<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
(AMENDMENT NO. 1)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 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 3600, 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 May 8, 2000, the registrant had outstanding 22,453,191 shares of common
stock, no par value.
<PAGE> 2
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................................ 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.................................................................. 9
Item 3. Quantitative And Qualitative Disclosures About Market Risk..................... 12
PART II--OTHER INFORMATION....................................................................... 13
Item 1. Legal Proceedings.............................................................. 13
Item 2. Changes In Securities And Use Of Proceeds...................................... 13
Item 3. Defaults Upon Senior Securities................................................ 13
Item 4. Submission Of Matters To A Vote Of Security Holders............................ 13
Item 5. Other Information.............................................................. 14
Item 6. Exhibits And Reports On Form 8-K............................................... 14
SIGNATURES..................................................................................... 14
</TABLE>
Restatement of Financial Statements and Changes to Certain Information
The Registrant has revised the accounting treatment of its February 23, 2000
acquisition of iseek PTY Limited. Accordingly, this quarterly report on Form
10-Q/A is being filed as Amendment No. 1 to the Registrant's Quarterly Report on
Form 10-Q filed with the Securities and Exchange Commission on May 15, 2000 for
the purpose of revising financial information and related disclosures for the
three month period March 31, 2000. See Note 1 to the Condensed Consolidated
Financial Statements.
2
<PAGE> 3
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
N2H2, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
<TABLE>
<CAPTION>
MARCH 31, SEPTEMBER 30,
2000 1999
------------ --------------
(REVISED)
(UNAUDITED)
<S> <C> <C>
ASSETS:
Current assets:
Cash................................................. $ 5,362 $ 7,743
Investments.......................................... 32,167 35,937
Accounts receivable, net............................. 1,693 1,434
Prepaid expenses and other assets.................... 850 1,136
-------- --------
Total current assets................................. 40,072 46,250
Long-term investments...................................... 4,704 16,698
Acquired intangible assets, net............................ 8,437 --
Property and equipment, net................................ 8,463 3,990
Other assets............................................... 1,327 618
-------- --------
Total assets......................................... $ 63,003 $ 67,556
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Current liabilities:
Accounts payable..................................... $ 1,049 $ 1,871
Royalties payable.................................... 148 100
Accrued liabilities.................................. 1,072 1,062
Deferred revenue..................................... 405 1,304
Current portion of capital leases.................... 164 466
-------- --------
Total current liabilities............................ 2,838 4,803
Deferred revenue........................................... 350 303
Capital lease obligations.................................. 390 952
-------- --------
Total liabilities.................................... 3,578 6,058
-------- --------
Shareholders' equity:
Common stock......................................... 93,250 75,528
Notes receivables from shareholders.................. -- (25)
Deferred stock compensation.......................... (9,707) (1,940)
Accumulated other comprehensive loss................. (15) --
Accumulated deficit.................................. (24,103) (12,065)
-------- --------
Total shareholders' equity........................... 59,425 61,498
-------- --------
Total liabilities and shareholder's equity........... $ 63,003 $ 67,556
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE> 4
N2H2, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands except share and per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31, MARCH 31,
--------------------------------- ------------------------------
2000 1999 2000 1999
--------------- --------------- --------------- -------------
(REVISED) (REVISED)
<S> <C> <C> <C> <C>
Revenues:
Internet filtering services......... $ 1,967 $ 1,332 $ 3,815 $ 2,430
Advertising......................... 958 121 1,367 251
----------- ----------- ----------- -----------
Total revenues.................... 2,925 1,453 5,182 2,681
Operating expenses:
Internet filtering services and
customer support................... 1,799 555 3,196 906
Educational content and advertising
costs.............................. 161 36 220 75
Sales and marketing (1)............. 3,875 639 6,684 1,084
General administrative (2).......... 2,057 932 3,527 1,299
Research and development (3)........ 1,060 428 2,254 792
Depreciation and amortization....... 786 135 1,271 293
Amortization of deferred stock
compensation....................... 714 -- 1,200 --
----------- ----------- ----------- -----------
Total operating expenses........ 10,452 2,725 18,352 4,449
----------- ----------- ----------- -----------
Loss from Operations.................. (7,527) (1,272) (13,170) (1,768)
Interest income (expense), net........ 608 (91) 1,132 (246)
----------- ------------ ----------- ------------
Net loss.............................. (6,919) (1,363) (12,038) (2,014)
----------- ----------- ----------- -----------
Foreign currency translation loss... (15) -- (15) --
----------- ----------- ----------- -----------
Comprehensive loss.................... $ (6,934) $ (1,363) $ (12,053) $ (2,014)
=========== =========== =========== ===========
Basic and diluted net loss per share.. $ (0.32) $ (0.11) $ (0.56) $ (0.19)
=========== =========== =========== ===========
Basic and diluted weighted average
shares outstanding.................... 21,365,077 11,866,530 21,452,296 10,461,472
=========== =========== =========== ===========
</TABLE>
(1) Excludes amortization of stock compensation of $454,000 for the three month
and six month periods ended March 31, 2000.
(2) Excludes amortization of stock compensation of $208,000 and $643,000 for the
three month and six month periods ended March 31, 2000, respectively.
(3) Excludes amortization of stock compensation of $52,000 and $103,000 for the
three month and six month periods ended March 31, 2000, respectively.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
<PAGE> 5
N2H2, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
<TABLE>
<CAPTION>
SIX MONTHS
ENDED MARCH 31,
--------------------
2000 1999
--------- --------
<S> <C> <C>
(REVISED)
Cash flows from operating activities:
Net loss................................................................... $(12,038) $(2,014)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization........................................ 1,271 352
Amortization of deferred stock compensation.......................... 1,200 --
Compensation expense on stock, stock options and warrants............ -- 306
Changes in certain assets and liabilities:
Accounts receivable.................................................. (234) (414)
Prepaid expenses and other current assets............................ 286 14
Other assets......................................................... (681) --
Accounts payable..................................................... (876) 201
Royalties payable.................................................... 48 (25)
Accrued liabilities.................................................. 10 160
Deferred revenue..................................................... (852) (6)
-------- -------
Net cash used by operating activities:..................................... (11,866) (1,426)
-------- -------
Cash flows from investing activities:
Maturities of investments............................................ 15,765 --
Additions to property and equipment.................................. (5,478) (417)
Transaction costs incurred for iseek, Ltd. acquisition, net of cash
acquired........................................................... (229) --
-------- -------
Net cash provided by (used in) investing activities........................ 10,058 (417)
-------- -------
Cash flows from financing activities:
Issuance of common stock............................................. -- 1,957
Exercise of stock options and warrants............................... 306 19
Payments under capital lease obligations............................. (864) (201)
Borrowings under notes payable....................................... -- 2,000
Repayments of notes payable.......................................... -- (669)
-------- -------
Net cash provided by (used in) financing activities........................ (558) 3,106
-------- -------
Effects of exchange rate changes..................................... (15) --
-------- -------
Net increase (decrease) in cash............................................ (2,381) 1,263
Cash, beginning of period.................................................. 7,743 121
-------- -------
Cash, end of period........................................................ $ 5,362 $ 1,384
======== =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest..................................................... $ 279 $ 259
======== =======
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING ACTIVITIES Relating to the
acquisition of Iseek, Limited:
Stock and warrants issued................................................ $ 17,359 $ --
======== =======
Acquired intangibles..................................................... $ 8,580 $ --
======== =======
Additions to deferred compensation....................................... $ 8,910 $ --
======== =======
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
<PAGE> 6
N2H2, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. BASIS OF PRESENTATION
The accompanying 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 adjustments, 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 six month periods
ended March 31, 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.
The Company has made two adjustments to the recorded amounts of intangible
assets related to the February 23, 2000 acquisition of iseek Pty Limited
(iseek). The changes consist of a reclassification of $8.9 million from goodwill
to deferred stock compensation in recognition of shares issued to the founders
of iseek which are held in employment escrow, and a $1.3 million addition to
acquired intangible assets in recognition of warrants issued as part of the
purchase consideration. The effect of these adjustments on the previously
reported results of operations and financial position are summarized as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31, 2000 MARCH 31, 2000
----------- ------------ ----------- -----------
AS REPORTED AS REVISED AS REPORTED AS REVISED
----------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
Net loss........................ $ 6,593,000 $ 6,919,000 $11,712,000 $12,038,000
Earnings per share, basic and
diluted....................... $ (0.31) $ (0.32) $ (0.54) $ (0.56)
Total assets.................... $70,531,000 $63,003,000 $70,531,000 $63,003,000
Total shareholders' equity...... $66,953,000 $59,425,000 $66,953,000 $59,425,000
</TABLE>
The increase in net loss is the result of an accelerated amortization
method used for deferred compensation. None of these changes have a cash impact
to the Company.
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 SIX MONTHS
ENDED MARCH 31, ENDED MARCH 31,
--------------------------- ---------------------------
2000 1999 2000 1999
----------- ----------- ------------ -----------
(REVISED) (REVISED)
<S> <C> <C> <C> <C>
Numerator:
Net loss.......................... $(6,919,000) $(1,363,000) $(12,038,000) $(2,014,000)
Denominator:
Basic and diluted weighted average
common shares outstanding....... 21,365,077 11,866,530 21,452,296 10,461,472
----------- ----------- ------------ -----------
Basic and diluted net loss per
share......................... $ (0.32) $ (0.11) $ (0.56) $ (0.19)
=========== =========== ============ ===========
</TABLE>
6
<PAGE> 7
3. BUSINESS COMBINATION
On February 23, 2000, the Company acquired iseek Pty Limited (iseek), a
privately held company incorporated in Queensland, Australia, in an all-stock
transaction. The transaction was accounted for as a purchase.
As consideration, the shareholders of iseek received 925,000 shares of N2H2
common stock. The shares were valued using the market price of the Company's
common stock for the two days before and after the acquisition was announced. A
total of 512,000 of the shares were issued to the founders of iseek and are
subject to an escrow provision. The escrowed shares will be released equally
over three years, based on the continued employment of the founders. The value
of these shares has been treated as deferred compensation to be amortized over
the three-year employment period. As of March 31, 2000, the Company has recorded
$454,000 of related compensation expense.
In addition, the Company issued a warrant for 100,000 shares of common
stock at the exercise price of $22.50 to certain iseek shareholders in exchange
for a covenant not to compete. The fair value of the warrants was determined
using the Black/Scholes option pricing model, using a 95% volatility factor, an
expected life of 5 years, and a risk-free interest rate of 6.38%.
The total purchase price was as follows:
<TABLE>
<CAPTION>
(REVISED)
-----------
<S> <C>
Common stock issued............ $16,104,000
Warrant issued................. 1,255,000
Acquisition costs incurred..... 287,000
Liabilities assumed............ 54,000
-----------
Total purchase price......... $17,700,000
===========
</TABLE>
The total purchase price of $17,700,000 was allocated to the fair value of
the assets acquired as follows:
<TABLE>
<CAPTION>
Amortization
(REVISED) Life
------------ ------------
<S> <C> <C>
Tangible assets....................... $ 210,000 --
Intangible assets:
Client redirect software............ 919,000 5
Customer lists...................... 572,000 5
Covenant not to compete............. 1,255,000 5
Goodwill............................ 5,834,000 5
------------
Total intangible assets........... 8,580,000
Deferred compensation................. 8,910,000 3
------------
Total purchase price.................. $ 17,700,000
============
</TABLE>
Intangible assets are amortized on a straight-line basis. Deferred
compensation is amortized using an accelerated method in accordance with
Financial Accounting Standards Board's interpretation number 28.
The following (revised) pro forma financial information gives effect to the
acquisition, assuming that the acquisition took place as of October 1, 1998:
<TABLE>
<CAPTION>
SIX MONTHS
ENDED MARCH 31,
---------------------------
2000 1999
------------ -----------
<S> <C> <C>
Revenue......................................$ 5,212,000 $ 2,681,000
Net loss.....................................$(14,328,000) $(5,618,000)
Basic and diluted net loss per share.........$ (0.66) $ (0.52)
</TABLE>
The results of operations of iseek have been included in the Company's
consolidated Statement of Operations since the purchase date.
7
<PAGE> 8
4. 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 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.
8
<PAGE> 9
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 registrant'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 period the company reached record user growth and revenues. The
company added 2.5 million new users during the quarter, achieving more than 12.5
million users and a network of more than 1,500 filtering-enabled servers in the
U.S., Canada, Australia, UK, Japan, Germany, Chile, Mexico, India, and Bermuda.
Based on annual industry forecasts from Quality Education Data, N2H2 estimates
it achieved over 80% market share in U.S. public schools initially adopting
filtering during the quarter. N2H2 landed statewide filtering contracts with
Arkansas, Idaho, and Massachusetts, and recently added the state of Iowa as well
as one of the nation's largest Education Service Centers in Houston. The
company's enterprise and consumer market efforts are positioned to generate a
significant portion of the Company's revenues in fiscal 2001, primarily through
strategic partnerships.
THREE MONTHS ENDED MARCH 31, 2000
Revenues
We generate our revenues from installation and subscription fees charged
for our filtering services and advertising fees.
Installation revenues for the quarter increased by 93% to $0.8 million from
$0.4 million for the comparable period in the prior fiscal year. Subscription
revenues increased by 27% to $1.2 million from $0.9 million for the comparable
period in the prior fiscal year. The increase in installation and subscription
revenues reflect growth from both domestic and international markets and is
offset by decreases in education fees as schools adopting N2H2's sponsor-based
filtering option received free or reduced price installations.
9
<PAGE> 10
Advertising revenue during the quarter contributed $1.0 million or 33% of
total revenues, up from $0.1 million or 8% of total revenues 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 us to sell sponsorship rights to advertisers and to make
Searchopolis the default search engine on their networks. This led to increased
usage and ad impressions on the N2H2 ResourceBar, which is offered on every page
viewed by education users.
Also included in revenues for the quarter are barter revenues generated
from exchanging advertising services for user access to Microsoft Encarta Online
via the N2H2 ResourceBar. 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. This quarter's results included
the first of ten quarters of such barter revenue from Microsoft's corporate
sponsorship.
Internet filtering services and customer support costs
Internet filtering services and customer support consist of the costs of
Website review, technical installation and support, search engine and Web
hosting services, and bandwidth. Internet filtering services and customer
support increased by 224% to $1.8 million from $0.6 million for the comparable
period in the prior fiscal year. This increase is primarily due to the hiring of
additional customer operations personnel to provide more technical support and
services to our expanded customer base.
Educational content and advertising costs
Educational content and advertising costs include product license fees and
advertising commissions. Educational content and advertising costs increased by
347% to $161,000 from $36,000 for the comparable period in the prior fiscal
year. The increase resulted from the official launch of the advertising fee
model in late fiscal 1999, which led to software license agreements, increased
sponsorship contracts and a higher volume of ads placed.
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 also includes an allocation of corporate facilities costs.
Sales and marketing expenses for the quarter increased by 506% to $3.9
million from $0.6 million for the comparable period in the prior fiscal year.
This increase is due to continued effort to improve our market position.
Particularly, we incurred significant trade show costs during the period,
increased staffing in the sales department, and incurred costs to expand our
enterprise and consumer market efforts. We also incurred additional sales and
marketing costs through the consolidation of iseek Limited, a wholly owned
subsidiary acquired during the quarter to enhance our market presence in
Australia.
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 and an allocation of corporate
facilities costs.
General and administrative expenses for the quarter increased by 121% to
$2.1 million from $0.9 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.
Research and development
Research and development costs consist primarily of salaries and benefits
for software developers, consulting fees and an allocation of corporate
facilities costs. 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 148% to $1.1
million from $0.4 million for the comparable period in the prior fiscal year.
The increase was primarily due to continued hiring of additional engineers and
other technical staff.
10
<PAGE> 11
Depreciation and amortization
Depreciation and amortization consist primarily of depreciation on all
fixed assets and amortization of acquired intangible assets. Depreciation and
amortization expenses increased by 482% to $0.8 million from $0.1 million for
the comparable period in the prior fiscal year. The increase is due to the
increased fixed asset balance, combined with the amortization of intangible
assets acquired from iseek during the period.
Amortization of deferred stock compensation
Amortization of deferred stock compensation for the quarter was $0.7
million. There was no such amortization for the comparable period in the prior
fiscal year. Deferred compensation expense is primarily a result of amortization
of deferred compensation recorded upon the acquisition of iseek and certain
stock options issued with an exercise price less than the deemed fair value at
the date of grant.
SIX MONTHS ENDED MARCH 31, 2000
Revenues
Installation revenues for the six-month period increased by 81% to $1.5
million from $0.8 million for the comparable period in the prior fiscal year.
Subscription revenues increased by 44% to $2.3 million from $1.6 million for the
comparable period in the prior fiscal year. The increase in installation and
subscription revenues reflect 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 installations.
Advertising revenue for the period contributed $1.4 million or 26% of total
revenues, up from $0.3 million or 9% of total revenues 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 us to sell sponsorship rights to advertisers and to make Searchopolis
the default search engine on their networks. Recognizing N2H2's audience reach,
new sponsors including Nickelodeon, Chevron, and others were added during the
period. We continue to work closely with 24/7 Media to develop sponsorships and
generate advertising revenue.
Also included in revenues for the period are barter revenues generated from
exchanging advertising services for user access to Microsoft Encarta Online via
the N2H2 ResourceBar. 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. This quarter's results included
the first of ten quarters of such barter revenue from Microsoft's corporate
sponsorship.
Internet filtering services and customer support costs
Internet filtering services and customer support for the six-month period
increased by 253% to $3.2 million from $0.9 million for the comparable period in
the prior fiscal year. This increase is primarily due to the hiring of
additional customer operations personnel to provide more technical support and
services to our expanded customer base.
Educational content and advertising costs
Educational content and advertising costs for the six-month period
increased by 193% to $220,000 from $75,000 for the comparable period in the
prior fiscal year. The increase resulted from the official launch of the
advertising fee model in late fiscal 1999, which led to software license
agreements, increased sponsorship contracts and a higher volume of ads placed.
Sales and marketing
Sales and marketing expenses for the six-month period increased by 517% to
$6.7 million from $1.1 million for the comparable period in the prior fiscal
year. This increase is due to continued effort to improve our market position.
Particularly, we incurred significant trade show costs during the period,
increased staffing in the sales department, and incurred costs to expand our
enterprise and consumer market efforts.
11
<PAGE> 12
General and administrative
General and administrative expenses for the six-month period increased by
172% to $3.5 million from $1.3 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.
Research and development
Research and development expenses for the six-month period increased by
185% to $2.3 million from $0.8 million for the comparable period in the prior
fiscal year. The increase was primarily due to the continued hiring of
additional engineers and other technical staff.
Depreciation and amortization
Depreciation and amortization expenses for the six-month period increased
by 334% to $1.3 million from $0.3 million for the comparable period in the prior
fiscal year. The increase is due to the increased fixed asset balance, combined
with the amortization of intangible assets acquired from iseek.
Amortization of deferred stock compensation
Amortization of deferred compensation for the six-month period was $1.2
million. There was no such amortization for the comparable period in the prior
fiscal year. Deferred compensation expense is primarily a result of amortization
of deferred compensation recorded upon the acquisition of iseek and certain
stock options issued with an exercise price less than the deemed fair value at
the date of grant.
LIQUIDITY AND CAPITAL RESOURCES
Our cash and marketable securities were $39 million or 62% of total assets
at March 31, 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 $11.9 million for the six months ended
March 31, 2000, compared to $1.4 million for the comparable period of the prior
fiscal year. We had working capital of $37.2 million at March 31, 2000, compared
to $41.4 million at September 30, 1999.
We made $5.5 million in capital expenditures during the six months ended
March 31, 2000, compared to $0.4 million during the comparable period of the
prior fiscal year. The additions during the six months ended March 31, 2000
primarily represent field servers and computer hardware purchased to support our
growth in customer base. Additional computer hardware and software were
purchased to augment our information systems infrastructure and provide computer
equipment for our increased number of employees. We also incurred capital
expenditures for leasehold improvements related to the expansion of our leased
facilities.
Financing activities consumed $0.6 million for the six months ended March
31, 2000, due to $0.9 million of payments under capital lease obligations,
offset by $0.3 million cash received from the exercise of options to purchase
our common stock.
We believe that current cash balances, along with ongoing maturity of
securities, will be sufficient to fund our 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 our 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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<PAGE> 13
PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There are no litigation matters pending.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In connection with the registrant's initial public offering, the registrant
received net proceeds of approximately $59.8 million. From the effective date of
the registration statement to March 31, 2000, the registrant has used those
proceeds as follows:
<TABLE>
<CAPTION>
(THOUSANDS)
-----------
<S> <C>
Increase in short term investments................................. 32,167
Increase in long term investments.................................. 4,704
Construction of facilities - leasehold improvements................ 654
Purchase of equipment.............................................. 6,900
Acquisition of iseek, Limited...................................... 229
Repayment of indebtedness.......................................... 2,631
General operations................................................. 12,560
-------
Total........................................................ $59,845
=======
</TABLE>
None of the above uses involved direct or indirect payments to directors,
officers, affiliates or 10% owners of the registrant.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its Annual Shareholders Meeting on March 9, 2000 at which
time the shareholders voted on the following proposals:
(1) Election of four directors for a one-year term:
<TABLE>
<CAPTION>
NAME OF CANDIDATE FOR WITHHELD
----------------- ---------- --------
<S> <C> <C>
Hollis R. Hill........................................ 15,923,646 79,465
Richard R. Rowe....................................... 15,993,306 9,805
Mark A. Segale........................................ 15,924,306 78,805
Peter H. Nickerson.................................... 15,993,106 10,005
</TABLE>
The aforesaid nominees have been elected, as Directors for the term set
forth above.
(2) Approval of the Company's Employee Stock Purchase Plan:
The vote was 14,017,114 for, 118,580 against, 15,585 abstentions and
1,851,832 broker non-votes. The Employee Stock Purchase Plan was approved.
(3) Approval of the Company's 2000 Stock Option Plan:
The vote was 12,505,250 for, 1,634,094 against, 11,935 abstentions and
1,851,832 broker non-votes. The 2000 Stock Option Plan was approved.
(4) Ratification of the appointment of PricewaterhouseCoopers LLP as the
Company's independent auditors:
The vote was 15,993,937 for, 6,132 against and 3,042 abstentions. There
were no broker non-votes. The appointment of PricewaterhouseCoopers LLP was
approved.
13
<PAGE> 14
ITEM 5. OTHER INFORMATION
Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits:
10.1+ Distribution Agreement dated March 6, 2000 between Microsoft
Corporation and the registrant*
27.1 Financial Data Schedule (revised)
+ Previously filed
* Information has been omitted pursuant to a request for confidential
treatment and has been filed separately with the Securities and
Exchange Commission.
b) Reports on Form 8-K.
The Company filed a Form 8-K and a Form 8-K/A regarding the acquisition of
iseek, Limited on February 23, 2000.
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: January 16, 2001 By: /s/ Peter H. Nickerson
----------------------------------
Peter H. Nickerson
Chairman, President and
Chief Executive Officer
(principal executive officer)
Dated: January 16, 2001 By: /s/ J. Paul Quinn
----------------------------------
J. Paul Quinn
Vice President - Chief Financial
Officer, Secretary and Treasurer
(principal financial and
accounting officer)
14
