UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
/ X / QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from ________ to ________.
Commission file number 000-27941
Delaware 87-0591719
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
754 E. Technology Avenue
Orem, Utah 84097
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(Address of Principal Executive Offices) (Zip Code)
(801) 227-000
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(Registrant's telephone number, including area code)
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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 proceeding 12 months and (2) has been subject to such filing requirements for the past 90 days.
The number of shares outstanding of the registrant's common stock as of September 30, 2001: 42,009,266.
When we refer in this Form 10-Q to "Netgateway," the "Company," "we," "our," and "us," we mean Netgateway, Inc., a Delaware corporation, together with our subsidiaries and their respective predecessors.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
Condensed Consolidated Balance Sheets at September 30, 2001
(unaudited) and at June 30, 2001.....................................3
Unaudited Condensed Consolidated Statements of Operations
for the three months ended September 30, 2001 .......................4
Unaudited Consolidated Statement of Capital Deficit for the three months
ended September 30, 2001.............................................5
Unaudited Consolidated Statements of Cash Flows for the three months
ended September 30, 2001 ............................................6
Notes to Unaudited Condensed Consolidated Financial Statements ................7
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NETGATEWAY, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, 2001 June 30,
(Unaudited) 2001
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Assets
Current assets
Cash $ 109,728 $ 149,165
Trade receivables, net of allowance for doubtful accounts of $2,152,754
at September 30, 2001 and $1,180,875 at June 30, 2001. 2,515,301 1,189,853
Inventories 29,408 44,726
Prepaid expenses 226,236 115,935
Common stock subscriptions receivable 300,000 107,000
Credit card reserves, net of allowance for doubtful accounts of $122,815
at September 30, 2001 and $173,000 at June 30, 2001. 1,018,784 1,187,502
Other current assets - 3,219
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Total current assets 4,199,457 2,797,401
Property and equipment, net 651,771 774,862
Intangible assets, net 566,869 588,544
Trade receivables, net of allowance for doubtful accounts of $1,129,276
at September 30, 2001 and $1,011,774 at June 30, 2001. 1,215,840 900,198
Other assets, net of allowance for doubtful accounts of $1,618,110
at September 30, 2001 and $1,390,640 at June 30, 2001. 354,042 993,992
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Total Assets $ 6,987,979 $ 6,054,997
====================== ======================
Liabilities and Capital Deficit
Current liabilities
Accounts payable $ 1,414,068 $ 2,663,066
Bank overdraft 672,384 666,683
Accrued wages and benefits 856,446 581,400
Past due payroll taxes 449,003 497,617
Accrued liabilities 330,178 567,916
Current portion of capital lease obligations 19,122 37,802
Notes payable current - 97,779
Notes payable - officers and stockholders - 490,000
Loan payable - 100,000
Other current liabilities 447,780 423,578
Current portion of deferred revenue 2,239,947 5,618,849
Convertible debenture - 2,405,062
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Total current liabilities 6,428,928 14,149,753
Deferred revenue, net of current portion 40,638 414,743
Convertible long term notes 65,366 442,172
Note Payable 400,000 -
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Total liabilities 6,934,932 15,006,667
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Commitments and contingencies
Minority interest 355,159 355,159
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Capital deficit
Capital stock, par value $.001 per share
Preferred stock - authorized 5,000,000 shares; none issued
Common stock - authorized 250,000,000 shares; issued and outstanding
42,009,266 and 24,460,191, at September 30, 2001 and June 30, 2001,
respectively 42,010 24,460
Additional paid-in capital 68,408,361 62,047,292
Subscribed common stock 682,200 398,200
Deferred compensation (45,859) (52,649)
Accumulated other comprehensive loss (4,902) (4,902)
Accumulated deficit (69,383,922) (71,719,230)
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Total capital deficit (302,112) (9,306,829)
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Total Liabilities and Capital Deficit $ 6,987,979 $ 6,054,997
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See Notes to Consolidated Financial Statements
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NETGATEWAY, INC.
Consolidated Statements of Operation for the
Three Months Ended September 30, 2001 and September 30, 2000
Three Months Ended
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September 30, September 30,
2001 2000
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Revenue $ 11,634,043 $ 7,425,857
Cost of revenue 1,589,569 2,189,907
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Gross profit 10,044,474 5,235,949
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Operating expenses
Product development 53,400 1,214,324
Selling and marketing 3,611,796 6,848,155
General and administrative 2,400,987 2,288,710
Depreciation and amortization 151,628 410,168
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Total operating expenses 6,217,811 10,761,357
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Operating income (loss) before items shown below 3,826,663 (5,525,407)
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Other income (expense):
Other income (expense) 101,773 (7,736)
Interest expense (1,593,128) (945,430)
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Total other expenses (1,491,355) (953,166)
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Income (loss) from continuing operations 2,335,308 (6,478,573)
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Discontinued operations:
Loss from discontinued operations - (201,462)
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Net Income (loss) 2,335,308 (6,680,035)
======================== ===================
Basic earnings (loss) per share:
Income (loss) from continuing operations $ 0.07 $ (0.30)
Loss from discontinued operations - (0.01)
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Net income (loss) $ 0.07 $ (0.31)
======================== ===================
Diluted earnings (loss) per share:
Income (loss) from continuing operations $ 0.07 $ (0.30)
Loss from discontinued operations - (0.01)
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Net income (loss) $ 0.07 $ (0.31)
======================== ===================
Weighted average common shares outstanding
Basic 34,507,113 21,691,464
Diluted 35,397,236 21,691,464
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See Notes to Consolidated Financial Statements
NETGATEWAY, INC.
Consolidated Statement of Capital Deficit
Common Stock Additional Common
------------------------------- Paid-in Stock
Shares Amount Capital Subscribed
---------------------------------------------------------------------- ------------- ---------------- ----------------
Balance June 30, 2001 24,460,191 $ 24,460 $ 62,047,292 $ 398,200
Stock options exercised 6,910 7 1,720
Amortization of deferred compensation -
Forfeiture of stock options - (180)
Conversion of convertible debenture 2,800,000 2,800 2,113,085
Conversion of long term notes 7,204,326 7,205 1,792,975
Private placement of common stock 6,705,924 6,706 2,005,070
Common stock shares issued for outstanding liabilities 831,915 832 448,400
Private placement offering subscriptions received, net 0 284,000
Net income
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Balance June 30, 2001 42,009,266 $ 42,010 $ 68,408,361 $ 682,200
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(CONTINUED ON NEXT PAGE)
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See Notes to Consolidated Financial Statements
NETGATEWAY, INC.
Consolidated Statement of Capital Deficit
(Continued From Previous Page)
Accumulated
Other Total
Deferred Accumulated Comprehensive Capital
Compensation Deficit loss Deficit
------------ ----------------- ------------------- ----------------
Balance June 30, 2001 $ (52,649) $ (71,719,230) $ (4,902) $ (9,306,829)
Stock options exercised 1,727
Amortization of deferred compensation 6,610 6,610
Forfeiture of stock options 180 -
Conversion of convertible debenture 2,115,885
Conversion of long term notes 1,800,180
Private placement of common stock 2,011,776
Common stock shares issued for outstanding liabilities 449,232
Private placement offering subscriptions received, net 284,000
Net income 2,335,308 2,335,308
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Balance June 30, 2001 $ (45,859) $ (69,383,922) $ (4,902) $ (302,112)
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See Notes to Consolidated Financial Statements
NETGATEWAY, INC
Consolidated Statements of Cash Flows
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Three months ended September 30,
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2001 2000
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CASH FLOWS FROM OPERATING ACTIVITIES
Income (loss) from continuing operations $ 2,335,308 $ (6,478,573)
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation and amortization 151,628 410,168
Amortization of deferred compensation 6,610 159,959
Interest expense from beneficial conversion feature 884,000
Common stock issued for services 199,657 7,000
Amortization of debt issue costs 642,019 9,333
Amortization of debt discount 1,482,422 21,583
Changes in assets and liabilities:
Trade receivables and unbilled receivables (1,641,089) (1,600,511)
Inventories 15,318 16,818
Prepaid expenses and other current assets (107,082) (358,063)
Credit card reserves 168,718 -
Other assets (2,069) -
Deferred revenue (3,753,007) 2,969,551
Accounts payable, accrued expenses and other liabilities (834,754) (292,050)
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Net cash used in continuing operating activities (1,336,320) (4,250,785)
Net cash used in discontinued operations - (219,214)
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Net cash used in operating activities (1,336,320) (4,469,999)
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CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of equipment (6,862) 91,442
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Net cash provided by (used in) investing activities (6,862) 91,442
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CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock 1,421,776 -
Proceeds for common stock subscribed 91,000 -
Proceeds from exercise of options and warrants 1,727 2,250
Bank overdraft borrowing 5,701 249,000
Proceeds from issuance of convertible debenture - 2,500,000
Repayment of convertible debenture (100,000)
Repayment of note payable - bank (97,779)
Repayment of capital lease obligations (18,680) -
Repayment of notes (52,502)
Cash paid for debt issue costs - (270,026)
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Net cash provided by financing activities 1,303,745 2,428,722
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NET DECREASE IN CASH (39,437) (1,949,835)
CASH AT THE BEGINNING OF THE PERIOD 149,165 2,606,991
Effect of exchange rate changes on cash balances - (608)
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CASH AT THE END OF THE PERIOD $ 109,728 $ 656,548
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Supplemental disclosures of non-cash transactions:
Interest Expense from beneficial conversion feature 884,000
Conversion of convertible notes to common stock 1,800,180 -
Conversion of debenture to common stock 2,115,885
Conversion of notes payable - officers and stockholders to common stock 490,000
Conversion of loan payable to common stock 100,000
Value of warrants in connection with the issuance of convertible long term notes - 371,000
Common stock issued for outstanding liabilities 449,234 -
Common stock issued for services - 7,000
Supplemental disclosure of cash flow information:
Cash paid for Interest 1,732 61,012
See Notes to Consolidated Financial Statements
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NETGATEWAY, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(1) Description of Business
Netgateway, Inc. and subsidiaries ("Netgateway" or the "Company"), was formed on March 4, 1998 as a Nevada corporation. Netgateway is an e-Services company that provides eCommerce training, technology, continuing education and a variety of other web-based resources to small businesses and entrepreneurs through informational Preview Training Sessions and Internet training workshops. Through these workshops and follow up telemarketing the Company sells a license to use its proprietary StoresOnline software and website development platform and an integrated package of services including hosting of the customer's website on the Company's Galaxy Mall Internet shopping mall, eCommerce services and a program of one on one Internet training services.
In January 2001, the Company sold one of its subsidiaries that was previously reported as a separate segment, and accordingly has reported the operations as discontinued operations in the accompanying consolidated financial statements.
The information at September 30, 2001 and for the three months ended September 30, 2001 and 2000, is unaudited, but includes all adjustments (consisting only of normal recurring adjustments) which in the opinion of management, are necessary to state fairly the financial information set forth therein in accordance with generally accepted accounting principles. The interim results are not necessarily indicative of results to be expected for the full fiscal year period. Certain information and footnote disclosures have been omitted pursuant to rules and regulations published by the Securities and Exchange Commission ("SEC"), although the Company believes that the disclosures are adequate to make the information presented not misleading. These financial statements should be read in conjunction with the audited financial statements for the year ended June 30, 2001 included in the Company's Annual Report on Form 10-K filed with the SEC.
(2) Summary of Significant Accounting Policies
(a) Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
(b) Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market. Inventory consists mainly of products provided in conjunction with the Internet training workshops.
(c) Property and Equipment
Property and equipment are stated at cost. Depreciation expense is computed principally on the straight-line method in amounts sufficient to write off the cost of depreciable assets over their estimated useful lives ranging from 3 to 5 years. The cost of leasehold improvements is being depreciated using the straight-line method over the shorter of the estimated useful life of the asset or the terms of the related leases. Depreciable lives by asset group are as follows:
Computer and office equipment ......................3 to 5 years Furniture and fixtures..............................4 years Computer software...................................3 years Leasehold improvements..............................term of lease |
Normal maintenance and repair items are charged to costs and expenses as incurred. The cost and accumulated depreciation of property and equipment sold or otherwise retired are removed from the accounts and gain or loss on disposition is reflected in net income in the period of disposition.
(d) Intangible Assets
Intangible assets are amortized on a straight-line basis over their estimated useful lives as follows:
Acquired technology.......................... 5 to 7 years Goodwill......................................... 10 years (e) Product and Development Expenditures |
Product and development costs are expensed as incurred.
(f) Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of
The Company reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted operating cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. No assets were determined to be impaired and were not disposed of for the three months ended September 30, 2001 and September 30, 2000.
(g) Financial Instruments
The carrying values of cash, accounts receivable, accounts payable, accrued liabilities, capital leases, current portion of notes payable and debenture approximated fair value due to the short maturity of those instruments. All financial instruments are held for purposes other than trading.
(h) Income Taxes
Income taxes are accounted for under the asset and liability method. The asset and liability method recognizes deferred income taxes for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.
Deferred tax assets are to be recognized for temporary differences that will result in deductible amounts in future years and for tax carryforwards if, in the opinion of management, it is more likely than not that the deferred tax assets will be realized.
(i) Accounting for Stock Options
The Company applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations, in accounting for its fixed plan employee stock options. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. Compensation expense related to stock options granted to non-employees is accounted for under Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," whereby compensation expense is recognized over the vesting period based on the fair value of the options on the date of grant.
(j) Revenue Recognition
During the year ended June 30, 2001, the Company changed its products offered relating to the "Complete Store-Builder Packet" (the "New Packet"). Prior to October 2000 the revenue related to the sales of the original Store Builder Packet were recognized over the period customers had to activate their web site which would require the Company to perform additional services and host the web site. Subsequent to October 1, 2000 the Company is providing customers with the New Packet that does not require the Company to perform any additional services. Revenue from the sale of software products is recognized upon the delivery of the products. Revenue related to the sale of web site hosting and banner licenses is recognized over the period representing the life of the license and the length of the prepaid service. Revenue related to banner advertising services is recognized over the period such advertising is usable and revenue related to the delivery of mentoring services is recognized over the estimated service period. The revenue recorded relating to the sale of merchant account software is reflected net of the cost of the product paid since the Company does not take title to the product prior to the sale.
Revenues relating to the Company's Internet Commerce Center from the design and development of Internet Web sites and related consulting projects is recognized using the percentage-of-completion method. Unbilled receivables represent time and costs incurred on projects in progress in excess of amounts billed, and are recorded as assets. Deferred revenue represents amounts billed in excess of costs incurred, and is recorded as a liability. To the extent costs incurred and anticipated costs to complete projects in progress exceed anticipated billings, a loss is recognized in the period such determination is made for the excess.
(k) Comprehensive Income
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income" establishes standards for reporting and displaying comprehensive income (loss) and its components in a full set of general-purpose financial statements. This statement requires that an enterprise classify items of other comprehensive income (loss) by their nature in a financial statement and display the accumulated balance of other comprehensive income (loss) separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. The Company has components of other comprehensive income (loss), which are classified in the accompanying statement of Capital deficit
(l) Business Segments and Related Information
Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS No. 131) establishes standards for the way public business enterprises are to report information about operating segments in annual financial statements. SFAS No. 131 requires enterprises to report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosure about products and services, geographic areas and major customers. It replaces the "industry segment" concept of SFAS No.14, "Financial Reporting for Segments of a Business Enterprise," with a "management approach" concept as the basis for identifying reportable segments.
The Company has operated under two principal business segments (Internet services and multimedia products). The primary business segment (internet services) is engaged in the business of providing its customers the ability to (i) acquire a presence on the Internet and (ii) to advertise and sell their products or services on the Internet. A secondary business segment (multimedia services) has been engaged in providing assistance in the design, manufacture and marketing of multimedia brochure kits, shaped compact discs and similar products and services intended to facilitate conducting business over the Internet. This second segment was sold on January 11, 2001 and accordingly is reported as discontinued operations in the accompanying consolidated statements of operations. As a result, the Company now operates in one business segment.
(m) Foreign Currency Translation
The financial statements of the Company's Canadian subsidiary, StoresOnline.com, Ltd. have been translated into U.S. dollars from its functional currency in the accompanying consolidated financial statements in accordance with Statement of Financial Accounting Standards No. 52, "Foreign Currency Translation." Balance sheet accounts of StoresOnline.com, Ltd. are translated at period-end exchange rates while income and expenses are translated at the average of the exchange rates in effect during the period. Translation gains or losses that related to StoresOnline.com, Ltd.'s net assets are shown as a separate component of shareholders' equity and comprehensive income (loss). There were no gains or losses resulting from realized foreign currency transactions (transactions denominated in a currency other than the entities' functional currency) during the three months ended September 30, 2001 and September 30, 2000.
(n) Per Share Data
Basic earnings (loss) per share is computed by dividing net income
(loss) available to common shareholders by the weighted average number of common
shares outstanding during the period. Diluted earnings (loss) per share reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock or resulted in
the issuance of common stock that then shared in the earnings of the entity.
Unexercised stock options to purchase 2,626,226 and 4,789,065 shares of the Company's common stock and unexercised warrants to purchase 882,346 and 2,319,003 shares of the Company's common stock at September 30, 2001, and 2000, respectively, were not included in the per share computations because their effect would have been antidilutive.
(o) Use of Estimates
Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the balance sheet date, and the reporting of revenues and expenses during the reporting periods to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.
(p) Reclassifications
Certain amounts have been reclassified to conform to current year presentation.
(q) Discontinued Operations
APB Opinion No. 30 states that discontinued operations refers to the operations of a segment of a business that has been sold, abandoned, spun off, or otherwise disposed of or, although still operating, is the subject of a formal plan for disposal. In accordance with APB Opinion No. 30, the results of continuing operations are reported separately from discontinued operations and any gain or loss from disposal of a segment is reported in conjunction with the related results of discontinued operations.
(r) Advertising Costs
The Company expenses costs of advertising and promotions as incurred. Advertising expenses included in selling and marketing expenses for the three months ended September 30, 2001 and 2000 were approximately $1.3 million and $1.7 million, respectively.
(s) Commission Expense
Commission expense relating to third-party telemarketing activity is recognized as incurred.
(t) Recently Issued Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statements of Financial Accounting Standards No. 141, "Business Combinations" and No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which establishes new standards for the treatment of goodwill and other intangible assets. SFAS 142 is effective for fiscal years beginning after December 15, 2001 and permits early adoption for companies with a fiscal year beginning after March 15, 2001. SFAS 142 prescribes that amortization of goodwill will cease as of the adoption date. Additionally, the Company will be required to perform an impairment test as of the adoption date, annually thereafter, and whenever events and circumstances occur that might affect the carrying value of these assets. The Company has not yet determined what effect, if any, the impairment test of goodwill will have on the Company's results of operations and financial position. In addition, subsequent to June 2001, SFAS 143 and SFAS 144 have been issued, but they are not effective until fiscal years beginning after June 15, 2002 and December 15, 2001, respectively and the Company is evaluating the impact of these pronouncements on financial position and results of operations.
(3) Going Concern
The accompanying financial statements have been prepared on the basis that the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has incurred losses since its inception and a cumulative net loss of approximately $69 million through September 30, 2001. At September 30, 2001 the Company had a working capital deficit of $2,229,471 and a capital deficit of $ 302,112. For the three months ended September 30, 2001 and 2000 the Company recorded negative cash flows from continuing operations of $1,336,320 and $4,250,785, respectively. The Company has historically relied upon private placements of its stock and issuance of debt to generate funds to meet its operating needs. Management's plans include the raising of additional debt or equity capital and, in addition, subject to shareholder approval, the merger of the Company with Category 5 Technologies (see Note 8). However, there can be no assurance that additional financing will be available on acceptable terms, if at all. The Company continues to work to improve the strength of its balance sheet and has restructured its ongoing operations in an effort to improve profitability and operating cash flow. If adequate funds are not generated, the Company may be required to further delay, reduce the scope of, or eliminate one or more of its products or obtain funds through arrangements with collaborative partners or others that may require it to relinquish rights to all or part of the intellectual property of its Stores Online software or the Internet Commerce Center or control of one or more of its businesses. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
(4) Debentures
In July 2000, the Company entered into a securities purchase agreement with King William, LLC. Under the terms of the agreement, the Company issued to King William an 8% convertible debenture due July 31, 2003 in the principal amount of $4.5 million. The debenture was convertible into the number of shares of our common stock at the lower of $1.79 or a conversion rate of 80% of the average market price of the common stock during any three non-consecutive trading days during the 20 trading days prior to conversion. The purchase price for the debenture was payable in two tranches. The first tranche of $2.5 million was paid at the closing in July 2000. The value of the beneficial conversion feature on the $2.5 million that has been drawn down was recorded as additional paid in capital and interest expense of $884,000 for the quarter ended September 30, 2000, as the convertible debentures were immediately exerciseable.
In connection with the securities purchase agreement, the Company issued to King William a warrant to purchase 231,000 shares of the Company's common stock. In connection with the issuance of the debenture, the Company also issued to Roth Capital Partners, Inc., a warrant to purchase 90,000 shares of common stock and to Carbon Mesa Partners, LLC, a warrant to purchase 10,000 shares of common stock. Each of the warrants is exercisable for five years from the date of issue, at an exercise price of $1.625 per share and with cashless exercise and piggyback registration rights. The fair value of the warrants has been determined to equal $371,000. Of the $371,000, $259,000 is accounted as additional paid in capital and debt discount and was amortized over the life of the debt. The remaining balance is accounted for as debt issuance costs included in other assets and was amortized over the life of the debt.
Effective as of January 25, 2001, the Company reached an agreement with King William LLC to restructure the debenture. As of the date of the Restructuring Agreement the Company was in breach and/or violation of the Purchase Agreement, the Debenture, the King William Warrant Agreement, the Registration Rights Agreements and the Equity Agreement. However, pursuant to the terms of the Restructuring Agreement the holder of the Convertible Debenture has waived all of these defaults as of the date of the Restructuring Agreement. Under the terms of the Restructuring Agreement the agreements were terminated effective as of the date of the Restructuring Agreement and no termination payment or additional warrants were issued in connection therewith.
Under the terms of the Restructuring and Amendment Agreement the second tranche of the debenture will not be available to the Company. The Company agreed to repay the full amount of the Debenture plus a 15% premium ($375,000) with respect to the original principal amount in ten payments. As of the date of the Restructuring and Amendment Agreement the current principal amount including accrued and unpaid interest was $2,972,781. Additionally, the Company has allowed King William to retain the right to convert any or all portions of the outstanding debt to equity, but only after the stock has traded at or above $3.00 for twenty consecutive trading days, or if the Company does not make a required payment of principal. Warrants already earned by King William were repriced at $.25 per share and King William was issued a warrant for an additional 269,000 shares of common stock at $.25 per share. The incremental fair value of the repricing of the warrants and the issuance of the new warrants was $9,009 and $129,927, respectively. These costs were classified on the balance sheet as debt restructuring costs and were being amortized over the life of the debt. The initial payment of $250,000, as called for by the Restructuring and Amendment Agreement, was made during the first week of February 2001. A second payment to be paid on February 28, 2001 was not made.
In May 2001 King William elected to convert $200,000 of the principal and accrued and unpaid interest of the debenture (Conversion Amount) into 800,000 shares of Common Stock of the Company, at a conversion price of $.25 per share. The Conversion Amount was credited toward the payment of $250,000 due on February 28, 2001, with the balance plus interest accrued to be paid on March 10, 2002. In addition, in May 2001, the Company entered into a Waiver Agreement with King William, LLC to amend certain of the terms of the Restructuring Agreement and to waive certain existing defaults under the Restructuring and Amendment Agreement. The waiver agreement amended the Restructuring Agreement payment schedule to postpone the remaining April 2001 payment of $247,278 to February 2002 and the May 2001 payment of $247,278 to March 2002. As of the date of the Waiver Agreement King William has withdrawn and waived all defaults and violations.
Effective July 11, 2001 the Company and King William entered into a Second Restructuring Agreement. The Company agreed to pay, and King William agreed to accept, in full and final satisfaction of the Debenture at a closing effective September 10, 2001, (i) a cash payment of $100,000, (ii) a $400,000 promissory note of the Company due August 2004 bearing interest at 8% per annum and (iii) 2,800,000 shares of the Company's common stock. No accrued interest was payable in connection with these payments. King William has agreed to certain volume limitations relating to the subsequent sale of its shares of the Company's common stock and has also agreed to forgive the promissory note if the Company meets certain specific requirement including a minimal amount ($2,250,000) of proceeds King William receives from its sale of Company common stock. No gain or loss on the exchange of shares for debt was recorded in the accompanying financial statements.
(5) Convertible Long Term Notes Payable
In January and April 2001, the Company issued long term Convertible Promissory Notes ("Notes") in a private placement offering totaling $2,076,500. The Notes mature on July 1, 2004 and interest accrues at the rate of eight percent (8%) per annum. The Notes are convertible prior to the Maturity Date at the option of the Holder any time after July 1, 2001, or by the Company at any time after July 1, 2001 upon certain conditions as detailed in the Convertible Promissory Notes. The Notes are convertible into shares of common stock of the Corporation by dividing the Note balance on the date of conversion by $.25, subject to Conversion Price Adjustments as defined in the agreement. The relative fair value of this Beneficial Conversion Feature of the notes has been calculated to be $1,347,480 and has been recorded as debt discount on the balance sheet, and is amortized over the life of the Notes.
In connection with the sale of the Notes, the Company issued a warrant to purchase a share of the Company's common stock at an exercise price of $.50 per share for every two shares of Common Stock into which the Note is originally convertible. The Company issued a total of 3,661,000 warrants in connection with the sale of the Notes, with a date of expiration not to exceed sixty calendar days following the commencement date of the warrants. The relative fair value of the warrants has been determined to be $512,540 and has been recorded as debt discount on the balance sheet and is amortized over the life of the Notes.
The debt discounts of $1,347,480 and $512,540 for the beneficial conversion feature and the warrants, respectively, have been netted against the $2,076,500 balance of the Notes on the Balance Sheet and are being amortized over the life of the notes.
As of September 30, 2001, note holders holding $1,801,083 of aggregate principal and accrued interest, had exercised their right to convert both principal and accrued interest into 7,204,334 shares of common stock. As of September 30, 2001, note holders holding approximately $350,000 of aggregate principal and accrued interest had not exercised their right to convert both principal and accrued interest into approximately 1,388,000 shares of common stock. As of September 30, 2001, the balance of the notes on the balance sheet net of the debt discount on the notes was $65,365 after recording the expense related to the September 2001 conversion.
(6) Shareholders' Equity
During the three-month period ended September 30, 2001, the Company issued 6,910 shares of common stock upon the exercise of employee stock options.
During the three months ended September 30, 2001 the Company issued 6,705,924 shares of common stock pursuant to a private placement agreement.
On August 1, 2001, the Company entered into an agreement with Electronic Commerce International ("ECI"), a company owned by a director of and the president of Netgateway, Inc., pursuant to which, among other matters, the Company agreed to issue to them a total of 831,915 shares of common stock of the Company at a price of $.30 per share in exchange for the release by ECI of trade claims by them against the Company totaling $249,575 in the aggregate. In connection with the exchange, the Company recorded a charge of $199,657, representing the difference between the market value and the exchange rate, which is included in the cost of goods sold.
(7) Discontinued Operations
On January 11, 2001, the Company sold IMI, Inc., dba Impact Media, a wholly-owned subsidiary, for $1,631,589 to Capistrano Capital, LLC. The principal shareholder of Capistrano subsequently became a shareholder of the Company. The Company received from Capistrano Capital, LLC. a cash payment of $300,000, with the balance owing of $1,331,589 in the form of a long-term note, payable by Capistrano Capital, LLC. With the purchase, Capistrano Capital assumed responsibility for all current and future funding obligations required by Impact. Since the Company has yet to receive required payments previously due on the note, and IMI, Inc. has not been successful in obtaining additional financing, the Company has reserved the entire $1,331,589 note balance at September 30, 2001.
Operating results for the three months ended September 2000 include the operating activity of IMI, Inc. Certain information with respect to discontinued operations is summarized as follows:
(8) Subsequent Events
In October 2001, the Company entered into an Agreement and Plan of Merger with Category 5 Technologies, Inc., pursuant to which, subject to stockholder approval, the Company will be acquired through a merger of a subsidiary of Category 5 Technologies with and into the Company. In the merger each share of the Company's common stock will be converted into .181818 shares of Category 5 Technologies, Inc. for each share of common stock.
On November 9, 2001 the Company was served with a summons and complaint from NFCC seeking 250,000 shares of the Company's common stock and damages in the amount of up to $1,000,000 as to be determined at trial. It is not possible at this time to determine the probable outcome of the action.
On November 13, 2001, the Company issued 2,333,333 shares of the common stock of the Company, and recorded an amount of $150,000 in its accounts payable, pursuant to the October 10, 2001 agreement with SBI E-2 Capital (USA) Ltd., for services as a financial advisor to the Company in connection with the acquisition of the Company by Category 5 Technologies. A member of the Company's Board of Directors is a managing director of SBI E-2 Capital (USA) Ltd.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
This management's discussion and analysis of financial condition and results of operations and other portions of this Quarterly Report on Form 10-Q contain forward-looking information that involves risks and uncertainties. Our actual results could differ materially from those anticipated by this forward-looking information. Factors that could cause or contribute to such differences include, but are not limited to, those discussed or referred to in the Annual Report on Form 10-K for the year ended June 30, 2001, filed on October 15, 2001, under the heading Information Regarding Forward-Looking statements and elsewhere. In addition, set forth below under the heading "Risk Factors" is a discussion of certain additional risks associated with the proposed acquisition of us by Category 5 Technologies, Inc. Investors should review this quarterly report in combination with our Annual Report on Form 10-K in order to have a more complete understanding of the principal risks associated with an investment in our common stock. This management's discussion and analysis of financial condition and results of operations should be read in conjunction with our financial statements and related notes included elsewhere in this quarterly report on Form 10-Q.
General
In October, we entered into an Agreement and Plan of Merger with Category 5 Technologies, Inc., pursuant to which, subject to stockholder approval, we will be acquired through a merger of a subsidiary of Category 5 Technologies with and into our company. In the merger, each share of our common stock will be converted into .181818 shares of common stock of Category 5 Technologies, Inc.
The financial statements for the three-month period ended September 30, 2000 have been reclassified to conform to current year presentation, including disclosures for discontinued operations.
For the last two quarters of our fiscal year ended June 30, 2001 and for the current quarter ended September 30, 2001 we have reported net income even though the full fiscal year ended June 30, 2001 showed a net loss of $3,638,736. In spite of the profitable operations for the past three quarters, we continue to have a negative working capital ratio and cash flow from operations in each of the last three quarters has been negative. As discussed in our annual report on Form 10-K and elsewhere in this filing, our liquidity still must be improved.
The current economic slow down in the United States and the effect of the events of September 11, 2001 have adversely impacted our revenues and operations. Finding the necessary liquidity to continue operations remains a high priority for our management team.
Fluctuations in Quarterly Results and Seasonality
In view of the rapidly evolving nature of our business and our limited operating history, we believe that period-to-period comparisons of our operating results, including our gross profit and operating expenses as a percentage of net sales, are not necessarily meaningful and should not be relied upon as an indication of future performance.
While we cannot say with certainty the degree to which we experience seasonality in our business because of our limited operating history, our experience to date indicates that we experience lower sales during our first and second fiscal quarters. We believe this to be attributable to summer vacations and the Thanksgiving and December holiday seasons.
Results of Operations
Three-month period ended September 30, 2001 compared to the three-month period ended September 30, 2000
Revenue
Revenues for the three-month period ended September 30, 2001, our first fiscal quarter of fiscal year 2002, increased to $11,634,043 from $7,425,857 in the three month period ended September 30, 2000, an increase of 57%. Operating revenues are from the design and development of Internet web sites and related consulting projects, revenues from our Internet training workshops (including attendance at the workshop, rights to activate web sites and hosting), sales of banner advertising, web traffic building products, mentoring and transaction processing. We expect future operating revenues to be generated principally from our Internet training workshops following a business model similar to the one used in the latter part of fiscal year 2001. The Internet environment continues to evolve, and we intend to offer future customers new products as they are developed. We anticipate that our offering of products and services will evolve as some products are dropped and are replaced by new and sometimes innovative products intended to assist our customers achieve success with their Internet-related businesses.
Formerly we reported product sales that came from our subsidiary, IMI, Inc. On January 11, 2001, we sold IMI for $1,631,589, including $1,331,589 owed to us by IMI at the time of the sale. We received a cash payment of $300,000 and a promissory note for the balance. Accordingly, IMI operations from prior periods are now reported as discontinued operations in the accompanying consolidated statement of operations.
The increase in revenues from fiscal 2000 to 2001 can be attributed to a change in the business model and products for our Galaxy Mall Internet workshop training business and an increase in the prices charged for the products delivered at the workshop.
Since October 1, 2000, the product sold to our customers at our Internet training workshop has been a "Complete Store-Building Packet" which contains a CD- ROM that includes the necessary computer software, links to the Internet and instructions to allow the customer to construct its storefront without any additional services being supplied by us. If additional assistance is required, we provide it for a fee and charge the customer after the services are rendered. The customer may host the storefront with us or any other provider of Internet hosting services. If the customer elects to prepay us for hosting, we recognize the revenue as the service is rendered. Under this new model, we now recognize most of the revenue generated at our Internet workshops at the time of sale. We anticipate enhanced revenues and earnings during the second fiscal quarter of fiscal year 2002 as well, since the amount of revenue deferred from each Internet training workshop sale will be greatly reduced and the revenue from prior period sales will continue to be recognized during the second fiscal quarter of this year.
We anticipate that the beneficial deferred revenue impact due to the October 2000 change in our product offerings will continue only during the second fiscal quarter of fiscal year 2002. Thereafter we anticipate that the amount of revenue recognized from earlier quarters will be approximately equal to that deferred into future periods. If we enjoy a strong growth rate, it is possible that during any one quarter the amount of revenue deferred into future periods will exceed that recognized during the same quarter from sales in prior periods.
The price of the Complete Store Builder Packet sold at the workshop during the three month period ended September 30, 2001 was $2,400 compared to the product it replaced that was sold for $1,950 during the three month period ended September 30, 2000. This is a 23% increase in the revenue generated from each unit sale.
The number of workshops conducted for the current fiscal quarter decreased to 73 from 95 in the fiscal quarter ended September 30, 2000. Due to our lack of cash, it was necessary to reduce the number of workshops held and use our limited resources to attract the maximum number of attendees at these workshops. We do not expect this trend to continue, based on our plan to expand into international operations, which is anticipated to result in an increased number of workshops. During October and November 2001, we have been conducting test workshops in New Zealand and Australia for the first time, and we will consider other geographical areas after we complete our evaluation of the results of the workshops conducted in New Zealand and Australia.
Historically, between 32% and 38% of the primary attendees (not including their guests) at our workshops make a purchase. This ratio remained approximately the same during the current fiscal quarter.
Gross Profit
Gross profit is calculated as revenue less the cost of sales, which consists of the costs to conduct Internet training workshops, program customer storefronts, provide customer support and the cost of tangible products sold. Gross profit for the fiscal quarter ended September 30, 2001 increased to $10,044,474 from $5,235,949 in the comparable quarter of the prior fiscal year. The increase in gross profit is the result of several factors:
o The increase in revenues for the period.
o The savings realized in programming and providing customer support because of the delivery of the "Complete Store-Building Packet" as the product sold at the workshop. The Complete Store-Building Packet contains powerful tools so our customers can develop their eCommerce-enabled storefront with no assistance from us. Prior technology was not as user friendly and thus required us to spend more resources assisting our customers to publish their storefronts.
o The cost of conducting our Internet training workshops remained relatively constant per workshop, while the selling price of the products delivered at the workshops increased.
o Our cost to provide on line, real time credit card processing decreased.
o The percentage of attendees at the workshops who purchased the Complete Store-Building Packet remained approximately the same as it had been in the former business model.
Gross margin percentages increased for the fiscal quarter ended September 30, 2001 to 86% of revenue from 71% of revenue for the fiscal quarter ended September 30, 2000. We anticipate that gross profit as a percentage of sales will decline in future quarters. This decline is expected because of the effect of the deferred revenue amortization discussed above. We believe the achievable gross profit percentage, after the second fiscal quarter of fiscal year 2002, will be similar to what was experienced by our Galaxy Mall subsidiary without regard to the amortization of the deferred revenue that was approximately 60% to 70%.
Product Development
Product development expenses consist primarily of payroll and related expenses for development, editorial, creative and systems personnel as well as outside contractors. Product development expenses for the quarter ended September 30, 2001 were $53,400. They consisted of work on the Stores On Line, version 4 product which is used in the "Complete Store Building Packet" sold at our Internet training workshops. During the three-month period ended September 30, 2000 they were $1,214,324 and consisted mostly of work on the Internet Commerce Center (ICC). Most of the development expenses for the ICC were incurred prior to December 2000. We have completed the basic development of the ICC, as redefined by us.
We intend to make enhancements to our technology as new methods and business opportunities present themselves, but our business model currently contemplates that in most cases we will pass these costs on to our customers. We will undertake additional development projects as the needs are identified and as the funds to undertake the work are available.
Selling and Marketing
Selling and marketing expenses consist of payroll and related expenses for sales and marketing and the cost of advertising, promotional and public relations expenditures and related expenses for personnel engaged in sales and marketing activities. We also contract with telemarketing companies and commissions earned by them are included. Selling and marketing expenses for the quarter ended September 30, 2001 decreased to $3,611,796 from $6,848,155 in the comparable three-month period. The decrease in selling and marketing expenses is primarily attributable to the closing of our Business to Business (B2B) and Cable Commerce divisions. As reported in our most recent annual report on Form 10-K and earlier filings when the management change took place in January 2001 sales and marketing activities for these two divisions were terminated because neither had achieved revenues sufficient to generate a positive cash flow. During the three-month period ended September 30, 2000 there were approximately $886,000 in selling and marketing expenses associated with our B2B and Cable Commerce divisions compared to none during the current fiscal quarter.
Selling and marketing expenses as a percentage of sales decreased to 31% of revenues for the current fiscal quarter from 92% in the comparable three-month period. We expect selling and marketing expenses to increase as a percentage of revenues in the future due to the effects of the deferred revenue explained above.
General and Administrative
General and administrative expenses consist of payroll and related expenses for executive, accounting and administrative personnel, professional fees, bad debts and other general corporate expenses. General and administrative expenses for the three-month period ended September 30, 2001 increased to $2,400,987 from $2,288,710 in the comparable prior year period. This increase is primarily attributable to an increase in bad debts expense. Salaries during the current quarter were less than in the comparable period of the prior fiscal year.
Bad debt expense consists of actual and anticipated losses resulting from the extension of credit terms to and the acceptance of credit cards from our customers when they purchase products at our Internet training workshops. We encourage customers to pay for their purchases by check or credit card since these are the least expensive methods of payment for our customers, but we do offer installment contracts with payment terms up to 24 months as an alternative. We offer these contracts to all workshop attendees not wishing to use a check or credit card regardless of their credit history, because it is our policy to assist everyone who attends a workshop and wishes to become a Galaxy Mall merchant to achieve their goal. A down payment at the time of purchase is required. These installment contracts are sold to various finance companies if our customer has a credit history that meets the finance company's criteria. If not sold, we carry the contract and out-source the collection activity.
Bad debt expense was $845,000 in the current fiscal quarter ended September 30, 2001 compared to $321,847 in the comparable period of the prior fiscal year. The increase is principally due to the increase in the number of installment contracts accepted by us as the sales volume grew and an increasing portion of our customers elected to take advantage of the financing alternatives offered by us rather than to pay in cash or by credit card. At the time of a contract sale to a finance company 20% of the sales price is placed in a reserve account held by the finance company. If our customer does not make its payments on the contract, the finance company may charge the reserve for the unpaid balance previously funded to the extent there are funds available in the reserve account. At maturity of the customer contract, the net balance of the reserve is returned to us. One of the finance companies holding a reserve that will be due to us when the contracts are collected has experienced financial difficulties and may not be able to return these reserves. We therefore established a loss provision of approximately $950,000 during the fiscal year ended June 30, 2001.
Depreciation and Amortization
Depreciation and amortization expenses consist of a systematic charge to operations for the cost of long-term equipment and a write down of the goodwill associated with the purchase of other businesses. Depreciation and amortization expenses for the three-month period ended September 30, 2001 decreased to $151,628 from $410,168 in the three-month period ended September 30, 2000.
Interest Expense
Interest expense for the fiscal quarter September 30, 2001 increased to $1,593,128 from $945,430 in the prior fiscal year. We included in interest expense in the current fiscal quarter a one-time charge of $437,474 relating to the conversion of an 8% convertible debenture issued to King William, LLC into common stock and a charge of $594,217 relating to the conversion into common stock of convertible long term notes held by investors who participated in a private placement of the notes in January and April 2001. Upon conversion of these items the debt discount previously recorded was written off in the current quarter instead of being amortized over the life of the notes
We have repaid the various debt instruments, which created the interest expense for the three-month ended September 30, 2000.
Discontinued Operations
In January 2001, we sold our subsidiary, IMI, Inc. to a third party. As a result, the loss from discontinued operations is listed on a separate line item in the statement of operations.
Liquidity and Capital Resources
Cash
We have incurred substantial losses in the past and may in the future incur additional losses. At September 30, 2001, we had a working capital deficit of $2,229,471 and at June 30, 2001, we had a working capital deficit of $11,352,352. Our capital deficit was $302,112 and $9,306,829 at September 30, 2001 and June 30, 2001, respectively. We generated revenues from continuing operations of $11,634,043 for the three-month period ended September 30, 2001 and $7,425,857 for the three-month period ended September 30, 2000. For the quarter ended September 30, 2001 we had a net income of $2,335,307 and for the quarter ended September 30, 2000, we incurred a net loss of $6,680,035. For the quarter ended September 30, 2001 and the quarter ended September 30, 2000, we recorded negative cash flows from continuing operations of $730,865 and $4,250,785, respectively.
At September 30, 2001, we had $109,728 cash on hand, a decrease of $39,437 from June 30, 2001.
Net cash used in operating activities was $1,336,320 for the fiscal
quarter ended September 30, 2001. Net cash used in operations was primarily
attributable to net income of $2,335,308 from continuing operations plus
non-cash charges, but off set by a decrease in deferred revenue of $3,753,007,
an increase in accounts receivable of $1,641,089, and a decrease in accounts
payable, accrued expenses and other liabilities of $834,754. The non-cash
charges include: (i) amortization of debt issue costs of $642,019 relative to
the King William debenture and warrants issued in January and April 2001, and
(ii) amortization of debt discount of $1,482,422 relative to the conversion of
the King William debenture and the beneficial conversion feature of the
convertible notes. The amortization of debt issue costs and debt discount was
accelerated due to the conversion of the King William debenture and the
convertible notes during the current quarter.
Net cash provided by financing activities for the fiscal quarter ended September 30, 2001 was $1,303,745.
As a result of our inability to sell a sufficient number of the installment contracts generated by our Galaxy Mall Internet workshop training business we do not have sufficient cash from operating activities to meet our immediate working capital and cash requirements. We have historically relied upon private placements of our stock and issuance of debt to generate funds to meet our operating needs. We have sought and will continue to seek to raise capital, however, there can be no assurance that additional financing will be available on acceptable terms, if at all. If adequate funds are not generated, we may be required to further delay, reduce the scope of, or eliminate one or more of our products or obtain funds through arrangements with collaborative partners or others that may require us to relinquish rights to all or part of the intellectual property of our StoresOnLine software or the Internet Commerce Center or control of one or more of our businesses.
In May 2001 we began a private placement of unregistered common stock at $.30 per. As of November 8, 2001, net proceeds to us from the offering were approximately $2,800,000, of which $240,000 resulted from one of our officers exchanging a loan due him for shares in the private placement. The private placement will continue into the second fiscal quarter.
Accounts Receivable
Accounts receivable, both current and long-term, net of allowance for doubtful accounts, was $3,731,141 at September 30, 2001 compared to $2,090,051 at June 30, 2001. This increase is due to a larger portion of our sales at the Internet training workshops being financed through installment sales contracts. We have in the past sold, on a discounted basis, a portion of these installment contracts to third party financial institutions for cash. Because these financial institutions are small, they are limited in the quantities of contracts they can purchase due to limitations on the amount of receivables they may purchase from one person imposed on them by their investors. In addition, the institution we worked with most closely in prior years has experienced financial difficulties and dramatically reduced its level of purchases. As a result, we are seeking to develop relationships with other potential purchasers of these installment contracts. In the interim, our inability to sell our installment contracts at historic levels has had a material negative impact on our near-term liquidity and cash position.
Other assets relating to our installment contract sales at September 30, 2001 were $354,042 net of an allowance for doubtful accounts of $1,618,110. When installment contracts are sold, the purchaser holds approximately 20% of the of the purchase price in a reserve that will be returned to us if the contracts are paid in full by our customer. If the customer fails to pay, the purchaser my charge this reserve account for the deficiency. Our obligation to accept such charge backs is limited to the amount in the reserve account. One of the purchasers holding such a reserve is having financial difficulties and therefore we have established an allowance for doubtful accounts of approximately $950,000 to provide for the possibility that the reserve funds may not be returned to us according to the terms of our contract with them.
Delisting of Common Stock
On January 10, 2001, our common stock was delisted from the NASDAQ National Market, and began to trade on the National Association of Securities Dealers OTC Electronic Bulletin Board. The delisting of our common stock has had an adverse impact on the market price and liquidity of our securities and has adversely affected our ability to attract additional investors. This has a material adverse effect on our liquidity because the sale of additional shares of our common stock is currently the principal potential source of additional funds required to operate our businesses.
Arrangements with King William, LLC
On September 10, 2001 King William exchanged the remaining balance of the convertible debenture into 2,800,000 shares of our common stock, a cash payment of $100,000 and note due on August 15, 2004 in the amount of $400,000.
Accounts Payable
Accounts payable at September 30, 2001, totaled $1,414,068 as compared to $2,663,066 at June 30, 2001 and compared to $4,708,716 as of March 31, 2001. The reduction since March is primarily due to the settlement agreements reached with vendors as described above funded with proceeds from the sale of convertible notes, common stock and unsecured loans from certain of our officers. Our business operations are dependent on the ongoing willingness of our suppliers and service providers to continue to extend their payment terms until we resolve our current liquidity problems. A number of suppliers and service providers now require payment in advance or on delivery.
Deferred Revenue
Deferred revenue at September 30, 2001 totaled $2,280,585 as compared to $6,033,592 at June 30, 2001. We recognize deferred revenue as our services are rendered or when the time period in which customers have the right to receive the services expires. The decrease from the prior fiscal year end is the result of a change in the products offered starting October 1, 2000 at our Internet training workshops.
We changed the product offered at our GalaxyMall Internet workshop training business and since October 1, 2000, have delivered a "Complete Store-Building Packet" which contains a CD-ROM that includes the necessary computer software, Internet links and instructions to allow the customer to construct its storefront without any additional services being supplied by us. If additional assistance is required, we will provide it for a fee and charge the customer after the services are rendered. The customer may host the storefront with us, or any other provider of Internet hosting services. If the customer elects to prepay us for hosting, we will recognize the revenue as the service is rendered.
Under this new model, we now recognize most of the revenue generated at our Internet workshops at the time of sale. We anticipate that revenues and earnings will be enhanced during the second fiscal quarter of fiscal year 2002 since the amount of revenue deferred from each Internet workshop sale will be greatly reduced and the revenue from prior period sales will continue to be recognized during this and future periods.
Capital Deficit
Total capital deficit decreased to $302,112 during the current fiscal quarter from $9,306,829 at June 30, 2001. This mainly resulted from additions to paid-in capital because of the conversion of debentures and long term notes into common stock, the sale of common stock in a private placement at $0.30 per share and the net income for the fiscal quarter ended September 30, 2001. (See the Statement of Capital Deficit in the financial statements.)
Financing Arrangements
We accept payment for the sales made at our Galaxy Mall Internet training workshops by cash, credit card, installment contract or a third party leasing option. As part of our cash flow management and in order to generate liquidity, we have sold on a discounted basis a portion of the installment contracts generated by our Galaxy Mall subsidiary to third party financial institutions for cash. Because these finance companies are small and have limited resources they have not been able to purchase all of the contracts we would like to sell. See "Liquidity and Capital Resources - Accounts Receivable," for further information.
On September 13, 2000, we retained the services of National Financial Communications Corp. (NFCC) for a six-month period as a nonexclusive advisor in connection with our investor relations, in consideration for which we paid $10,000 and gave a commitment to issue it 250,000 shares of common stock. In October 2000, National Financial notified us that it was unwilling to perform its obligations under its retainer agreement unless the consideration was substantially increased. This agreement has since been terminated.
On November 9, 2001, we were served with a summons and complaint from NFCC seeking 250,000 shares of our common stock and damages in the amount of up to $1,000,000 as to be determined at trial. It is not possible at this time to determine the probable outcome of the action.
Impact of Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, "Business Combinations" and No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which establishes new standards for the treatment of goodwill and other intangible assets. SFAS 142 is effective for fiscal years beginning after December 31, 2001 and permits early adoption for companies with a fiscal year beginning after March 15, 2001. SFAS 142 prescribes that amortization of goodwill will cease as of the adoption date. Additionally, we will be required to perform an impairment test as of the adoption date, annually thereafter, and whenever events and circumstances occur that might affect the carrying value of these assets. We have not yet determined what effect, if any, the impairment test of goodwill will have on our results of operations and financial position. In addition, subsequent to June 30, 2001, SFAS 143 and SFAS 144 have been issued, and we are evaluating the impact these pronouncements will have on our financial position and results of operations in future filings.
Proposed merger with Category 5 Technologies, Inc.
On October 23, 2001, we signed an Agreement and Plan of Merger with Category 5 Technologies, Inc. (Category 5 Technologies), pursuant to which, subject to stockholder approval, we will be acquired through a merger of a subsidiary of Category 5 Technologies into us. In the merger, each share of our common stock will be converted into .181818 shares of Category 5 Technologies common stock.
Risk Factors
Set forth below and elsewhere in this Quarterly Report and in the other documents we file with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended June 30, 2001, filed on October 15, 2001, under the heading Information Regarding Forward-Looking Statements, are risks and uncertainties that could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this Quarterly Report. The risks and uncertainties identified below are some of the additional risks associated with the proposed acquisition of our company by Category 5 Technologies, Inc.
Risk Factors Regarding the Proposed Merger with Category 5 Technologies
Our stockholders will receive 0.181818 shares of Category 5 Technologies common stock for each share of our common stock owned despite changes in the market value of Category 5 Technologies common stock or our common stock.
Upon completion of the merger, each share of our common stock will be exchanged for 0.181818 shares of Category 5 Technologies common stock. There will be no adjustment for changes in the market price of either Category 5 Technologies common stock or our common stock. Neither we nor Category 5 Technologies are permitted to abandon the merger, nor are we permitted to re-solicit the vote of our stockholders solely because of changes in the market price of Category 5 Technologies common stock. Accordingly, the specific dollar value of Category 5 Technologies common stock to be received upon completion of the merger will depend on the market value of Category 5 Technologies common stock at the time of completion of the merger. The share price of both Category 5 Technologies and our common stock is by nature subject to general fluctuations in the market for publicly traded securities and has experienced significant volatility and in addition there is only a very limited trading history for the common stock of Category 5 Technologies. No prediction can be made as to the market price of Category 5 Technologies common stock at the completion of the merger or as to the market price of Category 5 Technologies common stock after the completion of the merger.
Our officers and directors have conflicts of interest that may influence them to support or recommend the merger.
Our officers and directors participate in arrangements that provide them with interests in the merger that are different from, or are in addition to, that of our shareholders. In particular, certain of our officers and employees may enter into employment agreements with Category 5 Technologies which will provide for, among other things, employment with Category 5 Technologies after the merger and other payments and benefits. Shelly Singhal is a Managing Director and Executive Vice President of SBI-E2 Capital, which has agreed to provide significant financial services to Category 5 Technologies prior to the completion of the merger. In addition the merger agreement provides that Donald Danks shall have the right to designate three directors to the board of directors of Category 5 Technologies for a period of three years.
As a result of these interests, these officers and directors could be more likely to support or recommend to our stockholders the approval of the merger than if they did not have these interests. Our stockholders should consider whether these interests may have influenced these officers and directors to support or recommend the approval of the merger.
Category 5 Technologies may have difficulty integrating our operations and retaining important employees.
There can be no guarantee that management will be able to successfully integrate our employees and operations following the merger and there is the risk that Category 5 Technologies will be unable to retain all of our key employees for a number of reasons. There also can be no assurance that any contemplated synergies from the integration of the businesses will be realized. The challenges involved in this integration include the following:
o the risk that the cultures of the companies will not blend;
o obtaining synergies from the customer acquisition methodologies
of the companies; and
o obtaining synergies from the companies' product and service
offerings effectively and quickly integrating technology, back
office, human resources, accounting and financial systems.
Neither we nor Category 5 Technologies have experience in integrating the operations on the scale presented by the merger. The integration process will be complicated and will involve a number of special risks in addition to the challenges described above, including the possibility that management may be distracted from regular business operations. It is not certain that the two companies can be successfully integrated in a timely manner or at all or that any of the anticipated benefits will be realized. Failure to effectively complete the integration could materially harm the business and operating results of the combined companies.
The integration of our company with Category 5 Technologies will require substantial time and effort of key managers of Category 5 Technologies, which could divert the attention of those managers from other matters.
The merger will place significant demands on key managers of Category 5 Technologies. Managing the integration of the two companies and the growth of our business may limit the time available for those managers of Category 5 Technologies to attend to other operational, financial and strategic issues.
Our merger with Category 5 Technologies may be viewed as disadvantageous by certain customers of Category 5 Technologies and our company.
Certain of Category 5 Technologies' and our existing customers and other business partners may view the merger as disadvantageous to them. As a consequence, the future relationship with these persons could be adversely affected. The merger will require the consent of certain parties who have entered into contracts with us. There can be no assurance that such consents will be given and, if not given, that such contracts will not terminate.
Following the merger, Category 5 Technologies may not be able to retain our employees or the employees of Category 5 Technologies.
The success of Category 5 Technologies and us will be dependent in part on the retention and integration of management, technical, marketing, sales and customer support personnel. There can be no assurance that the companies will be able to retain such personnel or that the companies will be able to attract, hire and retain replacements for employees who leave following consummation of the Merger. The failure to attract, hire, retain and integrate such skilled employees could have a material adverse effect on the business, operating results and financial condition of Category 5 Technologies and us.
Category 5 Technologies' operating results may suffer as a result of the accounting treatment of goodwill relating to its proposed combination with us.
Under generally accepted accounting principles in the United States, Category 5 Technologies will account for the merger using the purchase method of accounting. Under purchase accounting, Category 5 Technologies will record the acquisition cost of our company based on the market value of Category 5 Technologies common stock issued in connection with the merger, other consideration and the amount of direct transaction costs incurred in acquiring us. Category 5 Technologies will allocate the total cost to the fair value of individual assets acquired and liabilities assumed from us, with the remaining cost being accounted for as goodwill. Under FASB 142 "Goodwill and other Intangible Assets," goodwill will not be amortized but will be evaluated for impairment each reporting period. The amount of the excess purchase cost allocated to goodwill is estimated to be approximately $31.2 million. Should it be determined that the goodwill is impaired, the write down of goodwill may adversely affect Category 5 Technologies' results of operations in the foreseeable future, which could cause the market value of the combined company's common stock to decline.
If the conditions to the merger are not met, the merger will not occur.
Several conditions must be satisfied or waived to complete the merger, and there can be no assurance that each of the conditions will be satisfied. If the conditions are not satisfied or waived, the merger will not occur or will be delayed, and we may lose some or all of the intended benefits of the merger.
If the merger is not completed, our stock price and future business and operations could be harmed.
If the merger is not completed, we may be subject to the following material risks:
o We may be required to pay Category 5 Technologies a termination fee of $1.5 million;
o the price of our common stock may decline to the extent that the current market price of our common stock reflects a market assumption that the merger will be completed; and
o We will incur significant costs related to the merger, such as legal, accounting and the fees and expenses of our financial advisor, which costs must be paid even if the merger is not completed.
Further, if the merger is terminated and our board of directors determines to pursue another merger or business combination, it is not certain that we will be able to find a partner willing to pay an equivalent or more attractive price than that which would be paid in the merger. In addition, while the merger agreement is in effect, and subject to limited exceptions, we and our officers, board members and advisors are generally prohibited from soliciting, initiating or knowingly encouraging or entering into extraordinary transactions, such as a merger, sale of assets or other business combination, with any party other than Category 5 Technologies.
The Merger will result in substantial costs whether or not completed.
The merger will result in significant costs to Category 5 Technologies and us. Excluding costs associated with combining the operations of the two companies and severance benefits and costs associated with discontinuing some redundant business activities, direct transaction costs are estimated at approximately $1.4 million. These costs are expected to consist primarily of fees for investment bankers, attorneys, accountants, filing fees and financial printing. The aggregate amount of these costs may be greater than currently anticipated. A substantial amount of these costs will be incurred whether or not the merger is completed.
The rights of our stockholders will be effected by the merger.
Our stockholders, as of the effective time of the merger, will become holders of Category 5 Technologies common stock. Certain differences exist between the rights of our stockholders under Delaware law and our Certificate of Incorporation and Bylaws, and the rights of stockholders of Category 5 Technologies under Nevada law, the Articles of Incorporation of Category 5 Technologies and the Bylaws of Category 5 Technologies.
The merger may have a dilutive effect to stockholders.
Although the companies believe that beneficial synergies will result from the merger, there can be no assurance that the combining of the two companies' businesses, even if achieved in an efficient, effective and timely manner, will result in combined results of operations and financial condition superior to what would have been achieved by each company independently, or as to the period of time required to achieve such result. The issuance of Category 5 Technologies common stock in connection with the merger may have the effect of reducing Category 5 Technologies' net income per share from levels otherwise expected and could reduce the market price of the Category 5 Technologies common stock unless revenue growth or cost savings and other business synergies sufficient to offset the effect of such issuance can be achieved.
The merger with Category 5 Technologies may create an opportunity loss for us as a stand-alone entity.
As a consequence of the merger, our stockholders will lose the chance to invest in the development and exploitation of our products on a stand-alone basis. It is possible that we, if we were to remain independent, could achieve economic performance superior to that which we could achieve as a subsidiary of Category 5 Technologies. Consequently, there can be no assurance that our stockholders would not achieve greater returns on investment if we were to remain an independent company.
Item 3. Quantitative and Qualitative Disclosures of Market Risk
We do not believe we have material market risk exposure. We do not invest in market risk sensitive instruments for trading purposes. Our excess cash is placed in short-term interest-bearing accounts or instruments that are based on money market rates.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
On September 13, 2000, we retained the services of National Financial Communications Corp. (NFCC) for a six-month period as a nonexclusive advisor in connection with our investor relations, in consideration for which we paid $10,000 and gave a commitment to issue it 250,000 shares of common stock. In October 2000, National Financial notified us that it was unwilling to perform its obligations under its retainer agreement unless the consideration was substantially increased. This agreement was subsequently terminated.
On November 9, 2001, we were served with a summons and complaint from NFCC seeking 250,000 shares of our common stock and damages in the amount of up to $1,000,000 as to be determined at trial. We dispute the damages claim and are in negotiations with NFCC relative to the shares of common stock NFCC is seeking. It is not possible at this time to determine the probable outcome of the action.
Item2. Changes in Securities and Use of Proceeds
Recent Sales of Unregistered Securities
Set forth below in chronological order is information regarding the numbers of shares of common stock sold by us, the number of options issued by us, and the principal amount of debt instruments issued by us between July 1, 2001 and September 30, 2001, the consideration received by us for such shares, options and debt instruments and information relating to the section of the Securities Act or rule of the Securities and Exchange Commission under which exemption from registration was claimed. None of these securities was registered under the Securities Act. Except as otherwise indicated, no sales of securities involved the use of an underwriters and no commissions were paid in connection with the sale of any securities.
On August 1, 2001, we entered into an agreement with Electronic Commerce International, a company owned by the president of Netgateway, pursuant to which, among other matters, we agreed to issue to them a total of 831,915 shares of our common stock at a price of $.30 per share in exchange for the release by it of trade claims by them against us totaling $249,575 in the aggregate. In connection with the exchange, we recorded a charge of $199,657 In our opinion, the offer and sale of these shares was exempt by virtue of Section 4(2) of the Securities Act and the rules promulgated thereunder.
On September 10, 2001, we completed the conversion of the $2.5 million convertible debenture held by King William and in connection therewith issued to King William a total of 2,800,000 shares of our common stock. We believe this transaction was exempt from registration by virtue of Sections 3(a)(9) and/or 4(2) of the Securities Act and the rules promulgated thereunder.
During the period from July 1, 2001 through September 30, 2001, we sold by way of private placement, a total of 6,705,924 shares of our common stock for an aggregate consideration of $2,011,776. In our opinion, the offer and sale of these shares was exempt by virtue of Section 4(2) of the Securities Act and the rules promulgated thereunder.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
2.1 Agreement and Plan of Merger among Netgateway, Inc., Category 5 Technologies, Inc., and C5T Acquisition Corp., dated October 23, 2001 (Incorporated by reference to Exhibit 2.1 to the Form S-4 Registration Statement filed by Category 5 Technologies, Inc. on November 9, 2001).
3.2* Amended and Restated By-Laws of Netgateway, Inc.
10.122 Second Restructuring Agreement dated as of July 11, 2001 between Netgateway, Inc. and King William, LLC (Incorporated by Reference from our Annual Report on Form 10-K filed on October 15, 2001).
10.123 Promissory Note from Netgateway, Inc. to King William, LLC (Incorporated by Reference from our Annual Report on Form 10-K filed on October 15, 2001).
10.124* Engagement Agreement dated October 10, 2001 between Netgateway, Inc. and SBI E2-Capital (USA) Ltd.
* Filed herewith.
(b) Reports on Form 8-K
(i) Form 8-K, Item 5, filed on July 25, 2001, with respect to press release describing conversion of debt to stock by King William, LLC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
NETGATEWAY, INC.
Date: November 19, 2001 /s/ Donald Danks
Donald Danks
Chief Executive Officer
Date: November 19, 2001 /s/ Frank C. Heyman
Frank C. Heyman
Chief Financial Officer
|
AMENDED AND RESTATED
BY-LAWS
OF
NETGATEWAY, INC.
NETGATEWAY, INC.
A DELAWARE CORPORATION
AMENDED AND RESTATED
BY-LAWS
ARTICLE I
STOCKHOLDERS
SECTION 1.1 ANNUAL MEETING.
An annual meeting of stockholders for the purpose of electing directors
and of transacting such other business as may come before it in accordance with
Section 1.8 of these By-Laws shall be held each year at such date, time, and
place, either within or without the State of Delaware, as may be specified by
the Board of Directors.
SECTION 1.2 SPECIAL MEETINGS.
A special meeting of stockholders for any purpose other than the election of directors may be called at any time upon call of the Chairman of the Board of Directors, if any, the President, any Vice President, or a majority of the Board of Directors, or by the holders of record of at least a majority of the outstanding voting securities of the Corporation at such time and place, either within or without the State of Delaware, as may be stated in the notice. At any special meeting of stockholders, no business transacted and no corporate action shall be taken other than as stated in the notice of the meeting.
SECTION 1.3 NOTICE OF MEETINGS.
Written notice of stockholders meetings, stating the place, date, and hour thereof, and the purpose or purposes for which the meeting is called shall be given by the Chairman of the Board of Directors, if any, the President, any Vice President, the Secretary, or any Assistant Secretary to each stockholder entitled to vote thereat at least twenty days, but not more than sixty days, before the date of the meeting, unless a different period is prescribed by law.
SECTION 1.4 QUORUM.
Except as otherwise provided by law or in the Certificate of Incorporation or these By-Laws, at any meeting of stockholders, the holders of a majority of the outstanding shares of each class of stock entitled to vote at the meeting shall be present or represented by proxy in order to constitute a quorum for the transaction of any business. In the absence of a quorum, a majority in interest of the stockholders present or the chairman of the meeting, as determined in accordance with Section 1.6 of these By-Laws, may adjourn the meeting from time to time in the manner provided in Section 1.5 of these By-Laws until a quorum shall attend.
SECTION 1.5 ADJOURNMENT.
Any meeting of stockholders, annual or special, may adjourn from time to time to reconvene at the same or some other place, and notice need not be given of any such adjourned meeting if the time and place thereof are announced at the meeting at which the adjournment is taken. At the adjourned meeting, the Corporation may transact any business which might have been transacted at the original meeting. If the adjournment is for more than thirty days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting.
SECTION 1.6 ORGANIZATION.
(a) The Chairman of the Board of Directors, or in his or her absence the President, or in their absence any Vice President, shall call to order meetings of stockholders and shall act as chairman of such meetings. The Board of Directors or, if the Board of Directors fails to act, the stockholders, may appoint any stockholder, director, or officer of the Corporation to act as chairman of any meeting in the absence of the Chairman of the Board, the President, and all Vice Presidents.
(b) The Secretary of the Corporation shall act as secretary of all meetings of stockholders, but, in the absence of the Secretary, the chairman of the meeting may appoint any other person to act as secretary of the meeting.
SECTION 1.7 VOTING.
Except as otherwise provided by law or in the Certificate of Incorporation or these By-Laws and except for the election of directors, at any meeting duly called and held at which a quorum is present, a majority of the votes cast at such meeting upon a given question by the holders of outstanding shares of stock of all classes of stock of the Corporation entitled to vote thereon who are present in person or by proxy shall decide such question. At any meeting duly called and held for the election of directors at which a quorum is present, directors shall be elected by a plurality of the votes cast by the holders (acting as such) of shares of stock of the Corporation entitled to elect such directors.
SECTION 1.8 INTRODUCTION OF BUSINESS AT MEETINGS OF STOCKHOLDERS.
At an annual meeting of the stockholders, only such business shall be
conducted as shall have been brought before the annual meeting (i) by or at the
direction of the Board of Directors or (ii) by any stockholder of the
Corporation who is a stockholder of record at the time of giving of notice
provided for in this Section 1.8, who shall be entitled to vote at such annual
meeting and who complies with the notice procedures set forth in this Section
1.8. For business to be properly brought before an annual meeting by a
stockholder, the stockholder must have given timely notice thereof in writing to
the Secretary of the Corporation. To be timely, a stockholder's notice must be
delivered or mailed to, and received at, the principal executive offices of the
Corporation not less than 30 days nor more than 60 days prior to the annual
meeting, regardless of any postponement, deferrals, or adjournments of that
meeting to a later date; PROVIDED, HOWEVER, that in the event that less than 40
days' notice or prior public disclosure of the date of the annual meeting is
given or made to stockholders, notice by the stockholder to be timely must be
received no later than the close of business on the 10th day following the day
on which such notice of the date of the annual meeting was mailed or such public
disclosure was made. A stockholder's notice to the Secretary shall set forth as
to each matter the stockholder proposes to bring before the annual meeting the
following: (i) a brief description of the business desired to be brought before
the annual meeting and the reasons for conducting such business at the annual
meeting; (ii) the name and address, as they appear on the Corporation's books,
of the stockholder proposing such business; (iii) the class and number of shares
of the Corporation which are beneficially owned by the stockholder; and (iv) any
material interest of the stockholder in such business. Notwithstanding anything
in these By-Laws to the contrary, no business shall be conducted at the
stockholder meeting, except in accordance with the procedures set forth in this
Section 1.8. The chairman of the meeting, as determined in accordance with
Section 1.6 of the By-Laws, shall, if the facts warrant, determine and declare
to the meeting that business was not properly brought before the meeting in
accordance with the provisions of these By-Laws, and if he should so determine,
he shall so declare to the meeting and any such business not properly brought
before the meeting shall not be transacted. Notwithstanding the foregoing
provisions of this Section 1.8, a stockholder shall also comply with all
applicable requirements of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), and the rules and regulations thereunder with respect to the
matters set forth in this Section 1.8.
ARTICLE II
BOARD OF DIRECTORS
SECTION 2.1 NUMBER AND TERM OF OFFICE.
The business, property, and affairs of the Corporation shall be managed by, or under the direction of, a Board of Directors of not less than one nor more than nine directors; PROVIDED, HOWEVER, that the Board of Directors, by resolution adopted by vote of a majority of the then authorized number of directors, may increase or decrease the number of directors. Each director shall serve (subject to the provisions of Section 2.10 and Article IV) until his or her term has expired and his or her successor is elected and qualified, or until his or her earlier death, resignation or removal.
SECTION 2.2 CHAIRMAN OF THE BOARD OF DIRECTORS.
The directors may elect one of their members to be Chairman of the Board of Directors. The Chairman shall be subject to the control of, and may be removed by, the Board of Directors. He or she shall perform such duties as may from time to time be assigned to him or her by the Board of Directors.
SECTION 2.3 MEETINGS.
(a) Regular meetings of the Board of Directors may be held without notice at such time and place as shall from time to time be determined by the Board.
(b) Special meetings of the Board of Directors shall be held at such time and place as shall be designated in the notice of the meeting whenever called by the Chairman of the Board of Directors, if any, the President, or a majority of the directors then in office.
SECTION 2.4 NOTICE OF SPECIAL MEETINGS.
The Secretary, or, in his or her absence, any other officer of the Corporation, shall give each director notice of the time and place of holding of special meetings of the Board of Directors by mail at least ten days before the meeting, or by telecopy, telegram, cable, radiogram, or personal service at least one day before the meeting. Unless otherwise stated in the notice thereof, any and all business may be transacted at any meeting without specification of such business in the notice.
SECTION 2.5 QUORUM AND ORGANIZATION OF MEETINGS.
A majority of the total number of members of the Board of Directors as constituted from time to time shall constitute a quorum for the transaction of business, but, if at any meeting of the Board of Directors (whether or not adjourned from a previous meeting) there shall be less than a quorum present, a majority of those present may adjourn the meeting to another time and place, and the meeting may be held as adjourned without further notice or waiver. Except as otherwise provided by law or in the Certificate of Incorporation or these By-Laws, a majority of the directors present at any meeting at which a quorum is present may decide any question brought before such meeting. Meetings shall be presided over by the Chairman of the Board of Directors, if any, or, in his or her absence, by the President, or, in the absence of both the Chairman of the Board of Directors and the President, by such other person or as the directors may select. The Secretary of the Corporation shall act as secretary of the meeting, but in his or her absence the chairman of the meeting may appoint any person to act as secretary of the meeting.
SECTION 2.6 COMMITTEES.
The Board of Directors may, by resolution passed by a majority of the entire Board of Directors, designate one or more committees, each committee to consist of one or more of the directors of the Corporation. The Board of Directors may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. In the event of the absence or disqualification of a member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he, she or they constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in place of any such absent or disqualified member. Any such committee, to the extent provided in the resolution of the Board of Directors, shall have, and may exercise, all the powers and authority of the Board of Directors in the management of the business, property, and affairs of the Corporation and may authorize the seal of the Corporation to be affixed to all papers which may require it; but no such committee shall have power or authority in reference to amending the Certificate of Incorporation of the Corporation (except that a committee may, to the extent authorized in the resolution or resolutions providing for the issuance of shares of stock adopted by the Board of Directors pursuant to authority expressly granted to the Board of Directors by the Corporation's Certificate of Incorporation, fix any of the preferences or rights of such shares relating to dividends, redemption, dissolution, any distribution of assets of the Corporation, or the conversion into, or the exchange of such shares for, shares of any other class or classes or any other series of the same or any other class or classes of stock of the Corporation), adopting an agreement of merger or consolidation under Section 251 or 252 of the General Corporation Law of the State of Delaware, recommending to the stockholders the sale, lease, or exchange of all or substantially all of the Corporation's property and assets, recommending to the stockholders a dissolution of the Corporation or a revocation of dissolution, or amending these By-Laws; and, unless the resolution expressly so provided, no such committee shall have the power or authority to declare a dividend, to authorize the issuance of stock, or to adopt a certificate of ownership and merger pursuant to Section 253 of the General Corporation Law of the State of Delaware. Each committee which may be established by the Board of Directors pursuant to these By-Laws may fix its own rules and procedures. Notice of meetings of committees, other than of regular meetings provided for by the rules of such committee, shall be given to all committee members. All action taken by committees shall be recorded in minutes of the meetings.
SECTION 2.7 ACTION WITHOUT MEETING.
Nothing contained in these By-Laws shall be deemed to restrict the power of members of the Board of Directors or any committee designated by the Board of Directors to take any action required or permitted to be taken by them without a meeting.
SECTION 2.8 TELEPHONE MEETINGS.
Nothing contained in these By-Laws shall be deemed to restrict the power of members of the Board of Directors or any committee designated by the Board of Directors, to participate in a meeting of the Board of Directors, or any committee thereof, by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other.
SECTION 2.9 NOMINATION OF DIRECTORS.
Only persons who are nominated in accordance with the procedure set
forth in these By-Laws shall be eligible to service as directors. Nominations of
persons for election to the Board of Directors of the Corporation may be made at
a meeting of stockholders (i) by or at the direction of the Board of Directors
or (ii) by any stockholder of the Corporation who is a stockholder of record at
the time of giving of notice provided for in this Section 2.9, who shall be
entitled to vote for the election of directors at the meeting and who complies
with the notice provision of this Section 2.9. Such nominations, other than
those made by or at the direction of the Board of Directors, shall be made
pursuant to timely notice in writing to the Secretary of the Corporation. To be
timely, a stockholder's notice shall be delivered or mailed to, and received at,
the principal executive offices of the Corporation not less than 30 days, nor
more than 60 days, prior to the meeting, regardless of postponements, deferrals,
or adjournments of that meeting to a later date; provided, however, that in the
event that less than 40 days' notice or public disclosure of the date of the
meeting is given or made to stockholders, notice by the stockholder to be timely
must be so received not later than the close of business on the 10th day
following the day on which such notice of the date of the meeting or such public
disclosure was made. Such stockholder's notice shall contain the written consent
of each proposed nominee to serve as a director if so elected and shall set
forth the following: (i) as to each person whom the stockholder proposes to
nominate for election or reelection as a director and as to each person, acting
alone or in conjunction with one or more other persons as a partnership, limited
partnership, syndicate or other group, who participates or is expected to
participate in making such nomination or in organizing, directing or financing
such nomination or solicitation of proxies to vote for the nominee (A) the name,
age, residence address, and business address of each proposed nominee and of
each such person; (B) the principal occupation or employment, and the name, type
of business, and address of the corporation or other organization in which such
employment is carried on, of each proposed nominee and of each such person; (C)
the amount of stock of the Corporation owned beneficially, either directly or
indirectly, by each proposed nominee and each such person; and (D) a description
of any arrangement or understanding of each proposed nominee and of each such
person with each other or any other person regarding future employment or any
future transaction to which the Corporation will or may be a party; and (ii) as
to the stockholder giving the notice (A) the name and address, as they appear on
the Corporation's books, of such stockholder; and (B) the class and number of
shares of the Corporation which are beneficially owned by such stockholder. At
the request of the Board of Directors, any person nominated by the Board of
Directors for election as a director shall furnish to the Secretary of the
Corporation that information required to be set forth in a stockholder's notice
or nomination which pertains to the nominee. Subject to the rights of holders of
preferred stock, if any, no person shall be eligible to serve as a director of
the Corporation unless nominated in accordance with the procedures set forth in
these By-Laws. The chairman of the meeting, determined in accordance with
Section 1.6 of these By-Laws, shall, if the facts warrant, determine and declare
to the meeting that a nomination was not made in accordance with the procedures
prescribed by these By-Laws, and if he should so determine, he shall so declare
to the meeting and the defective nomination shall be disregarded.
Notwithstanding the foregoing provisions of this Section 2.9, a stockholder
shall also comply with all applicable requirements of the Exchange Act and the
rules and regulations thereunder with respect to the matters set forth in this
Section.
SECTION 2.10 ELECTION OF DIRECTORS.
(a) The directors shall be elected by the holders of shares entitled to vote thereon at the record date fixed by the Board of Directors for the annual meeting or special meeting, as the case may be, for the election of directors, and the persons receiving the greatest number of votes, up to the number of directors to be elected, shall be the directors. The election of directors is subject to the provisions for a classified Board of Directors contained in this Section 2.10.
(b) Effective upon the election of the directors at the special meeting of stockholders scheduled for May 24, 2000 (or any postponement or adjournment thereof) (the "Special Meeting"), the directors shall be divided into two classes: Class I and Class II. Such classes shall be as nearly equal in number of directors as possible. Each director shall serve for a term ending at the annual meeting of stockholders for the second fiscal year following the annual meeting for the fiscal year at which such director was elected; provided, however, that the directors first elected to Class I at the Special Meeting shall serve for a term ending at the annual meeting to be held for fiscal year 2000 and the directors first elected to Class II at the Special Meeting shall serve for a term ending at the annual meeting to be held for fiscal year 2001.
(c) At each annual election held after the Special Meeting, the directors chosen to succeed those whose terms then expire shall be identified as being of the same class as the directors they succeed, unless, by reason of any intervening changes in the authorized number of directors, the Board of Directors shall designate one or more directorships whose term then expires as directorships of the other class in order more nearly to achieve equality in the number of directors between the classes. When the Board of Directors fills a vacancy resulting from the death, resignation or removal of a director, the director chosen to fill that vacancy shall be of the same class as the director being succeeded, unless, by reason of any previous changes in the authorized number of directors, the Board of Directors shall designate the vacant directorship as a directorship of the other class in order more nearly to achieve equality in the number of directors between the classes.
(d) Notwithstanding the rule that the two classes shall be as nearly equal in number of directors as possible, in the event of any change in the authorized number of directors each director then continuing to serve as such will nevertheless continue as a director of the class of which such director is a member, until the expiration of his or her current term or his earlier death, resignation or removal. Any newly created directorship or vacancy on the Board of Directors, consistent with the rule that the two classes shall be as nearly equal in number of directors as possible, shall be allocated to one of the two classes, and the Board of Directors shall allocate it to that of the available class whose term of office is due to expire at the earliest date following such allocation.
ARTICLE III
OFFICERS
SECTION 3.1 EXECUTIVE OFFICERS.
The executive officers of the Corporation shall be a President, one or more Vice Presidents, a Treasurer, and a Secretary, each of whom shall be elected by the Board of Directors. The Board of Directors may elect or appoint such other officers (including a Controller and one or more Assistant Treasurers and Assistant Secretaries) as it may deem necessary or desirable. Each officer shall hold office for such term as may be prescribed by the Board of Directors from time to time. Any person may hold at one time two or more offices.
SECTION 3.2 POWERS AND DUTIES.
The Chairman of the Board, if any, or, in his or her absence, the President, shall preside at all meetings of the stockholders and of the Board of Directors. Either the President or the Chairman of the Board of Directors, as determined by the Board of Directors, shall be the chief executive officer of the Corporation. In the absence of the President, a Vice President appointed by the President or, if the President fails to make such appointment, by the Board of Directors, shall perform all the duties of the President. The officers and agents of the Corporation shall each have such powers and authority and shall perform such duties in the management of the business, property, and affairs of the Corporation as generally pertain to their respective offices, as well as such powers and authorities and such duties as from time to time may be prescribed by the Board of Directors.
ARTICLE IV
RESIGNATIONS, REMOVALS, AND VACANCIES
SECTION 4.1 RESIGNATIONS.
Any director or officer of the Corporation, or any member of any committee, may resign at any time by giving written notice to the Board of Directors, the President, or the Secretary of the Corporation. Any such resignation shall take effect at the time specified therein or, if the time be not specified therein, then upon receipt thereof. The acceptance of such resignation shall not be necessary to make it effective.
SECTION 4.2 REMOVALS.
The Board of Directors, by a vote of not less than a majority of the entire Board, at any meeting thereof, or by written consent, at any time, may, to the extent permitted by law, remove with cause from office or terminate the employment of any officer or member of any committee and may, with or without cause, disband any committee.
Any director or the entire Board of Directors may be removed, with cause, by the holders of a majority of the shares entitled at the time to vote at an election of directors.
SECTION 4.3 VACANCIES.
Any vacancy in the office of any director or officer through death, resignation, removal, disqualification, or other cause, and any additional directorship resulting from increase in the number of directors, may be filled at any time by a majority of the directors then in office (even though less than a quorum remains), and, subject to the provisions of this Article IV, the person so chosen shall hold office until his or her successor shall have been elected and qualified; or, if the person so chosen is a director elected to fill a vacancy, he shall (subject to the provisions of this Article IV) hold office for the unexpired term of his or her predecessor.
ARTICLE V
CAPITAL STOCK
SECTION 5.1 STOCK CERTIFICATES.
The certificates representing shares of the capital stock of the Corporation shall be in such form as shall be prescribed by law and approved, from time to time, by the Board of Directors.
SECTION 5.2 TRANSFER OF SHARES.
Shares of the capital stock of the Corporation may be transferred on the books of the Corporation only by the holder of such shares or by his or her duly authorized attorney, upon the surrender to the Corporation or its transfer agent of the certificate representing such stock properly endorsed.
SECTION 5.3 FIXING RECORD DATE.
(a) In order that the Corporation may determine the stockholders entitled to notice of, or to vote at, any meeting of stockholders or any adjournment thereof, or entitled to receive payment of any dividend or other distribution or allotment of any rights or entitled to exercise any rights in respect of any change, conversion, or exchange of stock or for the purpose of any other lawful action other than stockholder action by written consent, the Board of Directors may fix a record date which shall not precede the date such record date is fixed and shall not be more than 60 days, nor less than 10 days, prior to the date of such meeting. If no record date is fixed, the record date for determining stockholders entitled to notice of, or to vote at, a meeting of stockholders shall be at the close of business on the day next preceding the day on which notice is given or, if notice is waived, at the close of business on the day next preceding the day on which the meeting is held. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjourned meeting.
(b) In order that the Corporation may determine the stockholders entitled to consent to corporate action in writing without a meeting, the Board of Directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the Board of Directors, and which date shall not be more than 10 days after the date upon which the resolution fixing the record date is adopted by the Board of Directors. Any stockholder of record seeking to have the stockholders authorize or take corporate action by written consent shall, by written notice to the Secretary, request the Board of Directors to fix a record date. The Board of Directors shall promptly, but in all events within 10 days after the date on which such a request is received, adopt a resolution fixing the record date. If no record date has been fixed by the Board of Directors within 10 days of the date on which such a request is received and no prior action by the Board of Directors is required by applicable law, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting shall be the first date on which a signed written consent setting forth the action taken or proposed to be taken is delivered to the Corporation by delivery to its registered office in the State of Delaware, the principal place of business, or an officer of agent of the Corporation having custody of the book in which proceedings of stockholders meetings are recorded, to the attention of the Secretary of the Corporation. Delivery shall be by hand or by certified or registered mail, return receipt requested. If no record date has been fixed by the Board of Directors and prior action by the Board of Directors is required by applicable law, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting shall be at the closed of business on the date on which the Board of Directors adopts the resolution taking such prior action.
(c) The fact and date of the execution by any stockholder of record of the Corporation of any written consent shall be provided by the certificate under the official seal of a notary public or of any other officer who, by the laws of public or of any other officer who, by the laws of the jurisdiction in which such written consent is executed, has power to take acknowledgments or proofs of deeds to be recorded within such jurisdiction, that the person who signed such written consent did acknowledge before such notary public or other officer the execution thereof and, in the event a record date has theretofore been established to determine the stockholders entitled to give such consents, the fact that he was on the record date the record holder of the applicable shares. No such written consent shall be valid without being so proved.
(d) In the event of the delivery to the Corporation of a written
consent or consents purporting to authorize or take corporate action and/or
related revocations (each such written consent and any revocation thereof is
referred to in this Section 5.3(d) as a "Consent"), the Secretary of the
Corporation shall provide for the safekeeping of such Consents and shall, as
soon as practicable thereafter, conduct such reasonable investigation as he
deems necessary or appropriate for the purpose ascertaining the validity of such
Consents and all matters incident thereto, including, without limitation,
whether the holders of shares having the requisite voting power to authorize or
take the action specified in the Consents have given consent; PROVIDED, HOWEVER,
that if the removal or election of one or more members of the Board of
Directors, the Secretary of the Corporation shall designate an independent,
qualified inspector with respect to such Consents and such inspector shall
discharge the functions of the Secretary of the Corporation under this Section
5.3(d). If, after such investigation, the Secretary or the inspector, as the
case may be, shall determine that any action purportedly taken by such Consents
has been validly taken, that fact shall be certified on the records of the
Corporation kept for the purpose of recording the proceedings of meetings of the
stockholders, and the Consents shall be filed with such records. In conducting
the investigation required by this Section 5.3(d) , the Secretary or the
inspector may, at the expense of the Corporation, retain to assist them special
legal counsel and any other necessary or appropriate professional advisers, and
such other personnel as they may deem necessary or appropriate.
SECTION 5.4 LOST CERTIFICATES.
The Board of Directors or any transfer agent of the Corporation may direct a new certificate or certificates representing stock of the Corporation to be issued in place of any certificate or certificates theretofore issued by the Corporation, alleged to have been lost, stolen, or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate to be lost, stolen, or destroyed. When authorizing such issue of a new certificate or certificates, the Board of Directors (or any transfer agent of the Corporation authorized to do so by a resolution of the Board of Directors) may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen, or destroyed certificate or certificates, or his or her legal representative, to give the Corporation a bond in such sum as the Board of Directors (or any transfer agent so authorized) shall direct to indemnify the Corporation against any claim that may be made against the Corporation with respect to the certificate alleged to have been lost, stolen, or destroyed or the issuance of such new certificates, and such requirement maybe general or confined to specific instances.
SECTION 5.5 REGULATIONS.
The Board of Directors shall have power and authority to make all such rules and regulations as it may deem expedient concerning the issue, transfer, registration, cancellation, and replacement of certificates representing stock of the Corporation.
ARTICLE VI
MISCELLANEOUS
SECTION 6.1 CORPORATE SEAL.
The corporate seal shall have inscribed thereon the name of the Corporation, the year of its organization, and the words "Corporate Seal" and "Delaware."
SECTION 6.2 FISCAL YEAR.
The fiscal year of the Corporation shall be determined by resolution of the Board of Directors.
SECTION 6.3 NOTICES AND WAIVERS THEREOF.
(a) Whenever any notice whatever is required by law, the Certificate of Incorporation, or these By-Laws to be given to any stockholder, director, officer, such notice, except as otherwise provided by law, may be given personally, or by mail, or, in the case of directors or officers, by telecopy, telegram, cable, or radiogram, addressed to such address as appears on the books of the Corporation. Any notice given by telecopy, telegram, cable, or radiogram shall be deemed to have been given when it shall have been delivered for transmission and any notice given by mail shall be deemed to have been given when it shall have been deposited in the United States mail with postage thereon prepaid.
(b) Whenever any notice is required to be given by law, the Certificate of Incorporation, or these By-Laws, a written waiver thereof, signed by the person entitled to such notice, whether before or after the meeting or the time stated therein, shall be deemed equivalent in all respects to such notice to the full extent permitted by law.
SECTION 6.4 STOCK OF OTHER CORPORATIONS OR OTHER INTERESTS.
Unless otherwise ordered by the Board of Directors, the Chairman of the Board of Directors, the President, the Secretary, and such attorneys or agents of the Corporation as may be, from time to time, authorized by the Board of Directors, the Chairman of the Board of Directors, or the President, shall have full power and authority on behalf of this Corporation to attend and to act and vote in person or by proxy at any meeting of the holders of securities of any corporation or other entity in which this Corporation may own or hold shares or other securities, and at such meetings shall possess and may exercise all the rights and powers incident to the ownership of such shares or other securities which this Corporation, as the owner or holder thereof, might have possessed and exercised if present. The Chairman of the Board, the President, the Secretary, or such attorneys or agents, may also execute and deliver on behalf of this Corporation powers of attorney, proxies, consents, waivers, and other instruments relating to the shares or securities owned or held by this Corporation.
ARTICLE VII
AMENDMENTS
The holders of shares entitled at the time to vote for the election of directors shall have the power to adopt, amend, or repeal the By-Laws of the Corporation by vote of not less than a majority of such shares, and, except as otherwise provided by law, the Board of Directors shall have power equal in all respects to that of the stockholders to adopt, amend, or repeal the By-Laws by vote of not less than a majority of the entire Board. However, any By-Law adopted by the Board of Directors may be amended or repealed by vote of the holders of a majority of the shares entitled at the time to vote for the election of directors.
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October 10, 2001
Netgateway, Inc.
754 E. Technology Avenue
Orem, UT 84097
Attention: Don Danks
Chairman of the Board of Directors and
Chief Executive Officer
Gentlemen:
1. We understand that Netgateway, Inc., (the "Company") intends to pursue a merger agreement with Category 5 Technologies, Inc. ("Category 5") (collectively, the "Merger"):
2. The purpose of this letter is to confirm the agreement (the "Agreement") through which SBI E2-Capital (USA) Ltd. ("SBI") is engaged to serve as a financial advisor ("Advisor") to the Company previous to and during the Merger.
3. During the term of this Agreement, the Advisor will provide the Company with (1) such regular and customary advice as is reasonably requested by the Company, provided that the Advisor shall not be required to undertake duties not reasonably within the scope of the advisory service contemplated by this Agreement, and (2) a fairness opinion (the "Fairness Opinion") to be provided to the Board of Directors of the Company relative to the proposed merger. In performance of these duties, the Advisor shall provide the Company with the benefits of its best judgment and efforts. It is understood and acknowledged by the parties that the value of the Advisor's advice is not measurable in any quantitative manner, and that the Advisor shall be obligated to render advice, upon the request of the Company, in good faith, but shall not be obligated to spend any specific amount of time in doing so.
4. In connection with our activities on your behalf, the Company agrees to cooperate with us, to furnish or cause to be furnished to us such information and data as we may reasonably request, and to give us reasonable access to the Company's officers, directors, employees, appraisers, and independent accountants. The Company represents that all information made available to SBI by the Company will be complete and correct in all material respects and will not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements therein not misleading in light of the circumstances under which such statement are made. The Company further represents and warrants that any projections provided by it to SBI will have been prepared in good faith and will be based on assumption which, in light of the circumstances under which they are made, are reasonable. The Company acknowledges and agrees that in rendering its services hereunder, SBI will be using and relying on the Information (and information available from public sources and other sources deemed reliable by SBI) without independent verification thereof by SBI, and SBI does not assume responsibility for the accuracy or completeness of the information or any other information regarding the Company or the Engagement.
5. For our services in connection with serving as Advisor, the Company shall pay, or cause to be paid, to SBI a fee equal to two percent (2%) of the Merger transaction value of $37,500,000. The fee shall be paid to us as follows:
(a) An aggregate cash fee of $150,000.00. This fee shall be payable to SBI E2-Capital upon delivery of the Fairness Opinion.
(b) 2,333,333 shares of common stock of the Company to be issued in the name of SBI E2-Capital or its designees, free of restrictive legend or any encumbrance. The shares shall be issued upon execution of the definitive merger agreement.
6. If (i) the Merger is not consummated within six months of the date of this letter or (ii) the form of consideration to be offered in the Merger is materially changed, SBI's continuation of its engagement hereunder shall be subject to additional compensation to be mutually agreed upon.
7. In addition to the fees described in paragraph 5 above, the Company agrees to promptly reimburse SBI, upon request from time to time, for all out-of-pocket expenses incurred by SBI, (including, without limitation, fees and expenses of counsel, and other consultants and advisors retained by SBI) in connection with the matters contemplated by this Agreement.
8. The Company agrees to indemnify SBI in accordance with the indemnification provisions (the "Indemnification Provisions") attached to this Agreement which Indemnification Provisions are incorporated herein and made a part hereof.
9. The benefits of this Agreement shall inure to the respective successors and assigns of the parties hereto and of the indemnified parties hereunder and then successors and assigns and representatives, and the obligations and liabilities assumed in this Agreement by the parties hereto shall be binding upon their respective successors and assigns.
10. Either party hereto may terminate this Agreement at any time upon 30 days prior written notice, without liability or continuing obligation, except as set forth in the following sentence. Neither termination nor completion of this assignment shall effect: (i) any compensation earned by SBI up to the date of termination or completion, as the case may be, (ii) any compensation to be earned after termination pursuant to paragraph 5 hereof, (iii) the reimbursement of expenses incurred by SBI up to the date of termination or completion, as the case may be, (iv) the provisions or paragraphs 5 through 12 of this Agreement and (v) the Indemnification Provisions hereof which are incorporated herein, all of which shall remain operatable and in full force and effect.
11. The validity and interpretation of this Agreement shall be governed by, and construed and enforced in accordance with, the laws of the State of California applicable to agreements made and to be fully performed therein.
12. For the convenience of the parties, any number of counterparts of this Agreement may be executed by the parties hereto. Each such counterpart shall be, and shall be deemed to be, an original instrument, but all such counterparts taken together shall constitute one and the same Agreement. This Agreement may not be modified or amended, except in wring signed by the parties hereto.
If the above terms are in accordance with your understanding, please sign the enclosed copy of this letter and return it to us.
Very truly yours,
SBI E2-CAPITAL (USA) LTD.
By: _________________________________
Name: Shelly Singhal
Title: Managing Director and
Executive Vice President
Confirmed and Agreed to this
|
_____ day of October, 2001:
NETGATEWAY, INC.
By: ___________________________
Name:
Title:
INDEMNIFICATION PROVISIONS
The Company (as such term is defined below) agrees to indemnify and hold harmless SBI against any and all losses, claims, damages, obligations, penalties, judgments, awards, liabilities, costs, expenses, and disbursements (and any and all actions, suits, proceedings, and investigations in respect thereof and any legal and other costs, expenses, and disbursements in giving testimony or furnishing documents in response to a subpoena or otherwise), including, without limitation, the costs, expenses, and disbursements, as and when incurred, of investigating, preparing, or defending any such action, suit, proceeding, or investigation (whether or not in connection with litigation in which SBI is a party) directly or indirectly caused by, relating to, based upon, arising out of, our in connection with (a) SBI's acting for the Company [and/or the Special Committee], including without limitation, any act or omission by SBI in connection with its acceptance of or the performance or nonperformance of its obligations under the agreement, between SBI and Netgateway, Inc., as it may be amended from time to time (the "Agreement"), (b) any untrue statement or alleged untrue statement of a material fact contained in, or omissions or alleged omissions from, any information furnished by the Company to SBI, or (c) any Merger (as such term is defined in the Agreement), however, such indemnity agreement shall not apply to any portion of any such loss, claim, damage, obligation, penalty, or judgment by a court of competent jurisdiction (not subject to further appeal) to have resulted primarily and directly from the gross negligence or willful misconduct of SBI. The Company also agrees that SBI shall not have any liability (whether direct or indirect, in contract or tort or otherwise) to the Company for, or in connection with, the engagement of SBI, except to the extent that any such liability is found in a final judgment by a court of competent jurisdiction (not subject to further appeal) to have resulted primarily and directly from SBI's willful misconduct.
These indemnification provisions shall be in addition to any liability which the Company may otherwise have to SBI or the persons indemnified below in this sentence and shall extend to the following: SBI, its affiliated entities, directors, officers, employees, legal counsel, agents, and controlling persons of SBI within the meaning of the federal securities laws. All references to SBI in this Indemnification Agreement shall be understood to include any and all of the foregoing.
If any action, suit, proceeding, or investigation is commenced, as to which SBI proposes to demand indemnification, it shall notify the Company with reasonable promptness; provided, however, that any failure by SBI to notify the Company shall not relieve the Company of its obligations hereunder. SBI shall have the right to retain counsel of its own choice to represent it, and the Company shall have the right to retain counsel of its own choice to represent it, and the Company shall pay the fees, expenses, and disbursements of each such counsel; and such counsel shall to the extent consistent with its professional responsibilities cooperate with the Company and any counsel designated by the Company. The Company shall be liable for any settlement of any claim against SBI made with the Company's written consent, which consent shall not be unreasonably withheld. The Company shall not, without the prior written consent of SBI, settle or compromise any claim, or permit a default or consent to the entry of any judgment in respect thereof, unless such settlement compromise or consent includes, as an unconditional term thereof, the giving by the claimant to SBI of an unconditional release from all liability in respect of such claim in respect of such claim.
In order to provide for just and equitable contribution, if a claim for indemnification pursuant to these indemnification provisions is made, but it is found in a final judgment by a court of competent jurisdiction (not subject to further appeal) that such indemnification may not be enforced in such case, even though the express provisions hereof provide for indemnification in such case, then the Company, on the one hand, and SBI, on the other hand, shall contribute to the losses, claims, damages, obligations, penalties, judgments, awards, liabilities, costs, expenses, and disbursements to which the indemnified persons may be subject in accordance with the relative benefits received by the Company, on the one hand, and SBI, on the other hand, and also the relative fault of the Company on the one hand, and SBI on the other hand, in connection with the statements, acts, or omissions which resulted in such loses claim, damages, obligations, penalties, judgments, awards, liabilities, costs, expenses, and disbursements relevant equitable considerations shall also be considered. No person found liable for a fraudulent misrepresentation shall be entitled to contribution from any person who is not also found liable for such fraudulent misrepresentation. Notwithstanding the foregoing, SBI shall not be obligated to contribute any amount hereunder that excess the amount of fees previously received by SBI pursuant to the Agreement.
Neither termination nor completion of the engagement of SBI referred to above shall affect these indemnification provisions which shall then remain operative and in full force and effect.