<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 1999.
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the transition period from ____ to ____.
Commission file number 0-23171.
ON2.COM INC.
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(Exact name of registrant as specified in its charter)
Colorado 84-1280679
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
375 Greenwich Street, New York, NY 10013
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(Address of principal executive offices) (Zip Code)
(212) 941-2400
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. |X| Yes |_| No
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. |_| Yes |_| No
<PAGE>
APPLICABLE ONLY TO CORPORATE ISSUERS:
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date:
23,178,337 as of September 30, 1999.
Transitional Small Business Disclosure Format (Check one): |_| Yes |X| No
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<PAGE>
PART I -- FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS.
The unaudited financial statements follow:
<TABLE>
<CAPTION>
CONTENTS
Page
<S> <C>
Consolidated Balance Sheets at September 30, 1999 and December 31, 1998..................... 4
Consolidated Statements of Operations, Nine Months Ended September 30, 1999 and 1998........ 5
Consolidated Statements of Operations, Three Months Ended September 30, 1999 and 1998..... 6
Consolidated Statement of Stockholders' Equity, Nine Months ended September 30, 1999...... 7
Consolidated Statements of Cash Flows, Nine Months ended September 30 1999 and 1998 ...... 8
Notes to Consolidated Financial Statements.................................................. 10
</TABLE>
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<PAGE>
ON2.COM INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
Unaudited Unaudited
------------------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 10,040,584 $ 1,227,706
Accounts receivable 4,862 13,762
Loans receivable from stockholders 294,624 292,088
Prepaid expenses and other current assets 262,159 17,201
------------------------------------------------
Total current assets 10,602,229 1,550,757
Fixed assets, net 1,030,681 360,417
Intangible asset (acquired technology - see Note 4) net of amortization
of $6,970 2,502,317 -
Patent and Trademark costs, net of accumulated amortization of $158,290
and $123,004 at September 30, 1999 and December 31,
1998, respectively 154,738 90,024
Other assets 120,576 116,076
------------------------------------------------
Total assets $ 14,410,541 $2,117,274
================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable to stockholders $ 664,624 $ -
Accounts payable and accrued expenses 635,227 181,515
------------------------------------------------
Total current liabilities 1,299,851 181,515
Commitments and contingency - Note 6
Stockholders' equity:
Series A Convertible preferred stock, no par value; 5,000,000 shares
authorized; 2,000,000 shares issued and outstanding, (stated at
liquidation value of $7.50 per share) (Note 3) 15,000,000 -
Common Stock, no par value; 50,000,000 shares authorized:
23,178,337 outstanding at September 30, 1999; 15,302,374 shares
outstanding at December 31, 1998 - Notes 2 and 3 8,268,828 7,171,013
Accumulated deficit (10,158,138) (5,235,254)
---------------------------------------------
Total stockholders' equity 13,110,690 1,935,759
================================================
Total liabilities and stockholders' equity $ 14,410,541 $ 2,117,274
================================================
</TABLE>
SEE ACCOMPANYING NOTES.
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<PAGE>
ON2.COM INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Nine Months Ended September 30,
1999 1998
Unaudited Unaudited
-------------------------------------------------
<S> <C> <C>
Revenues $ 23,543 $ 882,998
-------------------------------------------------
Operating expenses
Research and development 1,876,900 956,892
Sales and marketing 1,058,521 809,353
General and administrative 2,139,073 1,636,776
-------------------------------------------------
Total operating expenses 5,074,494 3,403,021
-------------------------------------------------
Loss from operations (5,050,951 (2,520,023)
Other income (expense):
Interest expense (754) (450)
Interest income and other 165,060 45,753
-------------------------------------------------
164,306 45,303
-------------------------------------------------
Loss before provision for income taxes (4,886,645) (2,474,720)
Provision for income taxes 2,119 50,060
-------------------------------------------------
Net loss $ (4,888,764) $ (2,524,780)
=================================================
Loss per share - basic and diluted $ (0.27) $ (0.17)
Weighted average shares outstanding - basic and diluted 18,345,478 15,299,921
</TABLE>
SEE ACCOMPANYING NOTES.
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<PAGE>
ON2.COM INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended September 30,
1999 1998
Unaudited Unaudited
--------------------------------------------------
<S> <C> <C>
Revenues $ 6,911 $ 163,256
--------------------------------------------------
Operating expenses
Research and development 1,197,578 340,590
Sales and marketing 579,756 263,163
General and administrative 1,093,409 579,002
--------------------------------------------------
Total operating expenses 2,870,743 1,182,755
--------------------------------------------------
Loss from operations (2,863,832) (1,019,499)
Other income (expense):
Interest expense - (450)
Interest income and other 129,452 (53,089)
--------------------------------------------------
129,452 (53,539)
--------------------------------------------------
Loss before provision for income taxes (2,734,380) (1,073,038)
Provision for income taxes - 158
--------------------------------------------------
Net loss $ (2,734,380) $ (1,073,196)
==================================================
Loss per share - basic and diluted $ (0.12) $ (0.07)
Weighted average shares outstanding - basic and diluted 23,013,457 15,300,344
</TABLE>
SEE ACCOMPANYING NOTES.
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<PAGE>
ON2.COM INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
SERIES A TOTAL
CONVERTIBLE ACCUMULATED STOCKHOLDERS'
PREFERRED STOCK COMMON STOCK DEFICIT EQUITY
----------------------- ------------------------ -------------- --------------
SHARES AMOUNT SHARES AMOUNT
(Note 3)
------- ------ --------- ------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1998 - Notes 2 and 3 -- -- 15,302,374 $ 7,171,013 $ (5,235,254) $ 1,935,759
Sale of warrant to
purchase Common Stock -- -- -- 1,000 -- 1,000
Purchase and retirement
Common Stock -- -- (302,374) (340,000) -- (340,000)
Reverse merger with
The Duck Corporation 8,000,000 34,120 (34,120) --
Issuance of Series A Convertible
preferred shares 2,000,000 $ 15,000,000 -- -- -- 15,000,000
Expenses related to Series A
Preferred share issuance -- -- -- (385,887) -- (385,887)
Sale of common stock on exercise
of employee stock option -- -- 8,893 20,010 -- 20,010
Common stock issued on
acquisition of MetaVisual
Creations Limited (Note 4) -- -- 169,444 1,768,572 -- 1,768,572
Net loss for the period -- -- -- -- (4,888,764) (4,888,764)
--------- ------------ ---------- ------------ ------------ ------------
Balance at September 30, 1999 2,000,000 $ 15,000,000 23,178,337 $ 8,268,828 $(10,158,138) $ 13,110,690
--------- ------------ ---------- ------------ ------------ ------------
--------- ------------ ---------- ------------ ------------ ------------
</TABLE>
SEE ACCOMPANYING NOTES.
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<PAGE>
ON2.COM INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Nine Months Ended September 30,
1999 1998
Unaudited Unaudited
------------------------------------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $ (4,888,764) $ (2,524,780)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 184,210 170,714
Changes in operating assets and liabilities:
Accounts receivable 8,900 (56,958)
Prepaid expenses and other current assets (244,955) 22,880
Other assets - (95,078)
Accounts payable and accrued expenses 372,774 (83,584)
------------------------------------------------
Net cash used in operating activities (4,567,835) (2,566,806)
------------------------------------------------
INVESTING ACTIVITIES
Purchase of fixed assets (806,230) (203,918)
Acquisition (net of cash acquired) (390,768) -
Security deposits (4,500) -
Purchase of trademarks (25,000) -
------------------------------------------------
Net cash used in investing activities (1,226,498) (203,918)
------------------------------------------------
FINANCING ACTIVITIES
Proceeds from warrant to purchase Common Stock 1,000 -
Proceeds from sale of Series A Convertible preferred stock, net of
expenses 14,614,113 -
Proceeds from sale of common stock 20,010 2,340
Payments on notes payable to stockholder (25,376) -
Loans to stockholders (2,536) 42,364
------------------------------------------------
Net cash provided by financing activities 14,607,211 44,704
------------------------------------------------
Net (decrease) increase in cash and cash equivalents 8,812,878 (2,726,020
Cash and cash equivalents at beginning of period 1,227,706 4,866,680
================================================
Cash and cash equivalents at end of period $ 10,040,584 $ 2,140,660
================================================
</TABLE>
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<PAGE>
ON2.COM INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION AND NON-CASH INVESTING AND
FINANCING ACTIVITIES
<TABLE>
<CAPTION>
Nine Months ended September 30,
1999 1998
Unaudited Unaudited
----------------------------------------------
<S> <C> <C>
Cash paid during the year for:
Interest $ 754 $ 450
==============================================
Taxes $ 22,218 $ 59,617
==============================================
Acquisition for common stock and note payable $ 2,118,572 -
==============================================
Purchase and retirement of common stock $ 340,000 -
==============================================
</TABLE>
Effective June 9, 1999, On2.com Inc. (the "Company") entered into a Separation
and Release Agreement with an officer and shareholder. In connection with the
agreement, the Company repurchased 302,374 shares of the Company's Common Stock
from the officer and shareholder at a price of $1.12 per share through issuance
of a note payable to the shareholder. Under the terms of the Separation and
Release Agreement, on January 15, 2000 the Company will offset the remaining
balance of the note payable to the shareholder against certain notes and
advances receivable from the shareholder.
At September 30, 1999, $75,000 had been accrued as a payable for the
purchase of a trade-name. The total cost of the trade-name was $100,000.
The trade-name is being amortized over ten years.
On September 27, 1999 the Company acquired the assets of MetaVisual Creations
Limited, a company incorporated under the laws of England. The purchase price
was valued at $2,518,572. In addition to paying $400,000 in cash, the Company
issued 169,444 shares of its common stock valued at $1,768,572 based on the
closing price of the Company's common stock on the American Stock Exchange on
the acquisition date and issued a note payable in the amount of $350,000.
SEE ACCOMPANYING NOTES.
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<PAGE>
ON2.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 UNAUDITED FINANCIAL INFORMATION
The interim consolidated financial data are unaudited. However, in the opinion
of management, the interim data include all adjustments, consisting only of
normal, recurring adjustments, necessary for a fair statement of the results for
the interim periods. The financial statements included herein have been prepared
by On2.com Inc. (the "Company") pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations, although the Company believes that the disclosures
included herein are adequate to make the information presented not misleading.
These financial statements should be read in conjunction with the annual
financial statements and notes thereto included in the Company's Form 8-K Report
filed with the Securities and Exchange Commission on June 22, 1999 and amended
on August 12, 1999 and Form 10KSB for the three month transition period ended
December 31, 1998 filed with the Securities and Exchange Commission on September
28, 1999 and amended on October 21, 1999.
NOTE 2 ORGANIZATION AND OPERATIONS
On2.com Inc. (the "Company"), formed by the merger of The Duck Corporation
("Duck") into and with a subsidiary of Applied Capital Funding, Inc.,
("Applied") a Colorado corporation, (the "Merger"), is developing a network of
Web channels for broadband-enabled internet users.The Company's technology
combines the classic elements of television with the interactivity of the
Internet, utilizing proprietary video compression and streaming technology.
In connection with the Merger, the Company changed its name from Applied Capital
Funding, Inc. to On2.com Inc. The consolidated balance sheet at September 30,
1999 includes the accounts of On2.com Inc. and its wholly owned-subsidiaries.
All intercompany accounts and transactions have been eliminated in
consolidation.
The Company's Common Stock was listed on the American Stock Exchange on June 30,
1999 and currently trades under the symbol "ONT." Prior to that time it was
traded on the Over-the-Counter Bulletin Board operated by the National
Association of Securities Dealers, Inc.
<PAGE>
NOTE 3 MERGER WITH THE DUCK CORPORATION AND PRIVATE OFFERING OF PREFERRED STOCK
On June 15, 1999, Applied Capital Acquisition Corp., a Delaware corporation, a
wholly-owned subsidiary of Applied merged with and into Duck , In connection
with the Merger, the Company, issued 15,000,000 shares of its Common Stock to
the shareholders of Duck's issued and outstanding common stock in exchange for
100% of the issued and outstanding common stock of Duck. After the Merger,
former Duck stockholders owned approximately 65% of the issued and outstanding
Common Stock of the Company. The Merger has been accounted for as a reverse
merger in which Duck is the accounting acquirer. The historical records of Duck
became the historical records of the Company. Following the Merger, the business
conducted by the Company is the business conducted by Duck prior to the Merger.
Prior to the Merger, the Company was a non-operating "shell" corporation.
Pursuant to SEC rules, the Merger of a private operating company (Duck) into a
non-operating public shell corporation with nominal net assets (Applied) is
considered a capital transaction and has the consequences referred to in the
following paragraph. The accounting is identical to that of a reverse merger but
there are no material assets, liabilities or operations included with those of
Duck beginning June 15, 1999.
Historical operations of the Company include only those operations of Duck.
Historical stockholders' equity and loss per share prior to the Merger have been
retroactively restated for the equivalent number of shares received in the
merger after giving effect to the difference in par value of Duck's common stock
($.001 par value) and Applied's Common Stock (no par value). Duck common stock
outstanding prior to the Merger has been converted, as of December 31, 1998, to
an equivalent number of shares of On2.com Inc. that were issued to Duck
stockholders as a consequence of the Merger. Common stock acquired by Duck prior
to the merger from an officer and stockholder, pursuant to the Separation and
Release Agreement, was converted to equivalent On2.com Inc. common shares at
December 31, 1998.
Coincident with the Merger, the Company issued 2,000,000 preferred
stock purchase units (the "Units") pursuant to Rule 506 under the
Securities Act of 1933, as amended, for an aggregate purchase price of
$15,000,000 in a private offering.
Each Unit consists of one share of no par value, Series A Convertible Preferred
Stock and a warrant to purchase 1.114404 shares of Common Stock of the Company
at an exercise price of $3.14 per share. Each share of Series A Preferred Stock
is non-voting and may be converted at the holder's option, at any time, into one
share of Common Stock of the Company. The conversion rate will be adjusted for
stock splits, stock dividends and similar events.
The Series A Convertible Preferred Stock includes a liquidation preference. In
the event of any liquidation, dissolution or winding up of the Company, either
voluntary or involuntary, the holders of shares of Series A Convertible
Preferred Stock are entitled to receive an amount per share equal to the
original purchase price of $7.50. The current total liquidation preference is
$15,000,000.
-11-
<PAGE>
Prior to the Merger, The Travelers Insurance Company ("Travelers"), a subsidiary
of Citigroup Inc., held approximately 27% of Duck's voting equity securities on
a fully diluted basis. In connection with the offering of the Units, Travelers
purchased from the Company 400,000 Units for an aggregate purchase price of
$3,000,000. In addition, prior to the Merger, Travelers purchased 1,600,000
shares of Common Stock of the Company from existing stockholders in privately
negotiated transactions. Following consummation of the Merger and after giving
effect to the foregoing purchases, Travelers holds approximately 20.4% of the
outstanding Common Stock of the Company and 20.4% of the total outstanding
voting stock of the Company. Prior to the Merger, Jack L. Rivkin, Executive Vice
President of Citigroup Investments, Inc., was a member of the board of directors
of Duck. Pursuant to the terms of the Merger agreement, Mr. Rivkin was appointed
to serve on the board of directors of the Company.
Costs of $385,887 related to the issuance of the Series A Convertible Preferred
Stock were paid at the closing.
NOTE 4 METAVISUAL CREATIONS LIMITED ACQUISITION
On September 27, 1999 the Company acquired the assets of MetaVisual Creations
Limited ("MetaVisual"), a foreign private issuer organized and incorporated
under the Small Companies Act of the United Kingdom, for a purchase price of
$2,518,572. The purchase price consisted of $400,000 cash, a $350,000 note and
169,444 shares of the Company's common stock valued at $1,768,572 based on the
closing price of the Company's common stock on the American Stock Exchange on
the acquisition date.
The purpose of the acquisition was to obtain video signal
compression/decompression technology ("codec") developed by MetaVisual's
majority shareholder and only employee.
Prior to the acquisition, MetaVisual generated limited revenue from development
contracts and licensing an earlier version of the technology. In any period,
this revenue was received from a single customer. After the acquisition, these
development and licensing activities have been discontinued. On2.com Inc. is
using the core technology acquired as part of its software architecture platform
for distribution of video signals over the World Wide Web.
MetaVisual had no corporate facilities, distribution systems or sales force.
On2.com did not acquire any customer base or trade names as part of the
acquisition.
The historical results of operations, cash flows and financial condition of
MetaVisual were not material to On2.com and have no relationship to On2.com's
future use of the technology.
-12-
<PAGE>
The purchase price was allocated to tangible assets and the identifiable
intangible asset, based on their fair values, as follows:
<TABLE>
<CAPTION>
<S> <C>
Purchase Price: $ 2,518,572
==============
Cash acquired: $ 9,232
Fixed assets (primarily computer equipment): 5,989
Less: accounts payable assumed (5,936)
Intangible asset - software technology acquired: 2,509,287
---------------
$ 2,518,572
==============
</TABLE>
The acquired technology is being amortized over a period of 4 years, on the
straight line method. The amortization period was determined by estimating the
useful life of the acquired technology after assessing the effects of
obsolescence, development of superior technology, competition and similar
economic factors. Rapid changes can often occur in the development of this
technology and the Company intends to replace inferior technology as it becomes
determined as such. Given this history of rapid change, codec technology can
have a relatively short useful life. Therefore, the recoverability of the
intangible asset's value will be addressed on an ongoing basis.
NOTE 5 FISCAL YEAR END
The Company's fiscal year end is December 31. The fiscal year end of Duck was
September 30. After the Merger the Company will continue to report on its
December 31 fiscal year-end schedule. Under SEC reporting rules, this results in
the requirement for a "transition report" to reconcile Duck's audited twelve
months results to the December 31 year-end. The report including audited
financial statements for the three months transition period ended December 31,
1998 was filed with the SEC on Form 10-KSB on September 28, 1999 and amended on
October 21, 1999.
NOTE 6 CONTINGENCY
The Company was a defendant in a lawsuit regarding an alleged breach of contract
that sought damages in the millions of dollars. The Company denied the
substantive allegations and contested the case vigorously. In September 1998,
the court ruled in the Company's favor on most issues and awarded the plaintiff
$60,000, plus interest. Accordingly, prior to the period covered by this report,
the Company accrued and paid $88,976 relating to this matter. However, the
plaintiff has appealed the ruling. An unfavorable result on appeal could have a
material adverse effect on the Company's results of operations, cash flows and
financial condition. See Item 1, "Legal Proceedings" in Part II of this filing.
-13-
<PAGE>
NOTE 7 STOCK OPTIONS
Effective May 25, 1999, the Company adopted its 1999 Stock Option Plan (the
"Plan") and reserved for issuance thereunder 4,000,000 shares of the Company's
Common Stock. The options may be granted to employees, consultants, advisors and
other persons providing goods or services and may be granted at not less than
the fair market value of the Common Stock at the date of grant. Cancelled
options are available for future grant. The number of options granted, the
option price, the term of the option and the vesting periods are determined by
the board of directors.
As of the Merger date, all outstanding options to purchase Duck common stock
were converted into options to purchase Common Stock of the Company. Duck
employee stock options to purchase an aggregate of 1,802,000 shares of Duck
common stock were converted into options to purchase 1,602,580 shares of the
Company's Common Stock. The number of options and exercise price for
converted options were determined according to the same formula that was used
to convert issued and outstanding Duck Common Stock in connection with the
Merger. Options were converted as follows:
(i) 557,613 shares of Company Common Stock at an exercise price of $.88
per share
(ii) 570,952 shares of Company Common Stock at an exercise price of $1.12
per share
(iii) 474,014 shares of Company Common Stock at an exercise price of $2.25
per share
In addition, in conjunction with the Merger, the Company granted 455,000
options to new employees at an exercise price of $1.50 per share
(representing fair market value at the time of the grants).
At September 30, 1999 options to purchase 2,380,247 shares had been granted.
The outstanding options vest over a period of 3 to 36 months. At September
30, 1999, 829,048 options were vested.
The Company measures compensation cost for employee stock options under
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees." Compensation expense is recognized only if the market price of the
underlying stock exceeds the exercise price of stock options on the date of
grant.
NOTE 8 WARRANTS
As of the Merger, all outstanding warrants to purchase Duck common stock were
converted into warrants to purchase Common Stock of the Company. Warrants to
purchase an aggregate of 2,552,974 shares of Duck common stock at an exercise
price of $3.917 and one warrant to purchase 175,000 shares of Duck common stock
at an exercise price of $2.79 were, after giving effect to certain anti-dilutive
provisions, converted into warrants to purchase an aggregate of 3,343,211 shares
of the Company's Common Stock at an exercise price of $3.14.
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<PAGE>
At September 30, 1999, the Company has reserved 5,572,019 shares of its Common
Stock for issuance upon exercise of outstanding warrants.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This document contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. These statements relate to future events or our future financial
performance. In some cases, you can identify forward-looking statements by
terminology such as "may," "will," "should," "expect," "plan," "anticipate,"
"believe," "estimate," "predict," "potential" or "continue," the negative of
such terms, or other comparable terminology. These statements are only
predictions. Actual events or results may differ materially. Although we believe
that the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance
or achievements. In this regard, the business and operations of the Company are
subject to substantial risks which increase the uncertainty inherent in the
forward-looking statements contained in this Form 10-QSB. In evaluating the
Company's business, you should give careful consideration to the information set
forth below under the caption "Risk Factors That May Affect Future Operating
Results," in addition to the other information set forth herein.
The inclusion of the forward-looking statements should not be regarded as a
representation by the Company, or any other person, that such forward-looking
statements will be achieved. Although we believe the that the expectations
reflected in the forward-looking statements are reasonable, we cannot guarantee
future results, levels of activity, performance, or achievements. We undertake
no duty to update any of the forward-looking statements, whether as a result of
new information, future events or otherwise. In light of the foregoing, readers
are cautioned not to place undue reliance on the forward-looking statements
contained in this report.
OVERVIEW
On2.com Inc. is developing a network of Web channels for broadband-enabled
consumers combining the classic elements of television with the interactivity of
the Internet. Leveraging proprietary video streaming and compression technology,
the On2.com network will initially provide a range of video-centric information
and entertainment in such areas as movies, games, music and travel. The Company
plans to launch its initial Web channel, On2Movies, by the end of 1999.
Additional Web channels will follow in 2000.
Founded in 1992, the Company developed and marketed video
compression/decompression software technology ("codecs") that enabled
developers of computer video games, video games for dedicated video game
consoles and multi-media presentations on computers to convert an analog
video signal to a digital video signal, and to compress the signal for
storage and playback on the required device. The Company also developed its
own proprietary video streaming technology, enabling delivery of high quality
video signals over high bandwidth networks.
-15-
<PAGE>
Additionally, the Company developed technology allowing for real-time
capture, compression and storage of digital video signals.
Historically, substantially all of the Company's revenue was derived from a few
large technology licensing agreements whereby the Company received
non-refundable advances against future royalties based on sales by the licensee,
or outright license of certain elements of the Company's technology. With video
codecs rapidly becoming a low-priced or even free commodity, the Company
determined that reliance on its historical business model placed serious
constraints on potential growth. The Company's current software technology
enables distribution of television quality video signals to broadband Internet
users (those with Internet connections faster than 250 kilobits per second).
Perceiving consumer broadband Internet usage to be the next high growth Internet
market, the Company elected to exploit its technology's commercial possibilities
by creating a unique, broadband-focused, video-enhanced, advertiser and
e-commerce supported Web destination, rather than to rely solely on its existing
technology licensing model. Management recognized that directing the Company's
efforts to build the On2.com network would have a negative short-term impact on
revenue, but believed it was warranted by the potential long-term opportunity.
In view of the rapidly evolving nature of its business and its limited operating
history, the Company has little experience forecasting its revenues. Therefore,
the Company believes that period-to-period comparisons of financial results are
not necessarily meaningful and should not be relied upon as an indication of
future performance. To date, the Company has incurred substantial costs to
create technology and services. The Company will continue to incur costs to
develop content, introduce and enhance services, build brand awareness and grow
the business. The Company may also incur significant additional costs and
expenses related to content creation, technology, marketing or acquisitions of
businesses and technologies to respond to changes in this rapidly changing
industry. These costs may not correspond with any meaningful increases in
revenues in the near term.
THE MERGER
On June 15, 1999, Applied Capital Acquisition Corp., a Delaware corporation, a
wholly-owned subsidiary of Applied Capital Funding, Inc., a Colorado
corporation, merged (the "Merger") with and into The Duck Corporation, a
Delaware corporation ("Duck"). In connection with the Merger, the Company issued
15 million shares of its Common Stock to the shareholders of Duck's issued and
outstanding shares of common stock in exchange for 100% of the issued and
outstanding common stock of Duck. After the Merger, former Duck stockholders
owned approximately 65% of the issued and outstanding Common Stock of the
Company. The Merger has been accounted for as a reverse merger in which Duck is
the accounting acquirer. The historical records of Duck became the historical
records of the Company.
Following the Merger, the business conducted by the Company is the business
conducted by Duck prior to the Merger. In conjunction with the Merger, the
Company changed its name to "On2.com Inc." Additionally, on June 30, 1999, the
Company listed its shares on the American
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Stock Exchange under the symbol, "ONT." Prior to that time its shares were
traded on the Over the Counter Bulletin Board operated by the National
Association of Securities Dealers, Inc.
METAVISUAL CREATIONS LIMITED ACQUISITION
On September 27, 1999 the Company acquired the assets of MetaVisual Creations
Limited, a foreign private issuer organized and incorporated under the Small
Companies Act of the United Kingdom, for a purchase price of $2,518,572. The
purchase price consisted of $400,000 cash, a $350,000 note and 169,444 shares of
the Company's common stock valued at $1,768,572 based on the closing price of
the Company's shares on the American Stock Exchange on the acquisition date. The
purpose of the acquisition was to obtain software technology developed by
MetaVisual's majority shareholder and only employee, relating to
compression/decompression ("codec") of video signals. This technology will
assist us in implementing our strategic operating plan for distribution of
television-quality video signals to broadband Internet users Our alternatives
were to develop the technology internally, or purchase it through the
acquisition. After considering the time and resources that would be required to
develop similar technology internally, along with the risks and costs of
unsuccessful attempts and related delays, we decided to pursue the acquisition.
Prior to the acquisition, MetaVisual generated limited revenue from development
contracts and licensing an earlier version of the technology to a single
customer. After the acquisition, this has been discontinued. On2.com is using
the core technology acquired as part of its software architecture platform for
distribution of video signals over the World Wide Web. The historic operations
of the developer have no relationship to On2.com's future use of the technology.
The historical results of operations, cash flows and financial condition of
MetaVisual were not material to On2.com. The purchase price was primarily
allocated to the identifiable intangible asset associated with the codec
technology acquired (see Note 4 to the financial statements).
RESULTS OF OPERATIONS
Nine Months Ended September 30, 1999 Compared To Nine Months Ended
September 30, 1998
Revenue
Net revenues of $23,543 and $882,998 for the nine months ended September 30,
1999 and 1998 respectively, were derived primarily from the sale and/or
licensing of the Company's TrueMotion-Registration Trademark- technology. For
the nine months ended September 30, 1998, approximately 70% of the Company's
revenue was derived from one customer, Sega Enterprises, Ltd. and its
subidiaries ("Sega"). 16% of revenue was earned from royalties paid pursuant
to license agreements with Sega, and 54% of revenue was a non-refundable
advance from Sega against future royalties. Future royalty payments from Sega
are dependent on Sega recouping its advances to the Company. There can be no
assurance that Sega will use the Company's
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technology in developing content for its systems, nor is it possible to
predict when, if ever, Sega will recoup the advances already paid. Two
additional customers accounted for 11% and 8% respectively of the Company's
revenue. The balance of revenue was sales of individual licenses to content
developers.
During the nine months ended September 30, 1999, the Company devoted
substantially all its efforts to building the On2.com network, developing the
technology to operate the site, attracting the investment to fund its efforts
and hiring the required staff.
Future revenue will be derived from the On2.com network and the licensing of the
associated technology to other companies. The Company's business model is based
on deriving revenue from advertising and sponsorship agreements with major
product and brand advertisers on the On2.com network, from the sales of goods
and services to users and from sales commissions from the sale of goods and
services on behalf of other companies. In addition, the Company expects to
generate revenue from the licensing of the Company's technology to other
companies, and providing consulting services to these licensees and other
services, including hosting video for others on the Company's server network.
The Company plans to introduce its first Web channel, On2Movies, by the end of
1999.
Operating expenses
The Company's operating expenses consist of research and development, sales and
marketing, and general and administrative expenses. Operating expenses of
$5,074,494 for the nine months ended September 30, 1999 increased $1,671,473 or
49% from the same period in 1998.
Research and development expenses consist primarily of salaries and related
expenses for personnel and fees to outside contractors and consultants. Research
and development expenses for the nine months ended September 30, 1999 of
$1,876,900 increased approximately $920,008 or 96% from the same period in 1998,
reflecting the additional costs incurred in developing new technology.
Research and development expenses to date have been focused on continuing
development of technology to deliver television quality video signals to
broadband Internet users, and the construction of the On2.com network. For the
nine months ended September 30, 1999, substantially all of the Company's
research and development effort was directed to these activities. For the nine
months ended September 30, 1998, the Company's efforts were primarily directed
to completing development of technology licensed to Sega and continuing
development of technology to be used on the On2.com network. The Company expects
research and development costs to continue to increase in coming periods as
development efforts continue on the On2.com network Web channels and on the
technology to operate the business.
Sales and marketing expenses for the nine months ended September 30, 1999 of
$1,058,521 increased $249,168 or 31% from the year earlier period as the Company
hired additional staff engaged in marketing activities related to its efforts to
develop the On2.com network. The sales and marketing expenses consist primarily
of salaries related to developing business arrangements
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with prospective partners, creating awareness of new services and costs of
communicating to the industry and potential users.
General and administrative expenses consist primarily of salaries and related
personnel expenses, rent, accounting and legal services and general operating
expenses. For the nine months ended September 30, 1999, general and
administrative expenses of $2,139,073 increased $502,297 or 31% from the year
earlier period, reflecting additional staff, space, legal and general expenses
related to developing its business.
As the Company expands its business in 1999 and beyond, its research and
development, sales and marketing, and general and administrative expenses will
continue to increase. Research and development expenses will increase as the
company adds engineers and outside consultants to its technology and Web
development teams. Sales and marketing expenses will increase as the Company
adds additional business development, sales and marketing personnel to build
business relationships, sell advertising time and build brand awareness. In
addition, advertising and public relations expenses will increase as the Company
invests to grow its business. General and administrative expenses will increase
as the Company continues to build its management infrastructure, including
additional personnel, office space and internal information systems.
From January 1999 to September 30, 1999 the Company hired 31 additional
employees in order to accelerate the growth of the business. The Company expects
the number of employees to continue to increase. At September 30, 1999 the
Company had 51 full-time employees.
Other income (expense)
Other income (primarily interest income) of $164,306 for the nine months ended
September 30, 1999 increased $119,003 or 263% from $45,753 for the same period
last year primarily due to increased investments from the sale of Series A
Convertible Preferred Stock on June 15, 1999 (see Notes 2 and 3 to Financial
Statements included herein). For the nine months ended September 30, 1998, other
income (expense) includes legal settlement expense in the amount of $86,748.
Provision for income taxes
The provision for income taxes consists of foreign taxes withheld at source upon
payment of royalties by a foreign licensee. The decrease in taxes from $50,060
for the nine months ended September, 1998 to $2,119 for the nine months ended
September 30, 1999, a decrease of $47,941 or 96%, reflects the decrease in
revenue received from Sega noted under the caption "Revenue" above.
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<PAGE>
Three Months Ended September 30, 1999 and 1998
Revenue
Net revenues for the three months ended September 30, 1999 of $6,911
decreased $156,345 or 96% from the same period in 1998 for the same reasons
disclosed above in the discussion of results for the nine months ended
September 30, 1999.
For the three months ended September 30, 1999, substantially all of our revenue
was derived from sales of individual licenses to content developers. During this
period, the Company devoted substantially all its efforts to building the
On2.com network, developing the technology to operate the site, attracting the
investment to fund its efforts and hiring the required staff. For the three
months ended September 30, 1998 approximately 59% of revenue was received from
one customer.
Operating expenses
Operating expenses of $2,870,743 for the three months ended September 30, 1999
increased $1,687,988 or 143% from the same period in 1998.
Research and development expenses, which consist primarily of salaries and
related expenses for personnel and fees to outside contractors and consultants,
of $1,197,578 for the three months ended September 30, 1999, increased
approximately $856,988 or 252% from $340,590 for the three months ended
September 30, 1998, reflecting the additional costs incurred in developing new
technology and the On2 network. During the quarter, the Company hired 13
additional employees involved in the development of its technology and web site.
At September 30, 1999 the Company employed 32 people in the development of its
technology and web site versus 13 at September 30, 1998. For the three months
ended September 30, 1999 total salaries related to research and development were
approximately $598,000 versus $260,000 for the same period in 1998. For the
three months ended September 30, 1999 the Company incurred costs of
approximately $422,000 for outside contractors versus approximately $48,000 for
the same period in 1998.
Sales and marketing expenses for the three months ended September 30, 1999 of
$579,756 increased $316,593 or 120% from $263,163 for the year earlier period as
the Company accelerated its marketing and business development efforts related
to the On2 network. The sales and marketing expenses consist primarily of
personnel costs related to developing business arrangements with prospective
partners, creating awareness of its new services and costs of communicating to
the industry and potential users and is expected to increase as we build the
business.
General and administrative expenses, which consist primarily of salaries and
related personnel expenses, rent, accounting and legal services and general
operating expenses, were $1,093,409 for the three months ended September 30,
1999, an increase of $514,407 or 89% from $579,002 for the same period in the
prior year. The increase is due primarily to the costs additional staff, of
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<PAGE>
recruiting additional staff, additional office space, legal and accounting fees.
These costs are expected to continue to increase as we grow the Company.
Other income (expense)
Other income, primarily interest income, of $129,452 for the three months ended
September 30, 1999 increased $182,991 from net expense of $53,539 for the same
period last year, which included a charge for a legal settlement of 86,748. The
increase is primarily due to increased cash balances from the sale of Series A
Convertible Preferred Shares on June 15, 1999 and the absence of the legal
settlement in the quarter last year. See notes 2 and 3 to Financial Statements
included herein.
Provision for income taxes
The provision for income taxes consisting primarily of foreign taxes withheld at
source were 0 in the three months ended September 30, 1999 and $$158 for the
same period last year, reflecting the decrease in revenue received from the
major foreign customer noted under the caption "Revenue" above for the nine
months ended September 30, 1999.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1999, the Company had cash and cash equivalents of $10,040,584
compared to $1,227,706 at December 31, 1998.
The Company's capital requirements have been, and will continue to be,
significant. Since inception, On2.com Inc. has financed its operations primarily
through sales of stock. Through September 30, 1999, On2.com Inc. had raised
approximately $22,000,000 from the sale of preferred stock and Common Stock. At
September 30, 1999, the principal source of liquidity for the Company was
$10,040,584 of cash and cash equivalents.
For the nine months ended September 30, 1999 and 1998, the Company used
significant cash in operating activities. Cash used in operating activities for
the nine months ended September 30, 1999 and 1998 was $4,567,835 and $2,566,806
respectively. Cash used in operating activities in the first nine months of 1999
compared to 1998 increased primarily as a result of increased costs to build the
business and reduced revenue to offset expenses.
Cash used by investing activities for the nine months ended September 30,1999 of
$1,226,498 was used for the acquisition of the assets of MetaVisual Creations
Limited (see Note 4 to Financial Statements), the acquisition of fixed assets
and the initial payment for the acquisition of a trade name. Cash used in
investing activities for the nine months ended September 30, 1998 of $203,918
primarily was used for the acquisition of fixed assets. The Company expects to
expend significant amounts for equipment, software and fixtures over the next 24
months.
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<PAGE>
Cash provided by financing activities was $14,607,211 for the nine months ended
September 30, 1999 and represents the proceeds received from the preferred stock
offering and proceeds from the sale of common stock to an employee pursuant to
the exercise of an incentive stock option, less payments on a note to a
stockholder and increased loans to a stockholder. For the nine months ended
September 30, 1998, cash from financing activities consisted of a reduction in a
loan to a stockholder and proceeds from the sale of common stock to an employee
pursuant to the exercise of an incentive stock option.
The market for distribution of interactive broadband video content is highly
competitive and requires significant expenditures to procure the personnel,
technology and business partners necessary to establish a leadership position in
the industry. The Company will continue to build the On2.com network, develop
its technology and hire additional employees. Operating costs are expected to
continue to increase during this period of development. The Company anticipates
it will require additional funding within the next 12 months to adequately
finance its growth and development objectives. The Company has several financing
alternatives available to it that it is currently pursuing. There can be no
assurance that the Company will be able to acquire such additional funding on
terms acceptable to the Company, or at all. In such event, the Company could
reduce the pace of development until such funds were available on terms
acceptable to the Company.
IMPACT OF YEAR 2000
Many computer systems and software products are coded to accept only two-digit
entries in date code fields. Beginning the year 2000, these date code fields
will need to distinguish 21st century dates from 20th century dates. As a
result, computer systems and/or software used by many companies may need to be
upgraded to comply with "Year 2000" requirements. Although the Company believes
that its network is Year 2000 compliant, it may discover coding errors or other
defects in the future.
The Company provides technology and applications to others and also relies on
third party off-the-shelf operating systems and applications from others in the
operation of its business. The Company has substantially completed the
assessment of its internal and external (third-party) computer systems and
products. At this point, the Company is not aware of any Year 2000 problems
relating to systems that it operates or that are operated by third parties that
would have a material effect on the Company's business, results of operations or
financial condition, without taking into account efforts to avoid such problems.
To date, the Company has not incurred any significant costs related to the
assessment of, and compliance with, Year 2000 issues. The Company does not
currently expect that the Year 2000 issue will materially adversely affect its
financial condition or results of operations.
The Company also relies on third party software and hardware systems to operate
its internal network, some or all of which could contain coding which is not
Year 2000 compliant. These systems include server software used to operate the
network servers, software controlled routers, switches and other components of
the data network, firewall, security, monitoring and back-up software used by
the Company. In each case, the Company employs widely available software
applications from leading third-party vendors and such vendors have provided all
required
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<PAGE>
upgrades or modifications. However, if any third party software suppliers
provided faulty Year 2000 compliant versions of the software, the Company's
operations, including its internal network, could be disrupted.
Year 2000 compliance problems also could undermine the general infrastructure
necessary to support the Company's broadband Internet operations. For instance,
the Company depends on third-party Internet service providers ("ISPs") and
hosting centers to provide connections to the Internet and to customers. Any
interruption of service from ISPs or hosting centers could result in a temporary
interruption of our services. The Company has attempted to address this risk by
obtaining the same service capacity from multiple ISPs. Any interruption in the
security, access, monitoring or power systems at the ISPs or hosting centers
could result in an interruption of services. Moreover, it is difficult to
predict what effects Year 2000 compliance problems will have on the integrity
and stability of the Internet. If businesses and consumers are not able to
reliably access the Internet, the demand for the Company's services could be
disrupted, resulting in an adverse impact to the Company's business, financial
condition and results of operations.
RISK FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
POTENTIAL FLUCTUATIONS OF QUARTERLY OPERATING RESULTS; UNPREDICTABILITY OF
FUTURE REVENUE; EXPECTED FUTURE LOSSES
Our quarterly operating results may fluctuate significantly in the future as a
result of a variety of factors, many of which are outside our control. These
factors include:
- the early stage of our development
- the level of Web usage;
- the level of broadband usage;
- traffic levels on our Web channels;
- the demand for advertising on our Web channels as well as on the Web in
general;
- our ability to enter into or renew key agreements;
- fees we may pay for distribution or content agreements or other costs we
incur as we expand our operations;
- competitive factors;
- technical difficulties or system downtime affecting the Web generally or
the operation of our Web channels; or
- economic conditions specific to the Web as well as general economic
conditions.
AS A RESULT OF THESE FACTORS, OUR OPERATING RESULTS FOR ANY PARTICULAR QUARTER
MAY NOT BE INDICATIVE OF FUTURE OPERATING RESULTS.
We expect that over time our revenues will come from a mix of advertising,
e-commerce relationships, licensing of our technology, consulting services and
hosting of video on our network of servers. Initially, our quarterly revenues
and operating results are likely to be particularly affected by the level of our
advertising revenue in each quarter. Our cost structure could also change
dramatically as we increase the number of Web channels in operation. Any
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shortfall in our revenues would have a direct impact on our operating results
for a particular quarter and these fluctuations could affect the market price of
our Common Stock in a manner unrelated to our long-term operating performance.
We have incurred operating losses in each fiscal quarter in the last twelve
months. We expect operating losses and negative cash flows to continue for the
foreseeable future as we intend to increase significantly our operating expenses
to grow our business.
DEPENDENCE ON GROWTH IN BROADBAND INTERNET USAGE
Our market is new and rapidly evolving. Our business would be adversely
affected if broadband Web usage does not continue to grow. Broadband Web
usage may be inhibited for a number of reasons, such as 1) inadequate network
infrastructure; 2) security concerns; 3) inconsistent quality of service; and
4) availability of cost-effective, high-speed service.
NEED TO ESTABLISH AND MAINTAIN STRATEGIC RELATIONSHIPS WITH CONTENT PROVIDERS
To build our broadband network, we must:
- - present sufficiently attractive content to draw broadband users to our
network on a regular basis,
- - keep broadband users at our site long enough on each visit to expose them
to targeted advertising and e-commerce opportunities, and
- - develop relationships with content owners to obtain sufficient and current
content.
There is no assurance that we will be successful in obtaining the content needed
to build and maintain an attractive destination Web site.
BROADBAND NETWORK COSTS AND MANAGEMENT
The services we are building require high-bandwidth access to the Internet and
delivery of data volumes that may be higher than most service providers are
commonly delivering. While we are confident we can overcome the technical and
business hurdles inherent in establishing a network of this nature, there can be
no assurance we will be successful in obtaining the bandwidth required to
provide our services, or obtain it at economical cost.
TECHNOLOGY DEVELOPMENT
Launch of the On2.com network requires completion of our proprietary technology.
While management is confident the technology development can be completed on
schedule, there can be no assurance we will be able to complete our development
in time or acquire alternate technology adequate to launch our services without
delays.
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PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company's quarterly report on Form 10-QSB filed on August 23, 1999
contains a description of a legal proceeding involving the Company. There
have been no material developments in that case during the period covered by
this report.
ITEM 2. CHANGES IN SECURITIES
The description of the preferred stock units issued on June 15, 1999,
included in the footnotes to the financial statements of Item 1 of Part I,
to this Form 10-QSB, is incorporated by reference, pursuant to the
provisions of this Form.
The preferred stock units were sold to accredited investors, without
registration, pursuant to Rule 506 under the Securities Act of 1933.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(b) REPORTS ON FORM 8-K. State whether any reports on Form 8-K were filed
during the quarter for which this report is filed, listing the items
reported, any financial statements filed and the dates of such reports.
The Company filed a Current Report on Form 8-K on June 22, 1999 in connection
with the Company's merger with The Duck Corporation. Items reported included
details of the merger transaction, audited financial statements for the
fiscal year ended September 30, 1998 of The Duck Corporation, the acquired
company, unaudited interim financial statements of The Duck Corporation for
the quarter ended March 31, 1999, and proforma conformed Statements of
Operations of the combined companies for the years ended December 31, 1998
and 1997. This filing was amended on August 13, 1999.
The Company filed a Current Report on Form 8-K on August 2, 1999 in
connection with its change in auditors. This filing was amended on August 9,
1999.
The Company filed a Current Report on Form 8-K on October 12, 1999 in
connection with its acquisition of MetaVisual Creations Limited.
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
On2.com Inc.
----------------------------------------
(Registrant)
November 15, 1999 /s/ Barry M. Shereck
- -------------------- ----------------------------------------
(Date) (Signature)
Barry M. Shereck
Chief Financial Officer
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