Filed On 3/31/97 · SEC File 0-21751 · Accession Number 936392-97-449
As Of Filer Filing On/For/As Docs:Pgs Issuer Agent
3/31/97 Messagemedia Inc 10-K 12/31/96 5:101 936392
Document/Exhibit Description Pages Size
1: 10-K Annual Report 63 453K
2: EX-10.29 Material Contract 16± 73K
3: EX-10.30 Material Contract 20± 99K
4: EX-11.1 Statement re: Computation of Earnings Per Share 1 5K
5: EX-27.1 Financial Data Schedule 1 6K
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
FOR THE PERIOD FROM TO .
COMMISSION FILE NUMBER: 000-21751
FIRST VIRTUAL HOLDINGS INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
------------------------
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DELAWARE 33-0612860
(STATE OR JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION)
11975 EL CAMINO REAL #200
SAN DIEGO, CA 92130
(ADDRESS, INCLUDING ZIP CODE, OF PRINCIPAL EXECUTIVE OFFICES)
(619) 793-2700
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF ACT: NONE
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NAME OF EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
---------------------------------------------- ----------------------------------------------
None None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.001 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers in response to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this form 10-K or any
amendment to this form 10-K: [ ]
As of January 31, 1997, there were outstanding 8,794,812 shares of the
Registrant's Common Stock, $.001 par value. As of that date, the aggregate
market value of the voting stock held by non-affiliates of the Registrant was
approximately $33,645,000 when the closing price of such stock, as reported on
the Nasdaq National Market was $9.00. Shares of Common Stock held by each
officer and director and each person who owns 5% or more of the of the
outstanding common stock have been excluded in that such persons may be
affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information called for by Part III is incorporated by reference
from the Proxy Statement relating to the Annual Meeting of Stockholders of the
Registrant to be held on June 20, 1997.
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PART I
The Business section and other parts of this Report contain forward-looking
statements that involve risks and uncertainties. The Company's actual results
may differ significantly from the results discussed in the forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, those discussed in the section entitled "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Factors Affecting
Operating Results and Market Price of Stock" commencing on page 29. Certain
sections in this report have been identified as containing forward looking
statements. The reader is cautioned that other sections and other sentences not
so identified may also contain forward looking information.
ITEM 1. BUSINESS
First Virtual Holdings Incorporated ("First Virtual" or "the Company") has
developed and implemented the VirtualPIN architecture which facilitates Internet
commerce and is designed to facilitate other forms of interactive Internet
communications. The VirtualPIN architecture uses E-mail which has the widest
reach and broadest use of any Internet application. First Virtual Internet
Payment System ("FVIPS"), a secure and easy-to-use payment system introduced in
October 1994, is the Company's first application of the VirtualPIN architecture.
As of December 31, 1996, the Company has processed over 300,000 FVIPS
transactions and has registered more than 3,000 merchants ("Sellers") and
200,000 consumers ("Buyers") in 166 countries. In the fourth quarter of 1996,
the Company introduced VirtualTAG. The VirtualTAG is an interactive advertising
applet within banners or "roving store fronts" which are designed to allow
Buyers to initiate the purchase and payment and arrange for the delivery of a
product without leaving the web page on which the advertisement appears. The
Company believes VirtualTAG may become one of the first solutions that takes
full advantage of the Internet's unique attributes by combining advertising,
selling and paying all in one application.* In December 1996, the Company
launched 1Virtual Place, a retail environment which permits the testing of
technologies and concepts along with the sale of products. The Company believes
that the VirtualPIN architecture can also serve as the basis for additional
Internet applications including direct marketing, interactive advertising,
merchandising, subscriptions and renewals, bill presentment and payment, client
response surveys and Internet communications.*
INDUSTRY BACKGROUND
The Internet is a rapidly growing network of computers and computer
networks that permits communication among users throughout the world. IDC
estimates that the number of Internet users will grow to approximately 200
million by the end of 1999 from 89 million at the end of 1996. The most widely
used application of the Internet is E-mail. The popularity of E-mail and the
emergence of the Web and easy-to-use browser software have fostered continued
rapid growth in Internet use by businesses and individuals.
The evolution of the Internet and the Web as vehicles for electronic
commerce have led to the emergence of new media, merchandising and transaction
processing opportunities. Advertisers, for example, can use newly provided
demographic data to cost effectively target individuals or narrowly defined
groups. Internet commerce can reduce, and in some cases eliminate, merchants'
requirements for physical store premises, warehouses and distribution centers,
by permitting shipment directly from manufacturer to consumer. Information
products, such as news, data and research, can be downloaded directly to a
personal computer, minimizing the cost of physical reproduction, packaging and
distribution of these products. Buyers are motivated to accept these new
offerings because they improve the likelihood of viewing information and
receiving merchandise offers of specific interest to them. The Internet provides
Buyers with the potential to conveniently locate and initiate purchases in a
single marketplace which is easily accessible from home or office.
---------------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will
meet the Company's current expectations. Investors are strongly encouraged to
review section entitled "Factors Affecting Operating Results and Market Price
of Stock" commencing on page 29, for a discussion of factors that could affect
future performance. The reader is cautioned that other sections and other
sentences not so identified may also contain forward looking information.
1
Consumers have accepted credit cards as a payment method for most mail
order, catalogue and similar transactions, and the majority of consumers hold at
least one credit card. In addition, credit card payment processing, refund
procedures and legal regulations are well established. As a result, the Company
believes that accommodating secure credit card usage on the Internet is one of
the key elements of Internet commerce. Several companies are seeking to provide
a viable secure transaction-based payment system to enable credit card
processing and business-to-consumer Internet commerce. In general, these payment
systems can be classified into two broad categories: those using off-line
process-based technologies which process and maintain sensitive financial
information off the Internet, and those using encryption-based technologies,
which encode sensitive financial information for transmission on the Internet.
BARRIERS TO INTERNET COMMERCE AND INTERACTIVE INTERNET COMMUNICATION
The Company believes that there are a number of barriers to the
proliferation of Internet commerce and related interactive Internet
communication applications including (i) developing effective methods of
Internet advertising to stimulate consumer interest, (ii) developing direct
marketing and merchandising capabilities and (iii) developing a secure and
effective transaction processing system.
Effective methods of Internet advertising to stimulate consumer
interest. Currently, Sellers are generally restricted to providing passive
advertising similar to that offered in traditional media. The effectiveness of
advertising on the Internet would likely be increased substantially by the
ability to proactively present advertising to specific Internet subscribers and
to incorporate interactive, stimulating images and sounds within Web page
advertisements.
Direct marketing and merchandising capability. The Company believes that
Sellers are becoming increasingly aware that having a Web page does not, of
itself, result in effective Internet commerce. Currently, Sellers lack the means
of effectively marketing directly to potential Buyers who fit specific profiles.
Buyers have the burden of actively searching the vast information and numerous
Web pages on the Internet, often in inefficient and time consuming ways, for
specific products or services. In addition, a purchase transaction may be more
time consuming, require moving through multiple Web pages or disconnecting from
the Internet to place a toll-free call.
Secure and effective transaction processing system. The Company believes
that an effective transaction processing system for Internet commerce must
successfully address the following:
- Lack of security. The Internet is a public network which potentially
allows third parties to gain unauthorized access to data as it is routed
to its intended destination or stored in databases. Current solutions
generally require encryption and specialized hardware or software
solutions which may be expensive, difficult to use and susceptible to
penetration by proficient and determined hackers.
- Lack of privacy. The open and public nature of the Internet reduces the
ability of the consumer to maintain the privacy of the personal data
typically submitted and compiled in order to process a commercial
transaction.
- Transaction fraud. The Internet may facilitate transaction fraud by
parties posing as legitimate merchants, collecting payment without
delivering goods or services, or as consumers, acquiring goods or
services without making a payment for such goods or services.
- Consumer reluctance to use new payment systems. In order for Buyers to
adopt Internet commerce on a widespread basis, purchasing and selling
over the Internet must be as convenient and easy-to-use as traditional
purchasing methods.
- Difficulty of widespread system deployment and acceptance. The interface
which enables Internet commerce must be compatible with existing hardware
and software and inexpensive and easy-to-use for the average consumer.
The payment systems must also interoperate with established financial
networks and protocols since financial institutions may be reluctant to
adopt and implement entirely new processing and payment methods.
---------------
Certain sections in this report have been identified as containing forward
looking statements. Although none of the sections on this page are so
identified, the reader is cautioned that such sections may contain forward
looking statements.
2
THE FIRST VIRTUAL SOLUTION
The Company has developed and implemented the VirtualPIN architecture which
facilitates Internet commerce and is designed to facilitate other forms of
interactive Internet communications. The VirtualPIN, an alphanumeric sequence
unique to each user, allows the user to establish and maintain identity on the
Internet in a controlled and confidential manner. FVIPS is the Company's first
application of the VirtualPIN architecture. To initiate a transaction using
FVIPS, the Buyer transmits a VirtualPIN to the Seller, who accepts it as a form
of payment for the Buyer's order and relays it to First Virtual for
verification. After the Buyer responds affirmatively to the Company's automated
request for E-mail confirmation of the transaction, First Virtual initiates
financial settlement through the established and secure credit card transaction
processing networks.
In order to bring the retail environment to any Web page, the Company
introduced the VirtualTAG, its second application of the VirtualPIN
architecture. The Company believes the VirtualTAG may become one of the first
solutions that takes full advantage of the Internet's unique attributes by
combining advertising, selling and paying all in one application.* The
VirtualTAG uses the programming language Java to create a cross-platform
multimedia environment with stimulating, interactive advertisements within
banners or "roving store fronts". The VirtualTAG is designed to allow Buyers to
initiate the purchase and payment and arrange for the delivery of a product
being advertised without leaving the Web page on which the advertisement
appears. The Company believes that the VirtualPIN architecture, FVIPS and the
VirtualTAG applications provide the following key advantages:
Targeted and interactive advertising. The Company's VirtualPIN
architecture is designed to enable merchandisers to target specific registered
users with the users' consent and without revealing the users' sensitive
personal or demographic data. The Company's VirtualTAG application is designed
to provide an interactive and engaging message by combining sound and motion
which is activated by the Buyer as the cursor moves near or on the
advertisement.
Direct marketing and merchandising facility. The Company believes the
VirtualTAG application may enable Sellers to directly market and merchandise
their products and services to Buyers. For example, if the advertisement were in
a newspaper, the VirtualTAG would be comparable to touching a retail store
advertisement, obtaining additional product information, and buying a product,
without having to stop reading the newspaper and visit the store.
Enhanced transaction processing system. By transmitting only a Buyer's
VirtualPIN over the Internet, using E-mail verification and processing and
storing sensitive information off-line, FVIPS offers a simple and effective
transaction processing solution with the following attributes:
- Security. Confidential information, such as credit card numbers, are
stored on servers which cannot be accessed from the Internet and are
never transmitted over the Internet by First Virtual. All that is
transmitted over the Internet is the non-confidential VirtualPIN.
Therefore, the Company believes that FVIPS virtually eliminates the risk
of credit card theft on the Internet.
- Privacy. The Buyer's E-mail address, VirtualPIN and any other personal
information that is willingly disclosed when registering are stored on
one of the Company databases which are connected to the Internet and are
protected by enhanced commercial fire walls and by restricted log-in
access. In addition, the Company's registered users maintain their
privacy by using their VirtualPIN in FVIPS transactions.
- Transaction safeguards. On receipt of the Seller's transaction request,
the Company automatically sends E-mail to the Buyer to confirm that the
Buyer authorizes the order, thereby ensuring authenticity without the
need to transmit confidential information.
---------------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will
meet the Company's current expectations. Investors are strongly encouraged to
review section entitled "Factors Affecting Operating Results and Market Price
of Stock" commencing on page 29, for a discussion of factors that could affect
future performance. The reader is cautioned that other sections and other
sentences not so identified may also contain forward looking information.
3
- Familiarity and accessibility. The VirtualPIN architecture and FVIPS
rely on E-mail, a widespread, proven and accepted technology with
established standards, and does not require Buyers to purchase or install
any additional hardware or software. The architecture is also based on
the PIN concept, which is widely understood and accepted. Once a Buyer
has completed the simple registration process with the Company, the Buyer
can purchase goods and information services from home or office, 24 hours
a day, through the familiar point-and-click process.
- Interoperability and adaptability. The VirtualPIN is designed for
integration with a broad set of Internet applications and evolving
platforms and protocols. In contrast to other Internet commerce and
communications solutions which require complex computer architectures
capable of deciphering intricate encrypted messages, the VirtualPIN can
be used on virtually any standard personal computer or Internet access
appliance. FVIPS uses traditional financial payment mechanisms and
enables financial institutions to maintain their existing financial
networks and back-office operations and still participate in the
potential growth opportunities offered by Internet commerce. As a result,
financial institutions incur little additional cost in adopting FVIPS.
STRATEGY
The Company's objective is to become a leading facilitator of Internet
commerce and other forms of interactive Internet communications.* The Company's
strategy includes the following key elements:
Leverage technological expertise. The Company intends to leverage its
technological expertise to accelerate the development of new and enhanced
products and services.* The Company has world-class expertise in E-mail
technology, with particular emphasis on E-mail-based distributed services, and
has invested significant resources to develop the VirtualPIN architecture to
operate seamlessly with most E-mail systems around the world. The Company also
has strong expertise in other key areas of Internet-related technology, such as
Java and Virtual Reality Markup Language ("VRML") technology and cryptography,
as well as in the development of scalable and reliable distributed systems.
Rapidly deploy VirtualPINs through strategic partners and other
distribution channels. The Company intends to establish a large installed base
of Buyer and Seller VirtualPINs through multiple channels including credit card
companies and other financial institutions, on-line and Internet service
providers, value added integrators and a variety of direct marketing programs.
To accelerate the distribution of the VirtualPIN, the Company has entered into
strategic relationships with several major financial institutions including
First USA Paymentech (NYSE: PTI), GE Capital and First Data Corporation ("First
Data") (NYSE: FDC). These relationships include financial investments in the
Company, representation on the Company's Board of Directors, and, in certain
instances, distribution and marketing arrangements.
Leverage the VirtualPIN architecture for additional applications. The
Company believes it may be able to expand the VirtualPIN architecture to address
a number of new applications including interactive advertising, targeted direct
marketing and consumer research.* For example, the Company's VirtualTAG
application is designed to enable Sellers to create stimulating, interactive
advertisements within banners or "roving store fronts" which allow Buyers to
initiate the purchase and payment and arrange for the delivery of a product
being advertised without leaving the Web page on which the advertisement
appears. This technology has also been demonstrated to work within certain
E-mail software. The Company hopes to pursue the development of VirtualPIN
enhancements and new applications through internal product development, the
establishment of joint ventures with businesses in complementary fields and the
acquisition of related products or businesses.*
Expand transaction-based business model providing recurring revenues. The
VirtualPIN architecture is designed to enable the Company to generate a
recurring revenue stream from Buyers and Sellers through fees
---------------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will
meet the Company's current expectations. Investors are strongly encouraged to
review section entitled "Factors Affecting Operating Results and Market Price
of Stock" commencing on page 29, for a discussion of factors that could affect
future performance. The reader is cautioned that other sections and other
sentences not so identified may also contain forward looking information.
4
from annual registration, transaction processing, automatic subscription
renewal, bill presentment and payment and royalties.*
THE VIRTUALPIN ARCHITECTURE AND ITS APPLICATIONS
The VirtualPIN, an alphanumeric sequence unique to each user, allows the
user to establish and maintain identity on the Internet in a controlled and
confidential manner.
The VirtualPIN is designed for integration with a broad set of Internet
applications and evolving platforms and protocols. FVIPS is the first
application of the VirtualPIN architecture and since it uses ASCII text, can be
used on virtually any standard personal computer or Internet access appliance.
The following table sets forth existing and currently proposed future
applications of the VirtualPIN architecture.
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PRODUCT/SERVICE INTRODUCTION DATE SUMMARY DESCRIPTION
-------------------------- -------------------- --------------------------------------------
FVIPS October 1994 Secure and easy-to-use Internet payment
system
VirtualTAG December 1996 Interactive advertising applet within
banners or "roving store fronts" on the Web
page
1 Virtual Place December 1996 "Virtual" store showcasing First Virtual
technologies and concepts in cooperation
with Sellers
Targeted Marketing Second Quarter 1997 Seller-initiated direct marketing to
consenting Buyers, who remain anonymous
Billing Notification Fourth Quarter 1997 Seller-initiated electronic billing
notification including subscription and
membership renewal and recurring bill
presentment and payment
The targeted marketing and billing notification products and services are
under development. There can be no assurance that such products or services will
be introduced in accordance with the dates above, or at all, or that if
introduced will achieve market acceptance.
THE FIRST VIRTUAL INTERNET PAYMENT SYSTEM (FVIPS)
The VirtualPIN acts as a substitute for the Seller's bank account number
and E-mail address and the Buyer's credit card number and E-mail address during
the course of the FVIPS transaction. Use of the VirtualPIN allows transactions
to be completed on the Internet without exposing sensitive Seller and Buyer
credit card information to unauthorized discovery.
FVIPS functions as a two-tier system of "Purchase" and "Back-Office"
authorization and settlement processes. A secure barrier exists between the
Purchase tier on the Internet and the Back-Office tier on existing credit card
processing networks. This barrier separates the sensitive Seller and Buyer
information from the Internet. The initiation and verification of the
transaction between the Seller and the Buyer occurs on the Purchase tier. The
Company's Purchase tier database server is connected to the Internet and
interacts with Sellers and Buyers to receive transaction details and manage the
transaction process. This server stores limited and non-financial Seller and
Buyer information, including the user's VirtualPIN, E-mail address and data
regarding any FVIPS transaction that has not yet been completed.
Financial authorization and credit card settlement occurs on the
Back-Office tier. The Company's Back-Office tier database server is connected to
existing financial networks and is used for processing Visa and MasterCard
transactions, but is not directly connected to the Internet. Functionally, this
server integrates FVIPS transactions with existing financial networks. This
server also stores credit card and bank account numbers and complete VirtualPIN
transaction histories. Since the sensitive information on this server is never
stored on nor transmitted over the Internet by First Virtual, the VirtualPIN
architecture is designed to prevent
---------------
This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will meet
the Company's current expectations. Investors are strongly encouraged to review
section entitled "Factors Affecting Operating Results and market Price of Stock"
commencing on page 29, for a discussion of factors that could affect future
performance. The reader is cautioned that other sections and other sentences not
so identified may also contain forward looking information.
5
unauthorized access to this sensitive information. Both the Purchase and
Back-Office servers are protected by extensive security measures. See "Server
Security" below.
The Company believes that FVIPS' security and privacy capabilities provide
significant advantages to both the Seller and the Buyer for conducting commerce
over the Internet. The security and privacy of the Buyer's sensitive financial
information is designed to be protected because the use of the VirtualPIN does
not require the transmission of this information over the Internet. By storing
sensitive financial information in the Back-Office tier, the Company believes
that its database of bank account and credit card numbers is protected from
electronic attempts to acquire or compromise the data. The required Buyer
confirmation of the transaction by E-mail renders the unauthorized possession of
a VirtualPIN and deters automated fraud. Through the use of process-based
security that does not require the protection of the VirtualPIN during
transmission over the Internet, FVIPS is designed to avoid the need for
complicated encryption methods characteristic of competing Internet payment
systems.
The following description relates to the current operation of FVIPS. The
Company may make changes to the operation of FVIPS in the future as warranted by
business conditions or changes in credit card association operating rules.
Buyer Registration
The registration process for Buyers is quick and simple. FVIPS requires
only that the Buyer possess a valid Visa or MasterCard credit card and have
access to Internet E-mail. No additional hardware or software is needed. Most
Buyers also want access to the Web, where most Sellers maintain retail sites. In
order to register, a Buyer completes an application containing the Buyer's name,
E-mail address and postal address via E-mail or by visiting a Seller's or the
Company's Web page. On receipt of the application, the Company confirms the
validity of the Buyer's E-mail address by sending the applicant E-mail
instructions to call a toll-free automated response unit to provide the Buyer's
credit card information. The Company validates the applicant's financial
information by submitting the registration fee as a charge to the applicant's
credit card. If the credit card information is valid, the Buyer is sent E-mail
issuing his VirtualPIN. If the credit card information is invalid, the Buyer is
notified via E-mail.
Seller Registration
A Seller can be any individual or entity that has an E-mail address and a
valid U.S. bank account. In addition to an account application process similar
to the one outlined for a Buyer above, a Seller applicant must also pay an
initial registration fee and provide the Company with information to identify
the U.S. bank account into which net sales receipts will be deposited by the
Company after settlement of the transaction. In most cases, a check is
sufficient to meet both requirements. After receiving the bank account
information, and, if applicable, upon qualifying as an Express Seller, the
Company issues a VirtualPIN to the Seller and notifies the Seller of its
VirtualPIN via E-mail.
To qualify as an Express Seller and receive transaction settlement in
approximately three to five business days, the Seller must meet First USA
Paymentech's traditional credit card merchant qualifications. In addition to the
standard Seller application process outlined above, Express Sellers must submit
an additional hard copy application to First USA Paymentech, the Company's
merchant acquiror, for credit screening, and to the Company for approval. The
Company is contemplating a program which would permit certain potential Express
Sellers to use their existing merchant acquiror arrangements.*
No additional hardware is needed and only minimal software is required if
the Seller wishes to integrate the Company's merchant software with the Seller's
Web server for manual processing. However, a Seller who wishes to enhance its
Web server to allow for automatic processing of FVIPS transactions may download
the
---------------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will
meet the Company's current expectations. Investors are strongly encouraged to
review section entitled "Factors Affecting Operating Results and Market Price
of Stock" commencing on page 29, for a discussion of factors that could affect
future performance. The reader is cautioned that other sections and other
sentences not so identified may also contain forward looking information.
6
Company's publicly available code, write customized software using
Company-provided specifications or use third party software incorporating FVIPS.
The Purchase Cycle
The Purchase Cycle of a FVIPS transaction involves the following steps:
[PURCHASE CYCLE ILLUSTRATION]
1. The Buyer initiates the purchase cycle by transmitting his order and
VirtualPIN to the Seller. This is typically done by accessing the Seller's Web
page. At the Seller's option, the Buyer's VirtualPIN can be verified in real
time with the Company's server, ensuring that the Buyer's VirtualPIN is valid.
2. The Seller submits a transaction request either by E-mail or SMXP
real-time messaging with the following information: the Seller's and Buyer's
VirtualPINs, purchase amount, item name, and an optional request to receive
notification of the credit card authorization result.
3. On receipt of the Seller's transaction request, the Company
automatically sends E-mail to the Buyer to confirm that the Buyer authorizes the
order.
4. The Buyer replies to the Company's confirmation E-mail by answering
"yes," "no," or "fraud." A "yes" response indicates the Buyer authorizes the
order. A "no" response indicates the Buyer does not authorize the order, for
reasons including changing his mind or, in the case of an information product
which has already been transmitted to the Buyer at the time of confirmation,
that the Buyer did not receive what he should have. A "fraud" response indicates
that the Buyer's VirtualPIN was used without his authorization.
5. If the Buyer replies "no," the Company cancels the transaction (however,
repeated "no" replies subject a Buyer to VirtualPIN revocation); if the Buyer
replies "fraud," the Company cancels the transaction and the Buyer's VirtualPIN
to protect the Seller and Buyer from further attempts at fraudulent use; if the
Buyer fails to reply to the confirmation E-mail, several additional attempts
will be made before the Company notifies the Seller of a "no sale." If the Buyer
replies "yes," the Company notifies the Seller by E-mail of the Buyer's
affirmative reply.
---------------
Certain sections in this report have been identified as containing forward
looking statements. Although none of the sections on this page are so
identified, the reader is cautioned that such sections may contain forward
looking statements.
7
One area of concern has been the needs of merchants who want to increase
sales volumes by relying upon impulse purchases. The FVIPS design which includes
Step 4 above, may reduce the quantity of such impulse purchases. To address this
issue, additional features are under development to allow for authorization
without requiring the "yes", "no", "fraud" interaction with the buyer.
6. The Company proceeds to process the transaction through the established
financial networks.
The Back-Office Cycle
The Back-Office Cycle of a financial transaction involves the following
steps:
[BACK-OFFICE AUTHORIZATION AND SETTLEMENT CYCLE ILLUSTRATION]
6. Once the Buyer replies "yes," the Company transmits the transaction
information (Seller and Buyer VirtualPINs and transaction details) to a secure
Back-Office server through dedicated lines using a one-way batch protocol. The
Back-Office server is not directly connected to the Internet.
7. At the secure Back-Office server, the Buyer's VirtualPIN is matched with
the Buyer's credit card number and the Seller's VirtualPIN is matched with the
Seller's Automated Clearing House ("ACH") routing number. The Company never
transmits Buyers' and Sellers' sensitive financial information on the Internet.
8. Credit authorization is requested through the Company's processor, which
in turn processes the credit authorization through the existing Visa/MasterCard
interchange networks.
9. The processor passes back credit authorization results to the Company's
Back-Office server.
10. If the Seller requested notification of credit authorization (see Step
2 above), it is transmitted to the Seller; if the Seller did not request
notification of credit authorization, the Seller will only be notified in the
---------------
Certain sections in this report have been identified as containing forward
looking statements. Although none of the sections on this page are so
identified, the reader is cautioned that such sections may contain forward
looking statements.
8
event of an authorization failure. If such a failure occurs, the transaction is
canceled, the Buyer is notified, and the Buyer's VirtualPIN is suspended.
11. The Buyer's credit card is charged through the Company's processor and
the Visa/MasterCard interchange networks. Transactions of less than $10 are
accumulated until they total more than $10 or have aged more than 10 days, and
the accumulated amount is processed as a single item. The issuing bank will bill
the Buyer on his next monthly statement. The processor bills the Company monthly
for transaction authorization and settlement fees.
12. The Buyer is automatically notified of the charge by E-mail.
13. The following morning, the issuing bank remits the transaction amount
(less its issuing bank interchange fee) to the Company's merchant acquiror, via
the Company's processor. First USA Paymentech is the Company's merchant
acquiror. The funds from the purchase are held at First USA Paymentech: for a
Pioneer Seller, the funds are held in escrow for 91 calendar days and for an
Express Seller, the funds are paid within three to five business days. The
merchant acquiror bills the Company monthly for transaction fees and a network
assessment fee paid to the credit card association.
14. At the end of the holding period, First USA Paymentech transfers the
funds to the Company's deposit account held at Northern Trust Company ("Northern
Trust"). The Company collects its transaction fees before transferring the net
proceeds to the Seller.
15. The following day, the Seller's net funds are transferred to the
Seller's bank account via ACH. Northern Trust bills the Company monthly for ACH
transfer fees.
16. The Seller is automatically notified of the deposit by E-mail.
The Seller may independently choose, depending on his security
requirements, to deliver the product at any of the following four points in the
transaction process: (i) following the verification of the validity of the
Buyer's VirtualPIN by the Purchase server; (ii) when the transaction has been
accepted by the Purchase server, indicating the VirtualPIN is valid and in good
standing; (iii) following the Buyer's confirmation of the transaction; or (iv)
following the receipt of credit card authorization.
Server Security
The Company's Purchase and Back-Office servers are located in two
facilities. One facility is leased from First USA Paymentech (Dallas) and a
planned second facility is leased from Time Warner (San Diego). The Company's
servers that connect directly to the Internet (the "Purchase" servers) are
protected by Company-modified commercial firewalls and restricted log-in-access.
Remote log-in sessions are protected through the use of one-time passwords and
encrypted communication. The only information that resides on or passes through
the Purchase servers includes nonsensitive information such as VirtualPINs,
E-mail addresses and recent VirtualPIN transaction histories.
The Company's servers which store and transmit financially sensitive
information, such as bank account and credit card numbers and complete
VirtualPIN transaction histories, are not directly connected to the Internet.
These Back-Office servers cannot be accessed from the Internet and can only be
accessed in person or by direct telephone connection using specific, unique
cryptographic hardware.
Communication between the Purchase servers and the Back-Office servers uses
a proprietary one-way batch protocol that allows extremely limited types of
transmission of information and activity between the servers. The Company
believes that it is virtually impossible for sensitive financial information to
be compromised without physical access to the Company's Back-Office servers.
Further, the Company has implemented a series of sophisticated auditing and
intruder-detection systems. Should an intruder ever be suspected, communications
between the Purchase and Back-Office servers would be severed to ensure the
---------------
Certain sections in this report have been identified as containing forward
looking statements. Although none of the sections on this page are so
identified, the reader is cautioned that such sections may contain forward
looking statements.
9
safety and integrity of the financial information. There can be no assurance
that, due to technological advancements or other factors beyond the control of
the Company, such measures will maintain absolute security.
Disaster Recovery
FVIPS is configured to provide hardware and data redundancy. In the event
that a computer within the system should fail, the Company believes that
adequate redundancy in hardware and data storage units exists to allow FVIPS to
continue operating at a reduced capacity. All data is backed up daily to tape
and stored off-site in a secure storage facility. The Company maintains on-site
duplicates of the system's data storage units, known as "mirrors," to provide
additional data integrity and security. The Company intends to build a second
system in 1997 to reduce the chance of system overload or failure. The second
system will be located at the Time Warner (San Diego) facility separate from the
existing FVIPS location.
Digital Signatures
When the Company sends credit authorization results to the Seller (see Step
10 under "The Back Office Cycle" above), the Company can use public key
cryptography to digitally sign authorization notices. This procedure is intended
to prevent the forging of authorization results and the subsequent fraudulent
inducing of product shipment. Copies of the Company's public authentication keys
are available on the Company's server. For security purposes, current plans
provide that the keys are to be changed monthly and are to be made available
only a few days before they are eligible for use. The private keys necessary for
full digital signing of messages are kept off the Internet. If the Seller wishes
to take advantage of this authentication feature, additional cryptographic
software (both publicly and commercially available) is required.
Optional Encryption of Seller Messages
FVIPS allows the Seller the option of encrypting messages with purchase
information to the Purchase servers for additional security. This option
requires the Seller to obtain additional cryptographic software and the
Company's public encryption keys, which are available without charge from the
Company's server.
Fraud and Chargebacks
Under Federal Reserve Regulation Z, credit cardholders have significant
rights to dispute charges including, but not limited to, up to two billing
cycles after the billing period in which the charge appears on the cardholder's
statement. If a credit cardholder purchases a product or service and is
dissatisfied after the purchase, the cardholder may be able to return the
product and demand a refund. If the merchant, after having received payment from
its merchant acquiror, refuses to issue a refund or properly provide the product
or service to the cardholder, the cardholder may initiate a "chargeback" through
the issuing bank. When a chargeback occurs, the merchant's acquiring bank is
responsible for refunding the amount of the charge to the issuing bank (who then
refunds the charge amount to the consumer) and collecting funds from the
merchant. If the merchant does not have sufficient funds to repay the
chargeback, the merchant acquiror is liable.
With respect to the Company's current operations, First USA Paymentech is
the merchant acquiror and thus liable to the consumer's issuing bank in the
event the merchant cannot pay the chargeback. First USA Paymentech has required,
and the Company has agreed, to indemnify First USA Paymentech in the event any
merchant cannot pay a chargeback. Pursuant to the terms of an agreement between
the parties, the Company is liable to First USA Paymentech for chargebacks if
First USA Paymentech cannot obtain payment from a Pioneer Seller or an Express
Seller. The Company's customer agreements provide for the allocation of the risk
of chargebacks (other than chargebacks caused by erroneous transmission by the
Company) to Pioneer Sellers and Express Sellers. In addition, under the Pioneer
Sellers service, funds are held for 91 calendar days, thereby minimizing the
Company's exposure to the risk of the Pioneer Seller being unable or unwilling
to fund
---------------
Certain sections in this report have been identified as containing forward
looking statements. Although none of the sections on this page are so
identified, the reader is cautioned that such sections may contain forward
looking statements.
10
a chargeback. Under the Express Seller service, funds are held for approximately
three to five business days. The Company believes that the Seller screening
associated with the Express Seller application process will help to mitigate
chargeback exposure.
The Company believes its fraud rate is below credit card industry standards
(i.e., unauthorized use of credit card or VirtualPIN) as well as its chargeback
rate. For Pioneer Sellers, the Company's policy of aging the settlement funds
before paying the Pioneer Seller protects the Company from having to seek
collection of chargebacks from Pioneer Sellers. In all cases, the Seller is
responsible for refunds, and any refunds are deducted by the Company from future
payments to the Seller. If there are no covering payments to the Seller, the
Seller is liable to pay the Company for such refund. While the Company believes
that the design of FVIPS and its Seller application process reduce the risk of
fraud and chargebacks, there can be no assurance that the low fraud and
chargeback rates the Company has experienced historically will continue in the
future. A substantial increase in fraudulent activity or chargebacks could have
a material adverse effect on the Company's business, financial condition and
results of operations.
Financial Industry Policies
The Company currently relies on credit cards as the payment method for
FVIPS transactions. Credit card associations are still in the process of
drafting operating regulations governing many credit card transactions on the
Internet. In some cases, the Company's access to the payment systems of credit
card associations and other payment providers may be conditioned on its
compliance, and the compliance of associated processors such as First USA
Paymentech, with interim regulations.
The Company's operations have been reviewed by MasterCard and Visa which
currently are the sole payment methods accepted by the Company. Visa has issued
to First USA Paymentech several conditions which govern First USA Paymentech's
processing of transactions for the Company over the Visa system. These
conditions, among other things, establish a maximum dollar amount and aging of
small-dollar transactions the Company can accumulate before they are submitted
to the Visa system for processing, and establish procedures for handling
chargebacks involving such bundled transactions. The Company does not believe
that these conditions materially burden the Company's current operations. The
conditions were initially issued pursuant to an oral communication, and were due
to expire on December 31, 1995. The conditions were renewed until the later of
the adoption of industry-wide operating regulations addressing Internet
transactions or December 31, 1997. If the Internet transaction operating
regulations are not in place by December 31, 1997, the conditions provide that
they can be extended, with Visa's concurrence. To date, MasterCard has not
issued any conditions that are specific to the Company's operations. The Company
is applying to accept Discover, JCB and American Express credit cards, although
there can be no assurance that any of such applications will be accepted. While
the Company hopes that it will be able to comply with Visa's future operating
regulations and regulations issued by any other credit card association, there
can be no assurance that it will be able to do so or that compliance will not
have a material adverse effect on its business, financial condition or results
of operations. In addition, there can be no assurance, if the operating
regulations have not been adopted, that the conditions agreement between First
USA Paymentech and Visa, or related agreements between First USA Paymentech and
the Company and other payment providers, will be issued or extended, if at all,
on terms that do not have a material adverse effect on the Company's business,
financial condition and results of operations.
---------------
Certain sections in this report have been identified as containing forward
looking statements. Although none of the sections on this page are so
identified, the reader is cautioned that such sections may contain forward
looking statements.
11
ADDITIONAL PRODUCTS AND SERVICES
VirtualTAG
In order to bring the retail environment to any Web page, the Company has
introduced the VirtualTAG, its second application of the VirtualPIN, in
December, 1996. The Company believes VirtualTAG will be one of the first
solutions that takes full advantage of the Internet's unique attributes by
combining advertising, selling and paying in one application.* The VirtualTAG
uses the Java programming language to create stimulating, interactive
advertisements within banners or "roving store fronts" which are designed to
allow Buyers to initiate the purchase, payment and arrange for the delivery of a
product being advertised without leaving the Web page on which the advertisement
appears. If the advertisement were in a newspaper, the VirtualTAG would be
comparable to touching a retail store advertisement, obtaining additional
product information and buying a product, without having to stop reading the
newspaper and visit the store.
The Company has designed and has in service a VirtualTAG for Casio. Casio
uses the VirtualTAG as a way for Internet users to order Casio products. The
Company has also designed a VirtualTAG for Saatchi & Saatchi on behalf of Bell
Atlantic. Currently, the Company is in discussion with numerous advertising
agencies and other clients in regards to uses of the VirtualTAG.
1 Virtual Place
The Company introduced 1 Virtual Place, a service through which Buyers can
purchase retail items directly from First Virtual, in December of 1996. The
Company believes that 1 Virtual Place may be an effective means of testing
technologies and concepts as well as increasing the number of VirtualPIN holders
and FVIPS transactions.* The Company is selling retail products through 1
Virtual Place ranging from electronic computer products to gourmet foods and
corporate gifts. The Company is currently testing 1 Virtual Place concepts
through two avenues. One is the 1 Virtual Place Web page (www.1virtualplace.com)
and the second is through an agreement with Juno e-mail services.
Presently, the Company orders product only from vendors following confirmed
Buyer purchase requests, thereby eliminating purchase commitments and the cost
of carrying inventory. The Company's vendor agreements generally provide for
rights of return of goods ultimately rejected by the Buyer. However, with
respect to goods ultimately rejected by the Buyer or lost in transit, the
Company has financial exposure for shipping costs, chargebacks and, in the event
the goods cannot be satisfactorily returned to the vendor, the Company's cost of
the product.
Targeted Marketing
The Company's Purchase database server has a "relay" capability which
enables the forwarding of messages from Sellers directly to Buyers using the
Buyer's VirtualPIN as an E-mail address (virtualpin@relay.card.com). This
function was designed to enable Sellers to transmit targeted marketing materials
or questionnaires while maintaining the Buyer's anonymity. The Buyer has the
option of declining to receive any of these communications from Sellers. If the
Buyer wishes to receive promotional offers from Sellers, this "relay" function
will not disclose the Buyer's name or E-mail address. Currently, FVIPS enables
Sellers to use this capability with respect to Buyers who have previously
purchased from them.
Billing Notification
FVIPS enables Sellers to initiate electronic billing notifications for
Buyer confirmation. This capability facilitates a number of future applications,
including subscription or membership renewals and recurring bill presentment and
payment.
---------------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will
meet the Company's current expectations. Investors are strongly encouraged to
review section entitled "Factors Affecting Operating Results and Market Price
of Stock" commencing on page 29, for a discussion of factors that could affect
future performance. The reader is cautioned that other sections and other
sentences not so identified may also contain forward looking information.
12
Subscription and membership renewal. In the magazine publishing industry,
publishers typically begin sending monthly renewal notices several months prior
to the expiration of the consumer's subscription which results in the incursion
of postal and printing costs for each notice. In addition, many subscribers
respond with a physical check which must then be processed by the fulfillment
house or publisher. Using FVIPS, fulfillment houses and publishers should be
able to simply E-mail a "confirmation-request" to the Buyer, to which a response
of "yes" will renew the subscription and initiate a FVIPS transaction. This
procedure has the potential to significantly reduce bill presentment and
subscription renewal costs for the Seller, while providing the Buyer with a
convenient and less costly method to effect a renewal.* An example of such a
capability is the Company's contract with Network Solutions, Inc. ("Network
Solutions" or "Internic"), the nationwide provider of domain name registration
and renewal services which it administers from the InterNIC domain site. As a
result of development work undertaken by the Company, the InterNIC site is
configured to enable those seeking registration and renewal of domain names to
pay with their VirtualPINs. Those not having VirtualPINs are able to apply for a
new VirtualPIN concurrent with paying their fees on the InterNIC site. In
addition, Network Solutions intends to notify each registrant in its billing
statements that VirtualPINs are accepted for payment. Network Solutions has also
agreed to work with the Company in devising outbound "value added" messages that
can be sent to its 1,000,000 plus mailing list of domain name registrants.
Recurring bill presentment and payment. As public utilities prepare to
face a deregulated environment and operate outside their traditional geographic
locale, FVIPS could provide a system and a process to facilitate convenient bill
presentment on a national scale.* As in the case of subscription renewals,
utility companies can benefit from reduced billing costs by using FVIPS to save
on printing, mailing and processing charges.* In addition to the convenience of
having utility payments itemized on a credit card bill, the Buyer would also
benefit from reduced postage cost. In the telecommunications, cable, electric,
and gas industries, FVIPS may offer utilities the potential to facilitate
consumer bill presentment by using the Buyer's existing E-mail account,
regardless of where that account may be held.* Although the current capability
of FVIPS might enable Sellers to utilize the subscription membership renewal and
recurring bill presentment and payment services with respect to a limited number
of Buyers, the Company intends to enhance FVIPS to enable Sellers and Buyers to
utilize these services on a widespread basis.
The Company is currently in the process of developing additional products
and services which enable targeted marketing and facilitate billing notification
and recurring bill presentment and payment. There can be no assurance that any
of such products will be introduced or, if introduced, achieve market
acceptance.
InfoHaus
For Sellers who offer information products and do not wish to establish
their own Web page, the Company offers the InfoHaus shared Web server
("InfoHaus"). InfoHaus is an on-line retail environment designed to provide
electronic store fronts for Sellers of information products. InfoHaus eliminates
the need for a Seller to maintain any hardware, software or continuous Internet
connection. InfoHaus, in conjunction with FVIPS, manages all aspects of the
selling process, including confirmation of purchases, distribution of
information goods, accounting, settlement and collection and payment of
proceeds. InfoHaus has been a part of the Company's services since the
deployment of FVIPS and had over 250 Sellers as of December 31, 1996. In
addition to the standard transaction processing fees, InfoHaus Sellers also pay
an additional surcharge as a percentage of the transaction amount and a monthly
storage fee for keeping files on the Company's server.
MARKETING AND DISTRIBUTION
First Virtual's marketing objective is to become the leading facilitator of
Internet commerce and other forms of interactive Internet communications.* The
Company intends to rapidly deploy VirtualPINs to all potential Buyers and
Sellers.* The Company intends to establish a large installed base of VirtualPINs
issued
---------------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will
meet the Company's current expectations. Investors are strongly encouraged to
review section entitled "Factors Affecting Operating Results and Market Price
of Stock" commencing on page 29, for a discussion of factors that could affect
future performance. The reader is cautioned that other sections and other
sentences not so identified may also contain forward looking information.
13
to Buyers and Sellers through multiple channels including credit card
companies and other financial institutions, on-line and Internet service
providers, value added integrators and a variety of direct marketing programs.*
The Company intends to market its services, including VirtualTAG, to merchants
regardless of their Web presence.* Initially the Company plans to work
cooperatively with advertising agencies and their clients to develop the
creative content and placement of VirtualTAGs.*
The Company believes that a variety of factors will motivate widespread
adoption of FVIPS.* Buyers could register with the Company to ensure a secure
and convenient method for on-line purchasing and to take advantage of premium
offers from well-known merchants. Merchants could become Sellers to offer a
secure and highly efficient sales channel that provides the opportunity for
two-way interaction with a broad customer base. The Company intends to enact
initiatives in a number of channels to promote universal availability and
adoption of FVIPS, including the following:
Buyer Enrollment
Credit card companies and other financial institutions. The Company
intends to work with First USA Paymentech, one of the largest credit card
issuers in the U.S., GE Capital, a major financial services company with one of
the world's largest portfolios of private label credit cards, First Data, the
largest credit card processor in the U.S., and other major credit card companies
and financial institutions to deploy VirtualPIN marketing campaigns tied to
credit card billing and solicitations.* The Company will provide the credit card
companies and other financial institutions with the opportunity to issue
VirtualPINs to their customers on a "co-branded" basis.*
On-line and Internet service providers. The Company intends to offer
on-line and Internet service providers the opportunity to provide their
customers co-branded VirtualPINs that will enable their customers to buy and
sell over the Internet.* Internet service providers' customers have a
demonstrated interest in using the Internet for diverse applications. In
addition, because they are currently using the Internet, these customers already
have the capability of conducting commercial transactions using FVIPS.
Information technology product firms. The Company plans to launch a
variety of co-marketing campaigns with firms communicating with, servicing and
selling products to on-line, computer-literate consumers.* These include iCat,
Farcast, Earthweb, Network Solutions, Microsoft and other personal computer
hardware, software and peripheral production and distribution companies. The
Company anticipates that these companies will integrate the Company's
promotional opportunities with their products, either as a ride-along with
product delivery or as an added inducement or premium to encourage purchase.*
Existing and future FVIPS Sellers. The Company hopes that a portfolio of
Sellers who support FVIPS will contribute significantly to the rate of Buyer
registration.* Individual consumers who use the Web will be motivated to
register as Buyers when they encounter Web merchants who accept payment using
FVIPS.
Direct sales. The Company hopes to attract VirtualPIN Buyers through
direct marketing programs including solo direct mail, co-op direct mail, inserts
in publications, space advertising and direct marketing public relations.* The
Company will be working with Harte-Hanks Direct to develop a marketing plan to
acquire brand name sellers and to acquire and retain new buyers. This plan may
include consumer research with sample groups, designing marketing databases,
development of sales brochures for the Company's sales channels and
introductions to integrated sales programs of direct and on-line marketing with
selected Harte-Hanks clients (i.e. retailers and banks).*
Any consumer can become a Buyer simply by visiting the Company's Web page
or sending E-mail to apply@card.com.
---------------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will
meet the Company's current expectations. Investors are strongly encouraged to
review section entitled "Factors Affecting Operating Results and Market Price
of Stock" commencing on page 29, for a discussion of factors that could affect
future performance. The reader is cautioned that other sections and other
sentences not so identified may also contain forward looking information.
14
Seller Enrollment
Credit card companies and other financial institutions. The Company has
established relationships with leading credit card companies and financial
institutions to enhance the value of the services these groups provide to their
merchant customers. The Company and credit card companies and financial
institutions, together with Web developers, can provide a turnkey solution to
enabling Internet commerce.* The Company intends to pursue relationships with
additional credit card companies and financial institutions.*
Value-added integrators. As previously described, the Company has
established a relationship with iCat and is establishing relationships with
additional Web and software development firms, which provide packaged
point-of-sale solutions, computer service companies, and advertising and
marketing agencies which provide services and assistance to merchants
establishing or maintaining Web pages. The Company will provide training,
software development tools and technical support to these firms to encourage
them to integrate FVIPS into their clients' Web sites. These firms are
potentially an effective sales force for the Company, reaching a large base of
potential Sellers.*
Existing and future FVIPS Buyers. As the number of Buyers and FVIPS
transactions increases, the Company believes that additional Sellers will be
attracted to the potential expanding user base.*
Direct sales. The Company has an internal sales force which identifies
businesses with large direct response customer bases (including those businesses
with an online presence). This sales force pursues opportunities through
personal contact, direct marketing, E-mail and industry events. The Company
believes that businesses which rely on a renewal revenue model, such as magazine
publishers and public utilities, are particularly good prospects, as they will
recognize the value of providing their customers with a means to pay their bills
easily and electronically.* Supporting payment through FVIPS will allow these
companies to bill, receive and process payment from their customers at a
significantly reduced cost. The sales force will also focus on software
companies, which have the opportunity to distribute their products online and
rely on a renewal revenue model with maintenance fees and upgrades. Any person
or organization can become a Seller simply by visiting the Company's Web page or
sending E-mail to apply@card.com.
CUSTOMER CARE
The Company's customer care activities are designed to provide timely, high
quality product and technical support to meet the diverse needs of a wide
variety of merchants and consumers. These support activities facilitate the
integration and use of First Virtual's products and services across the
Internet. The Company's customer care organization uses an e-mail monitoring
system 24 hours a day, seven days a week. In addition to toll-free telephone
support, customers also have access to numerous self-help reference materials at
the Company's Web and FTP pages.
The Company's customer care and support organization is comprised of three
groups:
- Customer care
- Implementation and integration services
- Systems administration
The customer care team provides support 24 hours a day, seven days a week
by E-mail and fax. Beyond the Web-based self help pages, toll-free telephone
support is available between 6 am and 5 pm (PST), Monday to Friday, and 8 am to
5 pm on weekends.
The majority of inquiries and support requests to customer care are
received via E-mail and processed and responded to using the Company's E-mail
based customer support application. Customer care responses match the various
experience levels of First Virtual's growing customer base and are closely
monitored for accuracy and timeliness. An escalation procedure allows for urgent
issues to be resolved by Company
---------------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will
meet the Company's current expectations. Investors are strongly encouraged to
review section entitled "Factors Affecting Operating Results and Market Price
of Stock" commencing on page 29, for a discussion of factors that could affect
future performance. The reader is cautioned that other sections and other
sentences not so identified may also contain forward looking information.
15
personnel who are most knowledgeable about the subject of inquiry. To ensure
quality products and services the Company's customer care team also provides
additional testing on all of the Company's new product releases.
Implementation and integration services act as the liaison between the
Company's sales staff and the Company's Sellers. This team assists new Sellers
in the implementation of FVIPS. The Integration team also provides ongoing
technical support for the Company's Sellers to provide smooth transitions as the
Company introduces new or enhanced products and services.
Systems Administrators proactively monitor the Company's critical computer
systems around the clock to assure maximum functionality and system optimum
efficiency. With a focus on prevention and awareness, these three customer care
groups strive to provide the best customer service on the Internet.
RESEARCH AND DEVELOPMENT
The Company's research and development activities are focused on the design
and development of new products and services for the Internet commerce market,
as well as on increasing the capacity and reliability of existing products and
services. The Company has devoted a significant portion of its resources to
research and development programs. As of December 31, 1996, the Company had 18
persons engaged in research and development activities. The Company's research
and development expenses were $3,250,000, $531,000 and $307,000, for the years
ended 1996 and 1995 and for the period from March 11, 1994 (date of inception)
through December 31, 1994, respectively. The Company believes that significant
research and development expenditures will be required in order for the Company
to remain competitive.* Accordingly, the Company expects that research and
development expenses will continue to constitute a significant portion of the
Company's overall expenses in the future.*
The Company's research and development and marketing departments work
closely in the selection of research and development projects. Current research
and development activities include projects in the following six areas:
- Extension of VirtualPIN architecture.
- Integration of FVIPS into Microsoft's Merchant Server software as a
payment option
- Development of a suite of Seller tools that facilitate various activities
using FVIPS.
- Development of a suite of tools using the Company's E-mail confirmation
technology for automated electronic mail dialogues with customers for a
variety of applications.
- The ability to send VirtualTAGS, or variations through new forms of
e-mail (i.e.: HTML E-mail)
- Development of advanced application-level services, including systems for
permitting extremely small payments (micro-transactions), systems for the
collection of royalties on copyrighted materials, systems for the
facilitation of pay-per-use software (including games) and systems for
the management of cryptographic keys.
There can be no assurance, however, that any of these services will be made
commercially available on a timely and cost-effective basis, or at all, or that
if introduced, these services will achieve market acceptance.
The Company believes that its software development team represents a
significant competitive advantage.* The Company has world-class expertise in
E-mail technology with particular emphasis on E-mail-based distributed services.
---------------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will
meet the Company's current expectations. Investors are strongly encouraged to
review section entitled "Factors Affecting Operating Results and Market Price
of Stock" commencing on page 29, for a discussion of factors that could affect
future performance. The reader is cautioned that other sections and other
sentences not so identified may also contain forward looking information.
16
The Company also has unique expertise in other key areas of
Internet-related technology, such as Java and VRML technology and cryptography,
as well as in the development of scalable and reliable distributed systems. The
Company's research and product development team includes, among others,
Nathaniel Borenstein, the primary author of a number of Internet E-mail
standards, and Marshall Rose, an expert in a number of Internet technologies.
The Company's ability to attract and retain highly qualified employees will be
the principal determinant of its success in maintaining technological
leadership.
The Company's ability to design, develop, test and support new software
products and enhancements on a timely basis that meet changing customer needs
and respond to technological developments and emerging industry standards is
critical to the Company's future success. There can be no assurance that the
Company will be successful in developing and marketing new software products and
enhancements that meet changing customer needs and respond to such technological
changes or evolving industry standards. The Company's current services are
designed around certain widely used and accepted standards, including the MIME
and SMTP E-mail standards and upon process-based security via E-mail
confirmation. Current and future use of the Company's services will depend, in
part, on industry acceptance of such standards and practices as they apply to
the Internet and Internet commerce.
COMPETITION
The market for products and services that enable the sale of goods and
services over the Internet is expected to be intensely competitive and, to the
extent commercial activity over the Internet increases, the Company expects
competition to increase significantly. There are no substantial barriers to
entry into the Company's business, and the Company expects established and new
entities to enter the market for Internet payment systems and interactive
Internet communications in the near future. It is possible that a single
supplier will dominate one or more market segments. Furthermore, since there are
many potential entrants to the field, it is extremely difficult to assess which
companies are likely to offer competitive products and services in the future,
and in some cases it is difficult to discern whether an existing service is
competitive with the Company's current services.
The Company's principal competitors in the market for consumer-initiated
purchases over the Internet include providers of encrypted credit card
transaction systems such as CyberCash, Verifone, Open Market, Netscape and GC
Tech and providers of electronic cash payment systems such as DigiCash. The
Company expects that credit card processors and acquiring banks will also offer
credit card-based payment systems if SET protocols proposed by Visa, MasterCard,
Microsoft and Netscape are adopted and/or accepted as a standard for Internet
commerce. SET comprises openly published communication and process protocols
intended to facilitate encrypted credit card transactions over the Web. The
Company may experience additional competition from Internet service providers
and Internet directory companies who enter the market for Internet payment
services. Companies such as AOL, CompuServe, Microsoft, IBM, AT&T, Hewlett-
Packard and Federal Express, which possess large, existing cu