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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2000
COMMISSION FILE NUMBER 000-28369
ANDOVER.NET, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 04-3153168
(STATE OR OTHER JURISDICTION (IRS EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
50 NAGOG PARK, ACTON, MA 01720
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(978) 635-5300
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
The number of shares outstanding of the registrant's Common Stock, $.01 par
value as of May 8, 2000 was 16,345,876.
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ANDOVER.NET, INC.
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
PAGE
----
PART I FINANCIAL INFORMATION....................................... 3
Item 1. Financial Statements 3
Condensed Consolidated Balance Sheets at March 31, 2000 and
December 31, 1999 3
Condensed Consolidated Statements of Operations for the
three months ended March 31, 2000 and March 31, 1999 4
Condensed Consolidated Statements of Cash Flows for the
three months ended March 31, 2000 and March 31, 1999 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 Disclosure About Market
Risks 16
PART II OTHER INFORMATION 16
Item 1. Legal Proceedings 16
Item 2. Changes in Securities and Use of Proceeds 16
Item 3. Defaults upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K 16
Signatures 17
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PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ANDOVER.NET, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
MARCH 31, DECEMBER 31,
2000 1999
--------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $73,030 $78,409
Restricted cash 606
Accounts receivable, net 1,329 1,084
Inventories 149 124
Other current assets 1,018 593
--------- ----------
Total Current Assets 75,526 80,816
Property and equipment, net 1,926 457
Other Assets:
Intangible assets 11,331 2,959
Other 148 185
--------- ----------
Total Other Assets 11,479 3,144
--------- ----------
Total Assets $88,931 $84,417
========= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $1,170 $344
Amounts due to stockholders 606
Accrued expenses 616 462
Long-term debt - Current Portion 1,568 1,163
--------- ----------
Total Current Liabilities 3,354 2,575
Long-term debt 816
Stockholders' equity:
Common stock 160 158
Additional paid in capital 116,267 110,116
Deferred stock-based compensation (4,042) (4,281)
Accumulated deficit (27,624) (24,151)
---------- ----------
Total Stockholders' equity 84,761 81,842
---------- ----------
Total liabilities and stockholders' equity $88,931 $84,417
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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ANDOVER.NET, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
Three Months Ended
March 31, 2000 March 31, 1999
-------------- --------------
<S> <C> <C>
Net revenues:
Advertising $ 1,678 $ 253
Barter advertising 529 0
E-commerce 605 0
------- ------
Total revenues 2,812 253
Cost of revenues:
Editorial content and related 451 147
E-commerce 283 0
------- ------
Total cost of revenues 734 147
------- ------
Gross profit 2,078 106
Operating expenses:
Sales and marketing 1,405 369
General and administrative 1,603 236
Research and development 541 160
Barter advertising 529 0
Amortization of deferred stock-based compensation 238 16
Amortization of intangible assets 1,209 0
Compensation expense related to acquisitions 999 0
------- ------
Total operating expenses 6,524 781
------- ------
Loss from operations (4,446) (675)
Interest income, net 973 28
------- ------
Net loss (3,473) (647)
------- ------
Accrued dividends on redeemable preferred stock 86
------
Net loss attributable to common shareholders ($3,473) ($733)
------- ------
Basic and diluted net loss per share applicable to
common shareholders ($0.22) ($0.09)
======= ======
Basic and diluted weighted average shares outstanding 15,862 7,804
======= ======
</TABLE>
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ANDOVER.NET, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
3 Months Ended 3 Months Ended
31-Mar-2000 31-Mar-1999
-------------- --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ($3,473) ($647)
Adjustments to reconcile net loss to net cash used in operating activities--
Depreciation and amortization 1,306 12
Amortization of deferred stock-based compensation 238 16
Amount related to beneficial conversion of Series B preferred stock
Compensation related to stock options issued to non-employees
Compensation expense related to acquisitions (526)
Non-cash interest expense 22
Changes in operating assets and liabilities--
Accounts receivable (245) 92
Inventories (25) --
Other current assets 83 (40)
Accounts payable 826 9
Accrued expenses 172 64
------- ------
Net cash used in operating activities (1,622) (494)
------- ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash paid for acquisitions (2,197)
Purchases of property and equipment (1,565) (44)
Net increase in other assets 286 (35)
------- ------
Net cash (used in) provided by investing activities (3,477) (79)
------- ------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock, net of issuance costs 6 99
Redemption of Series A redeemable preferred stock
Amounts due to stockholders (606)
Payment on notes relating to acquisitions (286)
------- ------
Net cash provided by (used in) financing activities (886) 99
------- ------
Net increase (decrease) in cash and cash equivalents (5,985) (474)
Decrease (increase) in restricted cash 606
Cash and cash equivalents, beginning of period 78,409 2,676
------- ------
Cash and cash equivalents, end of period $73,030 $2,202
======= ======
Cash paid for interest 24 --
======= ======
Notes payable and accrued interest recorded in connection with acquisitions 1,507 --
======= ======
Common stock issued in connection with acquisitions 6,172 --
======= ======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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ANDOVER.NET, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2000
(UNAUDITED)
(1) BASIS OF PRESENTATION
In the opinion of management, the accompanying consolidated condensed financial
statements have been prepared in conformity with generally accepted accounting
principles and include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation. The results of operations for
the three-month periods ended March 31, 2000 are not necessarily indicative of
the results to be expected for the full year. It is suggested that these interim
consolidated condensed financial statements be read in conjunction with the
audited consolidated financial statements for the period ended December 31,
1999, which are contained in the Company's Form 10-K filed with the Securities
and Exchange Commission on March 30, 2000.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Advertising revenues are derived from the sale of advertising space on
Andover.Net's various Web sites. Advertising revenues are recognized over the
period in which the advertisements are displayed, provided that no significant
obligations remain and collection of the receivable is reasonably assured.
Andover.Net's obligations typically include guarantees of a minimum number of
"impressions" (times that an advertisement is viewed by users of Andover.Net's
online services over a specified period of time). To the extent that minimum
guaranteed impressions are not met, Andover.Net does not recognize the
corresponding revenues until the guaranteed impressions are achieved.
Andover.Net has adopted Emerging Issued Task Force (EITF) Issue 93-11,
Accounting for Barter Transactions Involving Barter Credits, to account for
barter transactions. Revenues from barter transactions are recorded at the lower
of the estimated fair value of the advertisements, goods or services received or
the estimated fair value of the advertisements given. Andover.Net records barter
revenues only on the portion of the barter transactions for which Andover.Net is
able to determine fair value based on comparable cash transactions and for which
the advertiser has the financial ability to pay cash. Otherwise, barter revenue
is not recognized. Revenues from barter transactions, representing advertising
space given, is recognized as income when advertisements are delivered on
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Andover.Net's Web site. Barter expense, representing advertising space received,
is recognized when Andover.Net advertisements are run on other companies' Web
sites, which is typically in the same period when the related barter revenue is
recognized. Andover.Net recognized $0 and $529,000 of barter revenue for the
three months ended March 31, 1999 and 2000, respectively.
E-commerce revenue from the sale of software animation and e-commerce
merchandise, is recognized upon shipment of the products, net of estimated
returns. There is no technical support provided for any software animation
products.
Andover.Net derived revenue from Web-related software products during 1997
for use on desktop computers. Revenue from the licensing of software products
was recognized when the products were shipped, as there were no significant post
delivery obligations. Andover.Net provided for estimated returns and warranty
costs at the time of sale. Andover.Net did not offer maintenance and support on
its products. There were no significant software sales after fiscal 1997.
Net Loss Per Share
Basic and diluted net loss per common share is computed using the weighted
average number of shares of common stock outstanding during the period.
Potentially dilutive shares outstanding have been excluded because their effect
would be antidilutive.
Shares under option plans that were antidilutive for all periods presented
are as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
March 31,
--------------------
2000 1999
---- ----
<S> <C> <C>
Shares under option plans excluded in computation
of diluted earnings per share, due to
antidilutive effects............................ 1,613 1,109
===== =====
</TABLE>
Comprehensive Income
Comprehensive income includes all changes in equity during a period, except
those resulting from investments by owners and distributions to owners. For the
three months ended March 31, 1999 and 2000, Andover.Net's comprehensive loss is
the same as its reported net loss.
(3) MERGER AGREEMENT
On February 2, 2000, Andover.Net entered into a merger agreement (the
Transaction) with VA Linux Systems, Inc. (VA Linux), whereby VA Linux will
effectively acquire all common shares of Andover.Net. In connection with the
Transaction, each share of Andover.Net common stock will be exchanged for 0.425
of a share of VA Linux common stock as provided for in the transaction. The
transaction is subject to approval by the stockholders of Andover.Net and
customary closing conditions.
(4) INITIAL PUBLIC OFFERING
On December 8, 1999, the Company completed its initial public offering (the
Offering) of 4,600,000 shares of its common stock, including 600,000 shares
issued in connection with the exercise of the underwriters' overallotment option
on the
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date of the Offering. The shares were offered to the public at a price of
$18 per share. The proceeds to the Company from the offering, net of offering
expenses and the $1.17 per share underwriting discount, were approximately
$77,418,000. Concurrent with the Offering, all of the Series A Redeemable
Preferred Stock was redeemed for $4,874,000. Additionally, all of the Series B
Redeemable Convertible Preferred Stock was converted into 3,017,134 shares of
common stock on the date of the Offering. This conversion resulted in an
interest charge of $12,214,000 caused by the beneficial conversion of the Series
B preferred shares. For complete information regarding the Offering, see the
Company's prospectus dated December 8, 1999.
(5) ACQUISITION
On February 7, 2000, Andover.Net entered into a stock purchase agreement to
acquire all outstanding shares of QuestionExchange, Inc. for $12,500,000 in
Andover.Net common stock and cash. QuestionExchange provides a forum for
individuals who have questions regarding information technology to be connected
with individuals who can answer those questions.
The purchase price consists of $8,170,000 to be paid in common stock and
cash upon the closing of the agreement. Additional cash payments of
approximately $1,750,000 will be paid over the next three years. Additionally,
there are contingent stock payments totaling $2,500,000 based on meeting certain
financial targets. Additional contingent payments of $80,000 will be payable
over two years contingent on the continued employment of certain sellers.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Factors That May Affect Future Results
This report contains certain forward-looking statements (as such term is
defined in Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934) and information relating to the Company that
are based on the beliefs of the management of the Company as well as assumptions
made by and information currently available to the management of the Company
including statements related to the growth of the Company's business. In
addition, when used in this report, the words "likely," "will," "suggests,"
"target," "may," "would," "could," "anticipate," "believe," "estimate,"
"expect," "intend," "plan," "predict" and similar expressions and their
variants, as they relate to the Company or the management of the Company, may
identify forward-looking statements. Such statements reflect the judgment of the
Company as of the date of this quarterly report on Form 10-Q with respect to
future events, the outcome of which is subject to certain risks, including the
factors set forth in "Risk Factors," which may have a significant impact on the
Company's business, operating results or financial condition. Investors are
cautioned that these forward-looking statements are inherently uncertain. Should
one or more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results or outcomes may vary materially from
those described herein. Although we believe that the expectations reflected in
the forward-looking statements are reasonable, we cannot guarantee future
results, levels of activity, performance or achievements. Moreover, neither we
nor any other person assumes responsibility for the accuracy and completeness of
these forward-looking statements. Andover.Net undertakes no obligation to update
forward looking statements.
The following discussion and analysis should be read in conjunction with
the condensed financial statements and the notes thereto included in Item 1 in
this Quarterly Report and our annual report on Form 10-K filed with the
Securities and Exchange Commission on March 30, 2000.
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OVERVIEW
Andover.Net is a network of web sites that provides an independent,
unbiased source for content, community and commerce for the Linux and, more
generally, the Open Source communities. We provide products, online tools, news
and other services for programmers, software developers, web site designers,
technology managers and corporate buyers.
We were incorporated in Massachusetts in 1992 as Andover Advanced
Technologies, Inc. In September 1999, Andover Advanced Technologies, Inc. was
merged into its wholly owned subsidiary, Andover.Net, Inc., a Delaware
corporation, and we changed our fiscal year end from September 30 to December
31.
Prior to fiscal 1996, we were a software publisher of multimedia and web
authoring tools. We derived revenues from licensing; developing, marketing and
distributing packaged multimedia software, primarily to large distributors and
retailers. In fiscal 1996, we launched our first web site, DaveCentral.com.
During fiscal 1997, we transitioned from a software publisher to a web site
publisher to participate in the commercial opportunities emerging on the
Internet. Since March 1997, all of our activities have been focused on expanding
our Internet business.
We currently generate revenue from advertisements on our network of web
sites and from e-commerce. Advertising revenues of $1,678,093 represented 59.7%
of total net revenues during the quarter ended March 31, 2000. Advertising
revenues of $253,000 represented 100.0% of total net revenues during the quarter
ended March 31, 1999. Our current advertising products include standard banner
advertising, display advertisements, megabanners and web site and newsletter
sponsorships. We recognize advertising revenue in the period that the
advertising is displayed, provided that we deem the collectibility of the
resulting receivable as probable. We sell advertising through our nationwide
direct sales force.
We enter into barter transactions with other web sites in order to increase
traffic to our network of web sites and to strengthen the Andover.Net brand. A
barter transaction is the exchange by us of advertising space on our web sites
for reciprocal advertising space on the web sites of others. We record revenues
only on the portion of our barter transactions for which we are able to
determine fair value and for which the advertiser has the financial ability to
pay cash. To make the determination of whether the advertiser could pay cash,
Andover.Net reviews the current liquidity of the advertiser based on recent
public disclosures. Only advertisers with exceptional liquidity positions are
considered when recognizing barter revenue. We record revenue from these barter
transactions, and the corresponding advertising expense, based upon the fair
market value of the advertising space exchanged. Revenues from barter
transactions, representing advertising space given, is recognized as income when
advertisements are delivered on our network. Barter expense, representing
advertising space received, is recognized when our advertisements are run on
other companies' web sites, which is the same period when the related barter
revenue is recognized. We recognized $529,429 in barter revenues, which
represented 18.8% of total net revenues and $529,429 in barter expenses, which
represented 8.1% of total operating expenses, for the quarter ended March 31,
2000. For the quarter ended March 31, 1999, no barter revenues or expenses were
recognized.
E-commerce revenues related to the online sale of compact discs of animated
graphics and subscriptions to our animations archives online at
mediabuilder.com. Linux/Open Source related gifts, books and paraphernalia are
sold on thinkgeek.com. E-commerce revenues of $604,962 represented 21.5% of net
revenues for the quarter ended March 31, 2000. There were no E-commerce revenues
for the quarter ended March 31, 1999.
Revenue from e-commerce products and the online sale of compact discs of
animated graphics, for which no technical support is provided, are generally
recognized upon shipment of the products, net of estimated
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returns. We intend to increase e-commerce revenues by adding additional
merchandise to our e-commerce sites and through additional acquisitions.
We have incurred significant losses since our inception. As of March 31,
2000, we had an accumulated deficit of $27.6 million. We anticipate incurring
additional expenses to increase our product development and sales and marketing
efforts, to pursue additional strategic acquisitions and to support the growth
of the organization. As a result, we believe that we will incur additional
losses in the foreseeable future.
RECENT DEVELOPMENTS
Acquisition by VA Linux Systems. On February 2, 2000, we entered into a
merger agreement (the Transaction) with VA Linux Systems, Inc. (VA Linux),
whereby VA Linux will effectively acquire all common shares of Andover.Net. In
connection with the Transaction, each share of Andover.Net common stock will be
exchanged for 0.425 of a share of VA Linux common stock. The transaction is
subject to approval by the stockholders of Andover.Net and customary closing
conditions.
On December 8, 1999, Andover.Net completed its initial public offering
("Offering") of 4,600,000 shares of its common stock, including 600,000 shares
issued in connection with the underwriter's overallotment option on the date of
the Offering. The shares were offered to the public at a price of $18 per share.
The proceeds from the Offering, net of offering expenses and the $1.17 per share
underwriting discount, were approximately $77,418,000. Concurrent with the
Offering, all of the Series A Redeemable Preferred Stock was redeemed for
$4,874,000.
Acquisition of QuestionExchange, Inc. On February 7, 2000, we entered into
a stock purchase agreement to acquire all outstanding shares of
QuestionExchange, Inc. for $12,500,000 in Andover.Net common stock and cash.
QuestionExchange provides a forum for individuals who have questions regarding
information technology to be connected with individuals who can answer those
questions. The purchase price consists of $8,170,000 to be paid in common stock
valued at $32 per share and cash upon the closing of the agreement. Additional
cash payments of approximately $1,750,000 will be paid over the next three
years. Additionally, there are contingent stock payments totaling $2,500,000
based on meeting certain financial targets. Additional contingent payments of
$80,000 will be payable over two years contingent on the continued employment of
certain sellers.
Our recent acquisitions and licensing agreements have resulted in increased
page views on our network of web sites and we anticipate that our network's page
views, and therefore, our total net revenues, will continue to increase as a
result of these and future acquisitions.
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RESULTS OF OPERATIONS
The following table sets forth certain statements of operations data as a
percentage of revenues for the periods indicated:
<TABLE>
<CAPTION>
PERCENTAGE OF NET REVENUE
-------------------------
THREE MONTHS ENDED
------------------
MARCH 31, MARCH 31,
2000 1999
-------- --------
<S> <C> <C>
Net revenues 100.0% 100.0%
Cost of revenues 26.1 58.1
----- -----
Gross margin 73.9 41.9
Operating expenses:
Sales and marketing 68.8 145.8
General and administrative 57.0 93.3
Research and development 19.2 63.2
Amortization of deferred stock
based compensation 8.5 6.3
Amortization of intangible assets 43.0 --
Compensation related to acquisitions 35.5 --
----- -----
Total operating expenses 232.0 308.7
----- -----
Loss from operations (158.1) (266.8)
Interest and other income (expense),
net 34.6 11.1
----- -----
Net loss (123.5) (255.7)
----- -----
Dividend related to convertible
preferred stock -- 34.0
----- -----
Net loss attributable to common
stockholders (123.5%) (289.7%)
===== =====
</TABLE>
THREE MONTHS ENDED MARCH 31, 2000 AND MARCH 31, 1999
Revenues. Substantially all of the total net revenues for the quarter ended
March 31, 2000 and the quarter ended March 31, 1999 were from advertisements on
our network of web sites. In the quarter ended March 31,2000, our total net
revenues also included $605,000 of e-commerce revenue. There was no e-commerce
revenue in the quarter ended March 31, 1999. Total net revenues increased 663.2%
from $253,000 in the quarter ended March 31, 1999 to $2.8 million in the quarter
ended March 31, 2000. The increase was primarily due to an increase in banner
advertising and sponsorships on our network of web sites, the advertising
revenue attributed to the acquisitions of Slashdot.org, Animation Factory and
Freshmeat.net and the e-commerce revenue. Barter advertising was $529,000 or
18.8% of total net revenues in the quarter ended March 31, 2000. There was no
barter revenue in the quarter ended March 31, 1999.
Cost of Revenues. Cost of revenues primarily consists of expenses
associated with editorial content, communications infrastructure, and web site
hosting. Our web site hosting expenses include expenses associated with our
ownership and leasing of servers and media fees. Cost of revenues increased from
$147,000, or 58.1% of revenues, in the quarter ended March 31, 1999 to $734,000,
or 26.1% of revenues, in the quarter ended March 31, 2000. The increase in cost
of revenues reflects additional operations personnel and expenses for freelance
contributors for editorial content, as well as higher costs for hosting our
network of web sites, which includes expenses for our server leases. We
anticipate that cost of revenues will continue to increase in absolute dollars
as we continue to enhance our content
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offerings and services and expand the number of data centers hosting our web
sites. The cost of revenues will also continue to increase as we expand our
e-commerce merchandise.
Sales and Marketing Expenses. Sales and marketing expenses primarily
consist of advertising and promotional expenditures and payroll, sales
commissions and related expenses for personnel engaged in sales and marketing
activities. Sales and marketing expenses increased from $369,000, or 148.8% of
revenues, in the quarter ended March 31, 1999 to $1,405,000, or 50.0% of
revenues, in the quarter ended March 31, 2000. The increase in expenses relates
to added sales personnel and an increase in advertising and promotional
expenses. We anticipate our sales and marketing expenses will substantially
increase in the future as we continue to expand our direct sales force and
invest in advertising and promotions to strengthen the Andover.Net brand.
General and Administrative Expenses. General and administrative expenses
primarily consist of payroll and related costs of management and administrative
personnel, as well as professional fees and facility costs. General and
administrative expenses increased from $236,000, or 93.3% of revenues, in the
quarter ended March 31, 1999 to $1,603,000, or 57.0% of revenues, in the quarter
ended March 31, 2000. The increase in expenses largely reflects the hiring of
additional management and administrative personnel. We anticipate that our
general and administrative expenses will continue to increase in absolute
dollars as we continue to hire additional personnel.
Research and Development Expenses. Research and development expenses
primarily consist of payroll and related costs for developing our web sites,
including our internal banner advertising and page statistic systems, as well as
developing our e-Tools, our free software products that help our web site
visitors build their own web sites. Research and development expenses increased
from $160,000, or 63.2% of revenues, in the quarter ended March 31, 1999 to
$541,000, or 19.2% of revenues, in the quarter ended March 31, 2000. The
increase in research and development expenses largely reflects additions to our
research and development staff of direct and contract personnel. We anticipate
that these expenses will increase significantly as we continue to expand our
technical staff to handle the integration of future acquisitions and development
of new systems and e-Tools.
Barter Advertising Expenses. For the quarter ended March 31, 1999,
there were no barter advertising costs. For the quarter ended March 31, 2000
there were barter advertising costs of $529,000, or 18.8% of revenues.
Amortization of Deferred Stock-Based Compensation. Amortization expense of
deferred stock-based compensation represents the vested portion of stock options
that were granted to certain employees at exercise prices below the estimated
fair valve. Amortization expense for the quarter ended March 31, 1999 was
$16,000, or 6.3% of revenues as compared to $238,000, or 8.5% of revenues in the
quarter ended March 31, 2000.
Amortization of Intangible Assets. Amortization expense of intangible
assets relates to the intangible assets of acquisitions. These intangible assets
include goodwill, covenants not to compete, trademarks and animation libraries.
There was no amortization expense for the quarter ended March 31, 1999 as
compared to $1,209,000, or 43.0% of revenues in the quarter ended March 31,
2000.
Compensation Expense Related to Acquisitions. Compensation expense related
to acquisitions consists of the cash and stock payments related to acquisitions
that are contingent solely on the continued employment of certain key employees
of those acquisitions. These payments are considered by Andover.Net for
accounting purposes to be compensation for services performed by these key
individuals. There was no expense for the quarter ended March 31, 1999 as
compared to $999,000, or 35.5% for the quarter ended March 31, 2000.
Interest Income and Expense. Interest income increased from $28,000 in the
quarter ended March 31, 1999, or 11.1% of revenues to $973,000, or 34.6% of
revenues in the quarter ended March 31, 2000. The increase in interest income
reflects the higher average cash balances resulting from the initial public
offering.
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Provision for Income Taxes. We had no provision for income taxes for the
quarters ended March 31, 1999 and 2000 because we incurred losses during these
periods.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2000, we had $73.0 million in cash and cash equivalents,
total current assets of $75.5 million and working capital of $72.1 million. We
completed an initial public offering of our common stock on December 8, 1999. We
received proceeds of $77.4 million from the issuance of 4.6 million shares of
our common stock. In September 1999, we issued 600,568 shares of Series B
convertible preferred stock. We received proceeds of $10.1 million from the
issuance of the 480,354 shares of Series B convertible preferred stock to a new
investor. In addition, we issued 120,214 shares of Series B convertible
preferred stock upon conversion of approximately $2.1 million of principal and
interest under convertible notes that were issued to existing shareholders in
June 1999.
Net cash used in operating activities was $494,000 in the quarter ended
March 31, 1999 and $1.6 million in the quarter ended March 31, 2000. The net
cash used in operating activities for these periods was primarily a result of
our operating losses before non-cash expenses.
Cash used for additions to property and equipment was $79,000 in the
quarter ended March 31, 1999 and $3,5 million for the quarter ended March 31,
2000. Additions to property and equipment consisted of leasehold improvements,
furniture and office equipment for our leased office space, as well as computer
equipment necessary to support personnel additions.
In June 1999, we paid $1.75 million in cash at closing for our acquisitions
of Slashdot.org ($1.5 million) and Animation Factory ($250,000). Under the terms
of the Slashdot.org acquisition, there are additional contingent cash payments
of up to $1.5 million in January 2000, $1.0 million in June 2000 and $1.0
million in June 2001. The amount of each of these cash payments is dependent on
the continued employment of two key employees of Slashdot.org. In addition, the
acquisition price of Slashdot.org includes the issuance of $2.0 million of stock
valued at the initial public offering price upon the closing of this offering
and contingent payments of up to an additional $5.0 million of stock valued at
the initial public offering price and payable in installments over a two-year
period, following this offering. The payment of this stock consideration is
contingent upon the continued employment of the key employees of Slashdot.org
and the achievement of certain performance milestones relating to traffic on the
web site over the two-year period. Under the terms of the Animation Factory
acquisition, there are additional cash payments totaling $1.25 million, payable
in 15 equal monthly installments beginning October 1999. This amount payable of
$1.2 million as of September 30, 1999, representing future cash payments less
interest, is reflected in current liabilities for $910,000 and in long-term
liabilities for $244,000. In addition, the acquisition price of Animation
Factory includes the issuance of $200,000 of stock valued at the initial public
offering price upon the closing of this offering and contingent payments of up
to an additional $400,000 of stock valued at the initial public offering price
and payable in installments over a two-year period following this offering. The
payment of this stock consideration is contingent upon the continued employment
of the two key employees of Animation Factory and the achievement of certain
performance milestones relating to sales and traffic on the web site over the
two-year period.
As of March 31, 2000, we have intangible assets of $11.3 million,
consisting primarily of goodwill relating to the acquisitions of Slashdot.org,
Freshmeat.net, Animation Factory, and QuestionExchange.
The purchase price for these acquisitions represents the up-front cash
payment for both acquisitions, as well as the installment cash payments due
under
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the Animation Factory acquisition. The intangible assets will be amortized over
a three-year period on a straight-line basis. The future contingent cash
payments under the Slashdot.org acquisition, as well as the future contingent
stock payments under both acquisitions that are directly based on continued
employment, will be charged to operations over the period the payments are made.
The future contingent stock payments that are based on the achievement of future
milestones and the continued employment of the key employees will be recognized
upon the achievement of these milestones.
We currently anticipate that available funds as of March 31, 2000 will be
sufficient to meet our anticipated cash requirements for working capital and
capital expenditures through at least December 31, 2000.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
Although we began operating in May 1992, we only commenced our Internet
focus in March 1997. Prior to that time we were engaged in the business of
software publishing and derived our revenue from sales of packaged software
products. We discontinued this aspect of our business during the second quarter
of fiscal 1997 and commenced our current business, which generates revenues
primarily from advertising sales. Thus, we have a limited operating history in
our current market upon which you can evaluate our business. The limited amount
of information about us makes it difficult for you to predict whether we will be
successful. We are subject to the risks, expenses and uncertainties frequently
encountered by companies in the new and rapidly evolving markets for Internet
products and services.
We have incurred significant operating losses since our inception in 1992.
We had net losses of approximately $3,500,000 for the quarter ended March 31,
2000 and approximately $647,000 for the quarter ended March 31, 1999. We expect
to incur significant losses in the near term as we substantially increase our
sales and marketing, general and administrative, and research and development
expenses. In addition, we are investing considerable resources in our expansion
strategies. As a result, we cannot be certain when or if we will achieve
sustained profitability. Failure to become and remain profitable may materially
and adversely affect the market price of our common stock and our ability to
raise capital and continue operations.
Advertising revenues, including barter advertising, accounted for 78.5% of
our total net revenues for the quarter ended March 31, 2000. As we execute our
Internet strategy, we expect to continue to derive a majority of our revenue
from advertising on our network for the foreseeable future. We may not generate
these revenues if advertisers do not maintain or increase their current levels
of Internet advertising. Advertisers that currently advertise on the Internet
may reduce or eliminate this form of advertising, and advertisers that have
traditionally relied upon other advertising media may be reluctant to begin to
advertise on the Internet.
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Moreover, widespread adoption of currently available software programs that
limit or prevent advertisements from being delivered to an Internet user's
computer would negatively affect the commercial viability of Internet
advertising and would further deter advertisers from increasing or maintaining
current levels of Internet advertising. Our ability to execute our Internet
strategy successfully will suffer if the market for Internet advertising fails
to develop or develops more slowly than expected.
Different pricing models are used to sell advertising on the Internet. It
is difficult to predict which, if any, will emerge as the industry standard. We
currently use two different models to sell advertising. We sell advertisements
such as large and small banner advertisements and display advertisements to
customers on a month-to-month basis. Additionally, we enter into sponsorship
arrangements with some customers that include four to six month agreements, more
complex advertisements and preferential placement on our network. If we cannot
quickly and successfully respond to changes in pricing models for Internet
advertising, or identify and adopt any industry standards that may emerge, we
will not be able to attract a sufficient number of advertising customers, and
our Internet advertising strategy will fail.
We expect that it will be important to our advertisers that we accurately
measure the demographics of the visitors to our network. If we are unable to
provide this demographic data for any reason, or if it becomes costly to do so,
then companies may choose not to advertise on our network or may pay less for
advertising on our network.
While we currently engage in limited e-commerce through our online sales of
animation compact discs and Linux and Open Source related gifts, books and
paraphernalia and subscriptions to animation archives, we intend to expand the
scope of our e-commerce offerings through a combination of internal development
and strategic acquisitions. If our e-commerce strategy does not generate a
significant amount of revenue, then we expect to depend primarily on advertising
revenues for the foreseeable future. As a result, the level of advertising
revenues in each quarter is likely to significantly affect our quarterly
revenues and operating results. Our selling and marketing, general and
administrative, research and development, barter advertising, amortization of
deferred compensation, amortization of intangible assets and compensation
related to acquisitions expenses are based on expectations of future revenues
and are relatively fixed in the short term. Total operating expenses were
approximately $6.5 million during the quarter ended March 31, 2000. If our
advertising and other revenues are lower than expected, we might not be able to
reduce spending proportionately. In addition, we intend to significantly
increase total operating expenses to expand our business. Any shortfall in
revenues would have a direct impact on operating results for a particular
quarter, and these fluctuations could affect the market price of our common
stock.
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Andover.Net operates in a rapidly changing environment that involves a
number of risks and uncertainties, some of which are beyond the Company's
control. In addition to the factors discussed in this report, factors that could
cause or contribute to such differences include, but are not limited to, those
discussed in the "Factors Affecting Andover.Net's Business, Operating Results
and Financial Condition" in Andover.Net's Annual Report of Form 10-K for the
year ended December 31, 1999.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
We have no derivative financial instruments or derivative commodity
instruments in our cash and cash equivalents and investments. We invest our cash
and cash equivalents and investments in short-term, interest-bearing, investment
grade securities. Our transactions are conducted, and our accounts are
denominated, in United States dollars. Accordingly, we are not exposed to
significant foreign currency risk.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities in the
balance sheet and measure those instruments at fair value. Pursuant to SFAS No.
137, Accounting for Derivative Instruments and Hedging Activities -- Deferral of
the Effective Date of FASB Statement No. 133, SFAS No. 133 is effective for all
fiscal quarters of fiscal years beginning after June 15, 2000. SFAS No. 133 is
not expected to have a material impact on Andover.Net's Consolidated Financial
Statements.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position (SOP) 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. SOP 98-1 requires computer
software costs associated with internal use software to be charged to operations
as incurred until certain capitalization criteria are met. SOP 98-1 is effective
beginning January 1, 1999. The adoption of this statement did not have a
material impact on Andover.Net's financial position or consolidated results of
operations.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, Andover.Net is subject to legal proceedings, and claims
in the ordinary course of business. Andover.net is not currently involved in any
legal proceedings that it believes could have, either individually or in the
aggregate, a material adverse effect on its business or financial condition.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NO. TITLE
- ------- -----
27.1 Financial Data Schedule
(b) Reports on Form 8-K
Form 8-K was filed by the Company on February 16, 2000 with respect to the
transaction with VA Linux Systems, Inc.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Andover.Net, Inc.
By: /s/ PETER A. PHELPS
------------------------------------
Name: Peter A. Phelps
Title: Chief Financial Officer,
(Principal Financial Officer)
Date: May 15, 2000
Page 17
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