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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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/X/ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the Fiscal Year Ended DECEMBER 31, 1998
/ / Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Transition Period from to .
COMMISSION FILE NO. 000-24271
NETGRAVITY, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 77-0410283
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
1900 SOUTH NORFOLK STREET, SUITE 150
SAN MATEO, CALIFORNIA 94403-1151
(650) 425-6000
(Address of principal executive office, including zip code, and telephone
number)
Securities Registered Pursuant to Section 12(b) of the Act: NONE
Securities Registered Pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.001 PAR VALUE
(Title of Class)
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
As of February 5, 1999, there were 13,770,325 shares of the Registrant's
common stock outstanding, and the aggregate market value of the 7,326,388 of
such shares held by non-affiliates of the Registrant (based upon the closing
sale price of such shares on the Nasdaq National Market on February 5, 1999) was
approximately $150,190,954. Solely for purposes of providing the foregoing
disclosure, shares held by each of the Registrant's executive officers and
directors and by each holder of 5% or more of the Registrant's outstanding
common stock have been excluded in that such persons may be deemed to be
affiliates. This determination of affiliate status may not be applicable for
other purposes.
------------------------
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's definitive proxy statement (the "Proxy Statement")
to be mailed to stockholders in connection with its 1999 annual meeting of
stockholders scheduled to be held on May 27, 1999, are incorporated by reference
into Part III of this Report. Except as expressly incorporated by reference, the
Registrant's Proxy Statement shall not be deemed to be part of this Report.
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NETGRAVITY, INC.
TABLE OF CONTENTS
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PAGE
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PART I
Item 1. Business....................................................................................... 3
Item 2. Properties..................................................................................... 36
Item 3. Legal Proceedings.............................................................................. 36
Item 4. Submission of Matters to a Vote of Security Holders............................................ 36
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters...................... 38
Item 6. Selected Financial Data........................................................................ 40
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 42
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..................................... 52
Item 8. Financial Statements and Supplementary Data.................................................... 53
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosures.......... 53
PART III
Item 10. Directors and Executive Officers of the Registrant............................................. 54
Item 11. Executive Compensation......................................................................... 54
Item 12. Security Ownership of Certain Beneficial Owners and Management................................. 54
Item 13. Certain Relationships and Related Transactions................................................. 54
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K................................ 55
Signatures................................................................................................. 74
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PART I
THIS ANNUAL REPORT ON FORM 10-K (THIS "REPORT") AND THE DOCUMENTS
INCORPORATED HEREIN BY REFERENCE CONTAIN FORWARD-LOOKING STATEMENTS THAT HAVE
BEEN MADE PURSUANT TO THE PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995. SUCH FORWARD-LOOKING STATEMENTS ARE BASED ON CURRENT EXPECTATIONS,
ESTIMATES AND PROJECTIONS ABOUT NETGRAVITY'S INDUSTRY, MANAGEMENT'S BELIEFS AND
CERTAIN ASSUMPTIONS MADE BY NETGRAVITY'S MANAGEMENT. WORDS SUCH AS
"ANTICIPATES," "EXPECTS," "INTENDS," "PLANS," "BELIEVES," "SEEKS," "ESTIMATES,"
VARIATIONS OF SUCH WORDS AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY SUCH
FORWARD-LOOKING STATEMENTS. THESE STATEMENTS ARE NOT GUARANTEES OF FUTURE
PERFORMANCE AND ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND ASSUMPTIONS THAT
ARE DIFFICULT TO PREDICT; THEREFORE, ACTUAL RESULTS MAY DIFFER MATERIALLY FROM
THOSE EXPRESSED OR FORECASTED IN ANY SUCH FORWARD-LOOKING STATEMENTS. SUCH RISKS
AND UNCERTAINTIES INCLUDE THOSE SET FORTH HEREIN UNDER "FACTORS AFFECTING OUR
BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION" ON PAGES 23 THROUGH 35.
UNLESS REQUIRED BY LAW, THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE PUBLICLY
ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE
EVENTS OR OTHERWISE. HOWEVER, READERS SHOULD CAREFULLY REVIEW THE RISK FACTORS
SET FORTH IN OTHER REPORTS AND DOCUMENTS THAT THE COMPANY FILES FROM TIME TO
TIME WITH THE SECURITIES AND EXCHANGE COMMISSION, PARTICULARLY THE QUARTERLY
REPORTS ON FORM 10-Q AND ANY CURRENT REPORTS ON FORM 8-K.
In this Report, "NetGravity," the "Company," "we," "us" and "our" refer to
NetGravity, Inc. and its wholly owned subsidiaries, NetGravity Europe Limited,
NetGravity Asia Pacific K.K. and NetGravity (Hong Kong) Limited.
ITEM 1. BUSINESS
OVERVIEW
NetGravity, Inc. is a leading provider of online interactive marketing
solutions. We were a pioneer in the online advertising management software
market and believe that we were the first company to provide this software to
major online content publishers. We develop, market and support a broad range of
high-end, mission-critical software and transaction-based services. Our
solutions are designed to help our customers increase their revenues by
automating online interactive marketing, including online advertising and
e-commerce direct marketing, and by improving response rates through better
consumer targeting. We sell our solutions to each of the three constituents in
the interactive marketing supply chain: e-commerce merchants (vendors of
products and services); advertising agencies; and content publishers. Our core
product, AdServer, is a software solution targeted to large, sophisticated
e-commerce merchants and content publishers. AdServer manages the process of
placing advertisements, promotions and other offers on Web pages. We recently
began offering transaction-based services, including AdCenter for Publishers, an
outsourced version of AdServer. We have also announced AdCenter for Agencies,
which will extend AdCenter to include enhanced features designed for online
advertising agencies. We expect AdCenter for Agencies to be available in the
second quarter of 1999. In addition, we recently began offering our Global
Profile Service to our AdServer and AdCenter customers. Global Profile Service
is a transaction-based data service that gives our customers access to a
database of anonymous consumer profiles for use in targeting online
advertisements, promotions and other offers. The first release of Global Profile
Service allows for targeting based on geographic location. We are developing
future releases of Global Profile Service to allow targeting based on other
demographic and behavioral characteristics.
NetGravity markets and sells its products and services primarily through its
field sales and telesales organizations. We maintain sales and support
operations in North America, Europe and Asia Pacific. To date, we have sold our
software and services to over 325 customers, including 32% of the top 50
revenue-generating online content publishers listed in the March 31, 1998 CMR
Interwatch report. Our customers include agency.com, @Home Network, British
Telecom, broadcast.com, CNN Interactive,
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E*TRADE, IBM, Netscape Communications, Preview Travel, ONSALE, Real Cities
(Knight-Ridder New Media) and Time Inc. New Media.
INDUSTRY BACKGROUND
The competitive nature of the global marketplace requires merchants to
continually seek out and obtain new customers while preserving their
relationships with existing customers. Historically, merchants have communicated
with consumers through advertising in traditional media (such as print,
television and radio) and through traditional direct marketing channels (such as
telemarketing and direct mail) to establish and maintain their brand identities,
introduce new products, announce improved product features and target offers to
potential and current customers. McCann-Erickson has estimated that $200 billion
would be spent on traditional media advertising in the United States during
1998. The Direct Marketing Association estimated that $163 billion would be
spent on direct marketing in the United States during 1998.
INTERACTIVE MARKETING SUPPLY CHAIN. The traditional advertising and direct
marketing industries together can be viewed as a supply chain with three primary
constituents: merchants (vendors of products and services), advertising agencies
and content publishers. As the driving force in the supply chain, merchants seek
to increase their sales and brand awareness by targeting advertisements and
offers to current and prospective consumers of their products and services. To
build relationships with new and existing customers, merchants work with
advertising agencies to purchase advertising space targeted at the types of
consumers the merchants desire. Advertising agencies, in turn, contact content
publishers to identify and secure advertising space that meets the merchants'
criteria. Content publishers, such as magazines, newspapers, radio stations and
television programs, attract audiences of consumers by offering compelling
entertainment and information and deliver these audiences to merchants.
Established, larger content publishers generally work directly with advertising
agencies in order to retain greater control over their advertising inventories,
which, in turn, allows them to maintain and enhance the long-term value of their
advertising space to advertising agencies and merchants. Smaller, less
established content publishers generally work with advertising agencies through
advertising representatives or networks, which provide these content publishers
with an outsourced sales force for their advertising space. As depicted below,
advertising and direct marketing expenditures flow down the supply chain from
merchants to advertising agencies and then to content publishers. In turn,
audiences of consumers attracted by content publishers flow up to merchants as
prospective customers.
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[GRAPHIC: SUPPLY CHAIN]
The dramatic growth of the Internet in recent years has led, and continues
to lead, merchants, advertising agencies and content publishers to devote
increasing resources toward developing and improving their utilization of the
Internet as a medium for customer acquisition and retention.
GROWTH OF THE WEB AND E-COMMERCE. IDC estimated that by the end of 1998
there were over 97 million users of the World Wide Web (the Web) worldwide. IDC
projects that, by the end of 2002, the number of Web users will increase to over
320 million worldwide. We believe that the number of Web users and the amount of
time users spend on the Web will continue to increase as Internet access becomes
more widely available, as Internet bandwidth and reliability are enhanced and as
Internet content improves and becomes more multimedia intensive.
Because online transactions can be faster, less expensive and more
convenient than transactions conducted via traditional means, a growing number
of consumers are transacting business over the Web. Examples of such
transactions include buying consumer goods, trading securities, purchasing
airline tickets and paying bills. Jupiter Communications has estimated that 27%
of adult Web users made online purchases in 1997 and that 50% of adult Web users
will make online purchases in 2000. IDC estimates that purchases of goods and
services over the Internet will increase from $32.4 billion in 1998 to $237.2
billion in 2001. We believe that, as electronic commerce expands, e-commerce
merchants will increasingly seek to use the Web to locate customers, advertise
their products and services and facilitate transactions.
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ADVERTISERS AND MERCHANTS HAVE CONTINUED TO INCREASE THEIR ONLINE
INTERACTIVE MARKETING ACTIVITIES. The Web continues to emerge as a promising
new medium for advertisers due to the growth in the number of Web users, the
attractive demographic profiles of Web users, the ability to quickly gather
response data and other feedback, the interactive nature of the Web, the
potential for reduced costs-per-transaction, the Web's global reach and a
variety of other factors. The Web provides advertisers with the opportunity to
cost-effectively reach broad, global audiences and to target their advertising
based on consumers' demographic characteristics, specific interests and
geographic location. Online advertising also has the potential to allow
advertisers to measure, in real time, the number of times that a particular
advertisement has been viewed, the responses to the advertisement and certain
characteristics of the viewers of the advertisement. In addition, the
interactive nature of the Web gives advertisers the potential to establish
dialogues and one-on-one relationships with consumers, to receive direct
feedback on their advertising and to quickly refine their advertising based on
such feedback. Accordingly, we believe that the Web has the potential to become
a more effective and efficient means for advertisers to reach their target
audiences as compared to traditional media.
The unique characteristics of online advertising, combined with the growth
in the number of Internet users and their attractive demographic profiles, have
led to an increase in online advertising. Jupiter estimates that online
advertising expenditures in the United States will increase from $1.9 billion in
1998 to $7.7 billion in 2002. Historically, the leading online advertisers have
generally been technology companies, Internet search engines and Web content
publishers. However, many of the largest advertisers on traditional media,
including mass marketers such as consumer products companies and automobile
manufacturers, have recently expanded their use of online advertising.
NetGravity believes that online advertising will become an increasing component
of such merchants' advertising budgets and that this trend will drive demand for
sophisticated online advertising and direct marketing solutions.
Because highly targeted product offers can be made to consumers at their
personal computers, we believe that the Internet represents an attractive new
medium for direct marketing, which has traditionally been conducted through
direct mail and telemarketing. The success of a direct marketing campaign is
generally measured by return on investment (ROI), which is favorably affected by
either an increase in response rate (for example, number of leads, sales or
other transactions as a percentage of impressions viewed) or a reduction in
cost-per-transaction. If merchants are able to generate higher ROIs from online
interactive marketing than from traditional media campaigns, we believe that
merchants will allocate a higher percentage of their marketing expenditures to
online interactive marketing. Jupiter Communications estimates that expenditures
on online direct marketing would be $190 million in 1998 and will exceed $1.3
billion in 2002 and that combined expenditures for online advertising and online
direct marketing will exceed $9 billion in 2002.
USE OF CONSUMER TARGETING DATA TO INCREASE RETURN ON
INVESTMENT. Interactive marketers seek to increase their ROI by targeting their
messages to the consumers most likely to respond favorably to them. In
traditional media, the goal of consumer-specific targeting can be indirectly
approached by delivering messages to broadly-defined audiences (such as viewers
of particular television programs). Although this target audience approach is
also used in online media (for example, by targeting advertisements to
particular Web sites), interactive marketing offers incremental opportunity for
direct consumer-specific targeting based on anonymous profile data such as
geographic or demographic information about individual consumers. We believe
that potentially higher response rates generated by more consumer-specific
targeting will justify higher prices being paid by online advertisers and
e-commerce merchants to content publishers that are able to reach more narrowly
defined audiences. However, the effectiveness and efficiency of direct
consumer-specific targeting is limited both by the capabilities of the targeting
technology and by the breadth and depth of consumer profile data available to
e-commerce merchants, advertising agencies and content publishers.
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SUPPLY CHAIN CONSTITUENTS REQUIRE ENABLING TECHNOLOGY AND DATA. As the
constituents of the interactive marketing supply chain increase their online
presence, they seek technology and data solutions that allow them to exploit the
attractive demographics, consumer-specific targeting capability, real-time
feedback, business process efficiencies and other potential advantages of online
interactive marketing. E-commerce merchants, advertising agencies and content
publishers require comprehensive, reliable and scalable solutions to allow them
to effectively and efficiently leverage the power of the Internet for
interactive marketing. In particular, we believe that larger, more established
content publishers will generally require solutions that allow them to continue
to closely control their advertising inventory. Moreover, because the process of
directly managing the sale and delivery of online advertisements, promotions and
other offerings can generate valuable consumer profile and behavioral data, we
believe that the desirability of maintaining direct control over consumer data
may be even greater than with respect to traditional media. In addition, as
targeting capabilities become increasingly important, we believe that the
constituents of the interactive marketing supply chain will seek to augment
their own consumer data with broader and more detailed databases of anonymous
consumer profiles to enable them to further improve their targeting capabilities
and ROI.
NETGRAVITY SOLUTION
NetGravity, Inc. is a leading provider of solutions for online interactive
marketing. We were a pioneer in the online advertising software market and
believe that we were the first company to provide this software to major online
content publishers. We develop, market and support a broad range of high-end,
mission-critical software and transaction-based services. Our solutions are
designed to help our customers increase their revenues by automating online
interactive marketing and by improving response rates through better consumer
targeting. We sell our solutions to each of the three constituents in the
interactive marketing supply chain: e-commerce merchants (vendors of products
and services); advertising agencies; and content publishers. Our core product,
AdServer, is a software solution targeted to large, sophisticated e-commerce
merchants and content publishers. AdServer manages the process of placing
advertisements, promotions and other offers on Web pages. We recently began
offering transaction-based services, including AdCenter for Publishers, an
outsourced version of AdServer. We have also announced AdCenter for Agencies,
which will extend AdCenter to include enhanced features designed for online
advertising agencies. We expect AdCenter for Agencies to be available in the
second quarter of 1999. In addition, we recently began offering our Global
Profile Service to our AdServer and AdCenter customers. Global Profile Service
is a transaction-based data service that gives our customers access to a
database of anonymous consumer profiles for use in targeting online
advertisements, promotions and other offers. The first release of Global Profile
Service allows for targeting based on geographic location. We are developing
future releases of Global Profile Service to allow targeting based on other
demographic and behavioral characteristics.
NetGravity's current and planned products and services are designed to
provide benefits to each of the three primary constituents in the online
interactive marketing supply chain:
E-COMMERCE MERCHANTS. E-commerce merchants are focused on attracting
consumers to their Web sites and on maximizing revenue per customer. Our
AdServer software is designed to allow e-commerce merchants to gather consumer
behavior data on their sites and correlate this information with other
information, such as purchase history, to build detailed customer-profile
databases using third party technology. Merchants can then use AdServer to
target advertisements, promotions or other offerings for new or complementary
products to particular consumers based on their profiles. Merchants can share
this targeting information with their advertising agency to allow for more
effective customer acquisition campaigns.
ADVERTISING AGENCIES. Advertising agencies seek to maximize the impact of
their clients' online campaigns to promote brand awareness or to solicit
transactions, while minimizing their own overhead in conducting the campaign.
AdServer is designed to enable advertising agencies to manage their
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clients' online campaigns, to make changes to campaigns in real-time and to
collect information about consumer behavior that can be mined to create
sophisticated profiles. These profiles can be used to improve targeting for both
current and future campaigns.
We believe that many advertising agencies prefer outsourced solutions that
reduce their internal technical and administrative burdens. Several of our
advertising agency customers currently using our AdCenter service offering have
helped us identify ways to tailor AdCenter to their needs. As a result, we are
developing AdCenter for Agencies which will automate much of the campaign
management process for advertising agencies, including media planning, media
buying, trafficking, reporting and billing. In addition, AdCenter for Agencies
is being designed to track purchases made by consumers responding to particular
advertisements, making it easier to determine the cost-per-transaction for a
campaign. We expect AdCenter for Agencies to be released in the second quarter
of 1999.
CONTENT PUBLISHERS. Content publishers seek to attract consumers to their
Web sites to maximize the value of their advertising space and/or to solicit
e-commerce transactions. Using AdServer (or the outsourced version, AdCenter for
Publishers), content publishers can maintain control of their own advertising
inventory, consumer data, mission-critical advertising business processes, and
relationships with advertisers and advertising agencies. These solutions are
designed to allow content publishers to predict inventory available for sale, to
deliver targeted advertisements to consumers and to provide reports and analysis
to advertisers. Additionally, our AdServer software solution can be integrated
with content management, billing and commerce systems.
Our software is designed to be fault-tolerant, scalable, extensible and
platform-independent to meet the needs of even our largest customers. For
example, CNN Interactive, which operates one of the most visited Web sites on
the Internet, has served over 50 million impressions in a single day with our
AdServer software. NetGravity's software also supports industry standard
operating environments including popular Unix systems, Microsoft Windows NT,
standard relational databases, Web servers from Netscape and Microsoft and
Java-enabled Web browsers.
STRATEGY
NetGravity's objective is to become the leading provider of online
interactive marketing solutions for e-commerce merchants, advertising agencies
and content publishers. To achieve this objective, our strategy includes the
following key elements:
EXTEND LEADERSHIP IN ONLINE ADVERTISING SOFTWARE SOLUTIONS. NetGravity
intends to extend its leadership position in the market for online advertising
software solutions by continuing to enhance its technology through investment in
research and development activities and by incorporating industry-leading
components into its products. We believe that maintaining and enhancing our
products and services are critical to our ability to solidify our market
leadership, strengthen our relationships with current customers and acquire new
customers.
ESTABLISH LEADERSHIP IN INTERACTIVE MARKETING SOLUTIONS FOR
E-COMMERCE. NetGravity seeks to foster the growth of the emerging market for
interactive marketing solutions for e-commerce merchants and to establish
leadership in this market. Recognizing the potential of the Web as a direct
marketing channel, many of our e-commerce customers are already leveraging
AdServer's largely advertising-oriented features to deploy interactive marketing
systems for e-commerce. We believe that e-commerce interactive marketing is
emerging as a distinct market from online advertising and that customers
focusing on e-commerce will increasingly demand functionality tailored to their
specific requirements. Therefore, we intend to continue to add features to
AdServer designed to meet the specific requirements of e-commerce merchants as
well as to enhance our sales, marketing, professional services and support
capabilities to promote these new features. In addition, we plan to form
relationships with enterprise solutions vendors to accelerate the adoption of
our AdServer software by e-commerce
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merchants. In furtherance of this strategy, we recently established a
co-marketing and co-selling relationship with IBM relating to our AdServer
products.
IMPROVE OUR CUSTOMERS' ROI WITH GLOBAL PROFILE SERVICE. We are developing
solutions to allow e-commerce merchants to better target consumers, thereby
providing them the opportunity to increase their ROIs from investments in online
interactive marketing. The initial version of our Global Profile Service gives
our customers access to anonymous consumer profiles containing geographic data.
Through planned new releases of the Global Profile Service, we expect to provide
access to other demographic and behavioral data. We have already licensed access
to Matchlogic's database of approximately 45 million anonymous consumer profiles
and we plan to continue to form additional relationships with data providers to
improve the overall coverage of our profile database.
ENABLE EFFICIENT ADVERTISING BUYING ON THE INTERNET. NetGravity intends in
the future to develop products to link together its high-end interactive
marketing customers to allow them to automate the process of buying and selling
online advertising space. One of the key limitations of the Internet as compared
to other media is the difficulty merchants and advertising agencies experience
when trying to create and manage an online campaign across many selected content
publishers. Because we already work with several large and sophisticated content
publishers and advertising agencies, we believe we will have the opportunity to
leverage the compatability of our AdServer product and our planned AdCenter for
Agencies service to increase the efficiency of buying and selling ads for both
sides of the transaction. We believe that, if successful, this end-to-end
solution could be critical to establishing our solutions as the standard for
online interactive marketing.
EXPAND INTERNATIONAL PRESENCE. NetGravity plans to expand its international
operations to address the global adoption of the Internet and the international
demand for online interactive marketing solutions. We believe that there are
many international opportunities for our products and services and have
established sales and support operations in Europe and Asia Pacific with
regional headquarters in London and Tokyo and field offices in France, Germany
and Hong Kong. As part of this expansion, we intend to create reselling and
systems integration relationships in Europe and Asia Pacific to leverage our
sales and consulting forces in these regions. We also intend to develop
localized versions of our products. We believe that an early presence in these
markets will enhance our long-term competitive position in these regions.
SOFTWARE PRODUCTS AND TRANSACTIONAL SERVICES
NetGravity develops, markets and supports its family of online interactive
marketing solutions and offers associated services. The following illustrates
the role of AdServer in a typical consumer interaction with a customer's Web
site.
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[GRAPHIC: CONSUMER INTERACTION WITH WEB SITE THAT USES NETGRAVITY ADSERVER]
NetGravity markets three primary solutions to support the needs of companies
in the online interactive marketing industry: AdServer Enterprise, AdServer
Network and AdCenter for Publishers. NetGravity also offers its Global Profile
Service to extend the targeting capabilities of its primary solutions by
providing access to more extensive targeting data than may otherwise be
available to our customers. In addition, NetGravity is in the process of
developing AdCenter for Agencies, a version of AdCenter customized for
advertising agencies. NetGravity's solutions are designed to be scalable,
extensible and robust systems for deploying online interactive marketing
solutions on the Internet. The AdServer solutions utilize a common
fault-tolerant, scalable architecture for real-time delivery of targeted
advertisements, a management system for tracking advertising inventory and a
customizable reporting and analysis system allowing AdServer users to better
understand their customers.
ADSERVER ENTERPRISE. AdServer Enterprise is designed to manage interactive
marketing on individual Web sites. AdServer Enterprise manages the process of
placing advertisements, promotions and other offers on Web pages. It also allows
tracking of consumer action and movement on a Web site and captures consumer
responses to advertisements. AdServer Enterprise is designed to be integrated
with other systems, such as customer databases, to create rich consumer profiles
for more effective targeting. AdServer Enterprise comes pre-configured to
address many common targeting requirements and can be extended to perform more
specific targeting. AdServer Enterprise's scalable architecture allows Web sites
to reliably serve high volumes of targeted advertisements. AdServer Enterprise
also collects and summarizes user interaction data to allow detailed analysis
and reporting to advertisers and direct marketers.
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ADSERVER NETWORK. AdServer Network is an enhanced version of AdServer
Enterprise designed to manage multi-site interactive marketing. AdServer Network
is designed to allow central management of advertising inventories of multiple
Web sites, delivery of targeted advertisements to multiple remote Web sites
based on centralized targeting data, centralized collection and analysis of user
information and targeting of advertisements to consumers on remote Web sites.
These features make AdServer Network an attractive solution for a variety of
applications. For example, AdServer Network can be used by content publishers to
deliver targeted advertisements to a set of affiliated Web sites or by
advertising agencies to manage campaigns for their clients across all of the Web
sites in the campaign.
ADCENTER FOR PUBLISHERS. AdCenter for Publishers is an outsourced service
solution based on our AdServer software and is designed to allow our customers
to outsource certain advertising management functions to NetGravity. NetGravity
works with Web hosting organizations to manage this centralized solution for
customers that do not wish to hire a technical staff or to maintain their own
systems. To date, revenues from AdCenter for Publishers have not been material.
GLOBAL PROFILE SERVICE. NetGravity's Global Profile Service is a central
database of anonymous user profiles which allows customers to augment their own
consumer information to improve their ability to analyze and target their
consumers. NetGravity has established relationships with two initial data
providers, Excite/MatchLogic and HNC/Aptex to provide demographic and purchase
affinity data on consumers for the Global Profile Service. The Global Profile
Service contains over 45 million consumer profiles with demographic and
geographic fields. This covers a substantial portion of all Internet users and
contains detailed information such as location, age, gender, household income,
education and presence of children. We are designing Global Profile Service to
work with multiple data providers and to aggregate fields supplied from several
sources in real-time. Currently, NetGravity is offering only geographic profiles
to our customers. NetGravity is in the process of extending the Global Profile
Service to enable it to deliver more comprehensive consumer profiles, but does
not expect such release to be available until late 1999, however we cannot
assure you that this release schedule will be met. See "Factors Affecting Our
Business, Operating Results and Financial Condition--Our future success depends
on the timely completion of new solutions under development." To date, revenues
from the Global Profile Service have not been significant. See "Factors
Affecting Our Business, Operating Results and Financial Condition--We rely on
third-party software and consumer profile data."
ADCENTER FOR AGENCIES. AdCenter for Agencies is a solution under
development that will be a version of AdCenter tailored to requirements of
advertising agencies. We are designing AdCenter for Agencies to automate much of
the campaign management process for advertising agencies including media
planning, media buying, trafficking, reporting and billing. AdCenter for
Agencies will also be used to track purchases made by consumers responding to
particular advertisements and thereby determine the cost-per-transaction for
each campaign. AdCenter for Agencies is expected to be released in the second
quarter of 1999, however we cannot assure you that this release schedule will be
met. See "Factors Affecting Our Business, Operating Results and Financial
Condition--Our future success depends on the timely completion of new solutions
under development."
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The following table summarizes NetGravity's software products and
transactional services:
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PRODUCT OR
SERVICES MARKET BENEFITS INTRODUCTION DATES PRICING MODEL
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AdServer SINGLE-SITE Provides single-site Version 1.0: March 1996 Software Model:
Enterprise merchants and content management of user Version 2.0: September Perpetual software
publishers information, targeting 1996 license fee plus
of advertisements, and Version 2.1: March 1997 ongoing fees for
analysis and reporting Version 3.0: June 1997 upgrades and support
capabilities Version 3.5: September
1998
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AdServer MULTI-SITE Provides the Version 2.1: March 1997 Software Model:
Network merchants, advertising capability to target Version 3.0: June 1997 Perpetual software
agencies, content advertisements to Version 3.5: September license fee plus
publishers and consumers on remote 1998 ongoing fees for
advertising networks Web sites, while upgrades and support
aggregating all
consumer information
and providing
centralized management
capabilities
- -----------------------------------------------------------------------------------------------------------------
AdCenter for SINGLE AND Provides a service to April 1998 Transactional Model:
Publishers MULTI-SITE allow customers to Fees based on number
merchants, advertising outsource advertising of advertisements,
agencies, content management to promotions or other
publishers and NetGravity offerings delivered
advertising networks
- -----------------------------------------------------------------------------------------------------------------
Global ADSERVER AND ADCENTER Gives access to Geographic Profiles: Transactional Model:
Profile CUSTOMERS database of anonymous October 1998 Geographic-Annual fee
Service consumer profiles used Demographic and Behavioral based on expected
for enhanced targeting Profiles: Planned for number of profiles
second half of 1999 delivered
Demographic/
Behavioral--Pricing
expected to be based
on actual number of
profiles delivered
- -----------------------------------------------------------------------------------------------------------------
AdCenter for ADVERTISING AGENCIES Automates the campaign Currently in development; Transactional Model:
Agencies seeking outsourced management process for expected to be available Fees expected to be
online interactive advertising agencies in the second quarter of based on number of
marketing solutions 1999 advertisements,
promotions or other
offerings delivered
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
PROFESSIONAL SERVICES
NetGravity's professional services organization as of December 31, 1998
consisted of 29 individuals, including 14 consultants, who provide the following
range of services:
CONSULTING. NetGravity offers consulting services that address each of the
activities its customers require for the initial implementation and long-term
operation of their NetGravity products. NetGravity offers: implementation
services to assist its customers in deploying AdServer; system extension
services that enable customers to extend NetGravity's products to meet their
specific business needs or technical requirements; and migration services that
enable customers to migrate to NetGravity's current products from earlier
versions of our products, from their in-house systems or from competitors'
products. A typical AdServer implementation requires up to 10 days of
professional services. NetGravity also offers other consulting services,
including project management, requirements definition, business process re-
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engineering, system and solutions design, technical architecture design, systems
integration design, custom reporting and software development.
TECHNICAL SUPPORT. NetGravity provides product support services, including
telephone support and upgrade rights to new minor releases, under its standard
maintenance agreements. All of NetGravity's license customers have entered into
standard maintenance agreements. The annual maintenance fee for these services
is payable in advance and is based upon a percentage of the then-current list
price for the licensed software. A dedicated team of engineers trained to answer
questions on the installation and usage of AdServer products provides telephone
support from 6:30 a.m. to 4:30 p.m., Pacific time, Monday through Friday, from
NetGravity's corporate offices in San Mateo, California. NetGravity also offers
telephone support 24 hours a day, seven days a week through a call-back
procedure to certain customers who pay an additional fee for this service.
NetGravity believes that providing high quality customer service and technical
support is necessary to achieve rapid product implementation which, in turn, is
essential to customer satisfaction and revenue growth. Accordingly, NetGravity
is committed to continued recruiting and maintenance of a high-quality technical
support team.
EDUCATION. NetGravity provides training for both the users of AdServer and
the technical staffs who maintain AdServer. NetGravity also offers training in
advertising on the Internet, managing advertising sales with AdServer, and
administering AdServer. NetGravity is also offering training in developing
custom extensions to the AdServer product line. All training is made available
at either the customer's location or at NetGravity's facilities in San Mateo,
California, New York City, Tokyo or London.
TECHNOLOGY
All of NetGravity's products and transactional services are built around the
core AdServer architecture. NetGravity's AdServer is designed to be a robust
architecture for customers to implement flexible, scalable and reliable online
advertising and direct marketing solutions, as well as to integrate these
solutions with external systems such as electronic commerce and dynamic content
generation systems. The AdServer architecture is also extensible through
documented application programming interfaces (APIs) and adheres to numerous
industry standards. In addition, we believe that the AdServer system
architecture is flexible enough to serve as the foundation for related future
products.
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[GRAPHIC: ADSERVER SYSTEM MODULES]
ADSERVER ADVERTISING DELIVERY ENGINE. NetGravity's AdServer advertising
delivery engine performs the actual content delivery function for the AdServer
System. The AdServer engine was designed to deliver highly targeted messages
with low latency to Web browsers, Web servers and proprietary content delivery
systems. The AdServer delivery engine architecture is designed to be highly
scalable, reliable and extensible. NetGravity has also incorporated several
performance and reliability enhancing technologies into the AdServer engine,
including built-in load balancing, automatic fail-over, automatic restart and
monitoring tools that notify technicians in the event of system failure.
ADMANAGER BUSINESS PROCESS MANAGEMENT APPLICATION. AdManager is a
three-tier application (comprised of user interface, application server and
database tiers) designed to allow customers to manage certain online advertising
and direct marketing business processes and associated data. In particular,
AdManager utilizes proprietary software to automate certain inventory
management, scheduling and availability functions that enable more efficient use
of available inventory.
ADINSIGHT ADVERTISING PERFORMANCE AND REPORTING SYSTEM. NetGravity believes
that the information resulting from online interactive marketing placements and
consumer response is extremely valuable for understanding consumer behavior and
measuring return on investment. The AdInsight measurement and reporting system
has been designed to permit detailed reporting and analysis for Web sites and
networks. Because of the volume of data gathered from high-traffic sites and
networks, AdInsight offers customizable summarization and reporting functions to
reduce database size and storage requirements. AdInsight also implements a
scheduling system to generate reports for automatic delivery to advertisers and
others directly over the Internet.
ADCONSOLE SYSTEM MANAGEMENT APPLICATION. AdConsole is designed to simplify
the process of maintaining and administering the entire AdServer System by
providing system administrators with a user interface for common system
management tasks. For example, AdConsole permits centralized
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starting, stopping, monitoring and administering of multiple AdServer engines.
AdConsole allows system administrators to schedule routine tasks and monitor and
administer AdServer engines across multiple CPUs which increases the reliability
of the entire system by reducing the likelihood for administration or
configuration errors.
OPEN ARCHITECTURE AND EXTENSIBILITY
NetGravity designed the AdServer System with numerous extensibility features
to allow integration into existing systems and creation of new functionality.
NetGravity's open targeting architecture allows customers to augment AdServer's
standard targeting functionality through the addition of external targeting
capabilities. NetGravity's advertising delivery API allows integration into
custom electronic commerce systems, dynamic content delivery systems and other
kinds of advertising delivery mechanisms. In addition, AdServer stores business
process data, including advertisements, targeting information, delivery
statistics and reporting data in a standard relational database management
system (RDBMS) in documented data structures, allowing industry standard
reporting and query tools to be used to view and manipulate this data. These
open extensibility features allow AdServer to be integrated with customers'
legacy systems and/or third-party systems, such as sophisticated targeting
engines, content delivery systems and customized data mining and analysis tools.
INDUSTRY STANDARDS
NetGravity uses many widely accepted standards in developing its products,
including SQL for accessing RDBMSs, HTTP for Internet access, NSAPI (Netscape
Application Programming Interface) for access to Netscape's Internet servers,
ISAPI (Internet Server Application Programming Interface) for access to
Microsoft's Internet servers and HTML for formatting advertisements. Most of the
Company's software is written in C++, a widely accepted standard programming
language for developing object-oriented applications. Adherence to industry
standards provides compatibility with existing applications, enables ease of
modification, and reduces the need for software to be rewritten, thus protecting
the customer's investment. In addition, NetGravity is active in formulating
standards for advertising measurement on the Internet. For example, John W.
Danner, NetGravity's Chairman and Chief Executive Officer, serves on the Board
of Directors of the Internet Advertising Bureau, a standards setting body for
Web publishers.
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CUSTOMERS AND MARKETS
As of December 31, 1998, NetGravity had over 325 customers. NetGravity sells
its AdServer products and AdCenter services to e-commerce merchants, advertising
agencies, content publishers and advertising networks. The following is a
partial list of NetGravity's customers:
MERCHANTS
ArtNet
AutoWeb Interactive
Cendant Corporation
Commercial Dynamics
Didax Online L.C.
EGreetings, Inc.
E*TRADE Group
Garden.com
IBM
Ingram Micro
N(2)K
ONSALE
Planet Direct Corporation
Preview Travel
SRDS
TechWave
Ticketmaster Online CitySearch
TUCOWS Interactive
Vitamin Shoppe
West Group
ADVERTISING AGENCIES
Agency.com
Anderson and Lembke
Dentsu Inc. (CCI)
Giant Step
Ogilvy and Mather
Ogilvy Interactive GmbH
CONTENT PUBLISHERS
Aftonbladet
America's Health Network
Asahi Shimbun
Associated New Media
Athena 2000
audioSENSE Corporation
British Telecom
broadcast.com
CADE
Cahners Business Information
Children's Television Workshop
China Telecom
China Times Interactive
Chung Hwa Telecom
Cinetic GmbH
Clear Channel Communications
CMP Media
College Club
CondeNet
CyBear
Cyber Communications
Dallas Morning News
DeTeMedien GmbH
Detroit Newspapers
Deutsche Telekom Online Service GmbH (T-Online)
E-Pub
El Nuevo Dia Interactive
Express Newspapers
Financial Times Group
Focus Online GmbH
Fujitsu
GoGlobal.net
Guardian Media Group
Hachette Filipacchi Interactions SA
Hearst New Media and Technology
HjemmeNett AS
Hollywood Online
INFOACCES, S.A. de C.V.
Interactive Investor International
Internet Technologies China (Sohoo)
John Fairfax Holding
Jubii A/S
Jumbo
Knight Ridder New Media
Korea Telecom
Le Groupe Videotron LTEE
Matrix
Merrill Lynch
Mirror Group Newspapers
Miller Freeman PLC
Minneapolis Star Tribune Interactive
Monster.com
Mpath Interactive
MTV Interactive
NEC Corporation
Netpool
NetRadio
Netscape
NetZero
Nihon Keizai Shimbun
Nikkei Busines Publications
Objectif Net
Ordenamiento de Links Especializados, S.L. (OLE)
PDN Xinren Information Technology
Posten Sverige
Prima S.A.
Reed Business Information
Reuters
Rodale Press
Rogers New Media
Salon
SocialNet
Spinner.com
SuperBusinessNet
Swisscom AG
Sysware Corporation
Telecom New Zealand
Telstra Corporation
The Economist
The Mainichi Newspapers
The Weather Channel
Third Age Media
Thomson Financial Services
Time Inc. New Media
Toronto Morning Star
Toshiba Corporation
Tribune Interactive
Turner Broadcasting (CNN Interactive)
USA.NET
Virgin Net
Videotex (Planet Internet)
Warner Bros. Online
Wired Digital
World Opponent Network
World Wrestling Federation
WSI
Zaz
Zip2 Corporation
ADVERTISING NETWORKS
@Home Network
Active Agent GMBH
Canadian Broadcasting
Canoe, Canadian Online Explorer
CDA Investment Technology
China Internet
Digital Skies
EMC(2)
Hong Kong Telecom IMS
MediaLinx
News Interactive Pty.
NTT Navispace Corporation
Overseas Connections, Taipei
Scandinavia Online
Singapore Telecommunications
StarMedia Network
TeleDanmark
Telstra Corporation
Yellow Pages
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SELECTED CUSTOMER CASE STUDIES
E-COMMERCE MERCHANT: GARDEN.COM (WWW.GARDEN.COM). Garden.com, the leading
Internet retailer of gardening products, information and services, uses AdServer
software to manage its internal direct marketing activities to promote sales to
consumers after they arrive at the site. NetGravity worked with Garden.com to
integrate AdServer with Garden.com's proprietary e-commerce system, allowing
AdServer to use consumer profile data (including purchase history) from
Garden.com's e-commerce system to target promotions to consumers and track
consumer responses. These promotions include cross-sell and up-sell campaigns,
discounts, credits and free shipping. For example, if a consumer adds tulip
bulbs to his shopping cart, AdServer might deliver an offer to purchase a
complementary product, such as gardening tools, at a discounted price. If the
customer accepts the promotion, AdServer notifies Garden.com's e-commerce
system, which reflects the addition to the consumer's shopping cart and applies
the discount upon checkout. By tracking customers from the initial click on an
advertisement, through purchase activity on the Garden.com web site in response
to targeted direct marketing offers delivered by AdServer, Garden.com uses our
solutions to generate detailed reports on overall campaign effectiveness that go
beyond simple impression and click through data. Garden.com believes that the
tight integration of AdServer and its e-commerce system has allowed it to
improve the effectiveness and efficiency of its customer acquisition and
retention efforts.
ADVERTISING AGENCY: AGENCY.COM. Agency.com, the largest online interactive
marketing agency, focuses on online marketing opportunities for its clients.
Prior to becoming a NetGravity customer and beginning to use AdCenter for
Publishers, Agency.com manually managed its interactive marketing campaigns.
This manual approach involved executing media buys via phone and fax, emailing
"creatives" (which are the advertisement graphics themselves) to individual
content publishers and logging transactions into a spreadsheet. Weekly reports
were generated manually from data reported from Agency.com's ISP and were not as
detailed as its clients were requesting. In December 1998, Agency.com began an
interactive marketing campaign for Sprint Long Distance using AdCenter. With
AdCenter, advertisements are automatically distributed to content publishers and
all reporting data are gathered centrally, enabling on-the-fly performance
reporting. Agency.com is even able to offer Sprint direct access to AdCenter's
reports which, in addition to summarizing impressions viewed and click-through
rates, also track the actions of consumers visiting Sprint's web site in
response to the campaign. This detailed reporting data is used to gauge the
effectiveness of the campaign and to adjust the campaign by selecting the
content publishers and creatives that generate the highest ROI for Sprint. Based
on its experience with the Sprint campaign and other projects, Agency.com
provided NetGravity with important suggestions for the feature set of AdCenter
for Agencies, and expects to begin using AdCenter for Agencies when it is
released.
CONTENT PUBLISHER: CNN INTERACTIVE. Since August 1995, Cable News Network,
Inc. has operated CNN Interactive, a family of Web sites which now includes
CNN.com, CNNfn, CNN-Time All Politics, CNN enEspanol, CNN emPortugues and
CNN-Sports Illustrated. CNN Interactive is consistently ranked as one of the
most visited families of sites on the Web, and currently averages over 110
million page views per week. CNN Interactive initially relied on an internally
developed system to manage its online advertising. Daily advertisement rotations
were done manually by CNN Interactive personnel using spreadsheets to track
advertising inventory. As user traffic and advertising inventory grew
dramatically, CNN Interactive concluded that it needed to automate and
streamline its online advertising management activities to keep pace with such
growth. CNN Interactive turned to NetGravity and, in December 1996, deployed
AdServer Enterprise to replace its internal advertising management system.
AdServer Enterprise now performs automatic, real-time impression-based
advertisement rotation on the CNN Interactive sites. In addition, CNN
Interactive uses AdServer's reporting features to generate individualized weekly
reports for each of its more than 150 advertisers.
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SALES AND MARKETING
NetGravity markets and sells its products and services primarily through its
field sales and telesales organizations and maintains sales and support
operations in North America, Europe and Asia Pacific. On December 31, 1998,
NetGravity's sales organization consisted of 46 individuals. NetGravity has
sales and support offices in San Mateo, California, New York City, London,
Tokyo, Paris, Hong Kong and Frankfurt. NetGravity sells its products in Europe
and Asia Pacific through its subsidiaries in the United Kingdom, Japan and Hong
Kong. NetGravity intends to broaden its presence in international markets by
expanding its international sales force and by entering into distribution
agreements with foreign distributors. See "Factors Affecting Our Business,
Operating Results and Financial Condition-- We face risks associated with our
international operations and plans for expansion" and "--Our success depends on
certain key employees."
NetGravity's sales process begins with the generation of sales leads. Sales
leads are obtained primarily from telesales, customer referrals, our Web site,
responses to our public relations and marketing efforts and through trade shows.
Initial sales activity normally includes a product demonstration of AdServer
directly over the Internet to the prospective customer. This demonstration is
followed by one or more technical discussions where the customer's issues and
concerns are addressed. For interested accounts, a field sales representative
and a sales engineer make an on-site visit where the needs of such customer are
assessed. Soon thereafter, a proposal is generated containing a statement of
work for our consulting and training services and a quote for the package of
software license and services to be delivered. In addition, we have developed
pre-configured packages suitable for many common customer applications.
NetGravity uses a variety of marketing programs (including general brand
promotion) to: stimulate demand for its products; build market awareness through
the press and industry analysts; produce and maintain marketing information and
sales tools; generate and develop customer leads; and establish and manage
marketing alliances. As of December 31, 1998, 10 employees were engaged in a
variety of marketing activities, including: preparing marketing research and
collateral marketing materials; product planning; managing press coverage and
other public relations; identifying potential customers; attending trade shows,
seminars and conferences; establishing and maintaining close relationships with
recognized industry analysts; and maintaining our Web site.
To license our software products, we generally engage in a lengthy sales
effort. During the sales effort, we spend significant time educating prospective
customers on the use and benefit of our solutions. As a result, the sales cycle
for our products and services is long and currently averages approximately four
months. The sales cycle for our online direct marketing solutions is likely to
be longer than the sales cycle for the online advertising solutions, because we
believe that online direct marketing is less established and will require more
education of our potential customers. In addition, an increase in the average
size of transactions would also likely result in an even longer sales cycle as
the license of our software products becomes rises to the level of an
enterprise-wide decision by prospective customers requiring a significant
commitment of resources. Delays due to lengthy sales cycles could have a
material and adverse effect on our business, results of operations or financial
condition.
MARKETING ALLIANCES
An important element of NetGravity's sales strategy is to form business
alliances to assist NetGravity in marketing and selling its products and
developing customer applications. This approach is intended to increase the
resources available to perform application design and development services for
NetGravity's customers and to enhance NetGravity's market credibility, potential
for lead generation and access to large accounts. Additionally, business
partners can provide online interactive marketing expertise in solving the
business problems of NetGravity's customers. Certain of NetGravity's business
partners have entered into reseller agreements with us, whereby they are
permitted to resell our
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<PAGE>
products, and, in some cases, to customize the products. NetGravity works with
these partners to develop re-sale and co-marketing programs and to generate
business referrals that lead to sales. For example, NetGravity and IBM recently
entered a co-selling and co-marketing arrangement under which IBM is authorized
to promote our products and services to IBM's net.commerce customers and, based
on achieving certain performance milestones, IBM has agreed to fund certain
joint marketing activities. We do not provide exclusive sales territories and do
not impose minimum purchase requirements in connection with our reseller
agreements. We have reseller agreements with the following organizations:
WEB HOSTING ORGANIZATIONS. Web hosting organizations centrally house and
maintain Internet connectivity equipment, server hardware and software for their
customers. Many Web sites utilize the services of hosting organizations and rely
on their advice and recommendations in selecting Internet software solutions.
Because of their influence in the market, NetGravity strives to maintain good
business relationships with these organizations. The following Web hosting
organizations have provided hosting services to NetGravity customers: ANS
Communications, BBN Corporation, Digex Incorporated, EUnet International B.V.,
Exodus Communications, Inc., Frontier GlobalCenter, Inc. and Proxicom, Inc., the
data and Internet service business unit of Teleport Communications Group Inc.
INTERNET SYSTEMS INTEGRATORS. Internet systems integrators assist online
content publishers and merchants in the design, procurement and deployment of
their Web sites. These Internet systems integrators often recommend advertising
management and other Internet solutions to their clients. The following Internet
systems integrators have worked with NetGravity customers: CKS--Enterprise, a
systems integration and consulting organization within CKS Group, Inc., Fort
Point Partners, Horizon Technologies, Organic Inc. and Modem Media . Poppe
Tyson.
We have historically sold our products and services primarily through our
field sales and telesales organization, but our future success may depend in
part upon our ability to increase sales of our solutions through Web hosting
organizations and Internet systems integrators (collectively, "Resellers"). We
cannot assure you that we will be able to attract and retain Resellers. If we
are able to attract Resellers, our gross margins may narrow due to discounts we
would give to our Resellers. In addition, if any of our Resellers were to
provide inadequate support and services to our customers, our revenues could
decrease and our reputation could be damaged. Our inability to attract or
adequately manage Resellers could materially and adversely affect our business,
results of operations and financial condition.
PRODUCT AND SERVICE DEVELOPMENT
NetGravity believes that its future success will depend in large part on its
ability to enhance the AdServer System, develop new products, maintain
technological leadership, and satisfy an evolving range of customer requirements
for large scale online advertising and direct marketing applications.
NetGravity's product and services development organization is responsible for
product architecture, core technology, product testing and quality assurance,
writing user documentation, and expanding the ability of NetGravity products to
operate with the leading hardware platforms, operating systems, database
management systems, content management systems and electronic commerce systems.
Since inception, NetGravity has made substantial investments in product
development and related activities. In addition, certain technologies have been
acquired and integrated into NetGravity products through licensing arrangements.
As of December 31, 1998, there were 28 employees in NetGravity's product
development organization. NetGravity's research and development expenses were
$1.8 million, $3.0 million and $4.6 million for the years ended December 31,
1996, 1997 and 1998, respectively. To date, NetGravity has not capitalized any
software development costs. NetGravity expects to continue to devote substantial
resources to its product development activities. NetGravity plans to release its
next major version of AdServer in 1999. NetGravity also expects to release
AdCenter for Agencies in the second quarter of 1999. Finally, the Company is
developing an enhanced version of its Global Profile
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Service, adding the ability to supply more detailed demographic targeting data,
which is expected to be available in the second half of 1999.
Although NetGravity sells products to each of the constituents in the online
advertising and direct marketing supply chain (merchants, advertising agencies
and content publishers), it does not currently offer products automating the
online advertising purchasing process among such constituents. If demand for a
comprehensive solution develops and NetGravity fails to develop such a solution
on a timely basis, or at all, it could have a material adverse effect on
NetGravity's business, results of operations or financial condition. In
addition, as more customers demand online advertising and direct marketing
solutions, NetGravity must tailor its products to the specific requirements of
both online advertisers and direct marketers and provide a solution for
supplying demographic and behavioral data. If NetGravity does not develop a
satisfactory product to address the online direct marketing market, future
growth of NetGravity could be impaired and NetGravity could lose customers to
competitors with more comprehensive solutions. The occurrence of any such event
could have a material adverse effect on NetGravity's business, results of
operations or financial condition.
NetGravity's products are designed to operate on a variety of hardware and
software platforms employed by its customers in their individual networks.
NetGravity must continually modify and enhance its products to keep pace with
changes in hardware and software platforms and database technology. As a result,
uncertainties related to the timing and nature of new product announcements,
introductions or modifications by operating systems vendors, particularly
Microsoft and Sun, by vendors of relational database software, particularly
Oracle and Microsoft, and browsers, particularly Netscape and Microsoft could
materially adversely impact NetGravity's business, results of operations or
financial condition.
COMPETITION
The market for online interactive marketing solutions is new, intensely
competitive and rapidly evolving. We expect competition to continue to increase
both from existing competitors and new market entrants. We believe that our
ability to compete depends on many factors both within and beyond our control,
including:
- the ease of use, performance, features, price and reliability of our
solutions as compared to those of our competitors;
- the timing and market acceptance of new solutions and enhancements to
existing solutions developed by us and our competitors;
- the quality of our customer service and support; and
- the effectiveness of our sales and marketing efforts.
We believe that we presently compete favorably with respect to these
factors. However, we believe that our markets are still evolving, and we cannot
assure you that we will compete successfully in the future. Historically, our
competitive position with respect to prospective customers who favor outsourced
solutions has not been as strong as our position in the software market given
that we have not, until recently, offered outsourced solutions. Even with the
introduction of AdCenter we cannot assurance you that our competitive position
will improve among such customers. Our competitive position in our market (or
portions thereof) as compared to our competitors is otherwise difficult to
characterize, due principally to the variety of current and potential
competitors and the emerging nature of the market.
In the online advertising market, we compete directly with DoubleClick Inc.,
CMG plc (through its Engage/Accipiter unit), Excite, Inc. (through its
MatchLogic unit), AdForce, Inc., Real Media, Inc. and a variety of other online
advertising service providers. To date, we have focused primarily on developing
20
<PAGE>
software-based solutions, which we license to our customers, although we have
recently begun offering an outsourced solution (AdCenter). Some of our
competitors (including DoubleClick) have adopted a business model focused on
outsourcing of interactive marketing solutions. These competitors have much more
experience offering these outsourced solutions. If the outsourced model gains
popularity over the software model in our target market, we cannot assure you
that we will be able to compete effectively with our current products and
services.
In the online direct marketing market, we expect to face indirect
competition from the vendors of electronic commerce systems, including
BroadVision, Interworld and Open Market, among others. In addition, if providers
of electronic commerce systems begin including advanced online direct marketing
functionality in their products, this could reduce or eliminate the need for
separate direct marketing management solutions, including our current and future
products targeted at the direct marketing market. We also encounter competition
from Netscape and Microsoft, which build or bundle advertising management
products with their Internet commerce solutions. Both Netscape and Microsoft
have significantly greater resources than we do, and, due to their control of
the browser market, if either of them were to offer online advertising and
direct marketing management solutions with features comparable to those offered
by us, there can be no assurance that we would be able to compete effectively.
Many of our current and potential competitors have longer operating
histories and significantly greater financial, technical, marketing and other
resources than we do and thus may be able to respond more quickly to new or
changing opportunities, technologies and customer requirements. Also, many of
our current and potential competitors have greater name recognition, more
extensive customer bases and larger proprietary consumer databases. These
competitors may be able to undertake more extensive promotional activities,
adopt more aggressive pricing policies, or offer more attractive terms to
purchasers than we can. In addition, current and potential competitors have
established or may establish cooperative relationships among themselves or with
third parties to enhance their products. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and rapidly acquire
significant market share.
In addition to these current and potential commercial competitors, we also
face competition from the internal capabilities of some potential customers.
Some of the largest and most popular online content publishers use internally
developed interactive marketing solutions rather than the commercial solutions
offered by NetGravity and our competition. We cannot assure you that we will be
able to compete successfully with these internally-developed solutions.
Increased competition is likely to result in price reductions, reduced gross
margins and loss of market share, any one of which could impair our finances and
business prospects. We cannot assure you that we will be able to compete
successfully against existing or potential competitors or that competitive
pressures will not materially impair our finances or business prospects.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
IT IS DIFFICULT FOR US TO PREVENT THE MISAPPROPRIATION OF OUR INTELLECTUAL
PROPERTY. Policing unauthorized use of our products is difficult, particularly
because the global nature of the Internet makes it hard to control the ultimate
destination or security of software or other data transmitted. The laws of other
countries may afford us little or no effective protection of our technology. We
cannot assure you that the steps taken by us will prevent misappropriation of
our technology or that agreements entered into for that purpose will be
enforceable. In addition, litigation may be necessary in the future to enforce
our intellectual property rights, to protect our trade secrets, to determine the
validity and scope of the proprietary rights of others, or to defend against
claims of infringement or invalidity. Such litigation, whether successful or
unsuccessful, could result in substantial costs and diversions of resources,
either of which could have a material and adverse effect on our business,
results of operations or financial condition.
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WE PROTECT OUR INTELLECTUAL PROPERTY BY WAY OF SEVERAL LEGAL MEANS. The
success and competitiveness of our products depend in part upon our ability to
protect our current and future technology through a combination of trademark,
trade secret and copyright law. Because laws protecting certain ownership rights
in Internet-related industries are uncertain and still evolving, we cannot give
you any assurance about the future viability or value of any of our current
technology ownership rights.
OUR SOURCE CODE MAY BE RELEASED TO OUR CUSTOMERS UNDER CERTAIN
CIRCUMSTANCES. Under the general terms and conditions of our standard license
agreements with customers, we retain title to the trade secrets and copyrights
in the source code of our software products. However, some of our agreements
with our customers contain provisions requiring release of source code for
limited, non-exclusive use by the customer in the event that we cease to do
business or we fail to support our products. This release of source code may
increase the likelihood of misappropriation by third parties.
WE PROTECT OUR INTELLECTUAL PROPERTY BY ENTERING INTO INTELLECTUAL PROPERTY
AGREEMENTS WITH EMPLOYEES, CONSULTANTS AND VENDORS. We enter into
confidentiality and intellectual property assignment agreements with our
employees, consultants, and vendors and generally control access to and
distribution of our software, documentation, and other proprietary information.
Notwithstanding these precautions, it may be possible for a third party to copy
or otherwise obtain and use our software or other proprietary information
without authorization or to develop similar software independently.
From time to time we have been, and expect to continue to be, subject to
claims of alleged infringement of the copyrights, trade secrets and other
intellectual property rights of third parties by us. In addition, other parties
may assert invalidity claims (or claims for indemnification resulting from
infringement claims) against us. Any such assertions or prosecutions might
materially and adversely affect our business, results of operations or financial
condition. Although such claims have not resulted in litigation or had a
material and adverse effect on our business, results of operations or financial
condition, such claims could subject us to significant liability for damages and
could result in invalidation of our proprietary rights and be time-consuming and
expensive to defend, and result in the diversion of management time and
attention. If any such claims or actions are asserted against us, we may seek to
obtain a license under a third party's intellectual property rights. We cannot
assure you, however, that under such circumstances, a license would be available
on reasonable terms or at all.
EMPLOYEES
As of December 31, 1998, the Company had 125 employees, including 46 in
sales and marketing, 28 in research and development, 29 in professional
services, customer support and education, three in transactional services, and
19 in finance and administration. Of these, 11 are located in Asia, 15 are
located in Europe and the remainder are located in North America. None of the
Company's employees is represented by a labor union. The Company has experienced
no work stoppages and believes its relationship with its employees is good. See
"Factors Affecting Our Business, Operating Results and Financial Condition--Our
success depends on certain key employees."
RECENTLY PROPOSED PUBLIC OFFERING
On March 2, 1999, NetGravity filed a Registration Statement on Form S-1
(File No. 333-73203) with the Securities and Exchange Commission (the
"Commission") relating to the proposed public offering of 2,738,440 shares of
the Company's Common Stock by the Company, 861,560 shares of the Company's
Common Stock by certain stockholders of the Company and up to an additional
540,000 shares of the Company's Common Stock by the Company to cover
over-allotments, if any. The Company will not receive any proceeds from the sale
of Common Stock by the selling stockholders. The Company cannot assure you that
the proposed offering will be completed. If the offering is completed, the
Company expects to use the net proceeds therefrom for working capital and other
general corporate purposes.
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FACTORS AFFECTING OUR BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION
In addition to other information in this Report and in the documents
incorporated by reference herein, the following risk factors should be carefully
considered in evaluating us and our business because these factors currently
have a significant impact or may have significant impact in the future on our
business, operating results or financial conditions.
WE HAVE A LIMITED OPERATING HISTORY.
We were founded in September 1995 and commercially released version 1.0 of
AdServer in May 1996. Accordingly, we have a limited operating history, and we
face all of the risks and uncertainties encountered by early-stage companies.
The new and evolving nature of the online interactive marketing solutions
markets increases these risks and uncertainties. Also, because we have a limited
operating history, our past results may not be meaningful and you should not
rely on them as indicators of our future performance. For a detailed discussion
of our financial condition and results of operations, please see the section of
this report entitled "Item 7: Management's Discussion and Analysis of Financial
Condition and Results of Operations."
WE HAVE INCURRED SUBSTANTIAL LOSSES AND ANTICIPATE CONTINUED LOSSES.
Since our inception in September 1995, we have incurred substantial losses.
Our losses were $6.9 million for the year ended December 31, 1997 and $11.3
million for the year ended December 31, 1998. As of December 31, 1998, we had an
accumulated deficit of $23.0 million.
We anticipate that our expenses relating to developing, marketing and
supporting our current and future products and services will increase
substantially in the future. In particular, we expect to spend significantly on
the following activities:
- developing new market opportunities for our current and future products
and services;
- funding more research and development to improve our current solutions and
to create new solutions;
- expanding and improving our sales and marketing operations;
- expanding and enhancing our outsourced interactive marketing solution
(AdCenter), our enhanced targeting service (Global Profile Service) and
possible future products and services designed for e-commerce merchants
and advertising agencies (including our planned AdCenter for Agencies
offering);
- developing new channels for distributing our products and providing our
services;
- expanding and improving our financial and operational infrastructure; and
- broadening our customer support capabilities.
Accordingly, for the foreseeable future, we expect to experience additional
losses as our expenses for developing, marketing and supporting our current
solutions and developing new solutions exceed our total revenues. These
additional losses will increase our accumulated deficit.
For more detailed information concerning our losses and other operating
results, please see the sections of this report entitled "Item 6: Selected
Consolidated Financial Data" and "Item 7: Management's Discussion and Analysis
of Financial Condition and Results of Operations."
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OUR FUTURE OPERATING RESULTS ARE UNCERTAIN AND ARE LIKELY TO FLUCTUATE
SIGNIFICANTLY.
Our revenues, gross margins and other operating results may vary
significantly from quarter to quarter. The fluctuations may be due to a number
of factors, many of which are beyond our control. These factors include:
- our or our competitors' introduction of new or enhanced online interactive
marketing solutions;
- market acceptance of existing or planned products and services, including
future versions of AdServer and AdCenter, our enhanced targeting services
(Global Profile Service) and possible future products and services
designed for e-commerce merchants and advertising agencies (including
AdCenter for Agencies);
- the time it takes us to sell our services and license and implement our
products and the size of each transaction;
- the mix of software licenses, software upgrades, consulting and support
and transactional services revenues;
- the amount of advertising spending budgeted by advertisers and direct
marketers for online interactive marketing;
- our or our competitors' price changes or changes in pricing models;
- our customers' failure to renew their AdServer upgrade and support
contracts;
- the shift from higher gross margins from software license and upgrade
revenues to lower gross margins from consulting and support and
transactional services revenues;
- the mix of distribution channels through which we sell our products and
services;
- our sales and licensing activities in international markets;
- costs relating to possible acquisitions of technology or businesses; and
- the amounts of royalty payments, amortization charges and other costs
related to the licensing or acquisition of technology or other intangible
assets.
Due to all of the foregoing factors, we do not believe that period-to-period
comparisons of our historical results of operations are good predictors of
future performance. Furthermore, it is possible that in some future quarters our
results of operations may fall below the expectations of securities analysts and
investors. In such event, the trading price of our stock will likely be
materially and adversely affected. Please also see "Item 7: Management's
Discussion and Analysis of Financial Condition and Results of Operations" for a
more detailed analysis of our period-to-period results.
WE RELY HEAVILY ON SALES OF ONE PRODUCT FAMILY.
To date, we have generated nearly all of our revenues from the license and
related upgrades, consulting and support of our AdServer family of software
products. We expect that our current AdServer family of software products and
software products in development, together with the related consulting and
support services, will continue to account for a substantial majority of our
revenues for the foreseeable future.
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Therefore, our future financial performance is dependent, in significant
part, upon the successful development, introduction and customer acceptance of
new and enhanced versions of AdServer and of related new products and services
that we may develop. We cannot assure you that we will be successful in
upgrading AdServer or that we will successfully develop new products and
services or that any new product or service will achieve market acceptance.
Consequently, factors affecting the pricing of and demand for AdServer, such as
competition, technological changes, failure of the market for online interactive
marketing solutions to develop as we expect or lack of customer acceptance of
AdServer could have a material and adverse effect on our business, results of
operations or financial condition. For more information on the sources of our
revenues, please see the section of this Report entitled "Item 7: Management's
Discussion and Analysis of Financial Condition and Results of Operations."
OUR FUTURE SUCCESS DEPENDS ON THE TIMELY COMPLETION OF NEW SOLUTIONS UNDER
DEVELOPMENT.
We must successfully complete the development of AdCenter for Agencies and
the next version of Global Profile Service (which is being designed to provide
much more detailed consumer profiles than the current version). Our future
revenues will likely fall below our expectations (and the expectations of
investors in our common stock) if we do not successfully develop, market and
support these services. Any actual or expected revenue shortfall would likely
reduce the trading price of our common stock.
WE HAVE AN UNPROVEN AND CHANGING BUSINESS MODEL.
Our core business model has been to license software designed to enable our
customers to directly manage their online interactive marketing activities. We
believe that it is too early to determine whether this business model will be
successful in the future. An alternate business model employed by some of our
competitors (including DoubleClick) is to provide outsourced, service-based
solutions to customers who choose not to directly manage their online
interactive marketing activities.
In 1998 we broadened our business by releasing AdCenter for Publishers, a
service-based service that transfers to us the responsibility for managing our
customers' online systems and the data generated from their online interactive
marketing activities, but preserves customers' control over their advertising
sales functions. We also recently introduced our Global Profile Service which
allows our customers to more narrowly target consumers through the use of
anonymous consumer profiles from our centralized database. Although revenues
from AdCenter and the Global Profile Service to date have not been material, we
intend to place more emphasis on developing these services in the future. Our
increased emphasis on AdCenter and the Global Profile Service may not be
successful. In particular, AdCenter may not compete effectively with current or
future outsourced service providers based on price, performance or other
features. Similarly, our Global Profile Service may not be competitive with
current or future providers of consumer profile data. In addition, we expect to
devote significant engineering, marketing, sales, consulting and customer
support resources to enhance AdCenter's and the Global Profile Service's
competitiveness, scalability and cost-effectiveness. These actions may divert
resources from our other products and services and may thus harm our core
AdServer business. Please see the section of this report entitled "Item 1:
Business--Software Products and Transactional Services" for a description of
AdCenter and the Global Profile Service.
OUR MARKETS ARE HIGHLY COMPETITIVE.
See "Item 1: Business--Competition."
OUR SALES AND IMPLEMENTATION CYCLES ARE LONG.
SALES CYCLE. To license our software products, we generally engage in a
lengthy sales effort. During the sales effort, we spend significant time
educating prospective customers on the use and benefit of our solutions. As a
result, the sales cycle for our products and services is long and currently
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averages approximately four months. The sales cycle for our online direct
marketing solutions is likely to be longer than the sales cycle for online
advertising solutions, because we believe that online direct marketing is less
established and will require more education of potential customers. In addition,
an increase in the average size of transactions would also likely result in an
even longer sales cycle as the license of our software products rises to the
level of an enterprise-wide decision for prospective customers, requiring a
significant commitment of resources. Delays due to lengthy sales cycles could
have a material and adverse effect on our business, results of operations or
financial condition. For a detailed description of our sales cycle, please see
the sections of this report entitled "Item 7: Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Item 1:
Business-- Sales and Marketing."
IMPLEMENTATION CYCLE. Because we do not recognize revenues from a sale
until the customer has implemented the solution purchased, the timing of our
revenues depends on our customers' implementation cycles. The implementation of
our products often involves a significant commitment of resources by customers
and/or our consultants over an extended period of time. Our sales and customer
implementation cycles may be delayed due to product defects or errors and
factors over which we have little or no control, including customers' budgetary
constraints, internal acceptance reviews and the complexity of customers' online
interactive marketing needs. Delays in customer deployment of a product could
have a material and adverse effect on our business, results of operations or
financial condition. For example, due to errors contained in early versions of
AdServer 3.0, deployment of this earlier version of AdServer required a
significant amount of our and our customers' time and resources. For more
information about our revenue recognition policies please see the section of
this report entitled "Item 7: Management's Discussion and Analysis of Financial
Condition and Results of Operations."
ONLINE ADVERTISING AND ONLINE DIRECT MARKETING ARE NEW AND EVOLVING BUSINESSES.
Online interactive marketing is in its very early stages of development.
Like many new businesses, it is characterized by rapidly evolving technologies,
quickly changing marketing and sales strategies, multiple and aggressive market
participants, fluctuating demand and uncertain market acceptance for products
and services. Online advertising and online direct marketing (the two components
of online interactive marketing) are also characterized by their heavy
dependence on the success of the Internet, which itself is a new medium with an
unpredictable future. For a discussion of the risks associated with the
Internet, please see the section below entitled "Our success depends on the
widespread acceptance and use of the Internet."
ONLINE ADVERTISING
THE EFFECTIVENESS OF ONLINE ADVERTISING IS UNCERTAIN AND OUR FUTURE SUCCESS
DEPENDS HEAVILY ON THE CONTINUED AND INCREASED USE OF THE INTERNET AS AN
ADVERTISING MEDIUM. We believe that it is too early to accurately judge the
effectiveness of Internet advertising as compared to traditional advertising
media. If the market for Internet advertising fails to develop or develops more
slowly than we expect, our business, results of operations and financial
condition could be materially and adversely affected.
ADVERTISERS HAVE LIMITED EXPERIENCE WITH THE INTERNET. Our current and
potential advertising customers are generally not experienced in online
advertising and have allocated only a limited portion of their advertising
budgets to Internet advertising. There is no guarantee that our current and
potential customers will increase or even continue Internet advertising or that
advertisers that currently do not advertise on the Internet will begin to
advertise online.
WEB PUBLISHERS HAVE LIMITED ADVERTISING EXPERIENCE. Most of our current and
potential Web content publisher customers have little or no experience selling
advertising space on their Web sites. Consequently, such publishers may not
generate enough advertising revenues to be economically viable. If
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Web publishers stop using our products and services, our business, results of
operations and financial condition would be materially and adversely affected.
THE CURRENT METHODS OF MEASURING ONLINE ADVERTISING'S EFFECTIVENESS PRODUCE
UNCERTAIN RESULTS. There are currently no standards for measuring the
effectiveness of Internet advertising. Without standardized measurements, online
advertisers may challenge or refuse to accept our or third-party measurements of
the effectiveness of online advertisements. Our business, results of operations
and financial condition could be materially and adversely affected if standards
for measuring the effectiveness of Internet advertising are not developed and
widely adopted.
OUR BUSINESS DEPENDS HEAVILY ON BANNER ADVERTISEMENTS. Almost all of our
revenues ultimately come from the delivery of banner advertisements on Web
pages. If advertisers determine that banner advertising is an ineffective or
unattractive advertising medium, our business, results of operations and
financial condition would be materially adversely affected.
INTERNET USERS MAY USE "FILTER" SOFTWARE TO BLOCK ADVERTISEMENTS. Some
Internet users use "filter" software programs that limit or prevent advertising
from being delivered to such users' computers. The commercial viability of
Internet advertising, and our business, results of operations and financial
condition, would be materially and adversely affected by Web users' widespread
adoption of such software.
ONLINE DIRECT MARKETING
DIRECT MARKETERS MAY NOT BE ACCUSTOMED TO CONDUCTING DIRECT MARKETING ON THE
INTERNET. Online direct marketing is a new and substantially different approach
to direct marketing that has not reached broad acceptance by direct marketing
companies. Consequently, direct marketing companies may be reluctant to conduct
their business online until they understand and are comfortable with the medium.
If direct marketing companies do not accept the Internet as a viable medium for
direct marketing, our business, results of operations and financial condition
could be materially and adversely affected.
ONLINE DIRECT MARKETING MAY COMPETE WITH TRADITIONAL DIRECT MARKETING
MEDIA. Companies that have already invested substantial resources in other
methods of conducting their direct marketing business may be reluctant or slow
to adopt a new approach that may replace, limit or compete with their existing
systems. If direct marketing companies do not accept the Internet as a viable
medium for direct marketing, our business, results of operations and financial
condition could be materially and adversely affected.
WE HAVE NOT YET, BUT EXPECT THAT WE MAY NEED TO, TAILOR OUR PRODUCTS TO
ONLINE MARKETERS' NEEDS. Because online direct marketing is emerging as a new
and distinct market apart from online advertising, we believe that potential
adopters of online direct marketing solutions will increasingly demand
functionality tailored to their specific requirements. Although AdServer's
largely advertising-oriented features can be deployed for online direct
marketing, we have not yet developed products with the custom features required
by online direct marketers. We cannot assure you that we will develop any such
products, or if such products are developed, that they will achieve a
satisfactory level of market acceptance.
WE MUST SUCCESSFULLY DEVELOP NEW PRODUCTS AND KEEP UP WITH RAPID TECHNOLOGICAL
CHANGE.
OUR BUSINESS WILL SUFFER IF WE FAIL TO KEEP UP WITH RAPIDLY CHANGING
TECHNOLOGY. Rapidly changing technology, evolving industry standards, frequent
announcements and introductions of new or enhanced products and services and
changing customer demands characterize the markets for our products and
services. The emerging nature of the Web in general and online interactive
marketing in particular underscore these characteristics. Accordingly, we are
dependent upon our ability to adapt to rapidly changing technologies, to adapt
our solutions to meet evolving industry standards and to continually
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improve the performance, features and reliability of our solutions in response
to both changing customer demands and competitive product and service offerings.
For example, if the historical growth rate in the use of the Internet were to
continue, our current products may need to be redesigned in order to efficiently
process a significantly higher volume of transactions, particularly if each
transaction becomes more complex through the use of demographic targeting and
other advanced features. If we fail to successfully and quickly adapt to
changing technologies and customer requirements, our business, results of
operations or financial condition could be materially and adversely affected.
OUR DEVELOPMENT EFFORTS FACE THE FURTHER CHALLENGE OF MAINTAINING
COMPATIBILITY WITH THIRD-PARTY HARDWARE AND SOFTWARE. Our products are designed
to operate on a variety of hardware and software platforms employed by our
customers in their individual networks. We must continually modify and enhance
our products to keep pace with changes in hardware and software platforms and
database technology. As a result, uncertainties related to the timing and nature
of new product announcements, introductions or modifications by operating
systems vendors, particularly Microsoft and Sun, by vendors of relational
database software, particularly Oracle and Microsoft, and browser vendors,
particularly Netscape and Microsoft, could materially and adversely affect our
business, results of operations and financial condition. Please also see the
section of this Report entitled "Item 1: Business--Technology."
IF OUR TRANSACTIONAL SERVICES REVENUES GROW, WE MAY EXPERIENCE ADDITIONAL
REVENUE FLUCTUATIONS.
To date, the vast majority of our revenues has been from software licenses
and related support and upgrades, and has not been directly linked to the volume
of advertisements delivered by our customers. However, as we increasingly focus
on offering transaction-based services, our revenues may become more dependent
on the volume of transactions executed by our customers. In contrast to revenues
from existing software licenses and upgrades and support arrangements which are
reasonably predictable over the term of the customer contract, transactional
services revenues are inherently less predictable and may contribute to the
variability of our overall revenues and other operating results. For example, we
believe that advertising sales in traditional media, such as television and
radio, are generally lower in the first calendar quarter of each year and are
subject to other cyclical variations. We believe that our transactional services
revenues will be affected by similar seasonal and cyclical fluctuations as the
online advertising market matures.
WE HAVE TO EFFECTIVELY MANAGE OUR GROWTH.
We have recently experienced a period of rapid growth and expansion that has
placed and continues to place a significant strain upon our management, systems
and resources. We have grown from ten employees as of December 31, 1995 to 125
employees as of December 31, 1998 and currently plan to further expand our staff
both domestically and internationally. In particular, we plan to expand our
sales and marketing and customer support organizations both domestically and
internationally. Our ability to compete effectively and manage future growth, if
any, will require us to continue to implement and improve operational, financial
and management information systems on a timely basis and to attract, hire, train
efficiently and effectively and retain additional technical, managerial,
finance, sales and marketing and support personnel. Any failure to implement and
improve our operational, financial and management systems or to attract, hire,
train or retain employees could have a material and adverse effect on our
business, results of operations or financial condition. Please see the section
below entitled "Our success depends on certain key employees" for descriptions
of risks relating to our employees and the sections of this report entitled
"Item 7: Management's Discussion and Analysis of Financial Condition and Results
of Operations" and "Item 1: Business--Employees" for a description of our
growth.
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WE FACE RISKS ASSOCIATED WITH OUR INTERNATIONAL OPERATIONS AND PLANS FOR
EXPANSION.
WE HAVE A LIMITED OPERATING HISTORY IN OUR INTERNATIONAL MARKETS. We have
only limited experience in marketing, selling and distributing our products and
services internationally. Through our three subsidiaries, NetGravity Europe
Limited, NetGravity Asia Pacific K.K. and NetGravity (Hong Kong) Limited, we
recently began operations in a number of markets in Europe and Asia Pacific.
International revenues comprised approximately 28% of our total revenues in 1998
and are expected to comprise a significant portion of our total revenues in
1999.
THERE ARE CERTAIN RISKS AND CHALLENGES INHERENT IN DOING BUSINESS IN
INTERNATIONAL MARKETS. Such risks include:
- difficulties in collecting accounts receivable and longer collection
periods;
- changing and conflicting regulatory requirements;
- potentially adverse tax consequences;
- tariffs and general export restrictions, including export controls
relating to encryption technology;
- difficulties in staffing and managing foreign operations;
- political instability;
- fluctuations in currency exchange rates as evidenced by the ongoing Asia
Pacific financial crisis;
- the uncertain impact of the introduction of the Euro;
- seasonal reductions in business activity during the summer months in
Europe and certain other parts of the world; and
- the impact of local economic conditions and practices.
INTERNATIONAL MARKETS FOR ONLINE INTERACTIVE MARKETING ARE IN THEIR VERY
EARLY STAGES OF DEVELOPMENT. International markets for online advertising and
direct marketing are in earlier stages of development than in the United States,
and we cannot assure you that the market for, and use of online advertising and
direct marketing in international markets will be significant in the future.
Factors that may further account for slower growth in the online advertising and
direct marketing markets in Europe and Asia include:
- slower growth in the number of individuals using the Internet
internationally;
- privacy concerns;
- a lower rate of advertising spending internationally than in the United
States; and
- a greater reluctance internationally to use the Internet for advertising
and direct marketing.
WE NEED TO DEVELOP LOCALIZED VERSIONS OF OUR PRODUCTS AND TO EXPAND OUR
INTERNATIONAL PRESENCE. We believe that having localized versions of our
products may become an important competitive factor for international sales in
the future. We also believe that our international sales may be limited in the
future if we do not increase our physical presence abroad, including hiring
additional personnel for local service and support. In addition, before we can
efficiently deliver transactional services to international customers, we must
establish local hosting centers from which to deliver these services. The
development of localized versions of our products and the expansion of our
international presence will likely require significant resources.
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Any of the above factors could have a material and adverse affect on our
international sales and operations, which, in turn, could adversely affect our
overall business, operating results and financial condition.
OUR SUCCESS DEPENDS ON CERTAIN KEY EMPLOYEES.
Our future performance will depend largely on the efforts and abilities of
our key technical, customer support, sales and managerial personnel and on our
ability to retain them. We have in the past experienced difficulty in hiring
qualified technical, customer support, sales and managerial personnel. Our
success will depend on our ability to attract and retain such personnel in the
future. In particular, we are currently seeking to hire a senior executive to
expand the operational expertise of our management team. Although we have
engaged an executive search firm to assist us, we cannot assure you that we will
be able to successfully hire and retain such an executive. In addition, the loss
of any of our current executive officers could materially and adversely affect
our business, financial condition and operating results.
WE MAY ACQUIRE OTHER COMPANIES' PRODUCT LINES, TECHNOLOGIES OR BUSINESSES.
As part of our growth strategy, we may in the future attempt to purchase
other companies' product lines, technologies or businesses. In connection with
any such acquisitions, we may pay cash, issue stock, incur debt or be required
to amortize expenses related to goodwill and other intangible assets. For
example, in September 1998 we paid $2 million to MatchLogic for rights to use
certain of MatchLogic's proprietary consumer profile databases for limited
purposes. We accounted for this transaction as a purchase of an intangible
asset, which is being amortized over its expected useful life of three years. In
addition, acquisitions of companies and businesses involve numerous risks,
including difficulties in the assimilation of the operations, technologies,
products and personnel of the acquired company, the diversion of management's
attention from other business concerns, risks of entering markets in which we
have no or limited direct prior experience and the potential loss of key
employees of the acquired company. From time to time, we have engaged in
discussions with third parties concerning potential acquisitions of product
lines, technologies and businesses. In the event that such an acquisition were
to occur, our business, results of operations, financial condition and the
trading price of our common stock may be materially and adversely affected due
to the factors described above.
WE RELY ON THIRD-PARTY SOFTWARE AND CONSUMER PROFILE DATA.
WE RELY ON SOFTWARE LICENSED FROM THIRD PARTIES, including database access
technology and other tools from Rogue Wave. We intend to increase our use of
licensed third-party software in future releases of our solutions. We cannot
assure you that we will be able to continue to license this technology on
commercially reasonable terms, if at all. The loss or inability to maintain any
of these technology licenses could result in delays in the sale of our products
and services until equivalent technology, if available, is identified, licensed
and integrated. These delays could have a material and adverse effect on our
business, results of operations or financial condition. For more information
concerning the way our products work with third-party technology, see the
section of this Report entitled "Item 1: Business--Product and Service
Development."
WE ARE DEPENDENT ON THIRD PARTY DATA SOURCES FOR OUR GLOBAL PROFILE
SERVICE. Our Global Profile Service is a service we offer our customers that
allows them to more narrowly target their online interactive marketing by using
anonymous geographic data. We plan to expand this service to cover other
demographic and behavioral data. We license the underlying databases of
anonymous consumer profiles from third party sources, including
Excite/MatchLogic and HNC/Aptex. The performance of our Global Profile Service,
as measured by improved response rates to advertisements, promotions or other
offers is, in large part, dependent on the scope, accuracy and timeliness of the
profile data contained in these third party databases. These factors are largely
outside of our control. Although our
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contracts with MatchLogic and Aptex provide for access to their databases
through September 2001, if, for whatever reason, we were no longer able to
purchase access to these databases or equivalent databases on commercially
reasonable terms, or if the quality and scope of the available data was not
sufficient for effective targeting, we may have to discontinue our Global
Profile Service. In addition to the resulting loss of direct revenue from the
Global Profile Service, existing or potential customers may view the
unavailability or impaired functionality of the Global Profile Service as a
competitive disadvantage and may choose not to use AdServer in favor of a
solution offering superior targeting capabilities. For these reasons, any
unavailability or degradation of our Global Profile Service could have a
material and adverse effect on our business, results of operations or financial
condition.
WE MAY NEED TO EXPAND OUR USE OF RESELLERS.
We have historically sold our products and services primarily through our
field sales and telesales organization, but our future success may depend in
part upon our ability to increase sales of our solutions through Web hosting
organizations and Internet systems integrators (collectively, "Resellers"). We
cannot assure you that we will be able to attract and retain Resellers. If we
are able to attract Resellers, our gross margins may narrow due to discounts we
would give to our Resellers. In addition, if any of our Resellers were to
provide inadequate support and services to our customers, our revenues could
decrease and our reputation could be damaged. Our inability to attract or
adequately manage Resellers could materially and adversely affect our business,
results of operations and financial condition. Please see "Item 1:
Business--Marketing Alliances" for a more detailed description of our Reseller
and other third-party relationships.
OUR SUCCESS DEPENDS ON THE WIDESPREAD ACCEPTANCE AND USE OF THE INTERNET.
Because we are in the business of providing online interactive marketing
solutions, our success is directly tied to the widespread acceptance and
continued use of the Internet. However, the Internet may not be accepted as a
viable commercial medium for a number of reasons, including the potentially
inadequate development of the Internet's infrastructure. Even if the Internet
gains widespread acceptance and continued use, such acceptance and use may
decrease rapidly if, in the future, the Internet's infrastructure cannot support
the demands that users place upon it, or if significant governmental regulation
is imposed on the Internet. If use of the Internet does not grow as expected,
our business, results of operations and financial condition would be materially
and adversely affected. Also, if the Internet's current infrastructure or the
technical standards and protocols that support such infrastructure change or are
replaced by new technical standards and protocols, we may need to incur
substantial costs to adapt our current solutions.
WE DEPEND ON COOKIE TECHNOLOGY FOR AD TARGETING.
Our software, including our Global Profile Service software, uses "cookies"
to deliver targeted advertising, to help compile demographic information, and to
limit the frequency with which an advertisement is shown to a particular
Internet user. Cookies are small files of information about an Internet user's
movement through the Internet that are stored on the hard drive of the user's
computer. The cookie information is passed to the Web site through the Internet
user's browser software. Cookies are often placed on the user's hard drive
without the user's knowledge or consent, although users can often disable the
cookie functions of their Internet browser software.
Some Internet commentators and advocates and some governmental bodies
concerned with the privacy of Internet users have suggested limiting or
eliminating the use of cookies. These have led to legal and technical
limitations on the use of cookies. For example, the European Union has recently
adopted a directive addressing data privacy that may result in limitations on
the collection and use of certain information regarding Internet users. Also,
Germany has imposed its own laws limiting the use of cookies and other countries
may also place similar limitations.
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If legal or technological restrictions impose any significant reduction or
limitation on the use or effectiveness of cookies, we would likely have to
switch to other technology that allows the gathering of information for ad
targeting. This could require significant reengineering time and resources,
might not be done in time to avoid negative consequences to our business,
results of operations or financial condition, and might not be possible at all.
OUR BUSINESS IS SUBJECT TO GOVERNMENTAL REGULATIONS AND TO LEGAL UNCERTAINTIES.
CURRENT AND FUTURE LAWS MAY AFFECT ONLINE BUSINESSES. Due to concerns
arising from the increasing popularity and use of the Web, a number of laws and
regulations have been and may be adopted covering issues such as user privacy,
pricing, acceptable content, taxation and quality of products and services. Such
legislation could dampen the growth in use of the Internet generally and
decrease the acceptance of the Internet as a communications and commercial
medium. Further, due to the global nature of the Internet, it is possible that
multiple federal, state or foreign jurisdictions might attempt to concurrently
and inconsistently regulate the transmissions of our customers or levy sales or
other taxes relating to our activities. Moreover, the applicability to the
Internet of existing laws governing issues such as property ownership, libel and
personal privacy is uncertain. Any of the foregoing developments could have a
material and adverse effect on our business, results of operations or financial
condition.
CERTAIN ISP AND OSP ACCESS FEES HAVE BEEN PROPOSED AND MAY BE
IMPOSED. Because the growing popularity and use of the Web has burdened the
existing telecommunications infrastructure, many areas with high Web use have
begun to experience interruptions in phone service. Certain local telephone
carriers have petitioned governmental bodies to regulate Internet service
providers ("ISPs") and online service providers ("OSPs") in a manner similar to
long distance telephone carriers and to impose access fees on ISPs and OSPs. If
any of these petitions or the relief sought therein is granted, the costs of
communicating on the Web could increase substantially, potentially negatively
affecting the growth in use of the Web which could in turn decrease the demand
for our products and services.
WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR CUSTOMERS' INFORMATION.
We have included basic security features in certain of our products and
services that are intended to protect the privacy and integrity of data
collected from our customers. However, in our AdServer product, passwords for
certain operations are not encrypted and therefore are susceptible to hacker
interception, break-ins and disruption. Such computer break-ins and other
disruptions may jeopardize the security of information stored in and transmitted
through the computer systems of our customers. If such computer break-ins or
other disruptions were to happen to our current products or to any of our future
products, we might be subject to lawsuits by the affected customers, harm to our
reputation among our current and potential customers, and significant
expenditures of our capital and other resources.
WE FACE THE RISKS OF PRODUCT DEFECTS AND PRODUCT LIABILITY CLAIMS.
OUR BUSINESS WILL BE HARMED IF OUR SOFTWARE CONTAINS SIGNIFICANT
BUGS. Software products as complex as ours frequently contain errors, defects
or performance problems (commonly called "bugs"), especially when they are first
introduced or when new versions or enhancements are released. Although we test
our products extensively prior to introduction, in the past our products have
contained software errors that were not discovered until after commercial
introduction. For example, AdServer 3.0, although functional when released, had
a number of software errors that affected the product's performance, reliability
and compatibility with certain operating environments. We had to devote
significant customer support resources to address these errors. We cannot assure
you that our testing (which includes customer beta testing) will detect all
serious defects, errors and performance problems prior to commercial release of
our future software products. Any future software defects, errors or performance
problems discovered after commercial release could result in the diversion of
scarce resources away
32
<PAGE>
from customer service and product development, lost revenues or delays in
customer acceptance of our products and damage to our reputation, which, in each
case, could have a material and adverse effect on our business, results of
operations or financial condition. Our customers and potential customers may be
particularly sensitive to any such defects, errors or performance problems given
that a failure of a Web site's advertising management and delivery system often
immediately and directly results in lost or reduced advertising revenue during
such failure.
IF OUR PRODUCTS MALFUNCTION OR SUFFER FROM DESIGN DEFECTS, WE MAY BE SUBJECT
TO PRODUCT LIABILITY CLAIMS. Although our license agreements with our customers
typically contain provisions designed to limit our exposure to liabilities
arising from product liability claims, we cannot assure you that these
provisions will be enforceable under existing or future international, federal,
state or local laws and judicial decisions. We have not experienced any product
liability claims to date, but we may be subject to such claims in the future. A
product liability claim brought against us could have a material and adverse
effect on our business, results of operations or financial condition.
WE MAY BE UNABLE TO PROTECT OUR PROPRIETARY RIGHTS IN OUR PRODUCTS.
See "Item 1: Business--Intellectual Property and Other Proprietary Rights."
OUR PRODUCTS MAY INFRINGE UPON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS.
From time to time we have been, and expect to continue to be, subject to
claims of alleged infringement of the copyrights, trade secrets and other
intellectual property rights of third parties by us. In addition, other parties
may assert invalidity claims (or claims for indemnification resulting from
infringement claims) against us. Any such assertions or prosecutions might
materially and adversely affect our business, results of operations or financial
condition. Although such claims have not resulted in litigation or had a
material and adverse effect on our business, results of operations or financial
condition, such claims could subject us to significant liability for damages and
could result in invalidation of our proprietary rights and be time-consuming and
expensive to defend, and result in the diversion of management time and
attention. If any such claims or actions are asserted against us, we may seek to
obtain a license under a third party's intellectual property rights. We cannot
assure you, however, that under such circumstances, a license would be available
on reasonable terms or at all.
WE FACE YEAR 2000 RISKS.
We are aware that many currently installed information technology ("IT")
systems, such as computer systems and software products, as well as non-IT
systems that include embedded technology, were not designed to correctly process
dates after December 31, 1999. We are currently assessing the impact of this
issue, commonly referred to as the "Year 2000" issue, on our business and
operations. We cannot assure you that we will be able to identify and accurately
evaluate all Year 2000 issues that we face.
In September 1998, we released version 3.5 of our AdServer product which
included enhancements designed to correctly accept and process 21st century
dates and, as a result, we now believe that the current versions of our AdServer
family of software products are Year 2000 compliant. However, given the
complexity of software systems such as AdServer and the need for them to
interoperate with other systems, we cannot assure you that our products will not
experience Year 2000 problems in the future. Any such Year 2000 issues could
result in:
- a decrease in sales of our products;
- deferral of revenue recognition on contracts in which we have warranted
(or may in the future warrant) compliance with Year 2000 requirements;
33
<PAGE>
- an increase in the allocation of resources to address Year 2000 problems
of our customers without additional revenue commensurate with such
dedicated resources; or
- an increase in litigation costs relating to losses suffered by our
customers due to Year 2000 problems.
In addition, we have determined that certain of our software IT systems are
not currently Year 2000 compliant. We believe that our software IT systems will
become compliant through updates and upgrades purchased in the ordinary course
of business for reasons unrelated to Year 2000.
As we review our non-IT systems, we may identify situations that present
material Year 2000 risks or that will require substantial time and material
expense to address. In addition, if our customers or our potential customers are
required to expend significant resources to address their Year 2000 issues (or
if they fail to appropriately address such Year 2000 issues), our business,
results of operation and financial condition could be adversely affected due to
resulting changes in purchasing patterns.
Our Year 2000 compliance efforts related to AdServer consumed significant
software engineering resources that would otherwise have been devoted to product
development efforts. To the extent that significant additional software
engineering resources are required to address other Year 2000 issues that may be
discovered, our product development efforts may be significantly hampered which,
in turn, could have a material and adverse effect on our business, financial
condition and results of operations. For more information, please see the
section of this report entitled "Item 7: Management's Discussion and Analysis of
Financial Condition and Results of Operations--Year 2000 Compliance."
OUR CORPORATE GOVERNANCE STRUCTURE MAY DELAY OR PREVENT OUR ACQUISITION BY
ANOTHER COMPANY.
Our certificate of incorporation and by-laws and the Delaware General
Corporation Law include provisions that may be deemed to have anti-takeover
effects. These anti-takeover effects could delay or prevent a takeover attempt
that you or our other stockholders might consider in your or their best
interests.
In addition, our board of directors is authorized to issue, without
obtaining stockholder approval, up to 5,000,000 shares of preferred stock and to
determine the price, rights, preferences and privileges of such shares without
any further stockholder action. The existence of this "blank-check" preferred
stock could make more difficult or discourage an attempt to obtain control of us
by means of a tender offer, merger, proxy contest or otherwise.
In the future, we may adopt other measures that may have the effect of
delaying, deferring or preventing an unsolicited takeover, even if such a change
in control were at a premium price or favored by a majority of unaffiliated
stockholders. Certain of these measures may be adopted without any further vote
or action by the stockholders.
WE MAY REQUIRE ADDITIONAL FINANCING.
We believe that our cash reserves and cash flows from operations will be
adequate to fund our operations for at least the next 12 months. Nevertheless,
we may need to raise more money within the next 12 months or thereafter. Our
capital requirements depend on many factors, including, but not limited to:
- the rate at which we develop and introduce our products and services;
- the market acceptance and competitive position of our products and
services;
- the level of promotion and advertising required to market our products and
services and attain a competitive position in the marketplace; and
- the response of competitors to our products and services.
34
<PAGE>
If we were to require additional funding, such additional funding might not
be available on terms favorable to our stockholders or us or in sufficient
amounts. If additional funds are raised through the issuance of common stock,
such stock might be offered at a price lower than the fair market value of our
common stock at the time of the sale and would therefore reduce the value of the
common stock of our then current stockholders. Even if the value of our common
stock does not decrease, the percentage ownership of the then current
stockholders of the company will be reduced by the issuance of the new stock.
CERTAIN CURRENT STOCKHOLDERS OWN A LARGE PERCENTAGE OF OUR VOTING STOCK.
As of February 5, 1999, our officers and directors and their affiliated
entities together beneficially owned approximately 36.8% of our outstanding
common stock. As a result, these stockholders may, as a practical matter, be
able to control all matters requiring stockholder approval and, thereby, our
management and affairs. Matters that typically require stockholder approval
include:
- election of directors;
- merger or consolidation; and
- sale of all or substantially all of our assets.
This concentration of ownership may delay, deter or prevent acts that would
result in a change of control, which in turn could reduce the market price of
our common stock.
OUR STOCK PRICE IS VOLATILE.
The market price of our common stock is highly volatile and may be subject
to significant fluctuations in response to actual or anticipated variations in
quarterly operating results and other factors, such as:
- announcements of technological innovations;
- sales of common stock following the expiration of legal or contractual
transfer restrictions;
- new products or new contracts by us or our competitors;
- conditions and trends in the software and other technology industries;
- adoption of new accounting standards affecting the software industry;
- changes in earning estimates or recommendations by securities analysts;
and
- general market conditions.
From the time of our initial public offering through March 24, 1999, the
closing price of our common stock reported on the Nasdaq National Market has
ranged from $6 7/8 to $32 15/16. In addition, the stock market in general, and
the market for technology-related stocks in particular, have experienced extreme
volatility that often has been unrelated to the operating performance of
particular companies. These broad market and industry fluctuations may adversely
affect the trading price of our common stock, regardless of our actual operating
performance. We cannot assure you that the market price for our common stock
will not decline below the price of the common stock we are offering in this
report. Please see the section of this report entitled "Item 5: Market for the
Registrant's Common Equity and Related Stockholder Matters--Price Range of
Common Stock and Dividend Policy" for additional information about our stock
price.
In the past, following periods of volatility in the market price of a
particular company's stock, class action litigation has often been brought
against that company. We cannot assure you that we will not be the target of
such litigation in the future.
35
<PAGE>
ITEM 2. PROPERTIES
The Company is headquartered in San Mateo, California where it leases
approximately 26,500 square feet pursuant to a term lease that expires in
October 2005. The Company's principal product development operations are located
in the space in San Mateo. In addition, the Company maintains a regional office
in New York, New York where it leases approximately 3,000 square feet of office
space pursuant to a lease that expires in 2003. The Company also leases space in
London, Tokyo and Hong Kong to support its international operations. The Company
believes that its current facilities are adequate for its needs through the next
twelve months, and that, should it be needed, suitable additional space will be
available to accommodate expansion of the Company's operations on commercially
reasonable terms, although there can be no assurance in this regard. See Note 6
of Notes to Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceeding.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter of the fiscal year ended December 31, 1998.
EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company, and their ages as of February 5,
1999, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------- --- --------------------------------------------------
<S> <C> <C>
John W. Danner......... 31 Chairman of the Board and Chief Executive Officer
Stephen E. Recht....... 47 Chief Financial Officer and Secretary
Susan Atherton......... 42 Vice President of Worldwide Sales
Michael W. Davies...... 37 Vice President of Services and Support
John K. Donnelly....... 31 Vice President of North American Sales
Rick E. D. Jackson 38
IV................... Vice President of Marketing
Douglas S. Kaplan...... 32 Vice President and General Manager of Asia Pacific
Martin G. Lane-Smith... 51 Vice President of Engineering
Jitendra Valera........ 41 Vice President and General Manager of Europe
Larry C. Wear.......... 33 Vice President of Global Services
</TABLE>
JOHN W. DANNER co-founded the Company in 1995, served as its President from
inception until April 1998 and has served as Chief Executive Officer and as a
Director since inception. In April 1998, Mr. Danner was elected Chairman of the
Board. From November 1993 to January 1995, Mr. Danner was a technical lead/
architect for Silicon Graphics, Inc. ("Silicon Graphics"), where he architected
the set-top and server side of a component of Silicon Graphics' interactive
television system. From June 1990 to November 1993, Mr. Danner was a development
manager at Oracle Corporation, where he oversaw product development for Oracle
Book, a multimedia browser. Since January 1998, Mr. Danner has served on the
Board of Directors of the Internet Advertising Bureau, an online advertising
advocacy group and standards-setting body for online content publishers. Mr.
Danner holds B.S.E.E. and M.S.E.E. degrees from Stanford University.
STEPHEN E. RECHT has served as the Chief Financial Officer and Secretary of
the Company since 1996. From 1995 to 1996, Mr. Recht was the Chief Financial
Officer of AuraVision Corporation, a fabless, multimedia semiconductor company,
where Mr. Recht was responsible for all financial operations, investor
relations, contract administration, human resources and facilities. From 1992 to
1995, Mr. Recht was the Vice President, Finance and Administration and the Chief
Financial Officer of
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ViewStar Corporation, a client/ server, business process automation software
company, where Mr. Recht directed all financial operations and investor
relations. Mr. Recht holds a B.A. degree in Economics from Stanford University
and an M.B.A. degree from the Wharton School at the University of Pennsylvania.
SUSAN ATHERTON has served as the Company's Vice President of Worldwide Sales
since October 1998. From April 1998 to October 1998, Ms. Atherton served as the
Company's Vice President of Sales. From 1996 to 1998, Ms. Atherton was the Vice
President, Worldwide Sales, of DataMind Corporation, a developer of data mining
client/server and Web-enhanced products, where Ms. Atherton managed the
company's direct and indirect channels sales organization worldwide and helped
develop key strategic relationships with several technology companies. From 1995
to 1996, Ms. Atherton was the Vice President, Worldwide Sales, of Red Pepper
Software, a supply chain management software developer, where Ms. Atherton
managed the company's direct and indirect channels sales organization worldwide.
From 1993 to 1995, Ms. Atherton was the Area Vice President of Ross Systems,
Inc., a provider of supply chain management solutions and client/server business
software for enterprise resource planning, where Ms. Atherton helped manage the
company's Western U.S. sales force. Ms. Atherton holds a B.S. degree in
Economics from the University of California, Riverside.
MICHAEL W. DAVIES has served as the Company's Vice President of Services and
Support since October 1998. From December 1997 to October 1998, Mr. Davies
served as the Company's Director of Professional Services. Before joining the
Company, Mr. Davies was the Director of Professional Services of Walker
Interactive Systems ("Walker"), a provider of enterprise-wide business and
accounting solutions, where he worked for eight years developing many areas
within Walker including consulting, education, sales, customer support and
marketing and managing Walker's Asia Pacific professional services practice. Mr.
Davies holds a B.S. degree in Computer Information Systems from the University
of Nevada.
JOHN K. DONNELLY has served as the Company's Vice President of North
American Sales since October 1998. From April 1997 until October 1998 Mr.
Donnelly was the Company's Director of Sales. From January 1997 to April 1997,
Mr. Donnelly was the Company's East Regional Sales Manager. From May 1996 to
January 1997, Mr. Donnelly served as a field sales manager for the Company's
Northeast North America region. From October 1991 to May 1996, Mr. Donnelly
handled major account sales for Parametric Technology Corporation, a company
that develops, markets and supports integrated product development and
information management software. Mr. Donnelly holds B.A. degrees in
Communication and History from Boston College.
RICK E. D. JACKSON IV has served as the Company's Vice President of
Marketing since 1997. From 1996 to 1997, Mr. Jackson was the Vice President,
Marketing for mFactory, Inc., an advanced multimedia authoring tool company,
where Mr. Jackson assembled and led a team of professionals responsible for all
aspects of product and corporate marketing. From 1994 to 1996, Mr. Jackson was
the Director of Product Marketing for Taligent, Inc. ("Taligent"), a software
company, where Mr. Jackson managed the marketing organization responsible for
various Taligent products. From 1990 to 1994, Mr. Jackson was the Director of
Product Marketing for NeXT Computer, Inc., a desktop computer and software
manufacturer, where Mr. Jackson assembled, managed and led the company's product
marketing team. Mr. Jackson holds a B.S. degree in Computer Science from
California State University, Northridge.
DOUGLAS S. KAPLAN has served as the Company's Vice President and General
Manager of Asia Pacific since 1997. From 1995 to 1997, Mr. Kaplan was the Vice
President of Nikkei BP BizTech Inc. ("Nikkei"), a Japanese business and
technology publisher, which Mr. Kaplan founded. At Nikkei, Mr. Kaplan defined
the company's business plan and developed Nikkei as a consulting and research
company. From 1990 to 1995, Mr. Kaplan was a Representative Director and a
co-founder of CMP Japan, the Japanese subsidiary of CMP Media, Inc., a
technology publisher. At CMP Japan,
37
<PAGE>
Mr. Kaplan developed the company's business plan and implemented the business of
consulting with U.S. technology companies interested in conducting business in
Japan. Mr. Kaplan holds a B.A. degree in Asian Studies and Economics from the
University of California, Berkeley.
MARTIN G. LANE-SMITH has served as the Company's Vice President of
Engineering since 1997. From 1991 to 1997, Mr. Lane-Smith was the Vice
President, Engineering of Edify Corporation, a provider of software solutions
for interactive online services, where Mr. Lane-Smith was responsible for all
aspects of product development, product support and the management of the
company's engineering team. Mr. Lane-Smith holds a B.A. degree and an M.A.
degree, each in Natural Sciences (Math and Physics), from the University of
Cambridge.
JITENDRA VALERA has served as the Company's Vice President and General
Manager of Europe since 1997 and has been an employee of the Company since May
1998. From 1996 to May 1998, Mr. Valera was an employee of Protege Software
(Holdings) Limited, a consulting firm providing management services to
NetGravity Europe Limited. From 1994 to 1997, Mr. Valera was the Managing
Director of Applix (UK) Ltd., the United Kingdom subsidiary of Applix Inc., a
producer and marketer of enterprise software, where Mr. Valera was responsible
for management of the company. From 1989 to 1993, Mr. Valera held various
positions with Data Logic Ltd. ("Data Logic"), a computer services company,
including, most recently, Director of Sales, Professional Services Division
(International Territory) and Director, International Sales and Marketing,
Professional Services Division. Among Mr. Valera's responsibilities at Data
Logic was establishing sales groups and strategies. Mr. Valera holds a Business
Studies degree from Havering Technical College and an HND degree in Business
Studies from Hatfield Polytechnic.
LARRY C. WEAR has served as the Company's Vice President of Global Services
since October 1998. From the Company's inception until October 1998, Mr. Wear
served as the Company's Vice President of Support and Service. From 1994 to
1995, Mr. Wear was the Director of Customer Support for Mercury Interactive
Corporation, an automated client/server testing software company, where Mr. Wear
was responsible for all customer support, training, consulting and pre-sales
engineering in North America. From 1992 to 1993, Mr. Wear was the Vice President
of Software Development for XALT Software Corporation, a producer of personal
and group productivity tools, where he oversaw the design, development, testing,
porting and release of a suite of products. Mr. Wear holds a B.S.E.E. degree
from the University of California, Davis, and an M.S.E.E. degree from Stanford
University.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
a) PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The Company's common stock has traded publicly on the Nasdaq National Market
since June 12, 1998 under the symbol "NETG." The Company's initial public
offering price was $9.00 per share. The following table sets forth for the
periods indicated the high and low closing prices of the common
38
<PAGE>
stock. Prior to the Company's initial public offering, there was no established
public trading market for the common stock.
<TABLE>
<CAPTION>
HIGH LOW
---------- ----------
<S> <C> <C>
1998
Second Quarter (Beginning June 12, 1998).................. 14 1/8 9 3/4
Third Quarter............................................. 27 7 3/4
Fourth Quarter............................................ 26 6 7/8
1999
First Quarter (Through March 24, 1999).................... 32 15/16 15 7/16
</TABLE>
On December 31, 1998 the closing price of the common stock on the Nasdaq
National Market was $16 3/4 per share. On March 24, 1998, the closing price of
the common stock on the Nasdaq National Market was $28 1/4 per share. As of
December 31, 1998, there were approximately 191 holders of record (not including
beneficial holders of stock held in street name) of the common stock.
The Company has never paid cash dividends on its capital stock. The Company
currently expects to retain its future earnings, if any, for use in the
operation and expansion of its business and does not anticipate paying any cash
dividends in the foreseeable future. The Company's debt facilities contain
restrictive covenants that limit its ability to pay cash dividends or make stock
repurchases without the prior written consent of the lender.
b) Pursuant to a Registration Statement on Form S-1 (File No. 333-51007)
filed with and declared effective by the Commission on June 11, 1998, the
Company offered an aggregate of 3,250,000 shares of its Common Stock for an
aggregate offering price of $29.3 million and certain selling stockholders
offered an aggregate of 200,000 shares of the Company's Common Stock for
aggregate offering price of $1.8 million. The offering pursuant to the Form S-1
(such offering, the "IPO") commenced on or about June 11, 1998, terminated in
July 1998 and all offered shares have been sold. The managing underwriters of
the IPO were BancAmerica Robertson Stephens, NationsBanc Montgomery Securities
and FAC/Equities. Net of underwriters' discounts and commissions of 7% of the
offering price, the Company and the selling stockholders received proceeds of
$27.2 million and $1.7 million, respectively, from the IPO. In addition to
underwriters' discounts and commissions, the Company reasonably estimates that
it incurred approximately $1.3 in additional expenses related to the IPO,
leaving it with approximately $25.9 million in net proceeds.
Since June 11, 1998, the Company has used, from the net proceeds of the IPO,
approximately (i) $2.3 million to fund certain capital expenditures, (ii) $12.7
million to fund operating expenses related to entering new markets, increasing
research and development spending, expanding sales and marketing operations,
developing new distribution channels, improving its operational and financial
systems and broadening its customer support capabilities and (iii) $938,000 to
repay certain indebtedness. In addition, the Company used net proceeds from the
IPO to make a $2.0 million payment to MatchLogic pursuant to an agreement
between the Company and MatchLogic related to the use of certain of MatchLogic's
proprietary consumer profile databases. The use of proceeds from IPO does not
represent a material change in the use of proceeds described in the final
prospectus related to the IPO. Pending other uses, the Company has invested most
of the remaining net proceeds in investment grade, short-term interest bearing
securities.
None of the payments described in this Item 5(b) constituted direct or
indirect payments to directors, officers, general partners of the issuer or
their associates, or to persons owning ten percent or more of any class of
equity securities of the issuer or to affiliates of the issuer.
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<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below for each of the
years in the three-year period ended December 31, 1998, and as of December 31,
1997 and 1998, are derived from the consolidated financial statements of
NetGravity, Inc. and its subsidiaries, which consolidated financial statements
have been audited by KPMG LLP, independent certified public accountants, and are
included elsewhere in this Report. The consolidated statement of operations data
for the period from September 5, 1995 (inception) through December 31, 1995, and
the consolidated balance sheet data as of December 31, 1995 and 1996 are derived
from audited consolidated financial statements of the Company that are not
included herein. The selected consolidated financial data set forth below is
qualified in its entirety by, and should be read in conjunction with, "Item 7:
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements and Notes thereto included
elsewhere in this Report. Historical results are not necessarily indicative of
the results to be expected in the future.
40
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
PERIOD FROM
SEPTEMBER 5, 1995 YEAR ENDED DECEMBER 31,
(INCEPTION) TO ---------------------------------
DECEMBER 31, 1995 1996 1997 1998
----------------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues:
Software licenses....................................... $ -- $ 1,262 $ 2,901 $ 4,115
Software upgrades....................................... -- 107 1,123 2,394
Consulting and support.................................. -- 570 2,334 4,637
Transactional services.................................. -- -- -- 411
------ --------- ---------- ----------
Total revenues.......................................... -- 1,939 6,358 11,557
------ --------- ---------- ----------
Cost of revenues:
Cost of software licenses............................... -- -- 76 63
Cost of consulting and support.......................... -- 702 2,496 4,521
Cost of transactional services.......................... -- -- -- 644
------ --------- ---------- ----------
Total cost of revenues.................................. -- 702 2,572 5,228
------ --------- ---------- ----------
Gross Profit............................................ -- 1,237 3,786 6,329
Operating costs and expenses
Research and development................................ 39 1,764 3,033 4,639
Selling and marketing................................... 21 2,839 6,073 10,351
General and administrative.............................. 131 1,315 1,552 3,172
------ --------- ---------- ----------
Total operating costs and expenses...................... 191 5,918 10,658 18,162
------ --------- ---------- ----------
Income/ (loss) from operations.......................... (191) (4,681) (6,872) (11,833)
Other income/ (expense), net................................ (4) 54 (10) 540
------ --------- ---------- ----------
Net income/(loss)....................................... (195) (4,627) (6,882) (11,293)
------ --------- ---------- ----------
------ --------- ---------- ----------
Basic and diluted net income/ (loss) per share.......... $ (0.19) $ (2.19) $ (2.46) $ (1.28)
Shares used in per share calculation (1).................... 1,006 2,111 2,799 8,823
------ --------- ---------- ----------
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1995 1996 1997 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Consolidated Balance Sheet Data:
Working capital (deficit)......................................... $ (69) $ (221) $ 2,222 $ 17,705
Total assets...................................................... 486 3,159 9,887 33,420
Notes payable, less current portion............................... -- 682 727 1,109
Accumulated deficit............................................... (195) (4,822) (11,704) (22,997)
Total stockholders' equity (deficit).............................. (12) (164) 2,851 22,128
</TABLE>
- ------------------------
(1) See Note 1 of Notes to Consolidated Financial Statements in Item 14.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF THE COMPANY CONTAINS FORWARD-LOOKING
STATEMENTS RELATING TO THE FUTURE EVENTS OR THE FUTURE FINANCIAL PERFORMANCE OF
THE COMPANY, WHICH INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING
STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING, BUT NOT LIMITED TO, THOSE
SET FORTH UNDER "ITEM 1: BUSINESS--FACTORS AFFECTING OUR BUSINESS, OPERATING
RESULTS AND FINANCIAL CONDITION" AND ELSEWHERE IN THIS REPORT.
OVERVIEW
NetGravity, Inc. is a leading provider of online interactive marketing
solutions. The Company develops, markets and supports a broad range of high-end,
mission-critical software and transaction-based services. Our solutions are
designed to help the Company's customers increase their revenues by automating
online interactive marketing and by improving response rates through better
consumer targeting. The Company sells its solutions to each of the three
constituents in the interactive marketing supply chain: e-commerce merchants
(vendors of products and services); advertising agencies; and content
publishers.
From inception (September 5, 1995) to December 31, 1995, the Company was in
the development stage, and its activities primarily related to raising capital,
recruiting personnel, conducting research and development activities, purchasing
operating assets and building the NetGravity brand. From January 1996 through
December 31, 1998, the Company began shipping products, built a consulting and
support organization, continued investing in research and development, built
domestic and international sales organizations, established its AdCenter service
bureau, expanded its marketing activities and developed its operational and
financial infrastructure.
To date, the Company has generated its revenues primarily from the license
and related upgrade of, consulting for and support of its AdServer family of
software products. In March 1996, the Company initially released and made
generally available AdServer 1.0. Subsequently, the Company has had two major
releases of its AdServer products: AdServer 2.0 in October 1996 and AdServer 3.0
in June 1997. Revenues from software licenses in any given period are generally
attributable to the sale of the most recent version of the Company's products,
and the Company generally discontinues marketing older versions upon new version
introductions. The Company believes that its current AdServer family of software
products and software products in development, together with the related
consulting and support services, will continue to account for a substantial
majority of its revenues for the foreseeable future.
In August 1998, the Company formally launched its transactional services
business with the introduction of AdCenter for Publishers, an outsourced version
of AdServer. In October 1998, the Company announced the Global Profile Service,
which is a database of anonymous consumer profiles that the Company makes
available to its customers for use in enhanced targeting. Revenues from AdCenter
and Global Profile Service are included within the line-item "transactional
services." To date, transactional services revenues have not been material.
The Company records an account receivable and deferred revenue upon shipment
and invoicing of a software license to a customer. The Company recognizes
software license revenue upon completion of the product installation. The
Company's management has generally determined that installation occurs at the
point in time at which the customers begin "serving ads" by utilizing the
Company's products. This methodology has been applied consistently for all
software license revenue since the inception of the Company. A portion of the
initial software product license fee is attributed to the customer's right to
receive, at no additional charge, software upgrades released during the
subsequent twelve months.
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Revenues attributable to software upgrades are deferred and recognized ratably
over the period covered by the software license agreement, which is generally
one year. Revenue from consulting services are recognized as the services are
performed. Customer support revenue is deferred and recognized ratably over the
period covered by the customer support agreement, which is generally one year.
Transactional services revenue is recognized as the services are rendered. In
October 1997, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") No. 97-2, Software Revenue Recognition, which the
Company adopted, effective January 1, 1998. Such adoption had no material effect
on the Company's methods of recognizing revenue from its software licenses,
software upgrades, and consulting and support activities. See Note 1 of Notes to
Consolidated Financial Statements in Item 14.
Pricing for AdServer products is based on the number of copies licensed to
the customer, scaled to provide discounts based on the overall size of the
system being licensed. Initial license sales include a one-year subscription
entitling the licensee to free upgrades of major releases of the product. The
software upgrade revenue is broken out separately for every license in
accordance with SOP 97-2, based on vendor-specific objective evidence for the
upgrade element, and the revenue allocated to the upgrade element is recognized
over the agreement term. For subsequent years, customers may subscribe on an
annual basis for the right to receive major product upgrades. The cost to
subscribe to the upgrade program is based on a percentage of the list price of
software the customer has licensed. Annual support contracts, which are
generally purchased in conjunction with the licensing of a product, are sold
separately from the initial license for a fee, which is also based on a
percentage of the list price of the software. Support packages typically include
non-major product releases, online support and telephone support. Consulting
revenues consist of implementation services and training. Consulting is charged
at a per diem rate or on a fixed fee basis for a package of services.
AdCenter for Publishers pricing is based on the number of advertisements,
promotions or other offers delivered. Pricing for the sales of the initial
release of Global Profile Service (which currently includes only geographic
targeting) is based on the expected annual volume of profiles to be delivered to
the customer. The Company expects that pricing for future versions of Global
Profile Service will be based on the actual number of profiles delivered to
customers.
The Company licenses and sells its products and services primarily through
its direct sales force and telesales organizations and maintains sales and
support organizations in North America, Europe and Asia Pacific. See Note 7 of
Notes to Consolidated Financial Statements in Item 14. The Company does not
currently sell its transactional services to international customers. Indirect
sales channels, including resellers and Web hosting providers, also sell the
Company's products. Indirect channels generally provide less revenue per license
to the Company since the channel partner usually receives discounts. Through
December 31, 1998, revenues through indirect channels were not material.
The Company currently invoices its European customers in local currencies
and its customers in Asia Pacific in U.S. currency. The Company expects to
eventually invoice all of its international customers in local currencies.
Although the Company pays certain of the expenses of its European and Asia
Pacific operations in local currencies, the Company has not engaged in foreign
currency hedging activities, and international revenues are currently subject to
fluctuations in currency exchange rates. Historically, fluctuations in foreign
currency exchange rates have not had a material effect on the Company's revenues
or expenses. However, to the extent that international revenues increase as a
percentage of total revenues in the future, exposure to foreign currency
fluctuations may also increase.
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The Company's business has grown from inception through December 31, 1998,
with total revenues of $1.9 million, $6.4 million and $11.6 million for the
years ended December 31, 1996, 1997 and 1998, respectively. However, the Company
has experienced net losses over this entire period, and as of December 31, 1998
had an accumulated deficit of $23.0 million. The Company's loss from operations
and net loss were each $6.9 million for the year ended December 31, 1997 and
$11.8 million and $11.3 million, respectively, for the year ended December 31,
1998. Loss from operations exceeded total revenues in each of these periods.
These losses resulted from significant costs incurred in the development,
marketing and support of the Company's products and services. During this
period, the number of Company employees increased from 10 at December 31, 1995
to 125 at December 31, 1998. The Company currently expects to expand its sales
and marketing operations, to continue international expansion, to increase its
investment in product development, to further expand its transactional services
infrastructure and offerings, to further expand its consulting and support
organizations and to improve its internal operating and financial infrastructure
in support of the Company's business plan, all of which will increase operating
expenses. As a result, the Company expects to incur additional losses and
continued negative cash flow from operations for the foreseeable future. In
particular, as a result of recent and pending significant expenditures to expand
the Company's transactional services, such losses are anticipated to increase
significantly during the first half of 1999.
The Company has recorded deferred stock compensation of $1.8 million for the
year ended December 31, 1997 and $1.4 million for the year ended December 31,
1998 as a result of stock options granted during 1997 and 1998. Amortization of
deferred stock compensation of approximately $115,000 was recognized in 1997,
$1.4 million was recognized in 1998 and approximately $965,000 is expected to be
recognized in 1999. Amortization of deferred stock compensation is allocated to
costs of consulting and support and to all operating expense lines identified on
the statement of operations. Deferred stock compensation is amortized over the
vesting period of the options, generally four years. As a result, amortization
of deferred stock compensation will adversely impact the Company's operating
results for the next four years.
The Company believes that period-to-period comparisons of its operating
results are not meaningful and should not be relied upon as predictive of future
performance. The Company's prospects must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in the early stage
of development, particularly companies in new and rapidly evolving markets.
There can be no assurance that the Company will be successful in addressing such
risks and difficulties. In addition, although NetGravity has experienced
significant revenue growth recently, there can be no assurance that the Company
will increase or even sustain its current level of revenues or that the Company
will achieve profitability in the future. See "Item 1: Business--Factors
Affecting Our Business, Operating Results and Financial Condition--We have a
limited operating history," "--We have incurred substantial losses and
anticipate continued losses," "--Our future operating results are uncertain and
are likely to fluctuate significantly" and "--We have to effectively manage our
growth."
44
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth consolidated statement of operations data for
the periods indicated as a percentage of total revenue:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Revenues:
Software licenses............................................................. 65.1% 45.6% 35.6%
Software upgrades............................................................. 5.5 17.7 20.7
Consulting and support........................................................ 29.4 36.7 40.1
Transactional services........................................................ -- -- 3.6
--------- --------- ---------
Total revenues.............................................................. 100.0 100.0 100.0
--------- --------- ---------
Cost of revenues (1):
Cost of software licenses (2)................................................. -- 1.2 0.5
Cost of consulting and support (3)............................................ 36.2 39.3 39.1
Cost of transactional services (4)............................................ -- -- 5.6
--------- --------- ---------
Total cost of revenues...................................................... 36.2 40.5 45.2
--------- --------- ---------
Gross margin................................................................ 63.8 59.5 54.8
Operating costs and expenses:
Research and development...................................................... 91.0 47.7 40.1
Selling and marketing......................................................... 146.4 95.5 89.6
General and administrative.................................................... 67.8 24.4 27.4
--------- --------- ---------
Total operating costs and expenses.......................................... 305.2 167.6 157.2
--------- --------- ---------
Loss from operations........................................................ (241.4) (108.1) (102.4)
Other income (expenses), net.................................................... 2.8 (0.2) 4.7
--------- --------- ---------
Net loss.................................................................... (238.6)% (108.2)% (97.7)%
--------- --------- ---------
--------- --------- ---------
</TABLE>
- ------------------------------
(1) There are no material costs of revenues associated with software upgrades.
(2) As a percentage of software license revenues, cost of software licenses was
0.0%, 2.6% and 1.5% in the years ended December 31, 1996, 1997, 1998,
respectively.
(3) As a percentage of consulting and support revenues, cost of consulting and
support was 123.2%, 106.9% and 97.5% in the years ended December 31, 1996,
1997, 1998, respectively.
(4) As a percentage of transactional services revenues, cost of transactional
services was 0.0%, 0.0% and 156.7% in the years ended December 31, 1996,
1997, 1998, respectively.
REVENUES
The Company's total revenues grew 228% from 1996 to 1997 and 82% from 1997
to 1998. Total revenues for 1996, 1997 and 1998 were $1.9 million, $6.4 million
and $11.6 million, respectively. In general, NetGravity has experienced revenue
growth in all of its revenue sources as a result of an increased number of
software licenses, increased average deal sizes and the introduction of new
services. International revenues, primarily comprised of exported AdServer
products and related services, as a percentage of total revenues were 0% in
1996, 8% in 1997 and 28% in 1998. Growth in international revenues in all
periods was attributable to expanded sales and marketing efforts overseas and
the opening of a European regional office in April 1997 and a regional office in
the Asia Pacific region in April 1998. The Company does not currently sell its
transactional services to international services. In North America, revenues
grew 215% from 1996 to 1997 and 35% from 1997 to 1998. No customer, domestic or
international, accounted for more than 10% of total revenues in the years ended
1996, 1997 or 1998. The approximate number of NetGravity's AdServer customers
was 70, 190 and 295 at December 31, 1996, 1997 and 1998, respectively. In
addition, at December 31, 1998 the Company had 39 AdCenter for Publishers
customers and seven of its customers had purchased Global Profile Services.
45
<PAGE>
SOFTWARE LICENSES. Software licenses revenues for 1996, 1997 and 1998 were
$1.3 million, $2.9 million and $4.1 million, or 65.1%, 45.6%, and 35.6% of total
revenues, respectively. Software licenses revenues increased in absolute dollars
but decreased as a percentage of total revenues in all periods. The increase in
absolute dollars was primarily attributable to an increased number of software
licenses sold, the introduction of new versions of AdServer and an increase in
average deal sizes. The decrease in each period as a percentage of total
revenues was primarily a result of increased demand for consulting services, the
increased number of customers participating in software upgrade and support
plans and the revenues associated with the introduction of transactional
services in North America in the second quarter of 1998. Because software
upgrades revenues and consulting and support revenues are, to a large extent, a
function of software licenses revenues, the Company's future operating results
will be substantially dependent on growth of software licenses revenues, and the
failure to increase software licenses revenues would likely have a material
adverse effect on the Company's business, results of operations and financial
condition.
SOFTWARE UPGRADES. Software upgrades revenues for 1996, 1997 and 1998 were
$107,000, $1.1 million and $2.4 million, or 5.5%, 17.7% and 20.7% of total
revenues, respectively. The increase in each period was a result of software
upgrades being provided to a larger installed customer base, which more than
offset a reduction in the software upgrades pricing from 45% to 25% of the list
price of the related software license made in the last half of 1997, and a
further reduction to 20% of the list price of the related software license made
in the second quarter of 1998.
CONSULTING AND SUPPORT. Consulting and support revenues include revenues
related to the Company's consulting, support and training services. Consulting
and support revenues for 1996, 1997 and 1998 were $572,000, $2.3 million and
$4.6 million, or 29.4%, 36.7% and 40.1% of total revenues, respectively. The
increase in each period was primarily a result of the increased demand for
consulting services, increased offerings in consulting and education, expansion
into Europe and Asia, the larger installed customer base and the election of
customers to renew their support program. Consulting and training services
contributed $251,000, $1.2 million and $2.2 million in 1996, 1997 and 1998,
respectively.
TRANSACTIONAL SERVICES. The Company's transactional services were
introduced in 1998 with the formal release of AdCenter for Publishers during the
third quarter of 1998 and Global Profile Services in the fourth quarter of 1998.
Transactional services revenues were $411,000 in 1998, or 3.6% of total
revenues.
COST OF REVENUES
Gross margins decreased from 63.8% in 1996 to 59.5% in 1997 and to 54.8% in
1998, primarily as a result of the increase in consulting and support revenues
as a percentage of total revenues and the increased staffing levels in
consulting and support and, in 1998, the transactional services organization.
The impact of these factors was offset in part by the increase in software
upgrades as a percentage of revenues, as the costs of software upgrade revenues
is not material.
COST OF SOFTWARE LICENSES. Cost of software licenses consists of royalties
paid to third parties for licensed technology. Cost of software licenses for
1996, 1997 and 1998 was $0, $76,000 and $63,000, respectively. As a percentage
of software licenses revenues, cost of software licenses was 0.0%, 2.6% and 1.5%
in 1996, 1997 and 1998, respectively. The Company expects cost of software
licenses to increase in future periods due to costs of additional technology
licensed for future products.
COST OF CONSULTING AND SUPPORT. Cost of consulting and support consists
primarily of personnel-related costs incurred in providing consulting, support
and training to customers. The cost of consulting and support for 1996, 1997 and
1998 was $702,000, $2.5 million and $4.5 million, respectively. The increase in
each period was primarily due to an increase in personnel and related overhead,
as the
46
<PAGE>
Company increased staff to meet customer demand, and increased outside services
and travel costs associated with the increased volume of service provided by the
consulting and support organizations. Personnel and related overhead accounted
for $511,000, $2.0 million and $3.6 million of cost of consulting and support in
1996, 1997 and 1998, respectively. Outside services accounted for $105,000,
$226,000 and $455,000 of cost of consulting and support in 1996, 1997 and 1998,
respectively. Travel costs accounted for $86,000, $300,000 and $291,000 of cost
of consulting and support in 1996, 1997 and 1998, respectively. The Company
expects that the cost of consulting and support will continue to increase in
absolute dollar amounts in future periods as the Company continues to hire
additional consulting, training and customer support personnel. Cost of
consulting and support as a percentage of consulting and support revenues
decreased from 123.2% in 1996 to 106.9% in 1997 and to 97.5% in 1998, primarily
due to better utilization of consulting and support personnel associated with an
increased customer base.
COST OF TRANSACTIONAL SERVICES. The cost of transactional services consists
primarily of the personnel and related expenses, the hosting and bandwidth costs
and the amortization of intangibles associated with the AdCenter and Global
Profile Services offerings. The cost of transactional services in 1998 was
$644,000. There were no costs of transactional services prior to 1998. In 1998,
personnel and related expenses represented $128,000, hosting and bandwidth costs
represented $251,000 and the amortization of intangible assets represented
$222,000. The Company expects the cost of transactional services to continue to
increase in absolute dollars in future periods as the Company continues to hire
additional personnel and to serve increased volumes through its service bureau.
Cost of transactional services as a percentage of transactional services
revenues was 156.7% in 1998.
Gross margins may be impacted by the mix of products sold by the Company,
the mix of software licenses revenues, software upgrades revenues, consulting
and support revenues and transactional services revenues, the mix of
international and North American revenues, the mix of distribution channels used
by the Company, and the level of royalty payments, amortization charges and
other costs related to the acquisition of technology or other intangible assets.
The Company typically realizes higher gross margins on software upgrades
revenues than on software licenses revenues, substantially higher gross margins
on software licenses revenues than on consulting and support revenues, and
higher gross margins on direct sales than on indirect sales. Shifts in the mix
of revenues towards lower margin revenues or a greater percentage of sales
through indirect channels would adversely impact the Company's overall gross
margin and could materially adversely impact the Company's operating results.
For example, when consulting and support revenues increased as a percentage of
total revenues from 36.7% for 1997 to 40.1% for 1998, overall gross margins fell
from 59.5% to 54.8%, in part due to this shift in the mix of revenues. There can
be no assurance that such adverse fluctuations in the mix of revenue or costs of
revenues will not recur in the future. Moreover, the Company expects that
increases in costs of transactional services will materially and adversely
impact overall gross margins for the foreseeable future.
OPERATING COSTS AND EXPENSES
RESEARCH AND DEVELOPMENT. Research and development expenses consist
primarily of compensation and consulting expenses and depreciation expense on
related equipment. To date, the Company has not capitalized any such development
costs under Statement of Financial Accounting Standards ("SFAS") No. 86 because
the Company believes its process for developing software is essentially
completed concurrent with the establishment of technological feasibility; all
research and development costs have been expensed as incurred. Research and
development expenses of $3.0 million in 1997 represented a 67% increase from the
$1.8 million in expenses in 1996. Research and development expenses of $4.6
million in 1998 represented a 53% increase from the $3.0 million in expenses in
1997. The increase in absolute dollars in all periods was primarily due to
increased personnel and related overhead and, to a lesser extent, outside
services associated with enhancements of existing products and
47
<PAGE>
development of new products. Personnel and related overhead accounted for $1.6
million, $2.7 million and $3.9 million of research and development expenses in
1996, 1997 and 1998, respectively. Outside services accounted for $62,000,
$240,000 and $345,000 of research and development expenses in 1996, 1997 and
1998, respectively. Research and development costs decreased as a percentage of
total revenues from 91.0% and 47.7% in 1996 and 1997, respectively, to 40.1% in
1998. The Company believes that continued investment in research and development
is critical to attaining its strategic objectives and, as a result, expects
research and development expenses to increase in absolute dollars in future
periods.
SELLING AND MARKETING. Selling and marketing expenses consist primarily of
salaries, commissions, travel expenses, advertising expenses, trade show
expenses, seminars and costs of marketing materials. Selling and marketing
expenses of $6.1 million in 1997 represented a 114% increase from the $2.8
million in expenses in 1996. Selling and marketing expenses of $6.1 million in
1997 represented a 70% increase from $10.4 million in 1998. The increase in
absolute dollars in each period was due primarily to the increase in
compensation paid to sales and marketing personnel (including commissions) and
related overhead, and increased travel costs associated with the Company's
direct selling efforts. Compensation paid to selling and marketing personnel and
related overhead accounted for $1.6 million, $4.1 million and $7.0 million of
selling and marketing expenses in 1996, 1997 and 1998, respectively. Travel
costs accounted for $189,000, $761,000 and $1.3 million of selling and marketing
expenses in 1996, 1997 and 1998, respectively. The balance of selling and
marketing expenses during all periods consisted primarily of costs of
development and implementation of the Company's marketing campaign (including
general brand promotion) and did not vary significantly between comparable
periods. Selling and marketing expenses as a percentage of total revenues were
146.4%, 95.5% and 89.6% in 1996, 1997 and 1998, respectively. The Company
expects selling and marketing expenses to increase in absolute dollars in future
periods as the Company hires additional personnel, promotes AdCenter for
Publishers, Global Profile Service and other new products, expands into new
markets and continues to promote the NetGravity brand.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of salaries and related costs for the Company's executive,
administrative, finance and human resources personnel, support services and
professional services fees. General and administrative expenses increased from
$1.3 million in 1996 to $1.6 million in 1997 and to $3.2 million in 1998. The
increase in absolute dollars in each period was primarily a result of increased
personnel and related overhead necessary to support the Company's increased
scale of operations, including the additional costs associated with the
requirements of becoming a publicly traded company in June 1998. Personnel and
related overhead accounted for $624,000, $1.1 million and $1.8 million of
general and administrative expenses in 1996, 1997 and 1998, respectively.
General and administrative expenses increased as a percentage of total revenues
from 24.4% in 1997 to 27.4% in 1998. The increase as a percentage of total
revenues was primarily a result of the increased staffing and costs related to
the Company's expanded operation, and the requirements of being a public
company. General and administrative expenses decreased as a percentage of total
revenues from 67.8% in 1996 to 24.4% in 1997. The Company expects general and
administrative expenses to increase in absolute dollars in future periods as the
Company expands its management and staff, incurs additional costs related to
expansion of its operation and continues to incur the additional costs
associated with being a publicly traded company.
OTHER INCOME (EXPENSE). The increase in other income (expense) from net
expense of $10,000 in 1997 to net income of $540,000 in 1998 was primarily due
to the interest earned on the net proceeds from the Company's initial public
offering in June 1998.
INCOME TAXES. Deferred taxes are recognized as a result of temporary
differences that arise between the tax basis of assets and liabilities and the
related financial statement carrying amounts, as measured using the tax rates
that are expected to be in effect when the temporary differences reverse.
48
<PAGE>
During 1996, 1997 and 1998, the Company generated pre-tax losses of $4.7
million, $6.9 million and $11.3 million, respectively. The Company has
approximately $9.3 million in deferred tax assets; however, it has not
recognized any associated income tax benefit because the deferred tax assets are
fully reserved due to uncertainties regarding the realization of the assets,
given the lack of earnings history for the Company. See Note 4 to Consolidated
Financial Statements.
At December 31, 1998, the Company had net operating loss carryforwards for
U.S. federal and state income tax purposes of approximately $15.9 million. In
addition, the Company had U.S. federal and state research and development credit
carryforwards of approximately $318,000 and $272,000, respectively, available to
offset future tax liabilities. The Company's U.S. federal net operating loss and
research and development credit carryforwards expire in the years 2010 through
2018, if not utilized. Federal and state tax laws impose substantial
restrictions on the utilization of net operating loss and tax credit
carryforwards in the event of an "ownership change" as defined in Section 382 of
the Internal Revenue Code of 1986, as amended. The Company had such an ownership
change, as defined, in March 1997. Accordingly, $6.0 million of each of the
Company's U.S. federal and state net operating loss carryforwards are each
limited in their annual usage to approximately $700,000 per year. The Company
has not yet determined whether any ownership change, as defined, has occurred
since 1997.
As of December 31, 1998, NetGravity Europe Limited and NetGravity Asia
Pacific K.K. had net operating loss carryforwards of approximately $2.7 million
and $900,000 in the United Kingdom and Japan, respectively. The United Kingdom
net operating loss carryforward can be carried forward indefinitely. The Japan
net operating loss will expire in the year 2003, if not utilized.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date primarily through the private
placement of preferred stock and its initial public offering. Prior to the
Company's initial public offering, private placements provided net proceeds
totaling $17.4 million. In June 1998, the Company sold 3,000,000 shares of its
common stock in its initial public offering, generating net proceeds of $23.8
million. In July 1998, the Company sold an additional 250,000 shares of its
common stock and generated an additional $2.1 million of net proceeds in
connection with the exercise of the over-allotment option granted to the
underwriters of the Company's initial public offering. At December 31, 1998, the
Company had $20.8 million in cash and cash equivalents and short-term
investments, which represents an increase of $15.2 million as compared to $5.6
million at December 31, 1997. The Company currently has no significant capital
commitments other than obligations under operating leases.
At December 31, 1998, the Company had a revolving credit facility with a
bank in the amount of $4.0 million which bears interest at the prime rate (7.75%
as of December 31, 1998) and which matures in May 1999. Borrowings are limited
to the lesser of $4.0 million or 80% of the net amount of eligible accounts
receivable and are secured by the Company's assets. The credit facility has a
sub-facility for up to $1.5 million in non-revolving line of credit for
purchases of equipment all outstanding amounts are to be converted in May 1999
to a fully amortized 60 month term loan at prime, with principal and interest
payable monthly. As of December 31, 1998, borrowings under this credit facility
were $1.0 million, all of which were under the equipment sub-facility. See Note
3 of Notes to Consolidated Financial Statements.
As of December 31, 1997, the Company had a revolving credit facility with a
bank in the amount of $1.0 million which bore interest at the prime rate (8.50%
as of December 31, 1997) plus 0.75%, which matured in May 1998. Borrowings were
limited to the lesser of $1.0 million or 70% of the net amount of eligible
accounts receivable and were secured by the Company's accounts receivable. As of
December 31, 1997 and December 31, 1998, borrowings under this credit facility
were $655,000 and $0, respectively. As of December 31, 1997, the Company had an
equipment line of credit with the same bank that provided up to $1.0 million,
bears interest at the prime rate, and expires in June 2000. The
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<PAGE>
line of credit is secured by the Company's fixed assets. As of December 31, 1997
and 1998, $584,000 and $350,000, respectively, had been advanced under this
agreement with the principal amount due in 30 monthly installments of $19,467
beginning December 31, 1997. The Company also has a second equipment line of
credit with the same bank that provides up to $1.2 million, bears interest at
the prime rate, and expires in June 2000. The line of credit is secured by the
Company's fixed assets. As of December 31, 1997 and December 31, 1998, $628,000
and $377,000, respectively, had been advanced under this agreement with the
principal amount due in 30 monthly installments of $20,933 beginning December
31, 1997. See Note 3 of Notes to Consolidated Financial Statements in Item 14.
Net cash used in operating activities was $3.3 million, $5.1 million, and
$8.5 million in 1996, 1997 and 1998, respectively. In each period, cash used by
operating activities was primarily a result of a net loss and, in 1998, due to
increases in accounts receivable resulting from the significant increase in
revenue.
Net cash used in investing activities was $854,000, $1.2 million and $15.9
million in 1996, 1997 and 1998, respectively. In 1998, cash used in investing
activities was primarily for the acquisition of property and equipment, $2.3
million for the acquisition of other assets, and the purchase of $10.6 million
of short-term investments.
Cash provided by financing activities was $4.7 million, $10.9 million, and
$29.0 million in 1996, 1997 and 1998, respectively. The primary source of cash
provided by financing activities was proceeds from the issuance of stock and, to
a lesser extent, borrowings.
The Company's deferred revenue balance includes deferred software licenses
revenues and revenues attributable to uncompleted consulting engagements, as
well as the unamortized portion of the revenues from software upgrades and
support contracts. The Company records an account receivable and deferred
revenue upon shipment and invoicing of a software license to a customer. The
Company's accounts receivable balance is relatively large in comparison to
quarterly and annual revenues because the Company generally recognizes revenue
from the licensing of software later than shipment and invoicing. Further, the
Company's deferred revenue balance or changes therein may not be indicative of
the Company's backlog or changes in the ordering patterns of customers.
Although the Company has no other material commitments other than its
facilities leases (see Note 6 of Notes to Consolidated Financial Statements in
Item 14), management anticipates that it will experience an increase in its
capital expenditures and lease commitments consistent with its anticipated
growth in operations, infrastructure and personnel. The Company expects that
capital expenditures for 1999 will be at least $3.0 million. In particular, the
Company anticipates incurring capital expenditures in connection with its
expansion of its transactional services offerings. The Company currently
anticipates that it will continue to experience significant growth in its
operating expenses for the foreseeable future related to entering new markets
for the Company's products and services, increasing research and development
spending, increasing its sales and marketing operations, developing new
distribution channels, improving its operational and financial systems and
broadening its customer support capabilities. Such operating expenses will be a
material use of the Company's cash resources.
The Company believes that its available cash resources and amounts available
under its commercial credit facilities will be sufficient to meet its expected
working capital and capital expenditure requirements for at least the next 12
months. This estimate is a forward-looking statement that involves risks and
uncertainties, and actual results may vary as a result of a number of factors,
including those discussed under "Item 2: Business--Factors Affecting Our
Business, Operating Results and Financial Condition" and elsewhere herein.
The Company may need to raise additional funds in order to support more
rapid expansion, develop new or enhanced services, respond to competitive
pressures, acquire complementary businesses or technologies, or respond to
unanticipated requirements. The Company may seek to raise additional
50
<PAGE>
funds through private or public sales of securities, strategic relationships,
bank debt, financing under leasing arrangements, or otherwise. If additional
funds are raised through the issuance of equity securities, the percentage
ownership of the stockholders of the Company will be reduced, stockholders may
experience additional dilution, or 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 on acceptable terms, if at all. If adequate funds are not available or
are not available on acceptable terms, the Company may be unable to develop or
enhance its products, take advantage of future opportunities, or respond to
competitive pressures or unanticipated requirements, which could have a material
adverse effect on the Company's business, financial condition and operating
results.
RECENTLY PROPOSED PUBLIC OFFERING. On March 2, 1999, NetGravity filed a
Registration Statement on Form S-1 (File No. 333-73203) with the Securities and
Exchange Commission relating to the proposed public offering of 2,738,440 shares
of the Company's Common Stock by the Company, 861,560 shares of the Company's
Common Stock by certain stockholders of the Company and up to an additional
540,000 shares of the Company's Common Stock by the Company to cover
over-allotments, if any. The Company will not receive any proceeds from the sale
of Common Stock by the selling stockholders. The Company cannot assure you that
the proposed offering will be completed. If the offering is completed, the
Company expects to use the net proceeds therefrom for working capital and other
general corporate purposes.
YEAR 2000 COMPLIANCE
The Company is aware that many currently installed information technology
("IT") systems, such as computer systems and software products, as well as
non-IT systems that include embedded technology, were not designed to correctly
process dates after December 31, 1999. NetGravity is currently assessing the
impact this issue, commonly referred to as the "Year 2000" issue, on its
business and operations. The Company has formed an ad-hoc Year 2000 project team
to identify and address Year 2000 issues, including potential issues with the
significant non-IT systems in its buildings, plant, equipment and other
infrastructure. The Year 2000 project team has reviewed the Company's products,
is continuing to review the Company's IT systems and has recently begun
reviewing the Company's non-IT systems. NetGravity has not identified any
significant non-compliance issues with its products that have not already been
corrected. The Company expects that its review of its IT and non-IT systems will
be completed by June 30, 1999. In addition to its internal reviews, the Company
is discussing with its significant suppliers and service providers their plans
to investigate and address their Year 2000 issues. The Company cannot assure you
that it will be able to identify and accurately evaluate all Year 2000 issues
that it faces.
In September 1998, NetGravity released version 3.5 of its AdServer product
which included enhancements designed to correctly accept and process 21st
century dates and, as a result, the Company now believes that the current
versions of its AdServer family of software products are Year 2000 compliant.
However, given the complexity of software systems such as AdServer and the need
for them to interoperate with other systems, the Company cannot assure you that
its products will not experience Year 2000 problems in the future. Any such Year
2000 issues could result in:
- a decrease in sales of the the Company's products;
- deferral of revenue recognition on contracts in which the Company has
warranted (or may in the future warrant) compliance with Year 2000
requirements;
- an increase in the allocation of resources to address Year 2000 problems
of the Company's customers without additional revenue commensurate with
such dedicated resources; or
51
<PAGE>
- an increase in litigation costs relating to losses suffered by the
Company's customers due to Year 2000 problems.
In addition, NetGravity has determined that certain of its software IT
systems are not currently Year 2000 compliant. The Company believes that its
software IT systems will become compliant through updates and upgrades purchased
in the ordinary course of business for reasons unrelated to Year 2000. However,
the Company cannot assure you that the incremental costs of such IT software
will not materially exceed its preliminary estimates. Higher incremental costs
of upgrading or replacing its IT software could have a material and adverse
effect on the Company's business, results of operations and financial condition.
As the Company reviews its non-IT systems, it may identify situations that
present material Year 2000 risks or that will require substantial time and
material expense to address. In addition, if its customers or its potential
customers are required to expend significant resources to address their Year
2000 issues (or if they fail to appropriately address such Year 2000 issues),
the Company's business, results of operation and financial condition could be
adversely affected due to resulting changes in purchasing patterns. Furthermore,
if Year 2000 problems experienced by any of the Company's significant suppliers
or service providers cause or contribute to delays or interruptions in the
delivery of products or services, such delays or interruptions could have a
material and adverse effect on the Company's business, results of operations and
financial condition. Although the Year 2000 project team has not yet determined
the most likely worst-case Year 2000 scenarios or quantified the likely impact
of such scenarios, it is clear that the occurrence of one or more of the risks
described above could have a material and adverse effect on the Company's
business, financial condition or results of operations.
The Company does not separately account for Year 2000 related expenses but
estimates that the expenses it has incurred to date to address Year 2000 issues
have not been material and, although it has not completed its full assessment of
its Year 2000 readiness, it does not expect to incur material expenses in
connection with any required future remediation efforts. However, the Company's
Year 2000 compliance efforts related to AdServer consumed significant software
engineering resources that would otherwise have been devoted to product
development efforts. To the extent that significant additional software
engineering resources are required to address other Year 2000 issues that may be
discovered, the Company's product development efforts may be significantly
hampered which, in turn, could have a material and adverse effect on the
Company's business, financial condition and results of operations.
The Company's Year 2000 project team's activities will also include the
development of contingency plans in the event that the Company has not completed
all of its remediation programs in a timely manner. In addition, the Year 2000
project team will develop contingency plans in the event that any third parties
that provide goods or services essential to the Company's business fail to
appropriately address their Year 2000 issues. The Year 2000 project team expects
to conclude the development of these contingency plans by June 30, 1999. Even if
these plans are completed on time and put in place, it is possible that
unresolved or undetected internal and external Year 2000 issues will have a
material and adverse effect on the Company's business, financial condition and
results of operations.
The information set forth above and elsewhere in this Report relating to
Year 2000 issues constitute "Year 2000 Readiness Disclosures," as such term is
defined by the Year 2000 Information and Readiness Disclosure Act of 1998,
enacted October 19, 1998 (Public Law 105-271, 112 State. 2386).
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
FOREIGN CURRENCY HEDGING INSTRUMENTS
The Company transacts business in various foreign currencies. Accordingly,
the Company is subject to exposure from adverse movements in foreign currency
exchange rates. This exposure is primarily
52
<PAGE>
related to revenues and operating expenses in the U.K. and Japan denominated in
the respective local currency. However, as of December 31, 1998, the Company had
no hedging contracts outstanding.
The Company currently does not use financial instruments to hedge operating
expenses in the U.K. or Japan denominated in the respective local currency.
Instead, the Company believes that a natural partial hedge exists, because local
currency revenues will substantially offset the operating
expenses denominated in the respective local currency. The Company assesses the
need to utilize financial instruments to hedge currency exposures on an ongoing
basis.
The Company does not use derivative financial instruments for speculative
trading purposes, nor does the Company hedge its foreign currency exposure in a
manner that entirely offsets the effects of changes in foreign exchange rates.
The Company regularly reviews its hedging program and may as part of this review
determine at any time to change its hedging program. See "Item 1:
Business--Factors Affecting Our Business, Operating Results and Financial
Condition--We face risks associated with our international operations and plans
for expansion."
FIXED INCOME INVESTMENTS
The Company's exposure to market risks for changes in interest rates relates
primarily to investments in debt securities issued by U.S. government agencies
and corporate debt securities. The Company places its investments with high
credit quality issuers and, by policy, limits the amount of the credit exposure
to any one issuer.
The Company's general policy is to limit the risk of principal loss and
ensure the safety of invested funds by limiting market and credit risk. All
highly liquid investments with a maturity of three months or less at the date of
purchase are considered to be cash equivalents; investments with maturities
between three and twelve months are considered to be short-term investments;
investments with maturities in excess of twelve months are considered to be
long-term investments. The weighted average pre-tax interest rate on the
investment portfolio is approximately 5.49%.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required pursuant to this item are included in Part
IV, Item 14 of this Report and are presented beginning on page 56.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
Effective March 1997, the Company's Board of Directors engaged KPMG LLP
("KPMG") as the Company's principal accountants to audit the Company's financial
statements. Prior to such engagement, KPMG and the Company discussed matters
including the application of accounting principles and auditing standards. Such
discussions occurred in the normal course of business, and KPMG's responses were
not a condition to its engagement by the Company. Ernst & Young LLP ("Ernst &
Young") served as the Company's independent auditors from the Company's
inception until the Company's dismissal of Ernst & Young effective March 1997,
which dismissal was approved by the Company's Board of Directors. Ernst & Young
performed the first full fiscal year audit of the Company's financial statements
for the then fiscal year ended March 31, 1996 (the "March 31, 1996 Audit"),
which was the only audit of the Company performed by Ernst & Young. The report
of Ernst & Young on the financial statements of the Company prepared in
connection with the March 31, 1996 Audit did not contain an adverse opinion or
disclaimer of opinion and was not qualified or modified as to uncertainty, audit
scope or accounting principles. Furthermore, in connection with the March 31,
1996 Audit and during the subsequent interim period prior to the dismissal of
Ernst & Young, there were no disagreements between Ernst & Young and the Company
on any matters of accounting principles or practices, financial statement
disclosure or auditing scope or procedure which, if not resolved to the
53
<PAGE>
satisfaction of Ernst & Young, would have caused Ernst & Young to make reference
to the subject matter of such disagreements in connection with its report.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item concerning the Company's directors is
incorporated by reference to the information set forth in the sections entitled
"Proposal 1-- Election of Directors" and "Compliance with Section 16(a) of the
Exchange Act" in the Company's Proxy Statement for the 1999 Annual Meeting of
Stockholders to be filed with the Commission within 120 days after the end of
the Company's fiscal year ended December 31, 1998, except that the information
required by this item concerning the executive officers of the Company is
incorporated by reference to the information set forth in the section entitled
"Executive Officers of the Company" at the end of Part I of this Report.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item regarding executive compensation is
incorporated by reference to the information set forth in the sections entitled
"Proposal 1-- Election of Directors" and "Compensation of Executive Officers" in
the Company's Proxy Statement for the 1999 Annual Meeting of Stockholders to be
filed with the Commission within 120 days after the end of the Company's fiscal
year ended December 31, 1998.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item regarding security ownership of
certain beneficial owners and management is incorporated by reference to the
information set forth in the section entitled "Security Ownership of Certain
Beneficial Owners and Management" in the Company's Proxy Statement for the 1999
Annual Meeting of Stockholders to be filed with the Commission within 120 days
after the end of the Company's fiscal year ended December 31, 1998.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item regarding certain relationships and
related transactions is incorporated by reference to the information set forth
in the section entitled "Certain Relationships and Related Transactions" in the
Company's Proxy Statement for the 1999 Annual Meeting of Stockholders to be
filed with the Commission within 120 days after the end of the Company's fiscal
year ended December 31, 1998.
54
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
(a)(1) FINANCIAL STATEMENTS.
The following consolidated financial statements, and the related notes
thereto, of the Company and the Independent Auditors' Report are filed as a part
of this Report:
<TABLE>
<CAPTION>
PAGE NUMBER
-----------------
<S> <C>
Independent Auditors' Report.................................................................... 56
Consolidated Balance Sheets as of December 31, 1997 and 1998.................................... 57
Consolidated Statements of Operations for the Years ended December 31, 1996, 1997 and 1998...... 58
Consolidated Statements of Stockholders' Equity (Deficit) for the Years ended December 31, 1996,
1997 and 1998................................................................................... 59
Consolidated Statements of Cash Flows for the Years ended December 31, 1996, 1997 and 1998...... 60
Notes to Consolidated Financial Statements...................................................... 61
</TABLE>
(2) FINANCIAL STATEMENT SCHEDULE.
The following financial statement schedule of the Company for each of the
years ended December 31, 1996, 1997 and 1998 is filed as part of this Form 10-K
and should be read in conjunction with the consolidated financial statements,
and related notes thereto, of the Company:
<TABLE>
<CAPTION>
PAGE NUMBER
-----------------
<S> <C>
Schedule II--Valuation and Qualifying Accounts--Allowance for Doubtful Accounts................. 73
</TABLE>
Schedules other than the schedule listed above have been omitted because
they are either not required or not applicable, or the information is otherwise
included.
(3) EXHIBITS. See Item 14(c) below.
(b) REPORTS ON FORM 8-K. No Current Reports on Form 8-K were filed during the
last quarter of the period covered by this Report.
(c) EXHIBITS. The exhibits listed in the Exhibit Index at page 75 of this
Report are filed as part of, or incorporated by reference into, this
Report.
(d) FINANCIAL STATEMENT SCHEDULE. See Item 14(a) above.
55
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
NetGravity, Inc. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of NetGravity,
Inc. and subsidiaries as of December 31, 1997 and 1998, and the related
consolidated statements of operations, stockholders' equity (deficit), and cash
flows for each of the years in the three-year period ended December 31, 1998.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
NetGravity, Inc. and subsidiaries as of December 31, 1997 and 1998, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1998, in conformity with generally accepted
accounting principles.
/s/ KPMG LLP
KPMG LLP
San Francisco, California
January 27, 1999
56
<PAGE>
NETGRAVITY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1997 1998
--------- ----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.................................................................. $ 5,637 $ 10,236
Short-term investments..................................................................... -- 10,563
Accounts receivable, net of allowances of $223 and $202 at December 31, 1997 and 1998,
respectively............................................................................. 2,739 6,311
Prepaid expenses and other current assets.................................................. 155 778
--------- ----------
Total current assets..................................................................... 8,531 27,888
Property and equipment, net.................................................................. 1,356 3,473
Other assets, net............................................................................ -- 2,059
--------- ----------
$ 9,887 $ 33,420
--------- ----------
--------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable........................................................... $ 1,140 $ 618
Accounts payable........................................................................... 305 898
Accrued liabilities........................................................................ 1,344 2,867
Deferred revenue........................................................................... 3,520 5,800
--------- ----------
Total current liabilities................................................................ 6,309 10,183
Notes payable, less current portion.......................................................... 727 1,109
Commitments
Stockholders' equity:
Convertible preferred stock; $0.001 par value; 26,540,194 shares authorized; 11,149,788
shares issued and outstanding at December 31, 1997; 5,000,000 shares authorized; none
issued and outstanding at December 31, 1998.............................................. 11 --
Common stock, $0.001 par value; 35,000,000 shares authorized; 3,979,125 shares issued and
outstanding at December 31, 1997; 50,000,000 shares authorized; 13,589,894 shares issued
and outstanding at December 31, 1998..................................................... 4 14
Additional paid-in capital................................................................. 16,209 46,817
Deferred stock compensation................................................................ (1,669) (1,706)
Accumulated deficit........................................................................ (11,704) (22,997)
--------- ----------
Total stockholders' equity............................................................... 2,851 22,128
--------- ----------
$ 9,887 $ 33,420
--------- ----------
--------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
57
<PAGE>
NETGRAVITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1996 1997 1998
--------- --------- ----------
<S> <C> <C> <C>
Revenues:
Software licenses.............................................................. $ 1,262 $ 2,901 $ 4,115
Software upgrades.............................................................. 107 1,123 2,394
Consulting and support......................................................... 570 2,334 4,637
Transactional services......................................................... -- -- 411
--------- --------- ----------
Total revenues............................................................... 1,939 6,358 11,557
--------- --------- ----------
Cost of revenues:
Cost of software licenses...................................................... -- 76 63
Cost of consulting and support................................................. 702 2,496 4,521
Cost of transactional services................................................. -- -- 644
--------- --------- ----------
Total cost of revenues....................................................... 702 2,572 5,228
--------- --------- ----------
Gross profit................................................................. 1,237 3,786 6,329
--------- --------- ----------
Operating costs and expenses:
Research and development....................................................... 1,764 3,033 4,639
Selling and marketing.......................................................... 2,839 6,073 10,351
General and administrative..................................................... 1,315 1,552 3,172
--------- --------- ----------
Total operating costs and expenses........................................... 5,918 10,658 18,162
--------- --------- ----------
Loss from operations......................................................... (4,681) (6,872) (11,833)
Other income (expense), net...................................................... 54 (10) 540
--------- --------- ----------
Net loss..................................................................... $ (4,627) $ (6,882) $ (11,293)
--------- --------- ----------
--------- --------- ----------
Basic and diluted net loss per share............................................. $ (2.19) $ (2.46) $ (1.28)
--------- --------- ----------
--------- --------- ----------
Shares used in per share calculation............................................. 2,111 2,799 8,823
--------- --------- ----------
--------- --------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
58
<PAGE>
NETGRAVITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK ADDITIONAL
---------------------- ---------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
--------- ----------- --------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Balances as of December 31, 1995.................................... -- -- 4,364 5 178
Issuance of common stock upon exercise of stock options............. -- -- 310 -- 62
Repurchases of common stock......................................... -- -- (439) (1) (27)
Compensation expense related to non-employee option grants.......... -- -- -- -- 8
Issuance of Series A preferred stock, net of issuance costs of $15.. 4,405 4 -- -- 4,429
Net loss............................................................ -- -- -- -- --
--------- --- --------- --- -----------
Balances as of December 31, 1996.................................... 4,405 4 4,235 4 4,650
Issuance of common stock for cash................................... -- -- 17 -- 4
Issuance of common stock upon exercise of stock options............. -- -- 301 -- 67
Compensation expense related to non-employee option grants.......... -- -- -- -- 120
Deferred compensation related to grants of stock options............ -- -- -- -- 1,784
Amortization of deferred compensation............................... -- -- -- -- --
Repurchases of common stock in connection with revaluation.......... -- -- (446) -- (98)
Repurchases of common stock......................................... -- -- (126) -- (26)
Issuance of Series B preferred stock, net of issuance costs of $18.. 4,308 4 -- -- 4,277
Issuance of Series C preferred stock, net of issuance costs of
$566.............................................................. 2,437 3 -- -- 5,431
Net loss............................................................ -- -- -- -- --
--------- --- --------- --- -----------
Balances as of December 31, 1997.................................... 11,150 $ 11 3,979 $ 4 $ 16,209
Issuance of common stock upon exercise of stock options............. -- -- 204 -- 73
Repurchases of common stock......................................... -- -- (102) -- (23)
Issuance of Series C preferred stock, net of issuance costs of $1... 1,451 2 -- -- 3,247
Issuance of common stock upon exercise of warrants.................. -- -- 28 -- 7
Issuance of restricted common stock for cash........................ -- -- 11 -- 2
Conversion of Preferred Stock to Common............................. (12,601) (13) 6,220 7 6
Issuance of common stock in initial public offering................. -- -- 3,250 3 25,869
Deferred compensation related to grants of stock options............ -- -- -- -- 1,427
Amortization of deferred stock compensation......................... -- -- -- -- --
Net loss............................................................ -- -- -- -- --
--------- --- --------- --- -----------
Balances as of December 31, 1998.................................... -- -- 13,590 $ 14 $ 46,817
--------- --- --------- --- -----------
--------- --- --------- --- -----------
<CAPTION>
TOTAL
DEFERRED STOCKHOLDERS'
STOCK ACCUMULATED EQUITY
COMPENSATION DEFICIT (DEFICIT)
------------- ------------ ------------
<S> <C> <C> <C>
Balances as of December 31, 1995.................................... -- (195) (12)
Issuance of common stock upon exercise of stock options............. -- -- 62
Repurchases of common stock......................................... -- -- (28)
Compensation expense related to non-employee option grants.......... -- -- 8
Issuance of Series A preferred stock, net of issuance costs of $15.. -- -- 4,433
Net loss............................................................ -- (4,627) (4,627)
------------- ------------ ------------
Balances as of December 31, 1996.................................... -- (4,822) (164)
Issuance of common stock for cash................................... -- -- 4
Issuance of common stock upon exercise of stock options............. -- -- 67
Compensation expense related to non-employee option grants.......... -- -- 120
Deferred compensation related to grants of stock options............ (1,784) -- --
Amortization of deferred compensation............................... 115 -- 115
Repurchases of common stock in connection with revaluation.......... -- -- (98)
Repurchases of common stock......................................... -- -- (26)
Issuance of Series B preferred stock, net of issuance costs of $18.. -- -- 4,281
Issuance of Series C preferred stock, net of issuance costs of
$566.............................................................. -- -- 5,434
Net loss............................................................ -- (6,882) (6,882)
------------- ------------ ------------
Balances as of December 31, 1997.................................... $ (1,669) $ (11,704) $ 2,851
Issuance of common stock upon exercise of stock options............. -- -- 73
Repurchases of common stock......................................... -- -- (23)
Issuance of Series C preferred stock, net of issuance costs of $1... -- -- 3,249
Issuance of common stock upon exercise of warrants.................. -- -- 7
Issuance of restricted common stock for cash........................ -- -- 2
Conversion of Preferred Stock to Common............................. -- -- --
Issuance of common stock in initial public offering................. -- -- 25,872
Deferred compensation related to grants of stock options............ (1,427) -- --
Amortization of deferred stock compensation......................... 1,390 -- 1,390
Net loss............................................................ -- (11,293) (11,293)
------------- ------------ ------------
Balances as of December 31, 1998.................................... $ (1,706) $ (22,997) $ 22,128
------------- ------------ ------------
------------- ------------ ------------
</TABLE>
See accompanying notes to consolidated financial statements.
59
<PAGE>
NETGRAVITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1996 1997 1998
--------- --------- ----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................................................................. $ (4,627) $ (6,882) $ (11,293)
Adjustments to reconcile net loss to net cash used in operating activities:...............
Depreciation............................................................................ 172 540 965
Amortization of intangibles............................................................. -- -- 222
Amortization of deferred stock compensation............................................. -- 115 1,390
Compensation from grant of non-employee stock options................................... 8 120 --
Changes in operating assets and liabilities:
Accounts receivable, net.............................................................. (1,218) (1,521) (3,572)
Prepaid expenses and other assets..................................................... (178) 27 (623)
Accounts payable...................................................................... 239 48 593
Accrued liabilities................................................................... 635 678 1,523
Deferred revenue...................................................................... 1,718 1,802 2,280
--------- --------- ----------
Net cash used in operating activities............................................... (3,251) (5,073) (8,515)
--------- --------- ----------
Cash flows from investing activities:
Capital expenditures...................................................................... (810) (1,201) (3,082)
Purchases of short-term investments....................................................... (2,705) (2,466) (10,563)
Proceeds from maturities of short-term investments........................................ 2,705 2,466 --
Acquisition of intangibles................................................................ -- -- (2,000)
Other assets.............................................................................. (44) 44 (281)
--------- --------- ----------
Net cash used in investing activities............................................... (854) (1,157) (15,926)
--------- --------- ----------
Cash flows from financing activities:
Proceeds from notes payable............................................................... 683 1,185 1,000
Repayment of notes payable................................................................ (450) -- (1,140)
Proceeds from issuance of preferred stock, net............................................ 4,433 9,715 3,249
Proceeds from issuance of common stock.................................................... 62 71 25,954
Repurchases of common stock............................................................... (28) (124) (23)
--------- --------- ----------
Net cash provided by financing activities........................................... 4,700 10,847 29,040
--------- --------- ----------
Net increase in cash and cash equivalents................................................... 595 4,617 4,599
Cash and cash equivalents at beginning of year.............................................. 425 1,020 5,637
--------- --------- ----------
Cash and cash equivalents at end of year.................................................... $ 1,020 $ 5,637 $ 10,236
--------- --------- ----------
--------- --------- ----------
Supplemental disclosures of cash flow information:
Cash paid for interest.................................................................. $ 18 $ 91 $ 118
--------- --------- ----------
--------- --------- ----------
Non-cash financing activities:
Deferred compensation cost on employee stock option grants.............................. $ -- $ 1,784 $ 1,427
--------- --------- ----------
--------- --------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
60
<PAGE>
NETGRAVITY, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1996, 1997 and 1998
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
NetGravity, Inc. (the Company), a Delaware corporation, was incorporated in
September 1995. The Company is a leading provider of interactive marketing
solutions. The Company maintains its US headquarters in California. The Company
incorporated a subsidiary in the UK in April 1997 for its European operations
and incorporated subsidiaries in Japan in April 1998 and in Hong Kong in October
1998 for its Asia Pacific operations.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
the Company and its subsidiaries. All significant intercompany balances and
transactions have been eliminated on consolidation.
CASH AND CASH EQUIVALENTS
Cash equivalents are highly liquid investments with remaining maturities of
three months or less at the date of purchase.
INVESTMENTS
The Company has adopted Statement of Financial Accounting Standards ("SFAS")
No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES. SFAS
No. 115 requires entities to classify investments in debt and equity securities
with readily determined fair values as "held-to-maturity," "available-for-sale"
or "trading" and establishes accounting and reporting requirements for each
classification. Management determines the appropriate classification of
investment securities at the time of purchase and reevaluates such designation
as of each balance sheet date. As of December 31, 1998, all investment
securities were designated as "available-for-sale." Available-for-sale
securities are carried at fair value based on quoted market prices, with
unrealized gains and losses, if material, reported as a component of accumulated
other comprehensive income (loss) in stockholders' equity.
Realized gains and losses and declines in value judged to be
other-than-temporary for available-for-sale securities are included in the
consolidated statements of operations. There have been no such gains, losses or
declines through December 31, 1998. The cost of securities sold is based on the
specific identification method. Interest and dividends on securities classified
as available-for-sale are included in interest income.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, less accumulated depreciation.
Depreciation of property and equipment is provided over the estimated useful
lives of the respective assets, estimated to be three years on a straight-line
method.
SOFTWARE DEVELOPMENT COSTS
In accordance with SFAS No. 86, ACCOUNTING FOR THE COSTS OF COMPUTER
SOFTWARE TO BE SOLD, LEASED, OR OTHERWISE MARKETED, development costs related to
the software products are expensed as incurred
61
<PAGE>
NETGRAVITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
until the technological feasibility of the product has been established.
Technological feasibility in the Company's circumstances occurs when a working
model is completed. The Company believes its process for developing software is
essentially completed concurrent with the establishment of technological
feasibility and, accordingly, no research and development costs have been
capitalized to date.
REVENUE RECOGNITION
The Company records an account receivable and deferred revenue upon shipment
and invoicing of a software license to a customer. The Company recognizes
software license revenue upon completion of the product installation which the
Company's management has generally determined to occur at the point in time at
which customers begin "serving ads" utilizing the Company's software. A portion
of the initial software license fee is attributed to the customer's right to
receive, at no additional charge, software upgrades released during the
subsequent twelve months. Revenues attributable to software upgrades are
deferred and recognized ratably over the period covered by the software license
agreement, generally one year. Revenue from consulting services are recognized
as the services are performed. Customer-support revenue is deferred and
recognized ratably over the period covered by the customer support agreement,
generally one year.
Revenue from transactional services is primarily comprised of fees from
AdCenter advertising management outsourcing services, as well as fees from the
Company's Global Profile Service, which licenses the use of data to customers.
Fees derived from transactional services are recognized as the services are
rendered.
In October 1997, the American Institute of Certified Public Accountants
issued Statement of Position 97-2, SOFTWARE REVENUE RECOGNITION (SOP 97-2).
Effective January 1, 1998, the Company adopted SOP 97-2. SOP 97-2 generally
requires revenue earned on software arrangements involving multiple elements
such as software products, upgrades, enhancements, post-contract customer
support, installation and training to be allocated to each element based on the
relative fair values of the elements. The fair value of an element must be based
on evidence which is specific to the vendor. The revenue allocated to software
products, including specified upgrades or enhancements, generally is recognized
upon delivery of the products. The revenue allocated to unspecified upgrades and
updates and post contract customer support generally is recognized as the
services are performed. If evidence of the fair value for all elements of the
arrangement do not exist, all revenue from the arrangement is deferred until
such evidence exists or until all elements are delivered. There was no material
change to the Company's accounting for revenues as a result of the adoption of
SOP 97-2.
In February 1998, the Accounting Standards Executive Committee (AcSEC) of
the AICPA issued SOP 98-4, "DEFERRAL OF THE EFFECTIVE DATE OF SOP 97-2". The SOP
defers the effective date for applying the provisions regarding vendor-specific
objective evidence ("VSOE") of fair value until the AcSEC can reconsider what
constitutes such VSOE. There was no material change to the Company's accounting
for revenues as a result of the adoption of SOP 98-4.
In December 1998, AcSEC issued SOP 98-9 "SOFTWARE REVENUE RECOGNITION, WITH
RESPECT TO CERTAIN ARRANGEMENTS", which requires recognition of revenue using
the "residual method" in a multiple element arrangement when fair value does not
exist for one or more of the delivered elements in the arrangement. Under the
"residual method", the total fair value of the undelivered elements is deferred
62
<PAGE>
NETGRAVITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
and subsequently recognized in accordance with SOP 97-2. The Company does not
expect a material change to its accounting for revenues as a result of the
provisions of SOP 98-9.
Advances on commissions are paid upon receipt of a firm sales order for an
initial software license. These advances totaled $0 and $259,000 at December 31,
1997 and 1998, respectively, and are included in other current assets in the
accompanying consolidated balance sheets. Advances on commissions are expensed
as selling and marketing expenses when the related deferred revenue is
recognized.
INCOME TAXES
The Company uses the asset and liability method of accounting for income
taxes. Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amount of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled.
CONCENTRATION OF CREDIT RISK
Accounts receivable potentially subject the Company to concentrations of
credit risk. The Company performs ongoing credit evaluations of its customers'
financial condition and generally does not require collateral for accounts
receivable. When required, the Company maintains allowances for credit losses,
and to date such losses have been within management's expectations.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values of the Company's cash, cash equivalents, accounts
receivable, accounts payable and notes payable approximate their carrying values
due to the short maturity or variable-rate structure of those instruments.
ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews its long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets. Assets to be disposed
of are reported at the lower of their carrying amount or fair value less cost to
sell.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
63
<PAGE>
NETGRAVITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
STOCK-BASED COMPENSATION
The Company accounts for its stock-based compensation arrangements using the
intrinsic-value method pursuant to APB Opinion No. 25. As such, compensation
expense is recorded on the date of grant when the fair value of the underlying
common stock exceeds the exercise price for stock options or the purchase price
for issuance or sales of common stock. Pursuant to SFAS No. 123, the Company
discloses the pro forma effects of using the fair value method of accounting for
stock-based compensation arrangements.
COMPREHENSIVE LOSS
NetGravity has no significant components of other comprehensive loss and,
accordingly, the comprehensive loss is the same as net loss for all periods.
ADVERTISING EXPENSE
The cost of advertising is expensed as incurred. Such costs are included in
selling and marketing expense and totalled approximately $783,000, $831,000 and
$1,033,000 during the years ended December 31, 1996, 1997, and 1998,
respectively.
FOREIGN CURRENCY TRANSACTIONS
The functional currency of the Company's UK, Japan and Hong Kong
subsidiaries is the US dollar. Resulting foreign currency gains and losses are
included in operating results and have not been significant in any period
presented.
PER SHARE INFORMATION
Basic and diluted net loss per share are computed using the weighted average
number of outstanding shares of common stock.
Net loss per share for the year ended December 31, 1998 does not include the
effect of approximately 1,989,545 stock options with a weighted average exercise
price of $4.21 per share, or 463,468 shares of common stock issued and subject
to repurchase by the Company at a weighted average price of $0.22 per share,
because their effects are anti-dilutive.
Net loss per share for the year ended December 31, 1997 does not include the
effect of approximately 11,150,000 (5,563,000 on an as-if converted basis)
shares of convertible preferred stock outstanding, 1,312,399 stock options with
a weighted average exercise price of $0.22 per share, 15,908 common stock
warrants with a weighted average exercise price of $0.22 per share, or 1,171,546
shares of common stock issued and subject to repurchase by the Company at a
weighted average price of $0.22 per share, because their effects are
anti-dilutive.
RECENT ACCOUNTING PRONOUNCEMENTS
The FASB recently issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS
AND HEDGING ACTIVITIES. SFAS No. 133 establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives), and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in
64
<PAGE>
NETGRAVITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
the statement of financial position and measure those instruments at fair value.
For a derivative not designated as a hedging instrument, changes in the fair
value of the derivative are recognized in earnings in the period of change. The
Company must adopt SFAS No. 133 by July 1, 1999. Management does not believe the
adoption of SFAS No. 133 will have a material effect on the financial position
or results of operations of the Company.
(2) BALANCE SHEET COMPONENTS
SHORT-TERM INVESTMENTS
The following is a summary of short-term investments (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Cash equivalents:
Money market funds................................................... $ 5,637 $ 10,236
--------- ---------
Short-term investments:
Corporate Bonds...................................................... -- 10,563
--------- ---------
$ 5,637 $ 20,799
--------- ---------
--------- ---------
</TABLE>
Through December 31, 1998, the difference between the fair value and the
amortized cost of available-for-sale securities was not significant; therefore,
no unrealized gains or losses have been recorded in stockholders' equity. As of
December 31, 1998, the average portfolio duration and contractual maturity was
less than three months.
PURCHASE OF INTANGIBLE ASSETS
In September 1998, the Company entered into an agreement with MatchLogic,
Inc., a subsidiary of Excite, Inc. As part of this agreement, the Company paid
MatchLogic $2 million for the limited, non-exclusive right to use certain of
MatchLogic's proprietary consumer profile databases for certain purposes. This
transaction has been accounted for as a purchase of an intangible asset. The
cost of this intangible asset has been capitalized, is included in other assets
on the Company's consolidated balance sheet, and is being amortized over a
three-year period.
65
<PAGE>
NETGRAVITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
(2) BALANCE SHEET COMPONENTS (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment consisted of the following as of December 31, 1997
and 1998 (in thousands):
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Computer equipment and software........................................... $ 1,837 $ 3,228
Furniture and fixtures.................................................... 236 423
Leasehold improvements.................................................... -- 1,343
--------- ---------
2,073 4,994
Accumulated depreciation.................................................. (717) (1,521)
--------- ---------
Property and equipment, net............................................. $ 1,356 $ 3,473
--------- ---------
--------- ---------
</TABLE>
(3) NOTES PAYABLE
The Company had a revolving credit facility with a bank in the amount of
$1.0 million which bore interest at the prime rate (8.50% as of December 31,
1997) plus 0.75%, and expired in May 1998. Borrowings were limited to the lesser
of $1.0 million or 70% of the net amount of eligible accounts receivable and
were secured by the Company's accounts receivable. As of December 31, 1997 and
December 31, 1998, borrowings under this credit facility were $655,000 and $0,
respectively.
The Company has an equipment line of credit with a bank that provides up to
$1.0 million, bears interest at the prime rate (7.75% as of December 31, 1998),
and expires in June 2000. The line of credit is secured by the Company's fixed
assets. As of December 31, 1997 and 1998, $584,000 and $350,000, respectively,
were outstanding under this agreement with the principal amount due in 30
monthly installments of $19,467 beginning December 31, 1997.
The Company also has a second equipment line of credit with the same bank
that provides up to $1.2 million, bears interest at the prime rate, and expires
in June 2000. The line of credit is secured by the Company's fixed assets. As of
December 31, 1997 and 1998, $628,000 and $377,000, respectively, were
outstanding under this agreement with the principal amount due in 30 monthly
installments of $20,933 beginning December 31, 1997.
In September 1998, the Company secured a revolving credit facility with a
bank in the amount of $4.0 million, which bears interest at the prime rate and
expires in May 1999. Borrowings are limited to the lesser of $4.0 million or 80%
of the net amount of eligible accounts receivable, and are secured by the
Company's assets. The credit facility has a non-revolving sub-facility for up to
$1.5 million for purchases of equipment, bears interest at the prime rate, and
expires in December 2004. The line of credit is secured by the Company's
accounts receivable. As of December 31, 1998, $1.0 million was outstanding under
this agreement with the principal and interest due in 60 monthly installments
beginning in May 1999.
As of December 31, 1998, the Company was in compliance with the financial
covenants on all of the aforementioned credit facilities. The terms of the
aforementioned credit facilities include financial covenants related to certain
financial ratios and tangible asset requirements.
66
<PAGE>
NETGRAVITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
(3) NOTES PAYABLE (CONTINUED)
The aggregate principal payments on long-term debt for each of the years in
the five-year period subsequent to December 31, 1998 are as follows: 1999,
$618,000; 2000, $442,000; 2001, $200,000; 2002, $200,000; 2003, $200,000;
Thereafter $67,000.
(4) INCOME TAXES
The domestic and foreign components of loss before income taxes are as
follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1996 1997 1998
--------- --------- ----------
<S> <C> <C> <C>
Domestic..................................................... $ (4,627) $ (6,244) $ (8,586)
Foreign...................................................... -- (638) (2,707)
--------- --------- ----------
Loss before income taxes................................. $ (4,627) $ (6,882) $ (11,293)
--------- --------- ----------
--------- --------- ----------
</TABLE>
The difference between the amount of income tax benefit recorded and the
amount of income tax benefit calculated using the U.S. federal statutory rate of
34% is due to net operating losses not being benefited.
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets as of December 31, 1997 and 1998 are
presented below (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Deferred tax assets:
Various accruals and reserves not deductible for tax purposes............ $ 229 $ 340
Property and equipment................................................... 134 264
Capitalized start-up expenditures........................................ 89 51
Net operating loss carryforward.......................................... 4,446 8,079
Research and development credit carryforward............................. 265 590
--------- ---------
Total deferred tax assets............................................ 5,163 9,324
Valuation allowance...................................................... (5,163) (9,324)
--------- ---------
Net deferred tax assets.............................................. $ -- $ --
--------- ---------
--------- ---------
</TABLE>
As of December 31, 1998, NetGravity Europe Limited and NetGravity Asia
Pacific K.K. had net operating loss carryforwards of approximately $2,700,000
and $900,000 in the UK and Japan, respectively. The UK net operating loss can be
carried forward indefinitely. The Japan net operating loss will expire in the
year 2003, if not utilized.
As of December 31, 1998, the Company has a net operating loss carryforward
for U.S. federal and state income tax purposes of approximately $15.9 million.
In addition, the Company had U.S. federal and state research and development
credit carryforwards of approximately $318,000 and $272,000, respectively. The
Company's U.S. federal net operating loss and research and development credit
carryforwards will expire in the years 2010 through 2018, if not utilized. The
Company's state net
67
<PAGE>
NETGRAVITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
(4) INCOME TAXES (CONTINUED)
operating loss carryforwards will expire in the year 2003. The state research
and development credit can be carried forward indefinitely.
U.S. federal and state tax laws impose substantial restrictions on the
utilization of net operating loss and tax credit carryforwards in the event of
an "ownership change" as defined in Section 382 of the Internal Revenue Code.
The Company had such an ownership change, as defined, in March 1997.
Accordingly, $6.0 million of each of the Company's U.S. federal and state net
operating loss carryforwards are each limited in their annual usage to
approximately $700,000 per year. The Company has not yet determined whether any
ownership change, as defined, has occurred since 1997.
(5) STOCKHOLDERS' EQUITY
INITIAL PUBLIC OFFERING
In July 1998, the Company completed its initial public offering (IPO) in
which it sold 3,250,000 shares and raised approximately $25.9 million in
proceeds, net of offering costs of approximately $1.3 million. In connection
with the IPO, all outstanding shares of preferred stock automatically converted
into approximately 6,220,000 shares of common stock.
STOCK SPLIT
The Company's Board of Directors approved a 1-for-2.2 reverse split of the
Company's common stock (approved by the stockholders effective as of May 8,
1998) which was effected at the effectiveness of the IPO. All common share
amounts in the accompanying consolidated financial statements have been adjusted
retroactively.
COMMON STOCK
In connection with the Board of Directors' revaluation of the Company's fair
value in March 1997, the Company repurchased and retired approximately 446,000
shares of common stock previously held by two of the Company's founders, at an
average purchase price of $0.22 per share. Additionally, the Company adjusted
the conversion price of Series A convertible preferred stock to $1.78 per share
of common stock; previously the conversion price was $2.22 per share of common
stock. Approximately 494,340 additional shares of common stock (after giving
effect to the 1-for-2.2 reverse stock split) were in-substance issuable to the
holders of Series A convertible preferred stock due to the reduction in the
conversion price. The fair value of the assumed in-substance dividend on
reported basic and diluted net loss per share for fiscal 1997 was not
significant.
Common stock issued to certain individuals is subject to repurchase at the
option of the Company, at the original issuance price, in the event an
individual ceases to be employed by the Company. Such shares are subject to
repurchase on a pro rata basis over a four-year period from the date of
issuance. As of December 31, 1996, 1997 and 1998, there were approximately
1,688,000, 628,000 and 218,000 shares, respectively, subject to repurchase, at a
weighted average price of $0.07 per share. During 1996, 1997 and 1998,
approximately 439,000, 126,000 and 102,000 shares, respectively, were
repurchased.
The Company's Board of Directors adopted the 1998 Stock Plan (the "1998
Plan") on April 23, 1998 (approved by the stockholders effective as of May 8,
1998). The 1998 Plan provides for the grant
68
<PAGE>
NETGRAVITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
(5) STOCKHOLDERS' EQUITY (CONTINUED)
of incentive and nonstatutory stock options and stock purchase rights to
employees, directors and consultants. A total of 2,000,000 shares of common
stock, plus annual increases equal to the lesser of (i) 1,000,000 shares, (ii)
5% of the outstanding shares, or (iii) a lesser amount determined by the Board
of Directors, were reserved for issuance pursuant to the 1998 Plan.
The Company's Board of Directors adopted the 1998 Employee Stock Purchase
Plan (the "1998 Purchase Plan") on April 23, 1998 (approved by the stockholders
effective as of May 8, 1998). A total of 200,000 shares of common stock were
reserved for issuance under the 1998 Purchase Plan, plus annual increases equal
to the lesser of (i) 750,000 shares, (ii) 4% of the outstanding shares on such
date, or (iii) a lesser amount determined by the Board of Directors.
The Company's Board of Directors also adopted the 1998 Director Option Plan
(the "Director Plan") on April 23, 1998 (approved by the stockholders effective
as of May 8, 1998). The Director Plan provides for the grant of nonstatutory
stock options to non-employee directors of the Company or affiliates thereof. A
total of 200,000 shares of common stock were reserved for issuance under the
Director Plan plus annual increases to maintain 200,000 shares of common stock
reserved for additional option grants.
As of December 31, 1998, a total of 2,727,570 shares of common stock were
authorized for issuance under the 1995 Stock Option Plan (the Plan). Options may
be granted at an exercise price not less than 100% of the fair market value, as
determined by the Board of Directors, for incentive stock options and 85% of
fair market value for nonqualified stock options at the grant date. All options
are granted at the discretion of the Company's Board of Directors and have a
term not greater than 10 years from the date of grant. Options issued are
generally immediately exercisable and generally vest 25% on the first
anniversary date and 1/48th of the shares each month thereafter, so that all the
shares are vested 48 months after the vesting commencement date.
A summary of the status of the Company's options under the Plan is as
follows:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1996 DECEMBER 31, 1997 DECEMBER 31, 1998
------------------------ ------------------------ ------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year................... 5,000 $ 0.07 456,509 $ 0.22 1,312,399 $ 0.22
Granted at market value............................ 833,418 0.22 475,193 0.22 368,388 $ 12.13
Granted at less than market value.................. -- -- 845,092 0.22 643,468 $ 5.85
Exercised.......................................... (309,418) 0.22 (301,009) 0.22 (204,036) $ 0.36
Canceled........................................... (72,491) 0.22 (163,386) 0.22 (129,311) $ 1.84
----------- ----------- -----------
Options at end of year............................. 456,509 0.22 1,312,399 0.22 1,990,908 $ 4.21
----------- ----------- -----------
----------- ----------- -----------
Weighted-average fair value of options granted
during the year with exercise prices equal to
market value at date of grant.................... $ 0.07 $ 0.07 $ 12.13
----------- ----------- -----------
----------- ----------- -----------
Weighted-average fair value of options granted
during the year with exercise prices less than
market value at date of grant.................... -- $ 2.05 $ 8.07
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
69
<PAGE>
NETGRAVITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
(5) STOCKHOLDERS' EQUITY (CONTINUED)
The following table summarizes information about stock options outstanding
as of December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
- -----------------------------------------------------------------
WEIGHTED-AVERAGE
REMAINING
CONTRACTUAL LIFE OPTIONS
EXERCISE PRICE NUMBER (YEARS) VESTED
- ----------------- ---------- ------------------- -------------
<S> <C> <C> <C>
$0.22 1,037,993 8.50 332,675
$0.55 73,374 9.09 5,368
$6.60 409,866 9.28 4,734
$7.15-11.94 374,427 9.57 --
$13.31-$23.69 95,135 9.12 10,735
$26.06 113 4.52 113
---------- -------------
1,990,908 353,625
---------- -------------
---------- -------------
</TABLE>
The Company uses the intrinsic value-based method to account for all its
employee stock-based compensation arrangements. Accordingly, no compensation
cost has been recognized for its stock options in the accompanying consolidated
financial statements because the fair value of the underlying common stock
equals or exceeds the exercise price of the stock options at the date of grant,
except with respect to certain options granted in 1997 and 1998. The Company has
recorded deferred stock compensation expense of $1,784,000 and $1,427,000 for
the difference at the grant date between the exercise price and the fair value
of the common stock underlying the options granted in 1997 and 1998,
respectively. Amortization of deferred compensation of approximately $115,000
and $1,390,000 was recognized in 1997 and 1998, respectively.
Had compensation cost for the Company's stock-based compensation plans been
determined consistent with the fair value approach set forth in SFAS No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION, the Company's net losses for the years
ended December 31, 1996, 1997 and 1998, would have been as follows (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1996 1997 1998
--------- --------- ----------
<S> <C> <C> <C>
Net loss--as reported.................................................. $ (4,627) $ (6,882) $ (11,293)
Net loss--pro forma.................................................... $ (4,635) $ (6,883) $ (11,085)
Basic and diluted net loss per share--as reported...................... $ (2.19) $ (2.46) $ (1.28)
Basic and diluted net loss per share--pro forma........................ $ (2.20) $ (2.46) $ (1.26)
</TABLE>
The fair value of options granted during the years ended December 31, 1996
and 1997 is estimated on the date of grant using the minimum value method with
the following weighted-average assumptions: no dividend yield, risk-free
interest rates of 6.0% and 6.1% for 1996 and 1997, respectively, and expected
lives of 5 years.
The fair value of options granted during the year ended December 31, 1998 is
estimated on the date of grant using the Black-Scholes option pricing model with
the following weighted-average
70
<PAGE>
NETGRAVITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
(5) STOCKHOLDERS' EQUITY (CONTINUED)
assumptions: no dividend yield, risk free interest rate of 5.2%, expected lives
of 5 years, and an expected volatility of 80%.
WARRANTS
In March 1997, in connection with a lease termination agreement, the Company
issued the building landlord a warrant to purchase 6,818 shares of common stock
at a purchase price of $0.22 per share. There warrants were exercised in June
1998. The value of the warrant was not significant at the date of grant.
In October 1997, in connection with certain consulting activities, the
Company committed to deliver a warrant to purchase 9,090 shares of common stock
at a purchase price of $0.22 per share. These warrants were exercised in May
1998. The value of the warrant was not significant at the date of grant.
In January 1998, in connection with a non-employee compensation matter, the
Company committed to deliver a warrant to purchase 11,742 shares of common stock
at a purchase price of $0.22 per share. These warrants were exercised in May
1998. The value of the warrant was not significant at the date of grant.
(6) COMMITMENTS
The Company leases its facilities under various noncancellable operating
lease agreements that expire on various dates through 2005. As of December 31,
1998, the remaining future minimum payments for these facilities are as follows
(in thousands):
<TABLE>
<CAPTION>
OPERATING
YEARS ENDING DECEMBER 31, LEASES
- --------------------------------------------------------------------------------------- ---------------
<S> <C>
1999................................................................................... $ 1,396
2000................................................................................... 1,367
2001................................................................................... 1,363
2002................................................................................... 1,398
Thereafter,............................................................................ 3,558
------
$ 9,082
------
------
</TABLE>
Total rent expense, including month to month arrangements, was approximately
$149,000, $313,000 and $800,000 for the years ended December 31, 1996, 1997 and
1998, respectively.
(7) SEGMENT INFORMATION
The Company has adopted the provisions of SFAS No. 131, DISCLOSURE ABOUT
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 131 establishes
standards for the reporting by public business enterprises of information about
operating segments, products and services, geographic areas, and major
customers. The method for determining what information to report is based on the
way that management organizes the operating segments within the Company for
making operating decisions and assessing financial performance.
71
<PAGE>
NETGRAVITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
(7) SEGMENT INFORMATION (CONTINUED)
The Company's chief operating decision maker is considered to be the
Company's Chief Executive Officer ("CEO"). The CEO reviews financial information
presented on a consolidated basis accompanied by disaggregated information about
revenues by geographic region for purposes of making operating decisions and
assessing financial performance. The consolidated financial information reviewed
by the CEO is identical to the information presented in the accompanying
consolidated statement of operations. Therefore, the Company operates in a
single operating segment: interactive marketing software and services.
Revenue and asset information regarding operations in the different
geographic regions is as follows (in thousands):
<TABLE>
<CAPTION>
NORTH
AMERICA EUROPE ASIA CONSOLIDATED
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
1996................................................... 1,939 -- -- $ 1,939
1997................................................... 6,358 -- -- 6,358
1998................................................... 8,263 1,980 1,314 11,577
Identifiable assets:
1997................................................... 9,139 748 -- $ 9,887
1998................................................... 30,587 1,513 1,320 33,420
</TABLE>
No single customer accounted for greater than 10% of revenues in any period
reported.
72
<PAGE>
SCHEDULE II
NETGRAVITY, INC.
VALUATION AND QUALIFYING ACCOUNTS--
ALLOWANCE FOR DOUBTFUL ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT ADDITIONS
BEGINNING OF CHARGED TO BALANCE AT
PERIOD EXPENSE DEDUCTIONS END OF PERIOD
------------------ ---------- ---------- -------------
<S> <C> <C> <C> <C>
Year ended December 31, 1996 -- 197 28 169
Year ended December 31, 1997 169 67 13 223
Year ended December 31, 1998 223 204 235 202
</TABLE>
73
<PAGE>
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) 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.
NETGRAVITY, INC.
By: /s/ STEPHEN E. RECHT
-----------------------------------------
Stephen E. Recht
CHIEF FINANCIAL OFFICER AND SECRETARY
(PRINCIPAL FINANCIAL AND ACCOUNTING
OFFICER AND DULY AUTHORIZED OFFICER)
DATE: MARCH 24, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Report has been signed by the following persons in the capacities
indicated on March 24, 1999:
NAME TITLE
- ------------------------------ --------------------------
Chairman of the Board and
/s/ JOHN W. DANNER Chief Executive Officer
- ------------------------------ (Principal Executive and
(John W. Danner) duly authorized officer)
Chief Financial Officer
/s/ STEPHEN E. RECHT and Secretary (Principal
- ------------------------------ Financial Officer and
(Stephen E. Recht) Principal Accounting
Officer)
/s/ J. SCOTT BRIGGS
- ------------------------------ Director
(J. Scott Briggs)
/s/ JOHN D. D. KOHLER
- ------------------------------ Director
(John D. D. Kohler)
/s/ AMNON LANDAN
- ------------------------------ Director
(Amnon Landan)
/s/ JONATHAN D. LAZARUS
- ------------------------------ Director
(Jonathan D. Lazarus)
/s/ ALEXANDER R. SLUSKY
- ------------------------------ Director
(Alexander R. Slusky)
74
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- --------
<C> <S>
*3.1 Restated Certificate of Incorporation of the Registrant.
*3.2 Amended and Restated Bylaws of the Registrant.
**4.1 Specimen certificate representing shares of common stock of the
Registrant.
**4.2 Second Amended and Restated Registration and Information Rights Agreement.
**10.1(1) Form of Indemnification Agreement for Directors and Officers of the
Registrant.
**10.2(1) 1995 Stock Option Plan.
**10.3(1) 1998 Stock Option Plan, together with form of Stock Option Agreement and
form of Stock Issuance Agreement.
**10.4(1) 1998 Employee Stock Purchase Plan.
**10.5(1) 1998 Director Option Plan.
***10.6 Lease dated August 5, 1998 for the Registrant's headquarters in San Mateo,
CA.
**10.7 Lease dated March 2, 1998 for the Registrant's offices in New York, NY.
**10.8(1) Employment and Severance Agreement dated March 31, 1998 by and between the
Registrant and Stephen E. Recht.
**10.9 Professional Services Agreement dated March 27, 1997 by and between the
Registrant and Protege Software (Holdings) Limited as amended by
Amendment dated May 13, 1998.
**10.10(1) Common Stock Repurchase Agreement and Clarification of Founder's Stock
Purchase Agreement dated March 12, 1997 by and between the Registrant
and John W. Danner.
**10.12(1) Employment Agreement dated April 22, 1998 by and between the Registrant
and Susan Atherton.
**10.13(1) 401(k) Plan.
**10.14(1) Employment Agreement dated May 12, 1998 by and between the Registrant and
Jitendra Valera.
**10.15 Consultant and Representative Agreement dated June 1, 1998 by and between
the Registrant and Asia Pacific Ventures Co.
**10.16 Single User License Agreement by and between the Registrant and Rogue Wave
Software, Inc.
11.1 Statement Regarding Computation of Earnings Per Share (contained in Note 1
of the Notes to Financial Statements).
**16.1 Letter from Ernst & Young LLP regarding change in certified accountants.
*21.1 List of Subsidiaries of the Registrant.
23.1 Report on Schedule and Consent of Independent Auditors.
</TABLE>
- ------------------------
* Incorporated herein by reference to the exhibit of the same number filed
with the Registrant's Registration Statement on Form S-1 (Commission File
No. 333-73203).
** Incorporated herein by reference to the exhibit of the same number filed
with the Registrant's Registration Statement on Form S-1 (Commission File
No. 333-51007).
*** Incorporated herein by reference to exhibit 10.17 filed with the
Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended
September 30, 1998.
(1) Indicates management compensatory plan, contract or arrangement.
75
<PAGE>
EXHIBIT 23.1
REPORT ON SCHEDULE AND CONSENT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
NetGravity, Inc. and Subsidiaries:
The audits referred to in our report dated January 27, 1999, included the
related financial statement schedule as of December 31, 1998, and for each of
the years in the three-year period ended December 31, 1998, as listed in Item 14
herein. This financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion on this financial
statement schedule based on our audits. In our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
We consent to the incorporation by reference in the registration statement
(No. 333-59983) on Form S-8 of NetGravity, Inc. and subsidiaries of our reports
dated January 27, 1999 relating to the consolidated balance sheets of
NetGravity, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of operations, stockholders' equity (deficit),
and cash flows for each of the years in the three-year period ended December 31,
1998, and the related financial statement schedule, which reports are included
herein.
/s/ KPMG LLP
KPMG LLP
San Francisco, California
MARCH 24, 1999
