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, 2002
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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 (I.R.S.
of incorporation or organization) Employer 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]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes No X
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As of January 30, 2003, the aggregate market value of the voting common equity
held by non-affiliates of the registrant was $3,591,665, 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 January 30, 2003, the registrant's outstanding common stock consisted of
15,206,002 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 4
2 Properties 25
3 Legal Proceedings 25
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 30
7A Quantitative and Qualitative Disclosure about Market Risk 34
8 Financial Statements and Supplementary Data 35
9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 35
III 10 Directors and Officers of the Registrant 36
11 Executive Compensation 39
12 Security Ownership of Certain Beneficial Owners and Management 43
13 Certain Relationships and Related Transactions 44
14 Controls and Procedures 44
IV 15 Exhibits, Financial Statement Schedules and Reports on Form 8-K 46
Signatures 48
Certifications 49
Index to Consolidated Financial Statements 51
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PART I
FORWARD -LOOKING STATEMENTS
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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
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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.
ITEM 1: BUSINESS
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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 web hosting and domain name
registration segments for purposes of 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
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.
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NetNation hosts customer web sites and indirectly provides access to the
Internet through its ISPs. NetNation offers a range of basic and enhanced web
hosting services to businesses wishing to place 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 has strategically determined not to offer web site design,
development, or content services because it is labor intensive and would involve
significant human resources and time to service a broad customer base. These
"webmaster" functions are typically performed by specialized companies servicing
a number of customers. NetNation has developed programs for resellers and
affiliates 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
register 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, in order to obtain the recurring web hosting 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 through the
various registries.
ORGANIZATION
NetNation Communications Inc., the parent public company, 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
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site hosting business based in Vancouver, Canada. As of the date of this report,
the common shares of NetNation trade on the Nasdaq Small Capitalization Market
under the ticker symbol "NNCI".
NetNation has three wholly-owned subsidiaries: NetNation Communications Inc.,
DomainPeople, Inc.; and NetNation Communications (USA) Inc.
NetNation entered into the web hosting business through its 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. As
of the date of this report, NetNation conducts all of its web hosting operations
through its Canadian subsidiary.
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 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 Communications (USA) Inc. is currently
inactive.
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.
BACKGROUND
Web Hosting
During 2002, NetNation derived 67% 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.
According to research firm IDC, the web hosting market in 2001 was $4.8 billion
and is projected to grow to $16.2 billion in 2005. The small-to-medium hosting
segment, where NetNation mainly competes, represents an estimated 50% of the
total market. The hosting market is serviced by roughly 25,000 hosting
companies as at January 2003, according to HostCount.
To begin using a web hosting service, a customer would register and pay for a
domain name and would set up an 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. Customers can also transfer or migrate an existing web
site to NetNation's web hosting service. If the customer has a commercial web
site, NetNation can assist the customer in meeting its commercial
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objectives by making available services that enable commercial transactions over
the Internet such as shopping cart software and credit card merchant accounts
available through our partners.
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 resellers 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 $13-$175. 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
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
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.
Domain Name Registration
During 2002, NetNation derived 33% of its revenue from providing domain name
registration. A business or individual that wants a personalized web address
must first register 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. When the
registration term is completed, NetNation can renew the customer's domain name
for them. Customers can also transfer their existing domain name registration
to NetNation and renew subsequent terms with NetNation.
According to the "State of the Domain" report for Q3 2002 provided by
SnapNames.com, the number of total registrations for generic top level domain
names (.com, .net, .org, .info, .biz, and .name) as at September 30, 2002 was
approximately 29 million. NetNation's share of this market is 0.50%.
BUSINESS STRATEGY
NetNation has targeted the North American small and medium-sized business
markets as management believes that this market will continue to grow.
According to research firm IDC, the web hosting market is projected to grow from
$4.8 billion in 2001 to $16.2 billion in 2005. And the small and medium hosting
segment is estimated to represent about 50% of the total hosting market and has
continued to experience growth. This growth in the small and medium hosting
market is due to small office/home office, or SOHO-based companies seeing the
need to launch their own business presence on the Internet.
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The geographic location of the market for web hosting services is worldwide. In
2003, efforts to penetrate international and domestic markets will be augmented
by developing strategic partnerships, and reseller networks that have experience
in local markets, and will serve to offset the expense of marketing to end
users. In addition, focusing on a wider range of services is vital to provide
more of a complete solution to both resellers and end-users.
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. As
the company continues to assess the efficacy of its marketing expenditures, it
will allocate more resources to advertising with measurable results such as
search engine optimization and keyword buying, rather than solely on print
media.
NetNation's market for domain name registration consists of retail customers and
resellers. Roughly three quarters of NetNation's domain name sales are through
resellers. Resellers can set up a branded reseller account where they resell
NetNation's domain name registration services under their own name. Under this
arrangement, the reseller purchases domain names from NetNation at a discount
and resells the domain name at a price that they set. Under this arrangement,
NetNation collects the domain name registration fees from the end customer and
remits the difference between those fees and the reseller's discounted price to
the reseller. Resellers can also sell domain names under NetNation's
wholly-owned subsidiary, DomainPeople's name. Under this arrangement, the
reseller purchases domain names from NetNation at a discount and resells the
domain name at a price that they set and collects the domain name registration
fee directly from the end customer. The reseller remits the domain name
registration cost to NetNation. Again, the geographic location of this market,
domain name registration, is worldwide but the main market we service is North
America. The marketing vehicles for domain name registration consist of online
advertising, print advertising, and search engine optimization.
During 2002, NetNation's wholly owned subsidiary DomainPeople, Inc. completed
development of a unique and sophisticated brand-able domain reseller
application. This application is designed for multi-tiered resellers and
therefore is ideally suited for international distributors, and large domestic
ones. Accordingly, DomainPeople will focus much of its efforts on the reseller
channels. Part of this strategy will include targeted print media to industry
and country specific publications and periodicals, personal selling, and online
advertising. Also, two new extensions: .CN (China) and .PRO will be released
during 2003, and it is anticipated that DomainPeople's revenues will increase
with these introductions.
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.
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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.
4. Enhanced 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, .biz, and .name) for individuals and companies.
In addition to providing web hosting and domain name registration services
directly to its customers, NetNation also offers these services for resale 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.
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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
NetNation has developed a set of utilities for its customers called Account
Manager. Account Manager is a proprietary account interface tool that enhances
a customer's web site control and management capabilities. For example,
customers can use Account Manager 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 data center 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 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 and
creation 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 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.
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Using NetNation's enhanced services, its web hosting customers can construct
customized online storefronts with integrated end-to-end sales process support
and automated payment systems. For an initial setup fee and a subsequent
monthly fee, NetNation offers several packages that support online commerce
which includes "shopping cart" software. The packages are available to both
UNIX and Windows 2000 users. 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 are 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
register 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 ("TLDs") ending in .com, .net and .org. NetNation became
operational as a domain name registrar in December of 1999. As at December 31,
2002, the Company had registered approximately 397,000 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 who
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. NetNation also
offers a referral agent program whereby referral agents are compensated for
referring customers to NetNation's web hosting services. Referral agents do not
provide technical support for web hosting.
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).
Customers visiting the reseller's web site would not be aware that back-end is
linked to NetNation's servers in completing the service. The revenue generated
from the registration of domain names using this 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 2002, NetNation primarily utilized a combination of print and online media to
promote its products and services. The Company placed print advertising in
major business and technical publications to reach its target markets. Some of
the publications in which NetNation advertises are PC magazine, PC World, Small
Business Computing, Windows 2000, Linux Journal, the Computer Paper, Hosting
Tech, and Silicon
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Valley North. In 2002, NetNation allocated approximately 37% of its total
advertising budget to print advertising.
The Company's online marketing program consists of the purchase of targeted
keywords on search engines and directories, web banner advertisements, as well
as web site sponsorships and search engine optimization strategies. The Company
allocated approximately 40% of its total advertising budget to online
advertising in 2002. NetNation also utilized other marketing vehicles to
promote its products and services, including direct marketing, trade shows,
event sponsorship, collateral sales materials and the Company's web site.
DISTRIBUTION AND SALES
NetNation sells its products and services 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 23,000 websites for customers in over 120
countries as of December 31, 2002. For the year ended December 31, 2002,
Canadian customers comprised 45% of the total web hosting customer base,
followed by the United States at 41%, and all other countries, the majority in
Europe, combined at 14%.
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's sales force includes outbound sales and 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. NetNation's 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.
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).
Customers visiting the reseller's web site would not be aware that back-end is
linked to NetNation's servers in completing the service. The revenue generated
from the registration of domain names using this 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.
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Affiliate Program
NetNation has initiated a Referral Affiliate Program whereby independent
Referral Agents can refer customers to NetNation's shared web hosting services
and earn commissions. Referral Agents can be web developers, IT consultants,
computer retailers, or just someone who has access to a network of people who
have customers who have or want web sites. Once a Referral Agent is qualified,
they have access to a product page listing all of our shared hosting packages
which seamlessly integrates with the Referral Agent's web site. This product
page is linked directly to NetNation's order form. The Referral Agent promotes
the service to its customers and NetNation provides the billing and customer
support.
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 per 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. 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
can service 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 open source
software and has developed enhancements to provide maximum functionality,
scalability and performance. NetNation uses standard technologies such as the
Linux operating system, Apache web server software, Exim mail server, and
PowerDNS domain name server. Some of the technological barriers that NetNation
has overcome include the development of new routers to replace some of our Cisco
enterprise equipment.
NetNation has developed Account Manager which provides account management
features including email management, web statistics, in house bandwidth usage
tracking, integrated ticketing system, multi level access control, and password
management, and is fully brand-able for reseller usage. Account Manager is
constantly being improved to enhance customer service and to ensure high levels
of scalability as additional servers and customers are added. This same system
is provided to all of our hosting customers to manage their hosting accounts.
Network Operations
The provision of quality 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
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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 as 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. However, 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.
At December 31, 2002, the Company had one data center, located in Vancouver,
Canada. The Company does not have redundancy with respect to its data center's
connectivity to the Internet in the event of a general failure of Internet
infrastructure in the Vancouver area, due, for example, to earthquake or
terrorist attack and the Company has no formal disaster recovery plan.
COMPETITION
The markets for web hosting and domain name registration services are very
competitive. It is estimated that there are over 25,000 web hosting service
providers in the world. 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 160 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) cost of labor, bandwidth, computer infrastructure, and other expenses;
l) attraction and retention of key technical and managerial personnel;
m) location of data centers;
n) development of a broad international presence; and
o) 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. These
competitors also have strengths which includes being better financed, having
access to existing customers that they can cross-sell to, having larger
marketing budgets, and having better brand recognition among the general public.
The second major type of competitors are the pure web site hosting companies.
NetNation believes that some of these companies may 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 web site hosting companies may face these
competitive deficiencies, there are a number of larger web site hosting
companies that have shown the ability to compete effectively., The ability of
NetNation to compete with these companies over time is unproven.
NetNation believes the following aspects of its various service solutions
provide a competitive advantage in obtaining and retaining customers.
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 2002, 67% 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.
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.
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. Live 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
15
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.
NetNation believes the following are some of the disadvantages it faces in
competing in this market.
Location. Some web site hosting customers have the need or desire to have their
site hosted in a location close to their own location. This is especially true
for co-location and higher end service customers.
Brand recognition in local market. NetNation advertises mainly in North America
in national publications and online and in Vancouver while local providers in
other cities may have better brand recognition in their local market because
they advertise locally and are part of the local community.
Suite of services provided may be lacking in areas. Some customers may require
certain services that we do not currently offer and may go to another provider
who provide those specific services.
Pricing. NetNation does not compete on price as our business model has been to
provide good quality service at a competitive price but not necessarily at the
lowest price in the market. Many competitors offer their web hosting services
at prices lower than ours.
Competition in the domain name registration services industry will intensify as
the number of entrants into the market increases. As at December 31, 2002,
ICANN had accredited almost 160 competitive registrars, including NetNation, to
register domain names in the .com, .net, .org, .info, .biz, and .name domains.
NetNation faces substantial competition from competitive registrars and others
in that:
- 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.
Competition in the domain name registration industry has resulted in NetNation
lowering prices to its customers. Further price reductions may be required. In
addition, some of NetNation's competitors are offering domain name registrations
for free and derive their revenues from other sources.
TREND TOWARD CONSOLIDATION
Most of the pure web hosting service providers are small businesses. Many of
the larger pure web hosting service providers have annual revenues only in the
$5 million to $25 million range. As the industry matures, certain providers may
also seek to use acquisitions and the corresponding economies of scale they can
achieve as a competitive tool. Although recent financial market conditions have
not favored a trend toward consolidation in the industry, management believes
that a change in economic conditions could lead to consolidation activity in the
industry. From time to time management has evaluated whether business
combinations would be in the best interest of the shareholders. Management has
never received competing competitive bona fide proposals and has never reached
any definitive agreement for a business combination.
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GOVERNMENT REGULATIONS
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. 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.
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 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.
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.
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 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 and provincial taxes in Canada
where applicable.
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 may impose restrictions on NetNation's ability to follow current
business practices or increase its costs of doing business.
RESEARCH AND DEVELOPMENT
NetNation has spent approximately $231,000, $200,000, and $269,000 on
company-sponsored in-house research and development in 2002, 2001, and 2000
respectively.
ENVIRONMENTAL COMPLIANCE
Compliance with Federal, State and local provisions which have been enacted or
adopted regulating the discharge of materials into the environment, or otherwise
relating to the protection of the environment does not have a material effect
upon the capital expenditures, earnings and competitive position of NetNation
and its subsidiaries.
17
EMPLOYEES
As at December 31, 2002, NetNation had 72 employees. All employees are required
to enter into an employment agreement that contains industry standard terms for
the 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.
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
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. This
difficulty in evaluating NetNation's prospects may result in stock price
volatility, including dramatic price drops that could cause investor losses.
Future Losses
The web hosting industry is a new industry and NetNation cannot predict whether
its current business model will continue to enjoy acceptance from either a
pricing or service-level standpoint. 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:
- the ability to maintain or generate increased revenues and cash flow;
- 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; and
- potential regulatory developments that may apply to NetNation's
operations.
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If NetNation suffers negative cash flow in the future, some investors might sell
their shares resulting in a decrease in the price of its stock that would cause
losses for investors who did not sell. NetNation also might find it difficult
to raise capital to continue its business on acceptable terms, if at all.
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 as needed, expand its channels of
distribution, continue to respond to competitive developments, and retain and
motivate qualified personnel. If NetNation does not manage these risks, it may
not sustain revenue growth and profitability in future quarterly or annual
periods, which could result in a decrease in the price of its stock that could
cause losses for investors.
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 changes in the employee group;
d) changes in the pricing policies of NetNation; and
e) the timing and magnitude of expenditures on advertising, marketing,
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) the introduction by third parties of new Internet and networking
technologies;
f) increased competition in NetNation's markets;
j) changes in the pricing policies of NetNation's competitors; and
k) fluctuations in bandwidth and other resources used by customers.
NetNation's committed costs pertaining to premises, communication and wages
account for approximately 50% of total expenses for the foreseeable short term.
Absorbing 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 may result in
stock price volatility, including dramatic price drops that could cause investor
losses.
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
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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. In
addition, to be successful in this 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 does not succeed for any of these reasons, its
stock price could decline and cause losses for investors or it could be forced
to liquidate resulting in a total loss for investors
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. Some of NetNation's most likely long-term
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, 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. If NetNation
is unable to compete effectively in its markets, its stock price could decline
and cause losses for investors or it could be forced to liquidate resulting in a
total loss for investors.
Continued Growth May Strain Resources
NetNation has experienced growth but the pace of growth has slowed in the past
two years. Growth has placed, and future growth may continue to place, a
significant strain on the Company's managerial, operating, financial and other
resources. The Company's recent modest revenue growth comes at the same time
that the Company has reduced its headcount, mainly through attrition. The
combination of modest growth with work force reductions requires 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 as needed.
In addition, if the Company cannot obtain external capital resources, its
ability to grow rapidly in response to market opportunities may be significantly
undermined.
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
20
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.
Increased Domain Name Registration Competition
Competition in the domain name registration industry has resulted in the
lowering of prices to NetNation's customers. Further price reductions may be
required. In addition, 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.
Maintenance of ICANN Accreditation
NetNation needs to be an ICANN-accredited registrar in order to register domain
names in the .com, .net, .org, .info, .biz, and .name 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. In 2002, NetNation derived 33% of its
revenue from domain name registration services. 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.
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 Group
Telecom, Peer1 Network, Big Pipe, 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,
which could result in a decrease in the price of its stock that could cause
losses for investors.
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, which could result in a decrease in the price of its stock
that could cause losses for investors.
21
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
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, which could result
in a decrease in the price of its stock that could cause losses for investors.
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, which could result in a decrease in the price of its stock that could
cause losses for investors. 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.
Dependence Upon On-line Credit Card Processing
NetNation's business relies upon the ability to accept credit cards for payment
on-line. Incidences of credit card fraud on the Internet in general and credit
card fraud effecting NetNation specifically may affect the ability of NetNation
to maintain its credit card merchant accounts to process credit card payments
on-line. If NetNation is unable to process credit card payments on-line, this
could have a material adverse effect on NetNation's business, results of
operations and financial condition, which could result in a decrease in the
price of its stock that could cause losses for investors.
22
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 reasons based on the nature and content of
the materials disseminated through their networks. 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
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; Joseph Kibur, Chief Executive
Officer; Calvin Mah, Chief Financial Officer; and Jag Gillan, Chief Operating
Officer and General Counsel. The loss of the services of one or more of these
key persons could have a material adverse effect on NetNation's business,
results of operations and financial condition.
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, which could result in a decrease
in the price of its stock that could cause losses for investors.
23
Effective 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 46% of
NetNation's outstanding common stock as at January 30, 2003. 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.
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 the effect of preventing investors from receiving offers to
purchase their stock at a premium.
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, 2002, there were 8,163,520 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 the 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.
On January 7, 2003, the Company was notified by Nasdaq that it did not meet
listing requirements for the Nasdaq SmallCap Market at that time as it was not
in compliance with the US$1.00 minimum bid price. The Company has requested to
appeal its case before the Nasdaq Qualifications Panel for continued listing on
Nasdaq SmallCap Market and the hearing is scheduled for February 13, 2003.
24
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.
Compliance with Sarbanes-Oxley Act and Related Regulations
The United States Congress enacted sweeping legislative reforms in July 2002
known as the Sarbanes-Oxley Act, which tightened regulation of the securities
industry. Many of these reforms and their implementing regulations affect the
manner in which publicly-traded companies govern their affairs. Some of the key
regulations required by the Sarbanes-Oxley Act have not yet been adopted.
Specifically, the Securities and Exchange Commission is currently reviewing the
listing standards for companies that are traded on the Nasdaq SmallCap Market.
These standards may require NetNation to increase the size of its Board of
Directors significantly to add a number of independent directors. If NetNation
is unable to identify and obtain the services of qualified candidates to comply
with the new listing standards, it might lose its listing on the Nasdaq SmallCap
Market, which could reduce the liquidity of its common stock and potentially
cause investor losses due to depressed prices. Even if NetNation is able to
obtain the services of qualified candidates, the search for candidates may
divert scarce human and financial resources from focusing on the core business
of the Company. In addition, the increased size of the Board would impose
additional financial burdens on NetNation on an ongoing basis. This diversion
of resources could adversely affect the financial condition, operations and
prospects of NetNation, which could result in a decrease in the price of its
stock that would cause losses for investors.
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, excluding operating
costs, pursuant to agreements that expire on April 30, 2003 with an option to
renew for an additional 1 year term and an additional 3 year term. 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, 2000 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
and the Company has not accrued any amount in respect of this lawsuit in the
financial statements. 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. In December, 2002 a settlement of the suit was
proposed whereby NeuLevel, Inc. would refund any remaining pre-registration fees
not previously refunded and pay plaintiff's attorney's fees of up to $1,175,000.
A hearing to consider the proposed settlement is scheduled for March 17, 2003 in
the Superior Court
25
of California for the County of Los Angeles. It is not known what the effect, if
any, of the settlement, if approved, will be to DomainPeople, Inc.
The Company has been in a dispute with a web hosting company in the Netherlands
called Netnation Europe. On March 14, 2002, the Company won a World
Intellectual Property Organization (WIPO) dispute involving Netnation Europe for
the domain name "netnation.info". On November 1, 2002, the Company lost a WIPO
decision to Netnation Europe for the domain name "netnation.biz". Netnation
Europe had initially registered the domain name during the start-up period for
registration of .biz domain names and the Company contested Netnation Europe's
rights to the domain name. At this time, the Company has not formally served
Netnation Europe with notice of legal action. Currently, the Netherland market
does not represent a significant part of the Company's business.
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 2002.
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, 2002
First Quarter $ 3.200 $ 1.780
Second Quarter $ 2.300 $ 0.700
Third Quarter $ 0.770 $ 0.330
Fourth Quarter $ 0.690 $ 0.400
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
The above quotations were taken from Commodity Systems, Inc.
Holders
On January 30, 2003, NetNation's issued and outstanding common stock totaled
15,206,002 shares and was held by approximately 56 shareholders of record and by
an undetermined number of additional shareholders through nominee or street name
accounts with brokers.
Dividends
NetNation's board of directors has not declared or paid cash dividends on the
Company's common stock and does not have any plans to pay any cash dividends in
the near future. NetNation's current policy is to retain all earnings to finance
future growth.
RECENT SALES OF UNREGISTERED SECURITIES
During the year ended December 31, 2002, NetNation 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.
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. 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.
The selected data relating to fiscal years ending December 31, 2002, 2001 and
2000 and selected financial data as at December 31, 2002 and 2001 are derived
from the Company's audited financial statements included elsewhere herein. The
selected data relating to fiscal years ending December 31, 1999 and 1998 and
selected data as at December 31, 2000, 1999 and 1998 are derived from the
Company's audited financial statements not included or incorporated by reference
herein. This selected financial data should be read in conjunction with the
audited consolidated financial statements and accompanying notes contained in
this annual report.
28
SELECTED FINANCIAL DATA
==================================================================================================
Years ended
December 31,
2002 2001 2000 1999 1998
- --------------------------------------------------------------------------------------------------
Sales $ 6,818,316 $ 6,646,433 $ 5,011,859 $ 2,511,021 $1,108,430
Gross profit 4,532,005 4,566,731 3,199,603 1,799,065 687,191
Expenses
Sales & marketing 1,104,018 1,388,643 2,977,927 1,575,699 461,913
General & admin. 1,956,629 2,037,689 3,352,296 1,472,687 303,400
Write-off of advance -- -- 500,000 -- --
Depreciation 682,785 632,482 340,977 95,445 31,428
Deferred income tax recovery 150,000 250,000 -- -- --
Net earnings (loss) 938,573 757,917 (3,971,597) (1,344,766) (109,500)
Earnings (loss) per share $ 0.06 $ 0.05 $ (0.26) $ (0.10) $ (0.01)
Weighted average number 15,218,131 15,246,145 15,316,804 13,164,836 9,692,030
of common shares
Total assets $ 5,459,424 $ 4,126,428 $ 3,130,828 $ 1,518,165 $ 177,359
Debentures payable $ -- $ -- -- $ 1,100,000 $ --
Cash generated by (used for)
Operating activities $ 1,773,811 $ 1,155,973 $ (623,555) $ (604,773) $ 94,177
Investing activities (116,463) (235,258) (2,014,787) (435,922) (86,590)
Financing activities (1,737) 9,490 2,399,010 1,982,909 (4,734)
==================================================================================================
29
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATION
------------
The following discussion should be read in conjunction with NetNation's audited
consolidated financial statements beginning at page F-1 at the end of this
report of Form 10-K. Certain statements contained in this discussion may
constitute forward-looking statements, as discussed above in the section
entitled "Forward-Looking Statements". NetNation's actual results could differ
materially from the results anticipated in the forward-looking statements as a
result of a variety of factors, including those discussed in the sections
entitled "Risk Factors" and "Business".
OVERVIEW
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. Its products
and services are sold worldwide, directly to customers and through value added
resellers ("VARs").
NetNation began providing web hosting services in February 1997. 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 ("TLDs")
ending in .com, .net, .org, .info, .biz, and .name. NetNation, through its
wholly-owned subsidiary, DomainPeople, became operational as a domain name
registrar in December of 1999.
NetNation generates its revenue by providing web hosting services to SMEs and
domain name registration. NetNation's web hosting customers normally pay a
setup fee and regular charges, either monthly, quarterly, twice-yearly, 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 generally collects its web hosting service fees in advance, and
recognizes revenue over the period during which services are provided. Setup
fees are amortized over the estimated period during which services will be
provided, typically one to two years. Recurring service fees are amortized and
recognized on a straight-line basis over the period during which services are
provided. As a result, NetNation will generally have a significant amount of
deferred revenue attributable to web hosting services. An increase in the
number of web hosting customers will not necessarily produce corresponding
increased revenues, because adding a number of customers with low service levels
may not replace the revenue lost if one intensive user of NetNation's services
decides to use another web hosting service provider. Web hosting expenses are
largely paid currently.
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. NetNation generally collects its domain name registration
fees in advance, and recognizes revenue on a straight-line basis over the period
for which the name is registered. As a result, NetNation will generally have a
significant amount of deferred revenue attributable to domain name registration
services. An increase in the number of domain names that NetNation registers
will generally produce a corresponding increase in revenues, subject to changes
in the price charged for the service. The domain name registration fee which
NetNation pays to the registries for the domain names is paid in advance and is
recognized as an expense over the period for which the name is registered. As a
result, NetNation will generally have a significant amount of deferred expenses
attributable to domain registration services.
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
30
name registration fees are included in cost of sales as they are recognized as
an expense over the term of registration.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations, including the discussion on liquidity and capital resources, are
based upon our consolidated financial statements which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and the related disclosure of contingent assets and liabilities. On
an ongoing basis, our management re-evaluates its estimates and judgments.
We believe the following critical accounting policies requires our most
significant judgment and estimates used in the preparation of the consolidated
financial statements. 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 and for loss carry forwards. 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 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 deferred tax asset realized during
2002 is based on the assumption that our 2003 income will be generally
comparable to our 2002 income. If our future income is substantially greater or
substantially less than the income we assume, there would be a corresponding
change in the actual amount of the deferred tax asset considered realizable.
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. In estimating the period that hosting services are to be
provided to customers, our management considers our past history with our
customers, the type of services we provide, and other factors that could affect
the period of time a customer would be provided services. Accordingly, the
estimate of the period of time that hosting services are to be provided to
customers is a matter of judgment and could change in the near term based on
historical experience and other factors, resulting in a material change to
recorded revenue and deferred revenue for web hosting services. For example, if
our experience begins to show that customers fitting a certain profile generally
use our services for 4 years, and we have been estimating they will use our
services for 2 years, we would increase the amortization period to 4 years,
effectively reducing the set-up fee revenue recognized for such customers in
each of the first 2 years by 50%.
OPERATING RESULTS
YEAR ENDED DECEMBER 31, 2002 COMPARED WITH YEAR ENDED DECEMBER 31, 2001
Revenue
NetNation's 2002 revenues were derived from Web Hosting (67%) and Domain Name
Registration services (33%). As at December 31, 2002, NetNation was hosting
approximately 23,000 web sites and had registered approximately 397,000 Internet
domain names.
NetNation's 2002 revenue of $6,818,316 was an increase of $171,883, or 3%, over
2001 revenue. The increase in revenue was due mainly to the increase in the
domain name registration segment of NetNation's business. During 2002, the
number of sites hosted increased approximately 5%, from 22,000 to 23,000, but
did not result in a corresponding increase in web hosting revenues as the
average revenue per customer has dropped due to competitive pricing pressures.
31
The deferred revenue amount on the balance sheet as at December 31, 2002
includes $1,864,143 related to domain name registration and $720,975 related to
web hosting services.
Cost of Sales
Cost of sales of $2,286,311 was an increase of $206,609 or 10% from 2001 and as
a percentage of revenues, increased from 31% to 34%. The increase in cost of
sales was due to higher domain name registration costs and personnel costs. The
increase in cost of sales as a percentage of sales was due mainly to the reduced
margins on domain name registration from increased price competition and the
higher personnel costs. The price competition in domain name registrations is
expected to continue and may reduce margins further in the future.
Sales and Marketing Expenses
Sales and marketing expenses decreased $284,625, or 20%, from 2001, and as a
percentage of revenue, decreased from 21% to 16%. The decrease was mainly due
to a reduction in advertising expenses of $99,344 and personnel costs of
$182,381. Sales and marketing expense consists mainly of salaries, bonuses,
commissions and advertising costs.
General and Administrative Expenses
General and administration expenses decreased $81,060 or 4% compared to 2001.
As a percentage of sales, general and administration expenses decreased from 31%
in 2001 to 29% in 2002. The improvement in general and administration expenses
was due mainly to the reduction in rent expense as a result of the closure of
the UK office and consolidation of the Vancouver office space. General and
administrative expenses include administrative personnel costs, bad debt
expense, rent, general office expenses, audit and legal costs, and investor
relations expenses.
Depreciation and Amortization
Depreciation and amortization increased $50,303 or 8% compared to 2001. The
increase in depreciation and amortization expense was due to the ongoing
re-evaluation of the estimated useful life of our fixed assets
Deferred Income Tax Recovery
In 2002, the Company recognized a deferred income tax recovery of $150,000 which
increased the deferred tax asset to $400,000 at December 31, 2002. In 2001, the
Company recognized a deferred income tax recovery of $250,000 and a
corresponding deferred tax asset of the same amount. The amount of the tax
recovery is based on the assumption that the Company's net earnings in 2003 will
be generally comparable to the net earnings in 2002. If the Company's 2003 net
earnings are substantially greater or substantially less than 2002 net earnings,
a corresponding adjustment to the deferred tax asset considered realizable will
be required.
YEAR ENDED DECEMBER 31, 2001 COMPARED WITH YEAR ENDED DECEMBER 31, 2000
Revenue
NetNation's 2001 revenues were derived from Web Hosting (68%) and Domain Name
Registration services (32%). This compares to 74% of revenues from Web Hosting
and 26% from Domain Name Registration services in 2000. As at December 31,
2001, NetNation was hosting more than 22,000 web sites and had registered
approximately 300,000 Internet domain names.
NetNation's 2001 revenue of $6,646,433 was an increase of $1,634,574, or 33%,
over 2000 revenue. The increase in revenue was due to the increase in the
number of web sites hosted and a full year of growth in
32
the domain name registration segment of NetNation's business. During 2001, the
number of sites hosted increased approximately 37%, from 16,000 to 22,000.
The deferred revenue amount on the balance sheet as at December 31, 2001
includes $1,641,227 related to domain name registration and $748,937 related to
web hosting services.
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 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.
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.
LIQUIDITY AND CAPITAL RESOURCES
During 2002, operating activities generated net cash of $1,773,811 compared to
net cash generated from operations of $1,155,973 in 2001. The main reason for
the increase in cash from operations was the increase in earnings before tax
generated in 2002 compared to earnings before tax generated in 2001. Cash
generated from changes in working capital items also contributed to the increase
in cash from operation in 2002.
During 2002, the Company purchased fixed assets totaling $121,243. Management
considers this level of expenditure, on an annual basis, adequate to maintain
the current level of service and to allow for moderate growth in the number of
customers we service. 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 an increased level of capital
expenditure costs in the future.
As at December 31, 2002, the Company has cash and cash equivalents of $3,334,561
compared to $1,678,950 as at December 31, 2001. The increase reflects positive
cash flows from operations for 2002. Based on management's current projections,
the Company believes that it has adequate resources to maintain its current
level of operations 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
33
to accelerate growth but there is no guarantee that capital will be available at
acceptable terms or at all. While there are no commitments to make capital
expenditures, management may make capital expenditures from time to time as the
operations demand. Notes 8 and 12 to the consolidated financial statements
summarize the material commitments and contingencies known to management.
From time to time management has evaluated whether business combinations would
be in the best interest of the shareholders. Management has never received
competing bona fide proposals and has never reached any definitive agreement for
a business combination.
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 herein, 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.
34
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 2002 Quarter End
-----------------------------------------------
March 31 June 30 September 30 December 31
- --------------------------- --------- --------- ------------ -----------
Sales 1,686,431 1,740,954 1,736,434 1,654,497
Gross profit 1,143,359 1,166,211 1,155,631 1,066,804
Net earnings for the period 214,321 151,707 206,439 366,106
Net earnings per share 0.01 0.01 0.01 0.02
============================================================================
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
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.
35
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 45 Chairman, President and Director
- --------------- --- ---------------------------------
Joseph Kibur 30 CEO and Director
- --------------- --- ---------------------------------
Ernest Cheung 52 Director
- --------------- --- ---------------------------------
Anil Wirasekara 46 Director
- --------------- --- ---------------------------------
Calvin Mah 40 CFO
- --------------- --- ---------------------------------
Jag Gillan 32 COO, Secretary and Director
- --------------- --- ---------------------------------
The directors of NetNation serve one year terms and hold office until the next
annual meeting of the shareholders and until their successors have been elected
and qualified.
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, President and Co-Founder of NetNation
Communications, Inc., Delaware, U.S.A. In addition, Mr. Talmor is President,
Co-Founder and a Director of DomainPeople, Inc., NetNation's wholly-owned domain
registration subsidiary, where he also served as secretary of the Company from
November 1999 until February 2000. Mr. Talmor was appointed Chairman of the
Board, President, Chief Executive Officer and Secretary of NetNation
Communications, Inc. in April 1999. He served as Chief Executive Officer and
Secretary of NetNation until January 2000 and February 2000 respectively. 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 18 years of business experience, both in financial and business
administration roles, as well as experience in electronics engineering with the
Israeli Air Force and Eldat/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 at MacDonald Dettwiler &
Associates Ltd., Richmond, British Columbia, Canada, a Canadian company in the
field of satellites' ground stations. Mr. Talmor qualified as a Certified Public
Accountant in Israel with Kesselman & Kesselman, Chartered Accountants, the
country's largest accounting firm, which is associated with
PricewaterhouseCoopers. Mr. Talmor received a Bachelor of Arts in Economics and
Accounting, a Bachelor of Science in Statistics and a Masters of Business
Administration, all from Tel-Aviv University in 1985, 1985 and 1988
respectively. In addition, Mr. Talmor received an Electronics Diploma from the
Technological Institute of Tel-Aviv in 1976.
JOSEPH KIBUR is Chief Executive Officer, Co-Founder and a Director of NetNation
Communications, Inc., Delaware, U.S.A. In addition, Mr. Kibur is Vice
President, Co-Founder and a Director of DomainPeople, Inc., NetNation's wholly-
owned domain registration subsidiary. Mr. Kibur was appointed Chief Executive
Officer of NetNation Communications, Inc. in September 2000. Previously, he was
appointed a Director and Chief Operating Officer of NetNation Communications,
Inc. in April 1999. He held the position of Chief Operating Officer until
September 2000. From March 1997 to April 1999, Mr. Kibur 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. Mr. Kibur received a Bachelor of
36
Science in Management and Systems Science (Computer Science, Business and
Mathematics) in 1996 from Simon Fraser University, British Columbia.
ERNEST CHEUNG is a Director of NetNation Communications, Inc., Delaware, U.S.A.
Mr. Cheung was appointed to NetNation's Board of Directors in February 1999.
From 1993 to 1994, Mr. Cheung was Vice Chairman, Tele Pacific International
Communications Corp. of Vancouver, British Columbia, Canada. From 1991 to 1993,
he was Vice President of Midland Walwyn Capital, Inc. of Toronto, Ontario,
Canada. From 1984 to 1991, he was Vice President and Director, Capital Group
Securities, Ltd. in Toronto, Ontario, Canada. Mr. Cheung received a Masters of
Business Administration in Finance and Marketing in 1975 from Queen's
University, Kingston, Ontario, and he obtained a Bachelor of Math in 1973 from
University of Waterloo, Ontario.
He has served or serves 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 NasdaqSC 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 is a Director of NetNation Communications, Inc., Delaware,
U.S.A. Mr. Wirasekara was appointed to NetNation's Board of Directors in October
1999. In 1995, Mr. Wirasekara was appointed Chief Financial Officer of
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, having joined the Company in 1992 as
the Manager of Operations Accounting and Information. From 1988 to 1991, he was
Controller and Secretary of Rainex Limited, a Vancouver, British Columbia
company involved in project development, 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 United Kingdom, the
Chartered Institute of Marketing and Management of the United Kingdom, and the
Institute of Chartered Accountants of Sri Lanka.
CALVIN MAH is Chief Financial Officer of NetNation Communications, Inc.,
Delaware, U.S.A. Mr. Mah was appointed Chief Financial Officer of NetNation in
February 2001 after serving as its Financial Officer since November 2000. Mr.
Mah is also Chief Financial Officer of DomainPeople, Inc., NetNation's wholly-
owned domain registration subsidiary. He was appointed to this position in
February 2001. From 1996 to 2000, Mr. Mah was Chief Financial Officer of Simba
Technologies Inc., a privately held, venture-backed software development
company. From 1995 to 1996, he was Senior Financial Analyst for Pacific Forest
Products Ltd., a $400 million publicly traded logging and sawmilling company
with 1,100 employees. From 1993 to 1995, 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, he 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, with honours, from the University of British
Columbia in 1985.
JAG GILLAN is Chief Operating Officer, General Counsel, Secretary and a Director
of NetNation Communications, Inc., Delaware, U.S.A. Mr. Gillan has held the
position of General Counsel of NetNation since June 1999, and was appointed
Chief Operating Officer of NetNation in September 2001. He has
37
served as Secretary and a Director of NetNation since February 2000 and
September 2000 respectively. In addition, Mr. Gillan is Chief Operating Officer,
Secretary and a Director of DomainPeople, Inc., NetNation's wholly-owned domain
registration subsidiary, having been appointed to the position in February 2000.
He served as General Counsel of DomainPeople from October 1999 until September
2001. From May 1997 to May 1999, Mr. Gillan was an Attorney with Baker Newby,
Vancouver, British Columbia, Canada. From 1992 to 1994, he served as Chief
Operating Officer of Millstream Flour Mills Corp., a privately-held miller of
food products. Mr. Gillan attended Osgoode Hall Law School at York University in
Toronto, Ontario 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, British Columbia. Mr. Gillan is currently completing his Masters of
Business Administration with the Edinburgh Business School, Heriot-Watt
University Edinburgh, United Kingdom. Mr. Gillan was appointed, in January 2003,
as a director of Afilias, LLC, which DomainPeople, Inc. holds a 2% minority
interest.
Relationships Among Directors or Executive Officers
There are no family relationships among any of the directors or executive
officers of the Company.
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, 2002, its Directors, Executive Officers and greater-than-10% stockholders
complied with all Section 16(a) filing requirements.
38
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") and President or individuals acting in a similar capacity for the
years ended December 31, 2002, 2001 and 2000.
- -----------------------------------------------------------------------------------------------------
Annual Compensation Long Term Compensation
-------------------------------------- ----------------------------------
Awards Payouts
------------------------ --------
Securities
Other Restricted Underlying All Other
Name and Annual Stock Options/ LTIP Compen-
Principal Salary Bonus Compensation Awards SARs Payouts sation
Position Year (USD$) ($) ($) ($) (#) ($) ($)
(a) (b) (c) (d) (e) (f) (g) (h) (i)
- -----------------------------------------------------------------------------------------------------
David 2002 118,441 - - - - - -
Talmor, -------------------------------------------------------------------------------------
Chairman, 2001 96,874 - - - - - -
President, -------------------------------------------------------------------------------------
and Director 2000 105,785 - - - - - -
- -----------------------------------------------------------------------------------------------------
Joseph 2002 118,441 - - - - - -
Kibur,
CEO and 2001 96,874 - - - - - -
Director
2000 55,885 - - - - - -
- -----------------------------------------------------------------------------------------------------
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.
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
The Company has entered into employment contracts with Mr. Talmor, the Company's
Chairman and President, and Mr. Kibur, the Company's Chief Executive Officer.
These employment contracts allow the Company to terminate the individual
executive officer's active employment with the Company for any reason,
39
voluntary or involuntary, with or without cause, by 90-days notice to that
effect in writing. Upon termination, the individual executive officer would be
entitled to 6 months of severance pay.
The Company maintains no formal change of control agreements or arrangements
with individual Company executive officers.
Compensation Committee Interlocks and Insider Participation
The members of the Compensation Committee are Mr. Ernest Cheung and Mr. Anil
Wirasekara. All of the members of the committees are outside directors of the
Company.
Board Compensation Committee Report on Executive Compensation
The Board Compensation Committee was formed March 2000 and consists of Mr.
Ernest Cheung and Mr. Anil Wirasekara. The criteria used to determine the
compensation of the named executive officers includes an evaluation of the
Company's performance in terms of revenue growth and profitability, competitive
salaries for individuals holding similar positions in companies in similar
industries and of similar size, and the requirement to retain key employees of
the Company.
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.
COMPARISON OF CUMULATIVE TOTAL RETURN TO STOCKHOLDERS
SEPTEMBER 30, 1999 TO DECEMBER 31, 2002
[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
January 31, 2002 $ 55.00 $ 70.43 $ 33.00
February 28, 2002 $ 55.00 $ 63.05 $ 26.76
March 31, 2002 $ 56.25 $ 67.20 $ 27.81
April 30, 2002 $ 37.50 $ 61.48 $ 22.39
May 31, 2002 $ 23.00 $ 58.84 $ 21.25
June 30, 2002 $ 19.00 $ 53.28 $ 16.57
July 31, 2002 $ 13.75 $ 48.37 $ 15.45
August 31, 2002 $ 11.25 $ 47.88 $ 15.76
September 30, 2002 $ 11.50 $ 42.68 $ 14.15
October 31, 2002 $ 15.00 $ 48.42 $ 16.91
November 30, 2002 $ 11.75 $ 53.85 $ 19.28
December 31, 2002 $ 12.50 $ 48.63 $ 17.41
42
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
- --------------------------------------------------------------------------------
RELATED SHAREHOLDER MATTERS
- -----------------------------
The following table sets forth certain information regarding the beneficial
ownership of the common stock as of January 30, 2003 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
Title of Class Of Beneficial Owner Ownership Percent of Class(2)
- ----------------------------------------------------------------------------------------------------
Common David Talmor(3) 3,436,524(1) 22.6%
Chairman, President, and Director
- ----------------------------------------------------------------------------------------------------
Common Joseph Kibur(3) 3,575,000 23.5%
CEO and Director
- ----------------------------------------------------------------------------------------------------
Common Ernest Cheung 12,000(4) *
Director
830-789 West Pender Street,
Vancouver, British Columbia, V6C 1H2
- ----------------------------------------------------------------------------------------------------
Common Jag Gillan(3) 25,000(5) *
COO, Secretary and Director
- ----------------------------------------------------------------------------------------------------
Common Calvin Mah(3) 12,000(4) *
CFO
- ----------------------------------------------------------------------------------------------------
Common Anil Wirasekara 12,000(4) *
Director
13800 Commerce Parkway, Richmond,
British Columbia, V6V 2J3
- ----------------------------------------------------------------------------------------------------
Common All Executive Officers and Directors as 7,072,524 46.5%
a Group (6 persons)
- ----------------------------------------------------------------------------------------------------
* Less than one percent.
(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 January 30,
2003 of 15,206,002 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.
(5) Includes 9,000 exercisable options.
43
EQUITY COMPENSATION PLAN INFORMATION
- ------------------------------------
The following table sets forth information as of December 31, 2002 with respect
to compensation plans under which NetNation is authorized to issue shares of its
common stock, aggregated as follows:
- all compensation plans previously approved by security holders; and
- all compensation plans not previously approved by security holders.
(a) (b) (c)
- -------------------------------------------------------------------------------------------------
Plan Category Number of securities to Weighted-average Number of securities
be issued upon exercise exercise price of remaining available for
of outstanding options, outstanding options, future issuance under
warrants and rights warrants and rights equity compensation
plans (excluding
securities reflected in
column (a))
- ----------------------------------------------------------------------------------------------------
Equity compensation
plans approved by 437,000 $ 2.82 1,547,000
security holders
- ----------------------------------------------------------------------------------------------------
Equity compensation
plans not approved by 0 0 0
security holders
- ----------------------------------------------------------------------------------------------------
Total 437,000 $ 2.82 1,547,000
- ----------------------------------------------------------------------------------------------------
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.
CHANGES IN CONTROL
From time to time the Company considers proposals from various parties that
could involve a change in control of the Company if consummated.
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.
ITEM 14: CONTROLS AND PROCEDURES
- ------------------------------------
The Company's Chief Executive Officer, Joseph Kibur, and its Chief Financial
Officer, Calvin Mah, (its principal executive officer and principal financial
officer, respectively) have concluded, based on their evaluation as of a date
within 90 days prior to the filing date of this report, that the Company's
disclosure controls and procedures are effective to ensure that information
required to be disclosed by the Company in the reports filed or submitted by it
under the Securities Exchange Act of 1934, as amended, is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms, and include controls and procedures
designed to ensure that information required to be disclosed by the Company in
such reports is accumulated and communicated to the Company's management,
including the Chief Executive Officer and Chief Financial Officer, as
appropriate to allow timely decisions regarding required disclosure.
44
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect these controls subsequent to the date of
such evaluation including any corrective actions with regard to significant
deficiencies and material weaknesses.
45
PART IV
ITEM 15: 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 January 31, 2003 F-1
Consolidated Balance Sheets as of December 31, 2002 and 2001 F-2
Consolidated Statements of Operations for the years ended December 31, 2002, 2001, and 2000 F-3
Consolidated Statement of Stockholders' Equity for the years ended December 31, 2002, 2001, and 2000 F-4
Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001, and 2000 F-5
Notes to Consolidated Financial Statements F-6
2) REPORTS ON FORM 8-K
On November 13, 2002, NetNation filed a Form 8-K and reported an Item 7
Financial Statements, Pro Forma Financial Information and Exhibits and an Item 9
Other Events and Regulation FD Disclosure
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 Assignment of
Names and Numbers and DomainPeople, Inc.
10.2* Harbour Centre Office Lease
10.3** NetNation Communications, Inc.'s 2000 Stock Option Plan
46
21.1* List of Subsidiaries
99.1 Certification of Joseph Kibur, Chief Executive Officer, dated February 7, 2003 pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
99.2 Certification of Calvin Mah, Chief Financial Officer, dated February 7, 2003 pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Incorporated by reference from the Annual Report on Form 10-K of the Registrant filed with
the Securities and Exchange Commission on March 22, 2002
** Incorporated by reference from the Definitive Proxy Statement of the Registrant 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.
47
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: February 7, 2003.
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 February 7, 2003
- ---------------------- Director
Name: David Talmor
By:/s/ Joseph Kibur Chief Executive Officer and Director February 7, 2003
- ---------------------- (Principal Executive Officer)
Name: Joseph Kibur
By:/s/ Jag Gillan Chief Operating Officer and Secretary and February 7, 2003
- ---------------------- Director
Name: Jag Gillan
By:/s/ Anil Wirasekara Director February 7, 2003
- ----------------------
Name: Anil Wirasekara
By:/s/ Ernest Cheung Director February 7, 2003
- ----------------------
Name: Ernest Cheung
By:/s/ Calvin Mah Chief Financial Officer February 7, 2003
- ---------------------- (Principal Accounting Officer)
Name: Calvin Mah
48
CERTIFICATIONS
I, Joseph Kibur, certify that:
1. I have reviewed this annual report on Form 10-K of NetNation Communications,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: February 7, 2003 /s/ Joseph Kibur
------------------- -------------------------
Joseph Kibur
Chief Executive Officer
49
CERTIFICATIONS
I, Calvin Mah, certify that:
1. I have reviewed this annual report on Form 10-K of NetNation Communications,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: February 7, 2003 /s/ Calvin Mah
------------------- -------------------------
Calvin Mah
Chief Financial Officer
50
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Description Page
- ----------- ----
Independent Auditors' Report dated January 31, 2003 F-1
Consolidated Balance Sheets as of December 31, 2002 and 2001 F-2
Consolidated Statements of Operations for the years ended December 31, 2002, 2001, and 2000 F-3
Consolidated Statement of Stockholders' Equity for the years ended December 31, 2002, 2001, and 2000 F-4
Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001, and 2000 F-5
Notes to Consolidated Financial Statements F-6
51
AUDITORS' REPORT TO THE STOCKHOLDERS
We have audited the consolidated balance sheets of NetNation Communications Inc.
as at December 31, 2002 and 2001, and the consolidated statements of operations,
stockholders' equity and cash flows for each of the years in the three year
period ended December 31, 2002. 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, 2002 and 2001, and the results of its operations and its cash flows
for each of the years in the three year period ended December 31, 2002 in
accordance with accounting principles generally accepted in the United States of
America.
KPMG LLP
Chartered Accountants
Vancouver, Canada
January 31, 2003
F-1
NETNATION COMMUNICATIONS INC.
Consolidated Balance Sheets
(Expressed in United States dollars)
December 31, 2002 and 2001
==========================================================================================
2002 2001
- ------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents $ 3,334,561 $ 1,678,950
Accounts receivable, net of allowance for doubtful accounts
of $27,302 (December 31, 2001 - nil) 97,389 107,208
Prepaid expenses and deposits 216,120 245,733
Deferred expenses 623,363 557,941
Deferred tax asset (note 9) 400,000 250,000
----------------------------------------------------------------------------------------
4,671,433 2,839,832
Deferred expenses 205,676 135,734
Fixed assets, net of accumulated depreciation of $1,772,309
(December 31, 2001 - $1,092,999) (note 4) 482,315 1,050,862
Investments (note 5) 100,000 100,000
- ------------------------------------------------------------------------------------------
$ 5,459,424 $ 4,126,428
==========================================================================================
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued liabilities $ 269,463 $ 235,880
Contingent lease payments (note 12(a)) 381,254 381,254
Customer deposits 58,225 83,335
Deferred revenue 2,103,537 1,934,936
Capital lease liability (note 8) 20,338 19,183
----------------------------------------------------------------------------------------
2,832,817 2,654,588
Deferred revenue 481,581 455,228
Capital lease liability (note 8) 3,983 24,652
Stockholders' equity:
Share capital (note 7):
Authorized: 50,000,000 common shares with a par value of
$0.0001 each
Issued: 15,206,002 common shares (2001 - 15,245,321) 1,521 1,525
Additional paid-in capital (note 7(b)) 5,911,083 5,988,123
Deferred stock-based compensation (note 7(b)) - (287,554)
Accumulated other comprehensive income 14,601 14,601
Deficit (3,786,162) (4,724,735)
----------------------------------------------------------------------------------------
2,141,043 991,960
- ------------------------------------------------------------------------------------------
$ 5,459,424 $ 4,126,428
==========================================================================================
Commitments (note 8)
Contingencies (note 12)
See accompanying notes to consolidated financial statements.
F-2
NETNATION COMMUNICATIONS INC.
Consolidated Statements of Operations
(Expressed in United States dollars)
=====================================================================================================
Years ended December 31,
--------------------------------------
2002 2001 2000
- -----------------------------------------------------------------------------------------------------
Sales $ 6,818,316 $ 6,646,433 $ 5,011,859
Cost of sales 2,286,311 2,079,702 1,812,256
- -----------------------------------------------------------------------------------------------------
Gross profit 4,532,005 4,566,731 3,199,603
Expenses:
Sales and marketing 1,104,018 1,388,643 2,977,927
General and administration 1,956,629 2,037,689 3,352,296
Write-off of advance (note 3) - - 500,000
Depreciation and amortization 682,785 632,482 340,977
---------------------------------------------------------------------------------------------------
3,743,432 4,058,814 7,171,200
- -----------------------------------------------------------------------------------------------------
Net earnings (loss) before income taxes 788,573 507,917 (3,971,597)
Deferred income tax recovery 150,000 250,000 -
- -----------------------------------------------------------------------------------------------------
Net earnings (loss) for the year $ 938,573 $ 757,917 $(3,971,597)
=====================================================================================================
Earnings (loss) per share, basic and diluted $ 0.06 $ 0.05 $ (0.26)
=====================================================================================================
Weighted average shares used in computing earnings
(loss) per share, basic 15,218,131 15,246,145 15,316,804
Weighted average shares used in computing earnings
(loss) per share, diluted 15,218,131 15,306,107 15,316,804
=====================================================================================================
See accompanying notes to consolidated financial statements.
F-3
NETNATION COMMUNICATIONS INC.
Consolidated Statement of Stockholders' Equity
(Expressed in United States dollars)
=================================================================================================================================
Deferred Accumulated
Additional stock- other
paid-in based comprehensive
Shares Amount capital compensation income Deficit Total
- ---------------------------------------------------------------------------------------------------------------------------------
$ $ $ $ $ $
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 on exercise of
stock options 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
Amortization of deferred
stock-based compensation - - - 192,733 - - 192,733
Issuance of common stock
for cash on exercise of stock
options 8,000 1 18,249 - - - 18,250
Issuance of common stock
for cash 10,500 1 104 - - - 105
Cancellation of common stock (57,819) (6) (95,393) 94,821 - - (578)
Net earnings for the year - - - - - 938,573 938,573
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2002 15,206,002 1,521 5,911,083 - 14,601 (3,786,162) 2,141,043
=================================================================================================================================
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,
--------------------------------------
2002 2001 2000
- ----------------------------------------------------------------------------------------------
Cash provided by (used in):
Net earnings (loss) for the year $ 938,573 $ 757,917 $(3,971,597)
Items not involving cash:
Depreciation and amortization 682,785 632,482 340,977
Deferred income tax recovery (150,000) (250,000) -
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 192,733 379,178 432,785
Loss on disposal of fixed assets 2,225 2,867 78,777
Write-off of advance (note 3) - - 500,000
Changes in non-cash operating working capital:
Accounts receivable 9,819 (74,000) (22,247)
Prepaid expenses and deposits 29,613 (113,854) (68,671)
Deferred expenses (135,364) (27,631) (666,044)
Accounts payable and accrued liabilities 33,583 (357,639) 404,372
Contingent lease payments - - 381,254
Customer deposits (25,110) 18,818 64,517
Deferred revenue 194,954 187,835 1,802,322
--------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 1,773,811 1,155,973 (623,555)
Investments:
Advance to ADN (note 3) - - (500,000)
Purchase of fixed assets (121,243) (238,978) (1,414,787)
Purchase of investments - - (100,000)
Proceeds on disposal of fixed assets 4,780 3,720 -
--------------------------------------------------------------------------------------------
Net cash used in investing activities (116,463) (235,258) (2,014,787)
Financing:
Lease financing (19,514) (7,730) 51,565
Issue of share capital, net of share issue costs 18,355 18,000 2,348,942
Repurchase and cancellation of shares (578) (780) (1,497)
--------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities (1,737) 9,490 2,399,010
- ----------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 1,655,611 930,205 (239,332)
Cash and cash equivalents, beginning of year 1,678,950 748,745 988,077
- ----------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $3,334,561 $1,678,950 $ 748,745
==============================================================================================
Supplementary information:
Cash paid for:
Interest $ 6,263 $ 6,830 $ 2,350
Income taxes - - -
Non-cash transactions:
Shares issued to third parties for services - - 100,000
Conversion of debentures to common stock - - 1,100,000
==============================================================================================
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, 2002, 2001, and 2000
- --------------------------------------------------------------------------------
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.
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. (up to November 2001 when the
company was discontinued), 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 and 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, 2002, 2001, and 2000
- --------------------------------------------------------------------------------
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 performs reviews for the impairment of fixed assets
whenever events or 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, 2002, 2001, and 2000.
(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 $411,106,
$509,685, and $1,750,415 during the years ended December 31, 2002,
2001, and 2000, respectively.
F-7
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2002, 2001, and 2000
- --------------------------------------------------------------------------------
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 are 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, 2002, 2001, and 2000
- --------------------------------------------------------------------------------
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, including the estimate of the realizability of the
deferred income tax asset, 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 dollars 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 the accounts 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, 2002, 2001, and 2000
- --------------------------------------------------------------------------------
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:
(i) In June 2001, the FASB issued SFAS 143 "Accounting for Asset
Retirement Obligations." This standard established accounting
standards for the recognition and measurement of an asset
retirement obligation and its associated asset retirement cost.
The adoption of this standard on January 1, 2003 is not expected
to have a material impact on the Company's financial position,
cash flows or results of operations.
(ii) In April 2002, the FASB issued SFAS 145 "Rescission of SFAS 4, 44
and 64, Amendment of SFAS 13 and Technical Corrections." This
standard rescinds SFAS 4, which required all gains and losses
from extinguishment of debt to be aggregated and, if material,
classified as an extraordinary item, net of related income tax
effect. The standard also amends SFAS 13 to require that certain
lease modifications that have economic effects similar to
sale-leaseback transactions be accounted for in the same manner
as sale-leaseback transactions. The adoption of this standard
will have no impact on the Company's financial position, cash
flows or results of operations.
(iii) In July 2002, the FASB issued SFAS 146 "Accounting for Costs
Associated with Exit or Disposal Activities". This standard
addresses financial accounting and reporting for costs associated
with exit or disposal activities and nullifies Emerging Issues
Task Force ("EITF") Issue 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)".
The principal difference is that SFAS 146 requires that a
liability for a cost associated with an exit or disposal activity
be recognized when the liability is incurred versus on the date
of an entity's commitment to an exit plan. SFAS 146 also
establishes that fair value is the objective for initial
measurement of the liability. The adoption of this standard on
January 1, 2003, is not expected to have a material impact on the
Company's financial position, cash flows or results of
operations.
F-10
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2002, 2001, and 2000
- --------------------------------------------------------------------------------
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(o) Recent accounting pronouncements:
(iv) In November 2002, the EITF reached a consensus on Issue
00-21,"Multiple Element Arrangements". This issue addresses how
to account for arrangements that may involve the delivery or
performance of multiple products, services and/or rights to use
assets. The guidance can affect the timing of revenue recognition
for such arrangements. The final consensus will be applicable to
agreements entered into after June 15, 2003. The Company does not
expect this issue to have a material impact on its financial
position, cash flows or results of operations.
(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-11
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2002, 2001, and 2000
- --------------------------------------------------------------------------------
4. FIXED ASSETS:
=================================================================
Accumulated Net book
2002 Cost depreciation value
-----------------------------------------------------------------
Computer hardware $ 1,880,047 $ 1,500,811 $ 379,236
Computer software 115,184 97,858 17,326
Furniture 71,595 49,551 22,044
Office equipment 168,795 112,970 55,825
Leasehold improvements 19,003 11,119 7,884
-----------------------------------------------------------------
$ 2,254,624 $ 1,772,309 $ 482,315
=================================================================
=================================================================
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
=================================================================
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 .info and .org 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, 2002 as it has not
made further investments. The carrying value of the investment at December
31, 2002 is $100,000.
6. DEBENTURES PAYABLE:
As a condition of a capital transaction in a prior year, 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-12
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2002, 2001, and 2000
- --------------------------------------------------------------------------------
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 and expired unexercised in 2002.
(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-13
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2002, 2001, and 2000
- --------------------------------------------------------------------------------
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, 2002, 159,000 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
Cancelled (35,000) 2.25
Cancelled (24,000) 2.31
Cancelled (8,000) 4.63
Expired (100,000) 2.25
Expired (24,000) 4.13
Expired (88,000) 4.63
Exercised (4,000) 2.25
Exercised (4,000) 2.31
--------------------------------------------------------------------------
Outstanding, December 31, 2002 437,000 $ 2.82
==========================================================================
The options outstanding at December 31, 2002 expire between February
1, 2003 and January 9, 2006.
F-14
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2002, 2001, and 2000
- --------------------------------------------------------------------------------
7. SHARE CAPITAL (CONTINUED):
(b) Stock option compensation plan (continued):
(ii) Additional information regarding options outstanding as at
December 31, 2002 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 1.62 $ 2.13 12,000 $ 2.13
2.25 57,000 1.52 2.25 17,000 2.25
2.25 78,000 2.02 2.25 26,000 2.25
2.31 158,000 1.38 2.31 104,000 2.31
4.13 24,000 0.48 4.13 - -
4.63 84,000 0.09 4.63 - -
- --------------------------------------------------------------------
437,000 1.23 $ 2.82 159,000 $ 2.28
====================================================================
(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 $192,733 during the year ended December 31, 2002 (2001
- $379,178; 2000 - $432,785).
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:
==============================================================================
2002 2001 2000
- ------------------------------------------------------------------------------
Net earnings (loss) for the year:
As reported $938,573 $757,917 $(3,971,597)
Proforma 737,618 242,573 (5,272,830)
Basic and diluted earnings (loss) per share:
As reported $ 0.06 $ 0.05 $ (0.26)
Proforma 0.05 0.02 (0.34)
==============================================================================
F-15
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2002, 2001, and 2000
- --------------------------------------------------------------------------------
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%
==========================================================================
No options were granted during the year ended December 31, 2002.
8. COMMITMENTS AND CAPITAL LEASE LIABILITY:
The Company leases its Vancouver, Canada premises under an operating lease
agreement which expires April 30, 2003 and may be renewed for a term of one
additional year and a term of three additional years, at the Company's
option. The rent expense, including operating expenses, under this lease
for the years ended December 31, 2000, 2001, and 2002, totaled $297,148,
$312,251 and $245,174, 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 2003 of
approximately $36,000.
Future minimum commitments under non-cancelable capital leases at December
31, 2002 are as follows:
===================================================
2003 $22,456
2004 4,528
- ---------------------------------------------------
Total lease payments 26,984
Amount representing interest 2,663
- ---------------------------------------------------
Present value of capital lease obligations 24,321
Current portion 20,338
- ---------------------------------------------------
$ 3,983
===================================================
Computer hardware capitalized under non-cancelable capital leases amounted
to $75,522 as at December 31, 2002 and 2001, respectively. Accumulated
depreciation related to these capitalized assets amounted to $51,131 and
$25,957 as at December 31, 2002 and 2001, respectively.
F-16
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2002, 2001, and 2000
- --------------------------------------------------------------------------------
9. INCOME TAXES:
Income taxes attributable to net earnings (loss) in these financial
statements differ from amounts computed by applying the U.S. federal rate
of 34% (2001 - 34%, 2000 - 34%) as follows:
======================================================================================
2002 2001 2000
- --------------------------------------------------------------------------------------
Net earnings (loss) before income taxes $ 788,573 $ 507,917 $(3,971,597)
- --------------------------------------------------------------------------------------
Expected tax expense (recovery) $ 268,115 $ 172,692 $(1,350,343)
Tax effect of:
Earnings (loss) of foreign subsidiary taxed
at higher rate 36,232 29,338 (138,459)
Permanent and other differences 140,653 638,970 (45,198)
Change in valuation allowance (595,000) (1,091,000) 1,534,000
- --------------------------------------------------------------------------------------
$(150,000) $ (250,000) $ -
======================================================================================
Significant components of the Company's deferred tax assets at December 31,
2002 and 2001 are as follows:
============================================================
2002 2001
- ------------------------------------------------------------
Deferred tax assets:
Net operating loss carryforwards $ 433,000 $ 625,000
Fixed assets 247,000 481,000
Deferred revenue 158,000 87,000
Contingent lease payments 94,000 94,000
Share issuance costs - 24,000
----------------------------------------------------------
Gross deferred tax assets 932,000 1,311,000
Valuation allowance (462,000) (1,057,000)
- ------------------------------------------------------------
Total deferred tax assets 470,000 254,000
Deferred tax liability:
Deferred expenses (70,000) (4,000)
- ------------------------------------------------------------
Deferred tax asset $ 400,000 $ 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, 2002 was
$1,057,000. The net change in the total valuation allowance for the year
ended December 31, 2002 was a decrease of $595,000.
As of December 31, 2002, the Company has Canadian tax loss carryforwards of
approximately $791,000 available to reduce the future years' income for tax
purposes. These carryforward losses expire in 2006 to 2007.
As of December 31, 2002, the Company has U.S. tax loss carryforwards of
approximately $352,000 available to reduce the future years' income for tax
purposes. These carryforward losses expire in 2020.
F-17
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2002, 2001, and 2000
- --------------------------------------------------------------------------------
10. SEGMENTED INFORMATION:
The Company operates 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.
The Company's revenues are generated from the following business segments:
================================================================================
2002 2001 2000
- --------------------------------------------------------------------------------
Web hosting $4,557,347 $4,530,923 $3,721,519
Domain name registration 2,260,969 2,115,510 1,290,340
- --------------------------------------------------------------------------------
$6,818,316 $6,646,433 $5,011,859
================================================================================
The Company's gross profits are generated from the following business segments:
================================================================================
2002 2001 2000
- --------------------------------------------------------------------------------
Web hosting $3,368,763 $3,283,357 $2,478,708
Domain name registration 1,163,242 1,283,374 720,895
- --------------------------------------------------------------------------------
$4,532,005 $4,566,731 $3,199,603
================================================================================
The Company's revenues are generated from the following geographic segments:
================================================================================
2002 2001 2000
- --------------------------------------------------------------------------------
United States $2,744,106 $2,849,867 $2,538,673
Canada 2,940,240 2,387,953 1,427,849
Other 1,133,970 1,408,613 1,045,337
- --------------------------------------------------------------------------------
$6,818,316 $6,646,433 $5,011,859
================================================================================
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, 2002.
The Company does not allocate assets to business segments.
F-18
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2002, 2001, and 2000
- --------------------------------------------------------------------------------
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
are accrued in the consolidated financial statements as at December
31, 2002 and 2001, and a gain will be recognized in the event of a
favorable outcome.
F-19
NETNATION COMMUNICATIONS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
Years ended December 31, 2002, 2001, and 2000
- --------------------------------------------------------------------------------
12. CONTINGENCIES (CONTINUED):
(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 and the Company has
not accrued any amount in respect of this lawsuit in the financial
statements. 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.
In December, 2002 a settlement of the suit was proposed whereby
NeuLevel, Inc. would refund any remaining pre-registration fees not
previously refunded and pay plaintiff's attorney's fees of up to
$1,175,000. A hearing to consider the proposed settlement is scheduled
for March 17, 2003 in the Superior Court of California for the County
of Los Angeles. It is not known what the effect, if any, of the
settlement, if approved, will be to DomainPeople, Inc.
F-20
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 Assignment of 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
99.1 Certification of Joseph Kibur, Chief Executive Officer, dated
February 7, 2003 pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of Calvin Mah, Chief Financial Officer, dated
February 7, 2003 pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Incorporated by reference from the Annual Report on Form 10-K of
the Registrant filed with the Securities and Exchange Commission
on March 22, 2002
** 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.
F-21