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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(MARK ONE)
[x] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: JUNE 30, 2003
-------------
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER: 000-26881
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NETNATION COMMUNICATIONS, INC.
-------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 33-08034 38
--------------------------- ------------------------
(State or other jurisdiction (I.R.S. Employer I.D. No.)
of incorporation or organization)
1410 - 555 WEST HASTINGS STREET
VANCOUVER, BRITISH COLUMBIA, CANADA V6B 4N6
--------------------------------------- --------
(Address of principal executive offices) (Zip Code)
604/688-8946
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports 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 [ ]
The number of shares of the registrant's Common Stock outstanding as of August
1, 2003 was 6,083,000.
NETNATION COMMUNICATIONS, INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2003
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2003 (unaudited)
and December 31, 2002 (audited) 3
Condensed Consolidated Statements of Operations and Deficit for the Three Month
and Six Month Periods Ended June 30, 2003 (unaudited) and 2002 (unaudited) 4
Condensed Consolidated Statement of Stockholders' Equity for the Six Month
Period Ended June 30, 2003 (unaudited) 5
Condensed Consolidated Statements of Cash Flows for the Six Month Periods
Ended June 30, 2003 (unaudited) and 2002 (unaudited) 6
Condensed Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 14
Item 4. Controls and Procedures 15
PART II. OTHER INFORMATION
Item 1. Legal proceedings 15
Item 4. Submission of matters to a vote of security holders 15
Item 6. Exhibits and Reports on Form 8-K 16
Signatures 17
Certifications 18
2
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NETNATION COMMUNICATIONS, INC.
Condensed Consolidated Balance Sheets
(Expressed in U.S. dollars)
June 30, December 31,
2003 2002
------------ --------------
(unaudited) (audited)
ASSETS
Current assets:
Cash and cash equivalents $ 3,804,746 $ 3,334,561
Accounts receivable, net of allowance for doubtful accounts
of $nil (December 31, 2002 - $27,302) 114,218 97,389
Prepaid expenses and deposits 207,651 216,120
Deferred expenses 662,144 623,363
Deferred tax asset 400,000 400,000
------------ --------------
5,188,759 4,671,433
Deferred expenses 255,627 205,676
Fixed assets, net of accumulated depreciation of $2,042,737
(December 31, 2002 - $1,772,309) 497,051 482,315
Investments 100,000 100,000
------------ --------------
$ 6,041,437 $ 5,459,424
============ ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 380,827 $ 269,463
Contingent lease payments (Note 5(b)) 381,254 381,254
Customer deposits 59,373 58,225
Deferred revenue 2,212,601 2,103,537
Capital lease liability 15,201 20,338
------------ --------------
3,049,256 2,832,817
Deferred revenue 584,311 481,581
Capital lease liability 1,420 3,983
Stockholders' equity:
Share capital
Authorized:
50,000,000 common shares with a par value of $0.0001 each
Issued:
6,083,000 (December 31, 2002 - 6,083,000) common shares 608 608
Additional paid-in capital 5,911,996 5,911,996
Accumulated other comprehensive income 14,601 14,601
Deficit (3,520,755) (3,786,162)
------------ --------------
2,406,450 2,141,043
------------ --------------
$ 6,041,437 $ 5,459,424
============ ==============
See accompanying condensed notes to consolidated financial statements.
3
NETNATION COMMUNICATIONS, INC.
Condensed Consolidated Statements of Operations and Deficit
(Expressed in U.S. dollars)
Three month period ended June 30, Six month period ended June 30,
2003 2002 2003 2002
----------------- ------------------- --------------- -------------------
(unaudited) (unaudited) (unaudited) (unaudited)
Sales $ 1,924,951 $ 1,740,954 $ 3,737,993 $ 3,427,385
Cost of sales 672,687 574,743 1,293,807 1,117,815
----------------- ------------------- --------------- -------------------
Gross profit 1,252,264 1,166,211 2,444,186 2,309,570
Expenses:
Sales and marketing 333,616 252,905 658,591 519,154
General and administration 603,563 515,624 1,088,733 1,011,626
Foreign currency translation losses 117,718 27,617 121,813 38,595
Bad debt expense - 27,026 7,012 27,026
Gain on disposal of fixed assets - - (9,836) -
Depreciation and amortization 137,530 191,332 312,466 347,141
----------------- ------------------- --------------- -------------------
1,192,427 1,014,504 2,178,779 1,943,542
----------------- ------------------- --------------- -------------------
Net earnings 59,837 151,707 265,407 366,028
Deficit, start of period (3,580,592) (4,510,414) (3,786,162) (4,724,735)
----------------- ------------------- --------------- -------------------
Deficit, end of period $ (3,520,755) $ (4,358,707) $ (3,520,755) $ (4,358,707)
================= =================== =============== ===================
Earnings per share, basic and diluted $ 0.01 $ 0.02 $ 0.04 $ 0.06
================= =================== =============== ===================
Weighted average number of common
shares outstanding, basic 6,083,000 6,087,201 6,083,000 6,088,816
================= =================== =============== ===================
Weighted average number of common
shares outstanding, diluted 6,083,000 6,087,201 6,083,000 6,088,816
================= =================== =============== ===================
See accompanying condensed notes to consolidated financial statements.
4
NETNATION COMMUNICATIONS, INC.
Condensed Consolidated Statement of Stockholders' Equity
(Expressed in U.S. Dollars)
Six month period ended June 30, 2003
(Unaudited)
Accumulated
Common Stock Additional Other
---------------------- Paid-In Comprehensive
Shares Amount Capital Income Deficit Total
------------ -------- -------------- ------------- ------------ ----------
Balance at
December 31, 2002 6,083,000 $ 608 $ 5,911,996 $ 14,601 $(3,786,162) $2,141,043
Net earnings and
comprehensive income - - - - 265,407 265,407
------------ -------- -------------- ------------- ------------ ----------
Balance at
June 30, 2003 6,083,000 $ 608 $ 5,911,996 $ 14,601 $(3,520,755) $2,406,450
============ ======== ============== ============= ============ ==========
See accompanying condensed notes to consolidated financial statements.
5
NETNATION COMMUNICATIONS, INC.
Condensed Consolidated Statements of Cash Flows
(Expressed in U.S. dollars)
Six month Six month
period ended period ended
June 30, June 30,
2003 2002
-------------- --------------
(unaudited) (unaudited)
Cash provided by (used in):
Net earnings $ 265,407 $ 366,028
Items not involving cash:
Depreciation and amortization 312,466 347,141
Employee stock-based compensation - 116,227
Foreign currency translation losses 121,813 38,595
Bad debt expense 7,012 -
Gain on disposal of fixed assets (9,836) -
Changes in non-cash operating working capital:
Accounts receivable (9,320) 29,563
Prepaid expenses and deposits 25,516 44,526
Deferred expenses (81,531) (125,124)
Accounts payable and accrued liabilities 68,973 (16,854)
Deferred revenue 79,579 37,345
Customer deposits 1,148 (17,638)
-------------- --------------
Net cash provided by operating activities 781,227 819,809
-------------- --------------
Investing:
Purchase of fixed assets (331,342) (60,071)
Proceeds on disposal of fixed assets 13,974 -
-------------- --------------
Net cash used in investing activities (317,368) (60,071)
-------------- --------------
Financing:
Issue of share capital, net of share issue costs - 22,640
Lease financing (11,037) (11,400)
Repurchase and cancellation of shares - (458)
-------------- --------------
Net cash provided by (used in) financing activities (11,037) 10,782
-------------- --------------
Effect of exchange rates on cash 17,363 61,775
-------------- --------------
Increase in cash and cash equivalents 470,185 832,295
Cash and cash equivalents, beginning of period 3,334,561 1,678,950
-------------- --------------
Cash and cash equivalents, end of period $ 3,804,746 $ 2,511,245
============== ==============
Supplemental disclosure:
Cash paid for:
Interest $ 2,358 $ 3,676
Income taxes $ - $ -
See accompanying condensed notes to consolidated financial statements.
6
NETNATION COMMUNICATIONS, INC.
Condensed Notes to Consolidated Financial Statements
(Expressed in U.S. dollars)
Six month periods ended June 30, 2003 and 2002
(Unaudited)
GENERAL:
NetNation Communications, Inc. (the "Company") was incorporated on May 7,
1998 under the laws of the State of Delaware.
On November 24, 1999, DomainPeople Inc. ("DomainPeople"), a wholly-owned
subsidiary of the Company, 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.
On June 11, 2003, the Company entered into an agreement and plan of merger
with Hostway Corporation, a private corporation, in which Hostway seeks to
acquire all of NetNation's outstanding shares for cash. In return for all
outstanding shares, NetNation's shareholders will collectively receive
$10,036,950 in cash or $1.65 per share based on the post reverse stock
split (see Note 2) number of shares outstanding. The transaction is
expected to close in August 2003. The Board of Directors of the Company has
received a favorable fairness opinion from BDO Valuation Inc. ("BDO"), a
wholly owned subsidiary of BDO Dunwoody LLP Chartered Accountants and
Consultants, for the planned merger. The fairness opinion was dated July
10, 2003. BDO's opinion was that, as of the date of the opinion, the merger
consideration of $1.65 per share, post-consolidation, was fair from a
financial point of view to NetNation's stockholders.
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.
1. BASIS OF PRESENTATION:
These interim condensed consolidated financial statements have been
prepared using generally accepted accounting principles in the United
States. The interim financial statements include all adjustments,
consisting solely of normal recurring adjustments, which in management's
opinion are necessary for fair presentation of the financial results for
interim periods. The financial statements have been prepared consistent
with the accounting policies described in the Company's annual audited
financial statements. Reference should be made to those statements included
with the Company's annual report filed on Form 10-K. Certain comparative
figures have been reclassified to conform to the presentation adopted in
the current period.
These condensed consolidated financial statements include the accounts of
the Company's wholly owned subsidiaries, NetNation Communications Inc.,
NetNation Communications (USA) Inc., and DomainPeople Inc. All material
intercompany balances and transactions have been eliminated.
2. SIGNIFICANT ACCOUNTING POLICIES:
Stock option plan:
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("FAS No. 123"), and Statement of Financial
Accounting Standards No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure -
7
an Amendment of FASB Statement No. 123," ("FAS No. 148"), established
accounting and disclosure requirements using a fair value-based method of
accounting for stock-based employee compensation plans. However, as allowed
by FAS No. 123, the Company has elected to continue to apply the intrinsic
value-based method of accounting described below, and has adopted the
disclosure requirements of FAS No. 123 and FAS No. 148.
The Company applies the intrinsic value-based method of accounting
prescribed by APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations, including FASB Interpretation No.
44, "Accounting for Certain Transactions involving Stock Compensation, an
interpretation of APB Opinion No. 25," to account for its fixed plan
employee stock options. Under this method, compensation expense is recorded
on the date of grant only if the current market price of the underlying
stock exceeds the exercise price. Any compensation expense recorded is
charged against operations over the service period, which generally matches
the option vesting period. No stock-based employee compensation cost was
recorded for the three months ended and six months ended June 30, 2003, and
June 30, 2002, as all options granted under the Company's stock option plan
had an exercise price equal to or greater than the market value of the
underlying Common stock on the grant date. The following table illustrates
the effect on net income and net income per share, if the Company had
applied the fair value recognition provisions of FAS No. 123 to stock-based
employee compensation using the Black-Scholes option pricing methodology.
======================================================================================================
Three months ended June 30, Six months ended June 30,
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------
Net earnings for the period:
As reported $ 59,837 $ 151,707 $ 265,407 $ 366,028
Total stock-based employee
compensation expense
determined under fair value-
based method - (50,258) (139,634) (100,516)
- ------------------------------------------------------------------------------------------------------
Proforma $ 59,837 $ 101,449 $ 125,773 $ 265,512
- ------------------------------------------------------------------------------------------------------
Basic and diluted earnings per share:
As reported $ 0.01 $ 0.02 $ 0.04 $ 0.06
Proforma 0.01 0.02 0.02 0.04
- ------------------------------------------------------------------------------------------------------
Reverse stock split:
On June 12, 2003, the Company's shareholders approved a one-for-two and one
half (1:2 1/2) reverse stock split of the Company's outstanding common
stock. The reverse stock split was effected after the market close on June
13, 2003, thereby reducing 15,206,002 shares of issued common stock to
6,083,000 shares, of which six hundred (600) shares were issued on the
rounding up of fractional shares. The par value of the common stock was not
affected by the reverse stock split and remained at $0.0001 per share after
the reverse stock split. Consequently, the aggregate par value of the
issued common stock was reduced affecting the stockholder's equity section
of the balance sheet due to reclassifying the par value amount of the
reversed common shares from common stock to additional paid-in capital for
all periods presented. All per share amounts and outstanding shares,
including all common stock equivalents (stock options), have been
retroactively restated in the financial statements for all periods
presented to reflect the reverse stock split.
8
3. STOCK OPTIONS:
On February 14, 2003, the Company's Board of Directors approved the
immediate vesting of all non-vested stock options and that all options
would expire 30 days from that date if not exercised. On March 16, 2003,
all options unexercised at that date expired.
A summary of the Company's stock option activity is as follows:
=================================================================
Number of Weighted average
common shares exercise price
-----------------------------------------------------------------
Outstanding, December 31, 2002 174,800 $ 7.05
Cancelled (2,400) 5.63
Cancelled (12,000) 5.78
Cancelled (6,400) 11.58
Expired (14,400) 5.33
Expired (51,600) 5.63
Expired (51,200) 5.78
Expired (9,600) 10.33
Expired (27,200) 11.58
-----------------------------------------------------------------
Outstanding, June 30, 2003 - $ -
=================================================================
4. 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:
======================================================================================
Three months ended June 30, Six months ended June 30,
2003 2002 2003 2002
- --------------------------------------------------------------------------------------
Web hosting $ 1,293,239 $ 1,145,651 $ 2,506,973 $ 2,305,800
Domain name registration 631,712 595,303 1,231,320 1,121,585
- --------------------------------------------------------------------------------------
$ 1,924,951 $ 1,740,954 $ 3,737,993 $ 3,427,385
- --------------------------------------------------------------------------------------
The Company's gross profits are generated from the following business
segments:
======================================================================================
Three months ended June 30, Six months ended June 30,
2003 2002 2003 2002
- --------------------------------------------------------------------------------------
Web hosting $ 924,766 $ 843,942 $ 1,809,030 $ 1,726,128
Domain name registration 327,498 322,269 635,156 583,442
- --------------------------------------------------------------------------------------
$ 1,252,264 $ 1,166,211 $ 2,444,186 $ 2,309,570
- --------------------------------------------------------------------------------------
9
All of the Company's assets were located in Canada as at June 30, 2003.
5. COMMITMENTS AND CONTINGENCIES:
(a) The Company is committed to total operating lease payments for rent
for the remainder of 2003 and 2004 of approximately $63,000 and
$42,000, respectively.
(b) As at December 1, 2000, the Company discontinued lease payments on the
San Diego premises due to a number of circumstances. To date, the
landlord has not commenced legal action against the Company. Should
the landlord commence legal action against the Company, the outcome of
the proceedings is unknown. The remaining lease payments of $381,254
were accrued in the consolidated financial statements as at December
31, 2000, and a gain will be recognized in the event of a favorable
outcome.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
All share and per share amounts discussed in this Quarterly Report have been
adjusted to reflect the one-for-two and one-half reverse stock split effected on
June 13, 2003. See Note 2 to the consolidated financial statements "Significant
Accounting Policies".
The following discussion should be read in conjunction with our condensed
unaudited financial statements contained in Item 1 of this quarterly report on
Form 10-Q and audited consolidated financial statements contained in our annual
report on Form 10-K for the fiscal year ended December 31, 2002. Except for the
historical information presented in this document, the matters discussed in this
Form 10-Q, and specifically in the section entitled "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 us. These forward-looking
statements involve risks and uncertainties, including those identified within
the section entitled "Risk Factors" in our Form 10-K for the fiscal year ended
December 31, 2002. The actual results that we achieve may differ materially from
any forward-looking projections due to such risks and uncertainties. These
forward-looking statements are based on current expectations, and we assume 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 us in this quarterly report
on Form 10-Q, our annual report on Form 10-K for the fiscal year ended December
31, 2002 and in our other reports filed with the Securities and Exchange
Commission that attempt to advise interested parties of the risks and factors
that may affect our business.
PLANNED MERGER
On June 11, 2003, the Company entered into an agreement and plan of merger with
Hostway Corporation, a private corporation, in which Hostway seeks to acquire
all of NetNation's outstanding shares for cash. In return for all outstanding
shares, NetNation's shareholders will collectively receive $10,036,950 in cash
or $1.65 per share based on the post reverse stock split number of shares
outstanding. The transaction is expected to close in August 2003. The Board of
Directors of the Company has received a favorable fairness opinion from BDO
Valuation Inc. ("BDO"), a wholly owned subsidiary of BDO Dunwoody LLP Chartered
Accountants and Consultants, for the planned merger. The fairness opinion was
dated July 10, 2003. BDO's opinion was that, as of the date of the opinion, the
merger consideration of $1.65 per share, post-consolidation, was fair from a
financial point of view to NetNation's stockholders. Assuming our stockholders
approve the merger with Hostway, NetNation will cease to be a publicly-traded
company when the merger transaction closes.
10
OVERVIEW
We are 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. We compete
in the web hosting and domain name registration markets. Our products and
services are sold worldwide, directly to customers and through value added
resellers ("VARs").
We began providing web hosting services in February 1997. In May 1999, we were
selected as an official registrar of domain names by ICANN. The accreditation
allows us to register top-level domain names ("TLDs") ending in .com, .net,
..org, .info, .biz, and .name. Through our wholly-owned subsidiary, DomainPeople,
we became operational as a domain name registrar in December of 1999.
We generate revenue by providing web hosting services to SMEs and domain name
registration. Our web hosting customers normally pay a setup fee and regular
charges, either monthly, quarterly, twice-yearly, or annually, thereafter. We
offer 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.
We generally collect web hosting service fees in advance, and recognize 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, we 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 our services decides to use another web hosting
service provider. Web hosting expenses are largely paid currently.
Our accreditation as an official registrar of domain names has enabled us to
register domain names without the involvement of an intermediary. As an
accredited registrar, we have assumed responsibility for ensuring that current
information obtained from customers is supplied to the central registry. We
generally collect domain name registration fees in advance, and recognize
revenue on a straight-line basis over the period for which the name is
registered. As a result, we will generally have a significant amount of
deferred revenue attributable to domain name registration services. An increase
in the number of domain names that we register will generally produce a
corresponding increase in revenues, subject to changes in the price charged for
the service. The domain name registration fee that we pay 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, we 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 our customers. Domain 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 require our most
significant judgment and estimates used in the preparation of the consolidated
financial statements. Deferred tax liabilities and assets are recognized for
11
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 carryforwards. 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%.
RESULTS OF OPERATIONS
For the quarter ended June 30, 2003, we achieved net earnings of $59,837 ($0.01
per share) as compared to $151,707 ($0.02 per share) for the same period in 2002
and for the six month period ended June 30, 2003, net earnings of $265,407
($0.04 per share) as compared to $366,028 ($0.06 per share) for the same period
in 2002.
Revenue
Our revenue of $1,924,951 for the quarter ended June 30, 2003 represents an
increase of $183,997 or 11% over the quarter ended June 30, 2002. For the six
months ended June 30, 2003, revenue of $3,737,993 was an increase of $310,608 or
9% over the same period in 2002. The increase was due to increases in both our
web hosting business and domain name registration business.
The following table compares the composition of sales for the three and six
months ended June 30, 2003 to the same period in 2002:
Sales Three months ended June 30, Six months ended June 30,
------------------------------ ----------------------------
2003 2002 2003 2002
------------- --------------- ----------- ---------------
Web hosting 67% 66% 67% 67%
Domain name registration 33% 34% 33% 33%
------------- --------------- ----------- ---------------
Total sales 100% 100% 100% 100%
------------- --------------- ----------- ---------------
The deferred revenue amount on the balance sheet as at June 30, 2003 includes
$2,071,806 related to domain name registration and $725,106 related to web
hosting services.
Cost of sales
Cost of sales of $672,687 for the quarter ended June 30, 2003 represents an
increase of $97,944 or 17% over the quarter ended June 30, 2002. For the six
months ended June 30, 2003, cost of sales of $1,293,807 represents an increase
of $175,992 or 16% over the same period in 2002. As a percentage of sales, cost
12
of sales increased from 33% to 35% from the second quarter of 2002 to the same
period in 2003. As a percentage of sales, cost of sales increased from 33% to
35% from the first six months of 2002 compared to the same period in 2003. The
increase in costs was mainly due to increased personnel costs, increased
bandwidth usage, and the costs to register an increased number of domain names.
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 our customers. Domain name registration fees paid to
the central registries are recognized as an expense over the term of
registration.
Sales and marketing expenses
Sales and marketing expenses for the quarter ended June 30, 2003 increased
$80,711 or 32% from the same period in 2002. For the six months ended June 30,
2003, sales and marketing expenses increased $139,437 or 27% from the same
period in 2002. As a percentage of sales, sales and marketing expenses increased
from 15% in the second quarter of 2002 to 17% in the second quarter of 2003. As
a percentage of sales, sales and marketing expenses increased from 15% in the
first six months of 2002 to 18% in the first six months of 2003. This increase
was due to an increase in advertising expenses of $84,467 or 118% in the second
quarter of 2003 compared to the same period in 2002 and an increase of $139,241
or 86% for the first six months of 2003 compared to the same period in 2002.
This increase in advertising expenses was directed at various online forms of
advertising. Sales and marketing expense consists mainly of salaries, bonuses,
commissions and advertising costs.
General and administration expenses
General and administration expenses for the quarter ended June 30, 2003
increased $87,939 or 17% over the same period in 2002. For the six month period
ended June 30, 2003, general and administration expenses increased $77,107 or 8%
over the same period in 2002. As a percentage of sales, general and
administration expenses increased from 30% in the second quarter of 2002 to 31%
in the second quarter of 2003. As a percentage of sales, general and
administration expenses decreased from 30% in the first six months of 2002 to
29% in the first six months of 2003. The dollar increase was mainly due to
higher legal and professional fees associated with our planned merger with
Hostway Corporation. General and administrative expenses include administrative
personnel costs, rent, general office expenses, audit and legal costs, and
investor relations expenses.
Foreign currency translation losses
Foreign currency translation losses for the quarter ended June 30, 2003 of
$117,718 represents an increase of $90,101 or 326% over the same period in 2002.
For the six month period ended June 30, 2003, foreign currency translation
losses of $121,813 represents an increase of $83,218 or 216% over the same
period in 2002. These foreign currency translation losses are due to the
significant change in the US dollar to Canadian dollar exchange rate experienced
in the last six months. Currently we do not hedge against our exposure to
foreign currency risk.
Depreciation and amortization
Depreciation and amortization for the second quarter of 2003 decreased $53,802
or 28% as compared to the second quarter of 2002. For the six month period
ended June 30, 2003, depreciation decreased $34,675 or 10% as compared to the
same period in 2002. The decrease in depreciation and amortization expense was
due to the fixed assets acquired in 2000 reaching the end of their three-year
amortization period.
LIQUIDITY AND CAPITAL RESOURCES
During the six months ended June 30, 2003, operating activities generated net
cash of $781,227 compared to $819,809 for the same period in 2002. The main
reason for the decrease in cash from operations was the increase in cash
expenses including higher advertising expenses, and higher legal and
professional fees from the planned merger with Hostway Corporation.
13
During the six months ended June 30, 2003, the Company purchased fixed assets
totaling $331,342 compared to $60,071 for the same period in 2002. These
expenditures relate mainly to the network operations center and were for
customer-specific requirements and general improvements to our data center. We
have no contractual obligations to make further capital expenditures, but
similar costs may be incurred in the future for expanding the network operations
center when appropriate.
Net cash used in financing activities for the six months ended June 30, 2003 was
$11,037 compared to net cash provided by financing activities of $10,782 for the
same period in 2002. In 2002, $22,640 was raised from the exercise of stock
options by employees.
As at June 30, 2003, the Company has cash and cash equivalents of $3,804,746
compared to $3,334,561 as at December 31, 2002. The increase reflects positive
cash flows from operations for the first six months of 2003 after expenditures
on fixed assets. 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.
On June 12, 2003, the Company's shareholders approved a one-for-two and one half
(1:2 1/2) reverse stock split of the Company's outstanding common stock. The
reverse stock split was effected after the market close on June 13, 2003,
thereby reducing 15,206,002 shares of issued common stock to 6,083,000 shares,
of which six hundred (600) shares were issued on the rounding up of fractional
shares. The par value of the common stock was not affected by the reverse stock
split and remained at $0.0001 per share after the reverse stock split.
Consequently, the aggregate par value of the issued common stock was reduced
affecting the stockholder's equity section of the balance sheet due to
reclassifying the par value amount of the reversed common shares from common
stock to additional paid-in capital for all periods presented. All per share
amounts and outstanding shares, including all common stock equivalents (stock
options), have been retroactively restated in the financial statements for all
periods presented to reflect the reverse stock split.
On July 8, 2002, we received a Letter of Notice from Nasdaq indicating that we
were not in compliance with the minimum USD$1.00 per share bid price requirement
for continued inclusion under Nasdaq Marketplace Rule 4310(c)(4), and therefore,
in accordance with Marketplace Rule 4310(c)(8)(D), were provided with 180
calendar days, or until January 6, 2003, to regain compliance. We did not
regain compliance by January 6, 2003. On January 7, 2003, we were notified by
Nasdaq that we did not meet listing requirements for the Nasdaq SmallCap Market
at that time as we were not in compliance with the US$1.00 minimum bid price.
We requested to appeal our case before the Nasdaq Qualifications Panel for
continued listing on the Nasdaq SmallCap Market and the hearing was held on
February 13, 2003. The Qualifications panel granted us an extension to July 3,
2003 to regain compliance with the minimum USD$1.00 per share bid price. On
June 12, 2003, at the Company's annual general meeting, the shareholders of the
Company approved a proposal to amend our certificate of incorporation to give
our Board of Directors discretion to effect a one for two and one-half (1:2.5)
reverse stock split to attempt to come into compliance with the minimum USD$1.00
per share bid price requirement. The reverse stock split took effect on June
13, 2003. On July 7, 2003, we received a Letter of Notice from Nasdaq stating
that the Company has demonstrated compliance with the minimum closing bid price
requirement of US$1.00 per share for ten consecutive trading days, thus granting
the Company continued listing on the Nasdaq SmallCap Market.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
No significant changes in market risk have occurred since we filed our report on
Form 10-K for the fiscal year ended December 31, 2002.
14
ITEM 4: CONTROLS AND PROCEDURES
(a) Evaluation of Controls and Procedures
Within 90 days prior to the filing of this report, our Chief Executive Officer
(CEO) and Chief Financial Officer (CFO) performed an evaluation of the
effectiveness of our disclosure controls and procedures. Based on this
evaluation, our CEO and CFO have concluded that our disclosure controls and
procedures are effective to ensure that material information is recorded,
processed, summarized and reported by our management on a timely basis in order
to comply with our disclosure obligations under the Securities Exchange Act of
1934, as amended, and the SEC rules thereunder.
(b) Changes In Internal Controls
There were no significant changes in our internal controls or in other factors
that could significantly affect these controls subsequent to the date of the
evaluation.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As at December 1, 2000, we discontinued lease payments on the San Diego premises
due to a number of circumstances. To date, the landlord has not commenced legal
action against us. Should the landlord commence legal action against us, the
outcome of the proceedings is unknown. The remaining lease payments of $381,254
were accrued in the consolidated financial statements as at December 31, 2000,
and a gain will be recognized in the event of a favorable outcome.
We have been in a dispute with a web hosting company in the Netherlands called
Netnation Europe. On March 14, 2002, we won a World Intellectual Property
Organization (WIPO) dispute involving Netnation Europe for the domain name
"netnation.info". On November 1, 2002, we 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 we contested Netnation Europe's rights to the domain name. At
this time, we have not formally served Netnation Europe with notice of legal
action. Currently, the Netherland market does not represent a significant part
of our business.
To the knowledge of our officers and directors, there are no other pending legal
proceedings or litigation of a material nature and none of our property is the
subject of a pending legal proceeding. Further, our officers and directors know
of no legal proceedings against us or our property contemplated by any
governmental authority.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 12, 2002, we held our annual general meeting of stockholders in
Vancouver, British Columbia. The following matters were considered and voted
upon at the annual general meeting. Please note that the number of votes are
based on the pre-reverse stock split number of shares outstanding of 15,206,002.
15
The first matter voted upon at the meeting was the election of members to the
Board of Directors. David Talmor, Joseph Kibur, Ernest Cheung, Anil Wirasekara,
and Jag Gillan were nominated for election as directors of NetNation to hold
office until their successor are duly elected or appointed. All of the directors
nominated for election served as directors immediately prior to the annual
meeting. The votes cast and withheld for such nominees were as follows:
Name For Withheld
--------------- --------- --------
David Talmor 8,606,025 133,850
Joseph Kibur 8,736,925 2,950
Ernest Cheung 8,709,625 30,250
Anil Wirasekara 8,695,625 44,250
Jag Gillan 8,709,625 30,250
In addition to the election of directors, the following matters were voted upon
at the annual meeting:
- - To ratify the board of directors' selection and appointment of KPMG, LLP,
Chartered Accountants, as independent auditors for NetNation for the fiscal
year ending December 31, 2003. The votes were cast as follows: 8,737,175 in
favor of ratification; 2,700 against ratification; and 0 abstaining.
- - To approve an amendment to NetNation's certificate of incorporation to
effect a 1-for-2 and 1/2 reverse stock split of all the issued and
outstanding shares of our common stock, which resolution would give the
board of directors authority to, in its sole discretion, implement the
reverse stock split at any time prior to the next annual meeting. The votes
were cast as follows: 8,735,175 in favor of the amendment; 4,700 against
the amendment; and 0 abstaining.
No other matters were submitted to our members at the annual meeting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No. Description
- ------------- -----------------------------------------------------------------
99.1 Certification of Principal Executive Officer 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 Principal Financial Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
On June 4, 2003, we filed a report on Form 8-K dated June 3, 2003 that included
an Item 5, Other Events, disclosure.
On June 16, 2003, we filed two reports on Form 8-K both dated June 13, 2003 that
each included Item 5, Other Events, disclosures.
16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
NETNATION COMMUNICATIONS, INC.
Date: August 13, 2003 /s/ Joseph Kibur
--------------- --------------------------------------
Joseph Kibur
Chief Executive Officer
Date: August 13, 2003 /s/ Calvin Mah
--------------- --------------------------------------
Calvin Mah
Chief Financial Officer
17
CERTIFICATIONS
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Joseph Kibur, certify that:
1. I have reviewed this quarterly report on Form 10-Q of NetNation
Communications, Inc.;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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 we 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 quarterly 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
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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 function):
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
quarterly report whether or not 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: August 13, 2003 /s/ Joseph Kibur
--------------- --------------------------------------
Joseph Kibur
Chief Executive Officer
18
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Calvin Mah, certify that:
1. I have reviewed this quarterly report on Form 10-Q of NetNation
Communications, Inc.;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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 we 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 quarterly 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
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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 function):
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
quarterly report whether or not 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: August 13, 2003 /s/ Calvin Mah
--------------- --------------------------------------
Calvin Mah
Chief Financial Officer
19
EXHIBIT INDEX
Exhibit No. Description
- ------------- -----------------------------------------------------------------
99.1 Certification of Principal Executive Officer 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 Principal Financial Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
20