SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------
Form 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended December 31, 1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from ____ to ____.
Commission File Number: 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 (650) 482-3200
(Address of Principal Executive Offices) (Registrant's
Telephone Number)
NOT APPLICABLE
(Former Name, Former Address, and Former Fiscal Year,
If Changed Since Last Report)
----------
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
As of January 31, 2000, the Registrant had outstanding 27,216,982 shares of
common stock, $.01 par value.
================================================================================
<PAGE>
TABLE OF CONTENTS
Part I: Financial Information
Item 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets at December 31, 1999
and September 30, 1999................................................1
Condensed Consolidated Statements of Operations for the
three-months ended December 31, 1999 and December 31, 1998............2
Condensed Consolidated Statements of Cash Flows for the
three-months ended December 31, 1999 and December 31, 1998............3
Notes to Unaudited Condensed Consolidated Financial Statements........4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.............................................7
Item 3. Quantitative and Qualitative Disclosures about Market Risk...........18
Part II: Other Information
Item 2. Changes in Securities and Use of Proceeds............................19
Item 6. Exhibits and Reports on Form 8-K.....................................19
Signatures...........................................................19
ii
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NETOBJECTS, INC.
AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(In thousands, except share data)
(unaudited)
<TABLE>
<CAPTION>
December 31, 1999 September 30, 1999
--------- ---------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 15,041 $ 23,623
Short-term investments 7,952 9,331
Accounts receivable, net of allowances of $1,192
and $908 as of December 31, and September 30,
1999, respectively 9,598 6,065
Prepaid expenses and other current assets 1,329 1,486
--------- ---------
Total current assets 33,920 40,505
Property and equipment, net 2,464 2,204
Intangible assets, net of amortization of $2,016 and $0
as of December 31, and September 30, 1999, respectively 14,117 --
--------- ---------
Total assets $ 50,501 $ 42,709
========= =========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 2,183 $ 2,489
Accrued compensation 1,268 1,068
Other accrued liabilities 3,010 1,657
Deferred revenue 1,334 988
Current portion of capital lease obligations 324 281
--------- ---------
Total current liabilities 8,119 6,483
--------- ---------
Capital lease obligations, less current portion 154 54
--------- ---------
Stockholders' Equity:
Common stock, $0.01 par value; 60,000,000 shares
authorized as of December 31 and September 30, 1999,
respectively. 27,089,746 and 24,755,960 shares issued
and outstanding as of December 31 and September
30, 1999, respectively 271 248
Additional paid in capital 124,404 110,810
Notes receivable from stockholders (222) (23)
Accumulated other comprehensive losses (41) (30)
Deferred stock-based compensation (858) (1,205)
Accumulated deficit (81,326) (73,628)
--------- ---------
Total stockholders' equity 42,228 36,172
--------- ---------
Total liabilities and stockholders' equity $ 50,501 $ 42,709
========= =========
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
1
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(In thousands, except share and per share data)
(unaudited)
Three months ended December 31,
-----------------------------
1999 1998
------------ ------------
Revenues:
Software license fees and online revenues $ 5,662 $ 2,622
Service revenues 959 190
Software license fees from IBM 1,288 1,318
Service revenues from IBM -- 1,487
------------ ------------
Total revenues 7,909 5,617
------------ ------------
Cost of revenues:
Software license fees and online revenues 1,962 495
Service revenues 1,225 184
Service revenues from IBM -- 1,404
------------ ------------
Total cost of revenues 3,187 2,083
------------ ------------
Gross profit 4,722 3,534
------------ ------------
Operating expenses:
Sales and marketing 5,947 4,430
Research and development 3,229 2,204
General and administrative 1,384 894
Amortization of intangible assets 2,016 --
Stock-based compensation 206 100
------------ ------------
Total operating expenses 12,782 7,628
------------ ------------
Operating loss (8,060) (4,094)
Interest income (expense) 374 (511)
Accretion of discount on debt -- (191)
Interest on beneficial conversion
feature of convertible debt -- (3,792)
------------ ------------
Loss before income taxes (7,686) (8,588)
------------ ------------
Income taxes 12 2
------------ ------------
Net loss $ (7,698) $ (8,590)
Translation adjustment (11) (10)
------------ ------------
Comprehensive loss $ (7,709) $ (8,600)
============ ============
Basic and diluted net loss per share $ (0.29) $ (4.36)
============ ============
Shares used to calculate basic
and diluted net loss per share 26,829,265 1,970,533
============ ============
The accompanying notes are an integral part of these
condensed consolidated financial statements.
2
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(In thousands)
(unaudited)
<TABLE>
<CAPTION>
Three months ended
December 31,
--------------------
1999 1998
-------- --------
<S> <C> <C>
Cash used in operating activities:
Net loss $ (7,698) $ (8,590)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation 430 240
Accretion of discount on borrowings -- 44
Nonrecurring interest charge on beneficial
conversion feature of convertible debt -- 3,791
Amortization of intangible assets 2,016 --
Amortization of deferred stock-based compensation 206 64
Changes in operating assets and liabilities:
Accounts receivable (3,473) (781)
Prepaid expenses and other current assets (312) (11)
Accounts payable (524) (228)
Accrued compensation 200 (368)
Other accrued liabilities 1,103 14
Deferred revenue 293 (2,677)
Interest and income taxes payable (44) 224
-------- --------
Net cash used in operating activities (7,802) (8,276)
Cash used in investing activities:
Purchases of property and equipment (455) (704)
Cash paid for Sitematic Corporation, net of cash acquired (1,297) --
Maturities of short-term investments 1,379 --
-------- --------
Net cash used in investing activities (373) (704)
Cash used in financing activities:
Repayments of short-term borrowings -- (2,000)
Proceeds from convertible debt -- 8,326
Payment on capital lease obligations (86) (76)
Proceeds from issuance of preferred stock, net of issuance costs -- 3,468
Proceeds from issuance of common stock, net of issuance costs (110) 100
Repurchases of common stock -- (2)
Issuance of stockholder notes receivable (200) --
-------- --------
Net cash provided by (used in) financing activities (396) 9,816
Effect of exchange rate changes on cash (11) (6)
-------- --------
Net increase (decrease) in cash (8,582) 830
Cash and cash equivalents at beginning of period 23,623 459
-------- --------
Cash and cash equivalents at end of period $ 15,041 $ 1,289
======== ========
Supplemental disclosures of cash flow information:
Interest paid $ -- $ 350
Noncash investing and financing activities:
Equipment recorded under capital leases $ 478 $ 558
Discount on borrowings $ -- $ 4,679
Stock issued in exchange for services $ -- $ 35
Issuance of common stock for acquisitions $ 13,478 $ --
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
3
<PAGE>
NETOBJECTS, INC.
AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Summary 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. 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 the
time, all series of convertible preferred shares outstanding were converted to
common stock.
On October 4, 1999 NetObjects acquired Sitematic Corporation and issued
common stock that brought IBM's ownership to less than 50%.
NetObjects provides software, solutions, and services that enable small
businesses to build, deploy, maintain websites online, and conduct e-business;
and enable large enterprises to effectively create and manage corporate
intranets.
2. Summary of Significant Accounting Policies
Basis of Presentation of Interim Financial Statements
The accompanying unaudited condensed consolidated financial statements of
NetObjects, Inc. and subsidiaries ("the Company" or "NetObjects") have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. Certain 1998 amounts have been reclassified to conform to
the 1999 method of presentation. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the three-month period
ended December 31, 1999 are not necessarily indicative of the results that may
be expected for the fiscal year ending September 30, 2000. For further
information, refer to the audited financial statements and footnotes thereto for
the fiscal year ended September 30, 1999 included in the Company's Annual Report
on Form 10-K.
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 options and warrants to purchase common stock using the
treasury stock method and from convertible securities using the 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 anti-dilutive. To date, the Company has not had any issuances or
grants for nominal consideration.
Diluted net loss per share for the three-months ended December 31, 1999,
does not include the effect of warrants to purchase 4,626,840 shares of common
stock with a weighted average exercise price of $7.46, options to purchase
5,064,739 shares of common stock with a weighted-average exercise price of $7.75
per share, or 36,040 shares of common stock issued and subject to repurchase by
the Company at a weighted-average price of $0.13, because their effects are
anti-dilutive.
Diluted net loss per share for the three-months ended December 31, 1998,
does not include the effect of 11,965,826 shares of convertible preferred stock
outstanding, warrants to purchase 6,830,387 shares of convertible preferred
stock with a weighted average exercise price of $5.64, options to purchase
2,647,717 shares of common stock with a weighted-average exercise price of $2.36
per share, or 81,237 shares of common stock issued and subject to repurchase by
the Company at a weighted-average price of $0.12, because their effects are
anti-dilutive.
4
<PAGE>
As of December 31, 1999, the Company was authorized to issue 6,000,000
shares of preferred stock, par value $0.01, and 60,000,000 shares of common
stock, par value $0.01, and there were no shares of NetObjects preferred stock
outstanding and 27,089,476 shares of NetObjects common stock outstanding. At
December 31, 1999, the Company had outstanding warrants to purchase 3,482,838
shares of common stock with an exercise price of $6.68 that expire on April 11,
2000, 201,491 and 64,132 shares of common stock with an exercise price of $6.68,
that expire on October 8, 2003 and February 18, 2004, respectively, and 864,850
shares of common stock with an exercise price of $10.80 and an expiration date
between March 2000 and December 2000.
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
becomes effective for the Company as of October 1, 2000. The Company does not
expect SFAS 133 to have a material effect on its financial condition or results
of operations.
2. Business Combination
On October 4, 1999, the Company completed the acquisition of Sitematic
Corporation, exchanging 2,004,988 shares of NetObjects common for all issued and
outstanding capital stock of Sitematic. In addition to conversion of their
preferred shares to NetObjects common, Sitematic preferred stockholders received
approximately $1.6 million in cash for their shares. All issued and outstanding
Sitematic options were converted to options to purchase NetObjects common stock.
The acquisition was accounted for under the purchase method.
Total consideration, including the assumption of $0.8 million in debt, cash
advances by NetObjects of $0.5 million, and transaction costs of $0.4 million,
was approximately $16.7 million. NetObjects acquired tangible assets of
approximately $0.6 million, including approximately $0.3 million in cash.
Allocation of the purchase price that is in excess of Sitematic Corporation's
net book value resulted in the addition of approximately $16.1 million in
intangible assets to NetObject's balance sheet, of which approximately $14.6
million represents goodwill. The intangible assets are being amortized on a
straight-line basis over their estimated useful lives of two years. The results
of operations of Sitematic are included in the Company's financial statements
from the date of acquisition.
3. Balance Sheet Components
Intangible Assets
At September 30, 1999, there were no intangible assets on the Company's
balance sheet. At December 31, 1999, the Company allocated approximately $16.1
million to intangible assets, which includes $14.5 million in goodwill and $1.6
million of identifiable intangible assets. Amortization expense for the three
months ended December 31, 1999 was approximately $2.0 million.
4. 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 Online segment is
NetObjects Fusion, which is targeted to small businesses that would like to
establish a web site 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 sells NetObjects Fusion through
resellers, distributors, and a dedicated web site.
The Company's Chief Operating Decision Maker (CODM) is the Chief Executive
Officer. During the three months ended December 31, 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.
5
<PAGE>
Revenue information for the Company's two segments is as follows:
For the three month period ended
December 31, 1999
------------------------------------------
Small Business & Enterprise Total
Online Markets Markets NetObjects
-------------- ------- ----------
Revenues:
Domestic license and Online $2,562 $ 605 $3,167
International license 2,260 235 2,495
Domestic service -- 688 688
International service -- 271 271
IBM license 1,188 100 1,288
Total Revenue $6,010 $1,899 $7,909
For the three month period ended
December 31, 1998
------------------------------------------
Small Business & Enterprise Total
Online Markets Markets NetObjects
-------------- ------- ----------
Revenues:
Domestic license and Online $1,362 $ 413 $1,775
International license 847 1 848
Domestic service -- 54 54
International service -- 136 136
IBM license 1,318 -- 1,318
IBM service 1,486 -- 1,486
Total Revenue $5,013 $ 604 $5,617
In the Small Business & Online segment, two customers accounted for
approximately 38% of the outstanding accounts receivables at December 31, 1999.
There were no significant customer concentrations in the Enterprise segment.
For the three months ended December 31, 1999, revenues for the Small
Business & Online segment were concentrated in the United States and Europe,
representing approximately $3.7 million and $2.3 million, respectively. Sales
for the Enterprise segment were concentrated in the United States and Europe,
representing approximately $1.4 million and $0.5 million, respectively.
In the Small Business & Online segment, two customers accounted for
approximately 59% of the outstanding accounts receivables at December 31, 1998.
There were no significant customer concentrations in the Enterprise segment.
For the three months ended December 31, 1998, revenues for the Small
Business & Online segment were concentrated in the United States and Europe,
representing approximately $4.2 million and $0.8 million, respectively. Sales
for the Enterprise segment were concentrated in the United States and Europe,
representing approximately $0.5 million and $0.1 million, respectively.
6
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with the accompanying
condensed consolidated financial statements and notes included in this report.
This Form 10-Q 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 web site 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.
Overview
We provide both online and software solutions that enable small businesses
to build, deploy and maintain Internet web sites, and applications to conduct
e-business; and enable large enterprises to create corporate intranets. For
fiscal 2000, our revenues are derived principally from license fees from our
software products and, to a lesser extent, from fees on a range of services
complementing these products. We have two operating divisions. Our Small
Business Online division licenses NetObjects Fusion and offers online services
to small business customers. Our online business, announced in the quarter ended
December 31, 1999 and branded GoBizGo, was established with the acquisition of
Sitematic Corporation. We derived limited revenues from online services in the
quarter ended December 31, 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 experience with
product returns by those distributors. Software license fees earned from
products bundled with OEM resellers are recognized either upfront, if the OEM
vendor commits to a quantity and a fixed price with no right of return or, if
the volumes are not committed, then when the OEM resellers ship 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 important strategic relationships such as our relationships
with IBM and through our indirect (OEM) 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.
In October 1999, we acquired Sitematic Corporation, an Application Service
Provider (ASP), that offered on-line website building and hosting capabilities
to small businesses. In December 1999, we combined our online resources with the
Sitematic offering and launched GoBizGo.com. These combined services include
website building software, e-mail list management (for communicating with
cutomers), domain name and search engine registration, auction export, relevant
content information for building and maintaining an e-business online, and web
hosting services. Currently, our online business has two sources of revenue: (1)
From the sale of subscriptions of web-hosting services provided directly to
small businesses; (2) From fees charged to our business partners for
establishing co-branded sites, for which we share customer revenue with our
partners. In the latter case, our business partner is responsible for bringing
small businesses to our GoBizGo offering. We expect that the acquisition of
Sitematic will incrementally increase our operating expenses by less than 10%
from pre-acquisition levels. Furthermore, we will shift some of our existing
staff to support this new growth opportunity. Also, we will have to build
infrastructure to maintain and grow the online services, which will increase our
cost of revenue over time.
We have incurred substantial net losses in each fiscal period since our
inception and, as of December 31, 1999, had an accumulated deficit of $81.4
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,
7
<PAGE>
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 web site building software
and services.
To achieve our business objectives we need to do the following:
* Increase substantially our revenues from our two principal products,
NetObjects Fusion and NetObjects Authoring Server;
* Continue to develop successfully new versions of our products;
* Continue to be a leading provider of e-business software for building
websites and corporate intranet sites;
* Respond quickly and effectively to competitive, market, and
technological developments;
* Expand our professional services business;
* Expand our online services business;
* Control expenses;
* Continue to attract, train, and retain qualified personnel in the
competitive software industry; and
* 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.
8
<PAGE>
Results of Operations
The following table sets forth financial data for the periods indicated as a
percentage of total revenues:
Three months ended
December 31,
------------------
1999 1998
----- -----
Revenues:
Software license fees and online revenues 72% 47%
Service revenues 12 3
Software license fees from IBM 16 23
Service revenues from IBM -- 27
----- -----
Total revenues 100 100
----- -----
Cost of revenues:
Software license fees and online revenues 25 9
Service revenues 15 3
Service revenues from IBM -- 25
----- -----
Total cost of revenues 40 37
----- -----
Gross profit 60 63
----- -----
Operating expenses:
Sales and marketing 75 79
Research and development 41 39
General and administrative 17 16
Amortization of intangible assets 25 --
Stock-based compensation 3 2
----- -----
Total operating expenses 162 136
----- -----
Operating loss (102) (73)
Interest income (expense) 5 (9)
Accretion of discount on debt -- (3)
Interest on beneficial conversion
feature of convertible debt -- (68)
----- -----
Loss before income taxes (97) (153)
----- -----
Income taxes -- --
----- -----
Net loss (97) (153)
Translation adjustment -- --
Comprehensive loss (97) (153)
===== =====
Three Months Ended December 31, 1999 and 1998
Revenues. Total revenues increased to approximately $7.9 million from
approximately $5.6 million for the three months ended December 31, 1999 and
1998, respectively. The increase of 41% year-over-year was primarily due to
growth of our domestic and international partner agreements, in which our Fusion
products and related intellectual property were bundled with products offered by
our partners. In addition, our enterprise business, which is comprised of
license and service offerings, grew substantially from the same period in the
previous fiscal year, due to continued expansion of our sales organization.
For the three months ended December 31, 1999 and 1998, international
revenues were $2.8 million and $1.0 million or 35% and 18% of total revenues,
respectively. The increase in the amount of international revenues from the
comparable quarter in the last fiscal year resulted mainly from new OEM
arrangements with Internet Service Providers (ISP) in Europe, and the generation
of revenues from our professional services business.
IBM software license fees for the three months ended December 31, 1999 and
1998 were $1.3 million and $1.3 million, respectively. In the current quarter,
we signed an agreement with IBM, in which they made a commitment to bundle
NetObjects Fusion with one of their offerings, for $1 million in revenue. The
remaining $0.3 million represents our current run rate of sales through existing
IBM bundled offerings. We anticipate that future sales will grow from the
current run rate.
In the current quarter, we had no IBM revenue from services as compared to
approximately $1.5 million in the quarter ended December 31, 1998. Our contract
to provide services to IBM ended in the second quarter of fiscal year 1999. We
do not anticipate additional service revenue from IBM in the future.
9
<PAGE>
Cost of Revenues. Our cost of software license fees includes the cost of product
media, duplication, manuals, packaging materials, shipping, technology licensed
to us and fees paid to third-party vendors for order fulfillment, and was
approximately $2.0 and $0.5 for the three months ended December 31, 1999 and
1998, respectively. This increase was due primarily to the inclusion of our new
Internet Service Provider (ISP) OEM arrangement to provide twelve months of web
hosting services with our Fusion 5.0 product.
Our cost of services increased to $1.2 million from $0.2 million in the
three months ended December 31, 1999 and 1998, respectively. The increase was
driven by the revenue growth in services and our continued investment in
staffing to handle future growth.
Gross margins for the three months ended December 31, 1999 were 60% versus
63% for the three months ended December 31, 1998. The decrease in gross margins
was due to the cost of shipping Fusion 5.0 and increased cost of service
revenues for reasons that are described above. We anticipate that these costs as
a percentage of revenues will continue at current levels. As revenue from the
sale of software license fees combined with ISP hosting agreements becomes a
larger part of our business and as we derive greater revenue from the sale of
services, our gross margins may be adversely affected.
Research and Development. Our research and development expenses consist
primarily of salaries and consulting fees to support product development. To
date, we have expensed all research and development costs as we have incurred
them because we generally establish the technological feasibility of our
products upon completion of a working model. We have not yet incurred
significant costs between the date of completion of a working model and the date
of general release of a product. We believe that continued investment in
research and development is critical to attaining our strategic objectives and,
as a result, we expect research and development expenses to continue to increase
in dollar amounts from current levels. Research and development expenses were
approximately $3.2 million and $2.2 million for the three months ended December
31, 1999 and 1998, respectively, representing approximately 41% and 39%,
respectively, of total revenues for each period. The increase in percentage
terms reflects our increased staffing and recruiting costs during the latest
period.
Sales and Marketing. Our sales and marketing expenses consist primarily of
salaries, commissions, consulting fees, tradeshow expenses, advertising,
marketing materials and the cost of customer service operations. We intend to
continue to increase staff in our enterprise sales organization and to expand
our aggressive brand building and marketing campaign. Therefore, we expect sales
and marketing expenses to continue to increase. Sales and marketing expenses
were approximately $5.9 million and $4.4 million for the three months ended
December 31, 1999 and 1998, respectively, representing 75% and 79%,
respectively, of total revenues for each period. The increased amount resulted
primarily from personnel growth in our enterprise division, increased sales
commissions, and costs related to the continued development and implementation
of our branding and marketing campaigns.
General and Administrative. Our general and administrative expenses consist
primarily of salaries and fees for professional services. We expect general and
administrative expenses to increase as we expand our staff and incur additional
costs related to growth of our business. General and administrative expenses
were approximately $1.4 and $0.9 for the three months ended December 31, 1999
and 1998, respectively, representing approximately 17% and 16%, respectively, of
total revenues for each period. The increased amount resulted primarily from
additional personnel and facility expenses related to our growth, and the added
cost associated with the financial reporting requirements of a public company.
Goodwill and amortization. Amortization of goodwill and related intangible
assets increased to $2.0 million from $0 for the three months ended December 31,
1999 and 1998, respectively. The increase was attributable to the purchase of
Sitematic Corporation (See Note 2).
Stock-Based Compensation. For the three months ended December 31, 1999 and 1998,
we incurred stock-based compensation charges of $0.2 million and $0.1 million,
respectively. These stock-based compensation charges are being amortized on an
accelerated basis over the vesting period of the options in a manner consistent
with Financial Accounting Standards Board (FASB) Interpretation No. 28.
Other Income (Expense). The Company earned interest income of $0.4 million for
the three months ended December 31, 1999. The interest income was the result of
the investment of funds obtained at our initial public offering ("IPO").
Interest expense for the three months ended December 31, 1998 consisted
primarily of interest on our borrowings and amounted to approximately $0.5
million. In addition, the Company recognized an interest charge of
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approximately $3.8 million on convertible debt to IBM and a related party, and
recognized an accretion of discount on debt to IBM of approximately $0.2 million
for the three months ended December 31, 1998.
Income taxes. We have had a net operating loss for each period since our
inception through December 31, 1999. Our accumulated deficit through this period
is approximately $81.4 million. We recorded an income tax provision of
approximately $12,000 in the three months ended December 31, 1999 for our
international operations.
Liquidity and Capital Resources
The portion of our accounts receivable balance over 90 days increased by
approximately $1.4 million from the quarter ended September 30, 1999. The
increase was due primarily to delays in payment from an OEM partner and our
major US distributor as we made the transition to Fusion 5.0.
At December 31, 1999, NetObjects had cash and cash equivalents totaling
$15.0 million, a decrease of $8.6 million from September 30, 1999. The decrease
was attributable to expenses incurred and cash paid in the acquisition of
Sitematic Corporation as well as to losses from continuing operations.
Total cash expense for the Sitematic acquisition was approximately $2.0
million, which includes approximately $1.6 million paid to Sitematic preferred
stockholders and transaction costs of $0.4 million.
Net cash used in operating activities was $7.8 million and $8.3 million for
the three months ended December 31, 1999 and December 31, 1998, respectively.
For the period ended December 31, 1999, net cash used in operating activities
included an increase in accounts receivable of approximately $3.5 million, due
to slower than expected collections, and an increase of approximately $1.1
million in other accrued liabilities due to accruals for future royalties.
Adjustments to reconcile net loss to net cash used in operating activities for
the period ended December 31, 1999 included amortization of goodwill of
approximately $2.0 million related to the Sitematic acquisition. For the period
ended December 31, 1998, net cash used in operating activities included a
decrease in deferred revenues of approximately $2.7 million, principally due to
recognition of prepayments from IBM. Adjustments to reconcile net loss to net
cash used in operating activities for the period ended December 31, 1998
included a nonrecurring interest charge of approximately $3.8 million related to
convertible debt provided by IBM and Perseus.
Net cash used in investing activities was $0.4 million and $0.7 million for
the three months ended December 31, 1999 and December 31, 1998, respectively.
The decrease was primarily attributable to the payment of cash to Sitematic
stockholders for their preferred stock, offset by the maturity of short-term
investments.
Net cash used in financing activities was approximately $0.4 million for
the three months ended December 31, 1999 and net cash provided by financing
activities for the three months ended December 31, 1998 was $9.8 million. Cash
provided by financing activities for the three months ended December 31, 1998
included the issuance of a short-term note to IBM and the issuance of preferred
stock, which was offset by repayment of a short-term note to IBM.
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 the net proceeds from our initial public offering, together with
our current cash and cash equivalents, 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. We
currently have no plans to remedy our deficiency in cash generated from
operations relative to anticipated expenditures.
Year 2000 Readiness
As of this date, we are not 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. There can be no assurance that
we will not discover Year 2000 compliance problems in the future that will
require substantial revisions or replacements. Any material Year 2000 problems
could require us to incur unanticipated expenses to remedy and could divert our
management's time and attention, which could cause our revenues to decrease and
our stock price to fall.
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RISK FACTORS
NetObjects believes that its results of operations in any 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 December 31, 1999, we had an accumulated deficit of
approximately $81.4 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 that 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 year 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' obligation to create localized versions of our software
expired on December 31, 1999. 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 future revenue commitments from IBM or
Lotus. Although we expect to continue licensing our products to IBM and Lotus as
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 December 31, 1999
IBM owns approximately 46% of our common stock and holds warrants that 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, and 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:
* IBM retains "freedom of action" to conduct its business and pursue other
business opportunities, even in competition with us;
* IBM has no obligation to refrain from investing in our competitors, doing
business with our customers or hiring away our key personnel;
* 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
* 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.
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Furthermore:
* IBM is eligible to sell its stock subject to applicable securities laws,
contractual arrangements with the 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
* 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. IBM may obtain access to the source code upon events of default related
to the Company's failure to provide required maintenance and support or its
bankruptcy or similar event of financial reorganization. IBM may use the source
code that it obtains to create derivative works, which it will own subject to
the Company's rights in the underlying software.
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 web site 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 web site 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. The Company
competes for small businesses customers with Web content software makers like
Adobe, Macromedia, and Microsoft; in the online web hosting and services with
providers like Verio, Bigstep, Icat, and Yahoo store. For our Enterprise
customers, we compete in the Internet application development and services
market with companies such as Interwoven, and Vignette. Microsoft's FrontPage, a
web site 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
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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.
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 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:
* the success of NetObjects Authoring Server will depend on the rapid
emergence of a market for large-scale enterprise web site and intranet
building products and services;
* 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;
* NetObjects Authoring Server may not meet customer performance needs or be
free of significant software defects or bugs;
* NetObjects Authoring Server will have a longer sales cycle than NetObjects
Fusion due to higher pricing and different marketing and distribution
characteristics;
* there are no product bundles of NetObjects Authoring Server with IBM or
Lotus; and
* we may not be able to recruit and retain the additional sales personnel
needed to effectively market NetObjects Authoring Server.
We depend heavily on bundling arrangements with third parties to sell our
products. We currently do not have any arrangements for bundling 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 acquisition of Sitematic Corporation, providing online
services to enable small businesses to conduct e-commerce has become an integral
part of our business growth strategy. Including the period during which
Sitematic operated these services they have been offered to customers generally
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.
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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 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, and 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
web site 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
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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 December 31, 1999 IBM owns approximately 46% of our outstanding stock
and holds warrants that if exercised, would increase its ownership to
approximately 53% of our outstanding voting securities. 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.
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.
Since 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.
Our international operations continue to expand and may not be successful.
International sales represented approximately 35% of our total revenues in
the quarter ended December 31, 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:
* difficulties in staffing and managing international operations;
* lower gross margins than in the United States;
* slower adoption of the Internet;
* longer payment cycles;
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* fluctuations in currency exchange rates;
* seasonal reductions in business activity during the summer months in Europe
and other parts of the world;
* recessionary environments in foreign economies; and
* 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.
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:
* implement and improve our operational systems, procedures and controls on a
timely basis;
* 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;
* implement and manage new distribution channels to penetrate different and
broader markets, including the market for intranet software products; and
* 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.
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 acquisitions of, or large investments in,
businesses that offer products, services and technologies that we believe would
help us better provide e-business web site and intranet site building software
and services to businesses. Although historically we have not made acquisitions
of, or investments in, other companies, this may become an important part of our
strategy. 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 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.
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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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's 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. The Company places its investments with
high quality credit issuers and, by policy, limits the amount of the credit
exposure to any one issuer. The Company manages interest rate risk by limiting
investments to debt securities of relatively short maturities. In addition, the
Company maintains sufficient cash and cash equivalents so that it can hold
investments to maturity.
At December 31, 1999, the Company had short-term investments with an
amortized cost of approximately $8.0 million, consisting of high-grade
commercial paper issued by US companies, with maturities of up to 90 days. The
Company has classified these debt securities as held-to-maturity.
The Company's 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, the Company implemented an investment policy that limits
purchases of debt securities to maturities of three months or less.
To date, the Company has 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.
18
<PAGE>
PART II: OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) During the quarter, NetObjects issued an aggregate of approximately 2.0
million shares of its common stock in exchange for the outstanding capital stock
of Sitematic Corporation. The shares were issued pursuant to an exemption by
reason of Section 4(2) of the Securities Act of 1933. These sales were made
without general solicitation or advertising. Each purchaser was an accredited
investor or a sophisticated investor with access to all relevant information
necessary. NetObjects has agreed to file a registration statement covering the
resale of such securities in May 2000.
During the quarter, NetObjects issued options to purchase 1,400,000 shares
of common stock, in the aggregate, to senior executives. NetObjects also
increased the number of shares reserved for issuance under its Amended and
Restated 1997 Stock Option Plan by 3,500,000 shares, from which option grants to
existing and new employees have been made. None of the foregoing options may be
exercised prior to stockholder ratification at the 2000 Annual Meeting of
Stockholders on March 15, 2000. NetObjects intends to register all of these
options by amendment to its currently effective Form S-8 registration statement.
(d) Since the IPO, we have invested approximately $1.6 million in the
Sitematic acquisition. We have used approximately $15.5 million to provide
working capital to maintain our business operations. The remainder of the
original net proceeds of $40.1 million, approximately $23 million, were invested
in cash, cash equivalents and short-term investments at December 31, 1999.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
27.1 Financial Data Schedule.
(b) Reports on Form 8-K.
The Company filed one report on Form 8-K during the quarter ended
December 31, 1999.
Date Subject of Report
---------- -----------------
October 19, 1999 Acquisition of Sitematic Corporation
December 20, 1999 Amendment to Form 8K filed October 19, 1999
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
NETOBJECTS, INC.
Date: February 14, 2000
/s/ Russell F. Surmanek
----------------------------------------
Russell F. Surmanek
Executive Vice President, Finance and
Operations and Chief Financial Officer
19
<PAGE>
INDEX TO EXHIBITS
Exhibit Number Description
- -------------- -----------
27.1 Financial Data Schedule
20
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE TABLE BELOW HOLD SUMMARY FINANCIAL INFORMATION CONTAINED IN NETOBJECTS,
INC. INTERIM FINANCIAL REPORT ON FORM 10-Q FOR THE PERIOD ENDED DECEMBER
31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
DATA SCHEDULES.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-30-2000
<PERIOD-END> DEC-31-1999
<CASH> 15,041
<SECURITIES> 7,952
<RECEIVABLES> 10,790
<ALLOWANCES> (1,192)
<INVENTORY> 291
<CURRENT-ASSETS> 33,920
<PP&E> 5,893
<DEPRECIATION> (3,428)
<TOTAL-ASSETS> 50,501
<CURRENT-LIABILITIES> 8,119
<BONDS> 0
0
0
<COMMON> 271
<OTHER-SE> 41,957
<TOTAL-LIABILITY-AND-EQUITY> 50,501
<SALES> 0
<TOTAL-REVENUES> 7,909
<CGS> 3,187
<TOTAL-COSTS> 12,782
<OTHER-EXPENSES> 374
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 7
<INCOME-PRETAX> (7,686)
<INCOME-TAX> 12
<INCOME-CONTINUING> (7,698)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,709)
<EPS-BASIC> (0.29)
<EPS-DILUTED> (0.29)
</TABLE>
