10-K405/A 1 a2049284z10-k405a.txt 10-K405/A -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- UNITED STATES SECURITIES & EXCHANGE COMMISSION WASHINGTON, D.C. 20549 AMENDMENT NO. 2 TO FORM 10-K/A /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 2000 / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________. COMMISSION FILE NUMBER 000-26465 PURCHASEPRO.COM, INC. (Exact name of registrant as specified in its charter) NEVADA 88-0385401 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.)
3291 NORTH BUFFALO DRIVE, SUITE 2, LAS VEGAS, NEVADA 89129 (Address of principal executive offices) (Zip Code) (702) 316-7000 (Registrant's telephone number, including area code) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, PAR VALUE $0.01. 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 or Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. /X/ The number of outstanding shares of the Registrant's Common Stock, $0.01 par value, was 73,674,849 as of December 4, 2001. The aggregate market value of the voting common stock held by non-affiliates of the Registrant as of December 4, 2001 was $50.8 million. For the purposes of this calculation, shares owned by officers, directors (and their affiliates) and 10% or greater shareholders known to the registrant have been excluded. This exclusion is not intended, nor shall it be deemed, to be an admission that such persons are affiliates of the Registrant. Certain exhibits filed with the Registrant's prior registration statements and Forms 10-K and 10-Q are incorporated in Part IV. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- EXPLANATORY NOTE REGARDING THIS AMENDMENT TO FORM 10-K We are making this filing to add additional information about certain transactions to which we are or were a party. We do not believe that any of these revisions is material. PURCHASEPRO.COM, INC. FORM 10-K DECEMBER 31, 2000 TABLE OF CONTENTS
PAGE -------- PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters......................................... 3 6. Selected Consolidated Financial Data........................ 4 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....................................... 5 7a. Quantitative and Qualitative Disclosures about Market Risk........................................................ 24 8. Financial Statements and Supplementary Data................. 25 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................... 61 PART IV 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K......................................................... 61 Signatures.................................................. 63
2 PART II ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our common stock is traded on the Nasdaq National Market under the symbol "PPRO." The price range per share reflected in the table below, is the highest and lowest sale price for our stock as reported by the Nasdaq National Market during each quarter the stock has been publicly traded.
FOR THE THREE MONTHS ENDED --------------------------------------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, --------- -------- ------------- ------------ 1999 High............................................ -- -- $15.92 $87.50 Low............................................. -- -- $ 7.33 $ 9.17 2000 High............................................ $82.00 $37.69 $47.75 $47.44 Low............................................. $34.00 $ 9.19 $16.50 $11.00
The above information has been restated to reflect a two-for-one stock split, effected in the form of a stock dividend to each stockholder, which occurred on October 12, 2000. Our present policy is to retain earnings, if any, to finance future growth. We have never paid cash dividends and have no present intention to pay cash dividends. At March 23, 2001, there were approximately 346 stockholders of record and the price per share of our common stock was $6.59. In March 2000, we issued to AOL warrants to purchase up to 4,000,000 shares of our common stock at an exercise price of $63.26 (adjusted after one year, as to any unvested warrants, to the then-current market price of our common stock). The warrants are exercisable from the time they vest until March 2003 as follows: (i) 1,000,000 warrants vest immediately; and (ii) 3,000,000 warrants vest as revenue is earned by us under the terms of the agreement. Vesting begins when annualized revenue reaches $25 million for the quarter and vests one share per $80 of revenue received by us. In November 2000, we entered into an amended and restated AOL warrant agreement, amending the March 2000 warrant agreement. For the 3,000,000 performance-based warrants that had not been earned as of the date of the amendment, the strike price was adjusted to $0.01 per share. In exchange for the reduced strike price, the defined revenue for which AOL can vest the performance-based warrants was expanded to include software licenses recognized by us that resulted from referrals from AOL. The formula for vesting warrants on referral revenue is that for each $1 of revenue generated from the referrals during a fiscal quarter, AOL is able to earn a number of warrants calculated as three times the revenue recognized divided by the estimated fair value of our common stock, as defined. The agreement limits the total recognized revenue allowed in the calculation to $10.0 million in the quarter ended December 31, 2000, $15.0 million in the quarter ending March 31, 2001 and $20.0 million in the quarter ending June 30, 2001. For the quarter ended December 31, 2000, AOL earned approximately $1.8 million warrants under the amended agreement, and in January 2001, AOL exercised the warrant with respect to such shares. In September 2000, as consideration for training and marketing services to be rendered by Gateway Companies, Inc., we issued three separate warrants to purchase an aggregate of 3,000,000 shares of our common stock at an exercise price of $29.75 per share. Of the warrants issued to Gateway, 1,000,000 vested and were exercisable immediately and another 1,000,000 vested and became exercisable on October 31, 2000. The remaining 1,000,000 warrants may vest and become exercisable over a period of eighteen months, with one share vesting for each $40 in revenue generated from transaction fees charged for transactions executed over marketplaces Gateway purchased from us during the third quarter. The value of these warrants, using the Black Scholes model, totaled $38.2 million and was recorded in intangibles. 3 ITEM 6: SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and the notes to the consolidated financial statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations," which are included elsewhere in this report. The consolidated statement of operations data presented for each of the five years in the period ended December 31, 2000 are derived from our audited statements of operations. Activity for the period from October 8, 1996 (inception) to December 31, 1996, consisted of sales and marketing activities, and general and administrative expenditures that were paid for from owner contributions. The consolidated balance sheet data at December 31, 1998, 1999 and 2000, are derived from our audited consolidated balance sheets.
YEAR ENDED DECEMBER 31, ---------------------------------------------------- 1996 1997 1998 1999 2000 -------- -------- -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) STATEMENT OF OPERATIONS DATA: Revenues: Software licenses............................... $ -- $ -- $ -- $ -- $ 34,860 Network access and service fees................. -- 513 1,308 4,092 23,546 Advertising..................................... -- -- -- 1,142 3,219 Other........................................... -- 162 362 783 3,366 ------- ------- ------- -------- -------- Total revenues................................ -- 675 1,670 6,017 64,991 Cost of revenues.................................. -- 214 445 836 4,487 ------- ------- ------- -------- -------- Gross profit...................................... -- 461 1,225 5,181 60,504 Operating expenses: Sales and marketing............................. 22 1,179 3,841 61,850 77,980 Programming and development..................... 87 802 971 2,616 9,135 General and administrative...................... 10 1,345 2,896 12,846 41,251 Impairment of assets............................ -- -- -- -- 12,112 ------- ------- ------- -------- -------- Total operating expenses...................... 119 3,326 7,708 77,312 140,478 ------- ------- ------- -------- -------- Operating loss.................................... (119) (2,865) (6,483) (72,131) (79,974) Other income (expense): Interest income (expense), net.................. (4) (120) (317) 469 4,507 Other........................................... -- -- -- (279) 2,656 ------- ------- ------- -------- -------- Total other income (expense).................. (4) (120) (317) 190 7,163 ------- ------- ------- -------- -------- Net loss before benefit for income taxes.......... (123) (2,985) (6,800) (71,941) (72,811) Benefit for income taxes.......................... -- -- -- -- -- ------- ------- ------- -------- -------- Net loss.......................................... (123) (2,985) (6,800) (71,941) (72,811) Preferred stock dividends......................... -- -- (245) (511) -- Accretion of preferred stock to redemption value........................................... -- -- (90) (131) -- Value of preferred stock beneficial conversion feature......................................... -- -- -- (9,400) -- ------- ------- ------- -------- -------- Net loss applicable to common stockholders........ $ (123) $(2,985) $(7,135) $(81,983) $(72,811) ======= ======= ======= ======== ======== Loss per share: Basic........................................... $ (0.01) $ (0.13) $ (0.28) $ (2.44) $ (1.15) ======= ======= ======= ======== ======== Diluted......................................... $ (0.01) $ (0.12) $ (0.26) $ (2.39) $ (1.15) ======= ======= ======= ======== ======== Weighted average shares outstanding: Basic........................................... 23,100 23,100 25,800 33,598 63,399 ======= ======= ======= ======== ======== Diluted......................................... 24,780 24,780 27,480 34,273 63,399 ======= ======= ======= ======== ========
4
DECEMBER 31, ---------------------------------------------------- 1996 1997 1998 1999 2000 -------- -------- -------- -------- -------- (IN THOUSANDS) BALANCE SHEET DATA: Cash and cash equivalents........................... $ 1 $ 8 $1,690 $30,356 $86,335 Working capital (deficit)........................... (49) (1,907) 907 28,439 70,789 Total assets........................................ 70 609 2,745 66,477 320,222 Notes payable....................................... 133 2,567 1,545 25 -- Long-term liabilities, net of current portion....... -- -- -- -- 10,348 Redeemable convertible preferred stock.............. -- -- 6,339 -- -- Total stockholders' equity (deficit)................ (113) (2,709) (5,881) 61,854 260,920
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This annual report may contain predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties, including those discussed at "Quantitative and Qualitative Disclosures About Market Risk" below. This outlook represents our current judgment on the future direction of our business. Such risks and uncertainties could cause actual results to differ materially from any future performance suggested. We undertake no obligation to release publicly the results of any revisions to these forward-looking statements to reflect events or circumstances arising after the date of this annual report. OVERVIEW We are a provider of business-to-business electronic commerce products and services. We license our software products to businesses that own and operate their own on-line marketplaces for conducting electronic commerce. We also operate an on-line global marketplace that provides businesses of all sizes with a low cost and efficient e-commerce solution for buying and selling a wide range of products and services over the Internet. We also develop and host private labeled on-line marketplaces using our products and services that can connect to our public global marketplace. There are approximately 140,000 businesses with the capability to access and use marketplaces we power and our global marketplace. Our predecessor company was incorporated in October 1996 and in January 1998, we incorporated PurchasePro.com, Inc. and acquired all of the assets and assumed all the liabilities of our predecessor. In August 1998, we acquired our subsidiary company, Hospitality Purchasing Systems, Inc., dba ProPurchasing Systems ("PPS"). Our initial service, PurchasePro version 1.0, enabled our members to transact e-commerce in our global marketplace. Our next release provided this capability over the Internet. In September 1998, we released PurchasePro 3.0, our marketplace enabling software. In February 1999, we released PurchasePro 4.0, which allows members the additional capability of building private labeled marketplaces. In December 1999, the Company released PurchasePro 5.0, a browser-based version that allows members to access the global marketplace and private labeled marketplaces with a user identification and password over the Internet. In May 2000, we launched our suite of on-line marketplace software solutions. From inception through early 1999, substantially all of our revenues were derived from monthly membership subscription fees for access to our global marketplace and from application service fees for private-labeled marketplaces. In early 1999, with the release of version 4.0, we began contracting with business customers to set up private labeled marketplaces tailored to the needs of our customers. We began charging these customers an application service provider fee for a fully operational marketplace solution hosted and maintained by us during the period of service. In general, we recognize revenues as an application service provider over the period of service. 5 In September 1999, we began generating transaction fee revenues from transactions consummated by our members with value added merchandise and service providers. Also, we began generating advertising fees, which we believe will generate additional transaction fees in the future. In May 2000, we launched a suite of marketplace solutions designed for three large classes of businesses and began licensing our software. In September 2000, we began selling software licenses for these private labeled marketplace solutions through value added resellers. We have adopted the method of deferring revenue recognition until the time the reseller delivers the software to the end user. After delivery to the reseller, we cannot be assured of when the resellers will actually deliver the software. For our software license revenue, we apply the provisions of American Institute of Certified Public Accountants' Statement of Position ("SOP") 97-2, SOFTWARE REVENUE RECOGNITION, and SOP 98-9, MODIFICATION OF SOP 97-2, SOFTWARE REVENUE RECOGNITION WITH RESPECT TO CERTAIN TRANSACTIONS, which amends SOP 97-2. SOP 97-2 and 98-9, as amended, generally require revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of the elements. The fair value of an element must be based on the evidence that is specific to the vendor. License revenue allocated to software products generally is recognized upon delivery of the products or deferred and recognized in future periods to the extent that an arrangement includes one or more elements that are to be delivered at a future date and for which fair values have not been established. Revenue allocated to maintenance is recognized ratably over the maintenance term. Revenue allocated to training and other service elements is recognized as the services are performed. If evidence of fair value does not exist for all elements of a license agreement and professional consulting services are the only undelivered element, then all revenue for the license arrangement is recognized ratably over the term of the agreement as license revenue. If evidence of fair value of all undelivered elements exists but evidence does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. For software licenses sold to resellers, we defer revenue recognition until the time the reseller delivers the software to the end user. Under our standard reseller program, we have no obligation of future performance under licenses sold to resellers. If we provide other services that are considered essential to the functionality of the software products, both the software product revenue and service revenue are recognized at the time the services are completed. Such contracts typically consist of professional services and are generally completed within 45 days of the software sale. For software licensees who contract with us to host their marketplaces, we recognize hosting revenue over the period the hosting services are provided. Hosting contracts generally are terminable on 30-day notice and do not impact the license and maintenance agreement. We have issued warrants to several of our strategic marketing partners. In 1999, we issued 1,050,000 warrants to a strategic marketing partner in exchange for a license to business-to-business editorial content valued at approximately $10.7 million. The editorial content was amortized to operating expense until the fourth quarter of 2000, at which time we concluded that changes in estimated future cash flows from the editorial content asset were less than the carrying value, and we recognized an impairment loss of approximately $9.8 million. In 1999, we issued 2,700,000 warrants to a strategic partner valued at $50.1 million, which was charged to sales and marketing expense at the date of issuance. In 2000, we issued 4,000,000 warrants to a strategic marketing partner, of which 1,000,000 warrants that vested immediately were valued at $25.8 million and were recorded as an intangible asset. The remaining 3,000,000 warrants can be earned based on the strategic marketing partner's performance under the warrant agreement. The portion of the warrant agreement that related to the performance-based warrants was amended in late-2000 to reduce the strike price to $0.01 per share in exchange for additional revenues streams marketed by this partner. We recognize sales and marketing expense during periods that the warrants are earned. During the year ended December 31, 2000, we recognized $30.0 million of sales and marketing expense related to approximately 1.8 million warrants 6 earned under the agreement. In 2000, we issued 3,000,000 warrants to another strategic marketing partner in exchange for certain marketing services valued at approximately $38.2 million. We amortize the value of these services to sales and marketing expense during the periods that the services are provided. Although revenues have consistently increased from quarter to quarter, we have incurred significant costs to develop our technology, products and services; to recruit and train personnel for our technology, sales, marketing, professional services and administration departments; for the amortization of our intangible assets and for our strategic marketing warrants. As a result, we have incurred significant losses since inception, and as of December 31, 2000, had an accumulated deficit of $151.6 million. We believe our success is contingent on increasing our customer base and developing our products and services. We intend to continue to invest heavily in sales, marketing, and, to a lesser extent, support infrastructure. We also will have significant expenses going forward related to the amortization of our intangible assets, and we may continue to have substantial non-cash expenses related to the issuance of warrants to purchase our common stock. These warrant-related expenses will not be recognized until the warrants are earned and will fluctuate depending on the market value of our common stock. See Note 7 of the Notes to Consolidated Financial Statements for more detailed information. We had 592 employees as of March 23, 2000 and intend to hire a significant number of employees in the future. This expansion places significant demands on our management and operational resources. To manage this rapid growth and increased demand, we must invest in and implement scalable operational systems, procedures and controls. We must also be able to recruit qualified candidates to manage our expanding operations. We expect future expansion to continue to challenge our ability to hire, train, manage and retain our employees. In connection with the granting of stock options to our employees we recorded deferred stock-based compensation totaling approximately $27.3 million from inception through December 31, 2000. This amount represents the difference between the exercise price and the deemed fair value of our common stock for accounting purposes on the date these stock options were granted. This amount is included as a component of stockholders' equity and is being amortized by charges to operations over the vesting period of the options, consistent with the method described in Financial Accounting Standards Board Interpretation No. 44. During fiscal 2000 and 1999, we recorded $17.1 million and $5.8 million, respectively, of related stock-based compensation amortization expense. As of December 31, 2000, we had an aggregate of $4.4 million of related deferred compensation remaining to be amortized. The amortization of the remaining deferred stock-based compensation will result in additional charges to operations through fiscal 2003. The amortization of stock-based compensation is presented as a separate component of operating expenses in our consolidated statements of operations. 7 RESULTS OF OPERATIONS The following table sets forth certain statements of operations data as a percentage of revenues for the periods indicated. The data has been derived from the consolidated financial statements contained in this Form 10-K.
YEAR ENDED DECEMBER 31, ------------------------------------ 1998 1999 2000 -------- -------- -------- Revenues Software licenses......................................... --% --% 53.6% Network access and service fees........................... 78.3 68.0 36.2 Advertising............................................... -- 19.0 5.0 Other..................................................... 21.7 13.0 5.2 ------ -------- ------ 100.0 100.0 100.0 Cost of revenues............................................ 26.6 13.9 6.9 ------ -------- ------ Gross profit................................................ 73.4 86.1 93.1 Operating expenses Sales and marketing....................................... 230.0 1,027.9 120.0 Programming and development............................... 58.2 43.5 14.1 General and administrative................................ 173.4 213.5 63.4 Impairment of assets...................................... -- -- 18.6 ------ -------- ------ Total operating expenses................................ 461.6 1,284.9 216.1 ------ -------- ------ Operating loss.............................................. (388.2) (1,198.8) (123.0) Other income (expense)...................................... (19.0) 3.2 11.0 ------ -------- ------ Net loss.................................................... (407.2) (1,195.6) (112.0) Preferred stock dividends, accretion of preferred stock to redemption value and value of preferred stock beneficial conversion feature........................................ (20.0) (166.9) -- ------ -------- ------ Net loss applicable to common stockholders.................. (427.2)% (1,362.5)% (112.0)% ====== ======== ======
COMPARISON OF THE YEARS ENDED DECEMBER 31, 1999 AND DECEMBER 31, 2000 REVENUES. Our revenues are grouped into four categories. Software licenses are for marketplace licenses sold by us. Network access and service fees include subscription fees and transaction fees charged to individual subscribers for access to our global marketplace and application service fees for labeled marketplaces we power for our customers, maintenance fees for on-going software license maintenance, hosting fees for those customers who have licensed our software products and have contracted our hosting capabilities, services for setting up marketplaces, and our share of subscription fees. Advertising fees include fees for advertising on our global marketplace. Other revenues include fees generated by our purchasing aggregator subsidiary, PPS, and other ancillary services. Our net revenues increased from $6.0 million for the year ended December 31, 1999, to $65.0 million for the year ended December 31, 2000. Substantially all of this increase resulted from growth in our software license and network access and service fees. Software license revenue increased from $0 to $34.9 million for the year ended December 31, 1999 and December 31, 2000, respectively. Our network access and service fee revenue increased from $4.1 million for the year ended December 31, 1999, to $23.5 million for the year ended December 31, 2000. Of the increase, $11 million relates to a sales agreement with Office Depot, Inc., whereby Office Depot paid the network access fees for 100,000 subscribers for a one-year period through January 2001. Also contributing to the increase is $4.9 million paid by AOL for 100,000 subscribers. AOL paid these subscription fees on behalf of 100,000 of its subscribers as a one-month promotional subscription offer 8 for the month of December 2000. In addition, we depend on AOL for a substantial portion of our revenues. During the year ended December 31, 2000 AOL referred $10.5 million of revenue to us and resold $6.6 million of software licenses. We anticipate that future revenues from our AOL relationship will constitute a substantial portion of our revenues for the foreseeable future. Advertising revenues increased from $1.1 million to $3.2 million for the years ended December 31, 1999 and 2000, respectively. Other revenues, which include transaction fees and participation fees of our purchasing aggregator subsidiary, PPS, and other ancillary services, increased from $783,000 for the year ended December 31, 1999, to $3.4 million for the year ended December 31, 2000, of which $2.3 million related to a one-time contract to build network access web sites for one customer. During the year ended December 31, 1999, no customers accounted for more than 10 percent of net revenues. During the year ended December 31, 2000, two customers each accounted for 18 percent of net revenues. During the year ended December 31, 2000, we acquired certain software technology from third-parties to which we also sold our own software products. The acquired technology is used by us in a hosted environment and will only be available to customers who pay for such services. The acquired technology is not part of the software products sold by us. In accordance with the provisions of Accounting Principles Board Opinion No. 29, ACCOUNTING FOR NONMONETARY TRANSACTIONS, and EITF No. 00-3, APPLICATION OF AICPA STATEMENT OF POSITION 97-2 TO ARRANGEMENTS THAT INCLUDE THE RIGHT TO USE SOFTWARE STORED ON ANOTHER ENTITY'S HARDWARE, we determined the acquired technology was to be used as internal use software, and therefore recorded the acquired assets at their fair value of approximately $20.6 million as computer equipment and software. We also recognized revenue from the sale of our software at fair value based on our own vendor specific objective evidence. Total revenue for the year ended December 31, 2000 from these software sales totaled approximately $8.8 million, and no individual transaction was in excess of 10 percent of total revenues. COST OF REVENUES. Our cost of revenues consists primarily of costs for operating the public and private marketplace network and costs to develop private marketplaces, including fees for independent contractors and compensation for our personnel. Our cost of revenues increased from $836,000 for the year ended December 31, 1999, to $4.5 million for the year ended December 31, 2000. The increase was primarily the result of the increase in personnel in our customer service and project development departments. Expenses related to personnel costs increased from $699,000 for the year ended December 31, 1999, to $3.1 million for the year ended December 31, 2000. Other items also contributing to the increase between years were software/hardware maintenance. We expect that our cost of revenues will increase in absolute dollars, but will remain relatively constant as a percentage of revenues in future periods. SALES AND MARKETING EXPENSES. Our sales and marketing expenses are comprised of primarily non-cash marketing costs, compensation for our sales and marketing personnel, travel and related costs, and costs associated with our marketing activities such as advertising and other promotional activities. Our sales and marketing expenses increased from $61.8 million to $78.0 million between years. During the year ended December 31, 1999, we recognized non-cash charges of $50.9 million related to the issuance of stock options and warrants issued to strategic marketing partners. During the year ended December 31, 2000, we recognized non-cash charges of $2.8 million and $30.0 million related to the issuance of common stock and warrants, respectively. We issued common stock to re-acquire certain geographic marketing rights that, in 1999, we had sold to a then-member of our board of directors. The warrants were issued in connection with referrals from customers referred by AOL (see Note 7 to the Consolidated Financial Statements included herein). Sales and marketing expenses for the year ended December 31, 2000, also included $895,000 for amortization of editorial content, until the asset was determined to be impaired in the fourth quarter of 2000. We also recognized stock-based compensation costs of $1.7 million and $2.0 million for the years ended December 31, 1999 and 2000, respectively. Exclusive of the non-cash charges, sales and marketing expenses increased from $9.2 million for the year ended December 31, 1999, to $42.3 million for the year ended December 31, 2000. This increase is 9 primarily attributable to an increase in our marketing, promotional and branding efforts. Expenses related to our sales and marketing personnel increased from $5.9 million for the year ended December 31, 1999 to $19.3 million for the year ended December 31, 2000. Expenses associated with our marketing activities increased from $2.0 million for the year ended December 31, 1999, to $19.1 million for the year ended December 31, 2000. Travel and related costs increased from $1.1 million for the year ended December 31, 1999, to $1.8 million for the year ended December 31, 2000. We expect that our sales and marketing expenses will continue to increase, both in absolute dollars and as a percentage of net revenues, a result of charges under strategic marketing partner agreements (See Note 7 of the Notes to Consolidated Financial Statements) and other increased marketing efforts. PROGRAMMING AND DEVELOPMENT EXPENSES. Programming and development expenses consist primarily of compensation for our programming and development staff and payments to outside contractors. We also recognized stock-based compensation costs of $250,000 and $285,000 for the years ended December 31, 1999 and 2000, respectively. Exclusive of the non-cash charges, our programming and development expenses increased from $2.4 million for the year ended December 31, 1999, to $8.9 million for the year ended December 31, 2000. The increase is primarily attributable to an increase in our programming staff. Expenses related to programming and development personnel increased from $2.0 million for the year ended December 31, 1999, to $5.8 million for the year ended December 31, 2000. A portion of the personnel costs was capitalized and will be amortized over the life of the software asset. Amortization of software assets totaled $521,000 for 2000. Contract labor and consulting costs increased from $53,000 to $1.1 million during the year ended December 31, 1999 and 2000, respectively. We expect that our programming and development expenses will increase in absolute dollars as we anticipate continuing to develop and enhance our network capabilities, but remain relatively constant as a percentage of net revenues. GENERAL AND ADMINISTRATIVE EXPENSES. Our general and administrative expenses consist primarily of compensation for personnel and, to a lesser extent, fees for professional services, facility and communications costs. We also recognized stock-based compensation costs of $3.8 million and $14.8 million for the years ended December 31, 1999 and 2000, respectively. Exclusive of these costs our general and administrative expenses increased from $9.0 million for the year ended December 31, 1999, to $26.4 million for the year ended December 31, 2000. The increase is primarily attributable to the increased size of our executive and administrative staff and operating facilities, and increased depreciation. Expenses related to our general and administrative staff increased from $2.9 for the year ended December 31, 1999, to $5.9 million for the year ended December 31, 2000. Professional fees and outside services incurred increased from $1.5 million to $3.7 million between years. Facilities costs increased from $1.6 million for the year ended December 31, 1999, to $4.2 million for the year ended December 31, 2000, as the result of the expansion of our corporate location. Other general and administrative expenses increased primarily as a result of a larger amount charged to our reserve for doubtful accounts. The charge for doubtful accounts totaled $1.1 million for the year ended December 31, 1999, as compared to $3.4 million for the year ended December 31, 2000. The increase corresponds primarily to the increase in our revenues. Depreciation and amortization also increased over the same periods from $895,000 to $7.0 million, respectively. This increase is mainly related to the addition of computer equipment and leasehold improvements. We expect that our general and administrative expenses will increase in absolute dollars but remain relatively constant as a percentage of net revenues. IMPAIRMENT OF ASSETS. We recorded an impairment of asset charge of $12.1 million during 2000. A $9.8 million charge was related to our editorial content agreement with a strategic marketing partner, whereby the partner would supply us content for our global marketplace product. The value of this asset was originally based on projected future cash flows. We began using the content in 2000, but by the fourth quarter of 2000, we concluded that the asset would not be realized as originally 10 contemplated. Therefore, we recorded the impairment charge in accordance with generally accepted accounting principles. The Company still retains the right to use the content as outlined in the license agreement. In addition, a $2.3 million impairment of asset charge reflects the results of the Company's assessment of its strategic investments. After reviewing all of its investments, we recorded a charge to reflect the net realizable value of certain investments. OTHER INCOME (EXPENSE). Interest income increased from $656,000 to $6.1 million for the year ended December 31, 1999 and 2000, respectively. The increase relates to interest earned on public offering proceeds that were invested in short- and long-term investments. Our interest expense increased from $187,000 for the year ended December 31, 1999, to $1.6 million for the year ended December 31, 2000. The increase resulted primarily from imputed interest on long-term payment obligations to a strategic marketing partner. Interest expense in 1999 primarily related to borrowings from our Chairman and Chief Executive Officer on notes payable outstanding since September 1998 and December 1998. We also recognized a $2.7 million gain on the sale of certain marketable securities during the fourth quarter of 2000. COMPARISON OF THE YEARS ENDED DECEMBER 31, 1998 AND DECEMBER 31, 1999 REVENUES. Our net revenues increased from $1.7 million for the year ended December 31, 1998, to $6.0 million for the year ended December 31, 1999. Substantially all of this increase resulted from growth in our membership, new license arrangements to develop and host private procurement networks and advertising revenues. Our network access revenue increased from $1.3 million for the year ended December 31, 1998 to $4.1 million for the year ended December 31, 1999. Advertising revenue increased from $0 to $1.1 million due to contracts with Office Depot, Workflow Management and American Hotel Register. Other revenues increased from $362,000 for the year ended December 31, 1998, to $783,000 for the year ended December 31, 1999, including an increase in PPS revenues from $154,000 to $475,000. COST OF REVENUES. Our cost of revenues increased from $445,000 for the year ended December 31, 1998, to $836,000 for the year ended December 31, 1999. The increase was primarily the result of the increase in personnel in our member service department. Expenses related to personnel costs of our member service and web site operations departments increased from $357,000 for the year ended December 31, 1998 to $699,000 for the year ended December 31, 1999. SALES AND MARKETING EXPENSES. Our sales and marketing expenses increased from $3.8 million for the year ended December 31, 1998 to $61.8 million for the year ended December 31, 1999. During the year ended December 31, 1999, we recognized non-cash charges of $800,000 and $50.1 million related to the issuance of stock options and warrants, respectively, issued to strategic marketing partners. During the year ended December 31, 1999, we also recognized stock-based compensation costs of $1.7 million. Excluding non-cash charges, the increase in sales and marketing expenses was primarily attributable to an increase in the size of our sales force. Expenses that related to personnel costs of sales and marketing personnel increased from $2.2 million for the year ended December 31, 1998 to $5.9 million for the year ended December 31, 1999. Travel and related costs increased from $437,000 for the year ended December 31, 1998, to $1.1 million for the year ended December 31, 1999. Costs associated with our marketing activities increased from $362,000 for the year ended December 31, 1998, to $2.0 million for the year ended December 31, 1999. PROGRAMMING AND DEVELOPMENT EXPENSES. Our programming and development expenses increased from $971,000 for the year ended December 31, 1998, to $2.6 million for the year ended December 31, 1999. We recognized stock-based compensation costs of $250,000 during the year ended December 31, 1999. Exclusive of the non-cash charges, the increase is primarily attributable to an increase in our programming staff. Expenses related to programming and development personnel increased from $851,000 for the year ended December 31, 1998, to $2.0 million for the year ended December 31, 1999. 11 In 1999, we capitalized $396,000 of internal expenses related to programming and development personnel who worked directly on the development of new services on the network or on private network development. These costs are being amortized over a 24-month period. GENERAL AND ADMINISTRATIVE EXPENSES. Our general and administrative expenses increased from $2.9 million for the year ended December 31, 1998, to $12.8 million for the year ended December 31, 1999. We also recognized stock-based compensation costs of $3.8 million for the year ended December 31, 1999. Exclusive of these costs, the increase is primarily attributable to the increased size of our executive and administrative staff. Expenses related to personnel costs of our general and administrative personnel increased from $1.3 million for the year ended December 31, 1998, to $2.9 million for the year ended December 31, 1999. Professional fees increased from $222,000 to $1.5 million for the year ended December 31, 1998 and 1999, respectively, due to recruiting fees and legal fees related to items not associated with the initial public offering. Facilities costs increased from $723,000 for the year ended December 31, 1998 to $1.6 million for the year ended December 31, 1999, as the result of our move into our new corporate location and our expansion into new geographic areas throughout late 1998 and early 1999. Other general and administrative expenses increased primarily as a result of a larger amount charged to our reserve for doubtful accounts. The charge for doubtful accounts totaled $127,000 for the year ended December 31, 1998, as compared to $1.1 million for the year ended December 31, 1999. The increase resulted primarily from the increase in our revenues, and a better knowledge of the estimated bad debt percentage based on our collection experience. Our depreciation increased from $253,000 for the year ended December 31, 1998, to $847,000 for the year ended December 31, 1999. The increase is due to the addition of computer hardware and software used to enhance the capabilities of the network. OTHER INCOME (EXPENSE). Interest income increased from $16,000 to $656,000 for the years ended December 31, 1998 and 1999, respectively. The increase relates to interest earned on initial public offering proceeds that were invested in short-term investments. Our interest expense decreased from $333,000 for the year ended December 31, 1998, to $187,000 for the year ended December 31, 1999. The decrease resulted from the repayment of $2.3 million of notes payable. Interest expense primarily relates to borrowings from our Chairman and Chief Executive Officer in 1997, notes payable outstanding from January 1998 through September 1998, and notes payable outstanding since September 1998 and December 1998. Other expense includes the write-off of debt issuance costs of $279,000 related to $1.5 million of notes payable issued in September 1998 and repaid in June 1999. LIQUIDITY AND CAPITAL RESOURCES Since our inception on October 8, 1996, we have had significant negative cash flows from our operations. For the years ended December 31, 1998, 1999 and 2000, we used $6.0 million, $12.6 million and $21.4 million of cash, respectively, in our operations. Cash used in operating activities in each period resulted primarily from net losses in those periods, offset by non-cash charges and changes in current assets and liabilities. For the year ended December 31, 2000 our cash used in operating activities included an increase in our trade accounts receivable of $24.6 million. Days sales outstanding, a measure of the typical time to collect an accounts receivable balance, increased from 118 days to 130 days between years. The increase is primarily attributable to billings under terms of our software license contracts entered into during the fourth quarter of 2000. For the years ended December 31, 1998, 1999 and 2000, we used cash totaling $360,000, $15.6 million, and $67.9 million, respectively, in our investing activities. The increase in 2000 consisted of $30.5 million for computers and related equipment purchases and $13.1 million for investments in other companies. Net cash provided by financing activities for the years ended December 31, 1998, 1999 and 2000, was $8.1 million, $56.9 million and $145.3 million, respectively. Since inception, we have financed our 12 operations primarily from the issuance of common stock, proceeds of notes payable, the sale of Series A Preferred Stock and Series B Preferred Stock and the proceeds of our initial public offering and follow-on offering. Funds provided by financing in 1998 consisted primarily of the issuance of preferred stock of $7.0 million. In addition, we borrowed $2.3 million from various individuals in January 1998 and $1.5 million from various individuals, including our chairman and CEO, in September 1998. Our chairman and CEO also advanced us an additional $637,000. During 1998, we repaid $1.1 million of the loans from our chairman and CEO and the loans of $2.3 million. Funds provided by financing activities in 1999 included the completion of our initial public offering, with net proceeds of approximately $50.0 million after underwriting discounts and commissions and other offering costs, and the issuance of Series B Preferred Stock. Funds used in financing activities related to the repayment of the September 1998 Notes. Funds provided by financing activities in 2000 included the completion of a follow-on offering in February 2000. We completed a public offering of 6,000,000 shares of common stock for $40 per share. We sold 4,000,000 of the shares, with the remaining 2,000,000 shares being sold by then existing stockholders. Net proceeds to us from the follow-on offering were $150.7 million. As of December 31, 2000, our principal source of liquidity was approximately $86 million of cash and cash equivalents. As of December 31, 2000, we had material commitments for capital expenditures of $15.9 million for computer-related equipment. We have also entered into several non-cancelable lease commitments that will require payments of approximately $16.5 million over the next five years. We believe that we have sufficient cash and cash equivalents to fund our operating and investing activities for at least the next 12 months. However, we may need to raise additional funds in future periods through public or private financings, or other arrangements. Any additional financings, if needed, might not be available on reasonable terms or at all. Failure to raise capital when needed could harm our business, financial condition and results of operations. RECENT ACQUISITIONS STRATTON WARREN SOFTWARE, INC. On January 16, 2001, we completed the acquisition of all the outstanding stock of Stratton Warren Software, Inc. ("Stratton Warren"), a Georgia corporation that designs and markets software for hotels, resorts, casinos, and other food service operations with purchasing, inventory and materials management requirements. Stratton Warren's principal assets include its intellectual property and software, in addition to numerous license and maintenance agreements with companies that license and use Stratton Warren's software. The total consideration for the acquisition consisted of: 1. $1.5 million in cash, payable on October 30, 2000, plus $3.5 million used by Stratton Warren to redeem certain of its shares held by a shareholder prior to completion of the acquisition; 2. $9.0 million in shares of common stock of the Company (which totaled 541,353 shares based on the closing price of our common stock on January 16, 2001); and 3. $500,000 in cash deposited in escrow to secure indemnification obligations of Stratton Warren's sole remaining shareholder to be distributed ninety days after the closing date. The consideration for the outstanding stock of Stratton Warren was determined through arms-length negotiations. The cash portion of the purchase price for the shares of Stratton Warren was provided from the Company's working capital. BAYBUILDER In March 2001, the Company announced it had signed a definitive agreement to acquire Net Research, Inc., dba BayBuilder, a provider of self-service strategic sourcing technology for Fortune 1000 13 corporations. The Company will pay $15 million in stock and cash for BayBuilder. Completion of the acquisition is subject to customary conditions and is expected to close during the second quarter of 2001. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued SFAS No. 133, ACCOUNTING FOR DERIVATIVES AND HEDGING ACTIVITIES, which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. The FASB recently issued SFAS No. 137 and SFAS No. 138, which defers the effective date of SFAS No. 133 and amends certain provisions. SFAS No. 133, as amended, will be effective for all fiscal quarters of fiscal years beginning after June 15, 2000. We currently do not engage in, nor do we expect to engage in, derivative or hedging activities, and, therefore, we do not believe that SFAS No. 133 will have a material impact on our results of operations or financial position. In December 1999, the SEC issued Staff Accounting Bulletin (SAB) No. 101, REVENUE RECOGNITION IN FINANCIAL STATEMENTS, which summarizes the SEC's views in applying generally accepted accounting principles to revenue recognition in financial statements. We believe that we have followed the guidelines set forth in SAB No. 101 as it relates to revenue recognition in our financial statements. In March 2000, the Financial Accounting Standards Board issued Interpretation No. 44, ("FIN 44"), ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK COMPENSATION--AN INTERPRETATION OF APB 25. This Interpretation clarifies (a) the definition of employee for purposes of applying APB 25, (b) the criteria for determining whether a plan qualifies as a non-compensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. FIN 44 became effective July 1, 2000, but certain conclusions in FIN 44 cover specific events that occurred after either December 15, 1998, or January 12, 2000. The adoption of FIN 44 does not have a material effect on the Company's financial statements. RISK AND UNCERTAINTIES The following is a summary description of some of the many risks we face in our business. You should carefully review these risks in evaluating our business, including the businesses of our subsidiaries. You should also consider the other information described in this report. OUR QUARTERLY OPERATING RESULTS MAY BE VOLATILE AND DIFFICULT TO PREDICT. IF WE FAIL TO MEET THE EXPECTATIONS OF PUBLIC MARKET ANALYSTS OR INVESTORS, THE MARKET PRICE OF OUR COMMON STOCK MAY DECREASE SIGNIFICANTLY. Our quarterly operating results have varied significantly in the past and will likely vary significantly in the future. We believe that period-to-period comparisons of our results of operations may not be meaningful and should not be relied upon as indicators of future performance. Our quarterly operating results may fluctuate significantly due to the following factors, many of which are outside our control: - demand for and market acceptance of our products and services; - inconsistent growth, if any, of our member base; - loss of key customers or strategic partners; - timing of the recognition of revenue for large contracts; - intense and increased competition; - introductions of new products, services or enhancements; 14 - our ability to control costs; - ability to develop, introduce and market new products and enhancements to our existing products on a timely basis; - changes in our pricing policies and business model or those of our competitors; - integration of our recent and any future acquisitions; - success in maintaining and enhancing existing relationships and developing new relationships with strategic partners; - customer budget cycles and changes in these budget cycles; and - general economic factors, including an economic slowdown or recession. Furthermore, our quarterly revenues may be affected significantly by other revenue recognition policies and procedures. These policies and procedures may evolve or change over time based on applicable accounting standards and how these standards are interpreted. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Due to these and other factors, our operating results could be below market analysts' expectations in future quarters, which would most likely cause the market price of our stock to decline. We expect to increase our operating expenses to expand our sales and marketing operations, fund greater levels of research, programming and development, develop new partnerships, make tenant improvements to our facilities, increase our professional services and support capabilities and improve our operational and financial systems. Also our amortization of stock-based compensation and amortization of goodwill and other intangible assets will fluctuate based on our acquisition activity. Moreover, any non-cash expenses related to the issuance of warrants to purchase our common stock could fluctuate significantly as a result of fluctuations in the fair market value of our common stock. If our revenues do not increase along with these expenses or if we experience significant fluctuations in non-cash expenses related to these warrants, our business, operating results and financial condition could be seriously harmed and net losses in a given quarter could be even larger than expected. WE DEPEND HEAVILY ON OUR STRATEGIC RELATIONSHIPS WITH OUR PARTNERS, INCLUDING AMERICA ONLINE. We have formed strategic relationships with several companies with a strategy to leverage the customer bases and vendor relationships of our strategic partners for both software sales and increased membership on marketplaces we power. There is no guarantee that these alliances will be successful in creating a larger market for our product and services offerings. If these alliances are not successful, our business, operating results and financial position could be seriously harmed. We depend on America Online ("AOL"), both directly and as a source of referrals and other indirect sales to customers, for a substantial portion of our revenues and we anticipate that revenues from our AOL relationship will constitute a substantial portion of our revenues for the foreseeable future. During the year ended December 31, 2000, AOL accounted for 18 percent of our net revenues. If AOL is unable to generate substantial revenues for us in the future or if our relationship with AOL proves unsuccessful or deteriorates, our business, operating results and financial position would be seriously harmed. For a discussion of the business terms of our relationship with AOL, see Note 3 of the Notes to Consolidated Financial Statements. 15 CHANGES IN ACCOUNTING STANDARDS COULD ADVERSELY AFFECT THE CALCULATION OF OUR FUTURE OPERATING RESULTS. The e-commerce software industry is new, and we anticipate the e-commerce software business model is likely to evolve over time. As a result, the application of accounting standards to the e-commerce software industry may change. The impact of changes in the application of accounting standards can not be determined given that accounting standards are continually modified as changes occur in the business environment. We have engaged in transactions with some of our strategic partners comprising more than one element, such as sales of our products and the issuance of equity instruments such as warrants to purchase our common stock. The Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board is currently addressing a number of issues surrounding the accounting for multiple-element arrangements. If changes in existing accounting practices result from the conclusions reached by the EITF, these changes could affect our future operating results. OUR STOCK PRICE IS HIGHLY VOLATILE, WHICH MAY GIVE RISE TO SECURITIES CLASS ACTION LITIGATION. Our stock price has fluctuated dramatically. The market price of the common stock may decrease significantly in the future in response to the following factors, some of which are beyond our control: - variations in our quarterly operating results; - announcements that our revenue or income are below analysts' expectations; - changes in analysts' estimates of our performance or industry performance; - changes in market valuations of similar companies; - sales of large blocks of our common stock; - announcements by us or our competitors of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments; - loss of a major customer or failure to complete significant license transactions; - loss of a major strategic partner; - additions or departures of key personnel; and - fluctuations in stock market price and volume, which are particularly common among highly volatile securities of software and Internet-based companies. Futhermore, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. We may in the future be the target of similar litigation. Securities litigation could result in substantial costs and damaging publicity and may divert management's attention and resources, which could seriously harm our business. OUR LIMITED OPERATING HISTORY MAKES IT DIFFICULT TO EVALUATE OUR FUTURE PROSPECTS. We began operations in October 1996, and our business model is new and our ability to generate revenue or profits is unproven. We have entered into the majority of our contracts and significant relationships only within the last 28 months. Our limited operating history makes it difficult to evaluate our future prospects. Our prospects are subject to risks and uncertainties frequently encountered by start-up companies in new and rapidly evolving markets such as the business-to-business e-commerce market, including risks associated with our recent acquisitions. Many of these risks are unknown, but include the lack of widespread acceptance of the Internet as a means of purchasing products and services and managing our growth. Our failure to identify the challenges and risks in this new market and successfully address these risks would harm our business. 16 WE HAVE A HISTORY OF LOSSES AND ANTICIPATE CONTINUED LOSSES, AND WE MAY BE UNABLE TO ACHIEVE PROFITABILITY. We have never been profitable over a quarterly period. We may be unable to achieve profitability in the future. We have incurred net losses in each accounting period since our organization in October 1996, and as of December 31, 2000, we had an accumulated deficit of $151.6 million. Moreover, we expect to continue to make significant expenditures for sales and marketing, programming and development and general and administrative functions. As a result, we will need to generate significant revenues to achieve profitability. We cannot assure you that revenues will grow in the future or that we will achieve sufficient revenues to achieve profitability. If revenues grow more slowly than we anticipate, or if operating expenses exceed our expectations, our business would be severely harmed. WE FACE INTENSE COMPETITION IN THE BUSINESS-TO-BUSINESS E-COMMERCE MARKET, AND WE CANNOT ASSURE YOU THAT WE WILL BE ABLE TO COMPETE SUCCESSFULLY. The business-to-business e-commerce market is new, rapidly evolving and intensely competitive, and the intensity of competition has increased and is expected to further increase in the future. This increased competition may result in price reductions, reduced gross margins and loss of market share, any one of which could seriously harm our business. In addition to competition from several e-commerce trade communities, we also encounter competition from software providers such as Ariba and Commerce One. Further, we expect that additional companies will offer competing e-commerce products and services in the future. Barriers to entry are minimal, and competitors may develop and begin offering similar services. In the future, we may encounter competition from companies such as Peoplesoft, Oracle and SAP, as well as from our current customers, members and partners. Many of our current and potential competitors have longer operating histories, larger customer bases and greater brand recognition in business and Internet markets and significantly greater financial, marketing, technical and other resources. As a result, our competitors may be able to devote significantly greater resources to marketing and promotional campaigns, may adopt more aggressive pricing policies or may try to attract users by offering services for free and may devote substantially more resources to product development. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address customer needs. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. We also expect that competition will increase as a result of industry consolidations. Our business could be severely harmed if we are not able to compete successfully against current or future competitors. WE MAY NOT BE ABLE TO CONTINUOUSLY ENHANCE OUR PRODUCTS AND SERVICES. Our future success will depend on our ability to enhance our software products, and to continue to develop and introduce new products and services that keep pace with competitive introductions and technological developments, satisfy diverse and evolving member requirements, and otherwise achieve market acceptance. Any failure by us to anticipate or respond adequately to changes in technology and member preferences, or any significant delays in our development efforts, could make our products and services unmarketable or obsolete. We may not be successful in developing and marketing quickly and effectively future versions or upgrades of our software, or offer new products or services that respond to technological advances or new market requirements. In developing new products and services, we may: - fail to develop and market products that respond to technological changes or evolving industry standards in a timely or cost-effective manner; 17 - encounter products, capabilities or technologies developed by others that render our products and services obsolete or noncompetitive or that shorten the life cycles of our existing products and services; - experience difficulties that could delay or prevent the successful development, introduction and marketing of these new products and services; - experience deferrals in orders in anticipation of new products or releases of our marketplace software; or - fail to develop new products and services that adequately meet the needs of the marketplace or achieve market acceptance. As a result of the foregoing factors, we could experience a delay or loss of revenues and customer dissatisfaction when introducing new and enhanced products and services. WE ARE DEPENDENT UPON THE GROWTH OF THE INTERNET AS AN ACCEPTABLE MEANS OF COMMERCE, AND SECURITY RISKS OF ELECTRONIC COMMERCE OVER THE INTERNET MAY DETER USE OF THE INTERNET AND USE OF OUR PRODUCTS AND SERVICES. If the e-commerce market does not grow or grows more slowly than expected, our business will suffer. The possible slow adoption of the Internet as a means of commerce by businesses may harm our prospects. A number of factors could prevent the acceptance and growth of e-commerce, including the following: - e-commerce is at an early stage and buyers may be unwilling to shift their traditional purchasing to online purchasing; - businesses may not be able to implement e-commerce software applications; - increased government regulation or taxation may adversely affect the viability of e-commerce; - insufficient availability of telecommunication services or changes in telecommunication services may result in slower response times; and - adverse publicity and consumer concern about the reliability, cost, ease of access, quality of services, capacity, performance and security of e-commerce transactions could discourage its acceptance and growth. Even if the Internet is widely adopted as a means of commerce, the adoption of our products and services, particularly by companies that have relied on traditional means of procurement, will require broad acceptance of a new approach. In addition, companies that have already invested substantial resources in traditional methods of procurement, or in-house e-commerce solutions, may be reluctant to adopt our products and servicess. Furthermore, our global marketplace operates as an open bidding process allowing buyers to instantaneously compare the prices of suppliers. In some instances, suppliers have been reluctant to join or continue as members of our customers' marketplaces and our global marketplace and participate in an open bidding process because of the increased competition and comparisons this environment creates. We must add and retain a substantial number of smaller to medium sized businesses as members. A fundamental requirement to conduct business-to-business e-commerce is the secure transmission of information over public networks. If members are not confident in the security of e-commerce, they may not effect transactions on our customers' marketplaces or our public marketplace or renew their memberships, which would severely harm our business. We cannot be certain that advances in computer capabilities, new discoveries in the field of cryptography, or other developments will not result in the compromise or breach of the algorithms we use to protect content and transactions on our customers' marketplaces and our global marketplace or proprietary information in our databases. Anyone who is 18 able to circumvent our security measures could misappropriate proprietary, confidential member information, place false orders or cause interruptions in our operations. We may be required to incur significant costs to protect against security breaches or to alleviate problems caused by breaches. Further, a well-publicized compromise of security could deter people from using the Internet to conduct transactions that involve transmitting confidential information. Our failure to prevent security breaches, or well-publicized security breaches affecting the Internet in general could adversely affect our business. OUR CURRENT SALES AND MARKETING STRATEGIES MAY NOT BE SUCCESSFUL. We have recently implemented several indirect sales channel programs, including referral and reseller programs. Many of these relationships are new and our indirect sales channel strategy is unproven. Furthermore, because we elect to defer revenue recognition until the time the reseller delivers our software to an end user, we cannot be assured if or when we will recognize revenue from our reseller relationships. If our current or future indirect sales channel partners are not able to successfully sell or resell our products, our business could be seriously harmed. WE MAY NOT BE ABLE TO EFFECTIVELY MANAGE OUR GROWTH AND EXPANSION, AND IN ORDER TO MANAGE OUR GROWTH AND EXPANSION WE WILL NEED TO IMPROVE AND IMPLEMENT NEW SYSTEMS, PROCEDURES AND CONTROLS. Continued implementation of our business plan requires an effective planning and management process. Our business will suffer dramatically if we do not effectively manage our growth. We expect that we will need to continue to improve our financial and managerial controls and reporting systems and procedures, and to continue to expand, train and manage our workforce, all of which may be inadequate to support future operations. We continue to increase the scope of our operations both domestically and internationally, and we have grown our workforce substantially. Our growth has placed, and our anticipated future growth in our operations will continue to place, a significant strain on our management systems and resources. We have grown from eight employees in January 1997 to 592 employees as of March 23, 2001. In addition, we plan to continue to add to our sales and marketing, customer support and product development personnel. Our future performance may also depend on the effective integration of acquired businesses. This integration, even if successful, may take a significant period of time and expense, and may place a significant strain on our resources. IF WE ACQUIRE NEW AND COMPLEMENTARY BUSINESSES, PRODUCTS AND TECHNOLOGIES TO GROW OUR BUSINESS, SUCH ACQUISITIONS MAY NOT BE SUCCESSFUL. We recently acquired Stratton Warren and signed a definitive agreement to acquire BayBuilder, and we may acquire additional businesses, products and technologies that complement or augment our existing businesses, services and technologies. We currently are integrating our recent acquisition of Stratton Warren, which could prove unsuccessful, as could our proposed acquisition of BayBuilder. Moreover, if we identify an appropriate acquisition candidate, we may not be able to negotiate the terms of the acquisition successfully, finance the acquisition, or integrate the acquired business, products or technologies into our existing business and operations. The inability to integrate any newly acquired entities or technologies effectively could harm our operating results, business and growth. Integrating any newly acquired businesses or technologies may be expensive and time consuming. If we consummate one or more significant future acquisitions in which the consideration consists of stock or other securities, our equity could be significantly diluted. If we were to proceed with one or more significant future acquisitions in which the consideration included cash, we could be required to use a substantial portion of our available cash to consummate any acquisition. To finance any acquisitions, we may need to raise additional funds through public or private financing. Any equity or debt financing, if available at all, may be on terms that are not favorable to us and, in the case of equity financing, may result in dilution to our stockholders. We may not be able to operate any acquired businesses profitably 19 or otherwise implement our business strategy successfully. For a discussion of our recent acquisition of Stratton Warren Software, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Recent Acquisitions." IF WE ENCOUNTER SYSTEM FAILURE, SERVICE TO OUR CUSTOMERS COULD BE DELAYED OR INTERRUPTED, WHICH COULD SEVERELY HARM OUR BUSINESS AND RESULT IN A LOSS OF CUSTOMERS. Our ability to provide acceptable levels of customer service largely depends on the efficient and uninterrupted operation of our computer and communications hardware and marketplace systems. Any interruptions could severely harm our business and result in a loss of customers. Our computer and communications systems are located primarily in Las Vegas, Nevada. Our systems and operations are vulnerable to damage or interruption from human error, sabotage, fire, flood, earthquake, power loss, telecommunications failure and similar events. Although we have taken steps to prevent a system failure, we cannot assure you that our measures will be successful and that we will not experience system failures in the future. Moreover, we have in the past experienced delays and interruptions in our telephone and Internet access, which have prevented members from accessing our customer's marketplaces, our global marketplace and our customer service department. Furthermore, we may not carry sufficient business interruption insurance to compensate us for losses that may occur as a result of any system failure. The occurrence of any system failure or similar event could harm our business dramatically. UNKNOWN DEFECTS IN OUR SOFTWARE COULD RESULT IN SERVICE AND DEVELOPMENT DELAYS. Our products and services, including the operation of our customers' marketplaces and our global marketplace, depend on complex software developed internally and by third parties. Software often contains defects, particularly when first introduced or when new versions are released. Our testing procedures may not discover software defects that affect our new or current services or enhancements until after they are deployed. These defects could cause service interruptions, which could damage our reputation or increase our service costs, cause us to lose revenue, delay market acceptance or divert our development resources, any of which could severely harm our business. In the past, we have missed internal software development and enhancement deadlines. Some of our contracts contain software enhancement and development milestones. If we are unable to meet these milestones, whether or not the failure is attributable to us or a third party, we may be in breach of our contractual obligations. Such a breach could damage our reputation, lead to termination of the contract, and adversely affect our business. FAILURE TO MAINTAIN ACCURATE DATABASES COULD SERIOUSLY HARM OUR BUSINESS AND REPUTATION. We update and maintain extensive databases of member's products and services and records of transactions executed by members. Our computer systems and databases must allow for expansion as a member's business grows without losing performance. Database capacity constraints may result in data maintenance and accuracy problems, which could cause a disruption in our service and our ability to provide accurate information to our members. These problems may result in a loss of members, which could severely harm our business. Some of our customer contracts provide for service level guarantees for the accuracy of data. Our failure to satisfy these service level guarantees could result in liability or termination of the contract and a loss of business, and our business and our reputation would suffer. WE MAY NOT BE ABLE TO CONTINUE LICENSING THIRD-PARTY TECHNOLOGIES, WHICH COULD DELAY PRODUCT DEVELOPMENT AND RESULT IN A LOSS OF MEMBERS OR SLOW OUR GROWTH. We intend to continue to license technology from third parties, including our Web server and encryption technology. Our inability to obtain any of these licenses could delay product development until equivalent technology could be identified, licensed and integrated. Any such delays in services 20 could result in a loss of members, and slow our growth and severely harm our business. The market is evolving and we may need to license additional technologies to remain competitive. We may not be able to license these technologies on commercially reasonable terms or at all. In addition, we may fail to successfully integrate any licensed technology into our services. These third-party licenses may expose us to increased risks, including risks associated with the integration of new technology, the diversion of resources from the development of our own proprietary technology and our ability to generate revenues from new technology sufficient to offset associated acquisition and maintenance costs. OUR SALES CYCLE FOR OUR MARKETPLACE SOLUTIONS COULD CAUSE DELAYS IN REVENUE GROWTH. Our sales cycle for a complete marketplace solution typically takes three to six months to complete and varies from contract to contract, but can be even longer for some contracts. Lengthy sales cycles could delay our generation of revenues from other services we provide to operate marketplaces for customers, including hosting and maintaining services. Our sales cycle for our marketplace products and services could cause delays in revenue growth, and result in significant fluctuations in our quarterly operating results. The length of the sales cycle may vary depending on a number of factors over which we may have little or no control, including the internal decision-making process of the potential customer, the potential customer's concern about establishing business practices and conducting business in new ways, and the level of competition that we encounter in our selling activities. Additionally, because the market for business-to-business e-commerce is relatively new, we often have to educate potential customers about the use and benefits of our products and services, which can prolong the sales process. In addition, we believe that the purchase of our products by a marketplace owner is often discretionary and generally involves a significant commitment of capital and other resources by the customer. It frequently takes several months to finalize a sale and requires approval at a number of management levels within the customer organization. Our sales cycle can be further extended for product sales made through third parties, including our resellers. IF OUR INTELLECTUAL PROPERTY PROTECTION IS INADEQUATE, COMPETITORS MAY GAIN ACCESS TO OUR TECHNOLOGY AND UNDERMINE OUR COMPETITIVE POSITION, CAUSING US TO LOSE MEMBERS. We regard our copyrights, service marks, trademarks, patents, trade secrets and similar intellectual property as important to our success, and rely on trademark and copyright law, trade secret protection and confidentiality and/or license agreements with our employees, customers and business partners to protect our proprietary rights. We cannot assure you that any of our proprietary rights will be viable or of value in the future because the validity, enforceability and type of protection of proprietary rights in Internet-related industries are uncertain and evolving. Despite our precautions, unauthorized third parties may copy certain portions of our services or reverse engineer or obtain and use information that we regard as proprietary. End-user license provisions protecting against unauthorized use, copying, transfer and disclosure of the licensed program may be unenforceable under the laws of certain jurisdictions and foreign countries. The status of United States patent protection in the software industry is not well defined and will evolve as the U.S. Patent and Trademark Office grants additional patents. We have been granted one patent in the United States and we may seek additional patents in the future. We do not know if any future patent application will be issued with the scope of the claims we seek, if at all, or whether any patents we receive will be challenged or invalidated. In addition, the laws of some foreign countries do not protect proprietary rights to the same extent as do the laws of the United States. Our means of protecting our proprietary rights in the United States or abroad may not be adequate and competitors may independently develop similar technology. 21 IF A THIRD PARTY WERE TO ALLEGE THAT WE INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS, WE COULD BE EXPOSED TO SUBSTANTIAL LIABILITIES THAT WOULD SEVERELY HARM OUR BUSINESS. Third parties may assert infringement claims against us. We cannot be certain that our services do not infringe patents or other intellectual property rights that may relate to our services. In addition, because patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed which relate to our services. We may be subject to legal proceedings and claims from time to time in the ordinary course of our business, including claims of alleged infringement of the trademarks and other intellectual property rights of third parties. If our services violate third-party proprietary rights, we cannot assure you that we would be able to obtain licenses to continue offering such services on commercially reasonable terms, or at all. Any claims against us relating to the infringement of third-party proprietary rights, even if not meritorious, could become time-consuming, result in the expenditure of significant financial and managerial resources and in costly litigation and injunctions preventing us from distributing these services, or require us to enter into royalty or license agreements. Royalty or license agreements, if required, may not be available on terms acceptable to us or at all, which could seriously harm our business. WE DEPEND UPON OUR CURRENT KEY PERSONNEL, WHO MAY BE DIFFICULT TO REPLACE, AND ON ATTRACTING ADDITIONAL KEY PERSONNEL IN THE FUTURE. We believe that our success will depend on the continued employment of our senior management team and key personnel. We do not carry key person life insurance on any of these people. If one or more members of our senior management team were unable or unwilling to continue in their present positions, our business would suffer. We plan to expand our employee base to manage our anticipated growth. Competition for personnel, particularly for senior management personnel and employees with technical and sales expertise, is intense. The success of our business is dependent upon hiring and retaining suitable and skilled personnel. WE MAY NOT BE ABLE TO RAISE ADDITIONAL CAPITAL ON ACCEPTABLE TERMS, IF AT ALL. We believe that our existing cash and cash equivalents and our anticipated cash flow from operations will be sufficient to meet our working capital and operating resource expenditure requirements for at least the next year. However, there can be no assurance that we will be able to meet our capital needs in the future, in which case we may need to raise additional funds and we cannot be certain that we will be able to obtain additional financing on favorable terms, if at all. If we cannot raise funds on acceptable terms, if and when needed, we may not be able to develop or enhance our products and services, take advantage of future opportunities, grow our business or respond to competitive pressures or unanticipated requirements, which could seriously harm our business. WE MAY NOT BE ABLE TO ACCURATELY PREDICT THE RATE OF INCREASE IN THE USAGE OF PRODUCTS AND SERVICES, WHICH MAY AFFECT OUR TIMING AND ABILITY TO EXPAND AND UPGRADE OUR INFRASTRUCTURE. Usage of our products and services continues to increase, which will require us to expand and upgrade some of our infrastructure, including hardware and software and other systems. We may not be able to accurately predict the rate of increase in the usage of our products and services, which may affect our timing and ability to provide expansions and upgrades to our infrastructure to accommodate increased use of our products and services. If we do not upgrade our systems and hardware and software infrastructure appropriately, we may experience downgraded service, which could damage our business reputation, relationship with customers and members and our operating results. 22 IF WE EXPAND OUR INTERNATIONAL SALES AND MARKETING ACTIVITIES, OUR BUSINESS WILL BE EXPOSED TO THE NUMEROUS RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS. We intend to have operations in a number of international markets. To date, we have limited experience in developing localized versions of our software and in marketing, selling and distributing our products and services internationally. International operations are subject to many risks, including: - the impact of recessions in economies outside the United States, especially in Asia; - changes in regulatory requirements; - reduced protection for intellectual property rights in some countries; - potentially adverse tax consequences; - difficulties and costs of staffing and managing foreign operations; - political and economic instability; - fluctuations in currency exchange rates; - seasonal reductions in business activity during the summer months in Europe and certain other parts of the world; and - tariffs, export controls and other trade barriers. WE MAY BE SUBJECT TO LEGAL LIABILITY FOR COMMUNICATION ON OUR CUSTOMER'S MARKETPLACES AND ON OUR GLOBAL MARKETPLACE. We may be subject to legal claims relating to the content in our customer's marketplaces and on our global marketplace, or the downloading and distribution of such content. Claims could involve matters such as fraud, defamation, invasion of privacy and copyright infringement. Providers of Internet products and services have been sued in the past, sometimes successfully, based on the content of material. Our insurance may not cover claims of this type, or may not provide sufficient coverage. Even if we are ultimately successful in our defense of these claims, any such litigation is costly and these claims could harm our reputation and our business. OUR ARTICLES OF INCORPORATION AND BYLAWS AND NEVADA LAW CONTAIN PROVISIONS WHICH COULD DELAY OR PREVENT A CHANGE IN CONTROL AND COULD ALSO LIMIT THE MARKET PRICE OF OUR STOCK. Our articles of incorporation and bylaws contain provisions that could delay or prevent a change in control. These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. Some of these provisions: - divide our board of directors into three classes; - authorize the issuance of preferred stock that can be created and issued by the board of directors without prior stockholder approval, commonly referred to as "blank check" preferred stock, with rights senior to those of common stock; - prohibit stockholder action by written consent; and - establish advance notice requirements for submitting nominations for election to the board of directors and for proposing matters that can be acted upon by stockholders at a meeting. 23 Further, certain provisions of Nevada law make it more difficult for a third party to acquire us. Some of these provisions: - establish a supermajority stockholder voting requirement to approve an acquisition by a third party of a controlling interest; and - impose time restrictions or require additional approvals for an acquisition of us by an interested stockholder. GOVERNMENTAL REGULATION AND LEGAL UNCERTAINTIES COULD IMPAIR THE GROWTH OF THE INTERNET AND DECREASE DEMAND FOR OUR SERVICES AND INCREASE OUR COST OF DOING BUSINESS. The laws governing Internet transactions remain largely unsettled, even in areas where there has been some legislative action. The adoption or modification of laws or regulations relating to the Internet could increase our costs and administrative burdens. It may take years to determine whether and how existing laws such as those governing intellectual property, privacy, libel, consumer protection and taxation apply to the Internet. Laws and regulations directly applicable to communications or commerce over the Internet are becoming more prevalent. We must comply with new regulations in the United States and other countries where we conduct business. The growth and development of the business-to-business e-commerce market may prompt calls for more stringent laws governing consumer protection and the taxation of e-commerce. The cost of compliance with any newly adopted laws and regulations could severely harm our business and the failure to comply could expose us to significant liabilities. ITEM 7A: QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK At December 31, 2000, we held approximately $74.7 million cash equivalents that included various short-term marketable securities. We held only $3 million in convertible notes. Given the nature of our investments, an immediate 10 percent change in interest rates would have no material impact on our financial condition, results of operations or cash flows. We generally conduct business, including sales to foreign customers, in U.S. dollars and as a result we have very limited foreign currency exchange rate risk. The effect of an immediate 10 percent change in foreign exchange rates would have no material impact on our financial condition, results of operations or cashflows. 24 ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To PurchasePro.com, Inc.: We have audited the accompanying consolidated balance sheets of PurchasePro.com, Inc. (a Nevada corporation) and subsidiary as of December 31, 1999 and 2000, and the related consolidated statements of operations, redeemable convertible preferred stock and stockholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 PurchasePro.com, Inc. and subsidiary as of December 31, 1999 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States. /s/ Arthur Andersen LLP ARTHUR ANDERSEN LLP Las Vegas, Nevada February 12, 2001 25 PURCHASEPRO.COM, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
DECEMBER 31, -------------------- 1999 2000 -------- --------- ASSETS Current assets: Cash and cash equivalents................................. $ 30,356 $ 86,335 Trade accounts receivable, net of allowance for doubtful accounts of $594 and $2,471, respectively........................ 1,950 23,171 Other receivables......................................... 205 859 Prepaid expenses and other current assets................. 551 9,378 -------- --------- Total current assets.................................... 33,062 119,743 Property and equipment: Computer equipment and software........................... 8,650 49,620 Furniture and fixtures.................................... 890 2,327 Leasehold improvements.................................... 58 6,244 -------- --------- 9,598 58,191 Less -- accumulated depreciation and amortization......... (1,262) (7,940) -------- --------- Net property and equipment.............................. 8,336 50,251 Other assets: Intangibles, net (Note 3)................................. 927 128,926 Investments in other companies (Note 4)................... 12,587 15,718 Editorial content rights.................................. 10,747 -- Deposits and other........................................ 818 5,584 -------- --------- Total other assets, net................................... 25,079 150,228 -------- --------- Total assets............................................ $ 66,477 $ 320,222 ======== ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 2,847 $ 20,248 Accrued and other current liabilities..................... 1,526 3,421 Deferred revenues......................................... 250 3,030 Current portion of long-term liabilities.................. -- 22,255 -------- --------- Total current liabilities............................... 4,623 48,954 Long-term liabilities....................................... -- 10,348 -------- --------- Total liabilities....................................... 4,623 59,302 Commitments and contingencies (Note 6) Stockholders' equity: Common stock: $0.01 par value; 190,000,000 shares authorized; 56,367,360 and 66,686,238 shares issued and outstanding, respectively............................... 564 667 Additional paid-in capital................................ 137,488 414,667 Deferred stock-based compensation......................... (3,941) (4,390) Accumulated deficit....................................... (78,741) (151,552) Accumulated other comprehensive income.................... 6,484 1,528 -------- --------- Total stockholders' equity.............................. 61,854 260,920 -------- --------- Total liabilities and stockholders' equity.............. $ 66,477 $ 320,222 ======== =========
The accompanying notes to consolidated financial statements are an integral part of these consolidated statements. 26 PURCHASEPRO.COM, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, ------------------------------ 1998 1999 2000 -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Revenues: Software licenses......................................... $ -- $ -- $ 34,860 Network access and service fees........................... 1,308 4,092 23,546 Advertising............................................... -- 1,142 3,219 Other..................................................... 362 783 3,366 ------- -------- -------- Total revenues.......................................... 1,670 6,017 64,991 Cost of revenues............................................ 445 836 4,487 ------- -------- -------- Gross profit................................................ 1,225 5,181 60,504 Operating expenses: Sales and marketing (including stock-based compensation costs of $0, $1,708 and $1,994; and warrant charges, including amortization, of $0, $50,925 and $33,665)..... 3,841 61,850 77,980 Programming and development (including stock-based compensation costs of $0, $250 and $285)................ 971 2,616 9,135 General and administrative (including stock-based compensation costs of $0, $3,820 and $14,835)........... 2,896 12,846 41,251 Impairment of assets...................................... -- -- 12,112 ------- -------- -------- Total operating expenses................................ 7,708 77,312 140,478 ------- -------- -------- Operating loss.............................................. (6,483) (72,131) (79,974) Other income (expense): Interest income (expense), net............................ (317) 469 4,507 Other..................................................... -- (279) 2,656 ------- -------- -------- Total other income (expense)............................ (317) 190 7,163 ------- -------- -------- Net loss before benefit for income taxes.................... (6,800) (71,941) (72,811) Benefit for income taxes.................................... -- -- -- ------- -------- -------- Net loss.................................................... (6,800) (71,941) (72,811) Preferred stock dividends................................... (245) (511) -- Accretion of preferred stock to redemption value............ (90) (131) -- Value of preferred stock beneficial conversion feature...... -- (9,400) -- ------- -------- -------- Net loss applicable to common stockholders.................. $(7,135) $(81,983) $(72,811) ======= ======== ======== Loss per share: Basic..................................................... $ (0.28) $ (2.44) $ (1.15) ======= ======== ======== Diluted................................................... $ (0.26) $ (2.39) $ (1.15) ======= ======== ======== Weighted average shares outstanding: Basic..................................................... 25,800 33,598 63,399 ======= ======== ======== Diluted................................................... 27,480 34,273 63,399 ======= ======== ========
The accompanying notes to consolidated financial statements are an integral part of these consolidated statements. 27 PURCHASEPRO.COM, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT) (IN THOUSANDS)
STOCKHOLDERS' EQUITY (DEFICIT) REDEEMABLE CONVERTIBLE ------------------------------------------------ PREFERRED STOCK ----------------------------------------- SERIES A SERIES B COMMON STOCK ADDITIONAL DEFERRED ------------------- ------------------- ------------------- PAID-IN STOCK-BASED SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION -------- -------- -------- -------- -------- -------- ---------- ------------- Balance, December 31, 1997........ -- $ -- -- $ -- 23,100 $231 $ 168 $ -- Effect of recapitalization........ -- -- -- -- -- -- (3,108) -- Issuance of common stock.......... -- -- -- -- 6,900 69 (2) -- Redemption and retirement of common stock.................... -- -- -- -- (7,200) (72) 72 -- Contribution by principal stockholder..................... -- -- -- -- -- -- 1,782 -- Charge for services............... -- -- -- -- -- -- 720 -- Issuance of Series A preferred stock, net of issuance costs and value of warrants issued........ 6,300 4,004 -- -- -- -- 996 -- Issuance of warrants to holders of notes payable................... -- -- -- -- -- -- 398 -- Issuance of Series B preferred stock pursuant to subscription agreements...................... -- -- -- 2,000 -- -- -- -- Preferred stock dividends......... -- 245 -- -- -- -- (245) -- Accretion of preferred stock to redemption value................ -- 90 -- -- -- -- (90) -- Net loss.......................... -- -- -- -- -- -- -- -- ------ ------- ------ -------- ------ ---- -------- ------- Balance, December 31, 1998........ 6,300 4,339 -- 2,000 22,800 228 691 -- Issuance of common stock, net of offering costs.................. -- -- -- -- 13,800 138 49,376 -- Issuance of common stock to Series A stockholders.................. -- -- -- -- 1,350 14 (14) -- Issuance of Series B preferred stock, net of issuance costs.... -- -- 9,900 -- -- -- 9,400 -- Mandatory conversion of Series A and Series B preferred stock to shares of common stock.......... (6,300) (4,743) (9,900) (11,638) 16,200 162 16,219 -- Issuance of warrants to strategic marketing partners.............. -- -- -- -- -- -- 60,872 -- Strategic partner option grant.... -- -- -- -- -- -- 800 -- Exercise of warrants.............. -- -- -- -- 1,680 17 (11) -- Exercise of options............... -- -- -- -- 537 5 478 -- Deferred stock-based compensation.................... -- -- -- -- -- -- 9,719 (9,719) Amortization of deferred stock-based compensation........ -- -- -- -- -- -- -- 5,778 Preferred stock dividends......... -- 280 -- 231 -- -- (511) -- Accretion of preferred stock to redemption value................ -- 124 -- 7 -- -- (131) -- Value of preferred stock beneficial conversion feature... -- -- -- 9,400 -- -- (9,400) -- Net loss.......................... -- -- -- -- -- -- -- -- Unrealized gain on marketable securities...................... -- -- -- -- -- -- -- -- ------ ------- ------ -------- ------ ---- -------- ------- Balance, December 31, 1999........ -- -- -- -- 56,367 564 137,488 (3,941) Issuance of common stock, net of offering costs.................. -- -- -- -- 4,000 40 150,619 -- Issuance of common stock to marketing partner............... -- -- -- -- 100 1 2,768 -- Issuance of warrants to strategic marketing partners.............. -- -- -- -- -- -- 94,360 -- Exercise of warrants.............. -- -- -- -- 1,187 12 (6) -- Exercise of options............... -- -- -- -- 5,032 50 11,875 -- Deferred stock-based compensation.................... -- -- -- -- -- -- 17,563 (17,563) Amortization of deferred stock-based compensation........ -- -- -- -- -- -- -- 17,114 Net loss.......................... -- -- -- -- -- -- -- -- Change in unrealized gain on securities, including realized gain of $2,658 included in net loss............................ -- -- -- -- -- -- -- -- ------ ------- ------ -------- ------ ---- -------- ------- Balance, December 31, 2000........ -- $ -- -- $ -- 66,686 $667 $414,667 $(4,390) ====== ======= ====== ======== ====== ==== ======== ======= STOCKHOLDERS' EQUITY (DEFICIT) ---------------------------------------- ACCUMULATED OTHER ACCUMULATED COMPREHENSIVE DEFICIT INCOME TOTAL ------------ -------------- -------- Balance, December 31, 1997........ $ (3,108) $ -- $ (2,709) Effect of recapitalization........ 3,108 -- -- Issuance of common stock.......... -- -- 67 Redemption and retirement of common stock.................... -- -- -- Contribution by principal stockholder..................... -- -- 1,782 Charge for services............... -- -- 720 Issuance of Series A preferred stock, net of issuance costs and value of warrants issued........ -- -- 996 Issuance of warrants to holders of notes payable................... -- -- 398 Issuance of Series B preferred stock pursuant to subscription agreements...................... -- -- -- Preferred stock dividends......... -- -- (245) Accretion of preferred stock to redemption value................ -- -- (90) Net loss.......................... (6,800) -- (6,800) --------- ------ -------- Balance, December 31, 1998........ (6,800) -- (5,881) Issuance of common stock, net of offering costs.................. -- -- 49,514 Issuance of common stock to Series A stockholders.................. -- -- -- Issuance of Series B preferred stock, net of issuance costs.... -- -- 9,400 Mandatory conversion of Series A and Series B preferred stock to shares of common stock.......... -- -- 16,381 Issuance of warrants to strategic marketing partners.............. -- -- 60,872 Strategic partner option grant.... -- -- 800 Exercise of warrants.............. -- -- 6 Exercise of options............... -- -- 483 Deferred stock-based compensation.................... -- -- -- Amortization of deferred stock-based compensation........ -- -- 5,778 Preferred stock dividends......... -- -- (511) Accretion of preferred stock to redemption value................ -- -- (131) Value of preferred stock beneficial conversion feature... -- -- (9,400) Net loss.......................... (71,941) -- (71,941) Unrealized gain on marketable securities...................... -- 6,484 6,484 --------- ------ -------- Balance, December 31, 1999........ (78,741) 6,484 61,854 Issuance of common stock, net of offering costs.................. -- -- 150,659 Issuance of common stock to marketing partner............... -- -- 2,769 Issuance of warrants to strategic marketing partners.............. -- -- 94,360 Exercise of warrants.............. -- -- 6 Exercise of options............... -- -- 11,925 Deferred stock-based compensation.................... -- -- -- Amortization of deferred stock-based compensation........ -- -- 17,114 Net loss.......................... (72,811) -- (72,811) Change in unrealized gain on securities, including realized gain of $2,658 included in net loss............................ -- (4,956) (4,956) --------- ------ -------- Balance, December 31, 2000........ $(151,552) $1,528 $260,920 ========= ====== ========
The accompanying notes to consolidated financial statements are an integral part of these consolidated statements. 28 PURCHASEPRO.COM, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ------------------------------ 1998 1999 2000 -------- -------- -------- (IN THOUSANDS) Cash flows from operating activities: Net loss.................................................. $(6,800) $(71,941) $(72,811) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization........................... 253 847 16,437 Amortization of stock-based compensation................ -- 5,778 17,114 Non-cash sales and marketing expense.................... 720 50,925 32,770 Imputed interest........................................ 67 -- 1,575 Amortization of debt discount........................... 43 356 -- Provision for doubtful accounts......................... 127 1,078 3,393 Impairment of assets.................................... -- -- 12,112 Gain on sale of marketable securities................... -- -- (2,658) (Increase) decrease in: Trade accounts receivable............................. (323) (2,813) (24,613) Other receivables..................................... (81) (105) (654) Prepaid expenses and other current assets............. (20) (531) (8,828) Increase (decrease) in: Accounts payable...................................... (201) 2,748 37 Accrued and other current liabilities................. 74 1,023 1,920 Deferred revenues..................................... 118 85 2,780 ------- -------- -------- Net cash used in operating activities............... (6,023) (12,550) (21,426) ------- -------- -------- Cash flows from investing activities: Purchase of property and equipment........................ (257) (8,619) (30,539) Investments in other companies............................ -- (6,104) (13,050) Proceeds from sale of investment.......................... -- -- 5,262 Marketing and technology development agreement............ -- -- (25,000) Other assets.............................................. (103) (914) (4,551) ------- -------- -------- Net cash used in investing activities............... (360) (15,637) (67,878) ------- -------- -------- Cash flows from financing activities: Proceeds from notes payable and advances.................. 4,427 200 -- Repayment of notes payable and advances................... (3,362) (1,375) (25) Issuance of common stock, net............................. -- 50,002 162,159 Issuance of preferred stock and warrants, net............. 7,000 8,026 400 Payments under marketing and technology agreements........ -- -- (17,251) ------- -------- -------- Net cash provided by financing activities........... 8,065 56,853 145,283 ------- -------- -------- Increase in cash and cash equivalents....................... 1,682 28,666 55,979 Cash and cash equivalents: Beginning of year......................................... 8 1,690 30,356 ------- -------- -------- End of year............................................... $ 1,690 $ 30,356 $ 86,335 ======= ======== ========
The accompanying notes to consolidated financial statements are an integral part of these consolidated statements. 29 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 (1) THE COMPANY ORGANIZATION AND NATURE OF BUSINESS Purchase Pro, Inc., a Nevada corporation, was incorporated on October 8, 1996, as an S corporation for federal income tax purposes. On January 12, 1998, PP International, Inc. was incorporated in Nevada as a C corporation for federal income tax purposes. On January 15, 1998, PP International, Inc. changed its name to Purchase Pro International, Inc., and on June 1, 1999, changed its name to PurchasePro.com, Inc. (the "Company"). The Company initially authorized the issuance of 40,000,000 shares, $0.01 par value stock. On January 12, 1998, the Company issued 23,100,000 shares of common stock to the three stockholders of Purchase Pro, Inc. The Company's principal and controlling stockholder was the controlling stockholder of Purchase Pro, Inc. On January 15, 1998, the Company acquired substantially all of the assets and assumed substantially all of the liabilities of Purchase Pro, Inc. The purchase was accounted for as a reorganization of companies under common control in a manner similar to a pooling of interests. Accordingly, the financial position and results of operations of the Company and Purchase Pro, Inc. have been included in the accompanying consolidated financial statements. In August 1998, the Company formed its wholly owned subsidiary, Hospitality Purchasing Systems, Inc., a Nevada corporation, dba ProPurchasing Systems ("PPS"). PPS's principal business is negotiating contracts on behalf of independent hotels and hotel management companies for which it receives fees and rebates. The Company is a provider of business-to-business electronic commerce products and services. The Company licenses its software products to businesses that own and operate their own marketplaces. The Company operates a global marketplace that provides businesses of all sizes with a low cost and efficient e-commerce solution for buying and selling a wide range of products and services over the Internet. The Company also develops and hosts private labeled marketplaces that, at the option of the marketplace owner, can connect to the global marketplace. PurchasePro version 1.0 enabled members to transact e-commerce in the global marketplace. The Company's next release provided this capability over the Internet. In September 1998, the Company released PurchasePro 3.0, an marketplace enabling software. In February 1999, the Company released PurchasePro 4.0, which allows members the additional capability of building private labeled marketplaces. In December 1999, the Company released PurchasePro 5.0, a browser-based version that allows members to access the global marketplace and private labeled marketplaces with a user identification and password over the Internet. In May 2000, the Company launched a new suite of private-labeled marketplace software solutions. In September 1999, the Company began generating transaction fee revenues from transactions consummated by members with value added merchandise and service providers. Also, the Company began generating advertising fees. The Company considers its operations to be part of one operating segment. The Company is subject to risks common to rapidly growing, technology-based companies, including rapid technological change, growth and commercial acceptance of the Internet, dependence on principal products and strategic partners, new product development, new product introductions and other activities of competitors, and a limited operating history. 30 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (2) SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation. CASH AND CASH EQUIVALENTS Cash equivalents consist of investments in bank certificates of deposit and other interest bearing instruments with initial maturities of three months or less. Such investments are carried at cost that approximates fair value. TRADE ACCOUNTS RECEIVABLE Unbilled revenue of $525,000, which represents amounts earned but not yet billed, was included in accounts receivable at December 31, 1999 in the accompanying consolidated balance sheets. There was no unbilled revenue at December 31, 2000. PROPERTY AND EQUIPMENT Property and equipment is stated at cost, including costs of software purchased from third parties. Costs incurred for additions, improvements and betterments are capitalized as incurred. Costs incurred to acquire or develop software for internal use are accounted for in accordance with American Institute of Certified Public Accountants Statement of Position ("SOP") 98-1, ACCOUNTING FOR COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE. Costs for maintenance and repairs are charged to expense as incurred. Gains or losses on dispositions of property and equipment are included in the determination of income. Depreciation and amortization are computed using the straight-line method over the following estimated service lives of the related assets: Computer equipment and software............................. 3 years Furniture and fixtures...................................... 5 years Leasehold improvements...................................... 3 years
INTANGIBLES Identifiable intangible assets primarily include intellectual property, business partner agreements, agreements not-to-compete, trademarks, and core technology. The Company regularly performs reviews to determine if the carrying value of intangible assets is impaired. The purpose for the review is to identify any facts or circumstances, either internal or external, which indicate that the carrying value of the asset cannot be recovered. No such impairment has been indicated to date. Intangible assets are stated net of accumulated amortization and are amortized on a straight-line basis over their expected useful lives of three to six years. INVESTMENTS IN OTHER COMPANIES Investments in other companies consist of debt and equity securities. The Company has classified all investments in common stock with a readily determinable fair value as available-for-sale. Available-for-sale securities are recorded at market value, if determinable. Investments in private 31 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) companies are not marked to market, as exempted by SFAS No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES. However, the Company performs a periodic review for impairment as required by SFAS No. 115. Unrealized holding gains and losses on available-for-sale securities are excluded from earnings and are reported as a separate component of other comprehensive income. Dividend and interest income are recognized when earned. Realized gains and losses for securities classified as available-for-sale are included in earnings and are derived using the specific identification method for determining the cost of securities sold. Investments in preferred stock are carried at cost. OTHER ASSETS The Company capitalizes certain network development costs, which are amortized by the straight-line method over the estimated life of the asset, which is generally three years or less. The capitalized costs are payroll and payroll-related costs for employees who are directly associated with the enhancement or new functionality of the network or the development of private networks. At December 31, 1999 and 2000, unamortized network development costs were $296,000 and $590,000, net of accumulated amortization of $99,000 and $575,000, respectively. The amortization of these costs is included in programming and development costs in the accompanying consolidated statements of operations. The Company has also capitalized $4.9 million in costs associated with development of new functionality that has not been placed in service. Amortization of the capitalized costs will begin as the functionality is placed in service. IMPAIRMENT EVALUATION Long-lived assets are reviewed whenever indicators of impairment are present and the undiscounted cash flows are not sufficient to recover the related asset carrying amount. The Company recorded an impairment of asset charge of $12.1 million during 2000. A $9.8 million charge was taken in connection with the Company's editorial content agreement with a strategic marketing partner, whereby the partner would supply PurchasePro content for its product. The value of this asset was originally based on projected future cash flows. In the fourth quarter of 2000, the Company concluded that the estimated future cash flows were less than the carrying value. Therefore, an impairment charge was recorded in accordance with generally accepted accounting principles. The Company still retains the right to use the content as outlined in the license agreement. In addition, a $2.3 million impairment of asset charge reflects the results of the Company's assessment of its strategic investments. After reviewing all of its investments, the Company recorded a charge to reflect the net realizable value of certain investments. REVENUE RECOGNITION The Company earns revenue from several sources. The nature and revenue recognition policy for each major source of revenue are as follows: SOFTWARE LICENSE FEES: For software license revenue, the Company applies the provisions of SOP 97-2, SOFTWARE REVENUE RECOGNITION and SOP 98-9, MODIFICATION OF SOP 97-2, SOFTWARE REVENUE RECOGNITION WITH RESPECT TO CERTAIN TRANSACTIONS, which amends SOP 97-2. SOP 97-2 and 98-9, as amended, generally require revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of the elements. The fair value of an 32 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) element must be based on the evidence that is specific to the vendor. License revenue allocated to software products generally is recognized upon delivery of the products or deferred and recognized in future periods to the extent that an arrangement includes one or more elements that are to be delivered at a future date and for which fair values have not been established. Revenue allocated to maintenance is recognized ratably over the maintenance term and revenue allocated to training and other service elements is recognized as the services are performed. If evidence of fair value does not exist for all elements of a license agreement and professional consulting services are the only undelivered element, then all revenue for the license arrangement is recognized ratably over the term of the agreement as license revenue. If evidence of fair value of all undelivered elements exists but evidence does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. For software licenses sold to resellers, the Company defers revenue recognition until the time the reseller delivers the software to the end user. Under the Company's standard reseller program, the Company has no obligation of future performance under licenses sold to resellers. If the Company provides other services that are considered essential to the functionality of the software products, both the software product revenue and service revenue are recognized at the time the services are completed and acceptance is acknowledged by the customer. Such contracts typically consist of professional services and are generally completed within 45 days of the software sale. During the year ended December 31, 2000, the Company acquired certain software technology from third-parties to which it also sold its own software products. The acquired technology is used by the Company in either a hosted environment only available to customers who pay for such services or to enhance internal functions contained within PurchasePro's internal system platform. The acquired technology is not part of the software sold by the Company. In accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 29, ACCOUNTING FOR NONMONETARY TRANSACTIONS, and Emerging Issues Task Force ("EITF") No. 00-3, APPLICATION OF AICPA STATEMENT OF POSITION 97-2 TO ARRANGEMENTS THAT INCLUDE THE RIGHT TO USE SOFTWARE STORED ON ANOTHER ENTITY'S HARDWARE, the Company determined that the acquired technology was to be used as internal use software, and therefore, recorded the acquired assets at their fair value of approximately $20.6 million as computer equipment and software in the accompanying consolidated balance sheets. Also, in accordance with APB No. 29 and EITF No. 00-5, the Company recognized revenue from the sale of its software at the fair value based on its own vendor specific objective evidence. Total revenue for the year ended December 31, 2000 from these software sales was approximately $8.8 million, and no individual transaction was in excess of 10 percent of total revenues. NETWORK ACCESS AND SERVICE FEES: Network access and service fees consist of: member subscription fees, transaction fees, hosting, maintenance, and other service fees. Network access fees, including subscription, hosting, and maintenance fees, are recognized over the term of the executed contracts. Maintenance fees include the right to unspecified product upgrades over the life of the maintenance agreement. The Company has not provided specified upgrade rights or other upgrade rights outside of the maintenance agreements. These fees are generally terminable at any time by a customer with 30 days notice. Subscription fees are recorded, net of discounts, ratably over the subscription period and deferred revenues are recognized for amounts received before services are provided. Transaction 33 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) fees are recognized in the period the transaction occurs. Service for setting up marketplaces for software licensees are generally completed within 45 days of contract execution. During the year ended December 31, 1999, the Company exchanged subscriptions on its public procurement network for services and advertising, consisting of development of customized websites and designation as a preferred provider of procurement services for another web site. Revenues were recorded at the fair value of subscriptions given, with corresponding amounts recorded for expenses. Such revenue represented 7 percent of total revenues for the year ended December 31, 1999. No such transactions occurred during 2000. In March 2000, the Company entered into a bulk subscriptions agreement with Office Depot, whereby Office Depot paid $1,000,000 per month for 100,000 subscriptions on behalf of its customers. This agreement expired in January 2001. For software licensees who contract with the Company to host their marketplaces, hosting revenue is recognized over the period the hosting services are provided. Hosting contracts generally are terminable on 30-day notice and do not impact the license and maintenance agreement. ADVERTISING: Banner advertisements on the Company's public and private procurement networks and slotting fees for vendors designated as "preferred" or "exclusive" providers of a category of goods or services on the public procurement network. Advertising revenue is recorded over the term of the advertisements of slotting arrangements. OTHER: Other revenues represent website development, transaction and participation fees from groups buying services, and miscellaneous revenues. Other revenues are generally recognized as earned or as services are provided. DEFERRED REVENUE: The Company recognizes revenues as earned. Amounts billed in advance of the period in which service is rendered are recorded as a liability under "Deferred revenues." ADVERTISING COSTS The cost of advertising is generally expensed as incurred. Advertising expenses for the years ended December 31, 1998, 1999 and 2000 were $33,000, $413,000 and $4.0 million. STOCK-BASED COMPENSATION The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and complies with the disclosure provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. Under APB No. 25, compensation expense is based on the difference, if any, on the date of the grant, between the fair value of the Company's stock and the exercise price stated for the option. With respect to the stock options granted since inception through December 31, 2000, the Company has recorded deferred stock-based compensation of $27.3 million for the difference at the grant date between the exercise price and the fair value of the common stock underlying the options. This amount is being amortized on a staight-line basis over the vesting period of the individual options. Unamortized stock-based compensation totaled $3.9 million and $4.4 million, as of December 31, 1999 and 2000, respectively. 34 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INCOME TAXES The Company recognizes deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets, including tax loss and credit carryforwards, and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The components of the deferred tax assets and liabilities are individually classified as current and non-current based on their characteristics. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. EARNINGS (LOSS) PER SHARE Basic earnings per share ("EPS") is computed by dividing net loss applicable to common stock by the weighted average common shares outstanding during the period. Pursuant to SEC Staff Accounting Bulletin ("SAB") No. 98, REVISION OF CERTAIN SAB TOPICS TO REFLECT THE PROVISIONS OF STATEMENT OF FINANCIAL ACCOUNTING STANDARDS (SFAS) NO. 128, EARNINGS PER SHARE AND SFAS NO. 130, REPORTING COMPREHENSIVE INCOME, shares of common stock or convertible preferred stock are considered outstanding for all periods presented in the computation of basic and diluted EPS if issued for nominal consideration. Options, warrants or other common stock equivalents are considered outstanding for all periods presented in the computation of diluted EPS if issued for nominal consideration. For the years ended December 31, 1998 and 1999, the weighted average common shares outstanding used to compute diluted EPS includes the effect of warrants issued by the Company to acquire shares of common stock for $0.0035 per share. All such warrants were exercised by December 31, 1999. For those periods in which potentially dilutive securities such as stock options and convertible preferred stock have a dilutive effect, the weighted average shares outstanding used for computation of diluted EPS includes the effect of these potentially dilutive securities. All share and per share amounts in the accompanying consolidated financial statements have been restated to give effect to two-for-one stock split which occurred on October 12, 2000. COMPREHENSIVE INCOME Comprehensive income consists of net income and other gains and losses affecting shareholders' equity that, under generally accepted accounting principles, are excluded from net income. For the Company, such items consisted of unrealized gains on securities classified as available-for-sale. The components of comprehensive income are as follows (in thousands of dollars):
DECEMBER 31, 1999 DECEMBER 31, 2000 --------------------------- --------------------------- TAX EXPENSE TAX EXPENSE PRETAX AMOUNT (CREDIT) PRETAX AMOUNT (CREDIT) ------------- ----------- ------------- ----------- Net loss applicable to common stockholders............................. $(81,983) $ -- $(72,811) $ -- Unrealized gain (loss) on securities....... 6,484 -- (4,956) -- -------- ----- -------- ----- Total comprehensive income (loss).......... $(75,499) $ -- $(77,767) $ -- ======== ===== ======== =====
35 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) CASH FLOWS Supplemental cash flow information including the Company's non-cash investing and financing activities is as follows (in thousands):
YEAR ENDED DECEMBER 31, ------------------------------ 1998 1999 2000 -------- -------- -------- Other assets acquired with note payable..................... $ 50 $ -- $ -- ====== ======= ======= Other assets acquired with preferred stock.................. $ -- $ 674 $ -- ====== ======= ======= Conversion of notes payable to equity....................... $1,782 $ 700 $ -- ====== ======= ======= Conversion of preferred stock to common stock............... $ -- $16,381 $ -- ====== ======= ======= Value of warrants issued for editorial content rights....... $ -- $10,747 $ -- ====== ======= ======= Obligations under capital leases............................ $ -- $ -- $ 140 ====== ======= ======= Obligations under marketing and technology development agreements................................................ $ -- $ -- $48,137 ====== ======= ======= Warrants issued under marketing and technology development agreements................................................ $ -- $ -- $63,960 ====== ======= ======= Cash paid for interest, net of capitalized interest......... $ 166 $ 124 $ 1,533 ====== ======= =======
FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and notes payable are carried at cost, which approximates their fair value because of the short-term maturity of these instruments. Marketable securities that have readily determinable fair values are carried at fair value. The fair value of the long-term obligations are not determinable due to the unique nature of such obligations. CONCENTRATION OF CREDIT RISK Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents and accounts receivable. Cash and cash equivalents are deposited with high credit quality financial institutions. The Company's accounts receivable are derived from revenue earned from customers located in the U.S. and are denominated in U.S. dollars. Portions of the Company's accounts receivable balances are settled either through customer credit cards or electronic fund transfers. As a result, the majority of accounts receivable are collected upon processing of those transactions. The Company maintains an allowance for doubtful accounts based upon the expected collectibility of accounts receivable. During the years ended December 31, 1998 and 1999, no customers accounted for more than 10 percent of net revenues. During the year ended December 31, 2000, two customers each accounted for 18 percent of net revenues. As of December 31, 1998, no customers accounted for more than 10 percent of net accounts receivable. As of December 31, 1999, one customer accounted for 26 percent of net accounts receivable. As of December 31, 2000, two customers, one of which is America Online, accounted for 46 percent of net accounts receivable. 36 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The Company depends on America Online ("AOL") for a substantial portion of its revenues and anticipates that revenues from the AOL relationship will constitute a substantial portion of the Company's revenues for the foreseeable future. During the year ended December 31, 2000, the Company recognized $4.9 million from subscriptions paid by AOL on behalf of its subscribers, $10.5 million from revenue referred by AOL, and $6.6 million from software licenses resold by AOL. If AOL is unable to continue to generate substantial revenues for the Company or if its relationship with AOL proves unsuccessful, changes, or deteriorates, the Company's business, operating results and financial position would be seriously harmed. MANAGEMENT'S USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. RECLASSIFICATIONS Certain reclassifications have been made to prior period financial statements to conform to the 2000 presentation, which have no effect on previously reported net income. RECENTLY ISSUED ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, ACCOUNTING FOR DERIVATIVES AND HEDGING ACTIVITIES, which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. The FASB recently issued SFAS Nos. 137 and 138, which defer the effective date and amend portions of SFAS No. 133. SFAS No. 133 will be effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company currently does not engage in, nor does management expect the Company to engage in, derivative or hedging activities; therefore, management does not believe that the adoption of SFAS No. 133 will have a material impact on the Company's results of operations or financial position. In December 1999, the SEC issued SAB No. 101, REVENUE RECOGNITION IN FINANCIAL STATEMENTS, which summarizes the SEC's views in applying generally accepted accounting principles to revenue recognition in financial statements. SAB No. 101 requires, upon adoption, companies to report any changes in revenue recognition as cumulative change in accounting principle at the time of implementation in accordance with APB Opinion No. 20, ACCOUNTING CHANGES. Management believes that the Company has followed the guidelines set forth in SAB No. 101 as it relates to revenue recognition. In March 2000, the FASB issued Interpretation No. 44, ("FIN 44"), ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK COMPENSATION--AN INTERPRETATION OF APB 25. This Interpretation clarifies (a) the definition of employee for purposes of applying APB 25, (b) the criteria for determining whether a plan qualifies as a non-compensatory plan, (c) the accounting consequence of various 37 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. FIN 44 became effective July 1, 2000, but certain conclusions in FIN 44 cover specific events that occur after either December 15, 1998, or January 12, 2000. The adoption of FIN 44 does not have a material effect on the Company's financial statements. (3) INTANGIBLE ASSETS As of December 31, 1999 and 2000, intangible assets consisted of the following (in thousands):
DECEMBER 31, ------------------- 1999 2000 -------- -------- AOL marketing and technology agreements..................... $ -- $ 92,518 Gateway marketing agreement................................. -- 38,160 Other intangibles........................................... 1,120 7,095 ------ -------- 1,120 137,773 Less -- accumulated amortization............................ (193) (8,847) ------ -------- Net intangible assets....................................... $ 927 $128,926 ====== ========
AMERICA ONLINE In March 2000, the Company entered into a series of agreements with AOL to co-develop a new generation of the Company's marketplace technology and to co-develop and market a co-branded marketplace. The Company and AOL will each contribute technology to the development alliance and co-manage the development of the new marketplace technology. The Company will pay AOL $20.0 million in eight equal quarterly installments beginning August 1, 2000 and AOL will make AOL programmers available to the development alliance. The Company has made payments of $5.0 million through December 31, 2000 in connection with this obligation. The parties also agreed to market the co-branded marketplace across the AOL properties. The Company agreed to pay AOL $50.0 million for marketing support in the form of advertising impressions. The Company paid $25.0 million to AOL in March 2000 and the $25.0 million balance is payable in seven equal quarterly installments beginning June 30, 2000. The Company has made total payments of $10.7 million through December 31, 2000 in connection with this obligation. The Company imputed interest at 10 percent on the total $45.0 million of payments due to AOL. The discounted value of the payments have been included in the accompanying consolidated balance sheets in the "Long-term liabilities" and "Current portion of long-term liabilities" captions. The Company also issued AOL warrants to purchase up to 4,000,000 shares of the Company's common stock. This warrant was amended in November 2000 (see Note 7). The value of the 1,000,000 warrants that vested immediately was determined to be $25.8 million using the Black Scholes model with the following assumptions: risk-free interest rate of 7.0 percent; no expected dividend yield; warrant term of 36 months; and an expected volatility of 45 percent. The total net present value of future cash payments and the 1,000,000 warrants that vested immediately have been recorded as an intangible long-term asset. The marketing expense will be charged to sales and marketing expense as 38 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (3) INTANGIBLE ASSETS (CONTINUED) impressions are delivered, or on a straight-line basis, whichever is higher. For the year ended December 31, 2000, the Company amortized approximately $7.9 million to sales and marketing expense. The technology development costs will be amortized to programming and development expense over three years (the estimated useful life of such costs and the agreement term, including expected renewals). The Company and AOL have agreed to a revenue sharing arrangement, under which each will share revenue generated by the co-branded marketplace, including network access fees, transaction fees and advertising revenue. The marketplace was launched in September 2000. In addition, the Company and AOL will share revenue resulting from the marketing of marketplaces utilizing the co-developed technology to AOL's trading partners. At certain revenue thresholds and at certain times during the agreement term, AOL has the option to (i) receive a share of the revenue from the decision point forward, or (ii) receive a cash payment of $25.0 million in exchange for providing additional future advertising. The contingent payment will be accrued as revenue is earned, and a corresponding prepaid marketing expense will be recorded. Should AOL elect the revenue share, the asset and liability will be eliminated at that time. GATEWAY In September 2000, the Company entered into agreements with Gateway pursuant to which (i) the Company agreed to acquire approximately $500,000 of computer hardware for resale from Gateway, (ii) Gateway agreed to acquire three marketplace software licenses from the Company for approximately $3.3 million, and (iii) Gateway agreed to provide the Company with certain training services for customers using the Company's global e-commerce marketplace, including the Gateway marketplaces to be hosted by the Company (the "Gateway Marketplaces"), and certain marketing services in connection with the Gateway Marketplaces and the Company's global marketplace. The services shall be rendered during a two-year period, and the aggregate contractual value of the services shall be at least $40 million. The Company issued warrants as consideration for the training and marketing services to be rendered by Gateway (see Note 7). The minimum value of the training and marketing services to be received has been determined to be at least equal to the value of the warrants issued. The training services were valued based upon the estimated number of training units to be offered and the estimated fair value of each unit using information obtained from other companies that provide similar training services. The marketing services were valued based primarily upon the estimated number of icons to be placed on computers sold by Gateway, to their small- and medium-sized business customers, based on an independent appraisal. The value of these marketing and training services has been deferred and will be amortized over the life of the contract on the faster of the straight-line basis or as the services are used. OTHER INTANGIBLES Intangible assets also includes the costs of technology and a non-compete agreement with two individuals. These assets are being amortized over a 36-month and 60-month period, respectively. Other intangible assets also includes the purchase of a software license and trademarks, which are being 39 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (3) INTANGIBLE ASSETS (CONTINUED) amortized over a 60-month period. Amortization expense was $0, $194,000 and $705,000 for the years ended December 31, 1998, 1999 and 2000, respectively. (4) INVESTMENTS IN OTHER COMPANIES The Company's investments comprise convertible notes, preferred stock and common stock. Investments are carried at fair market value, if determinable. Investments in private companies are not marked to market, as exempted by SFAS No. 115. All investments are held in the Company's name. The specific identification method is used to determine the cost of securities disposed of, with realized gains and losses reflected in other income and expense. As of December 31, 1999 and 2000, all of the Company's investments were classified as available-for-sale. Unrealized gains and losses on these investments are included as a separate component of stockholders' equity. The following table summarizes the Company's investments (in thousands):
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED ESTIMATED COST GAINS LOSSES FAIR VALUE --------- ---------- ---------- ---------- DECEMBER 31, 1999 Common stocks..................................... $ 2,603 $6,484 $ -- $ 9,087 DECEMBER 31, 2000 Common stocks..................................... $ 1,000 $1,528 $ -- $ 2,528
The Company also has investments in convertible notes and preferred stocks totaling $3.5 million and $13.2 million as of December 31, 1999 and 2000, respectively. (5) NOTES PAYABLE The Company's Chief Executive Officer (the "Principal Stockholder") provided funds to finance development of the Company's product. In January 1998, the Company repaid $813,000 to the Principal Stockholder with proceeds from the Lenders' Notes Payable (see below) and the remaining obligation of $1.7 million with a note payable. In April 1998, the Principal Stockholder advanced an additional $387,000 to the Company. In June 1998, the Company repaid $310,000 and the Principal Stockholder contributed his remaining notes payable and advances totaling approximately $1.8 million to the Company in consideration for previously issued shares of common stock. The Company recorded the $1.8 million as additional paid-in capital. In January 1998, the Company issued promissory notes totaling $2.3 million (the "Lenders' Notes Payable") to several individuals (the "Lenders"). The Lenders were also issued 6,900,000 shares of the Company's common stock. The Lenders' Notes Payable were repaid in June 1998 and the Lenders contributed 4,425,000 shares of common stock back to the Company (see Note 7). The Company allocated the $2.3 million proceeds between the Lenders' Notes Payable and the shares issued based on their estimated fair values. Accordingly, an additional $67,000 of interest expense was recorded with a corresponding credit to additional paid-in capital. 40 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (5) NOTES PAYABLE (CONTINUED) In September 1998, the Company issued promissory notes to three individuals, including the Principal Stockholder and a then-member of the Company's Board of Directors, totaling $1.5 million. In connection with the issuance of these notes, the Company issued 479,998 warrants to the note holders whereby each warrant provided the holder the right to purchase one share of Company common stock for $0.0035 per share through September 2003. Using the Black-Scholes pricing model, the Company determined the value of these warrants to be $0.83 per share, or $398,400. The Company recognized the $398,400 as an original issue discount that was being amortized to interest expense. In June 1999, $700,000 of the notes payable were converted into 600,000 shares of Series B Preferred Stock, and the Company used $800,000 of the Series B proceeds to repay the remaining amounts outstanding (see Note 7). (6) COMMITMENTS AND CONTINGENCIES OPERATING LEASES The Company is party to several non-cancelable lease agreements for certain equipment as well as its principal administrative offices. Rent expense under non-cancelable operating leases totaled approximately $280,000, $418,000, and $2.4 million for the years ended December 31, 1998, 1999, and 2000, respectively. Minimum future lease obligations under non-cancelable operating leases in effect at December 31, 2000 are as follows (in thousands):
YEAR ENDING DECEMBER 31, AMOUNT ------------------------ -------- 2001........................................................ $ 4,130 2002........................................................ 3,834 2003........................................................ 3,240 2004........................................................ 2,728 2005........................................................ 2,575 Thereafter.................................................. 12,566 ------- Total..................................................... $29,073 =======
The Company has also committed to lease approximately 30,000 square feet of additional office space for 10 years, effective the second half of 2001. This office space will result in an additional $660,000 per year in rent expense. LEGAL PROCEEDINGS The Company is involved in various routine legal proceedings incidental to its normal course of business. The Company does not believe that any of these legal proceedings will have a material adverse effect on the financial condition, results of operations or cash flows. In February, 2001, All Creative Technologies, Inc. (the "Plaintiff") filed a lawsuit in the Eighth Judicial District Court, Clark County, Nevada, Case No. A43337, against PurchasePro.com, Charles E. Johnson, Jr., the Company's Chairman and CEO, and Ranel Erickson, the Company's former VP of Research and Development. The complaint alleges violations of the Nevada Racketeering, Influence and Corruption Act ("RICO"), and misappropriation of trade secrets by Mr. Johnson and 41 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (6) COMMITMENTS AND CONTINGENCIES (CONTINUED) Mr. Erickson, unlawful acquisition of trade secrets by the Company, and breach of contract by Mr. Johnson. The complaint seeks compensatory damages in excess of $10,000 for each of the four causes of action, treble damages with respect to the civil RICO claim, and exemplary damages with respect to the unlawful acquisition of trade secrets, as well as costs and attorney fees. The exact monetary amount being sought is unknown at this time. Although the Company is currently unable to predict the ultimate outcome of this lawsuit, the Company believes there is no merit to the suit and intends to vigorously defend this action. (7) STOCKHOLDERS' EQUITY COMMON STOCK All share and per share amounts have been restated to give effect to the three-for-two stock split that occurred on December 14, 1999 and the two-for-one stock split that occurred on October 12, 2000. The Company has authorized the issuance of 190,000,000 shares of common stock. In connection with the repayment of the Lenders' Notes Payable in June 1998 (see Note 5), the Company and the Lenders entered into an agreement whereby 4,425,000 shares were contributed back to the Company. Accordingly, the number of shares held by the Lenders was reduced to 2,475,000. In connection with the same agreement and in connection with the Series A Preferred Stock offering, two of the founders of the Company contributed an aggregate of 2,775,000 shares of common stock to the Company. In June 1998, the Principal Stockholder sold 900,000 of his shares of common stock to an unrelated third party for $0.035 per share. The Company recognized a charge of $720,000 that reflects the difference between the fair value of its stock on that date of $0.83 per share and the sales price. The third party provided significant assistance to the Company in obtaining subscriber contracts and, accordingly, the Company recorded the full amount of the charge to sales and marketing expense at the time the transaction occurred. During 1998, the Principal Stockholder sold an additional 4,410,000 shares of common stock that he owned to various individuals at prices that reflected their estimated fair value at the time of each sale. In September 1999, the Company completed an initial public offering ("IPO") in which it sold 13,800,000 shares of common stock, including 1,800,000 shares in connection with the exercise of the underwriters' over-allotment option, at $4.00 per share. The Company received approximately $50 million in cash, net of underwriting discounts, commissions and other offering costs. Upon the closing of the IPO, all of the Company's Series A preferred stock and Series B preferred stock automatically converted into an aggregate of 16,200,000 shares of common stock (see below). In February 2000, the Company completed a follow-on offering in which it sold 6,000,000 shares of common stock, including 2,000,000 shares sold by stockholders in connection with the exercise of the underwriters' over-allotment option, at $40 per share. The Company received $150.7 million in cash, net of underwriting discounts, commissions and other offering costs. In connection with the closing of the Series B Preferred Stock private placement in June 1999, the holders of Series A Preferred Stock were granted an aggregate 1,350,000 shares of common stock pursuant to certain anti-dilution rights of the holders of Series A Preferred Stock. 42 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (7) STOCKHOLDERS' EQUITY (CONTINUED) PREFERRED STOCK In June 1998, the Company issued 6,300,000 shares of 8% Series A Convertible Preferred Stock, par value $0.001 ("Series A"). In June 1998, the Company sold the 6,300,000 Series A shares at $0.83 per share. Net proceeds from the offering totaled $5,000,000, net of offering costs of $250,000, which were paid to a company that employs a member of the Company's Board of Directors. In connection with the issuance of the Series A, the Company granted warrants to purchase a total of 1,200,000 shares of common stock, including warrants to purchase 1,140,000 shares of common stock to three members of the Company's Board of Directors and a company which employs one such director. Each warrant provides for the holder to purchase one share of Company common stock for $0.0035 per share through June 1, 2003. Using the Black-Scholes pricing model, the Company determined that the value of the warrants was $996,000 as of the date of issuance. The value of the warrants has been recognized as a cost of issuance of the Series A shares. In May 1999, the Company issued 9,900,000 shares of 8% Series B Convertible Preferred Stock, par value $0.001 ("Series B") for $1.17 per share and received aggregate proceeds of $11.4 million net of offering costs of $150,000. Prior to the completion of the Series B offering, the Company had received cash totaling approximately $3.1 million pursuant to Series B subscription agreements. Of this amount, $2.0 million was received in December 1998, $500,000 was received in March 1999, and the remaining $640,000 was received in April 1999. The Series B shares subscribed and issued after December 1998 had a beneficial conversion feature totaling $9.4 million, measured as the difference between the conversion price of $1.17 per share and the fair value of the underlying common stock at the time of issuance. The beneficial conversion feature was recorded as additional paid-in capital. The value of the beneficial conversion feature was recognized immediately because the Series B shares are convertible at the option of the holder. Of the 9,900,000 Series B shares issued, 600,000 shares were issued to holders of the September 1998 Notes, including a former member of the Company's Board of Directors (see Note 5). The Company used cash proceeds from the Series B offering to repay $800,000 of the September 1998 Notes, including $500,000 to the Principal Stockholder, and to repay $450,000 and $100,000 of advances made by the Company's Principal Stockholder and President, respectively. The Company issued 500,000 shares of Series B to acquire the assets of a software development company and for non-compete agreements with the owners of the company. In May 1999, the Company issued 127,500 shares of Series B to an individual in exchange for his rescission of a future right to acquire up to 35 percent of PPS. In September 1999 at the time of the IPO, all shares of preferred stock were mandatorily converted to shares of common stock and all amounts included in the preferred stock accounts, including cumulative unpaid dividends and associated accretion totaling $642,000, were converted to common stock and additional paid-in capital. 43 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (7) STOCKHOLDERS' EQUITY (CONTINUED) COMMON STOCK WARRANTS In July 1999, the Company entered into a Joint Promotions Agreement with Office Depot pursuant to which each company agreed to jointly promote the other's products and services. Under the terms of the Joint Promotions Agreement, the Company agreed to include Office Depot in co-branded marketing and advertising, pay Office Depot a percentage of net revenues from transactions originating from Office Depot sites, and to create a private internet site (the "Private Site") that would link the Company's sites with Office Depot sites. The Company also agreed to pay Office Depot a referral fee for each visitor to the Private Site that registered with and became a paying member of the Company's global network. Further, the Company agreed to designate Office Depot as the exclusive preferred provider for office supplies on its global network. In exchange, Office Depot agreed to pay the Company for such exclusive preferred provider status and to pay a transaction fee for specified purchases that took place over the network from certain Office Depot members. Office Depot also offered to register its internet site users as the Company's members, to grant the Company the right to advertise and market PurchasePro as a preferred e-commerce solutions provider to Office Depot, and to facilitate registration over the Company's network by making it easier for Office Depot internet site visitors to link to the Private Site. The Company determined that the most beneficial way to induce Office Depot to enter into and perform under this agreement was to use warrants in lieu of cash which allowed the Company to preserve cash to fund the operating losses being incurred. In July 1999, the Company issued 1,500,000 warrants to Office Depot, Inc., whose Chairman was a member of the Company's board of directors until 2000. The exercise price for the warrants was $4.00 per share. At the time of issuance, the Company did not recognize a charge as the Company determined the value of the warrants of $100,000 to be immaterial. In connection with the Company's follow-on offering in February 2000, Office Depot exercised 555,554 warrants. As of December 31, 2000, 944,446 warrants remain outstanding and exercisable. In November 1999, the Company entered into an agreement with Advanstar to develop 20 web site communities for Advanstar. Advanstar was to pay $225,000 per web site plus $500,000 at the conclusion of Phase I of the development. The Company agreed to host and maintain the communities for a fee of $80,000 per year per site for the first two years and $60,000 per year per web site thereafter. Certain future revenues, such as subscriptions, transaction fees and advertising were to be shared by the Company and Advanstar. The Company was also to receive an advertising credit of $250,000 per year for the three-year contract term. In a separate Marketing Agreement, the Company agreed to pay Advanstar $2 million over three years for the ability to utilize various marketing opportunities at published Advanstar rates, including advertising in Advanstar publications, registration for attendance at conferences and exhibitions, admission fees and sponsorship of events, banner advertisements on web sites, and access to Advanstar mailing lists for promotional purposes for the three-year term. In addition, the Company was granted the right to place all existing Advanstar content applicable to the proposed industry marketplaces onto its public and private marketplaces. This content included Advanstar's printed material, including trade publications, business periodicals, directories, etc. and database of customers. In connection with the value of the content, the Company issued 1,050,000 44 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (7) STOCKHOLDERS' EQUITY (CONTINUED) warrants valued at $10.7 million to Advanstar in exchange for a right to use the editorial content. The fair value of the warrants was determined using the Black-Scholes pricing model with the following assumptions: risk-free rate of 5.3 percent; no expected dividend yield; warrant term of 6 months; and an expected volatility of 100 percent. The Company obtained an independent appraisal of the value of the content to ensure that such value equaled or exceeded the value of the warrant, and the content received was appraised at approximately $13.6 million, including prepaid advertising with a readily ascertainable value of $750,000. As a result, the Company concluded that the value of the warrant was exceeded by the value of the content received in exchange for the warrant. However, the Company recorded the value of the content other than the prepaid advertising at $9.95 million rather than $13.6 million because the warrants issued had a more readily determinable fair value than that of the content received. This determination was based on the fact that the Black Scholes Option Pricing Model is a widely accepted model used to value options and warrants and the inputs to this model were specific and determinable from the warrant agreement. An appraisal of the content was based on projected future cash flows from revenue streams that were new, unproven and subject to uncertainty as to their ultimate realization at the time of the appraisal. This uncertainty was due to the unique way in which the content was anticipated to be used on the internet in buying communities and the value that usage would create in future revenue streams to the Company. In June 2000, the web site development agreement with Advanstar was amended whereby Advanstar took over responsibility for completing the web site development project. Under the agreement, the Company retained $500,000 previously paid by Advanstar and Advanstar made additional payments for the web site development work completed of $2.25 million. Also in June 2000, the exercise period for the warrants was extended by six months to December 1, 2000 and the exercise price of the warrant was changed from $18.79 to $13.50. The resultant incremental value of the warrant of $400,000, based on the Black-Scholes model, was treated as a reduction of revenue, resulting in net revenues being reported from Advanstar of $2,350,000. As a result of the new measurement date and the lack of consideration received from Advanstar for the modification of the warrant in the agreement, the modified warrant was valued at $400,000 and was deemed to be a revenue offset given Advanstar's status as a customer of the Company. Advanstar exercised all of the warrants during 2000. A charge for the unamortized value of the asset was recognized in 2000 (see Note 2). In December 1999, the Company issued 2,700,000 common stock warrants valued at $50.1 million to a strategic marketing partner. The value of the warrant is included in the consolidated statements of operations as sales and marketing expense. The fair value of the warrants issued was determined using the Black-Scholes pricing model with the following assumptions: risk-free interest rate of 7 percent; no expected dividend yield; warrant term of 1.5 years; and an expected volatility of 75 percent. The value of the warrants was expensed immediately as they were fully vested and the strategic marketing partner has no further obligations related to the warrants. The strategic marketing partner may earn the right to exercise an additional 2,700,000 warrants if certain performance conditions are met. As of December 31, 2000, none of the vested warrants had been exercised. In March 2000, the Company issued to AOL warrants to purchase up to 4,000,000 shares of the Company's common stock at an exercise price of $63.26, of which 1,000,000 warrants vested 45 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (7) STOCKHOLDERS' EQUITY (CONTINUED) immediately. The warrants are exercisable from the time they vest until March 2003. At the time of issuance, AOL was not a customer in any capacity. In November 2000, the Company and AOL amended and restated the March 2000 warrant agreement. For the 3,000,000 performance-based warrants that had not been earned as of the date of the amendment, the strike price was adjusted to $0.01 per share. In exchange for the reduced strike price, the defined revenue for which AOL can vest the performance-based warrants was expanded to include software license revenue fees recognized by the Company that resulted from referrals from AOL. The modification benefited the Company by creating a new channel for additional sales of its software products and acted as an incentive to AOL to refer new business to the Company. The formula for vesting warrants on referral revenue is that for each $1 of revenue generated from the referrals during a fiscal quarter, AOL is able to earn a number of warrants calculated as three times the revenue recognized divided by the estimated fair value of the Company's common stock, as defined. As a result of this modification, the Company received fair value from the incremental revenue generated by AOL-referred customers in the fourth quarter of 2000 in excess of the value of the modification of the warrant. Under EITF No. 00-25, Issue 2, the Company received an identifiable benefit and the cost to obtain such benefit was classified as marketing expense because it did not exceed the fair value of that benefit. The value of the warrant modification, determined through an appraisal, was determined to be $1.47 million. The independent appraisal was completed using the Black-Scholes option pricing model with the terms of the warrant and the market factors prevailing at the date of the modification as the inputs to that calculation. This value of $1.47 million represented the additional value given up by the Company in exchange for additional revenue for software referrals. The fair value of the commission rate was determined by using the Company's historical experience of discounts given to AOL in prior dealings where AOL acted in a customer relationship with the Company as a reseller of its software products in September 2000. The agreement limits the total recognized revenue allowed in the calculation to $10.0 million in the quarter ended December 31, 2000, $15.0 million in the quarter ending March 31, 2001 and $20.0 million in the quarter ending June 30, 2001. For the quarter ended December 31, 2000, AOL earned approximately 1.8 million warrants, and the Company recognized a non-cash expense of $30.0 million that is included in sales and marketing expense in the accompanying consolidated statements of operations. In September 2000, as consideration for training and marketing services to be rendered by Gateway, the Company issued three separate warrants to purchase an aggregate of 3,000,000 shares of Company common stock at an exercise price of $29.75 per share. Of the warrants, 1,000,000 vested and are exercisable immediately and another 1,000,000 vested and became exercisable on October 31, 2000. The remaining 1,000,000 warrants may vest and become exercisable over a period of eighteen months, with one share vesting for each $40 in revenue generated from transaction fees charged for transactions executed over the Gateway Marketplaces. The value of these warrants, using the Black Scholes model, totaled $38.2 million. The following assumptions were used: risk-free interest rate of 6.5 percent; no expected dividend yield; warrant term of 12 months; and an expected volatility of 64 percent. The value of the warrant is recorded as additional paid-in capital. See Note 3 for further discussion of the agreement. As of December 31, 2000, none of the vested warrants had been exercised. (8) STOCK OPTION PLANS 1998 STOCK OPTION PLAN--In 1998, the Company adopted an incentive stock option plan (the "1998 Plan") that provides for the granting of stock options pursuant to the applicable provisions of the 46 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (8) STOCK OPTION PLANS (CONTINUED) Internal Revenue Code and regulations. The aggregate options available under the 1998 Plan are 9,000,000. As of December 31, 1999 and December 31, 2000, the Company had options outstanding totaling 7,866,352 and 3,365,486 to employees under the 1998 Plan. Generally, the options have five-year terms and are exercisable as follows: Class A options, 50 percent at the end of each of the first two years after grant; Class B options, 33 percent at the end of each of the first three years after grant; and Class C options, 25 percent at the end of each of the first four years after the date of grant. Through December 31, 1999 and 2000, the Company had issued a total of 1,110,000 options to non-employees, including 615,000 issued to members of the Board of Directors. These options were issued with exercise prices ranging from $0.83 to $1.17. The value of these options using the Black-Scholes option-pricing model was determined to be approximately $1.1 million, of which $800,000 was charged to expense for options granted primarily to one of the Company's directors who was the Chairman of the Board and Chief Executive Officer of Office Depot, one of the Company's strategic marketing partners. The remaining amount of $300,000 will be amortized over the vesting periods of the options. 1999 STOCK OPTION PLAN--The 1999 Stock Plan (the "1999 Plan") was adopted by the Company's Board of Directors in June 1999. The 1999 Stock Plan provided for the issuance of 4,500,000 shares of common stock, incentive stock options ("ISOs"), or non-statutory stock options to employees, directors, independent contractors and advisers until July 2000, when stockholders approved an amendment to the 1999 plan that increased total shares available to 13,500,000. The number of shares eligible for issuance increases each year by 3.25 percent of the number of shares of common stock outstanding at the prior calendar year-end. At December 31, 1999 and 2000, the Company had options outstanding totaling 4,124,600 and 11,089,517, respectively, to employees under the 1999 Stock Plan. The exercise price for ISOs is generally at least 100 percent of the fair market value of the stock on the date of grant, and 110 percent for stockholders with 10 percent or more ownership of the Company. Vesting provisions are determined at the time of grant. The Company's Chairman and Chief Executive Officer is authorized to grant up to 37,500 options in each instance to employees, with the exercise price to be approved by the compensation committee of the Company's Board of Directors. Through December 31, 2000, the Company had issued a total of 24,500 options to non-employees and 150,000 options to members of the Board of Directors. These options were issued with exercise prices ranging from $10.58 to $23.92. As of December 31, 2000, 2,000 non-employee options were outstanding under the 1999 Plan. 47 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (8) STOCK OPTION PLANS (CONTINUED) A summary of the options granted to employees under the Company's plans as of December 31, 1998, 1999 and 2000 is presented below (shares in thousands):
DECEMBER 31, DECEMBER 31, DECEMBER 31, 1998 1999 2000 ------------------- ------------------- ------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE NUMBER PRICE NUMBER PRICE NUMBER PRICE -------- -------- -------- -------- -------- -------- Options Outstanding, Beginning of year.......... -- $ -- 2,130 $0.83 10,427 $ 5.94 Granted......................................... 2,130 $0.83 9,094 $7.09 10,901 $30.47 Exercised....................................... -- $ -- (538) $0.90 (4,280) $ 2.46 Cancelled....................................... -- $ -- (259) $1.23 (2,593) $19.87 ----- ------ ------ Options Outstanding, End of year................ 2,130 $0.83 10,427 $5.94 14,455 $22.98 ===== ====== ======
The following table summarizes information about the options outstanding at December 31, 2000 (shares in thousands):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ---------------------------------------- ------------------------ WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE NUMBER CONTRACT LIFE EXERCISE NUMBER EXERCISE RANGE OF PRICES OUTSTANDING (YEARS) PRICE EXERCISABLE PRICE ---------------------------------------- ----------- ------------- ---------- ----------- ---------- $0.83--$3.60 2,667 8.30 $ 1.24 1,766 $ 1.19 $3.61--$18.99 2,544 9.16 $10.51 513 $ 8.11 $19.00--$23.99 5,372 9.60 $20.81 1,200 $20.13 $24.00--$53.99 2,960 9.19 $36.91 104 $44.92 $54.00--$75.15 912 9.11 $61.89 105 $62.08 ------ ------ 14,455 3,688 ====== ======
For stock options granted to employees from January through December 2000, with an exercise price less than the fair value on the date of grant, the Company recorded deferred stock-based compensation of $17.6 million. This amount is being amortized to operating expense over the vesting period of the individual options. The Company applies the provisions of APB No. 25 and its related interpretations in accounting for its stock option plans. Accordingly, compensation expense recognized was different than what would have been otherwise recognized under the fair value based method defined in SFAS No. 123. Had the Company accounted for these plans under SFAS No. 123, the 48 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (8) STOCK OPTION PLANS (CONTINUED) Company's net loss applicable to common stock and loss per share would have increased to the following pro forma amounts (in thousands, except per share amounts):
YEAR ENDED DECEMBER 31, ------------------------------ 1998 1999 2000 -------- -------- -------- Net Loss Applicable to Common Stockholders As Reported............................................... $(7,135) $(81,983) $(72,811) ======= ======== ======== Pro Forma................................................. $(7,205) $(86,002) $(98,446) ======= ======== ======== Basic Loss per Share As Reported............................................... $ (0.28) $ (2.44) $ (1.15) ======= ======== ======== Pro Forma................................................. $ (0.28) $ (2.56) $ (1.55) ======= ======== ======== Diluted Loss per Share As Reported............................................... $ (0.26) $ (2.39) $ (1.15) ======= ======== ======== Pro Forma................................................. $ (0.26) $ (2.51) $ (1.55) ======= ======== ========
The fair value of each option grant was determined using the Black-Scholes option-pricing model, which values options based on the stock price at the grant date, the expected life of the option, the estimated volatility of the stock, the expected dividend payments, and the risk-free interest rate over the expected life of the option. The assumptions used in the Black-Scholes model were as follows for stock options granted in over the three-year period:
1998 1999 2000 --------- -------- -------- Risk-free interest rate..................................... 7% 6% 6% Expected volatility of common stock......................... 0% 116% 118% Dividend yield.............................................. -- -- -- Expected life of options.................................... 2 years 3 years Class A................................................... 1.5 years Class B................................................... 2.0 years Class C................................................... 2.5 years
49 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (9) EARNINGS PER SHARE The computations of basic and diluted earnings per share for each period were as follows (in thousands, except per share amounts):
FOR THE YEAR ENDED DECEMBER 31, --------------------------------- 1998 1999 2000 --------- --------- --------- LOSS (NUMERATOR) Net loss.................................................... $(6,800) $(71,941) $(72,811) Preferred stock dividends................................... (245) (511) -- Accretion of preferred stock to redemption value............ (90) (131) -- Value of preferred stock beneficial conversion feature...... -- (9,400) -- ------- -------- -------- Basic EPS Net loss applicable to common stockholders................ $(7,135) $(81,983) $(72,811) ======= ======== ======== Diluted EPS Net loss applicable to common stockholders after assumed conversions............................................. $(7,135) $(81,983) $(72,811) ======= ======== ======== SHARES (DENOMINATOR) Basic EPS Weighted average shares outstanding....................... 25,800 33,598 63,399 Effect of securities issued for nominal consideration warrants.................................................. 1,680 1,680 -- Exercise of Warrants........................................ -- (1,005) -- ------- -------- -------- Diluted EPS Weighted average shares outstanding....................... 27,480 34,273 63,399 ======= ======== ======== Per Share Amount Basic EPS................................................... $ (0.28) $ (2.44) $ (1.15) ======= ======== ======== Diluted EPS................................................. $ (0.26) $ (2.39) $ (1.15) ======= ======== ========
Basic earnings per share ("EPS") is computed by dividing net loss applicable to common stock by the weighted average common shares outstanding during the period. Pursuant to SAB No. 98, REVISION OF CERTAIN SAB TOPICS TO REFLECT THE PROVISIONS OF STATEMENT OF FINANCIAL ACCOUNTING STANDARDS (SFAS) NO. 128, EARNINGS PER SHARE AND SFAS NO. 130, REPORTING COMPREHENSIVE INCOME, shares of common stock or convertible preferred stock are considered outstanding for all periods presented in the computation of basic and diluted EPS if issued for nominal consideration. Options, warrants or other common stock equivalents are considered outstanding for all periods presented in the computation of diluted EPS if issued for nominal consideration. For the years ended December 31, 1998 and 1999, the weighted average common shares outstanding used to compute diluted EPS includes the effect of warrants issued by the Company to acquire shares of common stock for $0.0035 per share. All such warrants were exercised by December 31, 1999. Options to purchase 2,549,550, 11,462,400, and 14,894,753 shares of common stock were outstanding as of December 31, 1998, 1999 and 2000, respectively, but were not included in the computation of diluted earnings per share because the Company incurred a loss in each of the periods presented and the effect would have been anti-dilutive. 50 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (9) EARNINGS PER SHARE (CONTINUED) Warrants to purchase 0, 7,950,000 and 13,344,446 shares of common stock were outstanding as of December 31, 1998, 1999 and 2000, respectively, but were not included in the computation of diluted earnings per share because the Company incurred a loss in each of the periods presented and the effect would have been anti-dilutive. (10) INCOME TAXES SFAS No. 109 requires the recognition of deferred tax assets and liabilities, net of applicable reserves, related to net operating loss carryforwards and certain temporary differences. The standard requires recognition of a future tax benefit to the extent that realization of such benefit is more likely than not. Otherwise, a full valuation allowance is applied. At December 31, 1998, 1999 and 2000, the Company believes that the "more likely than not" criteria has not been met, and accordingly, a full valuation allowance has been recognized. The Company did not record any provision (benefit) for income taxes for the years ended December 31, 1998, 1999, and 2000 because it experienced net losses and generated net operating losses for tax purposes. As of December 31, 2000, the Company has approximately $82 million of net operating loss carryforwards, which expire in 2018 and 2019. The Company's utilization of its net operating loss carryforwards will be limited pursuant to Internal Revenue Code Section 382 due to cumulative changes in ownership in excess of 50 percent within a three-year period. Prior to 1998, Purchase Pro, Inc. was not subject to Federal or state income taxes. A reconciliation of income tax benefit provided at the Federal statutory rate (35%) to income tax benefit is as follows (in thousands):
YEAR ENDED DECEMBER 31, ------------------------------ 1998 1999 2000 -------- -------- -------- Income tax benefit computed at Federal statutory rate....... $(2,380) $(25,179) $(25,484) Permanent and other items................................... 11 36 77 Change in valuation allowance............................... 2,369 25,143 25,407 ------- -------- -------- $ -- $ -- $ -- ======= ======== ========
51 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (10) INCOME TAXES (CONTINUED) The significant tax effected components of the Company's net deferred tax assets and liabilities are as follows (in thousands):
DECEMBER 31, ------------------- 1999 2000 -------- -------- Deferred Tax Assets Net operating loss carryforward........................... $ 7,450 $ 28,841 Trade accounts receivable................................. 182 846 Deferred revenue.......................................... 149 1,122 Accruals and reserves..................................... 105 4,582 Equity-based expenses..................................... 17,824 28,324 Stock-based compensation.................................. 2,023 -- -------- -------- 27,733 63,715 Less -- valuation allowance............................... (27,512) (52,919) -------- -------- Total deferred tax assets............................... 221 10,796 Deferred Tax Liabilities Depreciation and amortization............................. (221) (3,942) Stock-based compensation.................................. -- (6,854) -------- -------- Total deferred tax liabilities, net..................... $ -- $ -- ======== ========
(11) RETIREMENT BENEFIT PLAN In October 1999, the Company instituted a defined contribution 401(k) plan for eligible employees. Employees may contribute from 1 to 20 percent of their annual compensation to the Plan, limited to a maximum annual amount as set periodically by the Internal Revenue Service. Since inception of the 401(k) plan, the Company has not matched employee contributions, nor has it contributed any discretionary amounts to the plan. (12) RELATED PARTY TRANSACTIONS One of the founding stockholders of the Company provided significant services designing the Company's technology. The Company paid the stockholder for his services. Payments totaling $72,000, $93,000 and $0 are included in programming and development expense for the years ended December 31, 1998, 1999 and 2000, respectively. There were no amounts owed to the stockholder as of December 31, 1999 and 2000. In January 1998, concurrent with the acquisition of assets from Purchase Pro, Inc. (see Note 1), the stockholder and the Principal Stockholder transferred their rights in the technology to the Company. The Company paid certain costs on behalf of a company owned by a former member of the Board of Directors. At December 31, 1999 and 2000, there was $162,000 and $399,000, respectively, due to the Company, which is included in other receivables in the accompanying consolidated balance sheets. Subsequent to each respective year end, all amounts due the Company were collected. In 1998, the Company entered into an agreement to lease its corporate office space from a company owned by individuals who were then members of the Company's Board of Directors. Terms of 52 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (12) RELATED PARTY TRANSACTIONS (CONTINUED) the lease require monthly base payments of $29,000, which is adjusted on an annual basis, but in no case is the adjustment greater than five percent. During the year ended December 31, 1998, the Company did not pay any amounts under terms of the lease agreement and recorded expense related to the lease totaling approximately $20,000. During the years ended December 31, 1999 and 2000, the Company paid $308,000 and $1.2 million, respectively, under the terms of the lease agreement. In management's opinion, the terms of the lease are comparable to terms that the Company would receive from an independent third party. The Company recorded $500,000 and $514,000 in revenue for the years ended December 31, 1999 and 2000, respectively, from a customer, whose Chairman of the Board is a former member of the Company's Board of Directors. These revenues are included in network access and service fees, software license fees, and advertising revenue in the accompanying consolidated statements of operations. In 2000, the Company recorded $11.5 million in revenue from a strategic marketing partner, whose former Chief Executive Officer is a former member of the Company's Board of Directors. These revenues were included in network access and services fees and advertising revenue in the accompanying consolidated statements of operations. In 2000, the Company paid $50,000 in consulting fees to an investment banking firm, where a member of the Company's Board of Directors is a senior executive. (13) SUBSEQUENT EVENTS (UNAUDITED) On January 16, 2001, PurchasePro.com, Inc. completed its acquisition of all the outstanding stock of Stratton Warren Software, Inc. ("Stratton Warren"), a company that designs and markets software for hotels, resorts, casinos, and other food service operations with purchasing, inventory and materials management requirements. Stratton Warren's principal assets include its intellectual property and software, in addition to numerous license and maintenance agreements with companies that license and use Stratton Warren's software. The total consideration for the acquisition consisted of: 1. $1.5 million in cash, paid on October 30, 2000, plus $3.5 million used by Stratton Warren to redeem certain of its shares held by one of its two shareholders prior to completion of the acquisition. After redemption of this shareholder's shares, there was one remaining shareholder of Stratton Warren; 2. $9.0 million in shares of common stock of the Company (which totaled 541,353 shares based on the closing price of the Company's common stock on January 16, 2001); and 3. $500,000 in cash deposited in escrow to secure indemnification obligations of Stratton Warren's sole remaining shareholder to be distributed ninety days after the closing date. The transaction will be accounted for as a purchase business combination, with the purchase price allocated based on the fair values of the net assets acquired. The consideration for the outstanding stock of Stratton Warren was determined through arms-length negotiations. The cash portion of the purchase price for the shares of Stratton Warren was provided from the Company's working capital. Stratton Warren redeemed all outstanding shares of Stratton Warren held by one of its two shareholders for a total of $3.5 million in cash, which amount was provided to Stratton Warren by the Company for such purpose. Stratton Warren's obligation to 53 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (13) SUBSEQUENT EVENTS (UNAUDITED) (CONTINUED) make such payment and redeem such shares was guaranteed by the sole remaining shareholder. Also, in connection with the acquisition, the Company entered into a non-competition and non-disclosure agreement with the sole remaining shareholder. (14) QUARTERLY FINANCIAL DATA (UNAUDITED)
QUARTER ENDED, ----------------------- MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 -------- -------- ------------ ----------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1998 Total revenues................................... $ 236 $ 293 $ 502 $ 639 ======== ======== ======= ======== Gross profit..................................... $ 138 $ 179 $ 379 $ 528 ======== ======== ======= ======== Net loss applicable to common stockholders....... $ (1,258) $ (2,258) $(1,643) $ (1,977) ======== ======== ======= ======== Loss per share: Basic EPS...................................... $ (0.04) $ (0.08) $ (0.07) $ (0.09) ======== ======== ======= ======== Diluted EPS.................................... $ (0.04) $ (0.08) $ (0.07) $ (0.08) ======== ======== ======= ======== 1999 Total revenues................................... $ 674 $ 1,006 $ 1,670 $ 2,667 ======== ======== ======= ======== Gross profit..................................... $ 511 $ 819 $ 1,452 $ 2,399 ======== ======== ======= ======== Net loss applicable to common stockholders....... $ (2,710) $(13,643) $(7,786) $(57,844) ======== ======== ======= ======== Loss per share: Basic EPS...................................... $ (0.12) $ (0.57) $ (0.25) $ (1.03) ======== ======== ======= ======== Diluted EPS.................................... $ (0.11) $ (0.55) $ (0.25) $ (1.03) ======== ======== ======= ======== 2000 Total revenues................................... $ 4,550 $ 9,514 $17,337 $ 33,590 ======== ======== ======= ======== Gross profit..................................... $ 4,237 $ 8,814 $15,847 $ 31,606 ======== ======== ======= ======== Net loss applicable to common stockholders....... $(15,668) $(12,154) $(8,231) $(36,758) ======== ======== ======= ======== Loss per share: Basic EPS...................................... $ (0.27) $ (0.19) $ (0.13) $ (0.55) ======== ======== ======= ======== Diluted EPS.................................... $ (0.27) $ (0.19) $ (0.13) $ (0.55) ======== ======== ======= ========
(15) EVENTS (UNAUDITED) OCCURRING SUBSEQUENT TO THE DATE OF THE AUDITOR'S REPORT BAYBUILDER ACQUISITION In March 2001, the Company announced it had signed a definitive agreement to acquire Net Research, Inc., dba BayBuilder ("BayBuilder"), a provider of self-service strategic sourcing technology for Fortune 1000 companies. On April 20, 2001, the Company completed the acquisition of BayBuilder 54 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (15) EVENTS (UNAUDITED) OCCURRING SUBSEQUENT TO THE DATE OF THE AUDITOR'S REPORT (CONTINUED) for $3.0 million in cash and $5.5 million in common stock. During the quarter ended September 30, 2001, the Company recorded an additional $778,000 in goodwill for additional acquisition costs incurred. The transaction was accounted for using the purchase method of accounting with the purchase price allocated based on the fair values of the assets acquired and liabilities assumed. Consequently, the Company allocated $5.8 million of the purchase price to acquired software technologies and $3.5 million to goodwill. The pro forma effects of the BayBuilder acquisition on the Company's Consolidated Financial Statements were not material. In August 2001, the Company entered into an agreement with a shareholder group to repurchase shares of common stock issued in connection with the acquisition of BayBuilder. In connection therewith, the Company was obligated to reacquire 1,127,498 common shares at $2.00 per share. Fair market value on the date of the agreement was $0.80 per share. The difference between fair value and the purchase price totaled $1.4 million and was recorded as a general and administrative expense. The Company entered into an additional agreement with the former principal shareholder of BayBuilder. In connection with the repurchase of the principal shareholder's common shares, the agreement requires the Company establish a line of credit for the former shareholder in the amount of $1.8 million. This shareholder may draw down on the line of credit if the Company fails to make scheduled payments to the shareholder. The Company is required to make two payments of approximately $912,000 in October 2001 and January 2002. The October payment was made to the shareholder as required. The line of credit is collateralized by a certificate of deposit. CONTINGENCIES The Company is party to a class action suit filed against it and a number of current or former officers and directors in the United States District Court for the District of Nevada, Case No. CV-S-01-0483-JLQ(PAL), which results from the consolidation of other suits, the first of which was filed on or about April 26, 2001. The class action suit alleges certain violations of federal securities laws, and seeks damages on behalf of a class of shareholders who purchased the Company's common stock during defined periods. A related shareholder derivative lawsuit is also filed in District Court, Clark County, Nevada, Case No. A436614, which also results from the consolidation of other suits, the first of which was filed on June 28, 2001, alleging various breaches of fiduciary duty by certain current or former officers and directors and effectively alleging the same allegations which are the subject of the federal securities class actions. Management believes that the claims in the federal and state lawsuits are without merit and intends to defend them vigorously. In October 2001, Verizon Yellow Pages Company filed a lawsuit in District Court, Clark County, Nevada, Case No. A440979, against the Company. The complaint alleges breach of contract, unjust enrichment and monies due and owing, and seeks compensatory damages in excess of $10,000 for each of the three causes of action, as well as costs and attorney fees. The exact monetary amount being sought is unknown at this time. Although the Company is currently unable to predict the ultimate outcome of this lawsuit, management believes there is no merit to the suit and intends to vigorously defend this action. 55 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (15) EVENTS (UNAUDITED) OCCURRING SUBSEQUENT TO THE DATE OF THE AUDITOR'S REPORT (CONTINUED) ASSET IMPAIRMENTS, ABANDONMENTS AND OTHER CHARGES EMPLOYEE TERMINATION BENEFIT COSTS AND OTHER In response to deteriorating business conditions, management recognized the need to structure its operations around its core competencies and enhance shareholder value. During June 2001, the Company adopted a plan to dramatically reduce headcount and consolidate operations in an effort to preserve cash and better align resources with anticipated demand. As a result, the Company recorded a $4.4 million charge during the second quarter related to termination costs, fixed asset write-offs and the consolidation of certain offices at its main campus in Las Vegas. Termination costs of $3.2 million were recorded as operating expense related to the termination of approximately 190 employees from its Las Vegas offices. Fixed asset write-offs totaled approximately $427,000 for the quarter ended June 30, 2001. The write-offs relate primarily to abandoned computer equipment that resulted from headcount reductions. Office consolidation costs totaled approximately $803,000 for the quarter ended June 30, 2001. Consolidation costs consist of contractual lease commitments for vacated office space, as well as net capitalized leasehold improvements in vacated office space. The total cash outlay for these activities is expected to be approximately $3.4 million. The remaining $976,000 consists of non-cash charges primarily for asset write-offs. Through September 30, 2001, approximately $2.7 million had been paid. The Company effected a further headcount downsizing on October 23, 2001. This downsizing was aimed at reducing future operating costs and increasing operating cash flows. The Company reduced headcount by approximately 50 percent. In addition, the Company restructured executive management responsibilities and also intends to reduce certain senior management compensation. Anticipated savings for the quarter ending December 31, 2001 from the headcount reduction and other related employee cost reductions are approximately $1.0 million, net of estimated termination benefits of $800,000. Due to the reduced headcount, the need for office space has dramatically decreased. Accordingly, leasehold improvements of $920,000, related amortization of $23,000 and other additional costs currently being quantified, including furniture and equipment abandonments, associated with vacating the space, are expected to be expensed in the quarter ending December 31, 2001. Other key components of this plan include the rollout of additional pricing models for current product offerings and an examination of current financing opportunities aimed at increasing the Company's available cash. INVESTMENTS IN OTHER COMPANIES The Company recorded operating charges to write down several of its investments in private companies due to impairments that were deemed to be other than temporary. For the nine months ended September 30, 2001, total write-downs of investments in private companies totaled $12.2 million. ASSET IMPAIRMENTS AND ABANDONMENTS As a result of deteriorating business conditions experienced in 2001, the Company undertook a review of its assets to determine whether their carrying amounts may not be recoverable. For the three months ended June 30, 2001, the Company recorded operating charges of approximately $7.6 million for the impairment of certain assets. The charge consisted of approximately $6.1 million related to prepaid assets which the Company has abandoned and expects to receive no 56 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (15) EVENTS (UNAUDITED) OCCURRING SUBSEQUENT TO THE DATE OF THE AUDITOR'S REPORT (CONTINUED) future economic benefit, approximately $1.3 million related to the write-off of purchased software and approximately $231,000 for the write-off of certain furniture and fixtures the Company expects to dispose of as a result of the office space consolidation. Included in the $6.1 million prepaid asset write-off is approximately $5.3 million related to the abandonment of the Office Depot in-store kiosk program. For the three months ended September 30, 2001, the Company recorded operating charges of $98.0 million for the impairment of certain assets. The charges consist of approximately $71.0 million that stems from the termination of certain contracts with AOL, approximately $15.5 million related to certain intangible assets, and approximately $9.5 million related to the write-off of internally developed software as follows: - MUTUAL RELEASE AND TERMINATION OF AOL MARKETING AND TECHNOLOGY DEVELOPMENT AGREEMENTS In June 2001, the Company began discussions with AOL regarding its existing relationship, including its future required payments to AOL under the Interactive Marketing Agreement and the Technology Development Agreement each dated March 15, 2000, between the Company and AOL. The Company notified AOL that it did not expect to make any further payments under those agreements, pursuant to which the Company has paid approximately $49.8 million, in aggregate, through September 30, 2001. As consideration for release of the Company's payment obligation under such agreements, the Company proposed various modifications to the Interactive Marketing and the Technology Development Agreements as well as other existing arrangements that resulted in the abandonment of the Company's rights to certain advertising and technology assets under such agreements. In September 2001, a termination agreement was signed. Approximately $71.0 million, net of accumulated amortization, that related to these agreements was written off. In addition, since the Company is no longer required to make any further payments under the Interactive Marketing Agreement and the Technology Development Agreement, the cancellation of the obligation was recognized as an offset to operating expenses of approximately $19.8 million. Also, in connection with the termination, AOL made a one-time payment to the Company of $1.5 million in satisfaction of existing obligations. - GATEWAY TRAINING AND MARKETING AGREEMENT During the quarter ended September 30, 2001, vested warrants issued to Gateway to acquire 2,000,000 shares of common stock expired unexercised. Also, during the third quarter 2001, the Company began evaluating Gateway's ability to deliver under the contractual terms. To date, Gateway has, and continues to provide the contractual services, although, much more slowly than originally planned. As of September 30, 2001, one half of the contract period has expired, but Gateway has delivered less than five percent of its total obligation under the contract. In addition, current economic conditions may also make delivery of all of the remaining obligated training and marketing services during the remaining contract term unfeasible. Based on these factors and discussions the Company has had with Gateway, the Company made its best estimate of the realizable value of the benefits it would receive as a result of Gateway's anticipated performance under the contract. As a result of the analysis the Company wrote down the training and marketing asset by $15.5 million. - CAPITALIZED SOFTWARE DEVELOPMENT COSTS 57 PURCHASEPRO.COM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 (15) EVENTS (UNAUDITED) OCCURRING SUBSEQUENT TO THE DATE OF THE AUDITOR'S REPORT (CONTINUED) During the quarter ended September 30, 2001, the Company completed an evaluation of certain capitalized software development assets as part of its restructuring that was commenced in June 2001. This evaluation assessed the product development objectives and direction of the Company and the realizability of future revenue from certain in-process projects. As a result of the evaluation, certain in-process projects were abandoned. Approximately $9.5 million of such capitalized software development costs were written off during the quarter ended September 30, 2001. STOCKHOLDERS' EQUITY COMMON STOCK WARRANTS In January 2001, AOL exercised its vested warrant rights and purchased 1,875,436 shares of common stock by surrendering warrants to purchase 736 shares through a cashless exercise. In April 2001, AOL exercised its vested warrant rights and purchased 1,122,278 shares of common stock by surrendering warrants to purchase 1,550 shares through a cashless exercise. The warrants were earned by AOL under the amended November 2000 Warrant Agreement. DEFERRED STOCK-BASED COMPENSATION In June 2001, the Company cancelled 2,775,000 executive options in a stock for options swap, resulting in the issuance of 2,122,545 shares of common stock of which 1,061,272 shares were vested upon issuance and 1,061,273 shares are restricted. Of the shares vested upon issuance, 358,176 were cancelled upon surrender in consideration of income tax withholding requirements for the value on the date of issuance of such vested shares. The Company recorded stock-based compensation on the date of issuance of $3.2 million for the fair value of the common stock of which $1.6 million was recorded as deferred stock-based compensation related to the unvested portion. The deferred stock-based compensation will be amortized over the vesting period. 58 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SUPPLEMENTAL SCHEDULE To PurchasePro.com, Inc.: We have audited in accordance with auditing standards generally accepted in the United States, the consolidated financial statements included in PurchasePro.com, Inc.'s (the "Company") Form 10-K and have issued our report thereon dated February 12, 2001. Our audits were made for the purpose of forming an opinion on those financial statements taken as a whole. The supplemental Schedule II as shown on page 64 is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. /s/ Arthur Andersen LLP ARTHUR ANDERSEN LLP Las Vegas, Nevada February 12, 2001 59 SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS ACCOUNTS RECEIVABLE ALLOWANCES
CHARGED TO BEGINNING COSTS AND BALANCE EXPENSES DEDUCTIONS ENDING BALANCE --------- ---------- ---------- -------------- Year ended December 31, 1998.................. $ 72,796 $ 127,204 $ -- $ 200,000 Year ended December 31, 1999.................. $200,000 $1,078,235 $ 684,235 $ 594,000 Year ended December 31, 2000.................. $594,000 $3,393,019 $1,516,352 $2,470,667
60 ITEM 9: CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None PART IV ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) FINANCIAL STATEMENTS The financial statements appear in Item 8 to this Form 10-K. (2) FINANCIAL STATEMENT SCHEDULES Schedule II--Valuation and Qualifying Accounts appear in Item 8 to this Form 10-K. The other financial statement schedules have been omitted since they are either not required, not applicable, or the information is otherwise included. (3) EXHIBITS The exhibits listed below are required by Item 601 of Regulation S-K. Each management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K has been identified. (a) EXHIBITS
EXHIBIT NUMBER DESCRIPTION --------------------- ------------------------------------------------------------ 2.1 Stratton Warren Software, Inc. Stock Purchase Agreement dated October 30, 2000 (incorporated by reference to the Company's Current Report on Form 8-K, filed January 31, 2001). 3(i).1 Certificate of Amendment to Amended and Restated Articles of Incorporation (incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000). 3(ii).1 Bylaws of the Registrant, as amended (incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999). 4.1 Form of Common Stock Certificate. + 10.1* Form of Indemnification Agreement between the Registrant and each of its directors and officers. + 10.2* 1998 Stock Option and Incentive Plan and forms of agreements thereunder. + 10.3* 1999 Stock Plan. (incorporated by reference to the Company's Registration Statement on Form S-1 (No. 333-01865) and by reference to the Company's Definitive Proxy Statement, filed June 15, 2000). 10.4* Letter of Employment between Registrant and Charles E. Johnson, Jr. + 10.5* Letter of Employment between Registrant and Robert G. Layne. + 10.6 Warrant dated as of July 22, 1999, by and between Registrant and Office Depot, Inc. + 10.7* Letter of Employment between Registrant and Richard Moskal. ++ 10.8 Warrant Purchase Agreement dated November 29, 1999 by the Company and Sprint Communications Company L.P. ++ 10.9 Warrant to Purchase Common Stock of the Company dated November 1999 (issued to Sprint Communications, L.P.). ++
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EXHIBIT NUMBER DESCRIPTION --------------------- ------------------------------------------------------------ 10.10 Amendment to Warrant to Purchase Common Stock of the Company dated December 6, 1999 (by Sprint). ++ 10.11 AOL Technology Development Agreement. ** 10.12 AOL Interactive Marketing Agreement. ** ## 10.13 Advanstar Warrant Agreement Amendment No. 1 (incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2000). 10.14 Training and Management Services Agreement by and between the Company and Gateway Companies, Inc., dated September 29, 2000.*** ## 10.15 Warrant Agreement by and between the Company and Gateway Companies, Inc.*** 10.16 Warrant Agreement by and between the Company and Gateway Companies, Inc.*** 10.17 Warrant Agreement by and between the Company and Gateway Companies, Inc.*** 10.18 AOL Amended and Restated Warrant Agreement dated November 18, 2000.**** 10.19 AOL Bulk Subscription Sales Agreement dated December 1, 2000.**** 10.20 E-MarketPro Amended and Restated Assignment Agreement dated November 3, 2000.**** 10.21 AuctioNet.com, Inc. License Agreement dated December 29, 2000.**** 10.22 BroadVision PurchasePro Master Agreement dated December 19, 2000.**** # 10.23* Employment Agreement between the Company and Jeffrey Anderson**** 10.24* Employment Agreement between the Company and James P. Clough**** 10.25* Employment Agreement between the Company and Joseph Michael Kennedy**** 10.26* Employment Agreement between the Company and Shawn P. McGhee**** 23.1 Consent of Arthur Andersen LLP.
------------------------ + Incorporated by reference to the Company's Registration Statement on Form S-1 (No. 333-01865). ++ Incorporated by reference to the Company's Registration Statement on Form S-1 (No. 333-92303). * Indicates management contract or compensatory plan or agreement. ** Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2000. *** Incorporated by reference to the Company's Current Report on Form 8-K, filed October 23, 2000. ****Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 2000, filed April 2, 2001. # Confidential treatment has been requested with respect to certain portions of this agreement. ## Confidential treatment has been granted with respect to certain portions of these agreements. (b) REPORTS ON FORM 8-K On October 23, 2000, we filed a Current Report on Form 8-K reporting (i) our transaction with Gateway Companies, Inc., and (ii) the approval of the issuance or amendment of warrants to purchase common stock of the Company. 62 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, who are duly authorized, in the City of Las Vegas, State of Nevada, on the 7th day of December, 2001. PURCHASEPRO.COM, INC. By: /s/ RICHARD L. CLEMMER ----------------------------------------- Richard L. Clemmer VICE CHAIRMAN, CHIEF EXECUTIVE OFFICER AND PRESIDENT
Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.
NAME TITLE DATE ---- ----- ---- /s/ RICHARD L. CLEMMER -------------------------------------- Vice Chairman, Chief Executive December 7, 2001 Richard L. Clemmer Officer and President /s/ MARK R. DONACHIE -------------------------------------- Chief Financial Officer December 7, 2001 Mark R. Donachie /s/ R. TODD BRADLEY -------------------------------------- Chairman of the Board of December 7, 2001 R. Todd Bradley Directors /s/ MARTHA LAYNE COLLINS -------------------------------------- Director December 7, 2001 Martha Layne Collins /s/ JAMES T. SCHRAITH -------------------------------------- Director December 7, 2001 James T. Schraith /s/ W. DONALD BELL -------------------------------------- Director December 7, 2001 W. Donald Bell
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