-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ReXA50GHdN//0g/qiEqjxdXZnFSPNKNURoc5iaPXGmroQ4IRzLv+iWVnj/KxFbvM nS5r3h9jOY/NFqedfIVsUw== 0000910391-99-000003.txt : 19990402 0000910391-99-000003.hdr.sgml : 19990402 ACCESSION NUMBER: 0000910391-99-000003 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ONHEALTH NETWORK CO CENTRAL INDEX KEY: 0000910391 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 411686038 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22212 FILM NUMBER: 99581764 BUSINESS ADDRESS: STREET 1: 808 HOWELL STREET STREET 2: STE 400 CITY: SEATTLE STATE: WA ZIP: 98011 BUSINESS PHONE: 2065830100 MAIL ADDRESS: STREET 1: 808 HOWELL ST STREET 2: STE 400 CITY: SEATTLE STATE: WA ZIP: 98011 FORMER COMPANY: FORMER CONFORMED NAME: IVI PUBLISHING INC DATE OF NAME CHANGE: 19930809 10-K 1 FORM 10-K FOR YEAR ENDED DECEMBER 31, 1998 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark one) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________TO__________. COMMISSION FILE NUMBER 0-22212 ONHEALTH NETWORK COMPANY (Exact name of registrant as specified in its charter) WASHINGTON 41-1686038 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 808 HOWELL STREET, SUITE 400 SEATTLE, WASHINGTON 98101 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (206) 583-0100 -------------------------------------------------------- Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 par value Indicate by a check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to the Form 10-K. [ ] Aggregate market value of voting stock held by non-affiliates of the registrant as of March 9, 1999: $178,383,285 Number of shares outstanding of the registrant's class of common stock as of March 9, 1999: 15,856,292 DOCUMENTS INCORPORATED BY REFERENCE: Portions of registrant's definitive Proxy Statement for its 1999 Annual Meeting of Shareholders are incorporated herein by reference into Part III. =============================================================================== 1 TABLE OF CONTENTS PAGE ---- Part I Item 1. Business............................................................3 Item 2. Properties.........................................................20 Item 3. Legal Proceedings..................................................20 Item 4. Submission of Matters to a Vote of Security Holders................21 Part II Item 5. Market For Registrant's Common Equity and Related Stockholder Matters...............................................22 Item 6. Selected Financial Data............................................23 Item 7. Managements's Discussion and Analysis of Financial Condition and Results of Operations.........................................24 Item 7a. Quantitative and Qualitative Disclosures About Market Risk.........28 Item 8. Financial Statements And Supplementary Data........................28 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure..........................................28 Part III Item 10. Directors and Executive Officers of Registrant.....................29 Item 11. Executive Compensation.............................................29 Item 12. Security Ownership of Certain Beneficial Owners and Management.....29 Item 13. Certain Relationships and Related Transactions.....................29 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K....30 Signatures..................................................................33 2 PART I ITEM 1. BUSINESS FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K and the documents incorporated herein by reference contain forward-looking statements based on current expectations, estimates and projections about the Company's industry, management's beliefs and certain assumptions made by management. All statements, trends, analyses and other information contained in this report relative to trends in net sales, gross margin, anticipated expense levels and liquidity and capital resources, as well as other statements including, but not limited to, words such as "anticipate," believe," "plan," "estimate," "expect," "seek," "intend," and other forward-looking statements are not guarantees of future performance and are subject to certain risks and uncertainties that are difficult to predict. Accordingly, actual results may differ materially from those anticipated or expressed in such statements. Particular attention should be paid to the cautionary statements involving the Company's limited operating history, the unpredictability of its future revenues, the unpredictable and evolving nature of its business model, the intensely competitive nature of the online environment, risks associated with capacity constraints and the management of Company growth. Except as required by law, the Company undertakes no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise. GENERAL OnHealth Network Company ("OnHealth" or the "Company") intends to become the leading Internet resource dedicated to the management of family health and well-being. The Company is an Internet-based provider of high quality health and medical information and applications to a broad base of consumers. The Company's Internet site, onhealth.com, produces and distributes original, relevant health content including in-depth reports, personalized information retrieval, geographically specific guides to health services and information, editorials and interactive community environments. By leveraging management's years of experience in developing businesses, its skill in working with third-party content providers, and its unique knowledge of consumers of health information, the Company has created a broad site appealing to health consumers. The key attributes for success in this venture include building high-value editorial content, maintaining a friendly and easily accessible site on the Internet, building trust and credibility, and creating a conducive environment for community among site users. The Company has entered into, and intends to enter into additional distribution relationships with businesses which have significant reach on the Internet, such as search engines, portals, Internet access providers, community, news information and content and other specialty sites, media companies, promotional programs and other traditional media to build the OnHealth brand and drive traffic to the site. Capitalizing on this broad reach, the Company plans to create multiple revenue streams by leveraging the branding, customer set, and market awareness created by the onhealth.com site. OnHealth intends to generate advertising revenue by appealing to advertisers through its ability to reach targeted demographics and psychographics. Additional products and services, such as transactional based e-commerce, subscription and syndication, will be developed to exploit opportunities as they present themselves in the marketplace. The Company was founded in August 1990 in the State of Minnesota. The Company went public in 1993 as IVI Publishing, Inc. Until January 1998, its traditional line of business had been CD-ROM development, production and distribution. The best known title, "Mayo Clinic Ultimate Medical Guide", along with other CD-ROM works, has been distributed through retail and computer OEM channels. The Company's predecessor was also a supplier of video, animation and graphic assets to America's Health Network, a health and medical cable TV channel, and published a book version of its CD-ROM, "Taking Control of Your Health" in conjunction with Time Life Medical. The Company's first foray onto the Internet was a Web site, O@sis, which it developed on a joint venture basis with the Mayo Foundation in July 1996. Due to philosophical differences regarding the strategic direction of the site, full ownership of O@sis was later transferred to the Mayo Foundation with the Company receiving a $2.7 million termination settlement and the return of IVI Publishing Inc. stock held by Mayo. The Company's current relationship with Mayo consists of a content contract and certain agreements concerning CD-ROM properties. 3 INDUSTRY OVERVIEW THE INTERNET The Internet is an increasingly significant global medium for communications, information and commerce and continues to experience rapid growth in its user base. International Data Corporation estimates that the number of Internet users will grow to approximately 320 million by 2002 from approximately 69 million at the end of 1997. The Company believes that the growth in Internet use is due to a number of factors including a large and growing installed based of PCs, improvements in network infrastructure and easier and more cost effective access to the Internet. Current trends that specifically impact the Company's business model include the following: INCREASING ADOPTION OF INTERNET USE BY WOMEN. Women tend to be the healthcare decision-makers within their households, and therefore the seekers of health and wellness information. Internet use among women has increased rapidly in recent years, from 5% in early 1994 to 46% in 1998 and is expected to increase to 51% in 1999, according to International Data Corporation. INTERNET USERS VIEW THE WORLD WIDE WEB AS AN IMPORTANT INFORMATION RESOURCE. Approximately 90% of Internet users use the Internet at least once a month and more than 70% visit at least one "News and Information" site. In addition, 17 million U.S. adults searched for health information in the 12 months ended July 1998 and is estimated to increase to over 30 million in 2000, according to Cyber Dialogue. This number of U.S. adults searching for health information equals the number of searchers of financial information and is just slightly below the number of news seekers. ONLINE ADVERTISING HAS EMERGED AS A MORE SIGNIFICANT COMPONENT TO MARKETERS' MEDIA MIX. Online advertising in the United States is projected to grow from $1.9 billion in 1998 to $4.4 billion in the year 2000 and $7.7 billion in 2002, according to Jupiter Communications. E-COMMERCE HAS BECOME A SIGNIFICANT CHANNEL OF DISTRIBUTION FOR MERCHANDISERS. According to International Data Corporation, worldwide e-commerce is projected to increase from $12.4 billion, at the end of 1997, to approximately $425 billion in 2002. Average annual spending by individuals is expected to rise over the same period from $375/person to $672/person. HEALTHCARE According to the Congressional Budget Office, annual healthcare expenditures in the U.S. have grown from approximately $470 billion in 1982 to more than $1 trillion in 1998, representing more than 14% of the gross national product. Stimulating this growth is an aging U.S. population which is starting to enter its prime years for drug and healthcare expenditures. According to the U.S. Bureau of the Census, the number of individuals over the age of 65 is projected to increase from approximately 26 million in 1981 to 35 million by 2000, or from 11.5% to 13.0% of the total U.S. population. Dramatic changes in the U.S. healthcare delivery system are causing more patients to bear more healthcare costs on an out-of-pocket basis. Concurrently, more people are attempting to manage their own health rather than relying solely on medical practitioners. As consumers demand more information, wider choices and greater involvement in healthcare decision-making, they are seeking health information in greater numbers and from a wider variety of sources. Moreover, the "baby-boomer" consumer is characterized as highly educated and technology literate, increasingly leveraging technology in general and the Internet in particular to gain greater access to information. The fragmented nature of this information, whether it be from sources such as written publications, television, radio or the Internet, as well as the failure of available sources to properly address the wide variety of information needs and activities of consumers, provides a large business opportunity for OnHealth. ONHEALTH'S STRATEGY The Company believes it is well positioned to capitalize on the market opportunities created by the rising consumer demand for relevant, timely, high-quality health and wellness information and the emergence of the World Wide Web as a medium for both communications and commerce. The Company's strategy for achieving its goal of becoming the premier network of health-related channels on the Internet consists of the following: 4 CREATE THE LEADING INTERNET RESOURCE DEDICATED TO THE MANAGEMENT OF FAMILY HEALTH AND WELL-BEING. -Differentiate the onhealth.com site from other sources of health and Wellness information by continuing to offer content that occupies the targeted and practical ground between "lifestyle" Editorial content and undifferentiated "clinical" reference material. -Develop high quality, unique and independent editorial content. -Provide personalization to enable users to obtain information on specific diseases or conditions that are of importance to them, retrieve e-mail, track personal health records for themselves and their families, obtain local weather and pollen information and participate in relevant discussion groups, among other things. -Provide "intelligent" links to other reliable, relevant online content. -Provide regularly updated content to encourage user return visits. -Produce a user-friendly, easily accessible and editorially attractive format. Provide interactive, community and "smart" search capabilities. -Offer consumers the ability to purchase health-related products. -Provide interactive tools and programs such as risk assessments and behavior programs to help consumers actively manage their health and well being. -The above will drive frequent usage and long user sessions, thereby establishing an effective platform for advertisers to reach their targeted demographics. DRIVE TRAFFIC AND MAXIMIZE THE ONHEALTH.COM BRAND. -Enter into distribution agreements with Internet search engines and portals and strategic alliances with other specialty sites. -Facilitate increased user traffic through an integrated advertising campaign utilizing multiple channels. -Utilize "best-of-breed" partners such as TBWA/Chiat Day and Fleishman-Hillard to facilitate OnHealth's marketing and public relations efforts. -Establish pre-eminent market share and build barriers to entry. FUEL REVENUE GROWTH. -Develop multiple revenue streams including advertising/sponsorship, e-commerce/transactions, subscription and syndication. -Create a differentiated and productive advertising environment to include a wide variety and depth of sponsorship areas and a targeted, creative beyond-banner program. -Market acceptance of the onhealth.com site will allow the Company to produce additional content, products and services for its end-user base. ONHEALTH.COM INTRODUCTION Onhealth.com provides timely and relevant coverage of health news and issues, substantive resources and references, community discussions, direct access to experts, interactive tools and exclusive "smart" search capabilities directly to health consumers. Onhealth.com enables consumers to actively and successfully manage the health and well-being of themselves and their families. On July 20, 1998, the Company launched its redesigned flagship site, signaling a commitment to provide the healthcare consumer's best interactive source for health information and services. By logging onto onhealth.com, consumers will find aggressive coverage of important health issues and deep database reference materials in an interactive and personalized format. The site consists of unique services and features. ONHEALTH.COM CURRENT SERVICES AND FEATURES -DAILY BRIEFINGS: Each day, onhealth.com publishes health and medical news filtered and tailored to what is most practically relevant to the key demographic. Daily Briefings include: 1) ORIGINAL SUMMARIES of the most important health-related news stories, including links to deeper material and 2) DAILY HEALTH TIPS covering everything from diet and nutrition to stress reduction and relaxation techniques. 5 -IN-DEPTH REPORTS: Each week, onhealth.com publishes new reports that cover a broad range of health topics in-depth. Examples of topics include nutrition, stress management, emotional well-being, managed care and breast cancer. Onhealth.com's In-Depth Reports provide information beyond the superficial coverage offered by "lifestyle" health sites but in an insightful and informative manner which removes the medical jargon found in "clinical" health sites to provide meaningful coverage of a full range of health issues. Content for OnHealth's In-Depth Reports is produced by carefully selected and respected journalists who are assigned by OnHealth's staff of editors. -THE ONHEALTH PERSONAL HEALTH TRACKER: Personal Health Tracker is a free, personal, private service to track, retrieve and save important health information for onhealth.com users. The exclusive Personal Health Tracker searches a hand-selected universe of the Internet's best health and medical resources and sends the user an e-mail, on either a daily or weekly basis according to user specifications, when new information is found. The Personal Health Tracker searches against a user's selection of topics on a daily basis and can be customized to provide the most relevant information for a user's specific healthcare needs. -CITY HEALTH GUIDES: Onhealth.com currently provides localized information guides for 14 U.S. cities, providing timely, practical information and resource listings for onhealth.com's users. Services include local health news, community resources, calendars of health-related events, classes and support groups and local pollen, UV and pollution counts. -ASK OUR EXPERTS: Onhealth.com's exclusive columnists cover core beats that the site's users have said are most important to them by answering questions in an in-depth format. Columns like "A Woman's Body," "Active Aging," "Sex Matters," "Power to the Patient," "The Holistic Pediatrician" and "Alternative Health" are written by expert medical and science writers to whom users always have direct access for comments, questions and suggestions. -CONDITION CENTERS: Partnering with some of medicine's top research and clinical institutions, onhealth.com's condition-specific Condition Centers give consumers hands-on patient guides, expert answers, community support and the latest medical updates to help them most successfully manage chronic conditions. For example, institutions such as the Beth Israel Deaconess Cancer Center, the International Diabetes Center and the Mount Sinai Cardiovascular Institute will support those who are managing such difficult conditions as breast cancer, diabetes and cardiovascular health problems. Additional Condition Centers for asthma, allergy, and gastrointestinal disorders will be launched in 1999. -ONHEALTH LIVE HOSTED BY BROOKE GLADSTONE: Journalist Brooke Gladstone of National Public Radio hosts onhealth.com's weekly live Internet-audio interview show featuring leading health and wellness experts. Users can ask questions during the show and listen to previous shows through the extensive archive. The program airs every Tuesday night. -NEWSLETTER: Onhealth.com users can receive a free e-mail with alerts to the latest in-depth reports, columns, events and more. The newsletter is delivered free every Tuesday. -ILLNESS AND DISEASE DATABASE: Onhealth.com offers a comprehensive reference tool which enables the site's users access to the most comprehensive medical conditions database online. Through Conditions A-Z, users can access information on a full range of medical conditions. -USP DRUG DATABASE: Onhealth.com users have access to the most comprehensive pharmacy database online. Through onhealth.com's deep pharmacy reference, users can find information on the effects of a specific drug, its appropriate use and potential side effects. -ALTERNATIVE PRACTICES: Onhealth.com provides coverage of several of the most widely recognized alternative medical therapies including Acupressure, Hydrotherapy, Naturopathy and Ayurvedic medicine. -HERBAL INDEX: Onhealth.com offers the most comprehensive herbal database on-line. Users have access to general descriptions, target ailments, preparations and special information on a wide variety of herbs including Echinacea, Gingko, St. John's Wort and many others. 6 -RECOMMEND A DOCTOR: Onhealth.com has assembled a nationwide database of good doctors that have been recommended by its community of users. Over two thousand exceptional doctors are currently listed, and the database continues to grow. -DISCUSSION GROUPS: Onhealth.com provides a forum to discuss health issues and conditions with other consumers. In-depth reports and Ask Our Experts provide the catalyst for discussion among consumers within these groups, and information can be integrated within discussions to provide a meaningful environment. -MEDICAL ADVISORY BOARD: Onhealth.com has assembled an active Medical Advisory Board made up of specialists from the Condition Center partner institutions. The board also includes a large panel of doctors who review and update the Company's condition reference material. -INTERCONNECTED DATABASES AND SITE SEARCH: Since the entire site is databased, onhealth.com is the most dynamically interrelated health site on the web. Each page is categorized and cross-indexed so the most relevant information from across the site is readily available to the user on any given subject. CONTENT DEVELOPMENT The Company's goal for its editorial content is to continue to create high-value, useful, accessible, and trustworthy editorial elements for its users. By developing such content, the Company differentiates itself from "lifestyle" health sites and the medical and scientific jargon of "clinical" health sites. The editorial staff, working with the health and medical editors, controls all content on a daily basis. In general, the Company obtains and produces content for the onhealth.com site in one of three ways: (1) PROPRIETARY: Created exclusively for OnHealth by Company employees or high quality contractors who are experienced medical or scientific writers; (2) SYNDICATED: Licensed for distribution via OnHealth, on an exclusive or non-exclusive basis following review by the Company's staff editors; and (3) LINKED: OnHealth may "point" to other content elsewhere on the World Wide Web. Although linked content is not exclusive to OnHealth, the Company adds value by finding and pre-qualifying the best health-related content on the Internet. OnHealth currently has content relationships with the following organizations: Reuters AccuWeather New England Journal of Medicine/Massachusetts Medical Society International Diabetes Center Mount Sinai Cardiovascular Institute Beth Israel Deaconess Cancer Center Time Life Medical Additional content to be added to the network in the future may include high-value content, which may be licensed in the context of user models that go beyond advertising support. Management believes that through a combination of these content strategies, the OnHealth brand can create a unique product that will have more user value and therefore a potential for greater levels of usage than any health related content now on the World Wide Web. TARGETED DEMOGRAPHIC Onhealth.com is targeted to well-educated, technology adopting women aged 25-54 who are proactive in seeking information to actively maintain their health and well-being and reactive in addressing health and medical issues. OnHealth's audience is skewed predominantly female, as they are the key healthcare decision-makers within the household. According to International Data Corporation, women are expected to represent approximately 51% of on-line users in 1999, up from 46% in 1998. OnHealth believes that women represent an attractive demographic for advertisers since women have a disproportionate control over consumer spending in the United States. Industry experts estimate that women make 75% of the household's healthcare decisions, control 66% of the health dollars and spend 80% of a household's discretionary income. 7 UNIQUE USERS According to an article in the October 19, 1998 issue of Business Week, there are an estimated 15,000 health and wellness web sites today. Even though the re-launch of onhealth.com was on July 20, 1998, Media Metrix, the leading provider of measurement services for the Internet and digital technologies, in their December 1998 US Report, stated that 458,000 unique users visited onhealth.com, ranking the site third among health sites. This number of unique visitors represents more than a 60% increase from the October report, ranking onhealth.com the third most trafficked consumer health and wellness site. The Company plans to aggressively grow its unique user base. Onhealth.com's independent and unique content, ownership rights of the content and wide audience appeal allows the Company to enter into flexible and versatile strategic relationships to drive traffic. The Company believes that its primary source for driving traffic will result from distribution and marketing agreements. DISTRIBUTION OnHealth intends to leverage existing and planned distribution agreements in its execution of a business model that will generate rapid growth in reach and page views, thereby creating opportunities to generate multiple revenue streams. The Company has and will continue to enter into distribution agreements with leading search engine and portal companies, major Internet access providers, community, news, information and content and other specialty sites, media companies, promotional programs, other traditional media and corporate/HMOs. Distribution agreements serve to build the brand and to drive significant traffic to the onhealth.com Web site. By increasing its brand exposure and traffic through significant distribution agreements, onhealth.com will seek to be the most effective means of advertising health-related products on the Internet. Current distribution relationships include: SEARCH ENGINES AND PORTALS: THE GO NETWORK. With over 19.8 million unique visitors per month, as of January 1999, Go Network is one of the largest sites on the web. As one of only three Go Network Health Channel Premier Partners, onhealth.com has a major branded presence - an above the fold four-color logo button - and Daily Briefing headlines on the Go.com Health Channel Home page. In addition, OnHealth's content is featured prominently on the health related sub-channels throughout the site: "Health News & Information," "Eating Right & Looking Good," "Fitness" and "Wellness." PLANET DIRECT. As a featured Health Content Partner for Planet Direct - a comprehensive, personalized directory of online services - Planet Direct features access to OnHealth's Daily Briefing, Daily Health Tips, Conditions A-Z database, pharmacy resources, In-Depth Reports, Condition Centers, Herbal Index and links to OnHealth Resource areas. Planet Direct carries many of OnHealth's Ask our Experts, such as "Sex Matters", "Power to the Patient", "Alternative Health" and "A Woman's Body". In addition, OnHealth's logo appears on Planet Direct's homepage with a direct link to the Company's web site. Planet Direct is co-branded by more than 450 Internet Service Providers nationwide and affinity groups like RE/MAX, the U.S. Chess Federation, and Discover Card. Planet Direct, a wholly owned subsidiary of CMGI, is a personal Web service that tailors members' online experience to their interests and local community. By integrating brand name editorial content with enhanced links to popular sites and services, Planet Direct provides mainstream consumers with essential, everyday information such as news, weather, and financial data in a logical and intuitive manner, ensuring easy access to personal interests in a community atmosphere. NBC'S SNAP! As a featured content provider for the Snap! Health channel, OnHealth provides access to Daily Briefing, In-Depth Reports and partner content pages for over 180 conditions that are prominently promoted throughout the health channel. Snap! is a free Internet directory, search and navigation service that offers the most powerful way to organize and find anything on the Internet. The service is logically arranged to give users the quickest route to the best of what they are looking for on the Web, providing efficient, high-quality search results and directory listings and the most often-used content. At the heart of the Snap! portal service is a directory of Web sites, built by a team of editors and reviewers to ensure its quality, freshness and usefulness. Users may either search the directory by using key words, or browse through the directory's topics, including: Arts & Humanities, Business & Money, Computing & Internet, Entertainment, Education, Health, Kids & Family, Living, Local, News & Media, Oddities, People & Society, Science & Technology, Shopping, Sports and Travel. 8 MICROSOFT'S WEBTV: Under the terms of an agreement with WebTV, Inc., a subsidiary of Microsoft Corporation, onhealth.com is the primary supplier the health and wellness content for the Explore Reference and Health category receiving prominent placement and promotion on the WebTV homepage. Onhealth.com provides WebTV Network service subscribers with many unique features, including access to Daily Briefing, In-Depth Reports, Ask Our Experts, Condition Centers and Resource areas. YAHOO! CHAT: OnHealth works with Yahoo! Chat to produce weekly audience driven, interactive discussions with the country's most prominent health and wellness experts. Focusing on the most probing and crucial health issues of the day, the chats take place Wednesdays at 6 p.m. Eastern (3 p.m. Pacific). The chat programming is being promoted on both onhealth.com and the front page of Yahoo! Chat and run of site on Yahoo. INTERNET SERVICE PROVIDERS AND OTHER: MINDSPRING. As a Health Content Partner for MindSpring, Onhealth's four-color logo is prominently featured with direct links to onhealth.com. Onhealth supplies health and wellness information, including In-Depth Reports and Ask Our Experts, within the Health area. MindSpring is a leading Internet service provider focused on delivering outstanding service and support to its customers. MindSpring's dial-up subscribers can browse the World Wide Web, send electronic mail, participate in informative online chats and access over 20,000 newsgroups. MindSpring offers local Internet service in more than 360 locations throughout the United States. MindSpring is also a leading provider of Web Hosting services and domain registrations. iSYNDICATE: iSyndicate, the Web's leading content syndication service, will feature access to OnHealth's Daily Briefing, Ask Our Experts, and In-Depth Reports as part of its free Express Service, now serving over 18,432 sites. As of the end of February, there were 121 sites carrying OnHealth's headlines. With a few easy steps, iSyndicate Express allows affiliate sites to integrate selected headlines on their pages, which link to the content provider's site for the full-text article. Headline links are dynamically served and automatically updated, allowing affiliate sites to feature fresh, professional content, and allowing content providers to reach desirable new audiences, build their brand, and drive traffic to their site. Onhealth.com joins some of the Web's leading content providers as part of iSyndicate's Express service, such as CNET, ZDNet, Reuters and TheStreet.com. MOTOROLA: Motorola's i Kno! network features OnHealth's Daily Briefing. Pager customers can also choose to have the Daily Briefing sent directly to their pagers. Motorola's technology offers paging companies a broad range of information preformatted and ready for inclusion in service bundles that the carrier then offers to its customers. In addition too onhealth.com's health news, i Kno! offers standard news features such as local weather and traffic, sports, movie reviews, national and international news, and financial information. COMMUNITY: GEOCITIES. OnHealth is the exclusive content provider of health information on GeoCities. OnHealth provides health news and information to GeoCities, which is featured in the "Health" Avenue. Onhealth.com's headlines are also featured throughout the Health sub-avenue and subsequent topic pages, where users can seamlessly link to onhealth.com to access the complete stories. NEWS, INFORMATION AND CONTENT SITES: AOL'S DIGITAL CITY NEW YORK: OnHealth provides the first local health-related content area on AOL's Digital City New York. The "Health Guide" provides consumers with OnHealth's branded network of interactive health and wellness information as well as local news, community resources and listings of health events, classes and support groups. OnHealth offers to Digital City New York's users reliable health information and tools that empower them to make better decisions about themselves their family's healthcare. OnHealth's Recommend a Doctor Database provides a listing of New York doctors ranked "good", "great" or "amazing" by their patients; the Conditions A-Z database and Ask Our Experts, including "A Woman's Body," "Sex Matters," and "Holistic 9 Pediatrician." Digital City, Inc. is the nation's largest and the Internet Online's most popular local city resource and community guide. Digital City reaches more than 3 million people every month, provides an array of interactive products in 50 cities, an delivers locally relevant news, community resources, entertainment and commerce in a dynamic and easy-to-use format. Available on America Online at Keyword: Digital City, on CompuServe's Local Channel, on Netscape's NetCenter and on the Web at www.digitalcity.com, Digital City combines useful local information, expert reviews, and the personal contributions of the people who use the service to help residents get the most from their communities. Based in Vienna, VA, Digital City, an AOL Studios business, is owned primarily by America Online and Tribune Company. THIRDAGE: As a primary health content provider, ThirdAge features OnHealth's Daily Health Tip, In-Depth Reports, Conditions A-Z, and Personal Health Tracker within the Health Channel. ThirdAge Media is the leading media company for aging boomers--ThirdAgers--the fastest growing segment of the population in the United States and worldwide. Third Age Media embraces a fully integrated approach to communication through a branded Web site, ThirdAge.com; news syndicate and electronic distribution channel, Third Age News; and a market research arm, Third Age Research. ADVANCE INTERNET: Onhealth.com provides health and wellness content for Advance Internet's network of sites (www.advance.net), including New Jersey Online, Alabama Live, Oregon Live, Michigan Live and more. Advance Internet's users can access onhealth.com's, Daily Health Tips, OnHealth Live, In-Depth Reports, Ask Our Experts, and Daily Briefing, from their local sites. Advance Internet is a subsidiary of Advance Publications Inc., owner of newspapers in 22 cities as well as Conde Nast magazines; CondeNet; Parade; and React. Advance Internet Inc. is currently responsible for the development and management of non local Web sites that are created in alliance with newspapers owned and operated by Advance Publications Inc. COMCAST ONLINE COMMUNICATIONS. As a Content Provider for Comcast Online Communications, OnHealth's four-color logo is prominently featured with direct links to the OnHealth site. Onhealth.com's content, including Daily Briefing, Daily Health Tips, In-Depth Reports, Ask Our Experts, and OnHealth Live, are prominently featured in the Health Channel that serves 22 markets of the InYourTown.com sites and for the Comcast@Home service. Comcast's popular InYourTown.com sites can take users directly to OnHealth's localized City Health Guides. Comcast Online Communications, through its partnership with @Home Network, offers residential customers the fastest, easiest, and most entertaining way to access the Internet from home in six markets. InYourTown provides unique and local Internet content for Comcast@Home subscribers, as well as all Internet users in 23 Comcast Cable markets. SAN FRANCISCO CHRONICLE AND NBC AFFILIATE KRON THE TAMPA TRIBUNE AND NBC AFFILIATE WFLA These strategic relationships will enable OnHealth to build brand awareness, drive end-user traffic to the Web site, generate interest with potential and prospective distribution partners, and create visibility for its content. OnHealth's strategy is to continue to enter into distribution relationships to build the OnHealth brand and drive traffic to onhealth.com. MARKETING & PROMOTION The Company's media plan is designed to build brand awareness and drive traffic to the Company's onhealth.com web site. The Company has hired TBWA/Chiat/Day as its advertising agency of record, Fleishman-Hillard as its public relations agency and Thinking Media as its interactive agency. The Company's integrated marketing campaign is expected to begin in the second quarter of 1999 and will extend over several quarters. The campaign will consist of advertising online as well as advertising via television, radio, magazines, newspapers and tactical outdoor ad placements. The Company's strategy includes effectively communicating that onhealth.com is an indispensable resource for helping consumers manage their family's health. 10 ADVERTISING REVENUE OnHealth believes its demographic audience and its ability to target specific users of its site will be attractive to pharmaceutical and other advertisers. OnHealth believes it is able to create a differentiated and productive advertising environment by providing the following: -Targeted programs to reach the most desirable consumers -A wide variety and depth of sponsorship areas -Long-term exclusive relationships for highly prized condition-specific content -Creative, beyond-banner programs that appeal to more aggressive advertisers -Personalization and key word targets that provide flexible cross-site delivery Initially, The Company intends to continue to target pharmaceutical advertisers, and as the Company achieves critical mass, the demographics of the target user should appeal to a broader range of advertisers such as consumer goods companies and others. OnHealth utilizes an internal advertising sales department. Since launching the site, onhealth.com has developed advertising relationships with the following companies: Johnson & Johnson Astra Pharmaceuticals Merck & Co. Schering-Plough Proctor & Gamble Roche Laboratories Enzymatic Therapy Glaxo Wellcome SmithKline Beecham Eli Lilly Citibank Kellogg's American Lung Association Ortho Biotech Behealthynow.com Pfizer Biogen Women.com Talkway.com Greentree Nutrition Cancer Treatment Centers of America General Motors Jamieson Vitamins 1-800 Doctors Lifewise Insurance Hoescht Selfcare 11 E-COMMERCE The Company believes that for OnHealth to be the single best on-line destination for consumers to manage their health and well-being that it must offer product purchasing to its consumers. Of the 17 million adults in the U.S. searching on-line for health and medical information, approximately 50% of these adults made off-line purchases after seeking information on the Internet, according to Cyber Dialogue. OnHealth plans to launch a shopping page in the first quarter of 1999. OnHealth plans to partner with various e-commerce sites to offer a wide variety of prescription and over-the-counter ("OTC") drugs, vitamins/minerals, herbs, supplements, medical/health-related supplies, everyday health and wellness essentials, beauty products, books, insurance, financial services and other appropriate products and services. OnHealth's model is to generate revenue by focusing on any or all of three areas: 1) fees for guaranteed impressions, 2) slotting fees and 3) revenue sharing. OnHealth has recently partnered with drugstore.com as its exclusive on-line drugstore. The agreement consists of several major components to be rolled out in a multi-phased approach. The first phase consists of drugstore.com advertisements placed throughout the onhealth.com site. The second phase consists of establishing links from onhealth.com to drugstore.com through the network allowing OnHealth's users to purchase products sold by drugstore.com. For example, a user searching for information on arthritis will be offered the latest news, in-depth reports, discussion groups, and links to related OTC products. The links connecting consumers to drugstore.com's inventory will be clearly identified as advertisements, giving users immediate access to products related to their area of interest. To ensure a smooth transition for users going from onhealth.com to drugstore.com, the OnHealth logo and return button will be prominently featured on the entry and exit pages on drugstore.com that are accessed by OnHealth users. TECHNOLOGY AND SYSTEMS The Company's Web site is made available with the latest Internet hardware and software technologies. Exodus IT-class co-location facilities provide the Company with a secure, high availability and high bandwidth space for its servers. This includes redundant OC-3 and OC-12 backbone connections to the Internet, uninterruptible power supplies with diesel generator backup, all housed in a copper-lined, earthquake-proof building. Direct connections via "T-1" and DSL lines allow the main office to connect seamlessly and reliably to the servers and the Internet. A farm of Intergraph IS-8000 and IS80 mission-critical servers are housed behind a redundant F5 Big/IP switcher for complete software and hardware fault tolerance and load leveling. These servers run Microsoft Windows NT Enterprise Server with Internet Information Server 4.0, Active Server Pages with a proprietary page caching system and publishing tools for Web page hosting and production management. The resulting performance in preliminary tests shows dominance over other competitive sites. All advertisement hosting and reporting is handled through NetGravity Ad Server, a powerful ad management and forecasting toolset. The Web site's Personal Health Tracker and Search features utilize Microsoft SiteServer tools and technologies. This provides the customized Web crawling, user profile management, nightly process runs and e-mail support that the Personal Health Tracker requires. Microsoft SQL Server databases are heavily used for all content, process management and tracking needs. Offsite backups occur regularly throughout the day to protect against a total system failure. The Company believes the site has been built from the ground up as an extremely stable, scaleable, and high performance solution for OnHealth's current and future needs. See "FACTORS THAT MAY AFFECT FUTURE RESULT--Risks Related To System Operation." COMPETITION The editorial environment in interactive media is new, highly competitive and rapidly evolving. Since the Internet's commercialization in the mid-1990's, the number of Web sites on the Internet competing for consumers' attention and spending has proliferated with no substantial barriers to entry, and the Company expects that competition will continue to intensify. The Company competes, directly and indirectly, for users, distributors, advertisers and content 12 providers. The Company believes that the principal competitive factors in attracting and retaining users is the depth, breadth and timeliness of content, the ability to offer compelling and relevant content and brand recognition. Other important factors in attracting and retaining users include ease of use, service quality and cost. ONLINE COMPETITORS There is significant interest in health-related content among online consumers. Demographic factors and the growth of online audiences suggest that the popularity of this content will continue to increase. Similarly, major health advertisers are showing increased levels of interest in the Internet. The key operators of health-related sites on the Internet today include: DIVISIONS OR AFFILIATES OF PRINT PUBLISHERS; including Healthy Ideas (Rodale Press), PHYS (Conde Nast), Thrive (owned by Oxygen Media), MediConsult, Dr. Koop and HealthScout (a service of RX Remedy, Inc., a market research firm.) VENTURES OF ONLINE SERVICE FIRMS; including Better Health (iVillage) and Thrive (owned by Oxygen Media), Medscape and WebMD. PUBLIC SECTOR AND INSTITUTIONAL SITES; including the National Institute of Health, Mayo Clinic, InteliHealth and university sites. While these sites compete for viewer time and attention, they do not typically compete for advertising or transactional revenues. PORTALS/SEARCH ENGINES; principally the proprietary health-related content presented to subscribers to America Online, MSN.com, Yahoo!, Excite, etc. INTERNET SITES OTHER THAN HEALTH-RELATED SITES; including general interest sites, such as news sites and search engines, which often host some health-related content in the context of other editorial materials. OTHERS In addition, the online sites compete to some extent with other media, including print and television. The Company believes the principal competitive factors which differentiate OnHealth from competing brands and sites include the onhealth.com brand name, the independence and uniqueness of content, the users' perception of content interactivity, content reliability and trustworthiness, design and usability factors, comprehensiveness and level of promotion. This level of competition may result in an environment in which content or promotional expenses to the Company increase. It may also result in a higher level of competition for key promotional vehicles. The known and prospective competitors to the Company are often significantly larger and better financed than the Company and will likely be better able to afford a more intense competitive environment than the Company. See "FACTORS THAT MAY AFFECT FUTURE RESULTS--Competition." INTELLECTUAL PROPERTY The Company regards its copyrights, service marks, trademarks, trade secrets, proprietary technology and similar intellectual property as critical to its success, and relies on trademark, copyright, trade secret and patent protection to protect its proprietary rights. While the Company tries to assure that the quality of its brand is maintained through such actions, there can be no assurance that steps taken by the Company to protect its proprietary rights will be adequate or that third parties will not infringe on the Company's intellectual property. In addition, there can be no assurance that third parties will not assert infringement claims against the Company which, even if not meritorious, could result in the expenditure of substantial resources and management effort. EMPLOYEES As of December 31, 1998, the Company employed 34 people on a full-time basis. Of the total, 18 were in product development, 10 in sales and marketing and six (6) in general and administrative. When conditions demand it, the Company also uses part-time employees. None of the Company's employees are represented by a labor union and the Company considers its relationship with its employees to be good. 13 The Company believes that some measure of its future success is dependent upon attracting and retaining qualified employees, and competition for hiring such employees is intense. FACTORS THAT MAY AFFECT FUTURE RESULTS In addition to other information in this Annual Report on Form 10-K, the following factors should be considered in evaluating the condition and prospects of the Company. These factors may have a significant impact on the Company's future operating results. RELIANCE ON EXTERNAL FINANCING. We completed a $14.3 million private placement of common stock in January 1999. Based on the private placement and our cash and cash equivalents at December 31, 1998, we expect to have sufficient resources to meet our ongoing financial obligations and operate at least through December 31, 1999. Our operations generated a negative cash flow during 1998. The degree to which we are a net user of cash may increase during the calendar 1999, as a result of the expansion plans for the OnHealth network and our marketing and distribution relationships and as a consequence of focusing on a new business model. We are exploring and will continue to explore external financing to ensure continued operations beyond December 31, 1999. There can be no assurance that additional capital, on a debt or equity basis, will be found, or if found that it will be on economically viable terms. If additional funds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our shareholders will be reduced, shareholders may experience additional dilution and such securities may have rights, preferences or privileges senior to those of the holders of common stock. LIMITED OPERATING HISTORY AND ACCUMULATED DEFICIT; CONTINUING OPERATING LOSSES. We were incorporated in 1990 and have been operating continuously since 1991. However, we have only been active online since 1996 and the OnHealth network web site was established in July 1997 and relaunched in July 1998. Because of this limited history on the Internet, there is little information investors can use to analyze our financial results relating to our Internet web site. Since 1990, we have generated an accumulated deficit of approximately $90 million (through December 31, 1998). Our ability to generate profits depends upon our ability to attract consumers to our web site and how we leverage those visits. This means we need to create significant revenue streams from our web site, earn substantial gross margins on those revenue streams and control our costs of operation. We anticipate continued significant operating losses at least through 1999, as the OnHealth web site is improved and marketed and the OnHealth network is enhanced. There can be no assurance that profitability will ever be attained. SHIFT TO ADVERTISING REVENUES MAY NOT REPLACE REVENUES FROM SALES OF CD-ROMS. Since we began operations in 1990 and until early 1998, most of our revenues were based on development, sales and support of CD-ROM titles. In January 1998, the new management team changed our core business focus to Internet web site hosting of health care related content and the dissemination of health and wellness information from our web site. The principal form of revenue from this business model is advertising. Revenues from CD-ROMs have declined significantly since 1995; however, advertising revenues may never be sufficient to offset such declines in revenue. There is little information available to assess the potential profitability or viability of our business. In other words, we essentially face the same risks and uncertainties of any new venture, and there can be no assurance that we will be any more successful in this venture than in our previous business activities. RELIANCE ON ADVERTISING REVENUES. We anticipate that a substantial portion of our revenues will come from the sale of advertisements on our web pages. Our strategy is to continue to develop advertising and other methods of generating revenues. We are in the early stages of licensing our products and technology and in implementing our advertising program. To generate significant advertising revenues, several things need to happen: 1. Advertisers must accept the Internet as an attractive place to advertise; 2. We need to attract a large number of consumers to our web site; and 3. Those consumers need to have demographic characteristics attractive to advertisers. IMMATURE ADVERTISING MARKET. There is fluid and intense competition in the sale of advertising on the Internet. Advertising rates quoted by different vendors vary widely, which makes it difficult to project future levels of 14 advertising revenues. Further, significant and consistent use of the Internet by many advertisers depends upon confirmation that the Internet is an effective advertising medium. To date, advertisers have not by their actions become convinced of that. The Internet as an advertising medium has not been available for a sufficient period of time to gauge its effectiveness as compared with traditional advertising media. No standards have been widely accepted for the measurement of the effectiveness of Internet-based advertising. Internet advertising rates are based in part on third-party estimates of users of an Internet site (referred to as "impressions"). Such estimates are often based on sampling techniques or other imprecise measures, and may materially differ from our estimates. We do not know if advertisers will accept our or other parties' measurements of impressions. Filter software programs that limit or remove advertising from an Internet user's desktop are available to consumers. Widespread adoption or increased use of such software by users or the adoption of such software by certain Internet access providers could have a material adverse effect upon the viability of advertising on the Internet and on our business, results of operations and financial condition. SHORT TERM NATURE OF ADVERTISING CONTRACTS; GUARANTEE OF MINIMUM IMPRESSION LEVELS. Substantially all of our advertising contracts have been for terms averaging one to three months in length, with relatively few longer-term advertising contracts. Many of our advertising customers have limited experience with Internet advertising, and may not believe Internet advertising to be effective compared to traditional advertising media. We cannot assure you that our current advertisers will continue to purchase advertisements on our web site. Our advertising contracts typically guarantee the advertiser a minimum number of impressions. To the extent that minimum impression levels are not achieved for any reason, we may be required to "make good" or provide additional impressions after the contract term. Providing additional impressions may adversely affect the availability of advertising inventory. This may, in turn, adversely affect our business, results of operations and financial condition. NEED TO ENHANCE AND DEVELOP ONHEALTH.COM TO REMAIN COMPETITIVE. To remain competitive, we must continue to enhance and improve the responsiveness, functionality and features of onhealth.com and develop other products and services. Enhancements of or improvements to our web site may contain undetected programming errors that require significant design modifications, resulting in a loss of consumer confidence and user support and a decrease in the value of our brand name recognition. We plan to develop and introduce new features, functions, products and services, such as increased capabilities for user personalization and interactivity. This will require the development or licensing of increasingly complex technologies. We may not succeed in developing or introducing features, functions, products and services that will attract consumers. Such failure would likely have a material adverse effect on our business, results of operations and financial condition. FAILURE TO ACHIEVE BRAND IDENTITY. We believe that establishing and maintaining brand identity is a critical aspect of our efforts to attract and expand our user base, Internet traffic and advertising relationships. We believe that brand recognition will become increasingly important because of the minimal barriers to entry for competing web sites. We intend to increase our brand awareness through advertising campaigns in publications, radio, online media and other marketing and promotional efforts. If we cannot build a brand recognition that consumers (and eventually advertisers) seek out, we will likely be unable to generate revenues. Developing brand recognition is a complex process. It depends, in part, on our success in providing a high quality experience. The value of our brand could be diluted by a variety of events, including poor consumer or advertiser reaction to our web site and services offered on the web site. UNPREDICTABILITY OF FUTURE REVENUE STREAMS; POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS. Because our online operating history is very limited and the economics of the Internet are still evolving, it is difficult to forecast future revenues with a high degree of accuracy. The advertising and retail industries typically experience their best quarter in the fourth quarter of each year, and to the extent that we rely upon advertising revenues, our revenues could similarly fluctuate. Due to the health-related nature of editorial content, however, we believe that our revenues may not be as seasonal as the remainder of the advertising and retail industries. Since our expense levels are based upon anticipated advertising and licensing revenue, we may not be able to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. Accordingly, any significant shortfall in relation to our expectations would have an immediate adverse impact on our business, results of operations and 15 financial condition. In addition, we plan to increase significantly our operating expenses to develop new distribution channels, fund greater levels of research and development, increase our sales and marketing operations, broaden our customer support capabilities and establish brand identity and strategic alliances. DEPENDENCE ON THIRD-PARTY RELATIONSHIPS. We are and will continue to be significantly dependent on a number of third-party relationships to increase traffic on onhealth.com and thereby generate advertising revenues and maintain the current level of service and variety of content for our users. We are generally dependent on other web site operators that provide links to onhealth.com. Most of our arrangements with third-party Internet sites and other third-party service providers do not require future minimum commitments to use our services, are not exclusive and are short-term or may be terminated at the convenience of the other party. Moreover, we do not have agreements with the majority of other web site operators that provide links to onhealth.com, and such web site operators may terminate such links at any time without notice. There can be no assurance that third parties regard our relationship with them as important to their own respective businesses and operations, that they will not reassess their commitment to us at any time in the future or that they will not develop their own competitive services or products. There can be no assurance that we will be able to maintain relationships with third parties that supply us with software or products that are crucial to our success, or that such software or products will be able to sustain any third-party claims or rights against their use. Also, we cannot assure you that the software, services or products of those companies that provide access or links to our services or products will achieve market acceptance or commercial success. Accordingly, we cannot assure you that our existing relationships will result in sustained business partnerships, successful service or product offerings or the generation of significant revenues for us. Failure of one or more of our strategic relationships to achieve or maintain market acceptance or commercial success or the termination of one or more successful strategic relationships could have a material adverse effect on our business, results of operations and financial condition. COMPETITION. There are a number of competitors currently delivering online health content, and it is likely that more competitors will emerge in the near future. Many of today's competitors are better financed, have longer operating histories and better brand recognition than we do, and some have internal distribution or cross-promotional opportunities to support their online ventures that we do not have and can not replicate for a reasonable investment. It is possible that existing or emerging competitors may be able to secure critical editorial content or distribution relationships on an exclusive basis, or may raise a provider's expectation about the value of such assets. For these reasons, increased competition may result in diminished profit margins, market share or brand value. The intense competition in the consumer software business continues to accelerate as an increasing number of companies, many of which have financial, managerial, technical and intellectual property resources greater than ours, offer products that compete directly with one or more of our products or services. We believe that the principal competitive factors in attracting advertisers include the amount of traffic on our web site, brand recognition, customer service, the demographics of our user base, our ability to offer targeted audiences and the overall cost effectiveness of the advertising medium we offer. We believe that the number of Internet companies relying on Internet-based advertising revenue, as well as the number of advertisers and the number of users, will increase substantially in the future. Accordingly, we will likely face increased competition, resulting in increased pricing pressures on our advertising rates, which could have a material adverse effect on our business, results of operation and financial condition. See "BUSINESS--Competition." DEPENDENCE ON KEY PERSONNEL. Our development and operation is substantially dependent on the services of our President and Chief Executive Officer, Robert N. Goodman and on our General Manager, Rebecca Farwell. The loss of either Mr. Goodman's or Ms. Farwell's services could materially and adversely affect our business prospects. We are also dependent on the continued service of certain other key management as well as our software engineering personnel, the loss of whose services could significantly delay the achievement of our planned development objectives. We have not purchased key man life insurance on any of our personnel. Achievement of our business objectives will require substantial additional expertise in the areas of technology, finance, and marketing. We actively seek additional qualified personnel. Competition for qualified personnel is intense, and the loss of key personnel, or the inability to attract and 16 retain the additional highly skilled personnel required for the expansion of our activities, could have a material adverse effect on our business, results of operations and financial condition. RELIANCE ON INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS. We regard substantial elements of our web site and underlying technology as proprietary and attempt to protect them by relying on trademark, service mark, copyright and trade secret laws and restrictions on disclosure and transferring title and other methods. We also have entered into confidentiality agreements with our consultants and in connection with our license agreements with third parties and generally seek to control access to and distribution of our technology, documentation and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use our proprietary information without authorization or to develop similar technology independently. Effective trademark, service mark, copyright and trade secret protection may not be available in every country in which our services are made available through the Internet, and policing unauthorized use of our proprietary information is difficult. Legal standards relating to the validity, enforceability and scope of protection of certain proprietary rights in Internet-related businesses are uncertain and still evolving, and no assurance can be given as to the future viability or value of any of our proprietary rights. There can be no assurance that the steps taken will prevent misappropriation or infringement of our proprietary information, which could have a material adverse effect on our business, results of operations and financial condition. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Such litigation might result in substantial costs and diversion of resources and management attention. We cannot assure you that our business activities will not infringe upon the proprietary rights of others, or that other parties will not assert infringement claims against us, including claims that by directly or indirectly providing hyperlink text links to web sites operated by third parties. Moreover, from time to time, we may be subject to claims of our alleged infringement of the trademarks, service marks and other intellectual property rights of third parties. Such claims and any resultant litigation, should it occur, might subject us to significant liability for damages, might result in invalidation of our proprietary rights and, even if not meritorious, could result in substantial costs and diversion of resources and management attention and could have a material adverse effect on our business, results of operations and financial condition. We currently license from third parties certain technologies incorporated into onhealth.com. As we continue to introduce new services that incorporate new technologies, we may be required to license additional technology from others. We cannot assure you that these third-party technology licenses will continue to be available on commercially reasonable terms, if at all. Additionally, we cannot assure you that the third parties from which we currently license our technology will be able to defend their proprietary rights successfully against claims of infringement. As a result, any inability to obtain these technology licenses could result in delays or reductions in the introduction of new services or could adversely affect the performance of our existing services until equivalent technology can be identified, licensed and integrated. LIABILITY FOR INFORMATION RETRIEVED FROM OR TRANSMITTED OVER THE INTERNET; LIABILITY FOR PRODUCTS SOLD OVER THE INTERNET. Because materials may be downloaded by the online or Internet services that we operate or the Internet access providers with which we have relationships and may be subsequently distributed to others, there is a potential that claims will be made against us for defamation, negligence, copyright or trademark infringement or other theories based on the nature and content of such materials. In addition, the increased attention focused upon liability issues and legislative proposals could materially impact the overall growth of Internet use. We could also be exposed to liability with respect to third-party information that may be accessible through our web site, or through content and materials that may be posted by our users on discussion boards that we offer. Such claims might include, among others, that, by directly or indirectly providing hyperlink text links to web sites operated by third parties, we are liable for copyright or trademark infringement or other wrongful actions by such third parties through such web sites. It is also possible that, if any third-party content information provided on our web site contains errors, third parties could make claims against us for losses incurred in reliance on such information. Even to the extent such claims do not result in liability, we could incur significant costs in investigating and defending against such claims. The imposition of potential liability for information carried on or disseminated through our systems could require us to implement measures to reduce our exposure to such 17 liability, which may require the expenditure of substantial resources and limit the attractiveness of our services to users. Our general liability insurance may not cover all potential claims to which we are exposed or may not be adequate to indemnify for all liability that may be imposed. Any imposition of liability that is not covered by insurance or is in excess of insurance coverage could have a material adverse effect on our business, results of operations and financial condition. RISKS RELATED TO SYSTEM OPERATION. All companies that rely on the Internet are dependent upon the continuous, reliable and secure operation of Internet servers and related hardware and software. To the extent that service is interrupted, consumers will be inconvenienced and commercial clients will suffer from a loss in advertising or transaction delivery. These shortfalls would directly result in a revenue loss. Our computer and communications hardware are protected through physical and software safeguards. However, they are still vulnerable to fire, earthquake, flood, power loss, telecommunications failures, physical or software break-ins and similar events. We do not have full redundancy for all of our computer and telecommunications facilities and do not carry business interruption insurance to protect us in the event of a catastrophe. Such an event could lead to significant negative impacts on our operating results and financial condition. We are also dependent upon third parties to provide potential users with web browsers and Internet and online services necessary for access to our web site. In the past, users have occasionally experienced difficulties with Internet and online services due to system failures, including failures unrelated to our systems. Any sustained disruption in Internet access provided by third parties could have a material adverse effect on our business, results of operations and financial condition. IMPACT OF THE YEAR 2000. The Year 2000 issue is the potential for system and processing failures of date-related data and the result of computer-controlled systems using two digits rather than four to define the applicable year. For example, computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices or engage in similar normal business activities. We could be affected by Year 2000 issues related to non-compliant information technology ("IT") systems or non-IT systems that we operate or that are operated by third parties. We have substantially completed assessment of our internal and external (third-party) IT systems and non-IT systems. At this point in our assessment, we are not currently aware of any Year 2000 problems relating to systems we operate or that are operated by third parties that would have a material effect on our business, results of operations or financial condition, without taking into account our efforts to avoid such problems. Based on our assessment to date, we do not anticipate that costs associated with remediating our non-compliant IT systems or non-IT systems will be material, although there can be no assurance to such effect. To the extent that our assessment is finalized without identifying any additional material non-compliant IT systems we operate or that are operated by third parties, the most reasonably likely worst case Year 2000 scenario is a systemic failure beyond our control, such as a prolonged telecommunications or electrical failure. Such a failure could prevent us from operating our business, prevent users from accessing our web site, or change the behavior of advertising customers or persons accessing our web site. We believe that the primary business risks, in the event of such failure, would include, but not be limited to, lost advertising revenues, increased operating costs, loss of customers or persons accessing our web site, or other business interruptions of a material nature, as well as claims of mismanagement, misrepresentation, or breach of contract, any of which could have a material adverse effect on our business, results of operations and financial condition. We have not made any contingency plans to address such risks. MANAGEMENT OF POTENTIAL GROWTH. To accommodate the demand of additional editorial content and distribution channels for the OnHealth network, the employee base could grow significantly from the December 31, 1998 level of 34 employees. The expansion of our workforce could place a significant strain on our management, financial resources and infrastructure. We cannot assure you that we will be able to attract and retain employees with the appropriate skill sets, or that we will be able to manage growth effectively. If we are unable to manage growth in the coming years, there could be an adverse affect on our operations. 18 RISK ASSOCIATED WITH CERTAIN LITIGATION. In February 1996, an action in the District Court of Hennepin County (Minnesota) was brought by T. Randal Productions et al. against the Company and one current and two former employees. The plaintiffs made various allegations, including misappropriation of corporate opportunities and trade secrets by the Company and its employees and sought award of monetary damages, exemplary damages and royalties substantially in excess of $10.0 million. In November 1997, a jury found that there was no joint venture between T. Randal and the company and/or any of its employees but awarded T. Randal $480,000 plus interest for damages sustained to its business. Plaintiffs moved for a new trial, amended findings and for judgment notwithstanding the verdict. The jury verdict was upheld by the trial court. The plaintiffs appealed this decision to the Minnesota Court of Appeals. In March 1999, the Minnesota Court of Appeals affirmed the decision of the trial court. The Company believes the plaintiffs will petition for a rehearing which Company counsel believes will not be successful. The plaintiffs also have an action pending against certain affiliates of the Company on the same grounds on which the action against the Company was based. The Company has indemnified these affiliates against any damages arising out of these claims. Counsel has advised the Company that the jury verdict in the action against the Company should be controlling in this action against the affiliates. RELIANCE ON EXTERNAL CONTENT. We intend to produce only a portion of the editorial content that will be found on the OnHealth network. We will be reliant on third-party firms that have the expertise, technical capability, name recognition, and willingness to syndicate product content for branding and distribution by others. As health-related content grows on the web, there may be increasing competition for the best product suppliers, which may result in a competitor acquiring a key supplier on an exclusive basis, or in significantly higher content prices. Such an outcome could make the OnHealth network less attractive or useful for an end user, or could reduce our profitability. Either event would have a materially adverse impact our results. GOVERNMENTAL REGULATION AND LEGAL ISSUES. We are not governed by any laws of any government entity, other than general business and taxation regulations and the general regulations that surround online enterprises. However, with the growing popularity of online usage, various new regulations are possible which may affect privacy, intellectual property rights, marketing, pricing, content, or other issues. The adoption of additional laws in this field may reduce consumer demand for online services, or adversely impact our cost of doing business. Either outcome could have a material adverse affect on our financial results. SECURITY RISKS. Experienced programmers or "hackers" could attempt to penetrate our network security. Because a hacker who is able to penetrate our network security could misappropriate proprietary information or cause interruptions in our products and services, we may be required to expend capital and resources to protect against or to alleviate problems caused by such parties. In addition, we may not have a timely remedy against a hacker who is able to penetrate our network security. Such purposeful security breaches could have a material adverse effect on our business, results of operations and financial condition. In addition, the inadvertent transmission of computer viruses could expose us to a material risk of loss or litigation and possible liability. IMPACT OF GENERAL ECONOMIC CONDITIONS. Time spent on the Internet by individuals, purchases of new computers and purchases of membership subscriptions to Internet sites are typically discretionary for consumers and may be particularly affected by adverse trends in the general economy. The success of our operations depends to a significant extent upon a number of factors relating to discretionary consumer spending, including economic conditions (and perceptions of such conditions by consumers) affecting disposable consumer income such as employment, wages and salaries, business conditions, interest rates, availability of credit and taxation, for the economy as a whole and in regional and local markets where we operate. There can be no assurance that consumer spending will not be adversely affected by general economic conditions, which could negatively impact our results of operations or financial condition. Any significant deterioration in general economic conditions or increases in interest rates may inhibit consumers' use of credit and cause a material adverse effect on our revenues and profitability. In addition, our business strategy relies on advertising by and agreements with other Internet companies. Any significant deterioration in general economic conditions that adversely affected these companies could also have a material adverse effect on our business, results of operations and financial condition. DIVIDENDS. We intend to retain all of our earnings, if any, for use in the business and do not anticipate paying any cash dividends in the foreseeable future. Pursuant to our Articles of Incorporation and Bylaws, the payment of dividends is subject to the discretion of our Board of Directors and any terms and conditions imposed by law. 19 OTHER PRODUCT DEVELOPMENT/RESEARCH AND DEVELOPMENT In 1998, 1997, and 1996, product development expenses were $3,744,000, $4,243,000 and $5,651,000, respectively. In addition in 1997 and 1996, product development expenses paid for by third parties were $682,000 and $1,204,000, respectively. PROTECTION OF PROPRIETARY RIGHTS We regard the software we own as proprietary and rely upon a combination of copyrights, trade secret laws, employee and third-party non-disclosure agreements and other methods to protect our intellectual property. We believe that copyright protection for our intellectual property is less significant to our success than factors such as the knowledge, ability and experience of our personnel, and the quality of our new product development and distribution efforts. BACKLOG We had no significant backlog at fiscal year end of 1998, 1997, or 1996. MAJOR CUSTOMERS Three customers represent 40%, 16% and 13% of net revenue for the year ended December 31, 1998; one customer represents 12% of net revenue for the year ended December 31, 1997; and three customers represent 15%, 21%, and 11% of net revenue in 1996. The revenue recorded from the customer which represents 40% of the net revenue in 1998 was the result of a $603,000 payment received from Churchill Livingstone related to minimum sales requirements form a terminated CD-ROM distribution agreement. In 1997, we recognized revenue of $493,000 from our content agreement with America Health Network ("AHN"). Net sales to an OEM manufacturer in 1996 totaled $1,394,000. Also in 1996, we recognized $1,000,000 of revenue from our online content agreement with AT&T, which was terminated in that year. At December 31, 1998, two customers comprised 36% and 20% of outstanding accounts receivable. Two customers represented 77% and 27% of accounts receivable at December 31, 1997. ITEM 2. PROPERTIES Effective the first quarter of 1998, the Company's principal executive and administrative offices are located in Seattle, Washington. In January 1998, the Company subleased approximately 1,500 square feet of office space in Seattle, Washington on a month-to-month basis. Subsequently, the Company leased approximately 7,000 square feet of space located at 808 Howell Street, Suite 400, Seattle, Washington 98101. The lease expires July 1, 2003. Effective October 1998, the Company subleased approximately 525 square feet of office space located at 420 Lexington Avenue, Suite 300, New York, New York 10170. The lease expires in September 1999. During 1997, the Company's principal executive and administrative offices consisted of approximately 40,000 square feet in an office building in Eden Prairie, Minnesota, a suburb of Minneapolis. The lease also covered approximately 2,000 square feet of storage space. The Company terminated the Eden Prairie lease effective March 31, 1998. Prior to leasing the New York facility, the Company's sales personnel were located in an office building in Edina, Minnesota, a suburb of Minneapolis. The lease was for approximately 1,000 square feet and expired in September 1998. The Company also leases space in the following locations: (1) 4,124 square feet in an office building in Carlsbad, California ending in March 1999; and (2) 790 square feet in an office building in Carlsbad, California ending in May 1998. The Company did not renew the 790 square feet lease, and does not currently intend to renew the 4,124 square feet lease. The Company has a subtenant in the 4,124 square feet space through March 1999. ITEM 3. LEGAL PROCEEDINGS In February 1996, an action in the District Court of Hennepin County (Minnesota) was brought by T. Randal Productions et al. against the Company and one current and two former employees. The plaintiffs made various allegations, including misappropriation of corporate opportunities and trade secrets by the Company and its employees and sought award of monetary damages, exemplary damages and royalties substantially in excess of $10.0 million. In November 1997, a jury 20 found that there was no joint venture between T. Randal and the company and/or any of its employees but awarded T. Randal $480,000 plus interest for damages sustained to its business. Plaintiffs moved for a new trial, amended findings and for judgment notwithstanding the verdict. The jury verdict was upheld by the trial court. The plaintiffs appealed this decision to the Minnesota Court of Appeals. In March 1999, the Minnesota Court of Appeals affirmed the decision of the trial court. The Company believes the plaintiffs will petition for a rehearing which Company counsel believes will not be successful. The plaintiffs also have an action pending against certain affiliates of the Company on the same grounds on which the action against the Company was based. The Company has indemnified these affiliates against any damages arising out of these claims. Counsel has advised the Company that the jury verdict in the action against the Company should be controlling in this action against the affiliates. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of 1998. 21 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock, initially offered to the public on October 6, 1993 under the symbol "IVIP". Since June 17, 1998, the Common Stock has been quoted on the NASDAQ SmallCap Market system under the symbol "ONHN." The following table sets forth the high and low bid quotations for the Company's Common Stock as reported by NASDAQ for the last two fiscal years. Such quotations reflect inter-dealer prices, without retail mark-up, mark down or commission and may not necessarily represent actual transactions. HIGH LOW -------------- -------------- 1998 ---------------------- Fourth Quarter $ 6 5/8 $ 2 3/16 Third Quarter 11 3/8 3 5/8 Second Quarter 8 5/8 4 7/8 First Quarter 6 2 5/8 1997 ---------------------- Fourth Quarter $ 4 1/4 $ 2 Third Quarter 4 5/16 2 Second Quarter 3 7/8 2 1/16 First Quarter 4 1/2 2 7/8 At March 9, 1999, based on information received from the Company's transfer agent on the Company's common stock, there were approximately 160 record holders of the Company's Common Stock, excluding shareholders whose stock is held either in nominee name and/or street name brokerage accounts. The Company has never declared or paid any cash dividends on its Common Stock and does not intend to pay dividends on its Common Stock in the near future. To date, the Company has incurred losses and presently expects to retain its future anticipated earnings to finance development of and expansion of its business. The payment by the Company of dividends, if any, on its Common Stock in the future is subject to the discretion of the Board of Directors and will depend on the Company's earnings, financial condition, capital requirements and other relevant factors. RECENT SALES OF UNREGISTERED SECURITIES On April 10, 1998, the Company sold to certain investors a total of 5,000 shares of the company's Series B Convertible Preferred Stock. In addition, the Company issued to the same investors warrants to purchase a total of 66,778 shares of the Company's common stock. As an issuance to sophisticated investors not involving any public offering, the sale of the series B Convertible Preferred Stock and the issuance of the warrants was exempt under Section 4(2) of the Securities Act and Regulation D thereunder. On October 30, 1998, the Company closed a transaction involving the issuance of 1,000,898 shares of common stock. On December 14, 1998, the Company closed a transaction involving the issuance of 542,419 shares of common stock. The December 14, 1998 transaction resulted from the exercise of an put option by the Company issued to it in the October 30, 1998 transaction. The shares of common stock issued on October 30, 1998 and December 14, 1998 were issued to two different accredited investors. The terms of these issuances potentially obligated the Company to issue additional shares of common stock (depending on the future performance of the Company's common stock (the "Reset Provisions")). Such Reset Provisions only relate to those shares purchased by the two investors on October 30, 1998 and December 14, 1998. As of March 12, 1999, all of the shares of common stock subject to the Reset Provisions have been sold and no such Reset Provisions apply to any of the Company's outstanding Common stock. As an issuance to sophisticated investors not involving any public offering, the sale of the shares of Common Stock subject to such Reset Provisions was exempt under Section 4(2) of the Securities Act and Regulation D thereunder. During January 1999, the Company completed a $14,278,000 private placement, which resulted in the issuance of 2,596,000 shares of the Company's common stock at $5.50 per share. As an issuance to sophisticated investors not involving any 22 public offering, the sale of the shares of common stock was exempt under Section 4(2) of the Securities Act and Regulation D thereunder. ITEM 6. SELECTED FINANCIAL DATA The selected financial data presented below has been derived from the financial statements of the Company. For additional information, see the Financial Statements and Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Year Ended December 31, (In thousands, except per share data) ------------------------------------------------------------------ 1998 1997 1996 1995 1994 ---------- ---------- ---------- ---------- ---------- SUMMARY OF OPERATIONS: Net revenue $ 1,522 $ 3,761 $ 9,470 $ 11,970 $ 7,013 Loss from operations (11,019) (11,262) (10,326) (14,875) (32,434) Net loss (10,939) (10,947) (10,157) (14,234) (31,257) Net loss applicable to common shareholders $ (11,964) $ (13,965) $ (10,336) $ (14,254) $ (31,257) Net loss per common share: Basic and diluted $ (1.12) $ (1.73) $ (1.36) $ (1.90) $ (4.75) BALANCE SHEET DATA: Cash, cash equivalents and short-term investments $ 2,119 $ 2,488 $ 3,462 $ 7,759 $ 20,653 Working capital (deficiency) (1,158) (1,252) 3,230 8,607 20,735 Total assets 3,894 4,577 13,411 18,352 32,101 Convertible subordinated debentures - - 3,500 - - Total liabilities 4,195 4,559 8,606 3,627 5,133 Convertible redeemable preferred stock - - 1,905 1,845 - Shareholders' equity (deficit) (301) 18 2,900 12,880 26,968
23 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW OnHealth Network Company ("OnHealth" or the "Company") intends to become the leading Internet resource dedicated to the management of family health and well-being. The Company is an Internet-based provider of high quality health and medical information and applications to a broad base of consumers. The Company's Internet site, onhealth.com, produces and distributes original, relevant health content including in-depth reports, personalized information retrieval, geographically specific guides to healthcare services and information, editorials and interactive community environments. Until January 1998, its traditional line of business had been CD-ROM development, production and distribution. The Company was also a supplier of video, animation and graphic assets to a health and medical cable TV channel. Under this strategy, the Company was never able to attain profitability, and, at December 31, 1997, had an accumulated deficit of $78,576,000. In 1997, the Company's Board of Directors revised its business strategy and brought in an entirely new management team and other key employees skilled in the development of internet websites. In 1998 the Company was focused on the development of an Internet-delivered, consumer-oriented network of health and wellness sites. OnHealth intends to generate advertising revenue by appealing to advertisers through its ability to reach targeted demographics and psychographics. Additional products and services, such as transactional based e-commerce, subscription and syndication, will be developed to exploit opportunities as they present themselves in the marketplace. RESULTS OF OPERATIONS The following table sets forth selected income statement data for OnHealth Network Company and such data as a percentage of net revenues for the year ended December 31, 1998, 1997 and 1996:
Year Ended December 31, (Dollars in thousands) -------------------------------------------------------------------------- 1998 1997 1996 -------------------------------------------------------------------------- AMOUNT PERCENTAGE AMOUNT PERCENTAGE AMOUNT PERCENTAGE Net revenue $ 1,522 100% $ 3,761 100% $ 9,470 100% Gross margin 755 50% 1,220 32% 4,394 46% Operating expenses 11,774 774% 12,482 332% 14,720 155% Loss from operations (11,019) (724%) (11,262) (299%) (10,326) (109%) Net loss $ (10,939) (719%) $ (10,947) (291%) $ (10,157) (107%)
REVENUE Revenue for the year ended December 31, 1998, 1997 and 1996 was as follows:
Year Ended December 31, (In thousands) -------------------------------------------------- 1998 1997 1996 -------------- -------------- ---------------- Product sales and licensing revenue $ 754 $ 1,990 $ 5,152 Online revenue 388 58 1,000 Contract development revenue and other 380 1,220 1,346 Cable television licensing revenue - 493 1,972 ============== ============== ================ Net revenues $ 1,522 $ 3,761 $ 9,470 ============== ============== ================
24 Net revenue for 1998, 1997 and 1996 of $1,522,000, $3,761,000 and $9,470,000, respectively, represent a decrease of 60% from 1997 to 1998 and 60% from 1996 to 1997. The 1997 to 1998 decrease is due to a substantial reduction in product sales and licensing revenue of $1,236,000, or 62%, a reduction in contract development revenue and other of $840,000, or 69%, and a reduction in cable television licensing revenue of $493,000, or 100%. These decreases were partially offset by a $330,000, or 569%, increase in online revenues. The 1998 product sales and licensing revenue includes a $603,000 payment related to minimum sales requirements from a terminated CD ROM distribution agreement. The decrease from 1996 to 1997 is due to a substantial reduction in product sales and licensing revenue of $3,162,000, or 61%, a substantial reduction in cable television licensing revenue of $1,479,000, or 75%, and a decrease in online revenue from $1,000,000 to $58,000. PRODUCT SALES AND LICENSING REVENUE Product sales and licensing revenue have declined steadily over the past few years. The decrease generally reflects market conditions for CD ROM products, the Company's cancellation of a CD ROM distribution agreement, and the lack of new CD ROM product releases as the Company shifted its focus toward online efforts. In 1995, the Company entered into a five year distribution agreement which allowed for the promotion, marketing and distribution of certain of the Company's CD-ROM products. The agreement also provided for minimum levels of sales through the year 2000. In December 1998, the Company received a $603,000 payment related to minimum sales requirements from the termination of the CD ROM distribution agreement. The Company does not anticipate receiving any significant product sales and licensing revenue from CD ROM products in the future. ONLINE REVENUES From 1997 to 1998, online revenues increased from $58,000 to $388,000, an increase of $330,000, or 569%. The increase in 1998 reflects increased site sponsorship and advertising revenue from the Company's onhealth.com web site which was redesigned and re-launched in July 1998. The 1997 online revenues of $58,000 included site sponsorships, advertising and premium services revenue related to onhealth.com and the former O@SIS web site. In September 1997, the Company entered into an agreement with Mayo Foundation which included the full transfer to Mayo of the Company's ownership interest in the O@SIS web site. The online revenues in 1996 relate to nonrefundable advances payable to the Company under the exclusive agreement signed with AT&T in October 1995 and the discontinuance by AT&T of the AT&T Health site in August 1996. CONTRACT DEVELOPMENT REVENUE AND OTHER From 1997 to 1998, contract development revenues and other decreased $840,000, or 69%. The decrease generally reflected the Company's shift toward the online efforts. From 1996 to 1997, contract development revenues and other decreased slightly, representing management's efforts to control costs and focus on more profitable contracts. CABLE TELEVISION LICENSING REVENUE Cable television licensing revenue reflects revenue from the content and royalty agreement with America's Health Network (AHN). Under the agreement, the Company is licensing multimedia content to AHN starting in May 1995 and is to receive minimum licensing royalties over the life of the agreement. The revenue was being recognized evenly over the expected life of the agreement. Due to the gradual increase in actual payments versus the straight-line revenue recognition policy, a receivable was recorded for the difference between the revenue recognized and the cash received during the early years of the contract. The $1,479,000 decrease in revenue from 1996 to 1997 was a result of AHN's financial difficulties. In June 1997, as a result of the Company not receiving its quarterly payment, the outstanding AHN receivable was fully reserved. GROSS MARGIN Gross margin as a percentage of net revenues was 50% in 1998 compared to 32% in 1997. The improvement in gross margin in 1998 was primarily due to the high margins on online revenue and the product sales distribution agreement termination revenue. Gross margin as a percentage of net revenues was 32% in 1997 compared to 46% in 1996. The decrease in gross margin in 1997 was partially due to continued lower gross profits realized on CD-ROM retail sales, but was primarily due to decreases in higher margin cable television licensing and online revenue. 25 OPERATING EXPENSES PRODUCT DEVELOPMENT In 1998, product development expenses included primarily development, editorial, design and production costs related to the Company's onhealth.com web site. In 1997, development costs include primarily onhealth.com development costs and CD ROM development costs. From 1997 to 1998, product development expenses decreased from $4,243,000 to $3,744,000, a decrease of $499,000, or 12%. The decrease reflects no new 1998 CD ROM product releases, and a shift towards an Internet focused business. Product development expenses were $4,243,000 for 1997, a decrease of $1,408,000 or 25% from 1996, due to the Company's release of fewer CD ROM products and its shift to online publishing. SALES AND MARKETING Sales and marketing expenses in 1998 were $5,626,000 as compared to $1,347,000 in 1997, an increase of $4,279,000, or 318%. The increase primarily relates to increased marketing activities for the Company's onhealth.com web site. In July 1998, the Company began a marketing campaign to promote the launch of the onhealth.com web site which included online and radio advertising. In addition, the Company incurred distribution costs related to agreements signed in July 1998 with GeoCities and Go Network. Sales and marketing expenses were $1,347,000 in 1997, compared to $2,705,000 in 1996. The decrease of 50% was a result of the release of fewer CD ROM titles in 1997, decreases in expenditures to promote the Company's products and a smaller expense structure created by the downsizing of operations in late 1996. GENERAL AND ADMINISTRATIVE General and administrative expenses were $2,404,000 in 1998, compared to $6,892,000 in 1997, a decrease of $4,488,000, or 65%. General and administrative expenses consist primarily of compensation to administrative and executive personnel, fees for professional services, facility costs and bad debt expenses. The large decrease in 1998 relative to 1997 reflects substantially reduced legal costs, reduced bad debt costs, and general cost cutting measures including reduced rent costs from the Company's relocation to smaller facilities. The 1997 costs also included certain special charges including costs to relocate the Company from Minneapolis, Minnesota to Seattle, Washington. General and administrative expenses were $6,892,000 in 1997 compared to $6,364,000 in 1996. The increase of 8% was due to extensive litigation and special charges in 1997. The Company recorded $808,000 in expenses related to a settlement of litigation with Viridis, Inc. and received an adverse jury award of $480,000, plus interest from a dispute with T. Randal Productions, et al. in 1997. In the fourth quarter of 1997, the Company recorded charges of $1,572,000 for the relocation of the Company's headquarters from Minneapolis, Minnesota to Seattle, Washington. These charges included $610,000 in severance to officers and employees and $962,000 for asset dispositions and lease termination costs. Also in 1997, the Company wrote-off $1,741,000 in other assets related to an agreement with Time Life, Inc. Excluding the litigation and special charges, the Company's reduction in general and administrative expenses was the result of the downsizing of the facilities and personnel and management's efforts to streamline operating costs. OTHER INCOME (EXPENSE) Other expense was $4,000 in 1998, compared to other income of $473,000 in 1997. The 1998 other expense of $4,000 included a $285,000 loss related to fixed asset disposals, a $562,000 gain related to the collection of a previously reserved accounts receivable, and a $281,000 revenue sharing payment related to the collection of the receivable. The 1997 other income of $473,000 included a $2,700,000 cash payment that the Company received in connection with the transfer of ownership of the Company's O@sis Web site to Mayo. This was partially offset by other expense of $2,229,000 in connection with the Company's conversion of Convertible Subordinated Debentures. The expense represents the excess of the fair market value of Common Stock issued over the fair value of the Common Stock issuable pursuant to the original conversion terms of the debentures. 26 INTEREST INCOME (EXPENSE) Net interest income was $84,000 in 1998 compared to net interest expense of $158,000 in 1997. The net interest income in 1998 relative to net interest expense in 1997 reflects the lack of debt in 1998 relative to 1997. The 1997 net interest expense includes interest expense of $264,000 related to $3,500,000 in convertible subordinated debentures, which were outstanding for ten months in 1997. These debentures were converted to common stock in October 1997. Net interest expense was $158,000 in 1997 compared to net interest income of $169,000 in 1996. The net interest expense in 1997 versus net interest income in 1996 reflects lower interest income earned from cash and cash equivalents balances in 1997 relative to 1996 and higher interest expenses in 1997 related to 1996. The interest expense relates to the Company's $3,500,000 in convertible subordinated debentures which were outstanding for two months in 1996 versus ten months in 1997. These debentures were issued in November 1996 and were converted to common stock in October 1997. LIMITATION ON USE OF NET OPERATING LOSS AND OTHER TAX CREDIT CARRYFORWARDS At December 31, 1998, the Company had available net operating loss carryforwards of approximately $81,910,000 and available research and development credits of approximately $339,000 for federal income tax purposes. The net operating loss carryforwards and the credits expire at various times through 2013. These carryforwards are subject to the limitations of Internal Revenue Code Section 382. This section provides limitations on the availability of net operating losses to offset current taxable income if significant ownership changes have occurred for federal tax purposes. The Company incurred "ownership changes," pursuant to regulations currently in effect under Internal Revenue Code Section 382, as a result of sales of the Company's Preferred Stock in 1992 and 1993 and may have incurred ownership changes since that time. INFLATION Management believes that inflation has not had a material impact on the Company's results of operations. LIQUIDITY AND CAPITAL RESOURCES At December 31, 1998, the Company had cash and cash equivalents of $2,119,000. Total cash used by operating activities during 1998 was $9,962,000, which was primarily due to a net loss of $10,939,000. Investing activities used net cash of $472,000 primarily for purchases of computer equipment. Financing activities provided cash of $10,065,000 primarily from two private placements of common stock of $5,690,000; a $5,000,000 Convertible Redeemable Preferred Stock financing; and $1,068,000 from stock option exercises. Subsequent to the year ended December 31, 1998, the Company received net proceeds of $14,278,000 from a private placement of 2,596,000 shares of common stock. The Company believes that its cash and cash equivalents, including the $14,278,000 received in the January 1999 private placement, will be sufficient to fund its operations through December 31, 1999. Operations generated a negative cash flow during 1996, 1997 and 1998, and the Company expects a significant use of cash in 1999 as it markets and expands the onhealth.com web site. Any material unforeseen increase in expenses or reductions in projected revenues will likely require the Company to seek additional debt or equity financing. If additional cash is required, the Company may need to reduce its expenditures or curtail certain operations. There can be no assurance that additional capital, on a debt or equity basis, will be found, or if found that it will be on economically viable terms. YEAR 2000 The Year 2000 issue is the potential for system and processing failures of date-related data and the result of computer-controlled systems using two digits rather than four to define the applicable year. For example, computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices or engage in similar normal business activities. 27 We could be affected by Year 2000 issues related to non-compliant information technology ("IT") systems or non-IT systems that we operate or that are operated by third parties. We have substantially completed assessment of our internal and external (third-party) IT systems and non-IT systems. At this point in our assessment, we are not currently aware of any Year 2000 problems relating to systems we operate or that are operated by third parties that would have a material effect on our business, results of operations or financial condition, without taking into account our efforts to avoid such problems. Based on our assessment to date, we do not anticipate that costs associated with remediating our non-compliant IT systems or non-IT systems to exceed $100,000, although there can be no assurance to such effect, and any such cost will be funded through operating cash flows. To date the Company has incurred no significant costs related to the assessment of, and preliminary efforts in connection with, its Year 2000 project and the development of a remediation plan. Management does not currently expect the Company's financial condition or results of operations will be materially adversely affected by the Year 2000 issue. There can be no guarantee that the systems of other companies on which the Company's systems rely will be timely converted, or that a failure to convert by another company, or a conversion that is incompatible with the Company's systems, would not have a material adverse effect on the Company. To the extent that our assessment is finalized without identifying any additional material non-compliant IT systems we operate or that are operated by third parties, the most reasonably likely worst case Year 2000 scenario is a systemic failure beyond our control, such as a prolonged telecommunications or electrical failure. Such a failure could prevent us from operating our business, prevent users from accessing our web site, or change the behavior of advertising customers or persons accessing our web site. We believe that the primary business risks, in the event of such failure, would include, but not be limited to, lost advertising revenues, increased operating costs, loss of customers or persons accessing our web site, or other business interruptions of a material nature, as well as claims of mismanagement, misrepresentation, or breach of contract, any of which could have a material adverse effect on our business, results of operations and financial condition. We have not made any contingency plans to address such risks. FORWARD-LOOKING STATEMENTS Certain statements made in this Form 10-K, which are summarized here, are forward-looking statements that involve risk and uncertainties, and actual results may be materially different. Factors that could cause actual results to differ include, but are not limited to those identified: THE EXPECTATION THAT THE COMPANY WILL BECOME THE LEADING ON-LINE HEALTH INFORMATION NETWORK DEPENDS ON OUR ABILITY TO CONTINUE TO: (I) OBTAIN HIGH QUALITY EDITORIAL CONTENT, (II) IMPLEMENT EFFECTIVE TRAFFIC BUILDING PROGRAMS, AS WELL AS OTHER GENERAL MARKET CONDITIONS AND (III) COMPETITIVE CONDITIONS WITHIN THE MARKET, (INCLUDING, BUT NOT LIMITED TO, THE INTRODUCTION AND FURTHER DEVELOPMENT OF COMPETITIVE WEB SITES). THE EXPECTATION THAT THE COMPANY WILL SEE A GROWTH IN REVENUES AND POSITIVE NET INCOME AS A RESULT OF ITS SHIFT IN FOCUS TO ITS ON-LINE HEALTH NETWORK DEPENDS ON CUSTOMER INTEREST, THE ABILITY TO OBTAIN SUCCESSFUL REVENUE SOURCES FROM ADVERTISERS, AS WELL AS OTHER GENERAL MARKET AND COMPETITIVE CONDITIONS WITHIN THE ON-LINE HEALTH NETWORK MARKET. FOR ADDITIONAL INFORMATION REGARDING FORWARD-LOOKING STATEMENTS, PLEASE REFER TO THE FIRST PARAGRAPH IN "ITEM 1. BUSINESS" AND "FACTORS THAT MAY AFFECT FUTURE RESULTS." ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company believes that the market risk arising from holdings of its financial instruments is not material. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial information required by Item 8 is included elsewhere in this Report (see Part IV, Item 14). ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 28 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT The information required by this Item is incorporated by reference to the Company's definitive proxy statement to be filed within 120 days after the end of the Company's fiscal year ended December 31, 1998. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated by reference to the Company's definitive proxy statement to be filed within 120 days after the end of the Company's fiscal year ended December 31, 1998. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated by reference to the Company's definitive proxy statement to be filed within 120 days after the end of the Company's fiscal year ended December 31, 1998. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated by reference to the Company's definitive proxy statement to be filed within 120 days after the end of the Company's fiscal year ended December 31, 1998. 29 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: (1) FINANCIAL STATEMENTS PAGE ----- Report of Ernst & Young LLP, Independent Auditors............ F-1 Balance Sheet as of December 31, 1998 and 1997............... F-2 Statement of Operations for the years ended December 31, 1998, 1997 and 1996.......................... F-3 Statement of Shareholders' Equity for the years ended December 31, 1998, 1997 and 1996.......................... F-4 Statement of Cash Flows for the years ended December 31, 1998, 1997 and 1996.......................... F-5 Notes to Financial Statements................................ F-6 (2) FINANCIAL STATEMENT SCHEDULES PAGE ---- Valuation and Qualifying Accounts S-1 All other schedules are omitted because they are not applicable, or not required because the required information is included in the Financial Statements or notes thereto. (3) EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS WITH EACH MANAGEMENT CONTRACT OR COMPENSATORY PLAN OR ARRANGEMENT REQUIRED TO BE FILED IDENTIFIED. See paragraph (c) below. (b) REPORTS ON FORM 8-K. No reports on Form 8-K were filed by the registrant during the quarter ended December 31, 1998. (c) EXHIBIT LISTING. Certain exhibits have been previously filed with the Commission and are incorporated herein by reference. ONHEALTH NETWORK COMPANY EXHIBIT INDEX FISCAL YEAR ENDED DECEMBER 31, 1998
EXHIBIT NUMBER DESCRIPTION PAGE - ------- ------------- ------- 3.1 Amended and Restated Articles of Incorporation of the Company, incorporated herein by reference to Exhibit No. 3.1 to the Company's Registration Statement on Form S-3, No. 333-69989. 3.2 Bylaws of the Company, incorporated herein by reference to Exhibit No. 3.2 to the Company's Registration Statement on Form S-3, No. 333-69989. 30 4.1 Form of Stock Certificate, incorporated herein by reference to Exhibit No. 4.1 to the Company's Registration Statement on Form S-1, No. 33-67064 4.2 Statement of Registration Rights - Preferred Stock, incorporated herein by reference to Exhibit No. 4.2 to the Company's Registration Statement on Form S-1, No. 33-67064 4.3 Warrant Agreement, dated as of July 17, 1992, between the Company and Medical Innovation Fund, incorporated herein by reference to Exhibit No. 4.3 to the Company's Registration Statement on Form S-1, No. 33-67064 4.4 Warrant Agreement, dated as of November 30, 1992, between the Company and Ronald Eibensteiner, incorporated herein by reference to Exhibit No. 4.4 to the Company's Registration Statement on Form S-1, No. 33-67064 4.5 Warrant Agreement, dated as of December 20, 1992, between the Company and Wayne Mills, incorporated herein by reference to Exhibit No. 4.5 to the Company's Registration Statement on Form S-1, No. 33-67064. 4.7 Registration Rights Agreement, dated January 29, 1999, among the Company and certain investors named therein 51 10.1 License Agreement, dated April 24, 1991, among the Company, William Morrow Company and Mayo Foundation for Medical Education and Research, as amended, incorporated herein by reference to Exhibit No. 10.1 to the 1993 S-1 10.2 Electronic Publishing License, Development and Marketing Agreement, dated April 28, 1993, between the Company and Mayo Foundation for Medical Education and Research, incorporated herein by reference to Exhibit No. 10.4 to the 1993 S-1 10.3 401(k) Savings and Investment Plan, incorporated herein by reference to Exhibit No. 10.9 to Amendment No. 1 to the 1993 S-1 10.4 1997 Stock Option Plan, as amended, incorporated herein by reference to the Company's Preliminary Proxy Statement for the Annual Meeting of Shareholders held June 16, 1998 on Form PRE 14A, filed on May 6, 1998 with the Securities and Exchange Commission file No. 0000-22212 10.5 IVI Publishing, Inc. Director Stock Option Plan, as amended, incorporated herein by reference to Exhibit No. 10.12 to the Company's Registration Statement on Form S-1, No. 33-76496 10.6 License Agreement, dated February 9, 1994, between the Company and Time Life, Inc. and First Amendment to Titles Development Agreement, dated as of February 9, 1994 between the Company and Time Life, Inc., incorporated herein by reference to Exhibit No. 10.19 to the 1994 S-1 10.7 Lease Agreement, dated March 30, 1994, between the Company and Ryan/Wilson Limited Partnership, incorporated herein by reference to Exhibit No. 10.25 to the 1994 S-1 10.8 License, Development and Marketing Agreement, dated September 28, 1994, between the Company and Time Life, Inc., incorporated by reference to Exhibit No. 10.25 to the Company's Form 10-K for the year ended December 31, 1994* 10.9 1994 License, Development and Marketing Agreement, dated September 27, 1994, between the Company and Mayo Foundation for Medical Education and Research, incorporated by reference to Exhibit No. 10.26 to the Company's Form 10-K for the year ended December 31, 1994* 10.10 License Agreement, dated November 10, 1994, between the Company and Massachusetts Medical Society, incorporated by reference to Exhibit No. 10.27 to the Company's Form 10-K for the year ended December 31, 1994* 10.11 Sublicense Agreement, dated December 31, 1994, between the Company and Georg von Holtzbrinck GmbH & Co., incorporated by reference to Exhibit No. 10.28 to the Company's Form 10-K for the year ended December 31, 1994* 10.12 Agreement between America's Health Network, Inc. and the Company, dated May 25, 1995, incorporated by reference to Exhibit 10.14 to the Company's Form 10-K for the year ended December 31, 1995* 10.13 Amendment No. 2 to License Agreement among William Morrow Company, Mayo Foundation for Medical Education and Research and the Company, dated December 29, 1995, incorporated by reference to Exhibit 10.18 to the Company's Form 10-K for the year ended December 31, 1995* 31 10.14 Financial Advisor and Consulting Agreement with Frazier & Company LP, dated July 14, 1994, as amended by a letter agreement, dated June 28, 1995, incorporated by reference to Exhibit 10.19 to the Company's Form 10-K for the year ended December 31, 1995** 10.15 First Amendment dated June, 27, 1994 and Second Amendment dated October 10, 1995 to Lease Agreement between the Company and Ryan/Wilson Limited Partnership, incorporated by reference to Exhibit 10.20 to the Company's Form 10-K for the year ended December 31, 1995 10.16 Agreement dated April 1995 among Ryan/Wilson Limited Partnership, Wilson Learning Corporation the Company regarding a certain lease, incorporated by reference to Exhibit 10.21 to the Company's Form 10-K for the year ended December 31, 1995 10.17 Distribution on Consignment Agreement, dated February 29, 1996 between the Company and Davidson & Associates, Inc. , incorporated by reference to Exhibit 10.22 to the Company's Form 10-K for the year ended December 31, 1995* 10.22 Sublease Agreement, dated September 17, 1996, between the Company and Reality Interactive, Inc. for the fourth floor portion of the Main Lease between the Company and Ryan/Wilson Limited Partnership, Wilson Learning Corporation, incorporated herein by reference to Exhibit 10.27 to the Company's Form 10-K for the year ended December 31, 1996 10.24 Settlement Agreement and Mutual Release dated September 12, 1997 between the Company and Mayo Foundation for Medical Education and Research, incorporated herein by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarter ended September 30, 1997 10.25 Sublicense Agreement dated September 12, 1997 between the Company and Mayo Foundation for Medical Education and Research, incorporated herein by reference to Exhibit 10.2 to the Company's Form 10-Q for the quarter ended September 30, 1997 10.26 Separation Agreement and Release of Claims dated January 26, 1998 between the Company and Joy A. Solomon** 10.27 Letter Agreement dated November 9, 1997 between the Company and Robert Goodman, incorporated by reference to the Company's Form 10-K for the year ended December 31, 1997** 10.28 Subscription Agreement, dated January 29, 1999, among the Company and certain investors named therein 65 23.1 Consent of Ernst & Young LLP, Independent Auditors 80 27 Financial Data Schedule (electronic version only) 81 - ------------- ** Management Agreement or Compensatory Plan or Arrangement
32 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in Seattle, Washington, on the 31st day of March, 1999. ONHEALTH NETWORK COMPANY By: /s/ ROBERT N. GOODMAN --------------------------------------- Robert N. Goodman President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant, in the capacities and dates indicated.
SIGNATURE TITLE DATE ----------------- ------- ------- /S/ ROBERT N. GOODMAN President, Chief Executive Officer and March 31, 1999 - ----------------------- Director (Principal Executive Officer) Robert N. Goodman /S/ MICHAEL D. CONWAY Chief Financial Officer, Controller, March 31, 1999 - ----------------------- Secretary and Principal Financial Officer Michael D. Conway /S/ MICHAEL A. BROCHU Chairman of the Board March 31, 1999 - ----------------------- Michael A. Brochu /S/ ANN KIRSHNER Director March 31, 1999 - ----------------------- Ann Kirshner /S/ RAM SHRIRAM Director March 31, 1999 - ----------------------- Ram Shriram /S/ RICK THOMPSON Director March 31, 1999 - ---------------------- Rick Thompson
33 Report of Ernst & Young LLP, Independent Auditors The Board of Directors and Shareholders OnHealth Network Company We have audited the accompanying balance sheets of OnHealth Network Company as of December 31, 1998 and 1997 and the related statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of OnHealth Network Company at December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ ERNST & YOUNG LLP Seattle, Washington March 15, 1999 F-1 34 ONHEALTH NETWORK COMPANY BALANCE SHEETS (In thousands)
December 31, --------------------------------- 1998 1997 --------------- -------------- ASSETS: Current assets: Cash and cash equivalents $ 2,119 $ 2,488 Accounts receivable, net of allowances of $256 (1998) and $1,011 (1997) 509 337 Inventories - 150 Other current assets 409 332 --------------- -------------- Total current assets 3,037 3,307 Furniture and equipment: Computers and software 1,218 2,856 Office equipment 291 1,403 --------------- -------------- 1,509 4,259 Accumulated depreciation (774) (2,989) --------------- -------------- Furniture and equipment, net 735 1,270 Other non-current assets 122 - =============== ============== Total assets $ 3,894 $ 4,577 =============== ============== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,526 $ 1,919 Other accrued expenses 2,669 2,640 --------------- -------------- Total current liabilities 4,195 4,559 Commitments and contingencies Shareholders' equity: Preferred stock, $0.01 par value; authorized, 1,000; issued and outstanding, none. - - Common stock, $0.01 par value; authorized, 29,000; issued and outstanding, 12,800 (1998) and 10,106 (1997) 132 101 Additional paid-in-capital 89,082 78,493 Accumulated deficit (89,515) (78,576) --------------- -------------- Total shareholders' equity (deficit) (301) 18 --------------- -------------- Total liabilities and shareholders' equity $ 3,894 $ 4,577 =============== ==============
The accompanying notes are an integral part of the financial statements F-2 35 ONHEALTH NETWORK COMPANY STATEMENTS OF OPERATIONS (In thousands, except per share data)
Year Ended December 31, ----------------------------------------------------- 1998 1997 1996 --------------- --------------- --------------- Net revenue $ 1,522 $ 3,761 $ 9,470 Cost of revenue 767 2,541 5,076 --------------- --------------- --------------- Gross margin 755 1,220 4,394 Operating expenses: Product development 3,744 4,243 5,651 Sales and marketing 5,626 1,347 2,705 General and administrative 2,404 6,892 6,364 --------------- --------------- --------------- Total operating expenses 11,774 12,482 14,720 --------------- --------------- --------------- Loss from operations (11,019) (11,262) (10,326) Interest income (expense) 84 (158) 169 Other income (expense) (4) 473 - --------------- --------------- --------------- Total interest and other income and expense 80 315 169 --------------- --------------- --------------- Net loss (10,939) (10,947) (10,157) Preferred stock dividends (103) (100) (119) Preferred stock accretion (702) (43) (60) Preferred stock deemed dividend (220) (2,875) - =============== =============== =============== Net loss applicable to common shareholders $ (11,964) $ (13,965) $ (10,336) =============== =============== =============== Net loss per common share- Basic and diluted $ (1.12) $ (1.73) $ (1.36) =============== =============== =============== Weighted average number of common shares outstanding 10,680 8,056 7,580 =============== =============== ===============
The accompanying notes are an integral part of the financial statements F-3 36 ONHEALTH NETWORK COMPANY STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands)
Additional Total Common Stock Paid-In Accumulated Shareholders' Shares Par Value Capital Deficit Equity ------------- -------------- ------------- --------------- --------------- Balance at December 31, 1995 7,524 $ 75 $ 70,277 $ (57,472) $ 12,880 Issuance of common stock: Exercise of options 88 1 355 - 356 Dividends on convertible redeemable preferred stock ($0.06 per share) - - (119) - (119) Preferred stock accretion - - (60) (60) Net loss - - - (10,157) (10,157) ------------- -------------- -------------- --------------- --------------- Balance at December 31, 1996 7,612 76 70,453 (67,629) 2,900 Issuance of common stock: Exercise of options 59 1 97 - 98 Lawsuit settlement 175 2 431 - 433 Return of common stock per Mayo agreement (490) (5) 5 - - Preferred stock conversion to common 1,000 10 1,938 - 1,948 Dividends on convertible Redeemable preferred stock ($0.06 per share) - - (100) - (100) Preferred stock accretion - - (43) - (43) Convertible subordinated debenture conversion to common 1,750 17 5,712 - 5,729 Net loss - - - (10,947) (10,947) ------------- -------------- -------------- --------------- --------------- Balance at December 31, 1997 10,106 101 78,493 (78,576) 18 Issuance of common stock: Private placements 1,543 15 5,675 - 5,690 Exercise of options 371 4 1,064 - 1,068 Services 47 4 361 365 Discount on sale of convertible redeemable preferred stock - - 702 - 702 Preferred stock conversion to Common stock 733 8 3,622 - 3,630 Cash dividends on convertible redeemable preferred stock ($0.05 per share) - - (3) - (3) Non-cash dividends - preferred stock - - (100) - (100) Accretion of discount on preferred stock - - (702) - (702) Preferred stock deemed dividend - - (220) - (220) Issuance of stock options and warrants for services - - 190 - 190 Net loss - - - (10,939) (10,939) ============= ============== ============== =============== =============== Balance at December 31, 1998 12,800 $ 132 $ 89,082 $ (89,515) $ (301) ============= ============== ============== =============== ===============
The accompanying notes are an integral part of the financial statements F-4 37 ONHEALTH NETWORK COMPANY STATEMENTS OF CASH FLOWS (In thousands)
Year ended December 31, --------------------------------------------------- 1998 1997 1996 -------------- --------------- --------------- Cash flows from operating activities: Net loss $ (10,939) $ (10,947) $ (10,157) Adjustments to reconcile net loss to cash used in operating activities: Depreciation and amortization 722 1,252 1,409 Interest expense associated with debenture conversion - 2,229 - (Gain) loss on disposition of furniture and equipment 285 711 (3) Provision for (recoveries of) doubtful accounts and returns (755) 2,336 1,675 Amortization of warrants issued for services 8 - - Compensation from stock grants 130 - - Common stock issued as litigation settlement - 433 - Common stock issued for services 365 - - Changes in assets and liabilities: (Increase) decrease in accounts receivable 583 1,461 (2,601) Decrease in inventories 150 5 666 (Increase) decrease in other current assets (25) 253 (139) (Increase) decrease in other non-current assets (122) 1,885 (585) Increase (decrease) in accounts payable (393) (1,287) 843 Increase in other accrued expenses 29 760 636 -------------- --------------- --------------- Net cash used in operating activities (9,962) (909) (8,256) Cash flows from investing activities: Proceeds from disposition of furniture and fixtures 217 61 510 Capital expenditures (689) (104) (288) -------------- --------------- --------------- Net cash provided by (used in) investing activities (472) (43) 222 Cash flows from financing activities: Proceeds from issuance of convertible redeemable preferred stock 5,000 - - Proceeds from issuance of convertible subordinated debentures - - 3,500 Proceeds from issuance of common stock: Private placements 5,690 - - Exercise of options 1,068 98 356 Redemption of preferred stock (1,690) - - Preferred stock dividends paid (3) (120) (119) -------------- --------------- --------------- Net cash provided by (used in) financing activities 10,065 (22) 3,737 -------------- --------------- --------------- Net decrease in cash and cash equivalents (369) (974) (4,297) Cash and cash equivalents at beginning of year 2,488 3,462 7,759 ============== =============== =============== Cash and cash equivalents at end of year $ 2,119 $ 2,488 $ 3,462 ============== =============== ===============
The accompanying notes are an integral part of the financial statements F-5 38 ONHEALTH NETWORK COMPANY NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1998 NOTE 1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF THE BUSINESS OnHealth Network Company, formerly known as IVI Publishing, Inc., (the "Company"), is engaged in a single business consisting of electronic publishing of health and medical information in interactive multimedia formats. USE OF ESTIMATES The financial statements have been prepared in conformity with generally accepted accounting principles, which require management to make estimates and assumptions that affect the amounts and disclosures reported in the financial statements and accompanying notes. Actual results could differ from those estimates. FAIR VALUE OF FINANCIAL INSTRUMENTS Financial instruments of the Company consist of cash and cash equivalents, accounts receivable, other current assets, accounts payable and other accrued expenses. The Company's other financial instruments generally approximate their fair values at December 31, 1998 and 1997 based on the short-term nature of these instruments. CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents. At December 31, 1998 and 1997, cash and cash equivalents consisted principally of United States Government obligations for which the carrying amount approximates fair value. INVENTORIES All inventories are stated at the lower of cost (first-in, first-out method) or market and consist of packaging supplies and finished goods. FURNITURE AND EQUIPMENT Furniture and equipment are stated at cost and are depreciated using the straight-line method over the shorter of the estimated useful lives of the respective assets, generally five to seven years. CONCENTRATION OF CREDIT RISK AND SIGNIFICANT CUSTOMERS The Company is potentially subject to a concentration of credit risk from its trade accounts, which are not collateralized. The Company performs periodic credit reviews of its customers and maintains reserves for potential losses for uncollectible accounts. Such losses have historically been within management's expectations. Three customers represent 40%, 16% and 13% of net revenue for the year ended December 31, 1998; one customer represents 12% of net revenue for the year ended December 31, 1997; and three customers represent 15%, 21%, and 11% of net revenue in 1996. The revenue recorded from the customer which represents 40% of the net revenue in 1998 was the result of a $603,000 payment received from the customer related to minimum sales requirements form a terminated CD-ROM distribution agreement. At December 31, 1998, two customers comprised 36% and 20% of outstanding accounts receivable. Two customers represented 77% and 27% of accounts receivable at December 31, 1997. F-6 39 REVENUE RECOGNITION The Company's revenue consists of fees for online services, product sales and licensing revenue, contract development revenue, and fees relating to the licensing of its content for use on cable television. Online revenue is generated through the sale of advertising and sponsorship of the Company's onhealth.com web site. Advertising and sponsorship revenue is earned based upon the number of impressions delivered. Product sales and licensing revenue consists of retail distribution sales, direct mail sales, and product sales and royalties on licenses to original equipment manufacturers (OEM's). The revenue is recognized upon shipment of the product or in accordance with the licensing agreements. An allowance for return is recorded at the time revenue is recognized. Contract development revenue is generated through the use of the Company's personnel and facilities for the creation of custom multimedia products. The contract revenue is recognized on a percentage-of-completion basis or at a specific hourly rate, depending on the terms of the contract. Revenue relating to the licensing of the Company's health and medical content for use on cable television channels is recognized when payments are received. The Company recognized revenue under its cable television agreement with America's Health Network ("AHN") during 1997 and 1996. (See Note 12). Revenues for each of the three years ended December 31, 1998, 1997 and 1996 are as follows (in thousands): 1998 1997 1996 ----------- ------------ ----------- Online $ 388 $ 58 $ 1,000 Contract development and other 380 1,220 1,346 Product sales and licensing 754 1,990 5,152 Cable television - 493 1,972 ----------- ------------ ----------- Net revenues $ 1,522 $ 3,761 $ 9,470 =========== ============ =========== PRODUCT DEVELOPMENT COSTS Product development costs consist principally of payroll and related expenses for development, editorial, systems and telecommunications operations personnel and consultants, systems and telecommunications infrastructure and costs of acquired content. To date, all product development costs have been expensed as incurred. ADVERTISING COSTS Advertising costs are expensed as they are incurred. Advertising costs in 1998, 1997, and 1996 were $3,409,000, $190,000 and $556,000, respectively. INCOME TAXES Income taxes are provided based on earnings reported for financial statement purposes. Deferred income taxes are provided for temporary differences between financial reporting and income tax basis of assets and liabilities under the liability method. F-7 40 STOCK BASED COMPENSATION Pursuant to Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," the Company is required to disclose the effects on the net loss and per share data as if the Company had elected to use the fair value approach to account for all its employee stock-based compensation plans. The Company follows the disclosure-only provisions SFAS No. 123 but applies Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its employee stock options. Under APB 25, when the exercise price of employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recorded. LOSS PER COMMON SHARE Basic earnings per share ("EPS") excludes any dilutive effects of common stock equivalents - options, warrants and convertible securities - and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted EPS is computed by dividing income available to common shareholders by the weighted-average number of common stock equivalent shares outstanding. The effects of common stock equivalents are excluded from the computation for all periods presented as their effects are anti-dilutive. RECLASSIFICATIONS Certain reclassifications have been made for consistent financial statement presentation. IMPACT OF RECENTLY ISSUED OR ADOPTED ACCOUNTING STANDARDS SFAS No. 130, "Reporting Comprehensive Income," was issued in June 1997. This Statement, adopted by the Company on January 1, 1998, establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. This statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. This statement does not affect the results of operations or financial position of the Company. As of December 31, 1998, 1997 and 1996, the company had no items that would have been classified as other comprehensive income. SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," was issued in June 1997 and redefined how operating segments are determined. SFAS No. 131 requires disclosure of certain financial and descriptive information about a company's operating segments. This statement was adopted by the Company on January 1, 1998. Provisions of this statement require annual disclosure in the year of adoption and interim reporting for periods thereafter. This statement does not affect the results of operations or financial position of the Company. The company operates in one principal business segment across domestic markets. SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," was issued in June 1998 and establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The statement is effective for all fiscal years beginning after June 15, 1999. The impact of the adoption of the provisions of this statement on the results of operations or the financial position of the Company has not yet been determined. In March 1998, the Accounting Standards Executive Committee issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1 requires all costs related to the development of internal use software other than those incurred during the application development stage to be expensed as incurred. Costs incurred during the application development stage are required to be capitalized and amortized over the estimated useful life of the software. SOP 98-1 is effective for the Company's fiscal year ending December 31, 1999. Adoption is not expected to have a material effect on the Company's financial statements as the Company's policies are substantially in compliance with SOP 98-1. F-8 41 NOTE 2. LIQUIDITY The Company has experienced recurring losses from operations and has generated an accumulated deficit from inception to December 31, 1998 of approximately $89,515,000. At December 31, 1998, the Company has a working capital deficiency of $1,158,000 and total shareholders' deficit of $301,000. In January 1999, the Company completed a $14.3 million issuance of the Company's common stock (see "Note 19. Subsequent Events"). The Company believes that its cash and cash equivalents, including the $14.3 million received in the January 1999 private placement, will be sufficient to fund its operations through December 31, 1999. Operations generated a negative cash flow during 1996, 1997 and 1998 and the Company expects a significant use of cash in 1999 as it markets and expands the onhealth.com web site. Any material unforeseen increase in expenses or reductions in projected revenue will likely require the Company to seek additional debt or equity financing. If additional cash is required, the Company may need to reduce its expenditures or curtail certain operations. There can be no assurance that additional capital, on a debt or equity basis, will be found, or if found that it will be on economically viable terms. NOTE 3. COMPOSITION OF CERTAIN BALANCE SHEET ACCOUNTS December 31, -------------------------------- 1998 1997 --------------- --------------- (In thousands) Furniture and equipment: Computer hardware $ 1,032 $ 2,160 Software 186 455 Furniture & fixtures 220 1,403 Equipment - 241 Leasehold improvements 71 - --------------- --------------- 1,509 4,259 Less accumulated depreciation (774) (2,989) =============== =============== Total $ 735 $ 1,270 =============== =============== Other accrued expenses: Litigation loss $ 677 $ 961 Advertising 609 - Severance 90 610 Royalties 338 501 Rent obligation 53 252 Accrued wages and benefits 175 4 Payroll taxes 358 2 Other 369 310 --------------- --------------- Total $ 2,669 $ 2,640 =============== =============== NOTE 4. COMMON STOCK On October 30, 1998, the Company completed a $3,690,000 private placement involving the issuance of 1,000,898 shares of common stock at $3.69 per share. On December 14, 1998, the Company completed a $2,000,000 private placement involving the issuance of 542,419 shares of common stock at $3.69 per share. The shares of common stock issued on October 30, 1998 and December 14, 1998 were issued to two accredited investors. The terms of these issuances potentially obligated the Company to issue additional shares of common stock (depending on the future performance of the Company's common stock (the "Reset Provisions")). Such Reset Provisions only relate to those shares purchased by the two investors on October 30, 1998 and December 14, 1998. As of March 12, 1999, all of the shares of common stock subject to the Reset Provisions have been sold and no such Reset Provisions apply to any of the Company's outstanding Common stock. F-9 42 NOTE 5. CONVERTIBLE SUBORDINATED DEBENTURES In November 1996, the Company issued $3,500,000 of 9% Convertible Subordinated Debentures ($3,325,000 net of debt issue costs). These debentures were converted into Common Stock on October 28, 1997 at a rate of $2.00 per share, resulting in the issuance of 1,750,000 shares of Common Stock. The original conversion price was $3.25 per share. The excess of the fair value of the Common Stock issued over the fair value of the shares issuable pursuant to the original conversion terms was $2,229,000 and was recorded as an other expense at the date of conversion. NOTE 6. CONVERTIBLE REDEEMABLE PREFERRED STOCK In April 1998, the Company issued 5,000 shares of the Company's 5% Series B Convertible Redeemable Preferred Stock (the "Series B Preferred Stock") for $5,000,000. The Series B Preferred Stock was convertible at various increasing discount rates to the market value of the common stock. This discount aggregated $702,000 and was recorded as preferred stock accretion over the various periods of conversion. During 1998, 3,630 shares of the Series B Preferred Stock were converted into 732,605 shares of the Company's common stock and 1,470 of such preferred shares were redeemed. The excess of the redemption price over the carrying value of the preferred shares redeemed was $220,000 and was recorded as a preferred stock deemed dividend. The preferred stock accretion and deemed dividend increased the net loss applicable to common shareholders in the calculation of the 1998 net loss per share as shown in the statements of operations. In 1995, the Company issued 2,000 shares of 6% Series A Convertible Redeemable Preferred Stock (the "6% Series A Preferred Stock")for $2,000,000 ($1,845,000 net of brokerage expenses) to Davidson & Associates, Inc., ("Davidson") a distributor of multimedia educational and entertainment software. The 6% Series A Preferred Stock was converted into 1,000,000 shares of the Company's common stock on October 30, 1997, at a rate of $2.00 per share. The original conversion price was $11.21 per share. The excess of the fair value of the Common Stock issued over the fair value of the shares issuable pursuant to the original conversion terms was $2,875,000 and was recorded as a deemed preferred dividend at the date of conversion. This deemed dividend increased the net loss applicable to common shareholders in the calculation of the 1997 net loss per share as shown in the statements of operations. NOTE 7. STOCK OPTIONS AND WARRANTS In December 1997, the Company's Board of Directors adopted the 1997 Stock Option Plan ("1997 Plan") for its employees, directors and consultants. The Plan, which is administered by the Board of Directors, permits the Company to grant stock options for the purchase of Common Stock. The purpose of the 1997 Plan is to promote the success of the Company by facilitating the employment and retention of competent personnel and by furnishing incentive to directors, officers and employees of the Company and consultants and advisors to the Company, upon whose efforts the success of the Company will depend to a large degree. Incentive stock options ("ISOs") and non-qualified stock options may be granted pursuant to the 1997 Plan. The Company also has a 1991 Stock Option Plan (the "1991 Plan") for its employees. The 1991 Plan, which is administered by the Board of Directors, permits the Company to grant stock options for the purchase of Common Stock. The 1991 Plan provides for the granting of ISOs and non-qualified stock options. In the case of ISO's, the exercise price must be at least equal to the fair market value per share of the Common Stock on the date of grant. In the case of non-qualified stock options, the exercise price must be at least 85% of the fair market value per share on the date of grant. Options generally expire nine to ten years from the date of grant. In addition, the Company has a Director Stock Option Plan pursuant to which current non-employee directors are eligible to receive options to purchase shares of the Company's common stock at the market price on the date of grant. F-10 43 The number of shares of the Company's common stock that have been reserved for issuance for such plans total 2,378,000. Activity in the 1991 Plan, 1997 Plan and Director Stock Option Plan is as follows:
Remaining Number of Weighted- Shares Number Average Price Reserved of Shares Per Share ------------ ----------- ------------- ------------ ----------- ------------- TOTAL OUTSTANDING AT DECEMBER 31, 1995 489,000 907,000 $ 11.53 Options Reserved 200,000 - Options Granted (582,000) 582,000 4.98 Options Exercised - (88,000 4.06 Options Canceled 461,000 (461,000 13.24 ------------ ----------- TOTAL OUTSTANDING AT DECEMBER 31, 1996 568,000 940,000 7.10 Options Reserved 1,750,000 - Options Granted (684,000) 684,000 2.85 Options Exercised - (59,000) 1.64 Options Canceled 474,000 (474,000) 9.86 ------------ ----------- TOTAL OUTSTANDING AT DECEMBER 31, 1997 2,108,000 1,091,000 3.53 Options Granted (889,000) 889,000 5.05 Options Exercised - (371,000) 2.88 Options Canceled 393,000 (393,000) 3.84 ------------ ----------- TOTAL OUTSTANDING AT DECEMBER 31, 1998 1,162,000 1,216,000 $ 4.74 ============ ===========
At December 31, 1998, 1997 and 1996, options to purchase 237,000, 325,000, and 602,000 shares were exercisable, respectively. The following table summarizes information about the stock options outstanding at December 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------------- ----------------------------- Weighted- Weighted Average Weighted Average Range of Number Remaining Average Number Exercise Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Price - ----------------- -------------- ------------------ --------------- ---------------- ------------ $2.31 - 2.50 150,000 9 years $2.31 50,000 $2.31 2.51 - 3.00 75,000 8 years 2.82 46,000 2.85 3.01 - 3.50 190,000 8 years 3.32 71,000 3.36 3.51 - 4.00 205,000 10 years 3.75 - - 4.01 - 5.50 77,000 10 years 4.36 - - 5.51 - 6.00 30,000 4 years 5.75 30,000 5.75 6.01 - 6.50 429,000 9 years 6.25 - - 6.51 - 26.00 60,000 7 years 10.29 40,000 11.75 --------------- --------------- --------------- -------------- ------------ $2.31 - 26.00 1,216,000 9 years $3.25 237,000 $4.76
From time to time, the Company's Board of Directors may grant stock options outside of the existing stock option plans. In 1997, the Board of Directors adopted the 1997-1998 New Hire Stock Option Plan. This plan provides for the granting of 1,213,500 non-qualified stock options to newly hired employees in late 1997 through early 1998. In 1997, the Company granted options to purchase 522,500 shares at prices ranging from $2.31 to $2.50 per share. These options expire in 2007. In 1998, the Company granted options to purchase 996,000 shares at prices ranging from $2.75 to $7.88 per share. These options expire in 2008. F-11 44 The options granted under this plan had a weighted average price per share of $3.33. Of the options granted in 1997 and 1998, 40,000 and 265,000 stock options, respectively, were canceled in 1998 and none were exercised. The pro forma information regarding net loss and net loss per share required by SFAS NO. 123 has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options has been estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1998, 1997 and 1996: 1998 1997 1996 ------------- ----------- ------------ Risk-free interest rate 5.00% 5.50% 6.21% Dividend yield 0% 0% 0% Volatility factor .817 .760 .726 Weighted-average expected life 5 years 5 years 5 years The weighted-average fair value of options granted during 1998, 1997 and 1996 was $2.97, $1.74, and $2.99, respectively. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows:
1998 1997 1996 -------------- ------------- ------------ (In thousands, except per share data) Net loss applicable to common shareholders - as reported $ (11,964) $ (13,965) $ (10,336) Net loss applicable to common shareholders - pro forma (12,970) (14,294) (10,562) Basic and diluted net loss per share - as reported $(1.12) $(1.73) $(1.36) Basic and diluted net loss per common share pro forma $(1.21) $(1.77) $(1.39)
The pro forma effect on the net loss for 1998, 1997, and 1996 is not representative of the pro forma effect on the net loss in future years because it does not take into consideration pro forma compensation expense related to grants made prior to 1995. As of December 31, 1998 and 1997 the Company had warrants outstanding to purchase 678,577 and 547,260 shares of Common Stock at prices ranging from $3.25 per share to $30.94 per share. Warrants outstanding at December 31, 1998 expire from 1999 through 2003. The warrants were generally issued to underwriters and investment bankers for services performed in connection with several of the Company's financing transactions. Common stock reserved for future issuance at December 31, 1998 is as follows: 1991, 1997 and Director Stock Option Plans 2,378,000 1997 - 1998 New Hire Plan 1,213,500 Warrants 678,577 ============= 4,270,077 ============= F-12 45 NOTE 8. LOSS PER COMMON SHARE The components of basic and diluted loss per common share are as follows:
1998 1997 1996 -------------- --------------- ------------- (In thousands, except per share amounts) Net loss applicable to common shareholders (numerator) $ (11,964) $ (13,965) $ (10,366) ============== =============== ============= Weighted average common shares outstanding (denominator) 10,680 8,056 7,580 ============== =============== ============= Loss per share: Basic and diluted $ (1.12) $ (1.73) $ (1.36) ============== =============== =============
NOTE 9. COMMITMENTS AND CONTINGENCIES The Company leases office space under agreements accounted for as operating leases. The agreements expire at various times through 2003. Gross rent expense, including charges for monthly operating costs, was $522,000, $881,000 and $1,433,000 for 1998, 1997 and 1996, respectively. The Company has subleased certain facilities to various tenants under non-cancelable operating leases expiring in 1999. The Company also has several marketing agreements that require minimum payments to be made. Scheduled minimum lease commitments and annual marketing payments are as follows: Marketing Lease Payments -------------------- ----------------- (In thousands) 1999 $ 176 $ 1,885 2000 134 100 2001 142 50 2002 151 - 2003 52 - -------------------- ------------------ 655 2,035 Less sublease rental income (162) - -------------------- ------------------ Total $ 493 $ 2,035 ==================== ================== F-13 46 NOTE 10. SUPPLEMENTAL CASH FLOW INFORMATION
(In thousands) Year Ended December 31, 1998 ------------------------------------------------- 1998 1997 1996 ------------- -------------- -------------- Cash paid during the years for: Interest $ - $ 298 $ - Income taxes 7 5 10 Non-cash investing and financing transactions: Conversion of preferred stock to common stock 3,630 1,948 - Conversion of convertible subordinated debentures - 5,729 - Preferred stock/warrant discount 702 - - Preferred stock/warrant discount accretion (702) (43) (60) Preferred stock dividends 100 - - Stock options and warrants issued for services 190 - - Preferred stock deemed dividend - 2,875 - Common stock issued as litigation settlement - 433 -
NOTE 11. INCOME TAXES At December 31, 1997, the Company has net operating loss carryforwards of $81,910,000 for income tax purposes and unused research and development credits of $339,000 that expire at various times through 2013. These carryforwards are subject to the limitations of Internal Revenue Code Section 382. This section provides limitations on the availability of net operating losses to offset current taxable income if significant ownership changes have occurred for federal tax purposes. For financial reporting purposes, a valuation allowance has been recognized to completely reserve for the deferred tax assets related to those carryforwards. The reserve has been established because of the uncertainty of future taxable income, which is necessary to realize the benefits of the net operating loss carryforwards. Components of the Company's deferred tax assets and liabilities are as follows: December 31, ---------------------------------------- 1998 1997 ------------------- ------------------ ------------------- ------------------ DEFERRED TAX ASSETS: Accrued expenses and allowances $ 1,223,000 $ 2,788,000 Research and development credits 339,000 326,000 Net operating loss carryforwards 28,669,000 25,880,000 ------------------- ------------------ 30,231,000 28,994,000 DEFERRED TAX LIABILITIES: Depreciation 15,000 16,000 ------------------- ------------------ 15,000 16,000 ------------------- ------------------ ------------------- ------------------ Net deferred tax assets before valuation allowance 30,216,000 28,978,000 Less valuation allowance (30,216,000) (28,978,000) =================== ================== NET DEFERRED TAX ASSETS $ - $ - =================== ================== NOTE 12. INVESTMENT IN AMERICA'S HEALTH NETWORK In March 1994, the Company acquired an equity position in America's Health Network ("AHN"), a health information cable television network that combines live programming with medical consumer product sales. The network launched on March 25, 1996. In the first quarter of 1994, the Company expensed its entire investment of $2,000,000 along with the related investment banking fees of approximately $263,000. This approach to the investment was made on the basis that the F-14 47 invested amounts are not assured of recoverability through future revenue streams. As of December 31, 1998 and 1997, the Company's underlying equity in its investment in AHN was approximately $100,000 and $500,000 based on approximately 1% and 4% of AHN's net assets, respectively. However, because the Company expensed its investment, its equity in AHN's net assets is not recognized on the balance sheet. In May 1995, the Company entered into a content and royalty agreement with AHN. Under the agreement the Company licensed its multimedia content to AHN starting in May 1995 and was to receive minimum licensing royalties over the life of the agreement. This revenue was being recognized evenly over the expected life of the contract. Due to the gradual increase in actual payments versus the straight-line revenue recognition policy, a receivable was recorded for the difference between the revenue recognized and the cash received during the early years of the contract. In June 1997, as a result of the Company not receiving its quarterly payment, the outstanding AHN receivable was fully reserved. Due to the uncertainty of future payments, the Company began recognizing revenue on a cash basis. In December 1997 and in early 1998, AHN made payments which were applied against the receivable. At December 31, 1998, the Company has a fully reserved receivable of $153,000 and AHN had failed to make three scheduled payments totaling $1,688,000. The Company recorded $0, $493,000 and $1,972,000 in license royalty revenue in 1998, 1997 and 1996, respectively. NOTE 13. AGREEMENT WITH AT&T In October 1995, the Company entered into a four year agreement with AT&T whereby the Company agreed to provide content for AT&T's HealthSite, a division of AT&T's Personal Online Service ("POS"), in exchange for guaranteed revenues. In August 1996, AT&T discontinued the HealthSite, and subsequently discontinued POS. The Company received the 1996 guaranteed revenue payment of $1,000,000 from AT&T. NOTE 14. BENEFIT PLAN The Company has a defined contribution salary deferral plan covering substantially all employees under Section 401(k) of the Internal Revenue Code. The Plan allows eligible employees to make contributions up to the maximum amount provided under the Code. The Company may also make a discretionary contribution to the Plan. No such contributions have been made by the Company. NOTE 15. MAYO AGREEMENT In September 1997, the Company entered into an agreement with Mayo Foundation ("Mayo") which included a full transfer of ownership of the Company's O@sis web site to Mayo and a new arrangement for revenues and cost sharing concerning O@sis. Under the terms of the agreement, the Company received a $2,700,000 cash payment, an additional $300,000 cash payment for hosting the web site for a transition period, and the return of 490,000 shares of the Company's common stock. Through the year 2001, the Company will receive a royalty from Mayo on certain revenues generated by the Mayo Health O@sis site and certain other non-O@sis Internet projects. In addition, Mayo was released from the Company's "right of first offer" on Mayo health products produced for electronic media, and Mayo assumed operating expenses incurred for the web site retroactive to January 1, 1997 which were recorded as a reduction to product development expenses. The Company recorded the $2,700,000 payment as other income and recorded the $300,000 payment as contract development revenue during the third and fourth quarters, respectively, of 1997. NOTE 16. RELATED PARTY TRANSACTIONS During 1998, 1997 and 1996, the Company subleased approximately 20,000 square feet of its Eden Prairie office space to Reality Interactive, Inc. Reality Interactive, Inc. and the Company share a common Board member. The lease was terminated in 1998. During 1996, two officers of the Company participated in the Company's debt offering. The total amount of debt issued by the Company to these individuals was $120,000. Additionally, three directors of the Company participated in the debt offering, either individually or through affiliated organizations. The total amount of debt issued by the Company to these individuals and organizations was $550,000. On October 28, 1997, this debt was converted into common stock at a rate of $2.00 per share (see "Note 5. Convertible Subordinated Debentures"). F-16 48 NOTE 17. LEGAL PROCEEDINGS In February 1996, an action in the District Court of Hennepin County (Minnesota) was brought by T. Randal Productions et al. against the Company and one current and two former employees. The plaintiffs made various allegations, including misappropriation of corporate opportunities and trade secrets by the Company and its employees and sought award of monetary damages, exemplary damages and royalties substantially in excess of $10.0 million. In November 1997, a jury found that there was no joint venture between T. Randal and the company and/or any of its employees but awarded T. Randal $480,000 plus interest for damages sustained to its business. Plaintiffs moved for a new trial, amended findings and for judgment notwithstanding the verdict. The jury verdict was upheld by the trial court. The plaintiffs appealed this decision to the Minnesota Court of Appeals. In March 1999, the Minnesota Court of Appeals affirmed the decision of the trial court. The Company believes the plaintiffs will petition for a rehearing which Company counsel believes will not be successful. The plaintiffs also have an action pending against certain affiliates of the Company on the same grounds on which the action against the Company was based. The Company has indemnified these affiliates against any damages arising out of these claims. Counsel has advised the Company that the jury verdict in the action against the Company should be controlling in this action against the affiliates. As of December 31, 1998, the Company has accrued $480,000 plus estimated court costs. NOTE 18. RELOCATION OF OPERATIONS During early 1998, the Company relocated its primary operating facilities from Minneapolis, Minnesota to Seattle, Washington. As a result, certain of the Company's Minnesota leasehold improvements and computer and software equipment having a carrying value of $721,000 were not transferable or were not utilized in the Company's Seattle operations. In 1997, the Company had estimated and recorded the related relocation expense of $721,000 as a General and Administrative expense. In addition, in 1997 the Company recorded $252,000 and $610,000 in general and administrative expenses related to lease termination costs and severance for former officers and employees, respectively. NOTE 19. SUBSEQUENT EVENTS During January 1999, the Company completed a $14,278,000 private placement, which resulted in the issuance of 2,596,000 shares of the Company's common stock at $5.50 per share. F-16 49 ONHEALTH NETWORK COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (In thousands)
Additions Charged to (Recoveries Balance at Credited to) Balance Beginning Costs and at End of Period Expenses Deductions of Period --------------- --------------- ------------- ------------- Year Ended December 31, 1998: Allowance for doubtful accounts receivable, promotional allowances and sales returns $ 1,011 $ (755) (3) $ - (1) $ 256 Allowance for obsolete inventory 451 50 - (2) 501 =============== =============== ============= ============= $ 1,462 $ (705) - $ 757 =============== =============== ============= ============= Year Ended December 31, 1997: Allowance for doubtful accounts receivable, promotional allowances and sales returns $ 277 $ 2,336 $ (1,602) (1) $ 1,011 Allowance for obsolete inventory 485 200 (234) (2) 451 --------------- --------------- ------------- ------------- $ 762 $ 2,536 $ (1,836) $ 1,462 =============== =============== ============= ============= Year Ended December 31, 1996: Allowance for doubtful accounts receivable, promotional allowances and sales returns $ 753 $ 1,675 $ (2,151) (1) $ 277 Allowance for obsolete inventory 682 365 (562) (2) 485 =============== =============== ============= ============= $ 1,435 $ 2,040 $ (2,713) $ 762 =============== =============== ============= ============= - ------------------ 1) Deductions represent accounts receivable determined to be uncollectable and therefore charged against the allowance account; accounts receivable determined to be uncollectable due to return of product(s); and accounts credited due to promotional and administrative allowance arrangements with distributors. 2) Write-offs of inventory. 3) The $755 net credit to costs and expenses is primarily due to the 1998 recovery of an account previously written off.
S-1 50 EX-4.7 2 REGISTRATION RIGHTS AGREEMENT, DATED 1/29/99 EXHIBIT 4.7 ANNEX I REGISTRATION RIGHTS AGREEMENT THIS REGISTRATION RIGHTS AGREEMENT, dated as of January 29, 1999 (this "AGREEMENT"), is made by and between OnHealth Network Company, a Washington corporation (the "COMPANY"), and the Investors set forth on the signature page hereto (the "INVESTORS"). WITNESSETH: WHEREAS, in connection with the Subscription Agreement, dated as of January 29, 1999, between the Investors and the Company (the "SUBSCRIPTION AGREEMENT"), the Company has agreed, upon the terms and subject to the conditions of the Subscription Agreement, to issue and sell to the Investors shares of Common Stock, $.01 par value (the "SHARES"); WHEREAS, to induce the Investors to execute and deliver the Subscription Agreement, the Company has agreed to provide certain registration rights under the Securities Act of 1933, as amended, and the rules and regulations thereunder, or any similar successor statute (collectively, the "SECURITIES ACT"), and applicable state securities laws with respect to the Registrable Securities (as defined below) issuable to or for the account of the Investors pursuant to the Subscription Agreement; NOW, THEREFORE, in consideration of the premises and the mutual covenants contained herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Company and the Investor hereby agree as follows: 1. DEFINITIONS. (a) As used in this Agreement, the following terms shall have the following meanings: "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Investor" or "Investors" means the Investor and the other purchasers of Shares pursuant to the Subscription Agreement. "Nasdaq" means the Nasdaq SmallCap Market. "register," "registered," and "registration" refer to a registration effected by preparing and filing a Registration Statement or Statements in compliance with the Securities Act and pursuant to Rule 415 under the Securities Act or any successor rule providing for offering securities on a 1 51 continuous basis ("Rule 415"), and the declaration or ordering of effectiveness of such Registration Statement by the United States Securities and Exchange Commission (the "SEC"). "Registrable Securities" means the Shares. "Registration Period" means the period from the Closing Date to the earlier of (i) the date which is two years after the date of this Agreement, (ii) the date on which each Investor may sell all of its Registrable Securities without registration under the Securities Act pursuant to Rule 144, without restriction on the manner of sale or the volume of securities which may be sold in any period and without the requirement for the giving of any notice to, or the making of any filing with, the SEC and (iii) the date on which the Investors no longer beneficially own any Registrable Securities. "Registration Statement" means a registration statement of the Company under the Securities Act, including any amendment thereto. "Rule 144" means Rule 144 promulgated under the Securities Act or any other similar rule or regulation of the SEC that may at any time permit a holder of any securities to sell securities of the Company to the public without registration under the Securities Act. "SEC Effective Date" means the date the Registration Statement is first declared effective by the SEC. "SEC Filing Date" means the date the Registration Statement is first filed with the SEC pursuant to Section 2(a). (b) Capitalized terms defined in the introductory paragraph or the recitals to this Agreement shall have the respective meanings therein provided. Capitalized terms used herein and not otherwise defined herein shall have the respective meanings set forth in the Subscription Agreement. 2. REGISTRATION. (A) MANDATORY REGISTRATION. The Company shall prepare, and on or prior to March 1, 1999, file with the SEC a Registration Statement on Form S-3, or, if Form S-3 is not available, Form S-1 or S-2, which, on the date of filing with the SEC, covers the resale by the Investor the Shares sold pursuant to the Subscription Agreement. (B) CERTAIN OFFERINGS. If any offering pursuant to a Registration Statement pursuant to Section 2(a) hereof involves an underwritten offering, Investors who hold a majority in interest of the Registrable Securities subject to such underwritten offering shall have the right to select one legal counsel and an investment banker or bankers and manager or managers to administer the offering, which investment banker or bankers or manager or 2 52 managers shall be reasonably satisfactory to the Company. The Investors who hold the Registrable Securities to be included in such underwriting shall pay all underwriting discounts and commissions and other fees and expenses of such investment banker or bankers and manager or managers so selected in accordance with this Section 2(b) (other than fees and expenses relating to registration of Registrable Securities under federal or state securities laws, which are payable by the Company pursuant to Section 5 hereof) with respect to their Registrable Securities and the fees and expenses of such legal counsel so selected by the Investors. (C) OTHER REGISTRATIONS. The Company will not file another registration statement with the SEC covering shares of Common Stock prior to the SEC Effective Date, other than registration statements on Form S-4 or S-8. 3. OBLIGATIONS OF THE COMPANY. In connection with the registration of the Registrable Securities, the Company shall: (a) prepare promptly, and file with the SEC not later than March 1, 1999, a Registration Statement with respect to the number of Shares sold pursuant to the Subscription Agreement(s) and thereafter to use its commercially reasonable best efforts to cause such Registration Statement relating to Registrable Securities to become effective prior to March 30, 1999, and keep the Registration Statement effective pursuant to Rule 415 at all times during the Registration Period; and the Company represents and warrants to, and covenants and agrees with, the Investors that the Registration Statement (including any amendments or supplements thereto and prospectuses contained therein), at the time it is first filed with the SEC, at the time it is ordered effective by the SEC and at all times during which it is required to be effective hereunder (and each such amendment and supplement at the time it is filed with the SEC and at all times during which it is available for use in connection with the offer and sale of the Registrable Securities) shall not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein, or necessary to make the statements therein, in light of the circumstances in which they were made, not misleading; (b) prepare and file with the SEC such amendments (including post-effective amendments) and supplements to the Registration Statement and the prospectus used in connection with the Registration Statement as may be necessary to keep the Registration Statement effective at all times during the Registration Period, and, during the Registration Period, comply with the provisions of the Securities Act with respect to the disposition of all Registrable Securities of the Company covered by the Registration Statement until such time as all of such Registrable Securities have been disposed of in accordance with the intended methods of disposition by the seller or sellers thereof as set forth in the Registration Statement; (c) furnish to each Investor whose Registrable Securities are included in the Registration Statement and its legal counsel, (1) promptly after the same is prepared and publicly distributed, filed with the SEC or received by the Company, one copy of the Registration Statement and any amendment thereto, each preliminary prospectus and prospectus and each amendment or supplement 3 53 thereto, each letter written by or on behalf of the Company to the SEC or the staff of the SEC and each item of correspondence from the SEC or the staff of the SEC relating to such Registration Statement (other than any portion of any thereof which contains information for which the Company has sought confidential treatment) and (2) such number of copies of a prospectus, including a preliminary prospectus, and all amendments and supplements thereto and such other documents, as such Investor may reasonably request in order to facilitate the disposition of the Registrable Securities owned by such Investor; (d) use commercially reasonable best efforts to (i) register and qualify the Registrable Securities covered by the Registration Statement under such securities or blue sky laws of such jurisdictions as the Investors who hold a majority in interest of the Registrable Securities being offered reasonably request, (ii) prepare and file in those jurisdictions such amendments (including post-effective amendments) and supplements to such registrations and qualifications as may be necessary to maintain the effectiveness thereof at all times until the end of the Registration Period, (iii) take such other actions as may be necessary to maintain such registrations and qualifications in effect at all times during the Registration Period and (iv) take all other actions reasonably necessary or advisable to qualify the Registrable Securities for sale in such jurisdictions; PROVIDED, HOWEVER, that the Company shall not be required in connection therewith or as a condition thereto (I) to qualify to do business in any jurisdiction where it would not otherwise be required to qualify but for this Section 3(d), (II) to subject itself to general taxation in any such jurisdiction, (III) to file a general consent to service of process in any such jurisdiction, (IV) to provide any undertakings that cause more than nominal expense or burden to the Company or (V) to make any change in its Articles of Incorporation or by-laws, which in each case the Board of Directors of the Company determines to be contrary to the best interests of the Company and its shareholders; (e) in the event that the Registrable Securities are being offered in an underwritten offering, enter into and perform its obligations under an underwriting agreement, in usual and customary form, including, without limitation, customary indemnification and contribution obligations, with the underwriters of such offering; (f) as promptly as practicable after becoming aware of such event or circumstance, notify each Investor of any event or circumstance of which the Company has knowledge, as a result of which the prospectus included in the Registration Statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading, and use its best efforts promptly to prepare a supplement or amendment to the Registration Statement to correct such untrue statement or omission, file such supplement or amendment with the SEC at such time as shall permit the Investors to sell Registrable Securities pursuant to the Registration Statement as promptly as practical, and deliver a number of copies of such supplement or amendment to each Investor as such Investor may reasonably request; (g) as promptly as practicable after becoming aware of such event, notify each Investor who holds Registrable Securities being sold (or, in 4 54 the event of an underwritten offering, the managing underwriters) of the issuance by the SEC of any stop order or other suspension of effectiveness of the Registration Statement at the earliest possible time; (h) permit a single firm of counsel designated as selling shareholders' counsel by the Investors who hold a majority in interest of the Registrable Securities being sold to review and comment on the Registration Statement and all amendments and supplements thereto a reasonable period of time prior to their filing with the SEC; (i) make generally available to its security holders as soon as practical, but not later than ninety (90) days after the close of the period covered thereby, an earnings statement (in form complying with the provisions of Rule 158 under the Securities Act) covering a twelve-month period beginning not later than the first day of the Company's fiscal quarter next following the effective date of the Registration Statement; (j) at the request of the Investors who hold a majority in interest of the Registrable Securities being sold, furnish on the date that Registrable Securities are delivered to an underwriter, if any, for sale in connection with the Registration Statement (i) a letter, dated such date, from the Company's independent certified public accountants in form and substance as is customarily given by independent certified public accountants to underwriters in an underwritten public offering, addressed to the underwriters; and (ii) an opinion, dated such date, from counsel representing the Company for purposes of such Registration Statement, in form and substance as is customarily given in an underwritten public offering, addressed to the underwriters and the Investors; (k) use its best efforts (i) to cause all the Registrable Securities covered by the Registration Statement to be listed on the Nasdaq or such other principal securities market on which securities of the same class or series issued by the Company are then listed or traded or (ii) if securities of the same class or series as the Registrable Securities are not then listed on Nasdaq or any such other securities market, to cause all of the Registrable Securities covered by the Registration Statement to be listed on the New York Stock Exchange, the American Stock Exchange or the Nasdaq National Market; (l) provide a transfer agent and registrar, which may be a single entity, for the Registrable Securities not later than the effective date of the Registration Statement; (m) during the period the Company is required to maintain effectiveness of the Registration Statement pursuant to Section 3(a), the Company shall not bid for or purchase any Common Stock or any right to purchase Common Stock or attempt to induce any person to purchase any such security or right if such bid, purchase or attempt would in any way limit the right of the Investors to sell Registrable Securities by reason of the limitations set forth in Regulation M under the Exchange Act; and (n) take all other reasonable actions necessary to expedite and facilitate disposition by the Investors of the Registrable Securities pursuant to the Registration Statement. 5 55 4. OBLIGATIONS OF THE INVESTORS. In connection with the registration of the Registrable Securities, the Investors shall have the following obligations: (a) It shall be a condition precedent to the obligations of the Company to complete the registration pursuant to this Agreement with respect to the Registrable Securities of a particular Investor that such Investor shall furnish to the Company such information regarding itself, the Registrable Securities held by it and the intended method of disposition of the Registrable Securities held by it as shall be reasonably required to effect the registration of such Registrable Securities and shall execute such documents in connection with such registration as the Company may reasonably request. At least four (4) days prior to the first anticipated filing date of the Registration Statement, the Company shall notify each Investor of the information the Company requires from each such Investor (the "REQUESTED INFORMATION") if any of such Investor's Registrable Securities are eligible for inclusion in the Registration Statement. If at least one (1) business day prior to the filing date the Company has not received the Requested Information from an Investor (a "NON-RESPONSIVE INVESTOR"), then the Company may file the Registration Statement without including Registrable Securities of such Non-Responsive Investor but shall not be relieved of its obligation to file a Registration Statement with the SEC relating to the Registrable Securities of such Non-Responsive Investor promptly after such Non-Responsive Investor provides the Requested Information; (b) Each Investor by such Investor's acceptance of the Registrable Securities agrees to cooperate with the Company as reasonably requested by the Company in connection with the preparation and filing of the Registration Statement hereunder, unless such Investor has notified the Company in writing of such Investor's election to exclude all of such Investor's Registrable Securities from the Registration Statement; (c) In the event Investors holding a majority in interest of the Registrable Securities being registered determine to engage the services of an underwriter, each Investor agrees to enter into and perform such Investor's obligations under an underwriting agreement, in usual and customary form, including, without limitation, customary indemnification and contribution obligations, with the managing underwriter of such offering and take such other actions as are reasonably required in order to expedite or facilitate the disposition of the Registrable Securities, unless such Investor has notified the Company in writing of such Investor's election to exclude all of such Investor's Registrable Securities from the Registration Statement; (d) Each Investor agrees that, upon receipt of any notice from the Company of the happening of any event of the kind described in Section 3(f) or 3(g), such Investor will immediately discontinue disposition of Registrable Securities pursuant to the Registration Statement covering such Registrable Securities until such Investor's receipt of the copies of the supplemented or amended prospectus contemplated by Section 3(f) or 3(g) and, if so directed by the Company, such Investor shall deliver to the Company (at the expense of the 6 56 Company) or destroy (and deliver to the Company a certificate of destruction) all copies in such Investor's possession of the prospectus covering such Registrable Securities current at the time of receipt of such notice; and (e) No Investor may participate in any underwritten registration hereunder unless such Investor (i) agrees to sell such Investor's Registrable Securities on the basis provided in any underwriting arrangements approved by the Investors entitled hereunder to approve such arrangements, (ii) completes and executes all questionnaires, powers of attorney, indemnities, underwriting agreements and other documents reasonably required under the terms of such underwriting arrangements and (iii) agrees to pay its pro rata share of all underwriting discounts and commissions and other fees and expenses of investment bankers and any manager or managers of such underwriting and legal expenses of the underwriters applicable with respect to its Registrable Securities, in each case to the extent not payable by the Company pursuant to the terms of this Agreement. 5. EFFECTIVENESS OF REGISTRATION STATEMENT; PENALTIES. Company shall use its commercially reasonable best efforts to have the Registration Statement declared effective prior to March 30, 1999. In the event the Registration Statement has not been declared effective on or prior to April 29, 1999, the Company shall pay Investor in cash 1% of the initial investment in the Shares (measured by multiplying $5.50 by the number of Shares purchased by Investor pursuant to the Subscription Agreement), for each month after April 29, 1999 that the Registration Statement has not been declared effective. 6. EXPENSES OF REGISTRATION. All reasonable expenses, other than underwriting discounts and commissions and other fees and expenses of investment bankers and other than brokerage commissions, incurred in connection with registrations, filings or qualifications pursuant to Section 3, including, without limitation, all registration, listing and qualifications fees, printers and accounting fees and the fees and disbursements of counsel for the Company, shall be borne by the Company, PROVIDED, HOWEVER, that the Investors shall bear the fees and out-of-pocket expenses of the one legal counsel selected by the Investors pursuant to Section 2(b) hereof. None of the foregoing shall be construed to require the Investors to bear the fees or expenses of counsel to the underwriters. 7. INDEMNIFICATION. In the event any Registrable Securities are included in a Registration Statement under this Agreement: (a) To the extent permitted by law, the Company will indemnify and hold harmless each Investor who holds such Registrable Securities, the directors, if any, of such Investor, the officers, if any, of such Investor, each person, if any, who controls any Investor within the meaning of the Securities Act or the Exchange Act, any underwriter (as defined in the Securities Act) for the Investors, the directors, if any, of such underwriter and the officers, if any, of such underwriter, and each person, if any, who controls any such underwriter within the meaning of the Securities Act or the Exchange Act (each, an "INDEMNIFIED PERSON"), against any losses, claims, 7 57 damages, liabilities or expenses (joint or several) incurred (collectively, "CLAIMS") to which any of them may become subject under the Securities Act, the Exchange Act or otherwise, insofar as such Claims (or actions or proceedings, whether commenced or threatened, in respect thereof) arise out of or are based upon any of the following statements, omissions or violations in the Registration Statement, or any post-effective amendment thereof, or any prospectus included therein: (i) any untrue statement or alleged untrue statement of a material fact contained in the Registration Statement or any post-effective amendment thereof or the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, (ii) any untrue statement or alleged untrue statement of a material fact contained in any preliminary prospectus if used prior to the effective date of such Registration Statement, or contained in the final prospectus (as amended or supplemented, if the Company files any amendment thereof or supplement thereto with the SEC) or the omission or alleged omission to state therein any material fact necessary to make the statements made therein, in light of the circumstances under which the statements therein were made, not misleading or (iii) any violation or alleged violation by the Company of the Securities Act, the Exchange Act, any state securities law or any rule or regulation under the Securities Act, the Exchange Act or any state securities law (the matters in the foregoing clauses (i) through (iii) being, collectively, "VIOLATIONS"). Subject to the restrictions set forth in Section 7(d) with respect to the number of legal counsel, the Company shall reimburse the Investors and each such underwriter or controlling person, promptly as such expenses are incurred and are due and payable, for any legal fees or other reasonable expenses incurred by them in connection with investigating or defending any such Claim. Notwithstanding anything to the contrary contained herein, the indemnification agreement contained in this Section 7(a): (I) shall not apply to a Claim arising out of or based upon a Violation which occurs in reliance upon and in conformity with information furnished in writing to the Company by any Indemnified Person or underwriter for such Indemnified Person expressly for use in connection with the preparation of the Registration Statement, the prospectus or any such amendment thereof or supplement thereto, if such prospectus was timely made available by the Company pursuant to Section 3(c) hereof; (II) with respect to any preliminary prospectus shall not inure to the benefit of any such person from whom the person asserting any such Claim purchased the Registrable Securities that are the subject thereof (or to the benefit of any person controlling such person) if the untrue statement or omission of material fact contained in the preliminary prospectus was corrected in the prospectus, as then amended or supplemented, if such prospectus was timely made available by the Company pursuant to Section 3(c) hereof; and (III) shall not apply to amounts paid in settlement of any Claim if such settlement is effected without the prior written consent of the Company, which consent shall not be unreasonably withheld. Such indemnity shall remain in full force and effect regardless of any investigation made by or on behalf of the Indemnified Person and shall survive the transfer of the Registrable Securities by the Investors pursuant to Section 9. (b) In connection with any Registration Statement in which an Investor is participating, each such Investor agrees to indemnify and hold harmless, to the same extent and in the same manner set forth in Section 7(a), the Company, each of its directors, each of its officers who signs the Registration Statement, each person, if any, who controls the Company within the meaning of the Securities Act or the Exchange Act, any underwriter and any other 8 58 shareholder selling securities pursuant to the Registration Statement or any of its directors or officers or any person who controls such shareholder or underwriter within the meaning of the Securities Act or the Exchange Act (collectively and together with an Indemnified Person, an "INDEMNIFIED PARTY"), against any Claim to which any of them may become subject, under the Securities Act, the Exchange Act or otherwise, insofar as such Claim arises out of or is based upon any Violation, in each case to the extent (and only to the extent) that such Violation occurs in reliance upon and in conformity with written information furnished to the Company by such Investor expressly for use in connection with such Registration Statement; and such Investor will reimburse any legal or other expenses reasonably incurred by any Indemnified Party in connection with investigating or defending any such Claim; PROVIDED, HOWEVER, that the indemnity agreement contained in this Section 7(b) shall not apply to amounts paid in settlement of any Claim if such settlement is effected without the prior written consent of such Investor, which consent shall not be unreasonably withheld; PROVIDED, FURTHER, HOWEVER, that the Investor shall be liable under this Section 7(b) for only that amount of a Claim as does not exceed the amount by which the net proceeds to such Investor from the sale of Registrable Securities pursuant to such Registration Statement exceeds the cost of such Registrable Securities to such Investor. Such indemnity shall remain in full force and effect regardless of any investigation made by or on behalf of such Indemnified Party and shall survive the transfer of the Registrable Securities by the Investors pursuant to Section 9. Notwithstanding anything to the contrary contained herein, the indemnification agreement contained in this Section 7(b) with respect to any preliminary prospectus shall not inure to the benefit of any Indemnified Party if the untrue statement or omission of material fact contained in the preliminary prospectus was corrected on a timely basis in the prospectus, as then amended or supplemented. (c) The Company shall be entitled to receive indemnities from underwriters, selling brokers, dealer managers and similar securities industry professionals participating in any distribution, to the same extent as provided above, with respect to information so furnished in writing by such persons expressly for inclusion in the Registration Statement. (d) Promptly after receipt by an Indemnified Person or Indemnified Party under this Section 7 of notice of the commencement of any action (including any governmental action), such Indemnified Person or Indemnified Party shall, if a Claim in respect thereof is to be made against any indemnifying party under this Section 7, deliver to the indemnifying party a written notice of the commencement thereof and the indemnifying party shall have the right to participate in, and, to the extent the indemnifying party so desires, jointly with any other indemnifying party similarly noticed, to assume control of the defense thereof with counsel selected by the indemnifying party but reasonably acceptable to the Indemnified Person or the Indemnified Party, as the case may be; PROVIDED, HOWEVER, that an Indemnified Person or Indemnified Party shall have the right to retain its own counsel with the fees and expenses to be paid by the indemnifying party, if, in the reasonable opinion of counsel retained by the indemnifying party, the representation by such counsel of the Indemnified Person or Indemnified Party and the indemnifying party would be inappropriate due to actual or potential differing interests between such Indemnified Person or Indemnified Party and any other party represented by such counsel in such proceeding. In such event, the Company shall pay for only one separate legal counsel for the Investors; such legal counsel shall be selected 9 59 by the Investors holding a majority in interest of the Registrable Securities included in the Registration Statement to which the Claim relates. The failure to deliver written notice to the indemnifying party within a reasonable time of the commencement of any such action shall not relieve such indemnifying party of any liability to the Indemnified Person or Indemnified Party under this Section 7, except to the extent that the indemnifying party is prejudiced in its ability to defend such action. The indemnification required by this Section 6 shall be made by periodic payments of the amount thereof during the course of the investigation or defense, as such expense, loss, damage or liability is incurred and is due and payable. 8. CONTRIBUTION. To the extent any indemnification by an indemnifying party is prohibited or limited by law, the indemnifying party agrees to make the maximum contribution with respect to any amounts for which it would otherwise be liable under Section 6 to the fullest extent permitted by law; PROVIDED, HOWEVER, that (a) no contribution shall be made under circumstances where the maker would not have been liable for indemnification under the fault standards set forth in Section 7, (b) no seller of Registrable Securities guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any seller of Registrable Securities who was not guilty of such fraudulent misrepresentation and (c) contribution by any seller of Registrable Securities shall be limited in amount to the amount by which the net amount of proceeds received by such seller from the sale of such Registrable Securities exceeds the purchase price paid by such seller for such Registrable Securities. 9. REPORTS UNDER EXCHANGE ACT. With a view to making available to the Investors the benefits of Rule 144, the Company agrees to: (a) make and keep public information available, as those terms are understood and defined in Rule 144; (b) file with the SEC in a timely manner all reports and other documents required of the Company under the Securities Act and the Exchange Act; and (c) furnish to each Investor so long as such Investor owns Registrable Securities, promptly upon request, (i) a written statement by the Company that it has complied with the reporting requirements of Rule 144 and the Exchange Act, (ii) a copy of the most recent annual or quarterly report of the Company and such other reports and documents so filed by the Company and (iii) such other information as may be reasonably requested to permit the Investors to sell such securities pursuant to Rule 144 without registration. 10. AMENDMENT OF REGISTRATION RIGHTS. Any provision of this Agreement may be amended and the observance thereof may be waived (either generally or in a particular instance and either retroactively or prospectively), only with the written consent of the Company and Investors who hold a majority in interest of the Registrable Securities. Any amendment or 10 60 waiver effected in accordance with this Section 10 shall be binding upon each Investor and the Company. 11. MISCELLANEOUS. (a) A person or entity is deemed to be a holder of Registrable Securities whenever such person or entity owns of record such Registrable Securities. If the Company receives conflicting instructions, notices or elections from two or more persons or entities with respect to the same Registrable Securities, the Company shall act upon the basis of instructions, notice or election received from the registered owner of such Registrable Securities. (b) Notices required or permitted to be given hereunder shall be in writing and shall be deemed to be sufficiently given when personally delivered (by hand, by courier, by telephone line facsimile transmission or other means) (i) if to the Company, at 808 Howell Street, Suite 400, Seattle, Washington, 98101, Attention: Chief Financial Officer, telephone line facsimile transmission number (206) 652-9075, with a copy to C. Kent Carlson, Esq., Preston Gates & Ellis LLP, 701 Fifth Avenue, Seattle, Washington 98104 (telephone line facsimile number (206) 623-7022), and (ii) if to the Investor, to such address set forth on the signature page of this Agreement. (c) Failure of any party to exercise any right or remedy under this Agreement or otherwise, or delay by a party in exercising such right or remedy, shall not operate as a waiver thereof. (d) This Agreement shall be enforced, governed by and construed in accordance with the laws of the State of Washington applicable to agreements made and to be performed entirely within such State. In the event that any provision of this Agreement is invalid or unenforceable under any applicable statute or rule of law, then such provision shall be deemed inoperative to the extent that it may conflict therewith and shall be deemed modified to conform with such statute or rule of law. Any provision hereof which may prove invalid or unenforceable under any law shall not affect the validity or enforceability of any other provision hereof. (e) This Agreement constitutes the entire agreement among the parties hereto with respect to the subject matter hereof. There are no restrictions, promises, warranties or undertakings, other than those set forth or referred to herein. This Agreement supersedes all prior agreements and understandings among the parties hereto with respect to the subject matter hereof. (f) Subject to the requirements of Section 9 hereof, this Agreement shall inure to the benefit of and be binding upon the successors and assigns of each of the parties hereto. (g) All pronouns and any variations thereof refer to the masculine, feminine or neuter, singular or plural, as the context may require. (h) The headings in this Agreement are for convenience of reference only and shall not limit or otherwise affect the meaning hereof. 11 61 (i) The Company acknowledges that any failure by the Company to perform its obligations under this Agreement, including, without limitation, the Company's obligations under Section 3(n), or any delay in such performance could result in damages to the Investors and the Company agrees that, in addition to any other liability the Company may have by reason of any such failure or delay, the Company shall be liable for all direct and consequential damages caused by any such failure or delay. (j) This Agreement may be executed in two or more counterparts, each of which shall be deemed an original but all of which shall constitute one and the same agreement. This Agreement, once executed by a party, may be delivered to the other party hereto by telephone line facsimile transmission of a copy of this Agreement bearing the signature of the party so delivering this Agreement. 12 62 IN WITNESS WHEREOF, the parties have caused this Agreement to be duly executed by their respective officers thereunto duly authorized as of day and year first above written. ONHEALTH NETWORK COMPANY By:/s/MICHAEL D. CONWAY ------------------------ Name: Michael D. Conway Title: Vice President INVESTOR ---------------------------- By _________________________ Its __________________________ 13 63 List of Purchasers: Name Robert S. Colman as Trustee UDT dated 3/13/85 Number of Shares 100,000 Name UMBTRU Number of Shares 2,000,000 Name Larry Arnold Number of Shares 46,000 Name Wayne W. Mills Number of Shares 50,000 Name David R. Wilmerding Number of Shares 200,000 Name Jon C. Baker Number of Shares 200,000 14 64 EX-10.28 3 SUBSCRIPTION AGREEMENT DATED JANUARY 29, 1999 EXHIBIT 10.28 SUBSCRIPTION AGREEMENT THIS SUBSCRIPTION AGREEMENT, dated as of January 29, 1999 (this "AGREEMENT"), by and between OnHealth Network Company, a Washington corporation (the "COMPANY"), with headquarters located at 808 Howell Street, Suite 400, Seattle, Washington 98101, and the purchaser set forth on the Signature Page to this Agreement (the "BUYER"). WITNESSETH WHEREAS, the Buyer wishes to purchase, upon the terms and subject to the conditions of this Agreement, shares of the Company's Common Stock par value $.01 per share (the "SHARES"); and WHEREAS, the Company and the Buyer are executing and delivering this Agreement in reliance upon the exemption from securities registration afforded by Rule 506 of Regulation D as promulgated by the SEC under the 1933 Act; NOW THEREFORE, in consideration of the premises and the mutual covenants contained herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: 1. AGREEMENT TO SUBSCRIBE; PURCHASE PRICE. (a) SUBSCRIPTION The Buyer hereby agrees to purchase from the Company that number of Shares set forth on the Signature Page of this Agreement. The purchase price per Share shall be $5.50 (the "PER SHARE PURCHASE PRICE"). (b) FORM OF PAYMENT. At the Closing (as defined in Section 5) (1) the Buyer shall pay the Company, by wire transfer of immediately available funds to such account as specified by the Company to the Buyer that amount equal to the number of Shares purchased by the Buyer multiplied by the Per Share Purchase Price, and (2) Company shall agree to deliver certificates representing the Shares within three days of the Closing. 2. BUYER REPRESENTATIONS, WARRANTIES, ETC. The Buyer represents and warrants to, and covenants and agrees with, the Company as follows: (a) PURCHASE FOR INVESTMENT. The Buyer is purchasing the Shares for its own account for investment only and not with a view towards the public sale or distribution thereof. (b) ACCREDITED INVESTOR. The Buyer is an "ACCREDITED INVESTOR" as that term is defined in Rule 501 of the General Rules and Regulations under the 1933 Act by reason of Rule 501(a)(3); (c) REOFFERS AND RESALES. All subsequent offers and sales of the Shares by the Buyer shall be made pursuant to registration of the Shares being offered and sold under the 1933 Act or pursuant to an exemption from registration; 1 65 (d) COMPANY RELIANCE. The Buyer understands that the Shares are being offered and sold in reliance on specific exemptions from the registration requirements of United States federal and state securities laws and that the Company is relying upon the truth and accuracy of, and the Buyer's compliance with, the representations, warranties, agreements, acknowledgments and understandings of the Buyer set forth herein in order to determine the availability of such exemptions and the eligibility of the Buyer to acquire the Shares; (e) INFORMATION PROVIDED. The Buyer and its advisors, if any, have been furnished with all materials relating to the business, finances and operations of the Company and materials relating to the offer and sale of the Shares which have been requested by the Buyer; the Buyer and its advisors, if any, have been afforded the opportunity to ask questions of the Company and have received satisfactory answers to any such inquiries; without limiting the generality of the foregoing, the Buyer has had the opportunity to obtain and to review the Company's: (1) annual report on Form 10-K for the year ended December 31, 1997 (the "1997 10-K"), (2) Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 1998, June 30, 1998, and September 30, 1998, (3) definitive proxy statement for its 1998 Annual Meeting of Shareholders (to the extent incorporated by reference in the 1997 10-K), and (4) the Company's form S-3 Registration Statement filed December 30, 1998 (SEC 1933 Act Number 333-69989), in each case as filed with the SEC (the "SEC REPORTS"); and the Buyer understands that its investment in the Securities involves a high degree of risk; (f) ABSENCE OF APPROVALS. The Buyer understands that no United States federal or state agency or any other government or governmental agency has passed on or made any recommendation or endorsement of the Securities; and (g) SUBSCRIPTION AGREEMENT The Buyer has all requisite power and authority, corporate or otherwise, to execute, deliver and perform its obligations under this Agreement and the other agreements executed or to be executed by the Buyer in connection herewith and to consummate the transactions contemplated hereby and thereby. This Agreement has been duly and validly authorized, executed and delivered on behalf of the Buyer and is a valid and binding agreement of the Buyer enforceable in accordance with its terms, subject as to enforceability to general principles of equity and to bankruptcy, insolvency, moratorium and other similar laws affecting the enforcement of creditors' rights generally. 3. COMPANY REPRESENTATIONS, WARRANTIES, ETC. Except as set forth in a document of even date hereof (the "COMPANY DISCLOSURE SCHEDULE"), the Company represents and warrants to, and covenants and agrees with, the Buyer that: (a) ORGANIZATION AND AUTHORITY The Company is a corporation duly organized and validly existing under the laws of its jurisdiction of incorporation, and has all requisite corporate power and authority to (i) own, 2 66 lease and operate its properties and to carry on its business as described in the SEC Reports and as now being conducted, and (ii) to execute, deliver and perform its obligations under this Agreement and a Registration Rights Agreement to be delivered at the Closing (the "REGISTRATION RIGHTS AGREEMENT"), and to consummate the transactions contemplated hereby and thereby. (b) CAPITALIZATION The authorized capital stock of the Company consists of (i) 29,000,000 shares of Common Stock of which 12,981,652 shares of Common Stock were outstanding on January 25, 1999, all of which are fully paid and nonassessable; and (ii) 1,000,000 shares of Preferred Stock, $.01 par value, of which 5,800 shares are designated as Series B Preferred Stock, of which no shares are outstanding; and as of the Closing there will be no material increase from January 25, 1999 in the number of shares of Common Stock outstanding. As of January 25, 1999, the Company had outstanding options, warrants and similar rights entitling the holders to purchase 3,595,628 shares of Common Stock. Other than as set forth in the preceding sentence, the Company does not have outstanding any material amount of securities (or obligations to issue any such securities) convertible into, exchangeable for or otherwise entitling the holders thereof to acquire shares of Common Stock, except as disclosed in the SEC Reports. The Company has duly reserved from its authorized and unissued shares of Common Stock the full number of shares required for (y) all options, warrants, convertible securities and other rights to acquire shares of Common Stock which are outstanding and (z) all shares of Common Stock and options and other rights to acquire shares of Common Stock which may be issued or granted under the stock option and similar plans which have been adopted by the Company. (c) AUTHORIZATION. The Shares have been duly authorized. There are no preemptive or similar rights of any shareholder of the Company or any other Person to acquire any of the Shares. The Company and the Shares meet the criteria for continued listing and trading on the Nasdaq SmallCap Market ("NASDAQ SmallCap"); the Company has not been notified since January 1, 1999 by the Nasdaq SmallCap of any failure or potential failure to meet the criteria for continued listing and trading on the Nasdaq SmallCap and no suspension of trading in the Common Stock is in effect. Subject to compliance, if required, with Rule 4310(c)(25)(H) of the Nasdaq SmallCap, the Company knows of no reason that the Shares will not be eligible for listing on the Nasdaq SmallCap. For purposes of this Agreement, "PERSON" means an individual, partnership, corporation, limited liability company, trust, incorporated organization, unincorporated association or joint stock company. (d) SUBSCRIPTION AGREEMENT; REGISTRATION RIGHTS AGREEMENT. This Agreement, and the Registration Rights Agreement have been duly and validly authorized by the Company, this Agreement has been duly executed and delivered by the Company and this Agreement is, and the Registration Rights Agreement, when executed and delivered by the Company, will be, valid and binding obligations of the Company enforceable in accordance with their respective terms, subject as to enforceability to general principles of equity and to bankruptcy, insolvency, moratorium and other similar laws affecting the enforcement of creditors' rights generally. (e) NON-CONTRAVENTION. The execution and delivery by the Company of this Agreement and the other documents contemplated by this Agreement and the consummation by the Company of the issuance of the Shares as 3 67 contemplated by this Agreement, and the other transactions contemplated by this Agreement and the Registration Rights Agreement do not and will not, with or without the giving of notice or the lapse of time, or both (i) result in any violation of any terms of the Articles of Incorporation or by-laws of the Company, (ii) conflict with or result in a breach by the Company of any of the terms or provisions of, or constitute a default under, or result in the modification, amendment, termination or cancellation of, result in the acceleration of any obligation of the Company under, or result in the creation or imposition of any lien, security interest, charge or encumbrance upon any of the properties or assets of the Company pursuant to, any indenture, mortgage, deed of trust or other agreement or instrument to which the Company is a party or by which the Company or any of its respective properties or assets is bound or affected, (iii) violate or contravene any applicable law, rule or regulation or any applicable decree, judgment or order of any court, United States federal or state regulatory body, administrative agency or other governmental body having jurisdiction over the Company or any of its respective properties or assets or (iv) have any material adverse effect on any permit, certification, registration, approval, consent, license or franchise necessary for the Company to own or lease and operate any of their respective properties or to conduct any of their respective businesses or the ability of the Company to make use thereof. (f) APPROVALS. No authorization, approval or consent of, or filing with, any court, governmental body, regulatory agency, self-regulatory organization, or stock exchange or market or the shareholders of the Company is required to be obtained or made by the Company for (1) the execution, delivery and performance by the Company of this Agreement and the Registration Rights Agreement, and (2) the issuance and sale of the Shares as contemplated by this Agreement other than (w) the listing of the Shares on the Nasdaq SmallCap, (x) registration of the resale of the Shares under the 1933 Act as contemplated by the Registration Rights Agreement, and (y) filing of one or more Forms D with respect to the Shares as required under Regulation D of the Securities Act of 1933 and related filings under applicable state securities laws. (g) INFORMATION PROVIDED. The information provided by or on behalf of the Company to the Buyer in connection with the transactions contemplated by this Agreement, including, without limitation, the information referred to in Section 2(e) of this Agreement, does not contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they are made, not misleading, it being understood that, for purposes of this Section 3(g), any statement contained in such information shall be deemed to be modified or superseded for purposes of this Section 3(g) to the extent that a statement in any document included in such information which was prepared or filed with the SEC on a later date modifies or replaces such statement, whether or not such later prepared or filed statement so states. The Company has not filed any reports with the SEC under the 1934 Act since December 31, 1998. (h) ABSENCE OF CERTAIN CHANGES. Except as disclosed in the SEC Reports, since December 31, 1997, there has been no material adverse change and no material adverse development in the business, properties, operations, condition (financial or other), results of operations or prospects of the Company. Except as and to the extent disclosed, reflected or reserved against in the financial statements of the Company and the notes thereto included in the SEC Reports, the Company has no material (individually or in the aggregate) 4 68 liabilities, debts or obligations whether accrued, absolute, contingent or otherwise, and whether due or to become due. Since December 31, 1997, the Company has not incurred any liabilities, debts or obligations of any nature whatsoever which are individually or in the aggregate material to the Company, other than those incurred in the ordinary course of their respective businesses or disclosed in the SEC Reports. (i) ABSENCE OF CERTAIN PROCEEDINGS. Except as described in the SEC Reports, there is no action pending or, to the knowledge of the Company, threatened against the Company, in any such case likely to have a material adverse effect on the business, properties, condition (financial or other), results of operations or prospects of the Company or the transactions contemplated by this Agreement or any of the documents contemplated hereby or which would adversely affect the validity or enforceability of, or the authority or ability of the Company to perform its obligations under, this Agreement or any of such other documents; neither the Company nor any director or officer thereof is or has been the subject of any action involving (i) a claim of violation of or liability under federal or state securities laws or (ii) a claim of breach of fiduciary duty. The Company does not have pending before the SEC any request for confidential treatment of information and to the best of the Company's knowledge no such request will be made by the Company prior to the time the Registration Statement relating to the Shares which is contemplated by the Registration Rights Agreement is first ordered effective by the SEC; and there has not been, and the Company has not been notified of any pending or contemplated any investigation by the SEC involving the Company or any current or former director or officer of the Company. (j) SEC FILINGS. The Company has timely filed all required forms, reports and other documents required to be filed with the SEC under the 1934 Act. All of such forms, reports and other documents complied, when filed, in all material respects, with all applicable requirements of the 1933 Act and the 1934 Act. 4. CERTAIN COVENANTS AND ACKNOWLEDGEMENTS. (a) TRANSFER RESTRICTIONS. The Company and the Buyer acknowledge and agree that (1) the Shares have not been and are not being registered for resale under the 1933 Act (other than as provided in the Registration Rights Agreement), and the Securities may not be transferred unless (A) subsequently registered for resale thereunder or (B) the Buyer shall have delivered to the Company an opinion of counsel, reasonably satisfactory in form, scope and substance to the Company, to the effect that the Shares to be sold or transferred may be sold or transferred pursuant to an exemption from such registration and (2) any resale of the Shares made in reliance on Rule 144 promulgated under the 1933 Act may be made only in accordance with the terms of Rule 144 and further, if Rule 144 is not applicable, any such resale of Shares under circumstances in which the seller, or the person through whom the sale is made, may be deemed to be an underwriter, as that term is used in the 1933 Act, may require compliance with some other exemption under the 1933 Act or the rules and regulations of the SEC thereunder. (c) RESTRICTIVE LEGEND. 5 69 The Buyer further acknowledges and agrees that until such time as the Shares have been registered for resale under the 1933 Act as contemplated by the Registration Rights Agreement and such registration statement has been declared effective by the Securities and Exchange Commission, the certificates for the Shares may bear a restrictive legend in substantially the following form (and a stop-transfer order may be placed against transfer of the certificates for the Shares): The securities represented by this certificate have not been registered under the Securities Act of 1933, as amended. The securities have been acquired for investment and may not be resold, transferred or assigned in the absence of an effective registration statement for the securities under the Securities Act of 1933, as amended, or an opinion of counsel reasonably acceptable to the Company that registration is not required under said Act. (c) REGISTRATION RIGHTS AGREEMENT. On or before the Closing Date, the parties hereto agree to enter into the Registration Rights Agreement in the form attached hereto as ANNEX I. (d) FORM D. The Company agrees to file a Form D with respect to the Shares as required under Regulation D and to provide a copy thereof to the Buyer promptly after such filing. The Buyer agrees to cooperate with the Company in connection with such filing and, upon request of the Company, to provide all information relating to the Buyer reasonably required for such filing. (e) AUTHORIZATION FOR TRADING; REPORTING STATUS. Within ten business days after the Closing, the Company shall file a notification for listing of additional shares with the Nasdaq SmallCap relating to the Shares and provide evidence of such filing to the Buyer. So long as the Buyer beneficially owns any of the Shares, the Company shall file all reports required to be filed with the SEC pursuant to Section 13 or 15(d) of the 1934 Act and the Company shall not voluntarily terminate its status as an issuer required to file reports under the 1934 Act even if the 1934 Act or the rules and regulations thereunder would permit such termination. (f) BLUE SKY LAWS. The Company shall take such action as and to the extent it shall be necessary or required to qualify, or to obtain an exemption for, the Shares pursuant to this Agreement under such of the securities or "blue sky" laws of jurisdictions as shall be applicable to the sale of the Shares pursuant to this Agreement. The Company shall furnish copies of all filings, applications, orders and grants or confirmations of exemptions relating to such securities or "blue sky" laws. (g) CERTAIN EXPENSES Whether or not any closing occurs, the Company shall pay or reimburse the Buyer for all reasonable expenses (including, without limitation, legal fees and expenses of counsel to the Buyer) incurred by the Buyer, not in excess of $3,000, in connection with this Agreement and the transactions contemplated hereby. (h) CERTAIN TRADING RESTRICTIONS. The Buyer agrees that on the Closing Date it will have no short position in the Common Stock. So long as the Company is in compliance in all material respects with its obligations to the Buyer under this Agreement and the Registration Rights Agreement, the Buyer 6 70 agrees that (1) from the Closing Date until the SEC Effective Date (as defined in the Registration Rights Agreement), it will not sell or contract to sell any shares of Common Stock or engage in any short sales or other hedging transactions relating to the Common Stock, (2) during the period from the SEC Effective Date to the date on which the Buyer no longer owns any Common Shares, the Buyer shall not engage in short sales or other hedging transactions relating to the Common Stock. (i) BEST EFFORTS. Each of the parties shall use its commercially reasonably best efforts timely to satisfy each of the conditions to the other party's obligations to sell and purchase the Shares set forth in Section 6 or 7, as the case may be, of this Agreement on or before the Closing Date. 5. CLOSING. Subject to the satisfaction or waiver of the conditions set forth in Sections 6 and 7, the Closing shall take place shall be 12:00 noon, Seattle, Washington time (the "CLOSING"), on or before the date which is three Business Days after the date of this Agreement, or such other mutually agreed to time. The closing of such sale of the Shares shall occur on the Closing Date at the offices of Preston Gates & Ellis LLP, 701 Fifth Avenue, Suite 5000, Seattle, Washington 98104. 6. CONDITIONS TO THE COMPANY'S OBLIGATION TO SELL AND ISSUE. The Buyer understands that the Company's obligation to sell the Shares to the Buyer pursuant to this Agreement at the Closing is conditioned upon the satisfaction of the following conditions precedent on or before the Closing (any or all of which may be waived by the Company in its sole discretion): (a) Delivery by the Buyer to the Company of good funds as payment in full of an amount equal to the Per Share Purchase Price for each of the Shares; (b) The accuracy on the Closing Date of the representations and warranties of the Buyer contained in this Agreement as if made on the Closing Date and the performance by the Buyer on or before the Closing Date of all covenants and agreements of the Buyer required to be performed on or before the Closing Date; and (c) On the Closing Date, no legal action, suit or proceeding shall be pending or threatened which seeks to restrain or prohibit the transactions contemplated by this Agreement. 7. CONDITIONS TO THE BUYER'S OBLIGATION TO PURCHASE. The Company understands that the Buyer's obligation to purchase the Shares from the Company pursuant to this Agreement at the Closing is conditioned upon the satisfaction of the following conditions precedent on or before the Closing (any or all of which may be waived by the Buyer in its sole discretion): 7 71 (a) Delivery by the Company of the certificates for the Shares for the account of the Buyer in accordance with this Agreement (such delivery, the parties agree, may be up to three days after the Closing); (b) The accuracy on the Closing Date of the representations and warranties of the Company contained in this Agreement as if made on the Closing Date and the performance by the Company on or before the Closing Date of all covenants and agreements of the Company required to be performed on or before the Closing Date and receipt by the Buyer of a certificate, dated the Closing Date, of the Chief Executive Officer or the Chief Financial Officer of the Company confirming such matters and such other matters as the Buyer may reasonably request; (c) The receipt by the Buyer of a certificate, dated the Closing Date, of the Secretary of the Company certifying (1) the Articles of Incorporation and By-Laws of the Company as in effect on the Closing Date, (2) all resolutions of the Board of Directors (and committees thereof) of the Company relating to this Agreement and the transactions contemplated hereby and (3) such other matters as reasonably requested by the Buyer; (e) The parties shall have executed a Registration Rights Agreement in the form attached hereto as ANNEX I; (f) The Company and the Company's transfer agent shall have executed an Order to Issue and Register substantially in the form attached hereto as Annex II. (g) Receipt by the Buyer on the Closing Date of an opinion of Preston Gates & Ellis LLP, counsel for the Company, dated the Closing Date, in form, scope and substance reasonably satisfactory to the Buyer; (h) The Buyer shall have received a Certificate of the Company's transfer agent dated as of the Closing substantially in the form attached hereto as Annex III; and (i) On the Closing Date, no legal action, suit or proceeding shall be pending or threatened which seeks to restrain or prohibit the transactions contemplated by this Agreement. 8. MISCELLANEOUS. (a) GOVERNING LAW. This Agreement shall be governed by and interpreted in accordance with the laws of the State of Washington. (b) COUNTERPARTS. This Agreement may be executed in counterparts and by the parties hereto on separate counterparts, all of which together shall constitute one and the same instrument. A facsimile transmission of this Agreement bearing a signature on behalf of a party hereto shall be legal and binding on such party. Although this Agreement is dated as of the date first 8 72 set forth above, the actual date of execution and delivery of this Agreement by each party is the date set forth below such party's signature on the signature page hereof. Any reference in this Agreement or in any of the documents executed and delivered by the parties hereto in connection herewith to (1) the date of execution and delivery of this Agreement by the Buyer shall be deemed a reference to the date set forth below the Buyer's signature on the signature page hereof, (2) the date of execution and delivery of this Agreement by the Company shall be deemed a reference to the date set forth below the Company's signature on the signature page hereof and (3) the date of execution and delivery of this Agreement or the date of execution and delivery of this Agreement by the Buyer and the Company shall be deemed a reference to the later of the dates set forth below the signatures of the parties on the signature page hereof. (c) HEADINGS, ETC. The headings, captions and footers of this Agreement are for convenience of reference and shall not form part of, or affect the interpretation of, this Agreement. (d) SEVERABILITY. If any provision of this Agreement shall be invalid or unenforceable in any jurisdiction, such invalidity or unenforceability shall not affect the validity or enforceability of the remainder of this Agreement or the validity or enforceability of this Agreement in any other jurisdiction. (e) AMENDMENTS. No amendment, modification, waiver, discharge or termination of any provision of this Agreement nor consent to any departure by the Buyer or the Company therefrom shall in any event be effective unless the same shall be in writing and signed by the party to be charged with enforcement, and then shall be effective only in the specific instance and for the purpose for which given. No course of dealing between the parties hereto shall operate as an amendment of this Agreement. (f) WAIVERS. Failure of any party to exercise any right or remedy under this Agreement or otherwise, or delay by a party in exercising such right or remedy, or any course of dealings between the parties, shall not operate as a waiver thereof or an amendment hereof, nor shall any single or partial exercise of any such right or power, or any abandonment or discontinuance of steps to enforce such a right or power, preclude any other or further exercise thereof or exercise of any other right or power. (g) NOTICES. Any notices required or permitted to be given under the terms of this Agreement shall be delivered personally (which shall include telephone line facsimile transmission with answer back confirmation) or by courier and shall be effective upon receipt, if delivered personally or by courier, in the case of the Company addressed to the Company at its address shown in the introductory paragraph of this Agreement, Attention: Chief Financial Officer (telephone line facsimile transmission number (206) 652-9075), or, in the case of the Buyer, at its address or telephone line facsimile transmission number shown on the signature page of this Agreement, with a copy to Matthew Swartz; Brobeck Phleger & Harrison LLP, One Market, San Francisco, California, 94105 (telephone line facsimile transmission number (415) 442-1010) or such other address or telephone line facsimile transmission number as a party shall have provided by notice to the other party in accordance with this provision. 9 73 (h) ASSIGNMENT. No party to this Agreement may assign, by operation of law or otherwise, all or any portion of its rights, obligations, or liabilities under this Agreement without the prior written consent of the Company. (i) SURVIVAL OF REPRESENTATIONS AND WARRANTIES. The respective representations, warranties, covenants and agreements of the Buyer and the Company contained in this Agreement or made by or on behalf of them, respectively, pursuant to this Agreement shall survive the delivery of payment for the Shares and shall remain in full force and effect regardless of any investigation made by or on behalf of them or any Person controlling or advising any of them. (j) ENTIRE AGREEMENT. This Agreement and the Registration Rights Agreement set forth the entire agreement between the parties hereto with respect to the subject matter hereof and supersede all prior agreements and understandings, whether written or oral, with respect thereto. (k) TERMINATION. The Buyer shall have the right to terminate this Agreement by giving notice to the Company at any time at or prior to the Closing Date if: (1) the Company shall have failed, refused, or been unable at or prior to the date of such termination of this Agreement to perform any of its obligations hereunder; (2) any other condition of the Buyer's obligations hereunder is not fulfilled; or (3) the closing of the sale of the Shares shall not have occurred on or before February 5, 1999, other than solely by reason of a breach of this Agreement by the Buyer. Any such termination shall be effective upon the giving of notice thereof by the Buyer. Upon such termination, the Buyer shall have no further obligation to the Company hereunder and the Company shall remain liable for any breach of this Agreement or the other documents contemplated hereby which occurred on or prior to the date of such termination. (l) FURTHER ASSURANCES. Each party to this Agreement will perform any and all acts and execute any and all documents as may be necessary and proper under the circumstances in order to accomplish the intents and purposes of this Agreement and to carry out its provisions. (m) PUBLIC STATEMENTS, PRESS RELEASES, ETC. The Company and the Buyer shall have the right to approve before issuance any press releases or any other public statements with respect to the transactions contemplated hereby; PROVIDED, HOWEVER, that the Company shall be entitled, without the prior approval of the Buyer, to make any press release or other public disclosure with respect to such transactions as is required by applicable law and regulations (although the Buyer shall be consulted by the Company in connection with any such press release or other public disclosure prior to its release). (n) CONSTRUCTION. The language used in this Agreement will be deemed to be the language chosen by the parties to express their mutual intent, and no rules of strict construction will be 10 74 applied against any party. 11 75 SUBSCRIPTION AGREEMENT--SIGNATURE PAGE IN WITNESS WHEREOF, this Agreement has been duly executed by the Buyer and the Company by their respective officers or other representatives thereunto duly authorized on the respective dates set forth below. BUYERS Name Robert S. Colman as Trustee UDT dated 3/13/85 Number of Shares 100,000 Name UMBTRU Number of Shares 2,000,000 Name Larry Arnold Number of Shares 46,000 Name Wayne W. Mills Number of Shares 50,000 Name David R. Wilmerding Number of Shares 200,000 Name Jon C. Baker Number of Shares 200,000 ONHEALTH NETWORK COMPANY By: \s\ Michael D. Conway ------------------------ Name: Michael D. Conway Title: Vice President Date: January 29, 1999 12 76 ANNEX II OnHealth Network Company 808 Howell Street, Suite 400 Seattle, WA 98101 January 29, 1999 American Stock Transfer and Trust Company RE: ORDER TO ISSUE AND REGISTER Ladies and Gentlemen: The Board of Directors of OnHealth Network Company, a Washington corporation (the "Company"), has authorized the issuance and sale of 2,596,000 shares of the Company's Common Stock (the "Common Stock"), pursuant to the Subscription Agreement, dated January 29, 1999 (the "Subscription Agreement") between the Company and UMBTRU, Robert S. Colman as Trustee UDT dated 3/13/85, Wayne W. Mills, Larry Arnold, David R. Wilmerding, and Jon C. Baker (the "Purchasers"). The Company is selling 2,596,000 shares of its Common Stock to the Purchasers. You are, therefore, hereby authorized and requested, as Transfer Agent and Registrar of the Company's Common Stock: (i) to issue and register for original issuance 2,596,000 shares of the Company's Common Stock in the names and amounts set forth on the attached Exhibit A, and (ii) to cause certificates representing such shares of Common Stock to the Purchasers to be delivered to the Purchasers at the addresses set forth on the attached Exhibit A Attached please find a copy of the opinion of Preston Gates & Ellis LLP regarding the due authorization of the Common Stock issuable pursuant to the Subscription Agreement. Very truly yours, ON HEALTH NETWORK COMPANY -------------------------- Michael D. Conway Vice President ACCEPTED AND AGREED: American Stock Transfer and Trust Company By ------------------------------------- Print Name: --------------------------- 13 77 EXHIBIT A LIST OF PURCHASERS Name Robert S. Colman as Trustee UDT dated 3/13/85 Number of Shares 100,000 Send Shares to #1 Below Name UMBTRU Number of Shares 2,000,000 Send Shares to #1 Below Name Larry Arnold Number of Shares 46,000 Send Shares to #1 Below Name Wayne W. Mills Number of Shares 50,000 Send Shares to #1 Below Name David R. Wilmerding Number of Shares 200,000 Send Shares to #2 Below Name Jon C. Baker Number of Shares 200,000 Send Shares to #2 Below #1 Brobeck, Phleger & Harrison LLP One Market, Spear Street Tower San Francisco, CA 94105 Attention: Matthew B. Swartz Telephone: (415) 442-0900 #2 Charles Shchwab & Co Institutional Service Group 1958 Summit Park Place Suite 500 Orlando, Florida 32810-5938 Attention: Shandra Whitley 14 78 ANNEX III OnHealth Network Company CERTIFICATE OF TRANSFER AGENT AND REGISTRAR American Stock Transfer and Trust Company (the "Agent") does hereby certify that: 1. The Agent is duly appointed and authorized to act as Transfer Agent and Registrar for the Common Stock, par value $0.01 per share (the "Common Stock"), of OnHealth Network Company, a Washington corporation (the "Company"). 2. The Agent, as Transfer Agent and Registrar, pursuant to written instructions from the Company, has duly issued, countersigned and registered certificates evidencing an aggregate of 2,596,000 shares of Common Stock of the Company as an original issue by the Company, in the names and denominations previously requested by ______________________________, ______________________________, ______________________________, and ______________________________ (the "Purchasers") as set forth on the Subscription Agreement, dated as of January 29, 1999, by and between the Company and the Representative. 3. Such certificates were signed by duly authorized officers of the Company by their facsimile signatures and countersigned and registered on behalf of the Agent, as Transfer Agent and Registrar, by a representative of the Agent, who, at the time of affixing his or her signature, was and still is duly authorized to countersign and register said certificates. 4. The Agent is duly and validly registered as a "Transfer Agent" in accordance with Section 17A(c) of the Securities Exchange Act of 1934, as amended. 5. There are a total of __________ shares of Common Stock of the Company issued and outstanding as of this date, after giving effect to the action described in paragraph 2 above. IN WITNESS WHEREOF, the Agent has caused this Certificate to be executed by a duly authorized officer on its behalf on January 29, 1999. American Stock Transfer & Trust Company By: ________________________________ Name: Title: 15 79 EX-23.1 4 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS EXHIBIT 23.1 Consent of Ernst & Young LLP, Independent Auditors We consent to the incorporation by reference in the Registration Statement (Form S-3 No. 333-69989) of OnHealth Network Company and Registration Statements (Form S-8 No. 33-76498, Form S-8 No. 333-70147, Form S-8 No. 333-70149) pertaining to the 1991 Stock Option Plan and Director Stock Option Plan, 1997 Stock Option Plan, and 1997-1998 New Hire Option Plan of OnHealth Network Company of our report dated March 15, 1999, with respect to the financial statements and schedule of OnHealth Network Company included in the Annual Report (Form 10-K) for the year ended December 31, 1998. ERNST & YOUNG LLP Seattle, Washington March 29, 1999 80 EX-27 5 FDS -- WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE ONHEALTH NETWORK COMPANY'S FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 U.S. DOLLAR 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 2,119 0 765 256 0 3,037 1,509 774 3,894 4,195 0 0 0 132 (433) 3,894 919 1,522 767 767 11,774 (755) 0 (10,939) 0 (10,939) 0 0 0 (10,939) (1.12) (1.12)
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