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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934.
For the fiscal year ended December 31, 1998
Commission file number 000-20873
CONNECT, INC
(Exact name of registrant as specified in its charter)
DELAWARE 77-0431045
(State of incorporation) (IRS Employer Identification Number)
515 Ellis Street, Mountain View, CA 94043-2242
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (650)254-4000
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.001 PAR VALUE PER SHARE
(Title of Class)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. [X]
As of March 9, 1999 there were 14,796,509 shares of registrant's common stock
outstanding (as adjusted to reflect the one-for-five reverse stock split
effected in February, 1998), and the aggregate market value of such shares
held by non-affiliates of the registrant (based upon the closing sale price of
such shares on the Nasdaq National Market on March 9, 1999) was approximately
$52.2 million. Shares of the registrant's common stock held by each executive
officer, director and holder of five percent or more of the registrant's
common stock outstanding as of March 9, 1999 have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate
status is not necessarily a conclusive determination for other purposes.
DOCUMENTS INCORPORATED BY REFERENCE
-----------------------------------
Designated portions of Registrant's definitive proxy statement for the 1999
Annual Meeting of Stockholders are incorporated by reference into Part III of
this Form 10-K.
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<PAGE>
PART I.
The following trademarks of Connect, Inc. (doing business as
ConnectInc.com, the "Company") are used in this Form 10-K: OneServer,
OrderStream, PurchaseStream and MarketStream.
In February 1998, the Company effected a reverse split of all
outstanding shares of its common stock such that each five shares of
common stock were converted into one share of common stock. All common
shares in this Form 10-K, including in the financial statements have
been retroactively adjusted to reflect the reverse stock split. In
connection with the reverse stock split, the conversion and exercise
provisions of all outstanding shares, stock options, and warrants have
been adjusted accordingly. Additionally, the Company increased the
number of authorized shares of common stock from 40,000,000 to
60,000,000 and decreased the number of authorized shares of preferred
stock from 10,000,000 to 3,500,000.
Item 1. Business
THE BUSINESS OF THE COMPANY
In addition to the historical information contained in this
description of the business of the Company, this description contains
forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended (the "Securities Act") and Section
21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act") that involve risks and uncertainties. These forward-looking
statements include, without limitation, statements containing the words
"believes," anticipates," "expects," and words of similar import.
Such forward-looking statements will have known and unknown risks,
uncertainties and other factors that may cause the actual results,
performance or achievements of the Company, or industry results, to be
materially different from any future results, performance or
achievements expressed or implied by such forward-looking statements.
Such factors include, among others, the risk factors set forth below
under "-Risk Factors" and elsewhere in this Form 10-K. The Company
assumes no obligation to update any forward-looking statements contained
herein.
Overview
The Company provides integration solutions to enable its customers
to engage in Internet-based electronic commerce and extend their
businesses through the emerging network supply chain. The Company's
MarketStream software applications and Web time-driven professional
services are designed to enable Connected Corporations to build open,
multi-vendor e-business solutions that help them to compete effectively
in the digital economy using best-of-breed technologies. The Company
utilizes innovative methodologies and advanced technical expertise to
conceptualize, design, develop and deploy e-business solutions. This
process is facilitated by the use of emerging Internet technologies.
This business strategy allows the Company to leverage its core
competencies and deliver to its customers effective applications and
consulting services solutions.
The Company historically designed, developed, marketed and
supported application software for Internet-based interactive commerce.
In October, 1998, the Company announced a shift in business direction
and focus, to providing Internet systems and systems integration
services based on technologies from both the Company and industry
partners. It also focused on developing and concentrating its
intellectual property around a new version of its MarketStream software
application product. This combined applications, services and
intellectual property strategy is the Company's "ServiceWare" approach
to providing solutions for e-business. This decision effectively
unified the Company's consulting engineering 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.
Products and Services
The Company provides services and software to enable Internet-
based electronic commerce, and build "Connected Corporations" from any
link in the digital value chain.
Integration Services. The Company's services and support
capabilities address the growing demand for experienced electronic
commerce application architects, implementation and support services,
often collectively described as `web-sourcing', that helps companies to
compete effectively in the digital economy. The Company's engagements
are generally run on a fixed price basis. The Company has developed an
approach to implementing projects that uses the Internet as a shared
development platform. In addition, development is done on the Company's
web site, not the customer's web site. This helps increase resource
flexibility and reduce the cost of implementation for customers.
MarketStream. The Company's MarketStream product is a flexible
electronic commerce application that provides a broad technology
foundation for e-business. Targeted specifically at companies looking
to establish an e-business as an extension of their existing business
model, or at new start-up companies as informediaries, MarketStream
helps provide accelerated time-to-market. MarketStream includes support
for integrated cross-supplier catalog search, product-specific
attributes, tiered or customized pricing, buyer profiling and
personalization, back-end system integration and robust reporting
capabilities. Unlike many buy or sell-side applications that focus on
only a portion of the business, MarketStream's scope of functionality
reduces the technical effort required to build a customized application
to support a major vertical market. Additionally, MarketStream is well
suited to help customers create Extranet implementations, which allow
formation of powerful partnerships across supplier and customer value
chains.
Maintenance and Support. The Company provides software
maintenance, including product updates and technical support, to its
customers and Solutions Partners (as defined below in "-Solution
Partners"). Fees charged depend upon the support level and size of the
customer's application.
Licensing and Third-Party Software. The Company typically provides
its software on a component basis to its customers on a non-exclusive
object code basis. A variety of software products may be integrated for
its customers on an as-needed basis, including products from others at
the web server level, the application server level and the database
server level. If the Company's MarketStream application is to be
utilized, the Company will sublicense the required software to customers
and provide first line support. The Company's customers also may obtain
licenses for such software directly from third party software vendors.
The primary value of the Company's intellectual property is the
application software that resides at the application server level in the
technology architecture. This includes significant domain knowledge as
well as application code designed to enable customers to quickly and
easily address the business functionality that their application needs.
Customers
As of December 31, 1998, the Company had licensed software to over
thirty customers. Two customers accounted for 27% and 13% of the
Company's revenue in 1998, compared to 18% and 12% for the same two
customers for the comparable period in 1997.
Technology
The Company's technology supports supply-chain e-commerce
solutions for businesses expanding through the Internet. The supply-
chain application suite is based on the Company's five years of
experience in developing products and custom applications for the
electronic commerce industry.
Multi-buyer and multi-seller marketplace. MarketStream is
designed for those special applications where the buy-side and the sell-
side of a commerce transaction need to come together under one roof,
with multiple buyers and multiple sellers. This can happen with new
classes of vertical industry market-makers whose entire business model
is dependent upon the Internet. It also can happen as an extension of
an existing business to an Extranet. MarketStream software is designed
to facilitate both these business models.
Scalability. MarketStream is designed to support deployment over
multiple database servers, web servers, or application servers, allowing
for distributed processing.
Industry Standard Technology. The application incorporates the
following components: a web server layer, which can be represented by
any industry standard web server; an application server, which can be
any industry standard Java application server that supports Enterprise
Java Beans; and a database layer, which can be represented by any JDBC
compatible relational database. The product has been shipped by default
with an Apache Web server, IBM's WebSphere application server, and an
Oracle database license. The product does not rely upon any custom
clients and can be used by an end user with an industry standard
browser.
Modular Feature Design. MarketStream offers an extensive range of
features. Users can browse, perform full text searches, maintain a
favorites list, perform quick searches and quick orders, maintain order
templates, and track order status. Each functional element of the
supply chain is implemented in a separate module designed to function
independently of the other modules. Because business rules are localized
to the module, customers can configure the application to support their
particular supply chain model by activating or deactivating those
modules pertinent to their business. As customers requirements grow, new
modules can be created and added seamlessly to the application.
Configurability. Site administrators can use their web browser to
customize the presentation layer of their site through an intuitive user
interface. The customer can modify how buyers move through their site,
as well as change the look and feel of each page on the site.
Security. MarketStream's security module allows the administrator
to determine which types of users have access to the site and what they
can do. As with all administrative functions, security administration
is easily accomplished through a web browser and requires no coding
knowledge on the administrator's part.
Easy back-end administration. MarketStream's administration
wizard automatically knows what type of administration a user can
perform: content administration, customer service (user and order
management), and/or company administration. This makes for easy ability
to add buyers, change security and approval levels without any
particular level of technology competency on the administrator's side.
Marketing and Sales
The Company's primary sales and marketing efforts are through the
Internet and strategic partner programs. Marketing efforts are focused
on increasing awareness of the Company and its products in selected
target markets, and positioning the Company as a leading electronic
commerce services and software provider. The Company's marketing
programs have four primary goals: lead generation, market education and
awareness, sales effectiveness and product management. The Company's
market education and awareness activities include seminars, speaking
engagements and sponsorship of market studies by leading industry
analysts. In addition, the Company utilizes direct mail, public
relations, trade shows, telemarketing and innovative sales tools to
disseminate its marketing message, generate sales leads, and improve
sales effectiveness. The Company works with customers and industry
experts to ensure that its products will satisfy market requirements.
The Company's primary market is mid-sized companies ranging from
$200 million to $5 billion in annual sales. Additionally, the Company
markets its applications and services to start-up companies which wish
to establish their e-commerce businesses in a very short timeframe.
Marketing and sales efforts are focused on four channels - direct sales,
the IBM channel, other strategic partner opportunities and the Company's
Affinity Partner Program ("CAPP"). The Company conducts telemarketing
and other campaigns with leading analysts such as AMR Research aimed at
creating market awareness and generating leads. The Company's agreement
with IBM entitles IBM to sell the MarketStream application, and also
provides that the Company will have joint marketing and sales
opportunities through participating with IBM at trade shows and other
events. A goal of the CAPP program is to create re-marketers of the
Company's software in 12 strategic major metropolitan areas across the
United States, where the Company's software provides an electronic
commerce capability to integrate with other re-seller capabilities. The
CAPP program is currently scheduled to roll out during the first half of
1999.
Solution Partners
A key element of the Company's strategy is to continue to expand
its strategic alliances with business solution partners ("Solution
Partners"). The Company believes that such relationships promote the
visibility of its applications and services and enable the Company to
supplement its core products and services to provide a complete solution
to customers' e-commerce integration needs. The Company's Solution
Partners can be segmented into the following three categories:
Technology Providers. The Company has incorporated industry-
leading software as options into its products. The Company offers
software from IBM (Websphere and MQ Messaging), Fulcrum Technologies
("Fulcrum") (text search engine) and RSA Data Security, Inc. ("RSA")
(encryption). In addition, the Company has licensing agreements with
Intershop, Open Market and Netscape Communications Corporation
("Netscape"). The Company has engaged in joint marketing activities
with other technology companies, including Hewlett-Packard Company and
Sun Microsystems, Inc.
Solution Enhancement. The Company works with other companies that
offer additional complementary solution elements. These include TSI
Incorporated (data mapping/backend integration), Rational Software
Corporation (object modeling tool), CyberCash, Inc. (payment
processing), Verisign, Inc. (authentication), and Cognos Inc. (reporting
tools).
Professional Services. The Company works with a group of leading
professional service organizations to assist customers in implementing
its software solutions. These organizations include Andersen Consulting,
Computer Sciences Corporation, Compuware Corporation, and Cambridge
Technology Partners. These providers perform services such as business
process reengineering and integration, database design and application
development.
Research and Development
Since inception, the Company has made substantial investments in
research and product development. The Company's research and development
expenses were $3.2 million in 1998, $5.0 million in 1997, and $4.7
million in 1996.
The Company's research and development efforts are currently
focused on MarketStream, a flexible electronic commerce application that
provides a broad technology foundation for e-business. The cost
associated with the development of this product is not expected to be
material and will be expensed in the first quarter of 1999. The cost of
ongoing development and support of MarketStream is not expected to be
material. Research and development costs could vary, however, depending
upon the successful development and market acceptance of the product.
The Company's success will depend upon its ability to provide new
services and products that meet changing customer requirements. The
market for the Company's services and products is characterized by
rapidly changing technology, evolving industry standards and customer
requirements, emerging competition and frequent new service and product
introductions. As a result, the Company may be required to change and
improve its services and products in response to changes in operating
systems, application and networking software, computer and
communications hardware, programming tools and computer language
technology. There can be no assurance that the Company will be able to
successfully respond to changing technology, identify new opportunities
or develop and bring new services and products to market in a timely
manner. Failure of the Company, for technological or other reasons, to
develop and introduce new services, products and product enhancements
that are compatible with industry standards and that satisfy customer
requirements could have a material adverse effect on the Company's
business, operating results and financial condition.
Competition
The market for Internet-based electronic commerce solutions and
software is new, rapidly evolving and intensely competitive. The
Company expects competition to intensify in the future.
The Company competes with electronic commerce solution providers,
system integrators, providers of business application software, vendors
of prepackaged electronic commerce software and vendors of software
tools for developing electronic commerce applications for web-based
business. Additionally, potential customers may elect to utilize their
internal information technology resources to develop their own
electronic commerce solutions. The Company's competitors may compete
with its solution and service business and/or the applications the
Company has developed or may in the future develop. Competitors include
Viant Corporation, Scient, Corp., The Extraprise Group, Epicentric,
Inc., Webridge, Inc., Click Interactive, Inc., Open Market, Inc. and
BroadVision, Inc. in the application areas. The Company expects
additional competition from other emerging and established companies,
including Microsoft, IBM/Lotus, Oracle Corporation ("Oracle"),
Interworld, and Netscape (specifically the former Actra division) all of
which have announced or released products for Internet-based electronic
commerce or Intranet requisitioning. The Company's potential
competitors also include a number of successful client/server
applications software companies, such as Baan, PeopleSoft, Vantive and
SAP, and EDI solution vendors, including Sterling Commerce and General
Electric Information Services ("GEIS").
Many of the competitors listed above have longer operating
histories and significantly greater financial, technical, marketing and
other resources than the Company and thus may be able to respond more
quickly to new or changing opportunities, technologies and customer
requirements. Also, many current and potential competitors have greater
name recognition and more extensive customer bases that could be
leveraged, thereby gaining market share to the Company's detriment.
Such competitors may be able to undertake more extensive promotional
activities adopt more aggressive pricing policies and offer more
attractive terms to purchasers than the Company and to bundle their
products in a manner that may discourage users from purchasing products
and/or services offered by the Company. In addition, current and
potential competitors have established or may establish cooperative
relationships among themselves or with third parties to enhance their
products. Accordingly, it is possible that new competitors or alliances
among competitors may emerge and rapidly acquire significant market
share. There can be no assurance that the Company will be able to
compete effectively with competitors or that the competitive pressures
faced by the Company will not have a material adverse effect on the
Company's business, operating results and financial condition.
The Company believes that rapid implementation of electronic
commerce solutions and services as well as software applications are
critical to success in the Internet-based electronic commerce market.
The Company has a limited history in implementing its solutions,
services and products, and there can be no assurance that the Company
will be able to meet customer needs and expectations in this regard.
Additional competitive factors affecting the market for the Company's
solutions, services and software products include vendor and product
reputation, architecture, functionality and features, ease of use, time-
to-market, quality of support, product quality, performance and price.
In order to be successful in the future, the Company must continue to
respond promptly and effectively to the challenges of technical change
and competitors' innovations. Performance in these areas will, in turn,
depend upon the Company's ability to attract and retain highly qualified
technical and sales personnel in a competitive market for experienced
and talented software developers, sales representatives and managers.
Proprietary Rights
The Company relies on trademark, copyright and trade secret laws,
employee and third-party non-disclosure agreements and other methods to
protect its proprietary rights. The Company does not currently have any
patents or pending patent applications. The Company believes that, due
to the rapid pace of technological innovation for Internet products, the
Company's ability to establish and maintain a position of technology
leadership in the industry depends more on the skills of its development
personnel, new product developments, frequent product enhancements, and
name recognition than upon the legal protections afforded its existing
technology. The Company seeks to protect its software, documentation
and other written materials under trade secret and copyright laws, which
afford only limited protection. Despite the Company's efforts to
protect its proprietary rights, unauthorized parties may attempt to copy
aspects of the Company's products or to obtain and use information that
the Company regards as proprietary. Policing unauthorized use of the
Company's products is difficult, and while the Company is unable to
determine the extent to which piracy of its software products exists,
software piracy can be expected to be a persistent problem. In
addition, the laws of some foreign countries do not protect the
Company's proprietary rights as fully as do the laws of the United
States. There can be no assurance that the Company's means of
protecting its proprietary rights in the United States or abroad will be
adequate. There can be no assurance that its agreements with employees,
consultants and others who participate in the development of its
software will not be breached, that the Company will have adequate
remedies for any breach, or that the Company's trade secrets will not
otherwise become known to or independently developed by competitors.
Furthermore, there can be no assurance that the Company's efforts to
protect its rights through trademark and copyright laws will not fail to
prevent the development and design by others of products or technology
similar to or competitive with those developed by the Company.
The Company expects that software product developers will
increasingly be subject to infringement claims as the number of products
and competitors in the Company's industry segment grows and the
functionality of products in different industry segments overlaps and
there can be no assurance that third parties will not assert
infringement claims against the Company. Any such claims, with or
without merit, could be time consuming to defend, result in costly
litigation, divert management's attention and resources, cause product
shipment delays or require the Company to enter into royalty or
licensing agreements. Such royalty or licensing agreements, if
required, may not be available on terms acceptable to the Company, if at
all. In the event of a successful claim of product infringement against
the Company and failure or inability of the Company to license the
infringed or similar technology, the Company's business, operating
results and financial condition could be materially adversely affected.
Employees
At December 31, 1998, the Company employed 35 people full time, 4
of whom were involved in sales and marketing, 25 of whom were involved
in services and 6 of whom were involved in finance and administration.
The Company has not experienced any work stoppages and considers its
employee relations to be good.
Recent Developments
In December, 1998, the Company was informed by The Nasdaq Stock
Market, Inc. ("Nasdaq") that it did not meet the requirements for the
continued listing of its common stock on the Nasdaq National Market.
Specifically, Nasdaq's listing rules require the Company to maintain net
tangible assets of at least $4 million, and the Company's net tangible
assets were $1.1 million as of September 30, 1998. On January 22, 1999,
the Company completed a private placement of 1,538,462 shares of common
stock at $2.60 per share, resulting in net proceeds of approximately
$4.0 million. The Company believes that it is currently in compliance
with the net tangible assets requirement and all other continuing
listing requirements for the Nasdaq National Market.
RISK FACTORS
In evaluating our business, prospective investors should carefully
consider the following risks in addition to the other information in
this prospectus or in the documents referred to in this prospectus. Any
of the following risks could materially adversely affect our business,
operating results and financial condition and result in a complete loss
of your investment.
We may Continue to Experience Net Losses. Except for the fourth
quarter of 1998, we have not realized a net operating profit in any
quarter since we began our operations. In 1998, 1997 and 1996, we
experienced significant negative cash flow from our operations. If our
operating expenses exceed revenues in a given period, we may continue to
experience net losses and negative cash flow from operations. We may not
be able to increase our revenue, or sustain the increase in revenue that
we achieved. In addition, if increases in operating expenses are not
accompanied by increased revenues, our business, results of operations
and financial condition could be negatively impacted.
Our Net Revenues and Operating Results may Fluctuate. Our net
revenues and operating results may fluctuate significantly because of a
number of factors, many of which are outside our control. These factors
include:
o our ability to develop, introduce and market new and enhanced
versions of our products on a timely basis
o announcements of new and enhanced versions of products by us or
our competitors
o the length of time required to complete a sale of our products and
the demand for our products
o the pace of development of electronic commerce conducted on the
Internet
o the fact that customers may defer purchasing our products in
anticipation of enhancements or new products offered by us or our
competitors
o whether existing customers will renew existing service agreements
o software defects and other product quality problems
o our ability to attract and retain key personnel
o the success of our international sales efforts
o changes in the level of operating expenses
0 general economic conditions
We may not be Able to Generate or Maintain Sufficient Cash to Fund
our Operations. Since we began our operations, we have incurred net
losses and experienced significant negative cash flow from operations.
Based on our current operating plan, we believe we have adequate cash to
fund our operations through at least the end of 1999. However, our
actual cash requirements may exceed what we have anticipated. We would
then have to seek additional sources of cash to fund our operations. If
we issue additional shares of our stock, our stockholders' ownership may
be diluted, or the shares issued may have rights, preferences or
privileges senior to those of our common stock. Additional financing
may not be available to us, or may be available but in terms we cannot
accept. If we are unable to secure additional funds, we may be unable
to continue our operations, develop or enhance our products, take
advantage of future opportunities or respond to competitive pressures,
any of which could have a negative effect on our business, operating
results and financial condition.
We depend on Services Revenue. Services revenue represented a
majority of our total revenue in 1998. We anticipate that services
revenue will continue to account for a substantial majority of our total
revenue for the foreseeable future. Because services revenue has lower
gross margins than software license revenue, an increase in the
percentage of total revenue represented by services revenue or an
unexpected decrease in software license revenue could have a detrimental
impact on our overall gross margins and our operating results. We
subcontract certain product implementation, customer support and
training services to third-party service providers. Revenue from these
third-party service providers generally carries lower gross margins
which may vary from period to period, depending on the mix of revenue
from third-party service providers. Services revenue depends in part on
ongoing renewals of support contracts. If our services revenue is lower
than anticipated, our business, financial condition and results of
operations could be seriously harmed. Our ability to increase services
revenue will depend in large part on our ability to increase the scale
of our professional services organization. We may not be able to do so.
We do not know if our Recently Introduced Products or our Future
Products will be Accepted. Although we were founded in 1987, in 1998 we
announced a shift in business direction and focus, to providing
Internet-based systems integration based on technologies from us and
from industry partners. We also committed to developing and
concentrating our intellectual property around a new version of our
MarketStream software application product. Accordingly, you should
consider our business in light of the risks, expenses and problems
frequently encountered by companies in an early stage of development,
particularly companies in new and rapidly evolving markets such as the
Internet. These risks include:
o lack of acceptance of products and services by target customers
o development of equal or superior products or services by
competitors
o failure of Internet-based electronic commerce
o our inability to develop and enhance competitive products or to
successfully market these products
o our inability to identify, attract, retain and motivate qualified
personnel
We expect Internet-based applications and systems integration
services to account for most of our revenues for the foreseeable future.
As a result, our net revenue and operating results may fluctuate
significantly due to factors affecting our ability to market and sell
Internet-based systems integration services to new and existing
customers, many of which are beyond our control. These factors include:
o competition
o technological change
o failure of the market for Internet-based packaged applications to
develop as we anticipate
o lack of customer acceptance of these products
o our failure to develop and introduce new and enhanced versions of
these products on a timely basis
Further, if any of our customers are not able to successfully
develop and deploy electronic commerce applications with MarketStream or
are not satisfied with our products or services, our reputation could be
damaged, which could negatively impact our business, operating results
and financial condition.
We may not be able to keep Pace with Regulatory and Technological
Change. Our success may, in part, depend upon our ability to develop
new products and provide new services that meet changing customer needs.
The market for our products is characterized by:
o rapidly changing technology
o evolving industry standards and customer requirements
emerging competition
o frequent new product and service introductions
As a result, we may be required to change and improve our services
and products in response to changes in operating systems, application
and networking software, computer and communications hardware,
programming tools and computer language technology. If we cannot bring
to market new Internet-based services offerings that keep pace with
technology, this could negatively impact our business, operating results
and financial condition. If we cannot successfully develop MarketStream
to meet the requirements of the market, or Market Stream does not
perform as expected, this could negatively impact our business,
operating results and financial condition.
The Time required to engage a client and to Implement Internet-
based systems integration solutions may be Lengthy and Unpredictable.
Our services are complex and expensive and generally involve significant
investment decisions by prospective customers. Accordingly, the
engagement of our services is often an executive-level decision by
prospective customers and usually requires us to engage in a moderate
sales cycle to educate prospective customers regarding the use and
benefits of our service and product offerings. As such, the costs
associated with Internet-based systems integration solutions can cause
the sales and implementation cycle to be delayed, whether or not such
delays are within our control, and could negatively affect our business,
operating results and financial condition.
We do not know if Third-Party Technology Licenses will continue to
be available to us. We license some of our technology from third
parties, such as a relational database management system from Oracle, a
text search engine from Fulcrum Technologies Inc., a web server from
Netscape, encryption technology from RSA Data Security, Inc. and other
software that is integrated with internally developed software and used
in our software to perform key functions. Oracle offers products that
compete with our products. We do not know if the third-party technology
licenses will continue to be available to us on commercially reasonable
terms, or at all. The loss or inability to maintain any of these
technology licenses could delay the introduction of our products and
services until equivalent technology, if available, is identified,
licensed and integrated, which could negatively affect our business,
operating results and financial condition.
Our Expanding Distribution and Sales Channels creates additional
risks that may result in lower net revenue. Historically, we sold
products and services through a direct sales force. In 1998, we
announced a shift in business direction and focus, to providing
Internet-based systems and system integration services based on
technologies from us and from industry partners. Our primary sales and
marketing efforts are through innovative uses of the Internet and
strategic partner programs. Our ability to achieve revenue growth in
the future depends on our ability to establish and maintain
relationships with software developers, distributors, resellers and
system integrators. Any failure to expand our direct sales force or
other distribution channels could adversely affect our performance.
Year 2000 Problems may cause an Interruption in our Business.
Many existing computer programs and systems use only two-digit fields to
identify the year, e.g. 85=1985, and they are unable to process date and
time information between the twentieth and twenty-first centuries.
Accordingly, computer programs and software may need to be modified
prior to the year 2000 in order to remain functional. Although we have
invested a large amount of time and resources to address potential Y2K
problems, there is no assurance that we will be successful in our
efforts to identify and address all Y2K issues. Failure to complete the
necessary modifications could cause a disruption or failure of such
program and system. See "Management's Discussion and Analysis of
Financial condition and Results of Operations-Year 2000 Preparedness"
for a more detailed discussion.
We do not know if we will Effectively Compete in the Electronic
Commence Software and Software Implementation Industries. The market
for electronic commerce software and software implementation is
relatively new, rapidly changing and highly competitive. We compete
with:
o vendors of prepackaged electronic commerce software
o vendors of software tools for developing electronic commerce
applications
o system integrators
o providers of business application software.
In addition, potential customers may elect to develop their own
electronic commerce solutions. Our current competitors include:
o Viant Corporation
o Scient, Corp.
o The Extraprise Group
o Epicentric, Inc.
o Webridge, Inc.
o Click Interactive, Inc.
o Open Market, Inc.
o BroadVision, Inc.
We also expect additional competition from other companies,
including Microsoft, IBM/Lotus, Oracle Corporation, Interworld and
Netscape Communications, Inc., all of which have announced or released
products for Internet-based electronic commerce or intranet
requisitioning. Our potential competitors include a number of
successful client/server applications software companies, such as Baan
Company, PeopleSoft, Inc., Vantive Corporation and SAP AG, and
electronic data interchange solution vendors, including Sterling
Commerce, Inc. and General Electric Information Services Corporation.
Many of these competitors have longer operating histories and
significantly greater financial, technical, marketing and other
resources than we do and thus may be able to respond more quickly to new
or changing opportunities, technologies and customer requirements.
Also, many current and potential competitors have greater name
recognition and more extensive customer bases that could be leveraged,
thereby gaining market share to our detriment. Such competitors may be
able to undertake more extensive promotional activities, adopt more
aggressive pricing policies and offer more attractive terms to
purchasers than us and to bundle their products in a manner that may
discourage users from purchasing products we offer. In addition,
current and potential competitors have established or may establish
cooperative relationships among themselves or with third parties to
enhance their products. Accordingly, it is possible that new competitors
or alliances among competitors may emerge and rapidly acquire
significant market share. We may not be able to compete effectively with
competitors or that the competitive pressures we face will not
negatively affect our business.
We are Dependent on the Success of the Internet. Our services and
products facilitate online commerce over the Internet. The Internet,
and online commerce over the Internet, are at an early state of
development and are rapidly evolving. While the Internet is expected to
experience substantial growth in the number of users and amount of
traffic, Internet infrastructure may not continue to support the
increasing demands placed on it by this growth. Break-downs and slow-
downs in Internet traffic may slow expansion of its use. The
infrastructure or complementary services necessary to make the Internet
a viable commercial marketplace may not develop or may not develop in a
timely manner.
Demand and market acceptance for online commerce over the Internet
is subject to a high level of uncertainty. This uncertainty is
compounded for us since adequate Internet infrastructure development is
necessary in order to support increased online commerce, which in turn
is necessary in order for us to succeed. If the Internet develops more
slowly than expected, our operating results could be materially
adversely affected.
If the Internet Infrastructure is unable to support our current
growth, our performance may be negatively impacted. The use of our
products and services depends in large part upon the continued
development of the infrastructure for providing Internet access and
services. The Internet has experienced, and is expected to continue to
experience, substantial growth in the number of users and amount of
traffic. The Internet infrastructure may not continue to support the
demands placed on it by this growth. In addition, the Internet could
lose its viability due to delays in the development or adoption of new
standards and protocols to handle increased levels of Internet activity,
or due to increased governmental regulation. Further, the costs of use
of the Internet could increase to a degree that reduces its attraction
as a platform for electronic commerce. As a result, the infrastructure
or complementary services necessary to make the Internet a viable
commercial marketplace may not develop into a viable commercial
marketplace for our products and services.
Problems relating to Security, System Disruptions And Computer
Infrastructure could Negatively Affect our Business and the Business of
our Customers. Although we have implemented in our products various
security mechanisms, our products may be vulnerable to break-ins and
similar disruptive problems caused by Internet users. The level of
security provided by our products depends upon the level of security
selected by our customers and the proper configuration and use of the
products' security mechanisms. Computer break-ins and other disruptions
would jeopardize the security of information stored in and transmitted
through the computer systems of users of our products, which may result
in significant liability to us and may also deter potential customers.
The security and privacy concerns of existing and potential
customers, as well as concerns related to computer viruses, may inhibit
the growth of the Internet marketplace generally, and our customer base
and revenues in particular. Our attempts to implement contracts which
limit our liability to our customers, including liability arising from a
failure of the security feature contained in our products, may not be
enforceable. We currently do not have product liability insurance to
protect against these risks.
We operate and manage online networks for some of our customers
and provide hosting for certain customers' OneServer, OrderStream,
PurchaseStream and MarketStream applications. These services depend
upon our ability to protect the computer equipment and the information
stored in our data center against damage caused by fire, earthquakes,
power loss, telecommunications failures, unauthorized entry and other
similar events. Any such damage or failure that causes interruptions in
our operations could negatively affect the businesses of our customers,
which could expose us to liability.
We may not be able to Maintain the Requirements for Listing on the
Nasdaq National Market. We believe that continued listing on The Nasdaq
Stock Market provides additional prestige for us and enhanced liquidity
for our stockholders. In 1998, The Nasdaq Stock Market informed us that
we did not meet the requirements for the continued listing of our common
stock on The Nasdaq National Market. Specifically, Nasdaq's listing
rules require us to maintain net tangible assets of at least $4 million.
With the net proceeds of approximately $4.0 million from the financing
that was completed in January 1999, our net tangible assets were
approximately $6.0 million as of January 31, 1999. Accordingly, we
believe that our net tangible assets currently exceed the minimum level
required for continued listing on The Nasdaq Stock Market.
Nevertheless, in order for us to remain listed on The Nasdaq
National Market, we must continue to meet the Nasdaq continuing listing
criteria on an ongoing basis. We may not be able to maintain compliance
with the listing requirements. The removal of our common stock from
listing on The Nasdaq National Market may have a negative effect on the
market price of our common stock and on the ability of stockholders and
investors to buy and sell shares of the common stock in the public
markets.
Item 2. Properties
The Company is headquartered in Mountain View, California, where
it leases an aggregate of approximately 30,000 square feet of space that
houses administrative, sales and marketing, customer service and product
development activities. The Company's field operations occupy a leased
facility in Oakbrook Terrace, Illinois. The Company believes that its
existing facilities are adequate to meet current needs.
Item 3. Legal Proceedings
The Company is not subject to any material legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year ended December 31, 1998.
<PAGE>
PART II
Item 5. Market For The Company's Common Equity and Related Stockholder
Matters
MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the National Association
of Securities Dealers Automated Quote system. The Company's Nasdaq
National Market symbol is "CNKT." The number of record holders of the
Company's common stock as of March 9, 1999 was approximately 217.
High and low stock prices and cash dividends declared for each
quarter within the last two fiscal years were as follows (as adjusted to
reflect the one-for-five reverse stock split effected in February 1998):
<TABLE>
<CAPTION>
Sale Price
---------------------- Cash Dividends
Quarter Ended High Low Declared
- ------------------------ ----------- ---------- --------------
<S> <C> <C> <C>
March 31, 1997..... $ 40-5/8 19-3/8 None
June 30, 1997...... $ 20-5/8 4-5/8 None
September 30, 1997. $ 15 7-1/2 None
December 31, 1997.. $ 10-5/16 2-1/2 None
March 31, 1998..... $ 5-5/16 7/8 None
June 30, 1998...... $ 4-15/32 1-1/8 None
September 30, 1998. $ 3 3/8 None
December 31, 1998.. $ 15-1/16 1/4 None
</TABLE>
The Company expects to continue its current policy of not paying
cash dividends to holders of common stock for the foreseeable future.
RECENT SALES OF UNREGISTERED SECURITIES
On November 18, 1997, the Company closed a private placement (the
"1997 Private Placement") of 250 Units. Each Unit consisted of one (1)
convertible note (a "Note") in the principal amount of $40,000 and one
(1) warrant (a "Warrant") to purchase 2,666 shares of common stock of
the Company. The Units were priced at $40,000 per Unit, resulting in
gross proceeds of approximately $10 million. Lehman Brothers, Inc.
received a placement fee of 8% of gross proceeds (excluding proceeds
from sales of up to $2,000,000 of Units to stockholders of the Company)
from the 1997 Private Placement for services rendered in connection with
the 1997 Private Placement, 50% of which was paid in cash and the
balance of which was paid in Units (consisting of 8 Units issued to LBI
Holdings, an affiliate of Lehman Brothers, Inc.). The Company relied on
Rule 506 of Regulation D under the Securities Act, that, among other
things, provides an exemption from the registration requirements of the
Securities Act for sales to accredited investors (as defined by Rule
501(a) of Regulation D under the Securities Act).
In November 1997, the Company was informed by Nasdaq that it did
not meet the requirements for the continued listing of its common stock
on The Nasdaq National Market. Specifically, Nasdaq's listing rules
require the Company to maintain net tangible assets of at least $4
million, and the Company's net tangible assets were $2.4 million as of
September 30, 1997. While the Company completed the 1997 Private
Placement in November 1997, which increased the Company's cash assets by
approximately $10 million, the Notes were considered debt and,
therefore, the Company's net tangible assets did not increase as a
result of the 1997 Private Placement.
In order to achieve compliance with the foregoing listing
requirements, on February 26, 1998, the Company and each holder of the
Notes exchanged all the Notes that had not been converted as of such
date (which Notes had an aggregate principal amount of $9,744,250) for
4,905,209 shares of the Company's Series A Preferred Stock, plus accrued
interest on such Notes (the "Exchange"). As a result, the Company's
net tangible assets were increased and the Company brought itself into
compliance with the Nasdaq net tangible assets requirements.
Each share of Series A Preferred Stock issued in exchange for the
Notes was convertible at the option of the holder into that number of
shares of common stock equal to the greater of (i) the quotient obtained
by dividing $2.00, plus accumulated but unpaid dividends, by the
conversion price (which initially is $10.00 per share and shifts to
$7.50 per share on December 15, 1999) or (ii) the quotient obtained by
dividing $2.00, plus accumulated but unpaid dividends, by 80% (or 60% if
the conversion occurs after December 15, 1999) of the average closing
bid price for the 10 trading days prior to conversion. The initial
conversion price was to be subject to adjustment in the event of
issuances of capital stock at a purchase price of less than $10.00
(other than issuances of common stock to employees, directors or
consultants of the Company) and convertible securities with a conversion
price of less than $10.00 per share, as well as stock splits, stock
combinations and the like. For information regarding the rights,
preferences and privileges of the Series A Preferred Stock, see the
Company's Form 8-A/A, filed with the Securities and Exchange Commission
on March 9, 1998.
In February 1998, $575,750 principal amount of convertible notes
were converted into 249,006 shares of common stock under the terms of
the convertible note agreement. On April 1, 1998, each outstanding
share of Series A Preferred Stock was exchanged for 1.79 shares of
common stock of the Company. An aggregate of 8,784,318 shares of common
stock were issued as a result of the exchange. The Company relied on
Section 3(a)(9) of the Securities Act, that provides an exemption from
the registration requirements of the Act for exchanges of securities
with existing security holders.
In December 1998, the Company was informed by Nasdaq that it did
not meet the requirements for the continued listing of its common stock
on The Nasdaq National Market. Specifically, Nasdaq's listing rules
require the Company to maintain net tangible assets of at least $4
million, and the Company's net tangible assets were $1.1 million as of
September 30, 1998. On January 22, 1999, the Company completed a
private placement (the "1999 Private Placement") of 1,538,462 shares of
common stock at $2.60 per share, resulting in net proceeds of
approximately $4.0 million. The Company relied on Rule 506 of
Regulation D under the Securities Act, that, among other things,
provides an exemption from the registration requirements of the
Securities Act for sales to accredited investors (as defined by Rule
501(a) of Regulation D under the Securities Act).
As a result of the 1999 Private Placement, the Company's net
tangible assets were increased and the Company believes that as of the
date hereof it is currently in compliance with the Nasdaq net tangible
assets requirements. Nevertheless, in order for the Company to remain
listed on The Nasdaq National Market, the Company must continue to meet
the following Nasdaq continuing listing criteria on an ongoing basis in
addition to the net tangible assets requirement: (i) nonaffiliates of
the Company must hold at least 750,000 shares of common stock; (ii)
nonaffiliates of the Company must hold at least $5 million of common
stock (the "Float Requirement"); (iii) the Company must have at least
400 stockholders each holding at least 100 shares of common stock; (iv)
the minimum bid price of the common stock must be at least $1.00 per
share; and (v) the Company must have at least two market makers. There
can be no assurance that the Company will be able to maintain compliance
with the net tangible assets requirement or any such additional listing
requirements. Furthermore, the Company had net operating losses of $2.8
million, $2.0 million and $3.1 million for the quarters ended March 31,
June 30 and September 30, 1998, respectively. Continued losses by the
Company could cause the Company's net tangible assets to decline below
$4 million. As a result of any or a combination of these factors or the
failure of the Company to satisfy any other listing requirement, the
common stock would likely be delisted from The Nasdaq National Market.
The removal of the common stock from listing on The Nasdaq National
Market could have an 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.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the common stock is U.S.
Stock Transfer Corporation. Its telephone number is (800) 835-8778.
<PAGE>
Item 6. Selected Financial Data
The following table presents summary selected historical financial
data of the Company as of and for each of the five years in the period
ended December 31, 1998.
Summary Financial Information
(In thousands, except per share data)
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenue:
License...................... $1,828 $3,131 $4,693 $288 $1,627
Service...................... 4,651 6,231 5,487 8,285 6,345
--------- --------- --------- --------- ---------
Total revenue............... 6,479 9,362 10,180 8,573 7,972
Loss from operations(1)....... (7,833) (14,518) (16,358) (13,194) (1,540)
Net loss(1)................... ($7,904) ($14,585) ($16,142) ($14,139) ($1,765)
Net loss per share(2)......... ($0.74) ($3.85) ($4.81) ($15.57)
Shares used in computing
net loss per share(2)........ 10,682 3,784 3,358 908
Balance Sheet Data:
Cash and cash equivalents..... $3,965 $9,644 $12,214 $12,929 $1,594
Working capital (deficit)..... $1,528 $7,434 $10,344 $11,302 ($2,786)
Total assets.................. $5,453 $15,364 $19,154 $18,063 $5,161
Long-term debt................ $245 $10,591 $790 $1,636 $1,167
Stockholders' equity (deficit) $1,946 ($633) $13,355 $13,318 ($1,538)
</TABLE>
_________________
(1) Includes a one-time expense of $4.1 million in the first quarter of
1995 from the Company's termination of exclusive distribution rights of
its European distributor and includes an expense of $1.1 million in the
third quarter of 1998 for fixed asset write down and staff reductions
related to a change in the Company's business focus (See Note 1 and
Note 3 of the Notes to Financial Statements).
(2) For year ended December 31, 1995, amounts represent pro forma basic and
diluted net loss per share giving effect, even if antidilutive, to
common equivalent shares from convertible preferred stock that were
automatically converted to common stock upon the closing of the
Company's initial public offering.
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the
Financial Statements and the Notes thereto included in Item 8 of this
Form 10-K. In addition to the historical information contained in this
Item, this Item contains forward-looking statements within the meaning
of Section 27A of the Securities Act and Section 21E of the Exchange Act
that involve risks and uncertainties. These forward-looking statements
include, without limitation, statements containing the words
"believes," anticipates," "expects," and words of similar import.
Such forward-looking statements will have known and unknown risks,
uncertainties and other factors that may cause the actual results,
performance or achievements of the Company, or industry results, to be
materially different from any future results, performance or
achievements expressed or implied by such forward-looking statements.
Such factors include, among others, the risk factors set forth in "Risk
Factors" in Item 1 above and elsewhere in this Form 10-K. The Company
assumes no obligation to update any forward-looking statements contained
herein.
Overview
The Company provides integration solutions to enable its customers
to engage in Internet-based electronic commerce and extend their
businesses through the emerging network supply chain. The Company's
MarketStream software applications and web time-driven professional
services enable Connected Corporations to build open, multi-vendor e-
business solutions that help them to compete effectively in the digital
economy by using best-of-breed technologies. The Company utilizes
innovative methodologies combined with advanced technical expertise to
conceptualize, design, develop and deploy e-business solutions. This
process is facilitated by the use of emerging Internet technologies.
This business strategy allows the Company to leverage its core
competencies and deliver to its customers effective applications and
consulting services solutions.
The Company historically designed, developed, marketed and
supported packaged application software for Internet-based electronic
commerce. The Company was founded in 1987 to provide online information
services to businesses. During the period 1987 through 1992, the
Company's primary business was the operation and management of a private
online service and the licensing of related client software. In 1993
and 1994, the Company also offered software for creation, access and
operation of custom online systems. In late 1994, the Company began to
shift its focus from providing online services to developing packaged
software applications for Internet-based interactive commerce. During
1994 and 1995, the Company derived a significant portion of its revenue
from contract software development projects with two companies under
which the Company retained ownership of the technology developed. These
projects formed the foundation for the development of OneServer, the
Company's core software application, that was commercially released in
September 1995, and OrderStream, the first preconfigured implementation
of OneServer, that was commercially released in June 1996.
The Company transferred, effective December 31, 1997, its legacy
online services business to a new company formed primarily by former
Company employees, thus allowing the Company to focus entirely on its
electronic commerce applications software business in 1998. The online
services business accounted for $1.7 million of revenue in 1997. As a
result of the transfer, the Company was dependent solely on OrderStream
and PurchaseStream products and related services for revenue in fiscal
1998.
In October 1998, the Company announced a shift in business
direction and focus, to providing Internet systems integration solutions
based on technologies from both the Company and industry partners. This
decision effectively unified the Company's consulting service
organization and its software products group into a single consulting
services organization providing Internet systems integration, as well as
extending the Company's current service business to emphasize building
cross-enterprise e-business solutions.
The Company develops, markets and supports its packaged
application product, MarketStream, a flexible electronic commerce
application that provides a broad technology foundation for e-business.
Targeted specifically at companies looking to establish an e-business as
an extension of their existing business model, or at new start-up
companies as informediaries, MarketStream helps provide accelerated
time-to-market. MarketStream includes support for integrated cross-
supplier catalog search, product-specific attributes, tiered or
customized pricing, buyer profiling and personalization, back-end system
integration and robust reporting capabilities. Unlike many buy or sell-
side applications that focus on only a portion of the business,
MarketStream's scope of functionality reduces the technical effort
required to build a customized application to support a major vertical
market. Additionally, MarketStream is well suited to help customers
create Extranet implementations, which allow formation of powerful
partnerships across supplier and customer value chains.
The Company provides software maintenance, including product
updates and technical support, to its customers and Solutions Partners.
Fees charged depend upon the support level and size of the customer's
application.
The Company has incurred net losses in each fiscal year since
inception and, as of December 31, 1998, had an accumulated deficit of
$69.5 million.
Results of Operations
The following table sets forth, as a percentage of total revenue, items from
the Company's statements of operations for the periods indicated.
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1998 1997 1996
------------ ------------- -------------
<S> <C> <C> <C>
Revenue:
License............................. 28% 33% 46%
Service............................. 72% 67% 54%
------------ ------------- -------------
Total revenue..................... 100% 100% 100%
Cost of revenue:
License............................. 6% 8% 8%
Service............................. 67% 89% 81%
------------ ------------- -------------
Total cost of revenue............. 73% 97% 89%
Operating expenses:
Research and development............ 49% 53% 46%
Sales and marketing................. 47% 77% 103%
General and administrative.......... 35% 28% 23%
Termination of distribution rights.. 17% -- --
------------ ------------- -------------
Total operating expenses.......... 148% 158% 172%
------------ ------------- -------------
Loss from operations.................. -121% -155% -161%
Other income (expense), net........... -1% -1% 2%
------------ ------------- -------------
Loss before income taxes.............. -122% -156% -159%
Provision (benefit) for income taxes.. -- -- --
------------ ------------- -------------
Net loss.............................. -122% -156% -159%
============ ============= =============
Gross margin:
License............................. 77% 76% 83%
Service............................. 7% -33% -51%
</TABLE>
Revenue
License. License revenue was $1.8 million in 1998, $3.1 million in
1997, and $4.7 million in 1996. The decrease in license revenue by
42% in 1998 compared to 1997 is attributable to several factors,
including delays in potential customers' purchase decisions and shifts
in customers' internal MIS resources to Year 2000 projects or their
internal implementations of major enterprise resource plan systems. A
portion of the decrease may also be attributable to the Company's
decision in the third quarter to shift its business direction and focus,
to Internet-based electronic commerce solutions, services and its
software application, MarketStream. The decrease in revenue by 33% in
1997 compared to 1996 resulted primarily from lower unit sales
associated with increased length of sales cycles.
Service. Service revenue was $4.7 million in 1998, $6.2 million in
1997, and $5.5 million in 1996. The service revenue decrease in 1998 by
25% from 1997 is primarily due to fewer software implementation
projects. The increase in 1997 by 13% from 1996 resulted primarily from
completion of fixed price contracts early in 1997, allowing more
effective utilization of staff and outside consultants. The Company
anticipates that service revenues may continue to vary as a percentage
of total revenue in 1999.
Costs of Revenue
Cost of License Revenue. Cost of license revenue includes
sublicense fees and expenses relating to product media, duplication and
manuals. Cost of license revenue was $413,000 in 1998, $753,000 in
1997, and $791,000 in 1996, representing 23%, 24%, and 17% of license
revenue, respectively. The decrease in the cost of license revenue in
1998 by 45% from 1997 is attributed to the decrease in license revenue.
Although the dollar cost of license revenue decreased by 5% in 1997 from
1996, there was an increase in cost as a percentage of sales that was
primarily related to the costs of documentation and third party
royalties on the sales of OneServer and OrderStream.
Cost of Service Revenue. Cost of service revenue consists of costs
of implementation services, including fees of third-party contract
developers and Company personnel costs; training and customer support
costs for application software; costs associated with contract software
development projects; and telecommunications, personnel costs and
depreciation related to hosting services and the operation of the
Company's private online service. Cost of service revenue was $4.3
million in 1998, $8.3 million in 1997, and $8.3 million in 1996. Cost
of services as a percentage of service revenue was 93%, 133%, and 151%
for 1998, 1997, and 1996, respectively. The cost of service revenue
declined by 48% in 1998 from 1997 due to cost reduction steps taken in
the Company's services business and the absence of charges in 1998 which
related to fixed price contracts that existed in 1997. In 1997 and
1996, the cost of service percentage was negatively impacted by the
charges incurred in connection with the fixed price contracts. The
charges related to the fixed price contracts were due to implementation
costs that exceeded the implementation fees due under the fixed price
contracts.
Operating Expenses
Research and Development. Research and development expenses
consist primarily of personnel and equipment costs. Research and
development expenses were $3.2 million in 1998, $5.0 million in 1997,
and $4.7 million in 1996. Research and development expenses, as a
percentage of total revenue were 49%, 53%, and 46% in 1998, 1997 and
1996, respectively. The decrease in research and development expense by
36% in 1998 from 1997 is due primarily to the decision in late 1998 to
focus on Internet-based electronic commerce solutions and services, and
staff reductions associated with change in business direction and focus.
The increase by 6% in 1997 from 1996 is attributable to increased use of
outside contractors, primarily in Malaysia, to assist in development
efforts. The Company expects that research and development expenses in
1999 may continue to vary as a percentage of total revenue as the
Company engages in further development efforts relating to its
MarketStream applications.
Sales and Marketing. Sales and marketing expenses consist
primarily of salaries and commissions of sales and marketing personnel,
and travel, marketing and promotional expenses. Sales and marketing
expenses were $3.0 million in 1998, $7.2 million in 1997, and $10.4
million in 1996, representing 47%, 77%, and 103% of total revenue,
respectively. The decrease in sales and marketing expenses by 58% in
1998 from 1997 was attributable to lower commissions due to lower sales
revenue, decreased staffing and reduced marketing expenses. The
decrease by 31% in 1997 from 1996 was attributable to decreased staffing
and reduced marketing expenditures. The Company expects 1999 sales and
marketing expenses may increase in 1999 as the Company engages in
marketing efforts for its MarketStream applications, but may continue to
vary as a percentage of total revenue.
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 and
accounting expenses. General and administrative expenses were $2.3
million in 1998, $2.6 million in 1997 and $2.4 million in 1996,
representing 35%, 28%, and 23% of total revenue, respectively. The
decrease by 12% in 1998 from 1997 in total dollars was attributed
primarily to cost controls associated with lower revenue. The increase
in cost as a percentage of revenue in 1998 from 1997 is attributed to
the fixed nature of some general and administrative costs. The increase
by 8% in 1997 from 1996 in total dollars and as a percentage of total
revenue resulted from increased costs associated with being a public
company.
Other Income (Expense)
Other income (expense) consists primarily of interest expense and
interest income. Interest expense, which results principally from
interest incurred under notes payable and capital lease obligations, was
$352,000 in 1998, $414,000 in 1997, and $331,000 in 1996. Interest
expense decreased by 15% in 1998 from 1997 due primarily to reduction in
obligations associated with capital leases. Interest expense increased
in 1997 from 1996 due to interest associated with convertible notes
issued in November 1997. Interest income and other, principally
represents interest earned on cash balances, was $281,000 in 1998,
$347,000 in 1997, and $547,000 in 1996. The decrease in 1998 and 1997
is attributed principally to lower average cash balances over the prior
year.
Year 2000 Preparedness
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 20th and 21st century dates. The ability to properly
manage and manipulate such data is referred to herein as "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 generally have represented that their systems
are Year 2000 Compliant. The Company is also in the process of
determining what other changes to its IT and Non-IT 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, 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
expects to have completed all changes required to make its IT and Non-IT
internal systems Year 2000 Compliant by mid-1999.
The Company believes that its most current releases 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 customers directly, by mail and
by posting this information on the Company's web site. The inability of
the 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 believes that the
process of notifying customers not on the current release will be
complete by March 1999.
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
has had discussions with its suppliers and financial institutions to
ensure that those parties have appropriate plans to remediate Year 2000
issues where their systems interface with the Company's systems or
otherwise impact its operations. The Company has requested that all
significant vendors give assurance that their programs are Year 2000
Compliant. The Company is in the process of upgrading its internal
programs and systems that interface with significant vendors and
financial institutions. The Company expects to have completed
upgrading all internal programs and system interfaces with
significant vendors and financial institutions to be Year 2000
Compliant by June 1999.
The Company currently estimates that total Year 2000 costs incurred
in taking steps to address the Year 2000 Compliance of the Company's
products, internal IT and Non-IT systems and third party systems
interfaces will not be material. While the Company believes its
efforts are adequate, there can be no assurance that the systems of
the third parties on which our systems and operations rely will be
converted on a timely basis. Additionally, there can be no assurance
that a third party's failure to ensure Year 2000 compliance would not
have an adverse effect on the Company's operations.
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 $1.5 million at December 31, 1998.
During 1998, 1997, and 1996, net cash used in operating activities
was $5.6 million, $12.9 million and $14.0 million, respectively,
primarily due to net losses incurred by the Company. See "Risk Factors-
Year 2000 Problems may cause an Interruption in our Business."
During 1998, 1997 and 1996, the Company used $248,000, $540,000
and $2.0 million, respectively, in investing activities, primarily for
the purchase of property and equipment. Net cash provided by financing
activities in 1998, 1997 and 1996 was $190,000, $10.9 million and $15.3
million, respectively. Net cash provided by financing activities in
1998 was primarily from the issuance of common stock and notes payable
offset by the repayment of notes payable and principal under capital
lease obligations. Net cash provided by financing activities in 1997
resulted primarily from net proceeds of $9.7 million related to
convertible notes issued in November 1997 and $1.7 million of proceeds
from notes payable secured by specific unencumbered equipment. Net cash
provided by financing activities in 1996 resulted primarily from net
proceeds of $12.1 million from the Company's initial public offering of
its common stock in August 1996, and net proceeds of $3.9 million from
the issuance of preferred stock.
The Company has incurred net losses and experienced significant
negative cash flow from operations since inception. As of December 31,
1998, the Company had an accumulated deficit of approximately $69.5
million. Based upon its current operating plan and the decision to
focus its business on providing Internet-based electronic commerce
solutions and services, 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 may be unable to continue its
operations, develop or enhance its products, take advantage of future
opportunities or respond to competitive pressures or other requirements,
any of which could have a material adverse effect on the Company's
business, operating results and financial condition.
<PAGE>
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
As of December 31, 1998, the Company's investment portfolio
consisted of money market funds. The Company's primary objective with
its investment portfolio is to invest available cash while preserving
principal and meeting liquidity needs. These investments, which
approximate $3.0 million, have an average interest rate of approximately
6%, are subject to interest rate risk. However, based upon the
portfolio contents, the Company believes that if a significant change in
interest rates were to occur, it would not have a material effect on the
Company's financial condition.
<PAGE>
Item 8. Financial Statements and Supplementary Data
CONNECTINC.COM
INDEX TO FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors
Balance Sheets
Statements of Operations
Statements of Stockholders' Equity (Deficit)
Statements of Cash Flows
Notes to Financial Statements
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Connect, Inc.
We have audited the accompanying balance sheets of Connect, Inc.
as of December 31, 1998 and 1997 and the related statements of
operations, stockholders' equity (deficit) and cash flows for each of
the three years in the period ended December 31, 1998. Our audits also
included the financial statement schedule listed in the index at Item
14(a). These financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion
on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Connect,
Inc. at December 31, 1998 and 1997, and the results of its operations
and its cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements
taken as a whole, present fairly in all material respects the
information set forth therein.
ERNST & YOUNG LLP
San Jose, California
January 25, 1999
<PAGE>
CONNECT, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
-------------------------
1998 1997
------------ ------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents........................... $3,965,311 $9,643,883
Accounts receivable, less allowances for doubtful
accounts of $162,238 at December 31, 1998 and
$642,270 at December 31, 1997..................... 613,265 2,298,759
Prepaid expenses and other current assets........... 211,767 894,786
------------ ------------
Total current assets.................................. 4,790,343 12,837,428
Property and equipment, net........................... 608,913 2,442,059
Deposits and other assets............................. 53,636 84,444
------------ ------------
Total assets.................................. $5,452,892 $15,363,931
============ ============
Liabilities and stockholders' equity (deficit)
Current liabilities:
Notes payable....................................... $834,350 $619,921
Accounts payable.................................... 699,374 1,279,284
Accrued payroll and related expenses................ 166,580 608,516
Other accrued liabilities........................... 856,419 1,588,264
Deferred revenue.................................... 414,830 681,540
Current portion of extended vendor liabilities...... 282,461 271,694
Obligations under capital leases.................... 7,928 356,579
------------ ------------
Total current liabilities............................. 3,261,942 5,405,798
Notes payable......................................... 244,941 713,053
Long-term portion of extended vendor liabilities...... -- 223,512
Convertible notes..................................... -- 9,654,158
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--13,213,801 at December 31, 1998
and 3,827,806 at December 31, 1997................ 13,000 19,139
Additional paid-in capital.......................... 71,454,016 61,001,741
Deferred compensation............................... (59,935) (96,055)
Accumulated deficit................................. (69,461,072) (61,557,415)
------------ ------------
Total stockholders' equity (deficit).................. 1,946,009 (632,590)
------------ ------------
Total liabilities and stockholders' equity............ $5,452,892 $15,363,931
============ ============
</TABLE>
See accompanying notes.
<PAGE>
CONNECT, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1998 1997 1996
------------ ------------- -------------
<S> <C> <C> <C>
Revenue:
License............................. $1,828,199 $3,130,942 4,693,068
Service............................. 4,650,405 6,231,496 5,486,720
------------ ------------- -------------
Total revenue..................... 6,478,604 9,362,438 10,179,788
------------ ------------- -------------
Cost of revenue:
License............................. 413,481 752,793 790,652
Service............................. 4,332,857 8,311,870 8,277,358
------------ ------------- -------------
Total cost of revenue............. 4,746,338 9,064,663 9,068,010
------------ ------------- -------------
Operating expenses:
Research and development............ 3,153,400 4,990,156 4,652,633
Sales and marketing................. 3,050,954 7,194,058 10,444,510
General and administrative.......... 2,262,693 2,632,027 2,372,702
Termination of distribution rights.. 1,098,000 -- --
------------ ------------- -------------
Total operating expenses.......... 9,565,047 14,816,241 17,469,845
------------ ------------- -------------
Loss from operations.................. (7,832,781) (14,518,466) (16,358,067)
Interest expense...................... (352,179) (413,788) (330,913)
Interest income and other income
(expense), net...................... 281,303 347,458 546,940
------------ ------------- -------------
Loss before income taxes.............. (7,903,657) (14,584,796) (16,142,040)
Provision (benefit) for income taxes.. -- -- --
------------ ------------- -------------
Net loss.............................. ($7,903,657) ($14,584,796) ($16,142,040)
============ ============= =============
Pro forma basic and diluted net
loss per share...................... ($0.74) ($3.85) ($4.81)
============ ============= =============
Weighted average common shares
outstanding........................... 10,682,152 3,783,881 3,357,833
============ ============= =============
</TABLE>
See accompanying notes.
<PAGE>
CONNECT, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Total
Convertible Stock-
Preferred Stock Common Stock Deferred holders'
------------------------ ------------------------ Compensa- Accumulated Equity
Shares Amount Shares Amount tion Deficit (Deficit)
----------- ------------ ----------- ------------ ---------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995.. 2,822,580 $37,041,259 79,725 $7,107,474 $ -- ($30,830,579) $13,318,154
Issuance of Series F
preferred stock for cash..... 72,000 937,849 -- -- -- -- 937,849
Issuance of Series G
preferred stock for cash..... 54,550 2,963,532 -- -- -- -- 2,963,532
Issuance of common stock
in connection with initial
public offering ............ -- -- 480,000 12,130,474 -- -- 12,130,474
Conversion of preferred to
common stock................. (2,949,130) (40,942,640) 3,100,661 40,942,640 -- -- --
Exercise of warrants.......... -- -- 21,296 3,970 -- -- 3,970
Exercise of employee stock
options and other, net of
repurchases.................. -- -- 24,612 112,844 -- -- 112,844
Deferred compensation related
to grant of stock options.... -- -- -- 169,433 (169,433) -- --
Amortization of deferred
compensation................ -- -- -- -- 30,022 -- 30,022
Net loss .................... -- -- -- -- -- (16,142,040) (16,142,040)
----------- ------------ ----------- ------------ ---------- ------------- ------------
Balance at December 31, 1996.. -- -- 3,706,294 60,466,835 (139,411) (46,972,619) 13,354,805
Exercise of employee stock
options net of repurchases... -- -- 100,440 204,780 -- -- 204,780
Issuance of common stock
under Employee Stock
Purchase Plan................ -- -- 21,072 349,265 -- -- 349,265
Amortization of deferred
compensation................ -- -- -- -- 43,356 -- 43,356
Net loss .................... -- -- -- -- -- (14,584,796) (14,584,796)
----------- ------------ ----------- ------------ ---------- ------------- ------------
Balance at December 31, 1997.. -- -- 3,827,806 61,020,880 (96,055) (61,557,415) (632,590)
Conversion of debentures
plus accrued interest to
common stock................. -- -- 249,006 575,750 -- -- 575,750
Conversion of debentures
plus accrued interest to
Series A preferred stock,
net of issuance cost of
$784,379..................... 4,905,209 8,959,871 -- -- -- -- 8,959,871
Conversion of Series A
preferred stock to
common stock................. (4,905,209) (8,959,871) 8,784,318 8,959,871 -- -- --
Exercise of employee stock
options, net of repurchases.. -- -- 352,671 910,515 -- -- 910,515
Amortization of deferred
compensation................ -- -- -- -- 36,120 -- 36,120
Net and comprehensive loss.... -- -- -- -- -- (7,903,657) (7,903,657)
----------- ------------ ----------- ------------ ---------- ------------- ------------
Balance at December 31, 1998.. -- $ -- 13,213,801 $71,467,016 ($59,935) ($69,461,072) $1,946,009
=========== ============ =========== ============ ========== ============= ============
</TABLE>
See accompanying notes.
<PAGE>
CONNECT, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Operating activities:
Net loss............................. ($7,903,657) ($14,584,796) ($16,142,040)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Fixed asset write-off.............. 855,034 -- --
Depreciation and amortization...... 1,226,149 1,744,535 1,674,757
Amortization of deferred
compensation..................... 36,120 43,356 30,022
Changes in operating assets and
liabilities:
Accounts receivable.............. 1,685,494 235,131 (1,524,266)
Prepaid expenses and other
current assets.................. 683,019 (289,104) (133,863)
Deposits and other assets........ 30,808 69,530 235,171
Accounts payable, accrued payroll
and related expenses, other
accrued liabilities, and
extended vendor liabilities..... (1,966,436) (657,200) 2,084,220
Deferred revenue................. (266,710) 492,398 (233,842)
------------- ------------- -------------
Net cash used in operating activities. (5,620,179) (12,946,150) (14,009,841)
------------- ------------- -------------
Investing activities:
Purchase of property and equipment... (248,037) (539,785) (2,044,533)
------------- ------------- -------------
Financing activities:
Proceeds from issuance of common
stock............................... 910,515 554,045 12,247,288
Net proceeds from issuance of
preferred stock..................... -- -- 3,901,381
Issuance cost of convertible notes.... (118,537) -- --
Net proceeds from issuance of
convertible notes................... -- 9,654,158 --
Proceeds from issuance of notes
payable............................. 361,620 1,748,640 --
Repayment of principal on notes
payable............................. (615,303) (486,188) (191,425)
Repayment of principal under
capital lease obligations........... (348,651) (554,879) (617,739)
------------- ------------- -------------
Net cash provided by financing
activities.......................... 189,644 10,915,776 15,339,505
------------- ------------- -------------
Net decrease in cash and
cash equivalents................ (5,678,572) (2,570,159) (714,869)
Cash and cash equivalents at
beginning of period................. 9,643,883 12,214,042 12,928,911
------------- ------------- -------------
Cash and cash equivalents at
end of period....................... $3,965,311 $9,643,883 $12,214,042
============= ============= =============
Supplemental disclosure of cash flow
information
Cash paid for interest............... $319,464 $284,925 $328,448
Supplemental noncash investing and
financing information
Conversion of convertible notes into
preferred and common stock, including
$64,164 of accrued interest.......... $9,535,621 $ -- $ --
Capital lease obligations incurred... $ -- $ -- $14,003
</TABLE>
See accompanying notes.
<PAGE>
CONNECT, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998
1. Organization
Connect, Inc. (doing business as ConnectInc.com, the "Company")
historically designed, developed, marketed and supported packaged
application software for Internet-based electronic commerce. The
Company was founded in 1987 to provide online information services to
businesses. During the period 1987 through 1992, the Company's primary
business was the operation and management of a private online service
and the licensing of related client software. In 1993 and 1994, the
Company also offered software for creation, access and operation of
custom online systems. In late 1994, the Company began to shift its
focus from providing online services to developing packaged software
applications for Internet-based interactive commerce. During 1994 and
1995, the Company derived a significant portion of its revenue from
contract software development projects with two companies under which
the Company retained ownership of the technology developed. These
projects formed the foundation for the development of OneServer, the
Company's core software application, that was commercially released in
September 1995, and OrderStream, the first preconfigured implementation
of OneServer, that was commercially released in June 1996.
In October 1998, the Company announced a shift in business
direction and focus, to providing Internet systems integration based on
technologies from both the Company and industry partners. This decision
effectively unified the Company's consulting service organization and
its software products group into a single consulting services
organization providing Internet systems integration, as well as
extending the Company's current service business to emphasize building
cross-enterprise e-business solutions. The Company provides integration
solutions to enable Internet-based electronic commerce and build the
"Connected Corporation" from any link in the emerging network supply
chain.
For the years ended December 31, 1998, 1997 and 1996, the Company
derived 100%, 83%, and 75%, respectively, of its revenues from its
OneServer, OrderStream and PurchaseStream products. The remaining
revenue for 1997 and 1996 was derived from the Company's online products
and services. The Company transferred, effective December 31, 1997, the
online services business to a new company formed primarily by former
Company employees, thus allowing the Company to focus entirely on its
electronic commerce applications software business. The Company did not
receive any consideration upon consummation of this transaction;
however, the Company will receive future royalty payments based upon
revenue levels achieved by the new company. Royalty revenue in 1998 was
not material.
The Company has incurred net losses and experienced significant
negative cash flow from operations since inception. As of December 31,
1998, the Company had an accumulated deficit of approximately $69.5
million. Based upon its current operating plan and the decision to
focus its business on providing Internet-based electronic commerce
solutions and services, 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 may be unable to continue its
operations, develop or enhance its products, take advantage of future
opportunities or respond to competitive pressures or other requirements,
any of which could have a material adverse effect on the Company's
business, operating results and financial condition.
2. Summary of Significant Accounting Policies
Use of Estimates
The preparation of the financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could
differ from those estimates.
Concentration of Credit Risk
The Company licenses products and provides services to a variety
of customers. The Company generally does not perform credit evaluations
or require collateral on individual customer service or license
transactions that involve relatively small amounts. However, credit
worthiness on larger service or license transactions are evaluated on a
case-by-case basis.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an
original maturity (at the date of purchase) of three months or less to
be cash equivalents. The Company has classified all investments in debt
securities as available-for-sale. Available-for-sale securities are
carried at amounts that approximate fair value. Unrealized gains and
losses, if material, are reported in a separate component of
stockholders' equity. Realized gains and losses and declines in value
judged to be other-than-temporary are included in interest income and
other, net.
All of the Company's available-for-sale securities mature in three
months or less and are included in cash and cash equivalents. Available
for sale securities at December 31, 1998 and 1997 totaled $3,007,564 and
$4,982,813, respectively, and are comprised of money market funds for
1998, U.S. government obligations and commercial paper for 1997. At
December 31, 1998 and 1997, gross unrealized gains and losses were not
significant. There were no gross realized gains or losses on available-
for-sale securities for 1998, 1997, and 1996.
Property and Equipment
Property and equipment are stated at cost and are depreciated on a
straight-line basis over their estimated useful lives of three to seven
years. Leasehold improvements are amortized on a straight-line basis
over the shorter of the lease term or the estimated useful life of the
improvements.
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
December 31,
-------------------------
1998 1997
------------ ------------
<S> <C> <C>
Computer equipment........................... $4,202,402 $3,998,709
Equipment under capital leases............... 14,003 2,255,069
Furniture and fixtures....................... 61,623 314,842
Leasehold improvements....................... 480,350 655,842
------------ ------------
4,758,378 7,224,462
Accumulated depreciation and amortization.... 4,149,465 4,782,403
------------ ------------
$608,913 $2,442,059
============ ============
</TABLE>
Revenue Recognition and Deferred Revenue
The Company derives revenue primarily from software license fees
and services. License fees consist primarily of revenue from licenses
of the Company's application software. Services revenue consist of fees
for implementation, maintenance, support, training and contract software
development/enhancement projects associated with the software sale.
In October 1997, and March 1998, the Accounting Standards
Executive Committee (AcSEC") issued Statements of Position ("SOP") 97-
2, "Software Revenue Recognition," and SOP 98-4, "Deferral of the
Effective Date of a Provision of SOP 97-2, Software Revenue
Recognition," respectively, that provide guidance on applying generally
accepted accounting principles in recognizing revenue on software
transactions. The Company has adopted the provisions of the SOPs as of
January 1, 1998. In December 1998, AcSEC issued SOP 98-9, that amends
certain provisions of SOP 97-2 and extends the deferral of the
application of certain passages of SOP 97-2 provided by SOP 98-4 until
the beginning of the Company's fiscal year 2000. The impact of SOP 98-9
is not expected to have a material impact on the Company's financial
condition or results of operations.
Service Revenue
Fees for implementation services are recognized as the services
are performed, except for such fees under fixed price contracts that are
recognized on the percentage-of-completion method based on the ratio of
incurred costs to total estimated costs.
The Company also enters 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 system-hosting services, training
and other consulting services are recognized as the services are
performed.
Revenue from contract software development projects, in which the
Company developed specific technology for its customers, has been
recognized on the percentage-of-completion method as noted above.
License Revenue
The Company licenses application software to end-users under non-
cancelable license agreements. License revenue is recognized when the
license agreement has been signed, the product has been shipped, the
fees are fixed and determinable, collectibility is probable and vendor
specific objective evidence exists to allocate the total fees to
elements of the arrangement. License fees under contracts requiring
significant implementation, including customization of licensed software
products are recognized on the percentage-of-completion method based on
the ratio of incurred costs to total estimated costs. Actual costs and
gross margins on such contracts could differ from management's estimates
and such differences could be material to the financial statements.
Provisions for estimated losses on uncompleted contracts are made in the
period in which such losses are determined.
Deferred Revenue
Deferred revenue includes cash collections in excess of revenue
recognized on development arrangements, deferred maintenance, and other
payments received in advance of services to be performed.
Research and Development
Research and development expenditures are generally charged to
operations as incurred. Statement of Financial Accounting Standards No.
86, "Accounting for the Costs of Computer Software to be Sold, Leased or
otherwise Marketed," requires the capitalization of certain software
development costs subsequent to the establishment of technological
feasibility. Based on the Company's product development process,
technological feasibility is established upon the completion of a
working model. Costs incurred by the Company between the completion of
the working model and the point at which the product is ready for
general release have been insignificant. Accordingly, the Company has
charged all such costs to research and development expenses in the
accompanying statements of operations.
Advertising and Promotion Costs
The Company's policy is to expense advertising and promotion costs
as they are incurred. The Company's advertising and promotion expenses
were approximately $400,000, $800,000, and $1,064,000, in 1998, 1997,
and 1996, respectively.
Net Loss Per Share
The Company adopted the provisions of Statement of Financial
Accounting Standards No. 128 ("SFAS 128") beginning with the financial
statements for the year ended December 31, 1997 and all share and per
share data for the period have been restated to comply with SFAS 128.
The following table sets forth the computation of basic and dilutive loss
per share (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Basic and diluted net loss
per share....................... ($0.74) ($3.85) ($4.81)
Shares used in computing net
loss per share.................. 10,682 3,784 3,358
</TABLE>
Stock-Based Compensation
The Company has elected to follow Accounting Principles Board
Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to
Employees" and related interpretations, in accounting for its employee
stock options because the alternative fair value accounting provided for
Financial Accounting Standards Board Statement No. 123 ("SFAS 123"),
"Accounting for Stock-Based Compensation," requires use of option
valuation models that are not developed for use in valuing employee
stock options. Under APB 25, no compensation expense is recognized as
the exercise price of the Company's employee stock options equals the
market price of the underlying stock on the data of grant.
Comprehensive Income
During 1998, the Company adopted Financial Accounting Standards
Board Statement No, 130 ("SFAS No. 130"), "Reporting Comprehensive
Income". SFAS No. 130 establishes rules for reporting and displaying
comprehensive income or comprehensive net loss. The Company's total
comprehensive net loss was the same as its net loss for the years ended
December 31, 1998, 1997 and 1996.
Segment Information
During 1998, the Company adopted the Financial Accounting
Standards Board Statement No. 131 ("SFAS No. 131"), "Disclosures About
Segments of An Enterprise and Related Information". SFAS No. 131
requires the Company to use the "management approach" in disclosing
segment information. The Company conducts its business in one segment
for all periods presented (see Note 11).
Impact of Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133 ("SFAS No. 133"),
"Accounting for Derivative Instruments and Hedging Activities". SFAS
No. 133 provides a comprehensive and consistent standard for the
recognition and measurements of derivatives and hedging activities.
SFAS No. 133 is effective for fiscal years beginning after June 15, 1999
and management believes that the adoption of the Statement will not have
a significant impact on the financial position, operating results or
cash flows of the Company.
Reclassification
Certain previously reported amounts have been reclassified to
conform to the current presentation format.
3. Asset Write-Offs and Staff Reductions
During 1998, the Company recorded a charge of approximately $1.1
million, including $855,000 for write-off of certain fixed assets,
$183,000 for write-off of prepaid royalties, and $60,000 for severance
payments to certain terminated employees. These actions were taken as a
result of the Company's shift in business direction from designing,
marketing, developing and supporting software for the Internet base
interactive commence to being a consulting service organization
providing Internet systems integration. The assets written off are no
longer in use or have been scrapped, or have no future economic value.
All amounts accrued related to this charge were paid prior to December
31, 1998.
4. Convertible Notes
In November 1997, the Company completed a private placement of 258
Units, each unit consisting of one convertible note (each a "Note") in
the principal amount of $40,000 and one warrant to purchase 2,667 shares
of common stock of the Company. The Units were priced at $40,000 per
Unit, and net proceeds were approximately $9.7 million. Each Note
accrues interest at a rate of 5% per annum and is convertible at the
option of the holder into shares of the Company's common stock at a
price per share equal to the lesser of (i) $2.00 or (ii) 80% of the
average closing bid price of the Company's common stock during the 10
trading days prior to conversion. Interest is payable quarterly and may
be paid, at the option of the Company, either in cash or in additional
notes with one-year maturities and principal amounts equal to the
interest then due. Each warrant is exercisable at any time within three
years after the date of issuance, at a price of $12.50 per share.
In February 1998, the Company completed the exchange of $575,750
principal amount of outstanding convertible notes plus accrued interest,
that were converted into 249,006 shares of common stock under the
original terms of the convertible note agreement. Also, in February
1998, the Company completed the exchange of $9,744,250 principal amount
of outstanding convertible notes plus accrued interest, less issuance
cost of $784,379, for 4,905,209 shares of Series A Preferred Stock (the
"Exchange"). In April 1998, each outstanding share of Series A
Preferred Stock was exchanged for 1.79 shares of common stock. An
aggregate of approximately 8,784,318 shares of common stock was issued
as a result of the exchange.
5. Notes Payable
At December 31, 1998 the Company has a series of notes payable
totaling $1,079,291 of which $834,350 is due within a year. Notes
totaling $1,079,291 bear interest at 8.5%, are due in monthly payments
through May 1, 2000 and are secured by equipment, furniture and
fixtures.
6. Extended Vendor Liabilities
In April 1994, the Company terminated its service and license
agreement with a vendor, resulting in a reduction of $253,656 in
extended vendor liabilities. In addition, the repayment terms for
certain amounts due the vendor were extended from three to five years.
Beginning in December 1994, the total liability due the vendor of
$1,000,000 became due in monthly installments, plus interest, at an
annual rate of 6% through November 1999. Principal payments due as of
December 31, 1998 relating to the above agreements were $282,461.
7. Commitments
Operating Leases
The lease agreement for the Company's primary facility expires
December 9, 1999. At December 31, 1998, the future minimum lease
payments related to operating lease agreements are as follows:
<TABLE>
<S> <C>
1999......................................... $400,924
2000......................................... 95,583
2001......................................... 98,451
------------
$594,958
============
</TABLE>
For the years ended December 31, 1998, 1997 and 1996 rental
expense was $359,126, $446,125, and $290,690, respectively. The Company
subleases part of its facilities on a month to month basis for $15,000
per month. Additionally, the Company has a sublease agreement for part
of its facilities, and for the year ended December 31, 1999, future
minimum sublease income is $210,000.
Capital Leases
The Company leases certain equipment under capital leases having
terms of 36 to 42 months. Accumulated amortization on these assets was
$ 1,562,521 and $1,560,402 at December 31, 1998 and 1997, respectively.
The future minimum lease payments as of December 31, 1998 are $7,928.
8. Employee Benefit Plan
The Company maintains an employee savings plan for all of its
full-time employees that qualifies under Section 401(k) of the Internal
Revenue Code (the "Code"). The plan allows employees to make specified
percentage pre-tax contributions up to the maximum dollar limitation
prescribed by the Code. The Company has the option to contribute to the
plan. In 1998, the Company began contributing to the plan, with total
contributions of $51,144.
9. Stock Option and Stock Purchase Plans
In 1989, the Company established the a 1989 Stock Option Plan
("1989 Plan"). During 1998, the Company authorized the increase of
common stock reserved for grant by 125,053 to a total of 665,053 for the
1989 Plan. A committee, as appointed by the Board of Directors, grants
incentive or non-qualified stock options. Options are generally granted
at an exercise price of no less than the fair value per share of the
common stock on the date of grant. The options issued under the 1989
Plan generally vest over four years and are immediately exercisable,
expiring no later than ten years from the date of grant.
In 1996, stockholders approved the adoption of the 1996 Stock
Option Plan ("1996 Plan") pursuant to which 500,000 shares of common
stock have been reserved. During 1998, the Company authorized the
increase of common stock reserved for grant by 2,000,000 to a total of
2,500,000 for the 1996 Plan. A committee, as appointed by the Board of
Directors, grants incentive or non-qualified stock options. Options
issued under the 1996 Stock Option Plan are generally exercisable twelve
months from the date of grant and vest over four years, expiring no
later than 10 years from the date of grant.
In 1996, the Company offered to each employee with stock options
having an exercise price greater than the prevailing fair market value
of the common stock, the opportunity to amend the terms of such option
to reduce the exercise price to the prevailing fair market value. The
reduced exercise price was not less than fair market value per share of
common stock. The new options have the same vesting terms as the
surrendered options. Options representing 163,334 shares of common
stock were repriced, and are included in option grants and cancellations
in the year ended December 31, 1996.
In 1997, the Company offered to each employee with stock options
having an exercise price greater than the prevailing fair market value
of the common stock, the opportunity to amend the terms of such option
to reduce the reduced exercise price to the prevailing fair market
value. The new options have the same vesting terms as the surrendered
options. Options representing 166,708 shares of common stock were
repriced, and have been included in option grants and cancellations in
the year ended December 31, 1997.
In November 1998, the Company offered to each employee with stock
options having an exercise price greater than $0.50 per share, the
opportunity to amend the terms of such option to reduce the price to
$0.50 per share (an amount not less than the fair market value). The
new options have the same vesting terms as the surrendered options.
Options representing 1,122,950 shares of common stock were repriced, and
have been included in option grants and cancellations in the year ended
December 31, 1998.
A summary of activity under the Stock Option Plans is as follows:
<TABLE>
<CAPTION>
Outstanding Options
Shares --------------------------- Weighted-
Available Number Average
for of Price Exercise
Grant Shares Per Share Price
- ----------------------------- ----------- ----------- --------------- --------
<S> <C> <C> <C> <C>
Balance at December 31, 1995. 296,559 207,426 $1.00 -$65.00
Additional shares reserved. 500,000
Options granted............ (691,429) 691,429 $2.50 -$54.00 $15.05
Options exercised.......... -- (29,313) $1.00 - $2.50 $2.10
Options canceled........... 198,869 (198,869) $1.00 -$65.00 $32.70
Options repurchased........ 4,700 -- $1.30 - $3.50 $2.50
----------- -----------
Balance at December 31, 1996. 308,699 670,673 $1.00 -$54.00 $9.35
Options granted............ (544,987) 544,987 $5.45 -$30.65 $10.40
Options exercised.......... -- (102,318) $1.00 - $8.15 $2.10
Options canceled........... 446,150 (446,150) $1.30 -$41.25 $17.20
Options repurchased........ 1,878 -- $1.75 - $2.50 $2.40
----------- -----------
Balance at December 31, 1997. 211,740 667,192 $1.00 -$15.00 $6.00
Additional shares reserved. 2,125,053
Options granted............ (3,710,349) 3,710,349 $0.50 - $4.38 $0.66
Options exercised.......... -- (352,671) $0.50 - $7.19 $2.57
Options canceled........... 2,076,740 (2,076,740) $0.50 -$15.00 $2.98
----------- -----------
Balance at December 31, 1998. 703,184 1,948,130 $0.50 -$15.00 $0.83
=========== ===========
</TABLE>
At December 31, 1998, options to purchase 1,295,954 shares of
common stock were vested and exercisable.
In connection with certain of the Company's stock options granted
in 1996, the Company recorded deferred compensation of $169,433 for the
difference between the option grant price and the deemed fair value of
the Company's common stock at the date of grant. An amount is being
amortized over the vesting period of the individual options, generally a
48-month period. Amortization expense related to deferred compensation
was $36,120, $43,356 and $30,022 for the years ended December 31, 1998,
1997, and 1996, respectively.
The following table summarizes stock options outstanding and options
exercisable at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------- ----------------------
Weighted-
Average Weighted- Weighted-
Number Remaining Average Number Average
Range of of Contractual Exercise of Exercise
Exercise Prices Shares Life(Yrs) Price Shares Price
- --------------- ------------ ----------- --------- ------------ ---------
<S> <C> <C> <C> <C> <C>
$0.00 - $0.50 1,721,218 9.4 $0.50 1,125,673 $0.50
$0.51 - $1.50 77,011 7.1 $1.07 22,466 $1.27
$1.51 - $3.00 77,873 2.1 $2.04 75,787 $2.02
$3.01 -$50.00 72,028 0.4 $7.12 72,028 $7.12
------------ ------------
1,948,130 8.7 $0.83 1,295,954 $0.97
============ ============
</TABLE>
Pro forma information regarding net loss and net loss per share is
required by FAS 123, which also requires that the information be
determined as if the Company had accounted for its employee stock
options granted subsequent to December 31, 1994 under the fair value
method. In 1998 and 1997, the fair value of each option grant was
estimated on the date of the grant using the Black-Scholes option-
pricing model. In 1996, prior to the completion of the initial public
offering of common stock, the fair value of each option grant was
estimated using the minimum value method. The minimum value method
differs from other methods of valuing options, such as the Black-Scholes
option pricing model, because it does not consider the effect of expected
volatility. The fair value of options was estimated at the date of grant
using the following weighted average assumptions for the years ended
December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Risk Free interest rate.................... 5.15% 6.27% 5.88%
Dividend yield............................. None None None
Volatility................................. 1.16 0.94 0.18
Expected life of options in years.......... 5 5 5
</TABLE>
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, that have no vesting
restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the
expected stock price volatility. Because the Company's employee stock
options have characteristics significantly different from those of
traded options, and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion,
the existing models do not necessarily provide a reliable single measure
of the fair value of its employee stock options.
The Company maintains an Employee Stock Purchase Plan (the
"ESPP") pursuant to which 100,000 shares of the Company's common stock
are reserved for future issuance. Subject to certain limitations,
Company employees may purchase, through payroll deductions of 1% to 20%
of compensation, shares of common stock at a price per share that is the
lessor of 85% of the fair market value as of the beginning of the
offering period or the end of the purchase period. As of December 31,
1998, 98,984 shares have been issued and 1,016 remain to be issued under
the ESPP. The Company also maintains a Director's Stock Option Plan
pursuant to which 50,000 shares of common stock are reserved for future
issuance. As of December 31, 1998, all options under the Director's
Plan have been issued.
For purposes of pro forma disclosures, the estimated fair value of
the options is amortized to expense over the options' vesting period. The
Company's pro forma information is as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1998 1997 1996
------------ ------------- -------------
<S> <C> <C> <C>
Pro forma net loss.................... ($8,916,651) ($15,102,671) ($16,675,027)
Pro forma net loss per share.......... ($0.83) ($3.99) ($4.97)
</TABLE>
The pro forma net loss per share above is calculated using the
weighted average number of shares of common stock outstanding as
described in Note 1.
The weighted average fair value of options granted during the
years ended December 31, 1998, 1997 and 1996 was $1.28, $3.10 and $7.50,
respectively. Because FAS 123 is applicable only to options granted
subsequent to December 31, 1994, its pro forma effects will not be fully
reflected until the year ended December 31, 1999.
10. Stock Split
On February 26, 1998, the Company effected a reverse split of all
outstanding shares of common stock such that each five shares of common
stock were converted into one share of common stock. All common shares
in the accompanying financial statements have been retroactively
adjusted to reflect the reverse stock split. In connection with the
reverse stock split, the conversion and exercise provisions of all
outstanding shares, stock options, and warrants have been adjusted
accordingly.
11. Segment Information
The Company operates in one business segment -- internet-based e-
commerce solutions, for which the Company receives license and service
revenue from its customers.
Total revenue generated from U.S. customers totaled $5,492,344,
$8,103,497 and $10,179,788 for the years ended December 31, 1998, 1997
and 1996, respectively. Total revenue generated for foreign customers
totaled $986,260, $1,258,941 and $0 for the years ended December 31,
1998, 1997 and 1996, respectively.
Customers comprising 10% or greater of the Company's revenue are
summarized as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Customer A................................. 27% 18% *
Customer B................................. 13% 12% *
Customer C................................. * * 13%
</TABLE>
* Revenue less than 10%.
12. Income Taxes
No provision for income taxes has been recorded due to operating
losses with no current tax benefit.
The components of deferred income taxes consist of the following:
<TABLE>
<CAPTION>
December 31,
--------------------------
1998 1997
------------ ------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards....... $17,600,000 $13,000,000
Research credit carryforwards.......... 250,000 250,000
Deferred revenue....................... 400,000 400,000
Depreciation and amortization.......... 1,700,000 1,500,000
Other.................................. 500,000 700,000
------------ ------------
Total deferred tax assets................. 20,450,000 15,850,000
Valuation allowance....................... (20,450,000) (15,850,000)
------------ ------------
Total net deferred taxes.................. $ -- $ --
============ ============
</TABLE>
A valuation allowance has been recorded for the entire deferred tax
asset as a result of uncertainties regarding the realization of the
asset due to the lack of earnings history of the Company. To support
the Company's conclusion that a full allowance was required, management
primarily considered the Company's history of operating losses. The
Company will continue to assess the realizability of the deferred tax
assets based on actual and forecasted operating results. The valuation
allowance increased by $4,600,000 in 1998 and $2,183,000 in 1997.
At December 31, 1998, the Company had available federal net
operating loss carry forwards of approximately $52,000,000, that will
expire in 2010 through 2018, if not utilized. Also available at
December 31, 1998 are federal research credit carry forwards of
approximately $250,000, that will expire in 2011, if not utilized.
Utilization of the net operating losses and credits may be subject to
substantial limitation due to the ownership limitations provided by the
Internal Revenue Code of 1986, as amended, and similar state provisions.
The annual limitation may result in the expiration of net operating
losses and credits before utilization.
13. Subsequent Events
On January 22, 1999, the Company completed a private placement of
1,538,462 shares of common stock at $2.60 per share. The Company
received net proceeds of approximately $4.0 million.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Company
(a) Identification of Executive Officers:
The information concerning the Company's Executive Officers is
incorporated by reference from the Company's definitive proxy statement
(the "Proxy Statement") for the 1999 Annual Meeting of Shareholders, a
copy of which will be filed with the Securities and Exchange Commission
(the "SEC") no later than 120 days from the end of the Company's last
fiscal year.
(b) Identification of Directors:
The information concerning the Company's directors and nominees is
incorporated by reference from the section entitled "Proposal No. 1
Election of Directors" in the Proxy Statement, a copy of which will be
filed with the SEC no later than 120 days from the end of the Company's
last fiscal year.
(c) Compliance with Section 16 (a) of the Exchange Act: The
information concerning compliance with Section 16 (a) of the Exchange
Act is incorporated by reference from the section entitled "Compliance
with Section 16 (a) of the Exchange Act" in the Proxy Statement, a copy
of which will be filed with the SEC no later than 120 days from the end
of the Company's last fiscal year.
Item 11. Executive Compensation
The information required by this item is incorporated by reference
from the section entitled "Executive Compensation" in the Proxy
Statement, a copy of which will be filed with the SEC no later than 120
days from the end of the Company's last fiscal year.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is incorporated by reference
from the section entitled "Stock Ownership of Certain Beneficial Owners
and Management" in the Proxy Statement, a copy of which will be filed
with the SEC no later than 120 days from the end of the Company's last
fiscal year.
Item 13. Certain Relationships and Related Transactions
The information required by this item is incorporated by reference
from the section entitled "Certain Relationships and Related
Transactions" in the Proxy Statement, a copy of which will be filed with
the SEC no later than 120 days from the end of the Company's last fiscal
year.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K
(a) The following financial statements and supplemental data are
included in Item 8 of this Form 10-K:
(1) Financial Statements
Report of Ernst & Young, LLP, Independent Auditors
Balance Sheets at December 31, 1998 and 1997
Statements of Operations for each of the three years in the period
ended December 31, 1998
Statement of Stockholders' Equity (Deficit) for each of the three
years in the period ended December 31, 1998
Statement of Cash Flows for each of the three years for the period
ended December 31, 1998
Notes to Financial Statements
(2) Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable, or not
required, or because the required information was filed by the Company's
previously, or is included the consolidated financial statements or notes
thereto.
(3) Exhibits
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
- --------- -------------------------------------------------------------
<C> <S>
3.1 Second Amended and Restated Certificate of Incorporation of the
Company (1)
3.2 Bylaws of the Company (2)
4.1 Form of Exchange Agreement by and among the Company and certain
holders of the Company's securities (3)
4.2 Common Stock Purchase Agreement dated as of January 15, 1999, by and
among the Company and the purchasers listed therein (4)
9.1 Amended Stockholders Agreement dated July 3, 1996, by and among the
Company and certain holders of the Company's securities (2)
10.1 Form of Indemnification Agreement (2)
10.2 1989 Stock Option Plan, as amended, and form of stock option
agreement (2)
10.3 1996 Stock Option Plan, as amended, and form of stock option
agreement (5)
10.4 1996 Employee Stock Purchase Plan and form of subscription agreement
(2)
10.5 1996 Directors' Stock Option Plan and form of stock option agreement
(2)
10.6 Amended and Restated Registration Rights Agreement dated July 3,
1996, between the Company and certain holders of the Company's
securities (2)
10.7 Lease Agreement dated September 19, 1994, between the Company and
BRE Properties, Inc. (2)
10.8 Master Equipment Lease dated January 19, 1995, between the Company
and Phoenix Leasing Incorporated (2)
10.9 Software License Agreement dated February 5, 1996, between the
Company and Entex Information Services Inc. (2)(6)
10.10 Software License Agreement dated March 26, 1996, between the Company
and Union Underwear Company, Inc. (2)(6)
10.11 Software License Agreement dated November 7, 1995, between the
Company and PhotoDisc, Inc. (2)(6)
10.12 Amendment to Software License Agreement dated March 29, 1996,
between the Company and PhotoDisc, Inc. (2)(6)
10.14 OEM Master License Agreement dated June 30, 1995, between the
Company and RSA Data Security, Inc. (2)(6)
10.17 Option agreement dated January 16, 1996, between the Company and
Gordon J. Bridge (2)
10.18 Option agreement dated April 24, 1996, between the Company and
Gordon J. Bridge (2)
10.19 Letter agreement dated October 19, 1995, between the Company and
Gordon J. Bridge, and related interpretive letter (2)
10.20 Consulting Agreement dated March 9, 1992, between the Company and
Quaestus Limited Partnership (2)
10.23 Agreement and Mutual Release dated May 24, 1996, between the Company
and Henry V. Morgan (2)
10.24 Development and License Agreement dated March 29, 1996, between the
Company and Time Warner Cable (2)(6)
10.26 Agreement dated January 28, 1998, between the Company and Impresso
(7)
10.27 1998 Employment letter Agreement dated January 29, 1998 between the
Company and Gordon J. Bridge (7)
10.28 Consulting Agreement dated April 2, 1998, between the Company and
Gordon J. Bridge (8)
10.29 Agreement dated April 1, 1998, between the Company and Craig Norris
(8)
10.30 Agreement and Mutual Release dated March 27, 1998, between the
Company and Bart Foster (8)
10.31 Amended and Restated Change of Control Agreement dated as of April
30, 1998, between the Company and Kenneth M. Ross (8)
10.32 Amended and Restated Change of Control Agreement dated as of April
30, 1998, between the Company and Joseph G. Girata (8)
10.33 Amended and Restated Change of Control Agreement dated as of April
30, 1998, between the Company and Lucille Hoger (8)
10.34 Amended and Restated Change of Control Agreement dated as of April
30, 1998, between the Company and Craig D. Norris (8)
10.35 Change of Control Agreement dated as of July 22, 1998, between the
Company and Amanda Reed (1)
10.36 Change of Control Agreement dated as of July 22, 1998, between the
Company and Pia Chamberlain (1)
23 Consent of Independent Auditors
24 Power of Attorney included on the signature page on this Form 10-K
27.1 Financial Data Schedule
</TABLE>
----------------
(1) Incorporated by reference to the identically numbered exhibits to
the Company's quarterly report on Form 10-Q filed on August 14, 1998
(2) Incorporated by reference to identically numbered exhibits to the
Company's Registration Statement on Form S-1, as amended (File No.
333-05901), that became effective on August 14, 1996
(3) Incorporated by reference to Exhibit 99.3 to the Company's current
report on Form 8-K filed on April 3, 1998
(4) Incorporated by reference to Exhibit 4.1 to the Company's current
report on Form 8-K filed on February 4, 1999
(5) Incorporated by reference to Exhibit 10.3 to the Company's quarterly
report on Form 10-Q filed on November 16, 1998
(6) Confidential treatment has been previously granted with respect to
this exhibit
(7) Incorporated by reference to the identically numbered exhibits to
the Company's annual report on Form 10-K for the fiscal year ended
December 31, 1997
(8) Incorporated by reference to the identically numbered exhibits to
the Company's quarterly report on Form 10-Q filed on May 15, 1998
(b) Reports on Form 8-K
The Company filed the following reports on Form 8-K during the
fourth quarter of the fiscal year 1998.
(1) Form 8-K filed on October 13, 1998, regarding the Company's
October 12, 1998 announcement of its results for the third
quarter ended September 30, 1998 and its intention to focus
its business on providing internet systems integration.
(2) Form 8-K filed on October 21, 1998, regarding the Company's
notification by Nasdaq of a concern regarding the continued
listing of the Company's Common Stock on the Nasdaq National
Market.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
CONNECTINC.COM
Date: March 15, 1999 By: /s/ Craig D. Norris
---------------------
Craig D. Norris
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Craig D. Norris and Greigory Park,
and each of them, his attorneys-in-fact and agents, with full power of
substitution and resubstitution, for him and in his name, place, and stead,
in any and all capacities, to sign any and all amendments to this Report on
Form 10-K, and to file the same, with exhibits thereto and other documents
in connection therewith, with the Securities and Exchange Commission
granting unto such attorneys-in-fact and agents, and each of them, full
power and authority to do and perform each and every act and thing
requisite and necessary to be done in connection therewith, as fully to all
intents and purposes as he might or could do in person, hereby ratifying
and confirming that all such attorneys-in-fact and agents, or any of them
or their or his substitute or substituted, may lawfully do or cause to be
done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- ------------------------- ---------------------------------- ------------------
<S> <C> <C>
/s/ Craig D. Norris Chief Executive Officer March 15, 1999
- ------------------------- (Principal Executive Officer)
Craig D. Norris
/s/ Greigory Park Vice President of Finance and March 15, 1999
- ------------------------- Chief Financial Officer
Greigory Park (Principal Financial Officer and
Principal Accounting Officer)
/s/ Gordon Bridge Director March 15, 1999
- -------------------------
Gordon Bridge
/s/ Radha R. Basu Director March 15, 1999
- -------------------------
Radha R. Basu
/s/ Richard H. Lussier Director March 15, 1999
- -------------------------
Richard H. Lussier
/s/ Rory T. O'Driscoll Director March 15, 1999
- -------------------------
Rory T. O'Driscoll
</TABLE>
<PAGE>
SCHEDULE II
CONNECTINC.COM
VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
Additions
Charged
Balance at to costs Balance at
Beginning and End of
of Period Expenses Deductions Period
---------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Year ended December 31, 1998
Allowance for doubtful accounts.. $642,000 $232,000 ($712,000) $162,000
Year ended December 31, 1997
Allowance for doubtful accounts.. $222,000 $560,000 ($140,000) $642,000
Year ended December 31, 1996
Allowance for doubtful accounts.. $320,000 $157,000 ($255,000) $222,000
</TABLE>
<PAGE>
EXHIBIT 23
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration
Statements (Form S-8 Nos. 333-64803, 333-48927 and 333-21477 and Form
S-3 Nos. 333-47055 and 333-43197) of our report dated January 25, 1999
with respect to the financial statements and schedule of Connect, Inc.
included in the Annual Report (Form 10-K) for the year ended December
31, 1998.
/s/ Ernst & Young LLP
---------------------
Ernst & Young LLP
San Jose, California
March 15, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND> This schedule contains summary financial information extracted
from the Balance Sheet and Statement of Operations included in the
Company's Form 10-K for the year ended December 31, 1998 and is
qualified in its entirety by reference to such Financial Statements.
</LEGEND>
<MULTIPLIER>1
<S> <C>
<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-START> Jan-01-1998
<PERIOD-END> Dec-31-1998
<PERIOD-TYPE> 12-MOS
<CASH> 3,965,311
<SECURITIES> 0
<RECEIVABLES> 775,503
<ALLOWANCES> 162,238
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 4,758,378
<DEPRECIATION> 4,149,465
<TOTAL-ASSETS> 5,452,892
<CURRENT-LIABILITIES> 3,261,942
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0
0
<COMMON> 13,000
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<TOTAL-LIABILITY-AND-EQUITY> 5,452,892
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<TOTAL-REVENUES> 6,478,604
<CGS> 413,481
<TOTAL-COSTS> 4,746,338
<OTHER-EXPENSES> 9,565,047
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<INTEREST-EXPENSE> 352,179
<INCOME-PRETAX> (7,903,657)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,903,657)
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<CHANGES> 0
<NET-INCOME> (7,903,657)
<EPS-PRIMARY> (0.74)
<EPS-DILUTED> (0.74)
</TABLE>
