee grants
ESPP
Repurchase of restricted stock
Warrants exercised 652 7
Warrants to purchase Series E
preferred stock
Issuance of in-the-money convertible
debt and warrants to purchase
Series E preferred stock
Issuance of Series F preferred stock,
net of $30 in issuance costs 389 4
Issuance of Series E preferred stock,
net of $67 in issuance costs 82 1
Cashless exercise of C warrants
Issuance of common stock at IPO,
net of $7,076 in issuance costs
Conversion of Series A, C, E, and F
preferred to common (652) (652) (7) (11,007) (110) (389) (4)
Issuance of common stock for
Series A, C, E and F preferred
Convertible debt and interest
converted to common stock
Repayment of shareholder
notes receivable
Deferred compensation related
to stock option grants
Amortization of stock-based
compensation
Translation adjustment
Net loss
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Balance at September 30, 1999 -- -- -- -- -- -- -- -- -- --
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
Preferred Stock Common Stock
--------------- --------------- Additional
Paid-in
Shares Amount Shares Amount Capital
------ ------ ------ ------ -------
Balance at September 30, 1996 6,300 45 1,892 19 5,417
Exercise of stock options -- -- 127 1 15
Issuance of common stock -- -- 2 -- 1
Repurchase of restricted stock -- -- (164) (2) (18)
Warrants exercised 4,871 48 8,400
Issuance of Series E and F warrants -- -- 298
Conversion of Series A, B, and C
preferred stock to Series E
preferred stock (1) 12 (12)
Issuance of Series E preferred stock 225 2 1,498
Net loss
------ ------ ------ ------ -------
Balance at September 30, 1997 11,395 107 1,857 18 15,599
Exercise of stock options 144 2 89
Issuance of common stock 18 116
Repurchase of restricted stock (18) (2)
Warrants to purchase Series F
preferred stock 535
Issuance of Series E preferred stock 182 2 1,213
Repayment of stockholder
notes receivable
Deferred compensation related
to stock option grants 768
Amortization of stock-based
compensation
Net loss
------ ------ ------ ------ -------
Balance at September 30, 1998 11,577 109 2,001 20 18,318
Exercise of stock options 541 5 588
Issuance of common stock,
non-employee grants 33 316
Issuance of common stock
pursuant to ESPP 13 76
Repurchase of restricted stock (30) (6)
Warrants exercised 652 7 1,181
Warrants to purchase Series E
preferred stock 120
Discount on issuance of
in-the-money convertible
debt and warrants to purchase
Series E preferred stock 8,776
Issuance of Series F preferred stock,
net of $30 in issuance costs 389 4 3,466
Issuance of Series E preferred stock,
net of $67 in issuance costs 82 1 482
Cashless exercise of C warrants
for common stock 1,356 14 14
Issuance of common stock at IPO,
net of $7,076 in issuance costs 6,000 60 64,862
Conversion of Series A, C, E, and F
preferred to common (12,700) (121) 12,700 127 (6)
Convertible debt and interest
converted to common stock 2,142 22 11,428
Repayment of stockholder
notes receivable
Deferred compensation related
to stock option grants 1,223
Amortization of stock-based
compensation
Translation adjustment
Net loss
------ ------ ------ ------ -------
Balance at September 30, 1999 -- -- 24,756 248 110,810
====== ====== ====== ====== =======
Total
Deferred Notes Accumulated Stock-
Stock- Receivable Other holders'
Based from Comprehensive Accumulated Equity
Compensation Stockholders Loss Deficit (Deficit)
------------ ------------ ------ ------- ---------
Balance at September 30, 1996 (143) -- (6,695) (1,357)
Exercise of stock options 16
Issuance of common stock 1
Repurchase of restricted stock (20)
Warrants exercised 8,448
Issuance of Series E and F warrants 298
Conversion of Series A, B, and C
preferred stock to Series E
preferred stock --
Issuance of Series E preferred stock 1,500
Net loss (17,799) (17,799)
------------ ------------ ------ ------- ---------
Balance at September 30, 1997 (143) -- (24,494) (8,913)
Exercise of stock options 91
Issuance of common stock 116
Repurchase of restricted stock (2)
Warrants to purchase Series F
preferred stock 535
Issuance of Series E preferred stock 1,215
Repayment of stockholder
notes receivable 30 30
Deferred compensation related
to stock option grants (768) --
Amortization of stock-based
compensation 227 227
Net loss (22,224) (22,224)
------------ ------------ ------ ------- ---------
Balance at September 30, 1998 (541) (113) -- (46,718) (28,925)
Exercise of stock options 593
Issuance of common stock,
non-employee grants 316
Issuance of common stock
pursuant to ESPP 76
Repurchase of restricted stock (6)
Warrants exercised 1,188
Warrants to purchase Series E
preferred stock 120
Discount on issuance of
in-the-money convertible
debt and warrants to purchase
Series E preferred stock 8,776
Issuance of Series F preferred stock,
net of $30 in issuance costs 3,470
Issuance of Series E preferred stock,
net of $67 in issuance costs 483
Cashless exercise of C warrants
for common stock --
Issuance of common stock at IPO,
net of $7,076 in issuance costs 64,922
Conversion of Series A, C, E, and F
preferred to common ( --
Convertible debt and interest
converted to common stock 11,450
Repayment of stockholder
notes receivable 90 90
Deferred compensation related
to stock option grants (1,223) --
Amortization of stock-based
compensation 559 559
Translation adjustment (30) (30)
Net loss (26,910) (26,910)
------------ ------------ ------ ------- ---------
Balance at September 30, 1999 (1,205) (23) (30) (73,628) 36,172
============ ============ ====== ======= =========
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
35
<PAGE>
<TABLE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A Majority Owned Subsidiary of IBM)
Consolidated Statements of Cash Flows
(In thousands)
<CAPTION>
Year ended September 30,
------------------------
-------- -------- ---------
1999 1998 1997
-------- -------- ---------
<S> <C> <C> <C>
Cash used in operating activities:
Net loss $(26,940) $(22,224) $ (17,799)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 1,119 1,104 697
Accretion of discount on borrowings 1,653 201 --
Nonrecurring interest charge on beneficial conversion
feature of convertible debt 7,457 -- --
Amortization of deferred stock-based compensation 559 227 --
Changes in operating assets and liabilities:
Accounts receivable (3,772) (275) (2,018)
Prepaid expenses and other current assets (234) (306) 27
Accounts payable (1,919) 2,205 721
Accrued compensation (622) 649 699
Other accrued liabilities 810 382 685
Deferred revenue (4,301) (999) 6,186
Interest payable 321 -- --
-------- -------- ---------
Net cash used in operating activities (25,869) (19,036) (10,802)
Cash used in investing activities:
Purchases of property and equipment (1,684) (792) (1,028)
Bridge loan to Sitematic Corporation (500) -- --
Purchases of short-term investments (16,000) -- --
Maturities of short-term investments 6,669 -- --
-------- -------- ---------
Net cash used in investing activities (11,515) (792) (1,028)
Cash used in financing activities:
Proceeds from short-term borrowings 3,421 21,000 1,050
Repayments of short-term borrowings (24,421) (2,050) --
Proceeds from convertible debt 12,910 -- --
Repayment of convertible debt (2,000) -- --
Payment on capital lease obligations (298) (300) (252)
Proceeds from issuance of preferred stock, net of
issuance costs 5,262 1,215 10,246
Proceeds from issuance of common stock, net of
issuance costs 65,584 91 17
Repurchases of common stock -- (2) (20)
Repayment of stockholder notes receivable 90 30 --
-------- -------- ---------
Net cash provided by financing activities 60,548 19,984 11,041
Net increase (decrease) in cash 23,164 156 (789)
Cash and cash equivalents at beginning of period 459 303 1,092
-------- -------- ---------
Cash and cash equivalents at end of period $ 23,623 $ 459 $ 303
======== ======== ========
Supplemental disclosures of cash flow information:
Interest paid $ 1,471 $ 753 $ 293
Noncash investing and financing activities:
Equipment recorded under capital leases $ 335 $ 634 $ 934
Deferred stock-based compensation $ 1,223 $ 768 $ --
Discount on borrowings $ 1,653 $ 535 $ 298
Stock issued in exchange for services $ 316 $ -- $ --
Common stock issued in exchange for note receivable $ -- $ 116 $ --
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
36
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A Majority Owned Subsidiary of IBM)
Notes to Consolidated Financial Statements
(in thousands, except share and per share data)
1. Description of the Business
The Company was incorporated in Delaware on November 21, 1995 and
became a majority-owned subsidiary of IBM on April 11, 1997. The transaction did
not result in a new accounting basis for financial reporting purposes of the
Company. In fiscal 1998, the Company changed its fiscal year end from September
30 to the Saturday nearest September 30. For presentation purposes, the
consolidated financial statements and notes refer to the calendar month end.
On May 7, 1999, the Company completed its initial public offering. At
that time, all series of convertible preferred shares outstanding were converted
to common stock.
NetObjects provides software and solutions that enable small businesses
and large enterprises to build, deploy and maintain Internet and intranet web
sites and applications.
2. Summary of Significant Accounting Policies
The accompanying consolidated financial statements of NetObjects, Inc.
and subsidiary (a majority owned subsidiary of IBM) ("the Company" or
"NetObjects") have been prepared in accordance with generally accepted
accounting principles. Certain 1998 amounts have been reclassified to conform to
the 1999 basis of presentation.
Consolidation Principles
The accompanying consolidated accounts and financial statements include
the accounts of the Company and its wholly-owned subsidiary, NetObjects, Ltd.
All intercompany transactions have been eliminated in consolidation.
Estimates and Assumptions
In preparing these financial statements, management has made estimates
and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses and disclosures of contingent assets and liabilities at
the date of the financial statements. Actual results may differ from these
estimates.
Foreign Currency Translation
The functional currency of the Company's foreign subsidiary is its
local currency. Adjustments arising from the translation of the subsidiary
financial statements are reflected as a separate component of stockholder's
equity. Foreign currency transaction gains and losses are included in the
consolidated statements of operations.
Revenue Recognition
The Company recognizes revenue in accordance with American Institute of
Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2, Software
Revenue Recognition.
Through September 30, 1998, the Company recognized revenue in
accordance with American Institute of Certified Public Accountants (AICPA)
Statement of Position (SOP) 91-1, Software Revenue Recognition. Software license
fees were generally recognized upon delivery to distributors, net of an
allowance for estimated returns, price protection and rebates, provided no
significant obligations of the Company remained and collection for the resulting
receivable was probable.
37
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A Majority Owned Subsidiary of IBM)
Notes to Consolidated Financial Statements
Under SOP 97-2, which was adopted by the Company in fiscal 1999,
software license revenue is recognized upon delivery of the software, when
persuasive evidence of an agreement exists, and provided the fee is fixed,
determinable, and collectible, and the arrangement does not involve significant
customization of the software. Maintenance and service revenue are recognized on
a straight-line basis over the term of the maintenance agreement. In addition,
SOP 97-2 generally requires revenue earned on software arrangements involving
multiple elements to be allocated to each element based on the relative fair
values of the elements.
The fair value of an element must be based on evidence that is specific
to the vendor. If a vendor does not have evidence of the fair value for all
elements in a multiple-element arrangement, all revenue from the arrangement is
deferred until such evidence exists or until all elements are delivered.
Software license fees are generally recognized upon delivery to
distributors, net of an allowance for estimated returns, price protection and
rebates, provided no significant obligations of the Company remained and
collection for the resulting receivable was probable. The Company receives
inventory on hand and sales information from its significant distributors on a
periodic basis. The allowance for returns and price protection is determined
based on a comparison of inventory on hand in the distribution channel to
historical sales made by the distributors to their respective customers. This
analysis is performed on a product line basis to estimate potential excess
inventory in the distribution channel. The allowance for rebates is based upon
contractual rebate rates certain distributors earn upon selling products to
their respective customers. Software license fees earned from products bundled
with original equipment manufacturer's (OEM) products are recognized upon the
OEM shipping bundled products to its customer. IBM and Lotus are considered OEMs
for purposes of this accounting policy. See Note 8 for a discussion of software
license fees from IBM.
Service revenue from maintenance agreements for support and upgrades
of existing products are deferred and recognized ratably over the term of the
contract, which typically is 12 months. Service revenue for training and
consulting services are recognized as the services are performed. See Note 8 for
a discussion of service revenue from IBM.
In December 1998, AcSEC issued SOP 98-9 Software Revenue Recognition,
with Respect to Certain Arrangements, which requires recognition of revenue
using the "residual method" in a multiple element arrangement when fair value
does not exist for one or more of the delivered elements in the arrangement.
Under the "residual method", the total fair value of the undelivered elements is
deferred and subsequently recognized in accordance with SOP 97-2. The Company
will adopt SOP 98-9 in fiscal 2000 and does not expect that its adoption will
have a significant impact on the Company's results of operations.
Stock-Based Compensation
The Company accounts for its stock-based compensation plans using the
intrinsic value method. Deferred stock-based compensation expense is recorded
if, on the date of the grant, the current market value of the underlying stock
exceeds the exercise price. The Company amortizes deferred stock-based
compensation in accordance with FASB Interpretation 28.
Net Loss Per Share
Basic net loss per share is computed using the weighted-average number
of outstanding shares of common stock, excluding shares of common stock subject
to repurchase. Diluted net loss per share is computed using the weighted-average
number of shares of common stock outstanding and, when dilutive, potential
common shares from stock subject to repurchase, options and warrants to purchase
common stock using the treasury stock method and from convertible securities
using the "as if-converted" basis. All potential common shares have been
excluded from the computation of diluted net loss per share for all periods
presented because the effect would have been antidilutive. To date, the Company
has not had any issuances or grants for nominal consideration.
38
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A Majority Owned Subsidiary of IBM)
Notes to Consolidated Financial Statements
Diluted net loss per share for the year ended September 30, 1999, does
not include the effect of approximately 3,045,869 stock options with a
weighted-average exercise price of $4.42 per share, 4,614,550 common stock
warrants with a weighted-average exercise price of $7.49 per share, or 37,594
shares of common stock issued and subject to repurchase at a weighted-average
exercise price of $0.12, because their effects are antidilutive.
Diluted net loss per share for the year ended September 30, 1998, does
not include the effect of approximately 11,576,937 (on an "as if-converted"
basis) shares of convertible preferred stock outstanding, 2,466,694 stock
options with a weighted-average exercise price of $1.32 per share, 6,650,006
preferred stock warrants with a weighted-average exercise price of $5.60 per
share, or 88,177 shares of common stock issued and subject to repurchase at a
weighted-average exercise price of $0.12, because their effects are
antidilutive.
Diluted net loss per share for the year ended September 30, 1997, does
not include the effect of approximately 11,394,965 (on an "as if-converted"
basis) shares of convertible preferred stock outstanding, 2,517,670 stock
options with a weighted-average exercise price of $1.20 per share, 6,650,006
preferred stock warrants with a weighted-average exercise price of $5.60 per
share, or 134,524 shares of common stock issued and subject to repurchase at a
weighted-average exercise price of $0.12, because their effects are
antidilutive.
Property and Equipment
Fixed assets are stated at cost and depreciated over the useful life of
the related asset on a straight-line basis. Leasehold improvements and assets
recorded under capital leases are amortized on a straight-line basis over the
lesser of the related asset's estimated useful life or the remaining lease term.
The Company evaluates long-lived assets for impairment whenever events
or changes in circumstances indicate that the carrying value of an asset may not
be recoverable. If such assets are considered to be impaired, the impairment to
be recognized is measured as the difference between the carrying amount of the
asset and its fair value. To date, the Company has made no adjustments to the
carrying values of its long-lived assets.
Research and Development
Research and development costs are expensed as incurred up to the point
that technological feasibility is established. To date, the Company has not
capitalized any software development costs as software development has been
completed concurrent with the establishment of technological feasibility.
Accumulated Other Comprehensive Losses
Other comprehensive income refers to revenues, expenses, gains and
losses that under generally accepted accounting principles are included in
comprehensive income but excluded from net income. To date, accumulated other
comprehensive losses have consisted entirely of foreign currency translation
adjustments. The tax effects of translation adjustments were not significant.
39
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A Majority Owned Subsidiary of IBM)
Notes to Consolidated Financial Statements
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards 133 (SFAS 133), Accounting for
Derivative Instruments and Hedging Activities, which establishes accounting and
reporting standards for derivative instruments and hedging activities. SFAS 133
is effective as of the beginning of the first quarter of the fiscal year
beginning after June 16, 2000. The Company is determining the effect of SFAS 133
on its financial statements.
In February 1998, the Accounting Standards Executive Committee (AcSEC)
issued Statement of Position (SOP) 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. SOP 98-1 provides guidelines to
assist management in determining when software products developed or purchased
for internal use should be expensed or capitalized. The Company does not expect
SOP 98-1 to have a material effect on its financial condition or results of
operations.
Income Taxes
Income taxes are recorded using the asset and liability method. The
Company's tax provision for all years has been calculated on a stand-alone
basis. Deferred tax liabilities and assets are recognized for the expected
future tax consequences attributable to differences between the carrying amounts
and the tax bases of assets and liabilities. 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. A valuation allowance is recorded to reduce deferred tax assets to an
amount whose realization is more likely than not. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
Cash, cash equivalents and short-term investments
The Company considers cash held in checking accounts and highly liquid
investments held in money-market funds and certificates of deposit with
maturities of 90 days or less at the date of purchase to be cash equivalents.
Short-term investments consisting of high-quality commercial paper
having maturities of 90 to 180 days at September 30, 1999, were classified as
held to maturity, and measured at amortized cost. The Company does not hold
equity securities for investment purposes.
Concentration of Credit Risk
Accounts receivable potentially subject the Company to concentrations
of credit risk. The Company evaluates its customer's financial condition, prior
to extending terms, performs ongoing credit evaluations of its customers and
generally does not require collateral for accounts receivable. As necessary, the
Company maintains an allowance for doubtful accounts and to date the use of such
allowances has been within management estimates.
For the year ended September 30, 1999, software license fees and
service revenue from IBM represented approximately 29% of total revenues, while
three other customers accounted for approximately 24% of total revenues. No
other customer accounts for more than 5% of total revenues.
For the year ended September 30, 1998, software license fees and
service revenue from IBM represented approximately 36% of total revenues. Sales
to one other customer accounted for 29% of total revenues.
The Company's principal markets are North America, Europe and Japan.
International sales represented approximately 23%, 16% and 15% of revenues for
the fiscal years ended September 30, 1999, 1998 and 1997.
40
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A Majority Owned Subsidiary of IBM)
Notes to Consolidated Financial Statements
Fair Value of Financial Instruments
SFAS No. 107, Disclosures About Fair Value of Financial Instruments,
requires that fair values be disclosed for most of the Company's financial
instruments. The carrying amounts of cash and cash equivalents, short term
investments, account receivable, accounts payable, accrued compensation, other
accrued liabilities, and notes payable approximate fair value because of the
short maturity of these instruments.
Advertising Expense
The cost of advertising is expensed as incurred and included in selling
and marketing expenses. For the years ended September 30, 1999, 1998 and 1997,
those expenses totaled approximately $7.2 million, $5.8 million, and $4.9
million, respectively.
Employee Benefits Plan
The Company has established a qualified savings plan for employees
under Section 401(k) of the Internal Revenue Service Code, in which employees
may defer as much as 15% of their pretax annual salary up to the statutory
limits. The Company does not contribute to the Benefit Plan.
3. Property and Equipment
Property and equipment consisted of the following (in thousands):
September 30,
------------------
1999 1998
------- -------
Computer equipment and software $ 2,963 $ 2,166
Fulrniture and equipment 651 559
Leasehold improvements 1,589 795
------- -------
5,203 3,520
Less: accumulated depreciation and amortization (2,999) (1,880
------- -------
Total property and equipment $ 2,204 $ 1,640
======= =======
Equipment recorded under capital leases is $1.2 million and the related
accumulated amortization is approximately $912 thousand as of September 30,
1999.
4. Stockholder's Equity (Deficit)
Capital stock
On March 14, 1997, the Company issued warrants to purchase 274,604,
105,511, 73,190, 109,783, 188,636, 13,581 and 10,551 shares of Series F
preferred stock, originally classified as Series D preferred stock,
respectively, at a purchase price of $10.80 per share, to Perseus U.S.
Investors, L.L.C., Rae Technology, LLC, Venrock Associates, L.P., Venrock
Associates II, L.P., Norwest Equity Partners V, John Sculley and Studio
Archetype, respectively. On December 23, 1997, the Company issued a warrant to
purchase 83,333 shares of Series F preferred stock, at a purchase price of
$10.80 per share, to IBM Credit Corp. These warrants are exercisable for three
years from the date of issuance. At the closing of the Company's initial public
offering (IPO), these warrants became exercisable for common stock. The holders
of the warrants may surrender them on a cashless exercise basis by surrendering
shares of common stock as payment of the exercise price.
In connection with IBM's acquisition of approximately 80% of our stock on April
11, 1997, the Company issued a warrant to IBM to purchase up to 3,482,838 shares
of Series E preferred stock at an exercise price of approximately $6.68 per
share. This warrant expires on April 11, 2000 and became exercisable for common
stock at the closing of the IPO.
41
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A Majority Owned Subsidiary of IBM)
Notes to Consolidated Financial Statements
On October 8, 1998, the Company entered into Convertible Note and
Warrant Purchase Agreements with IBM and Perseus Capital LLC. Principal and
accrued interest on these notes was converted into Series E-2 preferred stock at
$5.35 per share upon the completion of the Company's initial public offering
(IPO). The Company recorded a $7.5 million nonrecurring interest charge in
fiscal 1999 to account for the "in-the-money" conversion right of the
convertible notes. These notes totaling $10.9 million were converted
automatically into 2,141,713 shares of common stock at the IPO.
In connection with the Convertible Note and Warrant Purchase
Agreement, the Company issued warrants to acquire 163,715 shares of Series E-2
preferred stock at an exercise price of $6.68 per share. The Company determined
the fair value of these warrants at the date of grant using the Black-Scholes
pricing model with the following assumptions: a risk-free interest rate of 6%;
an expected life of five years; volatility of 65%; and no dividend yield. The
resulting interest expense of $887,000, which appears on our statement of
operations as a portion of the accretion of discount on debt, was fully
amortized during the year ended September 30, 1999. The warrants remain
outstanding and are exercisable for shares of common stock at any time before
October, 2003.
On October 16, 1998, NetObjects entered into a Stock Purchase
Agreement with Novell authorizing the sale and issuance of 333,333 shares of
Series F-2 preferred stock at a purchase price of $9.00 per share for an
aggregate price of $3 million. The transaction closed on October 26, 1998. At
that time, Novell received a warrant to purchase an additional 16,666 shares of
Series F-2 preferred stock at $9.00 per share. The warrant was exercisable only
if the Company did not complete an initial public offering with aggregate
proceeds of more than $30 million by December 31, 2000 and it expired
unexercised.
On October 28, 1998, NetObjects entered into a Stock Purchase Agreement
with MC Silicon Valley, a subsidiary of Mitsubishi, authorizing the sale and
issuance of 55,555 shares of Series F-2 preferred stock at a purchase price of
$9.00 per share, for an aggregate price of $500,000. The transaction closed on
November 10, 1998. At the time of the IPO, these share of Series F-2 preferred
stock were converted into common stock.
In connection with notes issued to IBM, the Company issued warrants to
acquire 51,335 shares of Series E-2 preferred stock at an exercise price of
$6.68 per share. The Company determined the fair value of these warrants at the
date of grant using the Black-Scholes pricing model. The resulting discount of
$432,000 was accounted for as additional paid-in capital and was fully amortized
in fiscal 1999. The warrants are exercisable for common stock at any time before
February, 2004.
In May 1999, the Company sold 6,000,000 shares of its common stock
through its IPO. Net proceeds from the offering were approximately $65 million
after deducting the underwriting discount and other offering expenses. At the
time of the IPO, all of the Company's then authorized shares of preferred stock
were eliminated and all outstanding shares of preferred stock and convertible
debt automatically converted into 14,056,093 and 2,141,713 shares of common
stock, respectively. All outstanding warrants that were not exercised upon the
IPO became warrants to purchase common stock.
In the fiscal year ended September 30, 1999, the Company issued common
stock with a fair value of approximately $316,000 to various vendors in exchange
for services.
Stock split
On February 4, 1999, the board of directors authorized a
recapitalization of the Company's equity structure, including changes in par
value, the number of shares authorized and a 1-for-6 reverse split of all the
outstanding shares of the Company's preferred and common stock. The reverse
stock split took effect upon the closing of IPO. All share and per share amounts
have been restated to reflect the reverse stock split for all periods presented.
42
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A Majority Owned Subsidiary of IBM)
Notes to Consolidated Financial Statements
Stock option plans
The Company's 1997 Stock Option Plan provides for the issuance of
incentive stock options under the Internal Revenue Code of 1986 and for the
issuance of nonqualified stock options to purchase common stock to employees,
non-employee directors or consultants at prices not less than 85% of the fair
market value at the date of grant. A total of 2,158,943 shares of common stock
have been authorized for issuance under the 1997 Plan. The board of directors,
or the compensation committee of the board of directors, determines the fair
market value of the common stock. Options currently, outstanding generally vest
25% at the end of the first year and then monthly on a pro rata basis over the
next three years. Options expire ten years from the date of grant.
In connection with IBM's acquisition of approximately 80% of our
outstanding stock in April 1997, the 1996 Stock Option Plan was cancelled and
all options issued under that plan were reissued under the 1997 Plan. Under the
1996 Stock Option Plan, optionees had the right to exercise unvested options,
subject to the Company's right to repurchase unvested shares held at the time of
termination of employment. That right was carried over to the 1997 Plan for
optionees who held options under the 1996 Stock Option Plan that were reissued
under the 1997 Plan, but does not apply to new options granted since April 11,
1997 under the 1997 Plan. At September 30, 1999, 37,594 shares of common stock
were subject to our right of repurchase, and 1,631,079 shares of common stock
were available for future option grants, under the 1997 Plan.
In March 1997, the board of directors adopted, and in April 1997, the
stockholders approved, the 1997 Special Stock Option Plan. A total of 1,041,056
shares of common stock were authorized for issuance under the plan. On March 18,
1997, the board of directors authorized the grant of options for the purchase of
all shares of common stock authorized for issuance under the plan to 35 key
employees. The options granted under the plan generally vest 25% at the end of
the first year and then monthly on a pro rata basis over the next three years.
The board of directors does not intend to grant any more options under this
stock option plan.
In connection with options granted in fiscal year 1999 and 1998, the
Company has recorded deferred stock-based compensation of $1,223,000 and
$768,000, respectively, representing the difference between the exercise price
and the fair value of the Company's common stock at the date of grant.
Amortization of deferred stock-based compensation of $559,000 and $227,000 was
recognized during the fiscal years ended September 30, 1999 and 1998,
respectively.
<TABLE>
The Company's stock option plans and related activity are summarized in the table below:
<CAPTION>
Year ended Year ended Year ended
September 30, 1999 September 30, 1998 September 30, 1997
------------------------------- ------------------------- ------------------------
Weighted Weighted Weighted
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
Options Price Options Price Options Price
--------- --------- --------- -------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of
period 2,466,694 $ 1.32 2,517,670 $ 1.20 758,051 $ 0.12
Granted at market value 848,180 $ 7.28 173,362 $ 2.10 2,251,557 $ 1.05
Granted at less than market value 939,361 $ 7.47 167,940 $ 2.10 -- --
Exercised (541,498) $ 1.09 (144,410) $ 0.60 (126,353) $ 0.12
Canceled (666,868) $ 3.70 (247,768) $ 1.26 (365,585) $ 0.48
--------- --------- ---------
Outstanding at end of period 3,045,869 $ 4.42 2,466,694 $ 1.32 2,517,670 $ 1.20
========= ========= =========
Vested at period end 973,735 852,158 128,388 --
========= ========= =========
Weighted-average fair value
of options granted
during the period with
exercise prices equal to
market value at date of grant $ 5.41 $ 0.66 $ 1.08
Weighted-average fair value
of options granted
during the period with
exercise prices less than
market value at date of grant $ 5.65 $ 0.69 $ --
</TABLE>
43
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A Majority Owned Subsidiary of IBM)
Notes to Consolidated Financial Statements
The following table summarizes outstanding and exercisable options at September
30, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------------------------- ------------------------------
Range of Weighted average Weighted Weighted
of exercise Number contractual life average Number average
prices Outstanding remaining (In years) exercise price Exercisable exercise price
---------- ----------- -------------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
0.12 166,293 7.55 0.12 125,091 0.12
0.30 - 0.60 94,668 7.54 0.81 46,336 0.39
1.50 - 2.10 1,236,547 7.66 1.61 728,890 1.58
5.31 - 6.91 456,693 9.86 6.02 5,334 6.09
7.06 - 7.94 844,489 9.43 7.51 48,898 7.53
8.06-12.00 247,179 9.67 9.55 20,834 9.87
--------- ---- ---- ------- ----
3,045,869 8.64 4.44 975,383 1.83
========= ==== ==== ======= ====
</TABLE>
Employee stock purchase plan.
The Company's board of directors approved the 1999 Employee Stock
Purchase Plan (ESPP), which became effective on May 28, 1999, and 300,000 shares
were reserved under the plan.
The ESPP permits an eligible employee to purchase common stock, in an
amount which may not exceed 10% of his or her compensation, at a price equal to
85% of the lesser of the fair market value of the common stock at the beginning
of the offering period and the fair market value of the common stock at the end
of each purchase period.
During the first offering period of the ESPP, which concluded on July
31, 1999, 12,983 shares were purchased at $5.87 per share. The weighted average
fair market value of the stock purchase rights granted during fiscal 1999 was
$2.20.
Stock compensation
The Company accounts for stock-based compensation using the intrinsic
method. Had compensation expense for the Company's stock compensation plans been
determined using the fair-value method, as described by SFAS 123, Accounting for
Stock-Based Compensation, pro forma losses for 1999, 1998 and 1997 would have
been as follows (in thousands, except per share amounts):
Year ended September 30,
------------------------
1999 1998 1997
---- ---- ----
Net income (loss)
As reported $ (26,940) $ (22,224) $ (17,799)
Pro forma (28,011) (22,417) (17,851)
Net income (loss) per share -
basic and diluted
As reported (2.40) (12.26) (10.45)
Pro forma (2.50) (12.37) (10.48)
----------- ---------- ----------
Weighted average common
shares outstanding 11,215,118 1,812,484 1,702,726
=========== ========== ==========
For the fiscal year ended September 30, 1999 fair value was determined
for all of the Company's stock-based compensation plans using the Black-Scholes
option pricing method with the following weighted-average assumptions: an
expected life of two years, a risk-free interest rate of 5.875%, expected
volatility of 0.85 and no dividend yield. Expected volatility was calculated
using an average of NetObjects share price volatility and the share price
volatility of similar companies.
For the fiscal years ended September 30, 1998 and 1997, the fair value
of each option granted was estimated using the minimum value method on the date
of grant, assuming a risk-free interest rate of 6.5%, an expected life of four
years, and no dividend yield.
44
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A Majority Owned Subsidiary of IBM)
Notes to Consolidated Financial Statements
5. Income Taxes
The Company's deferred tax assets are as follows (in thousands):
Year ended September 30,
------------------------
1999 1998
---- ----
Net operating loss carryforwards $ 29,821 $ 17,506
Research and development credit carryforwards 1,811 1,649
Accruals and reserves not currently deductible 1,059 1,767
Depreciation on property and equipment 739 488
---------------- --------------
Gross deferred tax assets 33,430 21,410
---------------- --------------
Valuation allowance (33,430) (21,410)
---------------- --------------
Net deferred tax assets $ --- $ ---
================ ==============
The Company has recorded a valuation allowance on its deferred tax
assets due to uncertainty of future realization of such amounts. The valuation
allowance increased by approximately $12.0 million from fiscal 1998 to fiscal
1999, and by $10.8 million from fiscal 1997 to fiscal 1998.
As of September 30, 1999, the Company had net operating loss
carryforwards of $70.2 million and $67.3 million for federal and state income
tax purposes, respectively. The federal tax loss carryforwards expire in years
2012 through 2020, while the state tax loss carryforwards expire in the year
2005. As of September 30, 1999 the Company has research and development credit
carryforwards for federal and state tax purposes of approximately $1,041,000 and
$770,000 respectively. The federal research and development credit carryforwards
expire in the years 2012 through 2020. The state research and development
credits can be carried forward indefinitely.
The Tax Reform Act of 1986 and the California Tax Conformity Act of
1987 limit the use of net operating loss carryforwards in certain situations
where changes occur in the stock ownership of a company. The Company had such an
ownership change, as defined, in April 1997. Accordingly, $11.5 million of the
Company's federal and state net operating loss carryforwards are limited in
their annual usage to $3.9 million per year on a cumulative basis.
45
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A Majority Owned Subsidiary of IBM)
Notes to Consolidated Financial Statements
The Company's actual tax expense for the years ended September 30,
1999, 1998, and 1997 differs from the benefit at the federal statutory tax rate
of 34%, as follows (in thousands):
Year ended September 30,
------------------------
1999 1998 1997
---- ---- ----
Statutory federal income tax
benefit $(9,243) $ (7,556) $ (6,051)
Losses not benefited 9,243 7,556 6,051
State taxes 1 1 1
Foreign taxes 43 59 ---
------------ ------------- ------------
$ 44 $ 60 $ 1
============ ============= ============
The components of income taxes for the years ended September 30, 1999,
1998, and 1997 are as follows (in thousands):
Year ended September 30,
------------------------
1999 1998 1997
---- ---- ----
Current:
Foreign $ 43 $ 59 $ ---
State 1 1 1
------------ ------------ ----------
Total $ 44 $ 60 $ 1
============ ============ ==========
6. Commitments
Operating leases
Total rental expense for operating leases was approximately $686,000,
$683,000, and $341,000 for the years ended September 30, 1999, 1998 and 1997,
respectively. Future minimum rental payments under noncancellable leases are
approximately $893,000 $884,000, and $869,000 for the years ended September 30,
2000, 2001, and 2002, respectively. As of September 30, 1999, approximately
$360,000 of the Company's cash balance is pledged as security for a lease line
for furniture and fixtures.
7. Segment Information
The Company conducts its business in two distinct segments: Enterprise
and Small Business Online. The principal product of the Enterprise segment is
NetObjects Authoring Server, which is targeted toward the large business
intranet market. The principal product of the Small Business and Online segment
is NetObjects Fusion, which is targeted to small businesses that would like to
establish a website or upgrade an existing site. The Company uses a direct sales
force to distribute NetObjects Authoring Server domestically and through
resellers in international markets. The Company distributes NetObjects Fusion
through resellers, distributors, and a dedicated website.
46
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A Majority Owned Subsidiary of IBM)
The Company's Chief Operating Decision Maker (CODM) is the Chief
Executive Officer. During fiscal 1999, the CODM received only revenue
information on a disaggregated basis for the Company's two segments. All other
operating information was prepared on a basis consistent with the consolidated
statement of operations.
Revenue information for the Company's two segments is as follows:
Small Business
and Online Enterprise Total NetObjects
--------- ---------- ----------------
Revenues:
Domestic license 10,600 2,200 12,800
International license 4,400 -- 4,400
Domestic service -- 1,500 1,500
International service -- 700 700
IBM service 2,800 -- 2,800
------ ----- ------
Total Revenue 17,800 4,400 22,200
====== ===== ======
In the Small Business and Online segment, $3.7 million in software
license fees from IBM for the year ended September 30, 1999 represented the only
significant customer concentration. This compares to $2.7 million from IBM for
the year ended September 30, 1998, when the Company operated in a single
segment. There were no significant customer concentrations in the Enterprise
segment. The accounting policies of each segment are the same as those described
in the summary of significant accounting policies.
License fees for the Small Business Online segment were concentrated
in the United States and Europe, representing approximately $13.4 million and
$4.4 million, respectively. License fees for the Enterprise segment were
concentrated in the United States and Europe, representing approximately $3.7
million and $0.7 million, respectively.
The Company did not begin licensing NetObjects Authoring Server until
September 1998 and did not begin operating in two segments until the end of
fiscal 1999. As a result, a comparison with previous fiscal years would not be
meaningful.
Substantially all of the Company's assets are located within the United
States.
8. IBM Relationship
Sales and Service Agreements with IBM
The Company entered into a Master License Agreement with IBM in 1997
that was subsequently amended. The salient terms of the agreement were as
follows:
o IBM could sublicense the Company's software products in exchange for
per unit royalty payments.
o IBM was to make prepaid royalty payments of $1.5 million on a quarterly
basis beginning April 1, 1997 and ending October 1, 1998. However, the
Company could and did request that these prepayments be made in advance
of the due date. IBM made payments of $10.5 million to the Company
between April 1 and December 31, 1997, for which the Company paid
interest at the rate of 7.5% per annum.
47
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A Majority Owned Subsidiary of IBM)
Notes to Consolidated Financial Statements
o The Company agreed to integrate certain of the Company's software
products into IBM's WebSphere software products as part of a service
agreement with IBM, for which the Company was to be paid an amount not
to exceed $6.0 million.
In January 1999 the Company and IBM amended the Master License Agreement as
follows:
o Under an agreement with Lotus, a certain number of units of the
Company's products were to be bundled with Lotus products in a
promotional period that was to end September 30, 1998. The promotional
period was extended to June 30, 1999 and the maximum number of units to
be shipped under the program was increased from 200,000 to 225,000.
o The maximum amount to be paid to the Company in connection with the
services provided to IBM was reduced to approximately $5.3 million, and
the related mark-up on the services to be provided was reduced.
In March 1999 the Company and IBM amended the Master License Agreement
to establish a new special promotion program whereby Lotus will bundle certain
NetObjects products with certain Lotus products, and Lotus will pay the Company
royalties based on a percentage of Lotus' net revenue. The promotion period
began on January 1, 1999 and ends on December 31, 1999.
For the year ended September 30, 1999 and 1998, the Company recognized
license revenue from IBM of approximately $3.7 million and $2.7 million,
respectively. Service revenue from IBM for the same periods were approximately
$2.8 million and $2.9 million, respectively.
Debt and Equity Financing from IBM
IBM acquired controlling interest of NetObjects on April 11, 1997,
receiving 10,495,968 shares of Series E convertible preferred stock at $6.68 per
share. This represented about 80% of the Company's voting securities at the
time. In connection with this transaction, the Company issued a warrant to IBM
to purchase up to 3,482,838 shares of Series E convertible preferred stock at an
exercise price of approximately $6.68 per share. This warrant is currently
exercisable for common stock and expires April 11, 2000. The Series E preferred
stock issued to IBM when they acquired 80% of our voting shares was converted to
common stock at our IPO.
In December 1997, the Company obtained a line of credit from IBM
Credit Corp. that was eventually increased to a total of $19 million. The
interest rate on this line was LIBOR + 1.5%. In connection with this line, we
issued warrants to purchase 83,333 shares of Series F convertible preferred
stock at $10.80 per share to IBM Credit Corp. This note was repaid with proceeds
from our initial public offering in May 1999. The warrant is currently
exercisable for common stock and expires December 23, 2002. The Company
determined the fair value of these warrants using the Black-Scholes option
pricing model. Interest expense of $535,000, which appears on the statement of
operations as a portion of the accretion of discount on debt to IBM, has been
fully amortized as of Sept. 30, 1999.
In October 1998, the Company entered into a Convertible Note and
Warrant Purchase Agreement with IBM and Perseus Capital LLC, under which the
Company borrowed $10.9 million and issued warrants to purchase an additional
163,715 shares of Series E-2 preferred stock at $6.68 per share. These notes
totaling $10.9 million were converted automatically into 2,141,713 shares of
common stock at the IPO. The warrant is currently exercisable for common stock
and expires October 8, 2003. The preferred warrants automatically convert to
common stock upon exercise.
From February 1999 through March 1999, the Company borrowed an
additional $3.4 million from IBM at an interest rate of 10% per annum, for which
IBM received warrants to acquire 51,335 shares of Series E-2 preferred stock at
$6.68 per share. In April 1999, the Company borrowed an additional $2 million
from IBM under the Convertible Note and Warrant Purchase Agreement. The Company
repaid both notes with proceeds of its IPO. The warrant is currently exercisable
for common stock and expires February 19, 2004. The Company determined the fair
value of these warrants using the Black-Scholes option pricing model. Interest
expense of $432,000, which appears on the statement of operations as a portion
of the accretion of discount on debt, has been fully amortized as of Sept. 30,
1999.
48
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARY
(A Majority Owned Subsidiary of IBM)
Notes to Consolidated Financial Statements
As of September 30, 1999 IBM held 12,475,843 shares of the Company's
common stock and warrants to purchase an additional 3,819,365 shares of common
stock. If all outstanding warrants were exercised, IBM would own approximately
53% of the Company's common stock. All of these warrants may be exercised by
foregoing the receipt of that number of shares of common stock that would
otherwise have been issued upon exercise, equal in value to the exercise price
of all warrants exercised.
9. Other Related Party Transactions
During fiscal 1999 the Company received royalty payments of $777,000
from Novell Corporation, a stockholder of the Company.
10. Subsequent Events
On October 4, 1999, the Company acquired Sitematic Corporation, an
Application Services Provider (ASP) that offers e-business solutions for small
businesses. Under the terms of the acquisition, which will be accounted for as a
purchase, the Company exchanged approximately two million shares of common stock
for all issued and outstanding Sitematic equity.
In addition to conversion of its preferred shares to the Company's
common stock, Sitematic preferred shareholders received approximately $1.6
million for their shares. All issued and outstanding Sitematic options were
converted to options to purchase the Company's common stock.
Sitematic's operating results for the year ended September 30, 1999
included revenue of approximately $0.2 million and a net loss of approximately
$2.6 million.
Total consideration, including transaction costs of approximately $0.5
million, was $15.5 million. Allocation of the purchase price that is in excess
of Sitematic Corporation's net book value will result in the addition of about
$15.7 million in intangible assets to the Company's balance sheet, of which
about $14.1 million represents goodwill. The goodwill and intangible assets will
be amortized on a straight-line basis over 2 years.
49
NETOBJECTS, INC.
EXECUTIVE STOCK OPTION AGREEMENT
(Special Form)
Netobjects, Inc., a Delaware Corporation (The "Company"), has awarded
and hereby Grants ((Employee)) (The "Optionee"), an option (The "Option") to
purchase a total of (((Share_2))) shares of Common Stock (The "Shares") of the
Company, at the price set forth herein as an incentive to Optionee's continued
employment as a senior executive of the Company, and in all respects subject to
such continued employment and all other terms and conditions of this Agreement.
1. Nature of the Option. The Option is intended to be a "Nonstatutory
Stock Option", as defined in Section 2(N) of the Company's Amended and Restated
1997 Stock Option Plan (The "Plan").
2. Option Price. The Option Price is $((Price)) for each Share.
3. Vesting and Exercise of Option. The Option shall vest and, subject
to stockholder approval as described in Section 3(d), become exercisable during
its term in accordance with the following provisions:
(a) Vesting and Right of Exercise.
(i) The Option shall vest and become exercisable with respect
to [1/12] [1/24] of the shares at the end of each calendar month
beginning with December 1999 for a period of [12] [24] months, subject
to the Optionee's Continuous Employment by the Company or a Subsidiary
of the Company, as such terms are defined in the Plan.
(ii) In the event of the Optionee's death, disability or other
termination of employment, the Option shall be exercisable in the
manner and to the extent provided in Sections 9(d), (e) and (f) of the
Plans as if the Option had been granted under the Plan, which
provisions are incorporated into this Agreement by this reference; or,
as provided in Section 11 of this Agreement, if applicable.
(iii) The Option may not be exercised for fractional shares or
for less than one hundred (100) Shares.
(b) Method of Exercise. In order to exercise any portion of this Option
which has vested, the Optionee shall notify the Company in writing of the
election to exercise the Option and the number of shares in respect of which the
Option is being exercised, by executing and delivering the
<PAGE>
Notice of Exercise of Stock Option in the form attached as Exhibit A hereto. The
certificate or certificates representing Shares as to which this Option has been
exercised shall be registered in the name of the Optionee.
(c) Restrictions On Exercise. This Option may not be exercised if the
issuance of the Shares upon such exercise or the method of payment of
consideration for such shares would constitute a violation of any applicable
federal or state securities law or other law or regulation. Furthermore, the
method and manner of payment of the Option Price will be subject to the rules
under Part 207 OF Title 12 of the Code of Federal Regulations ("Regulation G")
as promulgated by the Federal Reserve Board if such rules apply to the Company
at the date of exercise. As a condition to the exercise of this Option, the
Company may require the Optionee to make any representation or warranty to the
Company at the time of exercise of this Option as in the opinion of legal
counsel for the Company may be required by any applicable law or regulation,
including the execution and delivery of an appropriate representation statement.
Accordingly, the stock certificates for the Shares issued upon exercise of this
Option may bear appropriate legends restricting transfer.
(d) Prior approval by stockholders. In no event may the Optionee
exercise any portion of this option before the holders of a majority of the
Corporation's outstanding shares of Common Stock have ratified the authorization
of the option by the Compensation Committee of the Board of Directors of the
Company (the "Committee") as of November 8, 1999.
4. Non-Transferability of Option. This Option may be exercised during
the lifetime of the Optionee only by the Optionee and may not be transferred in
any manner other than by will or by the laws of descent and distribution. The
terms of this Option shall be binding upon the executors, administrators, heirs
and successors of the Optionee.
5. Method of Payment. Payment of the exercise price shall be by any of
the following, or a combination thereof, at the election of the Optionee:
(a) cash;
(b) certified or bank cashier's check; or
(c) for as long as there exists a public market for the Company's
Common Stock on the date of exercise, by surrender of shares of the Company's
Common Stock, provided that if such shares were acquired upon exercise of an
incentive stock option, the Optionee must have first satisfied the holding
period requirements under Section 422(a)(1) of the Code. In this case payment
shall be made as follows:
(i) In addition to the execution and delivery of the Notice of
Exercise of Stock Option, Optionee shall deliver to the Secretary of
the Company a written notice which shall set forth the portion of the
purchase price the Optionee wishes to pay with Common Stock, and the
number of shares of such Common Stock the Optionee intends to surrender
pursuant to the exercise of this Option, which shall be determined by
dividing the aforementioned portion of the purchase price by the
average of the last reported bid and asked prices per share of Common
Stock of the Company, as reported in The Wall Street Journal (or, if
not so reported, as otherwise reported by Nasdaq or, in the event the
Common Stock is listed on a national securities exchange, or on the
Nasdaq National Market (or any successor national
-2-
<PAGE>
market system), the closing price of Common Stock of the Company on
such exchange as reported in The Wall Street Journal, for the day on
which the notice of exercise is sent or delivered);
(ii) Fractional shares shall be disregarded and the Optionee
shall pay in cash an amount equal to such fraction multiplied by the
price determined under subparagraph (i) above;
(iii) The written notice shall be accompanied by a duly
endorsed blank stock power with respect to the number of Shares set
forth in the notice, and the certificate(s) representing said Shares
shall be delivered to the Company at its principal offices within three
working days from the date of the notice of exercise;
(iv) The Optionee hereby authorizes and directs the Secretary
of the Company to transfer so many of the Shares represented by such
certificate(s) as are necessary to pay the purchase price in accordance
with the provisions herein; and
(v) Notwithstanding any other provision herein, the Optionee
shall only be permitted to pay the purchase price with Shares of the
Company's Common Stock owned by him as of the exercise date in the
manner and within the time periods allowed under 17 CFR ss.240.16b-3
promulgated under the Securities Exchange Act of 1934 as such
regulation is presently constituted, as it is amended from time to
time, and as it is interpreted now or hereafter by the Securities and
Exchange Commission.
The Optionee may elect to pay the exercise price by authorizing a third
party to sell Shares subject to the Option and remit to the Company a sufficient
portion of the sale proceeds to pay the entire exercise price and any tax
withholding resulting from such exercise.
6. Adjustments Upon Changes in Capitalization or Merger. The number of
Shares covered by this Option shall be adjusted in accordance with the
provisions of Section 10 of this Agreement in the event of changes in the
capitalization or organization of the Company, or if the Company is a party to a
merger or other corporate reorganization.
7. Term of Option. This Option may not be exercised more than ten (10)
years from the Date of Grant set forth in the signature page of this Agreement,
and may be exercised during such term only in accordance with the terms of this
Agreement.
8. Not Employment Contract. Nothing in this Agreement or in the Plan
shall confer upon the Optionee any right to continue in the employ of the
Company or shall interfere with or restrict in any way the rights of the
Company, which are hereby expressly reserved, to discharge the Optionee at any
time for any reason whatsoever, with or without cause, subject to the provisions
of applicable law.
9. Income Tax Withholding.
(a) The Optionee authorizes the Company to withhold in accordance with
applicable law from any compensation payable to him or her any taxes required to
be withheld by federal, state or local laws as a result of the exercise of this
Option.
-3-
<PAGE>
(b) Any adverse consequences incurred by an Optionee with respect to
the use of shares of Common Stock to pay any part of the Option Price or of any
tax in connection with the exercise of an Option, including, without limitation,
any adverse tax consequences arising as a result of a disqualifying disposition
within the meaning of Section 422 of the Code shall be the sole responsibility
of the Optionee.
The Optionee represents and warrants that: (i) the Optionee is familiar
with the terms and provisions of the Option Documents, and hereby accepts this
Option subject to all of the terms and provisions thereof; and (ii) the Optionee
is aware of and familiar with the provisions of the Restated Certificate of
Incorporation of the Company ("Restated Certificate"), in particular Article X
of the Restated Certificate.
10. Adjustments Upon Changes in Capitalization. Subject to any required
action by the shareholders of the Company, the number of Shares covered by this
Option, and the per share exercise price of the Option, shall be proportionately
adjusted for any increase or decrease in the number of issued shares of Common
Stock resulting from a stock split, reverse stock split, recapitalization,
combination, reclassification, the payment of a stock dividend on the Common
Stock or any other increase or decrease in the number of such shares of Common
Stock effected without receipt of consideration by the Company; provided,
however, that conversion of any convertible securities of the Company shall not
be deemed to have been "effected without receipt of consideration." Such
adjustment shall be made by the Committee, whose determination in that respect
shall be final, binding and conclusive. Except as expressly provided herein, no
issue by the Company of shares of stock of any class, or securities convertible
into shares of stock of any class, shall affect, and no adjustment by reason
thereof shall be made with respect to, the number or price of shares of Common
Stock subject to the Option.
Subject to the terms of any agreement between the Optionee and the
Company related to the Optionee's employment by the Company, the Committee may,
if it so determines in the exercise of its sole discretion, also make provision
for proportionately adjusting the number or class of securities covered by the
Option, as well as the price to be paid therefor, in the event that the Company
effects one or more reorganizations, recapitalizations, rights offerings, or
other increases or reductions of shares of its outstanding Common Stock, and in
the event of the Company being consolidated with or merged into any other
corporation.
[11. Post-acquisition Employment Termination. In the event that
Optionee's employment is terminated other than for cause within 12 months
following an acquisition of the Company, vesting of the options granted to
Optionee shall automatically accelerate to provide for vesting of 100% of the
total number of shares subject to such options as of the effective date of the
employment termination. Optionee will be considered employed under this Section
as long as Optionee has been offered employment by the Company or any
Subsidiary, or by the acquiring entity or its parent or subsidiary
organizations, except as otherwise provided below:
(i) For purposes of this Section 11, Optionee's resignation without
cause will not constitute an employment termination, and Optionee's resignation
with cause will constitute an employment termination. Optionee will be
considered to have resigned with cause only if the dollar value of the
-4-
<PAGE>
total compensation package represented by Optionee's annualized base pay,
benefits and potential bonus combined for the 12-month post-acquisition period
is less than the dollar value of the compensation package provided by the
Company (determined on the same annualized basis) prior to the acquisition,
excluding bonuses tied to stock price performance and the like.
(ii) For purposes of this Section 11, "CAUSE" shall mean where the
Company determines, in its discretion, that Optionee should be terminated for
willful beach or neglect of duty, failure or refusal to work, dishonesty,
insubordination, use of alcohol or drugs so as to interfere with his performance
of his duties, or conducting himself in a manner which a reasonable person would
believe would tend to bring the Company into disrepute or to adversely affect
its business. "Cause" also includes Optionee's resignation as an employee of the
Company without cause, as defined above.
(iii) For purposes of this Section, an "acquisition" means (A) any
transaction or series of transactions, in which all STOCKHOLDERS OF THE Company
are legally entitled to participate and pursuant to which shares of voting stock
representing more than 50% of the total outstanding shares of voting stock of
the Company are purchased by a person not controlled by, in control of or under
common control with the company immediately prior to such transaction, (b) the
merger or consolidation of the Company and another entity (other than a merger
or consolidation in which the holders of shares of voting stock of the Company
immediately before the merger or consolidation own immediately after the merger
or consolidation, voting securities of the surviving or acquiring entity or a
parent company of such surviving or acquiring entity possessing more than 50% of
the voting power of the surviving or acquiring entity or parent party) resulting
in the exchange of the outstanding shares of voting stock of the Company for
cash, securities or other property, or (C) any sale, lease, license, exchange or
other disposition (whether in one transaction or a series of related
transactions) of assets representing more than 50% of the total fair market
value of the Company's assets.
(iv) All disputes concerning the interpretation of the Section 11 must
be resolved by mediation and arbitration in Palo Alto, California pursuant to
the rules for commercial arbitration of the American Arbitration Association.]
THIS OPTION AGREEMENT is binding upon the parties and entered into
effective as of the date of grant set forth below.
NETOBJECTS, INC.
By: _____________________________
Its: ____________________________
Date of Grant: November 8, 1999
-5-
<PAGE>
ACKNOWLEDGEMENT BY OPTIONEE
The undersigned Optionee has reviewed all of the terms of this Option
Agreement, accepts them all and agrees to be bound by this Agreement [including
the arbitration provisions of Section 11.
_______________________________________
(signature)
_______________________________________
(name)
<PAGE>
CONSENT OF SPOUSE
I, ____________________, spouse of the Optionee who executed the
foregoing Option Agreement, hereby agree that my spouse's interest in the shares
of Common Stock subject to said Option Agreement shall be irrevocably bound by
the Option Agreement's terms. I further agree that my community property
interest in such shares, if any, shall similarly be bound by said Option
Agreement and that such consent is binding upon my executors, administrators,
heirs and assigns. I agree to execute and deliver such documents as may be
necessary to carry out the intent of said Option Agreement and this consent.
Dated: ____________, 19___
_______________________________________
<PAGE>
DAVE PAULSEN
12/22/99
Tech -- departed employees -- 2,000 shares
non-vested ___________
Quote -- about 12,000 non-vested
[6,000] not yet terminated
6,000
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
NetObjects, Inc.
We consent to incorporation by reference in the registration statement (No.
333-79669) on Form S-8 of NetObjects, Inc and subsidiary of our report dated
November, 5, 1999, relating to the Consolidated Balance Sheets of NetObjects,
Inc. and subsidiaries as of September 30, 1999 and 1998, and its related
Consolidated Statements of Operations and Comprehensive Loss, Stockholders'
Equity (deficit), cash flows and related financial statement schedule for each
of the years in the three-year period ended September 30, 1999, which report
appears in the September 30, 1999 annual report on Form 10-K of NetObjects, Inc.
KPMG LLP
Mountain View, California
December 20, 1999
Independent Auditors' Consent
The Board of Directors
NetObjects, Inc.:
We consent to incorporation by reference in the registration statement (No.
333-79669) on Form S-8 of NetObjects, Inc. of our report dated October 22, 1999,
relating to the balance sheet of Sitematic Corporation as of September 30, 1999,
and the related statements of operations, stockholders' deficit, and cash flows
for the year then ended, which report appears in the September 30, 1999 annual
report on Form 10-K of NetObjects.
/s/ KPMG LLP
San Diego, California
December 20, 1999
EXHIBIT 99.1
Index to Financial Statements
Sitematic Corporation Financial Statements:
Report of KPMG LLP, Independent Auditors.................................51
Balance Sheet at September 30, 1999......................................52
Statement of Operations for the year ended
September 30, 1999 ..................................................53
Statement of Cash Flows for the year ended
September 30, 1999 ..................................................54
Statements of Stockholders' Deficit for the year
ended September 30, 1999 ............................................55
Notes to Financial Statements............................................56
NetObjects, Inc. Pro Forma Condensed Combined Financial Statements:
Pro Forma Condensed Combined Balance Sheet at
September 30, 1999 (unaudited).......................................64
Pro Forma Condensed Combined Statement of Operations
for the year ended September 30, 1999 (unaudited)....................65
Notes to the Unaudited Pro Forma Condensed Combined
Financial Statements................................................66
50
<PAGE>
Independent Auditors' Report
The Board of Directors
Sitematic Corporation
We have audited the accompanying balance sheet of Sitematic Corporation
as of September 30, 1999, and the related statements of operations,
stockholders' deficit, and cash flows for the year then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Sitematic
Corporation as of September 30, 1999, and the results of its operations and its
cash flows for the year then ended, in conformity with generally accepted
accounting principles.
KPMG LLP
San Diego, California
October 22, 1999
51
<PAGE>
SITEMATIC CORPORATION
Balance Sheet
September 30, 1999
(in thousands, except share and per share data)
Assets
Current assets:
Cash and cash equivalents $ 257
Trade receivables, net of allowance for
doubtful accounts of $8 61
Deposits 4
-------
Total current assets 322
-------
Property and equipment, net 236
Other assets 26
-------
Total assets 584
=======
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable 218
Accrued expenses 124
Accrued payroll 80
Accrued commissions 89
Notes payable 500
Current portion of obligations under capital leases (Note 4) 79
Deferred revenue 53
-------
Total current liabilities 1,143
Obligations under capital leases 150
-------
Total liabilities 1,293
-------
Redeemable Preferred stock, no par value:
Series A convertible preferred stock:
Authorized shares - 8,200,000
Issued and outstanding shares - 8,200,000
liquidation preference of $2,216,900 plus
$0.02 per share dividend preference 2,067
-------
Stockholders' deficit:
Common stock, no par value:
Authorized shares - 19,100,000
Issued and outstanding shares - 7,645,990 89
Additional paid-in capital 58
Unearned compensation (57)
Accumulated deficit (2,866)
-------
Total stockholders' deficit (2,776)
-------
Commitments
Total liabilities and stockholders' deficit $ 584
=======
The accompanying notes are an integral part of these financial statements
52
<PAGE>
SITEMATIC CORPORATION
Statement of Operations
Year ended September 30, 1999
(in thousands, except share and per share data)
Service revenues $ 203
Cost of sales 29
-----------
Gross profit 174
-----------
Operating expenses:
Sales and marketing 1,270
Research and development 647
General and administrative 924
-----------
Total operating expenses 2,841
-----------
Loss from operations (2,667)
Interest income 43
Interest expense (10)
-----------
Loss before income taxes (2,634)
-----------
Income tax expense 1
-----------
Net loss $ (2,635)
===========
Basic and diluted net loss per share $ (0.35)
===========
Weighted average common shares outstanding 7,592,150
===========
The accompanying notes are an integral part of these financial statements.
53
<PAGE>
SITEMATIC CORPORATION
Statement of Cash Flows
Year ended September 30, 1999
(in thousands)
Cash flows used in operating activities
Net loss $(2,635)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 56
Stock compensation for services 45
Compensatory charge for issuance of stock options 2
Changes in operating assets and liabilities:
Trade receivables, net (61)
Current deposits (4)
Other assets (26)
Accounts payable and accrued liabilities 428
Deferred revenue 53
-------
Net cash used in operating activities (2,142)
-------
Cash flows used in investing activities
Purchases of property and equipment (21)
-------
Net cash used in investing activities (21)
-------
Cash flows used in financing activities
Net proceeds from issuance of preferred stock 1,921
Repayment of capital leases (22)
Proceeds from borrowing 500
Proceeds from exercise of stock options 1
-------
Net cash provided by financing activities 2,400
-------
Net decrease in cash and cash equivalents 237
-------
Cash and cash equivalents at beginning of year 20
Cash and cash equivalents at end of year $ 257
=======
Supplemental disclosures of cash flow information:
Interest paid $ 10
=======
Income taxes $ 2
=======
Noncash investing and financing activities:
In 1999, the Company entered into capital leases
for property and equipment
in the amount of $250,667
Conversion of promissory notes outstanding at
September 30, 1998 to Series
A preferred stock in fiscal 1999 $ 80
=======
Issuance of common stock as a ment for services
rendered by third-parties $ 45
=======
The accompanying notes are an integral part of these financial statements.
54
<PAGE>
<TABLE>
SITEMATIC CORPORATION
Statement of Stockholders' Deficit
Year ended September 30, 1999
(in thousands)
<CAPTION>
Common stock Total
----------------- Additional Unearned Accumulated stockholders'
Shares Amount paid-in capital compensation deficit deficit
------ ------ --------------- ------------ ------- -------
<S> <C> <C> <C> <C> <C> <C>
Balance at September 30, 1998 6,452 $ 43 -- -- (231) (188)
Conversion of Series A
preferred stock into
common stock 1,018 -- -- -- -- --
Issuance of common stock
for services rendered 168 45 -- -- -- 45
Issuance of stock options -- -- 58 (58) -- --
Amortization of unearned
compensation -- -- -- 1 -- 1
Exercise of stock options 8 1 -- -- -- 1
Net loss -- -- -- -- (2,635) (2,635)
------ ------ --------------- ------------ ------- -------
Balance at September 30, 1999 7,646 $ 89 58 (57) (2,866) (2,776)
====== ====== =============== ============ ======= =======
<FN>
The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>
55
<PAGE>
SITEMATIC CORPORATION
September 30, 1999
Notes to Financial Statements
1. Organization and Significant Accounting Policies
(a) Organization
Sitematic Corporation (the Company), based in San Diego,
California, offers a web-based service that enables small business
users to build simple e-commerce-enabled websites. The Company's
products compete in the market for Internet application
development tools.
(b) Cash and Cash Equivalents
The Company considers all investments with an original maturity of
less than three months to be cash and cash equivalents. The
Company evaluates the financial strength of institutions at which
significant investments are made and believes the related credit
risk is limited to an acceptable level.
(c) Concentration of Credit Risk
Credit is extended based on an evaluation of a customer's
financial condition and collateral generally is not required. To
date, credit losses have been minimal and such losses have been
within management's expectations.
For the year ended September 30, 1999, sales to two customers
accounted for 22% and 20% of total revenue. Outstanding
receivables from these customers accounted for 50% and 8% of trade
accounts receivable at September 30, 1999.
(d) Long-Lived Assets
Long-lived assets and certain identifiable intangibles are
reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of assets to be held and used
is measured by a comparison of the carrying amount of an asset to
future net cash flows (undiscounted and without interest) expected
to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the assets exceeds the fair
value of the assets. Assets to be disposed of are reported at the
lower of the carrying amount or fair value less costs to sell.
(e) Property and Equipment
Property and equipment are recorded at cost net of accumulated
depreciation. Depreciation is calculated using the straight-line
method over the estimated useful lives of the assets which are
generally three years. Amortization of assets under capital lease
is recorded using the straight-line method based on the shorter of
the lease term or the estimated useful lives of the assets.
(f) Revenue Recognition
Revenue is derived from providing server-based web publishing and
e-commerce tools and services and the web hosting of those
services and is accounted for under the provisions of Statement of
Position (SOP) 97-2, Software Revenue Recognition. Revenue from
software services sold to end users is deferred and recognized
ratably over the life of the service contract. Revenue from
customers for website preparation is recognized upon delivery of
the completed website.
(g) Research and Development Expenses
Expenditures for research and development costs are expensed in
the year incurred.
56
<PAGE>
(h) Fair Value of Financial Instruments
SFAS No. 107, Disclosures About Fair Value of Financial
Instruments, requires that fair values be disclosed for most of
the Company's financial instruments. The carrying amounts of cash
and cash equivalents, trade receivables, accounts payable, accrued
expenses, accrued payroll, accrued commissions and notes payable
approximate fair value because of the short maturity of these
instruments.
(i) Stock-Based Compensation
The Company applies the intrinsic value-based method of accounting
prescribed by Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related
interpretations, in accounting for its fixed plan stock options.
As such, compensation expense would be recorded for options
granted to employees on the date of grant only if the current
market price of the underlying stock exceeded the exercise price.
SFAS No. 123, Accounting for Stock-Based Compensation, permits
entities to recognize as expense over the vesting period the fair
value of all stock-based awards on the date of grant.
Alternatively, SFAS No. 123 also allows entities to continue to
apply the provisions of APB Opinion No. 25 and provide pro forma
net income and pro forma earnings per share disclosures for
employee stock option grants made in 1996 and future years as if
the fair-value-based method defined in SFAS No. 123 had been
applied. The Company has elected to continue to apply the
provisions of APB Opinion No. 25 and provide the pro forma
disclosure provisions of SFAS No. 123.
(j) Income Taxes
Income taxes are accounted for under the asset and liability
method. Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss and
tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
(k) Earnings per Share
The Company computes basic and diluted earnings per share in
accordance with SFAS No. 128, Earnings per Share (EPS). Basic EPS
excludes the dilutive effects of options, warrants and other
convertible securities. Diluted EPS reflects the potential
dilution of securities that could share in the earnings of the
Company. For the year ended September 30, 1999, options, warrants
and convertible preferred stock representing 10,630,857 shares
were excluded from the computation of diluted net loss per share
as their effect was antidilutive.
(l) Use of Estimates
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets, liabilities,
revenues and expenses and the disclosure of contingent assets and
liabilities to prepare these financial statements in conformity
with generally accepted accounting principles. Actual results
could differ from those estimates.
2. Property and Equipment
Property and equipment consists of the following as of September 30,
1999:
Computer equipment $ 18,148
Software 6,500
Assets under capital lease 289,603
-----------
314,251
Less accumulated depreciation and amortization (78,062)
-----------
$ 236,189
===========
Accumulated depreciation and amortization includes $53,295 of accumulated
amortization related to assets under capital lease.
57
<PAGE>
3. Notes Payable
On August 19, 1999, the Company entered into a Bridge Loan Agreement in
the form of an unsecured promissory note, (the Note), with NetObjects,
Inc. (NetObjects). Under the terms of the Note, the Company received
$250,000 in August and an additional $250,000 in September. Principal is
to be repaid upon demand of NetObjects Inc. (plus applicable interest).
Interest accrues at the annual rate of 9%. As of September 30, 1999, no
payments had been made by the Company. As discussed in Note 11,
NetObjects purchase the Company in October 1999.
58
<PAGE>
4. Lease Commitments
The Company leases its administrative offices and certain equipment under
noncancelable lease agreements. Future minimum lease payments under
noncancelable operating leases (with initial or remaining lease terms in
excess of one year) and future minimum capital lease payments as of
September 30, 1999 are:
Operating Capital
Year ending September 30, leases leases
---------------- -------------
2000 $ 126,699 94,815
2001 22,907 94,815
2002 460 67,759
---------------- -------------
Total minimum lease payments $ 150,066 257,389
================
Less estimated executory costs --
-------------
Net minimum lease payments 257,389
Less amount representing interest (at
rates ranging from 3.0% to 8.5%) (28,466)
-------------
Present value of net minimum
capital lease payments 228,923
Less current portion (79,272)
-------------
Long-term obligations under capital leases $ 149,651
=============
Total rent expense was $85,677 for the year ended September 30, 1999.
59
<PAGE>
5. Stock Option Plan
In August 1998, the Company adopted the 1998 Equity Incentive Plan (the
Plan). The maximum number of shares of common stock which may be optioned
and sold under the Plan to officers, employees, directors, and certain
other individuals providing services to the Company is 2,668,726. Options
granted under the Plan generally vest over four years and are exercisable
for a period of up to ten years from the date of grant. The following
table summarizes stock option activity:
Weighted- average
Shares exercise price
------------ -------------------
Balance at September 30, 1998 - $ -
Granted 2,988,000 0.03
Exercised (8,125) 0.03
Canceled (1,011,375) 0.03
------------ -------------------
Balance at September 30, 1999 1,968,500 $ 0.03
============ ===================
Balance exercisable at
September 30, 1999 215,250 $ 0.03
============ ===================
The weighted-average remaining contractual life of the outstanding
options at September 30, 1999 was 9.4 years. The exercise price of the
options outstanding at September 30, 1999 was $0.03, except for 35,500
shares that had an exercise price of $0.25 per share.
For the year ended September 30, 1999, compensation expense was recorded
in the amount of $1,568 for options granted to employees for which the
current market price of the underlying stock on the date of grant
exceeded the exercise price.
In applying SFAS No. 123, pro forma information regarding net loss has
been determined as if the Company has accounted for its employee stock
options under the fair value method of that statement. The fair value of
the options was estimated at the date of grant, using the Black-Scholes
option pricing model with the following weighted-average assumptions:
risk-free interest rates between 4.57% and 5.86%; dividend yield of zero;
expected volatility of zero; and expected life of options of 5.0 years.
The estimated fair value of the options is amortized to expense over the
options' vesting period. The weighted-average fair value of the options
granted in fiscal 1999 was $0.05.
Had the Company determined compensation cost based on the fair value at
the grant date for its stock options under SFAS No. 123, the Company's
net loss for the year ended September 30, 1999 would have been increased
to the pro forma amounts indicated below:
Net loss As reported $(2,634,871)
Pro forma (2,637,031)
Net loss per share As reported (0.35)
Pro forma (0.35)
6. Redeemable Convertible Preferred Stock
In August 1998, the Company issued 1,263,170 shares of Series A
convertible preferred stock and 1,736,830 shares of common stock for
aggregate net proceeds of $75,000 to a single stockholder. In connection
with the issuance of the Series A convertible preferred stock, the
Company amended its Articles of Incorporation to effect a 500-for-1 split
of the common stock, to create a new class of preferred stock, and to
increase the authorized shares of common stock and preferred stock to
15,000,000 and 5,000,000, respectively.
In October and December 1998 and March 1999, the Company issued an
aggregate of 7,954,705 shares of Series A convertible preferred stock at
$0.2703536 per share for cash and conversion of promissory notes. Net
proceeds of $2.0 million were received from the issuance of Series A
convertible preferred stock. In connection with the issuance of Series A
convertible preferred stock, the Company amended its Articles of
Incorporation to increase the authorized shares of common stock and
preferred stock to 19,100,000
60
<PAGE>
and 8,200,000, respectively. In addition, 1,017,875 shares of Series A
convertible preferred stock previously issued to a shareholder in August
1998 were converted to common stock.
The holders of the Series A convertible preferred stock were entitled to
receive dividends at the rate of $0.02 per share, per annum. Preferred
stock dividends were payable if and when dividends were declared by the
Board of Directors. The right to such dividends was not cumulative.
Series A convertible preferred stock was redeemable at the option of a
majority of the holders of Series A, at any time after October 1, 2003 in
six equal semi-annual installments. See Note 11(unaudited), for
information concerning the proceeds from the sale of the company that
were paid to the Series A convertible preferred stockholders.
7. Stockholders' Deficit
Certain shares of common stock are restricted and subject to a repurchase
by the Company in the event the shareholder leaves the employment of the
Company. As of September 30, 1999, 999,995 shares of common stock were
subject to repurchase under this restricted stock agreement.
(a) Warrants
In fiscal 1999, in connection with the issuance of the Series A
convertible preferred stock, warrants to purchase 369,885 shares
of the Company's common stock at $0.2703536 per share were issued.
These warrants are exercisable upon issuance and expire at the
earlier of an initial public offering or on October 4, 2003. The
fair value of the warrants was zero.
In connection with certain equipment leasing agreements entered
into during 1999, a warrant for 92,472 shares of the Company's
common stock was issued. This warrant entitles the holder to
purchase 92,472 shares of the Company's common stock at $0.2703536
per share. The warrant is exercisable at the earlier of nine years
from the date of grant or four years from the effective date of
the Company's initial public offering. The fair value of the
warrant of $185 was estimated using the Black-Scholes option
pricing model with the following weighted average assumptions:
risk-free interest rate of 4.70%; dividend yield of zero; expected
volatility of zero; and expected life of 9.0 years.
61
<PAGE>
(b) Shares Reserved for Future Issuance
Shares of common stock were reserved for issuance at September 30,
1999 as follows:
Conversion of preferred stock $ 8,200,000
Exercise of options 2,660,601
Exercise of warrants 462,357
Convertible note 720,000
-----------
$12,042,958
===========
8. Related Party Transactions
The outstanding balance on a promissory note issued to a related party in
1998 was converted into 259,909 shares of Series A preferred stock during
1999.
9. Income Taxes
Significant components of the Company's deferred tax assets as of
September 30, 1999 are shown below:
Deferred tax assets:
Net operating loss and credit carryforwards $ 1,156,011
Accrued vacation 15,086
Other - net 39,936
-----------
Total deferred tax assets 1,211,033
Valuation allowance for deferred tax assets (1,211,033)
-----------
Net deferred tax assets $ --
===========
The Company has recorded a 100% valuation allowance against the deferred
tax assets as management has determined that it is not more likely than
not that these assets will be realized.
As of September 30, 1999, the Company had net operating loss
carryforwards for federal and California income tax purposes of
approximately $2,698,600 and $2,698,600, respectively. The California tax
loss carryforwards will begin expiring in 2006, unless previously
utilized.
As a result of the "change in ownership" provisions of the Tax Reform Act
of 1986, utilization of the Company's tax net operating loss
carryforwards is subject to an annual limitation in future periods. As a
result of the annual limitation, a portion of these carryforwards may
expire before ultimately becoming available to reduce future taxable
income.
10. Employee Benefit Plan
The Company's 401(k) plan is for the benefit of substantially all
employees. Contributions to the plan by the Company are at the discretion
of the Board of Directors and are subject to certain limitations
described in the plan. There were no contributions made by the Company to
the plan during the year ended September 30, 1999.
62
<PAGE>
11. Subsequent Events (Unaudited)
NetObjects purchased the Company in October 1999. Subsequent to September
30, 1999, but immediately prior to the acquisition of the Company by
NetObjects, all outstanding principal and accrued interest under the Note
was converted into 566,152 shares of the Company's common stock. Upon the
acquisition of the Company by NetObjects, these shares were canceled.
On October 4, 1999, the Company was merged into SDI Acquisition Corp., a
wholly owned subsidiary of NetObjects, in a stock-for-stock plus cash
transaction. A total of approximately 2,005,000 shares of unregistered
NetObjects common stock plus $1,554,088 in cash were issued in
consideration for all of the outstanding shares of the Company. Each
Sitematic preferred share was converted into $0.189523 cash and 0.112482
share of NetObjects common stock for a total of 922,352 shares. Each
Sitematic common share was converted into 0.135870 share of NetObjects
common stock for a total of 1,038,863 shares. The remaining consideration
of 43,785 shares of NetObjects common stock was received by the former
holders of Sitematic warrants who converted their warrants into shares of
Sitematic common stock just prior to the merger under a net issuance
conversion option. Shares issued in conjunction with the acquisition are
to be registered by NetObjects no later than May 12, 2000. All of the
outstanding stock options in the Company were converted into similar
options in NetObjects common stock at a ratio of 0.135870 shares of
NetObjects for each share of the Company. The Company incurred legal
costs of approximately $100,000 with respect to the acquisition, all of
which were paid for by NetObjects. Shares approximating 10% of the total
consideration paid were placed in escrow for a period of one year against
undisclosed claims and breaches of representations and warranties.
63
<PAGE>
<TABLE>
NETOBJECTS, INC.
AND SUBSIDIARIES
(A Majority Owned Subsidiary of IBM)
Pro Forma Condensed Combined Balance Sheet
(In thousands)
September 30, 1999
(Unaudited)
<CAPTION>
Pro Forma Pro Forma
NetObjects Sitematic Adjustments Combined
--------- --------- --------- ---------
Assets
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents $ 23,623 $ 257 $ (1,554)(a) $ 22,326
Short-term investments 9,331 -- -- 9,331
Accounts receivable 6,065 61 -- 6,126
Prepaid expenses and other current assets 1,486 4 (500)(d) 990
--------- --------- --------- ---------
Total current assets 40,505 322 (2,054) 38,773
Property and equipment, net 2,204 236 -- 2,440
Other assets -- 26 -- 26
Goodwill and other intangible assets -- -- 14,121(g) 14,121
--------- --------- --------- ---------
Total assets $ 42,709 $ 584 $ 12,067 $ 55,360
========= ========= ========= =========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable 2,489 218 -- 2,707
Notes payable -- 500 (500)(d) --
Accrued compensation 1,068 -- -- 1,068
Other accrued liabilities 1,657 293 -- 1,950
Deferred revenue 988 53 -- 1,041
Current portion of capital lease obligations 281 79 -- 360
--------- --------- --------- ---------
Total current liabilities 6,483 1,143 (500) 7,126
--------- --------- --------- ---------
Capital lease obligations, less current pertion 54 150 -- 204
--------- --------- --------- ---------
Convertible preferred stock -- 2,067 (2,067)(c) 0
Total stockholders' equity (deficit) 36,172 (2,776) 14,634(c) 48,030
--------- --------- --------- ---------
Total liabilities and stockholders' equity $ 42,709 $ 584 $ 12,067 $ 55,360
========= ========= ========= =========
</TABLE>
64
<PAGE>
<TABLE>
NETOBJECTS, INC.
AND SUBSIDIARIES
(A Majority Owned Subsidiary of IBM)
Pro Forma Condensed Combined Statement of Operations
(In thousands, except per share data)
Year ended September 30, 1999
(Unaudited)
<CAPTION>
Pro Forma Pro Forma
NetObjects Sitematic Adjustments Combined
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
Software license fees $ 13,566 -- -- 13,566
Service revenues 2,178 203 -- 2,381
Software license fees from IBM 3,689 -- -- 3,689
Service revenues from IBM 2,782 -- -- 2,782
------------ ------------ ------------ ------------
Total revenues 22,215 203 -- 22,418
------------ ------------ ------------ ------------
Cost of revenues:
Software license fees 1,817 -- -- 1,817
Service revenues 2,113 29 -- 2,142
Service revenues from IBM 2,295 -- 2,295
------------ ------------ ------------ ------------
Total cost of revenues 6,225 29 -- 6,254
------------ ------------ ------------ ------------
Gross profit 15,990 174 -- 16,164
------------ ------------ ------------ ------------
Operating expenses:
Sales and marketing 18,800 1,270 -- 20,070
Research and development 9,358 647 -- 10,005
General and administrative 4,314 924 7,845 (f) 13,083
Stock-based compensation 559 -- -- 559
------------ ------------ ------------ ------------
Total operating expenses 33,031 2,841 7,845 43,717
------------ ------------ ------------ ------------
Operating income (loss) (17,041) (2,667) (7,845) (27,553)
Interest income (expense) (715) 33 (62)(e) (744)
Accretion of discount on debt to IBM (1,653) -- -- (1,653)
Interest on beneficial conversion feature of
convertible debt to IBM (7,457) -- -- (7,457)
------------ ------------ ------------ ------------
Income (loss) before income taxes (26,866) (2,634) (7,907) (37,407)
============ ============ ============ ============
Income taxes 44 1 -- 45
------------ ------------ ------------ ------------
Net income (loss) (26,910) (2,635) (7,907) (37,452)
============ ============ ============ ============
Basic and diluted net income (loss)
per share $ 2.40 $ (2.84)
============ ============
Shares used to calculate basic and diluted net
income (loss) pershare 11,215,118 2,005,000 (b) 13,220,118
============ =========== ============
</TABLE>
65
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARIES
(A Majority Owned Subsidiary of IBM)
Notes to the unaudited pro forma condensed combined financial statements
On October 4, 1999, NetObjects, Inc. acquired all of the outstanding
capital stock of Sitematic, Corporation. The total value of the capital invested
in Sitematic was approximately $15,482,000, which includes common stock valued
at approximately $12,657,000, $1,554,000 in cash, common stock options issued of
$821,000 and transaction costs of $450,000, and assumed liabilities.
At the close of the transaction, 7,968,260 shares of Sitematic common
and 8,200,000 shares of Sitematic preferred were converted to approximately
2,005,000 shares of NetObjects common stock. In addition to conversion of their
preferred shares to NetObjects common, Sitematic preferred shareholders received
about $0.19 for each share of preferred, representing total consideration of
$1,554,000. All issued and outstanding Sitematic options were converted to
options to purchase 269,000 shares of NetObjects common stock.
The unaudited pro forma condensed combined financial statements give
effect to the acquisition using the purchase method of accounting, whereby the
total cost of the acquisition will be allocated to the tangible and identifiable
intangible assets acquired and liabilities assumed based upon their respective
fair values. The unaudited pro forma condensed combined financial statements
have been prepared on the basis of assumptions set forth below, including
assumptions related to the allocation of the total purchase cost to the assets
and liabilities of Sitematic based upon preliminary estimates of fair value. The
actual allocation may differ from these assumptions.
The unaudited pro forma condensed combined financial statements as of
and for the year ended September 30, 1999 give effect to the acquisition of
Sitematic Corporation as if it had occurred on October 1, 1998. The condensed
combined financial statements should be read in conjunction with the historical
consolidated financial statements of NetObjects, and Sitematic, included herein.
These statements are not necessarily indicative of what the actual operating
results would have been had the acquisition occurred on the date indicated and
do not purport to indicate future results of operations. In addition, they do
not reflect any cost savings or other synergies resulting from the acquisition.
Intangible assets will be amortized on a straight-line basis over a
period of two years. The following table represents the allocation of the
purchase price based upon the fair value of Sitematic's assets and liabilities
as of the acquisition date.
Assets acquired:
Cash $ 257
Trade receivables, net 61
Deposits 4
Property and equipment 236
Other assets 26
-------
584
-------
Intangible assets
Developed product technology 490
Assembled workforce 340
Non-compete agreements 740
-------
1,570
-------
Liabilities assumed (793)
-------
Net assets acquired 1,361
-------
Purchase price 15,482
-------
Goodwill $14,121
=======
Pro Forma adjustments are as follows:
(a) Cash paid for Sitematic of $1,554,000 million.
(b) The pro forma basic and diluted net loss per share is calculated
by assuming that the 2,005,000 shares of NetObjects common stock
issued in the acquisition were outstanding for the entire year.
(c) Reflects the elimination of Sitematic's convertible preferred
stock and 2,005,000 shares of NetObjects stock for the
acquisition of Sitematic.
66
<PAGE>
(d) To eliminate Sitematic note payable to NetObjects in the amount
of $500,000
(e) To record the reduction of interest income on cash paid as part
of the total consideration.
(f) To record one year's amortization expense of goodwill and
identified intangible assets on a straight line basis over their
estimated useful lives of two years.
(g) To record goodwill and identifiable intangible assets.
67
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE TABLE BELOW HOLDS SUMMARY FINANCIAL INFORMATION CONTAINED IN NETOBJECTS,
INC. ANNUAL REPORT ON FORM 10-K FOR THE PERIOD ENDED SEPTEMBER 30, 1999 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-START> OCT-1-1998
<PERIOD-END> SEP-30-1999
<CASH> 23,623
<SECURITIES> 9,331
<RECEIVABLES> 6,064
<ALLOWANCES> 908
<INVENTORY> 0
<CURRENT-ASSETS> 40,505
<PP&E> 5,203
<DEPRECIATION> (2,999)
<TOTAL-ASSETS> 42,709
<CURRENT-LIABILITIES> 6,483
<BONDS> 0
0
0
<COMMON> 248
<OTHER-SE> 35,924
<TOTAL-LIABILITY-AND-EQUITY> 42,709
<SALES> 0
<TOTAL-REVENUES> 22,215
<CGS> 0
<TOTAL-COSTS> 6,225
<OTHER-EXPENSES> 33,031
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,471
<INCOME-PRETAX> (26,866)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (26,910)
<EPS-BASIC> (2.40)
<EPS-DILUTED> (2.40)
</TABLE>
