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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-26825
N2H2, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
WASHINGTON (STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION)
91-1686754
(I.R.S. EMPLOYER IDENTIFICATION NO.)
900 FOURTH AVENUE, SUITE 3400, SEATTLE, WA 98164
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (206) 336-1501
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 [ ]
As of August 4, 2000, the registrant had outstanding 22,492,462 shares of
common stock, no par value.
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N2H2, INC.
TABLE OF CONTENTS
<TABLE>
<S> <C>
PART I--FINANCIAL INFORMATION ...................................................................... 3
Item 1. Financial Statements ............................................................... 3
CONDENSED CONSOLIDATED BALANCE SHEETS .............................................. 3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME ........... 4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS .................................... 5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ............................... 6
Item 2. Management's Discussion And Analysis Of Financial Condition And Results Of
Operations ....................................................................... 8
Item 3. Quantitative And Qualitative Disclosures About Market Risk ......................... 11
PART II--OTHER INFORMATION ......................................................................... 12
Item 1. Legal Proceedings .................................................................. 12
Item 2. Changes In Securities And Use Of Proceeds .......................................... 12
Item 3. Defaults Upon Senior Securities .................................................... 12
Item 4. Submission Of Matters To A Vote Of Security Holders ................................ 12
Item 5. Other Information .................................................................. 12
Item 6. Exhibits And Reports On Form 8-K ................................................... 12
SIGNATURES ......................................................................................... 13
</TABLE>
2
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PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
N2H2, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
<TABLE>
<CAPTION>
JUNE 30, SEPTEMBER 30,
2000 1999
----------- -------------
(UNAUDITED)
<S> <C> <C>
ASSETS:
Current assets:
Cash ............................................. $ 8,327 $ 7,743
Investments ...................................... 22,277 27,937
Accounts receivable, net ......................... 2,412 1,434
Prepaid expenses and other assets ................ 625 1,136
-------- --------
Total current assets ............................. 33,641 38,250
Long-term investments .................................. 3,603 24,698
Acquired intangible assets, net ........................ 15,153 --
Property and equipment, net ............................ 10,034 3,990
Other assets ........................................... 1,227 618
-------- --------
Total assets ..................................... $ 63,658 $ 67,556
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Current liabilities:
Accounts payable ................................. $ 1,679 $ 1,871
Royalties payable ................................ 198 100
Accrued liabilities .............................. 1,555 1,062
Deferred revenue ................................. 428 1,304
Current portion of capital leases ................ 170 466
Current portion of long term debt and notes
payable ........................................ 667 --
-------- --------
Total current liabilities ........................ 4,697 4,803
Deferred revenue ....................................... 113 303
Capital lease obligations .............................. 340 952
Long term debt and notes payable, net of current
portion .............................................. 1,222 --
-------- --------
Total liabilities ................................ 6,372 6,058
-------- --------
Shareholders' equity:
Common stock ..................................... 91,727 75,528
Notes receivable from shareholders ............... (818) (25)
Deferred stock compensation expense .............. (473) (1,940)
Accumulated other comprehensive income ........... (26) --
Accumulated deficit ............................. (33,124) (12,065)
-------- --------
Total shareholders' equity ...................... 57,286 61,498
-------- --------
Total liabilities and shareholders' equity ...... $ 63,658 $ 67,556
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
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N2H2, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME
(unaudited, in thousands except share and per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------- -----------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues .............................................. $ 3,324 $ 1,732 $ 8,505 $ 4,337
Cost of revenues ...................................... 2,059 617 4,957 1,197
------------ ------------ ------------ ------------
Gross profit .......................................... 1,265 1,115 3,548 3,140
------------ ------------ ------------ ------------
Operating expenses:
Sales and marketing ............................. 5,956 779 12,551 1,661
Research and development ........................ 993 470 3,075 1,154
General administrative .......................... 4,146 1,688 10,596 3,915
------------ ------------ ------------ ------------
Total operating expenses ........................ 11,095 2,937 26,222 6,730
------------ ------------ ------------ ------------
Operating loss ........................................ (9,830) (1,822) (22,674) (3,590)
Interest income (expense), net ........................ 483 (92) 1,639 (338)
Gain (loss) on sale of investments .................... -- -- (24) --
------------ ------------ ------------ ------------
Net loss .............................................. (9,347) (1,914) (21,059) (3,928)
------------ ------------ ------------ ------------
Foreign currency translation gain (loss) .............. (26) -- (26) --
------------ ------------ ------------ ------------
Comprehensive income .................................. $ (9,373) $ (1,914) $ (21,085) $ (3,928)
============ ============ ============ ============
Basic and diluted net loss per share .................. $ (0.42) $ (0.13) $ (0.96) $ (0.33)
============ ============ ============ ============
Basic and diluted weighted average shares
outstanding ......................................... 22,437,913 14,520,178 21,915,816 11,998,672
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
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N2H2, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED JUNE 30,
---------------------
2000 1999
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss ......................................................................... $(21,059) $ (3,929)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization .............................................. 3,263 588
Amortization of deferred stock compensation ................................ 1,069 192
Compensation expense on stock, stock options and warrants ................. -- 304
Changes in operating assets and liabilities:
Accounts receivable ........................................................ (977) (1,314)
Prepaid expenses and other assets .......................................... 511 (116)
Other assets ............................................................... (559) --
Accounts payable ........................................................... (246) 430
Royalties payable .......................................................... 98 --
Accrued liabilities ........................................................ 493 177
Deferred revenue ........................................................... (1,066) 293
-------- --------
Net cash used in operating activities: ........................................... (18,473) (3,375)
-------- --------
Cash flows from investing activities:
Maturities of investments .................................................. 32,756 --
Purchases of investments ................................................... (6,000) --
Notes receivable from shareholders ......................................... (793) --
Additions to property and equipment ........................................ (8,125) (801)
Transaction costs incurred for iseek, Ltd. acquisition, net of cash
acquired ................................................................. (229) --
-------- --------
Net cash provided by (used in) investing activities .............................. 17,609 (801)
-------- --------
Cash flows from financing activities:
Issuance of common stock ................................................... -- 11,057
Exercise of stock options and warrants ..................................... 493 61
Payments under capital lease obligations ................................... (908) (583)
Borrowings under notes payable ............................................. 2,000 2,018
Repayments of notes payable ................................................ (111) (2,771)
-------- --------
Net cash provided by financing activities ........................................ 1,474 9,782
-------- --------
Effects of exchange rate changes ........................................... (26) --
-------- --------
Net increase (decrease) in cash .................................................. 584 5,606
Cash, beginning of period ........................................................ 7,743 121
-------- --------
Cash, end of period .............................................................. $ 8,327 $ 5,727
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest ........................................................ $ 348 $ 403
======== ========
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING ACTIVITIES
Relating to the acquisition of Iseek, Limited:
Stock issued .................................................................. $ 16,104 $ --
======== ========
Acquired intangibles .......................................................... $ 16,285 $ --
======== ========
Additions to property and equipment ........................................... $ 101 $ --
======== ========
Additions to intangibles and other ............................................ $ 51 $ --
======== ========
Additions to accounts payable ................................................. $ 54 $ --
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
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N2H2, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements of N2H2,
Inc. and subsidiaries (the Company) are unaudited. In the opinion of management,
the financial statements include all adjustments, consisting only of normal
recurring items, necessary for their fair presentation in conformity with
generally accepted accounting principles. Preparing financial statements
requires management to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenue, and expenses. Actual results may differ
from these estimates. Operating results for the three and nine month periods
ended June 30, 2000 are not necessarily indicative of results to be expected for
a full year. The information included in this Form 10-Q should be read in
conjunction with Management's Discussion and Analysis and financial statements
and notes thereto included in the Company's annual report on Form 10-K for the
year ended September 30, 1999.
2. NET LOSS PER SHARE
Basic net loss per share is computed on the basis of the weighted average
number of common shares outstanding. Diluted net loss per share includes common
equivalent shares during the period, if dilutive. As the Company had a net loss
attributable to common shareholders in each of the periods presented, basic and
diluted net loss per share are the same.
The components of basic and diluted earnings per share were as follows:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------------- -----------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Numerator:
Net loss ..................................... $ (9,347,000) $ (1,914,000) $(21,059,000) $ (3,928,000)
Denominator:
Basic and diluted weighted average
common shares outstanding .................. 22,437,913 14,520,178 21,915,816 11,998,672
------------ ------------ ------------ ------------
Basic and diluted net loss per share ...... $ (0.42) $ (0.13) $ (0.96) $ (0.33)
============ ============ ============ ============
</TABLE>
Warrants of 439,280 and options of 3,469,487 have been excluded from the
calculation because they are anti-dilutive.
3. LINE OF CREDIT
On April 6, 2000, the Company drew a $2 million equipment advance from
its credit facility with Imperial Bank. The advance is collateralized by the
Company's recently purchased computer hardware. Borrowings under this facility
are payable in thirty-six equal monthly installments of principal plus accrued
interest. Interest is accrued at the bank's prime rate plus 0.5%.
As of June 30, 2000, the Company has received a commitment from Imperial
Bank to increase its credit line to $7.5 million. This credit line may be used
for working capital and longer term equipment financing.
6
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4. BUSINESS COMBINATION
On February 23, 2000, the Company acquired iseek, Limited, a privately
held company incorporated in Queensland, Australia, in an all-stock transaction.
Under the terms of the acquisition, the shareholders of iseek received 925,000
shares of N2H2 common stock. The transaction was accounted for as a purchase.
The total purchase price was as follows:
<TABLE>
<S> <C>
Common stock issued $16,104,000
Acquisition costs incurred 287,000
Liabilities assumed 54,000
-----------
Total purchase price $16,445,000
===========
</TABLE>
The total purchase price of $16,445,000 was allocated to the fair value
of the assets acquired as follows:
<TABLE>
<CAPTION>
Amortization
Life
------------
<S> <C> <C>
Tangible assets $ 160,000 --
Intangible assets:
Client redirect software 969,000 5
Customer lists 572,000 5
Goodwill 14,744,000 5
-----------
Total intangible assets 16,285,000
-----------
Total purchase price $16,445,000
===========
</TABLE>
The following pro forma financial information gives effect to the
acquisition, assuming that the acquisition took place as of October 1, 1998:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED JUNE 30,
---------------------------
2000 1999
------------ -----------
<S> <C> <C>
Revenue $ 8,546,000 $ 4,336,000
Net loss $(23,120,000) $(6,431,000)
Basic and diluted net loss per share $ (1.01) $ (0.50)
</TABLE>
5. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 1999, SEC Staff Accounting Bulletin: No. 101 - Revenue
Recognition in Financial Statements (SAB 101) was issued. This pronouncement
summarizes certain of the SEC Staff's views on applying generally accepted
accounting principles to revenue recognition. SAB 101 is required to be adopted
by the Company for the year ended September 30, 2001. The Company is currently
reviewing the requirements of SAB 101. Adoption of this standard could have a
material impact on the Company's financial statements.
In March 2000, the Financial Accounting Standards Board's Emerging Issues
Task Force ("EITF") issued EITF 00-2 - Accounting for Web Site Development
Costs. This statement defines requirements for capitalization and expensing of
costs incurred during the development of a web site. The statement is effective
for interim periods beginning July 1, 2000. Costs incurred during the planning
stage should be expensed; costs incurred during the web application and
infrastructure development stage should be capitalized; and generally the costs
incurred during the operation stage should be expensed. The Company's website
and maintenance costs are currently expensed as incurred, therefore the adoption
of this statement is not expected to have any material effect on the Company's
results of operations or its financial position.
7
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In March 2000, the EITF reached a consensus on EITF Issue 00-3. This
consensus indicates that a software element covered by AICPA Statement of
Position ("SOP 97-2") is only present in a software hosting arrangement if the
customer has the contractual right to take possession of the software at any
time during the hosting period without significant penalty and it is feasible
for the customer to either run the software on its own hardware or contract with
another party unrelated to the vendor to host the software. Therefore, SOP 97-2
only applies to hosting arrangements in which the customer has such an option.
Arrangements that do not give the customer such an option are service contracts
and are outside the scope of SOP 97-2. The Task Force observed that hosting
arrangements that are service arrangements may include multiple elements that
affect how revenue should be attributed. The Company recognizes revenue related
to software hosting as service is provided, therefore this consensus is not
expected to have any material effect on the Company's results of operations or
its financial position.
In March 2000, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation (FIN) No. 44, "Accounting for Certain Transactions Involving
Stock Compensation." FIN 44, effective July 1, 2000, clarifies the application
of Accounting Principles Board Opinion No. 25 for certain issues relating to
stock compensation. The Company does not expect FIN 44 to have a material effect
on its or results of operations or financial position.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD LOOKING INFORMATION
Statements made in this filing that are not historical facts are
forward-looking statements. Forward-looking statements include, but are not
limited to, statements containing the words will, should, expect, plan, intend,
anticipate, believe, estimate, predict, potential, believes or continue, the
negative of such terms or other comparable terminology. Actual results may
differ materially from those projected in any forward-looking statements. Such
forward-looking statements are subject to various known and unknown risks and
uncertainties and are therefore not a guarantee of future performance. The
potential risks and uncertainties which could cause actual results to differ
materially include, but are not limited to, the competitive nature of the
Internet filtering industry, changes in domestic market conditions, the success
of our brand and systems development efforts, the absence of patent protection
for N2H2's technology, the fact that others have patented various filtering
technologies, and customer acceptance of our services, products and fee
structures. Further information on the factors and risks that could affect
N2H2's business, financial condition and results of operations are included in
Part 1, Item 1 to the Company's Form 10-K for the year ended September 30, 1999,
which has been filed with the Securities and Exchange Commission and is
available at http://www.sec.gov.
OVERVIEW
N2H2 is a leading Internet infrastructure company specializing in
filtering, Internet management and content delivery services for work, home and
school. The Company reviews and categorizes Web content and delivers it with
integrated Internet products and services through a global interactive network.
During the quarter, the Company added approximately 3 million new users and
reached a total of 15.5 million users, realizing record growth in new users.
Based on annual industry forecasts from Quality Education Data, N2H2 estimates
it provides services to over 40% of the U.S. public schools that use filtering.
The Company has achieved its long-standing goal of dominating the school market.
N2H2's market-leading position in K-12 schools in the U.S. has grown to
encompass 13.4 million students. N2H2 now provides filtering to statewide
networks in Iowa, Arkansas, Idaho, Tennessee, Massachusetts, and Maine, as well
as major school districts representing sizable student populations in Florida,
Texas, New York, Pennsylvania, Ohio, Nevada and Nebraska. Over the past year,
the Company estimates that its market share doubled and its user base increased
by 130%.
Continuing its strategy of opening new markets, N2H2 has expanded in the
consumer, enterprise, and international markets. The Company recently introduced
`N2H2 for Home -- ISP Edition,' a new ISP and consumer product. This patent
pending product is expected to accelerate the Company's growth in the consumer
market and to extend its technology leadership. With 15.5 million users driving
Internet traffic through the N2H2 global server network, N2H2 has amassed a vast
knowledge resource. Consistent with the Company's market expansion strategy, the
Company formed a new analytic services group to conduct custom traffic studies
for customers and use anonymous aggregate data from its network to develop
reports targeted to major marketing organizations.
8
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THREE MONTHS ENDED JUNE 30, 2000
Revenues
N2H2 generates revenue primarily from installations, subscriptions and
advertising fees.
Installation revenues increased by 590% to $1.6 million from $0.2 million
for the comparable period in the prior fiscal year. The increase reflects strong
growth in new customers.
Subscription revenues were $1.0 million for the quarter, compared to $1.2
million for the comparable period in the prior fiscal year. The change reflects
an expected shift in the revenue mix as schools adopting N2H2's sponsor-based
filtering choice received free or reduced price subscriptions.
Advertising revenue increased by 110% to $0.7 million from $0.3 million
for the comparable period in the prior fiscal year. The increase primarily comes
from the increased audience reach.
Also included in revenues for the quarter are barter revenues of $0.2
million generated from exchanging advertising services. Such transactions are
recorded at the fair value of advertisements delivered. Revenue from barter
transactions is recognized when advertising is provided, and services received
are charged to expense on a straight-line basis over the contract period.
Cost of revenues
Cost of revenues during the quarter were $2.1 million or 62% of total
revenues, up from $0.6 million or 36% of total revenues for the comparable
period in the prior fiscal year. Included in the cost of revenues are costs for
customer support and Web review, plus advertising commissions, hosting,
bandwidth and server depreciation expenses. The increase in cost of revenues is
primarily from depreciation charges resulting from the increase in customer
servers installed in the last two quarters. Increased advertising commissions
associated with N2H2's sponsor-based filtering model have also contributed to
the increase in cost of revenues.
Sales and marketing
Sales expenses consist primarily of salaries and commissions. Marketing
expenses consist primarily of salaries, marketing brochures, trade show costs,
direct mailing programs, advertising, public relations and travel.
Sales and marketing expenses for the quarter increased 665% to $6.0
million from $0.8 million for the comparable period in the prior fiscal year.
This increase is primarily due to the Company's continued effort to open new
markets and gain market share. During the quarter, the Company increased its
staff and spent aggressively to support its growth in new markets and new
products. This includes the creation and execution of several marketing
campaigns promoting the Company's leading network of school-aged Internet users
and its Internet management products, and education marketing costs which
typically peak during this quarter.
Research and development
Research and development costs consist primarily of salaries and benefits
for software developers plus consulting fees. Development costs and all costs
related to internal research and development have been expensed as incurred.
Research and development expenses for the quarter increased by 111% to
$1.0 million from $0.5 million for the comparable period in the prior fiscal
year. The increase is primarily due to increased engineers and other technical
staff to support the Company's ongoing product development activities.
9
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General and administrative
General and administrative expenses consist primarily of salaries,
benefits and related costs for executive, finance, human resources and
administrative personnel, third party professional service fees, the cost of
facilities and general depreciation expenses.
General and administrative expenses for the quarter increased by 146% to
$4.1 million from $1.7 million for the comparable period in the prior fiscal
year. This increase was primarily due to increases in the number of employees
and other costs supporting the growth of the Company. The Company also incurred
a one-time severance expense of $0.4 million during the quarter upon the
departure of its Chief Operating Officer in April 2000.
NINE MONTHS ENDED JUNE 30, 2000
Revenues
Installation revenues for the nine-month period increased by 191% to $3.2
million from $1.1 million for the comparable period in the prior fiscal year.
The increase reflects strong growth in new customers.
Subscription revenues for the nine-month period increased by 20% to $3.3
million from $2.7 million for the comparable period in the prior fiscal year.
The increase in subscription revenue reflects growth from both domestic and
international markets and is offset by decreases in education fees as schools
adopting N2H2's sponsor-based filtering choice received free or reduced price
subscriptions.
Advertising revenue for the nine-month period increased by 307% to $2.1
million from $0.5 million for the comparable period in the prior fiscal year.
Toward the end of fiscal 1999, the Company began offering customers the choice
of receiving filtering services in exchange for allowing N2H2 to sell
sponsorship rights to advertisers and to make Searchopolis the default search
engine on their networks. New sponsors including Nickelodeon, Chevron, and
others were added during the period. The Company continues to work closely with
24/7 Media to develop sponsorships and generate advertising revenue.
Also included in revenues for the period are $0.4 million of barter
revenues generated from exchanging advertising services. Such transactions are
recorded at the fair value of advertisements delivered. Revenue from barter
transactions is recognized when advertising is provided, and services received
are charged to expense on a straight-line basis over the contract period.
Cost of revenues
Cost of revenues during the period were $5.0 million or 58% of total
revenues, up from $1.2 million or 28% of total revenues for the comparable
period in the prior fiscal year. Included in the cost of revenues are costs for
customer support and Web review, plus advertising commissions, hosting,
bandwidth and server depreciation expenses. The increase in cost of revenues is
primarily from depreciation charges resulting from the ongoing increase in
customer servers installed during the period. Increased advertising commissions
associated with N2H2's sponsor-based filtering model, adopted at the end of
fiscal 1999, have also contributed to the increase in cost of revenues.
Sales and marketing
Sales and marketing expenses for the nine months ended June 30, 2000
increased 656% to $12.6 million from $1.7 million for the comparable period in
the prior fiscal year. This increase is primarily due to the Company's continued
effort to open new markets and gain market share. The Company increased its
staff and spent aggressively to support its growth in new markets and new
products. Particularly, the Company incurred significant trade show costs during
the period, launched several significant advertising campaigns, increased
staffing in the sales department, and incurred costs to expand the enterprise
and consumer market efforts.
10
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The Company also incurred additional sales and marketing costs through
the acquisition and consolidation of iseek Limited, a wholly owned subsidiary
acquired in the second quarter of fiscal 2000 to enhance market presence in
Australia.
Research and development
Research and development expenses for the nine months ended June 30, 2000
increased by 166% to $3.1 million from $1.2 million for the comparable period in
the prior fiscal year. The increase is primarily due to increased engineers and
other technical staff to support the Company's ongoing product development
activities.
General and administrative
General and administrative expenses for the nine months ended June 30,
2000 increased by 171% to $10.6 million from $3.9 million for the comparable
period in the prior fiscal year. This increase was primarily due to increases in
the number of employees and other costs supporting the growth of the Company. In
addition, the Company incurred increased non-cash charges to amortize
deferred compensation costs during the period.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and marketable securities were $31.2 million or 49% of
total assets at June 30, 2000 compared to $57 million or 84% of total assets at
September 30, 1999. The decrease is due primarily to cash used in operating
activities. Cash flow used in operations totaled $18.5 million for the nine
months ended June 30, 2000, compared to $3.4 million for the comparable period
of the prior fiscal year. The Company had working capital of $28.9 million at
June 30, 2000, compared to $33.4 million at September 30, 1999.
The Company made $8.1 million in capital expenditures during the nine
months ended June 30, 2000, compared to $0.8 million during the comparable
period of the prior fiscal year. The additions during the period primarily
represent field servers and computer hardware purchased to support the Company's
growth in customer base. Additional computer hardware and software was purchased
to augment the company's information systems infrastructure and provide computer
equipment for its increased number of employees. The Company also incurred
capital expenditures for leasehold improvements related to the expansion of its
leased facilities. The Company believes that its current internal infrastructure
is adequate to support additional growth. As such, capital expenditures are
expected to decrease in the near term.
Financing activities provided $1.5 million for the nine months ended June
30, 2000, primarily due to a $2.0 million draw on the Company's credit facility
with Imperial Bank plus $0.5 million cash received from the exercise of options
to purchase the Company's common stock, offset by $0.9 million of payments under
capital lease obligations and $0.2 million cash paid for the acquisition of
iseek, Limited in the second quarter of fiscal 2000.
As of June 30, 2000, the Company has received a commitment from Imperial
Bank to increase its credit line to $7.5 million. This credit line may be used
for working capital and longer term equipment financing.
The Company believes that current cash balances, along with ongoing
maturities of securities and financing available through the Company's line of
credit, will be sufficient to fund its activities for at least the next 12
months.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have assessed our vulnerability to certain market risks, including
interest rate risk associated with financial instruments included in cash and
investments. Due to the Company's investment policies and procedures, we have
determined that the risk associated with interest rate fluctuations related to
these financial instruments does not pose a material risk to the Company.
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PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There are no litigation matters pending.
ITEM 2(d). CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company received net initial public offering proceeds of $59,845,000
in July 1999. At September 30, 1999 the Company had remaining net proceeds from
its initial public offering of $52,124,000. During the nine months ended June
30, 2000, the Company used $21,085,000 to fund its operating loss, leaving
remaining net proceeds of $31,039,000.
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>
<S> <C>
10.1 Promissory Note dated April 27, 2000 between Kevin Fink, Chief
Technology Officer, and the registrant
10.2 Promissory Note dated May 17, 2000 between Kevin Fink, Chief
Technology Officer, and the registrant
10.3 Promissory Note dated May 23, 2000 between Kevin Fink, Chief
Technology Officer, and the registrant
10.4 Promissory Note dated April 27, 2000 between Peter Keane, Vice
President - Advertising, and the registrant
10.5 Promissory Note dated May 18, 2000 between Peter Keane, Vice
President - Advertising, and the registrant
27.1 Financial Data Schedule
</TABLE>
b) Reports on Form 8-K.
None
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<PAGE> 13
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.
N2H2, INC.
Dated: August 11, 2000 By: /s/ Peter H. Nickerson
-----------------------------------
Peter H. Nickerson
Chairman, President and Chief
Executive Officer
(principal executive officer)
Dated: August 11, 2000 By: /s/ John F. Duncan
-----------------------------------
John F. Duncan
Vice President - Chief
Financial Officer,
Secretary, and Treasurer
(principal financial
and accounting officer)
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