<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, 2000
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)
_______________________________
475 Brannan Street, 3rd Floor
San Francisco, California 94107
415-615-2000
(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. [X]
The number of shares outstanding of the Registrant's Common Stock, $.001 par
value per share, as of October 31, 2000 was 42,721,807.
<PAGE>
NETCENTIVES INC.
FORM 10-Q
For the Quarter Ended September 30, 2000
INDEX
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION PAGE
----
<S> <C>
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of September 30, 2000 and December 31, 1999 3
Condensed Consolidated Statements of Operations for the Three and Nine Months 4
Ended September 30, 2000 and 1999
Condensed Consolidated Statements of Cash Flows for the Nine Months 5
Ended September 30, 2000 and 1999
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk 23
PART II OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 2. Changes in Securities and Use of Proceeds 24
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURE 26
</TABLE>
<PAGE>
NETCENTIVES INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands) (unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999 *
------------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and equivalents $ 46,907 $ 75,290
Short-term investments 6,527 10,812
Accounts receivable 9,741 2,169
Prepaid incentive awards 987 1,534
Prepaid expenses and other current assets 1,454 1,169
--------- ---------
Total current assets 65,616 90,974
Property and equipment - net 25,776 8,963
Intangible assets - net 294,420 1,724
Marketable securities 11,929 -
Other assets 11,636 3,040
--------- ---------
Total assets $ 409,377 $ 104,701
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,105 $ 1,134
Accrued compensation and benefits 5,656 1,818
Accrued redemption costs 2,262 2,256
Other accrued liabilities 5,844 2,926
Deferred revenue-product 13,429 6,489
Deferred revenue-services 13,068 3,572
Current portion of long-term obligations 2,454 1,008
--------- ---------
Total current liabilities 47,818 19,203
Long-term obligations 3,911 1,234
Stockholders' Equity:
Common stock, $.001 par value--shares authorized:
100,000,000; shares outstanding:
September 30, 2000, 42,672,740; December 31, 1999,
32,355,099 43 33
Paid-in capital 628,646 165,731
Deferred stock expenses (77,676) (15,665)
Unrealized loss on marketable securities (28,044) -
Equity investment in unconsolidated subsidiary 373 -
Receivables from sales of stock (123) (450)
Accumulated deficit (165,571) (65,385)
--------- ---------
Total stockholders' equity 357,648 84,264
--------- ---------
Total liabilities and stockholders' equity $ 409,377 $ 104,701
========= =========
</TABLE>
*The December 31, 1999 amounts are derived from the Company's audited financial
statements.
See accompanying notes to the condensed consolidated financial statements.
<PAGE>
NETCENTIVES INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
--------------------- -----------------------
2000 1999 2000 1999
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues:
Product $ 3,146 $ 464 $ 4,785 $ 680
Program-related services 4,943 398 8,724 817
Direct marketing services 3,112 56 7,442 65
Technical and marketing consulting services 658 1,085 4,491 3,462
--------- --------- ---------- ----------
Total revenues 11,859 2,003 25,442 5,024
--------- --------- ---------- ----------
Costs and expenses:
Cost of product revenues 2,714 553 4,085 738
Program-related services, marketing and support costs 10,171 6,167 26,363 15,733
Cost of direct marketing services 1,984 - 3,824 -
Cost of technical and marketing consulting services revenues 480 880 2,374 2,376
Research and development 3,403 1,546 8,046 3,415
Selling, general and administrative 10,312 2,851 24,530 6,447
Amortization of deferred stock compensation 847 911 2,662 1,995
Amortization of supplier and other stock arrangements 5,072 610 10,892 1,554
Amortization of intangibles 22,016 449 45,523 1,327
--------- --------- ---------- ----------
Total costs and expenses 56,999 13,967 128,299 33,585
--------- --------- ---------- ----------
Loss from operations (45,140) (11,964) (102,857) (28,561)
Interest income 1,029 467 3,283 1,020
Interest expense (177) (91) (612) (197)
--------- --------- ---------- ----------
Net loss $ (44,288) $ (11,588) $ (100,186) $ (27,738)
========= ========= ========== ==========
Net loss per share- basic and diluted $ (1.06) $ (3.12) $ (2.61) $ (8.16)
========= ========= ========== ==========
Shares used in computing per share amounts-
basic and diluted 41,964 3,711 38,442 3,401
========= ========= ========== ==========
Pro forma net loss per share on a converted basis-
basic and diluted $ (1.06) $ (0.48) $ (2.61) $ (1.24)
========= ========= ========== ==========
Shares used in computing pro forma per share amounts
on a converted basis 41,964 24,158 38,442 22,282
========= ========= ========== ==========
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
<PAGE>
NETCENTIVES INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
-----------------------
2000 1999
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers $ 34,958 $ 9,634
Cash paid to suppliers and employees (56,009) (21,465)
Cash paid for interest (600) (197)
Interest received 3,283 1,020
--------- ---------
Net cash used in operating activities (18,368) (11,008)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (16,748) (6,175)
Maturity (purchases) of short-term investments, net 4,285 -
Cash paid in UVN acquisition, net of cash acquired (4,103) -
Cash acquired in MaxMiles acquisition 32 -
Cash acquired in Post acquisition 6,330 -
Other long term assets (835) (2,472)
--------- ---------
Net cash used in investing activities (11,039) (8,647)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Sales of common stock 2,662 169
Repayment (issuance) of receivable related to previous issuances of common stock 460 (100)
Sales of preferred stock - 35,058
Borrowings on long-term debt 493 1,463
Principal payments on long-term debt (2,591) (987)
Principal payments on bank loan, net - (100)
Deferred offering costs - (1,278)
--------- ---------
Net cash provided by financing activities 1,024 34,225
--------- ---------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS (28,383) 14,570
CASH AND EQUIVALENTS, Beginning of period 75,290 13,651
--------- ---------
CASH AND EQUIVALENTS, End of period $ 46,907 $ 28,221
========= =========
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
<PAGE>
<TABLE>
<CAPTION>
(In thousands)
NONCASH INVESTING AND FINANCING ACTIVITIES:
<S> <C>
Acquisition of UVN:
Value of stock issued 18,025
Cash paid 4,103
Liabilities assumed 4,631
---------
Assets acquired (including intangibles of $25,548) $ 26,759
=========
Acquisition of MaxMiles:
Value of stock and options issued, net of deferred stock compensation 11,325
Cash acquired (32)
Liabilities assumed 477
---------
Assets acquired (including intangibles of $11,625) $ 11,770
=========
Acquisition of Post Communications:
Value of stock issued and options assumed 315,278
Cash acquired (6,330)
Liabilities assumed 6,402
---------
Assets acquired (including intangibles of $309,021) $ 315,350
=========
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
<PAGE>
NETCENTIVES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
Note 1 - Basis of Presentation
The accompanying unaudited condensed consolidated 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, 2000, the results of operations for the quarters and nine months
ended September 30, 2000 and 1999, and changes in cash flows for the nine months
ended September 30, 2000 and 1999. The balance sheet at December 31, 1999,
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,
1999. 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, 1999
included in the Company's Form 10-K.
The results of operations for the interim periods presented are not necessarily
indicative of the results to be expected for the full year.
Certain prior period amounts have been reclassified for consistency with the
current period presentation. Such reclassifications had no impact to net loss
or stockholders' equity.
Note 2 - Subsequent Events and Acquisitions
On January 31, 2000, the Company completed the acquisition of all outstanding
capital stock of MaxMiles, Inc. ("MaxMiles"), a provider of personal aggregation
technologies, in exchange for issuance of 153,058 shares of the Company's common
stock valued at approximately $10,200,000 and options to purchase 21,922 shares
of the Company stock at prices ranging from $.03 to $10.44 per share, of which
17,388 were vested at the date of the acquisition and have been included as part
of the acquisition price at their fair value of approximately $1,100,000. The
remaining 4,534 unvested options have been recorded as deferred stock expense in
the amount of $254,000 and will be amortized over the remaining three year
vesting period.
The acquisition was accounted for as a purchase and, accordingly, the results of
operations of MaxMiles since the date of acquisition have been included in the
Company's consolidated financial statements. In connection with the acquisition,
the purchase price was allocated, based on an independent valuation, to goodwill
of $11,259,000, internal use software of $245,000 and assembled workforce of
$121,000. For the quarter and nine months ended September 30, 2000, the Company
recorded $972,000 and $2,593,000 for amortization of these intangibles, which
are amortized over their useful lives of two to four years.
<PAGE>
In connection with the acquisition, net assets acquired were as follows (in
thousands):
Current assets $ 69
Cash acquired 32
Property and equipment, net 76
Goodwill 11,259
Internal use software 245
Assembled workforce 121
Liabilities assumed (477)
-------
Net assets acquired $11,325
=======
On March 3, 2000, the Company completed the acquisition of all outstanding
capital stock of UVN Holdings, Inc., SHC Venture, LLC, and the outstanding
minority interest in UVN's majority owned subsidiary Universal Value Network,
LLC (collectively referred to as "UVN"). UVN's business utilizes payment card
data to recognize and reward online and offline purchasing behavior. Total
purchase price includes issuance of 335,532 shares of the Company's common stock
valued at approximately $16,300,000, cash payments totaling approximately
$4,900,000 (including approximately $2,100,000 of transaction costs), and 36,000
shares of the Company's common stock valued at approximately $1,800,000 to
extinguish certain debt of UVN. The acquisition also gives the Company a 49%
equity ownership in Golden Retriever Systems, LLC (GRS), which maintains
connectivity to information on approximately 90% of U.S. sources of payment card
transactions including data from payment card processors, merchant acquiring
banks and merchants. The Company is required to issue an additional 48,888
shares of common stock over the next 19 months to former shareholders of UVN.
The acquisition was accounted for as a purchase and, accordingly, the results of
operations of UVN since the date of acquisition have been included in the
Company's consolidated financial statements. In connection with the acquisition,
the purchase price was allocated, based on an independent valuation, to goodwill
of $17,141,000, internal use software of $500,000, investment in GRS of
$7,571,000, assembled workforce of $40,000 and sales channel and customer
relationships of $296,000. For the quarter and nine months ended September 30,
2000, the Company recorded $1,300,000 and $3,000,000 for amortization of these
intangibles, which are amortized over their useful lives of five years.
In connection with the acquisition, net assets acquired were as follows (in
thousands):
Current assets $ 930
Cash paid (4,103)
Property and equipment, net 281
Goodwill 17,141
Internal use software 500
Investment in GRS 7,571
Assembled workforce 40
Sales channel and customer relationships 296
Liabilities assumed (4,631)
-------
Net assets acquired $18,025
=======
On April 7, 2000, the Company completed the acquisition of all outstanding
capital stock of Post Communications, Inc. ("Post"), a provider of customized
email marketing services, in exchange for issuance of 6,282,289 shares of the
Company's common stock valued at $308,790,000 and options to purchase 316,550
shares of the Company stock at prices ranging from $.10 to $12.38 per share, of
which 23,481 were vested at the date of acquisition and have been included as
part of the acquisition price at their fair value of approximately $1,200,000
and 316,550 were unvested at the date of acquisition and have been included as
part of the acquisition price at their fair value of approximately $13,600,000.
<PAGE>
This acquisition was accounted for as a purchase, and accordingly, the results
of operations of Post since the date of acquisition have been included in the
Company's consolidated financial statements. In connection with the acquisition,
the purchase price was allocated, based on an independent valuation, to goodwill
of $286,871,000, internal use software of $10,150,000, customer relationships of
$8,650,000 and assembled workforce of $3,350,000. For the quarter and nine
months ended September 30, 2000, the Company recorded $19,300,000 and
$38,600,000 for amortization of these intangibles, which are amortized over
their useful lives of four years.
In connection with the acquisition, net assets acquired were as follows (in
thousands):
Current assets $ 3,015
Cash acquired 6,330
Property and equipment, net 3,314
Goodwill 286,871
Internal use software 10,150
Assembled workforce 3,350
Customer relationships 8,650
Liabilities assumed (6,402)
--------
Net assets acquired $315,278
========
The following unaudited proforma information shows the results of operations for
the quarters and nine months ended September 30, 2000 and 1999 as if the
MaxMiles, the UVN, and Post acquisitions had occurred at the beginning of 1999.
The results are not necessarily indicative of what would have occurred had the
acquisition actually been made at the beginning of the respective periods
presented or of future operations of the combined companies (in thousands,
except per share information).
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- ------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Total revenues $ 11,859 $ 3,435 $ 25,655 $ 8,138
Net loss $ (44,288) $ (35,236) $(105,215) $ (97,321
Net loss per share, basis and diluted $ (1.06) $ (3.53) $ (2.59) $ (10.06)
</TABLE>
On April 10, 2000, the Company announced an agreement to create an online
loyalty program for the CMGI network and its 70 member companies. As part of
this relationship, CMGI received approximately 4.9% or 1,694,492 shares of the
Company's outstanding common stock with a value of approximately $39,900,000.
The Company also received, in exchange for its shares, 425,317 shares of CMGI
outstanding common stock with a value of approximately $39,900,000. These shares
are restricted from being resold until April 2001 and were recorded as
Marketable Securities on the Company's balance sheet. At September 30, 2000, the
Company valued these at market value and recorded a $28,044,000 unrealized loss
which appears in the equity section of the balance sheet.
During the fourth quarter of 2000, the Company and CMGI agreed to end their
loyalty network arrangement, with the opt-in transition of existing members from
the AltaVista Rewards program to the ClickRewards program. In November 2000,
CMGI announced a plan to restructure its business activities through a set of
consolidations and divestitures.
<PAGE>
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,
------------------ -----------------
2000 1999 2000 1999
------ ------ ------ ------
<S> <C> <C> <C> <C>
Weighted average common shares outstanding 42,621 5,262 39,334 5,181
Weighted average common shares outstanding
subject to repurchase (657) (1,551) (892) (1,780)
------ ------ ------ ------
Shares used in computation, basic and diluted 41,964 3,711 38,442 3,401
Weighted average preferred stock outstanding - 20,447 - 18,881
------ ------ ------ ------
Shares used in computing pro forma per share
amounts on a converted basis 41,964 24,158 38,442 22,282
====== ====== ====== ======
</TABLE>
For the above-mentioned periods, the Company had securities outstanding, which
could potentially dilute basic earnings per share in the future, but were
excluded in the computation of diluted net loss per share in the periods
presented, as their effect would have been antidilutive. Such outstanding
securities consist of the following (in thousands):
September 30,
------ -------
2000 1999
------ -------
Convertible preferred stock - 20,522
Common stock subject to repurchase 579 1,358
Outstanding options 7,108 4,774
Warrants 634 662
<PAGE>
Note 4 - Consolidated Statement of Cash Flows Information
A reconciliation of net cash used in operating activities follows (in
thousands:)
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
-----------------------
2000 1999
----------- ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (100,186) $ (27,738)
Reconciliation to net cash used in operating activities:
Depreciation and amortization 50,340 3,070
Deferred stock compensation expense 2,946 1,995
Expenses relating to stock warrants and other stock arrangements 10,905 1,566
Advertising expense arising from barter transactions 220 772
ClickMiles issued for services 1,670 2,597
Changes in operating assets and liabilities:
Accounts receivable (6,165) (262)
Prepaid incentive awards 547 (3)
Prepaid expenses 1,366 (28)
Other assets 95 30
Accounts payable 1,710 289
Accrued compensation and benefits 3,068 289
Accrued redemption costs (1,664) (1,083)
Other accrued liabilities 1,099 2,626
Deferred revenue--product and services 15,681 4,872
---------- ---------
Net cash used in operating activities $ (18,368) $ (11,008)
========== =========
</TABLE>
<PAGE>
Note 5 - Segment Reporting
In 1999, the Company adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." SFAS No. 131 requires disclosures of
certain information regarding operating segments, products and services,
geographic areas of operation and major customers. The method of determining
what information to report under SFAS No. 131 is based upon the "management
approach," or the way that management organizes the operating segments within a
company, for which separate financial information is available that is evaluated
regularly by management in deciding how to allocate resources and in assessing
performance.
The Company's operating businesses are organized based on the nature of products
and services provided. Based on this approach, the Company classifies its
businesses into three identifiable segments: Currency, Direct Marketing
Services, and Technical and Marketing Consulting Services. Certain of the
Company's businesses do not meet the definition of a reportable operating
segment and have been aggregated under Currency. These include the ClickRewards
Network, Enterprise Incentive Programs, Custom Loyalty Programs and the Momentum
Program. Segment accounting policies are the same as the policies described in
Note 2 of the Company's audited consolidated financial statements for the year
ended December 31, 1999 included in the Company's Form 10-K.
Financial information for the Company's business segments is as follows (in
thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------------------------
2000 1999 2000 1999
--------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Revenues:
Currency $ 8,089 $ 862 13,509 $ 1,497
Direct marketing services 3,314 56 7,786 65
Technical and marketing consulting services 725 1,499 4,709 4,178
Elimination of intersegment revenues (269) (414) (562) (716)
--------- --------- ---------- ---------
Consolidated revenues $ 11,859 $ 2,003 $ 25,442 $ 5,024
========= ========= ========== =========
Gain/(Loss) from operations:
Currency $ (22,133) $ (11,573) $ (60,059) $ (27,262)
Direct marketing services (21,722) 56 (42,502) 65
Technical and marketing consulting services (1,028) (96) 90 (879)
Elimination of intersegment profits (257) (351) (386) (485)
--------- --------- ---------- ---------
Consolidated loss from operations $ (45,140) $ (11,964) $ (102,857) $ (28,561)
========= ========= ========== =========
Assets:
Currency $ 123,946 $ 40,414 $ 123,946 $ 40,414
Direct marketing services 283,353 - 283,353 -
Technical consulting services 2,078 3,209 2,078 3,209
--------- --------- ---------- ---------
Consolidated assets $ 409,377 $ 43,623 $ 409,377 $ 43,623
========= ========= ========== =========
</TABLE>
<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' Form 10-K dated March 30, 2000.
Overview
Netcentives was 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 Network in March
1998 and began recognizing revenue from non-trial program sales in April 1998.
In December 1998, we acquired Netcentives Professional Services (formerly 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 program
in July 1999.
In January 2000, the Company entered into an agreement with America Online, Inc.
("AOL") under which the Company's rewards technology will become the exclusive
online support infrastructure for AOL/AAdvantage, AOL's consumer rewards
network. In addition, the companies also agreed to create "ICQ ClickRewards"--a
rewards program for ICQ, AOL's online communications community. As part of
these agreements, the Company issued AOL 1,560,000 shares of the Company's
common stock. The Company has recorded $82.0 million in deferred stock expenses
based on the fair value of the stock issued to AOL. A portion of the deferred
stock expense will be recorded as an offset to revenue earned by the Company
over time related to the AOL program and a portion will be recorded over the
three-year agreement period as a non-cash marketing expense related to ICQ
ClickRewards. In the quarter and nine months ended September 30, 2000, the
Company recorded $6.2 million and $16.5 million, respectively, of non-cash
marketing expenses related to the AOL program.
On January 31, 2000, the Company completed the acquisition of all outstanding
capital stock of MaxMiles, Inc. ("MaxMiles"), a provider of personal aggregation
technologies, in exchange for issuance of 153,058 shares of the Company's common
stock valued at $10.2 million and options to purchase 21,922 shares of the
Company stock at prices ranging from $.03 to $10.44 per share, of which 17,388
were vested at the date of the acquisition and have been included as part of the
acquisition price at their fair value of $1.1 million. The remaining 4,534
unvested options have been recorded as deferred stock expense in the amount of
$254,000 and will be amortized over the remaining three year vesting period.
The acquisition was accounted for as a purchase and, accordingly, the results of
operations of MaxMiles since the date of acquisition have been included in the
Company's consolidated financial statements. In connection with the acquisition,
the purchase price was allocated, based on an independent valuation, to goodwill
of $11.3 million, internal use software of $245,000 and assembled workforce of
$121,000. For the quarter and nine months ended September 30, 2000, the Company
recorded $972,000 and $2.6 million for amortization of these intangibles, which
are amortized over their useful lives of two to four years.
On March 3, 2000, the Company completed the acquisition of all outstanding
capital stock of UVN Holdings, Inc., SHC Venture, LLC, and the outstanding
minority interest in UVN's majority owned subsidiary Universal Value Network,
LLC (collectively, "UVN"). UVN's business utilizes payment card data to
recognize and reward online and offline purchasing behavior. Total purchase
price includes issuance of 335,532 shares of the Company's common stock valued
at approximately $16.3 million, cash payments totaling approximately $4.9
million (including approximately $2.1 million of transaction costs), and 36,000
shares of the Company's common stock valued at approximately $1.8 million to
extinguish certain debt of UVN. The acquisition also gives the Company a 49%
equity ownership in Golden Retriever Systems, LLC which maintains connectivity
to information on approximately
<PAGE>
90% of U.S. sources of payment card transactions including data from payment
card processors, merchant acquiring banks and merchants. The Company is required
to issue an additional 48,888 shares of common stock to former shareholders of
UVN over the next 19 months.
The acquisition was accounted for as a purchase and, accordingly, the results of
operations of UVN since the date of acquisition have been included in the
Company's consolidated financial statements. In connection with the
acquisition, the purchase price was allocated, based on an independent
valuation, to goodwill of $17.1 million, internal use software of $500,000,
investment in GRS of $7.6 million, assembled workforce of $40,000 and sales
channel and customer relationships of $296,000. For the quarter and nine months
ended September 30, 2000, the Company recorded $1.3 million and $3.0 million for
amortization of these intangibles, which are amortized over their useful lives
of five years.
On April 7, 2000, the Company completed the acquisition of all outstanding
capital stock of Post Communications, Inc. ("Post"), a provider of customized
email marketing services, in exchange for issuance of 6,282,289 shares of the
Company's common stock valued at $308.8 million and options to purchase 316,550
shares of the Company stock at prices ranging from $.10 to $12.38 per share, of
which 23,481 were vested at the date of acquisition and have been included as
part of the acquisition price at their fair value of approximately $1.2 million
and 316,550 were unvested at the date of acquisition and have been included as
part of the acquisition price at their fair value of approximately $13.6
million.
This acquisition was accounted for as a purchase, and accordingly, the results
of operations of Post since the date of acquisition have been included in the
Company's consolidated financial statements. In connection with the
acquisition, the purchase price was allocated, based on an independent
valuation, to goodwill of $286.9 million, internal use software of $10.2
million, customer relationships of $8.7 million and assembled workforce of $3.4
million. For the quarter and nine months ended September 30, 2000, the Company
recorded $19.3 million and $38.6 million for amortization of these intangibles,
which are amortized over their useful lives of four years.
How our Programs Work
Netcentives is a leading outsource provider of loyalty and direct marketing
solutions that delivers a broad suite of relationship marketing services
including business, consumer and employee loyalty programs, customized email
marketing and consulting services which drive greater customer loyalty and
maximize lifetime customer value for clients. We have focused our business
strategy on providing relationship marketing products and services to our
clients both online and offline. Loyalty solutions are based on rewards
currencies sold to multi-channel retailers, portals and other Internet sites.
Our most established 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 customer branded loyalty and rewards
currencies for large Internet merchants, portals, content 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. During the
past several quarters, we have expanded our capabilities to offering offline
loyalty programs through the Momentum program and technology acquired in the UVN
acquisition. We also offer email marketing services through our Direct Marketing
division, Post Communications.
ClickRewards. 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.
<PAGE>
Custom Loyalty Programs and Enterprise Incentive Solutions. In 1999, we expanded
the flexible technology platform of our ClickRewards program to meet the
marketing needs of large portals and financial institutions with large
constituencies, and to enable large enterprises to motivate and reward their
employees, channel partners, and other stakeholders via intranets and extranets.
These Custom Loyalty programs and Enterprise Incentive Solutions are delivered
on both a fully configured "turn key" basis as well as on a separately-priced
basis, and are powered by Netcentives' secure and scalable technology. We may
separately charge these customers for various relationship management and other
services including transaction management, promotional consulting, direct
marketing services and integration and maintenance of our enabling software.
Momentum Program. In March 2000, the Company acquired UVN which operates a
program called Momentum. Momentum allows businesses to recognize and reward
purchase behavior both online and offline in permission based programs.
Direct Marketing. In April 2000, the Company acquired Post Communications.
Through Post Communications, the Company offers customized email marketing
services including the marketing strategy, program design, production and
technologies required to retain customers and drive sales.
Each of Netcentives' solutions can be supported by our promotional management
services such as account monitoring, reporting, reward fulfillment, customer
service support, customized e-mail communication services and rewards program
aggregation services. In the case of reward fulfillment, we purchase the
relevant awards and either have the merchandise delivered to the consumer
through third-party fulfillment houses, 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.
How We Recognize Revenues
Currency-related revenues; product and program-related services
The revenues we receive from the sale of rewards and loyalty currencies and
points-based programs 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 has
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, 2000, 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. 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
<PAGE>
impact on revenues in the year ended December 31, 1999 or for the three and nine
months ended September 30, 2000.
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 the quarter and nine months ended
September 30, 2000, approximately $56,000 and $220,000 of advertising expense
was recorded under these arrangements, of which 99% and 83% was transacted with
two merchants. In the quarter and nine months ended September 30, 1999,
approximately $162,000 and $771,000 of advertising expense was recorded under
these arrangements, of which 97% and 93% was transacted with three merchants.
We also derive program-related service revenues from the initial set-up fees
received from some of our Custom Loyalty programs. We recognize these set-up
fees and related costs over the minimum life of the Custom Loyalty program
contract. Additionally, we derive program-related service revenues from currency
point expirations and from licensing activities. In the quarter and nine months
ended September 30, 2000, we recognized $1.3 million and $2.9 million of
revenues related to these activities.
<PAGE>
A reconciliation of combined loyalty currencies activity for the ClickRewards
program, Custom Loyalty programs, Enterprise Incentive programs and Momentum
program, deferred revenue-product and non-revenue points awarded by Netcentives
follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- ----------------------
2000 1999 2000 1999
--------- -------- --------- ---------
<S> <C> <C> <C> <C>
Loyalty currencies activities (number of points):
Beginning balance 476,155 153,188 347,147 62,495
Awarded by merchants 435,156 72,441 659,172 140,380
Redeemed by members (151,754) (20,302) (228,398) (31,090)
Sold to merchants not yet awarded, net (1) 756 45,416 25,311 78,958
Expired (2) (49,786) (603) (92,705) (603)
--------- -------- --------- ---------
Ending balance 710,527 250,140 710,527 250,140
========= ======== ========= =========
In circulation (3) 569,046 154,893 569,046 154,893
========= ======== ========= =========
Deferred Revenues--Product:
Beginning balance $ 8,720 $ 2,963 $ 6,490 $ 1,250
Awarded by merchants 8,758 1,449 13,187 2,808
Redeemed by members (3,139) (452) (4,824) (668)
Sold to merchants not yet awarded, net (1) 86 955 430 1,525
Expired (2) (996) (12) (1,854) (12)
--------- -------- --------- ---------
Ending balance $ 13,429 $ 4,903 $ 13,429 $ 4,903
========= ======== ========= =========
Non-revenue points awarded by Netcentives (4):
Points outstanding at end of period 122,254 109,351 122,254 109,351
========= ======== ========= =========
Accrued redemption costs $ 2,262 $ 2,023 $ 2,262 $ 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. In addition, some points issued to consumers expire if
the consumer has no earning or redemption activity for a twelve month period.
This represents the number of points which expired unawarded and the amounts
recorded as revenue at that time related to merchant points and represents the
number of points which expired in consumers accounts and were recorded as
revenues.
(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.
<PAGE>
Direct marketing services
The Company recognizes revenue related to email marketing program services as
the services are provided. Revenue and related costs associated with the initial
set-up of client email marketing programs are recognized over the minimum life
of the client contract, beginning on the launch date of the email program.
Deferred project revenues and costs represent amounts associated with the
initial set-up of client email programs which have not been recognized at the
balance sheet date.
Technical and marketing consulting services revenues
We provide systems integration, technical consulting, strategic design,
marketing plan development, promotion consulting, creative services and content
development 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.
Results of Operations
Three and Nine months Ended September 30, 2000 and 1999
Revenues
Revenues increased to $11.9 million in the quarter ended September 30, 2000 from
$2.0 million in the quarter ended September 30, 1999 and revenues increased to
$25.4 million in the nine months ended September 30, 2000 from $5.0 million in
the nine months ended September 30, 1999. The increase in revenues was primarily
a result of growth of our ClickRewards Network launched in March 1998, the
growth in our Custom Loyalty programs, growth in the Enterprise Incentives
business, and the addition of Post Communications in the second quarter of 2000.
Product revenues reflect the redemption of currency points for awards during the
year and increased to $3.1 million for the quarter ended September 30, 2000 from
$464,000 for the quarter ended September 30, 1999 and increased to $4.8 million
for the nine months ended September 30, 2000 from $680,000 for the nine months
ended September 30, 1999. Consumers redeemed 151.8 million currency points in
the quarter ended September 30, 2000 compared to redeeming 20.3 million currency
points in the quarter ended September 30, 1999. For the nine months ended
September 30, 2000 and 1999, consumers redeemed 228.4 million currency points
and 31.1 million currency points, respectively. Program-related service revenues
in the quarter ended September 30, 2000 were $4.9 million compared to $398,000
in the quarter ended September 30, 1999. Program-related services revenues in
the nine months ended September 30, 2000 were $8.7 million compared to $817,000
for the nine months ended September 30, 1999. The increases in program-related
revenues were primarily due to growth in the ClickRewards Network, the Custom
Loyalty programs, and Enterprise Incentive programs. Program-related service
revenues in the three and nine months ended September 30, 2000 included $889,000
and $1.7 million related to consumer point expirations and $382,000 and $1.0
million related to licensing fees. Direct marketing services revenues increased
to $3.1 million in the quarter ended September 30, 2000 from $56,000 in the
quarter ended September 30, 1999. Direct marketing service revenues increased to
$7.4 million in the nine months ended September 30, 2000 from $65,000 for the
nine months ended September 30, 1999. This increase was primarily due to the
business activity of Post Communications subsequent to the date of acquisition.
Technical and marketing consulting services revenue decreased to $658,000 in the
quarter ended September 30, 2000 from $1.1 million in the quarter ended
September 30, 1999. The decrease in technical and marketing consulting revenues
in the quarter was due to having fewer consulting engagements. Technical and
marketing consulting services increased to $4.5 million in the nine months ended
September 30, 2000 from $3.5 million in the nine months ended September 30,
1999. This increase from the nine months ended September 30, 1999 to the nine
months ended September 30, 2000 was primarily due to the Company's marketing
consulting engagements with AOL.
Cost of Product Revenues
Cost of product revenues represents the actual cost of awards selected by
members in exchange for currency points. Cost of product revenues were $2.7
million in the quarter ended September 30, 2000 compared to $553,000 for the
quarter ended September 30, 1999 and was $4.1 million for the nine months ended
September 30, 2000 compared to
<PAGE>
$738,000 for the nine months ended September 30, 1999. These cost of product
revenues represented 86% and 119% of product revenues for the quarters ended
September 30, 2000 and 1999, respectively, and 85% and 109% for the nine-month
period ended September 30, 2000 and 1999. The increase in cost of product
revenues was a result of the increased redemption of currency points by members,
which was principally related to the increased number of currency points
outstanding.
The negative product margin in the quarter and nine months ended September 30,
1999 was principally related to 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 and nine
months 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 to $10.2 million in the quarter ended September 30,
2000 from $6.2 million in the quarter ended September 30, 1999 and increased to
$26.4 million in the nine months ended September 30, 2000 from $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 $4.8 million, an increase in allocated facilities and office
expenses of $1.3 million, offset by a decrease in advertising and promotions
expenses of $3.2 million associated with the ClickRewards Network. The increase
for the nine-month period relates to increased marketing and consumer support
personnel expenses of $11.5 million, and an increase in allocated facilities and
office expenses of $3.3 million, offset by a decrease in advertising and
promotions expenses of $4.2 million associated with the ClickRewards Network.
Cost of Direct Marketing Services
Cost of direct marketing services consists of costs related to the delivery of
email marketing program services. The cost of direct marketing services was $2.0
million in the quarter ended September 30, 2000 and $3.8 million in the nine
months ended September 30, 2000. These costs are primarily due to business
activity of Post Communications subsequent to the date of acquisition. Costs of
direct marketing services represented 64% and 51% of direct marketing services
revenues for the quarter and nine months ended September 30, 2000, respectively.
Cost of Technical and Marketing Consulting Services Revenues
Cost of technical and marketing consulting services consists of the personnel
and overhead costs incurred in connection with providing technical and marketing
consulting services. Cost of technical and marketing consulting services totaled
$480,000 for the quarter ended September 30, 2000 compared to $880,000 for the
quarter ended September 30, 1999, and was $2.4 million for both the nine months
ended September 30, 2000 and 1999. These expenses were related to technical
consulting services provided by Netcentives Professional Services (formerly the
Panttaja Consulting Group) and delivering marketing consulting services in the
three and nine month periods ended September 30, 2000. Cost of technical and
marketing consulting services were 73% and 81% of technical and marketing
consulting service revenues in the quarters ended September 30, 2000 and 1999
and 53% and 69% for the nine month periods ended September 30, 2000 and 1999,
respectively. This decrease in costs as a percentage of revenues was due to the
Company utilizing fewer high-cost consultants and achieving a higher rate of
utilization on its internal resources in the quarter and nine months ended
September 30, 2000 as compared to the comparable periods ended September 30,
1999.
<PAGE>
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 to $3.4 million in the
quarter ended September 30, 2000 from $1.5 million in the quarter ended
September 30, 1999 and increased to $8.0 million in the nine months ended
September 30, 2000 from $3.4 million in 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 development efforts
relating to our Custom Loyalty Networks and Enterprise Incentive programs, the
addition of Post Communications in the second quarter of 2000. The largest
component of the increases was the growth in compensation and related staff
expenses, which increased by $1.5 million for the quarter ended September 30,
2000 and $2.8 million for the nine-month period ended September 30, 2000. 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.
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 to $10.3
million in the quarter ended September 30, 2000 from $2.9 million in the quarter
ended September 30, 1999 and increased to $24.5 million in the nine months ended
September 30, 2000 from $6.4 million in the nine months ended September 30,
1999. The increase from period to period was primarily the result of increased
sales efforts to enroll merchants into the ClickRewards Network, increased
business development efforts for our Custom Loyalty Networks and Enterprise
Incentive programs, increased general and administrative personnel and increased
facilities and office costs and the addition of Post Communications in the
second quarter of 2000. The largest components of the increase were the growth
in compensation expense and related staff costs as a result of increased
staffing levels which increased by $6.3 million for the quarter ended September
30, 2000, compared to September 30, 1999, and the growth in the facilities and
office costs which increased by $600,000 from the quarter ended September 30,
2000, compared to September 30, 1999. The largest component of the increase for
the nine-month period ended September 30, 2000 compared to September 30, 1999
was also staff costs, which increased by $13.1 million. There was also an
increase of $1.8 million in facilities and office expenditures for the nine
months ended September 30, 2000 compared to the same period in 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, Custom Loyalty, and Enterprise Incentive programs and our
direct marketing services, our expansion into international markets and our
operation as a public company.
Amortization of Deferred Stock Compensation, Supplier and Other Stock
Arrangements 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 $847,000 and $2.7 million in the quarter and nine months ended
September 30, 2000, respectively, compared to $911,000 and $2.0 million in the
quarter and nine months ended September 30, 1999, respectively. These amounts
primarily resulted from amortization of deferred stock compensation related to
stock option grants and stock awards granted in 1998 and 1999.
Amortization of supplier and other stock arrangements represents the cost of
warrants granted to certain airlines and other rewards suppliers in return for
exclusivity and the cost of stock issued related to the ICQ ClickRewards
program. Expense related to contingent stock warrants granted to certain
airlines and other partners and the stock issued related to the ICQ ClickRewards
program was $5.1 million and $10.9 million in the quarter and nine months ended
September 30, 2000, respectively, and was $610,000 and $1.6 million for the
quarter and nine months ended September 30, 1999, respectively. Because the
vesting of certain of these awards is subject to these rewards suppliers
maintaining the exclusivity of the arrangement with Netcentives, the valuation
of the warrants is not
<PAGE>
finalized until the vesting date. A substantial number of these warrants had not
vested as of September 30, 2000. As a result, the charge relating to supplier
stock awards may 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. In January 2000,
we acquired MaxMiles in a transaction accounted for as a purchase. The resulting
intangibles of $11.6 million recorded in the acquisition are being amortized
over an estimated useful life of three years. In March 2000, we acquired UVN in
a transaction accounted for as a purchase. The resulting intangibles of $25.5
million recorded in the acquisition are being amortized over an estimated useful
life of five years. In April 2000, we acquired Post Communications in a
transaction accounted for as a purchase. The resulting intangibles of $309.0
million recorded in the acquisition are being amortized over an estimated useful
life of four years. In the quarter and nine months ended September 30, 2000, we
incurred $22.0 million and $45.5 million of expense related to amortization of
these intangibles. In the quarter and nine months ended September 30, 1999, we
incurred $449,000 and $1.3 million of expense related to amortization of these
intangibles.
Interest Income, Net
Interest income primarily represents interest earned on short-term investments
in highly-liquid debt instruments with a maturity at the time of purchase of
three months or less. Interest income, net, increased to $852,000 for the
quarter ended September 30, 2000 from $376,000 for the quarter ended September
30, 1999. Interest income, net, increased from $2.7 million for the nine months
ended September 30, 2000 to $823,000 for the nine months ended September 30,
1999. The increase was a result of increased interest income to $1.0 million and
$3.3 million for the quarter and nine months ended September 30, 2000,
respectively, from $467,000 and $1.0 million for the quarter and nine months
ended September 30, 1999. This increase was related to increased cash and short-
term investment balances, offset in part by an increase in interest expense
relating to capital leases and other financing arrangements to $177,000 and
$612,000 in the quarter and nine months ended September 30, 2000, respectively,
from $91,000 and $197,000 for the comparable periods in 1999.
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 quarter and nine months ended September 30, 2000 and 1999.
Net Loss
Net loss increased to $44.3 million from $11.6 million in the quarter ended
September 30, 2000 and 1999. Net loss increased to $100.2 million from $27.7
million in the nine months ended September 30, 2000 and 1999. The increases in
net loss were primarily due to an increase in operating costs and expenses to
$57.0 million and $128.3 million in the quarter and nine months ended September
30, 2000, respectively, compared to $14.0 million and $33.6 million in the
quarter and nine months ended September 30, 1999.
Liquidity and Capital Resources
Prior to our initial public offering in October 1999, we had funded our
operations primarily through the private placement of preferred equity
securities, through which we had raised net proceeds of $63.7 million through
October 1999. We raised approximately $68.8 million in our initial public
offering in October 1999. We have also financed our operations through equipment
lease financing and bank borrowings. As of September 30, 2000, we had
outstanding equipment lease financing and bank borrowings totaling $4.4 million
and note payables totaling $2.0 million. We have no other available lines of
credit or credit available under existing arrangements.
Cash used in operations was $18.4 million and $11.0 million in the nine months
ended September 30, 2000 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 $35.0 million and $9.6
million in the nine months ended September 30, 2000 and 1999, respectively,
offset by cash paid to suppliers and employees of $56.0 million and $21.5
million in the same periods.
<PAGE>
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 consumer redeems the
currency. 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 $15.7 million for the nine months ended September 30,
2000 compared to $4.9 million for the same period in 1999.
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 acquisition of
Panttaja Consulting Group, MaxMiles, UVN and Post Communications, and the use of
ClickMiles in lieu of cash to pay for certain expenses. Non-cash amortization
charges totaled $64.2 million in the nine months ended September 30, 2000 and
$6.6 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 $1.9 million and $3.4 million during the nine months ended September
30, 2000 and 1999, respectively.
Investments in property and equipment were $16.7 million and $6.2 million in the
nine months ended September 30, 2000 and 1999, respectively. This increase was
due to additional capital expenditures incurred as a result of the build-out and
furnishing of the Company's new headquarters and due to the Company's purchasing
more equipment as a result of headcount increases. Cash provided by financing
activities was $1.0 million and $34.2 million in the nine months ended September
30, 2000 and 1999, respectively. Cash was provided primarily by sales of
preferred stock of $35.1 million in the nine months ended September 30, 1999.
At September 30, 2000, we had 710.5 million currency points (including
ClickMiles (which are issued in the ClickRewards and Enterprise Incentive
programs), Custom Loyalty program points and Momentum program points)
outstanding which had been sold to merchants and clients (of which 569.0 million
had been awarded to members and are in circulation). The September 30, 2000
balance sheet includes $13.4 million of deferred revenues relating to the
product component of this currency, which will be recognized as revenue at the
time of redemption. Other than barter exchanges, we have already received cash
from our merchants and clients relating to these points, which is unrestricted
and which we can use for any corporate purpose. In addition, an additional 122.3
million currency points that had been issued by us to pay for expenses in lieu
of cash were outstanding. As of September 30, 2000, we had an accrued liability
of approximately $2.3 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 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, 2000, we had cash and equivalents totaling $46.9 million, short
term investments totaling $6.5 million and restricted marketable securities
totaling $11.9 million. 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
<PAGE>
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.
Recent Accounting Pronouncements
In June 1998 and June 1999, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for
Derivative Instruments and Hedging Activities" and Statement of Financial
Accounting Standards No. 137 (SFAS 137), "Deferral of the Effective Date of SFAS
133," respectively. SFAS 133 and SFAS 137 require the recognition of all
derivatives as either assets or liabilities in the statement of financial
position, and to measure those instruments at fair value, and are effective for
all fiscal years beginning after June 15, 2000 with earlier adoption encouraged.
As of September 30, 2000, the Company was not party to derivative instruments
or hedging activities that would require the application of SFAS 133.
In December 1999, the Securities and Exchange Commission issue Staff Accounting
Bulletin No. 101 ("SAB 101"), "Revenue Recognition," which provides guidance on
the recognition, presentation and disclosure of revenue in financial statements
filed with the Securities and Exchange Commission. SAB 101 outlines the basic
criteria that must be met to recognize revenue and provides guidance for
disclosures related to revenue recognition policies. SAB 101 is effective for
the fiscal quarter beginning October 1, 2000, although earlier adoption is
permitted. The Company has not yet determined the impact, if any, that adoption
will have on the consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We had no holdings of derivative financial or commodity instruments at September
30, 2000. 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, 2000, 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, 2000, 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.
Expected Estimated Fair Value
Maturity 2000 at September 30, 2000
------------- ---------------------
Federal instruments $ 6,962 $ 6,962
Weighted average fixed interest rate 6.37%
Commercial paper & short-term obligations 39,945 39,945
Weighted average fixed interest rate 6.54%
Total portfolio $ 46,907 $ 46,907
investment portfolio.
As of September 30, 2000, we had $46.9 million of cash and cash equivalents
earning a weighted average variable interest rate of 6.52%.
Part II. Other Information
Item 1. Legal proceedings
In February, March and July 2000, the Company filed suit in the Federal District
Court in the Northern District of California against eleven parties seeking
monetary damages and injunctive relief based on each party's alleged
infringement of certain patents held by the Company. This litigation is pending
although one of the defendants has subsequently licensed the subject patents and
has been dismissed from the suit. A default was entered against another
defendant. In July 2000, another of the
<PAGE>
defendants, Carlson Companies, Inc.'s subsidiaries and affiliates ("Carlson"),
filed a claim against the Company in the Federal District Court in the District
of Minnesota seeking a declaratory judgment alleging (a) that Carlson is the
owner of the Company's patents at issue based on the inventor's earlier
employment at Carlson, (b) in the alternative, that the Company's patents are
invalid and unenforceable and (c) in the alternative, that Carlson is not
infringing the Company's patents. Legal proceedings tend to be unpredictable and
costly and may be affected by events outside the control of the Company. In the
event that a final unappealable judgment were made that the Company's patents
are owned by Carlson, such ruling could have a material adverse effect on the
Company's financial position and results of operations. Due to the nature of the
litigation with Carlson and because the lawsuit is still in the initial stage,
the Company's management cannot estimate the total expenses, the possible loss,
if any, or the range of loss that may ultimately be incurred in connection with
Carlson's allegations. Although no assurances can be given as to the results of
this case, the Company believes it has meritorious defenses and intends to
defend itself vigorously in the matter.
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
underwriters' 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 $1.9
million in other related expenses, the net proceeds of the offering were
approximately $68.8 million. Of such amount, approximately $31.9 million has
been used for working capital, approximately $2.5 million has been used for debt
repayment, approximately $9.3 million has been used for acquisitions and the
remainder has been invested in investment grade, interest bearing securities.
The Company intends to use the remaining proceeds for capital expenditures and
for general corporate purposes, including working capital to fund anticipated
operating losses.
<PAGE>
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits
3.1* Amended and Restated Certificate of Incorporation of the
Registrant.
3.2* Bylaws of the Registrant.
27.1 Financial Data Schedule
___________________
* Incorporated by reference to the exhibit with the same numerical designation
filed as part of the Registrant's Registration Statement 333-83443, as amended,
declared effective on October 19, 1999.
b) Reports on Form 8-K
None
<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 14, 2000 NETCENTIVES INC.
By /s/ John F. Longinotti
-------------------------
John F. Longinotti
COO and Chief Financial Officer
(Principal Financial and Accounting Officer)
<PAGE>
Exhibit Index
Exhibit No. Description
---------- -----------
27.1 Financial Data Schedule.
