<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES AND EXCHANGE ACT OF 1934
For the period from _______ to _______.
Commission File Number: 000-21751
FIRST VIRTUAL HOLDINGS INCORPORATED
(Exact Name of Registrant as specified in its charter)
Delaware 33-0612860
------------------- -------------------------
(State or jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
11975 EL CAMINO REAL #200
SAN DIEGO, CA 92130
(Address, including zip code, of principal executive offices)
(619) 793-2700
(Registrant's telephone number, including area code)
N/A
(Former name, former address & 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 [ ]
Applicable Only to Issuers Involved in Bankruptcy
Proceedings During the Preceding Five Years
Indicate by check mark whether the registrant has filed all documents
and reports to be filed by sections 12,13, or 15(d) of the Securities Exchange
Act of 1934 subsequent to the distribution of securities under a plan confirmed
by the court. Yes [ ] No[ ]
Applicable Only to Corporate Issuers
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practical date.
Common Stock, $0.001 Par Value - 8,883,599 shares as of September 30, 1997.
<PAGE> 2
FIRST VIRTUAL HOLDINGS INCORPORATED
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets as of September 30, 1997 (unaudited) and
December 31, 1996 3
Statements of Operations for the three months (unaudited) and nine
months ended September 30, 1997(unaudited) and 1996 4
Statements of Cash Flows for the nine months ended September 30, 1997
(unaudited) and 1996 5
Notes to the Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 8
Factors Affecting Operating Results & Market Price of Stock 12
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 27
Item 2. Changes in Securities 27
Item 3. Defaults upon Senior Securities 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 5. Other Information 27
Item 6. Exhibits and Reports on Form 8-K 27
SIGNATURES 28
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FIRST VIRTUAL HOLDINGS INCORPORATED
BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------ ------------
(unaudited)
<S> <C> <C>
ASSETS
(unaudited)
Current assets:
Cash and cash equivalents $ 5,315,133 $ 17,127,971
Short-term investment, available-for-sale -- 200,000
Accounts receivable 319,517 88,278
Prepaid expenses and other 120,591 83,840
------------ ------------
Total current assets 5,755,241 17,500,089
Furniture, equipment and software, net 1,793,298 1,964,635
Information technology, net 26,565 59,226
Organization and other costs, net 84,672 105,798
Deposits and other 158,433 62,809
------------ ------------
Total assets $ 7,818,209 $ 19,692,557
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,091,299 $ 1,626,198
Accrued compensation and related liabilities 254,144 372,739
Accrued interest 265,903 196,340
Deferred revenue 670,917 64,683
Other accrued liabilities 588,446 576,077
Current portion, due to stockholders 1,600,000 400,000
------------ ------------
Total current liabilities 4,470,709 3,236,037
Amount due to stockholder 200,000 312,500
Notes payable to stockholders -- 1,200,000
------------ ------------
Total long term liabilities 200,000 1,512,500
Stockholders' equity:
Preferred stock, 5,000,000 shares authorized, none
outstanding at September 30, 1997 and December 31, 1996 -- --
Common stock, $0.001 par value; 40,000,000 shares authorized,
8,883,599 and 8,794,812 shares issued and outstanding at
September 30, 1997 and December 31, 1996, respectively 8,884 8,795
Additional paid-in-capital 25,999,991 25,758,015
Stock Options 52,138 --
Warrants 3,017,115 3,017,115
Deferred compensation (162,092) (44,305)
Accumulated deficit (25,768,536) (13,795,600)
------------ ------------
Total stockholders' equity 3,147,500 14,944,020
------------ ------------
Total liabilities and stockholders' equity $ 7,818,209 $ 19,692,557
============ ============
</TABLE>
See accompanying notes.
3
<PAGE> 4
FIRST VIRTUAL HOLDINGS INCORPORATED
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
1997 1996 1997 1996
------------ ------------ ------------ ------------
(unaudited) (unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenues $ 325,921 $ 97,180 $ 1,111,905 $ 498,262
Cost of Revenues 45,677 49,648 217,662 218,796
------------ ------------ ------------ ------------
Gross Profit 280,244 47,532 894,243 279,466
Operating Expenses:
Marketing and sales 1,843,868 422,946 4,015,239 745,006
Research, development
and engineering 1,817,490 1,380,454 4,876,311 2,327,296
General and administrative 962,919 1,606,307 3,536,161 2,962,193
Depreciation and amortization 274,868 161,744 821,901 297,382
------------ ------------ ------------ ------------
Total operating expenses 4,899,145 3,571,451 13,249,612 6,331,877
------------ ------------ ------------ ------------
Loss from operations (4,618,901) (3,523,919) (12,355,369) (6,052,411)
Interest income 103,256 73,439 452,939 152,674
Interest expense (21,562) (24,000) (70,506) (80,577)
------------ ------------ ------------ ------------
Net loss $ (4,537,207) $ (3,474,480) $(11,972,936) $ (5,980,314)
============ ============ ============ ============
Net loss per share $ (0.51) $ (0.40) $ (1.36) $ (0.72)
Shares used in per share
computation 8,876,032 8,659,442 8,827,919 8,335,199
</TABLE>
See accompanying notes.
4
<PAGE> 5
FIRST VIRTUAL HOLDINGS INCORPORATED
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------
1997 1996
------------ ------------
(unaudited)
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $(11,972,936) $ (5,980,314)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 821,901 302,843
Common stock issued for services -- 20,000
Compensation expense recognized for stock options 52,138 --
Changes in operating assets and liabilities:
Accounts receivable (231,239) (88,745)
Prepaid expenses and other (36,751) (24,789)
Deposits and other (95,624) (421,911)
Accounts payable (534,899) 745,976
Accrued compensation and related liabilities (118,595) 155,840
Deferred revenue 606,234 42,793
Accrued interest 69,563 72,000
Amount (paid to)/received from stockholder (112,500) 750,000
Other accrued liabilities 12,369 54,495
------------ ------------
Net cash used in operating activities (11,540,339) (4,371,812)
INVESTING ACTIVITIES
Additions to furniture and equipment (net) (581,208) (1,420,633)
Maturity/(purchase) of short-term investment 200,000 (200,000)
Organization and other costs -- (54,654)
------------ ------------
Net cash used in investing activities (381,208) (1,675,287)
FINANCING ACTIVITIES
Proceeds from issuance of Series B
preferred stock, net of issuance costs -- 1,365,775
Proceeds from issuance of Series C
preferred stock, net of issuance costs -- 1,928,189
Proceeds from issuance of Series D
preferred stock, net of issuance costs -- 2,990,837
Proceeds from issuance of common stock,
net of issuance costs 58,709 535,477
Proceeds from issuance or extension
of warrants 50,000 3,017,115
Proceeds from bank borrowings -- 486,111
Repayment of bank borrowings -- (486,111)
------------ ------------
Net cash provided by financing activities 108,709 9,837,393
Net (decrease)/increase in cash and cash equivalents (11,812,838) 3,790,294
Cash and cash equivalents at the beginning
of period 17,127,971 2,091,651
------------ ------------
Cash and cash equivalents at the end
of period $ 5,315,133 $ 5,881,945
============ ============
</TABLE>
See accompanying notes.
5
<PAGE> 6
FIRST VIRTUAL HOLDINGS INCORPORATED
NOTES TO THE FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The interim unaudited financial statements included herein have been prepared by
First Virtual Holdings Incorporated (the "Company"), in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all the information and disclosures required by
generally accepted accounting principles for complete financial statements.
These financial statements should be read in conjunction with the financial
statements and notes thereto for the year ended December 31, 1996, included in
the Company's Annual Report on Form 10-K. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation of the financial position of the Company as of September 30,
1997, and the results of operations for the three month and nine month periods
ended September 30, 1997 and 1996, and the changes in cash flows for the nine
months ended September 30, 1997 and 1996, have been included. The results of
operations for the interim period ended September 30, 1997 are not necessarily
indicative of the results which may be reported for any other interim period or
for the year ending December 31, 1997.
Reclassification of Expenses
On January 1, 1997, the Company reclassified certain expenses relating to its
operations from general and administrative expenses to research, development and
engineering expenses or cost of revenues. The net result of this
reclassification had no effect on the net loss of the Company. For the three
months and nine months ended September 30, 1996, approximately $423,000 and
$826,000 were reclassified as research, development and engineering expenses,
respectively, and approximately $50,000 and $219,000 were reclassified as cost
of revenues, respectively, which had previously been included in general and
administrative expenses.
2. INCOME TAXES
On May 24, 1995, in conjunction with the issuance of Series A Preferred Stock,
the Company changed its status for federal and state income tax purposes from an
S Corporation (whereby the Corporation's operating gains and losses flowed
through to the stockholders for tax purposes) to become a C Corporation (whereby
the Company is subject to federal and state income taxes). The Company accounts
for income taxes in accordance with Statement of Financial Accounting Standards
No. 109.
At December 31, 1996, the Company had federal and state net operating loss
carryforwards of approximately $11,300,000. These federal and state net
operating loss carryforwards will begin to expire in 2010 and 2000,
respectively, unless previously utilized. The Company also had federal and state
research credit carryforwards of approximately $185,000 and $78,000,
respectively, which will begin expiring in 2010, unless previously utilized.
Pursuant to Internal Revenue Code Section 382 and 383, use of the Company's net
operating loss and tax credit carryforwards may be limited if a cumulative
change in ownership of more than 50% occurs within a three year period.
6
<PAGE> 7
3. NET LOSS PER SHARE
The Company's net loss per share calculations are based upon the weighted
average number of shares of Common Stock outstanding. Pursuant to the
requirements of the SEC Staff Accounting Bulletin No. 83, convertible Preferred
Stock, convertible Preferred Stock warrants, Common Stock, and options to
purchase Common Stock issued at prices below the sales price to the public of
Common Stock sold in the Company's initial public offering ("IPO") during the
twelve months immediately preceding the IPO, have been included in the
computation of net loss per share as if they were outstanding through the date
of the Company's IPO for all periods presented (using the treasury method
assuming repurchase of Common Stock at the IPO price). Other shares issuable
upon the exercise of stock options have been excluded from the computation
because the effect of their inclusion would be antidilutive. Subsequent to the
IPO, options and warrants under the treasury stock method are only included to
the extent that their inclusion would be dilutive. Accordingly the number of
shares used in computing net loss per share for the three months and nine months
ended September 30, 1997, excludes: (i) the warrants held by First USA Merchant
Services to purchase 1,328,006 shares of Common Stock at an exercise price of
$0.01 per share, (ii ) the 3,365,418 shares of Common Stock reserved for
issuance under the Company's stock option plans, of which 2,086,140 shares were
subject to outstanding options at September 30, 1997, at a weighted average
exercise price of $4.45 per share, (iii) an aggregate of 1,000,000 shares of
Common Stock subject to additional outstanding options at September 30, 1997 at
an exercise price of $6.30 per share and (iv) an aggregate of 94,567 shares of
Common Stock reserved for issuance under the Company's Employee Stock Purchase
Plan. The First USA Merchant Services warrant and certain of the other
outstanding options were included in the number of shares used in computing net
loss per share for the three months and nine months ended September 30, 1996
pursuant to certain requirements of the SEC.
4. COMMITMENTS
First Virtual and ESPN/StarWave Partners have entered into an agreement whereby
First Virtual will pay monies for (i) promotional opportunities that are
exclusive to First Virtual and (ii) twelve million cumulative banner impressions
advertising First Virtual or one of its partners on certain web sites operated
by ESPN/Starwave Partners.* These payments are being made over a six month
period through January 1998.
5. SUBSEQUENT EVENT
On October 22, 1997, First Virtual completed a private placement of securities
to a New York-based investment group, with net proceeds to the Company of $4.9
million. The securities sold consisted of 1,000 shares of Series A Convertible
Preferred Stock, and warrants to purchase up to 850,000 shares of First Virtual
Common Stock at $5.75 per share. The Series A Convertible Preferred Stock is
convertible into Common Stock at the option of the investors at a per share
conversion price equal to the lesser of $5.50 or 80% of the average closing bid
price of the Common Stock for the prior ten days. The Series A Convertible
Preferred Stock is redeemable for cash under certain circumstances and carries
an annual dividend of 7% payable in cash or shares of Common Stock.
- -------------
*This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will meet
the Company's current expectations. Investors are strongly encouraged to review
the section entitled "Factors Affecting Operating Results and Market Price of
Stock" commencing on page 12, for a discussion of factors that could affect
future performance. The reader is cautioned that other sections not so
identified may also contain forward looking information.
7
<PAGE> 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This 10-Q report contains, in addition to historical information,
forward-looking statements that involve risks and uncertainties. The Company's
actual results may differ significantly from the results discussed in the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those discussed in the subsection entitled "Factors
Affecting Operating Results and Market Price of Stock" commencing on page 12 .
Certain sections in this report have been identified as containing
forward-looking statements. The reader is cautioned that other sections and
other sentences not so identified may also contain forward-looking information.
In addition to operating the First Virtual Internet Payment System ("FVIPS"),
developing a "tool kit" to build VirtualTAGs and building a "back end"
technology used to monitor performance of its VirtualTAGs, First Virtual
Holdings Incorporated ("First Virtual" or "the Company") is currently developing
an integrated electronic commerce solution, the Interactive Messaging Platform.
This service will allow merchants and credit card issuers to take advantage of a
sophisticated messaging system that facilitates relationship marketing on the
Internet and also provides a marketing system with an integrated payment
system.* The Interactive Messaging Platform represents the integration of First
Virtual's existing services and technology, which includes the FVIPS, the
VirtualPIN and VirtualTAG. The Interactive Messaging Platform has not been
commercially released and has not generated any significant revenues or customer
commitments to date. The Company anticipates that development and commercial
introduction of the Interactive Messaging Platform will entail significant
research, development and engineering expenses and sales and marketing expenses
during the next four quarters.*
First Virtual has previously developed and implemented the VirtualPIN
architecture which facilitates Internet commerce and is designed to facilitate
other forms of interactive Internet communications. The VirtualPIN architecture
and the Interactive Messaging Platform use e-mail, which has the widest reach
and broadest use of any Internet application. FVIPS, a secure and easy-to-use
payment system introduced in October 1994, was the Company's first application
of the VirtualPIN architecture. In the fourth quarter of 1996, the Company
introduced VirtualTAG. The VirtualTAG is an interactive advertising applet
within banners or "roving store fronts" which is designed to allow consumers to
initiate the purchase and payment and arrange for the delivery of a product
without leaving the web page on which the advertisement appears. The Company
believes VirtualTAG may become one of the first solutions to take full advantage
of the Internet's unique attributes by combining advertising, selling and paying
all in one application.* In December 1996, the Company launched 1Virtual Place,
an on-line Internet retail environment. In late June 1997, the Company launched
VPIN Central, a web site that presents marketing opportunities for VirtualPIN
merchants. Some of these initiatives have had greater success than others and
some have been scaled back due to insufficient revenue results. The Company
believes that the VirtualPIN architecture can also serve as the basis for
additional Internet applications including direct marketing, interactive
advertising, merchandising, subscriptions and renewals, bill presentment and
payment, client response surveys and Internet communications.*
The Company has incurred net operating losses in each quarter since inception.
As of September 30, 1997, the Company had an accumulated deficit of
approximately $25.8 million. To date, the Company has not generated significant
revenues. There can be no assurance that the Company's future revenues will
increase and the Company's ability to generate significant future revenues is
subject to substantial uncertainty. In addition, as a result of the anticipated
significant investments that the Company plans to make in its systems, sales,
marketing, research and development, customer support and administrative
infrastructure over the near term, the Company expects to continue to incur
significant operating losses on both a quarterly and an annual basis for the
foreseeable future.
- -------------
*This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will meet
the Company's current expectations. Investors are strongly encouraged to review
the section entitled "Factors Affecting Operating Results and Market Price of
Stock" commencing on page 12, for a discussion of factors that could affect
future performance. The reader is cautioned that other sections not so
identified may also contain forward looking information.
8
<PAGE> 9
RESULTS OF OPERATIONS
Revenues
The Company generates revenues from FVIPS, merchandising, interactive
advertising development and consulting, as detailed in the table below:
<TABLE>
<CAPTION>
THREE MONTHS ENDING SEPTEMBER 30, NINE MONTHS ENDING SEPTEMBER 30,
1997 1996 1997 1996
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Internet payment system $ 285,366 $ 59,680 $ 695,530 $ 460,762
Merchandising 4,305 -- 43,875 --
Interactive advertising development -- -- 115,000 --
Consulting 36,250 37,500 257,500 37,500
---------- ---------- ---------- ----------
Total revenues $ 325,921 $ 97,180 $1,111,905 $ 498,262
</TABLE>
Revenues increased to $325,921 for the quarter ended September 30, 1997 as
compared with $97,180 for the quarter ended September 30, 1996. This increase is
attributable primarily to revenues from FVIPS. For the quarter ending September
30, 1997, revenues from FVIPS benefited from bulk sales of consumer and merchant
registrations that occurred at the end of the first quarter 1997. Also, in
August 1997, the Company increased the consumer registration fees for both new
accounts and renewals. In July 1996, the Company began to recognize consumer and
merchant registration and renewal fees over a 12 month period. Prior to July 1,
1996, revenues from registration fees were recognized in the month the
consumer's or the merchant's registration fee was processed and the VirtualPIN
was issued. Revenues for the third quarter declined by $67,146 from the second
quarter of 1997, due primarily to a decline in consulting revenue and due to a
reallocation of technical resources to build a "toolkit" to build VirtualTAGs,
which led to the absence of interactive advertising development revenue in the
third quarter.
For the nine months ended September 30, 1997, revenues increased to $1,111,905
as compared to $498,262 for the nine months ended September 30, 1996. This
increase is attributable to a general increase in all categories of revenue.
Revenues from merchandising and interactive advertising development increased in
1997, as compared to the first nine months of 1996, as First Virtual began
selling on-line merchandise in December 1996 and VirtualTAGs in January 1997.
Consulting revenue increased for the nine months ended September 30, 1997 as
First Virtual experienced greater demand for Internet related consulting in 1997
and FVIPS revenue increased in 1997 for the nine months ended September 30,
1997, as a result of bulk sales of consumer and merchant registrations and an
increase in registration fees.
Operating Expenses
Operating expenses consist of marketing and sales, research, development and
engineering, and general and administrative expenses. The Company anticipates
that operating expenses will increase in connection with increasing levels of
research, development and engineering needed for the Interactive Messaging
Platform and other newly introduced or enhanced products and services, as well
as for related growth in the marketing and sales organization, and expansion of
the Company's support organization to accommodate new and existing customers.*
- -------------
*This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will meet
the Company's current expectations. Investors are strongly encouraged to review
the section entitled "Factors Affecting Operating Results and Market Price of
Stock" commencing on page 12, for a discussion of factors that could affect
future performance. The reader is cautioned that other sections not so
identified may also contain forward looking information.
9
<PAGE> 10
Marketing and sales expenses. Marketing and sales expenses, which include
salaries and wages, consulting fees, advertising, trade show expenses, travel
and other marketing expenses, increased to $1.8 million for the quarter ended
September 30, 1997, as compared to $423,000 for the quarter ended September 30,
1996. This increase is attributable primarily to an increase in salaries, wages
and payroll taxes of approximately $400,000, as well as to an increase in
advertising and promotional expenses of approximately $435,000, an increase in
consulting expenses of approximately $405,000, and a general increase in
spending of approximately $135,000 to support the Company's expanding marketing
and sales activities. The Company expects that marketing and sales expenses will
increase significantly in the future as the Company implements its marketing
plan to introduce its Interactive Messaging Platform.*
For the nine months ended September 30, 1997, marketing and sales expenses
increased to $4.0 million as compared to $745,000 for the nine months ended
September 30, 1996. This increase resulted primarily from increases in salaries,
wages and payroll taxes of approximately $1.6 million, an increase in
advertising and promotional expenses of $510,000, a consulting expense increase
of approximately $565,000, a recruiting and relocation expense increase of
approximately $150,000, a travel expense increase of approximately $110,000, and
a general increase in spending of approximately $320,000 to support the
Company's expanding marketing and sales activities.
Research, development and engineering expenses. Research, development and
engineering expenses which include salaries and wages and consulting fees to
support the development, enhancement and maintenance of the Company's products
and services, increased to $1.8 million for the quarter ended September 30,
1997, as compared to $1.4 million for the quarter ended September 30, 1996. This
increase is primarily due to an increase in salaries, wages and payroll taxes of
approximately $510,000, as well as to a general increase of approximately
$110,000 to support the expansion of the Company's research, development and
engineering activities, offset by a reduction in consulting expenses of
approximately $220,000. To date, all of the Company's software development costs
have been expensed as incurred. The Company anticipates that research,
development and engineering expenses will increase in future periods as the
Company leverages the VirtualPIN architecture to offer new products and
services, such as the Interactive Messaging Platform, along with enhancing the
functionality of FVIPS and VirtualTAGs.*
For the nine months ended September 30, 1997, research, development and
engineering expenses increased to $4.9 million as compared to $2.3 million for
the nine months ended September 30, 1996. This increase resulted primarily from
increases in salaries, wages and payroll taxes of approximately $1.6 million, a
consulting expense increase of approximately $390,000, and a general increase in
spending of approximately $610,000 to support the expansion of the Company's
research, development and engineering activity, which included the establishment
of a second data processing center in San Diego, California.
General and administrative expenses. General and administrative expenses consist
primarily of salaries and wages, professional and consulting fees and other
expenses associated with the general management and administration of the
Company. General and administrative expenses decreased to $963,000 for the
quarter ended September 30, 1997, as compared to $1.6 million for the quarter
ended September 30, 1996. This decrease is primarily due to the $1.0 million,
one-time charge that the Company incurred for the three months ended September
30, 1996, relating to a payment to First USA Merchant Services in consideration
for the waiver of certain exclusive processing rights, offset by an increase of
approximately $90,000 in salaries, wages and payroll taxes and an increase in
spending of approximately $270,000 to support the expansion of the Company's
corporate office.
- --------------
*This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will meet
the Company's current expectations. Investors are strongly encouraged to review
the section entitled "Factors Affecting Operating Results and Market Price of
Stock" commencing on page 12, for a discussion of factors that could affect
future performance. The reader is cautioned that other sections not so
identified may also contain forward looking information.
10
<PAGE> 11
For the nine months ended September 30, 1997, general and administrative
expenses increased to $3.5 million as compared to $3.0 million for the nine
months ended September 30, 1996. This increase resulted primarily from increases
in salaries, wages and payroll taxes of approximately $985,000, and an increase
of approximately $550,000 in promotional expenses, offset by a $1.0 million,
one-time charge that the Company incurred for the nine months ended September
30, 1996, relating to a payment to First USA Merchant Services in consideration
for the waiver of certain exclusive processing rights and a general reduction in
spending of approximately $35,000.
The Company expects to experience significant fluctuations in its future
quarterly operating results.* These fluctuations will be due to several factors,
many of which are beyond the control of the Company, including, among others,
market response to the Company's Interactive Messaging Platform; difficulties
encountered in the development or deployment of products or services, including
interactive messaging; market acceptance of Internet commerce in general and
FVIPS and the VirtualPIN concept in particular; fluctuating market demand for
the Company's products and services including the rate of merchant and consumer
registrations; the monthly volume and average dollar amount of transactions
using FVIPS; the degree of acceptance of the Internet as an advertising and
merchandising medium; the fees charged to the Company by third party processors
and financial institutions; the timing and effectiveness of collaborative
marketing efforts initiated by the Company's strategic partners; the timing of
the introduction of new products and services offered by the Company; the timing
of the release of enhancements to the Company's products and services; product
introductions and service offerings by the Company's competitors; the mix of the
products and services provided by the Company; the timing and rate at which the
Company increases its expenses to support projected growth; the cost of
compliance with applicable government regulations; competitive conditions in the
Company's marketplace; and general economic conditions. In addition, the fees
charged by the Company for consumer and merchant registration, advertising,
messaging, consulting services, transaction processing and co-marketing are
subject to change as the Company introduces its Interactive Marketing Platform,
continues to roll out FVIPS upgrades and its VirtualTAG "toolkit", and assess
its marketing strategy and competitive position.
LIQUIDITY AND CAPITAL RESOURCES
The Company finances its operations primarily through cash raised in its IPO and
private placements of its securities. On December 13, 1996, the Company received
net proceeds of approximately $15.0 million from its IPO. Prior to the IPO, the
Company funded its operations and satisfied its capital expenditure requirements
primarily through private sales of capital stock and borrowings under certain
subordinated lines of credit provided by two stockholders. The Company, prior to
the IPO, had raised $13.7 million from the sale and issuance of its Preferred
Stock, Common Stock and warrants, and $1.2 million of principal under the
stockholder lines of credit. The borrowings from such stockholders accrue
interest at 8% per annum and are due and payable upon the earlier of (i) January
31, 1998, or (ii) the closing of an underwritten public offering (other than the
IPO) of shares of the Company's Common Stock.
Operating activities used cash of $11.5 million during the nine months ended
September 30, 1997. Net cash used during this period was primarily to fund net
operating expenses of $11.1 million (excluding depreciation, amortization and
compensation expense recognized for stock options), reduce accounts payable and
other accrued liabilities by $653,500, pay down an amount due to a stockholder
of $112,500 and increase prepaid expenses, deposits and accounts receivable by
$363,500, offset by increases in deferred revenue of $606,000 and accrued
interest of $69,500.
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*This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will meet
the Company's current expectations. Investors are strongly encouraged to review
the section entitled "Factors Affecting Operating Results and Market Price of
Stock" commencing on page 12, for a discussion of factors that could affect
future performance. The reader is cautioned that other sections not so
identified may also contain forward looking information.
11
<PAGE> 12
Capital expenditures have been, and future capital expenditures are expected to
be, primarily for facilities, furniture and capital equipment to support the
expansion of the Company's operations and management information systems.*
Capital expenditures were $581,000 and $1.4 million for the nine months ended
September 30, 1997 and 1996, respectively. Furniture and equipment are stated at
cost and depreciated over three to five years using the straight line method.
At September 30, 1997, the Company had $5.3 million in cash and cash
equivalents. In October 1997, the Company completed a private placement of
securities with net proceeds to First Virtual of $4.9 million. The Company
believes that existing cash resources will be sufficient to support the
Company's currently anticipated working capital and capital expenditure
requirements through the second half of 1998.* The Company anticipates that it
will need to raise additional funds through the public or private sale of its
equity or debt securities or from other sources in 1998. The timing and amount
of the Company's capital requirements will depend on a number of factors,
including demand for the Company's products and services, the need to develop
new or enhanced products and services, competitive pressures and the
availability of complementary businesses or technologies that the Company may
wish to acquire. If additional funds are raised through the issuance of equity
securities, the percentage ownership of the Company's stockholders will be
diluted and such equity securities may have rights, preferences or privileges
senior to those of the holders of the Company's Common Stock. There can be no
assurance that additional financing will be available when needed or that, if
available, such financing will include terms favorable to the Company or its
stockholders. If adequate funds are not available on acceptable terms, the
Company may be unable to develop or enhance its products and services, take
advantage of opportunities or respond to competition, any of which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
FACTORS AFFECTING OPERATING RESULTS AND MARKET PRICE OF STOCK
First Virtual operates in a rapidly changing environment that involves a number
of uncertainties, some of which are beyond the Company's control. In addition to
the uncertainties described elsewhere in this report, these uncertainties
include:
HISTORY OF OPERATING LOSSES AND ANTICIPATED FUTURE LOSSES; LIMITED OPERATING
HISTORY
The Company has incurred net operating losses in each quarter since its
inception in March 1994. As of September 30, 1997, the Company had an
accumulated deficit of approximately $25.8 million. To date, the Company has not
generated significant revenues. There can be no assurance that the Company's
revenues will increase in the future. In addition, as a result of the
anticipated significant investment that the Company is making and plans to
continue to make in its systems, sales, marketing, research, development and
engineering, customer care and administrative infrastructure over the near term,
the Company expects to continue to incur significant operating losses on both a
quarterly and an annual basis for the foreseeable future. For these and other
reasons, there can be no assurance that the Company will ever achieve or be able
to sustain profitability.
The Company commenced operations in March 1994, launched FVIPS in October 1994,
and began recognizing revenues in the fourth quarter of 1994. The Company has a
limited operating history upon which to base an evaluation of its business and
prospects. The Company and its business prospects must be considered in light of
the risks, expenses and difficulties frequently encountered by companies in the
new and rapidly evolving market for Internet products and services. To address
these risks, the Company must, among other things, successfully respond to
competitive developments, market additional Internet commerce services, upgrade
its technologies and commercialize products and services incorporating such
technologies, and attract, retain and motivate qualified personnel. There can be
no assurance that the
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*This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will meet
the Company's current expectations. Investors are strongly encouraged to review
the section entitled "Factors Affecting Operating Results and Market Price of
Stock" commencing on this page for a discussion of factors that could affect
future performance. The reader is cautioned that other sections not so
identified may also contain forward looking information.
12
<PAGE> 13
Company will succeed in addressing any or all of these risks, and the failure to
do so would have a material adverse effect on the Company's business, financial
condition and results of operations. Furthermore, the limited operating history
of the Company makes the prediction of future results of operations very
difficult. Accordingly, the Company believes that period-to-period comparisons
of its operating results are not meaningful and that the results for any period
should not be relied upon as an indication of future performance.
ANTICIPATED FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
As a result of the early stage of development of the Interactive Messaging
Platform, FVIPS, VirtualTAGs and Internet commerce and the Company's limited
operating history, the Company's revenue expectations are based almost entirely
on internal estimates of future demand and not on actual experience. In
particular, it is difficult to forecast revenue expectations for the Interactive
Messaging Platform, since currently, the Interactive Messaging Platform strategy
is under development. Moreover, the Company has only limited historical
financial data for quarterly or annual periods on which to base planned
operating expenses. The Company's expense levels have been established in large
part due to its current expectations for future revenues and its expected
development and marketing requirements. In the event market demand and revenues
do not meet expectations, the Company may be unable to adjust its spending
levels on a timely basis to compensate for unexpected revenue shortfalls. To a
certain extent, the Company has encountered this problem to date. As a result,
the Company has not and may not be able to take advantage of revenue
opportunities as quickly as it would hope, because of an effort to scale down
its infrastructure to match lower than expected revenues. There can be no
assurance that revenues associated with use of the VirtualPIN, FVIPS or the
Interactive Messaging Platform will increase significantly, or at all. Any
material shortfall of demand for the Company's products and services would have
a material adverse effect on the Company's business and financial condition and
could cause significant fluctuations in the Company's results of operations.
The Company expects its future operating results over both the short and the
long term will be subject to annual and quarterly fluctuations due to several
factors, many of which are beyond the control of the Company, including, among
others, market response to the Company's Interactive Messaging Platform;
difficulties encountered in the development or deployment of products or
services, including interactive messaging; market acceptance of Internet
commerce in general and FVIPS and the VirtualPIN concept in particular;
fluctuating market demand for the Company's products and services including the
rate of merchant and consumer registrations; the monthly volume and average
dollar amount of transactions using FVIPS; the degree of acceptance of the
Internet as an advertising and merchandising medium; the fees charged to the
Company by third party processors and financial institutions; the timing and
effectiveness of collaborative marketing efforts initiated by the Company's
strategic partners; the timing of the introduction of new products and services
offered by the Company; the timing of the release of enhancements to the
Company's products and services; product introductions and service offerings by
the Company's competitors; the mix of the products and services provided by the
Company; the timing and rate at which the Company increases its expenses to
support projected growth; the cost of compliance with applicable government
regulations; competitive conditions in the Company's marketplace; and general
economic conditions. In addition, the fees charged by the Company for consumer
and merchant registration, advertising, messaging, consulting services,
transaction processing and co-marketing are subject to change as the Company
introduces its Interactive Marketing Platform, continues to roll out FVIPS
upgrades and its VirtualTAG "toolkit", and assess its marketing strategy and
competitive position. The Company believes that period-to-period comparisons of
its operating results are not meaningful and should not be relied upon as any
indication of future performance. Due to the foregoing factors, among others, it
is probable and possible, that the Company's future quarterly or annual
operating results from time to time will not meet the expectations of market
analysts or investors, which may have a material adverse effect on the price of
the Company's Common Stock.
13
<PAGE> 14
RISKS RELATED TO PRODUCT TRANSITION
The Company has derived substantially all of it revenues to date from, and has
devoted substantially all its research, development, engineering and marketing
resources to, FVIPS, VirtualTAGs and related services. In the second quarter of
fiscal 1997, the Company determined to refocus it resources on developing and
commercializing the Interactive Messaging Platform. The Interactive Messaging
Platform has not yet been commercially introduced and the Company has to date
not secured any significant customer commitments to license, use or implement
the Interactive Messaging Platform. Moreover, because the Interactive Messaging
Platform represents a departure from traditional methods of marketing and
information exchange, the market prospects for the Interactive Messaging
Platform are highly uncertain. Acceptance of the Interactive Messaging Platform
will require a transition to new ways of conducting business by enterprises that
have already made substantial investments in other means of conducting commerce
and exchanging information. In addition, since development of the technologies
underlying the Interactive Messaging Platform has not been completed, and since
the Interactive Messaging Platform has not yet been implemented other than on a
test basis, no assurance can be given that development of the Interactive
Messaging Platform will be successfully completed, that the cost of development
will not exceed future revenues generated by the Interactive Messaging Platform,
that prospective customers will be able to implement the Interactive Messaging
Platform without substantial additional cost, or that the Company's current
server capacity and communications systems will be adequate to support high
volumes of Interactive Messaging Platform usage. Moreover, the development and
introduction of the Interactive Messaging Platform has required the Company to
substantially curtail the resources devoted to development and enhancement of
FVIPS, and related technologies and services, and has limited the ability of the
Company's management and marketing and sales staff to pursue the Company's goal
of increasing FVIPS usage, sales of VirtualTAGs and merchant and consumer
registrations. As a result, the Company's FVIPS-related revenues,
VirtualTAG-related revenues and the number of new merchant and consumer
registrations declined during the third quarter of fiscal 1997, and may continue
to decline in future periods. Unless the Interactive Messaging Platform is
successfully introduced and marketed, and unless revenues from the Interactive
Messaging Platform are sufficient to return the cost of its development and to
compensate for adverse effect on FVIPS-related and VirtualTAG-related revenues,
the Company's business, financial condition and results of operation will be
materially and adversely affected.
DEPENDENCE ON DISTRIBUTION RELATIONSHIPS, COLLATERAL SYSTEMS AND EXPANSION OF
DIRECT SALES FORCE
A key element of the Company's current business and marketing strategy is to
establish, develop and maintain relationships with credit card issuers, direct
marketers, airlines and catalog merchants to promote the Company's products and
services to their merchant and consumer customers. Although the Company has
established relationships with such entities in an effort to enhance the
Company's ability to penetrate the market for interactive messaging, sales of
VirtualTAGs and Internet payment services, such relationships are nonexclusive
and have not resulted in any comprehensive or measurable increase in the
Company's revenues to date. In particular, the Company had granted certain
equity incentives to First Data Corporation ("FDC") in order to induce FDC to
cause its affiliated banks to distribute up to 2,500,000 VirtualPINs to their
customers by September 29, 1997. FDC did not achieve this goal and this equity
incentive expired. The Company had a similar equity incentive arrangement with
General Electric Capital Corporation ("GECC"), in order to induce GECC to
produce a marketing agreement between one of its affiliates and First Virtual by
July 3, 1997. GECC did not produce such a marketing agreement and this equity
incentive also expired. No assurance can be given that the Company will be able
to maintain its current strategic relationships or cultivate additional
partnering relationships in the future or that any such relationship will prove
to be effective in creating demand for the Interactive Messaging Platform or in
expanding the Company's merchant and consumer base. In addition, there can be no
assurance that the Company's existing or potential marketing partners, most of
whom have significantly greater financial and marketing resources than the
Company, will not change their business strategies or discontinue their
relationships with the Company, develop and market products and services that
compete with the Company's products and services in the future or form
collaborative marketing relationships with one or more of the Company's
competitors that offer alternative Internet commerce solutions.
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<PAGE> 15
The operation of the Interactive Messaging Platform and FVIPS is dependent on
the continued availability and reliability of collateral telecommunications.
FVIPS is also dependent on the continued availability and reliability of
information processing and financial clearance systems. In particular, the
Company is substantially dependent on Paymentech Inc. for merchant transaction
acquisition services and on Northern Trust Company ("Northern Trust") for
clearinghouse services. The Company also continues to depend on Electronic Data
Systems, Inc. ("EDS") for financial services processing. In addition, the
Company is substantially dependent on MCI Communications Corp. and WorldCom Inc.
for collateral telecommunication services. There can be no assurance that these
companies will continue to provide collateral services to the Company without
disruptions in service, at the current cost, or at all. Although the Company
believes that such services could be obtained from other sources in due course
if required, reengineering the Company's computer systems and telecommunications
infrastructure to accommodate a new service provider could only be accomplished
at significant cost and with significant delay. Any interruption of service by a
collateral services provider also would be likely to result in the disruption of
the operation of the Interactive Messaging Platform and FVIPS, with an attendant
loss of revenues and potential loss of customers. Such losses could have a
material adverse effect on the Company's business, financial condition and
results of operations.
In order to promote the use of the Interactive Messaging Platform and to
increase market acceptance of FVIPS, the Company will be required to
significantly expand its direct sales force and marketing organization and
manage such personnel effectively. Establishing required marketing and sales
capability will require substantial efforts and significant management and
financial resources. The Company's management has very limited experience in
recruiting, developing or managing a marketing and sales force. There can be no
assurance that the Company will be able to recruit and retain direct marketing
and sales personnel in order to build an effective marketing and sales
organization, that building such a marketing and sales organization will be cost
effective or that the Company's marketing and sales efforts will be successful.
UNDEVELOPED AND RAPIDLY CHANGING MARKETS
The markets for the Company's products and services are at a very early stage of
development, are rapidly changing and are characterized by an increasing number
of market entrants that have introduced or are developing competing products and
services for use on the Internet and the Web. As is typical for a new and
rapidly evolving industry, demand for and market acceptance of recently
introduced products and services are subject to a high level of uncertainty and
risk. While the number of individuals and businesses using the Internet and the
Web for commercial purposes has grown rapidly over recent years, the volume and
prevalence of Internet commerce generally, and of retail sales of goods and
services on the Internet in particular, has not grown as rapidly as certain
observers had projected, and, there can be no assurance that Internet commerce
will become widespread. Because acceptance and usage of the Interactive
Messaging Platform and increased usage of FVIPS is contingent on substantial and
sustained growth in sales of consumer products and services on the Web, it is
not assured that sufficient demand for the Company's products and services will
develop to sustain the Company's business. To date, the Company has not
generated any significant revenues from such services, and there can be no
assurance that demand for such applications will develop or increase. In
addition, it is not known whether individuals or businesses will use the
Internet as a means of purchasing goods and services. To establish the Internet
as a source of widespread and significant commercial activity, particularly by
those individuals and businesses which historically have relied upon traditional
means of commerce, will require the broad acceptance of new methods of
conducting business and exchanging information. Businesses that already have
invested substantial resources in traditional or other methods of conducting
business may be reluctant to adopt new commercial methodologies or strategies
that may limit or compete with their existing businesses. Individuals with
established patterns of purchasing goods and services may be reluctant to alter
those patterns. Banks and financial institutions with established methods of
handling payments may also be reluctant to accept new payment systems based on
Internet commerce. The Company expects such historical patterns of business
conduct to inhibit the growth of Internet commerce in general and market
acceptance of the Company's services in particular.
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<PAGE> 16
The Company's business includes products and services that are new, operate in a
market that did not previously exist and will be subject to rapid and
unpredictable market changes. It is uncertain whether a significant market will
ever emerge for the Interactive Messaging Platform, payments over the Internet
by means of FVIPS or any other payment system or that the Internet will develop
as an effective medium for advertising and merchandising. The Company's success
is critically dependent on the development of Internet commerce, which the
Company believes will require the significant expansion of the Internet
infrastructure in order to provide adequate Internet access, the proper
management of Internet traffic and a substantial amount of public education to,
among other things, increase confidence in the integrity and security of
Internet commerce. There can be no assurance that commerce over the Internet
will become widespread, that a market for the Company's products and services
will emerge or that the Interactive Messaging Platform, FVIPS or other
applications using the VirtualPIN architecture will be generally adopted. If the
market fails to develop, or develops more slowly than expected, if the Internet
infrastructure is not adequately expanded or managed, or if the Company's
products and services do not achieve market acceptance by a significant number
of individuals, businesses and financial institutions, then the Company's
business, financial condition and results of operations will be materially and
adversely affected.
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING
In October 1997, the Company completed a private placement of securities
consisting of 1,000 shares of Series A Convertible Preferred Stock and warrants
to purchase up to 850,000 shares of Common Stock. Because the Series A Preferred
Stock is convertible into Common Stock at a discount below the current market
price of the Common Stock and because the price at which such conversion may be
effected is the lesser of $5.50 or 80% of the average closing bid price per
share of Common Stock for the prior ten days, conversion of the Series A
Preferred Stock will result in at least modest dilution to existing investors,
and may result in substantial dilution. Additional dilution may result upon the
exercise of the Common Stock warrants issued in this financing. Moreover,
holders of Series A Convertible Preferred Stock enjoy certain rights and
preferences which may adversely affect holders of Common Stock, including a
right to quarterly dividend payments and a right to a preference payment in the
event of a liquidation or dissolution of the Company. Moreover, the Company
anticipates that it will need to raise additional funds in the near future to
fund its operations, as well as to develop new or enhanced services, to respond
to competitive pressures or to acquire complementary businesses or technologies.
If additional funds are raised through the issuance of equity securities, the
percentage ownership of the stockholders of the Company will be further reduced,
stockholders may experience significant additional dilution and such equity
securities may also have rights, preferences or privileges senior to those of
the holders of the Company's Common Stock. There can be no assurance that
additional financing will be available when needed or that if available, such
financing will include terms favorable to the Company or its stockholders. In
addition, the Company's ability to raise additional funds prior to May 1998
without the consent of the holders of Series A Convertible Preferred Stock, is
subject to certain limitations. If adequate funds cannot be obtained or are not
available on acceptable terms, the Company may be unable to develop or enhance
its products and services, take advantage of important opportunities or respond
to competitive pressures, any of which could have a material adverse effect on
the Company's business, financial condition and results of operations.
DEPENDENCE ON INCREASED USAGE AND STABILITY OF THE INTERNET
The future of the Internet as a center for commerce will depend in significant
part on continued rapid growth in the number of households and commercial,
educational and government institutions with access to the Internet, in the
level of usage by individuals and in the number and quality of products and
services designed for use on the Internet. Because usage of the Internet as a
medium for on-line exchange of information, advertising, merchandising and
entertainment is a recent phenomenon, it is difficult to predict whether the
number of users drawn to the Internet will continue to increase and whether any
significant market for the Interactive Messaging Platform, VirtualTAGs,
financial transactions over the Internet, or any substantial commercial use of
the Internet, will develop. There can be no assurance that Internet usage
patterns will not decline as the novelty of the medium recedes or that the
quality of products and services offered on-line will improve sufficiently to
continue to generate and maintain user interest. In addition, it is uncertain
whether the cost of Internet access will decline. Failure of the Internet or the
Web to stimulate
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<PAGE> 17
consumer interest and be accessible to a broad audience at moderate costs would
jeopardize the viability of Internet commerce and the market for the Company's
products and services. The Internet and the Web have experienced, and are
expected to continue to experience, significant growth in the number of users
and amount of traffic; however, the Internet may not prove to be a viable
commercial marketplace for a number of reasons, including potentially inadequate
development of the necessary infrastructure, such as a reliable network
backbone, or timely development of performance improvements including high speed
modems. In addition, there is no assurance that the number of vendors
maintaining sites on the Web will increase. Accordingly, there can be no
assurance that Internet commerce will become widespread or that sustainable
markets for the Company's products and services will develop. If such markets
fail to develop, develop more slowly than expected or become dominated by one or
more competitors, the Company's business, financial condition and results of
operations will be materially and adversely affected. Furthermore, if the
Internet were unable to support the demands of its users, the Internet could
lose its viability due to delays in the development or adoption of new standards
and protocols or due to increased governmental regulation. If the necessary
infrastructure, complementary services or facilities are not developed, or if
the Internet does not become a viable commercial marketplace, the Company's
business, financial condition and results of operations will be materially and
adversely affected.
Moreover, critical issues regarding the stability of the Internet's
infrastructure remain unresolved. The rapid rise in the number of Internet users
and increased transmission of audio, video, graphical and other multimedia
content over the Web has placed increasing strains on the Internet's
communications and transmission infrastructures. Continuation of such trends
could lead to significant deterioration in transmission speeds and reliability
of the Internet and could reduce the usage of the Internet by businesses and
individuals. In addition, to the extent that the Internet continues to
experience significant growth in the number of users and level of use without
corresponding increases and improvements in the Internet infrastructure, there
can be no assurance that the Internet will be able to support the demands placed
upon it by such continued growth. Any failure of the Internet to support such
increasing number of users due to inadequate infrastructure, or otherwise, would
seriously limit the development of the Internet as a viable commercial
marketplace and could materially and adversely affect the acceptance of the
Company's products and services which would, in turn, materially and adversely
affect the Company's business, financial condition and results of operations.
DEPENDENCE ON ACCEPTANCE OF FVIPS AND NEW PRODUCTS AND SERVICES; RISK OF CHANGES
IN CONSUMER PERCEPTIONS
Substantially all of the Company's revenues to date have been attributable to
the receipt of registration fees from consumers and merchants, transaction
processing fees, co-marketing fees and consulting fees associated with FVIPS.
For the three months ending September 30, 1997, revenues from FVIPS,
merchandising, interactive advertising development and consulting fees accounted
for approximately 88%, 1%, 0% and 11% of revenues, respectively. For the nine
months ended September 30, 1997 such revenues were approximately 63%, 4%, 10%
and 23% of total revenues, respectively. FVIPS fees are currently expected to
account for a significant portion of the Company's revenues. As a result, a
decline in demand for, or failure to achieve broad market acceptance of FVIPS,
as a result of competition, technological change or otherwise, would have a
material adverse effect on the Company's business, financial condition and
results of operations. A failure to significantly expand both the number of
merchants and consumers using FVIPS and the number of transactions processed by
FVIPS would also have a material adverse effect on the Company's business,
financial condition and results of operations. The Company's future financial
performance will depend in part on the successful development, introduction and
customer acceptance of new and enhanced products and services, such as the
Interactive Messaging Platform. There can be no assurance that the Company will
be successful in marketing the Interactive Messaging Platform, FVIPS or any new
or enhanced products or services.
The Company's future success is substantially dependent on the development of
demand for products and services that support transactions processed by FVIPS
over the Internet and, in particular, use credit card-based payment mechanisms.
Demand for secure payment solutions, including FVIPS, has been fueled in part by
wide-spread fears of the risks associated with the potential theft of credit
card account numbers
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<PAGE> 18
transmitted over the Internet and other manifestations of Internet-based credit
card fraud. Such consumer perceptions of the risks associated with credit
card-based Internet transactions have received substantial media attention, but
may lack empirical support. In addition, the Company believes that most
consumers may be unaware that the potential liability resulting from fraudulent
charges to their credit card accounts is limited by federal laws that limit the
liability of cardholders for unauthorized use of their card to no more than $50.
Any change in consumer perception of the incidence of credit card account number
theft over the Internet, or the potential liability attendant to such fraud,
could impact the demand for Internet security mechanisms, including FVIPS. Any
such decline in the perceived need for the security which the Company believes
to be a principal feature of FVIPS could have a material adverse effect on the
Company's business, financial condition and results of operations.
COMPETITION
The market for products and services that enable the sale of goods and services,
and the market for services that enable interactive messaging capabilities over
the Internet, is expected to be intensely competitive, and, to the extent
commercial activity over the Internet increases, the Company expects competition
to increase significantly. There are no substantial barriers to entry into the
Company's business, and the Company expects established and new entities to
enter the market for Internet payment systems, interactive messaging services
and interactive Internet communications in the near future. It is possible that
a single supplier will dominate one or more market segments. Furthermore, since
there are many potential entrants to the field, it is extremely difficult to
assess which companies are likely to offer competitive products and services in
the future, and in some cases it is difficult to discern whether an existing
service is competitive with the Company's current services.
The Company's principal competitors in the market for secure consumer-initiated
purchase systems include providers of encrypted credit card transaction systems
such as CyberCash, Inc., Open Market, Inc. and VeriFone, Inc. and providers of
electronic cash payment systems such as DigiCash, Inc. The Company's principal
competitors in the interactive messaging services arena include providers of
e-mail based services such as InfoBeat, Inc., Email Publishing Inc., America
OnLine, Inc., CompuServe Incorporated and Juno Online Services. The Company also
competes with Narrative Communication in the interactive advertising arena and
with BroadVision Inc., for one to one marketing. The Company expects that credit
card processors and acquiring banks or third party companies will also offer
credit card-based payment systems if Secure Electronic Transaction ("SET")
protocols proposed by Visa, MasterCard, American Express, Microsoft Corporation
and Netscape are adopted and/or accepted as a standard for Internet commerce.
SET comprises openly published communication and process protocols intended to
facilitate encrypted credit card transactions over the Web. Further, the Company
believes that the credit card associations may provide Internet merchants with
lower transaction fees in order to encourage usage of SET. There can be no
assurance that the Company's payment system will receive the same treatment, and
as such the Company may be at a competitive disadvantage. For example, in July
1997, Visa announced its intention to waive its transaction fees, beginning in
April 1998 for a two year period, for credit card transactions over the Internet
that use the SET protocol.
The Company may experience additional competition from Internet service
providers and Internet directory companies who enter the market for Internet
payment services. Companies such as America Online, CompuServe, Microsoft Corp.,
IBM Corp., Integrion ,AT&T, Hewlett-Packard Company, and Netscape Communications
Corporation which possess large, existing customer bases or ready distribution
channels, could develop, market or resell a number of payment alternatives
including, but not limited to, encrypted credit card payment and digital cash
payment systems. Such major information technology providers may also choose to
enter the market for secure Internet payments by acquiring one of the Company's
existing competitors or forming strategic alliances with such competitors,
either of which may impede the Company's ability to compete effectively. For
instance, Hewlett-Packard Company, in June 1997, acquired VeriFone and now
promotes VeriFone's Internet technologies. Netscape has established
relationships with VeriFone and CyberCash, and it announced in February 1997,
that it would recommend use of VeriFone's and CyberCash secure payment systems
to Netscape commerce server users. Additionally, competitors such as Checkfree
Corporation may emerge to provide payment systems based on alternative systems
or
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<PAGE> 19
methods other than credit cards or digital cash, such as Internet checking
transaction systems. The Company believes that mail order companies and
companies that sell from catalogues using "800" telephone numbers also compete
with Internet payment systems. As the Company expands the applications of its
VirtualPIN architecture, it will compete with a broader range of companies
including traditional advertising, merchandising and direct marketing companies
as well as additional entrants into the interactive Internet communications
market. Moreover, to date the predominant method of reducing the risks
associated with transmission of credit card information over the Internet has
been use of public key encryption software provided by RSA Data Security, Inc.
("RSA"), a subsidiary of Security Dynamics Technology, Inc. RSA's encryption
technology (Secure Socket Layer) is incorporated in Web server and browser
products offered by Netscape, Microsoft and other vendors, and thus has the
largest installed base of any technology for payment security. In addition,
credit card information relating to commercial transactions over the Internet is
frequently directly transmitted in an unprotected form (i.e. "in the clear"
transactions).
Several of the Company's current and potential competitors have longer operating
histories, greater name recognition, larger installed customer bases, more
diversified lines of products and services and significantly greater financial,
technical, marketing and other resources than the Company. Such competitors may
be able to undertake more extensive marketing campaigns, adopt more aggressive
pricing policies and make more attractive offers to individuals, businesses and
financial institutions. In addition, many of the Company's current or potential
competitors have broad distribution channels that may be used to bundle
competing products or services directly to end-users or purchasers. If such
competitors were to bundle competing products or services for their customers,
the demand, if any, for the Company's products and services might be
substantially reduced, and the ability of the Company to successfully effect the
distribution of its products and the utilization of its services would be
substantially diminished. As a result of the foregoing or other factors, there
can be no assurance that the Company will compete effectively with current or
future competitors or that the competitive pressures will not have a material
adverse effect on the Company's business, financial condition and results of
operations.
DEPENDENCE UPON PRODUCT AND SERVICE DEVELOPMENT; RISKS OF TECHNOLOGICAL CHANGE
AND EVOLVING INDUSTRY STANDARDS
The Company's success depends upon its ability to develop the Interactive
Messaging Platform and other new products and services that satisfy evolving
customer requirements including potential applications for Internet advertising,
merchandising and direct marketing. The market for the Company's services is
characterized by rapidly changing technology, emerging industry standards and
customer requirements that have been changing every few months. There can be no
assurance that the Company will successfully identify new product and service
opportunities and develop and bring to market new products and services in a
timely manner. Failure of the Company, for technological or other reasons, to
develop and introduce the Interactive Messaging Platform and other new products
and services that are compatible with emerging industry standards and that
satisfy customer requirements would have a material adverse effect on the
Company's business, financial condition and results of operations. In addition,
the Company or its competitors may announce enhancements to existing products or
services, or new products or services embodying new technologies, emerging
industry standards or customer requirements that render the Company's existing
products and services obsolete and unmarketable. There can be no assurance that
the announcement or introduction of new products or services by the Company or
its competitors or any change in emerging industry standards will not cause
customers to terminate use of the Company's existing products and services,
which could have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company's products and services are designed around certain technical
standards, and the Company's current and future revenues are dependent on
continued industry acceptance of such standards. While the Company intends to
provide compatibility with the standards promulgated by leading industry
participants and groups, widespread adoption of a proprietary or closed standard
could preclude the Company from effectively doing so. Moreover, a number of
leading industry participants have announced their intention to enter into or
expand their positions in the market for Internet payment systems through the
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<PAGE> 20
development of new technologies and standards. There can be no assurance that
the Company's products and services will achieve market acceptance, that the
Company will be successful in developing and introducing new products and
services that meet changing customer needs and respond to technological changes
or emerging industry standards in a timely manner, if at all, that the standards
upon which the Company's products and services are or will be based will be
accepted by the industry or that products, services or technologies developed by
others will not render the Company's products and services noncompetitive or
obsolete. The inability of the Company to respond to changing market conditions,
technological developments, emerging industry standards or changing customer
requirements or the development of competing technologies or products that
render the Company's products and services noncompetitive or obsolete would have
a material adverse effect on the Company's business, financial condition and
results of operations.
RISKS ASSOCIATED WITH FVIPS UPGRADES
In July 1996, the Company made a transition in the FVIPS from a system that
relied solely on EDS for financial services processing of transactions to a
system that is primarily managed by the Company. The Company now operates and
maintains the computer which communicates with the established financial
networks. The Company continues to use EDS as a back-up system to perform
authorization and settlement processing of credit card transactions for First
Virtual. Prior to this transition to a self-managed system, the Company relied
entirely on EDS for all financial services processing of FVIPS transactions and
for management of the Company's database, including the entry of new merchant
and consumer registrations, updating of customer information and the management
of customer accounts. This upgrade was the first upgrade of FVIPS.
In May 1997, the Company implemented a second upgrade to FVIPS. This upgrade
included the installation of a relational database management system and to
date, the upgrade has performed to the Company's expectations. The Company also
plans upgrades to FVIPS from time to time in the future. Any inability to
properly effect and manage upgrades to the Company's customer database could
result in a material adverse effect on the Company's business, financial
condition and results of operations. Given the limited time the upgraded system
has been in operation, there can be no assurance that complications resulting
from the upgrade will not arise, that the new system will prove to be capable of
functioning in a fully operating environment over an extended period of time or
that operating flaws or disruptions will not emerge. For example, subsequent to
the May 1997 upgrade, the Company experienced a situation that required
unscheduled database maintenance to be performed. As a result, transactions were
held in a queue for 5 hours until the database maintenance was completed. Any
similar systems failure, if prolonged or compounded, could cause a significant
interruption to the Company's products and services and could reduce the
viability of FVIPS and, if sustained or repeated, could reduce the demand for
the Company's products and services by current and potential Internet customers
which would result in a material adverse effect on the Company's business,
financial condition and results of operations. Furthermore, the Company has no
prior experience with managing a large database of customer and transactional
information. In order to properly manage its operational database, the Company
will need to (i) improve its management information systems and controls and
(ii) attract and retain qualified personnel.
DEPENDENCE ON REPEATED CUSTOMER USE OF FVIPS
The Company's future success is currently dependent on its ability to
significantly expand its base of merchants and consumers and to increase the
number of transactions that are conducted using FVIPS. The Company believes that
an increase in the number of FVIPS transactions depends primarily on the
repeated usage of the VirtualPIN by consumers. There can be no assurance that
the Company's historic rate of VirtualPIN use per consumer will continue or
increase, even if the Company is successful in increasing the variety and
quality of goods and services available over FVIPS. The ability of the Company
to increase the average number of transactions per VirtualPIN is subject to
substantial uncertainty. As of September 30, 1997, the Company has not yet
experienced any substantial increase in VirtualPIN registrations or transactions
per VirtualPIN. In the event the average number of transactions per VirtualPIN
does not
20
<PAGE> 21
substantially increase in the future, the Company's business, financial
condition and results of operations would be materially and adversely affected.
In addition, the Company anticipates that it will modify consumer and merchant
registration and renewal fees from time to time in the future and may modify its
transaction rates charged to merchants. In late August 1997, the Company
increased new consumer registration and renewal fees. At the time of this
filing, both the number of new consumer registrations and the number of consumer
renewals have declined, as a result of the Company implementing its new fee
structure. Because the fee change was only implemented recently, there can be no
assurance as to the aggregate effect of the fee change on the Company's
operating results. Any further modification in the fee structure may result in
further significant consumer and merchant attrition or reduce future consumer
and merchant registrations. Significant consumer or merchant attrition or the
failure of the Company to substantially increase the number of active users of
FVIPS would materially and adversely affect the Company's business, financial
condition and results of operations.
Certain merchants employing FVIPS have in the past reduced their use of the
system. Although the Company has very limited information regarding merchant
usage of FVIPS, the Company believes that declining usage of FVIPS by merchants
can occur when merchants cease to maintain their Web pages, discontinue product
or service offerings on their Web sites or find other sufficient payment means,
without using FVIPS, to satisfy their business needs. Such discontinuation could
have a material adverse effect on the Company's business, financial condition
and results of operations. The Company also faces the risk of losing merchants
that choose to employ alternative payment mechanisms or experience a decline in
transactions using FVIPS. Any significant decline in the usage of FVIPS by
merchants or increase in the rate of merchant attrition could have a material
adverse effect on the Company's business, financial condition and results of
operations.
RISK OF CAPACITY CONSTRAINTS
A key element of the Company's strategy is to generate a high volume of FVIPS
usage. Accordingly, the performance of the Company's products and services is
critical to the Company's ability to achieve market acceptance and continued use
of these products and services. Significant increases in the volume of
transactions through FVIPS could strain the capacity of the Company's software
or hardware, which could lead to slower response time or system failures. The
Company has and intends to make substantial investments to increase its server
capacity by adding new servers and upgrading its FVIPS management software, when
necessary. As the number of Web and Internet users increases, there can be no
assurance that the Company's products and services will be able to meet this
demand. The Company and its customers are also dependent upon Web browsers,
e-mail clients and Internet and online service providers for access to its
services, and users have experienced difficulties due to system failures
unrelated to the Company's system, products or services. To the extent that the
capacity constraints described above are not effectively addressed by the
Company, such constraints could have a material adverse effect on the Company's
business, financial condition and results of operations.
RISKS OF DEFECTS AND DEVELOPMENT DELAYS
Products and services based on sophisticated software and computing systems
often encounter development delays, and the underlying software may contain
undetected errors and failures when introduced or when usage increases. The
Company may experience delays in the development of the software and computing
systems underlying the Company's services. In addition, there can be no
assurance that, despite testing by the Company and merchants and consumers,
errors will not be found in the underlying software or that the Company will not
experience development delays, resulting in delays in the commercial release of
its products and services or in the market acceptance of its products and
services, each of which could have a material adverse effect on the Company's
business, financial condition and results of operations.
RISKS OF SYSTEMS FAILURES; LACK OF INSURANCE AND SECURITY RISKS
The operation of FVIPS is dependent on the Company's ability to protect its
computer equipment and the information stored in its data centers against loss
or damage that may be caused by system overloads, fire,
21
<PAGE> 22
power loss, telecommunications failures, unauthorized intrusion, infection by
computer viruses and similar events. The Company's data center and servers are
currently located in San Diego, California, and at a facility in Dallas, Texas.
There can be no assurance that a system failure at either of these locations
would not materially and adversely affect the Company's ability to provide its
products and services.
The Company currently retains highly confidential customer financial
information, including bank account and credit card information, in a secure
database server that the Company believes to be isolated from the Internet.
Although the server is protected by firewalls and proprietary, one-way batch
protocols along with regular Company reviews of the system for security
weaknesses, there can be no assurance that unauthorized individuals could not
obtain access to this database server. Any unauthorized penetration of the
Company's servers which are not directly connected to the Internet could result
in the theft of bank account and credit card information, E-mail addresses, and
comprehensive transaction histories. Any unauthorized penetration of the
Company's servers which are connected to the Internet could result in the theft
of VirtualPIN numbers, E-mail addresses and recent transaction histories.
Unauthorized penetration could lead to attempts to use such information to
effect fraudulent purchases, including the introduction of fabricated
transactions into the Company's financial processors. Although the Company
believes that the VirtualPIN architecture should thwart attempts to use
misappropriated account information, widespread attempts to effect such
transactions would require the Company to devote substantial resources to
counteracting such attempts and could result in a compromise of the system or
the interruption of the Company's ability to provide its products and services
and may result in adverse publicity to the Company and consequently have a
material adverse effect on the Company's business, financial condition and
results of operations. It is also possible that an employee of the Company could
attempt to divert customer funds or otherwise misuse confidential customer
information, exposing the Company to legal liability. In addition, although the
Company believes that the potential for the unauthorized interception of
information transmitted over the Internet through FVIPS is not likely to result
in the fraudulent use of VirtualPINs, there can be no assurance that
unauthorized use of such information will not occur and, if it does occur, that
it will not result in a financial loss or significant inconvenience to the
VirtualPIN holder. Furthermore, although the Company employs disclaimers and
limitation of warranty provisions in its customer agreements to attempt to limit
its liability to customers, including liability arising out of systems failure
or failure of security precautions, there can be no assurance that such
provisions will be enforceable, or will otherwise prove effective in limiting
the Company's exposure to damage claims.
Although the Company carries property, errors and omissions and business
interruption insurance, its coverage may not be adequate to compensate the
Company for all losses that may occur. The Company is in the process of
increasing its server capacity, improving its security mechanisms and taking
other precautions to protect itself and its customers from events that could
interrupt delivery of the Company's products and services or result in a loss of
transaction or customer data. However, these measures will not eliminate a
significant risk to the Company's operations from a natural disaster or systems
failure. There can be no assurance that these measures would protect the Company
from an organized effort to inundate the Company's servers with massive
quantities of e-mail or other Internet message traffic which could overload the
Company's systems and result in a significant interruption of service. In July
1997, the Company experienced a situation that required unscheduled database
maintenance to be performed. As a result, transactions were held in a queue for
4 hours until the database maintenance was completed. Any systems failure that
causes a significant interruption to or increases response time of the Company's
products and services could reduce use of the Company's products and services
and would reduce the attractiveness of the Company's products and services to
current and future customers. The Company's business interruption insurance
would not fully compensate the Company for lost revenues, income, additional
costs or increased costs experienced by the Company during the occurrence of any
disruption of its computer systems, nor is there any assurance that the Company
will be able to obtain such coverage on reasonable terms or at all in the
future. Significant service interruptions could also damage the Company's
reputation and result in the loss of a significant portion of its merchants and
consumers, which could have a material adverse effect on the Company's business,
financial condition and results of operations.
22
<PAGE> 23
MANAGEMENT OF POTENTIAL GROWTH; RISKS ASSOCIATED WITH NEW MANAGEMENT TEAM
The rapid development necessary for the Company to exploit the market
opportunity for the Interactive Messaging Platform, VirtualTAGs, FVIPS and its
other services requires an effective planning and management process. As of
September 30, 1997, the Company had grown to 96 employees from 21 employees on
December 31, 1995. As of September 30, 1997, the Company had seven executive
officers. Two officers were replaced during the second quarter of 1997. The
Company accepted resignations from both Michael Schauer, President of Financial
Services, and Thomas Daniel, Vice President of Merchant Services, and the
Company hired as officers, Keith Kendrick, Vice President of Marketing and Dr.
Carolyn Turbyfill, Vice President of Engineering and Operations. In October
1997, Mr. Kendrick was promoted to President of the Company. The Company's
success depends to a significant extent on the ability of its executive officers
and other members of its management to operate effectively, both individually
and as a group. There can be no assurance that the Company will satisfactorily
allocate responsibilities and that the new executives will succeed in these
roles in a timely and efficient manner. The Company has experienced some
difficulty and most likely in the future will continue to experience difficulty
in integrating or replacing members of management's team from a variety of
industry backgrounds. It is uncertain whether all members of the current
management team can be successfully assimilated or replaced. Furthermore, the
continued success of the Company is largely dependent on the personal efforts
and abilities of its senior management and certain other key personnel and on
the Company's ability to retain current management and to attract and retain
qualified personnel in the future. The Company's failure to assimilate these new
executives, or the failure of any of the executives to perform effectively, or
the loss of any such executive, could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company's growth has placed, and is expected to continue to place, a
significant strain on its managerial, operational and financial resources. The
growth in the Company's customer base and transaction volume, along with the
introduction of the Interactive Messaging Platform and the development of the
VirtualTAG "toolkit", will place increased demands on the Company's management
and operations, including its marketing and sales, customer support, research
and development, general and administrative operations. There can be no
assurance that the Company will be able to effectively manage the expansion of
its operations, that the Company's systems, procedures and controls will be
adequate to support the Company's operations or that Company's management will
be able to achieve the rapid execution necessary to exploit the market
opportunity for the Company's products and services. Any inability to manage
growth effectively could have a material adverse effect on the Company's
business, financial condition and results of operations.
DEPENDENCE ON KEY PERSONNEL
The Company's future performance is substantially dependent upon the continued
contributions of members of the Company's senior management and technical
personnel. In particular, the Company's success substantially depends on the
continued participation of its Chief Executive Officer, Lee Stein, its principal
senior technical employees, Nathaniel Borenstein and Marshall Rose, and other
members of its senior management team, which is currently composed of a small
number of individuals, some of whom have joined the Company only recently. See
"Management of Potential Growth; Risks Associated with New Management Team"
above. The loss of any of such persons could have a material adverse effect on
the Company's business, financial condition and results of operations. In
addition, the Company believes that its future success will depend upon its
continuing ability to identify, attract, train and retain other highly skilled
managerial, engineering, sales and marketing and other personnel. Competition
for such personnel is intense. There can be no assurance that the Company will
be successful in identifying, attracting, training and retaining the necessary
personnel, and the failure to do so could have a material adverse effect on the
Company's business, financial condition and results of operations.
23
<PAGE> 24
LIMITED INTELLECTUAL PROPERTY
The Company relies on a combination of trade secret, copyright and trademark
laws, nondisclosure agreements, and other contractual provisions and technical
measures to protect its proprietary rights. The Company believes that, due to
the rapid pace of technological innovation for Internet products, the Company's
ability to establish and maintain a position of technology leadership in the
industry depends more on the skills of its development personnel than upon the
legal protections afforded its existing technology. There can be no assurance
that trade secret, copyright and trademark protections will be adequate to
safeguard the proprietary software underlying the Company's products and
services, or that its agreements with employees, consultants and others who
participate in the development of its software will not be breached, that the
Company will have adequate remedies for any breach or that the Company's trade
secrets will not otherwise become known. Moreover, notwithstanding the Company's
efforts to protect its intellectual property, there is no assurance that
competitors will not be able to develop functionally equivalent interactive
messaging technologies or Internet payment services without infringing any of
the Company's intellectual property rights. Despite the Company's efforts to
protect its proprietary rights, unauthorized parties may attempt to copy or
otherwise obtain and use products or technology that the Company considers
proprietary, and third parties may attempt to develop similar technology
independently. In addition, effective protection of intellectual property rights
may be unavailable or limited in certain countries. Accordingly, there can be no
assurance that the Company's means of protecting its proprietary rights will be
adequate or that the Company's competitors will not independently develop
similar technology.
As the volume of Internet commerce increases, and the number of products and
service providers that support Internet commerce increases, the Company believes
that Internet commerce technology providers may become increasingly subject to
infringement claims. There can be no assurance that infringement claims will not
be filed by plaintiffs in the future. Any such claims, with or without merit,
could be time consuming, result in costly litigation, disrupt or delay the
enhancement or shipment of the Company's products and services or require the
Company to enter into royalty or licensing agreements. Such royalty or licensing
agreements, if required, may not be available on terms acceptable or favorable
to the Company, which could have a material adverse effect on the Company's
business, financial condition and results of operations. In addition, the
Company may initiate claims or litigation against third parties for infringement
of the Company's proprietary rights or to establish the validity of the
Company's proprietary rights. Litigation to determine the validity of any claims
could result in significant expense to the Company and divert the efforts of the
Company's technical and management personnel from productive tasks, whether or
not such litigation is determined in favor of the Company. In the event of an
adverse ruling in any such litigation, the Company may be required to pay
substantial damages, discontinue the use and sale of infringing products, expend
significant resources to develop non-infringing technology or obtain licenses to
infringing technology. The failure of the Company to develop or license a
substitute technology could have a material adverse effect on the Company's
business, financial condition and results of operations.
GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES
The Company believes it is not currently subject to direct regulation by any
government agency in the U.S., other than regulations generally applicable to
businesses, and there are currently few laws or regulations directly applicable
to access to, or commerce on, the Internet. However, no assurance can be given
that federal, state or foreign agencies will not attempt in the near future to
begin to regulate the market for Internet commerce. In addition, if a government
agency were to challenge the Company's position with respect to the
applicability of regulations to its activities, responding to such a challenge
could result in significant expenditures of the Company's financial and
management resources, which could have a material adverse effect on the
Company's business, financial condition and results of operations. More
generally, due to the increasing popularity and use of the Internet, it is
possible that a number of laws and regulations will be adopted with respect to
the Internet, covering issues such as user privacy, pricing, taxation and
characteristics and quality of products and services. For example, the
Telecommunications Reform Act of 1996 may subject certain Internet content
providers to criminal penalties for the transmission of certain
24
<PAGE> 25
information, and could also result in liability to Internet service providers,
Web hosting sites and transaction facilitators such as the Company. Various
foreign jurisdictions have also moved to regulate access to the Internet and to
strictly control Web content. Even if the Company's business is not directly
subject to regulation, the adoption of any such laws or regulations may inhibit
the growth of the Internet, or the businesses of the users of the Company's
products and services, which could in turn adversely affect the Company's
business, financial condition and results of operations. Moreover, the
applicability to the Internet of existing laws governing issues such as property
ownership, libel, taxation and personal privacy is uncertain. Such uncertainty
creates the risk that such laws could be interpreted in a manner that could
generally inhibit commerce on the Internet and adversely impact the Company's
business.
Due to the growth of Internet commerce, Congress has considered regulating
providers of services and transactions in this market, and federal or state
authorities could enact laws, rules or regulations affecting the Company's
business or operations. Senior officials from several regulatory agencies,
including the Board of Governors of the Federal Reserve System (the "Federal
Reserve Board") and the Office of the Comptroller of the Currency, have
indicated that those agencies have refrained from promulgating regulations in
order to encourage continued development of electronic commerce, but will
monitor this area closely in the future. For example, the Electronic Fund
Transfer Act and Regulation E, promulgated by the Federal Reserve Board, govern
certain electronic funds transfers made by regulated financial institutions from
a consumer's account, and govern providers of access devices and electronic
funds transfer services. Although the Company believes that its current services
are not subject to Regulation E, there is no assurance that the Federal Reserve
Board will not require all or certain of the Company's services to comply with
Regulation E, revise Regulation E or adopt new rules and regulations affecting
electronic commercial transactions. Other government agencies in addition to the
Federal Reserve Board, including the Federal Trade Commission and the Federal
Communications Commission, may promulgate rules and regulations affecting the
Company's activities or those of the users of its products and services. Any or
all of these potential actions could result in increased operating costs for the
Company or for the principal users of its services and could also reduce the
convenience and functionality of the Company's services, possibly resulting in
reduced market acceptance which would have a material adverse effect on the
Company's business, financial condition and results of operations.
EVOLVING FINANCIAL INDUSTRY POLICIES FOR INTERNET COMMERCE
The Company currently relies on credit cards as the payment method for FVIPS
transactions. Credit card associations are still in the process of drafting
operating regulations governing many credit card transactions on the Internet.
In some cases, the Company's access to the payment systems of credit card
associations and other payment providers may be conditioned on its compliance,
and the compliance of associated processors such as Paymentech Inc., with
interim regulations.
The Company's operations have been reviewed by MasterCard and Visa which
currently are the sole payment methods accepted by the Company. Visa has issued
to Paymentech Inc. several conditions which govern Paymentech Inc.'s processing
of transactions for the Company over the Visa system. These conditions, among
other things, establish a maximum dollar amount and aging of small-dollar
transactions the Company can accumulate before they are submitted to the Visa
system for processing, and establish procedures for handling chargebacks
involving such bundled transactions. The Company does not believe that these
conditions materially burden the Company's current operations. The conditions
were initially issued pursuant to an oral communication and were due to expire
on December 31, 1995. The conditions were renewed until the later of the
adoption of industry-wide operating regulations addressing Internet transactions
or December 31, 1997. If the Internet transaction operating regulations are not
in place by December 31, 1997, the conditions provide that they can be extended,
with Visa's concurrence. To date, MasterCard has not issued any conditions that
are specific to the Company's operations. While the Company hopes that it will
be able to comply with Visa's future operating regulations and regulations
issued by any other credit card association, there can be no assurance that it
will be able to do so or that compliance will not have a material adverse effect
on its business, financial condition or results of operations. In addition,
there can be no assurance, if the operating regulations have not been adopted,
that the conditions agreement between Paymentech Inc. and Visa, or related
agreements between
25
<PAGE> 26
Paymentech Inc. and the Company and other payment providers, will be issued or
extended, if at all, on terms that do not have a material adverse effect on the
Company's business, financial condition and results of operations.
RISK OF LOSS FROM RETURNED TRANSACTIONS, MERCHANT FRAUD OR ERRONEOUS
TRANSACTIONS
Because the Company acts as an intermediary and facilitator for credit card
transactions, the Company may be subject to the risks borne by merchants
generally in the use of credit card payment systems, primarily the risk that the
consumer's payment will be "charged back" because of unauthorized use of the
consumer's credit card, disputes over the goods or services purchased by the
consumer, erroneous transmission of information by the Company, or fraud by the
merchant or consumer. The Company's customer agreements provide for the
allocation of the risk of chargebacks (other than chargebacks caused by
erroneous transmission by the Company) to merchants, but such agreements may not
be enforceable. In addition, even if the Company has an enforceable right to
charge a merchant's account for the amount of a chargeback, the Company is
subject to the risk that the merchant may not have a sufficient positive balance
of net proceeds from other FVIPS transactions to cover the chargeback and may
otherwise be unable or unwilling to pay.
The Company manages these risks through its risk management systems and internal
controls, which are still in the process of being implemented. The Company
currently requires explicit authorization by consumers prior to initiating a
charge of the consumer's credit card, holds funds for 91 days for merchants who
do not qualify for accelerated settlement terms and subjects merchants who
attempt to so qualify to a screening process, and holds qualified merchants'
funds for three to five business days. As a result, the Company believes that
the risks associated with widespread chargebacks by customers are minimized, but
there can be no assurance that chargebacks will not increase significantly in
the future as the volume of FVIPS transactions increases and as more merchants
of goods and services requiring physical delivery begin to use FVIPS. There also
can be no assurance that the Company will not change FVIPS in a manner that
increases the risk of exposure to chargebacks, or that the Company's reserves
will be sufficient to protect the Company from increased chargebacks. A
significant increase in chargebacks could materially and adversely affect the
Company's business, financial condition and results of operations.
LIABILITY FOR INFORMATION STORED ON THE INFOHAUS SERVER
Because materials may be uploaded to the Company's InfoHaus shared Web server
("InfoHaus") and, without intervention by the Company, may be subsequently
distributed to others, it is possible that claims will be made against the
Company for defamation, negligence, copyright or trademark infringement or other
theories based on the nature and content of such materials. In the past, such
claims have been brought, and sometimes successfully pressed against electronic
bulletin boards, on-line service providers, and Web pages hosting content
provided by other parties. Although the Company carries general liability
insurance, the Company's insurance may not adequately cover claims of this type.
Any imposition of liability that is not covered by insurance or is in excess of
insurance coverage could have a material adverse effect on the Company's
business, financial condition and results of operations.
INTEGRATION OF POTENTIAL ACQUISITIONS
As a part of its business strategy, the Company may make acquisitions of, or
significant investments in, complementary companies, products or technologies.
Any such future acquisitions would be accompanied by the risks commonly
encountered in acquisitions of companies. Such risks include, among other
things, the difficulty of assimilating the operations and personnel of the
acquired companies, the potential disruption of the Company's ongoing business,
the inability of management to maximize the financial and strategic position of
the Company through the successful incorporation of acquired technology and
rights into the Company's products and services, additional expense associated
with amortization of acquired intangible assets, the maintenance of uniform
standards, controls, procedures and policies and the impairment of relationships
with employees and customers as a result of any integration of new management
personnel. There can be no assurance that the Company would be successful in
overcoming these risks or any other problems encountered in connection with such
acquisitions.
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<PAGE> 27
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
The management of the Company is not aware of any events
required to be reported hereunder.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibit Index
Exhibit 11.1 - Statement Regarding Computation of Earnings Per
Share
Exhibit 27.1 - Financial Data Schedule
(B) No reports on Form 8-K were filed during the three months ended
September 30, 1997.
27
<PAGE> 28
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.
FIRST VIRTUAL HOLDINGS INCORPORATED
Dated: November 14, 1997 By: /s/ Lee H. Stein
--------------------
Lee H. Stein
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Dated: November 14, 1997 By: /s/ John M. Stachowiak
--------------------
John M. Stachowiak
Vice President, Finance &
Chief Financial Officer
(Principal Financial and
Accounting Officer)
28
<PAGE> 1
EXHIBIT 11.1
FIRST VIRTUAL HOLDINGS INCORPORATED
STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1997 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net loss (4,537,207) (3,474,480) (11,972,936) (5,980,314)
Common Stock 8,876,032 4,431,931 8,827,919 4,349,337
Conversion of Redeemable Preferred
Stock into Common Stock --- 2,138,141 --- 1,816,412
Shares related to SAB No. 83 --- 2,089,370 --- 2,169,450
----------- ----------- ----------- -----------
Shares used in computing net
loss per share 8,876,032 8,659,442 8,827,919 8,335,199
=========== =========== =========== ===========
Net loss per share $(0.51) $(0.40) $(1.36) $(0.72)
=========== =========== =========== ===========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 5,315,133
<SECURITIES> 0
<RECEIVABLES> 319,517
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 5,755,241
<PP&E> 3,081,147
<DEPRECIATION> 1,287,849
<TOTAL-ASSETS> 7,818,209
<CURRENT-LIABILITIES> 4,470,702
<BONDS> 0
0
0
<COMMON> 8,884
<OTHER-SE> 3,138,616
<TOTAL-LIABILITY-AND-EQUITY> 7,818,209
<SALES> 0
<TOTAL-REVENUES> 1,111,905
<CGS> 217,662
<TOTAL-COSTS> 13,249,612
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 70,506
<INCOME-PRETAX> (11,972,936)
<INCOME-TAX> 0
<INCOME-CONTINUING> (11,972,936)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,972,936)
<EPS-PRIMARY> (1.36)
<EPS-DILUTED> 0
</TABLE>
