<PAGE> 1
FORM 10-Q FOR PERIOD ENDED SEPTEMBER 30, 1998
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDING SEPTEMBER 30, 1998
OR
[ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____ TO ______
Commission File Number 0-24457
SOFTWARE.NET CORPORATION
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C>
Delaware 94-3212136
(State of Incorporation) (IRS Employer Identification Number)
1195 West Fremont Avenue, Sunnyvale, California 94087
(Address of principal executive offices) (Zip Code)
</TABLE>
Registrant's Telephone Number, including Area Code: (408) 616-4200
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
The number of shares outstanding of each of the issuer's classes of common stock
as of September 30, 1998:
<TABLE>
<S> <C>
Class Number of Shares
Common Stock, par value $0.001 27,334,744
</TABLE>
<PAGE> 2
PART I. Financial Information
Item 1. Financial Statements
SOFTWARE.NET CORPORATION
(also known as Beyond.com)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------- ------------------
Sept 30, Sept 30, Sept 30, Sept 30,
1998 1997 1998 1997
--------- --------- --------- --------
<S> <C> <C> <C> <C>
Net revenues $9,742 $4,825 $23,511 $11,417
Cost of revenues 8,281 4,295 19,943 9,970
--------- --------- --------- --------
Gross Profit 1,461 530 3,568 1,447
Operating expenses:
Research and development 1,287 302 3,009 641
Sales and marketing 8,048 442 14,269 1,039
General and administrative 1,407 265 3,220 676
--------- --------- --------- --------
10,743 1,009 20,498 2,356
--------- --------- --------- --------
Operating loss (9,282) (479) (16,930) (909)
Interest income, net 384 24 241 96
--------- --------- --------- --------
Loss from continuing operations (8,898) (455) (16,689) (813)
Loss from discontinued operations - (1,036) - (2,074)
--------- --------- --------- --------
Net loss ($8,898) ($1,491) ($16,689) ($2,887)
Accretion of premium on redemption
of redeemable convertible preferred
stock in excess of purchase price - (25) (51) (76)
Net loss applicable to --------- --------- --------- --------
common shareholders ($8,898) ($1,516) ($16,740) ($2,963)
========= ========= ========= ========
Basic and diluted net loss
per share from continued operations ($0.33) ($0.05) ($1.04) ($0.10)
Basic and diluted net loss
per share from discontinued operations $ - ($0.12) - ($0.23)
--------- --------- --------- --------
Basic and diluted net loss
per share $ (0.33) ($0.17) ($1.04) ($0.33)
========= ========= ========= ========
Weighted average shares of common
stock outstanding used in computing
basic and diluted net loss per share 27,300 9,000 16,089 9,000
========= ========= ========= ========
Pro forma basic and diluted net loss
per share from continued operations ($0.72)
Pro forma basic and diluted net loss
per share from discontinued operations -
---------
Pro forma basic and diluted net loss
per share ($0.72)
Number of shares used in pro forma
basic and diluted net loss per share 23,213
=========
</TABLE>
See notes to consolidated financial statements.
<PAGE> 3
software.net Corporation
(also known as Beyond.com)
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands)
<TABLE>
<CAPTION>
Sept 30, December 31,
1998 1997
--------- -----------
(unaudited) (Note)
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents $33,199 $2,571
Accounts receivable less allowances of
$1,141 at September 30, 1998 and
$400 at December 31, 1997 9,097 1,181
Prepaid partnership agreements 6,954 516
Cost of deferred revenue 3,610 4,938
--------- ---------
Total current assets 52,860 9,206
Property and equipment, net 2,053 380
Other non-current assets 1,343 -
Intangible assets 932 -
--------- ---------
Total assets $57,188 $9,586
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Note payable $5,002 $ -
Accounts payable 6,723 2,256
Other accrued liabilities 2,865 270
Current obligations under capital leases - 18
Deferred revenue 3,991 5,569
--------- ---------
Total current liabilities 18,581 8,113
Note payable to stockholder and director - 60
Non-current obligations under capital leases - 39
Commitments
Redeemable convertible preferred stock - 12,565
Stockholders' equity: (net capital deficiency)
Common stock 69,286 47
Deferred compensation (2,701) -
Accumulated deficit (27,978) (11,238)
--------- ---------
Total stockholders' equity
(net capital deficiency) 38,607 (11,191)
--------- ---------
Total liabilities and stockholders'
equity (net capital deficiency) $57,188 $9,586
========= =========
</TABLE>
Note: The balance sheet at December 31, 1997 has been derived from the
audited financial statements at that date.
See notes to consolidated financial statements.
<PAGE> 4
software.net Corporation
(also known as Beyond.com)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
---------------------
Sept 30, Sept 30,
1998 1997
--------- --------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss ($16,689) $(2,887)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 419 47
Amortization of deferred compensation 1,090 -
Net loss of discontinued operations - 2,074
Changes in operating assets and liabilities:
Accounts receivable (7,916) (1,838)
Prepaid expenses and deposits (7,781) (473)
Cost of deferred revenue 1,328 (6,548)
Accounts payable 4,467 1,735
Other accrued liabilities 2,797 583
Deferred revenue (1,578) 7,123
Cash used in discontinued operations - (1,075)
--------- --------
Net cash used in operating activities (23,863) (1,259)
INVESTING ACTIVITIES
Purchases of property and equipment (1,949) (186)
Cash used in discontinued operations - (1,465)
--------- --------
Net cash used in investing activities (1,949) (1,651)
FINANCING ACTIVITIES
Proceeds from issuance of note payable 4,800 -
Repayment of note payable to related party (60) -
Repayment of capital lease obligations (57) (7)
Proceeds from sale of redeemable convertible
preferred stock 2,924 5,964
Proceeds from sale of common stock 48,833 -
--------- --------
Net cash provided by financing activities 56,440 5,957
--------- --------
Net increase in cash and equivalents 30,628 3,047
Cash and cash equivalents at beginning of period 2,571 3,737
--------- --------
Cash and cash equivalents at end of period $33,199 $6,784
========= ========
</TABLE>
See notes to consolidated financial statements.
<PAGE> 5
software.net Corporation
(also known as Beyond.com)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 1998
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
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. In the
opinion of Management, all adjustments (consisting primarily of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three- and nine-month periods ended September 30, 1998
are not necessarily indicative of the results that may be expected for the year
ending December 31, 1998. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's prospectus
dated June 17, 1998 comprising part of the Company's Registration Statement on
Form S-1 filed with the Securities and Exchange Commission.
In August 1998, the Company changed its name to Beyond.com subject to
stockholder approval.
The Company completed an initial public offering of its common stock on
June 22, 1998 (the "IPO"). A total of 5,750,000 shares of common stock was sold
by the Company to the public at a price of $9.00 per share. The underwriting
discount was $0.63 per share.
Pursuant to a Common Stock and Warrants Subscription Agreement entered into
in March 1998 and as a result of the Company's IPO, the Company issued a warrant
(the "IPO Warrant") and sold $2,000,000 in common stock to America Online,
Inc.("AOL") at $8.37 per share. The IPO Warrant was issued for the purchase of
358,422 shares of common stock at an exercise price per share of $8.37 and such
shares are non-forfeitable. The IPO Warrant vests in increments of 1/36 per
month period commencing March 1, 1998. The Company determined the value of the
IPO Warrant to be approximately $1,075,000 in total and recorded this amount as
additional purchase price for the marketing rights under the marketing
agreement. The value of the Warrant is being amortized on a consistent basis
with the marketing rights associated with the marketing agreement.
Additionally, at the time of the IPO each share of the Company's redeemable
convertible preferred stock was converted into shares of the Company's common
stock as specified in the Company's Certificate of Incorporation. Each
outstanding share of Series A, B, C, and D redeemable convertible preferred
<PAGE> 6
stock was converted into 2.00, 2.00, 1.00, and 1.00 shares of common stock,
respectively.
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 connection with
certain stock options granted in the nine months ended September 30, 1998, the
Company recorded deferred compensation for the estimated difference between the
exercise price of the options and the deemed fair value of $3.8 million which is
being amortized over the four year vesting period of the options.
In May 1998, the Company repaid CyberSource Corporation $400,000 plus
accrued interest for a loan memorialized in a promissory note issued by the
Company to CyberSource bearing interest at a rate of 5.32% compounded
semi-annually.
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 $600,000 (the "Credit Facility") and loaned the Company 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) the Deutsche Bank daily prime lending
rate ("Base Rate"), plus 3.0%, per annum (approximately 11.25% at September 30,
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. The Company has accrued approximately $200,000
related to the credit line fee as of September 30, 1998. 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, does not
anticipate a change to such status with respect to such terms, and intends to
pay all related interest and principal by 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 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 office space located in
Sunnyvale, California (the "Sublease").
<PAGE> 7
The Company intends that this location will serve as the Company's
principal administrative, engineering, marketing and customer service facility.
The Sublease term commenced 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 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.
The Company and Network Associates, a developer of electronic commerce
locations and publisher of certain products marketed under the McAfee and other
names, have entered into various agreements over the past fourteen (14) months
concerning the on-line sale of Software and the management of certain websites,
including the Co-Hosting Agreement and Web Site Services Agreement entered into
in September of 1998. Under these agreements, the Company acts as a reseller of
Network Associates' products, as co-host of certain internet sites developed by
Network Associates and as a provide of certain operational and management
services for Network Associates' Web site maintained at www.mcafeemall.com.
Pursuant to these agreements each of the Company and Network Associates is
obligated to the other for the payment of fees based on activities governed by a
particular agreement such as resales by the Company of Network Associates
products at the Company's Web site or the exclusive right to resell Network
Associates products at a co-hosted site. The Co-Hosting Agreement of September
1998 provides for substantial payments to Network Associates over the three year
term of the agreement. Termination of this relationship 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 volume of online
traffic, customers or revenues obtained as a result of this relationship will
justify the Company's significant fixed financial obligations to Network
Associates, or to satisfy its contractual obligations necessary to prevent
termination of such agreements. The amounts paid under the Co-Hosting agreement
are being amortized to sales and marketing on a straight-line basis over the 3
year period of the contract.
Net loss per share is presented under Statement of Financial Accounting
Standards No. 128, "Earnings per Share" (FAS 128). Pro forma net loss per share
has been computed under FAS 128 and also gives effect to the conversion of
redeemable convertible preferred stock not included in net loss per share that
converted upon completion of the IPO.
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 nine months ended September 30,
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.
Accounting standard SOP 98-1 was issued in first quarter, 1998, and is
effective in 1999. It requires capitalization of the development costs of
software to be used internally, e.g., for manufacturing or administrative
processes. The Company, which currently expenses such amounts as incurred,
expects to adopt the standard in the first quarter of 1999 for developmental
costs incurred in that quarter and thereafter. The Company does not expect the
adoption of SOP 98-1 to have a material impact on its financial condition or
results of operations.
From time to time, the Company has received, and may receive in the future,
notice of claims infringement of other parties' proprietary rights. In November
1998, the Company received a letter from a third party that appears to hold a
registered United States trademark for "A Better Way to Buy Software" asserting
that the Company's use of such phrase infringes such third party's trademark
rights in such phrase. The Company disputes the validity of this assertion.
However, there can be no assurance that such third party will not file a lawsuit
against the Company, which could subject the Company to injunctive relief or
money damages or that the Company will prevail in such litigations. In November
1998, the Company also received a letter from a third party asserting that the
Company's use of the name "Beyond.com" infringes the trademark and domain name
rights of such third party. The Company is monitoring this matter, the ultimate
outcome of which remains to be determined. The Company disputes the validity of
this assertion, however, there can be no assurance that the outcome of this
matter will not materially adversely affect the Company's ability to use the
"Beyond.com" mark, name or domain name, which would have a material adverse
effect on the Company's business, financial conditions or result of operations.
software.net Corporation
(also known as Beyond.com)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements in this "Management's Discussion and Analysis of
Financial Condition and Results of Operations" are forward looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended, and Section 27A of the Securities Act of 1933, as amended. When used in
this report or elsewhere by management from time to time, the words "believes,"
"anticipates," "intends," plans," estimates," and similar expressions are
forward looking statements. Such 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 the Company's final prospectus filed pursuant to Rule 424 of
the Securities Act of 1933, as amended (File No. 333-51121) dated June
<PAGE> 8
17, 1998 comprising a part of the Company's Registration Statement on Form S-1,
as amended, filed with the Commission.
OVERVIEW
software.net Corporation (also known as Beyond.com, the "Company") is a
leading online reseller of commercial off-the-shelf computer software
("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. In June 1998, the Company consummated the
initial public offering of its Common Stock. In August 1998, the Company began
doing business as "Beyond.com." A formal corporate name change will be submitted
for approval at a special meeting of stockholders to be held in December 1998.
Since inception the Company has experienced increasing net losses on an annual
basis. 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 Communications Corporation ("Netscape"), Network Associates, Inc.
("NAI") (described below) and Excite, Inc. ("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 revenues. 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 incurred in expanding the Company's employee base and 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 strategic marketing
agreements, and these levels are based on its operating plans and estimates of
future revenues which depend on anticipated sales resulting from the strategic
marketing agreements with AOL, Excite and NAI 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 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
<PAGE> 9
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, Netscape and NAI pursuant to which the Company
has exposure to traffic on third party Web sites, or the termination of
contracts with major purchasers, particularly the 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
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.
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 NAI 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 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.
The Company and Network Associates, a developer of electronic commerce
locations and publisher of certain products marketed under the McAfee and other
names, have entered into various agreements over the past fourteen (14) months
concerning the on-line sale of Software and the management of certain websites,
including the Co-Hosting Agreement and Web Site Services Agreement entered into
in September of 1998. Under these agreements, the Company acts as a reseller of
Network Associates' products, as co-host of certain internet sites developed by
Network Associates and as a provide of certain operational and management
services for Network Associates' Web site maintained at www.mcafeemall.com.
Pursuant to these agreements each of the Company and Network Associates is
obligated to the other for the payment of fees based on activities governed by a
particular agreement such as resales by the Company of Network Associates
products at the Company's Web site or the exclusive right to resell Network
Associates products at a co-hosted site. The Co-Hosting Agreement of September
1998 provides for substantial payments to Network Associates over the three year
term of the agreement. Termination of this relationship 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 volume of online
traffic, customers or revenues obtained as a result of this relationship will
justify the Company's significant fixed financial obligations to Network
Associates, or to satisfy its contractual obligations necessary to prevent
termination of such agreements.
RESULTS OF OPERATIONS: QUARTER AND NINE MONTHS ENDED September 30, 1998
Net Revenues. Net revenues increased from $11.4 million in the nine months
ended September 30, 1997 to $23.5 million in the nine months ended September 30,
1998, primarily as a result of increased sales to consumer and corporate
customers and as a result of a new U.S. government contract. Net revenues from
ESD Software sales were $12.8 million in the nine months ended September 30,
1998.
Net revenues increased from $4.8 million in the quarter ended September 30,
1997 to $9.7 million in the quarter ended September 30, 1998 primarily as a
result of new U.S. government contracts and increased sales to consumer and
<PAGE> 10
corporate customers. Net revenues from ESD Software sales were $4.7 million in
the quarter ended September 30, 1998.
Cost of Revenues. Cost of revenues consists primarily of the costs of
Software and Software licenses 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 $10.0 million in the nine months ended September 30, 1997 to
$19.9 million in the nine months ended September 30, 1998 as a result of
increased Software sales.
Total cost of revenues increased from $4.3 million in the quarter ended
September 30, 1997 to $8.3 million in the quarter ended September 30, 1998, as a
result of increased Software sales.
Gross Margin. Gross margin (gross profit as a percentage of net revenues)
increased from 12.7% in the nine months ended September 30, 1997 to 15.2% in the
nine months ended September 30, 1998. This increase primarily was due to a shift
in the Company's revenue mix, resulting from an increased percentage 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.
Gross margin increased from 11.0% in the quarter ended September 30, 1997
to 15.0% in the quarter ended September 30, 1998. This increase primarily was
due to a increase percentage of total revenue being derived from higher margin
advertising and promotional revenues received from Software publishers.
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 $641,000 in the nine
months ended September 30, 1997 to $3.0 million in the nine months ended
September 30, 1998. Research and development expenses as a percentage of net
revenues increased from 5.6% in the nine months ended September 30, 1997 to
12.8% in the nine months ended September 30, 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.
Research and development expenses increased from $302,000 in the quarter
ended September 30, 1997 to $1.3 million in the quarter ended September 30,
1998. Research and development expenses as a percentage of net revenues
increased from 6.3% in the quarter ended September 30, 1997 to 13.2% in the
quarter ended September 30, 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 promotional expenditures, personnel and related expenses, and costs
associated with operating the Company's Web sites. In addition, sales and
<PAGE> 11
marketing expenses include the expenditures associated with the Company's
strategic marketing alliances. Sales and marketing expenses increased from $1.0
million in the nine months ended September 30, 1997 to $14.3 million in the nine
months ended September 30, 1998. Sales and marketing expenses as a percentage of
net revenues were 9.1% in the nine months ended September 30, 1997 and 60.7% in
the nine months ended September 30, 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, branding and
marketing campaign (including charges associated with the Company's re-branding
efforts), as well as an increase in personnel and advertising expenditures.
Sales and marketing expenses increased from $442,000 in the quarter ended
September 30, 1997 to $8.0 million in the quarter ended September 30, 1998.
Sales and marketing expenses as a percentage of net revenues were 9.2% in the
quarter ended September 30, 1997 and 82.6% in the quarter ended September 30,
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, branding and marketing campaign, as well as an
increase in personnel and advertising expenditures.
The Company intends to continue to pursue an aggressive branding, sales and
marketing campaign and therefore expects sales and marketing expenses to
increase significantly in absolute dollars in future periods. As a portion of
these 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. At September 30, 1998
approximately $21.1 million remained to be paid. The costs associated with the
AOL and Netscape agreements will be expensed rateably over their respective
terms. The costs associated with the Excite agreement will be expensed as
payments become due under the contract terms. The Co-Hosting Agreement with
Network Associates will require significant minimum payments over the next three
years. The Company may enter into similar strategic marketing alliances
requiring significant minimum payments in the near future and, as a result, may
experience substantial increases in its sales and marketing expenses.
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 $676,000 in the
nine months ended September 30, 1997 to $3.2 million in the nine months ended
September 30, 1998. General and administrative expenses as a percentage of net
revenues were 5.9% in the quarter ended September 30, 1997 and 13.7% in the
quarter ended September 30, 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 provisions for bad
debts.
General and administrative expenses increased from $265,000 in the quarter
ended September 30, 1997 to $1.4 million in the quarter ended September 30,
1998. General and administrative expenses as a percentage of net revenues were
5.5% in the quarter ended September 30, 1997 and 14.4% in the quarter ended
September 30, 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 provisions for bad debts.
The Company expects general and administrative expenses to
<PAGE> 12
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, increased from $96,000 in the nine months ended September 30, 1997
to $241,000 in the nine months ended September 30, 1998, primarily as a result
of interest income from higher average cash balances offset by interest expenses
associated with the Company's credit facility.
Interest income, net, increased from $24,000 in the quarter ended September
30, 1997 to $384,000 in the quarter ended September 30, 1998, primarily as a
result of interest income associated with the Company's higher cash balances.
Income Taxes. The Company has recorded a net loss for the nine months and
quarters ended September 30, 1997 and September 30, 1998. As a result, no
provision for income taxes has been recorded in these periods.
LIQUIDITY AND CAPITAL RESOURCES
From inception through September 30, 1998, the Company has financed its
operations primarily through private sales of Preferred Stock and the initial
public offering ("IPO") of 5,750,000 shares of its Common Stock. The Company
raised net cash proceeds totaling $15.3 million through private sales of
Preferred Stock. On June 22, 1998, the Company received net proceeds of $46.8
million pursuant to the IPO. The Company raised an additional $2.0 million at
the closing of the IPO through the sale of Common Stock to AOL pursuant to a
Common Stock and Warrants Subscription Agreement entered into in March 1998 and
$4.8 million through a credit agreement entered into with Deutsche Bank, A.G. in
May 1998 (the "Deutsche Bank Credit Facility").
As of September 30, 1998, the Company had approximately $33.2 million of
cash and cash equivalents compared with $2.6 million at December 31, 1997. The
Company intends to repay the Deutsche Bank Credit Facility in November 1998. The
Company's current strategic marketing alliances provide for payments of
approximately $787,000 in the fourth quarter of 1998, approximately $8.7 million
in 1999, approximately $10.2 million in the year 2000 and approximately $1.5
million in the year 2001. The Company currently has no other material
commitments other than those under its operating leases, U.S. government
contracts, and certain equipment leases.
Net cash used in operating activities was $1.3 million for the nine months
ended September 30, 1997 and $23.9 million for the nine months ended September
30, 1998. Cash used in operating activities for the nine months ended September
30, 1998 resulted from a net loss of $16.7 million, increases in accounts
receivable and prepaid expenses totalling $15.7 million related to accounts
receivable from government contracts and prepaid partnership agreements and an
increase in deferred revenue. These amounts were offset by increases in accounts
payable, accrued liabilities and deferred revenue related to general Company
growth and the execution of a new government contract.
<PAGE> 13
Net cash used in investing activities for the nine months ended September
30, 1998 of $1.9 million was attributable to leasehold improvements and computer
equipment.
Net cash provided by financing activities of $56.4 million for the nine
months ended September 30, 1998 primarily consists of proceeds from the
Company's IPO, the Deutche Bank Credit Facility, the AOL purchase of Common
Stock and the sale of the Company's Series D redeemable convertible Preferred
Stock.
The Company believes that the net proceeds from this Offering, together
with its current cash and cash equivalents will be sufficient to meet its
anticipated cash needs for working capital and capital expenditures for at least
the next twelve months. The Company is evaluating alternatives of selling
additional equity or debt securities or obtaining additional credit facilities,
in part to fund its financial obligations to AOL, NAI and Excite and in order
to continue to expand the Company's sales and marketing efforts. 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.
Year 2000 Compliance. The "Year 2000 Issue" is typically the result of
software and firmware being written using two digits rather than four to define
the applicable year. If the Company's software and firmware with date-sensitive
functions are not Year 2000 compliant, they may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a system failure
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. The Company has evaluated its internal
systems and believes its internal systems are substantially Year 2000 compliant.
The Company is in the early stages of conducting an audit of its suppliers
and major customers as to the Year 2000 compliance of their systems. The Company
plans to develop a corporate awareness program, project plan (including
remediation, upgrading and replacement), validation testing and contingency
planning. The Company has initiated formal communication with significant
suppliers to determine the extent to which the Company's operations are
vulnerable to those third parties' failure to remediate their own Year 2000
issues. Suppliers of hardware, software or other products that might contain
embedded processors were requested to provide information regarding the Year
2000 compliance status of their products. The Company will continue to seek
information from non-responsive suppliers and plans to contact additional
suppliers during the fourth quarter of 1998. In addition, in order to protect
against the acquisition of additional non-compliant products, the Company now
requires suppliers to warrant that products sold or licensed to the Company for
the Company's internal systems are Year 2000 compliant. The Company's
expenditures to date have been immaterial with respect to Year 2000 compliance,
and the Company is currently evaluating the extent of its future expenditures in
addressing these issues. In the event that any of the Company's significant
suppliers do not successfully and timely achieve Year 2000 compliance, the
Company's business or operations could be adversely affected. There can be no
assurance that the systems of other companies on which the Company's systems
rely will be converted in a timely fashion and would not have an adverse effect
on the Company's operations.
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. The
<PAGE> 14
Internet market is highly dependent on such systems as it relates to information
transfer and e-commerce. Failure of internet companies to become Year 2000
compliant would have an adverse effect on the Company's ability to operate as a
business. The Company has not yet estimated all the Year 2000 costs but believes
the costs that will be incurred relating to the Company's internal computer
systems are immaterial to the Company's business operations or financial
condition and the Company is currently evaluating any financial exposure it may
face relating to the computer systems of its suppliers and major customers.
Additionally, the Company may incur material financial harm as a result of sales
of non-compliant commercial, off-the-shelf software to its customers. The
Company is currently evaluating any potential financial exposure related to this
issue.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
From time to time, the Company has received, and may receive in
the future, notice of claims of infringement of other parties'
proprietary rights. In November 1998, the Company received a letter
from a third party that appears to hold a registered United States
trademark for "A Better Way to Buy Software" asserting that the
Company's use of such phrase infringes such third party's trademark
rights in such phrase. The Company disputes the validity of such
claim. However, there can be no assurance that such third party will
not file a lawsuit against the Company, which could subject the
Company to injunctive relief or money damages or that the Company will
prevail in such litigation. In November 1998, the Company also
received a letter from a third party asserting that the Company's use
of the name "Beyond.com" infringes on the trademark and domain name
rights of such third party. The Company is monitoring this matter, the
ultimate outcome of which remains to be determined. The Company
disputes the validity of this assertion. However, there can be no
assurance that the outcome of this matter will not materially
adversely affect the Company's ability to use the "Beyond.com" mark,
name or domain name, which would have a material adverse effect on the
Company's business, financial conditions or results of operations.
ITEM 2. Changes in Securities-Not Applicable
ITEM 3. Defaults Upon Senior Securities-Not Applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders-Not
Applicable.
ITEM 5. Other Information-Not Applicable.
ITEM 6. Exhibits and Reports on Form 8-K
(a) EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
10.1 Agreement dated as of September 11, 1998, by and
between the Registrant and the United States
National Imaging and Mapping Agency ( NIMA
Contract # N00140-98-D-2139)+
10.2 Co-hosting Agreement dated as of September 21,
1998, by and between the Registrant and Network
Associates, Inc.* +
10.3 Web Site Service Agreement dated as of September 21, 1998,
by and between the Registrant and Network Associates, Inc.*
10.4 Electronic Services Distribution Agreement dated as of September 1, 1997, by and between The
Registrant and McAfee Software, Inc.* +
27.1 Financial Data Schedule
27.2 Financial Data Schedule
</TABLE>
*Confidential treatment requested.
+ To be filed by amendment.
<PAGE> 15
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
software.net Corporation
(Registrant)
DATE: November 16, 1998 BY: /s/ Michael J. Praisner
------------------ -------------------------------------
Michael J. Praisner
Vice President and
Chief Financial Officer
DATE: November 16, 1998 BY: /s/ Mark L. Breier
------------------ -------------------------------------
Mark L. Breier
President and
Chief Executive Officer
<PAGE> 16
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- -----------
<S> <C>
10.1 Agreement dated as of September 11, 1998, by and between the
Registrant and the United States National Imaging and Mapping
Agency ( NIMA Contract # N00140-98-D-2139)+
10.2 Co-hosting Agreement dated as of September 21, 1998, by and between
the Registrant and Network Associates, Inc.* +
10.3 Web Site Service Agreement dated as of September 21, 1998, by and
between the Registrant and Network Associates, Inc.*
10.4 Electronic Services Distribution Agreement dated as of September 1,
1997, by and between The Registrant and McAfee Software, Inc.* +
27.1 Financial Data Schedule
</TABLE>
*Confidential treatment requested.
+ To be filed by amendment.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
SOFTWARE.NET CORPORATION FORM 10-Q FOR THE PERIOD ENDED SEPTEMBER 30, 1998 AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1998
<CASH> 33,199
<SECURITIES> 0
<RECEIVABLES> 10,238
<ALLOWANCES> 1,141
<INVENTORY> 0
<CURRENT-ASSETS> 52,860
<PP&E> 2,427
<DEPRECIATION> 374
<TOTAL-ASSETS> 57,188
<CURRENT-LIABILITIES> 18,581
<BONDS> 0
0
0
<COMMON> 69,286
<OTHER-SE> 30,679
<TOTAL-LIABILITY-AND-EQUITY> 57,188
<SALES> 23,511
<TOTAL-REVENUES> 23,511
<CGS> 19,943
<TOTAL-COSTS> 19,943
<OTHER-EXPENSES> 20,498
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 241
<INCOME-PRETAX> (16,689)
<INCOME-TAX> 0
<INCOME-CONTINUING> (16,689)
<DISCONTINUED> 0
<EXTRAORDINARY> 51
<CHANGES> 0
<NET-INCOME> (16,740)
<EPS-PRIMARY> (1.04)
<EPS-DILUTED> (0.72)
</TABLE>
