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Filed pursuant to Rule 424(b)(1)
Registration No. 333-51121
LOGO
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5,000,000 SHARES
COMMON STOCK
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All of the 5,000,000 shares of Common Stock, par value $0.001 per share
("Common Stock"), are being sold by software.net Corporation ("software.net" or
the "Company"). Prior to this offering, there has been no public market for the
Common Stock. See "Underwriting" for a discussion of the factors considered in
determining the initial public offering price. The Common Stock has been
approved for quotation on the Nasdaq National Market under the symbol "SWNT."
FOR INFORMATION CONCERNING CERTAIN RISK FACTORS WHICH SHOULD BE CONSIDERED BY
PROSPECTIVE INVESTORS, SEE "RISK FACTORS" COMMENCING ON PAGE 5.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2)
<S> <C> <C> <C>
Per Share $9.00 $0.63 $8.37
Total(3) $45,000,000 $3,150,000 $41,850,000
</TABLE>
(1) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriting."
(2) Before deducting expenses estimated at $750,000, payable by the Company.
(3) The Company has granted the Underwriters a 30-day option to purchase up to
750,000 additional shares of Common Stock solely to cover over-allotments,
if any. If such option is exercised in full, the total Price to Public,
Underwriting Discount and Proceeds to Company will be $51,750,000,
$3,622,500 and $48,127,500, respectively. See "Underwriting."
The shares of Common Stock are offered by the Underwriters, subject to prior
sale, when, as and if delivered to and accepted by them, and subject to
approval of certain legal matters by counsel and certain other conditions. The
Underwriters reserve the right to withdraw, cancel or modify such offer and to
reject orders in whole or part. Delivery of the shares of Common Stock offered
hereby to the Underwriters is expected to be made in New York, New York on or
about June 22, 1998.
DEUTSCHE BANK SECURITIES
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
MERRILL LYNCH & CO.
C.E. UNTERBERG, TOWBIN
The date of this Prospectus is June 17, 1998.
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[INSIDE FRONT COVER -- GRAPHICS, LOGOS, ETC.]
The Company has applied for Federal registration of the mark "SOFTWARE.NET." All
other trademarks or service marks appearing in this Prospectus are trademarks or
service marks of the respective companies that utilize them.
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE MARKET PRICE OF THE COMMON STOCK OF
THE COMPANY, INCLUDING BY ENTERING STABILIZING BIDS, EFFECTING SYNDICATE
COVERING TRANSACTIONS OR IMPOSING PENALTY BIDS. SUCH STABILIZING ACTIONS, IF
COMMENCED, MAY BE DISCONTINUED AT ANY TIME. FOR A DESCRIPTION OF THESE
ACTIVITIES, SEE "UNDERWRITING."
Except as otherwise noted, all information in this Prospectus, including share
and per share information, (i) assumes no exercise of the Underwriters'
over-allotment option, and (ii) reflects the automatic conversion of each
outstanding share of the Company's Series A and Series B Preferred Stock into
two shares of Common Stock and each outstanding share of the Company's Series C
and Series D Preferred Stock into one share of Common Stock upon the
consummation of this offering (the "Preferred Stock Conversion").
Portions Copyright Netscape Communications Corporation, 1997. All Rights
Reserved. Netscape, Netscape Navigator and the Netscape N logo are registered
trademarks of Netscape in the United States and other countries.
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PROSPECTUS SUMMARY
The following summary should be read in conjunction with, and is qualified
in its entirety by, the more detailed information and financial statements and
notes thereto appearing elsewhere in this Prospectus.
THE COMPANY
software.net Corporation (the "Company") is a leading online reseller of
commercial off-the-shelf computer software ("Software") to the consumer, small
business and large enterprise markets. Through its online store
(www.software.net), the Company offers customers a comprehensive selection of
Software, customer service and competitive pricing. The Company believes that
the software.net site is one of the most widely known and used sites on the
World Wide Web for the purchase of Software. The Company fulfills a customer
purchase either through physical delivery of the shrink-wrap Software package or
through electronic software delivery ("ESD"). The Company believes it provides
superior value to its customers by offering one of the largest selections of
brand-name, high quality Software available online and the convenience of
shopping from home or office, twenty-four-hours-a-day, seven-days-a-week.
software.net's business is based on scaleable technology that permits the
sale, order processing and delivery of Software with limited human intervention.
This technology, combined with significant operational experience, enables the
Company to address the complex process of real time ESD. The Company has
developed relationships with approximately 300 leading Software publishers which
have granted the Company the right to distribute approximately 2,800 Software
stock-keeping units via ESD. The Company has also established strategic
marketing alliances with America Online, Inc., Excite, Inc. and Netscape
Communications Corporation.
THE OFFERING
Common Stock offered........................ 5,000,000 shares
Common Stock to be outstanding after the
offering.................................... 26,546,452 shares(1)
Use of Proceeds............................. Working capital, payment of
obligations and general
corporate purposes. See "Use of
Proceeds."
Proposed Nasdaq National Market Symbol...... "SWNT"
CONSOLIDATED SUMMARY FINANCIAL DATA
(In thousands)
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<CAPTION>
YEAR ENDED QUARTER ENDED
DECEMBER 31, MARCH 31,
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1995 1996 1997 1997 1998
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<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net revenues................................................ $1,003 $ 5,858 $16,806 $3,158 $ 6,192
Gross profit................................................ 380 721 1,933 375 938
Total operating expenses.................................... 898 1,585 3,843 584 3,190
Loss from continuing operations............................. (511) (779) (1,743) (169) (2,227)
Net loss.................................................... (511) (1,515) (5,359) (752) (2,227)
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1998
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PROFORMA
ACTUAL AS ADJUSTED(1)(2)
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<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 2,232 $46,051
Working capital............................................. 918 44,737
Total assets................................................ 8,388 52,207
Redeemable convertible preferred stock...................... 15,257 --
Stockholders' equity (net capital deficiency)............... (13,443) 45,633
</TABLE>
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(1) Based on shares outstanding as of March 31, 1998. Includes: (i) the
conversion into Common Stock of 276,466 shares of Series D Preferred Stock
issued in April 1998; and (ii) 238,948 shares of Common Stock to be issued
to AOL immediately prior to the consummation of this offering. Excludes as
of the date of this Prospectus: (i) 3,710,513 shares of Common Stock
issuable upon exercise of options outstanding under the Company's 1995 and
1998 Stock Option Plans, as amended (collectively, the "Plans"), at a
weighted average exercise price of $2.44 per share; (ii) 1,000,000 shares of
Common Stock issuable upon exercise of outstanding options granted outside
of the Plans at a weighted average exercise price of $0.004 per share; (iii)
1,180,945 shares of Common Stock reserved for future issuance under the
Plans; and (iv) 358,422 shares of Common Stock reserved for issuance
pursuant to the exercise of a warrant issued by the Company to AOL at an
exercise price of $8.37 per share. See "Certain Transactions," "Description
of Capital Stock" and Notes 3 and 7 of Notes to Consolidated Financial
Statements.
(2) Adjusted to give effect to the sale by the Company of the shares of Common
Stock offered hereby and after deducting the underwriting discount and
offering expenses, and the receipt of the net proceeds therefrom. See "Use
of Proceeds" and "Capitalization."
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THE COMPANY
software.net Corporation ("software.net" or the "Company") is a leading
online reseller of commercial off-the-shelf computer software ("Software") to
the consumer, small business and large enterprise markets. Through its online
store (www.software.net), the Company offers customers a comprehensive selection
of Software, customer service and competitive pricing. The Company believes that
the software.net site is one of the most widely known and used sites on the
World Wide Web (the "Web") for the purchase of Software. The Company fulfills a
customer purchase either through physical delivery of the shrink-wrap Software
package or through electronic software delivery ("ESD"). The Company believes it
provides superior value to its customers by offering one of the largest
selections of brand-name, high quality Software available online, and the
convenience of shopping from home or office, twenty-four-hours-a-day,
seven-days-a-week ("24x7").
The Company believes that the Internet is an ideal medium for the sale and
delivery of Software for several reasons: (i) the demographics of Internet users
overlap one-to-one with the demographics of potential Software purchasers; (ii)
many Software titles and their related stock-keeping units ("SKUs") can be
delivered via ESD, providing instant gratification to the customer; and (iii)
large enterprise customers can use ESD to achieve efficient and cost effective
distribution of Software. software.net's business is based on scaleable
technology that permits the sale, order processing and delivery of Software with
limited human intervention. This technology, combined with significant
operational experience, enables the Company to address the complex process of
real time ESD. The Company has developed relationships with approximately 300
leading Software publishers which have granted the Company the right to
distribute approximately 2,800 Software SKUs via ESD. The Company has also
established strategic marketing alliances with America Online, Inc. ("AOL"),
Excite, Inc. ("Excite") and Netscape Communications Corporation ("Netscape").
The Software reselling industry is large and growing. According to
International Data Corporation ("IDC"), total Software sales to consumers and
corporate end users from software retailers, dealers and third-party mail order
cataloguers in the United States were estimated to be approximately $14 billion
in 1997 and are expected to grow to approximately $24 billion in 2001,
representing a compound annual growth rate of approximately 14.7%. Jupiter
Communications, Inc. ("Jupiter") estimates that online PC software sales revenue
in 1997 were $69 million and are projected to grow to $2.3 billion in 2002. In
addition, the Company believes that the Software reselling industry is highly
fragmented with many participants, including regional and national chains of
superstores, systems integrators, VARs and small single location stores.
The Company intends to extend its momentum as a "first mover" in online
Software reselling to deliver outstanding value to its customers and to leverage
the online store model to achieve economies of scale. The Company's strategy is
to enhance recognition of its brand, promote ESD, leverage and further develop
its strategic relationships and capitalize on opportunities in the consumer,
small business and large enterprise markets while creating an economic model
that is superior to that of traditional Software reselling businesses. Since the
launch of its Web site in November 1994, the Company has sold Software products
to approximately 140,000 customers and has distributed freeware and trial
download products to tens of thousands of additional users. The Company's sales
increased from approximately $6 million in 1996 to approximately $17 million in
1997.
The Company (formerly CyberSource Corporation) was incorporated in 1994
under the laws of the State of California. In December 1997, in order to focus
on its core business of selling Software over the Internet, the Company spun-off
its Internet commerce services business to a new Delaware corporation which now
operates under the name CyberSource Corporation ("CyberSource"). See "Certain
Transactions." In June 1998, the Company reincorporated in the State of
Delaware. Unless the context otherwise requires, the term "Company" or
"software.net" refers to software.net Corporation and its California
predecessor.
The Company's executive offices are located at 3031 Tisch Way, Suite 900,
San Jose, California 95128, its telephone number is (408) 556-9300 and its Web
site address is www.software.net. Information contained on the Company's Web
site is not part of this Prospectus.
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RISK FACTORS
An investment in the shares of Common Stock offered hereby involves a high
degree of risk. In addition to the other information in this Prospectus, the
following risk factors should be considered carefully in evaluating an
investment in the Common Stock offered by this Prospectus. When used in this
Prospectus, the words "expects," "anticipates," "intends," "plans," "estimates"
and similar expressions are intended to identify forward looking statements.
Such statements are subject to risks and uncertainties that could cause actual
results to differ materially from those projected. These risks and uncertainties
include, but are not limited to, those risks discussed below and elsewhere in
this Prospectus. Actual results could differ materially from those projected in
the forward looking statements as a result of the risk factors discussed below
and elsewhere in this Prospectus.
Limited Operating History; History of Net Operating Losses; Accumulated
Deficit. Since inception, the Company has incurred significant losses, and as
of March 31, 1998, the Company had an accumulated deficit of approximately $13.5
million. The Company incurred net losses of $511,000, $1.5 million, $5.4 million
and $2.2 million in the periods ended December 31 1995, 1996, 1997 and the first
quarter of 1998, respectively. The Company was founded in August 1994 and began
selling Software on its Web site in November 1994. Accordingly, the Company has
a limited operating history on which to base an evaluation of its business and
prospects. The Company's prospects must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in their early
stage of development, particularly companies in new and rapidly evolving markets
such as online commerce. To address these risks, the Company must, among other
things, maintain and increase its customer base, maintain and develop
relationships with Software publishers, implement and successfully execute its
business and marketing strategy, continue to develop and upgrade its technology
and transaction-processing systems, improve its Web site, provide superior
customer service and order fulfillment, respond to competitive developments, and
attract, retain and motivate qualified personnel. There can be no assurance that
the Company will be successful in addressing such risks, and the failure to do
so could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
Anticipated Losses and Negative Cash Flow. The Company intends to expend
significant financial and management resources on brand development, marketing
and promotion, site content development, strategic relationships, and technology
and operating infrastructure, including ESD capabilities. Because the Company
has relatively low gross margins, achieving profitability given planned
investment levels depends upon the Company's ability to generate and sustain
substantially increased levels of net revenue. As a result, the Company expects
to incur additional losses and continued negative cash flow from operations for
the foreseeable future, and such losses are anticipated to increase
significantly from current levels. There can be no assurance that the Company's
revenues will increase or even continue at their current level or that the
Company will achieve or maintain profitability or generate cash from operations
in future periods. The Company's current and future expense levels are to a
large extent fixed and are based on its operating plans and estimates of future
revenues. Sales and operating results generally depend on the volume and timing
of orders received, which are difficult to forecast. The Company may be unable
to adjust spending in a timely manner to compensate for any unexpected revenue
shortfall. Accordingly, any significant shortfall in revenues would have an
immediate adverse effect on the Company's business, financial condition and
results of operations. In view of the rapidly evolving nature of the Company's
business and its limited operating history in the online Software reselling
business, the Company is unable to accurately forecast its revenues and believes
that period-to-period comparisons of its operating results are not necessarily
meaningful and should not be relied upon as an indication of future performance.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Unpredictability of Future Operating Results. The Company expects to
experience significant fluctuations in its revenues due to a variety of factors,
many of which are outside the Company's
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control. Factors that could have a material adverse effect on the business,
financial condition and results of operations of the Company include: (i) the
Company's ability to retain existing customers, attract new customers at a
steady rate and maintain customer satisfaction; (ii) the announcement or
introduction of new sites, services and products by the Company and its
competitors; (iii) price competition; (iv) the level of use of the Internet and
online services and decreased consumer acceptance of the Internet and other
online services for the purchase of consumer products such as those offered by
the Company; (v) the Company's ability to upgrade and develop its systems and
infrastructure and attract new personnel in a timely and effective manner; (vi)
the level of traffic on the Company's Web site; (vii) the termination of any
strategic marketing alliances such as those with AOL, Excite or Netscape
pursuant to which the Company has exposure to traffic on third-party Web sites,
or the termination of contracts with major purchasers, particularly United
States government agencies (the "U.S. government"); (viii) technical
difficulties, system downtime or Internet brownouts; (ix) the failure of
Internet bandwidth to increase significantly over time and/or an increase in the
cost to consumers of obtaining or utilizing Internet bandwidth; (x) the amount
and timing of operating costs and capital expenditures relating to expansion of
the Company's business, operations and infrastructure; (xi) the number of
popular Software titles introduced during the period; (xii) certain government
regulations; and (xiii) general economic conditions and economic conditions
specific to the Internet, online commerce and the Software Industry.
The Company's future success, and in particular its revenues and operating
results, depends upon its ability to successfully execute several key aspects of
its business plan. The Company must increase the dollar volume of Software sales
through its online sites, either by generating significantly higher and
continuously increasing levels of traffic to its online sites or by increasing
the percentage of visitors to its online sites who purchase Software, or through
some combination thereof. The Company must also increase the number of repeat
purchasers of Software through its online sites. Although the Company has
implemented strategies, including its relationships with AOL, Excite and
Netscape, designed to accomplish these objectives, there can be no assurance
that the Company will be able to increase the dollar volume of Software sales
through its online sites, increase traffic to its online sites, increase the
percentage of visitors who purchase Software or increase the number of repeat
purchasers. The failure to do one or more of the foregoing would likely have a
material adverse effect on the Company's business, financial condition and
operating results. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
The Company may experience seasonality in its business, reflecting seasonal
fluctuations in the Software industry, Internet and commercial online service
usage and traditional retail, government and corporate seasonal spending
patterns and advertising expenditures. In particular, Internet and online
service usage and the rate of growth of such usage may decline in the summer.
Such seasonality may cause quarterly fluctuations in the Company's operating
results and could have a material adverse effect on the Company's business,
operating results and financial condition. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
The Company's gross margins may be impacted by a number of factors,
including the mix of revenues from sales of shrink-wrap products and revenues
from ESD products, the mix of Software products sold, the mix of revenues among
sales to government, corporate and consumer purchasers, the mix of revenues
derived from its relationships with strategic partners such as AOL, Excite,
Netscape and the Company's Web site, and the amount of advertising or
promotional revenues received during a period. The Company realizes higher gross
margins from advertising and promotional revenues than it does from Software
product sales. The Company typically realizes higher gross margins on ESD
Software product sales than it does on sales of shrink-wrap Software products,
and also on sales of specialty Software products as compared to those on sales
of widely available commodity Software products. In addition, the Company
typically realizes
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higher gross margins on sales to consumer purchasers than it does on sales to
government or corporate purchasers. The Company also may from time to time offer
discount pricing, which periodically may reduce its gross margins. The Company
believes that the size of new Software products will continue to increase and
that such Software products will not be suitable for ESD in the absence of
significant increases in network bandwidth. This trend may impact the Company's
ability to realize the higher gross margins associated with ESD Software product
sales in respect of such Software products. Any change in one or more of the
foregoing factors could materially adversely affect the Company's gross margins
and operating results in future periods. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Due to the foregoing factors, the Company's annual or quarterly operating
results may fall below the expectations of securities analysts and investors. In
such event, the trading price of the Common Stock would likely be materially
adversely affected. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Dependence on the Internet and Internet Infrastructure Development. The
increased use of the Internet for retrieving, sharing and transferring
information among businesses, consumers and suppliers has only recently begun to
develop, and the Company's success will depend in large part on continued growth
in, and the use of, the Internet. Critical issues concerning the commercial use
of the Internet, including security, reliability, cost, ease of access, quality
of service and necessary increases in bandwidth availability, remain unresolved
and are likely to affect the development of the market for the Company's
services. The adoption of the Internet for information retrieval and exchange,
commerce and communications, particularly by those enterprises that have
historically relied upon traditional means of commerce and communications,
generally will require the acceptance by these entities of a new medium of
conducting business and exchanging information. Such acceptance is likely only
in the event that the Internet provides these entities with greater efficiency
and an improved area of commerce and communication. Demand and market acceptance
of the Internet are subject to a high level of uncertainty and are dependent on
a number of factors, including the growth in consumer access to and acceptance
of new interactive technologies, the development of technologies that facilitate
interactive communication between organizations and targeted audiences and
increases in user bandwidth. If the Internet as a commercial or business medium
fails to develop or develops more slowly than expected, the Company's business,
results of operations and financial condition could be materially adversely
affected. The recent growth in the use of the Internet has caused frequent
periods of performance degradation, requiring the upgrade of routers and
switches, telecommunications links and other components forming the
infrastructure of the Internet by Internet service providers and other
organizations with links to the Internet. Any perceived degradation in the
performance of the Internet as a whole could undermine the benefits of the
Company's services. The Company's ability to increase the speed with which it
provides services to customers and to increase the scope of such services
ultimately is limited by and reliant upon the speed and reliability of the
networks operated by third parties. Consequently, the emergence and growth of
the market for the Company's services is dependent on improvements being made to
the entire Internet infrastructure to alleviate overloading and congestion.
Online Commerce Security Risks; Credit Card Fraud. A significant barrier
to online commerce and communications is the secure transmission of confidential
information over public networks. The Company relies on encryption and
authentication technology licensed from third parties to provide the security
and authentication necessary to effect secure transmission of confidential
information, such as customer credit card numbers. There can be no assurance
that advances in computer capabilities, new discoveries in the field of
cryptography, or other events or developments will not result in a compromise or
breach of the algorithms used by the Company to protect customer transaction
data. If any such compromise were to occur, it could have a material adverse
effect on the Company's business, financial condition and results of operations.
A party who is able to circumvent the Company's security measures could
misappropriate proprietary information or cause interruptions in the Company's
operations. The Company may be required to expend
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significant capital and other resources to protect against such security
breaches or to alleviate problems caused by such breaches. Concerns over the
security of transactions conducted on the Internet and other online services and
the privacy of users may also inhibit the growth of the Internet and other
online services generally, and online commerce in particular. To the extent that
activities of the Company or third party contractors involve the storage and
transmission of proprietary information, such as credit card numbers, security
breaches could damage the Company's reputation and expose the Company to a risk
of loss or litigation and possible liability. There can be no assurance that the
Company's security measures will prevent security breaches or that a failure to
prevent such security breaches will not have a material adverse effect on the
Company's business, financial condition and results of operations. In addition,
the Company has suffered losses as a result of orders placed with fraudulent
credit card data, even though the payment of such orders had been approved by
the associated financial institution. Under current credit card practices, a
merchant is liable for fraudulent credit card transactions where, as is the case
with the transactions processed by the Company, no cardholder signature is
obtained. There can be no assurance that the Company will not suffer significant
losses as a result of fraudulent use of credit card data in the future, a
situation which could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business -- Technology."
Risks Associated with Electronic Software Delivery. The Company's success
will depend in large part on customer acceptance of ESD as a method of buying
Software. In addition, the Company typically derives higher gross margins from
sales of Software via ESD than it does on sales of shrink-wrap Software. ESD is
a relatively new method of selling Software products and the growth and market
acceptance of ESD is highly uncertain and subject to a number of factors. These
factors include: the availability of sufficient network bandwidth to enable
purchasers to rapidly download Software, the impact of time-based Internet
access fees, the number of Software SKUs that are available for purchase through
electronic delivery as compared to those available through traditional methods,
the level of consumer comfort with the process of downloading Software and the
relative ease of such process and concerns about transaction security. The
Company believes that ten-megabytes is the maximum size of a Software SKU that
most consumers are willing to purchase via ESD. The Company also believes that
the size of new Software products will continue to increase and that such
Software products will not be suitable for ESD in the absence of significant
increases in network bandwidth. If ESD does not achieve widespread market
acceptance, the Company's business, financial condition and results of
operations will be materially adversely affected. Even if ESD achieves
widespread acceptance, there can be no assurance that the Company will overcome
the substantial existing and future technical challenges associated with
electronically delivering Software reliably and consistently on a long-term
basis. A failure by the Company to do so would also materially and adversely
affect the Company's business, financial condition and results of operations.
See "Business -- Products."
Reliance on Strategic Marketing Alliances with America Online, Excite and
Netscape. The Company has entered into marketing agreements with AOL, Excite
and Netscape. The AOL agreement (the "AOL Agreement") provides that the Company
shall be the exclusive and semi-exclusive reseller of Software on certain
screens on the AOL service and AOL's Web site, aol.com. Under the terms of the
Excite agreement (the "Excite Agreement"), the Company has the right to display
banner advertisements and links to the Company's Web site on certain screens on
Excite Web sites, and Excite cannot display paid promotional links or banner
advertisements of any other Software reseller on specified screens of the Excite
Web site related to Software. Each of AOL and Excite is obligated, under its
respective agreement with the Company, to deliver minimum numbers of screen
views with links to the Company's Web site ("Impressions"). The Company's
current agreement with AOL provides for fixed payments to AOL totalling
approximately $21 million. In addition, the Company's agreement with Excite
provides for substantial payments to Excite during the three year term of that
agreement. In addition, the Company is obligated to pay AOL and Excite a
percentage of certain transactional revenues and, in the case of AOL,
advertising revenues
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earned by the Company in excess of specified thresholds. The AOL Agreement
terminates in August 2001, or earlier in the event of a material breach, and the
Excite Agreement terminates when Excite has satisfied certain obligations with
respect to delivery of Impressions, but no earlier than April 2001, other than
in the event of a material breach.
In June 1997, the Company entered into an agreement with Netscape for a
term of 24 months pursuant to which the Company created and manages a Web site,
the "Netscape Software Depot by software.net." This Web site is an online
Software store accessible through Netscape's Internet site, created for the
purpose of marketing and distributing Software products which are compatible
with the Netscape ONE platform. Under the terms of the Netscape agreement, sales
and advertising revenues generated from this online store are allocated between
the parties in accordance with specified percentages. In connection with this
agreement, the Company made an initial prepayment to Netscape for a license to
use certain Netscape trademarks. The Netscape agreement terminates on July 31,
1999, and can also be terminated by either party in the event that certain
specified Impressions and net revenue milestones have not been met.
There can be no assurance that the Company will achieve sufficient online
traffic, or generate sufficient sales to realize economies of scale that justify
the Company's significant fixed financial obligations to AOL and Excite, or to
satisfy its contractual obligations necessary to prevent termination of the AOL,
Excite or Netscape agreements. The failure of the Company to do so would likely
have a material adverse effect on the Company's business, results of operations
and financial condition. In addition, neither the AOL, Excite nor Netscape
agreements provides the Company with automatic renewal rights upon expiration of
their respective terms. There can be no assurance that such agreements will be
renewed on commercially acceptable terms, or at all. Furthermore, the Company's
significant investment in the AOL, Excite and Netscape relationships is based on
the continued positive market presence, reputation and anticipated growth of
AOL, Excite and Netscape, as well as the commitment by each of AOL and Excite to
deliver specified numbers of Impressions. Any decline in the significant market
presence, business or reputation of AOL, Excite or Netscape, or the failure of
any of AOL or Excite to deliver the specified numbers of Impressions, will
reduce the value of these strategic agreements to the Company and will likely
have a material adverse effect on the business, results of operations and
financial condition of the Company. In addition, AOL and the Company have the
right to separately pursue and sell advertising in the Company's content areas
distributed through AOL. There can be no assurance that the Company and AOL will
not compete for limited software reseller advertising revenues. The Company's
arrangements with AOL, Excite and Netscape are expected to represent significant
distribution channels for the Company's Software sales, and any termination of
any or all of the Company's agreements with AOL, Excite and Netscape would
likely have a material adverse effect on the Company's business, results of
operations and financial condition. See "Use of Proceeds,"
"Business -- Strategic Relationships" and Note 3 of Notes to Consolidated
Financial Statements.
Need for Additional Capital. The Company requires substantial working
capital to fund its business and expects to use a portion of the net proceeds of
this offering to fund its operating losses. Since inception, the Company has
experienced negative cash flow from operations and expects to continue to
experience significant negative cash flow from operations for the foreseeable
future. The Company currently anticipates that the net proceeds of this
offering, together with its existing capital resources, will be sufficient to
meet the Company's capital requirements through the next twelve months, although
there can be no assurance that the Company will not have additional capital
needs prior to the end of such period. Thereafter, the Company may be required
to raise additional funds, in part to fund its financial obligations to AOL and
Excite. There can be no assurance that such financing will be available when
required by the Company on terms acceptable to the Company, or at all. See "Use
of Proceeds" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources."
Competition. The online commerce market is new, rapidly evolving and
intensely competitive, and the Company expects competition to intensify in the
future. Barriers to entry are minimal, and
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current and new competitors can launch new Web sites at a relatively low cost.
In addition, the Software reselling industry is intensely competitive. The
Company currently competes primarily with traditional Software resellers, other
online Software resellers and other vendors. In the online market, the Company
competes with online Software resellers and vendors that maintain similar
commercial Web sites, including CompUSA, CNET, Cyberian Outpost and Egghead.com,
and a growing number of Software publishers that sell their Software products
directly online. The Company also anticipates that it may in the near future
compete with other Software publishers, including Microsoft, that plan to sell
their products directly to customers online, and with indirect competitors that
specialize in online commerce or derive a substantial portion of their revenues
from online commerce, including AOL, Netscape, Amazon.com and Yahoo!. These
entities may themselves offer, or others may offer through such entities,
Software products. In addition, entities experienced in mail-order and/or direct
marketing of computer products (including cataloguers such as Micro Warehouse
and manufacturers such as Dell Computer and Gateway), major Software product
distributors such as Ingram Micro and Tech Data, and other major retailers of
products, such as OfficeMax, Staples and Office Depot, have established, or may
establish in the near future, commercial Web sites offering Software products.
Competitive pressures created by any one of these current or future competitors,
or by the Company's competitors collectively, could have a material adverse
effect on the Company's business, financial condition and results of operations.
The Company believes that the principal competitive factors in its market
are brand recognition, selection, convenience, price, speed and accessibility,
customer service, quality of site content, and reliability and speed of
fulfillment. In addition to the foregoing, the large enterprise market focuses
on compatibility of products, administration and reporting, single source
supply, security and cost-effective deployment. Many of the Company's current
and potential competitors have longer operating histories, larger customer
bases, greater brand recognition and significantly greater financial, marketing
and other resources than the Company. In addition, larger, well-established and
well-financed entities may acquire, invest in or form joint ventures with online
competitors as the use of the Internet and other online services increases.
Certain of the Company's actual or potential competitors, such as Ingram Micro
and Tech Data, may be able to secure merchandise from vendors on more favorable
terms, devote greater resources to marketing and promotional campaigns, adopt
more aggressive pricing or inventory availability policies and devote
substantially more resources to Web site and systems development than the
Company. Certain of the Company's competitors such as Software Spectrum, GTSI
and Corporate Software & Technology have greater experience in selling Software
to the large enterprise market. In addition, new technologies and the expansion
of existing technologies, such as price comparison programs that select specific
titles from a variety of Web sites and may direct customers to online Software
resellers that compete with the Company, may increase competitive pressures on
the Company. Increased competition may result in reduced operating margins, as
well as a loss of both market share and brand recognition. Further, as a
strategic response to changes in the competitive environment, the Company may
from time to time make certain pricing, service or marketing decisions or
acquisitions that could have a material adverse effect on its business,
financial condition and results of operations. In addition, companies that
control access to Internet transactions through network access or Web browsers
could promote the Company's competitors or charge the Company a substantial fee
for inclusion in their product or service offerings. There can be no assurance
that the Company will be able to compete successfully against current and future
competitors, and any inability to do so could have a material adverse effect on
the Company's business, operating results and financial condition. See
"Business -- Competition."
Reliance on Software Publishers and Distributors. The Company is entirely
dependent upon the Software publishers and distributors that supply it with
Software for resale, and the availability of such Software is unpredictable. In
1997 and the first quarter of 1998, a substantial majority of the Company's
revenues were derived from sales of Software collectively supplied by Microsoft
and a major software distributor. As is common in the industry, the Company has
no long-term or
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exclusive contracts or arrangements with any publisher or distributor that
guarantees the availability of Software for resale. For example, the agreement
with Microsoft automatically renews for successive one-year periods but is
terminable for any reason by providing written notice of the election to
terminate at least thirty (30) days prior to the expiration of the given term.
Although the Company believes that the relationship with the major software
distributor may be replaced without substantial difficulty in the event that
such relationship terminates, there can be no assurance that the publishers or
distributors that currently supply Software to the Company will continue to do
so or that the Company will be able to establish new relationships with
publishers and distributors. The Company also relies on software distributors to
ship shrink-wrap Software to customers that do not utilize ESD. The Company has
limited control over the shipping procedures of its distributors, and shipments
by these distributors have in the past been, and may in the future be, subject
to delays. Although most Software sold by the Company carries a warranty
supplied by the publisher, the Company has accepted returns from customers for
which the Company did not receive reimbursements from its publishers or
distributors.
Furthermore, the Company's contract with Microsoft provides for Microsoft's
approval of the Company's credit worthiness. Under the contract, Microsoft may
make this determination through the evaluation of publicly-available information
or, in Microsoft's sole discretion, Microsoft may require the Company to provide
Microsoft with sufficient information as reasonably requested by Microsoft to
determine the Company's credit worthiness. In the event that Microsoft
determines that the Company is no longer creditworthy or not in compliance with
certain payment or reporting terms, Microsoft may require the Company to post
security acceptable to Microsoft.
If the Company is unable to develop and maintain satisfactory relationships
with publishers and distributors on acceptable commercial terms, if the Company
is unable to obtain sufficient quantities of Software (including ESD products),
particularly from Microsoft or the major distributor noted above, if the quality
of service provided by such publishers or distributors falls below a
satisfactory standard, if the Company's level of returns exceeds its
expectations, the Company's business, results of operations and financial
condition could be materially adversely affected.
Customer Concentration; Risks Associated with Reliance on United States
Government Contracts. The Company has entered into three contracts with United
States government agencies (the "U.S. government"). Collectively, these
agreements accounted for approximately 33.2% and 43.1% of the Company's revenues
in 1997 and the quarter ended March 31, 1998, respectively. These agreements
will expire in June 1998, July 1998, and August 1999. The Company expects that
these three contracts will continue to account for a substantial portion of the
Company's revenues for the foreseeable future. Each of these contracts is
subject to annual review and renewal by the applicable government entity, and
may be terminated, without cause, at any time. Accordingly, there can be no
assurance that the Company will derive any revenue from sales of Software to the
U.S. government in any given future period. In the event that any one of these
contracts is not renewed or is otherwise terminated by the U.S. government, the
Company's business, financial condition and results of operations would be
materially adversely affected. See "Business -- Products."
Management of Potential Growth; New Management Team; Limited Senior
Management Resources. The Company has rapidly and significantly expanded its
operations, and anticipates that further significant expansion will be required
to address potential growth in its customer base and market opportunities. This
expansion has placed, and is expected to continue to place, a significant strain
on the Company's managerial, operational and financial resources. The majority
of the Company's senior management joined the Company within the last two
months, including the Company's President and Chief Executive Officer and the
Company's Chief Financial Officer. The Chairman of the Company's Board of
Directors, William S. McKiernan, serves as the President and Chief Executive
Officer of CyberSource Corporation ("CyberSource") and, accordingly, plays a
limited role in the Company's management. The Company's new employees include a
number of key managerial, technical and operations personnel who have not yet
been fully integrated into the
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Company, and the Company expects to add additional key personnel in the near
future. To manage the expected growth of its operations and personnel, the
Company will be required to improve existing and implement new transaction
processing, operational and financial systems, procedures and controls, and to
expand, train and manage its growing employee base, including its finance,
administrative and operations staff. There can be no assurance that the
Company's current or planned personnel, systems, procedures and controls will be
adequate to support the Company's future operations, that management will be
able to hire, train, retain, motivate and manage required personnel or that the
Company's management will be able to successfully identify, manage and exploit
existing and potential market opportunities. If the Company is unable to manage
growth effectively, its business, financial condition and results of operations
would be materially adversely affected. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations,"
"Business -- Employees," and "Management."
Dependence on Key Personnel; Need for Additional Personnel. The Company's
performance is substantially dependent on the continued services and on the
performance of its senior management and other key personnel, particularly
William S. McKiernan, Chairman of the Company's Board of Directors, Mark L.
Breier, its President and Chief Executive Officer, and John P. Pettitt, its
Executive Vice President and Chief Technology Officer. The Company's performance
also depends on the Company's ability to retain and motivate its other officers
and key employees. The loss of the services of any of its executive officers or
other key employees could have a material adverse effect on the Company's
business, financial condition and results of operations. The Chairman of the
Company's Board of Directors, William S. McKiernan, is the President and Chief
Executive Officer of CyberSource and, accordingly, will play a limited role in
the Company's management. The Company does not have long-term employment
agreements with any of its key personnel. The Company's future success also
depends on its ability to identify, attract, hire, train, retain and motivate
other highly skilled technical, managerial, editorial, merchandising, marketing
and customer service personnel. Competition for such personnel is intense, and
there can be no assurance that the Company will be able to successfully attract,
assimilate or retain sufficiently qualified personnel. In particular, skilled
technical employees are highly sought after in the Silicon Valley area, and
there can be no assurance that the Company will be able to retain or attract
such employees. The failure to retain and attract the necessary technical,
managerial, merchandising, marketing and customer service personnel could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Business -- Employees" and "Management."
Risk of Capacity Constraints; Reliance on Internally Developed Systems;
System Development Risks. A key element of the Company's strategy is to
generate a high volume of traffic on, and use of, its Web site. The Company's
revenues depend on the number of customers who use its Web site to purchase
Software. Accordingly, the satisfactory performance, reliability and
availability of the Company's Web site, transaction-processing systems and
network infrastructure are critical to the Company's operating results, as well
as to its reputation and its ability to attract and retain customers and
maintain adequate customer service levels. Any systems interruptions that result
in the unavailability of the Company's Web site or reduced order fulfillment
performance would reduce the volume of goods sold and the attractiveness of the
Company's product and service offerings, which could have a material adverse
effect on the Company's business, financial condition and results of operations.
The Company has experienced periodic system interruptions, which it
believes will continue to occur from time to time. The Company is continually
enhancing and expanding its technology and transaction-processing systems, and
network infrastructure and other technologies to accommodate a substantial
increase in the volume of traffic on the Company's Web site. There can be no
assurance that the Company will be successful in these efforts or that the
Company will be able to accurately project the rate or timing of increases, if
any, in the use of its Web site or timely expand and upgrade its systems and
infrastructure to accommodate such increases. In addition, there can
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be no assurance that additional network capacity will be available from third
party suppliers as it is needed by the Company. There can be no assurance that
the Company's or its suppliers' network will be able to timely achieve or
maintain a sufficiently high capacity of data transmission, especially if the
customer usage of the Company's Web site increases. The Company's failure to
achieve or maintain high capacity data transmission could significantly reduce
consumer demand for its services and have a material adverse effect on its
business, financial condition and results of operations. See "Risks Associated
with Dependence on CyberSource Corporation; Relationship with CyberSource
Corporation" and "Business -- Technology."
Risks Associated with Dependence on CyberSource Corporation; Relationship
with CyberSource Corporation. The Company is dependent upon CyberSource for
certain services such as credit card processing, fraud screening, export
control, sales tax computation, electronic licensing, hosting of electronic
downloads and fulfillment messaging. In addition, pursuant to the terms of an
Inter-Company Cross License Agreement between the Company and CyberSource, the
Company licenses certain technology, including Sm@rtCert, from CyberSource on a
non-exclusive basis subject to certain limitations. Any discontinuation of such
services or termination of such license or any reduction in performance that
requires the Company to replace such services or internally develop or license
such technology from a third party, would be disruptive to the Company's
business and could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, any failure by
CyberSource to ensure that such software complies with "Year 2000" requirements
could have a material adverse effect on the Company's business, financial
condition and results of operations. CyberSource also provides these services
and licenses such technology to other customers, including competitors of the
Company.
Certain former and current members of the Company's management have joined
CyberSource in executive management positions including William S. McKiernan,
the Chairman of the Company's Board of Directors, who serves as President and
Chief Executive Officer of CyberSource. Furthermore, five of the six members of
the Company's Board of Directors serve on the CyberSource Board of Directors.
Nothing in the Company's agreements with CyberSource prohibits CyberSource from
competing directly with the Company or being acquired by a third party, either
of which could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business -- Technology,"
"Certain Transactions" and "Management -- Compensation Committee Interlocks and
Insider Participation."
Potential Conflicts of Interest with CyberSource. In connection with the
spin-off of the Company's internet commerce services business to CyberSource in
December 1997 (the "Spin-off"), the Company and CyberSource have entered into
certain agreements for the purpose of defining the ongoing relationship between
the two companies. Five out of six of the Company's directors are also directors
of CyberSource and certain other members of the Company's management team joined
CyberSource as executive officers. Accordingly, these agreements are not the
result of arm's length negotiations. Further, although the Company and
CyberSource are engaged in different businesses, the respective managements of
the Company and CyberSource currently have not adopted policies to govern the
pursuit or allocation of corporate opportunities between the Company and
CyberSource. In the event the overlapping board members of CyberSource and the
Company pursue the interests of CyberSource with respect to corporate
opportunities over those of the Company in the course of intercompany
transactions or where the same corporate opportunities are available to both
companies, the Company's business, financial condition and results of operation
could be materially adversely affected. See "Business -- Relationship with
CyberSource Corporation."
Risk of System Failure; Single Site. The Company's success, in particular
its ability to successfully receive and fulfill orders and provide high quality
customer service, largely depends on the efficient and uninterrupted operation
of its computer and communications systems. Substantially all of the Company's
development and management systems are located at a single facility leased by
the Company in San Jose, California. The Company contracts with a third party
for
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facilities for the Company's production, computer and communications hardware
systems and for mission critical Internet connectivity, and these systems are
located at a single location in Santa Clara, California. The Company's systems
and operations are vulnerable to damage or interruption from fire, flood, power
loss, telecommunications failure, break-ins, earthquake and similar events. The
Company does not have a formal disaster recovery plan and does not carry
sufficient business interruption insurance to compensate it for losses that may
occur. Furthermore, there can be no assurance that either the security
mechanisms of the Company or of the Company's other suppliers will prevent
security breaches or service breakdowns. Despite the implementation of these
security measures by the Company, its servers may be vulnerable to computer
viruses, physical or electronic break-ins and similar disruptions, which could
lead to interruptions, delays, loss of data or the inability to accept and
fulfill customer orders. The occurrence of any of the foregoing risks could have
a material adverse effect on the Company's business, financial condition and
results of operations. See "Business -- Technology" and "-- Facilities."
Risks Associated With Global Expansion. Although the Company sells
Software to customers outside the United States, the Company does not currently
have any overseas fulfillment or distribution facility or arrangement or any Web
site content localized for foreign markets, and there can be no assurance that
the Company will be able to expand its global presence. In addition, there are
certain risks inherent in doing business on a global level, such as regulatory
requirements, export restrictions, tariffs and other trade barriers,
difficulties in staffing and managing foreign operations, difficulties in
protecting intellectual property rights, longer payment cycles, problems in
collecting accounts receivable, political instability, fluctuations in currency
exchange rates and potentially adverse tax consequences, which could adversely
impact the success of the Company's global operations. In addition, the export
of certain Software from the United States is subject to export restrictions as
a result of the encryption technology in such Software and may give rise to
liability to the extent the Company violates such restrictions. There can be no
assurance that the Company will be able to successfully market, sell and
distribute its products in local markets or that one or more of such factors
will not have a material adverse effect on the Company's future global
operations, and consequently, on the Company's business, financial condition and
results of operations.
Uncertain Acceptance of the Company's Brand. The Company believes that
establishing, maintaining and enhancing the Company's brand is a critical aspect
of its efforts to attract and expand its online traffic. The growing number of
Internet sites that offer competing products and services, many of which already
have well-established brands in online services or the Software industry
generally, increase the importance of establishing and maintaining brand name
recognition. Promotion of the Company's brand will depend largely on the
Company's success in providing a high quality online experience supported by
dedicated customer service which cannot be assured. In addition, to attract and
retain online users and to promote and maintain the Company's brand in response
to competitive pressures, the Company may find it necessary to increase
substantially its financial commitment to creating and maintaining a strong
brand loyalty among customers. If the Company is unable to provide high quality
online services or customer support, or otherwise fails to promote and maintain
its brand, or if the Company incurs excessive expenses in an attempt to promote
and maintain its brand, the Company's business, financial condition and results
of operations would be materially adversely affected.
Rapid Technological Change. To remain competitive, the Company must
continue to enhance and improve the responsiveness, functionality and features
of the software.net online store. The Internet and the online commerce industry
are characterized by rapid technological change, changes in user and customer
requirements and preferences, frequent new product and service introductions
embodying new technologies and the emergence of new industry standards and
practices that could render the Company's existing Web site and proprietary
technology and systems obsolete. The Company's success will depend, in part, on
its ability to both license and internally develop leading technologies useful
in its business, enhance its existing services, develop
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new services and technology that address the increasingly sophisticated and
varied needs of its prospective customers, and respond to technological advances
and emerging industry standards and practices on a cost-effective and timely
basis. The development of Web site and other proprietary technology entails
significant technical and business risks. There can be no assurance that the
Company will successfully use new technologies effectively or adapt its Web
site, proprietary technology and transaction-processing systems to customer
requirements or emerging industry standards. If the Company is unable, for
technical, legal, financial or other reasons, to adapt in a timely manner to
changing market conditions, customer requirements or emerging industry
standards, its business, financial condition and results of operations could be
materially adversely affected. See "Business -- Technology."
Year 2000 Compliance. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. These date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. This could result in
system failures or miscalculations causing disruptions of operations including,
among other things, a temporary inability to process transactions, send
invoices, or engage in similar normal business activities. As a result, many
companies' software and computer systems may need to be upgraded or replaced in
order to comply with such "Year 2000" requirements. The Company utilizes
third-party equipment and software that may not be Year 2000 compliant. The
Company is in the early stages of conducting an audit of its third-party
suppliers as to the Year 2000 compliance of their systems. Failure of the
Company's internal computer systems or of such third-party equipment or
software, or of systems maintained by the Company's suppliers, to operate
properly with regard to the Year 2000 and thereafter could require the Company
to incur unanticipated expenses to remedy any problems, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. Furthermore, the purchasing patterns of customers or
potential customers may be affected by Year 2000 issues as companies expend
significant resources to correct their current systems for Year 2000 compliance.
These expenditures may result in reduced funds available to purchase products
from the Company, which could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Risks Associated with Acquisitions and Entry into New Business Areas. The
Company has experienced substantial changes in the expansion of its business and
operations since inception. The Company may choose to expand its operations by
developing new Web sites, promoting new or complementary products or sales
formats, expanding the breadth and depth of products and services offered or
expanding its market presence through relationships with third parties. In
addition, the Company may broaden the scope and content of its online store
through the acquisition of existing online services, or content and businesses
specializing in ESD and Software distribution. Although no such acquisitions are
currently being negotiated, any future acquisitions would expose the Company to
increased risks, including risks associated with the assimilation of new
operations, sites and personnel, the diversion of resources from the Company's
existing businesses, sites and technologies, the inability to generate revenues
from new sites or content sufficient to offset associated acquisition costs, the
maintenance of uniform standards, controls, procedures and policies and the
impairment of relationships with employees and customers as a result of any
integration of new management personnel. Acquisitions may also result in
additional expenses associated with amortization of acquired intangible assets
or potential businesses. There can be no assurance that the Company would be
successful in overcoming these risks or any other problems encountered in
connection with such acquisitions, and its inability to overcome such risks
could have a material adverse effect on the Company's business, financial
condition and results of operations.
Uncertain Protection of Intellectual Property. The Company regards its
copyrights, service marks, trademarks, trade dress, trade secrets and similar
intellectual property as critical to its
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success, and relies on trademark and copyright law, trade secret protection and
confidentiality and/or license agreements with its employees, customers,
partners and others to protect its proprietary rights. The Company pursues the
registration of its trademarks and service marks in the U.S., and has applied
for the registration of certain of its trademarks and service marks. The Company
applied for Federal registration of the service mark "SOFTWARE.NET" on August
24, 1994, and there can be no assurance that a Federal registration of this
service mark or any other service mark will issue. Effective trademark, service
mark, copyright and trade secret protection may not be available in every
country in which the Company's products and services are made available online.
The Company has licensed in the past, and expects that it may license in the
future, certain of its proprietary rights, such as trademarks or copyrighted
material, to third parties. While the Company attempts to ensure that the
quality of its brand is maintained by such licensees, there can be no assurance
that such licensees will not take actions that might materially adversely affect
the value of the Company's proprietary rights or reputation, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. There can be no assurance that the steps taken by the
Company to protect its proprietary rights will be adequate or that third parties
will not infringe or misappropriate the Company's trade secrets, copyrights,
trademarks, trade dress and similar proprietary rights. In addition, there can
be no assurance that others will not independently develop substantially
equivalent intellectual property. A failure by the Company to protect its
intellectual property in a meaningful manner could have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, litigation may be necessary in the future to enforce the Company's
intellectual property rights, to protect the Company's trade secrets or to
determine the validity and scope of the proprietary rights of others. Such
litigation could result in substantial costs and diversion of management and
technical resources, either of which could have a material adverse effect on the
Company's business, financial condition and results of operations.
In addition, there can be no assurance that other parties will not assert
infringement claims against the Company. From time to time, the Company has
received, and may receive in the future, notice of claims of infringement of
other parties' proprietary rights. There can be no assurance that such claims
will not be asserted or prosecuted against the Company in the future or that any
past or future assertions or prosecutions will not materially adversely affect
the Company's business, financial condition and results of operations. The
defense of any such claims, whether such claims are with or without merit, could
be time-consuming, result in costly litigation and diversion of technical and
management personnel, cause product shipment delays or require the Company to
develop non-infringing technology or enter into royalty or licensing agreements.
Such royalty or licensing agreements, if required, may not be available on terms
acceptable to the Company, or at all. In the event of a successful claim of
product infringement against the Company and the failure or inability of the
Company to develop non-infringing technology or license the infringed or similar
technology on a timely basis, the Company's business, financial condition and
results of operations could be materially adversely affected. See
"Business -- Legal Proceedings" and "-- Intellectual Property."
Government Regulation and Legal Uncertainties. The Company is not
currently subject to direct regulation by any domestic or foreign governmental
agency, other than regulations applicable to businesses generally, export
control laws and laws or regulations directly applicable to online commerce.
However, due to the increasing popularity and use of the Internet and other
online services, it is possible that a number of laws and regulations may be
adopted with respect to the Internet or other online services covering issues
such as user privacy, pricing, content, copyrights, distribution and
characteristics and quality of products and services. Furthermore, the growth
and development of the market for online commerce may prompt calls for more
stringent consumer protection laws that may impose additional burdens on those
companies conducting business online. The adoption of certain additional laws or
regulations may decrease the growth of the Internet or other online services,
which could, in turn, decrease the demand for the Company's
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products and services and increase the Company's cost of doing business, or
otherwise have an adverse effect on the Company's business, financial condition
and results of operations.
Applicability to the Internet of existing laws governing issues such as
property ownership, copyrights and other intellectual property issues, taxation,
libel, obscenity and personal privacy is uncertain. The vast majority of such
laws were adopted prior to the advent of the Internet and related technologies
and, as a result, do not contemplate or address the unique issues of the
Internet and related technologies. Changes to such laws intended to address
these issues, including some recently proposed changes, could create uncertainty
in the Internet marketplace which could reduce demand for the services of the
Company or increase the cost of doing business as a result of costs of
litigation or increased service delivery costs, or could in some other manner
have a material adverse effect on the Company's business, financial condition
and results of operations.
In addition, as the Company's services are available over the Internet in
multiple states and foreign countries, such jurisdictions may claim that the
Company is required to qualify to do business as a foreign corporation in each
such state or foreign country. The Company is qualified to do business only in
California and Virginia, and failure by the Company to qualify as a foreign
corporation in a jurisdiction where it is required to do so could subject the
Company to taxes and penalties for the failure to qualify and could result in
the inability of the Company to enforce contracts in such jurisdictions. Any
such new legislation or regulation, the application of laws and regulations from
jurisdictions whose laws do not currently apply to the Company's business, or
the application of existing laws and regulations to the Internet and other
online services could have a material adverse effect on the Company's business,
financial condition and results of operations.
Liability for Internet Content. The Company believes that its future
success will depend in part upon its ability to deliver original and compelling
descriptive content about the Software products it sells on the Internet. As a
publisher of online content, the Company faces potential liability for
defamation, negligence, copyright, patent or trademark infringement, or other
claims based on the nature and content of materials that the Company publishes
or distributes. Such claims have been brought, and sometimes successfully
litigated, against online services. In addition, in the event that the Company
implements a greater level of interconnectivity on its site, the Company will
not and cannot practically screen all of the content generated or accessed by
its users, and the Company could be exposed to liability with respect to such
content. Although the Company carries general liability insurance, the Company's
insurance may not cover claims of these types or may not be adequate to
indemnify the Company for all liability that may be imposed. Any imposition of
liability, particularly liability that is not covered by insurance or is in
excess of insurance coverage, could have a material adverse effect on the
Company's reputation and its business, financial condition and results of
operations.
Sales and Other Taxes. The Company does not currently collect sales or
other similar taxes in respect of shipments of goods or ESD sales into states
other than California and Virginia. However, one or more local, state or foreign
jurisdictions may seek to impose sales tax collection obligations on out of
state companies, such as the Company, which engage in online commerce. In
addition, any new operation in states outside California and Virginia could
subject shipments into such states to state sales taxes under current or future
laws. A successful assertion by one or more states or any foreign country that
the Company should collect sales or other taxes on the sale of merchandise could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Control of the Company. Upon completion of this offering, the Company's
directors and executive officers and their respective affiliates will
beneficially own in the aggregate approximately 61.3% of the outstanding Common
Stock. In particular, William S. McKiernan, the Chairman of the Company's Board
of Directors, will hold approximately 33.9% of the outstanding Common Stock. As
a result, these stockholders, if they act together, will be able to exercise
significant influence
17
<PAGE> 18
over all matters requiring stockholder approval, including the election of
directors and approval of significant corporate transactions. Such concentration
of ownership also may have the effect of delaying, preventing or deterring a
change in control of the Company which could have an adverse effect on the
market price of the Common Stock. See "Management," "Certain Transactions" and
"Principal Stockholders."
No Prior Public Market; Possible Volatility of Stock Price. The trading
price of the Common Stock is likely to be highly volatile and could be subject
to wide fluctuations in response to factors such as actual or anticipated
variations in quarterly operating results, announcements of technological
innovations, new sales formats or new products or services by the Company or its
competitors, changes in financial estimates by securities analysts, conditions
or trends in the Internet and online commerce industries, changes in the
economic performance and/or market valuations of other Internet, online service
or retail companies, announcements by the Company of significant acquisitions,
strategic partnerships, joint ventures or capital commitments, additions or
departures of key personnel, sales of Common Stock and other events or factors,
many of which are beyond the Company's control. In addition, the stock market in
general, and the Nasdaq National Market and the market for Internet-related and
technology companies in particular, has experienced extreme price and volume
fluctuations that have often been unrelated or disproportionate to the operating
performance of such companies. The trading prices of many technology companies'
stocks are at or near historical highs and reflect price earnings ratios
substantially above historical levels. There can be no assurance that these
trading prices and price earnings ratios will be sustained. These broad market
and industry factors may materially and adversely affect the market price of the
Common Stock, regardless of the Company's actual operating performance. In the
past, following periods of volatility in the market price of a company's
securities, securities class-action litigation has often been instituted against
such companies. Such litigation, if instituted, could result in substantial
costs and a diversion of management's attention and resources, which would have
a material adverse effect on the Company's business, financial condition and
results of operations.
Benefits of the Offering to Current Stockholders. The existing stockholders
of the Company may benefit from this offering of Common Stock through the
creation of a public market for the Common Stock and through a potential
increase in the market value of their shares. Following the offering, shares are
expected to trade in a regular public trading market. Although the Common Stock
held by the existing stockholders of the Company is not being registered in
connection with this offering, the existing stockholders will be able to sell
their shares into the public market upon the expiration of certain lock-up
agreements entered into by such stockholders with Representatives of the
Underwriters if such shares are registered under the Act or if they qualify for
an exemption from such registration, subject to certain limitations. In
addition, the price at which the Company's Common Stock publicly trades after
this offering may result in an increase in the market value of the shares held
by existing stockholders. However, the trading price of the Common Stock is
likely to be highly volatile and could be subject to wide fluctuations in
response to a number of factors. In addition, the stock market in general, and
the Nasdaq National Market and the market for Internet-related and technology
companies in particular, has experienced extreme price and volume fluctuations
at times that have often been unrelated or disproportionate to the operating
performance of such companies. See "-- No Prior Market, Possible Violatility of
Stock Price," "Dilution," "Principal Stockholders," "Shares Eligible for Future
Sale" and "Underwriting."
Shares Eligible For Future Sale. Sales of significant amounts of Common
Stock in the public market after the offering or the perception that such sales
will occur could materially and adversely affect the market price of the Common
Stock or the future ability of the Company to raise capital
18
<PAGE> 19
through an offering of its equity securities. The 21,546,452 shares of Common
Stock held by existing stockholders immediately prior to the closing of the
offering will be "restricted securities" as that term is defined in Rule 144
under the Securities Act of 1933, as amended (the "Securities Act") (which
amount includes 238,948 shares of Common Stock to be issued to AOL immediately
prior to the consummation of this offering. Restricted securities may be sold in
the public market only if registered or if they qualify for an exemption from
registration under Rule 144 or 701 promulgated under the Securities Act.
Beginning 180 days after the date of this Prospectus, upon expiration of lock-up
agreements (the "Lock-up Agreements") between the Representatives of the
Underwriters and the officers, directors and stockholders of the Company,
approximately 4,687,202 shares will be eligible for sale without restriction
under Rule 144(k) and 15,448,114 shares will be eligible for sale subject to
compliance with the volume and other restrictions of Rule 144. The remaining
1,441,205 shares will become eligible for sale at various times within a period
of 1 year from the expiration of the Lock-up Agreements, subject in some cases
to the volume and other restrictions of Rule 144. In addition, there are
outstanding options to purchase 3,710,513 shares of Common Stock which will be
eligible for sale in the public market from time to time upon the expiration of
the Lock-up Agreements, subject to vesting and in some cases the volume and
other restrictions of Rule 144. In addition, (i) certain stockholders,
representing approximately 21,198,962 shares of Common Stock and (ii) AOL in
respect of (a) the shares of Common Stock to be issued to AOL immediately prior
to the consummation of this offering and (b) the shares of Common Stock issuable
to AOL pursuant to a Warrant to be issued by the Company to AOL immediately
prior to the consummation of this offering have the right, subject to certain
conditions, to include their shares in future registration statements relating
to the Company's securities and/or to cause the Company to register certain
shares of Common Stock owned by them.
After the date of this Prospectus, the Company intends to file a Form S-8
registration statement under the Securities Act to register all shares of Common
Stock issuable under the Company's 1995 and 1998 Stock Option Plans. Such
registration statement is expected to become effective immediately upon filing,
and shares covered by that registration statement will thereupon be eligible for
sale in the public markets, subject to certain lock-up agreements and Rule 144
limitations applicable to affiliates. See "Management -- Stock Option Plans,"
"Description of Capital Stock -- Registration Rights," "Shares Eligible for
Future Sale," and "Underwriting."
Anti-Takeover Effect Of Certain Charter Provisions. Upon the closing of
this offering and following the automatic conversion and cancellation of the
8,176,404 presently outstanding shares of Preferred Stock concurrent herewith in
accordance with the Company's Amended and Restated Certificate of Incorporation,
the Company's Board of Directors will have the authority to issue up to
6,823,596 shares of Preferred Stock and to determine the price, rights,
preferences, privileges and restrictions, including voting rights, of those
shares without any further vote or action by the stockholders. The rights of the
holders of Common Stock will be subject to, and may be adversely affected by,
the rights of the holders of any Preferred Stock that may be issued in the
future. The issuance of Preferred Stock may have the effect of delaying,
deferring or preventing a change in control of the Company without further
action by the stockholders and may adversely affect the voting and other rights
of the holders of Common Stock. The Company has no present plans to issue shares
of Preferred Stock. Further, certain provisions of the Company's Certificate of
Incorporation and Bylaws and Delaware law could delay or make more difficult a
merger, tender offer or proxy contest involving the Company. See "Description of
Capital Stock."
Immediate and Substantial Dilution. The initial public offering price is
substantially higher than the value per outstanding share of Common Stock.
Accordingly, purchasers in this offering will suffer an immediate and
substantial dilution of $7.33 per share in the net tangible value of the
19
<PAGE> 20
Common Stock from the initial public offering price. Additional dilution will
occur upon exercise of outstanding options granted by the Company. See
"Dilution."
Potential Conflict of Interest with Certain of the Representatives of the
Underwriters. Affiliates of C.E. Unterberg, Towbin, one of the representatives
of the Underwriters, are stockholders of the Company, and Steven P. Novak, a
Director and a stockholder of the Company, is a Managing Director of C.E.
Unterberg, Towbin. After this offering, affiliates of C.E. Unterberg, Towbin
will hold in the aggregate more than 10.0% of the outstanding capital stock of
the Company, which could be deemed to constitute a conflict of interest in
accordance with Rule 2720 ("Rule 2720") of the National Association of Security
Dealers, Inc. (the "NASD"). Rule 2720 provides that, among other things, when an
NASD member firm participates in the offering of equity securities of a company
with who such member has a "conflict of interest" (as defined in Rule 2720), the
initial public offering price can be no higher than that recommended by a
"qualified independent underwriter" (as defined in Rule 2720) (a "QIU").
Deutsche Bank Securities Inc. ("Deutsche Bank Securities") plans to serve as the
QIU in connection with this offering and will recommend a price in compliance
with the requirements of Rule 2720. Deutsche Bank Securities, in its capacity as
QIU, will receive no additional compensation as such in connection with this
offering. In May 1998, Deutsche Bank AG ("Deutsche Bank") and the Company
entered into a credit agreement pursuant to which Deutsche Bank issued a standby
letter of credit for the benefit of the Company and Deutsche Bank loaned the
Company additional funds pursuant to a term loan. Deutsche Bank is the parent
corporation of Deutsche Bank Securities. See "Dividend Policy," "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" and "Underwriting."
20
<PAGE> 21
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 5,000,000 shares of
Common Stock offered hereby are $41.1 million ($47.4 million if the
Underwriters' over-allotment option is exercised in full), after deducting the
underwriting discount and estimated offering expenses.
The principal purposes of this offering are to obtain additional capital,
to create a public market for the Common Stock, to facilitate future access by
the Company to public equity markets, and to provide increased visibility and
credibility in a marketplace where many of the Company's current and potential
competitors are or will be publicly held companies. The Company intends to use a
portion of the net proceeds to pay for a portion of its obligations to AOL and
Excite pursuant to the Company's agreements with these parties, which total
approximately $25 million over the next three years, and of which approximately
$14 million must be paid within the next twelve months. In addition, the Company
may, when the opportunity arises, use an unspecified portion of the net proceeds
to acquire or invest in complementary businesses, products and technologies.
From time to time, in the ordinary course of business, the Company expects to
evaluate potential acquisitions of such businesses, products or technologies.
However, the Company has no present understandings, commitments or agreements
with respect to any material acquisition or investment. The Company has no
specific plan for use of the remaining proceeds and expects to use such proceeds
for general corporate purposes, including working capital to fund anticipated
operating losses and capital expenditures. Pending use of the net proceeds for
the above purposes, the Company intends to invest such funds in short-term,
interest bearing, investment grade securities. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources" and "Risk Factors -- Need for Additional Capital."
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its capital
stock. However, in connection with the Spin-off of the Company's Internet
commerce service business on December 31, 1997, the Company's shareholders were
issued shares of capital stock of Internet Commerce Services Corporation
(currently operating as CyberSource Corporation ("CyberSource")) in
consideration of the transfer by the Company to CyberSource of all of the assets
and liabilities of the Company's Internet commerce business. The Company
currently intends to retain all available funds and any future earnings of its
business for use in the operation of its business and does not anticipate paying
any cash or other dividends in the foreseeable future. See "Certain
Transactions."
In May 1998, the Company entered into a credit agreement (the "Credit
Agreement") with Deutsche Bank AG ("Deutsche Bank"). Deutsche Bank is the parent
corporation of Deutsche Bank Securities Inc., one of the representatives of the
Underwriters. The Credit Agreement contains covenants that restrict and limit
the payment of dividends by the Company such that dividends may be issued solely
in the Common Stock of the Company. Pursuant to these restrictions the Company
is unable to issue cash dividends during the term of the Credit Agreement.
Although the Company intends to convert the amounts outstanding under the Credit
Agreement into a new credit facility, the Company expects that any new credit
facility will contain similar restrictive covenants; provided, however, there
can be no assurances that any such conversion will be on similar terms or
subject to similar restrictive covenants. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
21
<PAGE> 22
CAPITALIZATION
The following table sets forth as of March 31, 1998: (i) the actual
capitalization of the Company; (ii) the proforma capitalization of the Company
giving effect to the conversion of the outstanding Preferred Stock into Common
Stock upon the closing of this offering, including 276,466 shares of Series D
Preferred Stock issued in April 1998, into an aggregate of 12,198,962 shares of
Common Stock; and (iii) the proforma capitalization of the Company as adjusted
to reflect the receipt of the estimated net proceeds from the sale of the
5,000,000 shares of Common Stock offered hereby after deducting underwriting
discounts and estimated offering expenses and the sale of 238,948 shares of
Common Stock at $8.37 per share to AOL immediately prior to the consummation of
this offering. This table should be read in conjunction with the Company's
Consolidated Financial Statements and Notes thereto included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
MARCH 31, 1998
-----------------------------------
(IN THOUSANDS)
PROFORMA AS
ACTUAL PROFORMA ADJUSTED
-------- -------- -----------
<S> <C> <C> <C>
Long-term obligations, net of current maturities.... $ 33 $ 33 $ 33
Redeemable Convertible Preferred Stock; no par
value, 10,000,000 shares authorized actual;
7,899,938 shares issued and outstanding, actual;
no shares authorized, issued or outstanding
proforma and proforma as adjusted................. 15,257 -- --
Stockholders' equity:
Preferred Stock, no par value, no shares
authorized, issued or outstanding actual;
15,000,000 shares authorized proforma and
proforma as adjusted; no shares issued or
outstanding proforma and proforma as
adjusted....................................... -- -- --
Common Stock, no par value: 30,000,000 shares
authorized actual; 50,000,000 shares,
authorized proforma and proforma as adjusted;
9,090,000 shares issued and outstanding actual;
40,000,000 shares authorized, 21,288,962 shares
issued and outstanding proforma; 26,527,910
shares issued and outstanding proforma as
adjusted(1).................................... 2,339 18,315 61,415
Deferred compensation............................. (2,292) (2,292) (2,292)
Accumulated deficit............................... (13,490) (13,490) (13,490)
-------- -------- --------
Total stockholders' equity (net capital
deficiency).................................. (13,443) 2,533 45,633
-------- -------- --------
Total capitalization...................... $ 1,847 $ 2,566 $ 45,666
======== ======== ========
</TABLE>
- ---------------
(1) Based on shares outstanding as of March 31, 1998. Includes: (i) the
conversion into Common Stock of 276,466 shares of Series D Preferred Stock
issued in April 1998, and (ii) 238,948 shares of Common Stock to be issued
to AOL immediately prior to the consummation of this offering. Excludes as
of the date of this Prospectus: (i) 3,710,513 shares of Common Stock
issuable upon exercise of options outstanding under the Company's 1995 and
1998 Stock Option Plans, as amended (collectively, the "Plans"), at a
weighted average exercise price of $2.44 per share; (ii) 1,000,000 shares of
Common Stock issuable upon exercise of outstanding options granted outside
of the Plans at a weighted average exercise price of $0.004 per share; (iii)
1,180,945 shares of Common Stock reserved for future issuance under the
Plans, and (iv) 358,422 shares of Common Stock reserved for issuance
pursuant to the exercise of a warrant issued by the Company to AOL at an
exercise price of $8.37 per share. See "Certain Transactions," "Description
of Capital Stock" and Notes 3 and 7 of Notes to Consolidated Financial
Statements.
22
<PAGE> 23
DILUTION
The proforma net tangible book value of the Company as of March 31, 1998
was approximately $1.3 million, or $0.06 per share of Common Stock. Proforma net
tangible book value per share represents the amount of total tangible assets
less total liabilities, divided by the total proforma number of shares of Common
Stock outstanding, after giving effect to the automatic conversion of all
outstanding 8,176,404 shares of Preferred Stock (including 276,466 shares of
Series D Preferred Stock issued in April 1998) into an aggregate of 12,198,962
shares of Common Stock. After giving effect to the sale of the 5,000,000 shares
of Common Stock offered by the Company hereby, after deducting underwriting
discounts and commissions and estimated offering expenses payable by the
Company, and the sale of 238,948 shares of Common Stock to AOL at the price of
$8.37 per share, the proforma net tangible book value of the Company, as
adjusted, at March 31, 1998 would have been $44.4 million or $1.67 per share of
Common Stock. This amount represents an immediate increase in such net tangible
book value of $1.61 per share to existing shareholders and an immediate dilution
of $7.33 per share to new investors. The following table illustrates this per
share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share..................... $9.00
Proforma net tangible book value at March 31, 1998........ $0.06
Increase attributable to AOL.............................. .09
Increase attributable to new investors.................... 1.52
-----
Adjusted proforma net tangible book value after this
offering and the sale of shares to AOL.................... 1.67
-----
Dilution per share to new investors......................... $7.33
=====
</TABLE>
The following table summarizes, on a proforma basis as of March 31, 1998,
the number of shares of Common Stock purchased from the Company, the total
consideration paid to the Company, and the average price per share paid by
existing shareholders and to be paid by AOL and purchasers of the shares offered
by the Company hereby (before deducting underwriting discounts and commissions
and estimated offering expenses payable by the Company).
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
--------------------- -------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- -------- -------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Existing Stockholders(1)(2)... 21,288,962 80.3% $15,741 25.1% $0.74
AOL(2)(3)..................... 238,948 0.9 2,000 3.2 7.44
New Investors................. 5,000,000 18.8 45,000 71.7 9.00
---------- ----- ------- -----
Total(1)(2)(3)...... 26,527,910 100.0% $62,741 100.0%
========== ===== ======= =====
</TABLE>
- ---------------
(1) Based on shares outstanding as of March 31, 1998, including conversion into
Common Stock of 276,466 shares of Series D Preferred Stock issued in April
1998.
(2) Excludes: (i) 3,710,513 shares of Common Stock issuable upon exercise of
options outstanding under the Company's 1995 and 1998 Stock Option Plans, as
amended (collectively, the "Plans"), at a weighted average exercise price of
$2.44 per share; (ii) 1,000,000 shares of Common Stock issuable upon
exercise of outstanding options granted outside of the Plans, at a weighted
average exercise price of $0.004 per share; (iii) 1,180,945 shares of Common
Stock reserved for future issuance under the Plans; and (iv) 358,422 shares
of Common Stock reserved for issuance pursuant to the exercise of a warrant
issued by the Company to AOL at an exercise price of $8.37 per share. See
"Certain Transactions," "Description of Capital Stock" and Notes 3 and 7 of
Notes to Consolidated Financial Statements.
(3) Reflects 238,948 shares of Common Stock to be issued to AOL immediately
prior to the consummation of this offering at a price of $8.37 per share.
23
<PAGE> 24
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements and Notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this Prospectus. The consolidated statement of
operations data for the years ended December 31, 1995, 1996 and 1997 and the
consolidated balance sheet data at December 31, 1996 and 1997 are derived from
the Consolidated Financial Statements of the Company which have been audited by
Ernst & Young LLP, independent auditors, and are included elsewhere in this
Prospectus, and are qualified by reference to such Consolidated Financial
Statements and the Notes thereto. The consolidated statement of operations data
for the period from August 12, 1994 (date of incorporation) to December 31, 1994
and the consolidated balance sheet data at December 31, 1995 are derived from
the consolidated financial statements of the Company not included herein which
have been audited by Ernst & Young LLP, independent auditors. The consolidated
balance sheet data as of December 31, 1994, are derived from unaudited financial
statements of the Company not included herein. The selected consolidated
financial data as of March 31, 1998, and for the quarters ended March 31, 1997
and 1998, are derived from unaudited consolidated financial statements of the
Company, which in the opinion of management include all adjustments, consisting
only of normal recurring adjustments, necessary for a fair presentation of the
financial information set forth therein. The historical results are not
necessarily indicative of future results.
<TABLE>
<CAPTION>
PERIOD FOR
AUGUST 12, 1994
(DATE OF
INCORPORATION) QUARTER ENDED
TO YEAR ENDED DECEMBER 31, MARCH 31,
DECEMBER 31, -------------------------- ----------------
1994 1995 1996 1997 1997 1998
--------------- ------ ------- ------- ------ -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net revenues...................................... $ 40 $1,003 $ 5,858 $16,806 $3,158 $ 6,192
Cost of revenues.................................. 3 623 5,137 14,873 2,783 5,254
------ ------ ------- ------- ------ -------
Gross profit...................................... 37 380 721 1,933 375 938
Operating expenses
Research and development........................ 164 388 431 1,060 155 602
Sales and marketing............................. 57 407 704 1,696 265 1,953
General and administrative...................... 43 103 450 1,087 164 635
------ ------ ------- ------- ------ -------
Total operating expenses...................... 264 898 1,585 3,843 584 3,190
------ ------ ------- ------- ------ -------
Loss from operations.............................. (227) (518) (864) (1,910) (209) (2,252)
Interest income, net.............................. -- 7 85 167 40 25
------ ------ ------- ------- ------ -------
Loss from continuing operations................... (227) (511) (779) (1,743) (169) (2,227)
Loss from discontinued operations................. -- -- (736) (3,616) (583) --
------ ------ ------- ------- ------ -------
Net loss.......................................... $ (227) $ (511) $(1,515) $(5,359) $ (752) $(2,227)
====== ====== ======= ======= ====== =======
Basic and diluted net loss per share from
continuing operations........................... $(0.03) $(0.07) $ (0.10) $ (0.21) $(0.02) $ (0.25)
Basic and diluted net loss per share from
discontinued operations......................... -- -- (0.08) (0.40) (0.07) --
------ ------ ------- ------- ------ -------
Basic and diluted net loss per share.............. $(0.03) $(0.07) $ (0.18) $ (0.61) $(0.09) $ (0.25)
====== ====== ======= ======= ====== =======
Share amounts used in the computation of net loss
per share....................................... 9,000 9,000 9,000 9,000 9,000 9,080
====== ====== ======= ======= ====== =======
Proforma basic and diluted net loss per share from
continuing operations........................... $ (0.10) $ (0.11)
Proforma basic and diluted net loss per share from
discontinued operations......................... (0.20) --
------- -------
Proforma basic and diluted net loss per share..... $ (0.30) $ (0.11)
======= =======
Shares used in computation of proforma net loss
per share amounts............................... 17,828 20,252
======= =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------ MARCH 31,
1994 1995 1996 1997 1998
------ ------ ------- -------- ---------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 12 $ 255 $ 3,737 $ 2,571 $ 2,232
Working capital (deficiency)................................ (89) (106) 3,543 1,093 918
Total assets................................................ 36 579 5,691 9,586 8,388
Long-term obligations, net of current portion............... 105 105 105 99 33
Redeemable convertible preferred stock...................... -- 651 6,395 12,565 15,257
Stockholders' equity (net capital deficiency)............... $ (181) $ (793) $(2,409) $(11,191) $(13,443)
</TABLE>
24
<PAGE> 25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto and the other
information included elsewhere in this Prospectus. Certain statements in this
"Management's Discussion and Analysis of Financial Conditions and Results of
Operations" are forward looking statements. The forward looking statements
contained herein are based on current expectations and entail various risks and
uncertainties that could cause actual results to differ materially from those
expressed in such forward looking statements. For a more detailed discussion of
these and other business risks, see "Risk Factors."
OVERVIEW
software.net is a leading online reseller of Software to the consumer,
small business and large enterprise markets. The Company operates its own Web
site and delivers Software to its customers over the Internet through electronic
software delivery ("ESD") and through physical delivery in shrink-wrap packages.
The Company launched its Web site in November 1994 and, in addition to selling
Software, the Company initially charged Software publishers a fee to list their
products on the Company's Web site. The Company ceased this practice in 1996. In
July of 1996, the Company expanded its business by entering into its first
contract with a U.S. government agency for the sale of Software products and
provision of related services. In July 1997, the Company expanded its
third-party sales channel by entering into an agreement with Netscape pursuant
to which the Company created, manages and maintains the Netscape Software Depot
Web site.
In March 1998, the Company further expanded its third-party sales channel
by entering into strategic relationships with AOL and Excite. The AOL agreement
(the "AOL Agreement") establishes the Company as the exclusive and
semi-exclusive reseller of Software on certain screens on the AOL service and
AOL's Web site, aol.com. Under the terms of the Excite agreement (the "Excite
Agreement"), the Company has the right to display banner advertisements and
links to the Company's Web site on certain Excite screens and Excite cannot
display paid promotional links or banner advertisements of any other Software
reseller on specified Excite screens related to Software. Each of AOL and Excite
is obligated, under their respective agreements with the Company, to deliver
minimum numbers of screen views with links to the Company's Web site
("Impressions"). The AOL Agreement provides for fixed payments totalling
approximately $21 million. In addition, the Company's agreement with Excite
provides for substantial payments to Excite during the three year term of that
agreement. In addition, the Company is obligated to pay AOL and Excite a
percentage of certain transactional revenues and, in the case of AOL,
advertising revenues earned by the Company in excess of specified thresholds.
The AOL Agreement terminates in August 2001, and the Excite Agreement terminates
when Excite has satisfied certain obligations with respect to delivery of
Impressions, but no earlier than April 2001. The Company's arrangements with
Netscape, AOL and Excite are expected to represent significant distribution
channels for the Company, and termination of one or more of such agreements
would likely have a material adverse effect on the Company's business, financial
condition and results of operations. There can be no assurance that the Company
will achieve sufficient online traffic, or generate sufficient revenues that
justify the Company's significant fixed financial obligations to AOL and Excite,
or to satisfy its contractual obligations necessary to prevent termination of
the AOL, Excite or Netscape agreements. See "Risk Factors -- Reliance on
Strategic Marketing Alliances with America Online, Excite and Netscape" and
"Business -- Strategic Relationships."
In order to focus on its core business of selling Software products online,
in December 1997, the Company spun off its Internet commerce related services
business (which included credit card processing, fraud screening, export
control, territory management, and electronic fulfillment) to CyberSource (the
"Spin-off"). As a result of the Spin-off, the Company's results of operations
25
<PAGE> 26
during 1996 and 1997 reflect a loss from discontinued operations in the amount
of $736,000 and $3.6 million, respectively. Under the terms of an Internet
commerce services agreement, the Company uses services supplied by CyberSource
on a non-exclusive basis for credit card processing, fraud screening, export
control, sales tax computation, electronic licensing, hosting of electronic
downloads and fulfillment notification. This Agreement expires on December 31,
1998 and automatically renews for an additional one year term, unless otherwise
terminated by either party. Pursuant to the terms of the services agreement, the
Company has agreed to indemnify CyberSource for an amount not to exceed $100,000
against any claim based upon an allegation that the Software distributed by the
Company infringes upon any third party's intellectual property rights.
CyberSource has agreed to indemnify the Company for an amount not to exceed
$100,000 against any claim based upon an allegation that the services, or the
use of any software provided by CyberSource in connection with the services,
provided by CyberSource to the Company infringes any third party's intellectual
property rights. The Company is also a party to a license agreement with
CyberSource pursuant to which the Company licenses certain technology, including
Sm@rtCert, from CyberSource on a non-exclusive, perpetual basis subject to
certain limitations. In addition, certain former members of the Company's
executive management have joined CyberSource in executive management positions.
In particular, William S. McKiernan, the Chairman of the Company's Board of
Directors, serves as the President and Chief Executive Officer of CyberSource.
In addition, five out of six members of the Company's Board of Directors serve
on CyberSource's Board of Directors. See "Risk Factors -- Risks Associated with
Dependence on CyberSource Corporation; Relationship with CyberSource
Corporation," "Business -- Relationship with CyberSource Corporation" and
"Certain Transactions."
Since inception the Company has experienced increasing net losses on an
annual basis. These annual net losses have increased from $511,000 in 1995 to
$5.4 million in 1997. The Company expects these annual net losses to continue to
increase as the Company expands its sales and marketing activities. For the
foreseeable future, the Company intends to expend significant financial and
management resources on brand development, marketing and promotion, site content
development, strategic relationships (such as those with AOL, Netscape and
Excite), and technology and operating infrastructure, including ESD
capabilities. Because the Company has relatively low gross margins, achieving
profitability given planned investment levels depends upon the Company's ability
to generate and sustain substantially increased levels of net revenue. As a
result, the Company expects to incur additional losses and continued negative
cash flow from operations for the foreseeable future, and such losses are
anticipated to increase significantly from current levels as marketing and
promotion costs increase, including new and increased expenses on greater staff
amounts and expenses on mass media advertising. There can be no assurance that
the Company's revenues will increase or even continue at their current level or
that the Company will achieve or maintain profitability or generate cash from
operations in future periods. The Company's current and future expense levels
are to a large extent fixed at a significant level primarily due to the
marketing agreements, and these levels are based on its operating plans and
estimates of future revenues which depend on anticipated sales resulting from
the marketing agreements and increased advertising and government sales. Sales
and operating results generally depend on the volume and timing of orders
received, which are difficult to forecast. Further, as noted above, the Company
expects these costs to increase above the fixed minimum. The Company may be
unable to adjust spending in a timely manner to compensate for any unexpected
revenue shortfall. Accordingly, any significant shortfall in revenues would have
an immediate adverse effect on the Company's business, financial condition and
results of operations. In view of the rapidly evolving nature of the Company's
business and its limited operating history in the online Software reselling
business, the Company is unable to accurately forecast its revenues and believes
that period-to-period comparisons of its operating results are not necessarily
meaningful and should not be relied upon as an indication of future performance.
The Company's revenues are primarily derived from sales of Software to
customers using credit cards, to corporate customers that are invoiced directly
under credit terms, to various U.S.
26
<PAGE> 27
government agencies pursuant to contractual arrangements and, to a lesser
extent, amounts received from Software publishers for advertising and promotion.
Revenues from the sale of Software, net of estimated returns, are recognized
upon either shipment of the physical product or delivery of the electronic
product. Net revenues associated with the sale of Software pursuant to contracts
with the U.S. government that require continuing service, support, and
performance by the Company, are deferred and recognized over the period that the
service, support, and performance are provided. Revenues derived from Software
publishers for advertising and promotional activities are recognized as the
services are provided. The Company's U.S. government contracts are subject to
annual review and renewal by the applicable government agency. Although all such
contracts presently remain in full force and effect, such contracts are
terminable without cause or prior notice. Because the government contracts may
be terminated without cause or prior notice, there can be no assurance that the
Company will generate any revenues from U.S. government contracts in any future
period. See "Risk Factors -- Customer Concentration; Risks Associated with
Reliance on United States Government Contracts."
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
relationship of certain items from the Company's consolidated statement of
operations to total net revenues.
<TABLE>
<CAPTION>
QUARTER ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
-------------------------- ----------------
1995 1996 1997 1997 1998
------ ------ ------ ------ ------
(UNAUDITED)
----------------
<S> <C> <C> <C> <C> <C>
Net Revenues.......................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues...................... 62.1 87.7 88.5 88.1 84.9
------ ------ ------ ------ ------
Gross profit.......................... 37.9 12.3 11.5 11.9 15.1
Operating expenses:
Research and development............ 38.7 7.3 6.3 4.9 9.7
Sales and marketing................. 40.6 12.0 10.1 8.4 31.5
General and administrative.......... 10.2 7.7 6.5 5.2 10.3
------ ------ ------ ------ ------
Total operating expenses............ 89.5 27.0 22.9 18.5 51.5
------ ------ ------ ------ ------
Loss from operations.................. (51.6) (14.7) (11.4) (6.6) (36.4)
Interest income, net.................. 0.7 1.4 1.0 1.3 0.4
------ ------ ------ ------ ------
Loss from continuing operations....... (50.9) (13.3) (10.4) (5.3) (36.0)
Loss from discontinued operations..... 0.0 (12.6) (21.5) (18.5) --
------ ------ ------ ------ ------
Net loss.............................. (50.9)% (25.9)% (31.9)% (23.8)% (36.0)%
====== ====== ====== ====== ======
</TABLE>
QUARTERS ENDED MARCH 31, 1997 AND 1998
Net Revenues. Net revenues increased from $3.2 million in the quarter
ended March 31, 1997 to $6.2 million in the quarter ended March 31, 1998,
primarily as a result of new U.S. government contracts and increased sales to
consumer and corporate customers. Net revenues from ESD Software sales were $3.8
million in the quarter ended March 31, 1998.
Cost of Revenues. Cost of revenues consists primarily of the costs of
Software sold to consumer and corporate customers and related credit card
processing fees, as well as the costs of Software licenses and Software updates
provided to the U.S. government. Total cost of revenues increased from $2.8
million in the quarter ended March 31, 1997 to $5.3 million in the quarter ended
March 31, 1998, as a result of increased Software sales.
Gross Margin. Gross margin (gross profit as a percentage of net revenues)
increased from 11.9% in the quarter ended March 31, 1997 to 15.1% in the quarter
ended March 31, 1998. This
27
<PAGE> 28
increase primarily was due to a shift in the Company's revenue mix, resulting
from an increased level of higher margin advertising and promotional revenues
received from Software publishers. The Company may in the future expand or
increase the discounts it offers to its customers and may otherwise alter its
pricing structures and policies. Such actions may have an adverse impact on
gross margin in future periods. In addition, the Company's gross margin in
future periods may decline to the extent that revenues from sales to the U.S.
government or sales to large enterprise customers increase as a percentage of
the Company's total net revenues.
Research and Development Expenses. Research and development expenses
primarily consist of personnel and other expenses associated with developing and
enhancing the Company's Web sites, as well as associated facilities-related
expenses. Research and development expenses increased from $155,000 in the
quarter ended March 31, 1997 to $602,000 in the quarter ended March 31, 1998.
Research and development expenses as a percentage of net revenues increased from
4.9% in the quarter ended March 31, 1997 to 9.7% in the quarter ended March 31,
1998. Research and development expenses increased in absolute dollars and as a
percentage of net revenues primarily due to an increase in personnel and
equipment-related costs. The Company believes that continued investment in
research and development is critical to attaining its strategic objectives and,
as a result, expects research and development expenses to increase significantly
in absolute dollars in future periods.
Sales and Marketing Expenses. Sales and marketing expenses consist
primarily of personnel and related expenses, promotional expenditures and costs
associated with operating the Company's Web sites. In addition, sales and
marketing expenses include the expenditures associated with the Company's
strategic marketing alliances. Sales and marketing expenses increased from
$265,000 in the quarter ended March 31, 1997 to $2.0 million in the quarter
ended March 31, 1998. Sales and marketing expenses as a percentage of net
revenues were 8.4% in the quarter ended March 31, 1997 and 31.5% in the quarter
ended March 31, 1998. Sales and marketing expenses increased in absolute dollars
and as a percentage of net revenues primarily due to costs associated with the
Company's strategic marketing alliances, as well as an increase in personnel and
advertising expenditures. The Company's current strategic marketing alliances
with AOL, Excite and Netscape provide for payments totaling approximately $26
million in accordance with the terms of these agreements. The costs associated
with the AOL and Netscape agreements will be expensed ratably over their
respective terms. The costs associated with the Excite agreement will be
expensed as payments become due under the contract terms. The Company may enter
into similar strategic marketing alliances requiring significant minimum
payments in the future and, as a result, may experience substantial increases in
its sales and marketing expenses. In addition, the Company intends to pursue an
aggressive branding and marketing campaign and therefore expects sales and
marketing expenses to increase significantly in absolute dollars in future
periods. See Note 3 of Notes to Consolidated Financial Statements.
General and Administrative Expenses. General and administrative expenses
primarily consist of personnel expenses, legal expenses and facilities-related
expenses. General and administrative expenses increased from $164,000 in the
quarter ended March 31, 1997 to $635,000 in the quarter ended March 31, 1998.
General and administrative expenses as a percentage of net revenues were 5.2% in
the quarter ended March 31, 1997 and 10.3% in the quarter ended March 31, 1998.
General and administrative expenses increased in absolute dollars and as a
percentage of net revenues primarily due to increased personnel-related costs
and facilities-related expenses associated with the hiring of additional
personnel as well as increased bad debt reserves associated with the increase in
net revenues. The Company expects general and administrative expenses to
increase in absolute dollars as the Company builds its infrastructure and as a
result of the costs associated with being a public company.
Interest Income, Net. Interest income, net, consists of earnings on the
Company's cash and cash equivalents, net of interest expense. Interest income,
net, decreased from $40,000 in the
28
<PAGE> 29
quarter ended March 31, 1997 to $25,000 in the quarter ended March 31, 1998, due
to reduced earnings on lower average cash and cash equivalents balances during
the quarter.
Income Taxes. The Company has recorded a net loss for the quarters ended
March 31, 1997 and March 31, 1998. As a result, no provision for income taxes
has been recorded in either of these quarters.
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1996 AND 1997
Net Revenues. Net revenues increased from $5.9 million in 1996 to $16.8
million in 1997, primarily as a result of increased sales to consumer and
corporate customers and new U.S. government contracts. Net revenues from ESD
Software sales were $10.3 million in 1997.
Cost of Revenues. Cost of revenues increased from $5.1 million in 1996 to
$14.9 million in 1997, due to the execution of additional U.S. government
contracts and increased product sales to consumer and corporate customers.
Gross Margin. Gross margin decreased from 12.3% in 1996 to 11.5% in 1997.
This decrease was due primarily to a shift in the Company's revenue mix,
resulting from an increased level of lower margin U.S. government contract
revenues as a percentage of total net revenues. The decrease in overall gross
margin was partially offset by an increase in higher margin advertising and
promotional revenues received from Software publishers.
Research and Development Expenses. Research and development expenses
increased from $431,000 in 1996 to $1.1 million in 1997. Research and
development expenses as a percentage of net revenues decreased from 7.3% in 1996
to 6.3% in 1997. The absolute dollar increase in research and development
expenses from 1996 to 1997 was primarily attributable to an increase in
personnel-related costs. The decrease in research and development expenses as a
percentage of net revenues was primarily attributable to the substantial
increase in net revenues in 1997.
Sales and Marketing Expenses. Sales and marketing expenses increased from
$704,000 in 1996 to $1.7 million in 1997. Sales and marketing expenses as a
percentage of net revenues were 12.0% in 1996 and 10.1% in 1997. The absolute
dollar increase in sales and marketing expenses from 1996 to 1997 primarily was
attributable to an increase in personnel and advertising expenditures, as well
as costs associated with a strategic marketing alliance. The decrease in sales
and marketing expenses as a percentage of net revenues primarily was
attributable to the substantial increase in net revenues in 1997.
General and Administrative Expenses. General and administrative expenses
increased from $450,000 in 1996 to $1.1 million in 1997. General and
administrative expenses as a percentage of net revenues were 7.7% in 1996 and
6.5% in 1997. The increase in general and administrative spending on an absolute
dollar basis in 1997 primarily was due to increased salaries and facilities-
related expenses associated with the hiring of additional personnel, increased
legal expenses associated with the settlement of certain litigation, and
increased bad debt reserves associated with the increase in net revenues. The
decrease in general and administrative expenses as a percentage of net revenues
primarily was attributable to the substantial increase in net revenues in 1997.
Interest Income, Net. Interest income, net, increased from $85,000 in 1996
to $167,000 in 1997 due to earnings on higher average cash and cash equivalents
balances in 1997.
Income Taxes. The Company had a net loss for both 1996 and 1997.
Accordingly, no provision for income taxes has been recorded in either of such
years. As of December 31, 1997, the Company had approximately $7.2 million of
net operating loss carryforwards for Federal income tax purposes, which expire
between 2009 and 2012. Given the Company's limited operating history, losses
incurred to date and the difficulty in accurately forecasting the Company's
future results, management does not believe that the realization of the related
deferred income tax
29
<PAGE> 30
assets meets the criteria required by generally accepted accounting principles
and, accordingly, a full 100% valuation allowance has been recorded to reduce
the deferred income tax assets to $0. Furthermore, as a result of changes in the
Company's equity ownership from the Company's Preferred Stock financings and
this offering, utilization of the net operating losses and tax credits may be
subject to substantial annual limitations due to the ownership change
limitations provided by the Internal Revenue Code of 1986, as amended and
similar state provisions. The annual limitation may result in the expiration of
net operating losses and tax credits before utilization. See Note 10 of Notes to
Consolidated Financial Statements.
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1995 AND 1996
Net Revenues. Net revenues increased from $1.0 million in 1995 to $5.9
million in 1996 due primarily to the growth of the Company's consumer and
corporate customer base.
Cost of Revenues. Cost of revenues increased from $623,000 in 1995 to $5.1
million in 1996, primarily reflecting an increase in product sales to consumer
and corporate customers.
Gross Margin. Gross margin decreased from 37.9% in 1995 to 12.3% in 1996.
This decrease was due primarily to a shift in the Company's business model.
During 1995, a number of Software publishers made certain payments to the
Company in exchange for the Company's inclusion of these publishers' products in
its online store. During 1996, the Company moved to its current Software
reseller model, resulting in the substantial reduction of such payments and the
associated decrease in gross margin.
Research and Development Expenses. Research and development expenses
increased from $388,000 in 1995 to $431,000 in 1996. Research and development
expenses as a percentage of net revenues decreased from 38.7% in 1995 to 7.3% in
1996. The absolute dollar increase in research and development expenses from
1995 to 1996 primarily was attributable to an increase in personnel-related
costs. The decrease in research and development expenses as a percentage of net
revenues primarily was attributable to the substantial increase in net revenues
in 1996.
Sales and Marketing Expenses. Sales and marketing expenses increased from
$407,000 in 1995 to $704,000 in 1996. Sales and marketing expenses as a
percentage of net revenues were 40.6% in 1995 and 12.0% in 1996. The absolute
dollar increase in sales and marketing expenses from 1995 to 1996 was primarily
attributable to an increase in personnel-related costs. The decrease in sales
and marketing expenses as a percentage of net revenues was primarily
attributable to the substantial increase in net revenues in 1996.
General and Administrative Expenses. General and administrative expenses
increased from $103,000 in 1995 to $450,000 in 1996. General and administrative
expenses as a percentage of net revenues were 10.3% in 1995 and 7.7% in 1996.
The increase in general and administrative spending on an absolute dollar basis
in 1996 primarily was due to increased salaries and facilities-related expenses
associated with the hiring of additional personnel, increased professional fees,
and increased bad debt reserves associated with the increase in net revenues.
The decrease in general and administrative expenses as a percentage of net
revenues primarily was attributable to the substantial increase in net revenues
in 1996.
Interest Income, Net. Interest income, net, increased from $7,000 in 1995
to $85,000 in 1996 due to earnings on higher average cash and cash equivalents
balances in 1996.
Income Taxes. The Company has recorded a net loss for the years ended
December 31, 1995 and 1996. Accordingly, no provision for income taxes has been
recorded in either of such years.
30
<PAGE> 31
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth certain unaudited quarterly consolidated
statement of operations data for each of the four quarters during the year ended
December 31, 1997 as well as the quarter ended March 31, 1998. In the opinion of
management, this information has been prepared substantially on the same basis
as the audited financial statements appearing elsewhere in this Prospectus, and
all necessary adjustments, consisting only of normal recurring adjustments, have
been included in the amounts stated below to present fairly the unaudited
quarterly results. The quarterly data should be read in conjunction with the
audited Consolidated Financial Statements of the Company and the Notes thereto
appearing elsewhere in this Prospectus. The operating results for any quarter
are not necessarily indicative of the operating results for any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
-------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31,
1997 1997 1997 1997 1998
--------- -------- --------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net revenues........................ $3,158 $3,434 $ 4,825 $ 5,389 $ 6,192
Cost of revenues.................... 2,783 2,892 4,295 4,903 5,254
------ ------ ------- ------- -------
Gross profit........................ 375 542 530 486 938
Operating expenses:
Research and development.......... 155 184 302 419 602
Sales and marketing............... 265 332 442 657 1,953
General and administrative........ 164 247 265 411 635
------ ------ ------- ------- -------
Total operating expense... 584 763 1,009 1,487 3,190
------ ------ ------- ------- -------
Loss from operations................ (209) (221) (479) (1,001) (2,252)
Interest income, net................ 40 32 24 71 25
------ ------ ------- ------- -------
Loss from continuing operations..... (169) (189) (455) (930) (2,227)
Loss from discontinued operations... (583) (455) (1,036) (1,542) --
------ ------ ------- ------- -------
Net loss............................ $ (752) $ (644) $(1,491) $(2,472) $(2,227)
====== ====== ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
AS A PERCENTAGE OF TOTAL REVENUE
-------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31,
1997 1997 1997 1997 1998
--------- -------- --------- -------- ---------
<S> <C> <C> <C> <C> <C>
Net revenues....................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues................... 88.1 84.2 89.0 91.0 84.9
------ ------- ------- ------- -------
Gross profit....................... 11.9 15.8 11.0 9.0 15.1
Operating expenses:
Research and development......... 4.9 5.4 6.3 7.8 9.7
Sales and marketing.............. 8.4 9.7 9.2 12.2 31.5
General and administrative....... 5.2 7.2 5.4 7.6 10.3
------ ------- ------- ------- -------
Total operating expense.......... 18.5 22.3 20.9 27.6 51.5
------ ------- ------- ------- -------
Loss from operations............... (6.6) (6.5) (9.9) (18.6) (36.4)
Interest income, net............... 1.3 0.9 0.5 1.3 0.4
------ ------- ------- ------- -------
Loss from continuing operations.... (5.3) (5.6) (9.4) (17.3) (36.0)
Loss from discontinued
operations....................... (18.5) (13.2) (21.5) (28.6) --
------ ------- ------- ------- -------
Net loss........................... (23.8)% (18.8)% (30.9)% (45.9)% (36.0)%
====== ======= ======= ======= =======
</TABLE>
The Company's net revenues have increased significantly in each consecutive
quarter presented due to increased sales to consumer and corporate customers and
the execution of new U.S. government contracts. The Company's gross margins
fluctuated on a quarterly basis during these quarters, primarily as a result of
changes in the Company's product mix. In particular, the Company's gross margin
increased in the second quarter of 1997 and in the first quarter of 1998
primarily due to an increase in advertising and promotional revenues as a
percentage of the Company's net revenues during such periods. Gross margins
decreased in the third and fourth quarters of 1997 primarily due to an increased
level of lower margin U.S. government contract revenues as a percentage of the
Company's net revenues and a decrease in advertising and
31
<PAGE> 32
promotional revenues as a percentage of the Company's net revenues. Research and
development and general and administrative expenses increased in absolute
dollars in each quarter presented primarily due to personnel-related costs.
Sales and marketing expenses also increased on a quarterly basis in each quarter
presented due to increases in personnel-related costs and significantly
increased in the first quarter of 1998 due to expenditures associated with the
Company's strategic marketing alliances. Sales and marketing expenses and
general and administrative expenses each increased in absolute dollars in the
third quarter of 1997, but declined as a percentage of net revenues due to the
increase in the Company's net revenues during such period.
As a result of the Company's limited operating history and the emerging
nature of the markets in which it competes, the Company may be unable to
accurately forecast its revenues. The Company's current and future expense
levels are to a large extent fixed and are based on its operating plans and
estimates of future revenues. Sales and operating results generally depend on
the volume and timing of orders received, which are difficult to forecast. The
Company may be unable to adjust spending in a timely manner to compensate for
any unexpected revenue shortfall. Accordingly, any significant shortfall in
revenues in relation to the Company's planned expenditures would have an
immediate adverse effect on the Company's business, financial condition and
results of operations. Further, as a strategic response to changes in the
competitive environment, the Company may from time to time make certain pricing,
service or marketing decisions that could have a material adverse effect on its
business, financial condition and results of operations. See "Risk
Factors -- Limited Operating History; History of Net Operating Losses;
Accumulated Deficit," "-- Unpredictability of Future Operating Results" and
"Business -- Competition."
The Company expects to experience significant fluctuations in its future
quarterly operating results due to a variety of factors, many of which are
outside of the Company's control. Factors that may adversely affect the
Company's quarterly operating results include (i) the Company's ability to
retain existing customers, attract new customers and maintain customer
satisfaction; (ii) the announcement or introduction of new sites, services and
products by the Company and its competitors: (iii) price competition; (iv) the
level of use of the Internet and online services and increasing consumer
acceptance of the Internet and other online services for the purchase of
consumer products such as those offered by the Company; (v) the Company's
ability to upgrade and develop its systems and infrastructure and attract new
personnel in a timely and effective manner; (vi) the level of traffic on the
Company's Web site; (vii) the termination of any strategic marketing alliances
such as those with AOL, Excite or Netscape pursuant to which the Company has
exposure to traffic on third party Web sites, or the termination of contracts
with major purchasers, particularly U.S. government agencies; (viii) technical
difficulties, system downtime or Internet brownouts; (ix) the failure of
Internet bandwidth to increase significantly over time and/or an increase in the
cost to consumers of exploiting Internet bandwidth; (x) the amount and timing of
operating costs and capital expenditures relating to expansion of the Company's
business, operations and infrastructure; (xi) the number of popular Software
titles introduced during the period; (xii) certain government regulations; and
(xiii) general economic conditions and economic conditions specific to the
Internet, online commerce and the Software industry. The Company expects that it
may experience seasonality in its business, reflecting a combination of seasonal
fluctuations in Internet usage and traditional retail, governmental and
corporate entity seasonal spending patterns. See "Risk
Factors -- Unpredictability of Future Operating Results."
Gross margins may be impacted by a number of different factors, including
the mix of revenues from sales of shrink-wrap products versus revenues from ESD
product sales, the mix of Software products sold, the mix of revenues among
sales to government, corporate and consumer purchasers and the mix of revenues
from strategic partners such as AOL, Excite, Netscape and the Company's Web
site. The Company typically derives higher gross margins from advertising and
promotional revenues than from Software product sales. The Company typically
realizes higher gross margins on ESD Software product sales than on sales of
shrink-wrap Software products and lower gross margins on sales of widely
available commodity Software products than on sales of
32
<PAGE> 33
specialty Software products. In addition, the Company typically realizes higher
gross margins on sales to consumer purchasers than on sales to government or
corporate purchasers. In addition, the Company also may from time to time offer
attractive pricing programs, which may reduce its gross margins periodically.
The Company believes that the size of new Software products will continue to
increase and that such Software products will not be suitable for ESD in the
absence of significant increases in network bandwidth. This trend may impact the
Company's ability to realize the higher gross margins associated in the ESD
Software product sales in respect of such Software products. Any change in one
or more of the foregoing factors could materially adversely affect the Company's
gross margins and operating results in future periods. See "Risk
Factors -- Unpredictability of Future Operating Results."
Due to the foregoing factors, quarterly revenues and operating results are
difficult to forecast, and the Company does not believe that period-to-period
comparisons of its operating results will necessarily be meaningful and should
not be relied upon as indicators of future performance. In one or more future
quarters the Company's operating results may fall below the expectations of
securities analysts and investors. In such event, the trading price of the
Common Stock would likely be materially adversely affected.
LIQUIDITY AND CAPITAL RESOURCES
From inception through March 31, 1998, the Company has financed its
operations primarily through private sales of Preferred Stock through which the
Company raised net cash proceeds totaling $14.1 million.
Net cash used in operating activities was $299,000 for the year ended
December 31, 1997 and $2.7 million for the first quarter of 1998. Cash used in
operating activities in 1997 was attributable to a net loss of $5.4 million and
increases in accounts receivable and costs of deferred revenue, partially offset
by increases in accounts payable, deferred revenue, and the loss from
discontinued operations. Accounts receivable and accounts payable increased as a
result of significantly increased sales and purchasing activity during the
fourth quarter of 1997. In addition, cost of deferred revenue and deferred
revenue increased significantly due to new U.S. government contracts entered
into in 1997. Cash used in operating activities for the first quarter of 1998
resulted from a net loss of $2.2 million and a decrease in deferred revenue,
largely offset by decreases in cost of deferred revenue. The decrease to both
deferred revenue and cost of deferred revenue was due to the recognition of
revenue and cost of revenue associated with U.S. government contracts. Net cash
used in investing activities of $4.9 million for the year ended December 31,
1997 was primarily attributable to cash used for discontinued operations. Net
cash used in investing activities for the first quarter of 1998 of $165,000 were
attributable to purchases of property and equipment.
Net cash provided by financing activities of $4.1 million and $2.6 million
for the year ended December 31, 1997 and the first quarter of 1998,
respectively, primarily consisted of proceeds from the issuance of Preferred
Stock, which was partially offset for the year ended December 31, 1997 by cash
used for discontinued operations.
As of March 31, 1998, the Company had approximately $2.2 million of cash
and cash equivalents. The Company's current strategic marketing alliances
provide for payments of approximately $6.9 million in the remainder of 1998,
approximately $8.3 million in 1999, approximately $9.0 million in the year 2000
and approximately $500,000 in the year 2001. The Company currently has no other
material commitments other than those under its operating leases and for certain
equipment leases.
The Company entered into a credit agreement (the "Credit Agreement") with
Deutsche Bank AG ("Deutsche Bank") in May 1998. Deutsche Bank is the parent
corporation of Deutsche Bank Securities, one of the representatives of the
Underwriters. Pursuant to the Credit Agreement, in May 1998, Deutsche Bank
issued a standby letter of credit to the Company in the amount of approximately
$600,000 (the "Credit Facility") and loaned the Company approximately an
additional $4,200,000 (the "Loan"). To date the Company has used the funds made
available
33
<PAGE> 34
under these arrangements to: (i) make a down-payment on an office lease entered
into by the Company in May 1998; (ii) meet rental obligations under that lease;
and (iii) fulfill working capital needs and general corporate purposes of the
Company. The Loan bears interest at a rate equal to the higher of (i) the daily
Federal Funds Rate plus 0.5% per annum or (ii) Deutsche Bank's daily prime
lending rate (the "Base Rate"), plus 3.0% per annum (approximately 12% at May
31, 1998). Interest is payable quarterly, in arrears, during the term of the
Credit Agreement. The Company is also required to pay a standby letter of credit
fee equal to a percentage of the face amount of the Credit Facility equal to the
Base Rate plus 3.0% less the LIBOR rate for a three-month loan. In conjunction
with the Credit Agreement the Company is required to pay Deutsche Bank (i) an
upfront fee of $120,000 and (ii) a credit line fee equal to 7.50% of the amount
by which the Company's gross revenues during the term of the Credit Agreement
exceed certain agreed upon thresholds, subject to maximum payments of $337,500
in the aggregate. The Company has $3.1 million in unused funds available under
these arrangements. All amounts borrowed under the Credit Agreement are due on
November 16, 1998. The Company is presently in full compliance with the terms of
the Credit Agreement and does not anticipate a change to such status with
respect to such terms. In connection with the Credit Agreement, Deutsche Bank
has received a first priority lien on all of the Company's assets, including
intellectual property. Pursuant to the terms of the Credit Agreement, the
Company is subject to certain financial and non-financial covenants; including
limitations on payments of dividends, additional borrowings, acquisitions and
disposition of assets and maintenance of maximum operating cash flow
deficiencies and minimum quick ratios. The Company intends, upon the expiration
of the Credit Agreement, to convert the amounts outstanding under the Credit
Facility and the Loan into a new credit facility in approximately the same or a
greater principal amount; however, there can be no assurances that the amounts
outstanding under the Credit Facility and the Loan will be converted into a new
credit facility on commercially acceptable terms, if at all. See "Underwriting."
The Company believes that the net proceeds from this offering, together
with its current cash and cash equivalents, and the funds borrowed under the
Credit Agreement in May 1998, will be sufficient to meet its anticipated cash
needs for working capital and capital expenditures through at least the next
twelve months. Thereafter, if cash generated from operations is insufficient to
satisfy the Company's liquidity requirements, the Company may seek to sell
additional equity or debt securities or to obtain additional credit facilities,
in part to fund its financial obligations to AOL and Excite. The sale of
additional equity or convertible debt securities could result in additional
dilution to the Company's stockholders. There can be no assurance that financing
will be available in amounts or on terms acceptable to the Company, if at all.
See "Risk Factors -- Need for Additional Capital."
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. This could result in system failures or miscalculations
causing disruptions of operations including, among other things, a temporary
inability to process transactions, send invoices, or engage in similar normal
business activities. As a result, many companies' software and computer systems
may need to be upgraded or replaced in order to comply with such "Year 2000"
requirements. The Company utilizes third-party equipment and software that may
not be Year 2000 compliant. The Company is in the early stages of conducting an
audit of its third-party suppliers as to the Year 2000 compliance of their
systems. The Company does not believe it will incur significant costs in order
to comply with Year 2000 requirements. However, failure of the Company's
internal computer systems or of such third-party equipment or software, or of
systems maintained by the Company's suppliers, to operate properly with regard
to the Year 2000 and thereafter could require the Company to incur unanticipated
expenses to remedy any problems, which could have a material adverse effect on
the Company's business, financial condition and results of operations. See "Risk
Factors -- Year 2000 Compliance."
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BUSINESS
software.net Corporation ("software.net" or the "Company") is a leading
online reseller of commercial off-the-shelf computer software ("Software") to
the consumer, small business and large enterprise markets. Through its online
store (www.software.net), the Company offers customers a comprehensive selection
of Software, customer service and competitive pricing. The Company believes that
the software.net site is one of the most widely known and used sites on the
World Wide Web (the "Web") for the purchase of Software. The Company fulfills a
customer purchase either through physical delivery of the shrink-wrap Software
package or through electronic software delivery ("ESD"). The Company believes it
provides superior value to its customers by offering one of the largest
selections of brand-name, high quality Software available online, and the
convenience of shopping from home or office, twenty-four-hours-a-day, seven-
days-a-week ("24x7").
The Company believes that the Internet is an ideal medium for the sale and
delivery of Software for several reasons: (i) the demographics of Internet users
overlap one-to-one with the demographics of potential Software purchasers; (ii)
many Software titles and their related stock-keeping units ("SKUs") can be
delivered via ESD, providing instant gratification to the customer; and (iii)
large enterprise customers can use ESD to achieve efficient and cost effective
distribution of Software. software.net's business is based on scaleable
technology that permits the sale, order processing and delivery of Software with
limited human intervention. This technology, combined with significant
operational experience, enables the Company to address the complex process of
real time ESD. The Company has developed relationships with approximately 300
leading Software publishers which have granted the Company the right to
distribute approximately 2,800 Software SKUs via ESD.
The Company also has established strategic marketing alliances with America
Online, Inc. ("AOL"), Excite, Inc. ("Excite") and Netscape Communications
Corporation ("Netscape"). According to RelevantKnowledge, Inc., an
Internet-focused market research firm, the Web sites of these companies are each
among the five most visited sites on the Internet. The agreements with these
companies provide software.net with prominent display space on certain screens
on each of these Web sites. The Company believes these alliances have enabled it
to further consolidate its position as a leading online Software reseller. Since
the launch of its Web site in November 1994, the Company has sold Software
products to approximately 140,000 customers and has distributed freeware and
trial download products to tens of thousands of additional users. The Company's
sales increased from approximately $6 million in 1996, to approximately $17
million in 1997.
INDUSTRY BACKGROUND
Growth of the Internet and Online Commerce
The Web and commercial online services such as AOL have emerged as
significant global communications media, enabling millions of people to share
information and conduct business electronically. International Data Corporation
("IDC") projects that the total value of goods and services purchased over the
Web will increase from approximately $12.4 billion in 1997 to approximately $425
billion by 2002. A number of factors have contributed to the growth of the
Internet and its commercial use, including: (i) the large and growing installed
base of advanced personal computers in the home and workplace; (ii) improvements
in network infrastructure and bandwidth; (iii) easier and cheaper access to the
Internet; (iv) increased awareness of the Internet among consumer and business
users; and (v) the rapidly expanding availability of online content and commerce
which increases the value to users of being connected to the Internet. According
to IDC, the number of Web users worldwide will grow from approximately 69
million at the end of 1997 to approximately 320 million by 2002. In addition,
IDC estimates that the percentage of such users buying goods and services on the
Internet is projected to grow from
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26% in December 1997 to 40% in December 2002. The Internet also has emerged as
an attractive medium for the purchase and distribution of Software. Jupiter
estimates that revenues from online sales of PC software in 1997 were $69
million and are projected to grow to $2.3 billion in 2002.
Traditional Software Industry
The Software reselling industry is large and growing. According to IDC,
total Software sales to consumer and corporate end users from software
retailers, dealers and third-party mail order cataloguers in the United States
were estimated to be approximately $14 billion in 1997 and are expected to grow
to approximately $24 billion in 2001, representing a compound annual growth rate
of approximately 14.7%. In addition, the Company believes that the Software
reselling industry is highly fragmented with many participants, including
regional and national chains of superstores, cataloguers, systems integrators,
VARs and small single location stores.
The two primary categories of Software purchasers are (i) consumers and
small businesses and (ii) large enterprises such as corporations, government
agencies and universities. These two market segments have different requirements
and are served by different sales channels. For the consumer and small business
market, Software publishers primarily sell their Software through a network of
distributors and resellers and, to a lesser extent, directly to consumers. There
are many Software resellers in the United States serving the consumer and small
business market. These resellers vary in size from large regional and national
chains of superstores, such as CompUSA, ComputerCity and Office Depot, which may
carry hundreds of Software titles in a single store, to cataloguers such as
Micro Warehouse and CDW Computer Centers that offer several thousand Software
titles, to small, single location stores carrying only a limited number of
titles. For the large enterprise market, publishers typically sell direct or
through large corporate and value-added resellers, including Software Spectrum
and Corporate Software and Technology. Large distributors, such as Ingram Micro,
Merisel and Tech Data, serve as the primary suppliers for most resellers and
carry extensive inventories of leading Software titles.
Several characteristics of the traditional Software reselling industry
create inefficiencies for all industry participants. In the consumer and small
business market, physical store-based resellers must make significant
investments in real estate, inventory (which is limited due to space constraints
and cost) and personnel for each retail location. Cataloguers are constrained by
practical catalog size limitations (limiting both the number of products and the
information on those products that can be included in the catalog), printing
expenses, mailing costs and inherent delays in reacting rapidly to price and
product changes. In each case, these constraints limit the Software product
selection available to consumers. The traditional Software reselling model also
creates inefficiencies for participants in the large enterprise market.
Publishers, resellers and the purchasing enterprises are each challenged by the
logistical complexities, administrative burden and costs of distributing and
tracking Software titles and updates across a large and dispersed user base.
Under the traditional model, publishers face additional inefficiencies. In
addition to only being able to offer a fraction of their total available titles
in retail stores and catalogs, publishers typically must grant their resellers
and distributors generous rights of return because of the high cost of inventory
and risk of product obsolescence that would otherwise be borne by their channel
partners. Therefore, publishers effectively bear the risk of customer demand
forecasting, creating administrative costs and significant revenue recognition
and restatement issues associated with any difference between projected and
actual sales. Finally, publishers, distributors, and traditional Software
resellers cannot easily obtain demographic and behavioral data about end users,
which limits the opportunities for direct marketing and personalized services.
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THE SOFTWARE.NET SOLUTION
software.net is a leading online reseller of Software to the consumer,
small business and large enterprise markets, and offers a solution to many of
the inefficiencies inherent in the traditional Software reselling industry. Key
components of the software.net solution include:
Customer Convenience. software.net provides enhanced customer convenience
by enabling customers to purchase Software online 24x7 from home or office.
Additionally, Software purchased online from software.net can be delivered in
shrink-wrap packages or immediately downloaded and installed via ESD. ESD also
enables large enterprise customers to achieve more efficient internal
distribution and tracking of Software and updates relative to the alternative
distribution methods.
Selection. software.net has the capacity for unlimited online shelf space
and offers customers an extensive selection of titles, SKUs and related product
information without the expense of maintaining a physical store-based
infrastructure. The Company carries approximately 30,000 Software SKUs, as well
as approximately 2,800 SKUs that can be delivered to customers via ESD.
Customized Service. The Company captures significant customer preference
data during each customer session from its online site and can use this
information to customize a user's shopping experience on subsequent visits. As
an online reseller, the Company also is better able to educate the customer
about Software products through online product reviews, trial downloads,
additional product information and online customer support.
Publisher Benefits. Because the Company is not constrained by the inherent
limitations of physical stores, the Company enables publishers to offer all of
their available titles to customers in its online store. In addition, by
offering products for ESD through software.net's publishers can reduce the risk
of customer demand forecasting, and the associated administrative costs and
significant revenue recognition and restatement concerns. Finally, publishers
can work with the Company to obtain demographic and behavioral data about end
users, which expands publishers' opportunities for marketing and targeted
services.
STRATEGY
The Company's objective is to be the dominant reseller of Software to
consumers, small businesses and large enterprises. The Company intends to
capitalize on and extend its market position as one of the "first movers" in
online Software reselling through the following key strategies:
Enhance Brand Recognition. The Company believes that building brand
awareness of its Web site is critical to attracting and expanding its Internet
customer base. The Company intends to promote, advertise and increase its brand
recognition through a variety of marketing and promotional techniques, including
co-marketing agreements with major online sites and services and through
customer service. The Company also intends to promote its brand through
advertising on leading Web sites and other media, conducting an ongoing public
relations campaign and developing other business alliances and partnerships.
Promote Electronic Software Delivery. The Company is currently a leader in
ESD, with approximately 2,800 Software SKUs available for ESD from the
software.net store direct to the end user's personal computer. ESD offers
convenience to customers and economic advantages to the Company and Software
publishers which the Company believes are superior to traditional methods of
Software delivery. By working with Software publishers on ESD initiatives,
enhancing its own technology and systems and implementing ESD promotional
activities, the Company is focused on increasing the number of Software SKUs
available for purchase by ESD and the number of customers who utilize ESD.
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Leverage and Further Develop Strategic Relationships. The Company intends
to continue to leverage its strategic marketing alliances with AOL, Excite and
Netscape to enhance brand recognition and increase customer acquisitions and
sales. The Company also intends to expand its online visibility and may enter
into relationships with additional Internet access providers, search engines and
other high-traffic Web sites.
Capitalize on Large Enterprise Opportunities. In addition to targeting
consumer and small business customers, the Company will also market its services
to large enterprise customers such as major corporations, government agencies
and universities. The Company believes that the speed, convenience and cost
advantages offered by ESD make ESD an attractive alternative method of
purchasing for large enterprises. The Company intends to capitalize on its
success in supplying the needs of its government customers to become the online
reseller of choice for large enterprise customers.
Maintain Technology Focus and Expertise. The Company intends to leverage
its scaleable, state-of-the-art, interactive commerce platform to enhance
software.net's service offering and expand the benefits of online Software
reselling. The Company's internal development group continues to expend
substantial efforts developing, purchasing, licensing and implementing
technology-driven enhancements to its Web site and transaction-processing
systems.
Leverage Superior Economic Model; Focus on Online Environment. The Company
believes it has an inherent economic advantage relative to Software resellers
operating from physical stores or through catalogs because it is not burdened by
the cost or legacy of a physical store network and related personnel or the
costs and limitations of selling through printed catalogs. The Company further
believes that the demographics of Internet users overlap one-to-one with the
demographics of potential Software purchasers, providing an exceptional target
market for online Software sales. The Company intends to leverage its online
model and focus on delivering an increasing number of Software products via ESD
to achieve cost and margin advantages as compared to traditional Software
resellers.
Strengthen First-Mover Advantages. The Company believes that significant
barriers exist that make it increasingly difficult to enter the online Software
marketplace in a cost-effective manner. These barriers include: (i) the
necessary up-front investment in technology and technical infrastructure, such
as that required for real time processing of both payment and order fulfillment;
(ii) the time and expense required to build a brand that effectively draws
customers to a Web site; (iii) the time, expense and expertise necessary to
develop publisher and distributor relationships; and (iv) the need to develop
strategic alliances with high-traffic, high-profile Web sites. The Company
intends to extend its first-mover advantages in each of these areas.
THE SOFTWARE.NET ONLINE SOFTWARE STORE
Customers enter the software.net store through the Company's simple,
intuitive and easy to use Web site. The Web site instantly recognizes the
browser type of the customer's computer and tailors the format of the
software.net store to that system. With customized pages for particular browsers
and for large enterprise accounts, the Company's goal is to make the shopping
process as easy as possible for customers. Users accessing the software.net
store generally fall into one of two categories: (i) individuals who know what
product they want to buy and seek to purchase it immediately in a highly
convenient manner; or (ii) individuals who are browsing the store and seeking an
entertaining and informative shopping experience. The software.net store is
designed to satisfy both types of users in a simple, intuitive fashion.
Presently, customers can conduct targeted searches through a catalog of
approximately 30,000 Software SKUs, browse from among featured titles and
special offers, participate in promotions and check order status. The
software.net site also offers visitors a variety of highlighted subject areas
and special features, including features of topical or current-event interest,
such as the Windows 95 Center, the Macintosh Center and the 1997 Tax Center. The
site also
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periodically offers previews of new or upcoming releases, such as Windows 98.
The Company expects to implement further improvements to its store which may
include specialty sections within the site, product reviews, greater
interactivity and customer-specific product presentations based on demonstrated
customer preferences.
Shoppers purchase products by simply clicking on a button to add products
to their virtual shopping baskets. Customers can add and subtract products from
their shopping baskets as they browse, prior to making a final purchase
decision, just as in a physical store. To execute orders, customers click on the
buy button and are prompted to supply shipping and, in the case of consumers,
credit card details, either by email or by telephone. The store design enables
purchasers to buy several products at once, rather than having to repeat the
same purchase process for each desired product. All customer information is
stored on the Company's secure server, and repeat customers are presented with a
customized order form. The Company's system automatically confirms each
physically shipped order by email to the customer within minutes after the order
is placed and advises customers by email shortly after orders are shipped.
Company representatives handle customer service and support and general
questions about software.net and provide product information over the telephone,
fax and via email. The Company believes that these representatives are a
valuable source of feedback regarding customer satisfaction, which the Company
uses to improve its services. Customers of the Company are not currently charged
for service and support services. See "-- Products" and "-- Marketing and
Sales."
PRODUCTS
The Company's software.net store carries approximately 30,000 Software SKUs
from leading Software publishers for physical delivery. The efficiencies of
online inventory permit the software.net store to offer a broad selection of
hard-to-find and specialty titles which may not be available in traditional
Software stores. A single Software title often has multiple SKUs depending upon
operating systems (i.e. MacIntosh, Windows, Windows NT); media (i.e. CD-Rom,
floppy disk) or license type (i.e. single or multi-user licenses). The Company
also offers approximately 2,800 SKUs from approximately 300 publishers for
immediate delivery via ESD, including popular titles by Adobe, Cybermedia,
FileMaker Pro Inc. (formerly Claris), IBM, JavaSoft, Lotus, Microsoft, Network
Associates (formerly McAfee), QUALCOMM, Sun Microsystems and Symantec.
The Company has focused on making available via ESD as many major Software
titles as practical. As a result of the limited bandwidth and relatively slow
modem speeds now available, the size of many popular Software titles currently
makes them unsuitable for ESD. The Company believes that ten-megabytes is the
maximum size of a Software SKU that most consumers are currently willing to
purchase via ESD. A ten-megabyte Software SKU, such as Norton Utilities for
Windows NT, will take approximately one hour for a complete download via ESD.
The Company believes that as the size of new Software products will continue to
increase and that such Software products will not be suitable for ESD in the
absence of significant increase in network bandwidth. However, as Internet
infrastructure and bandwidth improvements and advancements are made, such as
cable modems and digital subscriber line technologies, the Company believes that
the demand for products delivered via ESD and the speed by which such products
can be delivered via ESD will increase. However, if ESD does not achieve
widespread market acceptance, the Company's business, financial condition and
results of operations will be materially adversely affected. The Company's
revenues from Software products sold through ESD amounted to $10.3 million in
1997 and $3.8 million in the quarter ended March 31, 1998. Even if ESD achieves
widespread acceptance, there can be no assurance that the Company will overcome
the substantial existing and future technical challenges associated with
electronically delivering Software reliably and consistently on a long-term
basis. A failure by the Company to do so would materially and adversely affect
the Company's business, financial condition and results of operations. See "Risk
Factors -- Risks Associated with Dependence on Electronic Software Delivery."
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The Company sources product for physical delivery from traditional
distributors and sources the substantial majority of its ESD SKUs directly from
Software publishers. The Company does not carry any inventory and relies on
rapid fulfillment of physical products from distributors directly to customers.
When a customer places an order for shrink-wrap Software, the order information
is instantly transmitted to the distributor for processing and rapid
fulfillment. A major Software distributor supplied the Company with Software
that accounted for a substantial portion of the Company's total Software sales
in 1997 and in the first quarter of 1998. The Company has developed customized
information systems and automated ordering processes to enable it to offer an
extensive selection of products, avoid the high costs and capital requirements
associated with owning and warehousing product inventory, and escape the
significant operational effort associated with same day processing and shipment.
Although the Company believes that the relationship with the major software
distributor may be replaced without substantial difficulty in the event that
such relationship terminated, as is common in the Software industry, the Company
does not have long-term contracts or arrangements with its vendors that would
ensure the availability of SKUs, and there can be no assurance that the
Company's current vendors will continue to supply SKUs to the Company. See "Risk
Factors -- Reliance on Software Publishers and Distributors."
The Company has entered into three contracts with departments of United
States government agencies (the "U.S. government"). Collectively, these
agreements accounted for approximately 33.2% and 43.1% of the Company's revenues
in 1997 and the first quarter of 1998, respectively. A substantial majority of
the Software sold pursuant to these agreements is supplied to the Company by
Microsoft. Each of these contracts is subject to annual review and renewal with
the U.S. government, and may be terminated without cause at any time.
Accordingly, there can be no assurance that the Company will derive any revenue
from sales of Software to the U.S. government in any given future period. The
Company's contract with Microsoft is terminable for any reason by providing
written notice of the election to terminate at least thirty (30) days prior to
the expiration of a given term. In the event that any one of these agreements is
not renewed or is otherwise terminated by the U.S. government or if Microsoft
does not supply its Software product to the Company for resale to the U.S.
government pursuant to these agreements, the Company's business, financial
condition and results of operations would be materially adversely affected. The
Company does not have any other customers that accounted for more than 10% of
the Company's revenues in 1997 or the first quarter of 1998. Furthermore, the
Company's contract with Microsoft provides for Microsoft's approval of the
Company's credit worthiness. Under the contract, Microsoft may make this
determination through the evaluation of publicly-available information or, in
Microsoft's sole discretion, Microsoft may require the Company to provide
Microsoft with sufficient information as reasonably requested by Microsoft to
determine the Company's credit worthiness. In the event that Microsoft
determines that the Company is no longer creditworthy or not in compliance with
certain payment or reporting terms, Microsoft may require the Company to post
security acceptable to Microsoft. See "Risk Factors -- Reliance on Software
Publishers and Distributors; and -- Customer Concentration; Risks Associated
with Reliance on United States Government Contracts."
MARKETING AND SALES
Strategic Relationships
software.net pursues strategic relationships to expand the Company's online
presence, increase its access to online customers and build brand recognition.
In pursuing these relationships, the Company seeks exclusive or semi-exclusive
positioning for the sale of Software on key screens of major Web sites. To date,
the Company has established the following strategic marketing alliances:
America Online. software.net and AOL, the leading online service provider
with approximately twelve million members, entered into an agreement (the "AOL
Agreement") in March 1998 for a
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term of 42 months, pursuant to which AOL has agreed to promote software.net as
the exclusive and semi-exclusive reseller of Software products on certain
screens in the AOL service and AOL's Web site, aol.com (the "AOL Online Area").
AOL will promote software.net as the exclusive Software reseller on certain
screens in the Computing Channel, the AOL Personal Finance Channel and the Games
Channel areas, among others, of the AOL Online Area. AOL also will promote
software.net as a Software reseller on a semi-exclusive basis on certain screens
in the Computing Channel and the Entertainment Web Channel, among others, of the
AOL Online Area. The exclusivity rights set forth above are subject to a number
of significant exceptions, including Software products sold by or on behalf of
publishers and by AOL through "pop-ups." Over the term of the AOL Agreement,
subject to certain limitations or adjustment to the payments required of the
Company, AOL is obligated to deliver a specified number of screen views with
links to the Company's Web site ("Impressions"). The Company is obligated to
make minimum payments totaling $21 million to AOL by March 1, 2000, and over the
term of the AOL Agreement, is obligated to pay a percentage of certain
transactional revenues earned by the Company on Software sales to AOL members in
excess of certain thresholds. The Company has the right to sell advertising on
its promotional screens in the AOL Online Area, subject to the Company's
obligation to pay a percentage of certain advertising revenues above certain
threshold amounts to AOL. In addition, AOL has the right, in its sole
discretion, to reduce or cease placements of the promotions granted under this
agreement, or restrict access from the AOL service to the Company's Web site, in
certain circumstances, including, if the functional integrity of the AOL service
is compromised or the ability of AOL to provide service to its users is
adversely affected. Subject to adjustment to the payments required of the
Company, AOL may also change its business model so that a substantially larger
number of AOL members pay hourly charges for general access and use of the AOL
service, which may have a material adverse effect on the sale of the Company's
products. The Company's agreement with AOL expires in August 2001, or earlier in
the event of a material breach and AOL has the right to renew this agreement for
two successive one-year terms, during which time AOL has no exclusivity
obligations to the Company. Subject to certain conditions, (i) AOL has also
agreed to purchase shares of the Company's Common Stock at a price per share
equal to the initial public offering price (less the underwriting discount) for
an aggregate purchase price of $2 million and (ii) the Company has agreed to
concurrently issue to AOL a warrant for a number of shares of Common Stock equal
to 1.5 times the number of shares of Common Stock purchased by AOL in the
aforementioned investment at a per share exercise price equal to the initial
public offering price (less the underwriting discount), in each case in a
private placement transaction that will close immediately prior to the
consummation of the offering contemplated by this Prospectus. The Company has
also granted AOL certain registration rights. See "Certain Transactions" and
"Description of Capital Stock -- Registration Rights."
Excite. software.net and Excite, a leading search engine provider with
over two million visitors a day, entered into an agreement in March 1998 for a
term of at least 36 months, under which Excite agreed, subject to certain
limitations, not to display paid promotional links or banner advertisements of
other specified types of resellers of Software products on certain screens
within certain channels of Excite's Excite.com Web site (the "Excite Online
Area"). These screens include certain screens in Excite.com's Computers and
Internet Channel and the Computers and Software Department of the Shopping
Channel. In addition, the Company has the right to display links to the
Company's Web site on certain other screens within the Excite Online Area. Over
the term of the Excite Agreement, Excite is obligated to deliver a specified
number of Impressions. Over the first three years of the agreement, the Company
is obligated to make substantial payments to Excite as well as pay a percentage
of certain transactional revenues earned by the Company in excess of certain
thresholds. The Company's arrangement with Excite terminates when Excite has
satisfied certain obligations with respect to delivery of Impressions, but no
earlier than April 2001 except in the event of a material breach.
Netscape. software.net and Netscape, a leading provider of open software
for linking people and information over intranets, extranets and the Internet
entered into an agreement in June 1997
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for a term of 24 months from August 1, 1997, to create the "Netscape Software
Depot by software.net." This Web site is an online Software store, created for
the purpose of marketing and distributing Software products which are compatible
with the Netscape ONE platform Internet Site. Under the terms of the Netscape
agreement, sales and advertising revenues generated from this online store are
allocated in accordance with specified percentages. In connection with this
agreement, the Company made an initial payment to Netscape for a license to use
certain Netscape trademarks. The Netscape agreement terminates on July 31, 1999
and can also be terminated by either party in the event that certain specified
Impressions and net revenue milestones have not been met.
There can be no assurance that the Company will achieve sufficient online
traffic, or generate sufficient sales to realize economies of scale that justify
the Company's significant fixed financial obligations to AOL and Excite, or to
satisfy its contractual obligations necessary to prevent termination of the AOL,
Excite or Netscape agreements. The failure of the Company to do so would likely
have a material adverse effect on the Company's business, results of operations
and financial condition. In addition, neither the AOL, Excite nor Netscape
agreements provides the Company with automatic renewal rights upon expiration of
their respective terms. There can be no assurance that such agreements will be
renewed on commercially acceptable terms, or at all. Furthermore, the Company's
significant investment in the AOL, Excite and Netscape relationships is based on
the continued positive market presence, reputation and anticipated growth of
AOL, Excite and Netscape, as well as the commitment by each of AOL and Excite to
deliver specified numbers of Impressions. Any decline in the significant market
presence, business or reputation of AOL, Excite or Netscape, or the failure of
any of AOL and Excite to deliver the specified numbers of Impressions, will
reduce the value of these strategic agreements to the Company and will likely
have a material adverse effect on the business, results of operations and
financial condition of the Company. In addition, AOL and the Company have the
right to separately pursue and sell advertising in the Company's content areas
distributed through AOL. There can be no assurance that the Company and AOL will
not compete for limited software reseller advertising revenues. The Company's
arrangements with AOL, Excite and Netscape are expected to represent significant
distribution channels for the Company's Software sales, and any termination of
either or all of the Company's agreements with AOL, Excite and Netscape would
likely have a material adverse effect on the Company's business, results of
operations and financial condition. See "Risk Factors -- Reliance on Strategic
Marketing Alliances with America Online, Excite and Netscape," "Use of Proceeds"
and Note 3 of Notes to Consolidated Financial Statements.
Co-branded Sites. software.net has also sought to increase sales by
creating and managing co-branded stores such as CMP's TechShopper Software Store
(http:// www.techweb.com/shopper/softwarestore), Computer Currents Interactive
Software Shop (http://currents.software.net), and Gate Software Store
(http://sfgate.software.net) and others. These co-branded stores are intended to
further the software.net brand and access additional Internet traffic.
Information contained on these aforementioned Web sites is not a part of this
Prospectus.
Direct Marketing
The Company believes that the demographics of Internet users overlap
one-to-one with the demographics of potential Software purchasers and that the
Internet provides additional opportunities for direct marketing to the Company's
customers through a variety of mechanisms. The Company is exploring such direct
marketing opportunities as store customization to present each customer with a
customized merchandise assortment based on historic purchasing patterns and
equipment type. The Company is also investigating opportunities to use direct
marketing techniques to target new and existing customers with customized offers
such as an email newsletter that includes purchase recommendations based on
demonstrated customer preferences or prior purchases.
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Online Advertising
In addition to its primary strategic alliances, the Company utilizes
numerous online sales and marketing techniques to increase brand recognition and
drive traffic to the Company's online stores, including purchasing banner
advertising on search engine Web sites and Internet directories and direct links
from publisher home pages. Such banner advertisements can be permanently
displayed for designated periods of time or displayed when a user searches for
information relating to certain keywords (such as "software") and programs, as
well as the names of publishers. Direct links from certain publishers' home
pages enable customers electing to purchase Software directly from the publisher
to be automatically linked to the software.net order form.
Associates Program
The Company recently established an Associates Program for the purpose of
extending the Company's market presence. This program enables "Associate" Web
sites to offer Software to their audiences for fulfillment by software.net. The
Associate embeds a hyperlink to software.net's site, together with Software
recommended for that Associate's targeted customer base. The Associate's
customers are automatically connected to the software.net store and may place
their orders. The Associate is able to offer enhanced services and
recommendations, avoiding the expenses associated with ordering and fulfillment
and receives a commission for certain orders.
Traditional Advertising
To date, the Company has engaged in limited advertising utilizing
traditional media. However, the Company believes there is an opportunity to
promote its online stores through a proactive advertising program which will
target customers through national media outlets such as magazines, newspapers,
and radio and television broadcasts.
Customer Service and Support
The Company believes its ability to establish and maintain long-term
relationships with its customers and encourage repeat visits and purchases
depends, in part, on the strength of its customer support and service. Customer
support and service personnel are responsible for handling general customer
inquiries, answering customer questions about the ordering process and
investigating the status of orders, shipments and payments. The Company has
automated certain of the tools used by its customer support and service staff
including tracking screens that enable its support staff to track a transaction
by any of a variety of information sources. At any point in the purchasing
process, customers can access the Company's support staff by fax or email by
following prompts located throughout the software.net store, or by calling the
Company's toll-free telephone line. Customers who are reluctant to enter their
credit card numbers through the Web site are also invited to utilize the
toll-free line for purchases. The Company currently employs a staff of full-time
customer support and service personnel and also outsources its first level of
customer support and services through a leading provider of customer support
services.
A substantial portion of the Company's Software sales is made to the U.S.
government and corporate purchasers and the Company maintains specialized
support staffs for these departments. In addition to providing standard support
services, the Company's government and corporate support staffs target
particular government and corporate customers for specific new product releases
and version enhancements. The Company intends to continue to expand its sales
and marketing efforts with respect to both government and corporate purchasers.
See "Risk Factors -- Customer Concentration; Risks Associated with Reliance on
United States Government Contracts."
The Company maintains a structured return policy. Customers have the
ability to return product for replacement or credit upon authorization from the
Company. Shrink-wrapped product may be returned with a return material
authorization ("RMA") number. A corresponding credit is
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issued to the customer when the Company receives a credit from the appropriate
distributor indicating receipt of the returned product. Electronically
distributed product will be credited only when a signed "letter of destruction"
is received from the customer via facsimile. Historically, the Company has not
incurred outstanding RMA exposure necessitating reserves. The Company's
historical credit card chargebacks occur at a rate representing less than 1% of
total revenue.
TECHNOLOGY
The Company uses complex proprietary and commercially licensed technology
to make both the customer experience and the management reporting process as
seamless and simple as possible. To that end, the Company has developed
technologies and systems to support scaleable, flexible and seamless online
reselling in a secure and easy to use manner. By using a combination of
proprietary solutions and commercially available licensed technologies, the
Company has deployed systems for online content dissemination, online
transaction processing, customer service, market analysis and electronic data
interchange. The Company has integrated these proprietary and commercially
available systems into a unified Software sales and reporting system. Research
and development expenses were $388,000, $431,000, $1.1 million and $602,000 in
1995, 1996, 1997 and the first quarter of 1998, respectively.
Scaleability and Flexibility. The architecture of the Company's hardware
and software is built upon a distributed transaction-processing model which
allows the processing load to be distributed among multiple parallel servers.
This architecture allows the Company to scale by either adding new servers or
increasing the capacity of existing servers. The Company's hardware and software
configuration is designed to scale to support growth while maintaining user
performance and minimizing the cost per transaction. In the rapidly changing
Internet environment, the ability to update this system in order to stay current
with new technologies is important. The system's template technology and modular
database design allow the addition or replacement of software components, page
layout templates and search and retrieval engines with minimal effort and
disruption. This architecture also enables low-cost, rapid deployment of
additional, co-branded Web sites that integrate with the software.net store.
Seamlessness. The Company's multiple hardware and software systems
integrate seamlessly to manage real time transactions with limited human
intervention. Orders for downloadable Software are automatically processed to
completion. Orders for products that must be shipped are automatically routed
electronically to one of the Company's distributors. The transaction is
completed and the customer's credit card charged after shipment of the product
has been confirmed. Orders requiring human intervention are automatically routed
for processing by customer service representatives.
Components of Company Technology
The Company uses commercially available software as well as its own
internally developed proprietary software. The Company has a policy of limiting
the number of hardware and software vendors whose products are used in
production systems in order to facilitate integration, maintenance, performance
and upgrades.
Store Engine Architecture. The Company's hardware and software systems are
based upon a distributed transaction-processing model that allows applications
and data to be distributed among multiple parallel servers. Many of the software
components, and the pages of the Company's Web site, are developed in a manner
that enables the separation of the page look and feel from the individual data
elements and their associated database lookups. This separation permits frequent
changes to product pricing information, reduces Software updates for Web site
changes, and minimizes the engineering required to maintain a growing amount of
items and content. The Company utilizes proprietary technology that also enables
Web sites with different formats to integrate the software.net store elements
such as search, vendor and product pages.
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This technology allows the Company to maintain several Web storefronts over a
single order processing and customer service system.
Enterprise Download Manager. For the large enterprise environment, the
Company has developed technology to aid in the distribution of both large
Software products (in terms of number of bytes) as well as large numbers of
Software products. This technology comprises server software, which maintains a
cache of downloaded Software at key locations behind a customer's firewall and
an enhanced version of the Sm@rtCert technology licensed on a non-exclusive
basis from CyberSource which the Company offers as an integrated service
(collectively, the "Enterprise Download Manager"). By distributing caches of
Software (many of which would normally be considered too large to download) to
key locations within an enterprise, a large enterprise can ensure that the
current release of Software is available to staff with minimal management
intervention. By providing a dedicated server with Enterprise Download Manager
to manage and receive the download, typical problems of failed download and lost
connections can be overcome. By using a local cache, the Enterprise Download
Manager satisfies the majority of requests for Software updates internally with
a resultant significant reduction in network traffic. This technology is used to
deliver products electronically together with marketing and promotional
information. Enterprise Download Manager tracks the transmission of Software via
ESD. If the transmission is interrupted for any reason, Enterprise Download
Manager re-initiates the transmission and completes the interrupted download
without the need to restart the entire download. See "Business -- Relationship
with CyberSource Corporation" and "Certain Transactions."
Back Office Processing. The real time nature of fulfilling downloaded
Software orders adds significant complexity to the design of the Company's back
office system. Typical transaction processing systems assume that a physical
process must take place to deliver the product. The time required for physical
delivery obviates the need to process orders in real time (as well as the
customer's expectation of real time processing). In a Web-based sale of Software
to be delivered by ESD, the customer expects to be able to start downloading
within seconds of confirming the transaction. This need for almost instant
initiation of delivery impacts the design and operation of the Company's entire
back office system. Every element of a sale must be fully automated, as the time
needed for human intervention is not available.
The Company believes that its sophisticated back office transaction
processing system, which successfully processes, manages and fulfills Software
orders for ESD with limited human intervention in real time, is a significant
competitive advantage. The system incorporates commercially available database
components purchased from leading vendors, proprietary software products
developed by the Company, and Internet commerce services supplied by
CyberSource. This system accepts orders captured by the store engine and
processes them according to pre-coded rules. Each order is validated, screened
for possible fraud and its payment method authorized. Once an order is approved,
it is fulfilled either by electronically messaging the Company's distributor for
physical delivery or by allowing the customer to download the product via ESD.
The entire history of any order or customer is accessible to customer service
representatives online via a Web-based interface. All actions needed to manage
an order may be performed from within this interface. All actions of customer
service representatives are logged with the identity of the representative, the
action and a time stamp. See "Business -- Relationship with CyberSource
Corporation."
Data Warehouse. The Company utilizes a database management system to
index, retrieve and manipulate product information, content, product catalogs,
orders and transactions, and customer information. This system allows for rapid
searching, sorting, viewing and distribution of a large volume of content. The
Company deploys a data warehouse that enables it to access detailed transaction
and customer interaction data and perform proprietary market analysis. The data
warehouse provides a unified platform for the store engine and back office
systems. This data warehouse system incorporates commercially available hardware
and software combined with proprietary software of the Company in a
configuration developed by the Company. Any reduction
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in performance, disruption in the Internet access or discontinuation of services
provided by CyberSource could have a material adverse effect on the Company's
business, operating results and financial condition. There can be no assurance
that the Company's transaction-processing systems and network infrastructure
will be able to accommodate increases in traffic in the future, or that the
Company will, in general, be able to accurately project the rate or timing of
such increases or upgrade its systems and infrastructure to accommodate future
traffic levels on its online sites. In addition, there can be no assurance that
the Company will be able to either effectively upgrade and expand its
transaction-processing systems or to successfully integrate any newly developed
or purchased modules with its existing systems in a timely manner. There can be
no assurance that the Company will successfully utilize new technologies or
adapt its online sites, proprietary technology and transaction-processing
systems to customer requirements or emerging industry standards.
Substantially all of the Company's hardware associated with its development
and management system are located at a single facility leased by the Company in
San Jose, California. The Company contracts with a third party for facilities to
host the Company's production, computer and communications hardware systems and
for mission critical Internet connections, and these systems are located at a
single location in Santa Clara, California. The Company's systems and operations
are vulnerable to damage or interruption from fire, flood, power loss,
telecommunications failure, break-ins, earthquake and similar events. The
Company currently does not have a formal disaster recovery plan and does not
carry sufficient business interruption insurance to compensate it for losses
that may occur. The occurrence of any of the foregoing could have a material
adverse effect on the Company's business financial conditions and results of
operations. See "Risk Factors -- Risks of System Failure, Single Site."
SECURITY
Customer Reassurance. A critical issue for the success of online retailing
is maintaining the integrity of information, particularly the security of
information such as credit card numbers. The Company believes that its existing
security systems are at least as secure as those used for traditional
transactions (i.e., in-store or mail order purchases) and that it has a
comprehensive security strategy. The Company's system automatically monitors
each purchase and confirms each order by email to the customer within minutes
after the order is placed and advises customers by email shortly after physical
orders are shipped.
Fault Tolerance and Scaleable Internet Access. The Company's systems are
designed for automatic transfer to "hot" spare systems in the event of failure
and are equipped with fully automated reporting tools. These tools provide
automated trouble notification and detailed event logging. The Company maintains
a minimum of two of each critical production system. In the case of distributed
systems such as Web servers, as many as nine systems may be active. A load
distribution system monitors traffic to each server. Should a system fail to
respond to a request, the automated distribution system will redistribute
traffic among the remaining machines with no loss of user functionality. Both
the Company's firewall and the load distribution system are backed by standby
systems that monitor the health of the live machine, and automatically take over
in the event of a failure. After correcting the problem these automated systems
then notify technical staff by pager so the failed system may be replaced or
repaired.
The Company contracts with a Web site provider that specializes in
providing scaleable business solutions to high volume Internet sites for mission
critical Internet connectivity. The Company has contracted with the provider to
deliver a secure platform for server hosting with uninterruptible power supply
and back-up generators, fire suppression, raised floors, HVAC, separate cooling
zones, seismically braced racks, 24x7 operations and high levels of physical
security. The Company's systems are connected to a high speed Internet
connection with multiple, redundant interconnects to key backbone locations.
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Notwithstanding these precautions, there can be no assurance that either
the security mechanisms of the Company's Internet provider, the Company or the
Company's other suppliers will prevent security breaches or service breakdowns.
Despite the implementation of network security measures by the Company, its
servers may be vulnerable to computer viruses, physical or electronic break-ins
and similar disruptions, which could lead to interruptions, delays, loss of data
or the inability to accept and fulfill customer orders and have a material
adverse effect on the Company's finances, financial condition and results of
operations.
Year 2000 Concerns. Many currently installed computer systems and software
products are coded to accept only two digit entries in the date code field.
These date code fields will need to accept four digit entries to distinguish
21st century dates from 20th century dates. This could result in system failures
or miscalculations causing disruptions of operations including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities. As a result, many companies' software and
computer systems may need to be upgraded or replaced in order to comply with
such "Year 2000" requirements. The Company utilizes third-party equipment and
software that may not be Year 2000 compliant. The Company is in the early stages
of conducting an audit of its third-party suppliers as to the Year 2000
compliance of their systems. The Company does not believe it will incur
significant costs in order to comply with Year 2000 requirements. However,
failure of the Company's internal computer systems or of such third-party
equipment or software, or of systems maintained by the Company's suppliers, to
operate properly with regard to the Year 2000 and thereafter could require the
Company to incur unanticipated expenses to remedy any problems, which could have
a material adverse effect on the Company's business, financial condition and
results of operations. See "Risk Factors -- Year 2000 Compliance."
RELATIONSHIP WITH CYBERSOURCE CORPORATION
In December 1997, in order to focus on its core business of selling
Software over the Internet, the Company spun-off its Internet commerce services
business (the "Spin-off") to a new Delaware corporation which now operates under
the name CyberSource Corporation ("CyberSource").
In connection with the Spin-off, the Company and CyberSource have entered
into certain agreements for the purpose of defining the ongoing relationship
between the two companies. Five out of six of the Company's directors are also
directors of CyberSource and certain other members of the Company's management
team joined CyberSource as executive officers. Accordingly, these agreements may
not be deemed the result of arm's length negotiations.
Pursuant to the terms of a Conveyance Agreement between the Company and
CyberSource dated December 31, 1997, the Company transferred to CyberSource the
technology (including rights to patent applications, trademarks and other
intellectual property rights of the Company relating thereto), contracts and
licenses with third parties and certain tangible assets relating to or utilized
by the Company in connection with credit card processing, fraud screening,
export control, territory management and electronic fulfillment notification. In
addition, the Company's employees who were engaged in the Company's internet
commerce services business were transferred to CyberSource after the Spin-off.
In addition, pursuant to the terms of an Inter-Company Cross License
Agreement entered into in April 1998, and amended in May 1998, between the
Company and CyberSource (the "Cross License Agreement"), the Company granted to
CyberSource a non-exclusive, worldwide, perpetual, irrevocable royalty-free
license to internally use the Company's Cache Manager technology and to use and
sublicense the Company's customer database for certain limited purposes in
connection with fraud verification and detection. Under the Cross License
Agreement, CyberSource granted the Company a worldwide, perpetual, irrevocable
royalty-free license to internally use CyberSource's Sm@rtCert technology with
the right to modify such technology for purposes of
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embedding such technology into the Company's Cache Manager (either alone or in
combination with other software) for subsequent sublicense, for use by
enterprises and government agencies. The Cross License Agreement further
provides that the parties shall have joint ownership of certain utility tools
and allocates between the Company and CyberSource ownership of certain
inventions made by each party on or before June 30, 1998 and the ownership of
certain improvements, enhancements and modifications by the parties to the
Sm@rtCert and Cache Manager technologies made through 1999. Each party has
agreed to indemnify the other against any third party claims regarding the use
of the licensed technology by such licensee that results in a claim against the
licensor, except to the extent that such claim is based upon a claim that the
licensed technology infringes upon any third party's intellectual property
rights. CyberSource and the Company also entered into an Internet Commerce
Services Agreement (the "Services Agreement"), pursuant to which CyberSource has
agreed to provide certain services including credit card processing, fraud
screening, export control, territory management and electronic fulfillment, in a
"back office" capacity. This Agreement expires on December 31, 1998 and
automatically renews for an additional one year term, unless otherwise
terminated by either party. Pursuant to the terms of the Services Agreement, the
Company has agreed to indemnify CyberSource for an amount not to exceed $100,000
against any claim based upon an allegation that the Software distributed by the
Company infringes upon any third party's intellectual property rights.
CyberSource has agreed to indemnify the Company for an amount not to exceed
$100,000 against any claim based upon an allegation that the services, or the
use of any software provided by CyberSource in connection with the services,
provided by CyberSource to the Company infringes any third party's intellectual
property rights.
Any discontinuation of the services provided to the Company by CyberSource
under the Services Agreement, or termination of the Cross License Agreement, or
any reduction in performance that requires the Company to replace such services
or internally develop or license such technology from a third party, would be
disruptive to the Company's business, financial condition and results of
operations. CyberSource provides to other customers, including competitors of
the Company, the same services its provides to the Company. In addition, certain
former members of the Company's management hold executive management positions
with CyberSource, including William S. McKiernan, the Chairman of the Company's
Board of Directors, who serves as President and Chief Executive Officer of
CyberSource. Currently, five of the Company's six members of the Company's Board
of Directors serve on the CyberSource Board of Directors. Nothing in the
Company's agreements with CyberSource prohibits CyberSource from competing
directly with the Company or acquiring or being acquired by a third party which
competes with the Company, any of which could have a material adverse effect on
the Company's business, financial condition and results of operations. See "Risk
Factors -- Management of Potential Growth; New Management Team; Limited Senior
Management Resources," "-- Risks Associated with Dependence on CyberSource
Corporation; Relationship with CyberSource Corporation" and "Certain
Transactions."
On March 18, 1998, the Company borrowed $400,000 from CyberSource to assist
with short term liquidity needs. This loan is memorialized in a promissory note
issued by the Company to CyberSource, which provides for repayment in a lump sum
on or before September 18, 1998 and bears interest at a rate of 5.32% per annum
compounded semi-annually. The terms of this loan arrangement were not the result
of arm's length negotiation between the Company and CyberSource.
COMPETITION
The online commerce market is new, rapidly evolving and intensely
competitive, and the Company expects competition to intensify in the future.
Barriers to entry are minimal, and current and new competitors can launch new
Web sites at a relatively low cost. In addition, the Software reselling industry
is intensely competitive. The Company currently competes primarily with
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traditional Software resellers, other online Software resellers and other
vendors. In the online market, the Company competes with online Software sellers
and vendors that maintain commercial Web sites, including CompUSA, CNET,
Cyberian Outpost and Egghead.com, and a growing number of Software publishers
that sell their Software products directly online. The Company also anticipates
that it may in the near future compete with other Software publishers, including
Microsoft, that plan to sell their products directly to customers online and
with indirect competitors that specialize in online commerce or derive a
substantial portion of their revenues from online commerce, including AOL,
Netscape, Amazon.com and Yahoo!. These entities may themselves offer, or others
may offer through such entities, Software products. In addition, entities
experienced in mail-order and/or direct marketing of computer products
(including cataloguers such as Micro Warehouse and manufacturers such as Dell
Computer and Gateway), major Software product distributors such as Ingram Micro,
or Tech Data and other major retailers of products, such as OfficeMax, Staples
and Office Depot, have established, or may establish in the near future,
commercial Web sites offering Software products. Competitive pressures created
by any one of these current or future competitors, or by the Company's
competitors collectively, could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company believes that the principal competitive factors in its market
are brand recognition, selection, convenience, price, speed and accessibility,
customer service, quality of site content, and reliability and speed of
fulfillment. In addition to the foregoing, the large enterprise market focuses
on compatibility of products, administration and reporting, single source
supply, security and cost-effective deployment. Many of the Company's current
and potential competitors have longer operating histories, larger customer
bases, greater brand recognition and significantly greater financial, marketing
and other resources than the Company. In addition, larger, well-established and
well-financed entities may acquire, invest in or form joint ventures with online
competitors as the use of the Internet and other online services increases.
Certain of the Company's actual or potential competitors, such as Ingram Micro
and Tech Data, may be able to secure merchandise from vendors on more favorable
terms, devote greater resources to marketing and promotional campaigns, adopt
more aggressive pricing or inventory availability policies and devote
substantially more resources to Web site and systems development than the
Company. Certain of the Company's competitors such as Software Spectrum, GTSI
and Corporate Software & Technology have greater experience in selling Software
to the large enterprise market. In addition, new technologies and expansion of
existing technologies, such as price comparison programs that select specific
titles from a variety of Web sites, may direct customers to online Software
resellers that compete with the Company and may increase competitive pressures
on the Company. Increased competition may result in reduced operating margins,
as well as a loss of both market share and brand recognition. Further, as a
strategic response to changes in the competitive environment, the Company may
from time to time make certain pricing, service or marketing decisions or
acquisitions that could have a material adverse effect on its business,
financial condition and results of operations. In addition, companies that
control access to Internet transactions through network access or Web browsers
could promote the Company's competitors or charge the Company a substantial fee
for inclusion in their product or service offerings. There can be no assurance
that the Company will be able to compete successfully against current and future
competitors, and any inability to do so could have a material adverse effect on
the Company's business, operating results and financial condition. See "Risk
Factors -- Competition."
LEGAL PROCEEDINGS
From time to time, the Company may be involved in litigation relating to
claims arising out of its ordinary course of business. The Company presently is
not subject to any material legal proceedings.
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INTELLECTUAL PROPERTY
The Company regards its copyrights, service marks, trademarks, trade dress,
trade secrets and similar intellectual property as critical to its success, and
relies on trademark and copyright law, trade secret protection and
confidentiality and/or license agreements with its employees, customers,
partners and others to protect its proprietary rights. The Company pursues the
registration of its trademarks and service marks in the U.S., and has applied
for the registration of certain of its trademarks and service marks. The Company
applied for Federal registration of the service mark "SOFTWARE.NET" on August
24, 1994, and there can be no assurances that a Federal registration of the
service mark will issue in respect of SOFTWARE.NET. Effective trademark, service
mark, copyright and trade secret protection may not be available in every
country in which the Company's products and services are made available online.
The Company has licensed in the past, and expects that it may license in the
future, certain of its proprietary rights, such as trademarks or copyrighted
material, to third parties. While the Company attempts to ensure that the
quality of its brand is maintained by such licensees, there can be no assurance
that such licensees will not take actions that might materially adversely affect
the value of the Company's proprietary rights or reputation, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. There can be no assurance that the steps taken by the
Company to protect its proprietary rights will be adequate or that third parties
will not infringe or misappropriate the Company's trade secrets, copyrights,
trademarks, trade dress and similar proprietary rights. In addition, there can
be no assurance that others will not independently develop substantially
equivalent intellectual property. A failure by the Company to protect its
intellectual property in a meaningful manner could have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, litigation may be necessary in the future to enforce the Company's
intellectual property rights, to protect the Company's trade secrets or to
determine the validity and scope of the proprietary rights of others. Such
litigation could result in substantial costs and diversion of management and
technical resources, either of which could have a material adverse effect on the
Company's business, financial condition and results of operations.
In addition, there can be no assurance that other parties will not assert
infringement claims against the Company. From time to time, the Company has
received, and may receive in the future, notice of claims of infringement of
other parties' proprietary rights. There can be no assurance that such claims
will not be asserted or prosecuted against the Company in the future or that any
past or future assertions or prosecutions will not materially adversely affect
the Company's business, financial condition and results of operations. Any such
claims, with or without merit, could be time-consuming, result in costly
litigation and diversion of technical and management personnel, cause product
shipment delays or require the Company to develop non-infringing technology or
enter into royalty or licensing agreements. Such royalty or licensing
agreements, if required, may not be available on terms acceptable to the
Company, or at all. In the event of a successful claim of product infringement
against the Company and the failure or inability of the Company to develop
non-infringing technology or license the infringed or similar technology on a
timely basis, the Company's business, financial condition and results of
operations could be materially adversely affected. See "Risk
Factors -- Uncertain Protection of Intellectual Property."
EMPLOYEES
As of June 1, 1998, the Company employed 75 employees. The Company also
employs independent contractors and other temporary employees. None of the
Company's employees is represented by a labor union, and the Company considers
its employee relations to be good. Competition for qualified personnel in the
Company's industry is intense, particularly among software development and other
technical staff. The Company believes that its future success will depend in
part on its continued ability to attract, hire and retain qualified personnel.
See "Risk
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Factors -- Management of Potential Growth; New Management Team; Limited Senior
Management Resources" and "-- Dependence on Key Personnel; Need for Additional
Personnel."
FACILITIES
At present, the Company's principal administrative, engineering, marketing
and customer service facilities total approximately 13,500 square feet and are
located in San Jose, California under leases that expire in September 2002 and
August 1998. As soon as is practicable, the Company intends to sublet this
current facility to a third party for the remainder of the term of such lease.
There can be no assurance that the Company will be able to sublet this facility
on commercially acceptable terms or at all. The Company entered into a sublease
in May 1998 for approximately 75,197 square feet of office space located in
Sunnyvale, California (the "Sublease"). The Company intends that this location
will serve as the Company's principal administrative, engineering, marketing and
customer service facility. The Sublease term will commence as of July 1, 1998,
and will end sixty-two (62) months thereafter, unless sooner terminated. Under
the terms of the Sublease, the Company made a security deposit payment of
$297,000 cash, and issued an irrevocable letter of credit for $595,000 prior to
occupancy and commencement of the Sublease term. The Company is obligated to
make monthly payments of approximately $149,000 increasing to $174,000 over the
term of the Sublease. The Company does not have an option to renew or extend the
term of this Sublease.
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information regarding the executive
officers and directors of the Company as of June 1, 1998.
<TABLE>
<CAPTION>
NAME AGE POSITION WITH COMPANY
---- --- ---------------------
<S> <C> <C>
William S. McKiernan..................... 41 Chairman of the Board of Directors
Mark L. Breier........................... 38 President, Chief Executive Officer and
Director
John P. Pettitt.......................... 35 Executive Vice President and Chief
Technology Officer
James R. Lussier......................... 41 Vice President, Business Operations
Michael J. Praisner...................... 51 Vice President, Finance & Administration
and Chief Financial Officer
Alan C. DeClerck......................... 43 Vice President, Sales
Brian J. Sroub........................... 39 Vice President, Marketing
Bert Kolde(1)(2)......................... 44 Director
Linda Fayne Levinson(1)(2)............... 56 Director
Steven P. Novak(1)(2).................... 50 Director
Richard Scudellari(1)(2)................. 41 Secretary and Director
</TABLE>
- ---------------
(1) Member of Audit Committee
(2) Member of Compensation Committee
WILLIAM S. MCKIERNAN is a co-founder of the Company and has served as
Chairman of the Board of Directors of the Company since March 1998. Since the
Company's inception in 1994 to March 1998, Mr. McKiernan served as President and
Chief Executive Officer of the Company. Mr. McKiernan also currently serves as a
director and Chief Executive Officer of CyberSource Corporation. From 1992 to
1994, Mr. McKiernan held a number of positions at McAfee Associates, Inc. (now
known as Network Associates), including President and Chief Operating Officer,
the positions he held during its initial public offering in October 1992. Prior
to joining McAfee Associates in 1992, Mr. McKiernan was Vice President of
Princeton Venture Research, Inc., an investment banking and venture consulting
firm from 1990 to 1992. Mr. McKiernan has also held management positions with
IBM/ROLM and Price Waterhouse. Mr. McKiernan received his M.B.A. from the
Harvard University Graduate School of Business.
MARK L. BREIER joined the Company in March 1998, as a director, President
and Chief Executive Officer. From January 1997 until he joined the Company, Mr.
Breier served as Vice President of Marketing of Amazon.com, Inc. From April 1995
to January 1997, Mr. Breier served as Vice President of Marketing of Cinnabon
World Famous Cinnamon Rolls. Mr. Breier was involved in product management and
introduction at Dreyer's Grand Ice Cream from 1990 to April 1995, at Kraft
Foods, Inc., a multinational consumer products company, from April 1986 to
October 1988, and at Parker Brothers, a worldwide manufacturer of toys and
games, from August 1985 to March 1986. Mr. Breier received his B.A. in Economics
from Stanford University and his M.B.A. from the Stanford University Graduate
School of Business.
JOHN P. PETTITT is a co-founder of the Company and has served as Executive
Vice President and Chief Technology Officer since its inception in 1994. From
1992 to 1994, Mr. Pettitt consulted on a number of Internet and Intranet
projects including a national medical imaging network. From 1986 to 1992, Mr.
Pettitt served as Group Vice President and Technical Director of Specialix PLC,
a leading supplier of communications controllers for UNIX systems. While at
Specialix, Mr. Pettitt
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<PAGE> 53
received the 1992 British Design Award for designing a new distributed, fault
tolerant data switch. Mr. Pettitt also co-founded the United Kingdom Internet
Consortium.
MICHAEL J. PRAISNER joined the Company as Vice President, Finance and
Administration and Chief Financial Officer in April 1998. From 1995 to February
1998, Mr. Praisner served as Vice President, Finance and Administration, Chief
Financial Officer and Secretary of Silicon Storage Technology, Inc., a supplier
of flash memory devices. From 1994 to 1995, he served as Vice President, Finance
and Chief Financial Officer of MicroModule Systems, Inc., a manufacturer of
multichip modules for computer and telecommunications applications. From 1992 to
1993, he served as Vice President, Finance and Chief Financial Officer of
Electronics for Imaging, Inc., a manufacturer of color desktop publishing
computer systems. During part of 1991, he served as Vice President, Finance and
Chief Financial Officer of Digital Link Corp., a computer communications
equipment company. From 1989 to 1991, he served as Corporate Controller of
Applied Materials Inc., a manufacturer of semiconductor wafer fabrication
equipment. Mr. Praisner received his B.A. in Liberal Arts and his M.B.A. from
Southern Methodist University and is a Certified Public Accountant.
JAMES R. LUSSIER joined the Company in April 1998 as Vice President,
Business Operations. From September 1992 to April 1998, Mr. Lussier served as an
Associate Partner of Andersen Consulting where Mr. Lussier was responsible for
the Electronics and High Technology Strategy Practice Group and was a member of
the Commerce Core Team. Mr. Lussier received a B.S. in Finance from the Wharton
School, University of Pennsylvania, an M.A. in Sociology, with an emphasis in
Statistics, from the University of California at Berkeley and an M.B.A. from the
Stanford University Graduate School of Business.
ALAN C. DECLERCK joined the Company in April 1998 as Vice President, Sales.
From August 1995 until he joined the Company, Mr. DeClerck served as
International Director, ISVs & Integrators, for Sun Microsystems Computer
Corporation. From January 1989 until August 1995, Mr. DeClerck served other
roles at Sun Microsystems, including Director, Corporate Business Development,
Director of Marketing and Business Development at FirstPerson, a Sun
Microsystems subsidiary that developed the initial Java technology, and various
sales and sales management roles. Mr. DeClerck was involved in marketing and
sales roles from 1980 until 1989 at Network Equipment Technologies, Industrial
Networking, Inc. and General Motors Corporation. Mr. DeClerck received his A.B.
in International Relations from Brown University, his M. Phil. in International
Relations from Oxford University and his M.B.A. from Stanford University
Graduate School of Business.
BRIAN J. SROUB joined the Company in April 1998 as Vice President,
Marketing. From June 1995 to April 1998, Mr. Sroub served as the Vice President,
Marketing of Hearst New Media & Technology, a worldwide media company. From
November 1993 to May 1995, Mr. Sroub served as the Vice President, Sales &
Marketing of Sony Electronics. Prior to October 1993, Mr. Sroub co-founded Home
Environmental Products, a start-up horticultural corporation, and was a Brand
Manager at Procter & Gamble Company. Mr. Sroub received a B.A. in Economics &
Communications from Boston College, an M.A. in Economics from Boston College and
an M.B.A. from the Stanford University Graduate School of Business.
BERT KOLDE, a director of the Company since July 1996, serves as a
director, Vice President, Treasurer and Secretary of Vulcan Ventures Inc., Vice
Chairman of the Portland Trail Blazers, Seattle Seahawks, Oregon Arena
Corporation and First and Goal Corporation, and as President of the Paul G.
Allen Virtual Education Foundation and the Paul G. Allen Forest Protection
Foundation. Mr. Kolde co-founded Asymetrix Learning Systems, Inc. in 1985, and
serves as Chairman of its Board of Directors. Mr. Kolde also serves as a
director of MetaCreations Corporation, Precision Systems, Inc. and CyberSource
Corporation. Mr. Kolde received his B.A. in Business Administration from
Washington State University and his M.B.A. from the University of Washington.
LINDA FAYNE LEVINSON, a director of the Company since September 1997, has
served as a principal of Global Retail Partners, L.P. since April 1997. From
1994 to 1997, she served as
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<PAGE> 54
President of Fayne Levinson Associates, an independent general management
consulting firm that advised major corporations and start-up entrepreneurial
ventures. In 1993, Ms. Levinson was an executive with Creative Artists Agency,
Inc. From 1989 to 1992, Ms. Levinson was a partner of Wings Partners, Inc., a
merchant banking firm and was actively involved in taking Northwest Airlines
private. From 1984 to 1987, Ms. Levinson was a Senior Vice President of American
Express Travel Related Services, Inc. Prior to that, Ms. Levinson was a partner
at McKinsey & Co. Ms. Levinson presently serves as a Director of Administaff,
Inc., Genentech, Inc., Jacobs Engineering Group, Inc. and NCR Corporation as
well as several privately-held companies including CyberSource Corporation. Ms.
Levinson received her A.B. from Barnard College in Russian Studies, her M.A.
from Harvard in Russian Literature and her M.B.A. from New York University.
STEVEN P. NOVAK, a director of the Company since January 1995, is a
Managing Director and Director of Research of C.E. Unterberg, Towbin. From
February 1993 to January 1998, Mr. Novak served as Co-founder, President, and
Chief Investment Officer of C.E. Unterberg, Towbin Advisors, a registered
investment advisor. Mr. Novak also serves as a director of several privately
held companies including CyberSource Corporation. Mr. Novak's prior affiliations
include among others Forstmann-Leff Associates, Sanford C. Bernstein & Company,
Inc., and Harris Bankcorp. Mr. Novak received his B.S. from Purdue University
and his M.B.A. from the Harvard University Graduate School of Business.
RICHARD SCUDELLARI has served as a director and Secretary of the Company
since its inception in 1994. Mr. Scudellari has been a partner at Jackson Tufts
Cole & Black, LLP, since 1990. Mr. Scudellari serves as a director of several
privately held companies, including CyberSource Corporation. Mr. Scudellari
received his B.S. and J.D. from Boston College.
BOARD COMPOSITION
The Company currently has authorized six directors. Each director is
elected for a period of one year and serves until his or her successor is duly
elected and qualified. The Company's executive officers are appointed by, and
serve at the discretion of, the Board of Directors. Each of the Company's
officers and directors, excluding non-employee directors and Mr. McKiernan who
serves as Chief Executive Officer of CyberSource, devotes substantially full
time to the affairs of the Company. The Company's non-employee directors devote
such time to the affairs of the Company as is necessary to discharge their
duties. There are no family relationships among any of the directors, officers
or key employees of the Company. Five of the six members of the Company's Board
of Directors also serve as directors of CyberSource. See "Risk
Factors -- Management of Potential Growth; New Management Team; Limited Senior
Management Resources" and "Certain Transactions."
BOARD COMMITTEES
The Audit Committee reviews, acts on and reports to the Board of Directors
with respect to various auditing and accounting matters, including the selection
of the Company's independent accountants, the scope of the annual audits, fees
to be paid to the independent accountants, the performance of the Company's
independent accountants and the accounting practices of the Company.
The Compensation Committee recommends and establishes salaries, incentives
and other forms of compensation for officers and other employees of the Company
and administers the incentive compensation and benefit plans of the Company.
DIRECTOR COMPENSATION
Directors of the Company do not receive cash compensation for their
services as directors or members of committees of the Board of Directors, but
are reimbursed for their reasonable expenses incurred in attending meetings of
the Board of Directors. In April 1995, the Company
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<PAGE> 55
granted to Messrs. Novak and Scudellari a nonqualified stock option to purchase
20,000 shares of Common Stock and 40,000 shares of Common Stock, respectively,
at an exercise price of $0.008 per share. In January 1996, the Company granted
each of Messrs. Novak and Scudellari a nonqualified stock option to purchase
20,000 shares at an exercise price of $0.033 per share. In January 1997, the
Company granted each of Messrs. Novak, Scudellari and Kolde an option to
purchase 10,000 shares of Common Stock at an exercise price of $0.1125 per
share. In January 1998, the Company granted Ms. Levinson and each of Messrs.
Novak, Scudellari and Kolde, an option to purchase 10,000 shares of Common Stock
at an exercise price of $0.50 per share. In March 1998, the Company granted Mr.
Breier an option to purchase 1,000,000 shares of Common Stock at an exercise
price of $2.60 per share. Until April 4, 1998, under the terms of the Company's
1995 Stock Option Plan, each non-employee director of the Company received
options to purchase 10,000 shares of Common Stock upon initial election or
appointment to the Board of Directors and thereafter options to purchase 10,000
shares of Common Stock annually on January 1 of each year; following April 4,
1998, the Company's 1998 Stock Option Plan provides for identical grants. See
"Certain Transactions" and "Management -- Stock Option Plans."
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
The Company's Certificate of Incorporation limits the liability of
directors to the full extent permitted by Delaware law. Delaware law provides
that a corporation's certificate of incorporation may contain a provision
eliminating or limiting the personal liability of directors for monetary damages
for breach of their fiduciary duties as directors, except for liability (i) for
any breach of their duty of loyalty to the corporation or its stockholders, (ii)
for acts or omissions not in good faith or which involve intentional misconduct
or a knowing violation of law, (iii) for unlawful payments of dividends or
unlawful stock repurchases or redemptions as provided in Section 174 of the
Delaware General Corporation Law (the "DGCL"), or (iv) for any transaction from
which the director derived an improper personal benefit. The Company's Bylaws
provide that the Company may indemnify its directors and officers, employees and
agents to the fullest extent permitted by law. The Company believes that
indemnification under its Bylaws covers at least negligence and gross negligence
on the part of indemnified parties.
The Company has entered into agreements to indemnify its directors and
executive officers. These agreements, among other things, indemnify the
Company's directors and officers for certain expenses (including attorneys'
fees), judgments, fines and settlement amounts incurred by such persons in any
action or proceeding, including any action by or in the right of the Company,
arising out of such person's services as a director or officer of the Company,
any subsidiary of the Company or any other company or enterprise to which the
person provides services at the request of the Company. The Company believes
that these provisions and agreements are necessary to attract and retain
qualified directors and officers.
At present, there is no pending litigation or proceeding involving any
director, officer, employee or agent of the Company where indemnification will
be required or permitted. The Company is not aware of any threatened litigation
or proceeding that might result in a claim for such indemnification.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
None of the members of the Compensation Committee (effective upon the
consummation of this offering) is an officer or employee of the Company with the
exception of Richard Scudellari who is the Secretary of the Company. Five of the
six members of the Company's Board of Directors also serve as members of the
Board of Directors of CyberSource. Vulcan Ventures Inc., a holder of Series B,
C, and D Preferred Stock, maintains a limited partner interest in Global Retail
Partners L.P., a holder of Series C and D Preferred Stock. Other than this
relationship and the CyberSource board memberships, no interlocking relationship
exists between the Company's
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<PAGE> 56
Board of Directors or Compensation Committee and the board of directors or
compensation committee of any other company, nor has such an interlocking
relationship existed in the past.
EXECUTIVE COMPENSATION
The following table sets forth certain estimated compensation awarded or
paid by the Company during the fiscal year ended December 31, 1997 ("Last Fiscal
Year") to its President and Chief Executive Officer and its Executive Vice
President and Chief Technology Officer (together, the "Named Executives") and
certain individuals hired subsequent to the conclusion of the last fiscal year.
In March 1998, Mr. McKiernan resigned from the position of President and Chief
Executive Officer of the Company and commenced service as the Chairman of the
Company's Board of Directors, in which capacity he presently earns a salary of
$100,000 per annum.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
-------------------------------------- ------------
AWARDS
------------
SECURITIES
OTHER ANNUAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION(1) SALARY($) BONUS($) COMPENSATION($) OPTIONS(#) COMPENSATION($)
- ------------------------------ --------- -------- --------------- ------------ ---------------
<S> <C> <C> <C> <C> <C>
William S. McKiernan......... 165,000 -- -- -- --
Chairman of the Board
John P. Pettitt.............. 130,000 100 -- -- --
Executive Vice President
and Chief Technology
Officer
</TABLE>
- ---------------
(1) Mark L. Breier, the President, Chief Executive Officer and a director of the
Company, was hired in March 1998. Mr. Breier's annualized salary for the
1998 fiscal year is $200,000. In addition, Mr. Breier will receive a bonus
of $50,000 and relocation allowance payments totalling approximately $70,000
during the 1998 fiscal year. Mr. Breier also received an option to acquire
1,000,000 shares of Common Stock, subject to vesting over four years, unless
earlier accelerated.
OPTION GRANTS
No Named Executive received stock option grants in the fiscal year ended
December 31, 1997.
OPTION EXERCISES AND FISCAL YEAR-END VALUES
The following table sets forth information concerning the year-end number
and value of unexercised options with respect to each of the Named Executives.
No options and no stock appreciation rights were exercised by the Named
Executives in fiscal year 1997, and no stock appreciation rights were
outstanding at the end of that year.
<TABLE>
<CAPTION>
NUMBER OF VALUE OF
SECURITIES UNDERLYING UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
DECEMBER 31, 1997 DECEMBER 31, 1997
---------------------- ------------------------
VESTED UNVESTED VESTED UNVESTED
-------- --------- -------- ------------
<S> <C> <C> <C> <C>
William S. McKiernan............ -0- -0- N/A N/A
John P. Pettitt................. 1,250,000 -0- $619,750(2) -0-
</TABLE>
- ---------------
(1) Mark L. Breier received an option to acquire 1,000,000 shares during 1998.
None of such options are vested.
(2) Based on fair market value of the Company's Common Stock at fiscal year-end
(December 31, 1997), as determined by the Company's Board of Directors less
exercise price payable for such shares.
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<PAGE> 57
STOCK OPTION PLANS
The Company's Board of Directors and stockholders adopted the 1995 Stock
Option Plan (the "1995 Plan") in January 1995, and have reserved an aggregate of
3,000,000 shares of Common Stock for grants of stock options under such plan. In
addition, in April 1998 the Company's Board of Directors and stockholders
adopted the 1998 Stock Option Plan (the "1998 Plan" and collectively, with the
1995 Plan, the "Plans") and reserved an aggregate of 2,000,000 shares of Common
Stock for grants of stock options under such plan. The purpose of each Plan is
to enhance the long-term stockholder value of the Company by offering
opportunities to employees, directors, officers, consultants, agents, advisors
and independent contractors of the Company to promote and participate in the
Company's growth and success, and to encourage them to remain in the service of
the Company and acquire and maintain stock ownership in the Company.
As of June 1, 1998, options to purchase 3,710,513 shares of Common Stock
were outstanding under the Plans with exercise prices ranging from $0.004 to
$7.00 per share. As of May 1, 1998, options to purchase 6,445 shares were
available for grant and options for 108,542 shares had been exercised under the
1995 Plan. As of June 1, under the 1998 Plan, options to purchase 1,174,500
shares were available for grant and no shares had been exercised. As of the date
of this Prospectus, options to purchase approximately 290,903 shares of Common
Stock were held by employees of CyberSource. See "Certain Transactions."
The Plans may be administered by the Company's Board of Directors or a
committee appointed by the Board (the "Administrator").
1998 Plan. The Administrator has the authority to select individuals who
are to receive options under the 1998 Plan and to specify the terms and
conditions of options granted (including whether or not such options are
incentive or nonstatutory stock options), the vesting provisions, the option
term and the exercise price. The 1998 Plan provides for the granting to
employees, including officers and employee directors of the Company, of
incentive stock options within the meaning of Section 422 of the Internal
Revenue Code of 1986, as amended, and for the granting to employees and
consultants (including nonemployee directors) of nonstatutory stock options. In
addition, as described below, the 1998 Plan provides for automatic annual grants
of nonstatutory stock options to nonemployee directors.
The exercise price of incentive stock options granted under the 1998 Plan
shall equal the fair market value of the Company's Common Stock on the date of
grant (except in the case of grants to any person holding more than 10% of the
total combined voting power of all classes of the Company's, or any parent's or
subsidiary's, outstanding capital stock (a "Ten Percent Holder"), in which case
the exercise price shall equal 110% of the fair market value on the date of
grant). The exercise price of nonstatutory stock options shall be not less than
85% of the fair market value on the date of grant. Payment for shares upon
exercise of an option may be made in cash or other consideration, including a
promissory note, as approved by the Administrator. No individual may be granted
options under the 1998 Plan in any one fiscal year which in the aggregate would
permit him or her to purchase more than 1,000,000 shares of Common Stock, except
that a newly-hired optionee may receive a one-time grant of an option to
purchase up to an additional 500,000 shares of Common Stock.
Generally, options granted under the 1998 Plan (other than those issued to
non-employee directors as described below) vest at a rate of 25% of the shares
underlying the option after one year and the remaining shares vest monthly in
equal portions over the following 36 months, such that all shares are vested
after four years. Unless otherwise provided by the Administrator, an option
granted under the 1998 Plan generally expires ten years from the date of grant
(five years in the case of an incentive stock option granted to a Ten Percent
Holder) or, if earlier, 30 days after the optionee's termination of employment
or service with the Company or an affiliate of the Company for any reason other
than termination for death or disability, one year after termination for death
or total and permanent disability and six months in the case of other types of
disability.
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<PAGE> 58
Options granted under the 1998 Plan are not generally transferable by the
optionee except by will or the laws of descent and distribution and generally
are exercisable during the lifetime of the optionee only by such optionee.
In the event of (i) the merger or consolidation as a result of which the
holders of voting securities of the Company prior to the transaction hold shares
representing less than 51% of the voting securities of the Company after giving
effect to the transaction (other than a merger or consolidation with a
wholly-owned subsidiary or where there is no substantial change in the
stockholders of the Company and the options granted under the 1998 Plan are
assumed by the successor corporation), or (ii) the sale of all or substantially
all of the Company's assets, options outstanding under the 1998 Plan will be
assumed or substituted by the successor corporation or the successor corporation
shall provide substantially similar consideration to optionees as is provided to
the stockholders. In the event the successor corporation refuses to assume or
substitute outstanding options as provided above, or in the event of a
dissolution or liquidation of the Company, outstanding options shall expire on a
date specified in a written notice sent by the Compensation Committee to all
optionees (which date shall be at least 20 days after the date of such notice).
The 1998 Plan also provides for automatic grants to non-employee directors.
Each non-employee director, upon initial election or appointment to the Board of
Directors, is entitled to receive options to purchase 10,000 shares of Common
Stock, provided that such election or appointment does not occur within the last
quarter of a given year. Thereafter, each non-employee director is entitled to
receive options to purchase 10,000 shares of Common Stock annually on January 1
of each year, provided he or she is a non-employee director on the date of grant
and has continuously been an active member of the Board of Directors for the
year prior to the grant date. Options granted to non-employee directors pursuant
to the automatic grant provisions of the 1998 Plan are nonqualified stock
options with an exercise price equal to the fair market value of the Company's
Common Stock as of the date of grant and fully vest nine months after the date
of grant. Grants to non-employee directors are subject to the general
requirements of the 1998 Plan.
1995 Plan. The terms of options which may be issued under the 1995 Plan are
generally the same as those which may be issued under the 1998 Plan, except that
the 1995 Plan imposes a maximum number of shares which may be subject to options
issued to any individual of 1,000,000 shares. In addition, under the 1995 Plan,
in the event of a merger or consolidation of the Company in which the Company is
not a surviving corporation or a sale of all or substantially all of the
Company's assets, options outstanding under the 1995 Plan will be assumed or
substituted by the successor corporation or, in the event the successor
corporation refuses to assume or substitute the options or in the event of
dissolution or liquidation of the Company, outstanding options shall expire on a
date specified in a written notice sent by the Compensation Committee to all
optionees (which date shall be at least 20 days after the date of such notice).
Like the 1998 Plan, the 1995 Plan also provided for automatic annual grants
of nonstatutory stock options to nonemployee directors. As of the time the 1998
Plan was adopted, such grants ceased and were replaced by the automatic grants
provided for in the 1998 Plan.
Stock options previously granted under the 1995 Plan to the executives and
directors are described above under "Executive Compensation." The number of
shares of Common Stock that may be subject to options granted in the future to
executive officers and other officers, key employees and directors of the
Company under the 1998 Plan is not determinable at this time.
401(K) RETIREMENT PLAN
Effective January 1997, the Company established a 401(k) defined
contribution retirement plan (the "Retirement Plan") covering all
salaried/full-time employees with greater than one months' service. The
Retirement Plan provides for voluntary employee contributions from 1% to 15% of
annual compensation, subject to a maximum limit allowed by Internal Revenue
Service guidelines ($10,000 for 1998). The Company may contribute such amounts
to the accounts of participants in the Retirement Plan as determined by the
Board of Directors. However, to date, the Company has not made any contribution
to the Retirement Plan.
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<PAGE> 59
CERTAIN TRANSACTIONS
STOCK AND WARRANT ISSUANCES
Since January 1, 1995, the Company has issued shares of Common Stock to
certain insiders and shares of Preferred Stock in private placement transactions
each as set forth below.
In January 1995 and February 1996, the Company issued shares of Series A
Preferred Stock (the "Series A Financing") in private placements to certain
investors. Of such shares of Series A Preferred Stock, 500,000 shares were
issued to C.E. Unterberg Towbin Capital Partners I, L.P. (formerly Unterberg
Harris Capital Partners I, L.P., "Unterberg Partners I") at a purchase price of
$0.40 per share and 253,131 shares were issued to Unterberg Partners I at a
purchase price of $0.91 per share ($0.33 and $0.76 per share, respectively, as
adjusted for the Spin-off). An aggregate of 753,131 shares of Series A Preferred
Stock held by Unterberg Partners I will convert into 1,506,262 shares of Common
Stock upon consummation of this offering and such Preferred Stock then will be
cancelled and extinguished. In connection with the Series A Financing, the
holders of Series A Preferred Stock were given the right to designate one
director of the Company (the "Series A Director"). Steven P. Novak, the Series A
Director, is a Managing Director of C.E. Unterberg, Towbin ("Unterberg"), an
affiliate of the general partner of Unterberg Partners I. Mr. Novak disclaims
beneficial ownership of the shares of Series A Preferred Stock issued to
Unterberg Partners I, except for his proportional interest therein. The holders
of certain of such shares of Series A Preferred Stock are entitled to certain
registration rights with respect to the Common Stock issuable upon conversion
thereof. See "Description of Capital Stock -- Registration Rights."
In July 1996, the Company issued shares of Series B Preferred Stock (the
"Series B Financing") in a private placement to certain investors, including
925,926 shares to Vulcan Ventures Inc. ("Vulcan"), at a purchase price of $2.70
per share ($2.25 as adjusted for the Spin-off). In connection with the Series B
Financing, the holders of Series B Preferred Stock were given the right to
designate one director of the Company (the "Series B Director"). Bert E. Kolde,
the Series B Director, serves as a director, Vice President, Treasurer and
Secretary of Vulcan, as well as President of the Paul G. Allen Virtual Education
Foundation and the Paul G. Allen Forest Protection Foundation, and as a director
of several other companies controlled by Mr. Allen, who maintains a controlling
interest of Vulcan. Mr. Kolde disclaims beneficial ownership of the shares of
Series B Preferred Stock issued to Vulcan, except for his proportional interest
therein, if any. All of the outstanding shares of Series B Preferred Stock will
convert on a two-for-one basis into an aggregate of 4,074,076 shares of Common
Stock upon the consummation of this offering and such Preferred Stock then will
be cancelled and extinguished. The holders of certain of such shares of Series B
Preferred Stock are entitled to certain registration rights with respect to the
Common Stock issuable upon conversion thereof. See "Description of Capital
Stock -- Registration Rights."
In September and December 1997, the Company issued shares of Series C
Preferred Stock (the "Series C Financing") in private placements to certain
investors at a purchase price of $2.04 per share ($1.70 as adjusted for the
Spin-off), including issuances to the following entities in the number of shares
specified thereafter: (i) Global Retail Partners and its affiliates (1,470,588)
(each an affiliate of Donaldson, Lufkin & Jenrette Securities Corporation
("DLJ") and collectively "GRP"); (ii) UT Capital Partners International, LDC
(formerly UH Capital Partners International, LDC) (59,914); UT Technology
Partners, LDC (formerly UH Technology Partners, LDC) (185,184); Unterberg Harris
Private Equity Partners, LP (201,961); Unterberg Harris Private Equity Partners,
CV (43,137) (collectively, the "Unterberg Affiliates"); and (iii) Vulcan
(716,666). In connection with the Series C Financing, the holders of Series C
Preferred Stock were given the right to designate one director of the Company
(the "Series C Director"). Linda Fayne Levinson, the Series C Director, is a
principal of Global Retail Partners, L.P., an affiliate of DLJ. Messrs. Novak
and Kolde and Ms. Levinson disclaim beneficial ownership of the shares of Series
C Preferred Stock issued to the Unterberg Affiliates, Vulcan and GRP,
respectively, except for any proportional interest held therein, if any. All of
the outstanding shares of Series C Preferred Stock will convert into an
aggregate of 3,000,000 shares of Common Stock upon consummation of this offering
and such Preferred Stock then will be cancelled and extinguished. The holders of
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<PAGE> 60
certain of such shares of Series C Preferred Stock are entitled to certain
registration rights with respect to the Common Stock issuable upon conversion
thereof. See "Description of Capital Stock -- Registration Rights."
In March and April 1998, the Company issued shares of Series D Preferred
Stock (the "Series D Financing") in private placements to certain investors at a
purchase price of $2.60 per share, including issuances to the following entities
in the number of shares specified thereafter: GRP (458,106); certain of the
Unterberg Affiliates (229,052); and Vulcan (458,106), which shares in the
aggregate will convert into 1,145,264 shares of Common Stock upon the
consummation of this offering and such Preferred Stock then will be cancelled
and extinguished. Messrs. Novak and Kolde and Ms. Levinson, each a director of
the Company, disclaim beneficial ownership of the shares of Series D Preferred
Stock issued to the Unterberg Affiliates, Vulcan and GRP, respectively, except
for any proportional interest held therein, if any. All of the outstanding
shares of Series D Preferred Stock will convert into an aggregate of 1,153,846
shares of Common Stock upon consummation of this offering. The holders of
certain of such shares of Series D Preferred Stock are entitled to certain
registration rights with respect to the Common Stock issuable upon conversion
thereof. See "Description of Capital Stock -- Registration Rights."
In March and April of 1998, and concurrently with the sale of Series D
Preferred Stock, each of the holders of Series C Preferred and Series D
Preferred (collectively, the "Series C/D Holders") and the Company entered into
the Shareholders' Agreement (the "Shareholders' Agreement"), whereby the parties
agreed to the following: (A) the Series C/D Holders agreed to vote for the
person selected by GRP as the director designated by the holders of the Series C
and Series D Preferred Stock, and (B) the Company agreed to not permit the
transfer of any of the Series C or Series D Preferred Stock (or Common Stock
issuable upon conversion thereof) covered by the Shareholders' Agreement on its
books or issue a new certificate representing any such shares until the person
to whom such shares are to be transferred has executed a written agreement
substantially in the form of the Shareholders' Agreement and has agreed to be
bound by the terms thereof. This Shareholders' Agreement superseded the Series C
Shareholders' Agreement dated as of September 26, 1997, pursuant to which (A)
certain holders of Series C Preferred Stock agreed to vote for the person
selected by GRP as the director designated by the holders of the Series C
Preferred Stock, and (B) Vulcan agreed not to elect to redeem its shares of
Series B Preferred Stock until the holders of Series C Preferred Stock have the
right to seek redemption of their Series C Preferred Stock pursuant to the
Company's Certificate of Incorporation. The Shareholders' Agreement will
terminate upon the consummation of this offering.
In March 1998, the Company entered into an agreement with AOL pursuant to
which, subject to certain limited exceptions, AOL agreed to buy shares of the
Company's Common (the "AOL Shares") Stock at a price per share equal to the
initial public offering price (less the Underwriters' discount) for an aggregate
purchase price of $2,000,000 (the "Common Stock and Warrants Subscription
Agreement"). AOL will purchase 238,948 shares of Common Stock immediately prior
to the consummation of this offering. Concurrent with the purchase of the shares
of Common Stock by AOL immediately prior to the consummation of this offering,
the Company will issue to AOL a Warrant for a number of shares of Common Stock
equal to 1.5 times the number of shares of Common Stock purchased by AOL in the
aforementioned investment at a per share exercise price equal to the initial
public offering price (less the underwriting discount) which will vest in
increments of 1/36th per month commencing March 1, 1998. The AOL Warrant will
enable AOL to purchase 358,422 shares of Common Stock at an exercise price of
$8.37 per share. AOL also received certain registration rights pursuant to a
registration rights agreement entered into concurrently with the Common Stock
and Warrants Subscription Agreement. See "Description of Capital
Stock -- Registration Rights."
In March 1998, the Company also issued a Warrant to AOL to purchase 369,578
shares of the Company's Series D Preferred Stock at a price of $2.60 per share
vesting in increments of 1/36th per month commencing March 1, 1998, provided
however, that this Warrant is not
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exercisable until after August 31, 1999, except in the event of a change of
control of the Company (as defined therein). This Warrant will terminate in
accordance with its terms immediately prior to the consummation of this
offering.
OPTION GRANTS AND AGREEMENTS WITH EXECUTIVE OFFICERS AND DIRECTORS
In March 1995, the Company granted options to purchase 1,000,000 shares of
Common Stock to John P. Pettitt, the Company's Executive Vice President and
Chief Technology Officer, in consideration of services provided to the Company
by Mr. Pettitt. Mr. Pettitt's options have an exercise price of $0.004, as
adjusted for the Spin-off), and are fully vested. Mr. Pettitt's option rights
expire upon the earlier to occur of the date Mr. Pettitt ceases to be employed
by the Company or December 31, 2000. Upon termination of Mr. Pettitt's
employment for any reason except death or disability, the options must be
exercised within 30 days of the termination date or such options will be
forfeited. In the event of termination due to death or disability, Mr. Pettitt's
options shall be forfeited unless exercised within six months of the termination
date. In the event of certain corporate reorganizations or other specific
corporate transactions affecting the Common Stock of the Company, proportional
adjustments may be made to the number of shares available for Mr. Pettitt's
grant and to the number of shares and price awards made prior to the event. Mr.
Pettitt's grants are intended as non-qualified stock options. In April 1995, the
Company granted options to purchase 250,000 shares of Common Stock to Mr.
Pettitt under the 1995 Stock Option Plan. These options have an exercise price
of $0.004 per share and are fully vested. As of the date of this Prospectus, Mr.
Pettitt had vested options to purchase 1,250,000 shares of Common Stock, 250,000
of which were issued under the 1995 Stock Option Plan and are subject to the
general requirements of such Plan.
In December 1997, Richard Scudellari, a director and Secretary of the
Company and a partner of Jackson Tufts Cole & Black, LLP, the Company's counsel,
exercised options granted under the 1995 Stock Option Plan to purchase 70,000
shares of the Company's Common Stock for an aggregate purchase price of $1,950.
In January 1998, Mr. Scudellari was granted an option to purchase 10,000 shares
of the Company's Common Stock at an exercise price of $0.50 per share.
Under the terms of an oral agreement between the Company and William S.
McKiernan, the Chairman of the Company's Board of Directors, the Company repaid,
in two installments in December 1997 and January 1998, an aggregate of $105,000
for unpaid salary that had been accrued by the Company on Mr. McKiernan's behalf
for services provided by Mr. McKiernan to the Company from the date of the
Company's inception through December 1997.
On March 30, 1998 the Company granted an option to purchase 1,000,000
shares of Common Stock to Mark L. Breier, its President and Chief Executive
Officer, under the 1995 Stock Option Plan. This option has an exercise price of
$2.60 per share and is governed generally by the terms of the 1995 Stock Option
Plan, with certain limited exceptions. In the event that: (i) the Company is
sold or is party to a merger with another company resulting in the Company's
stockholders immediately prior to such transaction owning less than 50% of the
successor company's voting capital stock immediately following such transaction;
or (ii) Mr. Breier resigns due to (A) a material reduction in title or
responsibilities, or (B) the Company requires Mr. Breier's ongoing and regular
duties to be performed at a location more than 60 miles from the Company's
current headquarters (each, an "Accelerating Event") occurring prior to
September 30, 1999, a number of shares equal to the number exercisable one year
after the Accelerating Event will be immediately exercisable. In the event of an
Accelerating Event occurring after September 30, 1999, a number of shares equal
to the sum of the number of shares exercisable and one-half of the shares not
exercisable as of the Accelerating Event will be immediately exercisable. In the
event that Mr. Breier is terminated prior to March 30, 1999 for any reason,
125,000 shares will be immediately exercisable.
In March, 1998, Steven P. Novak, a director of the Company and a Managing
Director of C.E. Unterberg, Towbin, exercised options under the Company's 1995
Stock Option Plan to purchase 20,000 shares of the Company's Common Stock for an
aggregate purchase price of $200. In
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<PAGE> 62
addition, Mr. Novak received an option to purchase 20,000 of the Company's
Common Stock at an exercise price of $0.0333 per share in January 1996; an
option to purchase 10,000 shares in January 1997 at an exercise price of $0.1125
per share; and an option to purchase 10,000 shares in January 1998 at an
exercise price of $0.50 per share.
In April 1998, the Company granted an option to purchase 200,000 shares of
Common Stock to Michael J. Praisner, its Vice President, Finance &
Administration and Chief Financial Officer under the 1998 Stock Option Plan.
These options have an exercise price of $4.36 per share and are governed
generally by the terms of the 1998 Stock Option Plan.
In April 1998 Alan C. DeClerck, the Company's Vice President, Sales, was
granted an option to purchase 180,000 shares of Common Stock under the 1998
Stock Option Plan. These option have an exercise price of $4.96 per share and
are governed generally by the terms of the 1998 Stock Option Plan.
In April 1998, the Company granted Brian J. Sroub, the Company's Vice
President, Marketing, an option to purchase 180,000 shares of Common Stock at an
exercise price of $5.44 per share.
In April 1998, the Company granted James R. Lussier, the Company's Vice
President, Business Operations, an option to purchase 180,000 shares of Common
Stock at an exercise price of $5.50 per share. The Company has agreed to provide
Mr. Lussier with six months advance notice of termination, if such termination
occurs on or before April 27, 1999.
For additional information regarding options granted to the Company's
directors, see "Management -- Director Compensation."
RELATIONSHIP WITH CYBERSOURCE CORPORATION
In December 1997, in order to focus on its core business of selling
Software over the Internet, the Company spun-off (the "Spin-off") its internet
commerce services business to a new Delaware corporation which operates under
the name CyberSource Corporation ("CyberSource"). In connection with the
Spin-off, capital stock of CyberSource was issued to the stockholders of the
Company such that, following consummation of the Spin-off and the transactions
contemplated thereby, each stockholder of the Company was the holder of shares
of capital stock of CyberSource in equal number and ownership proportion and
with the same rights as such stockholder had as a stockholder of the Company. On
the date of the Spin-off, employees of the Company maintained their outstanding
options to purchase Common Stock of the Company and were granted additional
stock options in CyberSource based on the extent to which the employees original
options were vested. Employees of CyberSource immediately following the Spin-off
maintained their outstanding vested stock options in the Company and were
granted additional stock options in CyberSource. The exercise prices of the
original and additional option grants were adjusted to reflect the allocation of
the current fair market per share price between the Company's and CyberSource's
Common Stock, respectively, at the time of the Spin-off. Options held by the
CyberSource employees that had not vested as of the date of the Spin-off were
canceled.
The Company and CyberSource have entered into certain agreements for the
purpose of defining the ongoing relationship between the two companies. Five out
of six of the Company's directors are also directors of CyberSource and certain
other members of the Company's management team joined CyberSource as executive
officers. Accordingly, these agreements are not the result of arm's length
negotiations between independent parties. The following discussion of the
agreements between the Company and CyberSource are qualified in their entirety
by reference to the agreements, which have been filed as exhibits hereto.
Pursuant to the terms of a Conveyance Agreement dated December 31, 1997,
the Company transferred to CyberSource the technology (including rights to all
patent applications, trademarks and other intellectual property rights of the
Company relating thereto), contracts and licenses with third parties and certain
tangible assets relating to or utilized by the Company in connection with credit
card processing, fraud screening, export control, territory management and
electronic fulfillment services. In addition, those of the Company's employees
engaged in the Company's internet commerce services business were transferred to
CyberSource in connection with the Spin-off.
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In connection with such transfer, the Company and CyberSource entered into
an Inter-Company Cross-License Agreement (the "Cross License Agreement") in
April 1998, which was amended in May 1998, pursuant to which the Company granted
to CyberSource a non-exclusive, worldwide, perpetual, irrevocable, royalty-free
license to internally use the Company's Cache Manager technology and to use and
sublicense the Company's customer database for certain limited purposes in
connection with fraud detection and verification. Under the Cross License
Agreement, CyberSource granted the Company a worldwide, perpetual, irrevocable,
royalty-free license to internally use CyberSource's Sm@rtCert technology with
the right to modify such technology for purposes of embedding such technology
into the Company's Cache Manager technology (either alone or in combination with
other software) for subsequent sublicense, for use by enterprises and
governmental agencies, subject to certain limitations. The Cross License
Agreement further provides that the parties shall have joint ownership of
certain utility tools made by the parties and allocates between the Company and
CyberSource the ownership of improvements, enhancements and modifications made
by the parties to the Sm@rtCert and Cache Manager Technology during 1999. The
Cross License Agreement also allocates between the Company and CyberSource the
ownership of certain inventions made by each party on or before June 30, 1998.
Each party has agreed to indemnify the other against any third party claims
regarding the use of the licensed technology by such licensee that results in a
claim against the licensor, except to the extent that such claim is based upon a
claim that the licensed technology infringes upon any third party's intellectual
property rights.
CyberSource and the Company also entered into an Internet Commerce Services
Agreement, pursuant to which CyberSource has agreed to provide certain services
including credit card processing, fraud screening, export control, territory
management and electronic fulfillment, in a "back office" capacity. This
Agreement expires on December 31, 1998 and automatically renews for an
additional one year term, unless otherwise terminated by either party. Pursuant
to the terms of the Services Agreement, the Company has agreed to indemnify
CyberSource for an amount not to exceed $100,000 against any claim based upon an
allegation that the Software distributed by the Company infringes upon any third
party's intellectual property rights. CyberSource has agreed to indemnify the
Company for an amount not to exceed $100,000 against any claim based upon an
allegation that the services, or the use of any software provided by CyberSource
in connection with the services, provided by CyberSource to the Company
infringes any third party's intellectual property rights. See "Risk
Factors -- Risks Associated with Dependence on CyberSource Corporation;
Relationship with CyberSource Corporation" and "Business -- Relationship with
CyberSource Corporation."
In connection with the Spin-off, the Board of Directors of the Company and
the stockholders of the Company approved loans in amounts equal to the adverse
incremental income tax incurred by any stockholder as a result of the Spin-off
and the transactions contemplated thereby. In April 1998, the Company loaned
$270,000 to William S. McKiernan, the sole stockholder incurring such adverse
tax consequences, so as to offset Mr. McKiernan's incremental 1997 income tax.
The loan to Mr. McKiernan is secured by 129,808 shares of Common Stock held by
Mr. McKiernan and will be due and payable no later than 18 months from the
consummation of this offering. Interest accrues on the loan to Mr. McKiernan at
the rate of six and two hundredths percent (6.02%), compounded annually, and
shall be payable only at such time the principal is due and payable.
On March 18, 1998, the Company borrowed $400,000 from CyberSource to assist
with short term liquidity needs. This loan is memorialized in a promissory note
issued by the Company to CyberSource, which provides for repayment in a lump sum
on or before September 18, 1998 and bears interest at a rate of 5.32% compounded
semi-annually. The terms of this loan arrangement are not the result of arm's
length negotiation between the Company and CyberSource.
The Company has entered into indemnification agreements with each of its
executive officers and directors. See "Management -- Limitation of Liability and
Indemnification Matters."
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PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's outstanding Common Stock as of June 1, 1998, and as
adjusted to reflect the sale of the Common Stock offered hereby for (i) each of
the Named Executives of the Company, (ii) each director of the Company, (iii)
each person or entity known by the Company to beneficially own more than 5% of
the Common Stock, and (iv) all of the Company's directors and executive officers
as a group. Except as otherwise indicated, the Company believes that the
beneficial owners of the Common Stock listed below, based on information
furnished by such owners, have sole voting and investment power with respect to
such shares.
<TABLE>
<CAPTION>
PERCENTAGE OF
SHARES
OUTSTANDING(1)
NUMBER OF SHARES --------------------
BENEFICIALLY PRIOR TO AFTER
NAMED EXECUTIVE OFFICERS AND DIRECTORS OWNED(1) OFFERING OFFERING
-------------------------------------- ---------------- -------- --------
<S> <C> <C> <C>
William S. McKiernan(2)............................... 8,996,154 42.2% 33.9%
John P. Pettitt(3).................................... 1,250,000 5.5 4.5
Vulcan Ventures Inc.(4)............................... 3,036,624 14.3 11.4
110 110th Avenue NE,
Suite 550
Bellevue, Washington 98004
Entities affiliated with C. E. Unterberg, Towbin(5)... 2,275,510 10.7 8.6
Swiss Bank Tower
10 East 50th Street,
22nd Floor
New York, New York 10002
Global Retail Partners, L.P. and its affiliates(6).... 1,928,694 9.1 7.3
2121 Avenue of the Stars
Los Angeles, California 90067
Bert Kolde(7)......................................... 3,036,624 14.3 11.4
Linda Fayne Levinson(8)............................... 1,928,694 9.1 7.3
Steven P. Novak(9).................................... 2,275,510 10.7 8.6
Richard Scudellari(10)................................ 70,000 * *
WA&H Investments...................................... 1,153,321 5.4 4.3
First Bank Place
601 Second Ave. South,
31st Floor
Minneapolis, MN 55402
All Directors and Executive Officers as a Group (11
Persons)(11):......................................... 17,556,982 77.8 63.1
</TABLE>
- ---------------
* Represents beneficial ownership of less than 1% of the Company's
outstanding equity.
(1) Number of shares beneficially owned is determined based on: (i) 21,307,504
shares outstanding as of June 1, 1998; (ii) 26,546,452 shares outstanding
after this offering which assumes no exercise of the Underwriters' over-
allotment option and includes 238,948 shares of Common Stock to be issued
to AOL immediately prior to the consummation of this offering. Beneficial
ownership is determined in accordance with the rules of the Securities and
Exchange Commission. The number of shares beneficially owned by a person
includes shares of Common Stock subject to options held by that person
that are currently exercisable or exercisable within 60 days of June 1,
1998. Such shares issuable pursuant to such options are deemed outstanding
for computing the percentage ownership of the person holding such options
but not deemed outstanding for the purposes of computing the percentage
ownership of each other person. Accordingly, executive officers of the
Company Mark L. Breier, Michael J. Praisner, Alan C. DeClerck, Brian J.
Sroub and James R. Lussier, holders of options to purchase 1,000,000,
200,000, 180,000, 180,000 and 180,000 shares of Common Stock,
respectively, none of which are exercisable within 60 days of June 1,
1998, are not listed in this table. To the Company's knowledge, the
persons named in this table have sole voting and investment power with
respect to all shares of Common Stock shown as owned by them, subject to
community property laws where applicable and except as indicated in the
other footnotes to this table.
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<PAGE> 65
Unless otherwise indicated, the address of each of the individuals named
above is: c/o software.net Corporation, 3031 Tisch Way, Ste. 900, San
Jose, California 95128.
(2) Includes 8,938,464 shares held by Mr. McKiernan and 57,690 shares held by
members of Mr. McKiernan's immediate family. Mr. McKiernan disclaims
beneficial ownership of the shares held by his immediate family.
(3) Represents 1,250,000 shares issuable upon exercise of options immediately
exercisable.
(4) Represents 3,026,624 shares held by Vulcan Ventures Inc. ("Vulcan") and
options to purchase 10,000 shares of Common Stock, exercisable
immediately, held by Bert Kolde, a Director of the Company and a director,
Vice President, Secretary and Treasurer of Vulcan. Mr. Kolde disclaims
beneficial ownership of the shares owned by Vulcan, except for his
proportional interest therein; if any.
(5) Includes 59,914 shares held by UT Capital Partners International, LDC
(formerly U.H Capital Partners International, LDC), 368,426 shares held by
UT Technology Partners, LDC (formerly UH Technology Partners, LDC);
1,506,262 shares held by C. E. Unterberg Towbin Capital Partners I, L.P.
(formerly Unterberg Harris Capital Partners I, L.P.); 239,708 shares held
by Unterberg Harris Private Equity Partners, L.P. and 51,200 shares held
by Unterberg Harris Private Equity Partners, CV (collectively, the
"Unterberg Affiliates") and 20,000 shares of Common Stock, and options to
purchase 30,000 shares of Common Stock that are exercisable within 60 days
of June 1, 1998, held by Steven P. Novak, a Managing Director of
Unterberg. Mr. Novak disclaims beneficial ownership of all shares owned by
the Unterberg Affiliates.
(6) Represents 1,928,694 shares held by Global Retail Partners, L.P. and its
affiliates (collectively, "GRP"), each an affiliate of Donaldson, Lufkin &
Jenrette Securities Corporation ("DLJ").
(7) Represents options to purchase 10,000 shares of Common Stock held by Bert
Kolde, a Director of the Company and a director, the Vice President,
Secretary and Treasurer of Vulcan, all of which are exercisable
immediately, and 3,026,624 shares held by Vulcan. Mr. Kolde disclaims
beneficial ownership of the shares owned by Vulcan, except for his
proportional interest therein, if any.
(8) Represents 1,928,694 shares of Common Stock held, in the aggregate, by
GRP. Linda Fayne Levinson, the Series C Director, is a principal of Global
Retail Partners, L.P. Ms. Levinson disclaims beneficial ownership of all
shares owned by GRP, except for any proportional interest held therein.
(9) Represents 20,000 shares of Common Stock and options to purchase 30,000
shares of Common Stock held by Mr. Novak, all of which are exercisable
immediately, and 2,225,510 shares held, in the aggregate, by the Unterberg
Affiliates. Mr. Novak, a Director of the Company, is a Managing Director
of Unterberg. Mr. Novak disclaims beneficial ownership of all shares owned
by the Unterberg Affiliates.
(10) Represents 70,000 shares of Common Stock held by Mr. Scudellari.
(11) Includes options to purchase 1,290,000 shares of Common Stock that vest
within 60 days of June 1, 1998 held by all directors and executive
officers of the Company.
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<PAGE> 66
DESCRIPTION OF CAPITAL STOCK
Upon the completion of this offering, the authorized capital stock of the
Company will consist of 50,000,000 shares of Common Stock, $0.001 par value per
share, and 15,000,000 shares of Preferred Stock, $0.001 par value per share, of
which 6,823,596 shall be undesignated.
COMMON STOCK
As of June 1, 1998, there were 9,108,542 shares of Common Stock outstanding
held of record by 19 stockholders. There will be 26,546,452 shares of Common
Stock outstanding (assuming no exercise of the Underwriters' over-allotment
option and no exercise of outstanding options) after giving effect to the sale
of Common Stock offered to the public hereby and the sale of Common Stock to AOL
described below. Subject to preferences that may be applicable to any
outstanding shares of Preferred Stock, the holders of Common Stock are entitled
to receive ratably such dividends, if any, as may be declared by the Board of
Directors out of funds legally available for the payment of dividends. See
"Dividend Policy." In the event of liquidation, dissolution or winding up of the
Company, the holders of Common Stock are entitled to share ratably in all assets
remaining after payment of liabilities and liquidation preferences of any
outstanding shares of Preferred Stock. Holders of Common Stock have no
preemptive rights or other subscription rights to convert their Common Stock
into any other securities. There are no redemption or sinking fund provisions
applicable to the Common Stock. All outstanding shares of Common Stock and the
shares of Common Stock to be issued upon completion of this offering will be
fully paid and nonassessable.
PREFERRED STOCK
Upon the closing of this offering, all of the 8,176,404 outstanding shares
of Preferred Stock will be converted into 12,198,962 shares of Common Stock and
such Preferred Stock will be automatically retired in accordance with the
Company's Amended and Restated Certificate of Incorporation. Thereafter,
pursuant to the Company's Certificate of Incorporation, the Board of Directors
will have the authority, without further action by the stockholders, to issue up
to 6,823,596 shares of Preferred Stock in one or more series and to fix the
designations, powers, preferences, privileges and relative, participating,
optional or special rights and the qualifications, limitations or restrictions
thereof, including dividend rights, conversion rights, voting rights, terms of
redemption and liquidation preferences, any or all of which may be greater than
the rights of the Common Stock. The Board of Directors, without stockholder
approval, can issue Preferred Stock with voting, conversion or other rights that
could adversely affect the voting power and other rights of the holders of
Common Stock. Preferred Stock could thus be issued quickly with terms calculated
to delay or prevent a change in control of the Company or make removal of
management more difficult. Additionally, the issuance of Preferred Stock may
have the effect of decreasing the market price of the Common Stock, and may
adversely affect the voting and other rights of the holders of Common Stock. The
Company has no plans to issue any Preferred Stock.
WARRANTS
In March 1998, the Company entered into the Common Stock and Warrants
Subscription Agreement with AOL pursuant to which, subject to certain limited
exceptions, AOL agreed to buy shares of Common Stock at a price per share equal
to the initial public offering price (less the Underwriters' discount) for an
aggregate purchase price of $2,000,000. AOL will purchase 238,948 shares of
Common Stock immediately prior to the consummation of this offering. Concurrent
with the purchase of the shares of Common Stock by AOL immediately prior to the
consummation of this offering, the Company will issue to AOL a Warrant for a
number of shares of Common Stock equal to 1.5 times the number of shares of
Common Stock purchased by AOL in the aforementioned investment (the "AOL Warrant
Shares") at a per share exercise
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<PAGE> 67
price equal to the initial public offering price (less the Underwriters'
discount) which will vest in increments of 1/36th per month commencing March 1,
1998. Immediately prior to the consummation of the offering, the Company will
issue to AOL a warrant for 358,422 shares of Common Stock at an exercise price
of $8.37 per share.
In March 1998, the Company also issued a warrant to AOL (the "AOL Warrant")
to purchase 369,578 shares of the Company's Series D Preferred Stock at a price
of $2.60 per share vesting in increments of 1/36th per month commencing March 1,
1998; provided, however, that the AOL Warrant is not exercisable until after
August 31, 1999, except in the event of a change of control of the Company. The
AOL Warrant will terminate in accordance with its terms immediately prior to the
consummation of this offering.
AOL also received certain registration rights with respect to the foregoing
shares of Common Stock, Warrant and the AOL Warrant Shares.
REGISTRATION RIGHTS
Pursuant to agreements among the Company and the holders of an aggregate of
8,176,404 shares of Preferred Stock which will automatically convert in the
aggregate to 12,198,962 shares of Common Stock upon consummation of this
offering and the holders of 9,000,000 shares of Common Stock (the "Registration
Rights Holders"), the Registration Rights Holders are entitled to certain rights
with respect to the registration of such shares under the Securities Act. If the
Company proposes to register any of its securities under the Security Act,
either for its own account or for the account of other security holders, the
Registration Rights Holders are entitled to notice of such registration and to
include shares of Common Stock in such registration at the Company's expense
(subject to an underwriter's cutback). The Registration Rights Holders are
entitled to certain demand registration rights pursuant to which they may
require the Company to file a registration statement under the Securities Act at
the Company's expense with respect to their shares of Common Stock, and the
Company is required to use its commercially reasonable efforts to effect such
registration (a "Requested Registration"). All of these registration rights are
subject to certain conditions and limitations, among them the right of the
underwriters of an offering to limit the number of shares included in such
registration and the right of the Company not to effect a Requested Registration
in certain specific situations. The Company is required to bear all registration
expenses (other than underwriting discounts and commissions and fees, and
certain fees and disbursements of counsel of the Registration Rights Holders,
subject to certain limitations) and has agreed to indemnify the Registration
Rights Holders against, and provide contribution with respect to, certain
liabilities under the Securities Act in connection with such registration.
Pursuant to a registration rights agreement with AOL, the Company has
granted AOL certain registration rights with respect to the AOL Shares and AOL
Warrant Shares, including incidental registration rights if the Company files a
registration statement covering any of its securities under the Securities Act
(with the exception of an offering pursuant to a registration statement on Forms
S-1, S-8 or S-4). These registration rights include the right to require the
Company, subject to certain limitations, to register the AOL Shares and the AOL
Warrant Shares for resale by filing a shelf registration statement at any time
180 days following the effective date of the Company's registration statement
covering its initial public offering and to continuously maintain the
effectiveness of such registration statement for at least 90 days. The Company
is required to bear registration expenses (other than underwriting discounts and
commissions and fees) up to a specified limited and thereafter to bear its pro
rata share of such costs to the extent that the Company is selling shares in
such offering. The Company has also agreed to indemnify AOL against, and provide
contribution with respect to, certain liabilities under the Securities Act in
connection with incidental and demand registrations. AOL has agreed that it
shall not, to the extent requested by the Company and its underwriters and
subject to certain limitations, sell or otherwise
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<PAGE> 68
dispose or transfer any securities of the Company for a period of 180 days
following the effective date of the first registration statement of the Company
filed under the Securities Act.
ANTI-TAKEOVER EFFECTS OF CERTAIN PROVISIONS OF CERTIFICATE OF INCORPORATION
As noted above, the Company's Board of Directors, without stockholder
approval, has the authority under the Company's Certificate of Incorporation to
issue Preferred Stock with rights superior to the rights of the holders of
Common Stock. As a result, Preferred Stock could be issued quickly and easily,
could adversely affect the rights of holders of Common Stock and could be issued
with terms calculated to delay or prevent a change in control of the Company or
make removal of management more difficult.
Section 203 of the Delaware General Corporation Law ("DGCL") contains
certain provisions that may make more difficult the acquisition of control of
the Company by means of a tender offer, open market purchase, a proxy fight or
otherwise. These provisions are designed to encourage persons seeking to acquire
control of the Company to negotiate with the Board of Directors. However, these
provisions could have the effect of discouraging a prospective acquiror from
making a tender offer or otherwise attempting to obtain control of the Company.
To the extent that these provisions discourage takeover attempts, they could
deprive stockholders of opportunities to realize takeover premiums for their
shares or could depress the market price of the Common Stock.
Section 203 of the DGCL prohibits certain "business combination"
transactions between a publicly held Delaware corporation, such as the Company
after this offering, and any "interested stockholder" for a period of three
years after the date on which the latter became an interested stockholder,
unless (i) prior to that date either the proposed business combination or the
proposed acquisition of stock resulting in its becoming an interested
stockholder is approved by the board of directors of the corporation, (ii) in
the same transaction in which it becomes an interested stockholder, the
interested stockholder acquires at least 85% of those shares of the voting stock
of the corporation which are not held by the directors, officers or certain
employee stock plans or (iii) the business combination with the interested
stockholder is approved by the Board of Directors and also approved at a
stockholders' meeting by the affirmative vote of the holders of at least two
thirds of the outstanding shares of the corporation's voting stock other than
shares held by the interested stockholder.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is BankBoston, N.A.
The transfer agent's address is 150 Royall Street, Canton, Massachusetts 02021
and telephone number is (781) 575-2000.
68
<PAGE> 69
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for the Common
Stock. No prediction can be made as to the effect, if any, that market sales of
shares or the availability of shares for sale will have on the market price of
the Common Stock prevailing from time to time. The Company is unable to estimate
the number of shares that may be sold in the public market pursuant to Rule 144,
since this will depend on the market price of the Common Stock, the personal
circumstances of the sellers and other factors. Nevertheless, sales of
significant amounts of the Common Stock of the Company in the public market
could adversely affect the market price of the Common Stock and could impair the
Company's ability to raise capital through an offering of its equity securities.
Upon completion of this offering, the Company will have outstanding
26,546,452 shares of Common Stock. All of the 5,000,000 shares offered hereby
(plus any shares issued upon exercise of the Underwriters' over-allotment
option) will be freely tradable in the public market without restriction under
the Securities Act, unless such shares are purchased by "Affiliates" of the
Company, as that term is defined in Rule 144 under the Securities Act.
The remaining 21,546,452 shares of Common Stock outstanding upon completion
of this offering will be "restricted securities," as that term is defined in
Rule 144 ("Restricted Shares") (which amount includes 238,948 shares of Common
Stock to be issued to AOL immediately prior to the consummation of this
offering). The Restricted Shares were issued and sold by the Company in private
transactions in reliance upon exemptions from registration under the Securities
Act. Restricted Shares may be sold in the public market only if they are
registered or if they qualify for an exemption from registration under Rules
144, 144(k) or 701 promulgated under the Securities Act, which are summarized
below.
Pursuant to certain "Lock-up Agreements," AOL as well as all the executive
officers, directors, stockholders and employees of the Company have agreed not
to offer, sell, contract to sell, grant any option to purchase or otherwise
dispose of any such shares for a period of 180 days from the date of this
Prospectus without the prior written consent of Deutsche Bank Securities Inc.
Beginning 180 days after the date of this Prospectus, upon expiration of
the Lock-up Agreements, approximately 4,687,202 of the Restricted Shares will be
eligible for sale without restriction under Rule 144(k) and 15,448,114 of the
Restricted Shares will be eligible for sale subject to compliance with the
volume and other restrictions of Rule 144. The remaining 1,441,205 Restricted
Shares will become eligible for sale at various times within a period of one
year from the expiration of the Lock-up Agreements, subject in some cases to the
volume and other restrictions of Rule 144.
In general, under Rule 144, beginning approximately 90 days after the
effective date of the Registration Statement of which this Prospectus is a part,
a stockholder, including an Affiliate, who has beneficially owned his or her
restricted securities (as that term is defined in Rule 144) for at least one
year from the later of the date such securities were acquired from the Company
or (if applicable) the date they were acquired from an Affiliate, is entitled to
sell, within any three-month period, a number of such shares that does not
exceed the greater of 1% of the then outstanding shares of Common Stock
(approximately 265,578 shares immediately after this offering) or the average
weekly trading volume in the Common Stock during the four calendar weeks
preceding the date on which notice of such sale was filed under Rule 144,
provided certain requirements concerning availability of public information,
manner of sale and notice of sale are satisfied. In addition, under Rule 144(k),
a person who is not deemed to have been an Affiliate of the Company at any time
during the 90 days preceding a sale, and who has beneficially owned the shares
proposed to be sold for at least two years (including the holding period of any
prior owner except an Affiliate) is entitled to sell the shares immediately
without compliance with the foregoing requirements of Rule 144.
69
<PAGE> 70
Securities issued in reliance on Rule 701 (such as shares of Common Stock
that may be acquired pursuant to the exercise of certain options granted prior
to this offering) are also restricted securities and, beginning 90 days after
the date of this Prospectus, may be sold by stockholders other than Affiliates
of the Company subject only to the manner of sale provisions of Rule 144 and by
an Affiliate under Rule 144 without compliance with its one-year holding period
requirement. Presently 90,000 shares of Common Stock issued pursuant to the
exercise of options granted in reliance on Rule 701 are outstanding and held by
Affiliates. Therefore, these shares are not subject to the one-year holding
period requirement of Rule 144 and may be sold following the expiration of the
lock-up agreements subject only to the volume restrictions of Rule 144. As of
the date of this Prospectus, the holders of options exercisable into
approximately 3,710,513 shares of Common Stock will be eligible to sell their
shares upon the expiration of transfer restrictions specified in the Plans 180
days after the date of this Prospectus, subject in certain cases to vesting of
such options.
The Company intends to file after the effective date of this offering a
Registration Statement on Form S-8 to register approximately 3,000,000 shares of
Common Stock reserved for issuance under the 1995 Stock Option Plan, 2,000,000
shares of Common Stock reserved for issuance under the 1998 Stock Option Plan
and 1,000,000 shares reserved for issuance outside such plans. Such Registration
Statement will become effective automatically upon filing. Shares issued under
the foregoing option plans and the option grant outside the plans, after the
filing of a Registration Statement on Form S-8, may be sold in the open market,
subject, in the case of certain holders, to the Rule 144 limitations applicable
to Affiliates, the above-referenced lock-up agreements and vesting restrictions
imposed by the Company.
In addition, following this offering, the holders of 9,268,817 shares of
outstanding Common Stock will, under certain circumstances, have rights to
require the company to register their shares for future sale. See "Description
of Capital Stock -- Registration Rights."
In addition to the 5,000,000 shares of Common Stock offered hereby, 238,948
shares will be sold to AOL, which has agreed to purchase such shares from the
Company at the initial public offering price less the Underwriters' discounts.
Upon completion of this offering, the Company will also issue a warrant to AOL
for the future purchase of up to 358,422 additional shares of Common Stock at an
exercise price of $8.37 per share. See "Description of Capital
Stock -- Warrants."
70
<PAGE> 71
UNDERWRITING
The Underwriters named below, for whom Deutsche Bank Securities Inc.,
Donaldson, Lufkin & Jenrette Securities Corporation, Merrill Lynch, Pierce,
Fenner & Smith Incorporated and C. E. Unterberg, Towbin are acting as
representatives (the "Representatives"), have severally agreed, subject to the
terms and conditions contained in the Underwriting Agreement (the form of which
will be filed as an exhibit to the Company's Registration Statement, of which
this Prospectus is a part), to purchase from the Company the respective number
of shares of Common Stock indicated below opposite their respective names. The
Underwriters are committed to purchase all of the shares, if they purchase any.
<TABLE>
<CAPTION>
UNDERWRITERS NUMBER OF SHARES
------------ ----------------
<S> <C>
Deutsche Bank Securities Inc............................... 3,869,500
Donaldson, Lufkin & Jenrette Securities Corporation........ 86,875
Merrill Lynch, Pierce, Fenner & Smith
Incorporated.................................. 956,750
C. E. Unterberg, Towbin.................................... 86,875
---------
Total............................................ 5,000,000
</TABLE>
The Underwriting Agreement provides that the obligations of the several
Underwriters thereunder are subject to approval of certain legal matters by
counsel and to various other conditions.
The Representatives have advised the Company that the Underwriters
initially propose to offer the Common Stock to the public on the terms set forth
on the cover page of this Prospectus. The Underwriters may allow selected
dealers (who may include the Underwriters) a concession of not more than $0.35
per share below the initial public offering price. The selected dealers may
re-allow a concession of not more than $0.10 per share to certain other dealers.
After the initial public offering, the price and concessions and re-allowances
to dealers and other selling terms may be changed by the Representatives. The
Common Stock is offered subject to receipt and acceptance by the Underwriters,
and to certain other conditions, including the right to reject orders in whole
or in part. The Underwriters do not intend to sell any of the shares of Common
Stock offered hereby to accounts for which they exercise discretionary
authority.
The Company has granted an option to the Underwriters to purchase up to a
maximum of 750,000 additional shares of Common Stock to cover over-allotments,
if any, at the initial public offering price, less the Underwriters' discount
set forth on the cover page of this Prospectus. Such option may be exercised at
any time until 30 days after the date of the Underwriting Agreement. To the
extent the Underwriters exercise this option, each of the Underwriters will be
committed, subject to certain conditions, to purchase such additional shares in
approximately the same proportion as set forth in the above table. The
Underwriters may purchase such shares only to cover over-allotments made in
connection with this offering.
The officers and directors who are stockholders of the Company, other
existing stockholders of the Company and existing option holders have agreed,
subject to certain exceptions, that they will not, without the prior written
consent of Deutsche Bank Securities, offer, sell or otherwise dispose of any
shares of Common Stock, options or warrants to acquire shares of Common Stock or
securities exchangeable for or convertible into shares of Common Stock owned by
them during the 180-day period following the date of the final Prospectus. The
Company has agreed that it will not, without the prior written consent of
Deutsche Bank Securities, offer, sell or otherwise dispose of any shares of
Common Stock, options or warrants to acquire shares of Common Stock or
securities exchangeable for or convertible into shares of Common Stock during
the 180-day period following the date of the final Prospectus, except that the
Company may issue shares upon the exercise of options granted prior to the date
hereof, and may grant additional options, provided
71
<PAGE> 72
that, without the prior written consent of Deutsche Bank Securities such
additional options shall not be exercisable during such period.
The Underwriting Agreement provides that the Company will indemnify the
several Underwriters against certain liabilities, including civil liabilities
under the Securities Act, as amended, or will contribute to payments the
Underwriters may be required to make in respect thereof.
Prior to this offering, there has been no public market for the Common
Stock. The initial public offering price will be determined by negotiation
between the Company and the Representatives. The principal factors to be
considered in determining the public offering price include the information set
forth in this Prospectus and otherwise available to the Representatives; the
history and the prospects for the industry in which the Company will compete;
the ability of the Company's management; the prospects for future earnings of
the Company; the present state of the Company's development and its current
financial condition; the general condition of the securities markets at the time
of this offering; and the recent market prices of, and the demand for,
publicly-traded common stock of generally comparable companies. Each of the
Representatives has informed the Company that it currently intends to make a
market in the shares subsequent to the effectiveness of this offering, but there
can be no assurance that the Representatives will take any action to make a
market in any securities of the Company.
The Underwriters have reserved for sale, at the initial public offering
price, up to 7% of the Common Stock offered hereby (including shares of Common
Stock subject to the Underwriters' over-allotment option) for certain
individuals who have expressed an interest in purchasing such shares of Common
Stock in the offering. The number of shares available for sale to the general
public will be reduced to the extent such persons purchase such reserved shares.
Any reserved shares not so purchased will be offered by the Underwriters to the
general public on the same basis as other shares offered hereby.
Certain persons participating in this offering may over-allot or effect
transactions which stabilize, maintain or otherwise affect the market price of
the Common Stock at levels above those which otherwise might prevail in the open
market, including by entering stabilizing bids, effecting syndicate covering
transactions or imposing penalty bids. A stabilizing bid means the placing of
any bid or effecting of any purchase for the purpose of pegging, fixing or
maintaining the price of the Common Stock. A syndicate-covering transaction
means the placing of any bid on behalf of the underwriting syndicate or the
effecting of any purchase to reduce a short position created in connection with
this offering. A penalty bid means an arrangement that permits the Underwriters
to reclaim a selling concession from a syndicate member in connection with this
offering when shares of Common Stock sold by the syndicate member are purchased
in syndicate-covering transactions. Such transactions may be effected on the
Nasdaq Stock Market, in the over-the-counter market or otherwise. Such
stabilizing, if commenced, may be discontinued at any time.
The Company entered into a credit agreement (the "Credit Agreement") with
Deutsche Bank AG ("Deutsche Bank") in May 1998. Deutsche Bank is the parent
corporation of Deutsche Bank Securities, one of the Representatives. Pursuant to
the Credit Agreement, in May 1998, Deutsche Bank issued a standby letter of
credit for the benefit of the Company in the amount of approximately $600,000
(the "Credit Facility") and loaned the Company approximately an additional
$4,200,000 (the "Loan"). The Loan bears interest at a rate equal to the higher
of (i) the daily Federal Funds Rate plus 0.5% per annum or (ii) Deutsche Bank's
daily prime lending rate (the "Base Rate"), plus 3.0%. Interest is payable
quarterly, in arrears, during the term of the Credit Agreement. The Company is
also required to pay a standby letter of credit fee equal to a percentage of the
face amount of the Credit Facility equal to the Base Rate plus 3.0% less the
LIBOR rate for a three-month loan. In conjunction with the Credit Agreement the
Company is required to pay Deutsche Bank (i) an upfront fee of $120,000, and
(ii) a credit line fee equal to 7.50% of the amount by which the Company's gross
revenues during the term of the Credit Agreement exceed certain agreed upon
thresholds, subject to maximum payments of $337,500 in the aggregate. All
amounts borrowed
72
<PAGE> 73
under the Credit Agreement are due on November 16, 1998. In connection with the
Credit Agreement, Deutsche Bank has received a first priority lien on all of the
Company's assets, including intellectual property. Pursuant to the terms of the
Credit Agreement, the Company is subject to certain financial and non-financial
covenants. The Company intends, upon expiration of the Credit Agreement, to
convert the amounts outstanding under the Credit Facility and the Loan into a
new credit facility in approximately the same or a greater principal amount;
however, there can be no assurances that the amounts outstanding under the
Credit Facility and the Loan will be able to be converted into a new credit
facility upon commercially acceptable terms, if at all. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity."
Affiliates of C. E. Unterberg, Towbin are stockholders of the Company, and
Steven P. Novak, the Series A Director and stockholder of the Company, is a
Managing Director of C. E. Unterberg, Towbin. Global Retail Partners, L.P. and
its affiliates, each an affiliate of Donaldson, Lufkin & Jenrette Securities
Corporation ("DLJ") are stockholders of the Company, and Linda Fayne Levinson,
the Series C Director, is a principal of Global Retail Partners, L.P., an
affiliate of DLJ and a stockholder of the Company. See "Management," "Certain
Transactions" and "Principal Stockholders." In March and April of 1998, certain
entities affiliated with Global Retail Partners acquired an aggregate of 458,106
shares of the Company's Common Stock. Certain affiliates of Donaldson Lufkin
Jenrette, Inc. ("DLJ, Inc."), the corporate parent of DLJ, and DLJ have an
aggregate economic interest in approximately 43,987 of such shares (the
"Affiliated Shares"). The Affiliated Shares shall be subject to an agreement
with the National Association of Securities Dealers that restricts the sale,
transfer or hypothecation of such shares for a period of one year from the date
of this Prospectus. In March and April of 1998, certain entities affiliated with
C.E. Unterberg Towbin ("Unterberg") acquired an aggregate of 264,116 shares of
the Company's Common Stock. Certain individuals that are affiliates of Unterberg
have an aggregate economic interest in approximately 35,064 of such shares (the
"Affiliated Stock"). The Affiliated Stock shall be subject to an agreement with
the National Association of Securities Dealers that restricts the sale, transfer
or hypothecation of such shares for a period of one year from the date of this
Prospectus.
This Prospectus may be used in connection with offers and sales of Common
Stock which may be made from time to time in market making transactions at
negotiated prices related to prevailing market prices at the time of sale. The
Company will not receive any proceeds from the sale of Common Stock in any
market making transactions in connection with which this Prospectus may be
delivered.
This offering is being conducted in accordance with Rule 2720 ("Rule 2720")
of the National Association of Security Dealers, Inc. (the "NASD") which
provides that, among other things, when an NASD member firm participates in the
offering of equity securities of a company with whom such member has a "conflict
of interest" (as defined in Rule 2720), the initial public offering price can be
no higher than that recommended by a "qualified independent underwriter" (as
defined in Rule 2720) (a "QIU"). Certain underwriters in this offering may be
deemed to have such a conflict of interest with the Company due to the fact that
certain entities and individuals affiliated with such underwriters own shares of
the Company's Common Stock as described above. Deutsche Bank Securities plans to
serve as the QIU in the offering and will recommend a price in compliance with
the requirements of Rule 2720. Deutsche Bank Securities, in its capacity as QIU,
will receive no additional compensation as such in connection with this
offering.
73
<PAGE> 74
LEGAL MATTERS
Certain legal matters will be passed on for the Company by its counsel,
Jackson Tufts Cole & Black, LLP, San Jose, California. As of June 1, 1998,
Richard Scudellari, a partner in that firm and a director of the Company, owned
70,000 shares of Company's Common Stock and held options to purchase 10,000
shares of the Company's Common Stock. See "Principal Stockholders" and "Certain
Transactions." Certain legal matters will be passed on for the Underwriters by
Venture Law Group, A Professional Corporation, Menlo Park, California.
EXPERTS
The Consolidated Financial Statements of software.net at December 31, 1996
and 1997, and for each of the three years in the period ended December 31, 1997,
appearing in this Prospectus and the Registration Statement have been audited by
Ernst & Young LLP, independent auditors, as set forth in their report thereon
appearing elsewhere herein, and are included in reliance upon such report given
upon the authority of such firm as experts in accounting and auditing.
ADDITIONAL INFORMATION
The Company has filed with the Commission a Registration Statement, of
which this Prospectus constitutes a part, under the Securities Act with respect
to the shares of Common Stock offered hereby. This Prospectus omits certain
information contained in the Registration Statement, and reference is made to
the Registration Statement and the exhibits thereto for further information with
respect to the Company and the Common Stock offered hereby. Statements contained
herein concerning the provisions of any documents are not necessarily complete,
and in each instance reference is made to the copy of such document filed as an
exhibit to the Registration Statement. Each such statement is qualified in its
entirety by such reference. The Registration Statement, including exhibits filed
therewith, may be inspected without charge at the public reference facilities
maintained by the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street,
N.W., Washington, D.C. 20549 and at the regional offices of the Commission
located at 7 World Trade Center, Suite 1300, New York, New York 10048 and
Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661-2511. Copies of such materials may be obtained from the Public
Reference Section of the Commission, Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549 at prescribed rates. The Commission
maintains a Web site (http://www.sec.gov) that contains reports, proxy and
information statements and other information regarding registrants, such as the
Company, that file electronically with the Commission.
Statements contained in this Prospectus as to the contents of any contract
or other document to which reference is made are summaries of the material terms
of such contracts or documents, and in each instance reference is made to the
copy of such contract or other document filed as an exhibit to the Registration
Statement, each such statement being qualified in all respects by such
reference.
The Company intends to furnish its stockholders with annual reports
containing financial statements audited by independent accountants and with
quarterly reports containing updated summary financial information for each of
the first three quarters of each fiscal year.
74
<PAGE> 75
SOFTWARE.NET CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........... F-2
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Operations....................... F-4
Consolidated Statements of Redeemable Convertible Preferred
Stock and Stockholders' Equity (Net Capital Deficiency)... F-5
Consolidated Statements of Cash Flows....................... F-7
Notes to Consolidated Financial Statements.................. F-8
</TABLE>
F-1
<PAGE> 76
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
software.net Corporation
We have audited the accompanying consolidated balance sheets of
software.net Corporation as of December 31, 1996 and 1997, and the related
consolidated statements of operations, redeemable convertible preferred stock
and stockholders' equity (net capital deficiency), and cash flows for each of
the three years in the period ended December 31, 1997. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of software.net
Corporation at December 31, 1996 and 1997, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
San Jose, California
March 25, 1998
F-2
<PAGE> 77
SOFTWARE.NET CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
ASSETS
<TABLE>
<CAPTION>
PRO FORMA
STOCKHOLDERS'
DECEMBER 31, EQUITY AT
------------------ MARCH 31, MARCH 31,
1996 1997 1998 1998
------- -------- --------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents................... $ 3,737 $ 2,571 $ 2,232
Accounts receivable, net of allowances of
$65, $275, and $400 at December 31, 1996
and 1997, and March 31, 1998............. 431 1,181 1,785
Prepaid expenses and other current assets... 76 516 932
Cost of deferred revenue.................... 819 4,938 2,510
Net current assets of discontinued
operations............................... 80 -- --
------- -------- --------
Total current assets................ 5,143 9,206 7,459
Property and equipment, net................... 66 380 504
Net noncurrent assets of discontinued
operations.................................. 482 -- --
Intangible assets............................. -- -- 425
------- -------- --------
Total assets........................ $ 5,691 $ 9,586 $ 8,388
======= ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
(NET CAPITAL DEFICIENCY)
Current liabilities:
Note payable to related party............... $ -- $ -- $ 400
Accounts payable............................ 536 2,256 2,092
Other accrued liabilities................... 97 270 818
Current obligations under capital leases.... -- 18 17
Deferred revenue............................ 967 5,569 3,214
------- -------- --------
Total current liabilities........... 1,600 8,113 6,541
Note payable to a shareholder and director.... 105 60 --
Noncurrent obligations under capital leases... -- 39 33
Commitments
Redeemable convertible preferred stock, no par
value, issuable in series:
Authorized shares -- 10,000,000
Issued and outstanding shares --
4,022,558 in 1996, 7,022,558 in 1997,
7,899,938 in 1998, and none pro forma
(liquidation preference of $10,428 and
$12,709 at December 31, 1997 and March
31, 1998, respectively)................ 6,395 12,565 15,257 $ --
Stockholders' equity (net capital deficiency):
Common stock, no par value:
Authorized shares -- 30,000,000
Issued and outstanding shares --
9,000,000 in 1996, 9,070,000 in 1997,
9,090,000 in 1998, and 21,012,496 pro
forma.................................. 45 47 2,339 17,596
Deferred compensation....................... -- -- (2,292) (2,292)
Accumulated deficit......................... (2,454) (11,238) (13,490) (13,490)
------- -------- -------- --------
Total stockholders' equity (net
capital deficiency)............... (2,409) (11,191) (13,443) $ 1,814
------- -------- -------- ========
Total liabilities and stockholders'
equity (net capital deficiency)... $ 5,691 $ 9,586 $ 8,388
======= ======== ========
</TABLE>
See accompanying notes.
F-3
<PAGE> 78
SOFTWARE.NET CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------- ------------------
1995 1996 1997 1997 1998
------ ------- ------- ------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues....................... $1,003 $ 5,858 $16,806 $3,158 $ 6,192
Cost of revenues................... 623 5,137 14,873 2,783 5,254
------ ------- ------- ------ -------
Gross profit....................... 380 721 1,933 375 938
Operating expenses:
Research and development......... 388 431 1,060 155 602
Sales and marketing.............. 407 704 1,696 265 1,953
General and administrative....... 103 450 1,087 164 635
------ ------- ------- ------ -------
Total operating
expenses............... 898 1,585 3,843 584 3,190
------ ------- ------- ------ -------
Loss from operations............... (518) (864) (1,910) (209) (2,252)
Interest income.................... 7 96 173 40 27
Interest expense................... -- (11) (6) -- (2)
------ ------- ------- ------ -------
Loss from continuing operations.... (511) (779) (1,743) (169) (2,227)
Loss from discontinued operations.. -- (736) (3,616) (583) --
------ ------- ------- ------ -------
Net loss........................... $ (511) $(1,515) $(5,359) $ (752) $(2,227)
Accretion of premium on redemption
of redeemable convertible
preferred stock in excess of
purchase price................... (101) (101) (101) (25) (25)
------ ------- ------- ------ -------
Net loss applicable to common
stockholders..................... $ (812) $(1,616) $(5,460) $ (777) $(2,252)
====== ======= ======= ====== =======
Basic and diluted net loss per
share from continuing
operations....................... $(0.07) $ (0.10) $ (0.21) $(0.02) $ (0.25)
Basic and diluted net loss per
share from discontinued
operations....................... -- (0.08) (0.40) (0.07) --
------ ------- ------- ------ -------
Basic and diluted net loss per
share............................ $(0.07) $ (0.18) $ (0.61) $(0.09) $ (0.25)
====== ======= ======= ====== =======
Weighted average shares of common
stock outstanding used in
computing basic and diluted net
loss per share................... 9,000 9,000 9,000 9,000 9,080
====== ======= ======= ====== =======
Pro forma basic and diluted net
loss per share from continuing
operations....................... $ (0.10) $ (0.11)
Pro forma basic and diluted net
loss per share from discontinued
operations....................... (0.20) --
------- -------
Pro forma basic and diluted net
loss per share................... $ (0.30) $ (0.11)
======= =======
Shares used in computing pro forma
basic and diluted net loss per
share............................ 17,828 20,252
======= =======
</TABLE>
See accompanying notes.
F-4
<PAGE> 79
SOFTWARE.NET CORPORATION
CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
REDEEMABLE ----------------------------------------------- TOTAL
CONVERTIBLE STOCKHOLDERS'
PREFERRED STOCK COMMON STOCK EQUITY
------------------- ------------------ DEFERRED ACCUMULATED (NET CAPITAL
SHARES AMOUNT SHARES AMOUNT COMPENSATION DEFICIT DEFICIENCY)
--------- ------- --------- ------ ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1994.................... -- $ -- 9,000,000 $ 45 $ -- $ (226) $ (181)
Issuance of Series A
redeemable convertible
preferred stock at
$0.40 per share, net
of issuance costs of
$25................... 1,312,500 500 -- -- -- -- --
Issuance of Series A
redeemable convertible
preferred stock at
$0.40 per share in
exchange for
professional services
received.............. 125,000 50 -- -- -- -- --
Accretion of premium on
redemption of
redeemable convertible
preferred stock in
excess of purchase
price................. -- 101 -- -- -- (101) (101)
Net loss................ -- -- -- -- -- (511) (511)
--------- ------- --------- ------ -------- -------- --------
Balance at December 31,
1995.................... 1,437,500 651 9,000,000 45 -- (838) (793)
Issuance of Series A
redeemable convertible
preferred stock at
$0.91 per share....... 164,835 150 -- -- -- -- --
Issuance of Series A
redeemable convertible
preferred stock at
$0.91 per share for
the conversion of
notes payable and
accrued interest and
for services
received.............. 383,185 349 -- -- -- -- --
Issuance of Series B
redeemable convertible
preferred stock at
$2.70 per share, net
of issuance costs of
$356.................. 2,037,038 5,144 -- -- -- -- --
Accretion of premium on
redemption of
redeemable convertible
preferred stock in
excess of purchase
price................. -- 101 -- -- -- (101) (101)
Net loss................ -- -- -- -- -- (1,515) (1,515)
--------- ------- --------- ------ -------- -------- --------
</TABLE>
F-5
<PAGE> 80
<TABLE>
<CAPTION>
STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
REDEEMABLE ----------------------------------------------- TOTAL
CONVERTIBLE STOCKHOLDERS'
PREFERRED STOCK COMMON STOCK EQUITY
------------------- ------------------ DEFERRED ACCUMULATED (NET CAPITAL
SHARES AMOUNT SHARES AMOUNT COMPENSATION DEFICIT DEFICIENCY)
--------- ------- --------- ------ ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1996.................... 4,022,558 6,395 9,000,000 45 -- (2,454) (2,409)
Issuance of Series C
redeemable convertible
preferred stock at
$2.04 per share, net
of issuance costs of
$51................... 3,000,000 6,069 -- -- -- -- --
Issuance of common stock
upon exercise of
options under employee
stock option plan at
$0.03 per share....... -- -- 70,000 2 -- -- 2
Accretion of premium on
redemption of
redeemable convertible
preferred stock in
excess of purchase
price................. -- 101 -- -- -- (101) (101)
Spin-off of CyberSource
to software.net
preferred and common
stockholders on
December 31, 1997..... -- -- -- -- -- (3,324) (3,324)
Net loss................ -- -- -- -- -- (5,359) (5,359)
--------- ------- --------- ------ -------- -------- --------
Balance at December 31,
1997.................... 7,022,558 12,565 9,070,000 47 -- (11,238) (11,191)
Issuance of common stock
upon exercise of
options under employee
stock option plan at
$0.01 per share
(unaudited)........... -- -- 20,000 -- -- -- --
Issuance of Series D
redeemable convertible
preferred stock at
$2.60 per share, net
of issuance costs of
$50 (unaudited)....... 877,380 2,231 -- -- -- -- --
Issuance of warrant to
purchase 369,578
shares of Series D
redeemable convertible
preferred stock
(unaudited)........... -- 436 -- -- -- -- --
Accretion of premium on
redemption of
redeemable convertible
preferred stock in
excess of purchase
price (unaudited)..... -- 25 -- -- -- (25) (25)
Deferred compensation
related to stock
option grants
(unaudited)........... -- -- -- 2,292 (2,292) -- --
Net loss (unaudited).... -- -- -- (2,227) (2,227)
--------- ------- --------- ------ -------- -------- --------
Balance at March 31, 1998
(unaudited)............. 7,899,938 $15,257 9,090,000 $2,339 $ (2,292) $(13,490) $(13,443)
========= ======= ========= ====== ======== ======== ========
</TABLE>
See accompanying notes.
F-6
<PAGE> 81
SOFTWARE.NET CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
------------------------- -----------------
1995 1996 1997 1997 1998
----- ------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss............................................ $(511) $(1,515) $(5,359) $ (752) $(2,227)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization..................... 14 19 79 12 51
Services received and accrued interest in exchange
for Series A redeemable convertible preferred
stock........................................... 50 49 -- -- --
Net loss of discontinued operations............... -- 736 3,616 583 --
Changes in assets and liabilities:
Accounts receivable............................... (217) (202) (750) (394) (604)
Prepaid expenses and other current assets......... (26) (50) (440) (55) (415)
Cost of deferred revenue.......................... -- (819) (4,120) 136 2,428
Accounts payable.................................. 150 345 1,720 349 (164)
Other accrued liabilities......................... 54 (28) 172 (57) 548
Deferred revenue.................................. -- 967 4,602 (161) (2,355)
Cash provided by (used for) discontinued
operations...................................... -- (6) 181 108 --
----- ------- ------- ------- -------
Net cash used in operating activities............... (486) (504) (299) (231) (2,738)
INVESTING ACTIVITIES
Purchases of property and equipment................. (71) (16) (333) (60) (165)
Cash used for discontinued operations............... -- (1,292) (4,611) (702) --
----- ------- ------- ------- -------
Net cash used in investing activities............. (71) (1,308) (4,944) (762) (165)
FINANCING ACTIVITIES
Proceeds from issuance of notes payable............. 300 -- -- -- 400
Repayment of note payable to related party.......... -- -- (45) -- (60)
Repayment of capital leases......................... -- -- (3) -- (7)
Proceeds from sale of redeemable convertible
preferred stock................................... 500 5,294 6,069 -- 2,231
Proceeds from exercise of stock options............. -- -- 2 -- --
Cash used for discontinued operations............... -- -- (1,946) -- --
----- ------- ------- ------- -------
Net cash provided by financing activities........... 800 5,294 4,077 -- 2,564
----- ------- ------- ------- -------
Net increase (decrease) in cash and cash
equivalents....................................... 243 3,482 (1,166) (993) (339)
Cash and cash equivalents at beginning of period.... 12 255 3,737 3,737 2,571
----- ------- ------- ------- -------
Cash and cash equivalents at end of period.......... $ 255 $ 3,737 $ 2,571 $ 2,744 $ 2,232
===== ======= ======= ======= =======
SUPPLEMENTAL SCHEDULES OF CASH FLOW INFORMATION
Interest paid....................................... $ -- $ -- $ 6 $ -- $ 2
SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING
ACTIVITIES
Fixed assets acquired under capital leases.......... $ -- $ -- $ 60 $ -- $ --
Issuance of Series A redeemable preferred stock upon
conversion of notes payable....................... $ -- $ 300 $ -- $ -- $ --
Issuance of warrant to purchase Series D redeemable
convertible preferred stock....................... $ -- $ -- $ -- $ -- $ 436
Deferred compensation related to stock
option grants..................................... $ -- $ -- $ -- $ -- $ 2,292
</TABLE>
See accompanying notes.
F-7
<PAGE> 82
SOFTWARE.NET CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF MARCH 31, 1998 AND RELATING TO
THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Organization
software.net Corporation (formerly CyberSource Corporation) (the "Company")
was incorporated in the state of California on August 12, 1994. The Company is
engaged in the resale of commercial off-the-shelf software ("Software") via the
Internet. On December 31, 1997, the Company distributed capital stock of its
wholly owned subsidiary, CyberSource Corporation ("CyberSource"), in the form of
a dividend to all existing stockholders of the Company. The accompanying
consolidated financial statements have been prepared to reflect CyberSource as a
discontinued operation (see Note 2).
Interim Financial Statements
In the opinion of management, the unaudited interim consolidated financial
statements at March 31, 1998 and for the three months ended March 31, 1997 and
1998 include all adjustments, consisting only of normal recurring accruals,
necessary to present fairly the Company's financial position at March 31, 1998,
and results of operations and cash flows for the three months ended March 31,
1997 and 1998. Results for the three months ended March 31, 1998 are not
necessarily indicative of the results to be expected for the entire year.
Use of Estimates in the Preparation of Financial Statements
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 the
disclosure of contingent assets and liabilities at the date of the financial
statements as well as the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Revenue Recognition
The Company's revenues are primarily derived from sales of Software to
customers using credit cards, to corporate customers that are invoiced directly
under credit terms, to various U.S. government agencies pursuant to contractual
arrangements and, to a lesser extent, amounts received from Software publishers
for advertising and promotion. Revenue from the sale of Software, net of
estimated returns, is recognized upon either shipment of the physical product or
delivery of electronic product, at which time, collectibility is probable and
the Company has no remaining obligations. Revenue from the sale of Software
under contracts with the U.S. government require continuing service, support and
performance by the Company, and accordingly, the related revenues and costs are
deferred and recognized over the period the service, support, and performance
are provided. Revenues derived from Software publishers for advertising and
promotion are recognized as the services are provided. Costs of deferred revenue
relate to Software licenses purchased from Software publishers for U.S.
government agencies.
Research and Development
Research and development expenditures are generally charged to operations
as incurred. Statement of Financial Accounting Standards No. 86, "Accounting for
the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,"
requires the capitalization of certain software development costs subsequent to
the establishment of technological feasibility. In the Company's case,
capitalization would begin upon completion of a working model as the Company
does not prepare detailed program designs as part of the development process.
Through
F-8
<PAGE> 83
SOFTWARE.NET CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1998 AND RELATING TO
THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
December 31, 1997 and March 31, 1998, there were no significant capitalizable
software development costs incurred and, as a result, all such costs have been
expensed as incurred.
Advertising Expense
The cost of advertising is recorded as an expense when incurred.
Advertising costs for the years ended December 31, 1995, 1996, and 1997 and the
three months ended March 31, 1998, were approximately $50,000, $98,000,
$178,000, and $62,000, respectively.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original
maturity from the date of purchase of three months or less to be cash
equivalents. As of December 31, 1996 and 1997 and March 31, 1998, cash
equivalents consist primarily of investments in money market accounts and cost
approximates fair market value. The Company places its cash and cash equivalents
in high-quality U.S. financial institutions and, to date, has not experienced
losses on any of its investments.
Concentration of Credit Risk and Other Risks
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash equivalents and accounts
receivables. The Company operates in one business segment and sells Software and
advertising to consumers, various companies across several industries and
certain U.S. government agencies. The Company generally does not require
collateral. The Company maintains allowances for credit losses, and such losses
have been within management's expectations. For the year ended December 31, 1997
and for the three months ended March 31, 1998, U.S. government agencies,
principally the Defense Logistics Agency, accounted for 33% and 43% of revenues,
respectively. There were no customers accounting for greater than 10% of
revenues in 1995 and 1996.
The Company's contracts with the U.S. government are subject to annual
review and renewal by the applicable government entity, and may be terminated,
without cause, at any time.
The Company's success depends in large part on electronic software delivery
("ESD") as a method of selling Software over the Internet. If ESD does not
achieve widespread market acceptance, the Company's results of operations will
be materially adversely affected. In addition, there can be no assurance that
the Company will overcome the substantial existing and future technical
challenges associated with ESD reliably and consistently on a long-term basis.
Property and Equipment
Property and equipment are stated at cost and are depreciated on a
straight-line basis over estimated useful lives of three years. Leasehold
improvements are amortized on a straight-line basis over the shorter of the
lease term or the estimated useful lives.
F-9
<PAGE> 84
SOFTWARE.NET CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1998 AND RELATING TO
THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------- MARCH 31,
1996 1997 1998
---- ----- ---------
<S> <C> <C> <C>
Computer equipment and software............................. $98 $ 257 $ 347
Furniture and fixtures...................................... -- 122 154
Office equipment............................................ -- 70 107
Leasehold improvements...................................... -- 29 35
--- ----- -----
98 478 643
Less accumulated depreciation and amortization.............. (32) (98) (139)
--- ----- -----
$66 $ 380 $ 504
=== ===== =====
</TABLE>
Accounting for Stock-Based Compensation
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB Opinion No. 25), and related
interpretations in accounting for its employee stock options because, as
discussed in Note 7, the alternative fair value accounting provided for under
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (FAS 123), requires use of option valuation models that were not
developed for use in valuing employee stock options. Under APB Opinion No. 25,
when the exercise price of the Company's employee stock options equals the
market price of the underlying stock on the date of grant, no compensation
expense is recognized. See proforma disclosures of applying FAS 123 included in
Note 7.
Net Loss Per Share
Net loss per share is presented under Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" (FAS 128). FAS 128 replaced the
calculation of primary and fully diluted earnings per share with basic and
diluted earnings per share. Unlike primary earnings per share, basic earnings
per share excludes any dilutive effects of options, warrants, and convertible
securities. Diluted earnings per share is very similar to the previously
reported fully diluted earnings per share. Earnings per share amounts for all
periods have been presented to conform to FAS 128 requirements. Potentially
dilutive securities have been excluded from the computation as their effect is
antidilutive.
If the Company had reported net income, diluted earnings per share would
have included the shares used in the computation of pro forma net loss per share
as well as an additional approximately 959,000, 1,577,000, 1,879,000, 1,787,000,
and 2,046,000 common equivalent shares related to the outstanding options and
warrants not included above (determined using the treasury stock method at the
estimated fair value) for the years ended December 31, 1995, 1996 and 1997 and
for the three months ended March 31, 1997 and 1998, respectively.
Proforma Net Loss Per Share and Unaudited Proforma Stockholders' Equity
Proforma net loss per share has been computed as described above and also
gives effect, under Securities and Exchange Commission guidance, to the
conversion of redeemable convertible preferred shares not included above that
will automatically convert upon completion of the Company's initial offering
(using the if-converted method). If the offering contemplated by this Prospectus
is consummated, all of the redeemable convertible preferred stock outstanding as
of
F-10
<PAGE> 85
SOFTWARE.NET CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1998 AND RELATING TO
THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
March 31, 1998 will automatically be converted into an aggregate of 11,922,496
shares of common stock, based on the shares of redeemable convertible preferred
stock outstanding at March 31, 1998. Unaudited pro forma stockholders' equity at
March 31, 1998, as adjusted for the conversion of redeemable convertible
preferred stock, is disclosed on the balance sheet.
Pro forma basic and diluted net loss per share is as follows (in thousands,
except per share amount):
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS
DECEMBER 31, ENDED MARCH 31,
1997 1998
------------------ ---------------
<S> <C> <C>
Net loss.................................................. $(5,359) $ (2,227)
======= ========
Shares used in computing basic and diluted net loss per
share................................................... 9,000 9,080
Adjusted to reflect the effect of the assumed conversion
of redeemable convertible preferred stock from the date
of issuance............................................. 8,828 11,172
------- --------
Weighted average shares used in computing pro forma basic
and diluted net loss per share.......................... 17,828 20,252
======= ========
Pro forma basic and diluted net loss per share............ $ (0.30) $ (0.11)
======= ========
</TABLE>
Income Taxes
Income taxes are calculated under the provisions of Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" (FAS 109). Under FAS
109, the liability method is used in accounting for income taxes, which includes
the effects of temporary differences between financial and taxable amounts of
assets and liabilities.
Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (FAS
130). FAS 130 establishes standards for the reporting and display of
comprehensive income and its components in a full set of general purpose
financial statements and is effective for fiscal years beginning after December
15, 1997. The Company adopted FAS 130 in the three months ended March 31, 1998.
There was no impact to the Company as a result of the adoption of FAS 130, as
there is no difference between the Company's net loss reported and the
comprehensive net loss under FAS 130 for the periods presented.
Segment Information
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (FAS 131). FAS 131 will change the way
companies report selected segment information in annual financial statements and
requires companies to report selected segment information in interim financial
reports to shareholders. FAS 131 is effective for the Company's fiscal year
ended December 31, 1998. The Company has not reached a conclusion as to the
appropriate segments, if any, it will be required to report to comply under FAS
131.
F-11
<PAGE> 86
SOFTWARE.NET CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1998 AND RELATING TO
THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
Software Revenue Recognition
In May 1997, the Financial Accounting Standards Board approved the American
Institute of Certified Public Accountants Statement of Position, "Software
Revenue Recognition" (SOP 97-2). SOP 97-2 provides revised and expanded guidance
on software revenue recognition and applies to all entities that earn revenue
from licensing, selling, or otherwise marketing computer software. SOP 97-2 is
effective for transactions entered into in fiscal years beginning after December
15, 1997. The application of SOP 97-2 has not had a material impact on its
results of operations.
2. DISCONTINUED OPERATIONS
On December 31, 1997, the Company and its stockholders approved a transfer
of assets and liabilities to its wholly owned subsidiary, CyberSource, and the
distribution of CyberSource capital stock, (the "Spin-off"), in the form of a
dividend to the Company's existing stockholders, on a pro rata basis such that
the stockholders of CyberSource were the same as the stockholders of the Company
at the time of the distribution. Revenues of CyberSource were none, $170,000,
$1,128,000 and $96,000 for the years ended December 31, 1995, 1996, and 1997 and
for the three months ended March 31, 1997, respectively. The results of
operation of the discontinued business have been presented as a loss from
discontinued operations.
The components of net assets at December 31, 1996 and at the time of the
Spin-off on December 31, 1997 are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
------------ ------------
<S> <C> <C>
Assets:
Cash and cash equivalents........................... $ -- $2,000
Accounts receivable................................. 150 606
Prepaid expenses and other assets................... 71 118
Property and equipment.............................. 482 1,152
Less liabilities:
Accounts payable and accrued liabilities............ 141 397
Deferred revenue and other.......................... -- 155
---- ------
Net assets............................................... $562 $3,324
==== ======
</TABLE>
3. MARKETING AGREEMENTS
During 1997 and during the quarter ended March 31, 1998, the Company
entered into marketing agreements with America Online, Inc. ("AOL"), Excite,
Inc. ("Excite") and Netscape Communications Corporation ("Netscape").
The AOL Agreement is for a term of 42 months, unless earlier terminated,
and provides for a marketing relationship between AOL and the Company. Pursuant
to this agreement, the Company will be the exclusive provider of electronically
delivered Software on AOL's Web site to AOL customers through links to the
Company's Web site from various AOL Web pages. During the term, AOL is obligated
to deliver a cumulative number of Impressions (as defined in the agreement),
with various cumulative targets throughout the duration of the agreement term.
If AOL does not provide certain cumulative targeted Impressions, AOL will be
required to refund a
F-12
<PAGE> 87
SOFTWARE.NET CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1998 AND RELATING TO
THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
portion of the fees paid by the Company under this agreement (or under some
circumstances, as outlined in this agreement, AOL will have the option to extend
the term and deliver the Impressions by the end of that extended term). Upon
conclusion of the initial 42 month term, AOL will have the right to renew the
agreement for two successive one year terms.
The Excite agreement is for a term of 36 months pursuant to which the
Company will be the exclusive Software reseller on certain screens within
certain channels of Excite's Web site.
The Netscape agreement is for a term of 24 months pursuant to which the
Company created and manages an online Software store accessible through
Netscape's Internet site.
These marketing agreements provide for payments totalling $7,863,000 in
1998, $8,338,000 in 1999, $8,963,000 in 2000 and $536,000 in 2001. The Company
has paid $1,000,000 of the payments due in 1998 as of March 31, 1998.
Under these agreements, once the Company has generated a certain cumulative
net gross margin from Software sales, the Company will pay specified percentages
of the gross transaction margins from all subsequent software sales transactions
and a percentage of certain advertising revenues.
The amounts paid under the AOL and Netscape agreements are being amortized
to sales and marketing expenses on a straight-line basis over the period from
the launch dates to the termination dates of the services. The periods of
amortization are March 1998 to August 2001; and August 1997 to July 1999 for AOL
and Netscape, respectively. The Company has expensed $104,000 and $563,000
related to these agreements in 1997 and the quarter ended March 31, 1998,
respectively. The amounts paid under the Excite agreement are being amortized to
sales and marketing expenses as the payments become due over the contract term
beginning from the launch date of the services. The period of amortization for
this agreement is April 1998 to March 2001.
The Company also entered into a Common Stock and Warrants Subscription
Agreement which provides for the sale of $2,000,000 of common stock to AOL on or
immediately prior to the closing of an initial public offering ("IPO") at the
price paid by the Underwriters in the IPO. The agreement also provides for the
issuance of a warrant to purchase the Company's stock. This warrant will expire
upon the IPO. This warrant is for the purchase of 369,578 shares of Series D
preferred stock at an exercise price of $2.60 per share vesting in increments of
1/36 per month commencing March 1, 1998, provided, however that the warrant is
not exercisable until after August 31, 1999, if it does not expire prior to this
in connection with an IPO. In the event the Company initiates an IPO and as a
result the Series D warrant expires, the Company is obligated to deliver a new
warrant (the "IPO Warrant"). The Company is only required to issue this warrant,
however, if AOL purchases the $2,000,000 worth of common stock discussed above
at the time of the IPO.
The IPO Warrant will be for the purchase of 1.5 times the number of shares
of common stock purchased by AOL pursuant to the Stock Agreement at an exercise
price per share equal to the IPO price less the underwriter discount. The IPO
warrant will vest in increments of 1/36 per month commencing March 1, 1998.
The Company has determined the value of the Series D warrant to be
approximately $436,000 and has recorded this amount as additional purchase price
for the marketing rights under the
F-13
<PAGE> 88
SOFTWARE.NET CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1998 AND RELATING TO
THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
marketing agreement. The value of the warrant is being amortized on a consistent
basis with the marketing rights as described above.
4. LONG-TERM DEBT
In 1994, the Company issued a non-interest bearing note payable of $105,000
in exchange for costs incurred by and cash received from a founder of the
Company. The note payable has been repaid by the Company as of March 31, 1998.
In September 1995, the Company issued notes payable of $300,000. In
February 1996, the $300,000 of principal and $11,000 of accrued interest were
converted into 341,426 shares of Series A preferred stock at a price of $0.91
per share.
5. LEASE COMMITMENTS
Operating Leases
The Company leases its primary facilities and certain equipment under
noncancelable operating leases expiring at various dates through 2002. Rental
expense was approximately $23,000, $101,000, $266,000, and $84,000 for the years
ended December 31, 1995, 1996, and 1997 and for the three months ended March 31,
1998, respectively.
Future minimum lease payments under noncancelable operating leases are as
follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------
<S> <C>
1998........................................................ $ 344
1999........................................................ 298
2000........................................................ 279
2001........................................................ 279
2002........................................................ 240
------
Total minimum lease payments................................ $1,440
======
</TABLE>
Capital Leases
The Company also leases certain equipment under noncancelable lease
agreements that are accounted for as capital leases. Equipment under capital
lease arrangements, included in property and equipment, aggregated approximately
$60,000 at December 31, 1997 and March 31, 1998, respectively. Related
accumulated amortization was approximately $3,000 and $8,000 at December 31,
1997 and March 31, 1998, respectively. Amortization expense related to assets
under capital leases is included with depreciation expense.
F-14
<PAGE> 89
SOFTWARE.NET CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1998 AND RELATING TO
THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
Future minimum lease payments under noncancelable capital leases are as
follows: (in thousands)
<TABLE>
<CAPTION>
DECEMBER 31,
1997
------------
<S> <C>
1998........................................................ $24
1999........................................................ 24
2000........................................................ 20
---
Total minimum payments...................................... 68
Less amount representing interest........................... 11
---
57
Less current portion........................................ 18
---
$39
===
</TABLE>
6. REDEEMABLE CONVERTIBLE PREFERRED STOCK
Redeemable convertible preferred stock at December 31, 1996 and 1997 and
March 31, 1998 is as follows by series:
<TABLE>
<CAPTION>
SHARES ISSUED AND OUTSTANDING
---------------------------------
DECEMBER 31,
DESIGNATED --------------------- MARCH 31,
SHARES 1996 1997 1998
---------- --------- --------- ---------
<S> <C> <C> <C> <C>
A............................ 1,985,520 1,985,520 1,985,520 1,985,520
B............................ 2,500,000 2,037,038 2,037,038 2,037,038
C............................ 3,000,000 -- 3,000,000 3,000,000
D............................ 1,523,424 -- -- 877,380
--------- --------- --------- ---------
Total preferred stock........ 9,008,944 4,022,558 7,022,558 7,899,938
========= ========= ========= =========
</TABLE>
On April 3, 1998, the Company sold an additional 276,466 shares of Series D
redeemable convertible preferred stock at $2.60 per share.
Holders of Series A, B, C, and D redeemable convertible preferred stock are
entitled to receive annual noncumulative dividends at the rate of $0.040,
$0.2268, $0.1714, and $0.26 per share, respectively, plus, with respect to the
Series B, C and D redeemable convertible preferred stock, cumulative dividends
at a rate of $0.01323, $0.009996 and $0.0152 per share, per month, respectively,
when and if declared by the Board of Directors, payable in preference to common
stock dividends. There have been no dividends declared or payable by the Company
at December 31, 1997 or March 31, 1998.
Each share of preferred stock is convertible at any time at the option of
the holder into shares of common stock at the then effective conversion price.
Each outstanding share of Series A, B, C, and D redeemable convertible preferred
stock is convertible into 2.00, 2.00, 1.00, and 1.00 shares of common stock,
respectively, and is subject to adjustment as specified in the Articles of
Incorporation. The preferred stock will automatically convert into common stock
immediately prior to the consummation of a firm commitment underwritten public
offering under the Securities Act of 1933 in which the sale price to the public
is not less than $3.43 per share, in which the aggregate
F-15
<PAGE> 90
SOFTWARE.NET CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1998 AND RELATING TO
THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
offering price to the public is not less than $15,000,000, or at such time as
the Company receives the consent of not less than two-thirds of the holders of
the preferred stock.
Each preferred share has voting rights equal to the number of common shares
into which it is convertible. Upon liquidation, the holders of the Series A, B,
C, and D redeemable convertible preferred stock are entitled to receive $0.336,
$2.268, $1.7136, and $2.60 per share, respectively, plus any declared but unpaid
dividends, before any distribution may be made to the holders of common shares.
At any time on or after January 5, 2000, the holders of a majority of the
then outstanding shares of Series A preferred stock may request the redemption
of all outstanding shares of Series A preferred stock. The Company shall redeem
such shares at a price per share of $0.63, plus accrued dividends, if any, for
Series A preferred stock. At any time on or after the sixth anniversary of the
Series B original issue date, the holders of at least two-thirds of the then
outstanding shares of Series B, C and D preferred stock may request the
redemption of all of the outstanding shares of Series B, C and D preferred
stock. The Company shall redeem such shares at a price per share of $2.268,
$1.7136 and $2.60, respectively, plus accrued dividends, if any.
7. STOCKHOLDERS' EQUITY
Common Shares
The Company is authorized to issue 30,000,000 shares of common stock.
Holders of common stock are entitled to one vote per share on all matters to be
voted upon by the stockholders of the Company. Subject to the preferences that
may be applicable to any outstanding shares of preferred stock, the holders of
common stock are entitled to receive ratably such dividends, if any, that may be
declared by the Board of Directors.
The Company has reserved shares of common stock for future issuance as
follows:
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1997 1998
------------ ----------
<S> <C> <C>
1995 Stock Option Plan (the Plan):
Options outstanding.................................. 1,016,455 2,686,055
Options available for future grants.................. 913,545 223,945
Options outside of the Plan............................ 1,000,000 1,000,000
Redeemable convertible preferred stock................. 11,045,116 11,922,496
Outstanding warrants................................... -- 369,578
========== ==========
13,975,116 16,202,074
========== ==========
</TABLE>
1995 Stock Option Plan
The Company's 1995 Stock Option Plan (the "Plan") was adopted by the
Company on January 5, 1995. There are 3,000,000 shares of common stock
authorized for issuance under the Plan. The Plan provides for the issuance of
common stock and granting of options to employees, officers, directors,
consultants, independent contractors, and advisors of the Company. The exercise
price of a nonqualifying stock option and an incentive stock option shall not be
less than 85% and 100%, respectively, of the fair value of the underlying shares
on the date of grant. Options granted under the Plan generally vest over four
years at the rate of 25% one year from the grant date and ratably every month
thereafter.
F-16
<PAGE> 91
SOFTWARE.NET CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1998 AND RELATING TO
THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
In conjunction with the Spin-off of CyberSource on December 31, 1997,
employees of the Company maintained their outstanding options to purchase common
shares of the Company and were granted additional stock options in CyberSource
based on the extent that the employees original options were vested. Employees
of CyberSource immediately following the Spin-off maintained their outstanding
vested stock options in the Company (although these stock options will now be
treated as nonqualified stock options subsequent to the Spin-off) and were
granted additional incentive stock options in CyberSource. The exercise prices
of the original and additional option grants were adjusted to reflect the
allocation of the current fair market value per share price between the
Company's and CyberSource's common stock based on an independent valuation of
the respective fair market value of such shares of common stock. Options to
purchase common shares of the Company held by the CyberSource employees that had
not vested as of the date of the Spin-off were canceled. The following table
summarizes option activity for the period from January 5, 1995 (date of adoption
of the Plan) to December 31, 1995, the years ended December 31, 1996 and 1997,
and the three months ended March 31, 1998, and has been adjusted to
retroactively reflect the change in exercise prices of options to purchase
common shares of the Company. The adjustments and Spin-off of options resulted
in nonstapled options to the employees of each entity and were accounted for and
in compliance with the guidelines in Emerging Issues Task Force Issue No. 90-9
and, therefore, no compensation expense has been recorded.
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
-----------------------
WEIGHTED
AVERAGE
EXERCISE
SHARES NUMBER PRICE PER
AVAILABLE OF SHARES SHARE
---------- --------- ----------
<S> <C> <C> <C>
Shares reserved................................... 1,300,000 --
Options granted................................... (530,000) 530,000 $0.010
---------- ---------
Balance at December 31, 1995........................ 770,000 530,000 $0.010
Additional shares reserved........................ 700,000 -- $ --
Options granted................................... (618,500) 618,500 $0.052
---------- ---------
Balance at December 31, 1996........................ 851,500 1,148,500 $0.033
Options granted................................... (750,700) 750,700 $0.156
Options exercised................................. -- (70,000) $0.031
Options canceled.................................. 110,000 (110,000) $0.135
Cancellation of unvested options held by
CyberSource employees.......................... 702,745 (702,745) $0.097
---------- ---------
Balance at December 31, 1997........................ 913,545 1,016,455 $0.068
Additional shares reserved (unaudited)............ 1,000,000 -- --
Options granted (unaudited)....................... (1,689,600) 1,689,600 $2.253
Options exercised (unaudited)..................... (20,000) $0.008
---------- ---------
Balance at March 31, 1998 (unaudited)............... 223,945 2,686,055 $1.442
========== =========
</TABLE>
In connection with certain stock options granted in March 1998, the Company
recorded deferred compensation for the estimated difference between the exercise
price of the options and the deemed fair value of approximately $2.3 million
which will be amortized over the four year vesting period of the options.
F-17
<PAGE> 92
SOFTWARE.NET CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1998 AND RELATING TO
THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
The following table summarizes information about options outstanding at
December 31, 1997:
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED NUMBER OF
OPTIONS AVERAGE OPTIONS
OUTSTANDING WEIGHTED REMAINING EXERCISABLE WEIGHTED
AT AVERAGE CONTRACTUAL AT AVERAGE
EXERCISE DECEMBER 31, EXERCISE LIFE DECEMBER 31, EXERCISE
PRICE 1997 PRICE (YEARS) 1997 PRICE
-------- ------------ -------- ----------- ------------ --------
<S> <C> <C> <C> <C> <C>
$0.004 -- $0.038 669,375 $0.02 7.44 611,667 $0.02
$0.113 233,050 $0.11 9.29 54,781 $0.11
$0.170 79,530 $0.17 9.84 -- $ --
$0.50 34,500 $0.50 9.95 -- $ --
--------- -------
1,016,455 $0.068 666,448 $0.03
========= =======
</TABLE>
At December 31, 1995 and 1996, 194,686 and 573,498 options were exercisable
at a weighted average exercise price of $0.01 and $0.03, respectively.
Options Outside of the 1995 Stock Option Plan
On January 5, 1995, the Company granted options outside of the Plan to its
Chief Technical Officer to purchase 1,000,000 shares of common stock of the
Company at an exercise price of $0.004 per share. None of the options have been
exercised as of March 31, 1998. The remaining contractual life of the options is
approximately four years as of December 31, 1997. The options vested over
approximately fifteen months from the grant date at the rate of 25% one month
from the grant date and ratably every month thereafter. As of December 31, 1997
and March 31, 1998, all options were exercisable.
Stock-Based Compensation
Pro forma information regarding net loss is required by FAS 123, which also
requires that the information be determined as if the Company has accounted for
its employee stock options granted during the period from January 5, 1995 (date
of adoption of the Plan) through December 31, 1995 (1995) and the years ended
December 31, 1996 and 1997 under the fair value method of FAS 123. The fair
value for these options was estimated at the date of grant using the minimum
value method with the following weighted average assumptions: a risk-free
interest rate of 6.3%, 5.6%, and 6.1% for 1995, 1996, and 1997, respectively, no
dividend yield or volatility factors of the expected market price of the
Company's common stock, and a weighted average expected life of the option of
four years.
The option valuation models were developed for use in estimating the fair
value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including the expected life of the option. Because the
Company's employee stock options have characteristics significantly different
from those of traded options and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
Had compensation cost for the Company's stock-based compensation plans been
determined using the fair value at the grant dates for awards under those plans
calculated using the minimum
F-18
<PAGE> 93
SOFTWARE.NET CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1998 AND RELATING TO
THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
value method of FAS 123, the Company's net loss and pro forma basic and diluted
net loss per share would have been increased to the pro forma amounts indicated
below:
<TABLE>
<CAPTION>
1995 1996 1997
----- ------- -------
<S> <C> <C> <C>
Pro forma net loss (in thousands).................. $(511) $(1,515) $(5,364)
Pro forma basic and diluted net loss per share..... ($ 0.30)
</TABLE>
The weighted average fair value of options granted, which is the value
assigned to the options under FAS 123, was $0.01, $0.04 and $0.04 for options
granted during 1995, 1996, and 1997, respectively.
The pro forma impact of options on the net loss for the years ended
December 31, 1995, 1996, and 1997 is not representative of the effects on net
income (loss) for future years, as future years will include the effects of
options vesting as well as the impact of multiple years of stock option grants.
The effect of FAS 123 will not be fully reflected until 1998.
8. RELATED PARTY TRANSACTIONS
Pursuant to the terms of an agreement entered into in connection with the
Spin-off of CyberSource, the Company uses services supplied to the Company by
CyberSource on a non-exclusive basis. These services relate to credit card
processing, fraud screening, export control, sales tax computation, electronic
licensing, hosting of electronic downloads and fulfillment notification. Any
discontinuation of such services, or any reduction in performance that requires
the Company to replace such services, would be disruptive to the Company's
business. The Company also received a non-exclusive license to certain
CyberSource Technology. Under the services agreement, the Company is obligated
to compensate CyberSource on a basis of services used per order or transaction.
The Company recorded expenses of approximately $170,000 related to such services
in the quarter ended March 31, 1998.
During the years ended December 31, 1995, 1996, and 1997 and the three
months ended March 31, 1998, legal fees incurred were approximately $24,000,
$112,000, $304,000, and $133,333, respectively, relating to a law firm in which
a current director of the Company is a partner. As of December 31, 1996 and 1997
and March 31, 1998, amounts owed to the law firm were approximately $27,000,
$89,000, and $133,333, respectively.
On March 18, 1998, the Company borrowed $400,000 from CyberSource. This
loan is memorialized in a promissory note issued by the Company to CyberSource,
which provides for repayment in a lump sum on or before September 18, 1998 and
bears interest at a rate of 5.32% compounded semi-annually.
9. LITIGATION
In August 1995, the Company was named as a defendant in a lawsuit for
patent infringement alleging infringement of a patent by selling and
distributing Software over the Internet. The lawsuit was settled in 1997 for an
immaterial amount.
From time to time, the Company may be involved in litigation relating to
claims arising out of its ordinary course of business. The Company believes that
there are no claims or actions pending or threatened against the Company, the
ultimate disposition of which would have a material impact on the Company's
financial position or results of operations.
F-19
<PAGE> 94
SOFTWARE.NET CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1998 AND RELATING TO
THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
10. INCOME TAXES
No provision for income taxes has been recorded due to operating losses
with no current tax benefit.
As of December 31, 1997, the Company had federal and state net operating
loss carryforwards of approximately $7,200,000. The Company also had federal
research and development tax credit carryforwards of approximately $26,000. The
net operating losses and credit card carryforwards will expire at various dates
beginning in 2009 through 2012, if not utilized. The net operating loss
carryforwards differ from the accumulated deficit primarily as a result of the
accounting for the Spin-off of CyberSource to the Company's preferred and common
stockholders on December 31, 1997.
Utilization of the net operating losses and credits may be subject to a
substantial annual limitation due to the ownership change limitations provided
by the Internal Revenue Code of 1986, as amended, and similar state provisions.
The annual limitation may result in the expiration of net operating losses and
credits before utilization.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1996 1997
--------- ----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards....................... $ 816,000 $2,952,000
Research credit carryforwards.......................... 17,000 43,000
Reserves and accruals.................................. 109,000 151,000
--------- ----------
Total deferred tax assets...................... 942,000 3,146,000
Valuation allowance...................................... (942,000) (3,146,000)
--------- ----------
Net deferred tax assets.................................. $ -- $ --
========= ==========
</TABLE>
Under Statement of Financial Accounting Standards No. 109, (FAS 109),
deferred tax assets and liabilities are determined based on differences between
financial reporting and tax bases of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse. Based upon the weight of available evidence, which
includes the Company's historical operating performance, the reported net losses
in 1995, 1996, and 1997, and the uncertainties regarding future results of
operations of the Company, the Company has provided a full valuation allowance
against its net deferred tax assets as it is more likely than not that the
deferred tax assets will not be realized. The valuation allowance increased by
$571,000 during 1996 and increased by $2,204,000 during 1997.
F-20
<PAGE> 95
SOFTWARE.NET CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1998 AND RELATING TO
THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
11. SUBSEQUENT EVENTS (UNAUDITED)
On April 4, 1998, the Company's Board of Directors and stockholders adopted
the 1998 Stock Option Plan and reserved an aggregate of 2,000,000 shares of
Common Stock for grants of stock options under such plan.
In April 1998, the Company granted options to purchase 1,035,000 shares of
common stock at a weighted average exercise price of $4.94. These options
generally vest over four years at the rate of 25% one year from the grant date
and ratably every month thereafter. The Company expects to record the estimated
difference between the exercise price of the options and the deemed fair value
of approximately $1,406,000 over the four year vesting period of the options.
The Company entered into a credit agreement (the "Credit Agreement") with
Deutsche Bank AG ("Deutsche Bank")in May 1998. Pursuant to the Credit Agreement,
on May 21, 1998, Deutsche Bank issued a standby letter of credit to the Company
in the amount of approximately $600,000 (the "Credit Facility") and loaned the
Company approximately an additional $4,200,000 (the "Loan"). To date the Company
has used the funds made available under these arrangements to: (i) make a
down-payment on a lease entered into by the Company in May of 1998; (ii) meet
rental obligations under that lease; (iii) dispose of liabilities of the Company
accrued in the ordinary course of business; and (iv) support other working
capital needs of the Company. The Loan bears interest at a rate equal to the
higher of (i) the daily Federal Funds Rate plus 0.5% per annum or (ii) Deutsche
Bank daily prime lending rate ("Base Rate"), plus 3.0%, per annum (approximately
12% at May 31, 1998). Interest is payable quarterly, in arrears, during the term
of the Credit Agreement. The Company is also required to pay a standby letter of
credit fee equal to a percentage of the face amount of the Credit Facility equal
to the Base Rate plus 3% less the LIBOR rate for a three-month loan. In
conjunction with the Credit Agreement, the Company is required to pay to
Deutsche Bank (i) an upfront fee of $120,000 and (ii) a credit line fee equal to
7.50% of the amount by which the Company's gross revenues during the term of the
Credit Agreement exceed certain agreed upon thresholds, subject to maximum
payments of $337,500 in the aggregate. All amounts borrowed under the Credit
Agreement are due on November 16, 1998. The Company is presently in full
compliance with the terms of the Credit Agreement and does not anticipate a
change to such status with respect to such terms. In connection with the Credit
Agreement, Deutsche Bank will receive a first priority lien on all of the
Company's assets, including intellectual property. Pursuant to the terms of the
Credit Agreement, the Company is subject to certain financial and non-financial
covenants including limitations on payments of dividends, additional borrowings,
acquisitions and disposition of assets and maintenance of maximum operating cash
flow deficiencies and minimum quick ratios.
The Company entered into a sublease in May 1998 for approximately 75,197
square feet of office space located in Sunnyvale, California (the "Sublease").
The Company intends that this location will serve as the Company's principal
administrative, engineering, marketing and customer service facility. The
Sublease term will commence as of July 1, 1998, and will end sixty-two (62)
months thereafter, unless sooner terminated. Under the terms of the Sublease,
the Company made a security deposit payment of $297,000 cash and issued an
irrevocable letter of credit for $595,000 prior to occupancy and commencement of
the Sublease term. Under the terms of the sublease, the Company will be
obligated to make monthly payments of approximately $149,000 increasing to
$174,000 over the term of the Sublease. The Company will not have an option to
renew or extend the term of this Sublease.
F-21
<PAGE> 96
DESCRIPTION OF GRAPHICS
The graphic will depict the Company's Web Site, its customer value
proposition and its relationships with it key marketing partners, AOL, Netscape
and Excite.
<PAGE> 97
NO DEALER, SALESPERSON OR ANY OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS. IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL, OR A SOLICITATION OF ANY OFFER TO BUY, THE COMMON STOCK IN ANY
JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS UNLAWFUL TO MAKE SUCH AN
OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT THERE HAS
NOT BEEN ANY CHANGE IN THE FACTS SET FORTH IN THIS PROSPECTUS OR IN THE AFFAIRS
OF THE COMPANY SINCE THE DATE HEREOF.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 3
The Company........................... 4
Risk Factors.......................... 5
Use of Proceeds....................... 21
Dividend Policy....................... 21
Capitalization........................ 22
Dilution.............................. 23
Selected Consolidated Financial
Data................................ 24
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 25
Business.............................. 35
Management............................ 52
Certain Transactions.................. 59
Principal Stockholders................ 64
Description of Capital Stock.......... 66
Shares Eligible for Future Sale....... 69
Underwriting.......................... 71
Legal Matters......................... 74
Experts............................... 74
Additional Information................ 74
Index to Consolidated Financial
Statements.......................... F-1
</TABLE>
UNTIL JULY 12, 1998, (25 DAYS FROM THE DATE OF THIS PROSPECTUS) ALL DEALERS
EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
- ---------------------------------------------------------
LOGO
5,000,000 SHARES
COMMON STOCK
DEUTSCHE BANK SECURITIES
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
MERRILL LYNCH & CO.
C.E. UNTERBERG, TOWBIN
PROSPECTUS
JUNE 17, 1998
