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, 2001
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition Period from to
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Commission file number: 000-26881
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NETNATION COMMUNICATIONS INC.
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(Exact name of registrant as specified in its charter)
Delaware 33-0803438
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Suite 1410 - 555 West Hastings Street
Vancouver, British Columbia, Canada V6B 4N6
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (604) 688-8946
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Securities registered under Section 12(b) of the Act:
Title of Class Name of exchange on which registered
None None
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Securities registered under
Section 12(g) of the Act: Common Stock, $0.0001 par value
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(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Sec. 229.405 of this chapter) 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 this Form 10-K. [X]
As of March 12, 2002, the aggregate market value of the voting common equity
held by non-affiliates of the registrant was $16,330,650, based on the closing
trade reported on the Nasdaq Small Capitalization Market quotation system.
Shares of common stock held by each officer and director and by each person who
owns five percent or more of the outstanding common stock have been excluded
from this calculation as such persons may be considered to be affiliated with
the Company.
As of March 12, 2002, the registrant's outstanding common stock consisted of
15,218,002 shares, $0.0001 par value per share.
Documents incorporated by reference: None
TABLE OF CONTENTS
Part Item(s) Page No.
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I 1 Business 3
2 Properties 26
3 Legal Proceedings 26
4 Submission of Matters to a Vote of Security Holders 26
II 5 Market for Registrant's Common Equity and Related Stockholder Matters 27
6 Selected Financial Data 28
7 Management's Discussion and Analysis of Financial Condition
and Results of Operations 31
7A Quantitative and Qualitative Disclosure about Market Risk 34
8 Financial Statements and Supplementary Data 36
9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 36
III 10 Directors and Officers of the Registrant 37
11 Executive Compensation 39
12 Security Ownership of Certain Beneficial Owners and Management 43
13 Certain Relationships and Related Transactions 43
IV 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 44
Signatures 45
Index to Consolidated Financial Statements 46
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PART I
ITEM 1: BUSINESS
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FORWARD -LOOKING STATEMENTS
Except for the historical information presented in this document, the matters
discussed in this Form 10-K, and specifically in the sections entitled
"Business" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations," or otherwise incorporated by reference into this
document contain "forward-looking statements" (as such term is defined in the
Private Securities Litigation Reform Act of 1995). These statements can be
identified by the use of forward-looking terminology such as "believes,"
"expects," "may," "will," "should," or "anticipates" or the negative thereof or
other variations thereon or comparable terminology, or by discussions of
strategy that involve risks and uncertainties. The safe harbor provisions of
Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A
of the Securities Act of 1933, as amended, apply to forward-looking statements
made by the Registrant. These forward-looking statements involve risks and
uncertainties, including those identified within the section entitled "Factors
Affecting Future Operating Results" and elsewhere in, or incorporated by
reference into, this Form 10-K. The actual results that the Registrant achieves
may differ materially from any forward-looking projections due to such risks and
uncertainties. These forward-looking statements are based on current
expectations, and the Registrant assumes no obligation to update this
information. Readers are urged not to place undue reliance on these
forward-looking statements, and readers should carefully review and consider the
various disclosures made by the Registrant in this Annual Report on Form 10-K
and in the Registrant's other reports filed with the Securities and Exchange
Commission that attempt to advise interested parties of the risks and factors
that may affect the Registrant's business.
OTHER MATTERS OF NOTE
Unless otherwise indicated or the context otherwise requires, all references
herein to "NetNation" or the "Company" are to NetNation Communications Inc., a
Delaware corporation, and its consolidated wholly-owned subsidiaries: NetNation
Communications Inc. (the "Canadian Subsidiary"), NetNation Communications (UK)
Ltd. (the "U.K. Subsidiary"), NetNation Communications (USA) Inc. (the "U.S.
Subsidiary"), and DomainPeople Inc.
NetNation Communications Inc., NetNation.com, and DomainPeople.com are
trademarks or service marks of NetNation Communications, Inc. Other trademarks
and tradenames in this Form 10-K are the property of their respective owners.
OVERVIEW OF THE COMPANY
NetNation competes in the web hosting and domain name registration markets and
is focused on meeting the needs of small and medium-sized businesses and
individuals who are establishing a commercial or informational presence on the
Internet. Management organizes its business into two segments for making
operating decisions and assessing performance. Please see Note 10 to the
Company's audited financial statements for certain information about the
segments.
Web Hosting
NetNation commenced web hosting operations in February of 1997. Web hosting
services offered by NetNation can be described to fit between the creation and
development of web sites and the direct provision of Internet connectivity such
as by an Internet Service Provider (ISP). Web hosting encompasses a broad range
of possible services, including basic services such as simply posting a
customer's web site on the Internet using the hosting company's computer
hardware and software, to enhanced services such as enabling financial
transactions over the Internet (E-commerce), e-mail, audio and video
capabilities, security, backup, load balancing, and monitoring. Enhanced
services may be developed internally by the web hosting company or purchased
from external sources and resold by the web hosting company. NetNation offers a
range of basic and enhanced web hosting services to businesses wishing to place
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their web site on the Internet. These businesses often decide to use a web
hosting company in order to avoid the financial cost, time and expertise
requirements of hosting the web site and obtaining enhanced services themselves.
Web hosting can be differentiated into shared or dedicated hosting. NetNation
offers both services. Shared hosting involves multiple customers who have their
web sites hosted on a shared computer server. Dedicated server hosting is
available to customers that prefer not to host their web sites on a shared
server. Dedicated servers provide significantly more server and network
resources than those available from a shared server and give customers the
ability to run complex, high volume or high bandwidth web sites and
applications. NetNation offers a number of dedicated server options at various
prices, depending upon the specific hardware configuration, level of service and
data transfer rates required by the customer.
NetNation hosts customer web sites and indirectly provides access to the
Internet through its ISP's. However, NetNation has strategically determined not
to offer web site design, development, or content services. The person or
company typically responsible for assisting in the design and maintenance of a
web site is called a webmaster. This function is labor intensive and would
involve significant human resources and time to service a broad customer base.
Consequently, webmaster functions are typically performed by specialized
companies servicing a number of customers. These customers may also rely upon
their webmasters to direct them to suitable hosting and/or ISP companies.
NetNation has decided not to provide the services of webmasters to its customers
due to the intensive use of human resources required and the corresponding
impact on the ability of the Company to scale quickly. Instead, NetNation has
developed a program for resellers designed to provide incentive for the
webmasters to direct their customers to NetNation for web hosting.
NetNation also provides server co-location services. Server co-location services
involve a customer physically placing their computer hardware (referred to as a
"server") on NetNation's premises. The customer gains access to NetNation's
technical support and maintenance services, high-speed Internet connections,
security systems and appropriate physical environment for the server (e.g.
static free, air-conditioned). NetNation's data center also provides for data
backup, secure continuous power supply, and 24 hour-per-day, 7 day-per-week
monitoring by NetNation's technical staff.
Domain Name Registration
NetNation is an accredited and operational domain name registrar offering domain
name registration through its wholly-owned subsidiary, DomainPeople Inc. This
accreditation allows NetNation to register domain names (e.g. Top-level domains
such as .com, .net, .org, .info, and .biz) for individuals and
companies.
A business or individual that wants a personalized web address must first
reserve a domain name (such as "mycompany.com"). Customers can register a
domain name initially for a usual minimum one year period, depending upon the
minimum term established for that particular domain. Offering this service
provides a marketing advantage as the domain name registration customer may
return to NetNation when selecting a web hosting provider. NetNation provides a
number of incentives for domain name registration customers to migrate to its
web hosting services, which are expected to generate a recurring revenue stream.
Prior to November 30, 1999, registration of .com, .net, and .org domain names
was exclusively provided through Network Solutions Inc. The registration fee,
formerly payable to Network Solutions Inc., is now received directly by the
registrars. Each registrar, in turn, submits a fee of $6 per domain name, per
year, to Network Solutions Inc. as its contribution towards the maintenance of a
centralized database registry. To expand its domain name registration market
share, DomainPeople is forming alliances and is private labeling domain name
registration services for ISPs and other Internet companies worldwide, as well
as offering the new top level domain names as they become available.
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Marketing and Sales
NetNation's marketing is comprised of print and online advertising that is
designed to position the Company and increase brand awareness. NetNation also
has developed a number of initiatives designed to attract resellers, Original
Equipment Manufacturers ("OEMs"), and other revenue generating arrangements.
Operations
During 2001, NetNation had operations in Vancouver, Canada (its head office)
and London, England. The London, England sales office was closed in November
2001. Customers in Europe are now being serviced from the Company's Vancouver
headquarters; since the Company's inception, all customers have been serviced
from a technical perspective by NetNation's customer service and technical
support staff from its Vancouver facility.
BACKGROUND OF THE COMPANY
During 2001, NetNation derived 68% of its revenue from its web hosting services.
Web hosting, which is sometimes referred to as "web site outsourcing", involves
the rental of computer infrastructure space. The infrastructure consists of
computer hardware, referred to as "servers", and computer software. The
hardware and software facilitate the connection of customers' web sites to the
Internet. In addition to the basic infrastructure, web hosting companies may
also provide customer support services and access to additional services such as
the enabling of commercial transactions on the Internet. These additional
services, which are essentially software packages, may be developed directly by
the web hosting company or obtained under license from third parties.
To begin using a web hosting service, the typical customer would register and
pay for a domain name and would set up a billing account with NetNation for web
hosting services. The customer would pay the initial setup fee for the web
hosting service and then pay a recurring monthly fee. A customer would then
provide its web site to NetNation for placement on a computer server, which in
turn is connected to the Internet through an ISP. If the customer has a
commercial web site, NetNation can assist the customer in meeting its commercial
objectives by making available services that enable commercial transactions over
the Internet.
Typical customers of web hosting companies consist of small and medium-sized
businesses that wish to have a web site on the Internet without incurring the
costs and time delays involved with developing, maintaining and updating a web
presence on their own. The web site is an informational or an
informational/commercial tool for these customers. In addition to small and
medium-sized businesses, web hosting services may be purchased by entities, such
as resellers and OEMs, that will resell the services in connection with their
own web related services.
NetNation can host a customer's web site on NetNation's shared hosting computer
infrastructure for a basic monthly fee ranging from $20-$150. The fee entitles a
customer to basic services, including disk data storage space on NetNation's
server, the ability to receive and transmit data over the Internet, 24-hour
customer support, e-mail access, and e-mail forwarding capabilities. Additional
services available for an extra charge include, for example, the ability to add
security to data transmissions, to carry out financial transactions over the
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Internet, to track and send orders, to give a receipt for purchases made through
customer's web site, and to add audio/video capabilities. Additional information
on the services offered by NetNation is described under the section entitled
"NetNation's Products and Services".
NetNation believes that the Internet continues to represent a growing and
substantial opportunity for businesses or organizations that wish to interact in
innovative ways with offices, employees, customers, suppliers and partners
around the globe. Both small and large businesses are recognizing their
increasing need to take advantage of the Internet by establishing web sites. As
a result, reliable web site hosting services and enhanced services are becoming
increasingly critical to most mainstream businesses. Due to this ever-growing
importance, many businesses are outsourcing these functions in order to ensure
reliability, scalability for rapid growth, sophisticated performance monitoring
and expert management.
The skill and technology demands of the Internet can present a significant
barrier to in-house development for all but the largest Information Technology
("IT") departments. To set up an in-house solution, a company would have to buy
the computing hardware equipment, firewall/switching equipment, power backup
system, fire control system, physical security, fast network cable connection,
and pay the wages of a system administrator. Management believes it is able to
provide a significant cost savings to its customers relative to communications,
equipment, and labor costs.
BUSINESS STRATEGY
NetNation has targeted the North American and European small and medium-sized
business markets for a number of reasons. The percentage of these markets that
utilize the Internet is expected to continue to be one of the fastest growing
segments internationally. In addition, as globalization of business continues,
these businesses are required to compete domestically and internationally
against better capitalized and larger competitors. They need to be efficient
and make use of the latest technology in order to gain advantage or survive.
These businesses may look to outsource their web hosting because they typically
lack the technology, expertise, resources, capital, personnel, and time required
to install, maintain and monitor their own web servers and added services.
The geographic location of the market for web hosting services is worldwide,
although NetNation's marketing plan targets prospective customers in countries
with high Internet use backed by good ISP and telecommunications support.
Marketing in all geographic areas includes exposure to prospective customers of
NetNation's services through resellers. Up to December 31, 2001, NetNation's
marketing efforts have been directed primarily to North American and European
markets. In 2002, subject to improved economic conditions, the Company may
consider further enhancing its strategic business efforts which require
additional resources, such as directing its marketing efforts to expanding its
advertising coverage, developing strategic partnerships, expanding its reseller
network, and increasing its shared hosting customer base. To date, NetNation
has primarily utilized print, marketing agreements with other online service
providers, online media, trade shows, and co-marketing with creators of web site
creation/authoring tools, to effect its marketing plan.
Due to the constantly evolving nature of the Internet and related technologies,
existing web hosting products and services, such as online commerce packages,
continue to be reviewed on an ongoing basis in order to keep pace with changes
in third party technologies and generally in how business is transacted on the
Internet.
ORGANIZATION
NetNation was incorporated under the laws of the State of Delaware on May 7,
1998, under the name Collectibles Entertainment Inc. ("Collectibles"), for the
purpose of operating an online sports card and other tradeable memorabilia
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distribution business. Collectibles changed its name to NetNation
Communications, Inc. on April 14, 1999, in conjunction with the acquisition of a
web site hosting business based in Vancouver, Canada. The common shares of
NetNation currently trade on the Nasdaq Small Capitalization Market under the
ticker symbol "NNCI".
NetNation has three wholly-owned subsidiaries: NetNation Communications Inc.,
NetNation Communications (USA) Inc., and DomainPeople Inc. NetNation
Communications UK Ltd. ceased operations in November 2001. Customers in Europe
are now being serviced from the Company's Vancouver headquarters; since the
Company's inception, all customers have been serviced from a technical
perspective by NetNation's customer service and technical support staff from its
Vancouver facility.
NetNation entered into the web hosting business through its acquisition of the
Canadian Subsidiary. The Canadian Subsidiary is a private company incorporated
under the laws of the Province of British Columbia, Canada on February 19, 1997.
The Canadian Subsidiary became a wholly-owned subsidiary on April 7, 1999,
pursuant to an agreement between the shareholders of the Canadian Subsidiary and
Collectibles (the "Share Purchase Agreement"). Pursuant to the Share Purchase
Agreement, Collectibles acquired 9,000,000 Class A common shares and 1,000,000
Class B preferred shares of the Canadian Subsidiary, being all of the issued and
outstanding shares of the Canadian Subsidiary. The purchase price for the
shares of the Canadian Subsidiary was $1,000,000 in Canadian currency, which was
paid by the issuance of 10,000,000 common shares of Collectibles. Upon
conclusion of the acquisition, Collectibles changed its name to NetNation.
NetNation has a wholly-owned subsidiary in the United States, NetNation
Communications (USA) Inc., a company incorporated under the laws of the State of
Delaware on October 20, 1999. The US Subsidiary was incorporated to facilitate
NetNation's U.S. operations.
NetNation has a wholly-owned subsidiary in the United States, DomainPeople Inc.,
a company incorporated under the laws of the State of Delaware on November 24,
1999. DomainPeople was incorporated to encompass the Company's Domain Name
Registration business.
NETNATION'S PRODUCTS AND SERVICES
NetNation offers a range of Internet products and services targeted to the
small- and medium-sized business market.
All of NetNation's services have been designed to meet the specific and evolving
needs of its target market. Customers pay a one-time setup fee and thereafter
pay monthly fees for the services they utilize. NetNation can then provide
enhanced services to these customers as their needs evolve.
The concept behind NetNation's products and services is to enable its customers
to create, update, upgrade and expand their web presence faster, and on a
substantially more cost-effective basis, than the customers could develop
internally. The services offered by NetNation can be summarized as follows:
Web hosting
1. Shared server web site hosting: This service permits a customer to post
their web site on the Internet using NetNation's hardware and software,
Internet access, web site management tools and support services. The
customer's web site is hosted on a server that is shared with a number of
other NetNation customers.
2. Dedicated server web site hosting: This service permits a customer to post
their web site on the Internet and access NetNation's Internet services.
The customer's web site is hosted on a dedicated server that is not shared
with any other web sites. This service is appropriate for those customers
that run complex or high bandwidth web sites and applications.
3. Server co-location: This service permits a customer to place their own
server hardware in NetNation's premises and access NetNation's Internet
services.
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4. Enhanced Internet services: These services permit a customer with a web
site to add features to that web site such as audio/video, online commerce
capabilities, e-mail and various other features.
5. Managed services: These services are an expansion of our dedicated server
web site hosting and is for the high-end corporate customer. These services
can be customized for the particular customer and can be configured to
completely outsource the customer's entire web site infrastructure and
technical support and maintenance.
Domain name registration
NetNation's ICANN accreditation and operational status allows for the
registration of domain names (e.g. top-level domains such as .com, .net, .org,
.info, and .biz) for individuals and companies.
Reseller services
These services consist of services that can be resold by third parties.
A description of each of the above services is set out below.
Shared Server Web Site Hosting
A core component of NetNation's business is the provision of shared web hosting
services for individuals and businesses that want an Internet presence at a
reasonable cost. Shared server means that a number of customers will share
space on one server. NetNation offers a number of shared server web site
hosting plans to meet the needs of a broad range of customers.
NetNation's entry-level shared server web site hosting plan is called Starter.
The Starter package of services offers customers up to 1 gigabyte ("GB") of data
transfer per month and 20 megabytes ("MB") of disk data storage on NetNation's
web servers. Customers can store HyperText Markup Language ("HTML"- a
programming language) coded files, graphics, video and audio on their web site.
This basic service meets the requirements of most individuals, as well as
relatively small businesses.
To allow customers to make effective use of their web presence, customers can
establish e-mail addresses using their domain name and have their e-mail
forwarded to another computer, establish online chat rooms on their web site,
and even have automated e-mail messages (autoresponders) sent to people who send
them e-mail. Support is also provided for popular web authoring tools such as
Microsoft FrontPage and its specialized extensions.
The more advanced and expensive web site hosting services offer enhanced
functionality and resources. NetNation has implemented a variety of tools to
allow its customers to use their sites more effectively. All of the
standardized web site hosting plans feature detailed web statistics and access
to raw log files, giving customers the ability to track the performance and
evaluate the effectiveness of their web sites. Customers are able to update web
sites remotely by sending files through File Transfer Protocol ("FTP"). In
addition, NetNation provides a number of popular Common Gateway Interface
("CGI", a programming language) scripts that allow customers to deploy web site
and web page hit counters, guest books, mail forms and discussion forums rapidly
and easily. NetNation also supports custom CGI scripts that enable customers to
build unique functionality into their web sites.
NetNation supports the following platforms and operating systems:
Intel based servers
Sun servers
Red Hat Linux
Windows NT 4.0 and Windows 2000
Apache web server
Microsoft IIS
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NetNation has developed a set of utilities for its customers called User
Services. User Services is a proprietary account interface tool that enhances a
customer's web site control and management capabilities. For example, customers
can use User Services to change passwords, set e-mail forwarding options, and
view web site statistics without the need to converse directly with NetNation
staff.
Dedicated Server Web Site Hosting
Dedicated server solutions are available for customers that prefer not to host
their web sites on a shared server. Dedicated servers are owned by NetNation and
provide significantly more server and network resources than those available
from a shared server and give customers the ability to run complex, high volume
or high bandwidth web sites and applications. NetNation offers a number of
dedicated server options at various prices depending upon the specific hardware
configuration, level of service, and data transfer rates required by the
customer.
Server Co-location
Server Co-location is the service of providing a physical space on NetNation's
premises where customers can place their own server while sharing NetNation's
Internet connectivity, network infrastructure, and physical security. This type
of service is useful for those customers that do not want to share server
resources with other customers in a hosted environment and have their own
equipment. A typical candidate for server co-location would be someone that
requires professional, enterprise level Internet infrastructure with fast
connectivity and high-level data center security. Co-located servers can be
managed by NetNation or by the customer using remote access software. Customers
outsourcing these services are often able to reduce expenses and eliminate many
of the problems associated with running web sites, particularly large ones, in
their own facilities.
Enhanced Internet Services
Due to the rapid evolution of web-based services, NetNation is continually
exploring complementary and new services targeted at the needs of its current
and prospective customers. Other industry specific web hosting activities
include audio and video streaming, and electronic commerce solutions, which are
currently offered by NetNation. Current areas of new product focus include
expanded electronic commerce products, simplified web site development tools,
and automated marketing services. Most of NetNation's service packages are a
combination of software licensed from third parties and enabling/facilitating
software that is developed in-house at NetNation.
NetNation provides electronic commerce solutions to allow businesses to develop
and maintain successful online storefronts, which may replicate many of the
features, products, services, payment methods, delivery options etc. offered by
land-based businesses. Dependent on the level of complexity and their specific
needs, businesses can choose online commerce solutions ranging from simple
online catalogues to complex full-featured interactive online stores. These
commerce solutions are distinguished from web site development, in that they are
packaged solutions that are available from a web host. Some modification may be
required by the user to ensure the application is specific to the business. Web
site development, which NetNation does not provide, instead concentrates on the
physical appearance of the entire web site, including graphics, color,
typestyles, text, layering of pages, placement of icons, and other similar
issues.
With these products, NetNation's web hosting customers can construct customized
online storefronts with integrated end-to-end sales process support and
automated payment systems with connections to their legacy accounting systems.
Customers can select the credit card processing services we offer or another
service of their own choosing. Any financial arrangements for these services
are between the customer and the credit card processing company. NetNation does
not purchase credit card processing services from these entities for resale
purposes.
For an initial setup fee and a subsequent monthly fee, NetNation offers several
packages that support online commerce. The packages are available to both UNIX
and Windows NT users. Both UNIX and NT packages are based on a "shopping
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cart" licensed from Miva. A "shopping cart" refers to a program that allows a
business to implement an online storefront by enabling tracking and sending of
orders made through the web site and giving a customer a receipt for purchases
made through the web site.
Managed services
These services are an expansion and extension of our dedicated server web site
hosting and is targeted at the high-end corporate customer. These services can
be customized for the particular customer and can be configured to completely
outsource the customer's entire web site infrastructure and technical support
and maintenance. Services provided can include increased security, firewalls,
data backup, special reporting, load balancing, monitoring, virus scanning,
e-mail server and domain name server and FTP server configuration and
maintenance, and business protection services. Typically a customer would have a
longer term contract and there would be service level agreements which specify
the exact level of service or "up-time" agreed upon.
Domain Name Registration
Every individual or business entity desiring a web site address must first
reserve a domain name that will serve as the basis for their personalized web
site address through which users of the Internet can connect to their web site.
In May 1999, NetNation was selected as an official registrar of domain names by
ICANN. Prior to then, Network Solutions Inc. held sole authority to register
top-level domain names ("TLD's") ending in .com, .net and .org, which account
for between 50% - 75% of the world's Internet addresses. NetNation became
operational as a domain name registrar in December of 1999. As at December 31,
2001, the Company had registered approximately 300,000 Internet domain names.
The domain name registration service also provides NetNation with leads to
market its web hosting services.
Reseller Services
These services consist of web hosting and domain name registration services that
can be resold by third parties. NetNation works with a variety of resellers
which are typically web developers and system integrators. These resellers do
not offer web hosting services themselves and see web hosting as a complementary
service they can offer as a reseller of NetNation's services.
Another type of reseller relationship is offered for domain name registration.
NetNation, through its wholly owned subsidiary DomainPeople, is currently
providing a private label domain search and registration service, using
NetNation's proprietary "Smart Whois" service (http://www.swhois.com. In this
particular case, NetNation is a third-party provider of the service (Smart
Whois) that the reseller wishes to obtain and utilize on a private label basis.
Customers visiting the reseller's web site would not know that back-end is
linked to NetNation's servers in completing the service. The revenue, generated
from the registration of domain names using the Smart Whois service, is shared.
The advantage to the reseller is the ability to offer domain name registrations
without having to develop and maintain the technical and administrative
infrastructure.
MARKETING AND PUBLIC RELATIONS
NetNation's marketing and public relations teams are responsible for integrated
marketing communications, competitive market research, product and service
planning, advertising and public relations.
In 2001, NetNation primarily utilized a combination of print and online
advertising to promote its products and services. The Company placed aggressive
print advertising in major business and technical publications to accelerate its
customer growth. Some of the publications in which NetNation advertises are PC
magazine, Small Business Computing, Windows 2000, Linux Journal, the Computer
Paper, and Silicon Valley North. Each one of these publications is considered
by NetNation to be a major publication for the market segment that NetNation
targets. In 2001, NetNation allocated approximately 89% of its total
advertising budget to print advertising.
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The Company's online marketing program consists of a rotation of keyword
specific, web banner advertisements, as well as web site sponsorships and select
search engine optimization. Each web property chosen for advertising was
carefully selected. User demographics for each site were examined and compared
to NetNation's target; if there was a significant match, a site was selected and
NetNation's advertising appeared. The Company allocated approximately 8% of its
total budget to online advertising in 2001. NetNation also utilized other
marketing vehicles to promote its products and services, including direct
marketing, collateral sales materials and the Company's web site.
NetNation is continuously analyzing the effectiveness of each of these marketing
initiatives for the purpose of developing future marketing strategies. The
Company is increasing its public relations program and
cultivating media relationships with the goal of securing more media coverage
and better public recognition of NetNation.
DISTRIBUTION AND SALES
NetNation sells its products and services worldwide directly to existing and
potential customers and indirectly through resellers. Direct sales are generated
through the use of traditional media and online marketing campaigns. Indirect
sales are generated from NetNation's resellers in various countries. The
resellers attract customers to NetNation because the potential customer has
already developed an Internet-based business relationship with the reseller.
NetNation hosts approximately 22,000 websites for customers in over 130
countries as of December 31, 2001. For the year ended December 31, 2001, United
States customers comprised 46% of the total web hosting customer base, followed
by Canada at 41%, and all other countries combined at 13%.
Direct Sales
At present, NetNation generates most of its new web hosting accounts from online
orders on its web site, and inbound sales calls in its tele-sales center, all
generated by its traditional media and online advertising campaigns, as well as
outbound sales calls. NetNation's web site enables customer orders around the
clock and its automated voice mail system allows sales calls to be captured 24
hours a day. NetNation has expanded its sales force to include outbound sales,
and has specialized sales personnel for dedicated and co-located hosting and
domain name registration services.
Resellers
NetNation has a network of resellers in various countries that resell
NetNation's services. Most of these resellers base their businesses on selling
web page design, integration and consulting services. Approximately 70% of the
resellers are in the business of web page design and 30% are in the business of
integration and consulting. NetNation's International Reseller Program was
designed for these webmasters, consultants and other resellers that wish to
offer web hosting services as a value added service in their particular market.
The resellers are responsible for maintaining customer relationships, technical
support, customer billing, and the provision of value-added services such as web
page design and system integration. When a customer of the reseller requests a
particular set of services configured with a specific web site package, the
reseller arranges with NetNation to provide the bundled web hosting package to
the customer. The reseller then buys the web hosting services from NetNation at
a discount from retail and resells the services to their customers as a complete
package. Resellers set their own price, marketing and technical support policy
that is best suited to the market that they are serving. In order to terminate a
reseller relationship, the reseller must typically give 30 days notice.
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OEMs
OEM stands for "original equipment manufacturer", which in this document refers
to other service providers that may buy NetNation's services in bulk and resell
them under their own brand name. To further expand its distribution channels,
NetNation is establishing OEM relationships with companies that have an
attractive target customer base for NetNation's services. Candidates for OEM
partnering include telecommunication and cable companies, online communities and
Internet portal companies, ISPs, marketing organizations, and large system
integrators. NetNation believes that OEMs will typically consist of potential
competitors that for cost reasons have opted to outsource their web hosting and
domain name registration services and resell them under their own brand name.
NetNation believes that various OEMs already have access to NetNation's target
markets but that not all of the customer demands are being met. NetNation
believes that by entering into OEM relationships with such entities there will
be an overlap of customer demands. For example, an OEM relationship with an
online search company will allow NetNation to offer web hosting solutions and
domain name registration services to customers of the search company, whereas
the online search company could provide the search capabilities. Such
relationships create situations where customers can be referred among the OEM
parties.
CUSTOMER SERVICE
NetNation uses online and automated customer support through its web site and
online "frequently asked questions" (FAQs ) feature. These online services are
in addition to NetNation's technical support staff who are accessible via
telephone or email 24 hours per day, 7 days a week. Technical support staff are
responsible for helping customers with their web site hosting accounts, web page
setup and transfer, and use of the various online web site management tools that
NetNation provides.
NetNation's Customer Service and Accounts Receivable Group handles accounting
and billing information. NetNation has implemented a feature to its "User
Services" to allow customers to check their billing statements online.
Additionally, customers can call NetNation during normal business hours to
discuss their account.
TECHNOLOGY
NetNation has created a secure, scalable and reliable web site hosting service.
NetNation believes that this technology provides a significant competitive
advantage and is focused on combining its internally developed technology with
third party software and hardware.
Web Site Hosting Platform
NetNation attempts to balance and limit the number of web site customers per
server to ensure high quality service levels. Even though industry standard web
servers can support multiple web sites on a single machine, the ability to
manage large numbers of sites is difficult and requires significant
technological innovation. NetNation has expended significant resources
developing technology and tools to efficiently manage a high ratio of customers
to servers and to simultaneously monitor service quality. Although NetNation
has developed the technology to allow over 3,000 simultaneous web sites on a
single server, it generally limits the number of web sites to approximately
2,000 or less per server.
NetNation has the capability to accommodate most hardware/software
configurations that prospective customers may have. NetNation uses standard
technologies such as the Linux operating system, Apache web server software,
Exim mail server, and Bind for DNS. Some of the technological barriers that
NetNation has been able to overcome include the ability to communicate with a
Microsoft Windows NT based SQL server from a UNIX machine, the elimination of
the "file handle" limits on the servers and the ability to run Microsoft
FrontPage extensions on Linux machines.
To facilitate customer maintenance and support, NetNation has developed various
tools that enable customers to change their own passwords, setup POP3 mail
accounts, modify e-mail routing for automatic message forwarding, and to monitor
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their web site statistics. Customers access these services through a proprietary
User Services front-end interface. The User Services front-end tools are
continually being upgraded to enhance customer service and ensure a high level
of scalability as additional servers and customers come online.
Network Operations
The provision of qualified service is of the utmost importance to NetNation's
business. Accordingly, NetNation invests significant resources into building a
scalable network infrastructure. Wherever feasible, NetNation makes its network
fault tolerant with redundant equipment. Such actions include standby equipment
to handle additional capacity if a server has to be replaced for such reasons as
malfunction of a hard drive or software. The redundancy allows for operations
to continue efficiently as possible although a particular piece of equipment
has failed. Another instance of failure can occur when power to a server is
interrupted. In this situation, NetNation's emergency backup power would
automatically operate to allow the service to continue with minimal or no
interruption. The availability of redundancy of equipment or excess capacity
allows for the alternative processing of data until the defective equipment or
software can be replaced or repaired. These measures, along with continual
monitoring, are designed to help minimize down time and provide early
identification of potential sources of failure. At December 31, 2001, the
Company had one data center, located in Vancouver, Canada.
COMPETITION
The markets for web hosting and domain name registration services are very
competitive. It is estimated that there are over 5,000 web hosting service
providers in North America alone. The majority of them are very small and run
by programmers or other technical people. Others are ISPs that offer limited
web site hosting as an add-on service to their dial-up web access services.
There are approximately 150 accredited registrars of top-level domain names
worldwide.
NetNation's current and potential competitors include:
a) other web hosting and Internet services companies;
b) "pure" domain name registrars that are accredited and operational;
c) domain name registrars that are accredited but not yet operational;
d) regional and national ISPs;
e) regional and national telecommunications companies;
f) large information technology outsourcing firms; and
g) cable and satellite service providers.
The principal competitive factors in this market include:
a) efficient, available customer service and technical support;
b) quality and reliability of service;
c) network capability and scalability (scalability refers to the ability of
the hardware and software to support increasingly larger or more complex
web site requirements of customers);
d) pricing of services;
e) brand name recognition;
f) breadth of products and services offered and the timely introduction
thereof;
g) technical and engineering expertise;
h) network security;
i) maintenance and expansion of marketing distribution channels;
j) financial resources;
k) attraction and retention of key technical and managerial personnel;
l) development of a broad international presence; and
m) compliance with and the leveraging of industry standards.
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NetNation considers that most web hosting competitors fit into two major
groupings, each having its own set of competitive strengths and weaknesses. The
first grouping, and most obvious of NetNation's direct competitors, are the
large telephone and cable companies. NetNation believes that because of their
large corporate size, it takes these competitors much longer to develop and
incorporate new features into their hosting services and to offer those services
at a competitive price without subsidizing the pricing. As a result, NetNation
believes that by careful attention to its cost structure and rapid response to
market demand for new features, it can effectively compete with larger and more
financially secure companies, both in services provided and on price.
The second major type of competitors are the pure-play web site hosting
companies. NetNation believes that many of these companies have insufficient
resources, inadequate infrastructure, insufficient Internet connectivity, and/or
inadequate technical support. These companies may have congested network
servers and slow Internet connectivity causing delays in web site access and
upload. The smaller of these companies may not have scalable systems that can
respond quickly to their customers' growth requirements and may not be capable
of supporting large numbers of new customers. NetNation is aware that some of
its customers came to NetNation as a result of experiencing an inadequate level
of service from a competitor. While some of these pure-play web site hosting
companies may face these competitive deficiencies, there are a number of web
site hosting companies that have shown the ability to compete effectively,
including Interland, Interliant, Verio, and Webhosting.com. The ability of
NetNation to compete with these companies over time is unproven.
Competitive Advantages
The following key advantages are provided to the customers of NetNation through
its various service solutions.
High-performance with quality service and reliability. NetNation's web
site hosting solutions are designed to deliver hardware and software performance
to ensure customers' web sites load rapidly when visited. NetNation believes
that features such as redundant and fault tolerant equipment housed in secure
and environmentally protected facilities permit NetNation to offer a reliable
service with minimal downtime to customer web sites.
Large number of service options. NetNation's services range from domain
name registration to sophisticated managed web hosting offerings. In 2001, 68%
of NetNation's revenues were generated by web site hosting services. This
includes a number of fee based Internet enhancement services. These enhanced
services include electronic commerce solutions for the Web, expanded data
storage and data bandwidth options, web site to database interfaces, multimedia
support tools for applications such as RealAudio and RealVideo, security,
backup, load balancing, and monitoring. NetNation also offers the ability for
customers to co-locate their web servers on NetNation's secure premises and gain
access to technical support services, expertise, and Internet connectivity.
Cost-effective solutions. There are potentially significant cost saving
benefits to NetNation's customers through the elimination of high capital costs
for web site equipment, labor, and software. Customers can tap directly into the
knowledge and operating experience of NetNation's staff. Ongoing operating
costs to customers are usually a small fraction of costs of staffing, support
and bandwidth of an internally hosted web site. The shared nature of
NetNation's services provides customers with access to the huge bandwidth at a
cost of less than $100 versus over a $1,000 per month for their own T-1 (1.54
megabits) or greater bandwidth connection.
Flexibility and Scalability. NetNation's web site hosting solutions offer
a highly scalable structure designed to support tens of thousands of web sites.
This enables NetNation to provide a continual level of reliable service to both
existing and new customers. NetNation's structure permits the quick expansion of
available data storage space and network bandwidth required to accommodate rapid
growth in the activity or number of visitors to customers' web sites.
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Customer Support. Through its standardized systems, NetNation has the
ability to rapidly deploy customer web sites. Most of this process is automated
and does not require the extensive involvement of any NetNation personnel.
NetNation believes it has developed an efficient system of support and related
customer services via e-mail or telephone through NetNation's technical service
group. Customer support services are available 24 hours per day, 7 days per
week.
Ease of Use. Through interactions with its thousands of customers,
NetNation has developed and implemented proprietary software tools to assist its
customers. These tools allow customers to easily order, change, and manage
their web sites, remotely. Detailed statistics and activity logs are available
for customers to review their account and performance information. For
customers that are buying the "DomainPlus" package, NetNation has developed a
tool that allows customers to create a one page web site with a simple template.
By using this tool, customers can create a simple web site within minutes.
EMPLOYEES
As at December 31, 2001, NetNation had 80 employees. All employees, with the
exception of the founders, are required to enter into an employment agreement
that contains industry standard terms including protection of proprietary
interests, confidentiality, and non-competition terms.
NetNation believes that its ability to attract, hire, and retain qualified
personnel now and in the future is important to its success. While sourcing and
recruiting appropriate technical personnel is often difficult and competitive,
NetNation expects that its need to recruit additional personnel in the future
will not negatively affect its operations. Management believes that its
employee relations are good. None of NetNation's employees are represented by a
collective bargaining unit.
INTELLECTUAL PROPERTY RIGHTS
NetNation relies on copyrights, trademarks, trade secret laws, and contractual
restrictions to establish and protect its proprietary rights in its services and
products. NetNation does not have any patented technology at this time that
would limit competitors from entering NetNation's market. Management of
NetNation believes that the steps taken by NetNation to protect its intellectual
property are consistent with industry standards for web site hosting companies
today.
All employees and contractors are required to and have entered into
confidentiality and invention assignment agreements. Suppliers, distributors,
and certain customers are also required to enter into confidentiality
agreements.
To date, NetNation has received no notification that its services or products
infringe the proprietary rights of third parties. Third parties could however
make such claims of infringement in the future. Any future claims that do occur
may have a material adverse affect on NetNation and its business.
RISK FACTORS AFFECTING FUTURE OPERATING RESULTS
Limited Operating History
NetNation has only been operating since February 1997. As a result, the
NetNation business model is still in an evolving stage. The limited operating
history means NetNation does not have the benefit of the many years of
experience that some other companies have and can use to modify their business
plans and optimize their business strategies. The ability of NetNation to
sustain revenue and income, in the future, is unproven. Therefore NetNation's
limited operating history makes an evaluation of NetNation and its prospects
difficult. See "Management's Discussion and Analysis" in this Form 10-K.
Future Losses
The Company may incur losses and generate negative operating cash flows in the
future. The extent to which negative cash flow will occur depends upon a number
of factors, including the following:
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- the number, size, and timing of any investments and/or acquisitions;
- the expense and time required to integrate any future acquired
operations;
- the time and effort required to capture operating efficiencies;
- the ability to generate increased revenues and cash flow; and
- potential regulatory developments that may apply to NetNation's
operations.
Industry Risks
NetNation and its prospects must be considered in light of the risks, expenses
and difficulties encountered by companies in the rapidly evolving market for web
hosting, domain name registration, and related enhanced Internet services. To
address these risks, NetNation must market its services and build its brand
names effectively, provide scalable, reliable and cost-effective services,
continue to grow its infrastructure to accommodate additional customers and
increased use of its network bandwidth, expand its channels of distribution,
continue to respond to competitive developments, and retain and motivate
qualified personnel. NetNation may not sustain revenue growth and profitability
in future quarterly or annual periods.
Fluctuations in Results of Operations
NetNation has experienced significant fluctuations in its results of operations
on a quarterly and an annual basis. NetNation expects to continue to experience
significant fluctuations in its quarterly and annual results of operations due
to a variety of factors, many of which are outside the Company's control. These
controllable and non-controllable factors include:
Controllable Factors
a) introductions of products or services by NetNation;
b) the mix of services sold by NetNation;
c) the timing and magnitude of capital expenditures, including
construction costs relating to the expansion of operations;
d) the timing and magnitude of expenditures on advertising and promotion;
e) changes in the pricing policies of NetNation; and
f) the timing and magnitude of expenditures on advertising and promotion.
Non-controllable Factors
a) demand for and market acceptance of NetNation's services;
b) introductions of products or services by NetNation's competitors;
c) reliable continuity of service and network availability;
d) the ability to increase bandwidth as necessary;
e) provisions for customer discounts and credits;
f) customer retention;
g) timing and success of marketing efforts and service introductions by
the Company, its resellers and OEMs;
h) the introduction by third parties of new Internet and networking
technologies;
i) increased competition in NetNation's markets;
j) changes in the pricing policies of NetNation's competitors; and
k) fluctuations in bandwidth used by customers.
NetNation's committed costs pertaining to premises, communication and wages
account for approximately 55% of total expenses for the foreseeable short term.
Absorbing
16
these costs within the short term as well as variable marketing expenses, and
maintaining efficient operations means that NetNation's earnings would be
particularly sensitive to fluctuations in revenues. If NetNation was unable to
continue using third-party products in NetNation's services offerings,
NetNation's service development costs could increase significantly. For these
and other reasons, in some future quarters, NetNation's results of operations
may not meet or exceed the expectations of the investors, which could have a
material adverse effect on NetNation's worth. See "Management's Discussion and
Analysis" in this Form 10-K.
Dependence Upon New Markets; Uncertainty of Acceptance of Services
The markets for web site hosting, domain name registration, and related enhanced
Internet services have only begun to develop in the past few years and are
evolving rapidly. There is significant uncertainty regarding whether these
markets ultimately will prove to be viable over the long term or, if they prove
viable, whether they will continue to grow. NetNation's future growth, if any,
will depend upon the willingness of businesses to outsource web site hosting
services and NetNation's ability to market its services in a cost-effective
manner to a sufficiently large number of customers. The market for NetNation's
services may not develop further, NetNation's services may not be more widely
adopted, and significant numbers of businesses or organizations may not use the
Internet for commerce and communication. If these markets fail to develop
further or develop slower than expected, or if NetNation's services do not
achieve broader market acceptance, NetNation's business, results of operations
and financial conditions would be materially and adversely affected. In
addition, to be successful in this emerging market, NetNation must be able to
differentiate itself from its competition through its service offerings and
brand recognition. NetNation may not be successful in differentiating itself or
achieving market acceptance of its services and may experience difficulties that
could delay or prevent the successful development, introduction or marketing of
these services. If NetNation incurs increased costs, or is unable, for
technical or other reasons, to develop and introduce new services or products or
enhancements to existing services in a timely manner, or if new services do not
achieve market acceptance in a timely manner or at all, NetNation's business,
results of operations and financial condition could be materially adversely
affected.
Dependence Upon Expansion of Service Offerings
NetNation's success depends on the growth of its current web hosting and domain
name registration businesses. The Company expects to drive this internal growth
by expanding and enhancing its product and service base with additional
value-added products and product lines. The Company may be able to develop
these additional product capabilities internally, but expects that primarily the
development of strategic relationships with various vendors and distribution
partners will be critically important. Accordingly, it will be important that
the Company either develops these capabilities internally or identifies suitable
potential product and service vendors and distributors with whom the Company can
complete agreements on acceptable terms. NetNation expects that competition for
strategic relationships with key vendors and potential distributors could be
significant, and that the Company may have to compete with other companies with
greater financial and other resources to obtain these important relationships.
There can be no assurance that NetNation will be able to identify suitable
partnering candidates or be able to complete agreements on acceptable terms with
these parties.
Dependence Upon Channel Partners
An important element of NetNation's strategy for growth is to continue to
develop its reseller channel through the marketing of Reseller Packages, which
is being used by NetNation's network of domestic and international resellers,
and through the development of NetNation's OEM relationships. NetNation's
resellers typically are web development or web consulting companies that also
sell NetNation's web site hosting services but that do not generally have
established customer bases to which they can market NetNation's services.
Therefore, in those markets, primarily international, where NetNation does not
directly focus its marketing efforts, NetNation is dependent on third parties to
stimulate demand for NetNation's services. Currently, NetNation does not have
marketing efforts in South America, Africa, and Australia. The failure of
NetNation's services to be commercially accepted in certain markets, whether as
a result of a reseller performance or otherwise, could cause NetNation's current
channel partners to discontinue their relationships with NetNation, and
NetNation may not be successful in establishing additional channel partner
relationships as required. OEMs and resellers have no obligation to market or
resell NetNation's web site hosting and domain name registration services, and
17
OEMs can terminate their relationships with NetNation with limited or no penalty
with as little as 30 days' notice. The loss of resellers or OEMs, the failure of
such parties to perform under agreements with or the inability of NetNation to
attract and retain new resellers or OEMs with the industry experience required
to market NetNation's web site hosting and domain name registration services
successfully in the future could have a material adverse effect on NetNation's
business, results of operations and financial condition. NetNation's direct
sales efforts may conflict with the efforts of its indirect channel partners,
which may adversely affect NetNation's relationships with such partners. In
addition, to the extent that NetNation succeeds in increasing its sales through
indirect channels such as resellers or OEMs, those sales will be at discounted
rates, and revenue and gross margin to NetNation for each such sale will be less
than if NetNation had sold the same services to the customer directly. Refer to
"Distribution and Sales" in this Form 10-K.
Highly Competitive Markets With Few Barriers to Entry
The markets served by NetNation are highly competitive and are becoming more so.
There are few substantial barriers to entry, and NetNation expects that it will
face additional competition from existing competitors and new market entrants in
the future.
NetNation may not have the resources, expertise or other competitive factors to
compete successfully in the future. Many of NetNation's competitors have
substantially greater financial, technical and marketing resources, larger
customer bases, longer operating histories, greater name recognition and more
established relationships in the industry than NetNation. As a result, certain
of these competitors may be able to develop and expand their network
infrastructures and service offerings more rapidly, adapt to new or emerging
technologies and changes in customer requirements more quickly, take advantage
of acquisition and other opportunities more readily, devote greater resources to
the marketing and sale of their services and adopt more aggressive pricing
policies than can NetNation. In addition, these competitors have entered and
will likely continue to enter into joint ventures or consortiums to provide
additional services competitive with those provided by NetNation.
Continued Growth May Strain Resources
NetNation has been growing, and expects to continue to experience growth. This
growth has placed, and is likely to continue to place, a significant strain on
the Company's managerial, operating, financial and other resources. The
expansion efforts also require significant time commitments from the Company's
senior management and places a strain on their ability to manage the existing
business. The Company also may be required to manage multiple relationships with
third parties as the Company's value-added service offerings, including web
hosting, are expanded. Future performance will depend, in part, upon NetNation's
ability to manage this growth effectively. To that end, the Company will have to
undertake the following improvements, among others:
- implement additional management information systems capabilities;
- further develop operating, administrative and financial and accounting
systems and controls;
- improve coordination between engineering, accounting, finance,
marketing and operations; and
- hire and train additional personnel.
In addition, if the Company cannot obtain external capital resources, its
ability to grow rapidly may be significantly undermined.
Risks Associated with International Expansion and Operations
NetNation's success is dependent in part on expanding its international
presence, primarily through NetNation's resellers. As a result, NetNation will
depend upon its reseller network to market and sell its services and manage the
accounts of customers internationally. NetNation's resellers may not be able to
continue to market and sell NetNation's web site hosting services successfully.
NetNation denominates its sales to resellers in U.S. dollars. Thus,
fluctuations in the value of the U.S. dollar relative to the Canadian dollar and
to the currency of a given country may make NetNation's services less (or more)
profitable and therefore less (or more) attractive to resellers selling in that
country. In addition, there are certain risks inherent in conducting business
18
internationally, such as changes in regulatory requirements, export
restrictions, tariffs and other trade barriers, differing technology standards,
longer payment cycles, political and economic instability, fluctuations in
currency exchange rates, imposition of currency exchange controls, seasonal
reductions in business activity, increased difficulty in enforcing contracts and
potentially adverse tax consequences, any of which could adversely affect
NetNation's international operations. Furthermore, foreign governments where
NetNation currently operates or plans to operate, have enforced laws and
regulations related to the operations of Internet service providers that are
stricter than those currently in place in the United States and Canada.
One or more of these factors could have a material adverse effect on NetNation's
current or future international operations and, consequently, on NetNation's
business, results of operations and financial condition. To the extent that
NetNation does business in foreign markets directly, NetNation will also be
subject to risks such as challenges in staffing and managing foreign operations,
employment laws, and practices in foreign countries and problems in collecting
accounts receivable. In addition, NetNation or its channel partners may not be
able to compete effectively in international markets.
General Acquisition Risks
The Company may acquire strategically important companies and operations. These
acquisitions could materially adversely affect the Company's operating results
as a result of dilutive issuances of equity securities or the incurrence of
debt. In addition, the purchase price for many of these acquired businesses
likely will significantly exceed the current fair values of the net assets of
the acquired businesses. As a result, material goodwill and other intangible
assets would be required to be recorded, which could result in significant
amortization charges in future periods. These charges, in addition to the
financial impact of such acquisitions, could have a material adverse effect on
NetNation's business, financial condition and results of operations.
Increased Bandwidth Requirements
As customers' usage of bandwidth increases, NetNation will need to make
additional investments in its infrastructure to maintain adequate downstream
data transmission speeds, the availability of which may be limited or the cost
of which may be significant. Additional network capacity may not be available
from third party suppliers as NetNation needs it, and, as a result, NetNation's
network may not be able to achieve or maintain a sufficiently high capacity of
data transmission, especially if the usage by NetNation's customers increases.
NetNation's failure to achieve or maintain high-capacity data transmission could
significantly reduce consumer demand for its services and have a material
adverse effect on its business, results of operations and financial condition.
To accommodate a higher degree of scalability from the present structure will
require further additions to capital assets, possible upgrade and partial
replacement of existing capital assets, and additional costs to accommodate
increased bandwidth usage. The Company has implemented an infrastructure
maintenance program to ensure that these issues are proactively addressed. This
program, however, may result in increased capital expenditure costs.
Network Solutions/Verisign's and Other Registries Competitive Advantage
The Internet domain name registration system is composed of two principal
functions: registry and registrar. Registries maintain the database that contain
names registered within the top-level domains and their corresponding Internet
protocol addresses. Registrars act as intermediaries between the registry and
individuals and businesses, referred to as registrants, seeking to register
domain names. The agreements among Network Solutions, ICANN and the U.S.
Department of Commerce have given Verisign the parent company of Network
Solutions, the exclusive right to operate and maintain the registry for the
.com, .net and .org domains at least until November 30, 2003. Registrars other
than Verisign are known in the industry as "competitive registrars." As the
exclusive registry for these domains, Verisign receives from NetNation, and
every other competitive registrar, $6 per domain name per year. Although
registry fees may not be used directly to fund Verisign's registrar business,
the substantial net revenues from these fees, and the certainty of receiving
them, provide Verisign significant advantages over any competitive registrar.
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Afilias, LLC and Neulevel, Inc. have recently been appointed the registries for
the .info and .biz top-level domain names respectively. They hold a similar
competitive position with respect to their top-level domain names as Network
Solutions/Verisign has to the .com, .net, and .org top-level domain names.
Increased Domain Name Registration Competition
Competition in the domain name registration services industry will intensify as
the number of entrants into the market increases. As at December 31, 2001,
ICANN had accredited almost 150 competitive registrars, including NetNation, to
register domain names in the .com, .net, and .org domains. NetNation faces
substantial competition from competitive registrars and others in that:
- many accredited registrars that are not currently registering domain
names may begin to do so in the near future;
- companies that are not accredited registrars may offer domain name
registrations through a competing accredited registrar's system; and
- ICANN may accredit new registrars to register domain names in the
.com, .net, .org, .info, and .biz domains.
The Company faces competition from other competitive registrars and others in
the domain name registration industry who may have longer operating histories,
greater name recognition or greater resources. Competitors in the domain name
registration industry include companies with strong brand recognition and
Internet industry experience, such as major telecommunications firms, cable
companies, ISPs, web hosting providers, Internet portals, systems integrators,
consulting firms and other registrars. Many of these companies also possess
core capabilities to deliver ancillary services, such as customer service,
billing services and network management. NetNation's market position could be
harmed by any of these existing or future competitors, some of which may have
longer operating histories, greater name recognition and greater financial,
technical, marketing, distribution and other resources than NetNation does.
Since competition in the domain name registration industry is in its early
stages, NetNation cannot provide assurance that the Company will not be
required, by market factors or otherwise, to reduce, perhaps significantly, the
prices charged for domain name registration and related products and services.
Further, some of NetNation's competitors are offering domain name registrations
for free and derive their revenues from other sources. Reducing the prices
NetNation charges for domain name registration services in order to remain
competitive could materially adversely affect the Company's results of
operations.
Accreditation to New Top-Level Domains
ICANN or another approving entity may introduce new generic top-level domains.
The Company cannot provide assurance that, if introduced, NetNation will be
accredited to offer registrations in these domains or that customers will rely
on NetNation to provide registration services within any new generic top-level
domains. The Company's business, financial condition, and results of operations
would be materially adversely affected if substantial numbers of customers turn
to other registrars for these registration needs.
Maintenance of ICANN Accreditation
NetNation needs to be an ICANN-accredited registrar in order to register domain
names in the .com, .net, .org, .info, and .biz domains. The Company's current
ICANN accreditation agreement, through DomainPeople Inc., a wholly-owned
subsidiary of NetNation, expires on August 16, 2005. While NetNation
anticipates that ICANN will renew this agreement when it expires, there is no
assurance that it will do so. If ICANN does not renew the Company's
accreditation when it expires, NetNation's business, financial condition and
results of operations would be materially adversely affected in the future.
20
Risk of System Failure
NetNation's operations depend upon its ability to protect its network
infrastructure, equipment and customer files against damage from human error,
fire, earthquakes, hurricanes, floods, power loss, telecommunications failures,
sabotage, intentional acts of vandalism or terrorism and similar events. The
occurrence of a natural disaster or other unanticipated problems at NetNation's
Network Operations Centers could result in interruptions in the services
provided by NetNation. The Company has no formal disaster recovery plan.
Although NetNation is currently building redundancy into its network,
NetNation's network is currently subject to various single points of failure,
and a problem with one of NetNation's routers or switches could cause an
interruption in the services provided by NetNation to a portion of its
customers. NetNation has, in the past, experienced periodic interruptions in
service ranging from 2 minutes to 3 hours, totaling between 20 and 24 hours a
year. Although these interruptions were of short duration, they did occur and
the extent of future interruptions is indeterminable. The interruptions had no
significant impact on the business of NetNation.
In addition, failure of any of NetNation's telecommunications providers to
provide the data communications capacity required by NetNation, as a result of
human error, a natural disaster, or other operational disruption, could result
in interruptions in NetNation's services. Any damage to, or failure of, the
systems of NetNation or its service providers could result in reductions in, or
terminations of, services supplied to NetNation's customers, which could have a
material adverse effect on NetNation's business, results of operations, and
financial condition. In addition, NetNation's reputation could be materially
adversely affected.
Dependence Upon Network Infrastructure
NetNation's success will depend upon the capacity, scalability, reliability and
security of its network infrastructure, including the capacity leased from AT&T
Canada Inc., Group Telecom, Peer1 Network, and WorldCom, its telecommunications
network suppliers. NetNation is dependent on such companies to maintain the
operational integrity of their telecommunications networks. Therefore,
NetNation's operating results depend, in part, upon the pricing and availability
of telecommunications network capacity from a limited number of providers in a
consolidated market. In the event of a material increase in pricing or decrease
in telecommunications capacity available to NetNation, if NetNation were unable
either to access alternative networks on a cost-effective basis to distribute
its customers' content or to pass through any additional costs of utilizing
existing or alternative networks to its customers, NetNation's business, results
of operations and financial condition could be materially adversely affected.
Dependence Upon the Internet and Internet Infrastructure Development
NetNation's success will depend largely upon continued growth in the use of the
Internet. Critical issues concerning the commercial use of the Internet,
including security, reliability, cost, ease of access, quality of service and
necessary increases in bandwidth availability, remain unresolved and are likely
to affect the development of the market for NetNation's services. The adoption
of the Internet for information retrieval and exchange, commerce and
communications, particularly by those enterprises that have historically relied
upon alternative means of information gathering, commerce and communications,
generally will require the acceptance of a new medium of conducting business and
exchanging information. Demand and market acceptance of the Internet are
subject to a high level of uncertainty and depend upon a number of factors,
including the growth in consumer access to and acceptance of new interactive
technologies, the development of technologies that facilitate interactive
communication between organizations and targeted audiences, and increases in the
speed of user access. If the Internet, as a commercial or business medium,
fails to develop further, or develops more slowly than expected, NetNation's
business, results of operations, and financial condition could be materially
adversely affected.
Rapid Technological Change; Evolving Industry Standards
NetNation's future success will depend, in part, upon its ability to offer
services that incorporate leading technologies, address the increasingly
sophisticated and varied needs of its current and prospective customers, and
respond to technological advances and emerging industry standards and practices
21
on a timely and cost- effective basis. The market for NetNation's services is
characterized by rapidly changing and unproven technologies, evolving industry
standards, changes in customer needs, emerging competition and frequent new
service introductions. Technological advances may have the effect of encouraging
certain of NetNation's current or future customers to rely on in-house personnel
and equipment to furnish the services currently provided by NetNation. In
addition, keeping pace with technological advances in NetNation's industry may
require substantial expenditures and lead time, which may have a material
adverse effect on NetNation's business, results of operations and financial
condition.
NetNation believes that its ability to compete successfully also depends upon
the continued compatibility and interoperability of its services with products
offered by various vendors. Enhanced or newly developed third party products may
not be compatible with NetNation's infrastructure, and such products may not
adequately address the needs of NetNation's customers. Although NetNation
currently intends to support emerging standards, industry standards may not be
established, and even if they are established, NetNation may not be able to
conform to these new standards in a timely fashion and maintain a competitive
position in the market. The failure of NetNation to conform to the prevailing
standard, or the failure of a common standard to emerge, could have a material
adverse effect on NetNation's business, results of operations and financial
condition. In addition, products, services or technologies developed by others
could render NetNation's services noncompetitive or obsolete.
System Security Risks
A significant barrier to electronic commerce and communications is the need for
secure transmission of confidential information over public networks. Certain of
NetNation's services rely on security technology licensed from third parties to
provide the encryption and authentication necessary to effect secure
transmission of confidential information. Unauthorized access, computer viruses,
accidental or intentional actions and other disruptions could occur. NetNation
has in the past experienced minor delays or interruptions in service as a result
of the accidental and intentional actions of Internet users or "hackers", and
may in the future experience such interruptions because of the same actions.
Furthermore, such inappropriate use of the network by third parties could also
potentially jeopardize the security of confidential information, such as credit
card and bank account numbers, stored in the computer systems of NetNation,
which could result in liability to NetNation and the loss of existing customers
or the deterrence of potential customers. NetNation's security measures have
been circumvented in the past, and any new measures implemented by NetNation
could be circumvented in the future. The costs required to eliminate computer
viruses and alleviate other security problems could be prohibitively expensive
and the efforts to address such problems could result in interruptions, delays
or cessation of service to NetNation's customers, which could have a material
adverse effect on NetNation's business, results of operations and financial
condition. Concerns over the security of Internet transactions and the privacy
of users may also inhibit the growth of the Internet, especially as a means of
conducting commercial transactions.
Government Regulation and Legal Uncertainties
Only a small body of laws and regulations currently apply specifically to
content of, access to, or commerce on, the Internet. It is possible that laws
and regulations with respect to the Internet may be adopted by governments in
any of the jurisdictions in which NetNation can sell its products, covering
issues such as user privacy, freedom of expression, pricing, characteristics and
quality of products and services, taxation, advertising, intellectual property
rights, information security and the convergence of traditional
telecommunications services with Internet communications. The nature of future
legislation and the manner in which it may be interpreted and enforced cannot be
fully determined and, therefore, future legislation could subject NetNation
and/or its customers to potential liability, which in turn could have a
materially adverse effect on NetNation's business, results of operations and
financial condition. The adoption of any such laws or regulations might slow the
growth of the Internet, which in turn could decrease the demand for the services
of NetNation or increase the cost of doing business or in some other manner have
a material adverse effect on NetNation's business, results of operations and
financial condition. In addition, applicability to the Internet of existing laws
governing issues such as property ownership, copyright and other intellectual
property issues, taxation, libel, obscenity and personal privacy is uncertain.
The vast majority of such laws were adopted prior to the advent of the Internet
and related technologies and, as a result, do not contemplate or address the
22
unique issues of the Internet and related technologies. Changes to such laws
intended to address these issues could create uncertainty in the marketplace
that could reduce demand for the services of NetNation or increase the cost of
doing business as a result of costs of litigation or increased service delivery
costs, or could in some other manner have a materially adverse effect on
NetNation's business, results of operations and financial condition. In
addition, because NetNation's services are available over the Internet virtually
worldwide, and because NetNation facilitates sales by its customers to end users
located in multiple provinces, states and foreign countries, such jurisdictions
may claim that NetNation is required to qualify to do business as a foreign
corporation in each such state/province or that NetNation has a permanent
establishment in each such foreign country. Failure by NetNation to qualify as a
foreign corporation in a jurisdiction where it is required to do so could
subject NetNation to taxes and penalties for failure to qualify and could result
in the inability of NetNation to enforce contracts in such jurisdictions. Any
new legislation or regulation, or the application of laws or regulations from
jurisdictions whose laws do not currently apply to NetNation's business, could
have a materially adverse effect on NetNation's business, results of operations
and financial condition.
NetNation is not currently subject to direct regulation by the Federal
Communications Commission or any other governmental agency, other than
regulations applicable to businesses in general. However, in the future, it may
become subject to regulation by the FCC or another regulatory agency.
NetNation's business could suffer depending on the extent to which its
activities are regulated or proposed to be regulated
NetNation does not currently collect sales or other taxes with respect to the
sale of services or products in states and countries where NetNation believes it
is not required to do so. NetNation does collect sales and other taxes in the
states and countries in which NetNation has offices and is required by law to do
so. Currently, NetNation collects federal taxes in Canada from Canadian
residents and provincial taxes where applicable. One or more jurisdictions have
sought to impose sales or other tax obligations on companies that engage in
online commerce within their jurisdictions. A successful assertion by one or
more jurisdictions that NetNation should collect sales or other taxes on its
products and services, or remit payment of sales or other taxes for prior
periods, could have a minor adverse effect on the Company's business.
It is possible that the U.S. or any other jurisdiction may impose taxes on
Internet based commerce. The materiality of such taxes on the results of
operations cannot be determined by the Company at this time. The growth of the
Internet, coupled with publicity regarding Internet fraud, may lead to the
enactment of more stringent consumer protection laws. If NetNation becomes
subject to claims that NetNation has violated any laws, even if NetNation
successfully defends against these claims, the business could suffer. Moreover,
new laws that impose restrictions on NetNation's ability to follow current
business practices or increase its costs of doing business could hurt the
business.
Risks Associated With Information Disseminated Through NetNation's Network
The law relating to the liability of online services companies and Internet
access providers for information carried on or disseminated through their
networks is currently unsettled. Despite the passage of the Communications
Decency Act which provided some relief to online service providers from civil
liability for content they did not create, it is possible that claims could be
made against online services companies and Internet access providers under
United States, Canadian and foreign laws for defamation, negligence or copyright
or trademark infringement, or other theories based on the nature and content of
the materials disseminated through their networks. Several private lawsuits
seeking to impose such liability upon online services companies and Internet
access providers are currently pending. In addition, legislation has been
proposed that imposes liability for or prohibits the transmission over the
Internet of certain types of information. The imposition upon NetNation and
other web site hosting providers of potential liability for information carried
on or disseminated through their systems could require NetNation to implement
measures to reduce its exposure to such liability, which may require the
expenditure of substantial resources, or to discontinue certain service
offerings. The increased attention focused upon liability issues as a result of
these lawsuits and legislative proposals also could affect the growth of
Internet use. In addition, NetNation is subject to a number of risks associated
with the potential actions of customers utilizing NetNation's network. For
example, if a customer were to engage in "spamming" (a practice of sending large
quantities of unsolicited e-mail), NetNation would have an obligation to block
that customer's access to the Internet through NetNation's network. A failure by
NetNation to satisfy this obligation could result in NetNation being denied
23
access to the telecommunications networks through which NetNation's network
links to the Internet. Spamming could also cause a significant disruption in
NetNation's ability to route e-mail to and from its customers.
Dependence on Key Personnel
NetNation's success depends in a significant part upon the continued services of
its key personnel. The Company's technical, sales and administrative matters
come under the direct responsibility of, or are shared by, the following key
personnel: David Talmor, Chairman and President; and Joseph Kibur, Chief
Executive Officer. The loss of the services of one or both of these key persons
could have a material adverse effect on NetNation's business, results of
operations and financial condition.
Ability to Attract, Train and Retain Personnel
If NetNation is unable to attract additional qualified personnel, this could
have a material adverse effect on NetNation's business, results of operations
and financial condition. Any officer or employee of NetNation can terminate his
or her relationship with NetNation at any time. NetNation's future success will
also depend on its ability to attract, train, retain and motivate highly
qualified technical, marketing, sales and management personnel. Competition for
such personnel is intense, and NetNation may not be able to attract and retain
key personnel.
Protection and Enforcement of Intellectual Property Rights
NetNation relies on a combination of copyright, trademark, service mark and
trade secret laws and contractual restrictions to establish and protect certain
proprietary rights in its services. NetNation has no patented technology that
would preclude or inhibit competitors from entering NetNation's market.
NetNation has entered into confidentiality and invention assignment agreements
with its employees and contractors, and nondisclosure agreements with its
suppliers, distributors and certain customers in order to limit access to and
disclosure of its proprietary information. These contractual arrangements or the
other steps taken by NetNation to protect its intellectual property may not
prove sufficient to prevent misappropriation of NetNation's technology or to
deter independent third party development of similar technologies. The laws of
certain foreign countries may not protect NetNation's services or intellectual
property rights to the same extent as do the laws of the United States and
Canada. NetNation also relies on certain technologies that it licenses from
third parties. These third party technology licenses may not continue to be
available to NetNation on commercially reasonable terms. The loss of the ability
to use such technology could require NetNation to obtain the rights to use
substitute technology, which could be more expensive or offer lower quality or
performance, and therefore have a material adverse effect on NetNation's
business, results of operations and financial condition. To date, NetNation is
not a subject of a lawsuit in respect to NetNation's services infringing the
proprietary rights of third parties, but third parties could claim infringement
by NetNation with respect to current or future services. NetNation expects that
participants in its markets will be increasingly subject to infringement claims
as the number of services and competitors in NetNation's industry segment grows.
Any such claim, whether meritorious or not, could be time-consuming, result in
costly litigation, cause service installation delays or require NetNation to
enter into royalty or licensing agreements. Such royalty or licensing agreements
might not be available on terms acceptable to NetNation, or at all. As a result,
any such claim could have a material adverse effect upon NetNation's business,
results of operations and financial condition.
24
Control by Principal Stockholders, Executive Officers and Directors
NetNation's Chairman and President, David Talmor, and Chief Executive Officer,
Joseph Kibur, in the aggregate, beneficially own approximately 53% of
NetNation's outstanding common stock as at December 31, 2001. As a result, such
persons, acting together, will have the ability to control most matters
submitted to stockholders of NetNation for approval (including the election and
removal of directors) and to control the management and affairs of NetNation.
However, there are no voting trusts or other agreements between David Talmor and
Joseph Kibur to vote in concert. Accordingly, such concentration of ownership
may have the effect of delaying, deferring or preventing a change in control of
NetNation, impeding a merger, consolidation, takeover or other business
combination involving NetNation or discouraging a potential acquirer from making
a tender offer or otherwise attempting to obtain control of NetNation, which in
turn could have a material adverse effect on NetNation's worth.
Dilutive Effect of Future Sales of Securities
Future sales of substantial amounts of NetNation's Common Stock in the public
market could adversely affect the market price of the common stock and
shareholders could experience dilution in their stock ownership of the Company
and in the value of their shares. Dilution is a reduction in the value of the
holder's investment measured by the difference between the purchase price of the
shares of the common stock and the net tangible book value of the shares after
the purchase takes place. As at December 31, 2001, there were 9,887,621 shares
of common stock which are restricted or affiliate shares ("Restricted Shares").
Those Restricted Shares will gradually be converted to free-trading shares, the
sale of which could have a material adverse effect on the future market price of
NetNation's common stock.
Stock Price Volatility
The market price of NetNation's common stock has fluctuated significantly in the
past, and is likely to continue to be highly volatile. To date, the trading
volume in the Company's stock has been relatively low and significant price
fluctuations can occur as a result. If the low trading volumes experienced to
date continue, such fluctuations could occur in the future. The Company cannot
provide assurance that the sale price of its common stock will not fluctuate or
decline significantly in the future. In addition, the U.S. equity markets have
from time to time experienced significant price and volume fluctuations that
have particularly affected the market prices for the stocks of technology
companies. These broad market fluctuations may materially adversely affect the
market price of NetNation's common stock in future. Such fluctuations and
variations may be the result of changes in NetNation's business, operations or
prospects, announcements of technological innovations and new products by
competitors, NetNation or its competitors entering into new contractual
relationships with strategic partners, proposed acquisitions by NetNation or its
competitors, financial results that fail to meet public market analyst
expectations of performance, regulatory considerations and general market and
economic conditions in the U.S. and throughout the world.
Nasdaq SmallCap Market Listing
The Company is subject to continued inclusion rules to maintain its Nasdaq
SmallCap Market listing. In August 2001, the Company was notified by Nasdaq that
it did not meet listing requirements for the Nasdaq SmallCap Market at that
time. The Company appealed its case before the Nasdaq Qualifications Panel for
continued listing on Nasdaq SmallCap Market. In a determination provided to the
Company by the Nasdaq Qualifications Panel on October 26, 2001, the Panel stated
that the Company had demonstrated market capitalization of at least $35,000,000
for 18 consecutive trading days. Furthermore, the Panel noted that the Company
appeared to satisfy all other requirements for continued listing. Accordingly,
the Panel determined to continue listing the Company's securities on the Nasdaq
SmallCap Market, and closed the hearing file.
If NetNation is unable to maintain its listing on the Nasdaq SmallCap Market in
the future, the liquidity of its common stock on the public markets could be
affected. The ability of NetNation to meet the continued listing requirements is
affected by factors affecting the Company itself, and by market factors that
affect all Nasdaq and/or all publicly traded stocks.
25
ITEM 2: PROPERTIES
- --------------------
NetNation's executive offices and Network Operation Center, are located in
Vancouver B.C., Canada. They consist of approximately 11,000 square feet, which
is leased at a rate of approximately $9,000 per month pursuant to agreements
that expire on April 30, 2002 with an option to renew for 2 years. All property
is insured to industry standards. The Company believes that these facilities
will be suitable for the operation of its business for the foreseeable future.
ITEM 3: LEGAL PROCEEDINGS
- ----------------------------
As at December 1, 2000, the Company had discontinued lease payments on its San
Diego premises due to a number of circumstances. To date, the landlord has not
commenced legal action against the Company. Should the landlord commence legal
action against the Company, the outcome of the proceedings is unknown. The
remaining lease payments of $381,254 as at December 31, 2001 have been accrued
in the consolidated financial statements as at December 31, 2000, and a gain
will be recognized in the event of a favorable outcome.
The distribution process for .biz domain names has been the subject of
litigation in the Los Angeles Superior Court in the State of California. On
August 1, 2001 a lawsuit was brought by David Scott Smiley against NeuLevel,
Inc., the .biz registry, the Internet Corporation for Assigned Names and Numbers
("ICANN"), and most of the .biz-accredited registrars, including DomainPeople
Inc., a wholly-owned subsidiary of NetNation. This lawsuit alleges among other
things, that the method for assigning domain names during the start-up period
for registration of .biz domain names constituted an illegal lottery under
California law. The lawsuit seeks a refund of the fees paid to the defendants,
additional damages, costs, attorney fees, and an injunction to stop the
pre-registrations. NeuLevel has subsequently changed its distribution process in
response to this litigation. At this time, DomainPeople Inc. has not been
formally served with notice of the legal proceedings and the outcome of the
proceedings and the amount of potential damages to DomainPeople Inc. is unknown.
However, should the plaintiff prevail in its claim, the Company may be required
to pay damages which could have a material effect on the Company's operating
results.
To the knowledge of the officers and directors of NetNation, there are no other
pending legal proceedings or litigation of a material nature and none of its
property is the subject of a pending legal proceeding. Further, NetNation's
officers and directors know of no legal proceedings against NetNation or its
property contemplated by any governmental authority.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ---------------------------------------------------------------------
No items were submitted to a vote of security holders during the fourth quarter
of 2001.
26
PART II
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- --------------------------------------------------------------------------------
MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S
COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
NetNation's common shares are principally traded on the Nasdaq Small
Capitalization Market under the ticker symbol NNCI. From February 3, 1999 to
April 27, 1999, the common shares of NetNation traded under the ticker symbol
CBET, reflecting the previous name of NetNation as Collectibles Entertainment
Inc. On April 27, 1999, NetNation began trading under the ticker symbol NNCI.
Price Range of Common Stock
---------------------------
High Low
------------ -------------
Fiscal Year Ended December 31, 2001
First Quarter . . . . . . . . . . . . $ 4.000 $ 2.063
Second Quarter. . . . . . . . . . . . $ 3.750 $ 2.250
Third Quarter.. . . . . . . . . . . . $ 3.010 $ 0.900
Fourth Quarter. . . . . . . . . . . . $ 3.510 $ 2.200
Fiscal Year Ended December 31, 2000
First Quarter . . . . . . . . . . . . $ 17.875 $ 4.563
Second Quarter. . . . . . . . . . . . $ 15.500 $ 3.500
Third Quarter . . . . . . . . . . . . $ 6.375 $ 3.375
Fourth Quarter. . . . . . . . . . . . $ 4.000 $ 1.313
The above quotations were taken from Commodity Systems, Inc.
Holders
On March 12, 2002, NetNation's issued and outstanding common stock totalled
15,218,002 shares and was held by approximately 75 shareholders of record and by
undetermined number of additional shareholders through nominee or street name
accounts with brokers.
Dividends
NetNation has not declared any cash dividends on its common stock and does not
intend to pay cash dividends in the foreseeable future. NetNation's policy is
to reinvest all earnings into the business.
RECENT SALES OF UNREGISTERED SECURITIES
During the year ended December 31, 2001, NetNations sold no unregistered
securities.
27
ITEM 6: SELECTED FINANCIAL DATA
- -----------------------------------
OVERVIEW
NetNation was incorporated under the laws of the State of Delaware on May 7,
1998, under the name Collectibles Entertainment Inc. ("Collectibles"), for the
purpose of operating an online sports card and other tradeable memorabilia
distribution business. Collectibles changed its name to NetNation
Communications, Inc. on April 14, 1999, in conjunction with the acquisition of a
web site hosting business based in Vancouver, Canada. The common shares of
NetNation currently trade on the Nasdaq Small Capitalization Market under the
ticker symbol "NNCI".
NetNation entered into the web hosting business through its acquisition of the
Canadian Subsidiary. The Canadian Subsidiary is a private company incorporated
under the laws of the Province of British Columbia, Canada on February 19, 1997.
The Canadian Subsidiary became a wholly-owned subsidiary on April 7, 1999,
pursuant to an agreement between the shareholders of the Canadian Subsidiary and
Collectibles (the "Share Purchase Agreement"). Pursuant to the Share Purchase
Agreement, Collectibles acquired 9,000,000 Class A common shares and 1,000,000
Class B preferred shares of the Canadian Subsidiary, being all of the issued and
outstanding shares of the Canadian Subsidiary. The purchase price for the
shares of the Canadian Subsidiary was $1,000,000 in Canadian currency, which was
paid by the issuance of 10,000,000 common shares of Collectibles. Upon
conclusion of the acquisition, Collectibles changed its name to NetNation.
Prior to the acquisition, there were no significant business operations. In
accordance with generally accepted accounting principles, this transaction was
accounted for as a recapitalization of the Canadian Subsidiary, as if it issued
stock for consideration equal to the net monetary assets of NetNation.
Accordingly, the results from the Canadian Subsidiary are presented as the prior
period comparative information of the consolidated companies.
28
Prior to April 1999, NetNation did not raise significant external equity or debt
to assist in growth. Historically, NetNation has reinvested all excess cash
flow in order to maximize growth. The majority of any surplus funds were
invested in expanded marketing activities, particularly advertising since
advertising has been NetNation's prime driver of new business and has
consistently proven its ability to generate revenue growth and new customers.
On April 7, 1999, NetNation raised $0.9 million through the issuance of common
shares. On April 12, 1999, NetNation raised a further $1.1 million of
convertible debt financing which was subsequently converted to common shares on
February 18, 2000. On March 3, 2000, NetNation raised $2.5 million through the
issuance of common shares.
29
SELECTED FINANCIAL DATA
======================================================================================
Years ended December 31,
2001 2000 1999 1998
- --------------------------------------------------------------------------------------
Sales $ 6,646,433 $ 5,011,859 $ 2,511,021 $ 1,108,430
Gross profit 4,566,731 3,199,603 1,799,065 687,191
Expenses
Sales & marketing 1,388,643 2,977,927 1,575,699 461,913
General & admin. 2,037,689 3,352,296 1,472,687 303,400
Write-off of advance -- 500,000 -- --
Depreciation 632,482 340,977 95,445 31,428
Deferred income tax recovery 250,000 -- -- --
Net earnings (loss) 757,917 (3,971,597) (1,344,766) (109,500)
Earnings (loss) per share $ 0.05 $ (0.26) $ (0.10) $ (0.01)
Weighted average number 15,246,145 15,316,804 13,164,836 9,692,030
of common shares
Total assets $ 4,126,428 $ 3,130,828 $ 1,518,165 $ 177,359
Debentures payable $ -- -- $ 1,100,000 --
Cash generated by (used for)
Operating activities $ 1,155,973 $ (623,555) $ (604,773) $ 94,177
Investing activities (235,258) (2,014,787) (435,922) (86,590)
Financing activities 9,490 2,399,010 1,982,909 (4,734)
======================================================================================
30
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATION
- -------------
OVERVIEW
NetNation was incorporated under the laws of the State of Delaware on May 7,
1998, under the name Collectibles Entertainment Inc. ("Collectibles") for the
purpose of operating an online sports card and other tradeable memorabilia
distribution business. Collectibles changed its name to NetNation
Communications, Inc. on April 14, 1999 in conjunction with the acquisition of a
web-site hosting business based in Vancouver, Canada. The common shares of
NetNation currently trade on the Nasdaq Small Capitalization Market under the
ticker symbol "NNCI".
NetNation entered into the web hosting business through its acquisition of the
Canadian Subsidiary. The Canadian Subsidiary is a private company incorporated
under the laws of the Province of British Columbia, Canada on February 19, 1997.
The Canadian Subsidiary became a wholly owned subsidiary on April 7, 1999
pursuant to an agreement between the shareholders of the Canadian Subsidiary and
Collectibles (the "Share Purchase Agreement"). Pursuant to the Share Purchase
Agreement, Collectibles acquired 9,000,000 Class A common shares and 1,000,000
Class B preferred shares of the Canadian Subsidiary, being all of the issued and
outstanding shares of the Canadian Subsidiary. The purchase price for the
shares of the Canadian Subsidiary was $1,000,000 in Canadian currency, which was
paid by the issuance of 10,000,000 common shares of Collectibles. Upon
conclusion of the acquisition, Collectibles changed its name to NetNation.
NetNation is an internet infrastructure solutions provider focused on meeting
the needs of small and medium-sized enterprises ("SMEs") and individuals who are
establishing a commercial or informational presence on the Internet. NetNation
competes in the web hosting and domain name registration markets. It's products
and services are sold worldwide, directly to customers and through value added
resellers ("VARs").
In May 1999, NetNation was selected as an official registrar of domain names by
ICANN. The accreditation allows NetNation to register top-level domain names
("TLD's") ending in .com, .net and .org, which account for approximately 50% -
75% of the world's Internet addresses. NetNation, through its wholly-owned
subsidiary, DomainPeople, became operational as a domain name registrar in
December of 1999.
NetNation's 2001 revenue was generated mainly from providing web hosting
services to SMEs and domain name registration. Also included in revenue were
co-located server services; during the year 2001, however, these were relatively
minor contributors. NetNation's web hosting customers normally pay a setup fee
and regular charges, either monthly, quarterly or annually, thereafter. The
Company offers a variety of hosting packages in addition to a number of
value-added services and products. This enables customers to easily select and
modify a solution that precisely meets their individual requirements.
NetNation's accreditation as an official registrar of domain names has enabled
it to register domain names without the involvement of an intermediary. As an
accredited registrar, NetNation, through DomainPeople, has assumed
responsibility for ensuring that current information obtained from customers is
supplied to the central registry.
OPERATING RESULTS
YEAR ENDED DECEMBER 31, 2001 COMPARED WITH YEAR ENDED DECEMBER 31, 2000
For the year ended December 31, 2001, NetNation achieved net earnings of
$757,917 or net earnings per share of $0.05 as compared to a net loss of
$3,971,597 or a net loss per share of $0.26 for the same period in 2000.
Revenue
NetNation's 2001 revenues were derived from Web Hosting (68%) of which 5% was
from Server Co-Location, and Domain Name Registration services (32%). As at
December 31, 2001, NetNation had registered approximately 300,000 Internet
domain names and was hosting more than 22,000 web sites. NetNation's products
and services are sold worldwide, directly to customers and through resellers.
NetNation's 2001 revenue of $6,646,433 was an increase of $1,634,574, or 33%,
over 2000 revenue. During 2001, the number of sites hosted increased
approximately 37%, from 16,000 to 22,000. The increase in revenue was due to
the increase in the number of web sites hosted and a full year of growth in the
domain name registration segment of NetNation's business.
Domain name registration services are billed and collected in advance of
provision of the service and are deferred and recorded as revenue on a
straight-line basis over the term of registration. The unrecognized portion of
the fees has been recorded as deferred revenue. The deferred revenue amount on
the balance sheet as at December 31, 2001 includes $1,708,233 related to domain
name registration.
Cost of Sales
Cost of sales of $2,079,702 was an increase of $267,446 or 15% from 2000 and as
a percentage of revenues, decreased from 36% to 31%. The majority of cost of
sales consists of personnel costs for the network operations center and
technical support, bandwidth costs, and the costs to register domain names for
the Company's customers. Domain name registration fees paid to the central
registry are recognized as an expense over the term of registration. The
improvement in cost of sales as a percentage of sales was due mainly to the
economies of scale experienced for personnel costs.
Sales and Marketing Expenses
Sales and marketing expenses decreased $1,589,284, or 53%, from 2000, and as a
percentage of revenue, decreased from 59% to 21%. The decrease was mainly due to
a reduction in advertising expenses of $1,240,730 due to a more focused approach
to the media and venues chosen to place advertisements. NetNation's advertising
is focused in media types that are believed to best engage the attention of its
target market, SMEs. Sales and marketing expense consists mainly of salaries,
bonuses, commissions and advertising costs.
31
General and Administrative Expenses
General and administration expenses decreased $1,314,607 or 39% compared to
2000. As a percentage of sales, general and administration expenses decreased
from 67% in 2000 to 31% in 2001. The improvement in general and administration
expenses as a percentage of sales was due to cost control and the economies of
scale for the various costs included in general and administration expenses such
as administrative personnel, rent, general office expenses, legal costs, and
investor relations expenses.
Depreciation and amortization
Depreciation and amortization increased $291,505 or 85% compared to 2000. This
increase was related to the significant investment in the network operation
center and computer equipment during 2000.
Deferred Income Tax Recovery
In 2001, the Company recognized a deferred income tax recovery of $250,000 and a
corresponding deferred tax asset of the same amount. In assessing the
realizability of deferred tax assets, management considers whether it is more
likely than not that some portion or all of the deferred tax assets will not be
realized. The ultimate realization of deferred tax assets is dependent upon the
generation of future taxable income during the periods in which those temporary
differences become deductible. Management considers the scheduled reversal of
deferred tax liabilities, projected future taxable income, and tax planning
strategies in making this assessment. The amount of the deferred tax asset
considered realizable could change materially in the near term based on future
taxable income during the carry forward period.
YEAR ENDED DECEMBER 31, 2000 COMPARED WITH YEAR ENDED DECEMBER 31, 1999
Revenue
NetNation's 2000 revenue was generated from providing web hosting services to
SMEs and domain name registration. Also included in revenue were co-located
server services; during the year 2000, however, these were relatively minor
contributors. NetNation's web hosting customers normally pay a setup fee and
regular charges, either monthly, quarterly or annually, thereafter. There are a
variety of hosting packages offered by NetNation in addition to a number of
value-added services and products, to enable customers to easily select and
modify a solution that precisely meets their individual requirements.
NetNation's 2000 revenues were derived from Web Hosting (72%), Domain Name
Registration services (26%), and Server Co-Location (2%). As at December 31,
2000, NetNation had registered approximately 150,000 Internet domain names and
was hosting more than 16,000 web sites. NetNation's products and services are
sold worldwide, directly to customers and through resellers.
In December 1999, the SEC issued Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements" ("SAB 101"). SAB 101 and related material
indicates that the fair value of initial set-up fees should be recognized over
the estimated period of service. The Company's contracts generally include such
fees. The Company has determined the impact of SAB 101 and the resulting
cumulative adjustment of $597,950 has been recorded in the Company's financial
statements in 2000.
NetNation's 2000 revenue of $5,011,859 was an increase of $2,500,838, or 100%,
over 1999 revenue. During 2000, the number of sites hosted increased
approximately 60%, from 10,000 to 16,000.
32
The growth in hosted sites and revenue was entirely "organic" and resulted from
a significant number of valuable partnerships and reselling relationships
established during the year.
Cost of Sales
Cost of sales increased $1,100,300 or 155% from 1999 and as a percentage of
revenues, increased from 28% to 36%. Part of the change as a percentage of
revenue was due to the effect of the SAB 101 adjustment in 2000 mentioned above.
The majority of cost of sales consists of personnel costs for the network
operations center and technical support and the costs to register domain names
for the Company's customers.
Sales and Marketing Expenses
Sales and marketing expenses rose $1,402,228, or 89%, from 1999, and as a
percentage of revenue, decreased from 63% to 59%. The increase was due to
higher expenditures on advertising and the increase in the number of personnel.
The largest single expenditure category in sales and marketing expenses
continues to be the advertising expenditures. Advertising, online and print, is
considered to be a significant driver of NetNation's web hosting business.
In March 2000, an equity financing was secured that allowed NetNation to further
increase advertising activities in support of its internal growth plan.
NetNation's advertising is focused in media where NetNation's advertising is
believed to best engage the attention of the target hosting market, small and
medium-sized businesses.
General and Administrative Expenses
General and administrative expenses include expenditures on administrative
personnel, rent, general office costs, professional advisors and public
relations. In 2000, general and administrative expenses increased $1,879,609,
or 128%, over 1999, and as a percentage of revenue, increased from 59% to 67%.
The overall increase was due mainly to additional personnel, the amortization of
the deferred compensation expense, additional rent on the Company's expanded
office space, and increased legal costs.
The Company has set up a provision of $381,254 for the remaining lease payments
on the lease on the San Diego premises. As at December 1, 2000, the Company has
discontinued lease payments due to a number of circumstances. To date, the
landlord has not commenced legal action against the Company. Should the
landlord commence legal action against the Company, the outcome of the
proceedings is unknown. In the event of a favourable outcome, a gain will be
recognized.
Write-Off of Advance
In 2000, the Company made an unsuccessful attempt to acquire American Digital
Network ("ADN"), a company involved in the web hosting, ISP, and Internet
services industry. As part of the planned acquisition, NetNation advanced ADN
$500,000 and received as security the intellectual property rights to the
eStoreManager software. The acquisition was terminated and NetNation has not
been able to recover its advanced funds and has taken possession of the
eStoreManager software. If ADN is unable to repay the advances, NetNation will
retain the full rights to the eStoreManager software. To date, ADN has not
exercised its option to repurchase the software. As the Company does not expect
to recover the amounts advanced to ADN, nor does it expect to make commercial
use of the intellectual property rights acquired, the Company has decided to
write-off the amount advanced to ADN.
33
LIQUIDITY AND CAPITAL RESOURCES
During 2001, operating activities generated net cash of $1,155,973 compared to
net cash used in operations of $623,555 and $604,773 for 2000 and 1999,
respectively. The main reason for the increase in cash from operations was the
earnings from operations generated in 2001 compared to the losses from
operations incurred in 2000 and 1999.
Investing activities for 2001 used net cash of $235,258 compared to $2,014,787
and $435,922 in 2000 and 1999, respectively. In 2000 and 1999 there were
significant investments in the network operations center. Similar costs may be
incurred in the future for expanding the network operations center when
appropriate.
Financing activities generated net cash of $9,490 in 2001 compared to $2,399,010
and $1,982,909 in 2000 and 1999, respectively. In 2000, $2,348,942 was raised
from the net proceeds of a private placement of common stock. In 1999,
$1,100,000 was raised from the net proceeds of a debenture issue and $900,000
was raised from the net proceeds of a private placement of common stock.
As at December 31, 2001, the Company has cash and cash equivalents of $1,678,950
compared to $748,745 as at December 31, 2000 and $988,077 as at December 31,
1999. The increase reflects positive cash flows from operations for 2001 less
the investment in fixed assets. Based on management's current projections, the
Company believes that it has adequate resources for continued very moderate
growth in revenues for the foreseeable future. The Company's management may
evaluate from time to time the availability of external financing. The Company
may seek additional capital to accelerate growth but there is no guarantee that
capital will be available at acceptable terms or at all. While there are no
commitments, management may make capital expenditures from time to time as the
operations demand.
34
OUTLOOK: ISSUES AND UNCERTAINTIES
Refer to "Risk Factors Affecting Future Operating Results" in this Form 10-K.
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
- --------------------------------------------------------------------------
NetNation believes its exposure to overall foreign currency risk is immaterial.
Most of its revenues are collected in US dollars and most of its expenses are
paid in Canadian dollars. Except for a small portion of funds deposited in
Canadian dollar accounts, all other funds are held in US dollars.
NetNation does not manage or maintain market risk sensitive instruments for
trading or other purposes and is, therefore, not subject to multiple foreign
exchange rate exposures. As disclosed in Item 7, on February 24, 2000, the
holders of the convertible debentures exercised their option and converted all
of the debentures into common shares. After giving effect to this conversion,
the Company has no outstanding long-term indebtedness for which the Company is
subject to the risk of interest rate fluctuations.
NetNation reports its operations in US dollars and its currency exposure,
although considered by NetNation as immaterial, is primarily between the US and
Canadian dollars. Exposure to the currencies of other countries is also
immaterial as most international transactions are settled in US dollars. Any
future financing undertaken by NetNation will most likely be denominated in US
dollars. As NetNation increases its marketing efforts, the related expenses are
normally in US dollars except for the marketing efforts in Canada. If these
advertisements are coordinated through a US agency, then the expenses are in US
dollars.
35
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ---------------------------------------------------------
The Consolidated Financial Statements of NetNation Communications Inc.,
including the Report of Independent Auditors, are set forth beginning on page
F-1.
UNAUDITED QUARTERLY FINANCIAL INFORMATION
The following table sets forth selected unaudited quarterly information for the
Company's last eight fiscal quarters:
================================================================================
Fiscal 2001 Quarter End
---------------------------------------------------
March 31 June 30 September 30 December 31
---------------------------------------------------
Sales 1,574,786 1,615,550 1,691,773 1,764,324
Gross profit 1,070,468 1,096,054 1,142,839 1,257,370
Net earnings for the period 18,060 14,596 209,997 515,264
Net earnings per share 0.00 0.00 0.01 0.03
================================================================================
Fiscal 2000 Quarter End
---------------------------------------------------
March 31 June 30 September 30 December 31
---------------------------------------------------
Sales 991,515 1,249,710 1,369,050 1,401,584
Gross profit 590,823 750,596 880,241 977,943
Net loss for the period (582,302) (635,191) (1,067,571) (1,686,533)
Net loss per share (0.04) (0.04) (0.07) (0.11)
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- --------------------------------------------------------------------------------
FINANCIAL DISCLOSURE
- ---------------------
No changes in and disagreements with accountants are reportable pursuant to this
item.
36
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -------------------------------------------------------------------
IDENTIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS
The following table contains information regarding the members of the Board of
Directors and the Executive Officers of the Company:
Name Age Position(s)
- --------------- --- ---------------------------------
David Talmor 44 Chairman, President and Director
- --------------- --- ---------------------------------
Joseph Kibur 29 CEO and Director
- --------------- --- ---------------------------------
Ernest Cheung 51 Director
- --------------- --- ---------------------------------
Anil Wirasekara 45 Director
- --------------- --- ---------------------------------
Calvin Mah 39 CFO
- --------------- --- ---------------------------------
Jag Gillan 31 COO, Secretary and Director
- --------------- --- ---------------------------------
All of the officers identified above serve at the discretion of the Board and
have consented to act as officers of the Company. The biographies for the above
individuals are presented below:
DAVID TALMOR is Chairman of the Board and President of NetNation Communications,
Inc., Delaware, U.S.A. Mr. Talmor was Chief Executive Officer of the Company
until January 2000. Previously, he was appointed Chairman of the Board,
President, Chief Executive Officer and Secretary of NetNation Communications,
Inc., Delaware, U.S.A., in April 1999. From March 1997 to April 1999, Mr.
Talmor served as Director, Chief Executive Officer and President of the Canadian
subsidiary of NetNation Communications, Inc. Mr. Talmor has over 15 years of
business experience, both in Financial/Business roles (more recently), and in
Electronics Engineering roles (Israeli Air Force, Eldat and Moldat). From 1996
to 1997, he was President of Minerva Ventures Management, Richmond, British
Columbia, Canada, investigating suitable technological companies as investment
and acquisition candidates. From 1994 to 1995, he was Business Development
Manager of MacDonald Dettwiler & Associates Ltd., Richmond, British Columbia,
Canada, (www.mda.ca), a Canadian company in the field of satellites' ground
stations. Mr. Talmor qualified as a Certified Public Accountant (CPA) in Israel
with Kesselman & Kesselman, Chartered Accountants, the country's largest
accounting firm and associated with Coopers & Lybrand. Mr. Talmor received a BA
in Economics and Accounting, a B.Sc. in Statistics and an MBA, all from Tel-Aviv
University in 1985, 1985 and 1988 respectively. In addition, Mr. Talmor
received an Electronics Diploma from both "The Technological Institute of
Tel-Aviv" in 1976 and from "The Israeli Air-Force", IDF in 1978.
JOSEPH KIBUR was appointed Chief Executive Officer of NetNation Communications,
Inc., Delaware, U.S.A. in September 2000. He was appointed a Director and Chief
Operating Officer of NetNation Communications, Inc., Delaware, U.S.A., in April
1999. From March 1997 to April 1999, he served as Director, Chief Operating
Officer and Secretary of the Canadian Subsidiary of NetNation Communications,
Inc. From 1995 to 1997 Mr. Kibur operated his own Internet consulting business
(Superhighway Consulting, Vancouver, British Columbia, Canada) until he
co-founded the Canadian Subsidiary of NetNation Communications, Inc. with Mr.
David Talmor. Prior, Mr. Kibur attended Simon Fraser University, Burnaby,
British Columbia, Canada, and in 1996 obtained his Bachelor of Science (B.Sc.)
degree in Management and Systems Science (Computer Science, Business and
Mathematics).
ERNEST CHEUNG has served as Director of NetNation Communications, Inc.,
Delaware, since February 1999. Mr. Cheung received an MBA in Finance and
Marketing from Queen's University, in Kingston, Ontario in 1975, and obtained
a Bachelors Degree in Math in 1973 from University of Waterloo, Ontario.
From 1984 to 1991 he was Vice President and Director, Capital Group Securities,
Ltd. in Toronto, Canada.
37
From 1991 to 1993 he was Vice President of Midland Walwyn Capital, Inc. of
Toronto, Canada. From 1993 to 1994 he was Vice Chairman, Tele Pacific
International Communications Corp. of Vancouver, B.C. He has served or served as
a director of the following companies:
Name of Issuer Symbol Market Position From To
- -------------------------------- ------ ----------------- ---------- ------ -------
Agro International Holdings Inc. AOH CDNX President Jan-97 Current
China NetTV Holdings Inc.* CNHD OTCBB President May-00 Current
Drucker, Inc.*. DKIN OTCBB Secretary Apr-97 Current
ITI World Investment Group Inc. IWI.A CDNX Jun-98 Current
NetNation Communications Inc. NNCI Nasdaq Small Cap. Apr-99 Current
Pacific E-Link Corp. PLC CDNX Sep-92 Jun-95
Richco Investors Inc. YRU.A CDNX President May-95 Current
Spur Ventures Inc. SVU CDNX Mar-97 Current
Xin Net Corp.* XNET OTCBB Secretary Mar-97 Current
- ----------------
* Reporting Companies in US
ANIL WIRASEKARA has served as Director of NetNation Communications, Inc.,
Delaware, since October 1999. In 1992, Mr. Wirasekara joined MacDonald
Dettwiler and Associates Ltd., one of Canada's largest space technology and
information systems companies and a world leader in satellite mapping and
spatial information services, as the Manager of Operations Accounting and
Information, and in 1995 was appointed Chief Financial Officer. From 1988 to
1991, he was Controller and Secretary of Rainex Limited, a Vancouver company
involved in project developments, technology transfers and international trade.
Mr. Wirasekara holds the designations of a Chartered Accountant and Certified
Management Accountant. Mr. Wirasekara is also a member of the Chartered
Institute of Management Accountants of the U.K., the Chartered Institute of
Marketing and Management of the U.K. and the Institute of Chartered Accountants
of Sri Lanka.
CALVIN MAH was appointed Chief Financial Officer of NetNation Communications,
Inc. in February 2001. Prior to joining NetNation, from 1996 to 2000, Mr. Mah
was CFO of Simba Technologies Inc., a privately-held, venture-backed software
development company. In 1995-96, Mr. Mah was Senior Financial Analyst for
Pacific Forest Products Ltd., a $400 million publicly-traded logging and
sawmilling company with 1,100 employees. In 1993-95, Mr. Mah was Controller of
Brookdale International Systems Inc., a privately-held developer and
manufacturer of emergency respiratory devices for industrial and consumer use.
From 1989 to 1993, Mr. Mah was Manager of Corporate Finance for Granges Inc., a
$60 million publicly-traded gold, silver, copper and zinc mining company with
operations in the U.S. and Canada. Mr. Mah is professionally qualified as a
Chartered Accountant. He graduated with a Bachelor of Commerce in Accounting
and Management Information Systems (Honours) from the University of British
Columbia in 1985.
JAG GILLAN has served as Director of NetNation Communications, Inc., Delaware,
since September 2000. Mr. Gillan was appointed Chief Operating Officer of
NetNation Communications Inc. in September 2001. Prior to his appointment as
COO, Mr Gillan served, and continues to serve, as General Counsel of NetNation
Communications, Inc. from June 1999. During May 1997 to May 1999, Mr. Gillan
practiced law with Baker Newby, Vancouver, Canada. Mr. Gillan was COO of
Millstream Flour Mills Corp., a privately-held wholesale food products producer,
from 1992 to 1994. Mr. Gillan attended the Edinburgh Business School,
Heriot-Watt University Edinburgh, United Kingdom and will graduate with a
Masters of Business Administration in 2002. Mr. Gillan attended Osgoode Hall
Law School, York University, Toronto, Canada and graduated with a Bachelor of
Laws in 1997. He received his Bachelor of Arts in Economics, with Distinction,
in 1993 from the University of Victoria in Canada.
Relationships Among Directors or Executive Officers
There are no family relationships among any of the directors or executive
officers of the Company.
38
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the
Company's Directors, executive officers and persons who own more than 10% of a
registered class of the Company's securities to file with the SEC initial
reports of ownership and reports of changes in ownership of common stock and
other equity securities of the Company. Directors, executive officers and
greater-than-10% stockholders are required by SEC regulation to furnish the
Company with copies of all Section 16(a) reports they file.
To the Company's knowledge, based solely on a review of the copies of such
reports furnished to the Company and written representations that no other
reports were required, the Company believes that during the year ended December
31, 2001, its Directors, Executive Officers and greater-than-10% stockholders
complied with all Section 16(a) filing requirements.
ITEM 11: EXECUTIVE COMPENSATION
- ----------------------------------
SUMMARY COMPENSATION TABLE
The following table discloses all plan and non-plan compensation awarded to,
earned by, or paid to the Chief Executive Officer ("CEO") or individual acting
in a similar capacity, and the four most highly compensated executive officers
for the year ended December 31, 2001. The table includes executive compensation
paid to the principals of the Canadian Subsidiary prior to it being acquired by
the Company.
Annual Compensation Long Term Compensation
------------------------------------------ -------------------------------------
Awards Payouts
----------- -----------
Restricted
Shares
Or Securities
Restricted Under
Name Other Share Options/
and Annual Units SARs LTIP
Principal Salary Compensation ($) Granted Payouts
Position Year (USD$) Bonus ($) ($) (f) (#) ($)
(a) (b) (c) (d) (e) (g) (h)
- ----------- ------ -------- --------- ------------- ----------- ----------- -----------
David
Talmor, 2001 96,688
Chairman, ------ -------- --------- ------------- ----------- ----------- -----------
President, 2000 105,348 - - - - -
and ------ -------- --------- ------------- ----------- ----------- -----------
Director 1999* 109,029 - - - - -
- ----------- ------ -------- --------- ------------- ----------- ----------- -----------
- ----------------
* As the acquisition of the Canadian Subsidiary by the Company occurred on
April 7, 1999, the Principal Position and compensation prior to this relate
to payments made by the Canadian Subsidiary and not the Company. Payments
of $36,000 were made by the Canadian Subsidiary to David Talmor with the
remainder of the compensation for 1999 being paid by the Company.
OPTION/SAR GRANTS OR EXERCISES AND LONG TERM INCENTIVE PLAN
There were no stock option grants, stock appreciation rights (SAR's) grants,
option/SAR exercises or long term incentive plans (LTIP's) awarded to the named
executive officers in the last three financial years.
39
DEFINED BENEFIT OR ACTUARIAL PLAN
The Company does not have a defined benefit or actuarial plan in place.
COMPENSATION OF DIRECTORS
Directors are not compensated for their service as directors other than with
stock options. All directors are reimbursed for any reasonable expenses
incurred in the course of fulfilling their duties as a director of the Company.
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND
CHANGE-IN-CONTROL ARRANGEMENTS
There are currently no employment contracts in place with the executive officers
of the Company other than the standard employment agreements used for all
employees. The Company intends to review its contracts with certain key
individuals, including the rights and obligations of the Company upon the
resignation of an officer, or upon a change in control of the Company.
Compensation Committee Interlocks and Insider Participation
The members of the Compensation Committee are Mr. Cheung and Mr. Wirasekara.
All of the members of the committees are directors of the Company.
Board Compensation Committee Report on Executive Compensation
The Board Compensation Committee was formed March 2000. The board has not
prepared a report on executive compensation at this time. As at March 12, 2002,
no policies have been defined with respect to compensation for executive
officers by the committee.
2000 STOCK OPTION PLAN
For a summary of the terms of NetNation's 2000 Stock Option Plan, see Note 7 to
the Company's audited consolidated financial statements contained in this Annual
Report on Form 10-K and incorporated herein by this reference.
40
PERFORMANCE GRAPH
The following graph compares the cumulative total stockholder return on the
Company's common stock with the cumulative total return on The Nasdaq Composite
Index and The Nasdaq Telecommunications Index. These two indices have been
chosen for their relevance in assessing the performance of the Company against
that of companies in the same or similar lines of business. The period
displayed commences on September 30, 1999, being the end of the month date that
the Company's common stock became registered under Section 12 of the Securities
Exchange Act of 1934, as amended. The graph assumes an investment of $100 on
September 30, 1999, and the reinvestment of any dividends.
[GRAPHIC OMITTED]
41
- ---------------------------------------------------------
NetNation Nasdaq Nasdaq
Communications Composite Telecom
Inc. Index Index
- ---------------------------------------------------------
September 30, 1999 $ 100.00 $ 100.00 $ 100.00
October 31, 1999 $ 103.13 $ 108.02 $ 118.69
November 30, 1999 $ 109.38 $ 121.48 $ 131.39
December 31, 1999 $ 115.63 $ 148.18 $ 162.52
January 31, 2000 $ 231.25 $ 143.49 $ 158.04
February 28, 2000 $ 294.53 $ 171.03 $ 182.64
March 31, 2000 $ 299.61 $ 166.52 $ 176.38
April 30, 2000 $ 181.25 $ 140.58 $ 142.53
May 31, 2000 $ 121.88 $ 123.84 $ 120.81
June 30, 2000 $ 110.94 $ 144.42 $ 139.36
July 31, 2000 $ 128.13 $ 137.17 $ 128.26
August 31, 2000 $ 100.00 $ 153.17 $ 133.09
September 30, 2000 $ 96.88 $ 133.74 $ 116.83
October 31, 2000 $ 75.78 $ 122.70 $ 99.89
November 30, 2000 $ 71.88 $ 94.60 $ 74.16
December 31, 2000 $ 75.00 $ 89.96 $ 74.18
January 31, 2001 $ 87.50 $ 100.97 $ 88.96
February 28, 2001 $ 85.94 $ 78.36 $ 63.14
March 31, 2001 $ 86.72 $ 67.01 $ 52.51
April 30, 2001 $ 65.00 $ 77.06 $ 56.71
May 31, 2001 $ 68.75 $ 76.85 $ 54.06
June 30, 2001 $ 63.75 $ 78.67 $ 49.81
July 31, 2001 $ 53.50 $ 73.82 $ 44.87
August 31, 2001 $ 42.25 $ 65.74 $ 38.53
September 30, 2001 $ 56.75 $ 54.58 $ 32.51
October 31, 2001 $ 65.00 $ 61.55 $ 33.84
November 30, 2001 $ 67.50 $ 70.30 $ 38.59
December 31, 2001 $ 75.00 $ 71.02 $ 37.87
42
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- --------------------------------------------------------------------------------
The following table sets forth certain information regarding the beneficial
ownership of the common stock as of March 12, 2002 by:
(i) each person or entity known by the Company to beneficially own more
than 5% of the common stock;
(ii) each Director of the Company;
(iii) each of the named Executive Officers of the Company; and
(iv) all Directors and executive officers as a group.
Except as noted below, the Company believes that the beneficial owners of the
common stock listed below, based on information furnished by such owners, have
sole voting and investment power with respect to such shares.
Name and Address Amount of Beneficial Percent of
Title of Class Of Beneficial Owner Ownership Class(2)
- -------------- ---------------------------------------- -------------------- ----------
Common David Talmor(3) 3,969,224(1) 26.1%
Chairman, President, and Director
- -------------- ---------------------------------------- -------------------- ----------
Common Joseph Kibur(3) 4,092,000 26.9%
CEO and Director
- -------------- ---------------------------------------- -------------------- ----------
Common Ernest Cheung 12,000(4) 0.1%
Director
830-789 West Pender Street,
Vancouver, British Columbia, V6C 1H2
- -------------- ---------------------------------------- -------------------- ----------
Common Jag Gillan(3) 43,000(4) 0.3%
COO, Secretary and Director
- -------------- ---------------------------------------- -------------------- ----------
Common Calvin Mah(3) 12,000(4) 0.1%
CFO
- -------------- ---------------------------------------- -------------------- ----------
Common Anil Wirasekara 12,000(4) 0.1%
Director
13800 Commerce Parkway, Richmond,
British Columbia, V6V 2J3
- -------------- ---------------------------------------- -------------------- ----------
Common All Executive Officers and Directors as 8,140,224 53.3%
a Group (6 persons)
- -------------- ---------------------------------------- -------------------- ----------
- ----------------
1 2,160,000 common shares beneficially held by David Talmor are registered in the name of Shelley
Talmor, wife.
2 Based on a total issued and outstanding share capital as at March 12, 2002 of 15,218,002
common shares.
3 The business address for the individuals indicated above is : 1410 - 555 West Hastings Street,
Vancouver, British Columbia, Canada, V6B 4N6.
4 Includes 12,000 exercisable options.
CHANGES IN CONTROL
There are no arrangements known to the Company, the operation of which may
result in a change of control of the Company.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------------------------------------------------------------
No transactions with management or other parties occurred during the year that
would otherwise be reported under this section.
43
PART IV
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------------
1) FINANCIAL STATEMENTS
The following consolidated financial statements of the Company and the notes
thereto, the related reports thereon of the independent certified public
accountants, and financial statement schedules, are filed pursuant to Item 8 of
this Report:
Description Page
- ----------- ----
Independent Auditors' Report dated March 4, 2002 F-1
Consolidated Balance Sheets as of December 31, 2001 and 2000 F-2
Consolidated Statements of Operations for the years ended December 31, 2001, 2000 and 1999 F-3
Consolidated Statement of Stockholders' Equity (Deficiency) for the years ended December 31, F-4
2001, 2000, and 1999
Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000, and 1999 F-5
Notes to Consolidated Financial Statements F-6
2) REPORTS ON FORM 8-K
On October 11, 2001, NetNation filed a Form 8K and reported an Item 5 Other
Event. On October 29, 2001, NetNation filed a Form 8K and reported an Item 5
Other Event. On December 11, 2001, NetNation filed a Form 8K and reported an
Item 5 Other Event.
3) LIST OF EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
2.1 ** Agreement dated March 31, 1999 between the shareholders of NetNation (The Canadian
Subsidiary), NetNation (The Canadian Subsidiary), and NetNation (formerly Collectibles
Entertainment Inc.)
3.1 ** Articles of Incorporation
3.2 ** By-laws
4.1 ** Convertible Debenture for $550,000 Maturing on September 30, 2000 issued to Polaris
Investitionen Ltd.
4.2 ** Convertible Debenture for $550,000 Maturing on September 30, 2000 issued to Beste
Investitionen Ltd.
4.3 Specimen share certificate
10.1 Registrar Accreditation Agreement between the Internet Corporation for Assigned Names
and Numbers and DomainPeople, Inc.
10.2 Harbour Centre Office Lease
10.3 NetNation Communications, Inc.'s 2000 Stock Option Plan*
21.1 List of Subsidiaries
* Incorporated by reference from the Definitive Proxy Statement filed with the
Securities and Exchange Commission on May 8, 2000.
** Incorporated by reference from the Registration Statement on Form 10
of the Registrant filed with the Securities and Exchange Commission on
July 29, 1999, as amended.
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NETNATION COMMUNICATIONS INC.
By: /s/ Joseph Kibur
------------------
Name: Joseph Kibur
Title: Chief Executive Officer
Dated: March 19, 2002.
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
By: /s/ David Talmor President and Chairman of the Board and March 19, 2002
-------------------
Name: David Talmor Director
By: /s/ Joseph Kibur Chief Executive Officer and Director March 19, 2002
-------------------
Name: Joseph Kibur (Principal Executive Officer)
By: /s/ Jag Gillan Chief Operating Officer and Secretary and March 19, 2002
-------------------
Name: Jag Gillan Director
By: /s/Anil Wirasekara Director March 19, 2002
-------------------
Name: Anil Wirasekara
By: /s/ Ernest Cheung Director March 19, 2002
-------------------
Name: Ernest Cheung
By: /s/ Calvin Mah Chief Financial Officer March 19, 2002
-------------------
Name: Calvin Mah (Principal Accounting Officer)
45
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Description Page
- ----------- ----
Independent Auditors' Report dated March 4, 2002 F-1
Consolidated Balance Sheets as of December 31, 2001 and 2000 F-2
Consolidated Statements of Operations for the years ended December 31, 2001, 2000, and 1999 F-3
Consolidated Statement of Stockholders' Equity (Deficiency) for the years ended December 31, F-4
2001, 2000, and 1999
Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000, and 1999 F-5
Notes to Consolidated Financial Statements F-6
46
AUDITORS' REPORT TO THE STOCKHOLDERS
We have audited the consolidated balance sheets of NetNation Communications Inc.
as at December 31, 2001 and 2000, and the consolidated statements of operations,
stockholders' equity (deficiency) and cash flows for each of the years in the
three year period ended December 31, 2001. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as at
December 31, 2001 and 2000, and the results of its operations and its cash flows
for each of the years in the three year period ended December 31, 2001 in
accordance with accounting principles generally accepted in the United States of
America.
KPMG LLP
Chartered Accountants
Vancouver, Canada
March 4, 2002
F-1
NETNATION COMMUNICATIONS INC.
Consolidated Balance Sheets
(Expressed in United States dollars)
December 31, 2001 and 2000
==========================================================================================
2001 2000
- ------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents $ 1,678,950 $ 748,745
Accounts receivable 107,208 33,208
Prepaid expenses and deposits 245,733 131,879
Deferred expenses 557,941 541,000
Deferred tax asset (note 9) 250,000 -
----------------------------------------------------------------------------------------
2,839,832 1,454,832
Deferred expenses 135,734 125,044
Fixed assets (note 4) 1,050,862 1,450,952
Investments (note 5) 100,000 100,000
- ------------------------------------------------------------------------------------------
$ 4,126,428 $ 3,130,828
==========================================================================================
Liabilities and Stockholders' Equity (Deficiency)
Current liabilities:
Accounts payable and accrued liabilities $ 235,880 $ 593,518
Contingent lease payments (note 12(a)) 381,254 381,254
Customer deposits 83,335 64,517
Deferred revenue 1,934,936 1,901,042
Capital lease liability (note 8) 19,183 13,867
----------------------------------------------------------------------------------------
2,654,588 2,954,198
Deferred revenue 455,228 301,287
Capital lease liability (note 8) 24,652 37,698
Stockholders' equity (deficiency):
Share capital (note 7):
Authorized: 50,000,000 common shares with a par value of
$0.0001 each
Issued: 15,245,321 common shares (2000 - 15,315,321) 1,525 1,532
Additional paid-in capital (note 7(b)) 5,988,123 5,970,896
Deferred stock-based compensation (note 7(b)) (287,554) (666,732)
Accumulated other comprehensive income 14,601 14,601
Deficit (4,724,735) (5,482,652)
----------------------------------------------------------------------------------------
991,960 (162,355)
- ------------------------------------------------------------------------------------------
$ 4,126,428 $ 3,130,828
==========================================================================================
Commitment (note 8)
Contingencies (note 12)
See accompanying notes to consolidated financial statements.
Approved on behalf of the Board:
/s/ Joseph Kibur Director /s/ David Talmor Director
- ----------------------- ----------------------
F-2
NETNATION COMMUNICATIONS INC.
Consolidated Statements of Operations
(Expressed in United States dollars)
========================================================================================
Years ended December 31,
-----------------------------------------
2001 2000 1999
- ----------------------------------------------------------------------------------------
Sales $ 6,646,433 $ 5,011,859 $ 2,511,021
Cost of sales 2,079,702 1,812,256 711,956
- ----------------------------------------------------------------------------------------
Gross profit 4,566,731 3,199,603 1,799,065
Expenses:
Sales and marketing 1,388,643 2,977,927 1,575,699
General and administration 2,037,689 3,352,296 1,472,687
Write-off of advance (note 3) - 500,000 -
Depreciation and amortization 632,482 340,977 95,445
- ----------------------------------------------------------------------------------------
4,058,814 7,171,200 3,143,831
- ----------------------------------------------------------------------------------------
Net earnings (loss) before income taxes 507,917 (3,971,597) (1,344,766)
Deferred income tax recovery 250,000 - -
- ----------------------------------------------------------------------------------------
Net earnings (loss) for the year $ 757,917 $(3,971,597) $ (1,344,766)
========================================================================================
Earnings (loss) per share, basic and diluted $ 0.05 $ (0.26) $ (0.10)
========================================================================================
Weighted average shares used in comparing
loss per share, basic 15,246,145 15,316,804 13,164,836
Weighted average shares used in comparing
loss per share, diluted 15,306,107 15,316,804 13,164,836
========================================================================================
See accompanying notes to consolidated financial statements.
F-3
NETNATION COMMUNICATIONS INC.
Consolidated Statement of Stockholders' Equity (Deficiency)
(Expressed in United States dollars)
=================================================================================================================================
Deferred Accumulated
Additional stock- other
paid-in based comprehensive
Shares Amount capital compensation income Deficit Total
$ $ $ $ $ $
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 1,097,000 110 29,590 - 14,601 (166,289) (121,988)
Issuance of common stock for
cash 4,000,000 400 39,600 - - - 40,000
Common stock cancelled in
conjunctionwith the
recapitalization (1,000,000) - - - - - -
Adjustment in accordance with
recapitalization accounting
principles - (100) (62,864) - - - (62,964)
Common stock issued to effect
the recapitalization 10,000,000 1,000 25,672 - - - 26,672
Issuance of common stock for
cash 450,000 45 899,955 - - - 900,000
Issuance of common stock for
Services provided to the
Company 60,000 6 266,394 - - - 266,400
Deferred stock-based compensation - - 1,141,124 (1,141,124) - - -
Amortization of deferred stock-
based compensation - - - 125,658 - - 125,658
Loss for the year - - - - - (1,344,766) (1,344,766)
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 14,607,000 1,461 2,339,471 (1,015,466) 14,601 (1,511,055) (170,988)
Conversion of debentures to
Common stock 550,000 55 1,099,945 - - - 1,100,000
Cash proceeds from private
placement of common stock,
net of offering costs 250,000 25 2,348,437 - - - 2,348,462
Deferred stock-based compensation - - (12,829) 12,829 - - -
Amortization of deferred stock-
based compensation - - - 432,785 - - 432,785
Issuance of common stock
to settle share issue costs 5,000 1 49,999 - - - 50,000
Issuance of common stock
for cash 48,000 4 97,356 (96,880) - - 480
Common shares to be issued 5,000 1 49,999 - - - 50,000
Cancellation of common stock (149,679) (15) (1,482) - - - (1,497)
Loss for the year - - - - - (3,971,597) (3,971,597)
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 15,315,321 1,532 5,970,896 (666,732) 14,601 (5,482,652) (162,355)
Amortization of deferred stock-
based compensation - - - 379,178 - - 379,178
Issuance of common stock
for cash 8,000 1 17,999 - - - 18,000
Cancellation of common stock (78,000) (8) (772) - - - (780)
Net earnings for the year - - - - - 757,917 757,917
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 15,245,321 1,525 5,988,123 (287,554) 14,601 (4,724,735) 991,960
=================================================================================================================================
See accompanying notes to consolidated financial statements.
F-4
NETNATION COMMUNICATIONS INC.
Consolidated Statements of Cash Flows
(Expressed in United States dollars)
==================================================================================================
Years ended December 31,
-----------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------------------------
Cash provided by (used in):
Net earnings (loss) for the year $ 757,917 $(3,971,597) $ (1,344,766)
Items not involving cash:
Depreciation and amortization 632,482 340,977 95,445
Deferred income tax recovery (250,000) - -
Value assigned to shares issued for services - - 266,400
Value assigned to shares issued in settlement
of share issue costs - 50,000 -
Value assigned to shares to be issued for
settlement of share issue costs - 50,000 -
Employee stock-based compensation 379,178 432,785 125,658
Loss on disposal of fixed assets 2,867 78,777 -
Write-off of advance (note 3) - 500,000 -
Changes in non-cash operating working capital:
Accounts receivable (74,000) (22,247) 1,674
Prepaid expenses and deposits (113,854) (68,671) (59,789)
Deferred expenses (27,631) (666,044) -
Accounts payable and accrued liabilities (357,639) 404,372 91,346
Contingent lease payments - 381,254 -
Customer deposits 18,818 64,517 -
Deferred revenue 187,835 1,802,322 219,259
------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 1,155,973 (623,555) (604,773)
Investments:
Advance to ADN (note 3) - (500,000) -
Purchase of fixed assets (238,978) (1,414,787) (435,922)
Purchase of investments - (100,000) -
Proceeds on disposal of fixed assets 3,720 - -
------------------------------------------------------------------------------------------------
Net cash used in investing activities (235,258) (2,014,787) (435,922)
Financing:
Redemption of capital - - (49,302)
Issue of debentures - - 1,100,000
Lease financing (7,730) 51,565 -
Issue of share capital, net of share issue costs 18,000 2,348,942 932,211
Repurchase and cancellation of shares (780) (1,497) -
------------------------------------------------------------------------------------------------
Net cash provided by financing activities 9,490 2,399,010 1,982,909
- --------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 930,205 (239,332) 942,214
Cash and cash equivalents, beginning of year 748,745 988,077 45,863
- --------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $1,678,950 $ 748,745 $ 988,077
==================================================================================================
Supplementary information:
Cash paid for:
Interest $ 6,830 $ 2,350 $ -
Income taxes - - 959
Non-cash transactions:
Shares issued to third parties for services - 100,000 266,400
Conversion of debentures to common stock - 1,100,000 -
Shares issued to employees for services - - 1,141,124
==================================================================================================
See accompanying notes to consolidated financial statements.
F-5
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2001, 2000 and 1999
================================================================================
1. DESCRIPTION OF BUSINESS:
NetNation Communications Inc. (the "Company") was incorporated on May 7,
1998 under the laws of the State of Delaware as Collectibles Entertainment
Inc. ("Collectibles").
On April 7, 1999, Collectibles acquired all of the outstanding common
shares of NetNation Communications Inc. ("NetNation Canada"). After the
transaction, the former shareholders of NetNation Canada controlled
Collectibles. As Collectibles was inactive at the time of the transaction,
this issuance was accounted for as a capital transaction of NetNation
Canada, effectively as if NetNation Canada issued common shares to acquire
the net monetary assets of Collectibles followed by a recapitalization.
Results for the year ended December 31, 1999 reflect the operations of
NetNation Canada for the entire year consolidated with those of
Collectibles from April 7, 1999. Subsequent to the transaction,
Collectibles changed its name to NetNation Communications Inc.
On November 24, 1999, DomainPeople Inc. ("DomainPeople"), a wholly-owned
subsidiary of NetNation, was incorporated under the laws of the State of
Delaware and was formed to offer domain name registration and related
services. DomainPeople is accredited by the Internet Corporation for
Assigned Names and Numbers, the regulatory body charged with administering
accreditation, as a registrar for top-level domain names.
The Company's principal business activities are the provision of web site
hosting, domain name registration, and related services to small and medium
sized businesses.
2. SIGNIFICANT ACCOUNTING POLICIES:
(a) Basis of presentation:
These consolidated financial statements include the accounts of the
Company's wholly owned subsidiaries, NetNation Communications Inc.,
NetNation Communications (UK) Inc., NetNation Communications (USA)
Inc., and DomainPeople Inc. All material intercompany balances and
transactions have been eliminated.
These consolidated financial statements have been prepared in
accordance with generally accepted accounting principles in the United
States of America.
(b) Cash and cash equivalents:
Cash and cash equivalents include highly liquid investments, such as
term deposits, having terms to maturity of three months or less when
acquired that are readily convertible to contracted amounts of cash.
F-6
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2001, 2000 and 1999
================================================================================
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(c) Fixed assets:
Fixed assets are stated at cost less accumulated depreciation.
Depreciation is computed annually as follows:
==================================================
Assets Basis Rate
--------------------------------------------------
Computer hardware straight-line 3 years
Computer software straight-line 3 years
Furniture straight-line 5 years
Office equipment straight-line 4 years
Leasehold improvements straight-line lease term
==================================================
The Company changed its amortization policy with respect to computer
hardware, computer software, furniture, and office equipment to the
straight-line method for fiscal year ended December 31, 2001.
Previously, these fixed assets were depreciated on a declining-balance
basis at 30%, 30%, 20%, and 30%, respectively per annum. The adoption
of this policy effective January 1, 2001 did not have a material
effect on the Company's financial position or results of operations.
The Company performs reviews for the impairment of fixed assets
whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. An impairment loss is
recognized when estimates of undiscounted future cash flows expected
to result from the use of an asset and its eventual disposition are
less than its carrying amount. When such a difference arises, the
impairment loss is calculated as the excess of the carrying value over
the asset's fair value. No such impairment losses have been identified
by the Company for the years ended December 31, 2001, 2000 and 1999.
(d) Investments:
The Company has an investment in a non-publicly traded company in
which it has a 2% interest (note 5) and in which it does not exercise
significant influence. This investment is carried at cost. The Company
monitors this investment for impairment, and recognizes an impairment
loss if the decline in value below its carrying value is determined to
be other than temporary.
(e) Advertising costs:
Advertising costs are expensed as incurred and totaled $509,685,
$1,750,415 and $1,271,350 during the years ended December 31, 2001,
2000 and 1999, respectively.
F-7
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2001, 2000 and 1999
================================================================================
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(f) Revenue recognition:
Revenue is recognized as web site hosting, domain name and related
services are provided. Revenue from web site hosting set-up fees is
recognized over the estimated period the hosting services are provided
to customers, which typically ranges from 1 to 2 years. Domain name
registration and maintenance revenue is recognized ratably over the
contract term which is between one and ten years. Cash received in
advance of meeting these revenue recognition criteria is recorded as
deferred revenue.
In December 1999, the SEC issued Staff Accounting Bulletin No. 101
"Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 and
related material indicates that the fair value of initial set-up fees
should be recognized over the estimated period of service. The
Company's contracts generally include such fees. The Company has
determined the impact of SAB 101 and the resulting cumulative
adjustment of $597,950 has been recorded in the Company's financial
statements in 2000. Substantially all of this adjustment has been
recognized as revenue by the Company in 2001.
(g) Deferred expenses:
The cost of acquiring domain names is deferred and amortized in
conjunction with the recognition of domain name registration and
maintenance revenue.
(h) Stock-based compensation:
The Company applies the intrinsic value-based method of accounting
prescribed by Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees," and related
interpretations, in accounting for awards of common stock granted to
employees and directors. Deferred stock-based compensation is recorded
at the measurement date, which is generally the date of grant, when
the market value of the underlying common stock exceeds the exercise
price for stock options or the purchase price for the shares of common
stock. SFAS No. 123, "Accounting for Stock-Based Compensation,"
established accounting and disclosure requirements using a fair
value-based method of accounting for stock-based employee compensation
plans. As allowed by SFAS No. 123, the Company has elected to continue
to apply the intrinsic value-based method of accounting described
above, and has adopted the disclosure requirements of SFAS No. 123.
Non-employee options are accounted for under SFAS 123 and recognized
at the fair value of the options as determined by an option pricing
model as the related services are provided and the options earned.
(i) Fair value of financial instruments:
Carrying values of the Company's financial instruments, including cash
and cash equivalents, accounts receivable, accounts payable, capital
lease liability and accrued liabilities approximate fair value due to
their short terms to maturity.
F-8
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2001, 2000 and 1999
================================================================================
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(j) Use of estimates and assumptions:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities, and disclosure of contingent assets and liabilities, at
the date of the financial statements and the reported amounts of
revenue and expenses during the period then ended. Actual results may
differ from these estimates.
(k) Translation of foreign currencies:
The Company's functional and reporting currency is the United States
dollar. Transactions undertaken in a currency other than the United
States dollar are remeasured into United States dollars using exchange
rates at the date of the transaction. Monetary assets and liabilities
denominated in foreign currencies are remeasured at each balance sheet
date at the exchange rate prevailing at the balance sheet date. Gains
and losses arising on remeasurement or settlement of foreign currency
denominated transactions or balances are included in the determination
of income.
Monetary assets and liabilities of integrated subsidiaries are
translated into United States at the exchange rates in effect at the
balance sheet date and non-monetary items are translated at the
exchange rates in effect on transaction dates. Revenue and expense
items, except amortization, are translated at average exchange rates
for the period, and amortization is translated at the same exchange
rate as the asset to which it relates. Exchange gains and losses
resulting from the translation of foreign currency financial
statements of integrated subsidiaries are recognized in earnings.
(l) Income taxes:
The Company provides for income taxes under the asset and liability
method. Deferred tax liabilities and assets are recognized for the
estimated future tax consequences of differences between the financial
statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates in effect for the year in which
temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates
is recognized in income in the period that includes the enactment
date. To the extent that realization of deferred tax assets is not
considered to be more likely than not, a valuation allowance is
recognized.
(m) Comprehensive earnings (loss):
The Company reports comprehensive earnings (loss), which includes net
earnings as well as changes in equity from other non-owner sources,
specifically the foreign currency translation adjustment. For all
years presented, comprehensive earnings (loss) is the same as net
earnings (loss).
F-9
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2001, 2000 and 1999
================================================================================
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(n) Net earnings and loss per share:
Net earnings and loss per share is calculated in accordance with SFAS
No. 128, "Earnings per Share". Under SFAS No. 128, basic net earnings
or loss per share is computed by dividing net earnings (loss) by the
weighted-average number of outstanding shares of common stock,
excluding common stock subject to repurchase. Diluted net earnings or
loss per share is computed using the weighted-average number of
outstanding shares of common stock and, when dilutive, potential
common shares from options and warrants to purchase common stock and
common stock subject to repurchase using the treasury stock method,
and from convertible securities using the as-if converted basis.
(o) Recent accounting pronouncements:
The FASB issued SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities" which established standards relating to the
recognition and disclosure of all aspects of derivative instruments
and hedging activities. To date, the Company has not engaged in
hedging activities and the adoption of SFAS 133 did not have an impact
on its financial position, results of operations or cash flows.
(p) Comparative figures:
Certain comparative figures have been reclassified to conform with the
presentation adopted in the current year.
3. WRITE-OFF OF ADVANCE:
In 2000, the Company made an unsuccessful attempt to acquire American
Digital Network ("ADN"), a company involved in the web-hosting, ISP, and
internet services industry. As part of the planned acquisition, NetNation
advanced to ADN a total of $500,000, and received as security the
intellectual property rights to the eStoreManager software. The acquisition
was terminated and NetNation has not been able to recover its advanced
funds, and has taken possession of the eStoreManager software. If ADN is
unable to repay the advances, NetNation will retain the full rights to the
eStoreManager software. To date, ADN has not exercised its option to
repurchase the software.
As the Company does not expect to recover the amount advanced to ADN, nor
does it expect to make commercial use of the intellectual property rights
acquired, the Company has written off the amount advanced to ADN.
F-10
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2001, 2000 and 1999
====================================================================
4. FIXED ASSETS:
=============================================================
Accumulated Net book
2001 Cost depreciation value
-------------------------------------------------------------
Computer hardware $1,778,528 $ 928,877 $ 849,651
Computer software 113,918 49,787 64,131
Furniture 69,854 39,960 29,894
Office equipment 167,664 69,651 98,013
Leasehold improvements 13,897 4,724 9,173
-------------------------------------------------------------
$2,143,861 $ 1,092,999 $1,050,862
=============================================================
=============================================================
Accumulated Net book
2000 Cost depreciation value
-------------------------------------------------------------
Computer hardware $1,579,217 $ 397,240 $1,181,977
Computer software 93,694 12,903 80,791
Furniture 70,439 26,096 44,343
Office equipment 168,257 34,152 134,105
Leasehold improvements 10,736 1,000 9,736
-------------------------------------------------------------
$1,922,343 $ 471,391 $1,450,952
=============================================================
5. INVESTMENTS:
In 2000, the Company, through its wholly-owned subsidiary, DomainPeople,
Inc., made a 5% minority interest investment in Afilias, LLC ("Afilias"),
through the purchase of 100 Class A Units representing a 5% voting
interest. Afilias is a company formed for the purpose of bidding for,
developing, financing, marketing, owning and operating a registry to
register and maintain Internet top-level domain names and has obtained the
exclusive rights to register and maintain the new dot-info top-level domain
names. NetNation does not have significant influence over Afilias, and
therefore has accounted for the investment using the cost method. Since the
original investment in Afilias was made, DomainPeople's ownership
percentage has been diluted to 2% as at December 31, 2001 as it has not
made further investments. The carrying value of the investment at December
31, 2001 is $100,000.
6. DEBENTURES PAYABLE:
As a condition of a capital transaction, the Company raised $1,100,000
through the sale of two $550,000 Series A Convertible Debentures. Each
debenture was convertible into 275,000 shares of common stock of the
Company at a rate of $2.00 per share which was not less than the market
price of the Company's common stock on the arrangement date. The debentures
were non-interest bearing. On February 18, 2000, the holders of the
convertible debentures exercised their option to convert the debentures
into common shares of the Company.
F-11
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2001, 2000 and 1999
================================================================================
7. SHARE CAPITAL:
(a) Private placement:
On March 3, 2000, the Company finalized an agreement to issue 250,000
common shares at $10 per share for gross cash proceeds of $2,500,000.
The Company also issued warrants entitling the investors to purchase
one additional share for every two shares owned. The warrants are
exercisable during a two-year period at $12 per additional share
purchased.
(b) Stock option compensation plan:
On January 3, 2000, the Company's Board of Directors approved the
adoption of a stock option compensation plan. The plan provides for
the issuance of both incentive and non-qualified stock options, at the
Board of Directors' discretion, to key employees, directors and
consultants. The Company's policy is to grant options with a purchase
price equivalent to market value at the time of the grant. 2,000,000
shares have been reserved for issuance under the plan. Except where
noted below, the options vest over a three year period and expire 30
days after each vesting, subject to change under management's
discretion.
Effective January 3, 2000, the Company granted 564,000 options at
$4.63 per share under the stock option compensation plan. Effective
January 20, 2000, the Company granted 24,000 options at $7.69 per
share under the stock option compensation plan. Effective May 24,
2000, the Company granted 144,000 options at $4.13 per share under the
stock option compensation plan. Effective June 26, 2000, the Company
granted 24,000 options at $3.63 per share under the stock option
compensation plan. Effective November 16, 2000, the Company granted
270,000 options at $2.31 per share under the stock option compensation
plan.
Effective January 8, 2001, the Company granted 234,000 options at
$2.25 per share under the stock option compensation plan. These
options expire 18 months after each vesting, subject to change under
management's discretion. Of these options, 114,000 vested immediately
on the date of grant.
Effective February 13, 2001, the Company granted 36,000 options at
$2.13 per share under the stock option compensation plan. These
options expire 18 months after each vesting, subject to change under
management's discretion.
Effective July 9, 2001, the Company granted 94,000 options at $2.25
per share under the stock option compensation plan. These options
expire 18 months after each vesting, subject to change under
management's discretion.
F-12
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2001, 2000 and 1999
================================================================================
7. SHARE CAPITAL (CONTINUED):
(b) Stock option compensation plan (continued):
Effective August 23, 2001, the Company extended the exercise period on
the options granted November 16, 2000. These options now expire 18
months after each vesting, subject to change under management's
discretion. The modification of the grant did not result in additional
compensation expense.
As at December 31, 2001, 168,000 options granted under the stock
option compensation plan were exercisable.
(i) A summary of the Company's stock option activity is as follows:
================================================================================
Number of Weighted average
common shares exercise price
- --------------------------------------------------------------------------------
Outstanding, December 31, 1999 and 1998 - $ -
Granted 1,026,000 4.00
Cancelled (306,000) 4.55
- --------------------------------------------------------------------------------
Outstanding, December 31, 2000 720,000 $ 3.76
Granted 328,000 2.25
Granted 36,000 2.13
Expired (122,000) 4.63
Expired (4,000) 7.69
Expired (24,000) 4.13
Cancelled (46,000) 2.25
Cancelled (84,000) 2.31
Cancelled (64,000) 4.63
Cancelled (8,000) 7.69
Exercised (8,000) 2.25
- --------------------------------------------------------------------------------
Outstanding, December 31, 2001 724,000 $ 2.98
================================================================================
The options outstanding at December 31, 2001 expire between February
3, 2002 and January 9, 2006.
F-13
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2001, 2000 and 1999
================================================================================
7. SHARE CAPITAL (CONTINUED):
(b) Stock option compensation plan (continued):
(ii) Additional information regarding options outstanding as at
December 31, 2001 is as follows:
======================================================================
Options outstanding Options exercisable
--------------------------------- --------------------
Weighted
average Weighted Weighted
remaining average average
Exercise Number contractual exercise Number exercise
prices of shares life (years) price of shares price
- ---------------------------------------------------------------------
2.13 36,000 2.62 $ 2.13 - $ -
2.25 106,000 0.52 2.25 106,000 2.25
2.25 84,000 2.52 2.25 - -
2.25 84,000 3.02 2.25 - -
2.31 186,000 2.38 2.31 62,000 2.31
4.13 48,000 0.98 4.13 - -
4.63 180,000 0.59 4.63 - -
- ----------------------------------------------------------------------
724,000 1.67 $ 2.98 168,000 $ 2.27
======================================================================
(iii) Stock-based compensation:
With respect to the stock options granted and stock issued to the
employees, the Company recorded total stock-based compensation
expense of $379,178 during the year ended December 31, 2001 (2000
- $432,785; 1999 - $125,658).
Pursuant to SFAS No. 123, the Company is required to disclose the
proforma effects on net earnings (loss) and net earnings (loss)
per share as if the Company had elected to use the fair value
approach to account for its employee stock-based compensation
plans. If this approach had been applied, the Company's net
earnings (loss) per share would have been as indicated below:
==================================================================================
2001 2000 1999
- ----------------------------------------------------------------------------------
Net earnings (loss) for the year:
As reported $757,917 $(3,971,597) $(1,344,766)
Proforma 242,573 (5,272,830) (1,344,766)
Basic and diluted earnings (loss) per share:
As reported $ 0.05 $ (0.26) $ (0.10)
Proforma 0.02 (0.34) (0.10)
==================================================================================
F-14
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2001, 2000 and 1999
================================================================================
7. SHARE CAPITAL (CONTINUED):
(b) Stock option compensation plan (continued):
(iii) Stock-based compensation (continued):
The fair value for the options was estimated using the
Black-Scholes option pricing model assuming no expected dividends
and the following weighted average assumptions:
===========================================================================
Options
--------------------------------------------------
Weighted
Average Grant Interest
Date Fair Value Rate Term Volatility
- ---------------------------------------------------------------------------
Year ended December 31:
2001 $ 1.83 4.95% 3 years 151%
2000 $ 2.97 5.66% 3 years 137%
===========================================================================
8. COMMITMENTS AND CAPITAL LEASE LIABILITY:
The Company leases its Vancouver, Canada premises under an operating lease
agreement which expires April 30, 2002 and may be renewed for two
additional years at the Company's option. The rent expense under this lease
for the years ended December 31, 1999, 2000, and 2001, totaled $108,242,
$297,148, and $312,251, respectively. In 2000, $73,797 was incurred on the
San Diego lease, which was held for six months of the year. The Company
also leases certain fixed assets under capital leases, which expire at
various dates through 2004.
The Company is committed to operating lease payments for rent in 2002 of
approximately $35,748.
Future minimum commitments under non-cancelable capital leases at December
31, 2001 are as follows:
===================================================
2002 $24,247
2003 21,875
2004 4,731
- ---------------------------------------------------
Total lease payments 50,853
Amount representing interest 7,018
- ---------------------------------------------------
Present value of capital lease obligations 43,835
Current portion 19,183
- ---------------------------------------------------
$24,652
===================================================
Computer hardware capitalized under non-cancelable capital leases amounted to
$75,522 and $61,529 as at December 31, 2001 and 2000, respectively. Accumulated
depreciation related to these capitalized assets amounted to $25,957 and $3,115
as at December 31, 2001 and 2000, respectively.
F-15
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2001, 2000 and 1999
================================================================================
9. INCOME TAXES:
Significant components of the Company's deferred tax assets at December 31,
2001 and 2000 are as follows:
============================================================
2001 2000
- ------------------------------------------------------------
Deferred tax assets:
Net operating loss carryforwards $ 625,000 $ 1,160,000
Fixed assets 481,000 470,000
Deferred revenue 87,000 332,000
Contingent lease payments 94,000 174,000
Share issuance costs 24,000 55,000
-----------------------------------------------------------
Gross deferred tax assets 1,311,000 2,191,000
Valuation allowance (1,057,000) (2,148,000)
- -------------------------------------------------------------
Total deferred tax assets 254,000 43,000
Deferred tax liability:
Deferred expenses (4,000) (43,000)
- -------------------------------------------------------------
Deferred tax asset $ 250,000 $ -
=============================================================
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred
tax assets will not be realized. The ultimate realization of deferred tax
assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities, projected
future taxable income, and tax planning strategies in making this
assessment. The amount of the deferred tax asset considered realizable
could change materially in the near term based on future taxable income
during the carry forward period.
The valuation allowance for deferred tax assets as of January 1, 2001 was
$2,148,000. The net change in the total valuation allowance for the year
ended December 31, 2001 was a decrease of $1,091,000.
As of December 31, 2001, the Company has Canadian tax loss carryforwards of
approximately $1,200,000 available to reduce the future years' income for
tax purposes. These carryforward losses expire in 2006 to 2007.
As of December 31, 2001, the Company has U.S. tax loss carryforwards of
approximately $272,000 available to reduce the future years' income for tax
purposes. These carryforward losses expire in 2020.
F-16
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2001, 2000 and 1999
================================================================================
10. SEGMENTED INFORMATION:
For the period from January 1, 2000 to December 31, 2001 the Company
operated primarily two business segments consisting of web site hosting and
domain name registration. These business segments have been segregated
based on how management organizes the segments within the business for
making operating decisions and assessing performance. The accounting
policies of the business segments are the same as those described in the
summary of significant accounting policies. Prior to 2000, the Company
operated in one business segment, web site hosting.
The Company's revenues are generated from the following business segments:
============================================================
2001 2000 1999
- ------------------------------------------------------------
Web hosting $4,530,923 $3,721,519 $2,511,021
Domain name registration 2,115,510 1,290,340 -
- ------------------------------------------------------------
$6,646,433 $5,011,859 $2,511,021
- ------------------------------------------------------------
The Company's gross profits are generated from the following business
segments:
============================================================
2001 2000 1999
- ------------------------------------------------------------
Web hosting $3,283,357 $2,478,708 $1,799,065
Domain name registration 1,283,374 720,895 -
- ------------------------------------------------------------
$4,566,731 $3,199,603 $1,799,065
============================================================
The Company's revenues are generated from the following geographic
segments:
==================================================
2001 2000 1999
- --------------------------------------------------
United States $2,849,867 $2,538,673 $1,406,172
Canada 2,387,953 1,427,849 602,645
Other 1,408,613 1,045,337 502,204
- --------------------------------------------------
$6,646,433 $5,011,859 $2,511,021
==================================================
Revenues from external customers are attributed based on the customer's
country of domicile.
All of the Company's assets were located in Canada as at December 31, 2001.
The Company does not allocate assets to business segments.
F-17
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2001, 2000 and 1999
================================================================================
11. FINANCIAL INSTRUMENTS:
(a) Credit risk:
The majority of the Company's sales is prepaid and to a large number
of customers. Consequently, the exposure to concentrations of credit
risks relating to individual customers is limited.
(b) Currency risk:
Significant amounts of the Company's expenditures are denominated in
the Canadian dollar. Fluctuations in the exchange rates between
Canadian and United States dollars could have a material effect on the
Company's business, financial condition, and results of operations.
The Company has not entered into foreign currency contracts or other
instruments to mitigate this risk.
(c) Fair value:
The Company's financial instruments consist of cash and cash
equivalents, accounts receivable, deposits, accounts payable and
accrued liabilities, and the capital lease liability. It is
management's opinion that the Company is not exposed to significant
interest or currency risks arising from these financial instruments.
The fair values of these financial instruments approximate their
carrying values, unless otherwise noted.
12. CONTINGENCIES:
(a) As at December 1, 2000, the Company discontinued lease payments on the
San Diego premises due to a number of circumstances. To date, the
landlord has not commenced legal action against the Company. Should
the landlord commence legal action against the Company, the outcome of
the proceedings is unknown. The remaining lease payments of $381,254
were accrued in the consolidated financial statements as at December
31, 2001 and 2000, and a gain will be recognized in the event of a
favorable outcome.
(b) The distribution process for .biz domain names has been the subject of
litigation in the Los Angeles Superior Court in the State of
California. A lawsuit has been brought against NeuLevel, Inc., the
.biz registry, the Internet Corporation for Assigned Names and
Numbers, and most of the .biz-accredited registrars, including
DomainPeople Inc., a wholly-owned subsidiary of the Company. This
lawsuit alleges among other things, that the method for assigning
domain names during the start-up period for registration of .biz
domain names constituted an illegal lottery under California law. The
lawsuit seeks a refund of the fees paid to the defendants, additional
damages, costs, attorney fees, and an injunction to stop the
pre-registrations. NeuLevel, Inc. has subsequently changed its
distribution process in response to this litigation. At this time,
DomainPeople Inc. has not been formally served with notice of the
legal proceedings and the outcome of the proceedings and the amount of
potential damages to DomainPeople Inc. is unknown. However, should the
plaintiff prevail in its claim, the Company may be required to pay
damages which could have a material effect on the Company's operating
results.
F-18
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
2.1 ** Agreement dated March 31, 1999 between the shareholders of NetNation (The Canadian
Subsidiary), NetNation (The Canadian Subsidiary), and NetNation (formerly Collectibles
Entertainment Inc.)
3.1 ** Articles of Incorporation
3.2 ** By-laws
4.1 ** Convertible Debenture for $550,000 Maturing on September 30, 2000 issued to Polaris
Investitionen Ltd.
4.2 ** Convertible Debenture for $550,000 Maturing on September 30, 2000 issued to Beste
Investitionen Ltd.
4.3 Specimen share certificate
10.1 Registrar Accreditation Agreement between the Internet Corporation for Assigned Names and
Numbers and DomainPeople, Inc.
10.2 Harbour Centre Office Lease
10.3 NetNation Communications, Inc.'s 2000 Stock Option Plan*
21.1 List of Subsidiaries
* Incorporated by reference from the Definitive Proxy Statement filed with the
Securities and Exchange Commission on May 8, 2000.
** Incorporated by reference from the Registration Statement on Form 10
of the Registrant filed with the Securities and Exchange Commission on
July 29, 1999, as amended.