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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 000-20873
CONNECT, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0431045
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
515 Ellis Street
Mountain View, California 94043-2242
(Address of principal executive offices) (Zip code)
(650) 254-4000
(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 [_]
As of November 11, 1998 there were 12,893,843 shares of the Registrant's Common
Stock outstanding.
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CONNECT, INC.
TABLE OF CONTENTS
Page
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PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited)
Condensed Balance Sheets as of 3
September 30, 1998 and December 31, 1997
Condensed Statements of Operations for the three months 4
and nine months ended September 30, 1998 and 1997
Condensed Statements of Cash Flows for the 5
nine months ended September 30, 1998 and 1997
Notes to Condensed Financial Statements 6
ITEM 2. Management's Discussion and Analysis of Financial 6
Condition and Results of Operations
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 13
ITEM 2 Changes in Securities and Use of Proceeds 13
ITEM 3 Defaults Upon Senior Securities 13
ITEM 4. Submission of Matters to Vote of Security Holders. 13
ITEM 5. Other Information 13
ITEM 6. Exhibits and Reports on Form 8-K. 13
SIGNATURES 14
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ITEM 1. FINANCIAL STATEMENTS
CONNECT, INC.
CONDENSED BALANCE SHEETS
(in thousands, except share data)
(Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
-------------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................................... $ 3,812 $ 9,644
Accounts receivable, less allowances for doubtful accounts of $433
at September 30, 1998 and $642 at December 31, 1997............ 781 2,298
Prepaid expenses and other current assets.......................... 241 895
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Total current assets.................................................... 4,834 12,837
Property and equipment, net............................................. 714 2,442
Other assets............................................................ 55 85
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Total assets...................................................... $ 5,603 $ 15,364
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Notes payable...................................................... $ 797 $ 620
Accounts payable................................................... 713 1,279
Accrued payroll and related expenses............................... 291 609
Other accrued liabilities.......................................... 1,577 1,588
Deferred revenue................................................... 375 681
Current portion of extended vendor liabilities..................... 280 272
Obligations under capital leases................................... 63 355
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Total current liabilities............................................... 4,096 5,404
Notes payable...................................................... 366 713
Long-term portion of extended vendor liabilities................... 78 224
Long-term obligations under capital leases......................... -- 2
Convertible notes.................................................. -- 9,654
Commitments and contingencies Stockholders' equity (deficit):
Preferred stock:
Authorized shares--3,500,000
Issued and outstanding shares--None............................ -- --
Common stock: $.001 par value
Authorized shares--60,000,000
Issued and outstanding shares--12,893,847 at September 30, 1998
and 3,827,806 at December 31, 1997............................. 13 4
Additional paid-in capital......................................... 70,613 61,016
Deferred compensation.............................................. (64) (96)
Accumulated deficit................................................ (69,499) (61,557)
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Total stockholders' equity (deficit).................................... 1,063 (633)
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Total liabilities and stockholders' equity (deficit).................... $ 5,603 $ 15,364
========= =========
</TABLE>
See accompanying notes.
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CONNECT, INC.
CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except loss per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
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1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
REVENUE:
License........................................... $ 123 $ 613 $ 1,608 $ 2,495
Service........................................... 978 1,410 3,433 4,595
-------- -------- -------- --------
Total revenue................................. 1,101 2,023 5,041 7,090
COST OF REVENUE:
License........................................... 121 151 415 545
Service........................................... 963 1,788 3,428 6,584
-------- -------- -------- --------
Total cost of revenue......................... 1,084 1,939 3,843 7,129
-------- -------- -------- --------
Gross profit (loss) 17 84 1,198 (39)
OPERATING EXPENSES:
Research and development.......................... 853 1,105 3,153 3,727
Sales and marketing............................... 742 1,473 3,050 5,827
General and administrative........................ 411 634 1,761 1,976
Nonrecurring charges.............................. 1,098 -- 1,098 --
-------- -------- -------- --------
Total operating expenses...................... 3,104 3,212 9,062 11,530
-------- -------- -------- --------
LOSS FROM OPERATIONS.............................. (3,087) (3,128) (7,864) (11,569)
Interest expense....................................... (27) ( 67) (274) (213)
Interest income and other income, net.................. 50 40 196 266
-------- -------- -------- --------
LOSS BEFORE INCOME TAXES.......................... (3,064) (3,155) (7,942) (11,516)
Provision (benefit) for income taxes................... -- -- -- --
-------- -------- -------- --------
NET LOSS......................................... $(3,064) $(3,155) $(7,942) $(11,516)
======== ======== ======== =========
BASIC AND DILUTED NET LOSS PER SHARE................... ($0.24) ($0.83) ($0.80) ($3.05)
======== ======== ======== =========
Weighted average common shares outstanding............. 12,890 3,807 9,909 3,770
</TABLE>
See accompanying notes.
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CONNECT, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
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1998 1997
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<S> <C> <C>
OPERATING ACTIVITIES
Net loss..................................................................... $(7,942) $(8,361)
Adjustments to reconcile net loss to net cash used in operating activities:
Write-off of certain assets relating to nonrecurring charges.............. 1,038 --
Depreciation and amortization............................................. 1,081 912
Amortization of deferred compensation..................................... 32 21
Changes in operating assets and liabilities:
Accounts receivable................................................. 1,517 (281)
Prepaid expenses and other current assets........................... 471 (70)
Other assets........................................................ 30 28
Accounts payable, accrued payroll and related expenses, other
accrued liabilities, and extended vendor liabilities................ (1,081) (97)
Deferred revenue.................................................... (306) (58)
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Net cash used in operating activities..................................... (5,160) (7,906)
INVESTING ACTIVITIES
Purchases of property and equipment.......................................... (208) (418)
-------- --------
Net cash used in investing activities..................................... (208) (418)
FINANCING ACTIVITIES
Proceeds from issuance of common stock....................................... -- 411
Proceeds from issuance of notes payable...................................... 311 1,750
Repayment of principal on notes payable...................................... (481) (199)
Repayment of principal under capital lease obligations....................... (294) (265)
-------- --------
Net cash provided (used) by financing activities.......................... (464) 1,697
-------- --------
Net decrease in cash and cash equivalents.................................... (5,832) (6,627)
Cash and cash equivalents at beginning of period............................. 9,644 12,214
-------- --------
Cash and cash equivalents at end of period................................ $ 3,812 $ 5,587
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest....................................................... $ 274 $ 146
SUPPLEMENTAL NON-CASH FINANCING INFORMATION
Conversion of convertible notes into preferred stock and common stock........ $ 9,654 $ --
</TABLE>
See accompanying notes.
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CONNECT, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
1) THE COMPANY AND SIGNIFICANT ACCOUNTING P0LICIES
BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. The financial information should be read in conjunction with the
financial statements and notes thereto included in CONNECT, Inc.'s ("CONNECT" or
the "Company") Annual Report on Form 10-K for the year ended December 31, 1997
(the "Annual Report"). The results of operations for the nine months ended
September 30, 1998 are not necessarily indicative of the results that may be
expected for the full fiscal year or for any future periods. Certain prior year
amounts previously reported, have been reclassified to conform to 1998
presentation.
2) NET LOSS PER SHARE
Basic and diluted net loss per share is based on the weighted average number
of shares of Common Stock outstanding during the period presented, in accordance
with statement of financial accounting standards No. 128 (earnings per share).
The numbers of shares for three and nine months ended September 30, 1998, are
adjusted to reflect the one-for-five reverse stock split effected in February
1998.
3) NONRECURRING CHARGES
During the quarter the Company recorded a nonrecurring charge of approximately
$1.1 million. The charge included $1.04 million for write off of certain assets
and $60,000 for severance payments to certain employees. This charge was
recorded as a result of the Company's shift in business direction from
designing, marketing, developing and supporting software for internet base
interactive commerce to being a consulting service organization providing
internet systems integration.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This report contains, in addition to historical information, forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended that involve risks and uncertainties. The Company's actual results
could differ materially from the results discussed in the forward-looking
statements. Factors that could cause or contribute to such differences include,
but are not limited to, those discussed under the caption, "Risk Factors" in the
Annual Report on Form 10-K for the year ended December 31, 1997, as well as the
risks discussed elsewhere in this Quarterly Report. In particular such factors
include: the Company's ability to implement and execute its revised business
model focused on software services; acceptance by the marketplace of the
Company's services; the Company's ability to implement its revised business
model with its existing cash resources; the Company's ability to obtain
additional capital on terms favorable to the Company, or at all; the Company's
ability to offer new services to meet market demand or that incorporate evolving
industry standards; the Company's ability to compete effectively; acceptance of
the Internet as a medium for electronic commerce and order management; the
Company's dependence on the Internet infrastructure; and the Company's
dependence on certain third party software and services vendors. Readers are
cautioned not to place undue reliance on these forward-looking statements, which
may be made to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events. Readers should carefully review
the risk factors described in other documents the Company
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files from time to time with the Securities and Exchange Commission, including,
the Annual Report on Form 10-K, the Quarterly Reports on Form 10-Q, and any
Current Reports on Form 8-K filed by the Company.
OVERVIEW
The Company historically designed, developed, marketed and supported
application software for Internet-based interactive commerce. On October 12,
1998, the Company announced a shift in business direction and focus, to
providing Internet systems integration based on technologies from both Connect
and industry partners. This decision effectively unified its consulting service
organization and its software products group into a single consulting services
organization providing Internet systems integration, as well as extending its
current service business to emphasize building cross-enterprise e-Business
solutions. Connect provides integration solutions to enable Internet-based
electronic commerce and build the "Connected Corporation" from any link in the
emerging network supply chain. CONNECT's Web time-driven professional services
enable Connected Corporations to build open, multi-vendor e-business solutions
that allow them to compete effectively in the digital economy using best-of-
breed technologies. Utilizing innovative methodologies combined with cutting-
edge technical expertise to conceptualize, design, develop, and deploy e-
Business solutions facilitated by Internet technologies. This will allow the
Company to leverage its core competencies and deliver to its customers
consulting services solutions.
The Company has historically derived revenues from software license fees and
services. License fees primarily consisted of revenue from licenses of the
Company's application software. Service revenue consisted of fees from
implementation (including customization of licensed software), training,
maintenance and support, contract software development projects, and system
hosting and on-line services. On January 1, 1998, the Company adopted Statement
of Position No. 97-2, "Software Revenue Recognition" (SOP 97-2) which superceded
Statement of Position 91-1, "Software Revenue Recognition" (SOP 91-1).
Arrangements with effective dates prior to January 1, 1998 have been and will be
accounted for under SOP 91-1. Any amendments after January 1, 1998 to
arrangements with effective dates prior to January 1, 1998 will be accounted for
under SOP 97-2. The implementation of SOP 97-2 did not have a material adverse
affect on the Company's business or revenue accounting practices or on the
Company's reported revenues and earnings for the three and nine months ended
September 30, 1998. In accordance with SOP 97-2, all elements of software
licensing arrangements are separately identified and accounted for based on
relative fair values of each element, and revenue is recognized as elements are
delivered. License fees under contracts requiring significant implementation,
including customization, of licensed application software are recognized on a
percentage-of-completion basis. Revenue from implementation services is
recognized as the services are performed.
The Company has also typically entered into maintenance agreements in
connection with licenses of its application software under which revenue is
recognized ratably over the term of the agreement, generally one year. Usage
fees related to the Company's training, system-hosting services, private on-line
services and consulting services are recognized as the services are performed.
The Company incurred net losses in each fiscal year since its inception and as
of September 30, 1998, has an accumulated deficit of $69.5 million. The
Company's operating expenses increased in 1997 and 1996 as the Company made
investments related to the development and introduction of OneServer,
OrderStream and PurchaseStream. To date, all research and development costs
have been expensed as incurred, instead of being capitalized, because the costs
have not been material. The Company anticipates its operating expenses will
continue to decrease during the reminder of the 1998 fiscal year as compared to
1997, primarily as a result of a headcount reductions and one-time charges
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associated with write-off's resulting from the Company's decision to focus its
business on providing Internet systems integration.
Although the reduction in headcount could help the Company meet its operating
expense objectives, such reduction could adversely impact the Company's sales
and marketing efforts. As the market for Internet-based electronic commerce
continues to evolve, the combination of an evolving market and the Company's
decision to focus on its Internet systems integration business has created
additional complexities in forecasting revenues and, therefore, staffing
requirements. Because of these conditions, and the Company's limited resources,
the Company has focused on controlling expenses and has reduced headcount until
a clearer picture of market demands, and its abilities to meet them, exists.
The Company anticipates that operating expenses will continue to exceed
revenues, resulting in continuing net losses and negative cash flow from
operations for the remainder of 1998.
The Company's prospects are dependent upon the successful acceptance of its
service offerings by the market. In addition, the Company's markets are new and
rapidly evolving, which heightens these risks and uncertainties. To address
these risks, the Company must, among other things, successfully implement its
marketing strategy, respond to competitive developments, and integrate new
technologies and industry standards into its solutions offerings. There can be
no assurance that the Company will succeed in addressing any or all of these
risks. See "Risk Factors" in the Annual Report, as well as the risks discussed
elsewhere in this Quarterly Report.
The Company has incurred net losses and experienced significant negative cash
flow from operations since inception. As of September 30, 1998, the Company has
an accumulated deficit of $69.5 million. Based upon its current operating plan,
the Company believes it has adequate cash balances to fund its operations
through December 31, 1998. There can be no assurance, however, that the
Company's actual cash requirements will not exceed anticipated levels, or that
the Company will generate sufficient revenue to fund its operations in the
absence of additional funding sources. If additional funds are raised through
the issuance of equity securities, stockholders of the Company may experience
additional dilution, or the securities may have rights preferences or privileges
senior to those of the Company's Common Stock. There can be no assurance that
such additional financing will be available on acceptable terms, if at all. If
adequate funds are not available or are not available on acceptable terms, the
Company may be unable to continue operations, develop or enhance its products,
take advantage of future opportunities or respond to competitive pressures of
other requirements, any of which would have a material adverse effect on the
Company's business, operating results and financial condition.
In July 1998, the Company announced that it had hired Alliant Partners, a Palo
Alto, California based investment-banking firm, to assist the Company in
evaluating opportunities to enhance stockholder value through strategic
relationships, including those that could lead to the sale of the Company. On
October 12, 1998, the Company announced the formal effort to identify investment
partners working with Alliant Partners had ended.
On October 15, 1998, the Company was informed by the Nasdaq Stock Market
("Nasdaq") of a concern regarding the continued listing of the Company's Common
Stock on the Nasdaq National Market, specifically, the Common Stock failed to
maintain a minimum bid price of at least $1.00 per share. The Company was given
90 days (until January 13, 1999) to regain compliance. In order to regain
compliance, the bid price must be greater than or equal to $1.00 per share for
10 consecutive trading days. There can be no assurance that the Company will be
able to regain compliance with such requirement.
In addition, the listing requirements of Nasdaq require the Company to
maintain net tangible assets of at least $4 million (the "NTA Requirement"). The
Company's net tangible assets were approximately $1.1 million as of September
30, 1998. It is unlikely that the Company will be able to regain
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compliance with the NTA Requirement in 90 days, which will likely cause the
Company's stock to be delisted from The Nasdaq National Market. The removal of
the Common Stock from listing on The Nasdaq National Market most likely would
have a material adverse effect on the market price of the Common Stock and on
the ability of stockholders and investors to buy and sell shares of the Common
Stock in the public markets.
Revenue
Total revenue was $1,101,000 for the three months ended September 30, 1998,
compared to $2,023,000 for the comparable period in 1997, a decrease of 46%.
Total revenue for the nine months ended September 30, 1998 was $5,041,000
compared to $7,090,000 for the comparable period in 1997, a decrease of 29%. For
the three months ended September 30, 1998, three customers represented
approximately 28%, 20% and 17% of total revenue. For the nine months ended
September 30, 1998, two customers represented approximately 26% and 13% of total
revenue, respectively. Two customers were represented in both the three and nine
months' periods. No other customer contributed more than 10% for the three and
nine months ended September 30, 1998.
License. License revenue was $123,000 or 11% of total revenue for the three
months ended September 30, 1998, compared to $613,000, or 30% of total revenue,
for the comparable period in 1997. This represents a decrease of $490,000 or
80%. For the nine months ended September 30, 1998 license revenue was $1,608,000
or 32% of total revenue, compared to $2,495,000 or 35% of total revenue, for the
nine months ended September 30, 1997. This represents a decrease of $887,000 or
36%. The three and nine month decreases in license revenue is attributable to
several factors, including potential customers extending their decision process,
limitations on MIS resources that are committed to Year 2000 projects or their
derivative, and the implementation of major ERP systems.
Service. Service revenue was $978,000, or 89% of total revenue for the three
months ended September 30, 1998, compared to $1,410,000, or 70% of total
revenue, for the comparable period in 1997. This represents a decrease of
$432,000 or 31%. For the nine months ended September 30, 1998 service revenue
was $3,433,000 or 68% of total revenue, compared to $4,595,000 or 65% of total
revenue for the comparable period in 1997. This represents a decrease of
$1,162,000 or 25%. Service revenue in 1998 is lower than 1997 primarily due to
reduced staff associated with fewer software implementation projects.
Cost of Revenue
Cost of License Revenue. Cost of license revenue includes sub-license fees
and expenses relating to product media duplication and manuals. Cost of license
revenue was $121,000, or 98% of license revenue, for the three months ended
September 30, 1998, compared to $151,000, or 25% of license revenue for the
comparable period in 1997. The increase in cost of license revenue as a
percentage from 1997 to 1998 is due primarily to the write-down of prepaid
royalty costs associated with the decision to focus is business on providing
Internet systems integration. For the nine months ended September 30, 1998 cost
of license revenue was $415,000 or 26% of license revenue, compared to $545,000
or 22% of license revenue for the comparable period in 1997.
Cost of Service Revenue. Cost of service revenue consists of cost of
implementation services including fees for third-party contract developers,
company personnel costs, training and customer support costs for OneServer;
costs associated with contract software development projects,
telecommunications, depreciation related to hosting services and the operation
of the Company's private online service. Cost of service revenue was $963,000 or
98% of service revenue for the three months ended September 30, 1998, compared
to $1,788,000, or 127% of service revenue, for the comparable period in 1997.
For the nine months ended September 30, 1998 cost of service revenue
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was $3,428,000 or approximately 100% of service revenue, compared to $6,584,000
or 143% of service revenue for the comparable period of 1997. The cost as a
percent of revenue declined in 1998 due to cost reduction steps taken in the
Company's services business and the absence of charges in the first and second
quarters of 1998 related to fixed price contracts that existed in the previous
year.
Operating Expenses
Research and Development. Research and development expenses consist primarily
of personnel and equipment costs. Research and development expenses for the
three months ended September 30, 1998 were $853,000 or 77% of total revenue,
compared with $1,105,000 or 55% for the comparable period in 1997. Expenses for
the nine months ended September 30, 1998 were $3,153,000 or 63% of total
revenue, compared with $3,727,000 or 53% for the comparable period in 1997. The
decline in total research and development expenses is related to staffing
reductions and cost reduction measures. The Company expects research and
development expenses for the balance of 1998 to decrease significantly due to
the decision to focus its business on providing Internet systems integration
services.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, commissions of sales and marketing personnel, travel, and marketing
and promotional expense. Sales and marketing expenses were $742,000 or 67% of
total revenue for the three months ended September 30, 1998 compared with
$1,473,000 or 73% of total revenue for the comparable period in 1997. For the
nine months ended September 30, 1998 expenses were $3,050,000 or 61% of total
revenue, compared to $5,827,000 or 82% of total revenue for the comparable
period in 1997. The decrease in sales and marketing expenses in 1998 from 1997
was attributable to lower sales revenue, decreased staffing and reductions in
marketing expenditures. For the balance of 1998 sales and marketing costs are
expected to decrease significantly due to the decision to focus its business on
providing Internet systems integration services.
General and Administrative. General and administrative expenses consist
primarily of salaries of financial, administrative and management personnel and
related travel expenses, as well as legal, accounting and public company related
expenses. General and administrative expenses were $411,000 or 37% of total
revenue for the three months ended September 30, 1998, compared with $634,000 or
31% of total revenue for the comparable period in 1997. Included in the third
quarter results, general and administrative expenses had $1.1 million in one-
time charges and write-offs resulting from the Company's decision to focus its
business on providing Internet systems integration. For the nine months ended
September 30, 1998, expenses were $1,761,000 or 35% of total revenue, compared
with $1,976,000 or 28% of total revenue for the comparable period in 1997. The
Company expects the balance of 1998 general and administrative expenses to
decrease as it focuses its business on providing Internet systems integration
services.
NonRecurring Charge. During the quarter the Company recorded a nonrecurring
charge of approximately $1.1 million. The charge included $1.04 million for
write off of certain assets and $60,000 for severance payments to certain
employees. This charge was recorded as a result of the Company's shift in
business direction from designing, marketing, developing and supporting
software for internet base interactive commerce to being a consulting
service organization providing internet systems integration.
Other Income (Expense)
Other income (expense) consists primarily of interest expense and interest
income. Interest expense, which resulted principally from interest incurred
under notes payable and capital lease obligations, was $27,000 or 2% of total
revenue for the three months ended September 30, 1998, compared with $67,000 or
3% for the comparable period in 1997. For the nine months ended September 30,
1998 interest expense was $274,000 or 5% of total revenue, compared to $213,000
or 3% for the comparable period in 1997. Interest expense increased in 1998 from
1997 due to interest associated with the convertible notes issued in November
1997.
Interest and other income principally represents interest earned on cash
balances. Interest and other income was $50,000 or 5% of total revenue for the
three months ended September 30, 1998, compared with $40,000 or 2% of total
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revenue for the comparable period in 1997. For the nine months ended September
30, 1998 interest income was $196,000 or 4% of total revenue, compared to
$266,000 or 4% of total revenue for the comparable period in 1997. This
decrease is primarily due to lower cash balances in 1998.
The Company has a tax loss carry forward and is currently incurring losses for
tax purposes. Accordingly, there is no provision for income taxes.
FACTORS AFFECTING QUARTERLY OPERATING RESULTS
The Company has experienced and expects to continue to experience significant
fluctuations in quarterly operating results that may be caused by many factors
including, among others, the Company's ability to implement and execute its new
business strategy, rapid changes in the market place, risks related to the
management of growth, the Company's ability to attract, train and retain
qualified personnel, the Company's ability to build its sales staff and re-
deploy its employees previously focused on the Company's software product
offerings, development and promotional expenses related to the introduction of
new services, changes in technology and industry standards, changes in the
market for the Company's services, the rate of acceptance of the Company's
services, dependence of the company's business on the Internet, increased
competition, changing of pricing policies by the Company or its competitors, the
timing of receipt and orders from major customers, dependence on key personnel,
proprietary technology and the inherent difficulties in protecting intellectual
property, dependence on third-party technology, and exposure for product and
professional services liability.
Further, the Company's expense levels are based, in significant part, on the
Company's expectations as to future revenue and are therefore relatively fixed
in the short term. If revenue levels fall below expectations, net loss is likely
to be disproportionately adversely affected because a proportionately smaller
amount of the Company's expenses varies with its revenue. There can be no
assurance that the Company will be able to achieve profitability on a quarterly
or annual basis in the future. Due to all the foregoing factors, the Company's
future operating results may be below the expectations of securities analysts
and investors. In such event, the price of the Company's Common Stock would
likely be materially adversely affected. See "Risk Factors - Fluctuations in
Quarterly Operating Results" in the Company's Annual Report on Form 10-K.
YEAR 2000 COMPLIANCE
The Year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year, thus rendering them
incapable of properly managing and manipulating data that includes both 20/th/
and 21st century dates "Year 2000 Compliant". In connection with a normal plan
Of upgrading its computer resources, the Company is currently installing or
upgrading internal information systems in connection with operating its
business. The vendors of these systems have represented that their systems are
Year 2000 Compliant. The Company is also in the process of determining what
other changes to its other information systems are necessary in order to make
them Year 2000 Compliant. While the Company currently expects that the Year 2000
issue will not pose significant internal operational problems, delays in the
implementation of new information systems, or a failure to fully identify all
Year 2000 dependencies in the Company's systems, could have a material adverse
effect on the Company's business or results of operations.
The Company believes that its most current release's of its software products
are Year 2000 Compliant and the Company has begun a process of notifying each of
its customers who are not on its current release. The Company is contacting its
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customers directly, by mail and by posting this information on the Company's web
site. The inability of Company's previously released products to properly
manage and manipulate data in the Year 2000 could result in increased warranty
costs, customer satisfaction issues and potential lawsuits, any of which could
have a material adverse effect on the Company's business, results of operations
or financial condition.
The Company has contacted each of its critical suppliers and vendors to
determine the extent to which the Company's capabilities are vulnerable to
failure by those third parties to mediate their own Year 2000 issues. The
Company expects to complete this analysis by March 30, 1999.
The Company will proceed with further analysis or testing of its vendors'
systems as needed. However, there can be no assurance that the systems and
products of other companies on which the Company relies will be timely converted
or that they will not have a material adverse impact on the Company.
The Company is in the process of developing a contingency plan. This plan is
expected to be in place in the first half of 1999. The inability of the
Company to develop and implement a contingency plan could result in a material
adverse impact on the Company.
The Company currently estimates that total Year 2000 costs will not be material.
Accordingly, the Company believes it has sufficient resources for the Year 2000
project from currently available cash reserves. The cost estimate is based on
the current assessment of the Company's Year 2000 readiness needs and is subject
to change.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations to date primarily through the private
and public sale of debt and equity securities and the use of capitalized leases
for equipment financing. The Company had working capital of $.7 million at
September 30, 1998.
During the nine months ended September 30, 1998 and 1997, net cash used in
operating activities was $5.2 million and $7.9 million respectively, primarily
due to net losses incurred by the Company.
During the nine months ended September 30, 1998 and 1997, the Company used
$208,000 and $418,000 respectively, in investing activities for the purchase of
property and equipment. Net cash used by financing activities for the nine
months ended September 30, 1998 was $464,000, primarily from the repayment of
notes payable and principal under capital lease obligations. Net cash provided
by financing activities for the nine months ended September 30, 1997 was
$1,697,000, primarily from the issuance of notes payable.
The Company has incurred net losses and experienced significant negative cash
flow from operations since inception. As of September 30, 1998, the Company has
an accumulated deficit of $69.5 million. Based upon its current operating plan
and the decision to focus its business on providing Internet systems
integration, the Company believes it has adequate cash balances to fund its
operations through December 31, 1999. There can be no assurance, however, that
the Company's actual cash requirements will not exceed anticipated levels, or
that the Company will generate sufficient revenue to fund its operations in the
absence of additional funding sources. If additional funds are raised through
the issuance of equity securities, stockholders of the Company may experience
additional dilution, or the securities may have rights preferences or privileges
senior to those of the Company's Common Stock. There can be no assurance that
such additional financing will be available on acceptable terms, if at all. If
adequate funds are not available or are not available on acceptable terms, the
Company me be unable to continue operations, develop or enhance its products,
take advantage of future opportunities or respond to competitive pressures of
other requirements, any of which would have a material adverse effect on the
Company's business, operating results and financial condition.
-12-
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable
ITEM 2. CHANGES IN SECURITIES
Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) EXHIBITS
ITEM DESCRIPTION
----- -----------
10.3 1996 Stock Option Plan, as amended, and form of stock option
agreement.
27 Financial Data Schedule
b) REPORT ON FORM 8-K
1. Form 8-K filed on September 17, 1998.
Item 5. Other Events. (Chief Financial Officer resignation
and appointment of Controller as acting CFO.)
2. Form 8-K filed on October 12, 1998.
Item 5. Other events. (Accounting results for the quarter
ended September 30, 1998.)
3. Form 8-K filed on October 21, 1998.
Item 5. Other events. (Delisting Notification and
compliance requirements from Nasdaq)
-13-
<PAGE>
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.
CONNECT, Inc.
Date: November 14, 1998 /s/ Craig D. Norris
- ------------------------- --------------------------
Craig D. Norris
President and Chief Executive
Officer
(Principal Executive Officer)
Date: November 14, 1998 /s/ Greigory O. Park
- ------------------------- --------------------------
Greigory O. Park
Vice President, Finance &
Administration, and
(Principal Financial and
Accounting Officer)
-14-
<PAGE>
EXHIBIT 10.3
CONNECT, INC.
1996 STOCK OPTION PLAN
1. Purposes of the Plan. The purposes of this Stock Option Plan are to
--------------------
attract and retain the best available personnel for positions of substantial
responsibility, to give Employees and Consultants of the Company a greater
personal stake in the success of the Company's business, to provide additional
incentive to the Employees and Consultants of the Company to continue and
advance in their employment and service to the Company and to promote the
success of the Company's business.
Options granted hereunder may be either Incentive Stock Options or
Nonstatutory Stock Options, at the discretion of the Board and as reflected in
the terms of the written option agreement.
2. Definitions. As used herein, the following definitions shall
-----------
apply:
(a) "Administrator" shall mean the Board or any of its Committees
-------------
appointed pursuant to Section 4 of the Plan.
(b) "Applicable Laws" shall have the meaning set forth in Section
---------------
4(a) below.
(c) "Board" shall mean the Board of Directors of the Company.
-----
(d) "Code" shall mean the Internal Revenue Code of 1986, as amended.
----
(e) "Committee" shall mean the Committee appointed by the Board of
---------
Directors in accordance with Section 4(a) of the Plan, if one is appointed.
(f) "Common Stock" shall mean the Common Stock of the Company.
------------
(g) "Company" shall mean Connect, Inc., a California corporation.
-------
(h) "Consultant" shall mean any person who is engaged by the Company
----------
or any Parent or Subsidiary to render consulting services and is compensated
for such consulting services, and any director of the Company whether
compensated for such services or not; provided that if and in the event the
Company registers any class of any equity security pursuant to Section 12 of
the Exchange Act, the term Consultant shall thereafter not include directors
who are not compensated for their services or are paid only a director's fee
by the Company.
(i) "Continuous Status as an Employee or Consultant" shall mean the
----------------------------------------------
absence of any interruption or termination of service as an Employee or
Consultant. Continuous Status as an Employee or Consultant shall not be
considered interrupted in the case of sick leave, military leave, or any other
leave of absence approved by the Administrator; provided that such leave is
<PAGE>
for a period of not more than 90 days or reemployment upon the expiration of
such leave is guaranteed by contract or statute. Notwithstanding the
foregoing, a leave of absence shall not be considered as interrupting the
Continuous Status of an Employee or Consultant if the leave has been
designated by the Company as (or required by law to be) a leave for which such
status shall continue. For purposes of this Plan, a change in status from an
Employee to a Consultant or from a Consultant to an Employee will not
constitute a termination of employment.
(j) "Director" shall mean a member of the Board.
--------
(k) "Employee" shall mean any person, including Officers, Named
--------
Executives and those Directors who are also employees of the Company, who are,
employed by the Company or any Parent or Subsidiary of the Company. The payment
by the Company of a director's fee to a Director shall not be sufficient to
constitute "employment" of such Director by the Company.
(l) "Exchange Act" shall mean the Securities Exchange Act of 1934,
------------
as amended.
(m) "Fair Market Value" means, as of any date, the value of Common
-----------------
Stock determined as follows:
(i) If the Common Stock is listed on any established stock
exchange or a national market system including without limitation the National
Market System of the National Association of Securities Dealers, Inc.
Automated Quotation ("NASDAQ") System, its Fair Market Value shall be the
closing sales price for such stock as quoted on such system on the date of
determination (if for a given day no sales were reported, the closing bid on
that day shall be used), as such price is reported in The Wall Street Journal
-----------------------
or such other source as the Administrator deems reliable;
(ii) If the Common Stock is quoted on the NASDAQ System (but
not on the National Market thereof) or regularly quoted by a recognized
securities dealer but selling prices are not reported, its Fair Market Value
shall be the mean between the bid and asked prices for the Common Stock or;
(iii) In the absence of an established market for the Common
Stock, the Fair Market Value thereof shall be determined in good faith by the
Administrator.
(n) "Incentive Stock Option" shall mean an Option intended to qualify
----------------------
as an incentive stock option within the meaning of Section 422 of the Code, as
designated in the applicable written option agreement.
(o) "Named Executive" shall mean any individual who, on the last day
---------------
of the Company's fiscal year, is the chief executive officer of the Company (or
is acting in such capacity) or among the four highest compensated officers of
the Company (other than the chief executive officer). Such officer status shall
be determined pursuant to the executive compensation disclosure rules under the
Exchange Act.
<PAGE>
(p) "Nonstatutory Stock Option" shall mean an Option not intended to
-------------------------
qualify as an Incentive Stock Option, as designated in the applicable written
option agreement.
(q) "Officer" shall mean a person who is an officer of the Company
-------
within the meaning of Section 16 of the Exchange Act and the rules and
regulations promulgated thereunder.
(r) "Option" shall mean a stock option granted pursuant to the Plan.
------
(s) "Optioned Stock" shall mean the Common Stock subject to an Option.
--------------
(t) "Optionee" shall mean an Employee or Consultant who receives an
--------
Option.
(u) "Parent" shall mean a "parent corporation," whether now or
------
hereafter existing, as defined in Section 424(e) of the Code.
(v) "Plan" shall mean this 1995 Stock Option Plan.
----
(w) "Rule 16b-3" shall mean Rule 16b-3 promulgated under the Exchange
------------
Act as the same may be amended from time to time, or any successor provision.
(x) "Share" shall mean a share of the Common Stock, as adjusted in
-----
accordance with Section 14 of the Plan.
(y) "Subsidiary" shall mean a "subsidiary corporation," whether now
----------
or hereafter existing, as defined in Section 424(f) of the Code.
3. Stock Subject to the Plan. Subject to the provisions of Section 14 of
-------------------------
the Plan, the maximum aggregate number of shares that may be optioned and sold
under the Plan is the sum of (i) _________ Shares of Common Stock plus (ii) such
number of shares as are subject to outstanding and unexercised stock options
under the Company's 1989 Stock Option Plan as of the date of adoption of this
Plan by the shareholders, and which options are canceled or otherwise terminated
without exercise; provided that the total number of shares available under this
Plan shall in no event exceed __________. The Shares may be authorized, but
unissued, or reacquired Common Stock.
If an Option should expire or become unexercisable for any reason without
having been exercised in full, the unpurchased Shares that were subject thereto
shall, unless the Plan shall have been terminated, become available for future
grant under the Plan. Notwithstanding any other provision of the Plan, Shares
issued under the Plan and later repurchased by the Company shall not become
available for future grant or sale under the Plan.
<PAGE>
4. Administration of the Plan.
---------------------------
(a) Composition of Administrator.
----------------------------
(i) Multiple Administrative Bodies. If permitted by Rule 16b-
------------------------------
3, and by the legal requirements relating to the administration of incentive
stock option plans, if any, of applicable securities laws and the Code
(collectively, the "Applicable Laws"), the Plan may (but need not) be
administered by different administrative bodies with respect to Directors,
Officers and Employees who are neither Directors nor Officers.
(ii) Administration with respect to Directors and Officers.
-----------------------------------------------------
With respect to grants of Options to Employees or Consultants who are also
Officers or Directors of the Company, the Plan shall be administered by (A)
the Board, if the Board may administer the Plan in compliance with Rule 16b-3
as it applies to a plan intended to qualify thereunder as a discretionary plan
and Section 162(m) of the Code as it applies so as to qualify grants of
Options to Named Executives as performance-based compensation, or (B) a
Committee designated by the Board to administer the Plan, which Committee
shall be constituted in such a manner as to permit the Plan to comply with
Rule 16b-3 as it applies to a plan intended to qualify thereunder as a
discretionary plan, to qualify grants of Options to Named Executives as
performance-based compensation under Section 162(m) of the Code and to satisfy
the Applicable Laws.
(iii) Administration with respect to Other Persons. With
--------------------------------------------
respect to grants of Options to Employees or Consultants who are neither
Directors nor Officers of the Company, the Plan shall be administered by (A)
the Board or (B) a Committee designated by the Board, which Committee shall be
constituted in such a manner as to satisfy the Applicable Laws.
(iv) General. Once a Committee has been appointed pursuant to
-------
subsection (ii) or (iii) of this Section 4(a), such Committee shall continue
to serve in its designated capacity until otherwise directed by the Board. From
time to time the Board may increase the size of any Committee and appoint
additional members thereof, remove members (with or without cause) and appoint
new members in substitution therefor, fill vacancies (however caused) and remove
all members of a Committee and thereafter directly administer the Plan, all to
the extent permitted by the Applicable Laws and, in the case of a Committee
appointed under subsection (ii), to the extent permitted by Rule 16b-3 as it
applies to a plan intended to qualify thereunder as a discretionary plan, and to
the extent required under Section 162(m) of the Code to qualify grants of
Options to Named Executives as performance-based compensation.
(b) Powers of the Administrator. Subject to the provisions of the
---------------------------
Plan and in the case of a Committee, the specific duties delegated by the Board
to such Committee, the Administrator shall have the authority, in its
discretion:
(i) to determine the Fair Market Value of the Common Stock,
in accordance with Section 2(m) of the Plan;
<PAGE>
(ii) to select the Employees and Consultants to whom Options
may from time to time be granted hereunder;
(iii) to determine whether and to what extent Options are
granted hereunder;
(iv) to determine the number of shares of Common Stock to be
covered by each such award granted hereunder;
(v) to approve forms of agreement for use under the Plan;
(vi) to determine the terms and conditions, not inconsistent
with the terms of the Plan, of any award granted hereunder (including, but not
limited to, the share price and any restriction or limitation, or any vesting
acceleration or waiver of forfeiture restrictions regarding any Option and/or
the shares of Common Stock relating thereto, based in each case on such
factors as the Administrator shall determine, in its sole discretion);
(vii) to determine whether, to what extent and under what
circumstances Common Stock and other amounts payable with respect to an award
under this Plan shall be deferred either automatically or at the election of
the participant (including providing for and determining the amount, if any,
of any deemed earnings on any deferred amount during any deferral period); and
(viii) to reduce the exercise price of any Option to the then
current Fair Market Value if the Fair Market Value of the Shares covered by such
Option shall have declined since the date the Option was granted;
(c) Effect of Administrator's Decision. All decisions,
----------------------------------
determinations and interpretations of the Administrator shall be final and
binding on all Optionees and any other holders of any Options.
5. Eligibility.
-----------
(a) Nonstatutory Stock Options may be granted only to Employees and
Consultants. Incentive Stock Options may be granted only to Employees. An
Employee or Consultant who has been granted an Option may, if he or she is
otherwise eligible, be granted an additional Option or Options.
(b) Each Option shall be designated in the written option agreement
as either an Incentive Stock Option or a Nonstatutory Stock Option. However,
notwithstanding such designations, to the extent that the aggregate Fair
Market Value of Shares with respect to which Incentive Stock Options are
exercisable for the first time by an Optionee during any calendar year (under
all plans of the Company or any Parent or Subsidiary) exceeds $100,000, such
excess Options shall be treated as Nonstatutory Stock Options.
<PAGE>
(c) For purposes of Section 5(b), Incentive Stock Options shall be
taken into account in the order in which they were granted, and the Fair
Market Value of the Shares shall be determined as of the time the Option with
respect to such Shares is granted.
(d) The Plan shall not confer upon any Optionee any right with
respect to continuation of employment or consulting relationship with the
Company, nor shall it interfere in any way with his or her right or the
Company's right to terminate his or her employment or consulting relationship
at any time, with or without cause.
6. Term of Plan. The Plan shall become effective upon the earlier to
------------
occur of its adoption by the Board or its approval by the shareholders of the
Company as described in Section 20 of the Plan. It shall continue in effect
for a term of ten (10) years unless sooner terminated under Section 16 of the
Plan.
7. Term of Option. The term of each Option shall be the term stated in
--------------
the Option Agreement; provided, however, that in the case of an Incentive Stock
Option, the term shall be no more than ten (10) years from the date of grant
thereof or such shorter term as may be provided in the Option Agreement.
However, in the case of an Option granted to an Optionee who, at the time the
Option is granted, owns stock representing more than ten percent (10%) of the
voting power of all classes of stock of the Company or any Parent or Subsidiary,
the term of the Option shall be five (5) years from the date of grant thereof or
such shorter term as may be provided in the Option Agreement.
8. Limitation on Grants to Employees. Subject to adjustment as provided
---------------------------------
in this Plan, the maximum number of Shares which may be subject to Options
granted to any one Employee under this Plan for any fiscal year of the Company
shall be ________________.
9. Option Exercise Price and Consideration.
---------------------------------------
(a) The per Share exercise price for the Shares to be issued pursuant
to exercise of an Option shall be such price as is determined by the
Administrator, but shall be subject to the following:
(i) In the case of an Incentive Stock Option
(A) granted to an Employee who, at the time of the
grant of such Incentive Stock Option, owns stock representing more than ten
percent (10%) of the voting power of all classes of stock of the Company or
any Parent or Subsidiary, the per Share exercise price shall be no less than
110% of the Fair Market Value per Share on the date of grant;
(B) granted to any Employee, the per Share exercise
price shall be no less than 100% of the Fair Market Value per Share on the
date of grant.
(ii) In the case of a Nonstatutory Stock Option
<PAGE>
(A) granted to a person who, at the time of the grant
of such Option, owns stock representing more than ten percent (10%) of the
voting power of all classes of stock of the Company or any Parent or
Subsidiary, the per Share exercise price shall be no less than 110% of the
Fair Market Value per Share on the date of the grant;
(B) granted to a person who, at the time of the grant
of such Option, is a Named Executive of the Company, the per share Exercise
Price shall be no less than 100% of the Fair Market Value on the date of
grant;
(C) granted to any person other than a Named Executive,
the per Share exercise price shall be no less than 85% of the Fair Market
Value per Share on the date of grant.
(iii) In the case of an Option granted on or after the
effective date of registration of any class of equity security of the Company
pursuant to Section 12 of the Exchange Act and prior to six months after the
termination of such registration, the per Share exercise price shall be no
less than 100% of the Fair Market Value per Share on the date of grant.
(b) The consideration to be paid for the Shares to be issued upon
exercise of an Option, including the method of payment, shall be determined by
the Administrator (and, in the case of an Incentive Stock Option, shall be
determined at the time of grant) and may consist entirely of (1) cash, (2)
check, (3) promissory note, (4) other Shares that (x) in the case of Shares
acquired upon exercise of an Option either have been owned by the Optionee for
more than six months on the date of surrender or were not acquired, directly
or indirectly, from the Company, and (y) have a Fair Market Value on the date
of surrender equal to the aggregate exercise price of the Shares as to which
said Option shall be exercised, (5) authorization from the Company to retain
from the total number of Shares as to which the Option is exercised that
number of Shares having a Fair Market Value on the date of exercise equal to
the exercise price for the total number of Shares as to which the Option is
exercised, (6) delivery of a properly executed exercise notice together with
irrevocable instructions to a broker to deliver promptly to the Company the
amount of sale or loan proceeds required to pay the exercise price, (7)
delivery of an irrevocable subscription agreement for the Shares that
irrevocably obligates the option holder to take and pay for the Shares not
more than twelve months after the date of delivery of the subscription
agreement, (8) any combination of the foregoing methods of payment, or (9)
such other consideration and method of payment for the issuance of Shares to
the extent permitted under Applicable Laws. In making its determination as to
the type of consideration to accept, the Administrator shall consider if
acceptance of such consideration may be reasonably expected to benefit the
Company.
10. Exercise of Option.
------------------
(a) Procedure for Exercise; Rights as a Shareholder. Any Option
-----------------------------------------------
granted hereunder shall be exercisable at such times and under such conditions
as determined by the Admin-
<PAGE>
istrator, including performance criteria with respect to the Company and/or
the Optionee, and as shall be permissible under the terms of the Plan.
An Option may not be exercised for a fraction of a Share.
An Option shall be deemed to be exercised when written notice of such
exercise has been given to the Company in accordance with the terms of the
Option by the person entitled to exercise the Option and full payment for the
Shares with respect to which the Option is exercised has been received by the
Company. Full payment may, as authorized by the Administrator, consist of any
consideration and method of payment allowable under Section 9(b) of the Plan.
Until the issuance (as evidenced by the appropriate entry on the books of the
Company or of a duly authorized transfer agent of the Company) of the stock
certificate evidencing such Shares, no right to vote or receive dividends or any
other rights as a shareholder shall exist with respect to the Optioned Stock,
notwithstanding the exercise of the Option. The Company shall issue (or cause
to be issued) such stock certificate promptly upon exercise of the Option. No
adjustment will be made for a dividend or other right for which the record date
is prior to the date the stock certificate is issued, except as provided in
Section 14 of the Plan.
Exercise of an Option in any manner shall result in a decrease in the
number of Shares which thereafter may be available, both for purposes of the
Plan and for sale under the Option, by the number of Shares as to which the
Option is exercised.
(b) Termination of Status as an Employee or Consultant. In the
---------------------------------------------------
event of termination of an Optionee's Continuous Status as an Employee or
Consultant, such Optionee may, but only within thirty (30) days (or such other
period of time, not exceeding three (3) months in the case of an Incentive
Stock Option or six (6) months in the case of a Nonstatutory Stock Option, as is
determined by the Administrator, with such determination in the case of an
Incentive Stock Option being made at the time of grant of the Option) after the
date of such termination (but in no event later than the date of expiration of
the term of such Option as set forth in the Option Agreement), exercise his or
her Option to the extent that he or she was entitled to exercise it at the date
of such termination. To the extent that the Optionee was not entitled to
exercise the Option at the date of such termination, or if the Optionee does not
exercise such Option (which he or she was entitled to exercise) within the time
specified herein, the Option shall terminate.
(c) Disability of Optionee. Notwithstanding the provisions of
----------------------
Section 10(b) above, in the event of termination of an Optionee's Continuous
Status as an Employee or Consultant as a result of his or her total and
permanent disability (as defined in Section 22(e)(3) of the Code), he or she
may, but only within six (6) months (or such other period of time not exceeding
twelve (12) months as is determined by the Administrator, with such
determination in the case of an Incentive Stock Option being made at the time of
grant of the Option) from the date of such termination (but in no event later
than the date of expiration of the term of such Option as set forth in the
Option Agreement), exercise his or her Option to the extent he or she was
entitled to exercise it at the date of such termination. To the extent that he
or she was not
<PAGE>
entitled to exercise the Option at the date of termination, or if he does not
exercise such Option (which he was entitled to exercise) within the time
specified herein, the Option shall terminate.
(d) Death of Optionee. In the event of the death of an Optionee:
-----------------
(i) during the term of the Option who is at the time of his
death an Employee or Consultant of the Company and who shall have been in
Continuous Status as an Employee or Consultant since the date of grant of the
Option, the Option may be exercised, at any time within six (6) months (or
such other period of time, not exceeding six (6) months, as is determined by
the Administrator, with such determination in the case of an Incentive Stock
Option being made at the time of grant of the Option) following the date of
death (but in no event later than the date of expiration of the term of such
Option as set forth in the Option Agreement), by the Optionee's estate or by a
person who acquired the right to exercise the Option by bequest or inheritance
but only to the extent of the right to exercise that would have accrued had
the Optionee continued living and remained in Continuous Status as an Employee
or Consultant three (3) months (or such other period of time as is determined
by the Administrator as provided above) after the date of death, subject to
the limitation set forth in Section 5(b); or
(ii) within thirty (30) days (or such other period of time
not exceeding three (3) months as is determined by the Administrator, with
such determination in the case of an Incentive Stock Option being made at the
time of grant of the Option) after the termination of Continuous Status as an
Employee or Consultant, the Option may be exercised, at any time within six
(6) months following the date of death (but in no event later than the date of
expiration of the term of such Option as set forth in the Option Agreement),
by the Optionee's estate or by a person who acquired the right to exercise the
Option by bequest or inheritance, but only to the extent of the right to
exercise that had accrued at the date of termination.
(e) Rule 16b-3. Options granted to persons subject to Section 16(b)
----------
of the Exchange Act must comply with Rule 16b-3 and shall contain such
additional conditions or restrictions as may be required thereunder to qualify
for the maximum exemption from Section 16 of the Exchange Act with respect to
Plan transactions.
11. Withholding Taxes. As a condition to the exercise of Options granted
-----------------
hereunder, the Optionee shall make such arrangements as the Administrator may
require for the satisfaction of any federal, state, local or foreign withholding
tax obligations that may arise in connection with the exercise, receipt or
vesting of such Option. The Company shall not be required to issue any Shares
under the Plan until such obligations are satisfied.
12. Stock Withholding to Satisfy Withholding Tax Obligations. At the
--------------------------------------------------------
discretion of the Administrator, Optionees may satisfy withholding obligations
as provided in this paragraph. When an Optionee incurs tax liability in
connection with an Option which tax liability is subject to tax withholding
under applicable tax laws, and the Optionee is obligated to pay the Company an
amount required to be withheld under applicable tax laws, the Optionee may
satisfy the withholding tax obligation by one or some combination of the
following methods: (a) by cash payment, or (b) out of Optionee's current
compensation, (c) if permitted by the Administrator, in
<PAGE>
its discretion, by surrendering to the Company Shares that (i) in the case of
Shares previously acquired from the Company, have been owned by the Optionee
for more than six months on the date of surrender, and (ii) have a fair market
value on the date of surrender equal to or less than Optionee's marginal tax
rate times the ordinary income recognized, or (d) by electing to have the
Company withhold from the Shares to be issued upon exercise of the Option that
number of Shares having a fair market value equal to the amount required to be
withheld. For this purpose, the fair market value of the Shares to be withheld
shall be determined on the date that the amount of tax to be withheld is to be
determined (the "Tax Date").
Any surrender by an Officer or Director of previously owned
Shares to satisfy tax withholding obligations arising upon exercise of this
Option must comply with the applicable provisions of Rule 16b-3 and shall be
subject to such additional conditions or restrictions as may be required
thereunder to qualify for the maximum exemption from Section 16 of the
Exchange Act with respect to Plan transactions.
All elections by an Optionee to have Shares withheld to satisfy
tax withholding obligations shall be made in writing in a form acceptable to
the Administrator and shall be subject to the following restrictions:
(a) the election must be made on or prior to the applicable Tax
Date;
(b) once made, the election shall be irrevocable as to the
particular Shares of the Option as to which the election is made;
(c) all elections shall be subject to the consent or disapproval of
the Administrator;
(d) if the Optionee is an Officer or Director, the election must
comply with the applicable provisions of Rule 16b-3 and shall be subject to
such additional conditions or restrictions as may be required thereunder to
qualify for the maximum exemption from Section 16 of the Exchange Act with
respect to Plan transactions.
In the event the election to have Shares withheld is made by an
Optionee and the Tax Date is deferred under Section 83 of the Code because no
election is filed under Section 83(b) of the Code, the Optionee shall receive
the full number of Shares with respect to which the Option is exercised but
such Optionee shall be unconditionally obligated to tender back to the Company
the proper number of Shares on the Tax Date.
13. Non-Transferability of Options. No Option may be sold, pledged,
------------------------------
assigned, hypothecated, transferred, or disposed of in any manner other than by
will or by the laws of descent or distribution. The designation of a
beneficiary by an Optionee will not constitute a transfer. An Option may be
exercised, during the lifetime of the Optionee, only by the Optionee or a
transferee permitted by this Section 13.
<PAGE>
14. Adjustments Upon Changes in Capitalization; Corporate Transactions.
-------------------------------------------------------------------
(a) Adjustments. Subject to any required action by the shareholders
-----------
of the Company, the number of Shares covered by each outstanding Option, the
number of Shares that have been authorized for issuance under the Plan but as to
which no Options have yet been granted or which have been returned to the Plan
upon cancellation or expiration of an Option, the maximum number of Shares for
which Options may be granted to any Employee under Section 8 of the Plan, and
the price per Share covered by each such outstanding Option, shall be
proportionately adjusted for any increase or decrease in the number of issued
shares of Common Stock of the Company resulting from a stock split, reverse
stock split, stock dividend, combination or reclassification of the Common
Stock, or any other increase or decrease in the number of issued shares of
Common Stock effected without receipt of consideration by the Company; provided,
however, that conversion of any convertible securities of the Company shall not
be deemed to have been "effected without receipt of consideration." Such
adjustment shall be made by the Administrator, whose determination in that
respect shall be final, binding and conclusive. Except as expressly provided
herein, no issuance by the Company of shares of stock of any class, or
securities convertible into shares of stock of any class, shall affect, and no
adjustment by reason thereof shall be made with respect to, the number or price
of shares of Common Stock subject to an Option.
(b) Corporate Transactions. In the event of the proposed dissolution
----------------------
or liquidation of the Company, the Option will terminate immediately prior to
the consummation of such proposed action, unless otherwise provided by the
Administrator. The Administrator may, in the exercise of its sole discretion
in such instances, declare that any Option shall terminate as of a date fixed by
the Administrator and give each Optionee the right to exercise his or her Option
as to all or any part of the Optioned Stock, including Shares as to which the
Option would not otherwise be exercisable. In the event of a proposed sale of
all or substantially all of the assets of the Company, or the merger of the
Company with or into another corporation, the Option shall be assumed or an
equivalent option shall be substituted by such successor corporation or a parent
or subsidiary of such successor corporation, unless the Administrator
determines, in the exercise of its sole discretion and in lieu of such
assumption or substitution, that the Optionee shall have the right to exercise
the Option as to some or all of the Optioned Stock, including Shares as to which
the Option would not otherwise be exercisable. If the Administrator makes an
Option exercisable in lieu of assumption or substitution in the event of a
merger or sale of assets, the Administrator shall notify the Optionee that the
Option shall be exercisable for a period of thirty (30) days from the date of
such notice, and the Option will terminate upon the expiration of such period.
15. Time of Granting Options. The date of grant of an Option shall, for
------------------------
all purposes, be the date on which the Administrator makes the determination
granting such Option or such other date as is determined by the Administrator.
Notice of the determination shall be given to each Employee or Consultant to
whom an Option is so granted within a reasonable time after the date of such
grant.
<PAGE>
16. Amendment and Termination of the Plan.
-------------------------------------
(a) Authority to Amend or Terminate. The Board may amend or
-------------------------------
terminate the Plan from time to time in such respects as the Board may deem
advisable; provided that, the following revisions or amendments shall require
approval of the shareholders of the Company in the manner described in Section
20 of the Plan:
(i) any increase in the number of Shares subject to the
Plan, other than in connection with an adjustment under Section 14 of
the Plan;
(ii) any change in the designation of the class of persons
eligible to be granted Options;
(iii) any change in the limitation on grants to employees as
described in Section 8 of the Plan or other changes which would
require shareholder approval to qualify options granted hereunder as
performance-based compensation under Section 162(m) of the Code; or
(iv) if the Company has a class of equity securities
registered under Section 12 of the Exchange Act at the time of such
revision or amendment, any material increase in the benefits accruing
to participants under the Plan.
(b) Shareholder Approval. If any amendment requiring shareholder
--------------------
approval under Section 13(a) of the Plan is made subsequent to the first
registration of any class of equity securities by the Company under Section 12
of the Exchange Act, such shareholder approval shall be solicited as described
in Section 20 of the Plan.
(c) Effect of Amendment or Termination. Any such amendment or
----------------------------------
termination of the Plan shall not affect Options already granted and such
Options shall remain in full force and effect as if this Plan had not been
amended or terminated, unless mutually agreed otherwise between the Optionee and
the Board, which agreement must be in writing and signed by the Optionee and the
Company.
17. Conditions Upon Issuance of Shares. Shares shall not be issued
----------------------------------
pursuant to the exercise of an Option unless the exercise of such Option and the
issuance and delivery of such Shares pursuant thereto shall comply with all
relevant provisions of Applicable Laws, including, without limitation, the
Securities Act of 1933, as amended, the Exchange Act, the rules and regulations
promulgated thereunder, and the requirements of any stock exchange upon which
the Shares may then be listed, and shall be further subject to the approval of
counsel for the Company with respect to such compliance. As a condition to the
exercise of an Option, the Company may require the person exercising such
Option to represent and warrant at the time of any such exercise that the Shares
are being purchased only for investment and without any present intention to
sell or distribute such Shares if, in the opinion of counsel for the Company,
such a representation is required by any of the aforementioned relevant
provisions of law.
<PAGE>
18. Reservation of Shares. The Company, during the term of this Plan,
---------------------
will at all times reserve and keep available such number of Shares as shall be
sufficient to satisfy the requirements of the Plan. The inability of the
Company to obtain authority from any regulatory body having jurisdiction, which
authority is deemed by the Company's counsel to be necessary to the lawful
issuance and sale of any Shares hereunder, shall relieve the Company of any
liability in respect of the failure to issue or sell such Shares as to which
such requisite authority shall not have been obtained.
19. Option Agreement. Options shall be evidenced by written option
----------------
agreements in such forms as the Administrator shall approve.
20. Shareholder Approval.
--------------------
(a) Continuance of the Plan shall be subject to approval by the
shareholders of the Company within twelve (12) months before or after the date
the Plan is adopted. Such shareholder approval shall be obtained in the manner
and to the degree required under applicable federal and state law.
(b) In the event that the Company registers any class of equity
securities pursuant to Section 12 of the Exchange Act, any required approval of
the shareholders of the Company obtained after such registration shall be
solicited substantially in accordance with Section 14(a) of the Exchange Act and
the rules and regulations promulgated thereunder.
(c) If any required approval by the shareholders of the Plan itself
or of any amendment thereto is solicited at any time otherwise than in the
manner described in Section 20(b) hereof, then the Company shall, at or prior
to the first annual meeting of shareholders held subsequent to the later of
(1) the first registration of any class of equity securities of the Company
under Section 12 of the Exchange Act or (2) the granting of an Option
hereunder to an officer or director after such registration, do the following:
(i) furnish in writing to the holders entitled to vote for
the Plan substantially the same information that would be required (if proxies
to be voted with respect to approval or disapproval of the Plan or amendment
were then being solicited) by the rules and regulations in effect under
Section 14(a) of the Exchange Act at the time such information is furnished;
and
(ii) file with, or mail for filing to, the Securities and
Exchange Commission four copies of the written information referred to in
subsection (i) hereof not later than the date on which such information is
first sent or given to shareholders.
21. Information to Optionees. The Company shall provide to each
------------------------
Optionee, during the period for which such Optionee has one or more Options
outstanding, copies of all annual reports and other information which are
provided to all shareholders of the Company. The Company shall not be required
to provide such information if the issuance of Options under the Plan is limited
to key employees whose duties in connection with the Company assure their access
to equivalent information.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1998
<PERIOD-START> JUL-01-1998 JAN-01-1998
<PERIOD-END> SEP-30-1998 SEP-30-1998
<CASH> 3,812 3,812
<SECURITIES> 0 0
<RECEIVABLES> 1,231 1,231
<ALLOWANCES> 433 433
<INVENTORY> 0 0
<CURRENT-ASSETS> 4,834 4,834
<PP&E> 4,853 4,853
<DEPRECIATION> 4,138 4,138
<TOTAL-ASSETS> 5,603 5,603
<CURRENT-LIABILITIES> 4,096 4,096
<BONDS> 0 0
0 0
0 0
<COMMON> 1,063 1,063
<OTHER-SE> 444 444
<TOTAL-LIABILITY-AND-EQUITY> 5,603 5,603
<SALES> 1,101 5,041
<TOTAL-REVENUES> 1,101 5,041
<CGS> 1,084 3,843
<TOTAL-COSTS> 1,084 3,843
<OTHER-EXPENSES> 3,104 9,062
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> (23) 78
<INCOME-PRETAX> (3,064) (7,942)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> 0 0
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (3,064) (7,942)
<EPS-PRIMARY> (.24) (.80)
<EPS-DILUTED> (.24) (.80)
</TABLE>
