SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter period ended March 31, 2005
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______ TO _________
COMMISSION FILE NO. 0-25053
THEGLOBE.COM, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
STATE OF DELAWARE 14-1782422
---------------------------- -------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
110 EAST BROWARD BOULEVARD, SUITE 1400
FORT LAUDERDALE, FL. 33301
--------------------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(954) 769 - 5900
(Registrant's telephone number, including area code)
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. |X| Yes |_| No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 the Securities Exchange Act of 1934). Yes |_| No |X|
The number of shares outstanding of the Registrant's Common Stock, $.001 par
value (the "Common Stock") as of May 4, 2005 was 175,816,973
THEGLOBE.COM, INC.
FORM 10-Q
TABLE OF CONTENTS
PART I: FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets at March 31, 2005
(unaudited) and December 31, 2004 3
Unaudited Condensed Consolidated Statements of Operations for
the three months ended March 31, 2005 and 2004 4
Unaudited Condensed Consolidated Statements of Cash Flows for
the three months ended March 31, 2005 and 2004 5
Notes to Unaudited Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures about Market Risk 43
Item 4. Controls and Procedures 43
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 44
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 44
Item 3. Defaults Upon Senior Securities 44
Item 4. Submission of Matters to a Vote of Security Holders 44
Item 5. Other Information 44
Item 6. Exhibits 44
SIGNATURES 46
2
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THEGLOBE.COM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
2005 2004
------------ -------------
ASSETS (UNAUDITED)
------
Current Assets:
Cash and cash equivalents $ 3,280,189 $ 6,828,200
Marketable securities 42,736 42,736
Accounts receivable, less allowance for doubtful
accounts of approximately $268,000 and
$274,000, respectively 7,541,329 7,740,692
Inventory, less reserves of approximately
$271,000 and $1,333,000, respectively 229,894 589,579
Prepaid expenses 998,654 1,590,139
Deposits on inventory purchases 77,250 77,250
Other current assets 292,881 316,926
------------ -------------
Total current assets 12,462,933 17,185,522
Goodwill 11,709,952 11,702,317
Intangible assets 1,590,000 1,680,000
Property and equipment, net 3,220,881 3,406,370
Other assets 79,356 42,956
------------ -------------
Total assets $ 29,063,122 $ 34,017,165
============ =============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable $ 6,187,071 $ 7,447,550
Accrued expenses and other current liabilities 3,020,065 2,803,544
Deferred revenue 571,668 739,665
Notes payable and current portion of long-term debt 1,257,345 1,277,405
------------ -------------
Total current liabilities 11,036,149 12,268,164
Long-term debt 15,972 26,997
Other long-term liabilities 130,366 204,616
------------ -------------
Total liabilities 11,182,487 12,499,777
------------ -------------
Stockholders' Equity:
Common stock, $0.001 par value; 500,000,000 shares
authorized; 175,904,504 and 174,315,678 shares
issued at March 31, 2005 and December 31, 2004,
respectively 175,905 174,316
Additional paid-in capital 282,616,635 282,289,404
Treasury stock, 699,281 common shares, at cost (371,458) (371,458)
Accumulated deficit (264,540,447) (260,574,874)
------------ -------------
Total stockholders' equity 17,880,635 21,517,388
------------ -------------
Total liabilities and stockholders' equity $ 29,063,122 $ 34,017,165
============ =============
See notes to unaudited condensed consolidated financial statements.
3
THEGLOBE.COM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended March 31,
----------------------------
2005 2004
------------- ------------
(UNAUDITED)
Net Revenue $ 9,438,728 $ 855,997
------------- ------------
Operating Expenses:
Cost of revenue 8,273,362 1,323,127
Sales and marketing 1,173,396 827,296
Product development 325,841 175,516
General and administrative 2,939,646 2,072,017
Depreciation 368,543 216,000
Amortization of intangible assets 90,000 20,111
------------- ------------
13,170,788 4,634,067
------------- ------------
Loss from Operations (3,732,060) (3,778,070)
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Other Income (Expense):
Interest income (expense), net 12,125 (793,829)
Other expense, net (229,288) (89,799)
------------- ------------
(217,163) (883,628)
------------- ------------
Loss Before Provision for Income Taxes (3,949,223) (4,661,698)
Provision for Income Taxes 16,350 --
------------- ------------
Net Loss $ (3,965,573) $ (4,661,698)
============= ============
Basic and Diluted Net Loss Per Common Share $ (0.02) $ (0.07)
============= ============
Weighted Average Common Shares Outstanding 174,821,229 70,986,256
============= ============
See notes to unaudited condensed consolidated financial statements.
4
THEGLOBE.COM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31,
---------------------------
2005 2004
----------- ------------
(UNAUDITED)
Cash Flows from Operating Activities:
Net loss $(3,965,573) $ (4,661,698)
Adjustments to reconcile net loss to net cash
and cash equivalents used in operating activities:
Depreciation and amortization 458,543 236,111
Provision for excess and obsolete inventory -- (4,485)
Provision for uncollectible accounts receivable -- 20,000
Non-cash interest expense -- 785,886
Reserve against amounts loaned to Internet venture 230,000 110,000
Employee stock compensation 208,281 150,533
Compensation related to non-employee stock options 42,124 294,796
Other, net (173) 5,262
Changes in operating assets and liabilities, net:
Accounts receivable, net 199,363 177,531
Inventory, net 359,685 (580,085)
Prepaid and other current assets 615,530 115,537
Accounts payable (1,260,479) (690,480)
Accrued expenses and other current liabilities 208,886 375,335
Deferred revenue (167,997) 52,668
----------- ------------
Net cash and cash equivalents used in operating
activities (3,071,810) (3,613,089)
----------- ------------
Cash Flows from Investing Activities:
Proceeds from sales and maturities of marketable securities -- 225,070
Purchases of property and equipment (183,054) (288,601)
Amounts loaned to Internet venture (230,000) (110,000)
Patent costs incurred -- (25,252)
Other, net (36,400) (3,500)
----------- ------------
Net cash and cash equivalents used in
investing activities (449,454) (202,283)
----------- ------------
Cash Flows from Financing Activities:
Borrowings on notes payable and long-term debt -- 2,000,000
Payments on notes payable and long-term debt (30,912) (24,655)
Proceeds from issuance of common stock, net -- 27,055,281
Proceeds from exercise of common stock options 3,094 139,545
Proceeds from exercise of warrants 1,071 --
----------- ------------
Net cash and cash equivalents provided by (used in)
financing activities (26,747) 29,170,171
----------- ------------
Net Increase (Decrease) in Cash and Cash Equivalents (3,548,011) 25,354,799
Cash and Cash Equivalents, at beginning of period 6,828,200 1,061,702
----------- ------------
Cash and Cash Equivalents, at end of period $ 3,280,189 $ 26,416,501
=========== ============
See notes to unaudited condensed consolidated financial statements.
5
THEGLOBE.COM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) DESCRIPTION OF THEGLOBE.COM
theglobe.com, inc. (the "Company" or "theglobe") was incorporated on May 1, 1995
(inception) and commenced operations on that date. Originally, theglobe.com was
an online community with registered members and users in the United States and
abroad. That product gave users the freedom to personalize their online
experience by publishing their own content and by interacting with others having
similar interests. However, due to the deterioration of the online advertising
market, the Company was forced to restructure and ceased the operations of its
online community on August 15, 2001. The Company then sold most of its remaining
online and offline properties. The Company continues to operate its Computer
Games print magazine and the associated website Computer Games Online
(www.cgonline.com), as well as the computer games distribution business of Chips
& Bits, Inc. ("Chips & Bits") (www.chipsbits.com). On June 1, 2002, Chairman
Michael S. Egan and Director Edward A. Cespedes became Chief Executive Officer
and President of the Company, respectively.
On November 14, 2002, the Company acquired certain Voice over Internet Protocol
("VoIP") assets and is now aggressively pursuing opportunities related to this
acquisition. In exchange for the assets, the Company issued warrants to acquire
1,750,000 shares of its Common Stock and an additional 425,000 warrants as part
of an earn-out structure upon the attainment of certain performance targets. The
earn-out performance targets were not achieved and the 425,000 earn-out warrants
expired on December 31, 2003.
On May 28, 2003, the Company acquired Direct Partner Telecom, Inc. ("DPT"), a
company engaged in VoIP telephony services in exchange for 1,375,000 shares of
the Company's Common Stock and the issuance of warrants to acquire 500,000
shares of the Company's Common Stock. The transaction included an earn-out
arrangement whereby the former shareholders of DPT may earn additional warrants
to acquire up to 2,750,000 shares of the Company's Common Stock at an exercise
price of $0.72 per share upon the attainment of certain performance targets by
DPT, or upon a change in control as defined, over approximately a three year
period following the date of acquisition. Effective March 31, 2004, 500,000 of
the earn-out warrants were forfeited as performance targets had not been
achieved for the first of the three year periods. An additional 750,000 of the
warrants were forfeited effective March 31, 2005, as performance targets for the
second of the three year periods were not achieved.
The Company acquired all of the physical assets and intellectual property of DPT
and originally planned to continue to operate the company as a subsidiary and
engage in the provision of VoIP services to other telephony businesses on a
wholesale transactional basis. In the first quarter of 2004, the Company decided
to suspend DPT's wholesale business and dedicate the DPT physical and
intellectual assets to its retail VoIP business. As a result, the Company
wrote-off the goodwill associated with the purchase of DPT as of December 31,
2003, and has since employed DPT's physical assets in the build out of the
retail VoIP network.
On September 1, 2004, the Company acquired SendTec, Inc. ("SendTec"), a direct
response marketing services and technology company. As more fully discussed in
Note 3, "Acquisition of SendTec, Inc.," the Company paid $6.0 million in cash,
excluding transaction costs, and issued debt and equity securities valued at a
total of approximately $12 million to purchase SendTec.
As of March 31, 2005, the Company's revenue sources were derived principally
from the acquired operations of SendTec which comprises our marketing services
division, as well as from the operations of our games related businesses. The
Company's retail VoIP products and services have yet to produce any significant
revenue.
(b) PRINCIPLES OF CONSOLIDATION
The condensed consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries from their respective dates of
acquisition. All significant intercompany balances and transactions have been
eliminated in consolidation.
(c) UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL INFORMATION
The unaudited interim condensed consolidated financial statements of the Company
as of March 31, 2005 and for the three months ended March 31, 2005 and 2004
included herein have been prepared in accordance with the instructions for Form
10-Q under the Securities Exchange Act of 1934, as amended, and Article 10 of
Regulation S-X under the Securities Act of 1933, as amended. Certain information
and note disclosures normally included in consolidated financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations relating to interim
condensed consolidated financial statements.
6
In the opinion of management, the accompanying unaudited interim condensed
consolidated financial statements reflect all adjustments, consisting only of
normal recurring adjustments, necessary to present fairly the financial position
of the Company at March 31, 2005 and the results of its operations and its cash
flows for the three months ended March 31, 2005 and 2004.
(d) USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. These estimates and assumptions relate to estimates of collectibility of
accounts receivable, the valuation of inventory, accruals, the valuations of
fair values of options and warrants, the impairment of long-lived assets and
other factors. Actual results could differ from those estimates.
(e) CASH AND CASH EQUIVALENTS
Cash equivalents consist of money market funds and highly liquid short-term
investments with qualified financial institutions. The Company considers all
highly liquid securities with original maturities of three months or less to be
cash equivalents. Included in cash and cash equivalents in the accompanying
condensed consolidated balance sheet at March 31, 2005, was approximately
$62,000 of cash held in escrow for purposes of sweepstakes promotions being
conducted by the VoIP telephony division.
(f) MARKETABLE SECURITIES
The Company accounts for its investment in debt and equity securities in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." All such
investments are classified as available-for-sale as of March 31, 2005 and
December 31, 2004. Available-for-sale securities are stated at market value,
which approximates fair value, and unrealized holding gains and losses are
excluded from earnings and included as a component of stockholders' equity until
realized.
Available-for-sale securities at March 31, 2005 and December 31, 2004, consisted
of U.S. Treasury Bills with a cost basis and fair value of $42,736. During the
three months ended March 31, 2005 and 2004, the Company had no significant gross
realized gains or losses on sales of available-for-sale securities.
(g) COMPREHENSIVE INCOME (LOSS)
The Company reports comprehensive income (loss) in accordance with SFAS No. 130,
"Reporting Comprehensive Income." Comprehensive income (loss) generally
represents all changes in stockholders' equity during the year except those
resulting from investments by, or distributions to, stockholders. The Company's
comprehensive loss was approximately $4.0 million and $4.7 million for the three
months ended March 31, 2005 and 2004, respectively, which approximated the
Company's reported net loss.
(h) INVENTORY
Inventories are recorded on a first in, first out basis and valued at the lower
of cost or market value. The Company's reserve for excess and obsolete inventory
as of March 31, 2005 and December 31, 2004, was approximately $271,000 and
$1,333,000, respectively.
The Company manages its inventory levels based on internal forecasts of customer
demand for its products, which is difficult to predict and can fluctuate
substantially. In addition, the Company's inventories include high technology
items that are specialized in nature or subject to rapid obsolescence. If the
Company's demand forecast is greater than the actual customer demand for its
products, the Company may be required to record additional charges related to
increases in its inventory valuation reserves in future periods. The value of
inventories is also dependent on the Company's estimate of future average
selling prices, and, if projected average selling prices are over estimated, the
Company may be required to further adjust its inventory value to reflect the
lower of cost or market.
(i) CONCENTRATION OF CREDIT RISK
Financial instruments which subject the Company to concentrations of credit risk
consist primarily of cash and cash equivalents, marketable securities and trade
accounts receivable. The Company maintains its cash and cash equivalents with
various financial institutions and invests its funds among a diverse group of
issuers and instruments. The Company performs ongoing credit evaluations of its
customers' financial condition and establishes an allowance for doubtful
accounts based upon factors surrounding the credit risk of customers, historical
trends and other information. Amounts receivable from four of SendTec's
customers represented approximately $4,009,000, or 59%, of SendTec's total
accounts receivable as of March 31, 2005. Concentration of credit risk in the
Company's computer games and VoIP telephony services divisions is generally
limited due to the large number of customers in these businesses.
7
(j) REVENUE RECOGNITION
Computer Games Businesses
Advertising revenue from the sale of print advertisements under short-term
contracts in the games information magazine, Computer Games, are recognized at
the on-sale date of the magazine.
Newsstand sales of the games information magazine are recognized at the on-sale
date of the magazine, net of provisions for estimated returns. Subscription
revenue, which is net of agency fees, is deferred when initially received and
recognized as income ratably over the subscription term.
Sales of video games and related products from the Company's online store are
recognized as revenue when the product is shipped to the customer. Amounts
billed to customers for shipping and handling charges are included in net
revenue. The Company provides an allowance for returns of merchandise sold
through its online store. The allowance for returns provided to date has not
been significant.
Marketing Services
Revenue from the distribution of Internet advertising is recognized when
Internet users visit and complete actions at an advertiser's website. Revenue
consists of the gross value of billings to clients, including the recovery of
costs incurred to acquire online media required to execute client campaigns.
Recorded revenue is based upon reports generated by the Company's tracking
software.
Revenue derived from the purchase and tracking of direct response media, such as
television and radio commercials, is recognized on a net basis when the
associated media is aired. In many cases, the amount the Company bills to
clients significantly exceeds the amount of revenue that is earned due to the
existence of various "pass-through" charges such as the cost of the television
and radio media. Amounts received in advance of media airings are deferred and
included in deferred revenue in the accompanying condensed consolidated balance
sheet.
Revenue generated from the production of direct response advertising programs,
such as infomercials, is recognized on the completed contract method when such
programs are complete and available for airing. Production activities generally
take eight to twelve weeks and the Company usually collects amounts in advance
and at various points throughout the production process. Amounts received from
customers prior to completion of commercials are included in deferred revenue
and direct costs associated with the production of commercials in process are
deferred and included within other current assets in the accompanying condensed
consolidated balance sheet.
VoIP Telephony Services
VoIP telephony services revenue represents fees charged to customers for voice
services and is recognized based on minutes of customer usage or as services are
provided. The Company records payments received in advance for prepaid services
as deferred revenue until the related services are provided. Sales of peripheral
VoIP telephony equipment are recognized as revenue when the product is shipped
to the customer. Amounts billed to customers for shipping and handling charges
are included in net revenue.
(k) NET LOSS PER SHARE
The Company reports net loss per common share in accordance with SFAS No. 128,
"Computation of Earnings Per Share." In accordance with SFAS No. 128 and the SEC
Staff Accounting Bulletin No. 98, basic earnings-per-share is computed using the
weighted average number of common shares outstanding during the period. Common
equivalent shares consist of the incremental common shares issuable upon the
conversion of convertible preferred stock and convertible notes (using the
if-converted method), if any, and the shares issuable upon the exercise of stock
options and warrants (using the treasury stock method). Common equivalent shares
are excluded from the calculation if their effect is anti-dilutive.
Due to the Company's net losses, the effect of potentially dilutive securities
or common stock equivalents that could be issued was excluded from the diluted
net loss per common share calculation due to the anti-dilutive effect. Such
potentially dilutive securities and common stock equivalents consisted of the
following for the periods ended March 31:
8
2005 2004
---------- ----------
Options to purchase common stock 15,605,000 9,924,000
Common shares issuable upon exercise
of warrants 20,782,000 26,504,000
---------- ----------
Total 36,387,000 36,428,000
========== ==========
(l) RECENT ACCOUNTING PRONOUNCEMENTS
In March 2005, the FASB issued Interpretation ("FIN") No. 47, "Accounting for
Conditional Asset Retirement Obligations", an interpretation of FASB Statement
No. 143, "Accounting for Asset Retirement Obligations." The interpretation
clarifies that the term conditional asset retirement obligation refers to a
legal obligation to perform an asset retirement activity in which the timing and
(or) method of settlement are conditional on a future event that may or may not
be within the control of the entity. An entity is required to recognize a
liability for the fair value of a conditional asset retirement obligation if the
fair value of the liability can be reasonably estimated. FIN 47 also clarifies
when an entity would have sufficient information to reasonably estimate the fair
value of an asset retirement obligation. The effective date of this
interpretation is no later than the end of fiscal years ending after December
15, 2005. The Company is currently investigating the effect, if any, that FIN 47
would have on the Company's financial position, cash flows and results of
operations.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29." SFAS No. 153 requires exchanges of
productive assets to be accounted for at fair value, rather than at carryover
basis, unless (1) neither the asset received nor the asset surrendered has a
fair value that is determinable within reasonable limits or (2) the transactions
lack commercial substance. This statement is effective for nonmonetary asset
exchanges occurring in fiscal periods beginning after June 15, 2005. The Company
does not expect the adoption of this standard to have a material impact on its
financial condition, results of operations, or liquidity.
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment." This
standard replaces SFAS No. 123, "Accounting for Stock-Based Compensation" and
supersedes Accounting Principles Board ("APB") Opinion No. 25, "Accounting for
Stock Issued to Employees." The standard requires companies to expense the fair
value of stock options on the grant date and is effective for annual periods
beginning after June 15, 2005. In accordance with the revised statement, the
expense attributable to stock options granted or vested subsequent to January 1,
2006 will be required to be recognized by the Company. The Company has not yet
evaluated the impact of this pronouncement on the Company.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - An Amendment
of ARB No. 43, Chapter 4." SFAS No. 151 requires all companies to recognize a
current-period charge for abnormal amounts of idle facility expense, freight,
handling costs and wasted materials. This statement also requires that the
allocation of fixed production overhead to the costs of conversion be based on
the normal capacity of the production facilities. SFAS No. 151 will be effective
for fiscal years beginning after June 15, 2005. The Company does not expect the
adoption of this statement to have a material effect on its consolidated
financial statements.
In December 2003, the FASB issued FIN No. 46-R "Consolidation of Variable
Interest Entities." FIN 46-R, which modifies certain provisions and effective
dates of FIN 46, sets forth the criteria to be used in determining whether an
investment in a variable interest entity should be consolidated. These
provisions are based on the general premise that if a company controls another
entity through interests other than voting interests, that company should
consolidate the controlled entity. The Company believes that currently, it does
not have any material arrangements that meet the definition of a variable
interest entity which would require consolidation.
(m) RECLASSIFICATIONS
Certain 2004 amounts have been reclassified to conform to the 2005 presentation.
(2) GOING CONCERN CONSIDERATIONS
The Company's March 31, 2005 condensed consolidated financial statements have
been prepared assuming the Company will continue as a going concern. The Company
has suffered recurring losses from operations since inception, has an
accumulated deficit as of March 31, 2005, of $264,540,447 and has recorded
impairment charges related to its VoIP telephony services division totaling
$2,570,359 during 2004 and 2003. Net cash and cash equivalents used in
operations totaled $3,071,810 for the first quarter of 2005 due primarily to net
losses incurred by its VoIP telephony services division.
During 2004, the Company expended significant costs to implement a number of
marketing programs geared toward increasing the number of its VoIP retail
customers and telephony revenue. None of these programs have proven to be
successful to any significant degree. At March 31, 2005, the Company's sole
source of liquidity consisted of $3,280,189 of cash and cash equivalents. The
Company continues to incur substantial consolidated net losses and management
believes the Company will continue to be unprofitable for the foreseeable
future. These conditions raise significant doubt about the Company's ability to
continue as a going concern.
9
Management's Plans
During October 2004, the Company engaged financial advisors to assist the
Company in raising capital through a private placement of its equity securities,
or in entering into other business relationships with certain strategic
investors. In February 2005, the Company engaged an additional financial advisor
to assist the Company in connection with raising capital through a private
placement of equity securities in either the Company or its SendTec wholly-owned
subsidiary or alternatively in selling either part or all of the Company's
businesses or assets, including its SendTec business. The Company currently has
no access to credit facilities with traditional third party lenders and there
can be no assurance that it would be able to raise capital or sell any of its
businesses or assets. In addition, any financing that could be obtained would
likely significantly dilute existing shareholders. Management is exploring a
number of strategic alternatives regarding the Company's future business
operations. Management has also implemented a number of internal actions in an
effort to improve the Company's liquidity and business performance, including
those described below. The Company's future strategic direction is highly
dependent upon the outcome of its efforts to raise capital and/or sell certain
businesses or assets.
During the first quarter of 2005, the Company reevaluated its existing VoIP
telephony services business plan and is currently in the process of terminating
and/or modifying certain of its existing product offerings and marketing
programs, as well as developing and testing certain new VoIP products and
features. The Company also, during the first quarter of 2005, made the decision
to discontinue using its SendTec business to perform marketing services for its
VoIP business, and to instead dedicate 100% of SendTec's marketing services to
support and grow its own third party customer base. Additionally, in order to
reduce its near term consolidated net losses and cash usage, the Company
implemented a number of cost-reduction actions at its VoIP telephony services
business, including decreases in personnel and salary levels, carrier and data
center costs, and marketing/advertising expenses during the first quarter of
2005.
Management believes that it will be difficult to implement its new VoIP product
and marketing plans, once fully developed and tested, without additional cash
being provided from a prospective financing or sale transaction(s). Should the
Company's new product offerings achieve market acceptance and significantly
increase the Company's current customer and revenue base, additional cash
resources to fund capital expenditures related to the Company's VoIP network and
customer billing systems and to fund future marketing and other business
development costs would be required.
There can be no assurance that the Company's new VoIP product offerings will be
successful in attracting a sufficient number of new customers to its VoIP
network and increasing telephony revenue to desired levels. Even if the Company
is able to raise additional capital, management may at any time, decide to
terminate the operations of its VoIP telephony services business, either by
asset sale or abandonment, if future investment returns are considered
inadequate and/or preferable investment alternatives exist. The Company may
alternatively decide to enter into new lines of business. (See Note 4, "Other
Assets" for further details regarding the Company's acquisition of Tralliance
Corporation in May 2005).
On April 22, 2005, entities controlled by our Chairman and Chief Executive
Officer and our President entered into an agreement with the Company pursuant to
which the entities acquired secured demand convertible promissory notes in the
aggregate amount of $1,500,000 together with options to acquire an additional
$2,500,000 in the aggregate of such notes on or before July 22, 2005 (see Note
9, "Subsequent Events," for further details). The proceeds from the sale of the
notes are intended to provide the Company with temporary short-term liquidity to
operate its businesses while it seeks to raise additional capital, which may
involve the potential sale of one or more of the Company's subsidiaries,
including SendTec. The Company's cash and cash equivalents balance at May 6,
2005, inclusive of the $1,500,000 in proceeds received from the sale of the
notes, was approximately $4,000,000.
Summary
If the Company is not successful in entering into a financing, sale, or business
transaction that infuses sufficient additional cash resources into the Company,
by sometime during the third quarter of 2005, management expects to pursue the
remaining $2.5 million of optional convertible promissory note financing. If
such funding is received, management believes the funding will provide the
Company with additional short-term liquidity into the fourth quarter of 2005.
There can be no assurance that this financing will be available when and if
required, nor that demand for repayment will not be made prior to such date. In
the event that the Company is not successful in obtaining the remaining $2.5
million funding, or in the event that such remaining funds are received and
depleted prior to our raising of sufficient additional capital, management
believes that the Company will no longer be able to continue the implementation
of its current VoIP business plan. As a result, it is likely that the Company
would be required to either temporarily suspend or permanently shutdown the
operation of its VoIP telephony services business. Additionally, in such event,
management believes that it may also be required to revise the business plan of
some or all of its other business segments and/or further implement company-wide
cost-reduction programs. There can be no assurance that the Company would be
successful in implementing such revised business plans and effectively
restructuring its businesses so that the Company would have the ability to
continue to operate as a going concern in the future.
10
The condensed consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
(3) ACQUISITION OF SENDTEC, INC.
On September 1, 2004, the Company acquired SendTec, a direct response marketing
services and technology company. In exchange for all of the issued and
outstanding shares of capital stock of SendTec the Company paid consideration
consisting of: (i) $6,000,000 in cash, excluding transaction costs, (ii) the
issuance of an aggregate of 17,500,024 shares of the Company's Common Stock,
(iii) the issuance of an aggregate of 175,000 shares of Series H Automatically
Converting Preferred Stock (which was converted into approximately 17,500,500
shares of the Company's Common Stock effective December 1, 2004), and (iv) the
issuance of a subordinated promissory note in the amount of $1,000,009. The
Company also issued an aggregate of 3,974,165 replacement options to acquire the
Company's Common Stock for each of the issued and outstanding options to acquire
SendTec shares held by the former employees of SendTec.
The preliminary SendTec purchase price allocation was as follows:
Cash $ 3,610,000
Accounts receivable 5,534,000
Other current assets 194,000
Fixed assets 1,031,000
Non-compete agreements 1,800,000
Goodwill 11,710,000
Other assets 124,000
Assumed liabilities (5,605,000)
------------
$ 18,398,000
============
In addition, warrants to acquire shares of theglobe.com Common Stock will be
issued to SendTec shareholders when and if SendTec exceeds forecasted operating
income, as defined, of $10.125 million, for the year ending December 31, 2005.
The number of earn-out warrants may range from an aggregate of 250,000 to
2,500,000 (if actual operating income exceeds the forecast by at least 10%).
Because the number of warrants that will be earned is not yet determinable, no
consideration related to this contingency was included in the determination of
the SendTec purchase price.
As part of the Merger, 100,000 shares of Series H Preferred Stock (which was
subsequently converted into 10 million shares of Common Stock) (the "Escrow
Shares") are being held in escrow for potential recovery by the Company in the
event of a breach of the Merger Agreement by SendTec or its former shareholders.
In general, the Escrow Shares, together with the sums due under the subordinated
promissory note, are the sole source of recourse against the shareholders of
SendTec in the event of breach of the Merger Agreement and theglobe would not
have recourse against the cash portion or other shares of Common Stock
distributed to the SendTec shareholders as part of the Merger Consideration.
Assuming no claims are then pending, the Escrow Shares will be distributed to
SendTec shareholders after expiration of one year from the date of closing.
As part of the SendTec acquisition transaction, certain executives of SendTec
entered into new employment agreements with SendTec. The employment agreements
each have a term of five years and automatically renew for an additional year at
expiration unless either party provides the requisite notice of non-renewal. The
agreements also contain certain non-compete provisions for periods as specified
by the agreements. The $1,800,000 value assigned to the non-compete agreements
is being amortized on a straight-line basis over 5 years. Annual amortization
expense of the non-compete agreements is estimated to be $360,000 in 2005
through 2008 and $240,000 in 2009. The related accumulated amortization as of
March 31, 2005 and December 31, 2004, was $210,000 and $120,000, respectively,
and amortization expense was $90,000 for the three months ended March 31, 2005.
The following pro forma condensed consolidated results of operations for the
three months ended March 31, 2004 assumes the acquisition of SendTec occurred as
of January 1, 2004. The pro forma results reflected below include SendTec's
revenue utilizing the revenue recognition methods employed by the Company since
SendTec's date of acquisition. The pro forma information is not necessarily
indicative of what the actual results of operations of the combined company
would have been had the acquisition occurred on January 1, 2004, nor is it
necessarily indicative of future results.
11
PRO FORMA RESULTS 2004
-------------
Three months ended March 31,
Revenue $ 8,103,000
Net loss (3,766,000)
Basic and diluted net loss per common share $ (0.04)
Weighted average common shares 105,986,780
(4) OTHER ASSETS
On February 25, 2003, theglobe.com entered into a Loan and Purchase Option
Agreement, as amended, with Tralliance Corporation ("Tralliance"), a development
stage Internet related business venture, pursuant to which it agreed to fund, in
the form of a loan, at the discretion of the Company, Tralliance's operating
expenses and obtained the option to acquire all of the outstanding capital stock
of Tralliance in exchange for, when and if exercised, $40,000 in cash and the
issuance of an aggregate of 2,000,000 unregistered restricted shares of
theglobe.com's Common Stock (the "Option"). The Loan was secured by a lien on
the assets of the venture. On May 5, 2005, Tralliance and the Internet
Corporation for Assigned Names and Numbers ("ICANN") entered into an agreement
designating Tralliance as the registry for the ".travel" top-level domain. On
May 9, 2005, the Company exercised its option to acquire all of the outstanding
capital stock of Tralliance. The purchase price consisted of the issuance of
2,000,000 shares of theglobe.com Common Stock, warrants to acquire 475,000
shares of theglobe.com Common Stock and $40,000 in cash. The warrants are
exercisable for a period of five years at an exercise price of $0.11 per share.
The Common Stock issued as a result of the acquisition of Tralliance is entitled
to certain "piggy-back" registration rights. In addition, as part of the
transaction, the Company agreed to pay approximately $154,000 in outstanding
liabilities of Tralliance immediately after the closing of the acquisition.
Upon acquisition, the existing CEO and CFO of Tralliance entered into employment
agreements, which include certain non-compete provisions, whereby each would
agree to remain in the employ of Tralliance for a period of two years in
exchange for base compensation plus participation in a bonus pool based upon the
pre-tax income of the venture.
Advances to Tralliance totaled $1,231,500 as of March 31, 2005. Due to the
uncertainty of the ultimate collectibility of the Loan, the Company has
historically provided a reserve equal to the full amount of the funds advanced
to Tralliance. Additions to the reserve of $230,000 and $110,000 were included
in other expense in the accompanying condensed consolidated statements of
operations for the three months ended March 31, 2005 and 2004, respectively.
(5) STOCK OPTION PLANS
A total of 111,000 stock options were granted to employees during the three
months ended March 31, 2005. No stock options were granted to non-employees
during the first quarter of 2005. A total of 892,500 stock options were granted
during the three months ended March 31, 2004, including grants of 215,000 stock
options to non-employees. Compensation expense of $180,281 was recorded during
the three months ended March 31, 2005, related to vesting of prior year employee
option grants with below-market exercise prices. In addition, $28,000 of
compensation expense was recorded during the first quarter of 2005 as a result
of the accelerated vesting of stock options issued to a terminated employee. The
remaining $42,124 of stock compensation expense recorded during the 2005 first
quarter resulted from the vesting of non-employee stock options granted in prior
years. During the three months ended March 31, 2004, stock compensation expense
included $150,533 related to employee option grants with below-market exercise
prices and $294,796 recognized with respect to non-employee stock options. A
total of 218,226 stock options were exercised and a total of 272,247 stock
options were cancelled during the three months ended March 31, 2005. During the
first quarter of 2004, 286,500 stock options were exercised and 625,110 stock
options were cancelled.
In 2000, the Company repriced a group of stock options issued to its employees.
The Company is accounting for these re-priced options using variable accounting
in accordance with FIN No. 44. No compensation expense was recorded in
connection with the re-priced stock options during the three months ended March
31, 2005 and 2004. At March 31, 2005, a total of 29,060 options remained
outstanding which were being accounted for in accordance with FIN No. 44.
The Company estimates the fair value of each stock option at the grant date by
using the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 2005: no dividend yield; an expected life of
three to five years; 160% expected volatility and 3.00% risk free interest rate.
In accordance with SFAS No. 123, the Company applies Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," to account for
stock-based awards granted to employees. The following table presents the
Company's pro forma net loss for the three months ended March 31, 2005 and 2004,
had the Company determined compensation cost based on the fair value at the
grant date for all of its employee stock options issued under SFAS No. 123:
12
Three Months Ended March 31,
--------------------------
2005 2004
----------- -----------
Net loss - as reported $(3,965,573) $(4,661,698)
Add: Stock-based employee compensation
expense included in net loss as
reported 208,281 150,533
Deduct: Total stock-based employee
compensation expense determined
under fair value method for all awards (296,708) (842,835)
----------- -----------
Net loss - pro forma $(4,054,000) $(5,354,000)
=========== ===========
Basic net loss per share -
as reported $ (0.02) $ (0.07)
=========== ===========
Basic net loss per share -
pro forma $ (0.02) $ (0.08)
=========== ===========
(6) LITIGATION
On and after August 3, 2001 and as of the date of this filing, the Company is
aware that six putative shareholder class action lawsuits were filed against the
Company, certain of its current and former officers and directors (the
"Individual Defendants"), and several investment banks that were the
underwriters of the Company's initial public offering. The lawsuits were filed
in the United States District Court for the Southern District of New York.
The lawsuits purport to be class actions filed on behalf of purchasers of the
stock of the Company during the period from November 12, 1998 through December
6, 2000. Plaintiffs allege that the underwriter defendants agreed to allocate
stock in the Company's initial public offering to certain investors in exchange
for excessive and undisclosed commissions and agreements by those investors to
make additional purchases of stock in the aftermarket at pre-determined prices.
Plaintiffs allege that the Prospectus for the Company's initial public offering
was false and misleading and in violation of the securities laws because it did
not disclose these arrangements. On December 5, 2001, an amended complaint was
filed in one of the actions, alleging the same conduct described above in
connection with the Company's November 23, 1998 initial public offering and its
May 19, 1999 secondary offering. A Consolidated Amended Complaint, which is now
the operative complaint, was filed in the Southern District of New York on April
19, 2002. The action seeks damages in an unspecified amount. On February 19,
2003, a motion to dismiss all claims against the Company was denied by the
Court. On October 13, 2004, the Court certified a class in six of the
approximately 300 other nearly identical actions and noted that the decision is
intended to provide strong guidance to all parties regarding class certification
in the remaining cases. Plaintiffs have not yet moved to certify a class in
theglobe.com case.
The Company has approved a settlement agreement and related agreements which set
forth the terms of a settlement between the Company, the Individual Defendants,
the plaintiff class and the vast majority of the other approximately 300 issuer
defendants. Among other provisions, the settlement provides for a release of the
Company and the Individual Defendants for the conduct alleged in the action to
be wrongful. The Company would agree to undertake certain responsibilities,
including agreeing to assign away, not assert, or release certain potential
claims the Company may have against its underwriters. The settlement agreement
also provides a guaranteed recovery of $1 billion to plaintiffs for the cases
relating to all of the approximately 300 issuers. To the extent that the
underwriter defendants settle all of the cases for at least $1 billion, no
payment will be required under the issuers' settlement agreement. To the extent
that the underwriter defendants settle for less than $1 billion, the issuers are
required to make up the difference. It is anticipated that any potential
financial obligation of the Company to plaintiffs pursuant to the terms of the
settlement agreement and related agreements will be covered by existing
insurance. The Company currently is not aware of any material limitations on the
expected recovery of any potential financial obligation to plaintiffs from its
insurance carriers. Its carriers are solvent, and the Company is not aware of
any uncertainties as to the legal sufficiency of an insurance claim with respect
to any recovery by plaintiffs. Therefore, we do not expect that the settlement
will involve any payment by the Company. If material limitations on the expected
recovery of any potential financial obligation to the plaintiffs from the
Company's insurance carriers should arise, the Company's maximum financial
obligation to plaintiffs pursuant to the settlement agreement would be less than
$3.4 million. On February 15, 2005, the Court granted preliminary approval of
the settlement agreement, subject to certain modifications consistent with its
opinion. The Court ruled that the issuer defendants and the plaintiffs must
submit a revised settlement agreement which provides for a mutual bar of all
contribution claims by the settling and non-settling parties and does not bar
the parties from pursuing other claims. The issuers and plaintiffs have
negotiated a revised settlement agreement consistent with the Court's opinion
and are in the process of obtaining approval from those issuer defendants that
are not in bankruptcy. The parties have submitted a revised settlement agreement
to the Court. The underwriter defendants will have until May 16, 2005, to object
to the revised settlement agreement. There is no assurance that the Court will
grant final approval to the settlement. If the settlement agreement is not
approved and the Company is found liable, we are unable to estimate or predict
the potential damages that might be awarded, whether such damages would be
greater than the Company's insurance coverage, or whether such damages would
have a material impact on our results of operations or financial condition in
any future period.
13
On December 16, 2004, the Company, together with its wholly-owned subsidiary,
voiceglo Holdings, Inc., were named as defendants in NeoPets, Inc. v. voiceglo
Holdings, Inc. and theglobe.com, inc., a lawsuit filed in Los Angeles Superior
Court. The Company and its subsidiary, were parties to an agreement dated May 6,
2004, with NeoPets, Inc. ("NeoPets"), whereby NeoPets agreed to host a voiceglo
advertising feature on its website for the purpose of generating registered
activations of the voiceglo product featured. Consideration to NeoPets was to
include specified commissions, including cash payments based on registered
activations, as defined, as well as the issuance of Common Stock of theglobe.com
and additional cash payments, upon the attainment of certain performance
criteria. NeoPets' complaint asserts claims for breach of contract and specific
performance and seeks payment of approximately $2.5 million in cash, plus
interest, as well as the issuance of 1,000,000 shares of theglobe.com Common
Stock. On February 22, 2005, the Company and voiceglo answered the complaint and
asserted cross-claims against NeoPets for fraud and deceit, rescission, breach
of contract, breach of the implied covenant of good faith and fair dealing and
set-off. NeoPets has not yet answered the cross-claims and discovery has not yet
begun.
Through March 31, 2005, the Company has recorded amounts due for commissions
pursuant to the terms of the agreement totaling approximately $246,000. The
Company believes that this is the amount NeoPets has earned relating to services
performed and intends to vigorously defend its position. It is too early in the
process to determine the likelihood of an unfavorable outcome, however, an
unfavorable outcome could result in a liability in excess of the amount recorded
and could have a material adverse effect on the Company.
The Company is currently a party to certain other legal proceedings, claims,
disputes and litigation arising in the ordinary course of business, including
those noted above. The Company currently believes that the ultimate outcome of
these other proceedings, individually and in the aggregate, will not have a
material adverse affect on the Company's financial position, results of
operations or cash flows. However, because of the nature and inherent
uncertainties of litigation, should the outcome of these actions be unfavorable,
the Company's business, financial condition, results of operations and cash
flows could be materially and adversely affected.
(7) SEGMENTS AND GEOGRAPHIC INFORMATION
The Company applies the provisions of SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information," which establishes annual and interim
reporting standards for operating segments of a company. SFAS No. 131 requires
disclosures of selected segment-related financial information about products,
major customers and geographic areas. Effective with the September 1, 2004
acquisition of SendTec, the Company is now organized in three operating segments
for purposes of making operating decisions and assessing performance: the
computer games division, the marketing services division and the VoIP telephony
services division. The computer games division consists of the operations of the
Company's Computer Games print magazine and the associated website Computer
Games Online (www.cgonline.com) and the operations of Chips & Bits, Inc. ("Chips
& Bits"), its games distribution business. The marketing services division
consists of the operations of the Company's acquired subsidiary, SendTec. The
VoIP telephony services division is principally involved in the sale of
telecommunications services over the Internet to consumers.
The chief operating decision maker evaluates performance, makes operating
decisions and allocates resources based on financial data of each segment. Where
appropriate, the Company charges specific costs to each segment where they can
be identified. Certain items are maintained at the Company's corporate
headquarters ("Corporate") and are not presently allocated to the segments.
Corporate expenses primarily include personnel costs related to executives and
certain support staff and professional fees. Corporate assets principally
consist of cash and cash equivalents. Subsequent to its acquisition on September
1, 2004, SendTec provided various intersegment marketing services to the
Company's VoIP telephony services division. Prior to the acquisition of SendTec,
there were no intersegment transactions. The accounting policies of the segments
are the same as those for the Company as a whole.
The following table presents financial information regarding the Company's
different segments:
Three Months Ended
March 31,
----------------------------
2005 2004
------------ ------------
(UNAUDITED)
NET REVENUE:
Computer games $ 561,392 $ 756,449
Marketing services 9,105,820 --
VoIP telephony services 87,092 99,548
Intersegment eliminations (315,576) --
------------ ------------
$ 9,438,728 $ 855,997
============ ============
14
Three Months Ended
March 31,
----------------------------
2005 2004
------------ ------------
(UNAUDITED)
INCOME (LOSS) FROM OPERATIONS:
Computer games $ (315,154) $ (109,888)
Marketing services 800,626 --
VoIP telephony services (3,322,862) (2,128,367)
Corporate expenses (894,670) (1,539,815)
------------ ------------
Loss from operations (3,732,060) (3,778,070)
Other expense, net (217,163) (883,628)
------------ ------------
Consolidated loss before income tax $ (3,949,223) $ (4,661,698)
============ ============
DEPRECIATION AND AMORTIZATION:
Computer games $ 7,719 $ 3,429
Marketing services 172,612 --
VoIP telephony services 268,633 226,770
Corporate expenses 9,579 5,912
------------ ------------
$ 458,543 $ 236,111
============ ============
March 31, December 31,
2005 2004
------------ ------------
(UNAUDITED)
IDENTIFIABLE ASSETS:
Computer games $ 2,129,164 $ 2,000,230
Marketing services 22,903,952 24,764,361
VoIP telephony services 2,842,182 3,497,698
Corporate assets 1,187,824 3,754,876
------------ ------------
$ 29,063,122 $ 34,017,165
============ ============
(8) COMMITMENTS
As of March 31, 2005, the Company had approximately $20,000 in outstanding
standby letters of credit used to support the agreement with one of our
telecommunications carriers.
Revenue generated by three customers of SendTec represented approximately 59% of
consolidated net revenue reported for the three months ended March 31, 2005.
(9) SUBSEQUENT EVENTS
On April 22, 2005, E&C Capital Partners, LLLP and another entity controlled by
the Company's Chairman and Chief Executive Officer and the Company's President,
entered into a Note Purchase Agreement (the "Agreement") with theglobe pursuant
to which they acquired secured demand convertible promissory notes (the "Notes")
in the aggregate principal amount of $1,500,000. Under the terms of the
Agreement, E&C Capital Partners, LLLP and the other entity were also granted the
optional right, for a period of 90 days from the date of the Agreement, to
purchase additional secured demand convertible promissory notes such that the
aggregate principal amount of Notes issued under the Agreement may total
$4,000,000. The Notes are convertible at the option of the noteholders into
shares of the Company's Common Stock at an initial price of $0.05 per share. The
Notes provide for interest at the rate of ten percent per annum and are secured
by a pledge of substantially all of the assets of the Company.
Reference should be made to Note 4, "Other Assets", for details regarding the
Company's acquisition of Tralliance Corporation in May 2005.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS
This Form 10-Q contains forward-looking statements within the meaning of the
federal securities laws that relate to future events or our future financial
performance. In some cases, you can identify forward-looking statements by
terminology, such as "may," "will," "should," "could," "expect," "plan,"
"anticipate," "believe," "estimate," "project," "predict," "intend," "potential"
or "continue" or the negative of such terms or other comparable terminology,
although not all forward-looking statements contain such terms. In addition,
these forward-looking statements include, but are not limited to, statements
regarding:
o implementing our business plans;
o marketing and commercialization of our existing products and those
products under development;
o plans for future products and services and for enhancements of
existing products and services;
o our ability to implement cost-reduction programs;
o potential governmental regulation and taxation;
o the outcome of any litigation;
o our intellectual property;
o our estimates of future revenue and profitability;
o our estimates or expectations of continued losses;
o our expectations regarding future expenses, including cost of
revenue, product development, sales and marketing, and general and
administrative expenses;
o difficulty or inability to raise additional financing, if needed, on
terms acceptable to us;
o our estimates regarding our capital requirements and our needs for
additional financing;
o attracting and retaining customers and employees;
o rapid technological changes in our industry and relevant markets;
o sources of revenue and anticipated revenue;
o plans for future acquisitions and entering new lines of business;
o plans for divestitures of certain businesses or assets;
o competition in our market; and
o our ability to continue to operate as a going concern.
These statements are only predictions. Although we believe that the expectations
reflected in these forward-looking statements are reasonable, we cannot
guarantee future results, levels of activity, performance or achievements. We
are not required to and do not intend to update any of the forward-looking
statements after the date of this Form 10-Q or to conform these statements to
actual results. In light of these risks, uncertainties and assumptions, the
forward-looking events discussed in this Form 10-Q might not occur. Actual
results, levels of activity, performance, achievements and events may vary
significantly from those implied by the forward-looking statements. A
description of risks that could cause our results to vary appears under "Risk
Factors" and elsewhere in this Form 10-Q. The following discussion should be
read together in conjunction with the accompanying unaudited condensed
consolidated financial statements and related notes thereto and the audited
consolidated financial statements and notes to those statements contained in the
Annual Report on Form 10-KSB for the year ended December 31, 2004.
16
OVERVIEW
As of March 31, 2005, theglobe.com, inc. (the "Company" or "theglobe") managed
three primary lines of business. One line of business, Voice over the Internet
Protocol ("VoIP") telephony services, includes voiceglo Holdings, Inc., a
wholly-owned subsidiary of theglobe that offers VoIP-based phone services and
features. The term VoIP refers to a category of hardware and software that
enables people to use the Internet to make phone calls. The second line of
business consists of our historical network of three wholly-owned businesses,
each of which specializes in the games business by delivering games information
and selling games in the United States and abroad. These businesses are: our
print publication Computer Games Magazine; our Computer Games Online website
(www.cgonline.com), which is the online counterpart to Computer Games Magazine;
and our Chips & Bits, Inc. ("Chips & Bits") (www.chipsbits.com) games
distribution company. We entered a third line of business, marketing services,
on September 1, 2004, with our acquisition of SendTec, Inc. ("SendTec"), a
direct response marketing services and technology company.
At the current time, the Company's revenue is derived principally from the
acquired operations of SendTec, as well as from the operations of our computer
games related businesses. Our VoIP products and services have yet to produce any
significant revenue.
During the first quarter of 2005, management began actively re-evaluating the
Company's primary business lines, particularly in view of the Company's critical
need for cash and the overall net losses of the Company. As a result, management
is currently exploring a number of strategic alternatives for the Company and/or
its businesses, including continuing to operate the businesses, selling certain
businesses or assets, or entering into new lines of businesses. See the
"Liquidity and Capital Resources" section of Management's Discussion and
Analysis of Financial Condition and Results of Operations for a more complete
discussion.
BASIS OF PRESENTATION OF CONSOLIDATED FINANCIAL STATEMENTS; GOING CONCERN
Certain matters discussed below under "Liquidity and Capital Resources" raise
substantial doubt about our ability to continue as a going concern. In addition,
we received a report from our independent accountants, relating to our December
31, 2004 audited financial statements containing an explanatory paragraph
stating that our recurring losses from operations and our accumulated deficit
raise substantial doubt about our ability to continue as a going concern. Our
condensed consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America on
a going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. Accordingly, our
condensed consolidated financial statements do not include any adjustments
relating to the recoverability of assets and classification of liabilities that
might be necessary should we be unable to continue as a going concern.
OUR VOIP TELEPHONY BUSINESS
During the third quarter of 2003, the Company launched its first suite of
consumer and business level VoIP services. The Company launched its
browser-based GloPhone product during the first quarter of 2004. These services
allow consumers and enterprises to communicate using VoIP technology for
dramatically reduced pricing compared to traditional telephony networks. The
services also offer traditional telephony features such as voicemail, caller ID,
call forwarding, and call waiting for no additional cost to the consumer, as
well as incremental services that are not currently supported by the public
switched telephone network ("PSTN") like the ability to use numbers remotely and
voicemail to email services.
Additionally, in November 2004, the Company announced a beta version of an
"instant messenger" or "IM" related application which it is marketing under the
name "GloConnect." The new GloConnect application utilizes the Company's
proprietary web and PC-based GloPhone platform and enables users to chat via
voice or text across multiple platforms using their preferred instant messenger
service, such as AOL's AIM, MSN's Messenger, Yahoo! Messenger and ICQ.
The Company now offers VoIP services, on a retail basis, to individual consumers
and currently provides two primary types of services:
o Browser-Based - full functioning voice and messaging capabilities
that reside on the computer desktop and also include web-based
solutions. The only system requirements are a browser and an
Internet connection. The Company is seeking various patents to
protect its position. The browser-based products work on broadband,
dial-up and wi-fi Internet connections and can optionally be used
with a USB phone or other peripheral devices.
o Hardware-Based - a traditional phone line replacement service.
Requires a voiceglo adapter, a regular phone and an Internet
connection or can optionally be used with a USB phone directly over
a user's computer if desired. The service works on broadband,
dial-up and wi-fi Internet connections.
17
During the latter part of 2004, the Company discontinued offering its "voiceglo"
hardware-based home and business replacement products to new customers, and is
now only providing service to and supporting existing "voiceglo" customers. The
Company is currently developing and testing a number of new VoIP products and
features, which allow users to communicate via mobile phones, traditional land
line phones and/or computers. It plans to release a number of these new products
and features beginning in the second quarter of 2005.
OUR COMPUTER GAMES BUSINESS
Computer Games Magazine is a consumer print magazine for gamers. As a leading
consumer print publication for games, Computer Games magazine boasts: a
reputation for being a reliable, trusted, and engaging games magazine; more
editorial content, tips and hints than most other similar magazines; a
knowledgeable editorial staff providing increased editorial integrity and
content; and, broad-based editorial coverage, appealing to a wide audience of
gamers. In Spring 2004, a new magazine, Now Playing began to be delivered within
Computer Games magazine and in March 2005, Now Playing began to be distributed
as a separate publication. Now Playing covers movies, DVD's, television, music,
games, comics and anime, and is designed to fulfill the wider pop culture
interests of our current readers and to attract a more diverse group of
advertisers; autos, television, telecommunications and film to name a few.
Computer Games Online (www.cgonline.com) is the online counterpart to Computer
Games magazine. Computer Games Online is a source of free computer games news
and information for the sophisticated gamer, featuring news, reviews and
previews. Features of Computer Games Online include: game industry news;
truthful, concise reviews; first looks, tips and hints; multiple content links;
thousands of archived files; and easy access to game buying.
Now Playing Online (www.nowplayingmag.com) is the online counterpart for Now
Playing magazine. Now Playing Online provides free, up-to-date entertainment
news and information for the pop culture consumer. Features of Now Playing
Online include: industry news in music, movies and games; reviews of concerts,
movies and DVDs; and exclusive video interviews by Now Playing writers done with
well-known Hollywood stars.
Chips & Bits (www.chipsbits.com) is a games distribution business that attracts
customers in the United States and abroad. Chips & Bits covers all the major
game platforms available, including Macintosh, Window-based PCs, Sony
PlayStation, Sony PlayStation2, Microsoft's Xbox, Nintendo 64, Nintendo's
GameCube, Nintendo's Game Boy, and Sega Dreamcast, among others.
OUR MARKETING SERVICES BUSINESS
On September 1, 2004, the Company acquired SendTec, a direct response marketing
services and technology company. SendTec provides clients a complete offering of
direct marketing products and services to help their clients market their
products both on the Internet ("online") and through traditional media channels
such as television, radio and print advertising ("offline"). SendTec is
organized into two primary product line divisions: the DirectNet Advertising
Division, which provides digital marketing services; and the Creative South
Division, which provides creative production and media buying services.
Additionally, its proprietary iFactz technology provides software tracking
solutions that benefit both the Direct Net Advertising and Creative South
businesses.
o DirectNet Advertising ("DNA") - DNA delivers results based
interactive marketing programs for advertisers through a network of
online distribution partners including websites, search engines and
email publishers. SendTec's proprietary software technology is used
to track, optimize and report results of marketing campaigns to
advertising clients and distribution partners. Pricing options for
DNA's services include cost-per-action ("CPA"), cost-per-click
("CPC") and cost-per-thousand impressions ("CPM"), with most
payments resulting from CPA agreements.
o Creative South - Creative South provides online and offline agency
marketing services including creative development, campaign
management, creative production, post production, media planning and
media buying services. Most services provided by Creative South are
priced on a fee-per-project basis, where the client pays an agreed
upon fixed fee for a designated scope of work. Creative South also
receives monthly retainer fees from clients from service to such
clients as their Agency of Record.
o iFactz - iFactz is SendTec's Application Service Provider ("ASP")
technology that tracks and reports on a real time basis the online
responses generated from offline direct response advertising, such
as television, radio, print advertising and direct mail. iFactz'
Intelligent Sourcing (TM) is a patent-pending media technology that
informs the user where online customers come from, and what
corresponding activity they produced on the user's website. The
iFactz patent application was filed in November 2001 and the Company
expects the application to be reviewed during 2005. iFactz is
licensed to clients based on a monthly fixed license fee, with
license terms ranging from three months to one year.
18
RESULTS OF OPERATIONS
Effective September 1, 2004, we entered into a new line of business, marketing
services, as a result of our acquisition of SendTec. SendTec's results are
included in the Company's consolidated operating results from its date of
acquisition. As a result of the SendTec acquisition, the results of operations
for the three months ended March 31, 2005, are not necessarily comparable to the
three months ended March 31, 2004.
THREE MONTHS ENDED MARCH 31, 2005 COMPARED TO THE THREE MONTHS ENDED MARCH 31,
2004
NET REVENUE. Net revenue totaled $9.4 million for the three months ended March
31, 2005 as compared to $0.9 million for the three months ended March 31, 2004.
The $8.5 million increase in consolidated net revenue was principally the result
of the $8.8 million in additional net revenue, net of intersegment eliminations,
resulting from the operations of SendTec, which was acquired on September 1,
2004. Partially offsetting this additional revenue was a decline of $0.2 million
in net revenue of our computer games business segment due primarily to a
decrease in the volume of games products sold by Chips & Bits, our computer
games distribution business. Net revenue generated by our telephony services
division totaled approximately $0.1 million in each of the first quarters of
2005 and 2004.
NET REVENUE BY BUSINESS SEGMENT:
2005 2004
----------- --------
Computer games .......... $ 561,392 $756,449
Marketing services ...... 9,105,820 --
VoIP telephony services . 87,092 99,548
Intersegment eliminations (315,576) --
----------- --------
$ 9,438,728 $855,997
=========== ========
SendTec's DirectNet Advertising division, which provides online interactive
marketing services for its clients, generated approximately 91% of the net
revenue reported for the marketing services segment for the three months ended
March 31, 2005. SendTec also provided marketing services to our VoIP telephony
services business segment which resulted in the recording of approximately $0.3
million of intersegment marketing services revenue during the first quarter of
2005.
OPERATING EXPENSES BY BUSINESS SEGMENT:
Depreciation
Cost of Sales and Product General and and
Three months ended: Revenue Marketing Development Administrative Amortization Total
----------- ----------- ----------- -------------- ------------ -----------
2005
- ----
Computer games ................ $ 491,567 $ 85,683 $ 155,139 $ 136,438 $ 7,719 $ 876,546
Marketing services............. 6,479,044 518,633 -- 1,134,905 172,612 8,305,194
VoIP telephony services ....... 1,491,815 695,592 170,702 783,212 268,633 3,409,954
Corporate expenses............. -- -- -- 885,091 9,579 894,670
Intersegment eliminations...... (189,064) (126,512) -- -- -- (315,576)
----------- ----------- ----------- -------------- ------------ -----------
$ 8,273,362 $ 1,173,396 $ 325,841 $ 2,939,646 $ 458,543 $13,170,788
=========== =========== =========== ============== ============ ===========
Depreciation
Cost of Sales and Product General and and
Revenue Marketing Development Administrative Amortization Total
----------- ----------- ----------- -------------- ------------ -----------
2004
- ----
Computer games ................ $ 585,925 $ 87,728 $ 119,666 $ 69,589 $ 3,429 $ 866,337
VoIP telephony services ....... 737,202 739,568 55,850 468,525 226,770 2,227,915
Corporate expenses............. -- -- -- 1,533,903 5,912 1,539,815
----------- ----------- ----------- -------------- ------------ ----------
$ 1,323,127 $ 827,296 $ 175,516 $ 2,072,017 $ 236,111 $4,634,067
=========== =========== =========== ============== ============ ==========
19
COST OF REVENUE. Cost of revenue totaled $8.3 million for the three months ended
March 31, 2005, an increase of $7.0 million from the $1.3 million reported for
the three months ended March 31, 2004. An increase of $0.8 million in costs
incurred by our VoIP telephony services business segment, as well as the
inclusion of marketing services cost of revenue related to the operations of
SendTec totaling approximately $6.3 million, net of intersegment eliminations,
were slightly offset by a decrease of $0.1 million in cost of revenue reported
by our computer games segment as compared to 2004.
Cost of revenue related to our computer games business segment consists
primarily of printing costs of our games magazine, Internet connection charges,
personnel costs, maintenance costs of website equipment and the costs of
merchandise sold and shipping fees in connection with our online store. Cost of
revenue of our computer games segment totaled approximately $0.5 million for the
three months ended March 31, 2005, a decrease of approximately $0.1 million from
the same period in 2004, due primarily to the revenue decreases discussed above.
Cost of revenue related to our marketing services business segment consists of
fees paid to third party vendors for project related research, production and
post-production services and products. Additionally, cost of revenue includes
third party vendor fees incurred to acquire online advertising media, including
the actual cost of the media. Intersegment eliminations in 2005, represent
approximately $0.2 million of costs incurred by SendTec related to marketing
services provided to our VoIP telephony services segment.
Cost of revenue of our VoIP telephony services business segment is principally
comprised of carrier transport and circuit interconnection costs related to our
retail products, as well as personnel and consulting costs incurred in support
of our Internet telecommunications network. Although VoIP telephony services net
revenue was essentially unchanged compared to the first quarter of 2004, cost of
revenue attributable to this segment increased $0.8 million in comparison to the
same period in 2004. Throughout 2004, the Company increased its VoIP network
capacity by entering into agreements with numerous carriers for leased equipment
and services and with third parties for a number of leased data center
facilities. The Company also expanded its internal network support function by
hiring additional technical personnel. As a result, our VoIP network capacity,
as well as our network's operating and support costs, have increased in 2005
compared to 2004.
SALES AND MARKETING. Sales and marketing expenses consist primarily of salaries
and related expenses of sales and marketing personnel, commissions, advertising
and marketing costs, public relations expenses and promotional activities. Sales
and marketing expenses totaled $1.2 million for the three months ended March 31,
2005 versus $0.8 million for the same period in 2004. The rise in consolidated
sales and marketing expenses as compared to 2004 was principally the result of
the $0.4 million in sales and marketing expenses, net of intersegment
eliminations, incurred by the Company's marketing services business segment.
PRODUCT DEVELOPMENT. Product development expenses include salaries and related
personnel costs; expenses incurred in connection with website development,
testing and upgrades; editorial and content costs; and costs incurred in the
development of our VoIP telephony products. Product development expenses totaled
$0.3 million for the three months ended March 31, 2005 as compared to $0.2
million for the three months ended March 31, 2004. The period over period
increase in product development expenses was principally attributable to
increases in personnel and consulting costs related to the development of our
retail VoIP telephony products and services.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses consist
primarily of salaries and other personnel costs related to management, finance
and accounting functions, facilities, outside legal and professional fees,
information-technology consulting, directors and officers insurance, bad debt
expenses and general corporate overhead costs. General and administrative
expenses of $2.9 million in the first quarter of 2005 increased $0.8 million
from the $2.1 million reported for the same period of 2004. The increase in
consolidated general and administrative expenses as compared to the 2004 first
quarter was primarily attributable to the $1.1 million of general and
administrative expenses incurred by the Company's marketing services segment. At
year-end 2004, the Company wrote-off the carrying value of its VoIP telephony
billing system as a result of its review and evaluation of the VoIP telephony
services segment's long-lived assets for impairment. Costs incurred during the
2005 first quarter in the further development of the VoIP telephony billing
system have been included within general and administrative expenses. These
costs, as well as higher salaries and facilities costs contributed to the $0.3
million increase in general and administrative expenses of the VoIP telephony
services segment as compared to the first quarter of 2004. Corporate general and
administrative expense declined $0.6 million as compared to the 2004 first
quarter primarily due to decreases in stock compensation expenses recorded as a
result of stock option grants, personnel related expenses and legal expenses.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense totaled
$0.5 million for the three months ended March 31, 2005. The $0.3 million
increase from the same period of the prior year resulted principally from the
depreciation and intangible asset amortization expenses incurred by the
Company's marketing services business.
INTEREST INCOME (EXPENSE), NET. Approximately $0.7 million of non-cash interest
expense was recorded during the first quarter of 2004 related to the beneficial
conversion feature of the $2,000,000 demand convertible promissory note acquired
by our Chairman and Chief Executive Officer and his spouse in February 2004.
20
OTHER EXPENSE, NET. Other expense, net, includes reserves against the amounts
advanced by the Company to Tralliance Corporation, a development stage internet
related business venture, totaling $0.2 million and $0.1 million in the three
month periods ended March 31, 2005 and 2004, respectively. See Note 4, "Other
Assets", in the accompanying Notes to Unaudited Condensed Consolidated Financial
Statements for information regarding the Company's acquisition of Tralliance in
May 2005.
INCOME TAXES. The income tax provision of $16,350 recorded for the three months
ended March 31, 2005 consisted solely of state and local income taxes. No
federal tax benefit was recorded for the first quarters of 2005 and 2004 as we
recorded a 100% valuation allowance against our otherwise recognizable deferred
tax assets due to the uncertainty surrounding the timing or ultimate realization
of the benefits of our net operating loss carry forwards in future periods. Our
effective tax rate differs from the statutory Federal income tax rate, primarily
as a result of the uncertainty regarding our ability to utilize our net
operating loss carryforwards. As of December 31, 2004, the Company had net
operating loss carryforwards available for U.S. and foreign tax purposes of
approximately $162 million. These carryforwards expire through 2024. The Tax
Reform Act of 1986 imposes substantial restrictions on the utilization of net
operating losses and tax credits in the event of an "ownership change" of a
corporation. As defined in the Internal Revenue Code of 1986, as amended, due to
the change in our ownership interests in August 1997 and May 1999 and the
Company's private offering of securities in March 2004 (together with the
exercise and conversion of various securities in connection with such private
offering of securities) and the issuance of shares in connection with our
acquisition of SendTec on September 1, 2004, the Company may have substantially
limited or eliminated the availability of its net operating loss carryforwards.
There can be no assurance that the Company will be able to avail itself of any
net operating loss carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
FUTURE AND CRITICAL NEED FOR CAPITAL
At March 31, 2005, the Company's sole source of liquidity consisted of $3.3
million of cash and cash equivalents. On April 22, 2005, we entered into a Note
Purchase Agreement (the "Agreement") with E&C Capital Partners, LLLP, and E&C
Capital Partners II, Ltd. ("the E&C Partnerships"), entities controlled by our
Chairman and Chief Executive Officer and our President, pursuant to which the
E&C Partnerships acquired secured demand convertible promissory notes (the
"Notes") in the aggregate principal amount of $1.5 million. Under the terms of
the Agreement, the E&C Partnerships were also granted the optional right, for a
period of 90 days from the date of the Agreement, to purchase additional secured
demand convertible promissory notes such that the aggregate principal amount of
Notes issued under the Agreement may total $4.0 million. The Notes are
convertible, at the option of the noteholders into shares of our Common Stock at
an initial price of $0.05 per share. The Notes provide for interest at the rate
of ten percent per annum and are secured by a pledge of substantially all of the
assets of the Company. The Notes are due and payable five days after demand for
payment by the E&C Partnerships. Based on its current financial position, the
Company would not have the resources to pay the Notes following any such demand.
The Company's cash and cash equivalents balance at May 6, 2005, inclusive of the
$1.5 million in proceeds received from the sale of the Notes, was approximately
$4.0 million.
The Company continues to incur substantial consolidated net losses and
management believes the Company will continue to be unprofitable for the
foreseeable future. The Company's consolidated net losses and cash usage during
its recent past and projected future periods relate primarily to the operation
of its VoIP telephony services business and to a lesser extent to corporate
overhead expenses. SendTec, the Company's marketing services business, has
contributed net income and cash flow since being acquired on September 1, 2004,
and management expects that SendTec will continue to be profitable and provide
positive cash flow in future periods. Management does not expect that its
computer games business segment will incur significant net losses or use
significant amounts of cash in the foreseeable future.
In order to offer our VoIP services, we have invested substantial capital and
made substantial commitments related to the development of the VoIP network. The
VoIP network is comprised of switching hardware and software, servers, billing
and inventory systems, and telecommunications carrier services. We own and
operate VoIP equipment located in leased data center facilities in Miami, New
York, Atlanta and Boston, and interconnect this equipment utilizing a leased
transport network through numerous carrier agreements with third party
providers. Through these carrier relationships we are able to carry the traffic
of our customers over the Internet and interact with the public switched
telephone network. We generally enter into one year agreements with these data
centers and carriers, with the term of several agreements extending to three or
five years. Based upon our existing contractual commitments at December 31,
2004, minimum amounts payable during calendar year 2005 for network data center
and carrier circuit interconnection service expenses, exclusive of regulatory
taxes, fees and charges, are approximately $2.1 million.
During 2004, the Company expended significant costs to implement a number of
marketing programs geared toward increasing the number of its VoIP retail
customers and telephony revenue. None of these programs proved to be successful
to any significant degree. Our inability to generate telephony revenue
sufficient to cover the fixed costs of operating our VoIP network, including
carrier, data center, personnel and administrative costs, as well as our
marketing and other variable costs, has resulted in the Company incurring
substantial net losses during 2004 and during the first quarter of 2005.
21
The Company believes that the capacity of its VoIP network, including its lease
obligations relating to such network, will continue to be greatly in excess of
customer demand and usage levels for the foreseeable future. The Company was
successful in recently terminating certain minimum usage requirement commitments
for which it was previously obligated to make carrier payments totaling
approximately $1.9 million, exclusive of regulatory taxes, fees and charges,
during 2005. Additionally, the Company is currently negotiating to reduce the
approximate $2.1 million remaining minimum amounts payable during 2005 for other
network data center and carrier circuit interconnection services.
During October 2004, the Company engaged financial advisors to assist the
Company in raising capital through a private placement of its equity securities,
or in entering into other business relationships with certain strategic
investors. In February 2005, the Company engaged an additional financial advisor
to assist the Company in connection with raising capital through a private
placement of equity securities in either the Company or its SendTec wholly-owned
subsidiary or alternatively in selling either part or all of the Company's
businesses or assets, including its SendTec business. We currently have no
access to credit facilities with traditional third party lenders and there can
be no assurance that we would be able to raise capital or sell any of our
businesses or assets. In addition, any financing that could be obtained would
likely significantly dilute existing shareholders. As more fully described
below, management is exploring a number of strategic alternatives regarding the
Company's future business operations and is in the process of developing and
implementing internal actions to improve the Company's liquidity and business
performance. The Company's future strategic direction is highly dependent upon
the outcome of its efforts to raise capital and/or sell certain businesses or
assets.
During the first quarter of 2005, the Company reevaluated its existing VoIP
telephony services business plan and is currently in the process of terminating
and/or modifying certain of its existing product offerings and marketing
programs, as well as developing and testing certain new VoIP products and
features. The Company also, during the first quarter of 2005, made the decision
to discontinue using its SendTec business to perform marketing services for its
VoIP business, and to instead dedicate 100% of SendTec's marketing services to
support and grow its own third party customer base. Additionally, in order to
reduce its near term consolidated net losses and cash usage, the Company
implemented a number of cost-reduction actions at its VoIP telephony services
business, including decreases in personnel and salary levels, carrier and data
center costs (including the minimum commitment costs discussed above), and
marketing/advertising expenses during the first quarter of 2005.
Management believes that it will be difficult to implement its new VoIP product
and marketing plans, once fully developed and tested, without additional cash
being provided from a prospective financing or sale transaction(s). Should the
Company's new VoIP product offerings achieve market acceptance and significantly
increase the Company's current customer and revenue base, additional cash
resources to fund capital expenditures related to the Company's VoIP network and
customer billing systems and to fund future marketing and other business
development costs would be required. No significant capital expenditures are
expected to be required to accommodate the operation or growth of either the
Company's SendTec marketing services business or its computer games business in
the near term future.
There can be no assurance that the Company's new VoIP product offerings will be
successful in attracting a sufficient number of new customers to its VoIP
network and increasing telephony revenue to desired levels. Even if the Company
is able to raise additional capital, management may at any time, decide to
terminate the operations of its VoIP telephony services business, either by
asset sale or abandonment, if future investment returns are considered
inadequate and/or preferable investment alternatives exist.
On May 9, 2005, the Company exercised its purchase option and we acquired
Tralliance Corporation ("Tralliance"), a development stage Internet-related
business venture. Tralliance was created to develop, operate and administer the
".travel" top-level domain, a new segment of the Internet devoted to the travel
industry. Tralliance recently entered into an agreement with the Internet
Corporation for Assigned Names and Numbers ("ICANN") to become the registry for
the ".travel" top-level domain. The Tralliance purchase price consisted of the
issuance of 2,000,000 shares of theglobe.com Common Stock, warrants to acquire
475,000 shares of theglobe.com Common Stock and $40,000 in cash. The warrants
are exercisable for a period of five years at an exercise price of $0.11 per
share. The Common Stock issued as a result of the acquisition of Tralliance is
entitled to certain "piggy-back" registration rights. In addition, as part of
the transaction, the Company agreed to pay approximately $0.2 million in
outstanding liabilities of Tralliance immediately after the closing of the
acquisition. Additionally, the Company expects to fund approximately $0.7
million of Tralliance's start-up costs prior to the end of the third quarter of
2005.
Based upon the foregoing, Company management does not presently believe that
cash on hand and cash flow generated internally by the company will be adequate
to fund the operation of its businesses and the implementation of its current
VoIP business plan beyond a short period of time. We received a report from our
independent accountants, relating to our December 31, 2004 audited financial
statements containing an explanatory paragraph stating that our recurring losses
from operations and our accumulated deficit raise substantial doubts about our
ability to continue as a going concern. We believe that the funding received and
potentially receivable in connection with the E&C Partnerships' Note Purchase
Agreement (maximum of $4.0 million as discussed above and assuming that no
demand for payment is made by the Noteholders) provides the Company with
temporary short-term liquidity to operate its businesses while it seeks to raise
sufficient additional capital, which may involve the potential sale of one or
more of the Company's subsidiaries, including SendTec.
22
If we are not successful in entering into a financing, sale, or business
transaction that infuses sufficient additional cash resources into the Company,
by sometime during the third quarter of 2005, we expect to pursue the remaining
$2.5 million of optional convertible promissory note financing. If such funding
is received we believe the funding will provide the Company with additional
short-term liquidity into the fourth quarter of 2005. There can be no assurance
that this financing will be available when and if required, nor that demand for
repayment will not be made prior to such date. In the event that we are not
successful in obtaining the remaining $2.5 million in funding from E&C
Partnerships or in the event that such remaining funds are received and depleted
prior to our raising of sufficient additional capital, we believe that the
Company will no longer be able to continue the implementation of its current
VoIP business plan. As a result, it is likely that we would be required to
either temporarily suspend or permanently shutdown the operation of our VoIP
telephony services business. Additionally, in such event, management believes
that it may also be required to revise the business plan of some or all of its
other business segments and/or further implement company-wide cost-reduction
programs. There can be no assurance that the Company would be successful in
implementing such revised business plans and effectively restructuring its
businesses so that the Company would have the ability to continue to operate as
a going concern in the future.
The shares of our Common Stock were delisted from the NASDAQ national market in
April 2001 and are now traded in the over-the-counter market on what is commonly
referred to as the electronic bulletin board or OTCBB. Since the trading price
of our Common Stock is less than $5.00 per share, trading in our Common Stock is
also subject to the requirements of Rule 15g-9 of the Exchange Act. Our Common
Stock is also considered a penny stock under the Securities Enforcement Remedies
and Penny Stock Reform Act of 1990, which defines a penny stock, generally, as
any equity security not traded on an exchange or quoted on the Nasdaq SmallCap
Market that has a market price of less than $5.00 per share. Under Rule 15g-9,
brokers who recommend our Common Stock to persons who are not established
customers and accredited investors, as defined in the Exchange Act, must satisfy
special sales practice requirements, including requirements that they make an
individualized written suitability determination for the purchaser; and receive
the purchaser's written consent prior to the transaction. The Securities
Enforcement Remedies and Penny Stock Reform Act of 1990 also requires additional
disclosures in connection with any trades involving a penny stock, including the
delivery, prior to any penny stock transaction, of a disclosure schedule
explaining the penny stock market and the risks associated with that market.
Such requirements may severely limit the market liquidity of our Common Stock
and the ability of purchasers of our equity securities to sell their securities
in the secondary market. Consequently, it has also made it more difficult for us
to raise additional capital, although the Company has had some success in
offering its securities as consideration for the acquisition of various business
opportunities or assets. We may also incur additional costs under state blue sky
laws if we sell equity due to our delisting.
CASH FLOW ITEMS
As of March 31, 2005, we had approximately $3.3 million in cash and cash
equivalents as compared to $6.8 million as of December 31, 2004. Net cash used
in operating activities was $3.1 million and $3.6 million, for the three months
ended March 31, 2005 and 2004, respectively. The period-to-period decrease in
net cash used in operating activities resulted primarily from the decrease in
our net operating losses and favorable working capital changes offset by
decreases in non-cash charges.
Net cash of $0.4 million was used in investing activities during the three
months ended March 31, 2005. The Company incurred costs totaling $0.2 million
and $0.3 million for capital expenditures related primarily to the development
of its VoIP telephony network and to a lesser extent to the development of its
VoIP telephony customer billing system during the three months ended March 31,
2005 and 2004, respectively. We also loaned approximately $0.2 million and $0.1
million to Tralliance Corporation, a development stage Internet related business
venture, during the three months ended 2005 and 2004, respectively.
Net cash used in financing activities was $27,000 and net cash provided by
financing activities was $29.2 million for the three months ended 2005 and 2004,
respectively. As discussed in the Company's Annual Report on Form 10-KSB for the
year ended December 31, 2004, the Company completed a private offering of its
Common Stock and warrants to acquire its Common Stock in March 2004 resulting in
the issuance of 33,381,647 shares of Common Stock, and warrants to acquire
16,690,824 shares of its Common Stock, for gross proceeds of approximately $28.4
million. Offering costs included $1.2 million in cash commissions paid to the
placement agent and approximately $0.2 million in legal and accounting fees. In
addition, on February 2, 2004, the Company issued a $2,000,000 Bridge Note which
was subsequently converted into our Common Stock in connection with the March
2004 private offering. Proceeds of approximately $0.1 million were received from
the exercise of stock options and warrants during 2004.
EFFECTS OF INFLATION
Due to relatively low levels of inflation in 2005 and 2004, inflation has not
had a significant effect on our results of operations since inception.
MANAGEMENT'S DISCUSSION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of our financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Our estimates, judgments and assumptions are continually
evaluated based on available information and experience. Because of the use of
estimates inherent in the financial reporting process, actual results could
differ from those estimates.
23
Certain of our accounting policies require higher degrees of judgment than
others in their application. These include revenue recognition, valuation of
customer receivables, valuation of inventories, valuation of goodwill,
intangible assets and other long-lived assets and capitalization of computer
software costs. Our accounting policies and procedures related to these areas
are summarized below.
REVENUE RECOGNITION
The Company's revenues were derived principally from the sale of print
advertisements under short-term contracts in our games information magazine
Computer Games; through the sale of our games information magazine through
newsstands and subscriptions; from the sale of video games and related products
through our online store Chips & Bits; from the sale of direct response
marketing services by our recently acquired wholly-owned subsidiary, SendTec and
from the sale of VoIP telephony services. There is no certainty that events
beyond anyone's control such as economic downturns or significant decreases in
the demand for our services and products will not occur and accordingly, cause
significant decreases in revenue.
Computer Games Businesses
Advertising revenues for the games information magazine are recognized at the
on-sale date of the magazine.
Newsstand sales of the games information magazine are recognized at the on-sale
date of the magazine, net of provisions for estimated returns. Subscription
revenue, which is net of agency fees, is deferred when initially received and
recognized as income ratably over the subscription term.
Sales of video games and related products from the online store are recognized
as revenue when the product is shipped to the customer. Amounts billed to
customers for shipping and handling charges are included in net revenue. The
Company provides an allowance for returns of merchandise sold through its online
store. The allowance provided to date has not been significant.
Marketing Services
Revenue from the distribution of Internet advertising is recognized when
Internet users visit and complete actions at an advertiser's website. Revenue
consists of the gross value of billings to clients, including the recovery of
costs incurred to acquire online media required to execute client campaigns.
Recorded revenue is based upon reports generated by the Company's tracking
software.
Revenue derived from the purchase and tracking of direct response media, such as
television and radio commercials, is recognized on a net basis when the
associated media is aired. In many cases, the amount the Company bills to
clients significantly exceeds the amount of revenue that is earned due to the
existence of various "pass-through" charges such as the cost of the television
and radio media. Amounts received in advance of media airings are deferred as
customer advances until the associated media is aired.
Revenue generated from the production of direct response advertising programs,
such as infomercials, is recognized on the completed contract method when such
programs are complete and available for airing. Production activities generally
take eight to twelve weeks and the Company usually collects amounts in advance
and at various points throughout the production process. Amounts received from
customers prior to completion of commercials are reported as deferred revenue
and direct costs associated with the production of commercials in process are
deferred and reported as deferred production costs until the associated project
is complete.
VoIP Telephony Services
VoIP telephony services revenue represents fees charged to customers for voice
services and is recognized based on minutes of customer usage or as services are
provided. The Company records payments received in advance for prepaid services
as deferred revenue until the related services are provided. Sales of peripheral
VoIP telephony equipment are recognized as revenue when the product is shipped
to the customer. Amounts billed to customers for shipping and handling charges
are included in net revenue.
VALUATION OF CUSTOMER RECEIVABLES
Provisions for the allowance for doubtful accounts are made based on historical
loss experience adjusted for specific credit risks. Measurement of such losses
requires consideration of the Company's historical loss experience, judgments
about customer credit risk, and the need to adjust for current economic
conditions.
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VALUATION OF INVENTORIES
Inventories are recorded on a first-in, first-out basis and valued at the lower
of cost or market value. We generally manage our inventory levels based on
internal forecasts of customer demand for our products, which is difficult to
predict and can fluctuate substantially. Our inventories include high technology
items that are specialized in nature or subject to rapid obsolescence. If our
demand forecast is greater than our actual demand for our products, we may be
required to record charges related to increases in our inventory valuation
reserves. The value of our inventory is also dependent on our estimate of future
average selling prices, and, if our projected average selling prices are over
estimated, we may be required to adjust our inventory value to reflect the lower
of cost or market.
GOODWILL AND INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that
certain acquired intangible assets in a business combination be recognized as
assets separate from goodwill. SFAS No. 142 requires that goodwill and other
intangibles with indefinite lives should no longer be amortized, but rather
tested for impairment annually or on an interim basis if events or circumstances
indicate that the fair value of the asset has decreased below its carrying
value.
Our policy calls for the assessment of the potential impairment of goodwill and
other identifiable intangibles with indefinite lives whenever events or changes
in circumstances indicate that the carrying value may not be recoverable or at
least on an annual basis. Some factors we consider important which could trigger
an impairment review include the following:
o significant under-performance relative to historical, expected or
projected future operating results;
o significant changes in the manner of our use of the acquired assets or the
strategy for our overall business; and
o significant negative industry or economic trends.
When we determine that the carrying value of goodwill or other identified
intangibles with indefinite lives may not be recoverable, we measure any
impairment based on a projected discounted cash flow method.
LONG-LIVED ASSETS
Historically, the Company's long-lived assets, other than goodwill, have
primarily consisted of property and equipment, capitalized costs of internal-use
software, values attributable to covenants not to compete, acquired technology
and patent costs.
Long-lived assets held and used by the Company and intangible assets with
determinable lives are reviewed for impairment whenever events or circumstances
indicate that the carrying amount of assets may not be recoverable in accordance
with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets." We evaluate recoverability of assets to be held and used by comparing
the carrying amount of the assets, or the appropriate grouping of assets, to an
estimate of undiscounted future cash flows to be generated by the assets, or
asset group. If such assets are considered to be impaired, the impairment to be
recognized is measured as the amount by which the carrying amount of the assets
exceeds the fair value of the assets. Fair values are based on quoted market
values, if available. If quoted market prices are not available, the estimate of
fair value may be based on the discounted value of the estimated future cash
flows attributable to the assets, or other valuation techniques deemed
reasonable in the circumstances.
CAPITALIZATION OF COMPUTER SOFTWARE COSTS
The Company capitalizes the cost of internal-use software which has a useful
life in excess of one year in accordance with Statement of Position No. 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." Subsequent additions, modifications, or upgrades to internal-use
software are capitalized only to the extent that they allow the software to
perform a task it previously did not perform. Software maintenance and training
costs are expensed in the period in which they are incurred. Capitalized
computer software costs are amortized using the straight-line method over the
expected useful life, or three years.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In March 2005, the FASB issued Interpretation ("FIN") No. 47, "Accounting for
Conditional Asset Retirement Obligations", an interpretation of FASB Statement
No. 143, "Accounting for Asset Retirement Obligations." The interpretation
clarifies that the term conditional asset retirement obligation refers to a
legal obligation to perform an asset retirement activity in which the timing and
(or) method of settlement are conditional on a future event that may or may not
be within the control of the entity. An entity is required to recognize a
liability for the fair value of a conditional asset retirement obligation if the
fair value of the liability can be reasonably estimated. FIN 47 also clarifies
when an entity would have sufficient information to reasonably estimate the fair
value of an asset retirement obligation. The effective date of this
interpretation is no later than the end of fiscal years ending after December
15, 2005. The Company is currently investigating the effect, if any, that FIN 47
would have on the Company's financial position, cash flows and results of
operations.
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In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29." SFAS No. 153 requires exchanges of
productive assets to be accounted for at fair value, rather than at carryover
basis, unless (1) neither the asset received nor the asset surrendered has a
fair value that is determinable within reasonable limits or (2) the transactions
lack commercial substance. This statement is effective for nonmonetary asset
exchanges occurring in fiscal periods beginning after June 15, 2005. The Company
does not expect the adoption of this standard to have a material impact on its
financial condition, results of operations, or liquidity.
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment." This
standard replaces SFAS No. 123, "Accounting for Stock-Based Compensation" and
supersedes Accounting Principles Board ("APB") Opinion No. 25, "Accounting for
Stock Issued to Employees." The standard requires companies to expense the fair
value of stock options on the grant date and is effective for annual periods
beginning after June 15, 2005. In accordance with the revised statement, the
expense attributable to stock options granted or vested subsequent to January 1,
2006 will be required to be recognized by the Company. The Company has not yet
evaluated the impact of this pronouncement on the Company.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - An Amendment
of ARB No. 43, Chapter 4." SFAS No. 151 requires all companies to recognize a
current-period charge for abnormal amounts of idle facility expense, freight,
handling costs and wasted materials. This statement also requires that the
allocation of fixed production overhead to the costs of conversion be based on
the normal capacity of the production facilities. SFAS No. 151 will be effective
for fiscal years beginning after June 15, 2005. The Company does not expect the
adoption of this statement to have a material effect on its consolidated
financial statements.
In December 2003, the FASB issued FIN No. 46-R "Consolidation of Variable
Interest Entities." FIN 46-R, which modifies certain provisions and effective
dates of FIN 46, sets forth the criteria to be used in determining whether an
investment in a variable interest entity should be consolidated. These
provisions are based on the general premise that if a company controls another
entity through interests other than voting interests, that company should
consolidate the controlled entity. The Company believes that currently, it does
not have any material arrangements that meet the definition of a variable
interest entity which would require consolidation.
RISK FACTORS
In addition to the other information in this report, the following factors
should be carefully considered in evaluating our business and prospects.
RISKS RELATING TO OUR BUSINESS GENERALLY
We May Not Be Able To Continue As A Going Concern.
We have recently engaged certain financial advisors to assist the Company in
raising capital through private placement of equity securities or alternatively
in selling either part or all of the Company's businesses or assets. We
currently have no access to credit facilities with traditional third party
lenders and there can be no assurance that we would be able to raise any such
capital or sell any of our businesses or assets. In addition, any financing that
could be obtained would likely significantly dilute existing stockholders.
We do not presently believe that cash on hand and cash flow generated internally
by the Company will be adequate to fund the operation of our businesses and the
implementation of our current VoIP business plan beyond a short period of time.
We received a report from our independent accountants, relating to our December
31, 2004 audited financial statements containing an explanatory paragraph
stating that our recurring losses from operations and our accumulated deficit
raise substantial doubts about our ability to continue as a going concern. We
believe that the funding received and potentially receivable in connection with
the E & C Partnerships' Note Purchase Agreement (maximum of $4.0 million and
assuming that no demand for payment is made by the Noteholders) provides the
Company with temporary short-term liquidity to operate its businesses while it
seeks to raise sufficient additional capital, which may involve the potential
sale of one or more of the Company's subsidiaries, including SendTec.
26
If we are not successful in entering into a financing, sale, or business
transaction that infuses sufficient additional cash resources into the Company,
by sometime during the third quarter of 2005, we expect to pursue the remaining
$2.5 million, of optional convertible promissory note financing. If such funding
is received, we believe the funding will provide the Company with additional
short-term liquidity into the fourth quarter of 2005. There can be no assurance
that this financing will be available when and if required, nor that demand for
repayment will not be made prior to such date. In the event that we are not
successful in obtaining the remaining $2.5 million in funding from E&C
Partnerships or in the event that such remaining funds are received and depleted
prior to our raising of sufficient additional capital, we believe that the
Company will no longer be able to continue the implementation of its current
VoIP business plan. As a result, it is likely that we would be required to
either temporarily suspend or permanently shutdown the operation of our VoIP
telephony services business. Additionally, in such event, management believes
that it may also be required to revise the business plan of some or all of its
other business segments and/or further implement company-wide cost-reduction
programs. There can be no assurance that the Company would be successful in
implementing such revised business plans and effectively restructuring its
businesses so that the Company would have the ability to continue to operate as
a going concern in the future.
Although the secured demand convertible notes (the "Notes") are owned by certain
entities which are controlled by our Chairman, if any of such entities were to
make demand for payment of the Notes, we do not have the financial resources to
honor such payment. Absent additional financing, in the event demand is made for
repayment of the Notes, the Company will not have the resources to repay the
Notes. Inasmuch as substantially all of the assets of the Company and its
subsidiaries secure the Notes, in connection with any resulting proceeding to
collect the indebtedness relating to the Notes, the Noteholders could seize and
sell the assets of the Company and its subsidiaries, any or all of which would
have a material adverse effect on the Company and its operations.
We Have A History Of Operating Losses And Expect To Continue To Incur Losses.
Since our inception, we have incurred net losses in each quarter, except the
fourth quarter of 2002 where we had net income of approximately $17,000. We
expect that we will continue to incur net losses for the foreseeable future. We
had net losses of approximately $24.3 million and $11.0 million for the years
ended December 31, 2004 and 2003, respectively, and approximately $4.0 million
for the first three months of 2005. The principal causes of our losses are
likely to continue to be:
o costs resulting from the operation of our businesses;
o costs relating to entering new business lines;
o failure to generate sufficient revenue; and
o selling, general and administrative expenses.
Although we have restructured our businesses, we still expect to continue to
incur losses as we continue to develop our VoIP telephony services business and
while we explore a number of strategic alternatives for our businesses,
including continuing to operate the businesses, selling certain businesses or
assets, or acquiring or developing additional businesses or complementary
products.
Our Entry Into New Lines Of Business, As Well As Potential Future Acquisitions,
Joint Ventures Or Strategic Transactions Entails Numerous Risks And
Uncertainties.
We have entered into new business lines, VoIP telephony services and marketing
services. In November 2002, we acquired certain VoIP assets from an entrepreneur
in exchange for 1,750,000 warrants to purchase our Common Stock. On May 28,
2003, we acquired Direct Partner Telecom, Inc. ("DPT"), an international
licensed telecommunications carrier then engaged in the purchase and resale of
telecommunication services over the Internet. On September 1, 2004, we acquired
SendTec, Inc. ("SendTec"), a direct response marketing services and technology
company. On May 9, 2005, we acquired Tralliance Corporation ("Tralliance"), a
development stage Internet-related business venture. Tralliance was recently
awarded the contract to operate as the registry for the ".travel" top-level
domain by the Internet Corporation for Assigned Names and Numbers. Although
highly dependent upon our obtaining additional capital, we may also enter into
new or different lines of business, as determined by management and our Board of
Directors. Our acquisitions, as well as any future acquisitions or joint
ventures could result, and in some instances have resulted in numerous risks and
uncertainties, including:
o potentially dilutive issuances of equity securities, which may be issued
at the time of the transaction or in the future if certain performance or
other criteria are met or not met, as the case may be. These securities
may be freely tradable in the public market or subject to registration
rights which could require us to publicly register a large amount of our
Common Stock, which could have a material adverse effect on our stock
price;
o diversion of management's attention and resources from our existing
businesses;
o significant write-offs if we determine that the business acquisition does
not fit or perform up to expectations;
o the incurrence of debt and contingent liabilities or impairment charges
related to goodwill and other long-lived assets;
o difficulties in the assimilation of operations, personnel, technologies,
products and information systems of the acquired companies;
27
o regulatory and tax risks relating to the new or acquired business;
o the risks of entering geographic and business markets in which we have no
or limited prior experience;
o the risk that the acquired business will not perform as expected; and
o material decreases in short-term or long-term liquidity.
Our Net Operating Loss Carry Forwards May Be Limited.
As of December 31, 2004, we had net operating loss carryforwards potentially
available for U.S. and foreign tax purposes of approximately $162 million. These
carryforwards expire through 2024. The Tax Reform Act of 1986 imposes
substantial restrictions on the utilization of net operating losses and tax
credits in the event of an "ownership change" of a corporation. Due to the
change in our ownership interests in August 1997 and May 1999, the Company's
private offering in March 2004 (together with the exercise and conversion of
various securities in connection with such private offering) and the issuance of
Common Stock in connection with the acquisition of SendTec on September 1, 2004,
as defined in the Internal Revenue Code of 1986, as amended, we may have
substantially limited or eliminated the availability of our net operating loss
carryforwards. There can be no assurance that we will be able to utilize any net
operating loss carryforwards in the future.
We Could Be Adversely Affected By An Impairment Of Goodwill And/Or Intangible
Assets On Our Balance Sheet.
Our acquisition of SendTec has resulted in the recording of a significant amount
of goodwill and intangible assets on our balance sheet. The goodwill was
recorded because the fair value of the net assets acquired was less than the
purchase price. We may not realize the full value of the goodwill and/or
intangible assets. As such, we evaluate on a regular basis whether events and
circumstances indicate that some or all of the carrying value of goodwill and/or
intangible assets are no longer recoverable, in which case we would write off
the unrecoverable portion as a charge to our earnings.
We Depend On The Continued Growth In The Use And Commercial Viability Of The
Internet.
Our marketing services business, VoIP telephony services business and computer
games businesses are substantially dependent upon the continued growth in the
general use of the Internet. Internet and electronic commerce growth may be
inhibited for a number of reasons, including:
o inadequate network infrastructure;
o security and authentication concerns;
o inadequate quality and availability of cost-effective, high-speed service;
o general economic and business downturns; and
o catastrophic events, including war and terrorism.
As web usage grows, the Internet infrastructure may not be able to support the
demands placed on it by this growth or its performance and reliability may
decline. Websites have experienced interruptions in their service as a result of
outages and other delays occurring throughout the Internet network
infrastructure. If these outages or delays frequently occur in the future, web
usage, as well as usage of our services, could grow more slowly or decline.
Also, the Internet's commercial viability may be significantly hampered due to:
o delays in the development or adoption of new operating and technical
standards and performance improvements required to handle increased levels
of activity;
o increased government regulation;
o potential governmental taxation of such services; and
o insufficient availability of telecommunications services which could
result in slower response times and adversely affect usage of the
Internet.
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We May Face Increased Government Regulation, Taxation And Legal Uncertainties In
Our Industry, Which Could Harm Our Business.
There are an increasing number of federal, state, local and foreign laws and
regulations pertaining to the Internet and telecommunications. In addition, a
number of federal, state, local and foreign legislative and regulatory proposals
are under consideration. Laws or regulations have been and may continue to be
adopted with respect to the Internet relating to, among other things, fees and
taxation of VoIP telephony services, liability for information retrieved from or
transmitted over the Internet, online content regulation, user privacy, data
protection, pricing, content, copyrights, distribution, electronic contracts and
other communications, consumer protection, the provision of online payment
services, broadband residential Internet access, and the characteristics and
quality of products and services.
Changes in tax laws relating to electronic commerce could materially affect our
business, prospects and financial condition. One or more states or foreign
countries may seek to impose sales or other tax collection obligations on
out-of-jurisdiction companies that engage in electronic commerce. A successful
assertion by one or more states or foreign countries that we should collect
sales or other taxes on services could result in substantial tax liabilities for
past sales, decrease our ability to compete with traditional telephony, and
otherwise harm our business.
Currently, decisions of the U.S. Supreme Court restrict the imposition of
obligations to collect state and local sales and use taxes with respect to
electronic commerce. However, a number of states, as well as the U.S. Congress,
have been considering various initiatives that could limit or supersede the
Supreme Court's position regarding sales and use taxes on electronic commerce.
If any of these initiatives addressed the Supreme Court's constitutional
concerns and resulted in a reversal of its current position, we could be
required to collect sales and use taxes. The imposition by state and local
governments of various taxes upon electronic commerce could create
administrative burdens for us and could adversely affect our VoIP business
operations, and ultimately our financial condition, operating results and future
prospects.
Moreover, the applicability to the Internet of existing laws governing issues
such as intellectual property ownership and infringement, copyright, trademark,
trade secret, obscenity, libel, employment and personal privacy is uncertain and
developing. It is not clear how existing laws governing issues such as property
ownership, sales and other taxes, libel, and personal privacy apply to the
Internet and electronic commerce. Any new legislation or regulation, or the
application or interpretation of existing laws or regulations, may decrease the
growth in the use of the Internet or VoIP telephony services, may impose
additional burdens on electronic commerce or may alter how we do business. This
could decrease the demand for our existing or proposed services, increase our
cost of doing business, increase the costs of products sold through the Internet
or otherwise have a material adverse effect on our business, plans, prospects,
results of operations and financial condition.
Our ability to offer VoIP services outside the U.S. is also subject to the local
regulatory environment, which may be complicated and often uncertain. Regulatory
treatment of Internet telephony outside the United States varies from country to
country.
We Rely On Intellectual Property And Proprietary Rights.
We regard substantial elements of our websites and underlying technology, as
well as certain assets relating to our VoIP and direct response marketing
businesses and other opportunities we are investigating, as proprietary and
attempt to protect them by relying on intellectual property laws and
restrictions on disclosure. We also generally enter into confidentiality
agreements with our employees and consultants. In connection with our license
agreements with third parties, we generally seek to control access to and
distribution of our technology and other proprietary information. Despite these
precautions, it may be possible for a third party to copy or otherwise obtain
and use our proprietary information without authorization or to develop similar
technology independently. Thus, we cannot assure you that the steps taken by us
will prevent misappropriation or infringement of our proprietary information,
which could have an adverse effect on our business. In addition, our competitors
may independently develop similar technology, duplicate our products, or design
around our intellectual property rights.
We pursue the registration of our trademarks in the United States and, in some
cases, internationally. We are also seeking patent protection for certain VoIP
and direct response marketing assets which we acquired or which we have
developed. However, effective intellectual property protection may not be
available in every country in which our services are distributed or made
available through the Internet. Policing unauthorized use of our proprietary
information is difficult. Legal standards relating to the validity,
enforceability and scope of protection of proprietary rights in Internet-related
businesses are also uncertain and still evolving. We cannot assure you about the
future viability or value of any of our proprietary rights.
Litigation may be necessary in the future to enforce our intellectual property
rights or to determine the validity and scope of the proprietary rights of
others. However, we may not have sufficient funds or personnel to adequately
litigate or otherwise protect our rights. Furthermore, we cannot assure you that
our business activities and product offerings will not infringe upon the
proprietary rights of others, or that other parties will not assert infringement
claims against us, including claims related to providing hyperlinks to websites
operated by third parties or providing advertising on a keyword basis that links
a specific search term entered by a user to the appearance of a particular
advertisement. Moreover, from time to time, third parties have asserted and may
in the future assert claims of alleged infringement by us of their intellectual
property rights. Any litigation claims or counterclaims could impair our
business because they could:
29
o be time-consuming;
o result in significant costs;
o subject us to significant liability for damages;
o result in invalidation of our proprietary rights;
o divert management's attention;
o cause product release delays; or
o require us to redesign our products or require us to enter into royalty or
licensing agreements that may not be available on terms acceptable to us,
or at all.
We license from third parties various technologies incorporated into our
products, networks and sites. We cannot assure you that these third-party
technology licenses will continue to be available to us on commercially
reasonable terms. Additionally, we cannot assure you that the third parties from
which we license our technology will be able to defend our proprietary rights
successfully against claims of infringement. As a result, our inability to
obtain any of these technology licenses could result in delays or reductions in
the introduction of new products and services or could adversely affect the
performance of our existing products and services until equivalent technology
can be identified, licensed and integrated.
The regulation of domain names in the United States and in foreign countries may
change. Regulatory bodies could establish additional top-level domains, appoint
additional domain name registrars or modify the requirements for holding domain
names, any or all of which may dilute the strength of our names. We may not
acquire or maintain our domain names in all of the countries in which our
websites may be accessed, or for any or all of the top-level domain names that
may be introduced. The relationship between regulations governing domain names
and laws protecting proprietary rights is unclear. Therefore, we may not be able
to prevent third parties from acquiring domain names that infringe or otherwise
decrease the value of our trademarks and other proprietary rights.
We May Be Unsuccessful In Establishing And Maintaining Brand Awareness; Brand
Identity Is Critical To Our Company.
Our success in the markets in which we operate will depend on our ability to
create and maintain brand awareness for our product offerings. This has in some
cases required, and may continue to require, a significant amount of capital to
allow us to market our products and establish brand recognition and customer
loyalty. Many of our competitors are larger than us and have substantially
greater financial resources. Additionally, many of the companies offering VoIP
services have already established their brand identity within the marketplace.
We can offer no assurances that we will be successful in establishing awareness
of our brand allowing us to compete in the VoIP market.
If we fail to promote and maintain our various brands or our businesses' brand
values are diluted, our businesses, operating results, financial condition, and
our ability to attract buyers for any of our businesses could be materially
adversely affected. The importance of brand recognition will continue to
increase because low barriers of entry to the industries in which we operate may
result in an increased number of direct competitors. To promote our brands, we
may be required to continue to increase our financial commitment to creating and
maintaining brand awareness. We may not generate a corresponding increase in
revenue to justify these costs.
Our Quarterly Operating Results Fluctuate.
Due to our significant change in operations, including the entry into new lines
of business, our historical quarterly operating results are not necessarily
reflective of future results. The factors that will cause our quarterly
operating results to fluctuate in the future include:
o acquisitions of new businesses or sales of our businesses or assets;
o changes in the number of sales or technical employees;
o the level of traffic on our websites;
o the overall demand for Internet telephony services, print, television,
radio and Internet advertising and electronic commerce;
30
o the addition or loss of VoIP customers, clients of our marketing services
business, advertisers of our computer games businesses, subscribers to our
magazine, and electronic commerce partners on our websites;
o overall usage and acceptance of the Internet;
o seasonal trends in advertising and electronic commerce sales and member
usage in our businesses;
o other costs relating to the maintenance of our operations;
o the restructuring of our business;
o failure to generate significant revenues and profit margins from new
products and services; and
o competition from others providing services similar to ours.
Our Limited Operating History Makes Financial Forecasting Difficult. Our
Inexperience In The Internet Telephony Business Will Make Financial Forecasting
Even More Difficult.
We have a limited operating history for you to use in evaluating our prospects
and us. Our prospects should be considered in light of the risks encountered by
companies operating in new and rapidly evolving markets like ours. We may not
successfully address these risks. For example, we may not be able to:
o maintain or increase levels of user traffic on our e-commerce websites;
o attract customers to our VoIP telephony service;
o adequately forecast anticipated customer purchase and usage of our retail
VoIP products;
o maintain or increase advertising revenue for our computer games magazine;
o maintain or increase direct response marketing services revenue;
o adapt to meet changes in our markets and competitive developments; and
o identify, attract, retain and motivate qualified personnel.
Our Management Team Is Inexperienced In The Management Of A Large Operating
Company.
Only our Chairman has had experience managing a large operating company.
Accordingly, we cannot assure you that:
o our key employees will be able to work together effectively as a team;
o we will be able to retain the remaining members of our management team;
o we will be able to hire, train and manage our employee base;
o our systems, procedures or controls will be adequate to support our
operations; and
o our management will be able to achieve the rapid execution necessary to
fully exploit the market opportunity for our products and services.
We Depend On Highly Qualified Technical And Managerial Personnel.
Our future success also depends on our continuing ability to attract, retain and
motivate highly qualified technical expertise and managerial personnel necessary
to operate our businesses. We may need to give retention bonuses and stock
incentives to certain employees to keep them, which can be costly to us. The
loss of the services of members of our management team or other key personnel
could harm our business. Our future success depends to a significant extent on
the continued service of key management, client service, product development,
sales and technical personnel. We do not maintain key person life insurance on
any of our executive officers and do not intend to purchase any in the future.
Although we generally enter into non-competition agreements with our key
employees, our business could be harmed if one or more of our officers or key
employees decided to join a competitor or otherwise compete with us.
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We may be unable to attract, assimilate or retain highly qualified technical and
managerial personnel in the future. Wages for managerial and technical employees
are increasing and are expected to continue to increase in the future. We have
from time to time in the past experienced, and could continue to experience in
the future if we need to hire any additional personnel, difficulty in hiring and
retaining highly skilled employees with appropriate qualifications. Also, we may
have difficulty attracting qualified employees to work in the geographically
remote location in Vermont of Chips & Bits, Inc. and Strategy Plus, Inc. If we
were unable to attract and retain the technical and managerial personnel
necessary to support and grow our businesses, our businesses would likely be
materially and adversely affected.
Our Officers, Including Our Chairman And Chief Executive Officer And President
Have Other Interests And Time Commitments; We Have Conflicts Of Interest With
Some Of Our Directors; All Of Our Directors Are Employees Or Stockholders Of The
Company Or Affiliates Of Our Largest Stockholder.
Because our Chairman and Chief Executive Officer, Mr. Michael Egan, is an
officer or director of other companies, we have to compete for his time. Mr.
Egan became our Chief Executive Officer effective June 1, 2002. Mr. Egan is also
the controlling investor of Dancing Bear Investments, Inc., an entity controlled
by Mr. Egan, which is our largest stockholder. Mr. Egan has not committed to
devote any specific percentage of his business time with us. Accordingly, we
compete with Dancing Bear Investments, Inc. and Mr. Egan's other related
entities for his time.
Our President, Treasurer and Chief Financial Officer and Director, Mr. Edward A.
Cespedes, is also an officer or director of other companies. Accordingly, we
must compete for his time. Mr. Cespedes is an officer or director of various
privately held entities and is also affiliated with Dancing Bear Investments,
Inc.
Our Vice President of Finance and Director, Ms. Robin Lebowitz is also
affiliated with Dancing Bear Investments, Inc. She is also an officer or
director of other companies or entities controlled by Mr. Egan and Mr. Cespedes.
Due to the relationships with his related entities, Mr. Egan will have an
inherent conflict of interest in making any decision related to transactions
between the related entities and us. Furthermore, the Company's Board of
Directors presently is comprised entirely of individuals which are employees of
theglobe, and therefore are not "independent." We intend to review related party
transactions in the future on a case-by-case basis.
We Rely On Third Party Outsourced Hosting Facilities Over Which We Have Limited
Control.
Our principal servers are located in Florida and New York primarily at third
party outsourced hosting facilities. Our operations depend on the ability to
protect our systems against damage from unexpected events, including fire, power
loss, water damage, telecommunications failures and vandalism. Any disruption in
our Internet access could have a material adverse effect on us. In addition,
computer viruses, electronic break-ins or other similar disruptive problems
could also materially adversely affect our businesses. Our reputation,
theglobe.com brand and the brands of our individual businesses could be
materially and adversely affected by any problems experienced by our sites or
our supporting VoIP network. We may not have insurance to adequately compensate
us for any losses that may occur due to any failures or interruptions in our
systems. We do not presently have any secondary off-site systems or a formal
disaster recovery plan.
Hackers May Attempt To Penetrate Our Security System; Online Security Breaches
Could Harm Our Business.
Consumer and supplier confidence in our businesses depends on maintaining
relevant security features. Substantial or ongoing security breaches on our
systems or other Internet-based systems could significantly harm our business.
We incur substantial expenses protecting against and remedying security
breaches. Security breaches also could damage our reputation and expose us to a
risk of loss or litigation. Experienced programmers or "hackers" have
successfully penetrated our systems and we expect that these attempts will
continue to occur from time to time. Because a hacker who is able to penetrate
our network security could misappropriate proprietary or confidential
information (including customer billing information) or cause interruptions in
our products and services, we may have to expend significant capital and
resources to protect against or to alleviate problems caused by these hackers.
Additionally, we may not have a timely remedy against a hacker who is able to
penetrate our network security. Such security breaches could materially
adversely affect our company. In addition, the transmission of computer viruses
resulting from hackers or otherwise could expose us to significant liability.
Our insurance may not be adequate to reimburse us for losses caused by security
breaches. We also face risks associated with security breaches affecting third
parties with whom we have relationships.
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We May Be Exposed To Liability For Information Retrieved From Or Transmitted
Over The Internet.
Users may access content on our websites or the websites of our distribution
partners or other third parties through website links or other means, and they
may download content and subsequently transmit this content to others over the
Internet. This could result in claims against us based on a variety of theories,
including defamation, obscenity, negligence, copyright infringement, trademark
infringement or the wrongful actions of third parties. Other theories may be
brought based on the nature, publication and distribution of our content or
based on errors or false or misleading information provided on our websites.
Claims have been brought against online services in the past and we have
received inquiries from third parties regarding these matters. Such claims could
be material in the future.
We May Be Exposed To Liability For Products Or Services Sold Over The Internet,
Including Products And Services Sold By Others.
We enter into agreements with commerce partners and sponsors under which, in
some cases, we are entitled to receive a share of revenue from the purchase of
goods and services through direct links from our sites. We sell products
directly to consumers which may expose us to additional legal risks, regulations
by local, state, federal and foreign authorities and potential liabilities to
consumers of these products and services, even if we do not ourselves provide
these products or services. We cannot assure you that any indemnification that
may be provided to us in some of these agreements with these parties will be
adequate. Even if these claims do not result in our liability, we could incur
significant costs in investigating and defending against these claims. The
imposition of potential liability for information carried on or disseminated
through our systems could require us to implement measures to reduce our
exposure to liability. Those measures may require the expenditure of substantial
resources and limit the attractiveness of our services. Additionally, our
insurance policies may not cover all potential liabilities to which we are
exposed.
We Are A Party To Litigation Matters That May Subject Us To Significant
Liability And Be Time Consuming And Expensive.
We are currently a defendant in a lawsuit asserting claims of breach of contract
and specific performance and which seeks payment of approximately $2.5 million
in cash, plus interest, as well as the issuance of 1.0 million shares of our
Common Stock. In addition, we are a party to securities class action litigation.
At this time we cannot reasonably estimate the range of any loss or damages
resulting from these lawsuits due to uncertainty regarding the ultimate outcome.
The defense of this litigation may be expensive to defend and divert
management's attention from day-to-day operations. An adverse outcome in this
litigation could materially and adversely affect our results of operations and
financial position and may utilize a significant portion of our cash resources.
We May Not Be Able To Implement Section 404 Of The Sarbanes-Oxley Act On A
Timely Basis.
The SEC, as directed by Section 404 of The Sarbanes-Oxley Act, adopted rules
generally requiring each public company to include a report of management on the
company's internal controls over financial reporting in its annual report on
Form 10-K that contains an assessment by management of the effectiveness of the
company's internal controls over financial reporting. In addition, the company's
independent registered public accounting firm must attest to and report on
management's assessment of the effectiveness of the company's internal controls
over financial reporting. This requirement will first apply to our annual report
on Form 10-K for the fiscal year ending December 31, 2006.
We are currently at the beginning stages of developing our Section 404
implementation plan. We have in the past discovered, and may in the future
discover, areas of our internal controls that need improvement. How companies
should be implementing these new requirements including internal control reforms
to comply with Section 404's requirements, and how independent auditors will
apply these requirements and test companies' internal controls, is still
reasonably uncertain.
We expect that we will need to hire and/or engage additional personnel and incur
incremental costs in order to complete the work required by Section 404. There
can be no assurance that we will be able to complete our Section 404 plan on a
timely basis. The Company's liquidity position in 2005 and 2006 may also
negatively impact our ability to adequately fund our Section 404 efforts.
Even if we timely complete our Section 404 plan, we may not be able to conclude
that our internal controls over financial reporting are effective, or in the
event that we conclude that our internal controls are effective, our independent
accountants may disagree with our assessment and may issue a report that is
qualified. This could subject the Company to regulatory scrutiny and a loss of
public confidence in our internal controls. In addition, any failure to
implement required new or improved controls, or difficulties encountered in
their implementation, could harm the Company's operating results or cause the
Company to fail to meet its reporting obligations.
RISKS RELATING TO OUR VOIP TELEPHONY BUSINESS
We Are Unable To Predict The Volume Of Usage And Our Capacity Needs For Our VoIP
Business; Disadvantageous Contracts Have Reduced Our Operating Margins And May
Adversely Affect Our Liquidity And Financial Condition.
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We have entered into a number of long-term agreements (generally for terms of
one year, with the terms of several agreements extending to three to five years)
for leased communications transmission capacity and data center facilities with
various carriers and other third parties. The minimum amounts payable under
these agreements and the underlying current capacity of our VoIP network greatly
exceeds our current estimates of customer demand and usage for the foreseeable
future. The Company is currently negotiating to reduce the amounts payable
during 2005 under these network-related agreements. Although the Company has
been successful in recently terminating substantially all of the minimum usage
requirement commitments for which it was previously obligated under certain of
its carrier agreements, there can be no assurance that it will be able to
further reduce its network-related contractual commitments. If the Company is
not successful in significantly reducing such commitments, its liquidity and
financial condition could be materially and adversely impacted.
The VoIP Market Is Subject To Rapid Technological Change And We Will Need To
Depend On New Product Introductions And Innovations In Order To Establish,
Maintain And Grow Our Business.
VoIP is an emerging market that is characterized by rapid changes in customer
requirements, frequent introductions of new and enhanced products, and
continuing and rapid technological advances. To enter and compete successfully
in this emerging market, we must continually design, develop and sell new and
enhanced VoIP products and services that provide increasingly higher levels of
performance and reliability at lower costs. These new and enhanced products must
take advantage of technological advancements and changes, and respond to new
customer requirements. Our success in designing, developing and selling such
products and services will depend on a variety of factors, including:
o access to sufficient capital to complete our development efforts;
o the identification of market demand for new products;
o the determination of appropriate product inventory levels;
o product and feature selection;
o timely implementation of product design and development;
o product performance;
o cost-effectiveness of products under development;
o securing effective sources of equipment supply; and
o success of promotional efforts.
Additionally, we may also be required to collaborate with third parties to
develop our products and may not be able to do so on a timely and cost-effective
basis, if at all. If we are unable, due to resource constraints or technological
or other reasons, to develop and introduce new or enhanced products in a timely
manner or if such new or enhanced products do not achieve sufficient market
acceptance, our operating results will suffer and our business will not grow.
Our Ability And Plans To Provide Telecommunication Services At Attractive Rates
Arise In Large Part From The Fact VoIP Services Are Not Currently Subject To The
Same Regulation As Traditional Telephony.
Because their services are not currently regulated to the same extent as
traditional telephony, some VoIP providers can currently avoid paying certain
charges that traditional telephone companies must pay. Many traditional
telephone operators are lobbying the Federal Communications Commission (FCC) and
the states to regulate VoIP on the same or similar basis as traditional
telephone services. The FCC and several states are examining this issue.
If the FCC or any state determines to regulate VoIP, they may impose surcharges,
taxes or additional regulations upon providers of VoIP. These surcharges could
include access charges payable to local exchange carriers to carry and terminate
traffic, contributions to the Universal Service Fund or other charges.
Regulations requiring compliance with the Communications Assistance for Law
Enforcement Act, or provision of enhanced 911 services could also place a
significant financial burden on us. The imposition of any such additional fees,
charges, taxes, licenses and regulations on VoIP services could materially
increase our costs and may reduce or eliminate the competitive pricing advantage
we seek to enjoy.
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The Internet Telephony Business Is Highly Competitive And Also Competes With
Traditional And Cellular Telephony Providers.
The long distance telephony market and the Internet telephony market are highly
competitive. There are several large and numerous small competitors and we
expect to face continuing competition based on price and service offerings from
existing competitors and new market entrants in the future. The principal
competitive factors in our market include price, quality of service, breadth of
geographic presence, customer service, reliability, network size and capacity,
and the availability of enhanced communications services. Our competitors
include major and emerging telecommunications carriers in the U.S. and abroad.
Financial difficulties in the past several years of many telecommunications
providers are rapidly altering the number, identity and competitiveness of the
marketplace. Many of the competitors for our current and planned VoIP service
offerings 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 we have. As
a result, certain of these competitors may be able to adopt more aggressive
pricing policies which could hinder our ability to market our voice services.
During the past several years, a number of companies have introduced services
that make Internet telephony or voice services over the Internet available to
businesses and consumers. All major telecommunications companies, including
entities like AT&T, Verizon, Sprint and MCI, either presently or potentially
compete or can compete directly with us. Other Internet telephony service
providers, such as Net2Phone and deltathree, also focus on a retail customer
base and compete with us. These companies may offer the kinds of voice services
we currently offer or intend to offer in the future. In addition, companies
currently in related markets have begun to provide voice over the Internet
services or adapt their products to enable voice over the Internet services.
These related companies may potentially migrate into the Internet telephony
market as direct competitors. A number of cable operators have also begun to
offer VoIP telephony services via cable modems which provide access to the
Internet. These companies, which tend to be large entities with substantial
resources, generally have large budgets available for research and development,
and therefore may further enhance the quality and acceptance of the transmission
of voice over the Internet. We also compete with cellular telephony providers.
Pricing Pressures And Increasing Use Of VoIP Technology May Lessen Our
Competitive Pricing Advantage.
One of the main competitive advantages of our current and planned VoIP service
offerings is the ability to provide discounted local and long distance telephony
services by taking advantage of cost savings achieved by carrying voice traffic
employing VoIP technology, as compared to carrying calls over traditional
networks. In recent years, the price of telephone service has fallen. The price
of telephone service may continue to fall for various reasons, including the
adoption of VoIP technology by other communications carriers. Many carriers have
adopted pricing plans such that the rates that they charge are not always
substantially higher than the rates that VoIP providers charge for similar
service. In addition, other providers of long distance services are offering
unlimited or nearly unlimited use of some of their services for increasingly
lower monthly rates.
If We Do Not Develop And Maintain Successful Partnerships For VoIP Products, We
May Not Be Able To Successfully Market Any Of Our VoIP Products.
Our success in the VoIP market is partly dependent on our ability to forge
marketing, engineering and carrier partnerships. VoIP communication systems are
extremely complex and no single company possesses all the technology components
needed to build a complete end to end solution. We will likely need to enter
into partnerships to augment our development programs and to assist us in
marketing complete solutions to our targeted customers. We may not be able to
develop such partnerships in the course of our operations and product
development. Even if we do establish the necessary partnerships, we may not be
able to adequately capitalize on these partnerships to aid in the success of our
business.
The Failure Of VoIP Networks To Meet The Reliability And Quality Standards
Required For Voice Communications Could Render Our Products Obsolete.
Circuit-switched telephony networks feature very high reliability, with a
guaranteed quality of service. In addition, such networks have imperceptible
delay and consistently satisfactory audio quality. VoIP networks will not be a
viable alternative to traditional circuit switched telephony unless they can
provide reliability and quality consistent with these standards.
Online Credit Card Fraud Can Harm Our Business.
The sale of our products and services over the Internet exposes us to credit
card fraud risks. Many of our products and services, including our VoIP
services, can be ordered or established (in the case of new accounts) over the
Internet using a major credit card for payment. As is prevalent in retail
telecommunications and Internet services industries, we are exposed to the risk
that some of these credit card accounts are stolen or otherwise fraudulently
obtained. In general, we are not able to recover fraudulent credit card charges
from such accounts. In addition to the loss of revenue from such fraudulent
credit card use, we also remain liable to third parties whose products or
services are engaged by us (such as termination fees due telecommunications
providers) in connection with the services which we provide. In addition,
depending upon the level of credit card fraud we experience, we may become
ineligible to accept the credit cards of certain issuers. We are currently
authorized to accept Discover, together with Visa and MasterCard (which are both
covered by a single merchant agreement with us). Visa/MasterCard constitutes the
primary credit card used by our VoIP customers. The loss of eligibility for
acceptance of Visa/MasterCard could significantly and adversely affect our
business. During 2004, we updated our fraud controls and will attempt to manage
fraud risks through our internal controls and our monitoring and blocking
systems. If those efforts are not successful, fraud could cause our revenue to
decline significantly and our business, financial condition and results of
operations to be materially and adversely affected.
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RISKS RELATED TO OUR MARKETING SERVICES BUSINESS
Any Decrease In Demand For Our Online Marketing Services Could Substantially
Reduce Our Revenues.
A substantial portion of our revenue is derived from Internet advertising. We
expect that online advertising will continue to account for a substantial
portion of our revenue in the future. However, our revenue from Internet
advertising may decrease in the future for a number of reasons, including the
following:
o the rate at which Internet users click on advertisements or take action in
response to an advertisement has always been low and could decline as the
volume of Internet advertising increases;
o Internet users can install software programs that allow them to prevent
advertisements from appearing on their screens or block the receipt of
emails;
o advertisers may prefer an alternative Internet advertising format, product
or service which we might not offer at that time; and
o we may be unable to make the transition to new Internet advertising
formats preferred by advertisers.
If Our Pricing Models Are Not Accepted By Our Advertiser Clients, We Could Lose
Clients And Our Revenue Could Decline.
Most of our services are offered to advertisers based on cost-per-action or
cost-per-click pricing models, under which advertisers only pay us if we provide
the results they specify. These results-based pricing models differ from the
fixed-rate pricing model used by many Internet advertising companies, under
which the fee is based on the number of times the advertisement is shown without
regard to effectiveness. Our ability to generate significant revenue from
advertisers will depend, in part, on our ability to demonstrate the
effectiveness of our primary pricing models to advertisers, who may be more
accustomed to a fixed-rate pricing model.
Furthermore, intense competition among websites and other Internet advertising
providers has led to the development of a number of alternative pricing models
for Internet advertising. The proliferation of multiple pricing alternatives may
confuse advertisers and make it more difficult for them to differentiate among
these alternatives. In addition, it is possible that new pricing models may be
developed and gain widespread acceptance that are not compatible with our
business model or our technology. These alternatives, and the likelihood that
additional pricing models will be introduced, make it difficult for us to
project the levels of advertising revenue or the margins that we, or the
Internet advertising industry in general, will realize in the future. If
advertisers do not understand the benefits of our pricing models, then the
market for our services may decline or develop more slowly than we expect, which
may limit our ability to grow our revenue or cause our revenue to decline.
Online Transactions From Which We Derive Our Revenue Are Subject To Validation.
Our Revenue And Margins Could Be Reduced As A Result Of Invalid Transactions.
SendTec derives revenue from its online cost per action advertising business
based on the number of actions it generates for clients each month. SendTec
determines the number of actions generated for clients based on digital tracking
technology and reports from its clients detailing the number of actions received
by them. SendTec relies upon its digital tracking methods and final reports from
its clients to determine the number of actions for which it pays its publisher
network. On average SendTec pays its network of publishers between 30 days and
60 days from the end of the month. In certain situations, SendTec may be
required to reimburse its clients for actions which SendTec has previously
verified as valid actions but the client has subsequently determined to be
invalid due to fraud or other factors. In these instances, SendTec generally may
not have recourse against the publishers in its network that have generated the
actions and therefore SendTec may not be able to recover any portion of the
reimbursements it makes to its clients from its publishers.
We Depend On A Limited Number Of Clients For A Significant Percentage Of Our
Revenue And The Loss Of One Or More Of These Advertisers Could Cause Our Revenue
To Decline.
The results of SendTec's operations have been included in our consolidated
results since date of acquisition, September 1, 2004. During the first quarter
2005, three customers of SendTec accounted for approximately 62% of SendTec's
total net revenue. For the four months ended December 31, 2004, two customers of
SendTec accounted for approximately 52% of SendTec's total net revenue. We
believe that a limited number of clients will continue to be the source of a
substantial portion of our revenue for the foreseeable future. Key factors in
maintaining our relationships with these clients include our performance on
individual campaigns, the strength of our professional reputation and the
relationships of our key executives with client personnel. To the extent that
our performance does not meet client expectations, or our reputation or
relationships with one or more major clients are impaired, our revenues could
decline and our operating results could be adversely affected. During the second
quarter of 2004, one of SendTec's major customers acquired a business that
competes with SendTec. This acquisition, other similar acquisitions, or general
business consolidation within the marketing services industry could also cause
our revenue and operating results to decline and adversely affect SendTec's
business.
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Any Limitation On Our Use Of Data Derived From Our Clients' Advertising
Campaigns Could Significantly Diminish The Value Of Our Services And Cause Us To
Lose Clients And Revenue.
When an individual visits our clients' websites, we use technologies, including
cookies and web beacons, to collect information such as the user's IP address,
advertisements delivered by us that have been viewed by the user and responses
by the user to such advertisements. We aggregate and analyze this information to
determine the placement of advertisements across our affiliate network of
advertising space. Although the data we collect from campaigns of different
clients, once aggregated, are not identifiable, our clients might decide not to
allow us to collect some or all of this data or might limit our use of this
data. Any limitation on our ability to use such data could make it more
difficult for us to deliver online marketing programs that meet client demands.
In addition, although our contracts generally permit us to aggregate data from
advertising campaigns, our clients might nonetheless request that we discontinue
using data obtained from their campaigns that have already been aggregated with
other clients' campaign data. It would be difficult, if not impossible, to
comply with these requests, and such requests could result in significant
expenditures of resources. Interruptions, failures or defects in our data
collection, mining and storage systems, as well as privacy concerns regarding
the collection of user data, could also limit our ability to aggregate and
analyze data from our clients' advertising campaigns. If that happens, we may
lose clients and our revenue may decline.
If The Market For Internet Advertising Fails To Continue To Develop, Our Revenue
And Our Operating Results Could Be Harmed.
Our future success is highly dependent on the continued use and growth of the
Internet as an advertising medium. The Internet advertising market is relatively
new and rapidly evolving, and it uses different measurements than traditional
media to gauge its effectiveness. As a result, demand for and market acceptance
of Internet advertising services is uncertain. Many of our current or potential
advertiser clients have little or no experience using the Internet for
advertising purposes and have allocated only limited portions of their
advertising budgets to the Internet. The adoption of Internet advertising,
particularly by those entities that have historically relied upon traditional
media for advertising, requires the acceptance of a new way of conducting
business, exchanging information, measuring success and evaluating new
advertising products and services. Such clients may find Internet advertising to
be less effective for promoting their products and services than traditional
advertising media. We cannot assure you that the market for Internet advertising
will continue to grow or become sustainable. If the market for Internet
advertising fails to continue to develop or develops more slowly than we expect,
our revenue and business could be harmed.
We Depend On Online Publishers For Advertising Space To Deliver Our Clients'
Advertising Campaigns And Any Decline In The Supply Of Advertising Space
Available Through Our Network Could Cause Our Revenue To Decline.
The websites, search engines and email publishers that sell or venture their
advertising space to or with us are not bound by long-term contracts that ensure
us a consistent supply of advertising space, which we refer to as our inventory.
We generate a significant portion of our revenue from the advertising inventory
provided by a limited number of publishers. In most instances, publishers can
change the amount of inventory they make available to us at any time, as well as
the price at which they make it available. In addition, publishers may place
significant restrictions on our use of our advertising inventory. These
restrictions may prohibit advertisements from specific advertisers or specific
industries, or restrict the use of certain creative content or format. If a
publisher decides not to make inventory available to us, or decides to increase
the price, or places significant restrictions on the use of such inventory, we
may not be able to replace this with inventory from other publishers that
satisfy our requirements in a timely and cost-effective manner. If this happens,
our revenue could decline or our cost of acquiring inventory may increase.
Our Growth May Be Limited If We Are Unable To Obtain Sufficient Advertising
Inventory That Meets Our Pricing And Quality Requirements.
Our growth depends on our ability to effectively manage and expand the volume of
our inventory of advertising space. To attract new advertisers, we must increase
our supply of inventory that meets our performance and pricing requirements. Our
ability to purchase or venture sufficient quantities of suitable advertising
inventory will depend on various factors, some of which are beyond our control.
These factors include:
o our ability to offer publishers a competitive price for our inventory;
o our ability to estimate the quality of the available inventory; and
o our ability to efficiently manage our existing advertising inventory.
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In addition, the number of competing Internet advertising networks that purchase
advertising inventory from websites, search engine and email publishers
continues to increase. We cannot assure you that we will be able to purchase or
venture advertising inventory that meets our performance, price and quality
requirements, and if we cannot do so, our ability to generate revenue could be
limited.
Any Limitation On Our Ability To Post Advertisements Throughout Our Network Of
Advertising Space Could Harm Our Business.
We execute advertising programs for clients primarily by posting advertisements,
which we refer to as ad delivery, on our affiliate network of advertising space.
Our business could suffer from a variety of factors that could limit or reduce
our ability to post advertisements across our affiliate network, including:
o technological changes that render the delivery of our advertisements
obsolete or incompatible with the operating systems of consumers and/or
the systems of online publishers;
o lawsuits or injunctions based on claims that our ad delivery methodologies
violate the proprietary rights of other parties; and
o interruptions, failures or defects in our ad delivery and tracking
systems.
Consolidation Of Online Publishers May Impair Our Ability To Provide Marketing
Services, Acquire Advertising Inventory At Favorable Rates And Collect Campaign
Data.
The consolidation of Internet advertising networks, web portals, search engines
and other online publishers could eventually lead to a concentration of
desirable advertising inventory on a very small number of networks and large
websites. Such concentration could:
o increase our costs if these publishers use their greater bargaining power
to increase rates for advertising inventory; and
o impair our ability to provide marketing services if these publishers
prevent us from distributing our clients' advertising campaigns on their
websites or if they adopt ad delivery systems that are not compatible with
our ad delivery methodologies.
Our Business Could Be Harmed If The Use Of Tracking Technology Is Restricted Or
Becomes Subject To New Regulation.
In conjunction with the delivery of advertisements to websites, we typically
place small files of information, commonly known as cookies, on an Internet
user's hard drive, generally without the user's knowledge or consent. Cookie
information is passed to us through an Internet user's browser software. We use
cookies to collect information regarding the advertisements we deliver to
Internet users and their interaction with these advertisements. We use this
information to identify Internet users who have received our advertisements in
the past and to monitor and prevent potentially fraudulent activity. In
addition, our technology uses this information to monitor the performance of
ongoing advertising campaigns and plan future campaigns.
Some Internet commentators and privacy advocates have proposed limiting or
eliminating the use of cookies and other Internet tracking technologies, and
legislation has been introduced in some jurisdictions to regulate Internet
tracking technologies. The European Union has already adopted a directive
requiring that when cookies are used, the user must be informed and offered an
opportunity to opt-out of the cookies' use. If there is a further reduction or
limitation in the use of Internet tracking technologies such as cookies:
o we may have to replace or re-engineer our tracking technology, which could
require significant amounts of our time and resources, may not be
completed in time to avoid losing clients or advertising inventory, and
may not be commercially or technically feasible;
o we may have to develop or acquire other technology to prevent fraud; and
o we may become subject to costly and time-consuming litigation or
investigations due to our use of cookie technology or other technologies
designed to collect Internet usage information.
Any one or more of these occurrences could result in increased costs, require us
to change our business practices or divert management's attention.
If We Or Our Advertiser Or Publisher Clients Fail To Comply With Regulations
Governing Consumer Privacy, We Could Face Substantial Costs And Our Business
Could Be Harmed.
Our collection, maintenance and sharing of information regarding Internet users
could result in lawsuits or government inquiries. These actions may include
those related to U.S. federal and state legislation or European Union directives
limiting the ability of companies like ours to collect, receive and use
information regarding Internet users. Litigation and regulatory inquiries are
often expensive and time-consuming and their outcome is uncertain. Any
involvement by us in any of these matters could require us to:
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o spend significant amounts on legal defense;
o divert the attention of senior management from other aspects of our
business;
o defer or cancel new product launches as a result of these claims or
proceedings; and
o make changes to our present and planned products or services.
Further, we cannot assure you that our advertiser and publisher clients are
currently in compliance, or will remain in compliance, with their own privacy
policies, regulations governing consumer privacy or other applicable legal
requirements. We may be held liable if our clients use our technology or the
data we collect on their behalf in a manner that is not in compliance with
applicable laws or regulations or their own stated privacy standards.
We May Be Liable For Content In The Advertisements We Deliver For Our Clients.
We may be liable to third parties for content in the advertisements we deliver
if the artwork, text or other content involved violates copyrights, trademarks
or other intellectual property rights of third parties or if the content is
defamatory. Although we generally receive warranties from our advertisers that
they have the right to use any copyrights, trademarks or other intellectual
property included in an advertisement and are normally indemnified by the
advertisers, a third party may still file a claim against us. Any claims by
third parties against us could be time-consuming, could result in costly
litigation and adverse judgments and could require us to change our business.
Misappropriation Of Confidential Information Held By Us Could Cause Us To Lose
Clients Or Incur Liability.
We retain highly confidential information on behalf of our clients in our
systems and databases. Although we maintain security features in our systems,
our operations may be susceptible to hacker interception, break-ins and other
disruptions. These disruptions may jeopardize the security of information stored
in and transmitted through our systems. If confidential information is
compromised, we could be subject to lawsuits by the affected clients or Internet
users, which could damage our reputation among our current and potential
clients, require significant expenditures of capital and other resources and
cause us to lose business and revenues.
We Face Intense And Growing Competition, Which Could Result In Price Reductions,
Reduced Operating Margins And Loss Of Market Share.
The direct response advertising market is highly competitive. If we fail to
compete effectively against other advertising service companies, we could lose
clients or advertising inventory and our revenues could decline. We expect
competition to continue to increase because there are no significant barriers to
entry.
Many current and potential competitors have advantages over us, such as longer
operating histories, greater name recognition, larger client bases, greater
access to advertising space on high-traffic websites and significantly greater
financial, technical and marketing resources. In addition, existing or future
competitors may develop or offer services that provide significant performance,
price, creative or other advantages over those offered by us.
Current and potential competitors may establish cooperative relationships among
themselves or with third parties to increase the ability of their products and
services to address the needs of our clients and prospective clients. As a
result, it is possible that new competitors may emerge and rapidly acquire
significant market share.
If we fail to compete successfully, we could have difficulties attracting and
retaining advertising clients or advertising inventory, which may decrease our
revenues and adversely affect our operating results. Increased competition may
also result in price reductions and reduced operating income.
We Generally Do Not Have Long-Term Contracts With Our Clients.
Our clients typically hire us on a project-by-project basis or on an annual
contractual relationship. Moreover, our clients generally have the right to
terminate their relationships with us without penalty and with relatively short
or no notice. Once a project is completed we cannot be assured that a client
will engage us for further services. From time to time, highly successful
engagements have ended because our client was acquired and the new owners
decided not to retain us. A client that generates substantial revenue for us in
one period may not be a substantial source of revenue in a subsequent period. We
expect a relatively high level of client concentration to continue, but not
necessarily involve the same clients from period to period. The termination of
our business relationships with any of our significant clients, or a material
reduction in the use of our services by any of our significant clients, could
adversely affect our future financial performance.
39
If We Fail To Manage Our Growth Effectively, Our Expenses Could Increase And Our
Management's Time And Attention Could Be Diverted.
As we continue to increase the scope of our operations, we will need an
effective planning and management process to implement our business plan
successfully in the rapidly evolving Internet advertising market. Our business,
results of operations and financial condition will be substantially harmed if we
are unable to manage our expanding operations effectively. We plan to continue
to expand the sales and marketing, customer support and research and development
organizations. Growth may place a significant strain on our management systems
and resources. We will likely need to continue to improve our financial and
managerial controls and our reporting systems and procedures. In addition, we
will need to expand, train and manage our work force. Our failure to manage our
growth effectively could increase our expenses and divert management's time and
attention.
If We Fail To Establish, Maintain And Expand Our Technology Business And
Marketing Alliances And Partnerships, Our Ability To Grow Our Marketing Services
Business Could Be Limited.
In order to grow our technology business, we must generate, retain and
strengthen successful business and marketing alliances with advertising
agencies. We depend, and expect to continue to depend, on our business and
marketing alliances, which are companies with which we have written or oral
agreements to work together to provide services to our clients and to refer
business from their clients and customers to us. If companies with which we have
business and marketing alliances do not refer their clients and customers to us
to perform their online campaign and message management, our revenue and results
of operations may be severely harmed.
RISKS RELATING TO OUR COMPUTER GAMES BUSINESS
The Market Situation Continues To Be A Challenge For Chips & Bits Due To
Advances In Console And Online Games, Which Have Lower Margins And Traditionally
Less Sales Loyalty To Chips & Bits.
Our subsidiary, Chips & Bits depends on major releases in the Personal Computer
(PC) market for the majority of sales and profits. Advances in technology and
the game industry's increased focus on console and online game platforms, such
as Xbox, PlayStation and GameCube, has dramatically reduced the number of major
PC releases, which resulted in significant declines in revenues and gross
margins for Chips & Bits. Because of the large installed base of personal
computers, revenue and gross margin percentages may fluctuate with changes in
the PC game market. However, we are unable to predict when, if ever, there will
be a turnaround in the PC game market, or if we will be successful in adequately
increasing our future sales of non-PC games.
We Have Historically Relied Substantially On Advertising Revenues, Which Could
Decline In The Future.
We historically derived a substantial portion of our revenues from the sale of
advertisements, primarily in our Computer Games Magazine. Our games business
model and our ability to generate sufficient future levels of print and online
advertising revenues are highly dependent on the print circulation of our
Computer Games magazine, as well as the amount of traffic on our websites and
our ability to properly monetize website traffic. Print and online advertising
market volumes have declined in the past and may decline in the future, which
could have a material adverse effect on us. Many advertisers have been
experiencing financial difficulties which could further negatively impact our
revenues and our ability to collect our receivables. For these reasons, we
cannot assure you that our current advertisers will continue to purchase
advertisements from our computer games businesses.
We May Not Be Able To Successfully Compete In The Electronic Commerce
Marketplace.
The games marketplace has become increasingly competitive due to acquisitions,
strategic partnerships and the continued consolidation of a previously
fragmented industry. In addition, an increasing number of major retailers have
increased the selection of video games offered by both their traditional "bricks
and mortar" locations and their online commerce sites, resulting in increased
competition. Our Chips & Bits subsidiary may not be able to compete successfully
in this highly competitive marketplace.
We also face many uncertainties, which may affect our ability to generate
electronic commerce revenues and profits, including:
o our ability to obtain new customers at a reasonable cost, retain existing
customers and encourage repeat purchases;
o the likelihood that both online and retail purchasing trends may rapidly
change;
o the level of product returns;
o merchandise shipping costs and delivery times;
40
o our ability to manage inventory levels;
o our ability to secure and maintain relationships with vendors; and
o the possibility that our vendors may sell their products through other
sites.
Additionally, if use of the Internet for electronic commerce does not continue
to grow, our business and financial condition would be materially and adversely
affected.
Intense Competition For Electronic Commerce Revenues Has Resulted In Downward
Pressure On Gross Margins.
Due to the ability of consumers to easily compare prices of similar products or
services on competing websites and consumers' potential preference for competing
website's user interface, gross margins for electronic commerce transactions,
which are narrower than for advertising businesses, may further narrow in the
future and, accordingly, our revenues and profits from electronic commerce
arrangements may be materially and adversely affected.
Our Electronic Commerce Business May Result In Significant Liability Claims
Against Us.
Consumers may sue us if any of the products that we sell are defective, fail to
perform properly or injure the user. Consumers are also increasingly seeking to
impose liability on game manufacturers and distributors based upon the content
of the games and the alleged affect of such content on behavior. Liability
claims could require us to spend significant time and money in litigation or to
pay significant damages. As a result, any claims, whether or not successful,
could seriously damage our reputation and our business.
RISKS RELATING TO OUR COMMON STOCK
The Volume Of Shares Available For Future Sale In The Open Market Could Drive
Down The Price Of Our Stock Or Keep Our Stock Price From Improving, Even If Our
Financial Performance Improves.
As of March 31, 2005, we had issued and outstanding approximately 175.2 million
shares, of which approximately 48.4 million shares were freely tradable over the
public markets. There is limited trading volume in our shares and we are now
traded only in the over-the-counter market. On April 16, 2004, we filed a
registration statement relating to the potential resale of up to approximately
131 million of our shares (including approximately 27 million shares underlying
outstanding warrants to acquire our Common Stock). The registration statement
became effective on May 11, 2004. As part of the acquisition of SendTec, we
issued an aggregate of approximately 35 million shares of our Common Stock.
Pursuant to our contractual obligations, we will file a registration statement
relating to the potential resale of these shares. We are obligated to cause such
registration statement to become effective on or before September 1, 2005. In
the event we fail to timely register such shares, we may be held liable for any
damages suffered by holders of such stock. Upon registration, and subject to
waiver or expiration of a lock-up agreement which expires September 1, 2005, all
such shares will be eligible for resale over the open market. Sales of
significant amounts of Common Stock in the public market in the future, the
perception that sales will occur or the registration of additional shares
pursuant to existing contractual obligations could materially and adversely
drive down the price of our stock. In addition, such factors could adversely
affect the ability of the market price of the Common Stock to increase even if
our business prospects were to improve. Substantially all of our stockholders
holding restricted securities, including shares issuable upon the exercise of
warrants to purchase our Common Stock, have registration rights under various
conditions. Also, we may issue additional shares of our Common Stock or other
equity instruments which may be convertible into Common Stock at some future
date, which could further adversely affect our stock price.
In addition, as of March 31, 2005, there were outstanding options to purchase
approximately 15,605,000 shares of our Common Stock, which become eligible for
sale in the public market from time to time depending on vesting and the
expiration of lock-up agreements. The issuance of shares upon exercise of these
options is registered under the Securities Act and consequently, subject to
certain volume restrictions as to shares issuable to executive officers, will be
freely tradable.
Also as of March 31, 2005, we had issued and outstanding warrants to acquire
approximately 16,782,000 shares of our Common Stock. In addition, the Company
holds in escrow warrants to acquire up to 1,500,000 shares of Common Stock,
subject to release over approximately the next year (some of which may
accelerate under certain events) upon the attainment of certain performance
objectives and may issue warrants to acquire up to an additional 2,500,000
shares of Common Stock upon attainment of certain performance criteria related
to the SendTec acquisition. Many of the outstanding instruments representing the
warrants contain anti-dilution provisions pursuant to which the exercise prices
and number of shares issuable upon exercise may be adjusted.
41
Our Chairman May Control Us.
After giving effect to the proxies to vote the shares of Common Stock granted by
five of the former shareholders of SendTec, Michael S. Egan, our Chairman and
Chief Executive Officer, beneficially owns or controls, directly or indirectly,
approximately 169.4 million shares of our Common Stock as of May 4, 2005, which
in the aggregate represents approximately 64.8% of the outstanding shares of our
Common Stock (assuming the full $4.0 million funding of the secured demand
convertible promissory notes and treating as outstanding for this purpose the
shares of Common Stock issuable upon exercise and/or conversion of the options,
secured demand convertible promissory notes and warrants owned by Mr. Egan or
his affiliates). Accordingly, Mr. Egan will be able to exercise significant
influence over, if not control, any stockholder vote.
Delisting Of Our Common Stock Makes It More Difficult For Investors To Sell
Shares. This May Potentially Lead To Future Market Declines.
The shares of our Common Stock were delisted from the NASDAQ national market in
April 2001 and are now traded in the over-the-counter market on what is commonly
referred to as the electronic bulletin board or "OTCBB." As a result, an
investor may find it more difficult to dispose of or obtain accurate quotations
as to the market value of the securities. The delisting has made trading our
shares more difficult for investors, potentially leading to further declines in
share price and making it less likely our stock price will increase. It has also
made it more difficult for us to raise additional capital. We may also incur
additional costs under state blue-sky laws if we sell equity due to our
delisting.
Our Common Stock Is Presently Subject To The "Penny Stock" Rules Which May Make
It A Less Attractive Investment.
Since the trading price of our Common Stock is less than $5.00 per share,
trading in our Common Stock is also subject to the requirements of Rule 15g-9 of
the Exchange Act. Our Common Stock is also considered a penny stock under the
Securities Enforcement Remedies and Penny Stock Reform Act of 1990, which
defines a penny stock, generally, as any equity security not traded on an
exchange or quoted on the Nasdaq SmallCap Market that has a market price of less
than $5.00 per share. Under Rule 15g-9, brokers who recommend our Common Stock
to persons who are not established customers and accredited investors, as
defined in the Exchange Act, must satisfy special sales practice requirements,
including requirements that they make an individualized written suitability
determination for the purchaser; and receive the purchaser's written consent
prior to the transaction. The Securities Enforcement Remedies and Penny Stock
Reform Act of 1990 also requires additional disclosures in connection with any
trades involving a penny stock, including the delivery, prior to any penny stock
transaction, of a disclosure schedule explaining the penny stock market and the
risks associated with that market. Such requirements may severely limit the
market liquidity of our Common Stock and the ability of purchasers of our equity
securities to sell their securities in the secondary market. For all of these
reasons, an investment in our equity securities may not be attractive to our
potential investors.
Anti-Takeover Provisions Affecting Us Could Prevent Or Delay A Change Of
Control.
Provisions of our charter, by-laws and stockholder rights plan and provisions of
applicable Delaware law may:
o have the effect of delaying, deferring or preventing a change in control
of our company;
o discourage bids of our Common Stock at a premium over the market price; or
o adversely affect the market price of, and the voting and other rights of
the holders of, our Common Stock.
Certain Delaware laws could have the effect of delaying, deterring or preventing
a change in control of our company. One of these laws prohibits us from engaging
in a business combination with any interested stockholder for a period of three
years from the date the person became an interested stockholder, unless various
conditions are met. In addition, provisions of our charter and by-laws, and the
significant amount of Common Stock held by our current executive officers,
directors and affiliates, could together have the effect of discouraging
potential takeover attempts or making it more difficult for stockholders to
change management. In addition, the employment contracts of our Chairman, CEO
and Vice President of Finance provide for substantial lump sum payments ranging
from 2 (for the Vice President) to 10 times (for each of the Chairman and CEO)
of their respective average combined salaries and bonuses (together with the
continuation of various benefits for extended periods) in the event of their
termination without cause or a termination by the executive for "good reason,"
which is conclusively presumed in the event of a "change-in-control" (as such
terms are defined in such agreements).
Our Stock Price Is Volatile And May Decline.
The trading price of our Common Stock has been volatile and may continue to be
volatile in response to various factors, including:
o the performance and public acceptance of our new product lines;
o quarterly variations in our operating results;
42
o competitive announcements;
o sales of any of our businesses;
o the operating and stock price performance of other companies that
investors may deem comparable to us;
o news relating to trends in our markets; and
o entrance into new lines of business and acquisitions of businesses,
including our SendTec acquisition.
In addition, with regard to our acquisition of SendTec the trading price of our
Common Stock may decline if:
o integration of theglobe.com and SendTec is unsuccessful or is delayed;
o the combined company does not achieve the perceived benefits of the
acquisition as rapidly or to the extent anticipated by investors;
o the effect of the acquisition on the combined company's financial results
or condition is not consistent with the expectations of financial
investors; or
o the dilution in shareholder ownership related to the issuance of shares of
theglobe.com's Common Stock in connection with the acquisition is
perceived negatively by investors.
The market price of our Common Stock could also decline as a result of
unforeseen factors related to the acquisition. The stock market has experienced
significant price and volume fluctuations, and the market prices of technology
companies, particularly Internet-related companies, have been highly volatile.
Our stock is also more volatile due to the limited trading volume.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk. Interest rate risk refers to fluctuations in the value of a
security resulting from changes in the general level of interest rates.
Investments that we classify as cash and cash equivalents have original
maturities of three months or less and therefore, are not affected in any
material respect by changes in market interest rates. Marketable securities at
March 31, 2005, of $42,736 are classified as available-for-sale and stated at
fair value. At March 31, 2005, debt outstanding includes approximately $1.1
million of fixed rate instruments with an aggregate average interest rate of
4.52% and approximately $0.2 million of variable rate instruments with an
aggregate average interest rate of 6.92%. All but approximately $16,000 of
principal of the variable rate debt outstanding as of the end of the 2005 first
quarter matures within the next twelve months.
Foreign Currency Risk. We transact business in U.S. dollars. Our exposure to
changes in foreign currency rates has been limited to a related party obligation
payable in Canadian dollars, which totals approximately $58,000 (U.S.) at March
31, 2005. Foreign currency exchange rate fluctuations do not have a material
effect on our results of operations.
ITEM 4. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure (1)
that information required to be disclosed by us in the reports we file or submit
under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's ("SEC") rules and forms, and (2)
that this information is accumulated and communicated to management, including
our Chief Executive Officer and Chief Financial Officer, as appropriate, to
allow timely decisions regarding required disclosure. In designing and
evaluating the disclosure controls and procedures, management recognizes that
any controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives,
and management necessarily was required to apply its judgment in evaluating the
cost benefit relationship of possible controls and procedures.
Our Chief Executive Officer and Chief Financial Officer have evaluated the
effectiveness of our disclosure controls and procedures as of March 31, 2005.
Based on that evaluation, our Chief Executive Officer and our Chief Financial
Officer have concluded that our disclosure controls and procedures are effective
in alerting them in a timely manner to material information regarding us
(including our consolidated subsidiaries) that is required to be included in our
periodic reports to the SEC.
Our management, with the participation of our Chief Executive Officer and our
Chief Financial Officer, have evaluated any change in our internal control over
financial reporting that occurred during the quarter ended March 31, 2005 that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting, and have determined there to be no
reportable changes.
43
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 6, "Litigation," of the Financial Statements included in this Report.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) Unregistered Sales of Equity Securities.
None. Subsequent to the quarter ended March 31, 2005, the registrant reported
the sale of unregistered secured demand convertible promissory notes on a Form
8-K dated April 26, 2005.
(b) Use of Proceeds From Sales of Registered Securities.
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
On January 31, 2005, theglobe.com, inc., and Promotion Display Technology Ltd.
("PDT"), entered into a termination of agreement related to an agreement dated
August 7, 2003 for the purchase of USB handsets. The provisions of this
termination of agreement are discussed in Item 6 under the caption "Loss on
Settlement of Contractual Obligation" in the discussion of our results of
operations for the year ended December 31, 2004 compared to the year ended
December 31, 2003, as included in our Annual Report on Form 10-KSB for the
fiscal year ended December 31, 2004.
Although we treated the original August 7, 2003 agreement with PDT as a material
contract, we did not file a Form 8-K relating to the termination of this
contract. Due to previous disclosures in theglobe.com's Quarterly Report on Form
10-QSB for the quarterly period ended September 30, 2004, of amounts written-off
related to USB handset inventory purchases pursuant to this contract and that a
material part of our business was no longer dependent upon this supplier, the
actual termination of the contract may not have been a termination of a material
agreement requiring it to be reported on Form 8-K.
ITEM 6. EXHIBITS
4.1 Form of Secured Demand Convertible Promissory Note (2).
4.2 Security Agreement dated April 22, 2005 by theglobe.com, inc. and certain
other parties named therein (2).
4.3 Unconditional Guaranty Agreement dated April 22, 2005 (2).
10.1 Termination of Agreement dated as of January 31, 2005 between
theglobe.com, inc. and Promotion and Display Technology Ltd. (1).
10.2 Consulting Agreement effective as of February 2, 2005 (fully executed as
of March 28, 2005) between theglobe.com, inc. and Albert J. Detz (1).
10.3 Carrier Services Agreement between XO Communications, Inc. and Direct
Partner Telecom, Inc., as amended and made effective by the First
Amendment to the Carrier Services Agreement dated March 25, 2005 (1).
44
10.4 Note Purchase Agreement dated April 22, 2005 between theglobe.com, inc.
and certain named investors (2).
31.1 Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)
and Rule 15d-14(a).
31.2 Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)
and Rule 15d-14(a).
32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section
1350 as adopted pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section
1350 as adopted pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.
- ----------
(1) Incorporated by reference from our Form 10-KSB for the year ended December
31, 2004, filed on March 30, 2005.
(2) Incorporated by reference from our Form 8-K filed on April 26, 2005.
45
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Dated: May 13, 2005 theglobe.com, inc.
By: /s/ Michael S. Egan
----------------------------------
Michael S. Egan
Chief Executive Officer
(Principal Executive Officer)
By: /s/ Edward A. Cespedes
----------------------------------
Edward A. Cespedes
President, Chief Financial Officer
(Principal Financial Officer)
46
EXHIBIT INDEX
4.1 Form of Secured Demand Convertible Promissory Note (2).
4.2 Security Agreement dated April 22, 2005 by theglobe.com, inc. and certain
other parties named therein (2).
4.3 Unconditional Guaranty Agreement dated April 22, 2005 (2).
10.1 Termination of Agreement dated as of January 31, 2005 between
theglobe.com, inc. and Promotion and Display Technology Ltd. (1).
10.2 Consulting Agreement effective as of February 2, 2005 (fully executed as
of March 28, 2005) between theglobe.com, inc. and Albert J. Detz (1).
10.3 Carrier Services Agreement between XO Communications, Inc. and Direct
Partner Telecom, Inc., as amended and made effective by the First
Amendment to the Carrier Services Agreement dated March 25, 2005 (1).
10.4 Note Purchase Agreement dated April 22, 2005 between theglobe.com, inc.
and certain named investors (2).
31.1 Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)
and Rule 15d-14(a).
31.2 Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)
and Rule 15d-14(a).
32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section
1350 as adopted pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section
1350 as adopted pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.
- ---------------
(1) Incorporated by reference from our Form 10-KSB for the year ended December
31, 2004, filed on March 30, 2005.
(2) Incorporated by reference from our Form 8-K filed on April 26, 2005.
47