10-Q 1 a2030193z10-q.txt FORM 10-Q ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000 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 0-21379 ROWECOM INC. (Exact name of registrant as specified in its charter) DELAWARE 04-3370008 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 60 ABERDEEN AVENUE, CAMBRIDGE, MA 02138 (Address of principal executive office) (617) 588-2800 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___ The number of shares outstanding of the registrant's common stock as of October 31, 2000 was 12,398,817. ------------------------------------------------------------------------------- ROWECOM INC. INDEX

-2- PART I -- FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS ROWECOM INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)

The accompanying notes to the unaudited consolidated financial statements are an integral part of these statements. -3- ROWECOM INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)

The accompanying notes to the unaudited consolidated financial statements are an integral part of these statements. -4- ROWECOM INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)

The accompanying notes to the unaudited consolidated financial statements are an integral part of these statements. -5- ROWECOM INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. THE COMPANY The consolidated financial statements include the accounts of RoweCom Inc. ("RoweCom") and its wholly owned subsidiaries. All significant intercompany accounts and transactions between RoweCom and its subsidiaries, included in the accompanying financial statements, have been eliminated. 2. INTERIM RESULTS As permitted by the rules of the Securities and Exchange Commission applicable to Quarterly Reports on Form 10-Q, these notes are condensed and do not contain all the disclosures required by generally accepted accounting principles. Reference should be made to the consolidated financial statements and related notes included in RoweCom's Annual Report on Form 10-K for the year ended December 31, 1999, as filed with the Securities and Exchange Commission on March 16, 2000. In the opinion of the management of RoweCom, the accompanying unaudited consolidated financial statements contain all adjustments (consisting primarily of normal recurring accruals) considered necessary for a fair statement of the results for the interim periods. The results disclosed in the Consolidated Statement of Operations for the three and nine months ended September 30, 2000, and the Consolidated Statement of Cash Flows for the nine months ended September 30, 2000 are not necessarily indicative of the results to be expected for the full year. The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of the contingent assets and liabilities at the date of the financial statements and the reported amounts of expense during the reporting period. Actual results could differ from those estimates. The financial statements of RoweCom are presented on a going concern basis that contemplates the realization of assets and satisfaction of liabilities in the normal course of business. RoweCom posted a net loss of $14.6 million for the 2000 Three Month Period and a net loss of $48.7 million for the 2000 Nine Month Period. As of September 30, 2000 RoweCom has an accumulated deficit of $78.0 million and a working capital deficit of $31.2 million. The financial statements do not include any adjustments relating to the recoverability of recorded asset amounts or to the classification of liabilities that may be necessary if RoweCom is unable to continue as a going concern. We have historically experienced seasonal fluctuations in revenues because approximately three quarters of our revenues have been generated in the fourth quarter of each year, the time when most institutional subscriptions are purchased or renewed. As such, we make substantial additional expenditures in the fourth quarter as we generally pay publishers by mid December of each year, prior to receipt of a significant portion of client payments. The majority of our outstanding receivables from clients relating to these advance payments are paid in the first quarter of the following year. As a result of this seasonal nature of our cash flows, we rely on bank financing and lines of credit to cover current operating expenses during this period. RoweCom believes that its current financial resources, as of the date of this filing, are not sufficient to meet the entirety of its short and long term financial needs. However, RoweCom currently has 335 million French Francs and 4.5 million British pounds (approximately $60 million at current exchange rates) available under existing credit facilities that are more than sufficient for RoweCom's European and other international business. In addition, RoweCom has a proposal for $85 million in credit insurance for its United States business and is in negotiations for a $35 million credit facility. Although there can be no assurance that either of these will be secured, given the quality of its client receivables and following the execution of the credit insurance agreement, RoweCom believes it is likely it will be able to secure the $35 million additional line of credit that will be sufficient for its U.S. operations. If, however, RoweCom were to be unable to secure this additional credit facility for its U.S. operations, it would be unable to make full payments to all of the publishers on behalf of those U.S. clients who have not paid RoweCom. In that event, RoweCom would nevertheless continue to send those orders to publishers and negotiate with publishers a schedule of payments, linked to the times that RoweCom's clients themselves pay their invoices to RoweCom. In such an event RoweCom's revenues would be correspondingly delayed or reduced. RoweCom's experience indicates that these advances to clients of the quality of RoweCom's clients are generally paid within 90 to 120 days, with virtually no defaults. RoweCom is continuing to aggressively pursue additional long term financing, including equity investments, as management believes that financing beyond short-term credit facilities is required. RoweCom has entered into a definitive sale-and-leaseback agreement for its Westwood headquarters, which will net RoweCom more than $4 million in cash to be completed in mid-December. To reduce cash outflows in the short-term, RoweCom has negotiated with lenders to extend the due date by one year on its $6.2 million promissory notes to May 26, 2002 from May 26, 2001. The lenders on the outstanding notes have received an additional 395,158 common stock purchase warrants with an exercise price of $2.34 in exchange for the maturity date extension. RoweCom has historically funded its operations through sales of its preferred stock, our initial public offering and limited borrowings from third-party financing sources. During 1999, RoweCom entered into additional financing arrangements including the sale of convertible promissory notes and domestic and foreign credit facilities. During May 2000, RoweCom issued one-year promissory notes to certain RoweCom directors and shareholders for proceeds of approximately $6.2 million. During September 2000, RoweCom issued convertible debentures to Montrose Investments Ltd. in the aggregate principal amount of $4.0 million, which bear interest at the stated rate of 7% per year payable at maturity or upon conversion or redemption of the principal. The maturity date is six months from the date of issuance. 3. NET LOSS PER COMMON SHARE Basic net loss per share excludes the effect of any dilutive options, warrants or convertible securities and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were issued, exercised or converted into common stock. Dilutive common share equivalents consist of stock options and warrants calculated using the treasury stock method. The pro forma net loss per common share is computed based upon the weighted average number of common shares and common equivalent shares (using the treasury stock method) outstanding after certain adjustments described below. Common equivalent shares are not included in the per share calculations where the effect of their inclusion would be anti-dilutive. In the computation of pro forma net loss per share, accretion of preferred stock to the mandatory redemption amount is not included as an increase to net loss. Also, the pro forma net loss per common share gives effect to the exchange of all outstanding preferred stock of RoweCom Canada into preferred stock of RoweCom, the mandatory conversion of all outstanding shares of preferred stock into shares of common stock and the exercise of all outstanding stock purchase warrants. -6- The following is a calculation of net loss per share: (dollars in thousands, except per share data)

Options to purchase shares of RoweCom's common stock totaling 1,093,253 and 1,030,807 at September 30, 2000 and 1999, respectively, and warrants to purchase common stock totaling 2,477,458 at September 30, 2000, were outstanding but were not included in the computation of diluted earnings per share as the inclusion of these shares would have been antidilutive. -7- 4. COMPREHENSIVE LOSS

5. DAWSON PURCHASE PRICE FINALIZATION In accordance with the Dawson purchase agreement, an additional 465,300 shares of RoweCom's common stock were issued in May 2000, which were valued at approximately $10.7 million. The value of the shares issued increased the intangible assets associated with the Dawson purchase. 6. EXTRAORDINARY LOSS During June 2000, RoweCom redeemed $16.1 million of convertible notes. In connection with this redemption, RoweCom recorded an extraordinary loss of $4.1 million, primarily attributable to a $1.1 million premium paid on the redemption and $2.7 million related to the remaining unamortized debt issuance costs at the time of conversion. 7. ISSUANCE OF CONVERTIBLE DEBENTURE AND WARRANTS On September 12, 2000, RoweCom issued a six-month convertible debenture in the original principal amount of $4 million. The debenture may be converted into shares of common stock at a conversion price of $5.884 per share. Conversion is at the holder's option, or if the closing bid price of RoweCom's stock exceeds $8.826 for 20 consecutive trading days, at RoweCom's option. RoweCom also issued 135,958 common stock purchase warrants with an exercise price of $7.268 per share. These warrants have a five-year term and are exercisable at the holder's option. In addition, RoweCom issued 1.5 million Class A common stock purchase warrants having a term of one year and two business days. During the first year that the Class A warrants are outstanding, they may be exercised only if called by RoweCom, at a floating exercise price equal to 92% of the average closing bid price of a share of RoweCom stock on the two trading days preceding exercise, subject to a maximum exercise price of $20. These warrants expire if not exercised when called. On the final two business days that they are outstanding, the Class A warrants are exercisable at the holder's option at an exercise price of $20 per share. RoweCom's rights to call the Class A warrants are subject to certain restrictions, including volume limitations based on the trading volume in RoweCom's stock. 8. SUBSEQUENT EVENT-ISSUANCE OF PROMISSORY NOTES AND WARRANTS On May 26, 2000, certain RoweCom shareholders and directors made available funds to repay the convertible notes' principal through the issuance of one-year promissory notes with an aggregate principal amount of $6,175,000. Additionally, 617,500 stock purchase warrants were issued with an exercise price of $5.00. The warrants vest immediately and expire 10 years from issuance. The one-year promissory notes are carried net of the warrant discount of approximately $2.3 million. Amortization of the warrant discount, which is recorded as interest expense, will total approximately $578,000 per quarter. -8- In October 2000, RoweCom negotiated with lenders to extend the due date by one year on its $6.2 million promissory notes to May 26, 2002 from May 26, 2001. The lenders on the outstanding notes have received an additional 395,158 common stock purchase warrants with an exercise price of $2.34 in exchange for the maturity date extension. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CAUTIONARY NOTE This quarterly report on Form 10-Q may contain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. This Act provides a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about themselves so long as they identify these statements as forward looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. All statements other than statements of historical fact made in this Form 10-Q are forward looking. In particular, the statements herein regarding industry prospects and future results of operations or financial position are forward-looking statements. Forward-looking statements reflect management's current expectations and are inherently uncertain. Actual results may differ materially from the results discussed in or implied by the forward-looking statements. Factors that might cause such a difference include, but are not limited to, the risks and uncertainties described or discussed in the section "Risk Factors" in the Registration Statement on Form S-3 (file no. 333-47434) of RoweCom filed on October 5, 2000.These risks include, among others, the following: - The failure to maintain our leadership position through enhancement of our services and catalog of magazines, newspapers, journals and e-journals, books and other knowledge resources. - The failure to significantly and rapidly increase our client base. - The development by competitors of services similar or superior to the services we offer. - The failure to increase penetration of our existing client base. - The failure of businesses to widely adopt intranets and the Internet as means for purchasing subscriptions and books. - The inability to identify, attract, retain and motivate qualified personnel. OVERVIEW OF ROWECOM'S OPERATIONS AND FINANCIAL PERFORMANCE RoweCom provides businesses and their employees with an e-commerce solution for purchasing and managing the acquisition of magazines, newspapers, journals, e-journals, books and other knowledge resources through a corporate intranet or the Internet. We offer our clients access to the largest catalog of magazines, newspapers, journals, e-journals, books and other knowledge resources on the Internet. RoweCom allows employees to purchase knowledge resources easily and conveniently from their desktop computers and provides businesses with a highly effective means of managing and controlling purchases of knowledge resources and reducing costs. Our target clients are in knowledge-intense industries, such as corporate and financial services; biomedical; academic; and the federal government. RoweCom's services initially focused on academic libraries and centralized purchasing groups. Beginning in 1998, we have increasingly focused our sales and marketing efforts on corporate clients and on desktop purchases by individuals rather than centralized purchasing groups. We believe that an increase in the number of desktop purchasers at a client would increase the amount of revenue generated by such client. -9- To date, a substantial majority of our revenues have been generated in the fourth quarter of each year, primarily because most subscriptions are purchased or renewed in that quarter, with subscriptions generally beginning on January 1st of each year. For the corporate e-commerce portion of the business, as purchases by individual employees increase as a percentage of total revenues, the seasonality described above has begun to decrease because desktop purchases are generally made as required, and thus are more evenly distributed throughout the year. Dawson Subscription Business, which was acquired by RoweCom in October 1999 by the purchase of certain assets of UK-based Dawson Information Services and all of the issued and outstanding capital stock of Dawson, Inc., has experienced similar seasonality. In June 1999, RoweCom acquired all of the issued and outstanding capital stock of Corporate Subscription Services, Inc. for $5,726,000 in cash, subject to certain post-closing adjustments, and 16,260 shares of RoweCom's common stock, which were valued at approximately $250,000. In August 1999, RoweCom acquired all of the issued and outstanding capital stock of International Subscription Agencies Pty. Ltd. for $1,486,596 in cash. In October 1999, RoweCom acquired all of the issued and outstanding capital stock of Dawson, Inc., a Delaware corporation, and certain assets of United Kingdom-based Dawson Information Services for $34.0 million cash and issued approximately 97,000 shares of RoweCom's common stock, which were valued at approximately $1.7 million. In accordance with the purchase agreement, an additional 465,300 shares of RoweCom's common stock were issued in May 2000, which were valued at approximately $10.7 million. The value of the shares issued increased the intangible assets associated with the Dawson purchase. RESULTS OF OPERATIONS COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 2000 (THE "2000 THREE MONTH PERIOD") WITH THE THREE MONTHS ENDED SEPTEMBER 30, 1999 (THE "1999 THREE MONTH PERIOD") REVENUES. Revenues for the 2000 Three Month Period were $41.2 million, as compared to $9.5 million for the 1999 Three Month Period, an increase of $31.8 million. The strengthening of the US dollar had a negative impact on revenues for the Three Month period of $2.8 million. Transaction volumes for the 2000 Three Month Period also increased significantly from the 1999 Three Month Period from 41,000 to 251,000 transactions. These increases resulted primarily from growth in our client base, particularly related to the acquisition of Dawson. COST OF REVENUES. Cost of revenues in the 2000 Three Month Period was $36.9 million as compared to $8.9 million during the 1999 Three Month Period, an increase of $28.0 million. As a percentage of revenues, cost of revenues decreased to 90% during the 2000 Three Month Period as compared to 94% in the 1999 Three Month Period. This improvement was primarily due to the fact that the acquired Dawson Subscription Business has more favorable margins than the RoweCom business and the actions taken to rationalize pricing. SALES AND MARKETING. Sales and marketing expenses increased to $8.3 million during the 2000 Three Month Period from $3.5 million in the 1999 Three Month Period, an increase of $4.8 million or 136%. This growth is primarily due to an increase of personnel as a result of the Dawson acquisition. Personnel expenses increased to approximately $5.1 million in the 2000 Three Month Period from $2.2 million in the 1999 Three Month Period. RESEARCH AND DEVELOPMENT. Research and development expenses increased to $2.6 million in the 2000 Three Month Period from $882,000 in the 1999 Three Month Period, an increase of $1.8 million or 199%, primarily as a result of costs incurred in an effort to integrate new content into our catalog, to enhance the user interface and functionality of the kStore, and to develop the transaction processing systems. -10- GENERAL AND ADMINISTRATIVE. General and administrative expenses increased to $4.0 million in the 2000 Three Month Period compared to $1.6 million in the 1999 Three Month Period, an increase of $2.3 million or 141%. This increase can be primarily attributed to growth in average headcount in the administrative, finance and human resources departments related to the Dawson acquisition. STOCK BASED COMPENSATION. Stock based compensation was $656,000 in the 1999 Three Month Period. Under an agreement among certain of RoweCom's shareholders, Working Ventures' Canadian Fund, Inc. ("Working Ventures") must transfer 310,371 shares of common stock to certain other shareholders and option holders of RoweCom when Working Ventures' initial investment increases by 45% or more (on an annually compounded basis) and they are not legally restricted from selling such shares. As a result of the expiration of the IPO lock up period on September 5, 1999, RoweCom was required to record a compensation charge equal to the aggregate fair market value of the common stock transferred to the RoweCom option and warrant holders who were eligible to receive such shares as described above. AMORTIZATION OF GOODWILL AND INTANGIBLES. Amortization of goodwill and intangibles was $2.0 million in the 2000 Three Month Period compared to $699,000 in the 1999 Three Month Period. As a result of the acquisitions of Corporate Subscription Services, Inc., International Subscription Agencies Pty. Ltd. and Dawson's Subscription Business, approximately $56.0 million in goodwill and intangibles were recorded and are being amortized over a range of 3 to 11 years from the date of such acquisitions. INTEREST AND OTHER INCOME, NET. Interest expense was $1.7 million in the 2000 Three Month Period, as compared to interest income of $605,000 in the 1999 Three Month Period. The 2000 Three Month Period expense is primarily a result of the amortization of the discount on the warrants and interest paid on the notes held by Promethean, RAM Capital, and the promissory notes issued in May 2000. PROVISION FOR INCOME TAXES. The provision for income taxes was $247,000 for the 2000 Three Month Period as compared to $7,000 for the 1999 Three Month Period. The provision has been recorded to account for profitable entities in foreign jurisdictions. COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2000 (THE "2000 NINE MONTH PERIOD") WITH THE NINE MONTHS ENDED SEPTEMBER 30, 1999 (THE "1999 NINE MONTH PERIOD") REVENUES. Revenues for the 2000 Nine Month Period were $131.9 million, as compared to $13.2 million for the 1999 Nine Month Period, an increase of $118.7 million. The strengthening of the US dollar had a negative impact on revenues for the Nine Month period of $4.4 million. Transaction volumes for the 2000 Nine Month Period also increased significantly from the 1999 Nine Month Period from 71,000 to 832,000 transactions. These increases resulted primarily from growth in our client base, particularly related to the acquisition of Dawson. COST OF REVENUES. Cost of revenues in the 2000 Nine Month Period was $119.1 million as compared to $12.3 million during the 1999 Nine Month Period, an increase of $106.8 million. As a percentage of revenues, cost of revenues decreased to 90% during the 2000 Nine Month Period as compared to 94% in the 1999 Nine Month Period. This improvement was primarily due to the fact that the acquired Dawson Subscription Business has more favorable margins than the RoweCom business and the actions taken to rationalize pricing. SALES AND MARKETING. Sales and marketing expenses increased to $26.7 million during the 2000 Nine Month Period from $8.1 million in the 1999 Nine Month Period, an increase of $18.7 million or 231%. This growth is primarily due to an increase of personnel as a result of the Dawson acquisition. Personnel expenses -11- increased to approximately $16.3 million in the 2000 Nine Month Period from $4.9 million in the 1999 Nine Month Period. RESEARCH AND DEVELOPMENT. Research and development expenses increased to $8.5 million in the 2000 Nine Month Period from $2.7 million in the 1999 Nine Month Period, an increase of $5.8 million or 212%, primarily as a result of costs incurred in an effort to integrate new content into our catalog, to enhance the user interface and functionality of the kStore, and to develop the transaction processing systems. GENERAL AND ADMINISTRATIVE. General and administrative expenses increased to $11.6 million in the 2000 Nine Month Period compared to $3.5 million in the 1999 Nine Month Period, an increase of $8.0 million or 227%. This increase can be primarily attributed to growth in average headcount in the administrative, finance and human resources departments related to the Dawson acquisition. STOCK BASED COMPENSATION. Stock based compensation was $656,000 in the 1999 Nine Month Period. Under an agreement among certain of RoweCom's shareholders, Working Ventures' Canadian Fund, Inc. ("Working Ventures") must transfer 310,371 shares of common stock to certain other shareholders and option holders of RoweCom when Working Ventures' initial investment increases by 45% or more (on an annually compounded basis) and they are not legally restricted from selling such shares. As a result of the expiration of the IPO lock up period on September 5, 1999, RoweCom was required to record a compensation charge equal to the aggregate fair market value of the common stock transferred to the RoweCom option and warrant holders who were eligible to receive such shares as described above. AMORTIZATION OF GOODWILL AND INTANGIBLES. Amortization of goodwill and intangibles was $5.5 million in the 2000 Nine Month Period compared to $903,000 in the Three Month Period. As a result of the acquisitions of Corporate Subscription Services, Inc., International Subscription Agencies Pty. Ltd. and Dawson's Subscription Business, approximately $56.0 million in goodwill and intangibles were recorded and are being amortized over a range of 3 to 11 years from the date of such acquisitions. INTEREST AND OTHER INCOME, NET. Interest expense was $4.4 million in the 2000 Nine Month Period, as compared to interest income of $1.7 million in the 1999 Nine Month Period. The 2000 Nine Month Period expense is primarily a result of the amortization of the discount on the warrants and interest paid on the notes held by Promethean, RAM Capital, and the promissory notes issued in May 2000. PROVISION FOR INCOME TAXES. The provision for income taxes was $716,000 for the 2000 Nine Month Period as compared to $63,000 for the 1999 Nine Month Period. The provision has been recorded to account for profitable entities in foreign jurisdictions. EXTRAORDINARY ITEM. During June 2000, RoweCom redeemed $16.1 million of convertible notes. In connection with this redemption, RoweCom recorded an extraordinary loss of $4.1 million, primarily attributable to a $1.1 million premium paid on the redemption, and $2.7 million related to the remaining unamortized debt issuance costs at the time of conversion. LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operating activities was $83.4 million for the 2000 Nine Month Period as compared to $11.0 million of cash used in for the 1999 Nine Month Period. Cash provided for the 2000 Nine Month Period resulted primarily from a decrease in accounts receivable of $69.3 million, an increase in deferred revenue of $60.6 million, and an increase in customer advances of $20.7 million. This was partially offset by a net loss of $48.7 million and a $20.3 million decrease in accounts payable. Cash used in operating activities for the 1999 Nine Month Period was primarily from a net loss of $13.5 million and an increase in accounts receivable of $1.6 million, partially offset by a $1.5 million increase in accrued expenses and accrued liabilities, and $1.3 million in depreciation and amortization expense. -12- Net cash used in investing activities for the 2000 Nine Month Period was $5.5 million, $2.3 million of which was used to purchase property and equipment and $3.2 million was used for acquisitions, as compared to $8.4 million for the 1999 Nine Month Period. Cash used for the acquisitions of CSS and ISA, net of cash acquired, was $7.3 million in the 1999 Nine Month Period. Net cash used in financing activities was $48.3 million for the 2000 Nine Month Period, as compared to cash provided by financing activities of $50.5 million for the 1999 Nine Month Period. Repayments on loans were $108.1 million, offset by loan proceeds of $59.8 million. During the 1999 Nine Month Period, net proceeds from the IPO, net of underwriting discounts and offering costs, were $51.6 million, of which $1.4 million was used to pay down existing credit facilities. At September 30, 2000, RoweCom had cash and cash equivalents of $41.8 million, a working capital deficit of $31.2 million, debt of $7.0 million and stockholders' equity of $27.6 million. The financial statements of RoweCom are presented on a going concern basis that contemplates the realization of assets and satisfaction of liabilities in the normal course of business. RoweCom posted a net loss of $14.6 million for the 2000 Three Month Period and a net loss of $48.7 million for the 2000 Nine Month Period. As of September 30, 2000 RoweCom has an accumulated deficit of $78.0 million and a working capital deficit of $31.2 million. The financial statements do not include any adjustments relating to the recoverability of recorded asset amounts or to the classification of liabilities that may be necessary if RoweCom is unable to continue as a going concern. As discussed in the Overview, we have historically experienced seasonal fluctuations in revenues because approximately three quarters of our revenues have been generated in the fourth quarter of each year, the time when most institutional subscriptions are purchased or renewed. As such, we make substantial additional expenditures in the fourth quarter as we generally pay publishers by mid December of each year, prior to receipt of a significant portion of client payments. The majority of our outstanding receivables from clients relating to these advance payments are paid in the first quarter of the following year. As a result of this seasonal nature of our cash flows, we rely on bank financing and lines of credit to cover current operating expenses during this period. RoweCom believes that its current financial resources, as of the date of this filing, are not sufficient to meet the entirety of its short and long term financial needs. However, RoweCom currently has 335 million French Francs and 4.5 million British pounds (approximately $60 million at current exchange rates) available under existing credit facilities that are more than sufficient for RoweCom's European and other international business. In addition, RoweCom has a proposal for $85 million in credit insurance for its United States business and is in negotiations for a $35 million credit facility. Although there can be no assurance that either of these will be secured, given the quality of its client receivables and following the execution of the credit insurance agreement, RoweCom believes it is likely it will be able to secure the $35 million additional line of credit that will be sufficient for its U.S. operations. If, however, RoweCom were to be unable to secure this additional credit facility for its U.S. operations, it would be unable to make full payments to all of the publishers on behalf of those U.S. clients who have not paid RoweCom. In that event, RoweCom would nevertheless continue to send those orders to publishers and negotiate with publishers a schedule of payments, linked to the times that RoweCom's clients themselves pay their invoices to RoweCom. In such an event RoweCom's revenues would be correspondingly delayed or reduced. RoweCom's experience indicates that these advances to clients of the quality of RoweCom's clients are generally paid within 90 to 120 days, with virtually no defaults. RoweCom is continuing to aggressively pursue additional long term financing, including equity investments, as management believes that financing beyond short-term credit facilities is required. RoweCom has entered into a definitive sale-and-leaseback agreement for its Westwood headquarters, which will net RoweCom more than $4 million in cash to be completed in mid-December. To reduce cash outflows in the short-term, RoweCom has negotiated with lenders to extend the due date by one year on its $6.2 million promissory notes to May 26, 2002 from May 26, 2001. The lenders on the outstanding notes have received an additional 395,158 common stock purchase warrants with an exercise price of $2.34 in exchange for the maturity date extension. RoweCom has historically funded its operations through sales of its preferred stock, our initial public offering and limited borrowings from third-party financing sources. During -13- 1999, RoweCom entered into additional financing arrangements including the sale of convertible promissory notes and domestic and foreign credit facilities. During May 2000, RoweCom issued one-year promissory notes to certain RoweCom directors and shareholders for proceeds of approximately $6.2 million. During September 2000, RoweCom issued convertible debentures to Montrose Investments Ltd. in the aggregate principal amount of $4.0 million, which bear interest at the stated rate of 7% per year payable at maturity or upon conversion or redemption of the principal. The maturity date is six months from the date of issuance. SALE OF CONVERTIBLE NOTES AND COMMON STOCK PURCHASE WARRANTS. On October 13, 1999, RoweCom entered into a Securities Purchase Agreement with two investors under which RoweCom issued and sold notes convertible into RoweCom common stock in the aggregate principal amount of $20.0 million and warrants to purchase up to 224,000 shares of RoweCom's common stock at an exercise price of approximately $27.50 per share. The sale of the convertible notes and the warrants generated net proceeds of approximately $19.2 million for RoweCom. RoweCom also granted the investors certain rights to require the registration under applicable securities laws of the shares of RoweCom common stock issuable upon conversion of the notes and exercise of the warrants. RoweCom filed a short-form registration on Form S-3 on March 16, 2000, which was effective on April 20, 2000. Between May 23 and May 26, 2000, the two holders of convertible notes converted approximately $5.7 million of principal and interest into an aggregate of approximately 1,499,893 million shares. On May 30, RoweCom negotiated an agreement with the two holders to redeem their outstanding balances. On June 12, 2000, RoweCom completed the redemption of the convertible notes. A portion of the $16.1 million used to redeem the notes, including conversion premium and accrued interest, came from the issuance of promissory notes. On May 26, 2000, certain RoweCom shareholders and directors made available funds to repay the convertible notes' principal through the issuance of one-year promissory notes with an aggregate principal amount of $6,175,000. Additionally, 617,500 stock purchase warrants were issued with an exercise price of $5.00. The warrants vest immediately and expire 10 years from issuance. The one-year promissory notes are carried net of the warrant discount of approximately $2.3 million. Amortization of the warrant discount, which is recorded as interest expense, will total approximately $578,000 per quarter. On September 12, 2000, RoweCom issued a six-month convertible debenture in the original principal amount of $4 million. The debenture may be converted into shares of common stock at a conversion price of $5.884 per share. Conversion is at the holder's option, or if the closing bid price of RoweCom's stock exceeds $8.826 for 20 consecutive trading days, at RoweCom's option. RoweCom also issued 135,958 common stock purchase warrants with an exercise price of $7.268 per share. These warrants have a five-year term and are exercisable at the holder's option. In addition, RoweCom issued 1.5 million Class A common stock purchase warrants having a term of one year and two business days. During the first year that the Class A warrants are outstanding, they may be exercised only if called by RoweCom, at a floating exercise price equal to 92% of the average closing bid price of a share of RoweCom stock on the two trading days preceding exercise, subject to a maximum exercise price of $20. These warrants expire if not exercised when called. On the final two business days that they are outstanding, the Class A warrants are exercisable at the holder's option at an exercise price of $20 per share. RoweCom's rights to call the Class A warrants are subject to certain restrictions, including volume limitations based on the trading volume in RoweCom's stock. In October 2000, RoweCom negotiated with lenders to extend the due date by one year on its $6.2 million promissory notes to May 26, 2002 from May 26, 2001. The lenders on the outstanding notes have received an additional 395,158 common stock purchase warrants with an exercise price of $2.34 in exchange for the maturity date extension. EURO CURRENCY ISSUES Effective January 1, 1999, eleven of the fifteen member countries of the European Union established fixed conversion rates between their existing currencies and one common currency (the "euro"). The euro trades on currency exchanges and is used in business transactions. Beginning in January 2002, bills and coins denominated in the euro will be issued and existing currencies will be withdrawn from circulation. RoweCom foreign subsidiaries do not expect to transact a material portion of their business in the euro until fiscal 2001. Also, RoweCom's foreign subsidiaries are not yet required to prepare reports to local regulatory agencies using the euro. Management expects that IT systems used by RoweCom's foreign subsidiaries will be repaired or replaced in a timely manner to facilitate business transactions and reporting to local government agencies. Cost to repair and/or replace IT systems are not expected to be material. -14- ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK EXCHANGE RATE RISK MANAGEMENT RoweCom enters into forward currency contracts primarily in European, Australian and Canadian currencies to hedge its foreign currency exposures. Forward currency contracts have maturities of less than one year. These contracts are used to reduce RoweCom's risk associated with exchange rate movements, as gains and losses on these contracts are intended to offset exchange losses and gains on underlying exposures. RoweCom does not engage in currency speculation. At September 30, 2000 the face amount of outstanding forward currency contracts to buy and sell U.S dollars and British pound sterling for non-U.S. currencies was $4.6 million. A 10% decrease in exchange rates for these currencies would increase the fair value by approximately $464,000. However, since these contracts hedge non-U.S. currency transactions, any change in fair value of the contracts would be offset by changes in the underlying value of the transactions being hedged. The hypothetical movement was estimated by calculating the fair value of the forward currency contracts at September 30, 2000 and comparing that with those calculated using hypothetical forward currency exchange rates. INTEREST RATE RISK MANAGEMENT Due to its short-term duration, the fair value of RoweCom's borrowings at September 30, 2000 approximated carrying value. Interest rate risk was estimated as the potential increase in fair value resulting from a hypothetical 10% increase in interest rates. The resulting hypothetical fair value was not materially different from the quarter-end carrying value. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivatives and Hedging Activities," which establishes accounting and reporting standards for derivative instruments, including derivative instruments embedded in other contracts, collectively referred to as derivatives, and for hedging activities. We will adopt SFAS No. 133 as required by SFAS No. 137, "Deferral of the effective date of the FASB Statement No. 133," in fiscal year 2001. We do not expect the adoption of SFAS 133 to have material impact on our financial position or results of operations. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements." SAB 101 summarizes the SEC's view in applying generally accepted accounting principles to selected revenue recognition issues. The application of the guidance in SAB 101 will be required in RoweCom's fourth quarter of fiscal year 2000. The effects of applying this guidance, if any, will be reported as a cumulative effect adjustment resulting from a change in accounting principle. RoweCom does not expect the adoption of SAB 101 to have a material effect on their financial statements. PART II -- OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On March 16, 2000 in connection with RoweCom's issuance of convertible notes and warrants, a Registration Statement on Form S-3 was filed with the SEC. See "SALE OF CONVERTIBLE NOTES AND COMMON STOCK PURCHASE WARRANTS" on page 14 within this document. The registration statement was declared effective on April 20, 2000. -15- On May 20, 2000, under the terms of the purchase agreement, RoweCom issued 465,300 shares of common stock to Dawson, Inc., at a price per share of approximately $22.98, as part of the purchase price for the acquisition. Between May 23 and May 26, 2000, RoweCom issued 1,499,893 shares of common stock as a result of the conversion of the convertible notes. See "SALE OF CONVERTIBLE NOTES AND COMMON STOCK PURCHASE WARRANTS" on page 14 within this document. On June 30, 2000 in connection with RoweCom's issuance of promissory notes and warrants, a Registration Statement on Form S-3 was filed with the SEC. See "SALE OF CONVERTIBLE NOTES AND COMMON STOCK PURCHASE WARRANTS" on page 14 within this document. The registration statement was declared effective on July 13, 2000. On September 12, 2000, RoweCom issued a six-month convertible debenture in the original principal amount of $4 million. The debenture may be converted into shares of common stock at a conversion price of $5.884 per share. Conversion is at the holder's option, or if the closing bid price of RoweCom's stock exceeds $8.826 for 20 consecutive trading days, at RoweCom's option. RoweCom also issued 135,958 common stock purchase warrants with an exercise price of $7.268 per share. These warrants have a five-year term and are exercisable at the holder's option. In addition, RoweCom issued 1.5 million Class A common stock purchase warrants having a term of one year and two business days. During the first year that the Class A warrants are outstanding, they may be exercised only if called by RoweCom, at a floating exercise price equal to 92% of the average closing bid price of a share of RoweCom stock on the two trading days preceding exercise, subject to a maximum exercise price of $20. These warrants expire if not exercised when called. On the final two business days that they are outstanding, the Class A warrants are exercisable at the holder's option at an exercise price of $20 per share. RoweCom's rights to call the Class A warrants are subject to certain restrictions, including volume limitations based on the trading volume in RoweCom's stock. On October 5, 2000 in connection with RoweCom's issuance of the aforementioned promissory notes and warrants, a Registration Statement on Form S-3 was filed with the SEC. The registration statement was declared effective on October 16, 2000. In October 2000, RoweCom negotiated with lenders to extend the due date by one year on its $6.2 million promissory notes to May 26, 2002 from May 26, 2001. The lenders on the outstanding notes have received an additional 395,158 common stock purchase warrants with an exercise price of $2.34 in exchange for the maturity date extension. No options were granted to purchase common stock under RoweCom's Amended and Restated 1998 Stock Incentive Plan during the 2000 Three Month Period. The grants of options, when made, are made in reliance on the exemptions from registration under the Securities Act of 1933, as amended (the "Securities Act") provided by Rule 701 there under. 12,384 stock options were exercised during the 2000 Three Month Period. -16- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 1.1 - Certificate of Incorporation of RoweCom * 1.2 - By-laws of RoweCom * 10.1 - Strategic Alliance and Marketing Agreement between RoweCom and AsiaSmart Pte Ltd. dated July 24, 2000 11 - Computation of Loss per Share*** 27 - Financial Data Schedule (b) Reports on Form 8-K On September 12, 2000, RoweCom filed a Current Report on Form 8-K in connection with a six-month convertible debenture in the original principal amount of $4 million and 1.5 million Class A common stock purchase warrants. ------------------------------------------------------------------------------- (*) Incorporated by reference to the same numbered exhibit to the Company's registration statement on Form S-1. (Reg. No. 333-68761) (***) Statement regarding computation of per share earnings is not required because the computation can be readily determined from the material contained in the financial statements included herein. -17- SIGNATURE 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. ROWECOM INC. November 20, 2000 By: /s/ Paul Burmeister ---------------------------------------- Paul Burmeister Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer, Authorized Officer) -18- EXHIBIT INDEX Exhibit Number Description 1.1 Certificate of Incorporation of RoweCom* 1.2 By-laws of RoweCom* 10.1 Strategic Alliance and Marketing Agreement between RoweCom and AsiaSmart Pte Ltd. dated July 24, 2000 11 Computation of Loss per Share*** 27 Financial Data Schedule (*) Incorporated by reference to the same numbered exhibit to the Company's registration statement on Form S-1. (Reg. No. 333-68761) (***) Statement regarding computation of per share earnings is not required because the computation can be readily determined from the material contained in the financial statements included herein.

ROWECOM INC 10-Q