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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the year ended December 31, 1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 000-26925
INTERWORLD CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware 13-3818716
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
395 Hudson Street, 6th Floor
New York, NY 10014-3669
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(Address of principal executive offices) (Zip code)
(212) 301-2500
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section
12(b) of the Act:
None None
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(Title of each class) (Name of each Exchange
on which registered)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value NASDAQ
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(Title of each class) (Name of each Exchange
on which registered)
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 the disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
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As of February 15, 2000, the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $798,858,970. As of February
15, 2000, there were 27,387,740 shares of the Registrant's Common Stock issued
and outstanding.
Documents Incorporated by Reference
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Portions of the Proxy Statements for the Registrant's Special Meeting of
Shareholders of InterWorld Corporation (for the adoption of the InterWorld
Corporation 2000 Equity Incentive Plan, which was affirmed), held on January 25,
2000 and for the 2000 Annual Meeting of Stockholders to be filed within 120 days
after the end of the Registrant's fiscal year, are incorporated by reference in
Parts I, II and III.
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INTERWORLD CORPORATION
TABLE OF CONTENTS
Page
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PART I
Item 1. Business 3
Item 2. Properties 11
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 11
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 14
Item 6. Selected Consolidated Financial Data 15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
Item 7(a). Quantitative and Qualitative Disclosure About
Market Risk 26
Item 8. Consolidated Financial Statements and Supplementary
Data 27
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 43
PART III
Item 10. Directors and Executive Officers of the Registrant 43
Item 11. Executive Compensation 43
Item 12. Security Ownership of Certain Beneficial Owners and
Management 43
Item 13. Certain Relationships and Related Transactions 43
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 43
SIGNATURES 44
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PART I
Item 1. Business
OVERVIEW
InterWorld Corporation ("InterWorld") provides Internet commerce software
solutions that enable businesses to sell goods and services over the Internet to
other businesses and consumers. InterWorld's products, which are called
enterprise commerce software, enable companies to build their online businesses
and integrate them with their existing business practices and enterprise
systems. Commerce Exchange is InterWorld's family of enterprise commerce
software, consisting of its Commerce Exchange platform, applications, tools and
business adapters. Commerce Exchange enables manufacturing, distribution and
retail companies to manage their business-to-business, or B2B, and
business-to-consumer, or B2C, selling and support processes, including sales,
order management, fulfillment and customer service. InterWorld's solution is
designed to enable businesses to:
- increase revenues by extending their sales efforts to include an
Internet-based distribution channel;
- reduce operating expenses by streamlining and automating their selling and
support processes;
- enhance customer loyalty by offering a personalized, online buying
experience; and
- create online processes based on existing and evolving business practices
and integrate information from existing systems with their online systems.
InterWorld's solution can be expanded to meet the demand of large organizations
with complex selling processes, and can manage a large number of simultaneous
users, high transaction volumes and complex databases. It can also be fully
integrated into every phase of selling and support processes, from order entry
to customer service. Commerce Exchange enables an organization to integrate its
online business with its existing business systems, including manufacturing,
financial, distribution and customer systems and business practices. The
functionality and ease of implementing, maintaining and upgrading InterWorld's
products address what it believes is a growing desire by businesses to maximize
return on investment by more efficiently using their existing information
systems.
INDUSTRY BACKGROUND
Commerce conducted over the Internet has grown dramatically in recent years.
According to a report by International Data Corporation, worldwide Internet
commerce spending is expected to increase from $50 billion in 1998 to $1.3
trillion in 2003. Businesses are embracing Internet commerce because it enables
them to both increase revenues and reduce operating expenses by:
- establishing a new distribution channel for products and services;
- enhancing customer relationships by offering increased convenience and
personalization; and
- automating sales, support and customer service processes.
Because of its convenience and widespread accessibility, the Internet provides
businesses greater access to both new and existing customers. Both businesses
and customers now demand the option of purchasing goods and services online in
addition to traditional means including stores and catalogs. Customer demand for
online services has compelled companies to respond both to traditional
competitors that have extended their sales efforts to the Internet and to new
competitors that only offer products and services online.
However, despite the large market potential for online commerce, nine out of ten
online shoppers experienced problems during the 1999 holiday season, according
to an Andersen Consulting study. Such mishandling of customer issues can lead to
costly customer defections to competitors. Still, 73% of online shoppers ranked
Internet shopping higher than brick and mortar stores and catalogs in terms of
overall satisfaction.
While a number of software products have been introduced to focus on the
purchase and procurement of goods and services within a business, InterWorld
believes that many of these solutions fail to address the specific needs of
suppliers. Buyer-focused approaches improve the efficiency of supplier
management, but typically lack the functionality to enable a supplier
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to automatically update prices and check the availability of products or the
status of an order. Consequently, suppliers typically still rely upon costly
processes to interact with their business customers.
In order to extend their operations to the Internet, businesses must implement
reliable information technology solutions to run mission-critical online
business applications without which the enterprise would not be able to operate
an online business. These solutions must meet rigorous performance requirements
and typically operate 24 hours per day, seven days per week. They must be easy
to use, while accessing a wide and complex array of databases and computing
platforms. During the initial years of Internet commerce, businesses typically
addressed these requirements by either building a custom solution or purchasing
a low-end system with only basic Internet commerce functionality.
InterWorld believes that few businesses have developed custom Internet commerce
solutions on a timely and cost-effective basis. Internet technology and business
requirements are evolving so rapidly that it is difficult for internal
information technology staffs to keep pace. Custom solutions are very expensive
to develop, install and maintain. Low-end systems, while less expensive, often
cannot support high transaction volumes, address complex and changing business
requirements or operate in conjunction with other systems. For these reasons,
InterWorld believes that many of these solutions have failed to deliver the full
benefits of Internet commerce. This shortcoming has led to market demand for
enterprise commerce solutions that provide:
- Complete functionality for automating sales, order management, fulfillment
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and customer service;
- Scalability to manage increasing numbers of users, high transaction
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volumes and complex databases;
- Flexibility to meet the varying and evolving needs of businesses and to
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permit rapid and cost-effective implementation, maintenance and upgrades;
and
- Interoperability to work in conjunction with new Internet technologies and
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with an organization's existing business systems.
INTERWORLD'S SOLUTION
InterWorld's Commerce Exchange family of products may be configured in a variety
of ways to meet both B2B and B2C specific requirements and to include:
Process Application Server, which provides an open, flexible foundation to
operate a sophisticated Internet business;
- WebBroker, which enables an enterprise commerce system to support
increasing demand;
- Enterprise Broker, which enables real-time integration with existing
computer systems; and
- Commerce Exchange applications, including Product Merchandising, Order
Management and Account Management.
The Commerce Exchange family of products also includes tools and business
adapters. InterWorld's tools include:
- development tools to add functions to the system;
- administration tools to manage the system; and
- reporting tools to measure the results of the system.
InterWorld's business adapters enable integration of the Commerce Exchange
solution with existing business systems within the organization, including
manufacturing, financial, distribution and customer systems, or across the
Internet with third parties.
InterWorld provides a range of services to enable clients to implement and use
the Commerce Exchange family of products. InterWorld's professional services
include project management, implementation and integration, education and
training and client support services. As of January 1, 2000, InterWorld had 60
employees dedicated to providing professional services as well as training for
its customers and systems integration partners.
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STRATEGY
InterWorld's objective is to become the leading provider of B2B and B2C Internet
software solutions that enable businesses to sell goods and services over the
Internet. InterWorld's strategy is to:
Target Manufacturing, Distribution and Retail Companies. InterWorld will
- -------------------------------------------------------
continue to focus on providing Internet software solutions to manufacturing,
distribution and retail companies with an expanding focus on B2B transactions.
InterWorld believes that these industries are characterized by the need to
provide new methods to improve sales functionality, product merchandising, order
management, payment processing, fulfillment, account management and customer
service. In order to increase brand awareness, InterWorld intends to expand its
marketing initiatives in its target markets.
Expand Relationships with Implementation Partners. Systems integrators and
- -------------------------------------------------
consulting firms have a strong influence on their clients' software purchasing
decisions, and InterWorld believes that many of these firms are seeking
interactive enterprise commerce solutions that enable them to satisfy their
clients' needs more rapidly than they can through custom development. InterWorld
plans to expand its existing relationships and seek new relationships to
increase its capacity both to sell and implement its products. InterWorld has
developed relationships with large, international systems integrators and
consulting firms, such as Andersen Consulting, Arthur Andersen, Cambridge
Technology Partners, KPMG Peat Marwick, USWeb/CKS and Whittman-Hart. InterWorld
believes that expanding on its existing relationships and creating new
relationships with selected partners will enable InterWorld to sell additional
products to its existing customer base and gain new customers more rapidly.
Continue Technology Leadership. InterWorld intends to continue to devote
- ------------------------------
substantial resources to the development of new and innovative products and to
continue to incorporate emerging Web technologies. InterWorld believes that the
increasing demands placed on enterprise commerce solutions will require an
application architecture that is adaptable, scalable and interoperable. To meet
these demands, InterWorld has developed an enterprise commerce software
architecture that operates on different computing platforms, integrates with a
customer's existing business practices and systems and is adaptable and scalable
to meet evolving business needs. InterWorld intends to continue to provide
innovative products based on this architecture.
Leverage and Expand Strategic Alliances. To accelerate the adoption of its
- ---------------------------------------
Internet commerce software solution, InterWorld intends to continue to develop
cooperative alliances with leading Internet technology vendors and e-commerce
marketplaces. InterWorld believes these relationships will provide opportunities
to gain customers in markets where its products and services may be used. In
1999, InterWorld established a strategic global marketing and technology
alliance with Ariba. Additionally, InterWorld has established a strategic
alliance with Interwoven to enhance the content management of its solution,
Active Software to facilitate the integration of its solution with existing
systems and Linkshare to improve its online merchandising tools. InterWorld
believes that these alliances will enable it to incorporate additional
capabilities into its solution and facilitate more rapid deployment of its
products.
Expand InterWorld's Suite of Enterprise Commerce Solutions. InterWorld plans to
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expand its suite of products and services that enables B2B and B2C organizations
to market and sell goods and services over the Internet. Many companies are
seeking comprehensive enterprise commerce solutions that meet a broad range of
needs. InterWorld intends to continue to develop additional applications and
features based on its existing Web-based architecture. InterWorld recently
launched version 3.0 of Commerce Exchange, which includes new merchandising
techniques and faster and more convenient order management. During the first
quarter of 2000, InterWorld plans to release version 3.1 of Commerce Exchange,
which will include additional functionality in the areas of online advanced
pricing and promotions, coupons, gift certificates, address book and customer
service, as well as performance enhancements and support for updated versions of
databases. InterWorld also believes that the licensing and the acquisition of
technologies from third parties can increase the speed-to-market of enhancements
to its product. InterWorld intends to seek appropriate arrangements with third
parties to improve its product offering.
COMMERCE EXCHANGE PRODUCTS AND SERVICES
InterWorld's Commerce Exchange solution is based on its Process-Centric
computing. The Process-Centric approach enables its clients to create software
functionality modeled on their existing business practices, while providing the
flexibility to implement new Internet business processes. Process-Centric
computing enables a client's online processes to take into account
characteristics of the client's selling environment and its customers'
preferences. This approach provides each user with a personalized buying
experience. By building on process components, Process-Centric computing also
enables businesses to make changes quickly to their systems to adapt to changing
business conditions and to reduce the long-term maintenance costs associated
with supporting highly customized applications.
InterWorld's solution is designed to provide businesses with enterprise commerce
application software that is functionally comprehensive, expandable to meet the
requirements of global operations and flexible enough to apply online processes
to
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existing and evolving business practices. InterWorld's solution operates in
conjunction with a wide variety of Internet technologies and existing legacy
systems. The functionality and the ease of implementing, maintaining and
upgrading InterWorld's products enable businesses to deploy more effectively
their information systems.
Commerce Exchange Platform
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Process Application Server. InterWorld's Process Application Server is a
- --------------------------
software platform upon which clients can build and deploy sophisticated
enterprise commerce solutions. The platform is designed to allow these solutions
to integrate with a wide variety of hardware, operating systems, databases, Web
servers and other business applications. The Process Application Server comes
bundled with InterWorld's Product Merchandising, Order Management and Account
Management applications.
Developed in the C++ and Java programming languages, the platform provides open
application programming interfaces to enable custom application components to be
developed to extend a client's enterprise commerce system. The platform supports
industry standard Web browsers, including Microsoft Explorer and Netscape
Navigator, and operates on multiple operating systems, including Microsoft
Windows NT, Sun Solaris-Unix and HP-UX. Data access is handled via native
drivers that support industry-standard databases, including Microsoft SQL
Server, Oracle and Sybase. Microsoft IIS, Netscape Enterprise and Apache Web
servers are supported. The architecture is designed to facilitate migration to
other database and server platforms as client demand or market conditions
require.
The Process Application Server incorporates both generally accepted and advanced
Internet security standards, such as Secure Socket Layer and X.509. The security
components enable secure communication across the Internet among businesses,
customers, trading partners and the information systems they use to manage their
businesses. These secure trading environments can be established without
affecting a client's existing security scheme or firewall. Commerce Exchange
supports three main layers of security: object-level, file system and database
security.
WebBroker. InterWorld's WebBroker product can be used by clients to manage the
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computing workload of their enterprise commerce system by intelligently
distributing Internet requests across multiple application servers. WebBroker
also enables multimedia content to be displayed quickly and efficiently. By
optimizing server utilization and minimizing wait times, WebBroker provides a
lower total cost of ownership and a higher level of client service. WebBroker
also increases fault tolerance and reliability for Internet commerce sites by
eliminating reliance on a single server.
Enterprise Broker. InterWorld's Enterprise Broker product enables clients to
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synchronize their Internet sales channel with their other business channels and
enterprise systems including stores, customer service representatives and call
centers, inventory, fulfillment and distribution. Enterprise Broker provides a
centralized messaging system enabling clients to send and receive data from
software applications located anywhere within their enterprise or across an
extranet. Systems integrators and developers can use pre-built templates
included with Enterprise Broker to create and customize their own business
messages, easing the burden of integration.
Commerce Exchange Applications
- ------------------------------
InterWorld's applications work in conjunction with its Process Application
Server to provide functionality for sales, order management, fulfillment and
customer service. InterWorld's applications encompass over 300 components that
represent business functions and 50 process templates that represent what
InterWorld believes are the best practices in the domain of enterprise commerce.
The adaptable nature of InterWorld's applications enables clients to deploy them
in their standard form or to customize or extend them easily to meet their
individual requirements.
InterWorld's Commerce Exchange applications include:
- Product Merchandising: InterWorld's Product Merchandising application
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enables a client to create an interactive catalog that provides an online
buying and selling experience. The application enables personalized product
views, as well as dynamic product pricing, discounting and promotions. It
also supports advanced up-selling, cross-selling, product comparison and
product alternative features. Self-service functions include advanced
search capabilities, resulting in an experience directed at buyers'
specific needs. Selling organizations can personalize their offerings for
different buyers, products and locations. Easy-to-use administrative
interfaces facilitate the management of the addition, modification and
usage of catalog product information.
- Order Management: InterWorld's Order Management application is designed to
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support the personalized processing of orders within Commerce Exchange,
including order entry and order processing functions. Order entry involves
the
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capture of information required to place an order. Order processing
involves payment, shipping, inventory and taxation processes once an order
has been entered. The Order Management application supports multiple
payment and shipping methods.
- Account Management: InterWorld's Account Management application provides
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user management, account tracking and management and online customer
self-service capabilities. The application enables the client to identify
and administer the users of the system and to assign those users to
specific groups. This enables the system functionality to be personalized
to different users and groups. The account tracking and management
functionality enables managers to set credit limits and control and monitor
the status of accounts. The application also provides online buyers with
the ability to manage their customer profile online, as well as review
shipment status and order and payment history. The easy-to-use graphical
interfaces also enable customers to cancel orders as well as generate
returns.
- Customer Service Application: InterWorld's Customer Service application
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enables Customer Service Representatives ("CSRs") to assist customers who
call into a call center. Using the web-based application, a CSR can sign on
to a web site on behalf of a customer, place orders on his/her behalf,
process returns, credit accounts, issue gift certificates and view customer
order history. This application enables InterWorld's clients to synchronize
their web site business channel with their traditional channels.
Tools
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InterWorld provides a number of software development, system administration and
reporting tools that enable clients with limited programming experience to
customize and manage InterWorld's software and monitor and analyze activity on
their enterprise commerce system. In addition, experienced engineers can utilize
InterWorld's tools to develop advanced, customized applications for enterprise
commerce as well as other markets based on InterWorld's software.
- Business Station: InterWorld's Business Station enables business managers
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to administer the deployment of their business strategies across all
aspects of their Enterprise Commerce site. Using Business Station, managers
can create personalized catalogs, administer products, pricing and
promotions and manage users, groups and accounts. Business Station gives
clients the flexibility to respond to changing customer demands and market
conditions.
- Dev Station: InterWorld's Dev Station enables systems integrators and
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developers to develop and deploy large-scale Enterprise Commerce sites. Dev
Station's visual process modeling tool enables clients to model online
processes to reflect their own business strategies. Dev Station's
development tools allow clients to rapidly build end-to-end Commerce
Exchange sites with little or no programming. If they choose, clients can
also customize their site using Java, COM or InterWorld's C++ SDK.
- Design Station: InterWorld's Design Station enables web site designers to
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create and maintain content-intensive Enterprise Commerce sites using its
repository of templates. Web site designers can also create their own
templates that reflect their own business strategies. Design Station
enables rapid content development, debugging and version control and
supports popular third-party content management and versioning tools.
- Control Station: InterWorld's Control Station provides clients with the
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ability to view, monitor and manage their Enterprise Commerce environment
through a single "dashboard." Using Control Station, systems administrators
can identify system bottlenecks and rapidly reconfigure system resources.
Control Station provides system administrators with a centralized
environment in which to manage distributed Commerce Exchange sites and
optimize site performance.
- Business Analyzer: InterWorld's Business Analyzer enables graphical
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analysis and manipulation of large amounts of data, such as products sold,
total sales, shipping analysis, site traffic, purchasing results and order
fulfillment. Clients can customize and easily build a wide variety of
reports to analyze captured data. Additionally, Business Analyzer can be
deployed over a corporate intranet, extranet or the Internet with links to
relational databases and existing data warehouses.
Business Adapters
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InterWorld's Business Adapters are designed to facilitate the seamless
integration of external business functions, allowing them to be managed within
the Commerce Exchange process framework. This technology allows existing
enterprise resource planning, supply chain management, client asset management
and fulfillment business functions to be extended to the Internet. InterWorld's
Business Adapters are available for products in the following areas:
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- enterprise resource planning;
- supply chain management;
- customer asset management;
- sales tax calculation;
- shipping and fulfillment;
- payment processing;
- digital product clearinghouse;
- messaging interfaces;
- electronic data interchange, or EDI, translators; and
- zip codes.
Services
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Professional services include consulting and system integration services that
are associated with the planning, installation and customization of InterWorld's
products. InterWorld also works closely with third-party systems integrators
whom they train to provide these services. InterWorld has developed an
implementation methodology that is designed to facilitate the rapid and
cost-effective implementation of InterWorld's products. InterWorld's
implementation methodology is based on the following phases:
- sales cycle analysis;
- project planning and management;
- technology analysis and preparation;
- business design;
- site design;
- site development;
- site testing;
- conversion; and
- post-implementation review.
Technical education and training services for InterWorld clients and certified
systems integration partners are available both on-site and off-site and cover
the implementation, management, utilization and customization of InterWorld's
products. Product training workshops are designed to give clients, marketing
partners and systems integrators the knowledge that they need to configure,
support and administer their Internet commerce systems. Product training can
also be customized to meet a client's specific business needs.
InterWorld's client support is available 24 hours a day, seven days a week.
Technical support services include online support via the Internet, toll-free
telephone technical support and direct support from a client satisfaction team.
InterWorld has developed client service programs, including one-on-one workshops
and client satisfaction teams consisting of a sales representative, a technical
account manager and, in many cases, an executive sponsor. Client satisfaction is
tracked on an account-by-account basis and reported to InterWorld's executive
management team. To maximize client satisfaction, InterWorld has created a
client support and satisfaction division. The division's mission is to provide a
high level of client support and service, account management and advisory
services.
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The InterWorld Advantage
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The advantages of InterWorld's solution are:
Comprehensive Functionality - InterWorld's solution provides a
comprehensive set of applications for the efficient management of online
selling, including sales, order management, fulfillment and customer
service. Consumers and business buyers are provided with personalized
buying experiences. Selling organizations are provided with a workplace
capable of the remote administration of online storefronts, user accounts,
products, prices and content.
- State-of-the-Art Technology Foundation - InterWorld's technology is
--------------------------------------
specifically designed to support the deployment of mission-critical online
business applications without which the enterprise would not be able to
operate an online business. InterWorld's solution scales to meet the
demands of large organizations that have complex transactions, a large
number of simultaneous users, high transaction volumes and complex
databases. The Commerce Exchange software architecture is designed to
operate on many different computing platforms and to provide a reliable,
secure and flexible environment.
- Process-Centric Computing Approach - The flexibility of InterWorld's
----------------------------------
Process-Centric computing approach allows the Commerce Exchange solution to
adapt to dynamically changing business and technology conditions. This
approach enables clients to create online processes based on existing and
evolving business practices and to integrate information from existing
systems with their online system. Process-Centric computing facilitates the
deployment of enterprise commerce systems.
- Interoperability - InterWorld's products are designed to work in
----------------
conjunction with new Internet technologies and with a client's existing
business systems and third-party technologies. InterWorld's component
architecture supports a variety of different programming models including
Java, C++, COM and others. InterWorld provides standard adapters that
enable its products to operate with software systems such as SAP,
PeopleSoft and Siebel.
SALES AND MARKETING
InterWorld markets its products and services primarily through its direct sales
organization and implementation partners. As of January 1, 2000, InterWorld's
sales force consisted of 50 employees located in 11 domestic locations (Atlanta,
Georgia; Bellevue, Washington; Boston, Massachusetts; Chicago, Illinois; Dallas,
Texas; Los Angeles, California; New York, New York; Phoenix, Arizona; Vienna,
Virginia; San Francisco, California; and Tampa, Florida) and six international
locations (Dusseldorf, London, Melbourne, Paris, Sydney and Tokyo). InterWorld
intends to continue to add sales personnel worldwide. InterWorld supplements its
direct sales efforts with strategic marketing alliances, including relationships
with Active Software, Agency.com, Ariba, Cambridge Technology Partners, Cisco
Systems, Electronic Data Systems, KPMG, Net Perceptions, Sun MicroSystems, Trans
Cosmos USA, USWeb/CKS and Whittman-Hart, all of which have referred clients to
InterWorld. The contractual arrangements provide for the partner to receive
training from InterWorld and then market or provide sales leads for InterWorld's
products through their direct sales force. InterWorld also has active technology
and distribution partnerships with Cisco Systems, CyberSource, Federal Express,
and Interwoven. The contractual arrangements provide for the joint development
of compatible products or extensions of InterWorld's products and for joint
marketing and sales effects.
InterWorld deploys sales teams consisting of both sales and technical
professionals to create proposals, presentations and demonstrations that address
the requirements of the client. The current sales cycle for InterWorld's
products typically ranges from two to six months.
InterWorld's marketing programs are targeted at sales, marketing and information
technology executives of large, multi-national organizations. Marketing
activities include branding, such as advertising and public relations campaigns;
lead generation and management; direct mail campaigns; field and channel
marketing, including joint marketing with strategic partners; product marketing
and development of technology alliances.
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CLIENTS
InterWorld believes that those organizations that are most likely to use its
products sell a large number of products through diverse distribution channels
with a large number of trading partners. Accordingly, InterWorld markets its
products and services to large domestic and international manufacturers,
distributors, retailers and direct marketers. As of January 1, 2000, InterWorld
had over 80 clients.
Set forth below is a representative list of InterWorld's current clients. Each
client listed accounted for an aggregate of at least $400,000 of revenues in
1999.
Ashford.com Guess? Online Retail Partners
Belkin Components Insight Enterprises Oven Digital
Bolt Media Internet Shopping Network Q Strategies
Boo.com Lids Shopnow.com
Brooks Brothers Lucy.com Simon Property Group
Buena Vista Internet Mammoth Golf Management Sony
Group (Disney)
EB2B Commerce MSC Industrial Direct TAKKT
GATX Logistics NIKE U.S.A. Floral Products
GTE Communication Systems Oki Data America
COMPETITION
There is intense competition in the Internet commerce software industry.
InterWorld expects competition to intensify in the future. InterWorld competes
against the in-house development efforts of companies engaging in Internet
commerce, as well as other software application vendors and developers.
InterWorld's current competitors include AOL (Netscape Communications), Art
Technology Group, BroadVision, IBM, Intershop Communications, Microsoft, Open
Market and Oracle. InterWorld expects other companies to enter its market.
InterWorld competes principally on the basis of product performance, client
service and price. Its market is still evolving, and InterWorld may not be able
to compete successfully with current or future competitors, and competitive
pressures faced by InterWorld have a material adverse effect on its business,
financial condition and results of operations. See "Risk Factors -- InterWorld
faces intense competition, which could adversely affect InterWorld's sales and
profitability."
PRODUCT DEVELOPMENT
As of January 1, 2000, InterWorld's development organization was comprised of
110 developers, development managers, quality assurance personnel and testing
engineers. Its expenses for research and development were $17.3 million, $9.6
million and $6.9 million in 1999, 1998 and 1997, respectively.
InterWorld employs a collaborative product planning and development process. The
planning process involves gathering product requirements from its sales and
marketing organization, as well as from clients and strategic partners. Clients
and partners have input into future product direction and functionality.
InterWorld follows a rigorous quality assurance and testing process. This
process is designed to identify software defects through the entire development
cycle. Several test types are employed, and defect reports and metrics are
tracked to facilitate resolution, including system testing and performance
benchmarking.
PROPRIETARY RIGHTS
InterWorld relies on intellectual property laws, employee and third-party
non-disclosure agreements and other methods to protect its proprietary rights.
InterWorld currently has one U.S. patent granted to it relating to its product
architecture and technology. While InterWorld believes that its patent is valid,
it may be challenged, invalidated or circumvented. Moreover, the rights granted
under any patent issued to InterWorld or under licensing agreements may not
provide competitive advantages to it. InterWorld believes that, due to the rapid
pace of technological innovation for Internet commerce solutions, its ability to
establish and maintain a position of technology leadership in the industry is
dependent more on the skills of its development personnel than upon the legal
protections afforded its existing technology.
InterWorld's agreements with employees, consultants and others who participate
in the development of its software may be breached, and it may not have adequate
remedies for any breach. In addition, InterWorld's trade secrets may otherwise
become known to or independently developed by competitors. Furthermore,
InterWorld's efforts to protect its proprietary
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technology may fail to prevent the development and design by others of products
or technology similar to or competitive with those developed by InterWorld.
The computer software market is characterized by frequent and substantial
intellectual property litigation. Intellectual property litigation is complex
and expensive, and the outcome of such litigation is difficult to predict.
BroadVision and Open Market, two of InterWorld's competitors, have been issued
U.S. patents on some aspects of their electronic commerce products. InterWorld
received a letter from counsel to Open Market concerning the potential
applicability of the Open Market patents to InterWorld products. The letter
stated that Open Market was prepared to meet with InterWorld to resolve issues
concerning the applicability of its patents and to discuss terms of an
appropriate license agreement. InterWorld responded to the Open Market inquiry,
informing Open Market that based on its review of the Open Market patents and
the analysis and advice of its patent counsel, InterWorld believes that its
products do not infringe the patents awarded to Open Market. InterWorld has not
received any further inquiries or correspondence from Open Market since
InterWorld's September 1998 response and have had no inquiries or discussions
with BroadVision with regard to patent matters. InterWorld has also received a
letter from TechSearch stating its belief that InterWorld's Web site induces the
infringement by others of one or more claims of a U.S. patent issued to
TechSearch. InterWorld's patent counsel has advised InterWorld that this patent
is invalid in view of prior art. Although InterWorld does not believe that it is
infringing their patent rights, any of these companies may claim that InterWorld
is doing so. If a claim of patent infringement by these or other companies was
made against InterWorld, it would likely incur significant expenses in defending
against the claim, which could adversely affect its financial condition and
results of operations. In addition, if a claim of infringement is made against
InterWorld and it is not successful in defending against the claim, InterWorld
could be liable for substantial damages and prevented from using any infringing
technology. InterWorld may also be required to make royalty payments, which
could be substantial, to the holder of the patent rights. These events could
have a material adverse effect on InterWorld's business, financial condition,
results of operations and prospects for growth.
InterWorld's success will depend in part on its continued ability to obtain and
use licensed technology that is important to the performance of its products. An
inability to continue to procure or use such technology would likely have a
material adverse effect on InterWorld. In general, license terms range from one
to three years and, unless terminated upon notice by one of the parties,
generally renew for additional one year periods.
EMPLOYEES
As of January 1, 2000, InterWorld had a total of 280 employees. Of the total
employees, 110 were in development and product management, 50 in sales, 15 in
marketing, 5 in alliances, 60 in worldwide services and 40 in administration.
None of InterWorld's employees are represented by a labor union. InterWorld has
not experienced any work stoppages and considers its relations with its
employees to be good.
Item 2. Properties
InterWorld's principal offices are located in New York, New York and consist of
approximately 98,000 square feet of leased office space. The lease for the New
York offices expires in December 2015. InterWorld believes that its existing
facilities are adequate to meet its needs for the foreseeable future. InterWorld
currently subleases approximately 43% of its leased space. See Notes 12 and 13
of Notes to Consolidated Financial Statements. InterWorld intends to continue to
sublease this space until it requires the space for its operations. InterWorld
also rents office space in various cities in the United States and in other
countries for sales and field service and support activities.
Item 3. Legal Proceedings
InterWorld is not a party to any material legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders
Information required in Item 4 is incorporated by reference to InterWorld's
Proxy Statements for the Special Meeting of Shareholders of InterWorld
Corporation for the adoption of the InterWorld Corporation 2000 Equity Incentive
Plan, held on January 25, 2000. The ballot for the adoption of the InterWorld
2000 Equity Incentive Plan was as follows: 15,875,991 shares present; 15,421,640
votes for; 414,968 votes withheld; and 39,383 votes abstained.
11
<PAGE>
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth information regarding InterWorld's executive
officers and directors:
Name Age Position
---- --- --------
Michael J. Donahue 37 Chairman
Alan J. Andreini 53 Vice Chairman
Jeremy M. Davis 45 President and Chief Executive Officer
Peter Schwartz 56 Chief Financial Officer
Daniel Turano 51 Senior Vice President, Worldwide Field
Operations
Stephen Law 46 Senior Vice President, Engineering
Leon S. DeMaille 36 Senior Vice President, Marketing
Kevin Kohn 34 Senior Vice President, Alliances
Mark Berlingeri 43 Senior Vice President, Worldwide Services
Amy Aguilar-Brown 34 Vice President, Legal Affairs and Corporate
Secretary
Kenneth G. Langone 64 Director
Joseph C. Robinson 36 Director
Yves Sisteron 44 Director
Jack Slevin 63 Director
Russell West 56 Director
Michael J. Donahue. Mr. Donahue co-founded InterWorld in March 1995 and serves
- ------------------
as its Chairman. He served as Co-Chairman and Chief Technology Officer of
InterWorld from April 1997 until June 1998. He also served as President of
InterWorld from March 1995 until April 1997. Prior to founding InterWorld, from
1992 to 1995, Mr. Donahue was the sole proprietor of Donahue & Associates, Inc.,
an information technology consulting firm specializing in strategic planning and
systems reengineering.
Alan J. Andreini. Mr. Andreini joined InterWorld in April 1997 and serves as its
- ----------------
Vice Chairman. He served as President and Chief Executive Officer from June 1998
to January 2000. He served as President and Chief Operating Officer of
InterWorld from April 1997 to June 1998. Prior to joining InterWorld, Mr.
Andreini was Executive Vice President and a member of the Office of the
President of Comdisco. Mr. Andreini joined Comdisco in 1978, and was named
Senior Vice President in 1986 and Executive Vice President in 1994.
Jeremy M. Davis. Mr. Davis joined InterWorld in January 2000 and serves as its
- ---------------
President and Chief Executive Officer and as a director. Prior to joining
InterWorld, Mr. Davis was President and Chief Executive Officer of InConcert,
Inc. from January 1997 to December 1999. From November 1995 to December 1996,
he served as President and Chief Executive Officer of Business Matters, Inc.
From November 1993 to October 1995, Mr. Davis was President of Sales
Technologies, Inc., a Dun & Bradstreet, Inc. company.
Peter Schwartz. Mr. Schwartz joined InterWorld in October 1998 and serves as its
- --------------
Chief Financial Officer. Since July 1983 and prior to joining InterWorld, Mr.
Schwartz served in various financial positions with Computer Associates
International, Inc., most recently as Chief Financial Officer from April 1987 to
June 1998. From June 1977 to June 1983, Mr. Schwartz served in various financial
positions with Xerox Corporation. Mr. Schwartz also currently serves as a
director of General Semiconductor, Inc.
Daniel Turano. Mr. Turano joined InterWorld in October 1997 and serves as its
- -------------
Senior Vice President, Worldwide Field Operations. Prior to joining InterWorld,
Mr. Turano was Vice President, North American Field Operations for Scopus
Technology, Inc. from January 1997 to October 1997. From September 1995 to
December 1996, he served as Senior Vice President of Worldwide Field Operations
for Siebel Systems, Inc. From September 1991 to September 1995, Mr. Turano
served in various senior sales capacities at Oracle Corporation, including Group
Vice President of Eastern U.S. Sales.
Stephen Law. Mr. Law joined InterWorld in May 1998 and serves as its Senior Vice
- -----------
President, Engineering. Prior to joining InterWorld, Mr. Law was the Chief
Technology Officer of Global Financial Services at Perot Systems Corporation
from February 1997 to May 1998. Prior to joining Perot Systems, Mr. Law was the
Vice President of Global Derivatives Systems Development at Citibank Corporation
from December 1992 to February 1997.
Leon DeMaille. Mr. DeMaille joined InterWorld in January 2000 and serves as its
- -------------
Senior Vice President, Marketing. Prior to joining InterWorld, Mr. DeMaille was
Vice President of Marketing for Erisco Managed Care Technologies from September
12
<PAGE>
1997 to January 2000. From February 1988 to September 1997, he was the president
and Chief Executive Officer of Synergy Marketing Solutions, that provides
start-up consulting services to vertical information technology companies.
Kevin Kohn. Mr. Kohn joined InterWorld in December 1999 and serves as its Senior
- ----------
Vice President, Alliances. Prior to joining InterWorld, Mr. Kohn was Vice
President and General Manager of the Communications Practice for TIBCO Software,
Inc in November 1999. From March 1997 to October 1999, he was Vice President,
Marketing and New Business Development for InConcert, which was acquired by
TIBCO in October 1999. From November 1987 to February 1997, Mr. Kohn served in
various sales and marketing capacities for Xerox Corporation.
Mark Berlingeri. Mr. Berlingeri joined InterWorld in October 1998 and serves as
- ---------------
its Senior Vice President, Worldwide Professional Services. Prior to joining
InterWorld, Mr. Berlingeri was a Vice President for FlexiInternational Software,
Inc. from January 1997 to October 1998. From October 1992 to December 1996, he
was a Regional Vice President for Sybase, Inc.
Amy Aguilar-Brown. Ms. Aguilar-Brown joined InterWorld in September 1997 as Vice
- -----------------
President, Legal Affairs. Ms. Aguilar-Brown was also elected Secretary of
InterWorld in May 1998. Prior to joining InterWorld, Ms. Aguilar-Brown served as
Director of Field Operations and Legal Affairs for Sybase, Inc. from April 1994
to September 1997. From January 1992 to April 1994, she served as Director of
Operations for MicroDecisionware, Inc., which was acquired by Sybase, Inc.
Kenneth G. Langone. Mr. Langone has been a director of InterWorld since 1996.
- ------------------
Mr. Langone has been Chairman and President of Invemed Associates LLC, which he
founded, since 1974. He is a director of The Home Depot, Inc., General Electric
Company, Unifi, Inc., DBT Online, Inc. and Tricon Global Restaurants, Inc.
Joseph C. Robinson. Mr. Robinson has been a director of InterWorld since 1995.
- ------------------
Mr. Robinson co-founded InterWorld in March 1995 and served as its Executive
Vice President until May 1998. Since October 1998, Mr. Robinson has served as
the Chairman of UGO Networks. Prior to joining InterWorld, from 1989 to 1995,
Mr. Robinson was employed by Douglas, Elliman, Gibbons and Ives, a real estate
brokerage firm.
Yves Sisteron. Mr. Sisteron has been a director of InterWorld since 1996. Mr.
- -------------
Sisteron has been a Principal of Global Retail Partners, L.P., an investment
fund, since January 1996 and Manager of U.S. Investments at Carrefour S.A. since
1993. Mr. Sisteron serves as a director of P.F. Chang's China Bistro, Inc. and
Zany Brainy, Inc.
Jack Slevin. Mr. Slevin has been a director of InterWorld since 1997. From June
- -----------
1995 until his retirement in January 1999, Mr. Slevin was the Chairman and Chief
Executive Officer of Comdisco. From October 1994 to June 1995, Mr. Slevin was
Chief Operating Officer at Comdisco and from January 1993 to October 1994, he
was Executive Vice President of North American Sales at Comdisco. He became a
member of the Office of the President when it was created in 1992 and was a
member of Comdisco's board of directors from 1979 until January 1999. Mr. Slevin
is also currently a director of U.S. West, Inc. and Telehub Network Services
Corporation.
Russell West. Mr. West has been a director of InterWorld since 1996. Mr. West
- ------------
has been President of OneNetPlus.com, a provider of Internet technology
solutions, since May 1999. He was an Executive Vice President and Chief
Technology Officer for Comdisco, where he was employed from 1977 to May 1999.
All directors hold office until the next annual meeting of stockholders or until
their successors have been duly elected and qualified.
13
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
InterWorld's common stock has been quoted on The Nasdaq Stock Market's National
Market under the symbol INTW since its initial public offering on August 11,
1999. The following table presents, for the periods indicated, the high and low
sales prices per share of InterWorld's common stock as reported on The Nasdaq
National Market.
1999 High Low
---- ---- ---
Third Quarter (beginning August 11,1999) $43.125 $16.4375
Fourth Quarter $93.50 $35.00
2000 High Low
---- ---- ---
First Quarter (through February 15, 2000) $87.875 $55.875
On February 15, 2000, the last reported sale price of InterWorld's Common Stock
on the Nasdaq National Market was $56.8125. As of January 31, 2000, there were
362 shareholders of record of InterWorld's common stock
14
<PAGE>
Item 6. Selected Consolidated Financial Data
The selected consolidated financial data below as of December 31, 1999 and 1998
and for the years ended December 31, 1999, 1998 and 1997 have been derived from
InterWorld's consolidated financial statements included in this Form 10-K which
have been audited by PricewaterhouseCoopers LLP, independent accountants. The
selected consolidated financial data below as of December 31, 1997, 1996 and
1995 and for the year ended December 31, 1996 and the period from inception
(March 28, 1995) through December 31, 1995, have been derived from audited
consolidated financial statements that are not included in this Annual Report on
Form 10-K. The selected consolidated financial data set forth below should be
read in conjunction with, and is qualified in its entirety by, InterWorld's
consolidated Financial Statements, related notes and other financial information
included elsewhere in this Annual Report on Form 10-K.
<TABLE>
Year Ended December 31, (March 28, 1995)
----------------------- To December 31,
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(In Thousands, Except Per Share Data)
Statement of Operations Data:
<S> <C> <C> <C> <C> <C>
Revenues, net:
Product licenses $ 23,855 $ 9,754 $ 4,883 $ 779 $ 25
Services 16,692 4,834 3,073 1,241 331
Other 100 -- 2 408 3
-------- -------- -------- -------- --------
Total revenues, net 40,547 14,590 8,056 2,428 359
-------- -------- -------- -------- --------
Cost of revenues:
Product licenses 1,884 671 278 82 1
Services 18,215 6,052 6,744 1,735 130
Other -- -- 107 322 --
-------- -------- -------- -------- --------
Total cost of revenues 20,099 6,723 7,129 2,139 131
-------- -------- -------- -------- --------
Gross profit 20,448 7,867 927 289 228
Operating expenses:
Research and development 17,334 9,558 6,863 2,362 234
Sales and marketing 23,086 11,969 8,487 2,435 --
General and administrative 6,806 6,356 6,405 2,730 258
Noncash employee Compensation 3,633 1,615 752 71 --
-------- -------- -------- -------- --------
Total operating expenses 50,859 29,498 22,507 7,598 492
-------- -------- -------- -------- --------
Loss from operations (30,411) (21,631) (21,580) (7,309) (264)
Total other income (expense) 52 (431) (95) 112 --
Income taxes -- -- -- -- --
-------- -------- -------- -------- --------
Loss from continuing operations (30,359) (22,062) (21,675) (7,197) (264)
Discontinued operations:
Expenses from discontinued operations* -- -- (1,310) -- --
Provision for operating losses to date
of disposition* -- -- (627) -- --
-------- -------- -------- -------- --------
Net loss $(30,359) $(22,062) $(23,612) $ (7,197) $ (264)
======== ======== ======== ======== ========
Basic loss per share and diluted loss
per share $ (1.59) $ (1.60) $ (1.75) $ (0.53) $ (0.02)
======== ======== ======== ======== ========
Basic loss per share and diluted loss
per share from continuing operations $ (1.59) $ (1.60) $ (1.61) $ (0.53) $ (0.02)
======== ======== ======== ======== ========
</TABLE>
<TABLE>
As of December 31,
------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(In Thousands)
Balance Sheet Data:
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents $ 21,583 $ 858 $ 6,081 $ 6,111 $ 50
Working capital (deficit) 33,217 (635) 3,802 4,653 (286)
Total assets 55,301 14,119 17,431 8,865 175
Long Term Obligations -- 51,162 39,180 13,431 --
Total stockholders' equity (deficit) 39,278 (46,216) (28,795) (7,119) (189)
</TABLE>
- On March 30, 1998, InterWorld completed a spin-off distribution of a
subsidiary, UGO Networks, reducing InterWorld's majority ownership of UGO
Networks to a minority interest of approximately 18%. Since March 30, 1998,
InterWorld's
15
<PAGE>
minority interest in UGO Networks has decreased to approximately 5.5% due
to private equity financings by UGO Networks. UGO Networks is an online
entertainment information and game company that commenced operations in
1997. The spin-off was made in order to permit UGO Networks to build a
separate management team that would concentrate on creating an online
entertainment information and game company and to position UGO Networks to
seek private equity financing. UGO Networks has been presented as a
discontinued operation in InterWorld's consolidated statement of operations
for the year ended December 31, 1997. See Note 12 of Notes to Consolidated
Financial Statements.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
FORWARD-LOOKING STATEMENTS
This Form 10-K contains forward-looking statements within the meaning of Section
21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the
Securities Act of 1933, as amended. Forward-looking statements include, without
limitation, statements about the market opportunity for Internet commerce
software solutions, new product development, competition, expected expense
levels, seasonality and the adequacy of our available cash resources and other
statements contained in this prospectus that are not historical facts. When used
in this prospectus, the words "anticipate," "believe," "estimate," "expect,"
"may" and similar expressions are generally intended to identify forward-looking
statements, but are not the exclusive expressions of forward-looking statements.
Because forward-looking statements involve risks and uncertainties, there are
important factors that could cause actual results to differ materially from
those expressed or implied by these forward-looking statements, including but
not limited to:
- uncertainties relative to global economic conditions;
- our reliance on a single family of products for substantially all of our
sales;
- our need to attract significant new clients on an ongoing basis;
- lack of market acceptance of our products;
- the introduction by our competitors of new or competing technologies;
- delays in delivery of new products or features;
- our ability to continue to update business application products, including
upgrades to meet international requirements;
- our inability to enter into and maintain relationships with systems
integration companies;
- the strength of our distribution channels;
- the ability either internally or through third-party service providers to
support client implementation of our products;
- our inability to recover our costs in sales of our products and services;
- product defects;
- changes in our business strategies;
- as well as the other factors discussed in this Form 10-K and in other
documents filed by InterWorld with the SEC.
We do not intend to update these forward-looking statements.
OVERVIEW
We derive revenues primarily from licensing our Internet commerce software
products and providing related services and support to our clients. We
commercially introduced our first product in December 1995.
We generally price licenses of our platform and applications on a per server or
site basis. Standard per server license fees for the Windows NT solutions are
$150,000 and for Unix solutions are $250,000. The recommended production
configuration that supports redundancy, fault-tolerance and distributed load
balancing across multiple processors is generally available for a license fee of
approximately $300,000 to $500,000. Licenses for product configurations that
support additional servers and users are available. Additional applications,
tools, business adapters, professional services and maintenance services are
provided at an additional cost to the client. Site licenses are also available.
Site licenses typically require the client to pay additional fees based on the
client achieving specified electronic commerce revenues. Payment terms are
generally net 30 days.
Revenue from product licenses is recognized upon shipment to the client under an
executed software license agreement when no significant obligations or
contractual commitments remain and collection is probable. If acceptance by the
client is required, revenue is recognized upon client acceptance. License
revenue from resellers of our products is recognized upon shipment by the
reseller when collection is probable.
16
<PAGE>
Revenue from services is recognized as the services are rendered. Revenue from
services requiring significant modification or customization of our software
products is recognized on a percentage-of-completion basis. Revenue from
maintenance and client support services is recognized ratably over the term of
the agreement for such services. Our license agreements typically require the
client to purchase one year of maintenance and client support services.
Beginning in the fourth quarter of 1998, we increased our use of systems
integration companies for implementation of our products. As a result, the cost
of our service revenues has increased substantially to $18.2 million in 1999
from $6.1 million in 1998. We anticipate that our increased use of systems
integration companies will continue for the foreseeable future and, accordingly,
that our cost of services revenues will in all probability exceed historical
amounts. In addition, our service revenues may decrease as a percentage of our
aggregate revenues in future periods as a result of our increased use and
training of systems integration companies.
We have incurred significant research and development expenses to develop our
products. We charge all research and development costs incurred to establish the
technological feasibility of a product or product enhancement to research and
development expense as incurred. In addition, we have made substantial
investments in our infrastructure to support revenue growth. We intend to
increase our staffing in all functional areas as required to accommodate any
revenue growth.
The following table sets forth certain statement of operations data for the
periods indicated expressed as a percentage of total revenues:
<TABLE>
Year Ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
Revenues, net:
<S> <C> <C> <C>
Product licenses 59.0% 66.9% 60.7%
Services 41.0 33.1 38.1
Other -- -- 1.2
----- ----- -----
Total revenues, net 100.0% 100.0% 100.0%
----- ----- -----
Cost of revenues:
Product licenses 4.6 4.6 3.5
Services 45.0 41.5 83.7
Other -- -- 1.3
----- ----- -----
Total cost of revenues 49.6 46.1 88.5
----- ----- -----
Gross profit 50.4 53.9 11.5
----- ----- -----
Operating expenses:
Research and development 42.8 65.5 85.2
Sales and marketing 56.9 82.0 105.4
General and administrative 16.8 43.6 79.5
Noncash employee compensation 8.9 11.1 9.3
----- ----- -----
Total operating expenses 125.4 202.2 279.4
----- ----- -----
Loss from operations (75.0) (148.3) (267.9)
Net loss (75.0)% (151.2)% (293.1)%
===== ===== =====
</TABLE>
RESULTS OF OPERATIONS
Our operating results will generally depend on the volume and timing of our
product license sales, and to a lesser extent, services revenues and expenses,
all of which are difficult to predict. We plan to increase our operating
expenses to achieve revenue growth. If our revenues do not increase as
anticipated and our spending levels are not reduced accordingly, a significant
decline in quarterly operating results could occur. We expect to experience
fluctuations in quarterly operating results due to many factors, including:
- the size and timing of significant client agreements, which typically occur
near the end of our fiscal quarter, but, if delayed, may not occur until
the next quarter;
- the length of the sales cycle for our products;
- fluctuations in demand for our products;
- the introduction of new products by us or our competitors;
- changes in prices by us or our competition; and
- the timing and amount of expenditures by us.
17
<PAGE>
In addition, we believe, based on general software industry trends, that sales
of our products will typically be highest in the fourth quarter of the year and
lowest in the first quarter. As a result, period-to-period comparisons of our
results of operations may not be meaningful, and should not be relied on as an
indication of future performance.
FISCAL YEARS 1999 AND 1998
Total Revenues, Net.
Total revenues, net include fees from product licenses and services. Total
revenues, net increased 178%, or $26.0 million, in 1999 from $14.6 million in
1998. Product revenues increased to $23.9 million in 1999 from $9.8 million in
1998. This increase was largely the result of licensing more of our software
products at a higher average fee per client, to a larger client base. Service
revenues increased in 1999 to $16.7 million from $4.8 million in 1998 due to an
increase in the number of InterWorld professional services employees and
employment on a subcontracting basis of systems integration partners.
Cost of Revenues.
Cost of product license revenues consists of royalties payable to third parties
for software that is embedded in or bundled with our products, the costs of
product media, documentation and manufacturing costs. Cost of product license
revenues increased to 7.9% of product revenues in 1999 from 6.9% of product
revenues in 1998 due to the increased in third-party royalties and more
elaborate licensed product documentation and packaging.
Cost of services revenues consists primarily of costs related to employees and
consultants providing services and support. Cost of services revenues increased
to $18.2 million in 1999 from $6.1 million in 1998. Our increased use and
training of systems integration companies, which began in the fourth quarter of
1998, and the institution of implementation methodologies, have resulted in
shorter implementation cycles but increased our cost of service revenues. The
implementation methodologies involve providing our clients and systems
integration partners with a checklist that sets forth the steps, timing and
procedures to more effectively enable them to implement our Commerce Exchange
family of products. We expect that our use of systems integration companies will
continue and that these expenses will also increase significantly in future
periods.
Research and Development.
Research and development expenses consist of costs related to research and
development personnel, including salaries and related expenses and consulting
fees, and costs related to facilities and equipment used in research and
development. Research and development expenses increased to $17.3 million in
1999 from $9.6 million in 1998. These increases were principally due to the
addition of personnel to support the continuous improvements and additions to
our product. We expect to continue to incur significant research and development
expenses in future periods.
Sales and Marketing.
Sales and marketing expenses consist of salaries and related expenses for sales
and marketing personnel, sales commissions and other incentive compensation,
travel and entertainment expenses and the costs of marketing programs, including
trade shows, promotional materials and advertising. Sales and marketing expenses
increased to $23.1 million in 1999 from $12.0 million in 1998. These increases
were due primarily to the expansion of our sales and marketing organizations and
expanded marketing activities, including advertising designed to increase
awareness of our brand. We expect to continue to incur significant sales and
marketing expenses in future periods.
General and Administrative.
General and administrative expenses consist of salaries and related expenses for
administrative, finance and human resources personnel and related facilities and
equipment. General and administrative expenses increased to $6.8 million in 1999
from $6.4 million in 1998. This increase reflected the additional administrative
personnel and infrastructure necessary to manage and support our growth.
Noncash Employee Compensation.
Noncash employee compensation consists primarily of noncash charges for stock
options granted to employees at exercise prices deemed below the fair market
value of our common stock at the time of grant. The amount of the charge is
equal to the difference between the exercise price of the stock option and the
deemed fair market value of our common stock
18
<PAGE>
multiplied by the number of options granted. The charge is amortized over the
vesting period of the options (typically, five years). We recorded noncash
employee compensation of $3.6 million in 1999 and $1.6 million in 1998.
Total Other Income (Expense).
Other income (expense) consists primarily of interest income earned on cash,
cash equivalents and short-term investments, net of cash and noncash interest
expense for leased equipment. Other income for 1999 was $1.0 million, an
increase of approximately $0.7 million from $0.3 in 1998. This increase was
largely attributable to interest income earned on higher cash and short-term
investment balances resulting from the August 1999 initial public offering
proceeds. See Note 6 of Notes to Consolidated Financial Statements. Other
expense increased to $1.0 in 1999 from $0.7 in 1998. This increase was primarily
due to interest expenses associated with warrants issued in conjunction with our
secured loan agreement. See Note 9 of Notes to Consolidated Financial
Statements.
FISCAL YEARS 1998 AND 1997
Total Revenues, Net.
Total Revenues, net increased 80%, or $6.6 million, in 1998 from $8.0 million in
1997. Product revenues increased to $9.8 million in 1998 from $4.9 million in
1997. This increase was largely the result of licensing more of our software
products at a higher average fee per client, to a larger client base. Service
revenues increased to $4.8 million in fiscal year 1998 from $3.1 million in 1997
because we were providing professional services to an increasing number of
clients.
Cost of Revenues.
Cost of product license revenues increased to 6.9% of product revenues in 1998
from 5.7% of product revenues in 1997 principally due royalty fees associated
with the introduction of third party software. Cost of services revenues
decreased to $6.1 million in 1998 from $6.7 million in 1997. This decrease was
the result of a decrease in our use and training of systems integration
companies.
Research and Development.
Research and development expenses increased to $9.6 million in 1998 from $6.9
million in 1997. This increase was principally due to the addition of personnel
to support the design and development of our products.
Sales and Marketing.
Sales and marketing expenses increased 41% to $12.0 million in 1998 from $8.5
million in 1997. This increase was due primarily to the expansion of our sales
and marketing organizations and the costs associated with significantly
increased sales.
General and Administrative.
General and administrative expenses were $6.4 million in 1998 and 1997. This was
the result of limited infrastructure outlays in a constrained resource
environment.
Noncash Employee Compensation.
We recorded noncash employee compensation of $1.6 million in 1998 and $0.8
million in 1997, primarily as a result of an increase in the number of below
fair market value grants of stock options to employee and consultant.
Total Other Income (Expense).
Other income (expense) for 1998 was $(0.4) million, an increase of approximately
$0.3 million from $(0.1) in 1997. This increase was largely attributable to
increased interest costs associated with warrants issued in conjunction with our
equipment lease and secured loan agreement.
19
<PAGE>
INCOME TAXES
We have incurred losses since inception which have generated net operating loss
carryforwards of approximately $48.0 million at December 31, 1999 for federal
and state income tax purposes. These carryforwards are available to offset
future taxable income and expire in 2011 through 2019 for federal income tax
purposes. We also had research and development tax credit carryforwards in the
amount of $1.1 million at December 31, 1999, which expire in 2002 through 2019.
These losses and credits may be subject to limitations on utilization in future
years because of ownership changes that have occurred. We have historically
filed our corporate income tax returns utilizing a fiscal year end of March 31,
which we changed to December 31, effective December 31, 1998. See Note 11 of
Notes to Consolidated Financial Statements.
The net operating loss carryforwards and temporary differences between carrying
amounts of assets and liabilities for financial reporting and income tax
purposes result in a net deferred tax benefit of $31.3 million at December 31,
1999. Our operating plans anticipate taxable income in future periods; however,
such plans make significant assumptions which cannot be assured, including
market acceptance of our products by clients. Therefore, in consideration of our
accumulated losses and the uncertainty of our ability to utilize this deferred
tax benefit in the future, we have recorded a valuation allowance in the amount
of $31.3 million at December 31, 1999, to offset the deferred tax benefit
amount.
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth unaudited quarterly statement of operations data
for each of the eight quarters in the period ended December 31, 1999. The
quarterly data have been prepared on the same basis as the audited financial
statements appearing in this prospectus and, in our opinion, include all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation. The results of operations for any quarter are not necessarily
indicative of results for any future period.
<TABLE>
Results of Operations
---------------------------------------------------------------------------------------------
1999 Quarter Ended 1998 Quarter Ended
---------------------------------------------- ---------------------------------------------
Dec. 31, Sept. 30, June 30, March 31, Dec. 31, Sept. 30, June 30, March 31,
(in thousands)
Revenues, net:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Product licenses $ 8,164 $ 5,653 $ 5,652 $ 4,386 $ 4,362 $ 3,002 $ 844 $ 1,546
Services 6,557 4,906 2,614 2,615 1,657 1,361 950 866
Other -- -- -- -- 1 1 -- --
-------- -------- -------- -------- -------- -------- -------- --------
Total revenues, net 14,721 10,559 8,266 7,001 6,020 4,364 1,794 2,412
-------- -------- -------- -------- -------- -------- -------- --------
Cost of revenues:
Product licenses 796 537 343 208 360 122 117 72
Services 5,284 5,104 5,071 2,756 2,072 1,530 1,318 1,132
Other -- -- -- -- -- -- -- --
-------- -------- -------- -------- -------- -------- -------- --------
Total cost of revenues 6,080 5,641 5,414 2,964 2,432 1,652 1,435 1,204
-------- -------- -------- -------- -------- -------- -------- --------
Gross profit (loss) 8,641 4,918 2,852 4,037 3,588 2,712 359 1,208
Operating expenses:
Research and development 5,030 4,390 4,277 3,637 2,932 2,569 2,093 1,964
Sales and marketing 6,821 5,869 5,428 4,968 4,124 3,199 2,582 2,064
General and administrative 1,853 1,880 1,860 1,213 1,254 1,615 2,062 1,425
Noncash employee compensation 647 1,247 618 1,121 375 375 488 377
-------- -------- -------- -------- -------- -------- -------- --------
Total operating expenses 14,351 13,386 12,183 10,939 8,685 7,758 7,225 5,830
-------- -------- -------- -------- -------- -------- -------- --------
Loss from operations (5,710) (8,468) (9,331) (6,902) (5,097) (5,046) (6,866) (4,622)
Other income (expense):
Interest income 579 315 38 92 15 48 139 63
Interest expense (73) (310) (293) (296) (383) (98) (130) (85)
-------- -------- -------- -------- -------- -------- -------- --------
Total other income 506 5 (255) (204) (368) (50) 9 (22)
(expense)
Income taxes 45 (1) -- (44) -- -- -- --
-------- -------- -------- -------- -------- -------- -------- --------
Loss from continuing
operations $ (5,159) $ (8,464) $ (9,586) $ (7,150) $ (5,465) $ (5,096) $ (6,857) $ (4,644)
======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
20
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
From inception through our initial public offering in August 1999, we financed
our operations primarily through approximately $64.6 million in private sales of
mandatorily redeemable preferred stock, all of which automatically converted to
common stock upon consummation of our initial public offering on August 16,
1999. At December 31, 1999, we had cash and cash equivalents of $21.6 million,
short-term investments of $18.0 million and working capital of $33.2 million.
We have had significant negative cash flows from operating activities to date.
Net cash used in operating activities for fiscal years 1999 and 1998 were $15.9
million and $16.6 million, respectively. Net cash used in operating activities
in each of these periods was primarily the result of significant expenditures
for product development, sales and marketing and infrastructure expenses. Our
net accounts receivable increased $0.3 million, to $6.5 million at December 31,
1999 from $6.2 million at December 31, 1998. This increase was primarily
attributable to increased customer sales in the fourth quarter of 1999.
Net cash used in investing activities consists primarily of the purchase of
short-term investments, specifically three to six month government securities
and capital expenditures for computer equipment, purchased software, office
equipment, furniture, fixtures and leasehold improvements. Capital expenditures
for property and equipment for the year ended December 31, 1999 aggregated $4.4
million.
The increase in cash and cash equivalents and working capital at December 31,
1999 was largely the result of the receipt of proceeds from our initial public
offering in August 1999 in the amount of $47.1 million.
As of December 31, 1999, we also had commitments under noncancelable operating
leases of $57.7 million and under noncancelable capital leases of $1.0 million.
UGO Networks is obligated to pay to us $23.9 million of our $57.7 million
operating lease obligation pursuant to a sublease agreement. See Notes 12 and 13
of Notes to Consolidated Financial Statements.
Year 2000 Compliance
Our business operations were not adversely affected by any year 2000 issues.
Prior to the end of 1999, we took action intended to ensure that our products
and critical internal business systems were year 2000 compliant.
Our total cost of effecting year 2000 compliance was not expected to exceed $0.4
million, of which $0.3 million had been incurred through December 31, 1999.
These costs were expensed in the period incurred and were paid out of working
capital. However, we may incur significant costs if unanticipated year 2000
compliance problems arise. These unanticipated costs, or our failure to correct
any unanticipated year 2000 problems in a timely manner, could have a material
adverse effect on our business, financial condition, results of operations and
prospects for growth.
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), which establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. SFAS 133
requires an entity to recognize all derivatives as either assets or liabilities
in the statement of financial position and measure those instruments at fair
value. SFAS 133 is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. At December 31, 1999, InterWorld did not own any derivative
instruments and had not engaged in any hedging activities during the year ended
December 31, 1999. InterWorld does not expect to purchase derivative instruments
or enter into hedging activities in the foreseeable future.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
If any of the events described below actually occur, our business, financial
condition, or results of operations could be materially adversely affected.
We have a limited operating history, significant historical losses and we may
never be profitable.
We expect to incur losses for the foreseeable future and we may never achieve or
sustain profitability. We were incorporated in 1995 and have only a limited
operating history. Since inception, we have incurred substantial costs to
develop and market our products, and have incurred net losses. As of December
31, 1999, we had an accumulated deficit of $83.6 million. We expect
21
<PAGE>
that our operating expenses will increase substantially in the foreseeable
future as we continue to develop our products, increase our sales and marketing
efforts and expand our operations.
If our products are not widely accepted in the Internet commerce market, our
business, sales and profitability will suffer.
The market for our products is new and rapidly evolving. Consequently, the
demand for products in this market is uncertain. Our business, financial
condition, results of operations and prospects for growth will be materially
adversely affected if our products are not widely accepted in the Internet
commerce software market. The following factors highlight the uncertainty of
market acceptance of our products:
- the market is characterized by rapid technological changes and evolving
industry standards;
- there is intense competition in the Internet commerce software industry;
- products are relatively expensive and require a large capital commitment by
the client;
- the infrastructure necessary to support increased commerce on the Internet
may not develop;
- consumers and businesses may not adopt electronic commerce; and
- our clients may not be successful in using our products to conduct their
commercial operations online.
Our future growth and success depends on broader acceptance of the Internet as a
medium for commerce. The Internet may not become a viable commercial marketplace
because of consumer concerns regarding reliability, cost, ease of use and
quality of service. In addition, consumer concerns regarding the security and
privacy of Internet transactions could inhibit the acceptance of the Internet as
a commercial medium. We have incorporated into our Commerce Exchange family of
products encryption algorithms to protect sensitive data such as customer
passwords and credit card information. However, we cannot assure you that this
technology will not be breached. If the security measures used in Commerce
Exchange are compromised, our business could suffer.
The imposition of sales and other taxes in respect of products sold by our
clients over the internet could have a negative effect on electronic commerce
generally and, as a result, on demand for our products.
Recent federal legislation limits the imposition of state and local taxes on
Internet-related sales. In 1998, Congress passed the Internet Tax Freedom Act,
which places a three-year moratorium on state and local taxes on:
- Internet access, unless such tax was already imposed prior to October 1,
1998; and
- discriminatory taxes on electronic commerce.
There is a possibility that Congress may not renew this legislation in 2001. If
Congress chooses not to renew this legislation, state and local governments
would be free to impose taxes on electronically purchased goods. The imposition
of new sales or other taxes could materially adversely affect the growth of
electronic commerce generally and, as a result, the demand for our products.
We believe that, in accordance with current industry practice, most companies
that sell products over the Internet do not currently collect sales or other
taxes in respect of shipments of their products into states or foreign countries
in which they are not physically present. However, one or more states or foreign
countries may seek to impose sales or other tax collection obligations on
out-of-jurisdiction companies that engage in electronic commerce. A successful
assertion by one or more states or foreign countries that companies engaged in
electronic commerce should collect sales or other taxes on the sale of their
products over the Internet, even though not physically present in the state or
foreign country, could have an adverse effect on electronic commerce generally,
and, as a result, on demand for our products.
All of our revenues are derived from a single family of products, and our
business, sales and profitability and prospects for growth will suffer if our
product offerings are not commercially successful.
The Commerce Exchange family of products and related services have accounted for
substantially all of our revenues to date, and we expect these products and
related services to continue to account for most of our revenues for the
foreseeable future.
22
<PAGE>
If our current limited product offerings are not commercially successful, our
business, financial condition, results of operations and prospects for growth
will be materially adversely affected. We may not successfully develop or market
any enhanced or new products. Moreover, competition or technological change
could adversely affect the pricing of or demand for our products, which would
have a material adverse effect on our business, financial condition and results
of operations. In addition, our products are currently being used by only a
limited number of clients to conduct electronic commerce. From time to time,
some of our clients experience difficulty implementing our software or the
software does not meet our clients' expectations, and they may choose not to,
and in at least two cases have chosen not to, continue to use our software. As a
result of these problems, our reputation may be damaged, which could have a
material adverse effect on our business.
We face intense competition, which could adversely affect our sales and
profitability.
There is intense competition in the Internet commerce software industry, and we
expect competition to intensify in the future. Our business, financial
condition, results of operations and prospects for growth will be materially
adversely affected if we are not able to compete successfully. We compete
against the in-house development efforts of companies engaging in Internet
commerce, as well as other software application vendors and developers. Our
current competitors include AOL (Netscape Communications), Art Technology Group,
BroadVision, IBM, Intershop Communications, Microsoft, Open Market and Oracle.
We expect that additional competitors will enter our market with competing
products as the size and visibility of the market opportunity increase. Many of
our present and potential competitors have greater financial, technical,
marketing and other resources than we have. This may place us at a disadvantage
in responding to the offerings of our competitors, technological changes or
changes in client requirements. Also, we may be at a competitive disadvantage
because many of our competitors have greater name recognition, more extensive
client bases and a broader range of product offerings.
If our financial results do not meet expectations as a result of fluctuations in
our quarterly operating results, our stock price is likely to decline.
Our quarterly operating results will generally depend on the volume and timing
of sales of our products, which are difficult to predict. It is likely that in
some future quarter or quarters, our operating results will not meet the
expectations of analysts and investors. In that case, the price of our common
stock is likely to decline.
We expect to experience fluctuations in our quarterly operating results due to
many factors, including:
- the size and timing of significant client agreements, which typically occur
near the end of our fiscal quarter, but, if delayed, may not occur until
the next quarter;
- the length of the sales cycle for our products;
- fluctuations in demand for our products;
- the introduction of new products by us or by our competitors;
- changes in prices by us or by our competition; and
- the timing and amount of our expenditures.
We plan to increase our operating expenses to achieve revenue growth. If our
revenues do not increase as anticipated and our spending levels are not reduced
accordingly, a significant decline in our quarterly operating results could
occur. In addition, we believe, based on general software industry trends, that
sales of our products may be highest in the fourth quarter of the year and
lowest in the first quarter. As a result, period-to-period comparisons of our
results of operations may not be meaningful, and you should not rely on them as
an indication of future performance.
Our stock price has been and may continue to be highly volatile.
Our stock price is subject to wide fluctuations in response to a variety of
factors, including:
- quarterly variations in operating results;
- announcements of technological innovations;
- announcements of new software or services by us or our competitors;
23
<PAGE>
- changes in financial estimates by securities analysts; or
- other events or factors that are beyond our control.
In addition, the stock market has experienced significant price and volume
fluctuations that have particularly affected the trading prices of equity
securities of many high technology companies. These fluctuations have often been
unrelated or disproportionate to the operating performance of these companies.
Any negative change in the public's perception of the prospects of Internet or
electronic commerce companies could depress our stock price regardless of our
results. Other broad market fluctuations may decrease the trading price of our
common stock. In the past, following declines in the market price of a company's
securities, securities class action litigation has often been instituted against
that company. Litigation could result in substantial costs and a diversion of
management's attention and resources.
We increasingly rely on systems integration companies to sell and implement our
products, and if we cannot establish or maintain relationships with these
companies, or if they are not successful in their efforts, the growth of our
business would suffer.
We increasingly depend on systems integration companies for sales and
implementation of our products. Our growth will depend, in part, on maintaining
and expanding our relationships with systems integration companies. We may not
be able to develop or maintain relationships with systems integration companies.
Moreover, if the systems integration companies with which we have a strategic
relationship are not successful in selling and implementing systems that include
our products, or if they adopt, or promote more vigorously, a competing product
or technology, the growth of our business would be materially adversely
affected. Additionally, our use and training of systems integration companies
have increased and are likely to continue to increase our cost of services
revenues for the foreseeable future.
If we do not respond to technological change, our enterprise commerce software
products may become obsolete, and our long-term viability would suffer.
The Internet commerce software industry is characterized by rapid technological
change, which can render products obsolete. Our success depends, in part, on our
ability to respond to technological change in a timely and cost-effective
manner. If we are not able to respond successfully to technological change, our
Commerce Exchange family of products may become obsolete. This would threaten
our long-term viability.
Our products may contain defects, which could result in reduced sales, increased
service and warranty costs and liability to our clients.
Our software products may contain errors that become apparent when the products
are introduced or when the volume of usage increases. Errors in our products,
implementation errors or other performance difficulties could result in
decreased sales of our products, increased service and warranty costs and
liability to our clients, which could have a material adverse effect on our
business, financial condition, results of operations and prospects for growth.
Although we carry errors and omissions insurance, it may not cover all product
liability claims made against us. Our risk of liability to clients is
particularly pronounced because of our belief that our products will be critical
to our clients' operations.
Because a significant portion of our revenues is derived from a limited number
of clients that will change from year to year, our sales will decline if we
cannot attract significant new clients.
We expect that our largest clients will change from year to year because our
revenues from any client are typically greatest when the client first licenses
our products. Moreover, because our products require a meaningful capital
commitment, a significant portion of our revenues in any period is derived from
a limited number of clients. Therefore, if we are not able to generate revenues
from significant new clients, our business, financial condition, results of
operations and prospects for growth would be materially adversely affected. In
1996, software license and service revenues from Scholastic Corporation
accounted for approximately 31% of our total revenues and those from Cliggot
Communications accounted for approximately 17% of total revenues. In 1997,
software license and service revenues from Toys "R" Us accounted for
approximately 11% of total revenues and those from Electronic Data Systems
accounted for approximately 10% of total revenues. In 1998, software license and
service revenues from Warnaco accounted for approximately 14% of total revenues.
In 1999, software license and service revenues from our top two clients in the
aggregate accounted for approximately 13% of total revenues.
If we fail to manage our growth effectively, our business will suffer.
24
<PAGE>
We have grown rapidly since we were incorporated in 1995. Many members of our
senior management have only recently joined us. Of the 10 employees listed in
the management section of this prospectus, six have worked for us for less than
two years. Three of our executive officers, including Jeremy Davis, our Chief
Executive Officer, joined us in January 2000. Our rapid growth has placed, and
is expected to continue to place, a significant strain on our management and
operations. To manage our growth, we must continue to enhance our operating and
financial systems, infrastructure and controls. In the past, we have experienced
some inadequacies in our operating and financial systems, infrastructure and
controls. In prior years, we were not able to improve internal controls and
upgrade our personnel as needed to accommodate our growth. This resulted in
errors in application of our accounting policies which affected some information
contained in our financial statements for unaudited interim periods in our 1998
fiscal year. These errors were corrected following the hiring of experienced
personnel, consultation with our independent accountants and enhancement of
internal controls. Our growth will also depend on our ability to expand, train
and manage our employee base. In addition, we must expand our sales and
marketing organization, penetrate different markets and expand our capacity to
support a larger client base. If we do not manage our growth successfully, our
business, financial condition, results of operations and prospects for growth
would be adversely affected.
Our proprietary rights may not be fully protected, and we may be subject to
intellectual property infringement claims by others.
InterWorld and Process-Centric are our registered trademarks and we have applied
for other trade and service marks. We have recently been granted a U.S. patent
relating to our product architecture and technology. Our efforts to establish
and protect our proprietary rights, including federal copyright and trademark
registrations, may be inadequate to prevent imitation of our products by others.
The laws of foreign countries in which our products are sold may offer less
protection to proprietary rights than the laws of the United States. Moreover,
others may claim violation of their proprietary rights by us. BroadVision and
Open Market, two of our competitors, have been issued U.S. patents on some
aspects of their electronic commerce software products. We received a letter
from counsel to Open Market concerning the potential applicability of the Open
Market patents to our products. The letter stated that Open Market was prepared
to meet with us to resolve issues concerning the applicability of its patents
and to discuss terms of an appropriate license agreement. We responded to the
Open Market inquiry, informing Open Market that based on our review of the Open
Market patents and the analysis and advice of our patent counsel, we believe
that our products do not infringe the patents awarded to Open Market. We have
not received any further inquiries or correspondence from Open Market since our
September 1998 response and have had no inquiries or discussions with
BroadVision with regard to patent matters. We have also received a letter from
TechSearch LLC stating its belief that our Web site induces the infringement by
others of one or more claims of a U.S. patent issued to TechSearch. Our patent
counsel has advised us that this patent is invalid in view of prior art.
Although we do not believe that we are infringing their patent rights, any of
these companies may claim that we are doing so. If a claim of patent
infringement by these or other companies was made against us, we would likely
incur significant expenses in defending against the claim, which could adversely
affect our financial condition and results of operations. In addition, if a
claim of infringement is made against us and we are not successful in defending
against the claim, we could be liable for substantial damages and prevented from
using any infringing technology. We may also be required to make royalty
payments, which could be substantial, to the holder of the patent rights. These
events could have a material adverse effect on our business, financial
condition, results of operations and prospects for growth.
If our planned international expansion is not successful, our long-term growth
could be jeopardized.
We may not be successful in expanding our activities in international markets.
Even if we are successful in penetrating international markets, we will confront
additional technological challenges in keeping our international product
offerings current and conforming them to commercial standards in various
countries. In addition, there are risks in doing business in international
markets, including:
- changes in laws and regulations;
- export controls on encryption technology and other export restrictions;
- tariffs and other trade barriers;
- difficulties in staffing and managing foreign operations;
- political and economic instability; and
- fluctuations in currency exchange rates.
25
<PAGE>
Our success in expanding our international operations will be dependent, in
part, on our ability to anticipate and manage effectively these and other risks.
Our failure or inability to anticipate or manage these risks could have a
material adverse effect on our business, financial condition, results of
operations and prospects for growth.
If we cannot obtain additional financing when needed, we may be unable to
respond to competitive pressures or unanticipated requirements.
We may need additional financing to support more rapid growth than currently
anticipated or to respond to competitive pressures or unanticipated
requirements. Additional financing, if needed, may not be available on
satisfactory terms or at all. If additional funds are not available on
acceptable terms, we may be unable to fund our growth, develop or enhance our
products and services, respond to competitive pressures or take advantage of
acquisition opportunities. Any additional equity financing may cause investors
to experience dilution in their ownership interest, and the newly issued
securities may have rights superior to those of the common stock. Any debt
financing may result in limitations on our operations, including restrictions on
our spending or payment of dividends. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Liquidity and Capital
Resources."
If we are unable to retain or replace our key personnel, our business, financial
condition, results of operations and prospects for growth could suffer.
We believe that our ability to implement successfully our business strategy and
to operate profitably depends on the continued employment of our executive
management team. We do not carry key-person insurance on any member of our
executive management team. If one or more members of our management team become
unable or unwilling to continue in their current positions and if additional key
personnel cannot be hired as needed, our business, financial condition, results
of operations and prospects for growth could be materially adversely affected.
Any acquisition we make could disrupt our business and consequently harm our
financial condition.
In order to remain competitive, we may find it necessary to acquire additional
businesses, products or technologies. We currently have no agreements or
understandings with respect to any acquisitions. If we identify an appropriate
acquisition candidate, we may not be able to negotiate the terms of the
acquisition successfully, finance the acquisition or integrate the acquired
business, products or technologies into our existing business and operations.
Further, completing a potential acquisition and integrating an acquired business
will cause significant diversions of management time and resources. If we
consummate one or more significant acquisitions in which the consideration
consists of stock or other securities, your equity could be significantly
diluted. If we were to proceed with one or more significant acquisitions in
which the consideration included cash, we could be required to use a substantial
portion of our available cash, including proceeds from this offering, to
consummate an acquisition, or we could be required to incur debt financing which
may result in restrictions on our business. Acquisition financing may not be
available on favorable terms, or at all. In addition, we may be required to
amortize significant amounts of goodwill and other intangible assets in
connection with future acquisitions, which would seriously harm our operating
results.
Item 7(a). Quantitative and Qualitative Disclosure About Market Risk
Interest Rate Risk
InterWorld's exposure to market risk for changes in interest rates relates
primarily to its investment portfolio. InterWorld has a prescribed methodology
where by it invests its excess cash in debt instruments of government securities
and high quality corporate issuers (Standard and Poor's single "A" rating and
higher). Holdings of any one issue, excluding the U.S. Government, do not exceed
25% of cash and cash equivalents and are generally limited to one year or less
maturities.
Foreign Currency Exchange Risk
InterWorld has limited its international operations to relatively few countries
with stable currencies. Less than 20% of its revenues are from non-U.S. clients.
Additionally, a portion of its international sales is denominated and payable in
U.S. dollars. InterWorld does not believe that there is any material market risk
exposure with respect to derivative or other financial instruments which would
require disclosure under this item.
26
<PAGE>
INTERWORLD CORPORATION
Item 8. Consolidated Financial Statements and Supplementary Data
The financial statements listed below are filed as part of the Annual Report on
Form 10-K.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Accountants 28
Consolidated Balance Sheets as of December 31, 1999 and 1998 29
Consolidated Statements of Operations for the years ended December
31, 1999, 1998 and 1997 30
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1999, 1998 and 1997 31
Consolidated Statements of Cash Flows for the years ended December
31, 1999, 1998 and 1997 32
Notes to Consolidated Financial Statements 33
27
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of InterWorld Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of InterWorld
Corporation and its subsidiaries at December 31, 1999 and 1998, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1999 in conformity with accounting principles
generally accepted in the United States. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States, which 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, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
New York, New York
February 7, 2000
28
<PAGE>
INTERWORLD CORPORATION
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Amounts)
<TABLE>
December 31,
------------
1999 1998
---- ----
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 21,583 $ 858
Short-term Investments 17,986 --
Accounts receivable - net 6,505 6,153
Prepayments and other current assets 1,580 497
--------- ---------
Total current assets 47,654 7,508
Property and equipment, net 7,161 6,070
Other assets 486 541
--------- ---------
Total assets $ 55,301 $ 14,119
========= =========
LIABILITIES, MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses $ 8,637 $ 5,791
Capital lease obligations to related party-current 599 1,328
Deferred revenue and customer deposits 5,201 1,024
--------- ---------
Total current liabilities 14,437 8,143
Notes payable to related Party -- 3,229
Capital lease obligations to related party-long term -- 599
Deferred rent 1,586 1,030
--------- ---------
Total liabilities 16,023 13,001
--------- ---------
Commitments:
Mandatorily redeemable series A convertible
preferred stock
($0.01 par value; -0- shares authorized, issued
and outstanding at December 31,1999, and 8,200,000
shares authorized, 7,539,999 issued and outstanding
at December 31, 1998)(Liquidating preference of -0-
and $48,097 at December 31, 1999 and 1998,
respectively) -- 47,334
Stockholders' equity (deficit):
Preferred stock
($.01 par value; 15,000,000 and -0- shares
authorized at December 31, 1999 and 1998,
respectively; -0- issued and outstanding at
December 31, 1999 and 1998) -- --
Common stock
($0.01 par value; 100,000,000 shares authorized,
27,234,238 and 13,869,786 issued and outstanding
at December 31, 1999 and December 31, 1998,
respectively) 272 139
Additional paid-in capital 122,612 6,840
Accumulated deficit (83,554) (53,195)
Equity Adjustments (52) --
--------- --------
Total stockholders' equity (deficit) 39,278 (46,216)
--------- --------
Total liabilities, mandatorily redeemable
convertible preferred stock and stockholders'
equity (deficit) $ 55,301 $ 14,119
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
29
<PAGE>
INTERWORLD CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts)
<TABLE>
Years ended December 31,
------------------------
1999 1998 1997
---- ---- ----
Revenues, net:
<S> <C> <C> <C>
Product licenses $ 23,855 $ 9,754 $ 4,883
Services 16,692 4,834 3,073
Other -- 2 100
-------- -------- --------
Total revenues, net 40,547 14,590 8,056
-------- -------- --------
Cost of revenues:
Product licenses 1,884 671 278
Services 18,215 6,052 6,744
Other -- -- 107
-------- -------- --------
Total cost of revenues 20,099 6,723 7,129
-------- -------- --------
Gross profit 20,448 7,867 927
Operating expenses:
Research and development 17,334 9,558 6,863
Sales and marketing 23,086 11,969 8,487
General and administrative 6,806 6,356 6,405
Noncash employee compensation 3,633 1,615 752
-------- -------- --------
Total operating expenses 50,859 29,498 22,507
-------- -------- --------
Loss from operations (30,411) (21,631) (21,580)
Other income (expense):
Interest income 1,024 265 218
Interest expense (972) (696) (313)
-------- -------- --------
Total operating expenses 52 (431) (95)
-------- -------- --------
Loss from continuing operations (30,359) (22,062) (21,675)
-------- -------- --------
Discontinued operations:
Expenses from discontinued operations of UGO
Networks, Inc. -- -- (1,310)
Provision for operating losses to date of disposition -- -- (627)
-------- -------- --------
Net loss $(30,359) $(22,062) $(23,612)
======== ======== ========
Basic loss per share and diluted loss per share $ (1.59) $ (1.60) $ (1.75)
======== ======== ========
Basic loss per share and diluted loss per share
from continuing operations $ (1.59) $ (1.60) $ (1.61)
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
30
<PAGE>
INTERWORLD CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In Thousands, Except Share Amounts)
<TABLE>
Total
Additional Exchange Stockholders'
Common Stock Paid-In Gain Accumulated Equity
Shares Amount Capital (Loss) Deficit (Deficit)
------ ------ ------- ------ ------- ---------
<S> > <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 13,500,000 $ 135$ 267 $ - $ (7,521) $ (7,119)
Issuance of Series A preferred stock warrants
in connection with equipment lease - - 161 - - 161
Issuance of Series A preferred stock warrants
in connection with security agreement - - 104 - - 104
Issuance of Series A preferred stock warrants
for consulting services - - 371 - - 371
Issuance of Series A preferred stock warrants
in connection with sale of Series A
preferred stock - - 587 - - 587
Issuance of common stock upon exercise of
stock options 5,650 - 7 - - 7
Compensatory stock options issued to
employees and consultants - - 788 - - 788
Expenses related to issuance of Series A
preferred stock - - (54) - - (54)
Accretion of mandatorily redeemable
convertible preferred stock to redemption
value - - (28) - - (28)
Net loss - - - - (23,612) (23,612)
---------- ----- -------- ----- ---------- ----------
Balance at December 31, 1997 13,505,650 $ 135 $ 2,203 $ (31,133) $ (28,795)
Issuance of common stock upon exercise of
stock options 364,136 4 684 - - 688
Compensatory stock options issued to
employees and consultants - - 1,662 - - 1,662
Issuance of Series A preferred stock warrants
in connection with sale of Series A
preferred stock - - 252 - - 252
Issuance of Series A preferred stock warrants
in connection with loan agreement - - 1,023 - - 1,023
Expenses related to issuance of Series A
preferred stock - - (20) - - (20)
Accretion of mandatorily redeemable
convertible preferred stock to redemption
value - - (167) - - (167)
Distribution of net liabilities of UGO
Networks, Inc. - - 1,203 - - 1,203
Net loss - - - - (22,062) (22,062)
---------- ----- -------- ----- ---------- ----------
Balance at December 31, 1998 13,869,786 $ 139 $ 6,840 - $ (53,195) $ (46,216)
Issuance of common stock upon exercise of
stock options 659,188 6 1,825 - - 1,831
Issuance of common stock upon exercise of
warrants 65,265 1 (1) - - -
Issuance of common stock upon initial public
offering, net of expenses 3,450,000 34 47,036 - - 47,070
Issuance of common stock upon conversion
of Series A and B preferred stock with
initial public offering 9,189,999 92 64,505 - - 64,597
Compensatory stock options issued to
employees and consultants - - 4,127 - - 4,127
Accretion of mandatorily redeemable
convertible preferred stock to redemption
value - - (1,720) - - (1,720)
Foreign Exchange Gain/(Loss) - - - (52) - (52)
Net loss - - - - (30,359) (30,359)
---------- ----- -------- ----- ---------- ----------
Balance at December 31, 1999 27,234,238 $ 272 $122,612 $(52) $ (83,554) $ 39,278
========== ===== ======== ===== ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
31
<PAGE>
INTERWORLD CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(In Thousands)
<TABLE>
Year ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
Cash flow from operating activities:
<S> <C> <C> <C>
Net loss $(30,359) $(22,062) $(23,612)
Adjustments to reconcile net loss to net cash
used in operating activities:
Provision for operating losses-discontinued
operations -- -- 627
Depreciation and amortization 3,226 2,505 1,393
Loss on disposal of capital expenditures 13 -- --
Noncash consulting expense 530 47 407
Noncash employee compensation 3,633 1,615 752
Noncash interest expense 841 338 157
Changes in discontinued operations -- (175) (561)
Changes in assets and liabilities:
Accounts receivable (352) (1,866) (3,394)
Prepaid expenses and other current assets (1,052) (419) 249
Accounts payable and accrued expenses 2,810 2,300 1,790
Deferred revenue and customer deposits 4,177 534 (406)
Other assets and liabilities 55 70 (182)
Deferred rent 556 558 527
-------- -------- --------
Net cash used in operating activities (15,922) (16,555) (22,253)
-------- -------- --------
Cash flows from investing activities:
Short-term investments (17,986) -- --
Capital expenditures (4,361) (1,927) (3,530)
Capital expenditures of UGO Networks, Inc. -- -- (117)
-------- -------- --------
Net cash used in investing activities (22,347) (1,927) (3,647)
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of notes by UGO
Networks, Inc. -- -- 1,150
Principal payments on capital lease obligations (1,398) (1,284) (724)
Proceeds from sale and leaseback of equipment
to related party -- -- 819
Net proceeds from issuance of Series A preferred
stock -- 10,080 24,393
Net proceeds from issuance of Series B preferred
stock 15,543 -- --
Proceeds from exercise of common
stock options 1,831 688 7
Net proceeds from initial public offering 47,070 -- --
Deposits on preferred stock
subscriptions -- (225) 225
Proceeds from notes payable to related party 2,000 4,000 --
Notes payable to stockholders (6,000) -- --
-------- -------- --------
Net cash provided by financing activities 59,046 13,259 25,870
-------- -------- --------
Effect of exchange rate changes in cash and cash
equivalents (52) -- --
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 20,725 (5,223) (30)
Cash and cash equivalents, beginning of period 858 6,081 6,111
-------- -------- --------
Cash and cash equivalents, end of period $ 21,583 $ 858 $ 6,081
======== ======== ========
Cash paid for:
Interest $ 130 $ 357 $ 154
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
32
<PAGE>
INTERWORLD CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Share and Per Share Amounts)
1. Organization and Business
ORGANIZATION
InterWorld Corporation ("InterWorld") was incorporated in March 1995 under the
laws of the State of Delaware. The consolidated financial statements of
InterWorld include the accounts of InterWorld and its wholly owned subsidiaries,
InterWorld Technology Ventures Pty, Ltd., an Australian corporation incorporated
in November 1996, InterWorld U.K. Ltd., a United Kingdom corporation
incorporated in May 1998 and InterWorld Corporation Japan K.K., a Japanese
corporation incorporated in July 1998. In April 1997, InterWorld formed UGO
Networks, Inc., ("UGO") formerly ActionWorld, Inc., under the laws of the State
of Delaware. Until March 30, 1998, InterWorld was the majority owner of UGO and
UGO is included in the consolidated financial statements of InterWorld at
December 31, 1997. On March 30, 1998, InterWorld completed a spin-off
distribution of UGO (Note 12).
BUSINESS
InterWorld provides Internet commerce software solutions that enable businesses
to sell goods and services over the Internet to other businesses and consumers.
InterWorld's products, which are called enterprise commerce software, enable
companies to build their online businesses and integrate them with their
existing business practices and enterprise systems. Commerce Exchange is
InterWorld's family of enterprise commerce software, consisting of its Commerce
Exchange platform, applications, tools and business adapters. Commerce Exchange
enables manufacturing, distribution and retail companies to manage their
business-to-business, or B2B, and business-to-consumer, or B2C, selling and
support processes, including sales, order management, fulfillment and customer
service. InterWorld derives its revenues from the following products and
services: (i) licensing fees from its Internet commerce software, and (ii)
professional services including custom software development, installation,
integration, customer support and education.
2. Summary of Significant Accounting Policies
BASIS OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
InterWorld and its wholly owned and majority owned subsidiaries. All material
intercompany accounts and transactions have been eliminated in consolidation.
Assets and liabilities of InterWorld's foreign subsidiaries are translated to
U.S. dollars based on exchange rates at the end of the respective reporting
period. Income and expense items are translated at average exchange rates during
the period. Transaction gains and losses are included in the determination of
operating expenses. Cumulative translation adjustments were insignificant at
December 31, 1998.
RISKS AND UNCERTAINTIES
InterWorld operates in the software industry which is highly competitive and
rapidly changing. InterWorld has a history of significant losses from operations
and is subject to all of the risks inherent in a technology business, including
but not limited to, potential for significant technological changes in the
industry or customer requirements, potential for emergence of competitive
products with new capabilities and potential need for additional financing to
support more rapid growth then currently anticipated, as well as other risks and
uncertainties. In the event InterWorld does not successfully implement its
business plan, certain assets may not be recoverable.
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. The
most significant estimates and assumptions relate to the allowances for
receivables, deferred tax assets and the collectibility of the UGO sub-lease
obligation. Actual results could differ from those estimates.
CASH EQUIVALENTS
Cash equivalents, which are stated at cost, consist of short-term, highly liquid
investments, with original maturities of three months or less when purchased.
Interest is accrued as earned.
SHORT-TERM INVESTMENTS
Short-term investments consist of one highly liquid investment, with an original
maturity of more than three months, but less than one year when purchased.
Interest is accrued as earned.
33
<PAGE>
INTERWORLD CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
ACCOUNTS RECEIVABLE - NET
Accounts receivable are stated net of allowance for doubtful accounts of $1,256
and $1,217 at December 31, 1999 and 1998, respectively.
EQUIPMENT
Equipment is stated at cost. Depreciation is provided on a straight-line basis
over the estimated useful lives of the respective assets as follows:
Computer equipment and software 3 years
Leasehold improvements Shorter of lease term or estimated
useful life
Furniture and fixtures 5 years
Office equipment 3 years
EQUITY ADJUSTMENT
Equity adjustment includes foreign currency translation adjustments, a component
of other comprehensive loss amounting to $52 for the year ended December 31,
1999.
REVENUE RECOGNITION
InterWorld has adopted AICPA Statement of Position 97-2, "Software Revenue
Recognition" ("SOP 97-2"), as amended in 1998 by SOP 98-4 and further amended by
SOP 98-9 which is effective for transactions entered into after fiscal years
beginning after March 15, 1999. The SOP provides guidance on when revenue should
be recognized and in what amounts as well as what portion of InterWorld's
licensing transactions should be deferred. The adoption of these SOPs did not
have a material impact on InterWorld's results.
PRODUCT LICENSES
Revenue from the licensing of InterWorld's software products is recognized upon
shipment to the customer, pursuant to an executed software licensing agreement
when no significant vendor obligations exist and collection is probable. If
acceptance by the customer is required, revenue is recognized upon customer
acceptance. Amounts received from customers in advance of product shipment or
customer acceptance are classified as deposits from customers. InterWorld enters
into reseller arrangements for its products that typically provide for license
fees payable to InterWorld based on a percentage of the InterWorld's list price.
License revenues from InterWorld's reseller arrangements are recognized upon
shipment by the reseller when collection is probable.
SERVICES REVENUE
Revenue from professional services, such as custom development, installation and
integration support, is recognized as the services are rendered. Contracts for
professional services requiring significant production, modification or
customization to InterWorld's software products are recognized on a percentage
of completion basis.
Revenue from maintenance and post-contract customer support services, such as
telephone support and product enhancements is recognized ratably over the period
of the agreement under which the services are provided, typically one year.
Deferred revenue consists principally of billings in advance for services and
support not yet provided.
ADVERTISING COSTS
Advertising costs included in sales and marketing expenses are expensed as
incurred and approximated $1,786, $470 and $455 for the years ended December 31,
1999, 1998, and 1997, respectively.
RESEARCH AND DEVELOPMENT
InterWorld charges all costs incurred to establish the technological feasibility
of a product or product enhancement to research and development expense as
incurred.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying values of accounts receivable, accounts payable, accrued expenses
and notes payable approximates their fair values due to the relatively short
maturity of these instruments.
34
<PAGE>
INTERWORLD CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
INCOME TAXES
Income taxes are accounted for under the asset and liability method. Deferred
income taxes are recorded for temporary differences between financial statement
carrying amounts and the tax basis of assets and liabilities. Deferred tax
assets and liabilities reflect the tax rates expected to be in effect for the
years in which the differences are expected to reverse. A valuation allowance is
provided if it is more likely than not that some or all of the deferred tax
asset will not be realized.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), which establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. SFAS 133
requires an entity to recognize all derivatives as either assets or liabilities
in the statement of financial position and measure those instruments at fair
value. SFAS 133 is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. At December 31, 1999, InterWorld did not own any derivative
instruments and had not engaged in any hedging activities during the year ended
December 31, 1999. InterWorld does not expect to purchase derivative instruments
or enter into hedging activities in the foreseeable future.
3. Property and Equipment
Property and equipment is comprised of the following at December 31, 1999 and
1998:
<TABLE>
December 31,
-----------
1999 1998
---- ----
<S> <C> <C>
Computer equipment and software $ 8,646 $ 5,967
Office equipment 1,518 1,447
Leasehold improvements 3,032 1,974
Furniture and fixtures 1,361 867
-------- --------
14,557 10,255
Less: Accumulated depreciation
and amortization (7,396) (4,185)
-------- --------
Property and equipment, net $ 7,161 $ 6,070
======== ========
</TABLE>
At both December 31, 1999 and 1998, computer equipment, office equipment, and
furniture and fixtures include approximately $2,024, $1,149 and $827,
respectively, of fixed assets acquired under capital leases. Accumulated
depreciation related to these assets approximated $3,380 and $2,108 for the
years ended December 31, 1999 and 1998, respectively.
4. Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses are comprised of the following at December
31, 1999 and 1998:
<TABLE>
December 31,
------------
1999 1998
---- ----
<S> <C> <C>
Trade accounts payable $ 3,799 $ 3,047
Accrued commissions 1,527 264
Accrued incentive compensation 981 615
Accrued Professional Fees 677 674
Other accrued expenses 1,653 1,191
-------- --------
$ 8,637 $ 5,791
======== ========
</TABLE>
5. Loss Per Common Share
Effective December 31, 1997, InterWorld adopted SFAS No. 128, "Earnings per
Share" ("SFAS 128") which requires presentation of basic earnings per share
("Basic EPS") and diluted earnings per share ("Diluted EPS") by all entities
that have publicly traded common stock or potential common stock (options,
warrants, convertible securities or contingent stock arrangements). Basic EPS is
computed by dividing income available to common stockholders by the weighted
average number of common shares outstanding during the period. Diluted EPS gives
effect to all dilutive potential common shares outstanding during the period.
The computation of Diluted EPS does not assume conversion, exercise or
contingent exercise of securities that would have an antidilutive effect on
earnings.
35
<PAGE>
INTERWORLD CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The computations of basic loss per share and diluted loss per share for the
years ended December 31, 1999, 1998 and 1997, are as follows:
<TABLE>
Year Ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Net loss $ (30,359) $ (22,062) $ (23,612)
---------- ---------- ----------
Loss from continuing operations (30,359) (22,062) (21,675)
---------- ---------- ---------
Weighted average shares outstanding
used for basic loss and diluted loss
per share 19,045,278 13,771,371 13,500,709
Basic loss and diluted loss per share $ (1.59) $ (1.60) $ (1.75)
========== ========== ==========
Basic loss and diluted loss per share
from continuing operations $ (1.59) $ (1.60) $ (1.61)
========== ========== ==========
</TABLE>
At December 31, 1999, outstanding options to purchase 5,846,120 shares of common
stock, with exercise prices ranging from $1.25 to $51.125 per share, have been
excluded from the computation of diluted loss per share as they are
antidilutive. Outstanding warrants to purchase 459,070 shares of common stock
with exercise prices ranging from $2.00 to $9.775 per share were also
antidilutive and excluded from the computation of diluted loss per share at
December 31, 1999.
6. Common Stock, Preferred Stock and Convertible Preferred Stock
At December 31, 1998, InterWorld had authorized the issuance of 8,200,000 shares
of Mandatorily Redeemable Convertible Preferred Stock (designated Series A
Preferred) and 2,500,000 shares (designated Series B Preferred), of preferred
stock, $0.01 par value. The holders of Series A and B Preferred were entitled to
(i) share in dividends on a pro rata basis with common stockholders on an
as-converted basis; (ii) a liquidation preference equal to the sum of the price
paid per share and all declared and unpaid dividends (the "Preference Amount");
(iii) demand redemption of the Preference Amount in the event of a merger where
the shareholders of InterWorld do not control the surviving entity or a sale of
all or substantially all of InterWorld's assets; (iv) mandatory redemption of
the Preference Amount in cash at any date on or after March 2003 by a majority
vote of the Series A and B Preferred holders; (v) vote on all matters on an as
converted basis; and (vi) convert to common stock at the Preference Amount
multiplied by the shares to be converted divided by the conversion price (the
"Conversion Price") per share. The initial Conversion Price is equal to the
issuance price per share of Series A and B Preferred, and is subject to
adjustment in the event shares of common stock are issued without consideration
or for consideration per share less than the conversion price.
In June 1999, InterWorld has authorized the issuance of 15,000,000 shares of
preferred stock ("Preferred"). $0.01 par value.
In May 1999, the Board of Directors of InterWorld authorized management to
pursue an underwritten sale of shares of InterWorld's common stock in an initial
public offering pursuant to the Securities Act of 1933. Subsequently on August
11, 1999, InterWorld underwent an initial public offering ("IPO") in which
InterWorld sold 3,000,000 shares of common stock at a price of $15 per share.
The net proceeds from the sale of shares in the IPO were approximately $40.8
million, after deducting underwriting discounts and commissions and estimated
expenses of $1.0 million payable by InterWorld. On September 1, 1999, InterWorld
received additional net proceeds of approximately $6.3 million when the
underwriter exercised an option granted to it in connection with the IPO to
purchase 450,000 additional shares from InterWorld to cover over-allotments.
Upon the closing of the IPO, 7,539,999 shares of Series A Preferred and
1,650,000 shares of Series B Preferred converted into an aggregate of 9,189,999
shares of common Stock. In addition, outstanding warrants to purchase 534,070
shares of Series A Preferred converted to equivalent outstanding warrants to
purchase 534,070 shares of common Stock. These warrants were excluded from the
calculation of basic loss and diluted loss per share, as they were antidilutive.
In addition, upon closing of the IPO in August 1999, 8,200,000 authorized shares
of Series A and 2,500,000 authorized shares of Series B were cancelled.
36
<PAGE>
INTERWORLD CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
In December 1999, in connection with the cashless exercise of 75,000 warrants,
InterWorld issued and aggregate of 65,265 shares of InterWorld's common stock.
Also upon completion of the IPO, previously unvested options to purchase 178,570
shares of common stock automatically vested. InterWorld recognized approximately
$229 of noncash compensation expense upon the vesting of these options in 1999.
InterWorld had sold and issued in seven private placements an aggregate of
9,189,999 shares of Series A and B Preferred. Effective August 11, 1999, these
shares of Series A and B Preferred were subject to automatic conversion upon
consummation of an initial public offering of InterWorld's common stock
providing aggregate proceeds, net of underwriting discounts and commissions, of
greater than $10,000. A summary of the issuances are as follows:
<TABLE>
Issuance Carrying Value
Price Gross December 31, Redemption
Date Series Shares per Share Proceeds 1998 1997 Value
---- ------ ------ --------- -------- ---- ---- -----
<S> <C> <C> <C> <C> <C> <C> <C>
March 1996 A 1,287,500 $ 2.00 $ 2,575 $2,494 $2,475 $ 2,575
July 1996 A 1,056,631 4.732 5,000 5,000 5,000 5,000
December 1996 -
June 1997 A 1,120,000 6.25 7,000 7,000 7,000 7,000
August 1997 A 1,122,931 7.50 8,422 8,422 8,422 8,422
September 1997 A 1,764,705 8.50 15,000 14,532 14,422 15,000
March 1998 A 1,188,232 8.50 10,100 9,886 - 10,100
February 1999 B 1,650,000 10.00 16,500 - - 16,500
--------- ------- ------- ------- -------
Total 9,189,999 $64,597 $47,334 $37,319 $64,597
========= ======= ======= ======= =======
</TABLE>
In connection with the seven private placements InterWorld issued warrants to
purchase 328,578 shares of common stock to investors with exercise prices
ranging from $2.00 to $9.775 per share. In addition, InterWorld incurred cash
expenses of $957, $20 and $54 during 1999, 1998 and 1997, respectively, related
to these rounds.
The excess of the redemption value over the carrying value of Series A and
Series B Preferred was being recorded by periodic charges to stockholders'
equity through August 1999 at which time the Series A and Series B Preferred
were converted into common stock.
7. Transactions with Related Parties
In May 1996, InterWorld made loans in the aggregate amount of $193, bearing
interest at a rate of 6% per annum, to its three co-founders. The principal and
interest on the loans to one of the founders, in the aggregate amount of $89, is
being forgiven in equal installments starting in 1999, except that if he
voluntarily terminates his employment or service as a director prior to May
2001, his loan including interest will become due and payable in May 2001. In
May 1998 the second founder repaid $23 of the principal amount of his loan,
reducing the principal amount thereof to $75. The balance of such loan was
forgiven and expensed in June 1998. In May 1999, the loan to the third founder,
with the principal and interest in the aggregate amount of $27, was forgiven and
expensed. Interest income from such loans amounted to $2, $9 and $12 in 1999,
1998 and 1997, respectively. At December 31, 1999 and 1998, other assets
included $60 and $114, respectively, in amounts due from co-founders. (Notes 9,
12 and 13 for other related party transactions).
8. Stock Option, Defined Contribution and Profit Sharing Plans
STOCK OPTION PLANS
In March 1996, InterWorld implemented its 1996 Stock Option Plan (the "1996
Plan") whereby incentive and nonqualified options to purchase shares of
InterWorld's stock may be granted to directors and employees of InterWorld and
its subsidiaries. In June 1998, the Board of Directors approved amendments to
the 1996 Plan whereby the aggregate number of shares of common stock for which
options may be granted under the 1996 Plan was increased to 6,600,000. The
exercise and vesting periods and the exercise price for options granted under
the 1996 Plan are determined by the Board of Directors or a Committee of the
Board of Directors. The 1996 Plan stipulates that no option may be exercisable
after seven years from the date of grant. The fair market value of InterWorld's
common stock is determined by the Board of Directors. Options granted under the
Plan generally vest over a period of five years, 20% on the first anniversary of
the date of grant and 5% each quarter thereafter.
In January 2000, the shareholders of InterWorld approved the InterWorld
Corporation 2000 Equity Incentive Plan (the "2000 Plan"), which was approved by
the InterWorld's Board of Directors in November 1999. The aggregate number of
shares of common stock for which options may be granted under the 2000 Plan is
3,000,000 plus any available shares not
37
<PAGE>
INTERWORLD CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
covered by an option granted under the 1996 Plan. The exercise and vesting
periods and the exercise price for options granted under the 2000 Plan are
determined by the Board of Directors or a Committee of the Board of Directors.
The fair market value of InterWorld's common stock is determined by the Board of
Directors. Options granted under the Plan generally vest over a period of four
years, 25% on the first anniversary of the date of grant and 6.25% each quarter
thereafter.
The following tables summarize activity regarding stock options for the years
ended December 31, 1999, 1998 and 1997:
<TABLE>
1999 1998 1997
---- ---- ----
Weighted Weighted Weighted
Shares Average Shares Average Shares Average
Under Exercise Under Exercise Under Exercise
Option Price Option Price Option Price
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Options outstanding,
beginning of year 3,428,155 $2.86 2,904,737 $1.71 1,269,750 $1.25
Options granted 7,834 4.25 875,068 4.25 1,821,749 2.00
Options granted - - 291,050 8.50 - -
Options granted 1,604,567 10.00 - - - -
Options granted 866,550 15.00 - - - -
Options granted 94,600 30.00 - - - -
Options granted 1,577,150 51.125 - - - -
Options exercised (659,188) 2.78 (364,136) 1.89 (5,650) 1.25
Options forfeited (1,073,548) 6.95 (278,564) 2.39 (181,112) 1.38
--------- ------ ------- ----- ------- -----
Options outstanding,
end of year 5,846,120 $19.34 3,428,155 $2.86 2,904,737 $1.71
========= ====== ========= ===== ========= =====
Exercisable, end of year 1,705,286 $3.68 1,008,656 $2.10 754,903 $1.63
========= ===== ========= ===== ======= =====
</TABLE>
<TABLE>
Options Outstanding at December 31, 1999
----------------------------------------
Weighted Average
Options remaining
Outstanding contractual life
----------- ----------------
<S> <C> <C>
At $ 1.250 464,138 4.0
At $ 2.000 1,098,179 4.6
At $ 4.250 431,674 5.2
At $ 8.500 176,475 5.5
At $ 10.00 1,257,054 6.1
At $ 15.00 766,350 6.6
At $ 30.00 75,100 6.8
At $ 51.125 1,577,150 6.9
---------
Total 5,846,120
</TABLE>
InterWorld applies Accounting Principles Board Opinion No. 25 "Accounting for
Stock Issued to Employees," and related interpretations in accounting for its
1996 and 2000 Plans and other stock-based compensation issued to employees.
During the years ended December 31, 1999, 1998, and 1997, InterWorld has
recognized compensation expense for options granted to employees of $3,597, $
1,615 and $752, respectively. InterWorld estimates that it will recognize
compensation expense in an aggregate amount of $ 8,594 in future years as
options vest for all existing grants.
On August 11, 1999, the Compensation Committee of the Board of Directors of
InterWorld agreed to automatically vest previously unvested options to purchase
an aggregate of 334,818 shares of common stock. InterWorld recognized
approximately $429 of noncash compensation expense upon the vesting of these
options during 1999.
During 1999, 1998, and 1997 InterWorld issued options to purchase 80,000, 8,706,
and 15,000 shares of common stock, respectively to third party consultants in
exchange for services. InterWorld has recognized non-cash expense of $530 in
1999, $47 in 1998, and $36 in 1997 based on the fair value of such options at
the date of grant.
Had compensation cost for option grants to employees been determined based upon
the fair value at the date of grant for awards
38
<PAGE>
INTERWORLD CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
under the 1996 and 2000 Plans consistent with the methodology prescribed under
SFAS No. 123, "Accounting for Stock Based Compensation," ("SFAS 123"),
InterWorld's net loss and loss per share for the years ended December 31, 1999,
1998, and 1997 would have increased by approximately $5,303 or $0.28per share,
$1,568 or $0.11 per share and $677, or $0.05 per share, respectively.
The fair values of options granted to employees during the years ended December
31, 1999, 1998 and 1997 have been determined on the date of the respective grant
using the Black-Scholes option-pricing model based on the following weighted
average assumptions:
1999 1998 1997
---- ---- ----
Dividend yield None None None
Weighted average risk-free
interest rate on date of grant 5.34% 5.11% 5.90%
Forfeitures None None None
Expected life 5 years 5 years 5 Years
Volatility 110% 85% 75%
DEFINED CONTRIBUTION PLAN
InterWorld has a defined contribution savings plan (the "Plan"), which qualifies
under Section 401(k) of the Internal Revenue Code. Participants may contribute
up to 15% of their gross wages not to exceed, in any given year, a limitation
set by Internal Revenue Service regulations. The Plan provides for discretionary
contributions to be made by InterWorld as determined by the it's Board of
Directors. InterWorld has not made any contributions to the Plan.
EMPLOYEE STOCK PURCHASE PLAN
InterWorld adopted an employee stock purchase plan in 1999. Under the plan,
eligible employees are provided an opportunity to purchase shares of
InterWorld's common stock through regular payroll deductions. The total number
of shares of common stock that are authorized for issuance under the plan is
1,000,000. Employees are given an opportunity to purchase shares of common stock
during consecutive six-month periods, and the right to purchase shares will
expire on the last day of the six-month period. The purchase price for shares
offered under the plan for the first plan period ending February 29, 2000 will
be equal to a percentage designated by the compensation committee of the Board
of Directors (not less than 85%) of the closing price of InterWorld's common
stock on February 29, 2000 as reported on The Nasdaq Stock Market's National
Market. For each subsequent six-month period the purchase price for shares
offered under the plan will be equal to a percentage designated by the
compensation committee of the Board of Directors (not less than 85%) of the
lower of the fair market value of InterWorld's common stock at the commencement
or termination of the six-month period. The plan will expire on the tenth
anniversary of the effective date of the plan. During the year ended December
31, 1999, InterWorld has recognized noncash compensation expense for accrued
discounts associated with the Plan of $36.
9. Secured loan agreement
Effective October 1998, InterWorld's secured loan agreement with a holder of
common stock was amended under which maximum borrowings by InterWorld were
increased to $11,000. The loan accrued interest, which was payable monthly, at a
rate of 10% per annum and was secured by the accounts receivable of InterWorld.
Under the agreement InterWorld was able to borrow amounts for a period of twelve
months subsequent to its initial borrowing under the loan agreement or until
completion of an initial public offering by InterWorld, whichever was sooner.
The loan principal was due and payable the later of 15 months from the initial
borrowing or 21 months from the date of the agreement.
In January 1999, InterWorld utilized a portion of the net proceeds from the
issuance of Series B Preferred to repay the $4,000 under its secured loan
agreement. At December 31, 1999, InterWorld had repaid all outstanding
borrowings, and the agreement was terminated. Interest expense recognized on the
loan in 1999 amounted to $16.
10. Concentrations of Risk And Customer Information
Financial instruments which potentially subject InterWorld to concentrations of
credit risk are primarily cash, accounts receivable, accounts payable, and notes
payable. InterWorld generally does not require collateral and the majority of
its trade receivables are unsecured. InterWorld sells its products to a wide
range of commercial enterprises and governmental authorities. InterWorld had no
significant foreign income in any of the periods presented.
In 1999, no customer accounted for 10% of net revenues. At December 31, 1999,
two customers accounted for approximately 18% and 12%, respectively, of net
accounts receivable. In 1998, one customer accounted for 14% of net revenues. In
1997, two customers accounted for 11% and 10% of net revenues.
39
<PAGE>
INTERWORLD CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11. Income Taxes
InterWorld has incurred losses since inception which have generated net
operating loss carryforwards of approximately $47,950 and $39,210 at December
31, 1999 and 1998, respectively, for federal and state income tax purposes.
These carryforwards are available to offset future taxable income and expire in
2011 through 2019. At December 31, 1999 and 1998, InterWorld also had research
and development tax credit carryforwards in the amount of $1,100 and 1,437,
respectively, which expire in 2002 through 2019.
Section 382 of the Internal Revenue Code of 1986, as amended (the "IRC"), places
a limitation on the utilization of federal net operating loss carryforwards upon
the occurrence of an ownership change. In general, a change in ownership occurs
when a greater than 50 percent change in ownership takes place over a three-year
testing period. The annual utilization of net operating loss carryforwards
generated prior to such change is limited, in any one year, to a percentage of
the entity's fair value at the time of the change in ownership. As a result of
certain equity transactions consummated by InterWorld, a change in ownership, as
defined by Section 382 of the IRC has occurred, but as of December 31, 1999, it
is not expected that this will result in a material limitation to the amount of
net operating losses available to InterWorld in future periods.
The net operating loss carryforwards and temporary differences between carrying
amounts of assets and liabilities for financial reporting and income tax
purposes result in a net deferred tax benefit of $31,290 and $21,842 at December
31, 1999 and 1998, respectively. InterWorld's operating plans anticipate taxable
income in future periods; however, such plans make significant assumptions which
cannot be reasonably assured, including market acceptance of InterWorld's
products and services by customers. Therefore, in consideration of InterWorld's
accumulated losses and the uncertainty of its ability to utilize this deferred
tax benefit in the future, InterWorld has recorded valuation allowances of
$31,290 and $21,842 at December 31, 1999 and 1998, respectively, to fully offset
the deferred tax benefit amount.
Significant components of the noncurrent deferred tax asset at December 31, 1998
and 1999 are as follows:
<TABLE>
December 31,
------------
1999 1998
---- ----
Deferred tax assets:
<S> <C> <C>
Net operating loss $ 21,097 $ 17,250
Foreign operating loss carryforward 3,704 1,781
Accruals, reserves and other 2,122 1,061
Research and development expenditures 2,756 -
Research and development credits 1,100 1,437
Depreciation 394 101
Nonqualified stock options and warrants 166 212
---------- ----------
Total deferred tax assets 31,339 21,842
---------- ----------
Deferred tax liabilities:
Amortization 49 -
---------- ----------
Total deferred tax liabilities 49 -
---------- ----------
Net deferred tax asset 31,290 21,842
Less: valuation allowance (31,290) (21,842)
---------- ----------
Deferred tax asset, net $ - $ -
========== ==========
</TABLE>
The provision (benefit) for income taxes differs from the amount of income tax
determined by applying the applicable U.S. income tax rate to income (loss)
before taxes as follows:
<TABLE>
Year Ended
----------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Federal income tax statutory rate (35)% (35)% (35)%
State income taxes, net of federal
tax benefit (9) (9) (12)
Excess foreign tax benefit 5 4 -
Incentive stock options 5 3 1
Other nondeductible items 3 3 -
Valuation allowance 31 34 46
--------- --------- ---------
Income tax rate as recorded - - -
========== ========== ==========
</TABLE>
40
<PAGE>
INTERWORLD CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
12. Discontinued operations
On March 30,1998, InterWorld completed a spin-off distribution of its subsidiary
UGO, reducing its majority ownership to a minority interest of approximately
18%. Since March 30, 1998, InterWorld's minority interest in UGO has decreased
to approximately 5.5% as a result of private equity financings by UGO. Common
shares of UGO were distributed to InterWorld's common and preferred stockholders
of record as of March 30, 1998, on the basis of 0.18 a common share of UGO for
each common or preferred share (on an as converted basis) of InterWorld. UGO is
an online retailer of game and entertainment software.
InterWorld has presented UGO as a discontinued operation in the Consolidated
Statement of Operations for the year ended December 31, 1997. A provision of
$627 for estimated operating losses through the disposal date was recorded at
December 31, 1997. The cost of disposal was not significant.
A summary of the net liabilities distributed is as follows:
<TABLE>
December 31, 1997 March 30, 1998
<S> <C> <C>
Cash $ 596 $ 96
Equipment, net 92 315
Other current assets 20 53
Notes payable (1,150) (1,400)
Accounts payable and accrued expenses (30) (113)
--------- --------
$ (472) $(1,049)
========= ========
</TABLE>
InterWorld carries its investment in UGO at cost and it has no continuing
significant involvement in the operations of UGO.
During 1997, UGO had no revenues and incurred net losses of $1,310. The basic
loss per share and diluted loss per share for the year ended December 31, 1997,
attributable to discontinuance of the operations of UGO was approximately $0.14
per share.
13. Commitments
LEASES
InterWorld has entered into noncancelable operating leases primarily for office
space, furniture and office equipment with initial or remaining terms of six
months or more. Total rent expense amounted to $2,113, $1,283 and $ 1,349 for
the years ended December 31, 1999, 1998 and 1997, respectively.
Commencing October 1999, InterWorld extended its lease and leased additional
office space at its current headquarters location. InterWorld has subleased a
portion of the space to UGO, a related party. The lease and sublease will expire
in December 2015 and the sublease allows InterWorld to terminate all or a
portion of the subleased space under specific circumstances.
Future minimum lease payments by year under gross and net operating leases,
UGO's sublease obligation and capital leases with initial or remaining terms of
one year or more consisted of the following at December 31, 1999:
Gross UGO Net
Year Operating Sub-lease Operating Capital
- ---- -------- --------- --------- -------
2000 2,609 891 1,718 627
2001 2,565 1,214 1,351 -
2002 2,526 1,250 1,276 -
2003 2,474 1,285 1,189 -
2004 and thereafter 47,493 19,264 28,229 -
------ ------ ------ -----
Total minimum lease
payments $ 57,667 $ 23,904 $ 33,763 627
-------- -------- --------
Less: Amounts representing interest 11
-----
Present value of future minimum lease payments 616
----
Less: Current maturities 616
----
Capital lease obligations-long term $ -
----
14. Subsequent Events (unaudited)
Effective January 2000, Jeremy Davis, InterWorld's Chief Executive Officer and
President, entered into an employment agreement with InterWorld with an initial
term of three years. This agreement establishes a base salary and bonus
eligibility based on performance. InterWorld has also agreed to loan Mr. Davis
$750 to assist in his relocation expenses. The loan will bear interest at the
41
<PAGE>
INTERWORLD CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
prime rate and is due to be repaid upon the sale of his former principal
residence. InterWorld granted Mr. Davis a non-qualified option grant to purchase
500,000 shares of common stock at an exercise price equal to $51.125. This stock
option vests 20% on January 5, 2001 and 5% on the last day of each completed
quarter thereafter. In addition, InterWorld has agreed to issue an aggregate of
50,000 shares of common stock to Mr. Davis of which 16,667 shares were issued on
February 11, 2000, 16,667 and 16,666 to be issued on or about January 5, 2001
and 2002, respectively. InterWorld estimates that it will recognize
approximately $992 in non-cash compensation during the three months ended March
31, 2000.
In January 2000, InterWorld granted to an executive officer options to purchase
150,000 shares of common stock at an exercise price of $15.00. InterWorld
estimates that it will recognize $8,625 in additional compensation expense over
the remaining vesting period of these options.
In January 2000, InterWorld vested previously unvested options to purchase
25,000 shares of common stock granted to a consultant. InterWorld will recognize
approximately $304 in noncash compensation expense in January 2000.
In January 2000, the Board of Directors of InterWorld authorized management to
pursue an underwritten sale of shares of InterWorld's common stock in a
follow-on public offering (the "Offering") pursuant to the Securities Act of
1933, in which 1,250,000 shares will be offered by InterWorld and 2,500,000
shares will be offered by the selling stockholders.
42
<PAGE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
There are no changes in and/or disagreements with accountants on accounting and
financial disclosure.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information with respect to InterWorld's directors and compliance with
Section 16(a) of the Securities and Exchange Act of 1934, as amended, required
by Item 10 are incorporated by reference from the Proxy Statement. The
information for InterWorld's executive officers required by this item appears
under the caption "Executive Officers and Directors" at Item 1 of this report.
Item 11. Executive Compensation
The information required by this item is contained under the captions "Director
Compensation," "Compensation of Executive Officers" and "Compensation Committee
Interlocks and Insider Participation" in the 2000 Proxy Statement and is
incorporated herein by this reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is contained in the 2000 Proxy Statement
under the caption "Stock Ownership of Certain Beneficial Owners and Management"
and is incorporated herein by this reference.
Item 13. Certain Relationships and Related Transactions
The information required by this item is contained under the caption "Certain
Transactions" in the 2000 Proxy Statement and is incorporated herein by this
reference.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents are filed as a part of this report.
1. Financial Statements. The Consolidated Financial Statements of InterWorld
Corporation and Subsidiaries listed in the Index to Financial Statements
in Item 8 hereof are filed as part of this Annual Report on Form 10-K.
2. Financial Statement Schedule. Attached to this Annual Report on Form 10-K.
Schedule II Valuation and Qualifying Accounts is filed as part of this
Annual Report on Form 10-K immediately preceding the exhibit index.
All other schedules are omitted, since the required information is not
present or is not present in amounts sufficient to require submission of
the schedule or because the information required is included in the
consolidated financial statements and notes thereto.
3. Exhibits. The exhibits listed on the accompanying Index to Exhibits
immediately following the consolidated financial statement schedule are
filed as part of, or incorporated by reference into, this Annual Report
on Form 10-K.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed by InterWorld during the quarter ended
December 31, 1999.
43
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
InterWorld Corporation
By: /s/ Michael J. Donahue
----------------------------------
Michael J. Donahue
Chairman
Each person whose signature appears below hereby constitutes and appoints
Michael J. Donahue and Jeremy M. Davis, his true and lawful attorneys-in-fact
and agents, each acting alone, with the power of substitution, for him in any
and all capacities, to sign any amendments to this Report on Form 10-K, and to
file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming all that the said attorneys-in-fact, or his substitute or
substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
SIGNATURE TITLE
--------- -----
By: /s/ Jeremy M. Davis
---------------------------
Jeremy M. Davis President and Chief Executive Officer
(principal executive officer) and Director
By: /s/ Peter Schwartz
---------------------------
Peter Schwartz Chief Financial Officer (principal financial
and accounting officer)
By: /s/ Michael J. Donahue
---------------------------
Michael J. Donahue Chairman
By: /s/ Alan J. Andreini
---------------------------
Alan J. Andreini Vice Chairman
By: /s/ Kenneth G. Langone
---------------------------
Kenneth G. Langone Director
By: /s/ Joseph C. Robinson
---------------------------
Joseph C. Robinson Director
By: /s/ Yves Sisteron
---------------------------
Yves Sisteron Director
By: /s/ Jack Slevin
---------------------------
Jack Slevin Director
By: /s/ Russell West
---------------------------
Russell West Director
44
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and
Stockholders of InterWorld Corporation
Our audits of the financial statements referred to in our report dated February
7, 2000, included in the annual report on Form 10-K for the year ended December
31, 1999, also included an audit of the financial statement schedule listed in
Part II herein. In our opinion, this financial statement schedule presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related financial statements.
PricewaterhouseCoopers LLP
New York, New York
February 7, 2000
45
<PAGE>
Schedule II - Valuation and Qualifying Accounts
INTERWORLD CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
Additions
---------
Balance at Charged to Charged to Balance at
Beginning Costs and Other End of
of Period Expenses Accounts Deductions Period
--------- -------- -------- ---------- ------
(in thousands)
Allowance for Doubtful Accounts
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1997 269 353 -- -- 622
Year ended December 31, 1998 622 1,438 -- (843) 1,217
Year ended December 31, 1999 1,217 766 -- (727) 1,256
Valuation Reserve -- Deferred Tax Assets
Year ended December 31, 1997 3,501 10,773 -- -- 14,274
Year ended December 31, 1998 14,274 7,568 -- -- 21,842
Year ended December 31, 1999 21,842 9,448 -- -- 31,290
</TABLE>
46
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
------ -------------------------------------------------
3.1 Amended and Restated Certificate of Incorporation of the
Registrant (2)
3.2 Bylaws of the Registrant (1)
4.1 Form of Common Stock Certificate of the Registrant (9)
4.2 See Exhibits 3.1 and 3.2 for provisions of the Amended and Restated
Certificate of
Incorporation and Bylaws of the Registrant defining the rights of
holders of Common
Stock of the Registrant (included in Exhibit 3.1 and 3.2)
4.3 Amended and Restated Registration Rights Agreement, among the
Registrant and Certain
Stockholders (9)
10.1 Amended and Restated 1996 Stock Option Plan (4)
10.2 Employee Stock Purchase Plan (5)
10.3 Form of Indemnification Agreement between the Registrant and
each of its directors and executive officers (1)
10.4 Lease dated as of January 12, 1997 between the Registrant as
Tenant and New York City District Council of Carpenters
Pension Fund, as Landlord (1)
10.6 First Amendment to Lease, dated as of July 1, 1999, between
Registrant, as Tenant, and New York City District Council
of Carpenters Pension Fund, as Landlord (2)
10.7 2000 Equity Incentive Plan (6)
10.8 Warrant Agreement, between the Registrant and Comdisco, Inc. (9)
16.1 Letter from KPMG LLP regarding change in accountants (2)
21.1 List of Subsidiaries (7)
23.1 Consent of PricewaterhouseCoopers LLP (8)
24.1 Powers of Attorney (included on signature page)
27.1 Financial Data Schedule for the year ended December 31, 1999 (8)
- ----------
(1) Previously filed on June 3, 1999 with InterWorld's Registration Statement on
Form S-1 (No. 333- 79879), incorporated herein by reference.
(2) Previously filed on July 16, 1999 with InterWorld's Amendment No. 1 to
Registration Statement on Form S-1 (No. 333-79879), incorporated herein by
reference.
(3) Previously filed on August 9, 1999 with InterWorld's Amendment No. 4 to
Registration Statement on Form S-1 (No. 333-79879), incorporated herein by
reference.
(4) Previously filed on October 29, 1999 with InterWorld's Registration
Statement on Form S-8 (No. 333-89969), incorporated herein by reference.
(5) Previously filed on October 29, 1999 with InterWorld's Registration
Statement on Form S-8 (No. 333-89963), incorporated herein by reference.
(6) Previously filed on December 30, 1999 with InterWorld's Definitive Proxy
Statement on Form DEFS14A, incorporated herein by reference.
(7) Previously filed on February 7, 2000 with InterWorld's Registration
Statement on Form S-1 (No. 333-96245), incorporated herein by reference.
(8) Filed herewith.
(9) To be filed by amendment.
47
<PAGE>
Exhibit 23.1
CONSENT OF PRICEWATERHOUSE COOPERS LLP
To the Board of Directors and
Stockholders of InterWorld Corporation
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (Nos.333-89969 and 333-89963) of InterWorld Corporation
of our report dated February 7, 2000, relating to the financial statements of
InterWorld Corporation as of and for the year ended December 31, 1999, which
appears in the Form 10-K of InterWorld Corporation for the year ended December
31, 1999. We also consent to the incorporation by reference of our report dated
February 7, 2000 relating to the financial statement schedule, which also
appears in such Form 10-K of InterWorld Corporation.
PricewaterhouseCoopers LLP
New York, New York
February 7, 2000
48
<PAGE>
Exhibit 27.1
Financial Data Schedule for the year ended December 31, 1999
49
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 21,583
<SECURITIES> 17,986
<RECEIVABLES> 7,761
<ALLOWANCES> (1,256)
<INVENTORY> 0
<CURRENT-ASSETS> 47,654
<PP&E> 14,557
<DEPRECIATION> (7,396)
<TOTAL-ASSETS> 55,301
<CURRENT-LIABILITIES> 14,437
<BONDS> 0
0
0
<COMMON> 272
<OTHER-SE> 39,006
<TOTAL-LIABILITY-AND-EQUITY> 55,301
<SALES> 23,855
<TOTAL-REVENUES> 40,547
<CGS> 20,099
<TOTAL-COSTS> 70,958
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (52)
<INCOME-PRETAX> (30,359)
<INCOME-TAX> 0
<INCOME-CONTINUING> (30,359)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (30,359)
<EPS-BASIC> (1.59)
<EPS-DILUTED> (1.59)
</TABLE>
