<PAGE>
UNITED STATES
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 Quarter Ended June 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 001-15715
NETPLIANCE, INC.
Organized in the State of Delaware
Tax Identification No. 74-2902814
7600A North Capital of Texas Highway, Austin, Texas 78731
Telephone No. (512) 493-8300
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 each of the issuer's classes of common
stock as of July 31, 2000.
<TABLE>
<CAPTION>
Class Number of Shares
----- ----------------
<S> <C>
Common Stock, $0.01 par value 60,426,036
</TABLE>
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NETPLIANCE, INC.
INDEX
<TABLE>
<CAPTION>
Page
Number
------
<S> <C> <C>
PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements (unaudited)
Condensed Balance Sheets
as of June 30, 2000 and December 31, 1999 1
Condensed Statements of Operations
for the three and six months ended June 30, 2000 and 1999 2
Condensed Statements of Cash Flows
for the six months ended June 30, 2000 and 1999 3
Notes to Condensed Financial Statements 4
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition 9
Item 3. Quantitative and Qualitative Disclosure About Market Risk 25
PART II. OTHER INFORMATION:
Item 6. Exhibits and Reports on Form 8-K 25
Signatures 26
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION.
ITEM 1. FINANCIAL STATEMENTS.
NETPLIANCE, INC.
CONDENSED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents................................... $ 69,752,272 $ 9,563,362
Short-term investments...................................... 58,698,686 --
Accounts receivable......................................... 2,693,990 --
Prepaid expenses............................................ 3,172,852 5,984,595
Other current assets........................................ 4,238,434 514,036
------------- ------------
Total current assets...................................... 138,556,234 16,061,993
------------- ------------
Property and equipment, net.................................. 4,108,805 3,102,629
Other non-current assets..................................... 6,050,725 1,460,561
------------- ------------
$ 148,715,764 $ 20,625,183
============= ============
Liabilities and Stockholders' Equity
Current liabilities:
Trade accounts payable...................................... $ 6,169,034 $ 1,909,487
Accrued liabilities......................................... 8,130,734 2,208,087
Unearned revenue............................................ 1,317,186 --
Current portion of capital lease obligations................. 1,036,943 954,221
------------- ------------
Total current liabilities................................. 16,653,897 5,071,795
Non-current portion of capital lease obligations............. 97,418 636,302
------------- ------------
Total liabilities......................................... 16,751,315 5,708,097
------------- ------------
Deposit received on Series D preferred stock................. -- 2,000,000
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock................................. -- 29,492,885
Common stock................................................ 603,885 189,071
Additional paid-in capital.................................. 319,670,050 41,749,006
Deferred stock option compensation.......................... (19,423,198) (14,164,611)
Stockholder notes receivable................................ (652,800) (821,449)
Accumulated deficit......................................... (168,233,488) (43,527,816)
------------- ------------
Total stockholders' equity................................ 131,964,449 12,917,086
------------- ------------
$ 148,715,764 $ 20,625,183
============= ============
</TABLE>
See accompanying notes to unaudited condensed financial statements.
1
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NETPLIANCE, INC.
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Period from
January 12, 1999
Six months (Inception)
ended through
Three months ended June 30, June 30, June 30,
2000 1999 2000 1999
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C>
Subscription revenue, net $ 1,667,644 $ -- $ 2,299,701 $ --
Peripheral revenue, net 1,262,939 -- 1,922,353 --
------------ ------------ ------------- ------------
Total revenue, net 2,930,583 -- 4,222,054 --
Operating expenses:
Cost of services 6,980,777 -- 11,599,336 --
Cost of peripherals 776,081 -- 1,196,167 --
Loss on subsidized appliance sales 17,257,501 -- 25,160,011 --
Stock-based compensation 383,389 1,599 6,573,720 222,145
Research and development 2,474,141 1,239,768 4,835,620 1,467,272
Sales and marketing 15,040,010 1,071,362 34,809,461 1,618,037
General and administrative 3,060,069 593,101 5,387,926 700,711
------------ ------------ ------------- ------------
Loss from operations (43,041,385) (2,905,830) (85,340,187) (4,008,165)
Interest income 2,165,935 30,417 2,843,581 44,166
Interest expense (55,077) (4,508) (119,804) (5,016)
------------ ------------ ------------- ------------
Net loss (40,930,527) (2,879,921) (82,616,410) (3,969,015)
Effect of beneficial conversion feature
of Series D convertible preferred
stock and warrants -- -- (28,557,162) --
Effect of beneficial conversion feature
of Series E convertible preferred stock -- -- (13,532,100) --
------------ ------------ ------------- ------------
Net loss applicable to common stock (40,930,527) (2,879,921) (124,705,672) (3,969,015)
============ ============ ============= ============
Weighted average shares outstanding 60,372,263 13,558,335 42,845,646 11,768,621
============ ============ ============= ============
Loss per common share--basic and diluted $ (0.68) $ (0.21) $ (2.91) $ (0.34)
============ ============ ============= ============
Weighted average shares outstanding pro
forma 60,372,263 26,322,307 55,935,817 23,061,476
============ ============ ============= ============
Pro forma loss per common share--basic
and diluted $ (0.68) $ (0.11) $ (2.23) $ (0.17)
============ ============ ============= ============
</TABLE>
See accompanying notes to unaudited condensed financial statements.
2
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NETPLIANCE, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Period from
January 12, 1999
Six months (Inception)
ended through
June 30, June 30,
2000 1999
------------ -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss................................................ $(82,616,410) $(3,969,015)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................ 1,092,843 35,273
Noncash compensation expense......................... 6,573,720 222,145
Changes in operating assets and liabilities:
Accounts receivable............................... (2,693,990) --
Prepaid expenses.................................. 2,686,330 (505,000)
Other current assets.............................. (3,724,397) (461,505)
Other assets...................................... (4,048,092) (15,001)
Accounts payable and accrued liabilities.......... 10,627,807 1,025,551
Unearned revenue.................................. 1,317,185 --
------------ -----------
Net cash used in operating activities...................... (70,785,004) (3,667,552)
------------ -----------
Cash flows used in investing activities:
Purchases of property and equipment..................... (1,973,623) (594,650)
Maturities of investment securities..................... 10,000,000 --
Purchase of investment securities....................... (68,698,686) --
------------ -----------
Net cash used in investing activities...................... (60,672,309) (594,650)
------------ -----------
Cash flows from financing activities:
Increase in restricted cash related to capital leases... (1,000,000) (445,231)
Principal payments on capital lease obligations......... (456,162) (2,429)
Proceeds from issuance of common stock, net............. 132,722,255 847,402
Proceeds from exercise of stock options and warrants.... 1,337,844 --
Proceeds from issuance of preferred stock, net.......... 58,873,637 6,000,000
Proceeds received from shareholder for note............. 168,649 --
------------ -----------
Net cash provided by financing activities.................. 191,646,223 6,399,742
------------ -----------
Increase in cash and cash equivalents...................... 60,188,910 2,137,540
Cash and cash equivalents at beginning of period........... 9,563,362 --
------------ -----------
Cash and cash equivalents at end of period................. 69,752,272 2,137,540
Short-term investments..................................... 58,698,686 --
------------ -----------
Cash, cash equivalents and short-term investments.......... $128,450,958 $ 2,137,540
============ ===========
</TABLE>
See accompanying notes to unaudited condensed financial statements.
3
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NOTES TO FINANCIAL STATEMENTS
(1) Basis of Presentation
Netpliance, Inc. ("Netpliance" or the "Company") has experienced operating
losses since inception as a result of efforts to build and support its Internet
service offering for customers and expand its membership base. The Company
expects that it will continue to incur net losses as it continues to expend
significant resources on sales and marketing and to subsidize i-opener Internet
appliance sales. There can be no assurance that the Company will achieve or
sustain profitability or positive cash flow from its operations.
To date, the Company has funded its activities primarily through private
equity offerings and its initial public offering on March 17, 2000, which have
included sales of its common stock and preferred stock. In the future, the
Company expects to seek additional funding through private or public equity
offerings, credit facilities or other financing arrangements, until such time as
it achieves positive cash flow from operations; however, there can be no
assurance that such financing will be available or that positive operating cash
flows will be achieved.
In the opinion of management, the accompanying unaudited condensed
financial statements contain all adjustments, consisting only of normal
recurring adjustments and accruals, necessary for a fair presentation of such
information. The balance sheet at December 31, 1999 has been derived from the
audited financial statements at that date. While the Company believes that the
disclosures are adequate to make the information not misleading, it is suggested
that these financial statements be read in conjunction with the financial
statements and accompanying notes included in the Company's prospectus dated
March 17, 2000 related to the initial public offering of its common stock. The
results of operations for the interim period ended June 30, 2000 are not
necessarily indicative of results to be expected for the full year or any other
period.
Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. Short-term investments
consist of $58.7 million in certificates of deposit, commercial paper
obligations, corporate bonds and municipal bonds with original maturity dates of
approximately four to twelve months. The Company classifies its investments as
available-for-sale and fair value approximates cost at June 30, 2000.
(2) Subsidized Appliance Sales
The Company subcontracts the manufacturing and assembly of its i-opener
Internet appliance. In the past, the Company exclusively arranged for the
Company's overseas manufacturer to ship the appliances directly from the
manufacturer to the customer or a retailer, with the Company never taking title
to the appliances. The Company has restructured its arrangement with the
manufacturer of its i-opener Internet appliance and, in the future, the Company
intends to take title to the appliances from the manufacturer. In addition to
continuing direct shipments to customers and retailers, the Company has begun
warehousing an inventory of its i-opener Internet appliances with a third-party
warehouse facility in the United States to ensure that it will have an adequate
supply during periods of peak demand. The Company offers its i-opener Internet
appliance at a price below cost, as an incentive for new customers to subscribe
to its Internet service. Through June 30, 2000, the Company presented the loss
generated from the sale of the units as an operating expense. In future periods,
since the Company will be taking title to the appliances prior to their delivery
to customers or retailers, the Company intends to recognize revenue from sales
of the i-opener Internet appliance, and to recognize the cost of the i-opener
Internet appliance as a cost of revenue. The
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Company records a provision for estimated warranty costs and sales returns at
the time of sale. To date, the Company's warranty costs have not been
significant. The sales return allowance was approximately $200,000 at June 30,
2000. The loss on the sale of i-opener Internet appliances is as follows:
<TABLE>
<CAPTION>
Three months Six months
ended ended
June 30, 2000 June 30, 2000
------------- -------------
<S> <C> <C>
Appliance sales, net of return provision........................ $ 4,743,116 $ 7,833,936
Cost of appliance sales....................................... 22,000,617 32,993,947
----------- -----------
$17,257,501 $25,160,011
=========== ===========
</TABLE>
(3) Net Loss Per Share
Basic and diluted net loss per share are presented in conformity with
Statement of Financial Accounting Standard No. 128, "Earnings Per Share." In
accordance with Statement of Financial Accounting Standard No. 128 and
Securities and Exchange Commission Staff Accounting Bulletin No. 98, basic loss
per share is computed using the weighted average number of common shares
outstanding during the period. Diluted loss per share is equivalent to basic
loss per share because outstanding stock options, warrants and convertible
preferred stock are anti-dilutive. The calculation of net loss per share
excludes potential common shares if their effect is anti-dilutive. Potential
common shares consist of common shares issuable upon the exercise of stock
options and stock warrants.
5
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The following table sets forth the computation of basic and diluted loss
per share. Pro forma loss per share assumes the conversion of all preferred
stock into common stock and the recognition of the related effects of the
beneficial conversion feature on the later of January 1, 2000 or the date of
issuance of the preferred stock.
<TABLE>
<CAPTION>
Period
from
January
Six 12, 1999
months (Inception)
Three months ended June 30, ended June 30, to June 30,
2000 1999 2000 1999
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C>
Numerator:
Net loss........................... $(40,930,527) $(2,879,921) $ (82,616,410) $(3,969,015)
Effect of beneficial conversion
feature of Series D convertible
preferred stock and warrants...... -- -- (28,557,162) --
Effect of beneficial conversion
feature of Series E convertible
preferred stock................... -- -- (13,532,100) --
------------ ------------ ------------- ------------
Net loss applicable to
common stock...................... $(40,930,527) $(2,879,921) $(124,705,672) $(3,969,015)
============ ============ ============= ============
Denominator:
Weighted average common
shares outstanding............... 60,372,263 13,558,335 42,845,646 11,768,621
Conversion of Series A
preferred stock................. -- 12,763,972 8,359,749 11,292,855
Conversion of Series B
preferred stock................. -- -- 1,480,761 --
Conversion of Series C
preferred stock................. -- -- 846,171 --
Conversion of Series D
preferred stock................. -- -- 1,697,143 --
Conversion of Series E
preferred stock................. -- -- 706,347 --
------------ ------------ ------------- ------------
Shares used in pro forma
calculation..................... 60,372,263 26,322,307 55,935,817 23,061,476
============ ============ ============= ============
Net loss per share:
Basic and diluted $ (0.68) $ (0.21) $(2.91) $ (0.34)
Pro forma $ (0.68) $ (0.11) $(2.23) $ (0.17)
</TABLE>
6
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(4) Initial Public Offering
On March 17, 2000, the Company completed an initial public offering of
8,000,000 shares of its common stock and realized net proceeds of $132.7
million. As of the closing date of the offering, all of the Company's
convertible preferred stock outstanding was converted into common stock.
(5) Stock Options
In the three and six months ended June 30, 2000, the Company granted to
employees options to purchase 969,000 and 4,623,915 shares, respectively, of
common stock at exercise prices ranging from $1.70 to $18.50 per share that will
vest over a period of four years. In addition, in February 2000, the Company
granted options to non-employee directors to purchase 630,000 shares of common
stock at exercise prices ranging from $6.67 to $10.00 per share that vested
immediately. In the three and six months ended June 30, 2000, the Company
recorded approximately $383,000 and $6.6 million, respectively, of compensation
expense resulting from the grant of options with exercise prices below fair
value. Remaining deferred compensation as of June 30, 2000 of $19.4 million
will be amortized over the applicable vesting period.
During the second quarter of 2000, the departure of certain employees with
unvested options resulted in a reversal of $15.7 million of deferred stock
option compensation and $1.0 million of previously recognized stock-based
compensation expense.
(6) Capital Stock
Common Stock
On February 6, 2000, the Board of Directors approved a three-for-one stock
split of common stock and reincorporation of the Company in the State of
Delaware, to be effective immediately prior to the effective date of the
Company's initial public offering. The reincorporation was completed on March
15, 2000. All common stock information has been adjusted to reflect the stock
split as if such split had taken place at inception. On the same date, the
Board of Directors authorized an increase in the number of shares reserved for
issuance under the stock option plan to 10,500,000.
Convertible Preferred Stock
On December 22, 1999, the Company entered into an irrevocable agreement to
sell 1,430,000 shares of Series D Convertible Preferred Stock ("Series D") for
$20.00 per share in a private placement. On January 5, 2000, the Company
consummated the Series D offering and issued the Series D. Net proceeds to the
Company approximated $27.0 million. The Series D was converted into 4,290,000
shares of common stock upon the closing of the Company's initial public
offering. In December 1999, a purchaser of Series D paid $2.0 million for its
shares in advance of the issuance of the shares.
On February 4, 2000, the Company entered into an irrevocable agreement to
sell 1,127,675 shares of Series E Convertible Preferred Stock ("Series E") for
$30.00 per share in a private placement. The closing for the sale of these
shares was on February 7, 2000. The Series E was converted into 3,383,025
shares of common stock upon the closing of the Company's initial public
offering.
The 1,430,000 shares of Series D, warrants to purchase 221,400 shares of
common stock issued in conjunction with Series D and the 1,127,675 shares of
Series E were issued with beneficial conversion features approximating $27.2
million, $1.4 million and $13.5 million, respectively. The beneficial
conversion feature was calculated as the difference between the conversion price
and the fair value of the
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common stock into which the preferred stock is convertible. These amounts have
been accounted for as an increase in additional paid-in capital and in-substance
dividends to preferred stockholders in the first quarter of 2000 and accordingly
have resulted in an increase in the loss applicable to common stockholders of
$42.1 million for the six months ended June 30, 2000.
(7) Commitments and Contingencies
Prior to the effectiveness of the registration statement covering the sale
of Netpliance common stock sold in the initial public offering, Donaldson,
Lufkin & Jenrette Securities Corporation, an underwriter of the offering,
provided written materials to approximately 200 individuals that Netpliance had
designated as potential purchasers of up to 400,000 shares of common stock in
the offering through a directed share program. These materials may have
constituted a prospectus that does not meet the requirements of the Securities
Act of 1933. If the distribution of these materials by Donaldson, Lufkin &
Jenrette Securities Corporation did constitute a violation of the Securities Act
of 1933, the recipients of the materials who purchased common stock in the
offering would have the right, for a period of one year from the date of their
purchase of common stock, to recover from the Company the consideration paid in
connection with their purchase of common stock or, if they have already sold the
stock, to seek damages resulting from their purchase of common stock. These
damages could total up to approximately $7.2 million plus interest, based on the
initial public offering price of $18.00 per share, if these investors seek
recovery or damages after an entire loss of their investment. To the extent that
any of the recipients of the materials also purchased shares in the offering
outside the program from the underwriters, the potential damages would increase
by the purchase price of those shares. The Company does not believe that the
distribution in question is a violation of the Securities Act and, therefore,
believes that it would prevail in any litigation if any such claims are made.
While the ultimate outcome of these matters cannot be determined, Netpliance
does not expect that they will have a material adverse effect on its financial
position, results of operations or cash flows.
In July 2000, the Company entered into a network service agreement with
AT&T to provide Internet service to its subscribers. Under the agreement, the
Company is obligated to pay minimum commitment amounts over the term of the
agreement equaling $375,000, $7.5 million, $14.3 million and $7.5 million for
calendar years 2000, 2001, 2002 and 2003. The agreement may be terminated by
the Company upon 30 days written notice for any reason upon the payment of a
termination fee based on a percentage of the then current commitment level and
the remaining term of the agreement.
8
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.
The discussion in Management's Discussion and Analysis of Results of
Operations and Financial Condition contains trend analysis and other forward-
looking statements within the meaning of Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. Actual results could differ materially from those set forth in such
forward-looking statements as a result of the "Factors That May Affect Future
Operating Results" and other risks detailed in our reports filed with the
Securities and Exchange Commission.
OVERVIEW
The following is a discussion and analysis of our financial condition and
results of operations for the three months ended June 30, 2000 and June 30,
1999, and for the six months ended June 30, 2000 and the period from January 12,
1999 (inception) through June 30, 1999 (each referred to herein as "the six
months"), including significant factors that could affect our prospective
financial condition and results of operations. This discussion and analysis
should be read in conjunction with the financial statements included in this
report and notes thereto, and with our audited financial statements and notes
thereto for the fiscal year ended December 31, 1999 contained in our
Registration Statement on Form S-1, as amended (SEC File No. 333-93545) filed
with the Securities and Exchange Commission.
We offer Internet-based content, applications and services, through devices
specifically designed for Internet access, commonly known as Internet
appliances. We were formed in January 1999, and we introduced our i-opener
service in November 1999. Our i-opener service combines our i-opener Internet
appliance, Internet access and our own consumer portal and includes all of the
elements required for a consumer to access the Internet. We believe that our i-
opener offering simplifies Internet access for the consumer. As of June 30,
2000, we provided our i-opener service to approximately 44,400 subscribers.
We currently generate revenues from monthly subscriber fees for our i-
opener service and from the sale of printers and other accessories for use with
our i-opener Internet appliances. We charge our subscribers $21.95 per month
for our service and have offered the i-opener Internet appliance at a price
below our cost, as an incentive for new customers to subscribe to the i-opener
service. Through the period ended June 30, 2000, the cost of the i-opener
Internet appliance, net of sales proceeds, was classified in our statement of
operations as loss on subsidized appliance sales.
In the past, we have experienced periods of peak demand for our i-opener
Internet appliance, which at times exceeded our supply capacity. As a result,
we are creating an inventory of i-opener Internet appliances in a third-party
warehouse facility located in the United States to be used during such periods
of peak demand to compliment our direct shipment method of delivery. We believe
that this warehouse arrangement will lower the risk that we will be unable to
deliver promptly an i-opener Internet appliance to any new customer after an
order is placed during periods of high demand. However, the new warehouse
arrangement will not remove this risk altogether, and we cannot predict to what
extent we will make use of, or benefit from, the arrangement.
Beginning in July 2000, we are offering our i-opener service through a
package we call the "i-opener 2001 membership pak," which includes the i-opener
Internet appliance, at a sales price of $399, and our i-opener service at a
monthly rate of $21.95. The sales price for the i-opener 2001 membership pak
reduces our subsidy of the appliance. However, in the future we may revise our
pricing structure to increase the subsidy to respond to competitive pressures in
the industry or if we otherwise determine that such an increase is in our best
interest. The i-opener 2001 membership pak features an upgraded and
9
<PAGE>
enhanced i-opener service with additional applications and features. We will
provide these upgrades and enhancements to both existing and new i-opener
subscribers. In future periods, we intend to recognize revenues from sale of the
i-opener Internet appliance, as well as from monthly subscriber fees and the
sale of printers and other accessories for use with our i-opener Internet
appliances. The cost of the i-opener Internet appliance will be reported as a
cost of revenues and we do not anticipate recognizing a "loss on subsidized
appliance sales" in our statement of operations.
In the future we may generate revenue from sources in addition to
subscriber fees and appliance and peripheral sales, such as:
. application services;
. e-commerce;
. sponsorships and advertising; and
. software and other licensing arrangements.
To date, we have funded our activities primarily through private equity
offerings of our common stock and preferred stock, and through the sale of our
common stock in our initial public offering on March 17, 2000.
RESULTS OF OPERATIONS
The following discussion compares our financial condition and results of
operations for the periods ended June 30, 2000 and 1999, and significant factors
that could affect our prospective financial condition and results of operations.
Revenues. Revenues consist of subscription revenues and peripheral sales
revenues.
Subscription revenues consist primarily of monthly subscription fees paid
by consumers for our i-opener service. Subscription revenues increased to $1.7
million for the quarter ended June 30, 2000 as compared to $0 for the quarter
ended June 30, 1999. Subscription revenues increased to $2.3 million for the
six months ended June 30, 2000 as compared to $0 for the six months ended June
30,1999. The increase in subscription revenues is attributable to the increase
in the number of subscribers who used our i-opener service, which began in
November 1999. As of June 30, 2000, we had approximately 44,400 subscribers.
Peripheral revenues consist primarily of revenue earned from the sale, to
our i-opener subscribers, of printers and other accessories for use with our i-
opener Internet appliance. Peripheral revenues increased to $1.3 million for
the quarter ended June 30, 2000 as compared to $0 for the quarter ended June 30,
1999. Peripheral revenues increased to $1.9 million for the six months ended
June 30, 2000 as compared to $0 for the six months ended June 30, 1999.
Cost of Revenues. Cost of revenues through June 30, 2000 consists of the
costs of providing the i-opener service and costs of peripherals.
Cost of providing the i-opener service consists primarily of employee
salaries and expenses related to providing the i-opener service to subscribers,
content, consulting and telecommunications network charges paid to third parties
and depreciation on equipment used to provide the i-opener service.
10
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Cost of services increased to $7.0 million for the quarter ended June 30, 2000
as compared to $0 for the quarter ended June 30, 1999. Cost of services
increased to $11.6 million for the six months ended June 30, 2000 as compared to
$0 for the six months ended June 30, 1999. The increase in cost of services is
attributable to the initiation of our i-opener service in November 1999 and the
related cost of operations to provide the i-opener service to our subscribers.
Cost of peripherals consists primarily of the costs of printers and other
accessories sold to our i-opener subscribers during the period. Cost of
peripherals increased to $776,081 for the quarter ended June 30, 2000 as
compared to $0 for the quarter ended June 30, 1999. Cost of peripherals
increased to $1.2 million for the six months ended June 30, 2000 as compared to
$0 for the six months ended June 30, 1999. This increase in cost is
attributable to the purchases of printers and other accessories that began when
we initiated our i-opener service and the sale of our i-opener Internet
appliances in November 1999.
Loss on Subsidized Appliance Sales. We offer our i-opener Internet
appliance at a price below our cost, as an incentive for new customers to
subscribe to our i-opener service. We present the loss generated from the sale
of these units as an operating expense. A loss is recognized in the period in
which we ship an appliance to a customer or a retailer. Loss on subsidized
appliance sales increased to $17.3 million for the quarter ended June 30, 2000
as compared to $0 for the quarter ended June 30, 1999. Loss on subsidized
appliance sales increased to $25.2 million for the six months ended June 30,
2000 as compared to $0 for the six months ended June 30, 1999, due to the
initiation of appliance shipments in November 1999.
Stock-based Compensation. Stock-based compensation increased to $383,389
for the quarter ended June 30, 2000 as compared to $1,599 for the quarter ended
June 30, 1999. Stock-based compensation increased to $6.6 million for the six
months ended June 30, 2000 as compared to $222,145 for the six months ended June
30, 1999. These expenses are attributable to stock options granted during 2000
and 1999 with exercise prices that were less than the estimated fair value of
the underlying common stock on the date of grant. The $383,389 of expense in
the second quarter of 2000 consisted of $1.4 million in expense offset by $1.0
million in recapture of expense recorded in the prior quarter due to the
departure of certain employees with unvested options. Additional deferred stock
compensation totaled $19.4 million as of June 30, 2000. This amount will be
amortized over the remaining vesting period of the applicable options.
Sales and Marketing. Sales and marketing expenses consist primarily of
employee salaries for marketing, business development and sales personnel, and
costs of our marketing efforts to generate demand for and consumer awareness of
our i-opener service. These costs include development of advertising, public
relations events, promotions and trade shows. Sales and marketing expenses
increased to $15.0 million for the quarter ended June 30, 2000 as compared to
$1.1 million for the quarter ended June 30, 1999 and to $34.8 million for the
quarter ended June 30, 2000 as compared to $1.6 million for the quarter ended
June 30, 1999. Expenses during the second quarter of 2000 were largely funded
through the utilization of prepayments for advertising made during the first
quarter. The increase in sales and marketing expenses is primarily attributable
to the increase in advertising costs, totaling $22.0 million, and the increase
in our employment costs associated with the staffing of our i-opener sales and
customer care departments.
General and Administrative. General and administrative expenses consist
primarily of employee salaries and related expenses for the executive,
administrative, finance and information systems departments, and facility costs,
professional fees and recruiting. General and administrative expenses increased
to $3.1 million for the quarter ended June 30, 2000 as compared to $593,101 for
the quarter ended June 30, 1999, and to $5.4 million for the six months ended
June 30, 2000 as compared to $700,711 for the six months ended June 30, 1999.
The increase in general and administrative expenses is
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primarily attributable to the general increase in the number of employees
comprising the executive, administrative, finance and information systems
departments and to severance payments of $822,500 made to certain employees in
connection with their departures in the quarter ended June 30, 2000.
Research and Development. Our research and development expenses consist
primarily of employee salaries and related expenses and consulting fees relating
to the design of the i-opener service, as well as the development of our
technology to manage and deliver content and applications to various Internet
appliances. Research and development expenses increased to $2.5 million for the
quarter ended June 30, 2000 as compared to $1.2 million for the quarter ended
June 30, 1999. Research and development expenses increased to $4.8 million for
the six months ended June 30, 2000 as compared to $1.5 million for the six
months ended June 30, 1999.
Interest Income and Interest Expense. Interest income increased to $2.2
million for the quarter ended June 30, 2000 as compared to $30,417 for the
quarter ended June 30, 1999 and to $2.8 million for the six months ended June
30, 2000 as compared to $44,166 for the six months ended June 30, 1999 as a
result of an increase in the average cash balances held at banking and financial
institutions from the sale of common stock in our initial public offering and
previous sales of convertible preferred stock sold in private offerings.
Interest expense increased to $55,077 for the quarter ended June 30, 2000 as
compared to $4,508 for the quarter ended June 30, 1999 and to $119,804 for the
six months ended June 30, 2000 as compared to $5,016 for the six months ended
June 30, 1999, as a result of payments made on existing equipment financing
arrangements.
LIQUIDITY AND CAPITAL RESOURCES
From inception in January 1999 through June 30, 2000, we financed our
operations and met our capital expenditure requirements primarily from the net
proceeds of the private and public sale of equity securities totaling
approximately $230 million. At June 30, 2000, we had $128.5 million in cash,
cash equivalents and short-term investments. The expansion of our business will
require additional capital to fund operating losses, capital expenditures and
working capital needs until such time as we achieve positive cash flows from
operations; however, there can be no assurance that such financing will be
available or that positive operating cash flows will be achieved.
Working capital increased by $110.9 million to $121.9 million as of June
30, 2000 from $11.0 million at December 31, 1999. During the six months ended
June 30, 2000, we received $193.0 million from the private and public sale of
our common and preferred stock, including $132.7 million of net proceeds from
the sale of 8,000,000 shares of common stock in our initial public offering on
March 17, 2000.
Net cash used in operating activities was $70.8 million and $3.7 for the
six months ended June 30, 2000 and 1999, respectively. Cash used in operating
activities during the six months ended June 30, 2000 consisted primarily of net
operating losses of $82.6 million.
Net cash used in investing activities was $60.7 million and $594,650 for
the six months ended June 30, 2000 and 1999, respectively. Cash used in
investing activities consists of the purchase of property and equipment and the
purchase of certain investment securities.
Net cash provided by financing activities was $191.6 million and $6.4
million for the six months ended June 30, 2000 and 1999, respectively. The
$191.6 million provided during the six months ended June 30, 2000 includes
$132.7 million of net proceeds from the sale of 8,000,000 shares of our common
stock in our initial public offering and $58.9 million of net proceeds from the
private sale of shares of preferred stock.
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We have commitments under facility and other operating leases of $9.0
million, including a $5.9 million commitment under a second facility lease
agreement expiring in 2005, and obligations under capital leases of $1.1 million
as of June 30, 2000. The obligations under capital leases relate to equipment
leased under leases with three different vendors, each of which expires in the
year 2001.
In July 2000, we provided Quanta Computer, Incorporated, our third party
manufacturer of the i-opener Internet appliance, a standby letter of credit in
the amount of $11.7 million, which is secured by a certificate of deposit of
equal amount. The letter of credit may be drawn upon in the event we fail to
make payments to Quanta pursuant to the terms and conditions of our agreement
with them. Additionally, in July 2000, we entered into a network service
agreement with AT&T to provide Internet service to our subscribers. Under the
agreement, we are obligated to pay minimum commitment amounts over the term of
the agreement equaling $375,000, $7.5 million, $14.3 million and $7.5 million
for calendar years 2000, 2001, 2002 and 2003. We may terminate this agreement
upon 30 days written notice for any reason upon the payment of a termination
fee, which is based on a percentage of the then current commitment level and the
remaining term of the agreement.
Our future capital requirements will depend on a variety of factors,
including general market acceptance of Internet appliances and, in particular,
our i-opener service, including acceptance of our i-opener 2001 membership pak
and its pricing structure, as well as other factors, such as the resources we
devote to develop, market, sell and support our current and future product
offering. We expect to devote substantial capital resources:
. for our sales and marketing efforts;
. to purchase from our third-party manufacturer our i-opener Internet
appliances prior to shipment to customers;
. to hire and expand our engineering, sales and marketing and customer
support departments;
. to further develop our service offerings; and
. for general corporate purposes.
Although we have no specific plans regarding future expenditures, we
believe that our cash, cash equivalents and other short-term investments as of
June 30, 2000 will be sufficient to fund our operations for at least the next 12
months. Despite our expectations, we may need to raise additional capital
before that time. We may need to raise additional funds in order to:
. fund anticipated growth, including significant increases in personnel,
facilities and computer systems;
. develop new or enhance existing services and products, including our
network infrastructure;
. purchase from our third party manufacturer our i-opener Internet appliances
prior to their shipment to customers;
. subsidize the sales price of our i-opener Internet appliance under any
future pricing structure that requires such a subsidy; or
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. acquire or invest in complementary businesses, technologies, services or
products.
In addition, in order to meet long term liquidity needs, we may need to
raise additional funds, establish a credit facility or seek other financing
arrangements. Additional funding may not be available on favorable terms, or at
all.
Finally, shares of common stock that were sold in our initial public
offering through our directed share program in connection with our initial
public offering may have been offered or sold in violation of the federal
securities laws. If these offers or sales were in violation of those laws, the
purchasers could, for a period of one year after the date of their purchase of
common stock, recover the purchase price paid for their common stock, or, if
they sell the stock, seek damages resulting from their purchase of the common
stock. If any of these investors successfully seek recovery or damages, we may
need to raise additional funds in order to pay any recovery or damages awarded
to these investors.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivatives and
Hedging Activities," which establishes accounting and reporting standards for
derivative instruments, including derivative instruments embedded in other
contracts, and for hedging activities. We will adopt SFAS No. 133 as required
by SFAS No. 137, "Deferral of the Effective Date of the FASB Statement No. 133,"
in fiscal year 2001. We do not expect the adoption of SFAS No. 133 to have a
significant impact on our financial condition or results of operations.
In October 1999, the Chief Accountant of the Securities and Exchange
Commission (the "SEC") requested that the Emerging Issues Task Force (the
"EITF") address a number of accounting and financial reporting issues that the
SEC believes had developed with respect to Internet businesses. The SEC
identified several issues for which they believed some form of standard setting
or guidance may be appropriate either because (1) there appeared to be diversity
in practice, (2) the issues are not specifically addressed in current accounting
literature or (3) the SEC Staff is concerned that developing practice may be
inappropriate under generally accepted accounting principles. Many of the
issues identified by the SEC are potentially applicable to us. Although the
EITF has begun to deliberate these issues, it has not yet issued formal guidance
for the majority of them. In addition, in December 1999, the SEC issued Staff
Accounting Bulletin ("SAB") No. 101, Revenue Recognition in Financial Statements
(as recently amended by SAB 101A and SAB 101B), requiring implementation no
later than the fourth fiscal quarter of fiscal years beginning after December
15, 1999. We are currently analyzing the potential impact of SAB No. 101 on our
revenue recognition policies. Although we believe that our historical
accounting policies and practices conform with generally accepted accounting
principles, there can be no assurance that final consensuses reached by the EITF
on the issues referred to above, or other actions by standard setting bodies, or
our formal implementation of SAB No. 101, will not result in changes to our
historical accounting policies and practices or to the manner in which certain
transactions are presented and disclosed in our financial statements.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
In addition to the other information included in this report, the following
factors should be considered in evaluating our business and future prospects.
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We cannot predict our future results because we have a limited operating
history.
We were incorporated in January 1999, and we began offering our i-opener
service in November 1999. Given our limited operating history, it will be
difficult for you to evaluate our performance. You should consider the
uncertainties that we may encounter as an early stage company in a new and
rapidly evolving market. These uncertainties include:
. market acceptance of Internet appliances and related services;
. consumer demand for, and acceptance of, our i-opener service;
. market acceptance of our i-opener 2001 membership pak and its pricing
structure;
. our ability to create user-friendly applications and a portal that appeals
to consumers;
. our ability to contract with content providers who will furnish useful and
entertaining information to our subscribers;
. our ability to support a large number of subscribers;
. our ability to anticipate and adapt to a developing market and to rapidly
changing technologies;
. our unproven and evolving business model; and
. our need to expand significantly our internal resources to support growth
of our product and service offerings.
If we are not able to address successfully some or all of these
uncertainties, we may not be able to expand our business, compete effectively or
achieve profitability.
Our ability to generate revenues is unproven, and we may never achieve
profitability.
We have generated or expect to generate revenues from subscriber fees for
our i-opener service and other sources such as sales of our i-opener Internet
appliance, application services, e-commerce, sponsorships and advertising. Many
of our potential customers have never purchased Internet service for personal
use, used the Internet and e-mail or engaged in e-commerce transactions. We
must convince these potential subscribers to purchase the i-opener Internet
appliance and sign up for our service, and to continue to pay a subscriber fee
for our i-opener service. Other potential subscribers already pay a monthly fee
for Internet access and/or e-mail service, and we must convince these consumers
to pay our subscriber fee in addition to their existing fee or to switch from
their existing service to our service. In addition, certain online service
providers in the Internet industry offer Internet access at little or no cost to
the subscriber, which may cause us to lose existing and potential subscribers.
Our inability to convince potential subscribers to make the initial purchase of
our i-opener Internet appliance, and to pay fees for a significant period of
time, would prevent us from achieving profitability.
We have, through the second quarter 2000, priced our i-opener Internet
appliance below our cost. Beginning with our i-opener 2001 membership pak, we
intend to reduce the subsidy. However, we may in the future revise our pricing
structure to increase the subsidy to respond to competitive pressures in the
industry or if we otherwise determine that such an increase is in our best
interest. Based on the pricing levels in effect for new orders through our
second quarter of 2000, a new customer must pay monthly fees for our service for
a significant period of time before we recover the subsidy on that customer's
appliance. Any reduction in subscriber fee levels due to competitive or other
factors could increase significantly the
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period of time necessary to recoup the subsidies we have provided to date. We
remain exposed to the risk that the subscriber may discontinue monthly i-opener
service.
In the past, following the sale of some of our i-opener Internet
appliances, we received minimal or no subscriber fees related to these
appliances because they had been purchased by persons who reconfigured them for
use as a personal computer. We changed our hardware to help prevent such
reconfigurations in the future. However, similar tampering with appliances and
the related loss of expected subscriber fees could occur again. Due to our
pricing structure and the short period of time we have been offering our i-
opener service, we have experienced significant operating losses to date. If we
are unable to achieve sufficient revenues from subscriber fees and other
sources, we may never become profitable and our business model could fail.
We are not profitable and expect to incur future losses and negative cash
flow that could cause our stock price to fall.
As of June 30, 2000 we had an accumulated deficit of $168.2 million. We
have in the past, and may in the future, subsidize the sales price of our i-
opener Internet appliance. However, with our i-opener 2001 membership pak, our
revised pricing of our i-opener Internet appliance decreases the subsidy that we
provide with respect to our customers' purchase of the i-opener Internet
appliance. Our pricing structure is subject to additional future revision.
From January 1, 2000 through June 30, 2000, we generated only $4.2 million
in revenues. We will need to generate and sustain dramatically greater revenues
from sales of our services if we are to achieve profitability. If we are unable
to achieve dramatically greater revenues, our losses will likely continue
indefinitely and we may never generate profits. If this occurs, the market
price of our common stock could suffer.
We may in the future experience a delay in revenue recognition or be
required to encumber available funds in order to secure certain business
relationships, which could delay or reduce our recognition of revenue and
profitability.
Beginning in the third quarter of 2000, we intend to hold a certain amount
of inventory of our i-opener Internet appliances pending shipment. As a result,
we expect to experience some delay between our purchase of those i-opener
Internet appliances and our recognition of revenue from their sale. In the
future, we may offer our i-opener 2001 membership pak or other i-opener packages
through a variety of distribution channels, in addition to our existing retail
affiliations and telephone and web-based marketing methods. The terms of our
future distribution arrangements may include an unlimited right of return for
the distributor or retailer, in which case we will defer recognition of the
revenue associated with such distributors until the distributor resells its i-
opener inventory to the consumer. Therefore, under such arrangements, we may in
the future experience a significant delay between our purchase of i-opener
Internet appliances from our third party manufacturer and our recognition of
revenue from the distributor on those appliances.
We believe that, due in part to turbulence in the financial markets during
the first six months of 2000 and market skepticism about the stability of
Internet-related companies, some companies have begun to, and may in the future,
require businesses such as ours to post bonds, obtain letters of credit, or
otherwise encumber available funds as a pre-requisite for entering into business
relationships as suppliers, vendors, co-marketers, and other types of
conventional business relationships. If we are required to encumber our
resources in order to establish or maintain our current or future business
relationships, our cost to establish and maintain such relationships will
increase and our profitability may be reduced or
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delayed as a result, or we may not enter into some relationships that would
otherwise benefit the development of our business due to such requirements.
Our market share and revenues will suffer if we are not able to compete
successfully for subscribers.
The markets for Internet appliances, consumer portals and Internet access
service are intensely competitive, evolving and subject to rapid technological
change. These markets are characterized by an increasing number of entrants.
We compete for subscribers, and consequently for potential e-commerce and
advertising revenue, directly or indirectly, with the following categories of
companies:
. online service providers, such as AOL, EarthLink and Microsoft;
. software platform providers such as Aether Systems and Liberate
Technologies;
. operating system providers such as Redhat;
. Internet portals, such as Excite@Home, Lycos and Yahoo!;
. manufacturers of other stand alone Internet appliances, such as Cisco
Systems, WebTV, AOLTV and Oracle;
. manufacturers of portable Internet appliances, such as Hewlett Packard and
Palm, and cellular telephone and pager manufacturers; and
. manufacturers of personal computers, such as Apple, Compaq, Gateway,
Hewlett Packard and IBM.
Virtually all of our current and potential competitors have longer
operating histories, significantly greater financial, technical, marketing and
other resources, significantly greater name recognition and a substantially
larger installed base of customers than we do. In addition, many of our
competitors have nationally known brands and have extensive knowledge of our
industry. Moreover, our current and potential competitors have established or
may establish cooperative relationships among themselves or with third parties
to increase the ability of their products to address consumer needs or to
combine hardware product and service offerings. We expect the intensity of
competition in this market to increase in the future. Increased competition is
likely to result in price reductions, reduced or negative margins and difficulty
in gaining market share. Any of these effects could seriously harm our
business.
We rely on a single third-party to manufacture our Internet appliance. If
the manufacturer fails to deliver our products in a reliable, timely and
cost-efficient manner, our business will suffer.
We depend on our relationship with Quanta Computer, Incorporated, a
manufacturer based in Taiwan, for the production and delivery of our i-opener
Internet appliance. Since we do not have direct control over Quanta's
workmanship and the quality of its service, we cannot assure you that we will be
able to provide consistently reliable products for our subscribers. If Quanta
does not produce our products on a timely basis or delivers products of
unacceptable quality, that do not meet specifications or are otherwise flawed,
we may have to delay product delivery, recall or replace unacceptable products.
As a result, we could lose existing and potential subscribers.
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If Quanta is unable to manufacture our i-opener Internet appliance due to
natural disasters, limited availability of components, political turmoil or
other reasons, or if Quanta refuses to provide its manufacturing services on a
timely basis and on commercially acceptable price terms and alternative
providers of these services are not available on acceptable terms, our operating
expenses could increase significantly, reducing the likelihood of our becoming
profitable.
Our plans to warehouse inventory of our Internet appliance also exposes us
to potential liabilities and losses.
In the past, we have experienced periods of peak demand for our i-opener
Internet appliance, which at times exceeded our supply capacity. As a result, we
are creating an inventory of i-opener Internet appliances in a third-party
warehouse facility located in the United States to be used during such periods
of peak demand to compliment our direct shipment method of delivery. We believe
that this warehouse arrangement will lower the risk that we will be unable to
deliver promptly an i-opener Internet appliance to any new customer after an
order is placed during periods of high demand. However, the new warehouse
arrangement will not remove this risk altogether, and we cannot predict to what
extent we will make use of, or benefit from, the arrangement. We do not have
prior experience in warehousing our i-opener Internet appliances, and our use of
the warehouse arrangement, and the fact that we take title to the appliances
upon shipment, could in the future expose us to potential liabilities related to
our taking title to the appliances, investment in the appliances, ability to
sell the appliances, storage in or shipment from the warehouse, logistical
difficulties related to the operation of the warehouse, tax liabilities related
to ownership of the appliances, and other unforeseen costs or complications.
Additionally, our operation of the warehouse facility will expose us to the
increased risk of damage to, loss or obsolescence of, such inventory. We will
also have to use cash to build the inventory of i-opener Internet appliances in
our warehouse. Any delay in delivery of ordered i-opener Internet appliances
could negatively affect consumer interest or confidence in our ability to
deliver the appliances or service subscribers, which could result in fewer sales
of our i-opener 2001 membership pak and lower related subscriber revenues in the
future.
If our brand does not achieve the broad recognition necessary to expand and
maintain our subscriber base, our revenues may not grow and our financial
performance may suffer.
We believe that broad recognition and a favorable consumer perception of
our products and services is essential to our future success. Our success in
promoting and maintaining our brand, or any other brand that we may use in the
future, will depend largely on:
. the success of our brand-enhancement strategy, including mass marketing and
multi-media advertising, promotional programs and public relations
activities;
. the quality and ease-of-use of our services and applications; and
. our success in providing high-quality content accessible from our Internet
portal.
If we are unsuccessful in establishing or maintaining a favorable image of
our products and services, we may not be able to expand our subscriber base. In
addition, in order to attract and retain subscribers and to promote and maintain
our brand or future brands, we expect to increase substantially our marketing
expenditures. If we incur expenses in promoting and maintaining our brands
without a corresponding increase in revenue and income, our financial results
could be seriously harmed.
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If we are unsuccessful in obtaining compelling content, or in developing or
maintaining relationships with content providers, we may be unable to
attract and retain subscribers.
We rely on third parties to provide our content, including news, weather
and relevant local information, on our i-opener portal. In addition, some
content provided via links to third-party sites is provided without the
contractual agreement of the third party. Our inability to establish or
maintain any or all of the relationships with our content providers could put
our delivery of quality services in jeopardy. The inability to obtain any of
this content could result in delays in the development or delivery of our
services and the loss of existing or potential subscribers. Alternatively,
contracts or exclusive arrangements with content providers could result in
diminished demand for our service, if the content is not appealing to
subscribers, inferior in quality or less desirable than content available from
other portals or content providers.
We will not be able to support increased numbers of subscribers if our
network infrastructure is unable to expand to accommodate increased usage.
If our network systems cannot be expanded to manage increased demand, or if
our systems fail to perform, we could experience:
. unanticipated disruptions and reduced quality of service;
. decreased subscriber service and satisfaction; or
. delays in the introduction of new applications and services.
Any of these results could impair our reputation, damage our brand and result in
decreased revenues.
If the number of subscribers of our service increases substantially, we
will need to expand significantly and upgrade our technology, transaction
processing systems and network infrastructure. We do not know whether we will
be able to project accurately the rate or timing of any such increases in usage,
or expand and upgrade our systems and infrastructure to accommodate such
increases in a timely manner. In the event we do not have the required systems
and infrastructure to accommodate increased usage of our services, we will have
to contract for additional capacity. We cannot assure you that we will be able
to contract for additional capacity on terms acceptable to us, if at all.
Our systems may fail and consequently our business may suffer.
Our ability to facilitate transactions successfully and provide high-
quality customer service also depends on the efficient and uninterrupted
operation of our computer and communications hardware systems. Our systems and
operations also are vulnerable to damage or interruption from human error,
natural disasters, power loss, telecommunication failures, break-ins, sabotage,
computer viruses, intentional acts of vandalism and similar events. While we
currently maintain redundant servers to provide limited service during system
disruptions, we do not have fully redundant systems, a formal disaster recovery
plan or alternative providers of hosting services. In addition, we do not carry
any business interruption insurance to compensate us for any losses that may
occur. Any system failure that causes an interruption in service or decreases
the responsiveness of our services could impair our reputation, damage our brand
name and consequently reduce our revenues.
We are dependent upon our telecommunications carriers to provide Internet
access to our subscribers; if they fail to provide quality service, we may
be unable to retain subscribers.
Since we do not have direct control over the reliability of our carriers'
networks or the quality of their service, we cannot assure you that we will be
able to provide consistently reliable Internet access for
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our subscribers. If the quality of service provided by our telecommunications
carriers does not meet our clients' expectations, we may lose subscribers
because of dissatisfaction with our service.
We will not be able to expand our business if we fail to attract and retain
key personnel.
Our future success depends on our continuing ability to attract, hire,
train and retain a substantial number of highly skilled personnel and on the
continued service and performance of our senior management and other key
personnel, especially our Chief Executive Officer and Chairman of the Board.
The loss of the services of our executive officers or other key employees could
adversely affect our business, as could the loss of our technical support and
operations personnel who are key to developing and maintaining the operations of
our services. Our facilities are located in Austin, Texas, which has a high
demand for technical and other personnel and a relatively low unemployment rate.
Competition for qualified personnel in this area is intense, and we may fail to
attract or retain the employees necessary to execute our business model
successfully.
Rapid technological change could render our products and services obsolete.
The Internet and the e-commerce industries are characterized by rapid
technological innovation, sudden changes in subscriber and customer requirements
and preferences, frequent new product and service introductions and the
emergence of new industry standards and practices. Each of these
characteristics could render our services, products, intellectual property and
systems obsolete. The rapid evolution of our market will require that we
improve continually the performance, features and reliability of our products
and services, particularly in response to competitive offerings. Our success
also will depend, in part, on our ability:
. to develop or license new products, services and technology that address
the varied needs of our customers and prospective customers; and
. to respond to technological advances and emerging industry standards and
practices on a cost-effective and timely basis.
If we are unable, for technical, financial, legal or other reasons, to
adapt in a timely manner to changing market conditions or subscriber
preferences, we could lose subscribers, which would cause a decrease in our
revenue.
We may be unable to obtain the additional capital required to grow our
business, which could seriously harm our business. If we raise additional
funds, our current stockholders may suffer substantial dilution.
As of June 30, 2000, we had $128.5 million in cash, cash equivalents and
short-term investments on hand, which we expect will meet our working capital
and capital expenditure needs for at least the next 12 months. We may need to
raise additional funds at any time, and we cannot be certain that we will be
able to obtain additional financing on favorable terms, if at all. Due to the
recent volatility of the U.S. equity markets, particularly for smaller
technology companies, we may not have access to the capital markets when we need
to raise additional funds. Our future capital requirements will depend upon
several factors, including the rate of market acceptance of our products and
services, our ability to expand our subscriber base, our level of expenditures
for sales and marketing and the cost of product and service upgrades. If our
capital requirements vary materially from those currently planned, we may
require additional financing sooner than anticipated. If we cannot raise funds
on acceptable terms, we may not be able to develop our products and services,
take advantage of future opportunities or respond to competitive pressures or
unanticipated requirements, any of which could have a material adverse effect on
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our ability to grow our business. Further, if we issue equity securities, our
existing stockholders will experience dilution of their ownership percentage,
and the new equity securities may have rights, preferences or privileges senior
to those of our common stock.
We may not be able to compete effectively if we are not able to protect our
intellectual property.
We rely on a combination of trademark, trade secret and copyright law and
contractual restrictions to protect our intellectual property. We have applied
to register several trademarks, including Netpliance and i-opener, in the United
States. We have also applied for trademark protection for "i-opener" and
"Netpliance" in Europe and select Asian countries. We have not yet attempted to
register other marks that may become important to us in the future. We have
several United States patent applications currently pending. If we are not
successful in obtaining the patent protection we seek, our competitors may be
able to replicate our technology and compete more effectively against us. The
legal protections described above would afford only limited protection.
Unauthorized parties may attempt to copy aspects of our products, services, or
otherwise attempt to obtain and use our intellectual property. Enforcement of
trademark rights against unauthorized use, particularly over the Internet and in
other countries, may be impractical or impossible and could generate confusion
and diminish the value of those rights. Litigation may be necessary to enforce
our intellectual property rights, to protect our trade secrets and to determine
the validity and scope of the proprietary rights of others. Any litigation
could result in substantial costs and diversion of our resources and could
seriously harm our business and operating results. In addition, our inability
to protect our intellectual property may harm our business and financial
prospects. Also, if we cannot protect our domain names and prevent others from
using similar domain names or trademarks, we may not be able to establish a
strong brand and our business and financial results could suffer.
Our products and services employ technology that may infringe on the
proprietary rights of others, and we may be liable to others for
significant damages.
We believe there is an increasing amount of litigation in the Internet
industry regarding intellectual property rights. It is possible that third
parties may in the future claim that we or our products or services infringe
upon their intellectual property rights. We expect that developers and
providers of Internet appliances and similar devices, and providers of Internet
access and content services, will be subject to an increasing number of
infringement claims as the number of products, services and competitors in our
market grows. Any claim, with or without merit, could consume management time,
result in costly litigation, cause delays in implementation of our products or
services or require us to enter into royalty or licensing agreements. Royalty
or licensing agreements, if required and available, may be on terms unacceptable
to us or detrimental to our business. Moreover, a successful claim of product
infringement against us or our failure or inability to license the infringed or
similar technology on commercially reasonable terms could seriously harm our
business.
We may incur potential product and service liability for our i-opener
Internet appliance and for products and services sold over the Internet.
To date, we have had limited experience in selling our i-opener Internet
appliance and service. In addition, we have had limited experience in selling
products over the Internet and developing relationships with manufacturers or
suppliers of those products and services. We plan to enter into relationships
with manufacturers or suppliers to offer their products directly through our
Internet service. Such a strategy involves numerous risks and uncertainties.
Although our agreements with manufacturers and suppliers may sometimes contain
provisions intended to limit our exposure to liability claims, these limitations
may not prevent our exposure to all potential claims. Liability claims could
require us to
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spend significant time and money in litigation or to pay significant damages. As
a result, any such claims, whether or not successful, could seriously damage our
reputation and our business.
The market for Internet appliances and related services is new and may not
develop as we anticipate.
Because the market for Internet appliances and related services is new and
evolving, the potential size of this market opportunity and the timing of its
development are uncertain. Broad acceptance of Internet appliances and related
services will depend on many factors. These factors include:
. the willingness of large numbers of consumers to use devices other than
personal computers to access the Internet; and
. the development of content and applications that are accessible from
Internet appliances.
If the market for Internet appliances does not develop or develops more slowly
than we anticipate, our revenues will not grow as quickly as we anticipate, if
at all.
If Internet use does not continue to increase, we may not be able to expand
our business and increase our revenues.
Use of the Internet has grown dramatically, but we cannot assure you that
Internet use will continue to grow at the same rate, or at all. Substantially
all of our revenue is dependent on the continued growth in use of the Internet.
A decrease in the demand for Internet services or a reduction in the anticipated
growth for such services may prevent us from expanding our business and
increasing our revenue.
We could face liability for content retrieved through our Internet portal.
As a distributor of Internet content, we face potential liability for
defamation, negligence, copyright, patent or trademark infringement and other
claims based upon the nature and content of the materials that we distribute.
Although we carry general liability insurance, our insurance may not cover
claims of this type or may not be adequate to indemnify us for all liability
that we may suffer. Any of these claims, particularly those resulting in
liability that is not covered by insurance or is in excess of insurance
coverage, could occupy significant amounts of our management's time and
attention, harm our reputation and negatively affect our business.
We could be exposed to liability or increased costs if new case law is
decided, or new government regulation is enacted, regarding the Internet.
The law relating to our business and operations is evolving and no clear
legal precedents have been established. The adoption of any new Internet laws
and regulations or the application of existing laws and regulations to the
Internet and e-commerce may decrease the growth in the use of the Internet. For
example, tax authorities in a number of states are currently reviewing the
appropriate tax treatment of companies engaged in e-commerce, and new state tax
regulations may subject us to additional state sales or other taxes. These
results could decrease the demand for our products and services or increase the
cost of doing business, either of which would reduce our revenue or
profitability.
In addition, the applicability to the Internet of existing laws in various
jurisdictions governing issues such as property ownership, sales and other
taxes, libel and personal privacy is uncertain and may take years to resolve.
If we were alleged to have violated federal, state or foreign civil or criminal
law,
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even if we could successfully defend such claims, it could occupy significant
amounts of management's time, harm our business reputation and negatively affect
our operating results and financial condition.
Concerns regarding the security of transmission of confidential information
over the Internet may reduce consumer confidence in our product and service
offerings and negatively impact our business.
The secure transmission of confidential information over the Internet is
essential to maintaining subscriber confidence in our Internet service.
Substantial or ongoing security breaches on our system or other Internet-based
systems could significantly damage subscriber confidence and harm our business.
A party that is able to circumvent our security systems could steal proprietary
information or cause interruptions in our operations. Security breaches also
could damage our reputation and expose us to a risk of loss or litigation and
possible liability. Our insurance policies carry low coverage limits, which may
not be adequate to reimburse us for losses caused by security breaches. While
we attempt to protect against and remedy security breaches, we cannot guarantee
that our security measures will prevent such breaches. We also face risks
associated with security breaches affecting third parties conducting business
over the Internet. Any publicized security problems relating to third parties
could heighten concern regarding security and privacy on the Internet, inhibit
the growth of the Internet and, therefore, our Internet service as a means of
conducting commercial transactions.
Fluctuations in operating results, market volatility and other factors may
adversely affect our stock price.
The market price of our common stock may fluctuate significantly in
response to a number of factors, some of which are beyond our control,
including:
. variations in quarterly operating results;
. changes in estimates of our financial performance by securities analysts;
. changes in market valuations of comparable Internet-related companies;
. announcements by us or our competitors of new products, services,
significant contracts, acquisitions, strategic relationships, joint
ventures or capital commitments;
. our inability to locate or maintain suppliers of our manufactured products
at prices that will allow us to attain profitability;
. product or design flaws, product recalls or similar occurrences;
. loss of a major content provider;
. network outages;
. loss of our telecommunications providers;
. additions or departures of key personnel;
. sales of capital stock in the future; and
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. fluctuations in stock market prices and volume, which are particularly
common among highly volatile Internet-related securities.
If we expand our business internationally, our business would become
increasingly susceptible to numerous international business risks.
Although we have not had international sales and subscription fee revenue
to date, we intend to initiate international sales efforts. International
operations are subject to inherent risks, including:
. unexpected changes in international regulatory requirements and tariffs;
. difficulties in staffing and managing foreign operations;
. longer payment cycles;
. greater difficulty in accounts receivable collection;
. potentially adverse tax consequences;
. price controls or other restrictions on foreign currency; and
. difficulties in obtaining export and import licenses.
To the extent our dependence on revenues from international sales and
subscription fees increases, a material adverse effect on our international
business could materially and adversely affect our overall business, operating
results and financial condition.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
All of our current contracts are denominated in United States dollars and
we do not currently invest in derivative financial instruments. However, we
invest our excess cash balances in short-term, interest bearing, investment-
grade securities, certificates of deposit or direct or guaranteed U.S.
government obligations, such as Treasury bills, that are subject to market risk.
We believe the effect on our financial position, results of operations and cash
flows as the result of any reasonably likely changes in interest rates would not
be material.
PART II. OTHER INFORMATION.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
<TABLE>
<C> <S>
10.1 Assignment of the Internetworking Agreement by and between GTE Internetworking Incorporated ("GTE") and Netpliance dated
as of May 30, 1999 to Genuity Solutions, Inc., an affiliate of GTE.
10.2 Employment Agreement by and between Valerie Walden and Netpliance dated June 26,
2000.
10.3 Facility Lease by and between Hub Properties Trust and Netpliance, dated May 30,
2000.
27 Financial Data Schedule
</TABLE>
(b) No reports on Form 8-K have been filed during the quarter for which
this report is filed.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NETPLIANCE, INC.
Date: August 11, 2000 /s/ BARBARA A. KACZYNSKI
------------------------
Barbara A. Kaczynski
Chief Financial Officer
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EXHIBIT INDEX
10.1 Assignment of the Internetworking Agreement by and between GTE
Internetworking Incorporated ("GTE") and Netpliance dated as of May 30,
1999 to Genuity Solutions, Inc., an affiliate of GTE.
10.2 Employment Agreement by and between Valerie Walden and Netpliance dated
June 26, 2000.
10.3 Facility Lease by and between Hub Properties Trust and Netpliance, dated
May 30, 2000.
27 Financial Data Schedule
