<PAGE>
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
EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from _________ to _________
Commission file number: 0-27253
______________________
NETCENTIVES INC.
(Exact name of Registrant as specified in its charter)
Delaware 93-1213291
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
______________________
690 Fifth Street
San Francisco, California 94107
415-538-1888
(Address, including zip code, and telephone
number, including area code, of Registrant's principal
executive offices)
______________________
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 [ ] No [X]
The number of shares outstanding of the Registrant's Common Stock, $.001 par
value per share, as of November 18, 1999 was 32,345,499.
<PAGE>
NETCENTIVES INC.
FORM 10-Q
For the Quarter Ended September 30, 1999
INDEX
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<TABLE>
PART I FINANCIAL INFORMATION PAGE
<S> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 1999
and December 31, 1998 3
Condensed Consolidated Statements of Operations for the Three Months
and Nine Months Ended September 30, 1999 and September 30, 1998 4
Condensed Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1999 and 1998 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 16
PART II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 16
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURE 18
</TABLE>
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<PAGE>
NETCENTIVES INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and par value amounts)
(Unaudited)
<TABLE>
<CAPTION>
December 31, September 30,
1998 1999
------------ -------------
<S> <C> <C>
ASSETS *
Current Assets:
Cash and equivalents $ 13,651 $ 28,221
Accounts receivable 893 1,155
Prepaid incentive awards 1,600 1,603
Prepaid expenses 147 175
------------ -------------
Total current assets 16,291 31,154
Property and equipment - net 1,858 6,291
Intangible assets - net 3,611 2,296
Deferred offering costs - 1,278
Long term deposits - 2,471
Other assets 175 133
------------ -------------
Total assets $ 21,935 $ 43,623
============ =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Bank loan payable $ 100 $ -
Accounts payable 1,324 1,613
Accrued compensation and benefits 667 956
Accrued redemption costs 509 2,023
Other accrued liabilities 1,198 3,823
Deferred revenue- product 1,250 4,903
Deferred revenue- services 656 2,647
Current portion of long-term obligations 664 961
------------ -------------
Total current liabilities 6,368 16,926
Long-term obligations 1,233 1,412
Stockholders' Equity:
Convertible preferred stock, $.001 par value--16,050,000 shares
authorized; shares outstanding: 1998, 15,168,652; September 30, 1999,
20,522,235 (aggregate liquidation preference
of $28,760 at 1998) 15 21
Common stock, $.001 par value--shares authorized: 1998,
30,000,000; September 30, 1999, 33,240,000; shares outstanding:
1998, 4,894,069; September 30, 1999, 5,394,860 5 5
Paid-in capital 41,654 80,967
Deferred stock expenses (8,433) (8,963)
Receivables from sales of stock (350) (450)
Accumulated deficit (18,557) (46,295)
------------ -------------
Total stockholders' equity 14,334 25,285
------------ -------------
Total liabilities and stockholders' equity $ 21,935 $ 43,623
============ =============
</TABLE>
* The December 31, 1998 amounts are derived from the Company's audited financial
statements.
See accompanying notes to the condensed consolidated financial statements
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<PAGE>
NETCENTIVES INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
1998 1999 1998 1999
------- -------- ------- ---------
<S> <C> <C> <C> <C>
Revenues:
Product $ 15 $ 464 $ 25 $ 680
Program-related services 349 454 466 882
Technical consulting services - 1,085 - 3,462
------- -------- ------- ---------
Total revenues 364 2,003 491 5,024
------- -------- ------- ---------
Costs and expenses:
Cost of product revenues 14 553 23 738
Program-related services, marketing and support costs 1,640 6,167 4,079 15,733
Cost of technical consulting services revenues - 880 - 2,376
Research and development 804 1,546 2,205 3,415
Selling, general and administrative 715 2,851 2,034 6,447
Amortization of deferred stock compensation 86 911 117 1,995
Amortization of supplier stock awards 202 610 331 1,554
Amortization of intangibles 2 449 6 1,327
------- -------- ------- ---------
Total costs and expenses 3,463 13,967 8,795 33,585
------- -------- ------- ---------
Loss from operations (3,099) (11,964) (8,304) (28,561)
------- -------- ------- ---------
Interest income 121 467 237 1,020
Interest expense (39) (91) (81) (197)
------- -------- ------- ---------
Net loss $(3,017) $(11,588) $(8,148) $(27,738)
======= ======== ======= =========
Net loss per share- basic and diluted $ (1.71) $ (3.12) $ (5.37) $(8.16)
======= ======== ======= =========
Shares used in computing per share amounts - basic
and diluted 1,760 3,711 1,518 3,401
======= ======== ======= =========
Pro forma net loss per share on a converted basis-
basic and diluted $ (0.21) $ (0.48) $ (0.67) $ (1.24)
======= ======== ======= =========
Shares used in computing pro forma per share amounts
on a converted basis 14,072 24,158 12,093 22,282
======= ======== ======= =========
</TABLE>
See accompanying notes to the condensed consolidated financial statements
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<PAGE>
NETCENTIVES INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
---------------------------------
September 30, September 30,
1998 1999
------------ -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers $ 459 $ 9,634
Cash paid to suppliers and employees (7,873) (21,986)
Cash paid for interest (81) (197)
Interest received 237 1,020
------------ -------------
Net cash used in operating activities (7,258) (11,529)
------------ -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (512) (5,654)
Long term deposits (47) (2,472)
------------ -------------
Net cash used in investing activities (559) (8,126)
------------ -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Sales of common stock 19 169
Issuance of receivable related to previous issuances of common stock - (100)
Sales of preferred stock 17,231 35,058
Borrowings on long-term debt 1,140 1,463
Principal payments on long-term debt (168) (987)
Borrowings on bank loan payable, net (200) (100)
Deferred offering costs - (1,278)
------------ -------------
Net cash provided by financing activities 18,022 34,225
------------ -------------
NET INCREASE IN CASH AND EQUIVALENTS 10,205 14,570
CASH AND EQUIVALENTS, Beginning of period 6,608 13,651
------------ -------------
CASH AND EQUIVALENTS, End of period $ 16,813 $ 28,221
============ =============
</TABLE>
See accompanying notes to the condensed consolidated financial statements
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<PAGE>
NETCENTIVES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
Note 1 - Basis of Presentation
The accompanying unaudited condensed consolidate financial statements have been
prepared from the records of Netcentives Inc. (the "Company") without audit and,
in the opinion of management, include all adjustments (consisting of only normal
recurring adjustments) necessary to present fairly the financial position at
September 30, 1999, the results of operations for the three and nine months
ended September 30, 1999 and 1998, and changes in cash flows for the nine months
ended September 30, 1999 and 1998. The balance sheet at December 31, 1998,
presented herein, has been derived from the audited financial statements of the
company for the fiscal year then ended.
Accounting policies followed by the company are described in Note 1 to the
audited consolidated financial statements for the fiscal year ended December 31,
1998. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted for purposes of the interim
consolidated financial statements. The interim consolidated financial statements
should be read in conjunction with the audited consolidated financial
statements, including notes hereto, for the year ended December 31, 1998
included in the Company's Registration Statement on Form S-1 (No. 333-83443)
filed, and declared effective, on October 13, 1999 by the Securities and
Exchange Commission.
The results of operations for the three month and nine month periods herein
presented are not necessarily indicative of the results to be expected for the
full year.
Note 2 - Initial Public Offering
On October 19, 1999, the Company closed its initial public offering, in which
it sold 6,000,000 shares of its common stock at a price of $12.00 per share. In
addition, on November 9, 1999 the Company sold an additional 335,937 shares
under the underwriter's overallotment option. Total net proceeds received from
these two sales of stock were approximately $69.1 million. On the closing of the
initial public offering, each outstanding share of the Company's convertible
preferred stock was converted into one share of common stock.
Note 3 - Basic and Diluted Loss Per Share
Basic loss per share is computed by dividing the loss attributable to common
shareholders by the weighted average number of common shares outstanding for the
period (excluding shares subject to repurchase). Diluted loss per common share
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock.
Common share equivalents are excluded from the computation in loss periods, as
their effect would be antidilutive.
The following is a reconciliation of the denominators used in calculating basic
and diluted net loss per share (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- --------------------
1998 1999 1998 1999
------- ------ ------ ------
<S> <C> <C> <C> <C>
Weighted average common shares
outstanding 3,793 5,262 3,769 5,181
Weighted average common shares
outstanding subject to repurchase (2,033) (1,551) (2,251) (1,780)
------- ------ ------ ------
Shares used in computation, basic and diluted 1,760 3,711 1,518 3,401
Weighted average preferred stock outstanding 12,312 20,447 10,575 18,881
------- ------ ------ ------
Shares used in computing pro forma per share
amounts on a converted basis 14,072 24,158 12,093 22,282
======= ====== ====== ======
</TABLE>
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<PAGE>
Note 4 - Consolidated Statement of Cash Flows Information
A reconciliation of net loss to net cash used in operating activities follows
(in thousands):
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
-------------------------------
1998 1999
------- --------
<S> <C> <C>
Net loss $(8,148) $(27,738)
Reconciliation to net cash used in operating activities:
Depreciation and amortization 334 1,235
Deferred stock compensation expense 117 1,995
Expenses relating to stock warrants 331 1,554
Advertising expense arising from barter transactions 613 772
ClickMiles issued for services 267 2,597
Changes in operating assets and liabilities: -
Accounts receivable (37) (262)
Prepaid incentive awards (946) (3)
Prepaid expenses 57 (28)
Other assets (189) 1,357
Accounts payable (174) 289
Accrued compensation and benefits 28 289
Accrued redemption costs (110) (1,083)
Other accrued liabilities 594 2,625
Deferred revenue- product and services 5 4,872
------- --------
Net cash used in operating activities $ (7,258) $(11,529)
======= ========
</TABLE>
-7-
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following "Management's Discussion and Analysis of Financial Condition and
Results of Operations" contains forward-looking statements. In some cases,
readers can identify forward-looking statements by terminology such as "may,"
"will," "should," "could," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential," or "continue." These statements involve
known and unknown risks, uncertainties and other factors that may cause
Netcentives actual results, performance, or achievements to be materially
different from those stated herein. Although management of Netcentives believes
the expectations reflected in the forward-looking statements are reasonable; the
Company cannot guarantee future results, performance, or achievements. For
further information, refer to "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the "Risk Factors" sections of
Netcentives' Registration Statement on Form S-1 (File Number 333-83443).
Overview
We were incorporated in June 1996. From inception until March 1998, our
operations consisted primarily of various start-up activities, such as research
and development, personnel recruiting, capital raising and trial sales of our
products with initial customers. We launched the ClickRewards program in March
1998 and began recognizing revenue from non-trial program sales in April 1998.
In December 1998, we acquired the Panttaja Consulting Group, Inc., a provider of
technical consulting services to e-commerce merchants and other businesses. We
launched our first Enterprise Incentive Solutions program in January 1999 and
our first Custom Loyalty Network in July 1999.
How our Programs Work
We sell rewards currencies to electronic retailers and other Internet sites. Our
primary rewards currency is ClickMiles, which we sell to merchants who become
part of the ClickRewards Network. These merchants, in turn, award these
ClickMiles to consumers as purchase, loyalty and other incentives. ClickMiles
are redeemable for, among other things, frequent flyer miles on major airlines
at a ratio of one frequent flyer mile for each ClickMile. We have also developed
and continue to develop additional loyalty and rewards currencies for large
Internet merchants, portals, community sites and other business customers. We
sell these custom currencies to our customers, who then distribute them under
their own brands. The custom loyalty currencies are redeemable for items
specific to the customer for whom the currency has been developed and, in
certain cases, are exchangeable for ClickMiles.
Merchants who participate in the ClickRewards Network receive the benefit of our
promotion of the ClickRewards brand and network, which includes direct links to
the merchants' sites from our ClickRewards web page. We also provide merchants
who participate in the ClickRewards Network with a variety of related marketing
and promotional services. These services include promotional consulting, direct
marketing services to our member base and integration and maintenance of our
enabling software. Depending on the specific relationship we have with the
merchant, we may either include some of these services in our ClickMiles pricing
or we may price them separately. To the extent that services are bundled with
ClickMiles, we increase the price of the ClickMiles package to reflect the value
of these services.
We offer marketing services similar to our ClickRewards Network to our Custom
Loyalty and Enterprise Incentive customers on both a bundled and separately-
priced basis. We may separately charge for relationship management services to
these customers including promotional consulting, direct marketing services and
integration and maintenance of our enabling software.
Under both the ClickRewards Network and the Custom Loyalty Networks, we provide
services to members, such as allowing them to manage and track balances as they
earn currencies in their personal, online accounts at the designated Web site
for that program and redeem the currency for merchandise and other awards. We
purchase the relevant awards and either have the merchandise delivered to the
consumer through a third-party fulfillment house, or in the case of frequent
flyer miles offered through the Clickrewards Network, electronically credit
their chosen frequent flyer account. We also provide members with ongoing
support to assist them in managing and redeeming their currency.
-8-
<PAGE>
How We Recognize Revenues
Currency-related revenues; product and program-related services
The revenues we receive from the sale of currencies are made up of two
components: product revenues and program-related services revenues. Product
revenues reflect the value of the reward our members will ultimately receive
upon redemption of the promotion currency. Program-related services revenues
reflect the value of services that we perform for custom loyalty clients,
merchants and members. As a result, our revenues related to sale of currencies
are recognized at various times.
A merchant or custom loyalty client typically purchases currencies from us
before awarding them. Upon the sale of our loyalty currencies, we allocate these
revenues between the product component, and the program-related services
components. The product component of revenues is deferred until the member
redeems the currency for his or her selected reward. At the time of redemption,
we recognize the product component of revenues and the associated cost of
revenue based on the actual cost of the redemption reward. The revenue related
to the services component of the currency sale is deferred until the sale of the
currency becomes non-refundable, which in the ClickRewards program have
historically been upon award of the currency to a consumer by the merchant.
Services revenues relating to separately-priced services are recognized when
these services are delivered. The remaining portion of services revenues is
recognized ratably over the period during which these services are provided. For
all ClickMiles sold through September 30, 1999, this service period has been
initially calculated for the maximum life of the ClickMile based on its
expiration date. To the extent ClickMiles are redeemed prior to expiration, the
remaining unamortized amount of deferred services revenues is recognized at the
time of redemption.
Currently, ClickRewards merchants buy ClickMiles in advance based on their
anticipated needs. Beginning in the third quarter of 1999, new merchants are
required to purchase a minimum of 450,000 ClickMiles. On an ongoing basis, each
merchant is required to purchase ClickMiles in quantities at least equal to its
expected monthly usage and to maintain a minimum balance generally equal to its
expected bi-weekly usage. We determine each merchant's expected usage based on
past trends and forecasted requirements in active promotions. These ClickMiles
are non-refundable and will expire if not awarded by the merchant within a
six-month period. The merchant services portion of revenues of any ClickMiles
sold under these arrangements is amortized over the maximum period during which
the merchant may use the ClickMiles, resulting in a shorter amortization period
than has historically been used. The member services component of revenues
continues to be amortized over the expected life of the ClickMile. This change
did not have a significant impact on revenues in the quarter ended September 30,
1999.
If loyalty currency points expire or are forfeited, we recognize the remaining
amount of deferred product and program-related services revenues at the time of
expiration or forfeiture. Since we do not have sufficient experience concerning
the redemption or forfeiture of currency points, we cannot currently predict in
which periods we will recognize these revenues.
We typically sell our loyalty currency products and related services to
merchants or custom clients for cash. However, from time to time, in connection
with promoting the ClickRewards Network, we also sell ClickMiles to our
merchants for non-cash consideration, such as advertising and merchandise. The
revenue from the sale of these ClickMiles is accounted for on the same basis as
cash sales and the value of the advertising or merchandise is recorded as an
expense or a prepaid asset as appropriate. In 1998, approximately $956,000 of
advertising expense was recorded under these arrangements, of which 74% was
transacted with two merchants. In the nine months ended September 30, 1999,
approximately $771,000 of advertising expense was recorded under these
arrangements, of which 93% was transacted with three merchants.
We also derive program-related service revenues from advertising and other
direct marketing services provided to third parties.
-9-
<PAGE>
A summary of loyalty currencies activities, deferred revenues-product and
non-revenue points awarded by Netcentives is as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- ------------------------
1998 1999 1998 1999
------- -------- -------- --------
<S> <C> <C> <C> <C>
Loyalty currencies activities (number of points):
Beginning balance 25,662 153,188 2,130 62,495
Awarded by merchants 4,349 72,441 14,414 140,380
Redeemed by members (853) (20,302) (1,390) (31,090)
Sold to merchants not yet awarded, net (1) 2,149 45,416 16,153 78,958
Expired (2) (9,900) (603) (9,900) (603)
------- -------- -------- --------
Ending balance 21,407 250,140 21,407 250,140
======= ======== ======== ========
In circulation (3) 13,257 154,893 13,257 154,893
======= ======== ======== ========
Deferred Revenues--Product:
Beginning balance $ 513 $ 2,963 $ 43 $ 1,250
Awarded by merchants 87 1,449 288 2,808
Redeemed by members (17) (452) (27) (668)
Sold to merchants not yet awarded, net (1) 43 955 322 1,525
Expired (2) (198) (12) (198) (12)
======= ======== ======== ========
Ending balance $ 428 $ 4,903 $ 428 $ 4,903
======= ======== ======== ========
Non-revenue points awarded by Netcentives (4):
Points outstanding at end of period 8,486 109,351 8,486 109,351
======= ======== ======== ========
Accrued redemption costs $ 157 $ 2,023 $ 157 $ 2,023
======= ======== ======== ========
</TABLE>
________
(1) Merchants are required to purchase points in advance before awarding them
to consumers. This represents the buying activity, net of awards to
members, of merchants.
(2) Some points purchased by merchants must be awarded within specified periods
and cannot be refunded. This represents the number of points which expired
unawarded and the amounts recorded as revenue at that time.
(3) In circulation represents that portion of the outstanding loyalty currency
points awarded by merchants and still held by members. Upon redemption of
these points, Netcentives will recognize the related product revenue
component.
(4) In addition to points purchased and awarded by merchants, Netcentives has
issued points to its merchants and directly to its members in connection
with promotional campaigns and in lieu of cash for other expenses. These
points are accounted for as an expense and an accrued obligation at the
time of award. This represents the number of points outstanding at the end
of each period and the amount of the related liability.
Technical consulting services revenues
We provide systems integration and technical consulting services to a variety of
clients, including ClickRewards merchants and Custom Loyalty and Enterprise
Incentive customers, to help them deploy our programs. These revenues are
recognized as the services are provided.
-10-
<PAGE>
Results of Operations
Three and Nine Months Ended September 30, 1999 and 1998
Revenues
Revenues increased from $364,000 in the quarter ended September 30, 1998 to $2.0
million in the quarter ended September 30, 1999. Revenues increased from
$491,000 for the nine months ended September 30, 1998 to $5.0 million for the
nine months ended September 30, 1999. The increases in revenues were primarily a
result of increased technical consulting service revenues related to the
acquisition of Panttaja Consulting Group in December 1998 and the growth of our
ClickRewards Network launched in March 1998. Merchants awarded 14.4 million
ClickMiles and 140.4 million ClickMiles in the nine months ended September 30,
1998 and 1999, respectively, which was principally attributable to increases in
the number of merchants participating in the ClickRewards Network. Product
revenues reflect the redemption of ClickMiles for awards during the year.
Program-related service revenues in the quarter and nine months ended September
30, 1998 included $296,000 relating to the expiration of ClickMiles owned by a
merchant which were not distributed to consumers as well as $84,000 of
consulting services revenues attributable to a non-recurring consulting contract
with Visa International.
Cost of Product Revenues
Cost of product revenues represents the actual cost of awards selected by
members in exchange for ClickMiles. Cost of product revenues were $14,000 and
$553,000 for the quarters ended September 30, 1998 and 1999, respectively. These
cost of product revenues represented 93% and 119% of product revenues for the
quarters ended September 30, 1998 and 1999, respectively. Cost of product
revenues were $23,000 and $738,000 for the nine months ended September 30, 1998
and 1999, respectively. These cost of product revenues represented 92% and 108%
of product revenues for the nine months ended September 30, 1998 and 1999,
respectively. The increase in cost of product revenues was a result of the
increased redemption of ClickMiles by members which was principally related to
the increased number of ClickMiles outstanding as well as a special promotion
offered in July 1999 during which we offered our members the ability to redeem
their outstanding ClickMiles for frequent flyer miles on a two-for-one basis. As
a result of this offer, we incurred approximately $138,000 of product costs
during the quarter ended September 30, 1999.
Program-Related Services, Marketing and Support Costs
Program-related services, marketing and support costs represents the cost of
marketing services provided for the ClickRewards Network, as well as costs
incurred to support merchants and members in the Network. These costs consist
primarily of compensation and related costs for marketing and sales personnel,
advertising and marketing for the ClickRewards Network, merchant account and
rewards supplier management, product management activities and ClickMiles issued
to acquire new members for the ClickRewards Network. Program-related marketing
and support costs increased from $1.6 million in the quarter ended September 30,
1998 to $6.2 million in the quarter ended September 30, 1999. Program-related
marketing and support costs increased from $4.1 million in the nine months ended
September 30, 1998 to $15.7 million in the nine months ended September 30, 1999.
The increase from quarter to quarter was primarily the result of increased
marketing and consumer support personnel expenses of $668,000, member
acquisition costs of $904,000, and advertising and promotions expenses of $2.3
million associated with the launch of the ClickRewards Network. The increase
between the nine month periods was primarily the result of increased marketing
and consumer support personnel expenses of $3.0 million, member acquisition
costs of $2.6 million, and advertising and promotions expenses of $5.0 million
associated with the launch of the ClickRewards Network. We expect to
substantially increase our marketing expenditures, particularly those related to
acquiring members for the ClickRewards Network, advertising and promoting our
brands and products, recruiting additional marketing personnel and managing
programs for our Custom Loyalty Networks and Enterprise Incentive Solutions
customers.
Cost of Technical Consulting Services Revenues
Cost of technical consulting services consists of the personnel and overhead
costs incurred in connection with providing technical consulting services. There
were no technical consulting services provided in 1998 and therefore
-11-
<PAGE>
no cost of technical consulting services revenues during that year. Cost of
technical consulting services totaled $880,000 and $2.4 million for the quarter
and nine months ended September 30, 1999, respectively, and were related to
technical consulting services provided by Netcentives Professional Services
(formerly the Panttaja Consulting Group).
Research and Development
Research and development expenses consist primarily of compensation and related
costs for research and development personnel, including independent contractors
and consultants, software licensing expenses and allocated operating expenses
such as site hosting, Web site production, facilities expenses, and equipment
costs. Research and development expenses increased from $804,000 in the quarter
ended September 30, 1998 to $1.5 million in the quarter ended September 30,
1999. Research and development expenses increased from $2.2 million in the nine
months ended September 30, 1998 to $3.4 million for the nine months ended
September 30, 1999. These increases were primarily the result of an increase in
expenses for enhancements to the ClickRewards Network, as well as initial
development efforts relating to our Custom Loyalty Networks. The largest
component of the increases was the growth in compensation and related staff
expenses. These expenses increased by $475,000 from the quarter ended September
30, 1998 to the quarter ended September 30, 1999 and the increased by $882,000
between the corresponding nine month periods. We expect to continue to increase
substantially research and development spending in absolute dollars as we
develop new products and expand our resources to maintain existing products.
The American Institute of Certified Public Accountants issued Statement of
Position 98-1, Accounting for the Costs of Software Developed for Internal Use,
which will be effective for Netcentives beginning in 1999. The effects will be
to capitalize certain development costs that were previously expensed. The
amortization of these costs will be charged to program-related services,
marketing and support costs.
Selling, General and Administrative
Selling, general and administrative expenses consist primarily of salaries and
related expenses, sales commissions, treasury expenses, accounting and
administrative expenses, professional fees, and other selling and corporate
expenses. Selling, general and administrative expenses increased from $715,000
in the quarter ended September 30, 1998 to $2.9 million in the quarter ended
September 30, 1999. Selling, general and administrative expenses increased from
$2.0 million in the nine months ended September 30, 1998 to $6.4 million in the
nine months ended September 30, 1999. The increases from period to period were
primarily the result of increased sales efforts to enroll merchants into the
ClickRewards Network, increased business development efforts for our Custom
Loyalty Networks and increased general and administrative personnel. The largest
component of these increases was the growth in compensation expense and related
staff costs as a result of increased staffing levels. These expenses increased
by $2.4 million from the quarter ended September 30, 1998 to the quarter ended
September 30, 1999 and by $3.8 million from the nine months ended September 30,
1998 to the nine months ended September 30, 1999. We expect selling, general and
administrative expenses to increase in absolute amounts as we add personnel and
incur additional costs related to the anticipated growth of our ClickRewards and
Custom Loyalty Networks, our expansion into international markets and our
operation as a public company.
Amortization of Deferred Stock Compensation, Supplier Stock Awards and
Intangibles
Amortization of deferred stock compensation represents the difference between
the purchase or exercise price of certain restricted stock and stock option
grants, and the deemed fair market value of our common stock at the time of
these grants. This difference is amortized over the vesting period for such
grants, which is typically four years. Amortization of deferred stock
compensation was $86,000 and $117,000 in the quarter and nine months ended
September 30, 1998, respectively, and $911,000 and $2.0 million in the quarter
and nine months ended September 30, 1999, respectively. These increases resulted
from amortization of deferred stock compensation related to stock options and
common stock granted in 1998.
Amortization of supplier stock awards represents the cost of warrants granted to
certain airlines and other rewards suppliers in return for exclusivity. Expenses
related to contingent stock warrants granted to certain airlines and other
partners was $202,000 and $331,000 in the quarter and nine months ended
September 30, 1998 as compared to $610,000 and $1.6 million in the quarter and
nine months ended September 30, 1999. Because the vesting of these awards is
subject to these rewards suppliers maintaining the exclusivity of the
arrangement with Netcentives, the
-12-
<PAGE>
valuation of the warrants is not finalized until the vesting date. Accordingly,
the amount of the expense recognized for these warrants increased as the value
of our stock increased. A substantial number of these warrants had not yet
vested as of September 30, 1999. As a result, we expect that the charge relating
to supplier stock awards to increase over remaining vesting periods through
2001.
In December 1998, we acquired Panttaja Consulting Group in a transaction that
was accounted for as a purchase. The resulting intangibles of $3.5 million
recorded in the acquisition will be amortized over two years.
Interest Income, Net
Interest income primarily represents interest earned on short-term investments
in highly-liquid debt instruments with a maturity at time of purchase of three
months or less. Interest income, net increased from $82,000 for the quarter
ended September 30, 1998 to $376,000 for the quarter ended September 30, 1999.
The increase was a result of increased interest income from $121,000 for the
quarter ended September 30, 1998 to $467,000 for the quarter ended September 30,
1999, relating to increased cash balances, offset in part by an increase in
interest expense relating to capital leases and other financing arrangements
from $39,000 to $91,000 for the comparable period. Interest income, net
increased from $156,000 for the nine months ended September 30, 1998 to $823,000
for the nine months ended September 30, 1999. The increase was a result of
increased interest income from $237,000 for the nine months ended September 30,
1998 to $1.0 million for the nine months ended September 30, 1999, relating to
increased cash balances, offset in part by an increase in interest expense
relating to capital leases and other financing arrangements from $81,000 to
$197,000 for the comparable period.
Income Taxes
We have recorded losses since inception, and anticipate losses for the
foreseeable future. We have therefore recorded no provision for income taxes for
the nine months ended September 30, 1998 and 1999.
Net Loss
Net loss increased from $3.0 million and $8.1 million in the quarter and nine
months ended September 30, 1998, respectively, to $11.6 million and $27.7
million during the comparable periods in the current year. The increases in net
loss were primarily due to an increase of operating costs and expenses from $3.5
million in the quarter ended September 30, 1998 to $14.0 million in the quarter
ended September 30, 1999 and $8.8 million in the nine months ended September 30,
1998 to $33.6 million in the nine months ended September 30, 1999.
Liquidity and Capital Resources
We have funded our operations since inception primarily through the private
placement of preferred equity securities, through which we had raised net
proceeds of $63.8 million through September 30, 1999. We have also financed our
operations through equipment lease financing and bank borrowings. As of
September 30, 1999, we had outstanding equipment lease financing and bank
borrowings totaling $2.3 million. We have no other available lines of credit or
credit available under existing arrangements.
Cash used in operations was $7.3 million and $11.5 million in the nine months
ended September 30, 1998 and 1999, respectively. The cash used was primarily the
result of our operating losses in these periods. Cash used in operations
primarily reflected cash received from customers of $459,000 and $9.6 million in
the nine months ended September 30, 1998 and 1999, respectively, offset by cash
paid to suppliers and employees of $7.9 million and $22.0 million in the same
periods.
We initially defer recording revenue at the time we sell our loyalty currencies,
even though we have received cash from our customers for these sales. A
significant portion of revenue is not recognized until the currency is redeemed
by the consumer. The remaining revenue is recognized on a ratable basis over the
periods in which marketing and support services are provided to merchants and
members. As a result of this accounting method, the cash received from customers
is substantially greater than the amount of revenues reported for these periods.
The difference in these amounts is reflected primarily as an increase in the
amount of deferred revenues for products and services shown on our condensed
consolidated balance sheet. Total deferred revenues increased on a net basis
from cash transactions by $5,000 for the nine months ended September 30, 1998
and $4.9 million during the nine months
-13-
<PAGE>
ended September 30, 1999. The growth in deferred revenues in the nine months
ended September 30, 1999 was offset in part by an increase in accounts
receivable of $262,000.
Cash paid to suppliers and employees was significantly less than costs and
expenses reported for these same periods. This resulted from non-cash charges
relating to depreciation, the amortization of deferred stock compensation,
supplier stock awards and intangible assets arising from the Panttaja Consulting
Group acquisition, and the use of ClickMiles in lieu of cash to pay for certain
expenses. Non-cash amortization charges totaled $454,000 in the nine months
ended September 30, 1998 and $4.9 million in the nine months ended September 30,
1999. The use of ClickMiles in lieu of cash to pay for certain expenses resulted
in the deferral of cash payments of $880,000 and $3.4 million during the nine
months ended September 30, 1998 and 1999, respectively.
Investments in property and equipment were $512,000 and $5.7 million in the nine
months ended September 30, 1998 and 1999, respectively. Cash provided by
financing activities was $18.0 million and $34.2 million in the nine months
ended September 30, 1998 and 1999, respectively. Cash was provided primarily by
sales of preferred stock of $17.2 million and $35.1 million in the nine months
ended September 30, 1998 and 1999, respectively.
At September 30, 1999, we had 250 million loyalty currency points outstanding
which had been sold to merchants (of which 155 million had been awarded to
members and are in circulation). The September 30, 1999 balance sheet includes
approximately $4.9 million of deferred revenues relating to the product
component of these currencies, which will be recognized as revenue at the time
of redemption. Other than barter exchanges, we have already received cash from
our merchants relating to these points, which is unrestricted and which we can
use for any corporate purpose. In addition, an additional 109 million points
were outstanding which had been issued by us to pay for expenses in lieu of
cash. As of September 30, 1999, we have an accrued liability of approximately
$2.0 million for the estimated cost of redemption of these points. All of these
points expire if not redeemed by December 31, 2001. Although we have purchased
some frequent flyer miles in advance, most of the funding to pay for the costs
associated with these product redemption liabilities must come from available
cash resources at the time of redemption. Although these liabilities are
reflected as current liabilities in our balance sheet, the timing of the related
liability is controlled by the actual redemptions, which could occur in
irregular patterns over the next 2 1/4 years until expiration. Because we cannot
control the timing of our members' decision to redeem points, should the rate of
redemption of points exceed our estimates, it could be necessary for us to
obtain additional working capital and our results of operations could be
materially and adversely affected.
At September 30, 1999, we had cash and equivalents totaling $28.2 million. On
October 19, 1999, the Company closed its initial public offering, in which
it sold 6,000,000 shares of its common stock at a price of $12.00 per share. In
addition, on November 9, 1999 the Company sold an additional 335,937 shares
under the underwriters' overallotment option. Total net proceeds received from
these two sales of stock were approximately $69.1 million. On the closing of the
initial public offering, each outstanding share of the Company's convertible
preferred stock was converted into one share of common stock. We anticipate that
our available cash resources will be sufficient to meet our presently
anticipated working capital and capital expenditure needs for at least the next
twelve months.
Our future liquidity and capital requirements will depend on numerous factors.
For example, our pace of expansion will affect our future capital requirements,
as may our decision to acquire or invest in complementary businesses and
technologies. Therefore, we may be required to raise additional funds in the
future through the issuance of debt or equity securities. If additional funds
are raised through the issuance of equity securities, our existing stockholders
may experience significant dilution. Furthermore, additional financing may not
be available when needed or, if available, such financing may not be on terms
favorable to us or our stockholders. If financing is not available when required
or is not available on acceptable terms, we may be unable to develop or enhance
our programs or other services. In addition, we may be unable to take advantage
of business opportunities or to respond to competitive pressures. Any of these
events could harm our business and financial condition.
Year 2000 Compliance
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. As a result, software that
records only the last two digits of the calendar year may not be able to
distinguish whether "00" means 1900 or 2000. This may result in software
failures or the creation of erroneous results.
-14-
<PAGE>
We have defined Year 2000 Compliant as the ability to:
. handle correctly date information needed for the December 31, 1999 to
January 1, 2000 date change;
. function according to the product documentation provided for this date
change, without changes in operation resulting from the advent of a new
century, assuming correct configuration;
. respond to two-digit date input where appropriate in a way that resolves
the ambiguity as to century in a disclosed, defined, and predetermined
manner;
. store and provide output of date information if the date elements in
interfaces and data storage specify the century in ways that are
unambiguous as to century; and
. recognize Year 2000 as a leap year.
All software developed by Netcentives utilizes the JavaSoft implementation of
date object and calendar classes for expression and manipulation of dates. When
dates are saved in persistent storage, the values are either serialized objects
or date fields in a relational database; in both cases, the full 4-digit year is
maintained. Our products do not perform any kind of truncation of century values
or any string operations that jeopardize the integrity of the date values. We
have also tested all of the third-party software incorporated in our products to
ensure their proper processing of twenty-first century dates. As a result, we
believe that all versions of our products including the production systems that
manage our promotional networks are Year 2000 Compliant, provided that the
underlying operating system of the host machine and any other software used with
or on the host machine or our products are also Year 2000 Compliant. Statements
published by the providers of this software, hardware and these operating
systems indicate that they are or will be Year 2000 Compliant by December 1999.
Our internal analysis of this software, hardware and these operating systems
indicates that they are all currently Year 2000 Compliant.
We have evaluated the data feeds from each of our rewards suppliers to determine
if they are Year 2000 Compliant. Data feeds from approximately 13% of our active
rewards suppliers may not be Year 2000 Compliant and we have informed these
suppliers of the potential deficiencies we have identified. These suppliers have
orally assured us that any such problems have been corrected. We do not have any
information regarding the Year 2000 Compliance of the systems of any of our
rewards suppliers with which we do not directly interface. To the extent that
our rewards suppliers are unable to transmit data to or receive data from
Netcentives as a result of their failure to be Year 2000 Compliant, or they
inaccurately maintain balances of frequent flyer miles for member accounts,
general member dissatisfaction with frequent flyer programs may result and have
an adverse effect on our business.
We do not currently have any information concerning the Year 2000 Compliance
status of any of our merchant customers. We plan to notify merchants to remind
them of the Year 2000 problem and its potential effects on their systems.
However, to the extent that our merchants are no longer able to process
e-commerce transactions, process them incorrectly, or transmit incorrect data to
our systems, our business could be adversely affected. If our current or future
merchants fail to achieve Year 2000 Compliance or if they divert technology
expenditures, especially technology expenditures that were reserved for
promotional products, to address Year 2000 Compliance problems, our business,
results of operations, or financial condition could be materially adversely
affected.
We have initiated an assessment of our material internal information technology
systems and our non-information technology systems. Our material internal
information technology systems are primarily comprised of a local area network,
telecommunications network, computer hardware, operating systems and
applications software. Our material non-information technology systems are
primarily comprised of facilities-related systems, such as heating and cooling
and security. We have completed our assessment and the associated remediation of
our information technology systems. To date, we have identified one deficiency
in the software operating system for our local area network server for which an
upgrade is publicly available and this upgrade has been installed. We are not
currently aware of any material operational issues or costs associated with
preparing our internal systems for the Year 2000. However, we may experience
material unanticipated problems and costs caused by undetected errors or defects
in the technology used in our internal systems.
We have funded our Year 2000 plan from available cash and have not separately
accounted for these costs in the past. To date, these costs have not been
material, and we do not expect these costs to exceed $100,000. In addition, we
may experience material problems and costs with Year 2000 Compliance that could
adversely affect our business, results of operations, and financial condition.
-15-
<PAGE>
We have not developed a contingency plan to address situations that may result
if our products are not Year 2000 Compliant, or if our suppliers or customers
suffer major Year 2000 related problems or our internal systems fail as a result
of Year 2000 issues. Based on the completion of our Year 2000 Compliance, the
production of a contingency plan is no longer deemed necessary. We are also
subject to external forces that might generally affect e-commerce, such as
retailing and distribution company Year 2000 Compliance failures and related
service interruptions.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We had no holdings of derivative financial or commodity instruments at September
30, 1999. However, we are exposed to financial market risks associated with
fluctuations in interest rates. Because all of the amounts in our portfolio have
expected maturities of three months or less, we believe that the fair value of
our investment portfolio or related income would not be significantly impacted
by increases or decreases in interest rates due mainly to the short-term nature
of our investment portfolio. If market rates were to increase immediately by 10
percent from levels on September 30, 1999, the fair value of this investment
portfolio would decline by an immaterial amount. A sharp decline in interest
rates could reduce future interest earnings of our investment portfolio. If
market rates were to decrease immediately by 10 percent from levels on September
30, 1999, the resultant decrease in interest earnings of our investment
portfolio would not have a material impact on our earnings as a whole.
The table below presents principal amounts (in thousands) and related weighted
average fixed interest rates for our investment portfolio.
<TABLE>
<CAPTION>
Expected Maturity Estimated Fair Value
1999 at September 30, 1999
----------------------------------------------------
<S> <C> <C>
Federal Instruments $ 5,000 $ 5,000
Weighted average fixed interest rate 5.19%
Commercial paper & short-term obligations $ 23,221 $ 23,221
Weighted average fixed interest rate 5.00%
Total portfolio $ 28,221 $ 28,221
</TABLE>
As of September 30, 1999, we had $28.2 million of cash and cash equivalents
earning a weighted average variable interest rate of 5.03%.
Part II. Other Information
Item 2. Changes in Securities and Use of Proceeds
On October 13, 1999, in connection with the Company's initial public offering, a
Registration Statement on Form S-1 (No. 333-83443) was declared effective by the
Securities and Exchange Commission (and closed on October 19, 1999), pursuant to
which 6,000,000 shares of the Company's Common Stock were offered and sold for
the account of the Company at a price of $12.00 per share. In addition, on
November 9, 1999 the Company sold an additional 335,937 shares under the
underwriter's overallotment option. The managing underwriters were Credit Suisse
First Boston Corporation, Hambrecht & Quist LLC and Thomas Weisel Partners LLC.
After deducting approximately $5.3 million in underwriting discounts and $1.6
million in other related expenses, the net proceeds of the offering were
approximately $69.1 million. The $69.1 million has been invested in investment
grade, interest bearing securities. The Company intends to use such remaining
proceeds for capital expenditures and for general corporate purposes, including
working capital to fund anticipated operating losses.
-16-
<PAGE>
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits
27.1 Financial Data Schedule
b) Reports on Form 8-K
None.
-17-
<PAGE>
Signature
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.
Date: November 24, 1999 NETCENTIVES INC.
By /s/ John F. Longinotti
------------------------------
Executive VP, Operations and Chief
Financial Officer
(Principal Financial Officer)
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<PAGE>
Exhibit Index
Exhibit No. Description
- ----------- -----------
27.1 Financial Data Schedule.
-19-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM 10-Q ENDED
9/30/99 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 28,221
<SECURITIES> 0
<RECEIVABLES> 1,155
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1,778
<PP&E> 0
<DEPRECIATION> 2,445
<TOTAL-ASSETS> 43,623
<CURRENT-LIABILITIES> 16,926
<BONDS> 0
0
21
<COMMON> 5
<OTHER-SE> 25,259
<TOTAL-LIABILITY-AND-EQUITY> 43,623
<SALES> 5,024
<TOTAL-REVENUES> 5,024
<CGS> 18,847
<TOTAL-COSTS> 33,585
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 197
<INCOME-PRETAX> (27,738)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (27,738)
<EPS-BASIC> (8.16)
<EPS-DILUTED> (8.16)
</TABLE>
