<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
- --------------------------------------------------------------------------------
Form 8-K/A
----------------
CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Date of Report: January 31, 2000
Commission File Number 000-26365
----------------
GOTO.COM, INC.
(Exact name of Registrant as specified in its charter)
Delaware 95-4652060
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
74 North Pasadena Avenue, 3rd Floor
Pasadena, California 91103
(Address of principal executive offices)
Telephone: (626) 685-5600
(Registrant's telephone number, including area code)
<PAGE>
ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS
This Form 8-K/A amends the Current Report on Form 8-K filed with the
Securities and Exchange Commission on February 3, 2000 to include required
information under Item 7, Financial Statements and Exhibits.
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS
(a) Financial statements of businesses acquired.
See exhibit 99.4 and 99.5.
(b) Pro forma financial information.
See exhibit 99.3.
(c) Exhibits.
Exhibit No. Description
---------- -----------
2.1 Agreement and Plan of Reorganization, dated November
19, 1999, by and among GoTo.com, Inc., Cadabra Inc.,
Roy Acquisition Corp., and as to certain sections,
ChaseMellon Shareholder Services, L.L.C. as escrow
agent and Narinder P. Singh as representative of the
Cadabra securityholders (previously filed)
99.1 Press release of GoTo.com, Inc., dated November 22,
1999 (previously filed).
99.2 Press release of GoTo.com, Inc., dated January 31,
1999.
99.3 Unaudited Pro Forma Condensed Combined Financial
Information.
99.4 Cadabra Inc. (formerly Tesserae Information Systems,
Inc.) Financial Statements for 1999
99.5 Cadabra Inc. (formerly Tesserae Information Systems,
Inc.) Financial Statements for 1998.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: March 16, 2000 GoTo.com, Inc.
By: /s/ TODD TAPPIN
------------------------------------------
Todd Tappin
Chief Financial Officer
<PAGE>
Exhibit 99.2
GOTO.COM COMPLETES ACQUISITION OF
E-COMMERCE COMPANY, CADABRA
GoTo.com expands its online marketplace
through acquisition of shopping service engine
PASADENA, California, January 31, 2000 - GoTo.com (NASDAQ: GOTO), the company
that pioneered an online marketplace introducing consumers and advertisers,
today announced that it has completed its acquisition of Cadabra Inc., a leading
Internet-based provider of comparison-shopping services. The $250 million deal,
which was announced November 22, 1999, was comprised of $8 million in cash and
the balance in GoTo stock.
"In the past, web search and shopping comparison have been operated as
completely separate offerings and supported by different business models,"
commented Jeffrey Brewer, Executive Chairman of GoTo.com. "Our business model
allows us to create a completely unified and integrated user experience.
Shopping comparison isn't a new business for GoTo, but rather a significant
enhancement to our existing search offering."
Cadabra's comparison shopping tool allows GoTo to further enhance its
marketplace by facilitating more targeted, high-value introductions between
consumers and advertisers/merchants. Consumers will be able to search for
products and services using more precise search criteria. Merchants will receive
more targeted leads because consumers can take advantage of Cadabra's powerful
product search and comparison technology. Affiliates are provided with an
additional revenue stream by deploying this powerful new feature at their web
sites.
San Mateo-based Cadabra has invented a flexible data normalization technology
called Dynamic Data Integration (DDI), a parametric search engine that allows
consumers to comparison-shop online using everyday shopping terminology and
techniques. The technology is the result of years of research by the companies'
founders, Narinder Singh and Donald Geddis. Cadabra's technology solves the
difficult problem of integrating disparate databases, which enables accurate,
relevant product comparisons on price, model and detailed product attributes.
Cadabra can be found online at http://www.cadabra.com.
-----------------------
About GoTo.com
GoTo.com (NASDAQ: GOTO) created an online marketplace that introduces consumers
and advertisers. Advertisers bid in an ongoing auction for priority placement in
the search results with the highest bidder's site appearing first in the
results. Consumers conduct searches using the GoTo.com search service at its Web
site and at thousands of locations across the Internet where GoTo.com can be
accessed through its Search Syndication Network . GoTo.com's streamlined search
method improves a consumer's ability to quickly and easily find relevant Web
sites providing information, products and services. GoTo.com ended the third
quarter of 1999 having made more than 54,000,000 paid introductions between
consumers and advertisers, and had more than 21,000 advertisers in its
marketplace at the end of December 1999. GoTo.com is located in Pasadena,
California and can be found online at http://www.goto.com.
--------------------
Certain statements in this news release constitute "forward-looking
statements". These forward-looking statements are inherently uncertain.
Actual results may differ materially from these forward-looking statements
due to risks such as: the risk that GoTo.com will not realize value from
the acquisition and the risk that GoTo.com will not be able to integrate
Cadabra in an efficient and timely manner. For a discussion of some of the
other risks and factors that could affect GoTo.com's future results, see
the discussion of "Risk Factors" in its Prospectus, dated June 18, 1999,
its June 30, 1999 10Q, and its September 30, 1999 10Q.
# # #
<PAGE>
Exhibit 99.3
GoTo.com, Inc.
Unaudited Pro Forma Condensed Combined Financial Information
Overview
On January 31, 2000, GoTo.com, Inc. (GoTo) acquired Cadabra Inc. (Cadabra),
an online comparison shopping service. Pursuant to the Agreement and Plan of
Reorganization, GoTo acquired all of the outstanding shares of capital stock and
assumed all outstanding options to acquire shares of capital stock of Cadabra,
for $8 million in cash and 3,283,672 shares of GoTo common stock, including
214,833 shares to be issued upon exercise of options assumed by GoTo.com. The
acquisition was accounted for as a purchase. Under the purchase method of
accounting, the purchase price is allocated to the assets acquired and
liabilities assumed based on their estimated fair values as determined by GoTo
at the date of the acquisition. The total purchase price of the acquisition was
approximately $263.1 million and consisted of cash of $8 million; GoTo common
stock of $252.5 million valued at the closing price of GoTo's common stock on
the date the acquisition exchange ratio was set, net of expected proceeds from
the exercise of Cadabra stock options assumed by GoTo; and acquisition costs of
$2.6 million, primarily for investment banking, legal and accounting services.
The following unaudited pro forma condensed combined balance sheet as of
December 31, 1999 gives effect to the acquisition of Cadabra as if it had
occurred on December 31, 1999, and the unaudited pro forma condensed combined
statement of operations for the year ended December 31, 1999 gives effect to the
acquisition of Cadabra as if it had occurred as of January 1, 1999.
The unaudited pro forma condensed combined information is for illustrative
purposes only and reflects certain estimates and assumptions regarding the
transactions as described in the notes to unaudited pro forma condensed combined
financial information. The unaudited pro forma condensed combined financial
information is based on the historical financial statements of GoTo and Cadabra,
and should be read in conjunction with those financial statements and related
notes. The unaudited pro forma condensed combined balance sheet and statement of
operations are not necessarily indicative of the financial position and
operating results that would have been achieved had the transactions been in
effect as of the beginning of the period presented and should not be construed
as being representative of future financial position or operating results.
<PAGE>
GoTo.com, Inc.
Unaudited Pro Forma Condensed Combined Balance Sheet
As of December 31, 1999
(in thousands)
<TABLE>
<CAPTION>
Pro Forma Pro Forma
GoTo.com Cadabra Adjustments Combined
---------- --------- ------------- ---------
<S> <C> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents............................ $ 11,914 $ 5,018 $ -- $ 16,932
Short-term investments............................... 93,409 -- (8,000)(a) 85,409
Accounts receivable, net............................. 2,927 52 -- 2,979
Prepaid expenses and other........................... 851 110 (88)(b) 873
Prepaid marketing expenses........................... 2,034 -- -- 2,034
--------- -------- ------------- ---------
Total current assets................................... 111,135 5,180 (8,088) 108,227
Property and equipment:
Furniture and fixtures............................... 1,923 130 -- 2,053
Computer hardware.................................... 9,036 380 -- 9,416
Computer software.................................... 4,234 95 -- 4,329
--------- -------- ------------- ---------
15,193 605 -- 15,798
Accumulated depreciation and amortization............ (2,490) (162) -- (2,652)
--------- -------- ------------- ---------
12,703 443 -- 13,146
Goodwill............................................... -- -- 244,501 (a) 244,501
Intangible assets...................................... -- -- 6,035 (a) 6,035
Long-term investments.................................. 4,932 -- -- 4,932
Other assets........................................... 742 101 (721)(c) 122
--------- -------- ------------- ---------
Total assets........................................... $ 129,512 $ 5,724 $ 241,727 $ 376,963
========= ======== ============= =========
Liabilities And Stockholders' Equity
Current liabilities:
Accounts payable .................................... $ 10,465 $ 517 $ -- $ 10,982
Accrued expenses .................................... 2,562 193 1,879 (c) 4,634
Deferred revenue .................................... 2,058 -- (88)(b) 1,970
Current portion of debt ............................. 131 -- -- 131
Current portion of capital lease obligations ........ 754 -- -- 754
--------- -------- ------------- ---------
Total current liabilities ............................. 15,970 710 1,791 18,471
Long-term capital lease obligations ................... 768 -- -- 768
Convertible redeemable preferred stock ................ -- 7,704 (7,704)(d) --
Stockholders' equity:
Convertible preferred stock ......................... -- 1,498 (1,498)(d) --
Common stock ........................................ 5 15,500 (15,500)(d) 5
Additional paid-in capital on common stock .......... 158,799 -- -- 411,299
-- -- 252,500 (a)
Deferred compensation, net .......................... (2,584) (11,446) 11,446 (d) (2,584)
Accumulated deficit ................................. (43,405) (8,242) 8,242 (d) (43,405)
(7,550)(a) (7,550)
Unrealized losses on short-term and
long-term investments ............................. (41) -- -- (41)
--------- -------- ------------- ---------
Total stockholders' equity ............................ 112,774 (2,690) 247,640 357,724
--------- -------- ------------- ---------
Total liabilities and stockholders' equity ............ $ 129,512 $ 5,724 $ 241,727 $ 376,963
========= ======== ============= =========
</TABLE>
See accompanying notes.
<PAGE>
GoTo.com, Inc.
Unaudited Pro Forma Condensed Combined Statement of Operations
For the Year Ended December 31, 1999
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Pro Forma Pro Forma
GoTo.com Cadabra Adjustments Combined
--------- --------- ----------- -----------
<S> <C> <C> <C> <C>
Revenue ...................................................... $ 26,809 $ 48 $ (112)(e) $ 26,745
Cost of revenue .............................................. 6,213 108 -- 6,321
--------- -------- ----------- -----------
Gross profit ................................................. 20,596 (60) (112) 20,424
Operating expenses:
Marketing, sales and services .............................. 34,459 499 (112)(e) 34,846
General and administrative ................................. 12,467 1,224 -- 13,691
Product development ........................................ 3,689 2,078 -- 5,767
Amortization of goodwill ................................... -- -- 81,500 (f) 81,500
Amortization of intangible assets .......................... -- -- 2,012 (g) 2,012
Amortization of deferred compensation ...................... 3,585 3,420 -- 7,005
--------- -------- ----------- -----------
54,200 7,221 83,400 144,821
--------- -------- ----------- -----------
Loss before provision for income taxes........................ (33,604) (7,281) (83,512) (124,397)
Other income:
Government grant ........................................... -- 580 -- 580
Interest income ............................................ 3,777 202 (440)(h) 3,539
Other income ............................................... 566 -- -- 566
--------- -------- ----------- -----------
Other income ................................................. 4,343 782 (440) 4,685
Loss before provision for income taxes ....................... (29,261) (6,499) (83,952) (119,712)
Provision for income taxes ................................... 1 1 -- 2
--------- -------- ----------- -----------
Net loss ..................................................... $ (29,262) $ (6,500) $ (83,952) $ (119,714)
========= ======== =========== ===========
Pro forma net loss per share.................................. $ (0.77) $ (2.96)
Historical basic and diluted net loss per share............... $ (1.04) $ (3.93)
Weighted average shares used to compute
pro forma net loss per share................................ 38,219 2,230 (i) 40,449
Weighted average shares used to compute
historical basic and diluted net loss per share............. 28,207 2,230 (i) 30,437
</TABLE>
See accompanying notes.
<PAGE>
GoTo.com, Inc.
Notes To Unaudited Pro Forma Condensed
Combined Financial Information
Pro forma adjustments giving effect to the acquisition of Cadabra in the
unaudited pro forma condensed combined balance sheet as of December 31, 1999,
reflect the following:
(a) Allocation of purchase consideration to the fair value of net tangible
assets, identified intangible assets, and in-process research and development
acquired as illustrated below (in thousands):
Estimated acquisition cost:
Cash (converted from short-term investments)..... $ 8,000
Stock............................................. 252,500
Acquisition expenses.............................. 2,600
--------
Total estimated acquisition cost.................. $263,100
========
Purchase price allocation:
Fair value of net tangible assets................. $ 5,014
In-process research and development............... 7,550
Identified intangible assets...................... 6,035
Goodwill.......................................... 244,501
--------
Total purchase price allocation................... $263,100
========
The projects identified as in-process research and development are those
that are currently underway, that will require additional effort to establish
technological feasibility and have no alternative future use. The projects are
expected to add features that will enhance the Web site scraping ability and
operating capability of the service. At the acquisition date, these projects
were approximately 80 percent complete and will require additional expected
costs of approximately $2.0 million to complete these projects, consisting
principally of personnel related costs. These projects are expected to be
completed during fiscal year 2000. To determine the value of in-process
research and development, the expected future cash flows, including costs to
reach technological feasibility, were discounted at an after-tax rate of 25
percent, taking into account risks related to the characteristics and
applications of the technology, existing and future markets, and assessments
of the life cycle stage of the technology. GoTo obtained an independent
expert's appraisal to derive the purchase price allocation. The resulting
valuation of $7.6 million will be expensed immediately following the
acquisition. The effect of the write-off of in-process research and
development is reflected in the unaudited pro forma condensed combined balance
sheet as an increase to accumulated deficit; however, the unaudited pro forma
condensed combined statement of operations does not reflect this charge.
Identified intangible assets consist of developed technology of $5.5
million and assembled workforce of $585,000. To determine the value of
developed technology, the expected future cash flows attributable to existing
technology were discounted, taking into account risks related to the
characteristics and applications of the technology, existing and future
markets, and assessments of the life cycle stage of the technology. The value
of the assembled work force was derived by estimating the costs to replace the
existing employees, including recruiting and hiring costs and training costs
for each category of employee. GoTo obtained an independent expert's appraisal
to derive the purchase price allocation. Identified intangible assets will be
amortized on a straight-line basis over three years.
For purposes of the unaudited pro forma condensed combined financial
information above, amounts allocated to goodwill are based on the estimated
fair value of assets acquired and liabilities as of December 31, 1999. The
estimated fair value of the net tangible assets as of the acquisition closing
date of January 31, 2000, was $4.4 million, which resulted in an allocation of
goodwill in an amount of $245.1 million. Goodwill will be amortized on a
straight-line basis over a period of three years.
(b) Elimination of intercompany prepaid expenses and deferred revenue.
(c) Accrual and reclassification of estimated acquisition costs of $2.6
million.
(d) Elimination of Cadabra's stockholders' equity, including convertible
redeemable preferred stock, convertible preferred stock and deferred
compensation.
<PAGE>
Pro forma adjustments giving effect to the acquisition of Cadabra in the
unaudited pro forma condensed combined statement of operations for the year
ended December 31, 1999, reflect the following:
(e) Elimination of intercompany revenue and expense.
(f) Amortization of goodwill from the Cadabra acquisition on a straight-
line basis over three years.
(g) Amortization of identified intangible assets from the Cadabra
acquisition on a straight-line basis over three years.
(h) Imputed decrease in interest income resulting from pro forma
decrease in short-term investments that would have resulted from the $8
million acquisition payment calculated at GoTo's average rate of return on
short-term investments for the year.
(i) Increase to the denominator in the loss per share calculation is
based on approximately 2,229,802 shares of GoTo common stock as calculated
below. The effect of outstanding stock options and unvested stock are
excluded from the calculation of pro forma net loss per share and
historical basic and diluted net loss per share as their inclusion would be
antidilutive.
Shares
----------
Total GoTo common stock.................. 3,283,672
Unissued shares related to options....... (214,833)
Unvested GoTo common stock............... (839,037)
----------
2,229,802
==========
<PAGE>
EXHIBIT 99.4
Report of Independent Auditors
The Board of Directors and Stockholders
Cadabra Inc.
We have audited the accompanying balance sheet of Cadabra Inc. as of December
31, 1999, and the related statements of operations, stockholders' deficit, and
cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Cadabra Inc. as of December 31,
1999, and the results of its operations and its cash flows for the year then
ended, in conformity with accounting principles generally accepted in the United
States.
/s/ Ernst & Young LLP
Los Angeles, California
January 31, 2000
<PAGE>
Cadabra Inc.
(formerly Tesserae Information Systems, Inc.)
Balance Sheet
<TABLE>
<CAPTION>
December 31,
1999
-------------------
Assets
<S> <C>
Current assets:
Cash and cash equivalents........................................................... $ 5,018,000
Accounts receivable................................................................. 52,000
Prepaid expenses.................................................................... 110,000
------------
Total current assets.................................................................. 5,180,000
Property and equipment, net........................................................... 443,000
Other assets.......................................................................... 101,000
------------
Total assets.......................................................................... $ 5,724,000
------------
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable.................................................................... $ 517,000
Accrued expenses.................................................................... 193,000
------------
Total current liabilities............................................................. 710,000
Commitments
Series B Convertible and Redeemable Preferred Stock, no par value, liquidation
preference of $8.37 per share (aggregate liquidation preference of $12,000,000),
1,450,000 shares authorized, 1,432,948 shares issued and
outstanding at December 31, 1999.................................................... 7,704,000
Stockholders' deficit:
Series A Convertible Preferred Stock, no par value, liquidation preference of $1.00
per share, 1,550,000 shares authorized, 1,537,966 shares issued and
outstanding at December 31, 1999................................................. 1,498,000
Common stock, no par value, authorized--40,000,000 shares; issued and
outstanding--3,636,750 shares at December 31, 1999............................... 15,500,000
Deferred compensation, net.......................................................... (11,446,000)
Accumulated deficit................................................................. (8,242,000)
------------
Total stockholders' deficit........................................................... (2,690,000)
------------
Total liabilities and stockholders' deficit........................................... $ 5,724,000
============
</TABLE>
See accompanying notes.
<PAGE>
Cadabra Inc.
(formerly Tesserae Information Systems, Inc.)
Statement of Operations
<TABLE>
<CAPTION>
Year ended
December 31,
1999
------------------
<S> <C>
Revenue:
License revenue.................................... $ 37,000
Advertising revenue................................ 11,000
-----------
48,000
Cost of advertising revenue.......................... 108,000
-----------
(60,000)
Operating expenses:
Marketing and sales................................ 499,000
General and administrative......................... 1,224,000
Product development................................ 2,078,000
Amortization of deferred compensation.............. 3,420,000
-----------
Loss from operations................................. (7,281,000)
Other income:
Government grant................................... 580,000
Interest income.................................... 202,000
-----------
Net loss before income taxes......................... (6,499,000)
Income taxes......................................... 1,000
-----------
Net loss............................................. $(6,500,000)
===========
</TABLE>
See accompanying notes.
<PAGE>
Cadabra Inc.
(formerly Tesserae Information Systems, Inc.)
Statement of Stockholders' Deficit
<TABLE>
<CAPTION>
Series A
Convertible
Preferred Stock Common Stock Deferred Accumulated
Shares Amount Shares Amount Compensation Deficit
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1998............. 1,537,966 $1,498,000 3,000,000 $ 1,316,000 $ (762,000) $ (984,000)
Issuance of Common Stock............... -- -- 636,750 80,000 -- --
Stock option compensation.............. -- -- -- 14,104,000 (14,104,000) --
Amortization of deferred compensation.. -- -- -- -- 3,420,000 --
Accretion on Preferred Stock........... -- -- -- -- -- (758,000)
Net loss............................... -- -- -- -- -- (6,500,000)
--------- ----------- --------- ----------- ------------ -----------
Balance at December 31, 1999............. 1,537,966 $1,498,000 3,636,750 $15,500,000 $(11,446,000) $(8,242,000)
========= =========== ========= =========== ============ ===========
<CAPTION>
<S> <C>
Total
Balance at December 31, 1998............. $ 1,068,000
Issuance of Common Stock............... 80,000
Stock option compensation.............. --
Amortization of deferred compensation.. 3,420,000
Accretion on Preferred Stock........... (758,000)
Net loss............................... (6,500,000)
-----------
Balance at December 31, 1999............. $(2,690,000)
===========
</TABLE>
See accompanying notes.
<PAGE>
Cadabra Inc.
(formerly Tesserae Information Systems, Inc.)
Statement of Cash Flows
<TABLE>
<CAPTION>
Year ended
December 31,
1999
------------------
<S> <C>
Cash flow from operating activities
Net loss................................................................ $(6,500,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization......................................... 132,000
Amortization of deferred compensation................................. 3,420,000
Changes in operating assets and liabilities:
Accounts receivable................................................ 306,000
Prepaid expenses................................................... (94,000)
Other assets....................................................... (100,000)
Accounts payable................................................... 493,000
Accrued expenses................................................... 193,000
Deferred revenue................................................... (95,000)
-----------
Net cash used in operating activities................................... (2,245,000)
Cash flow from investing activities
Purchase of property and equipment...................................... (505,000)
-----------
Net cash used in investing activities................................... (505,000)
Cash flow from financing activities
Proceeds from the issuance of preferred stock, net...................... 6,946,000
Proceeds from the issuance of common stock.............................. 80,000
Repayment of bank borrowings............................................ (62,000)
-----------
Net cash provided by financing activities............................... 6,964,000
-----------
Net increase in cash and cash equivalents............................... 4,214,000
Cash and cash equivalents at beginning of year.......................... 804,000
-----------
Cash and cash equivalents at end of year................................ $ 5,018,000
===========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest........................................................... $ --
===========
Income taxes....................................................... $ 1,000
===========
</TABLE>
See accompanying notes.
<PAGE>
Cadabra Inc.
(formerly Tesserae Information Systems, Inc.)
Notes to Financial Statements
December 31, 1999
1. Nature of Business and Significant Accounting Policies
Nature of Business
Cadabra Inc. (the Company), formerly Tesserae Information Systems, Inc., was
incorporated on June 13, 1996 in the state of California. The Company was
engaged in the business of developing software for the integration of structured
databases into meta-databases. The Company's revenue through December 31, 1999
consisted principally of amounts earned under a government grant. In 1999, the
Company began developing Web-based software which can be used for consumer
comparison shopping through its Web site and through syndicated private-label
versions of the shopping site for its customers.
Acquisition by GoTo.com
On January 31, 2000, the Company was acquired by GoTo.com, Inc. (GoTo).
Pursuant to the Agreement and Plan of Reorganization, GoTo acquired all of the
outstanding shares of capital stock and assumed all outstanding options to
acquire capital stock of the Company, for $8 million in cash and 3,283,672
shares of GoTo common stock.
Estimates and Assumptions
The preparation of 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, disclosure of contingent
assets and liabilities, and reported amounts of revenue and expenses in the
financial statements and accompanying notes. Actual results could differ from
those estimates.
License Revenue
The Company accounts for software license revenue in accordance with the
American Institute of Certified Public Accountants Statement of Position 97-2,
"Software Revenue Recognition." The Company recognizes revenue from sales of
software licenses to end users upon obtaining persuasive evidence of an
arrangement, delivery of the software to a customer, determination that
collection of a fixed or determinable license fee is considered probable, and
there are no remaining commitments or contingencies.
Cost of Advertising Revenue
Cost of revenue consists of the cost of serving the Company's Web site
including salaries and depreciation of Web site equipment.
Product Development
Product development expenses consist primarily of costs incurred under the
NIST grant to develop software for the integration of structured databases into
meta-databases, which the Company initially intended to license. Costs incurred
under the NIST grant have been expensed in accordance with certain requirements
of Statement of Financial Accounting Standards No. 86 "Accounting for the Costs
of Computer Software to be Sold, Leased, or Otherwise Marketed."
In 1999, the Company changed its business strategy and applied previously
developed technology to a Web-based application which can be used for consumer
comparison shopping. Cost incurred in developing a Web-based solution have been
expensed as incurred in accordance with Statement of Position 98-1 "Accounting
for the Costs of Computer Software Developed or Obtained for Internal Use" (SOP
98-1). SOP 98-1 requires that costs incurred in the preliminary
<PAGE>
project and post-implementation stages of an internal use software project be
expensed as incurred and that certain costs incurred in the application
development stage of a project be capitalized.
Product development expenses include compensation and related expenses and
overhead costs incurred related to the product development efforts.
Government Grant
In 1997, the Company was awarded a federal grant from the National Institute
of Standards and Technology (NIST) that provided funding over a three-year
period.
The Company recognizes amounts received from government grants as expenses
are incurred based on the reimbursement percentage specified in the grant
agreement (generally 47% of allowable cost incurred). Reimbursements are
requested (and received) on a monthly basis through the end of the contract
period (December 31, 1999). During 1999, the Company recorded amounts of
$580,000 under the program under other income.
Property and Equipment
Property and equipment are recorded at cost and depreciated using the
straight-line method over estimated useful lives of three to five years.
Leasehold improvements are recorded at cost and amortized using the
straight-line method over the shorter of the term of the related lease or
estimated useful lives of the assets.
Income Taxes
Income taxes are accounted for under Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" (SFAS No. 109). Under SFAS No.
109, deferred tax assets and liabilities are determined based on differences
between the financial reporting and tax basis of assets and liabilities, and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse. Valuation allowances are established when
necessary.
Cash and Cash Equivalents
The Company considers all highly-liquid investments with original maturities
of three months or less to be cash equivalents.
Concentrations of Credit Risk
Financial instruments which potentially subject the Company to concentrations
of credit risk consist primarily of cash and accounts receivable. The Company
maintains its cash accounts with one financial institution. Cash balances at
this financial institution are in excess of the $100,000 Federal Deposit
Insurance Corporation insurable limit. Approximately 73% of accounts receivable
at December 31, 1999 consist of balances due from a federal government agency.
Management believes all balances are collectible and no allowance for potential
credit losses is necessary.
Accounting for Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" (SFAS No. 123), requires that stock awards granted
subsequent to January 1, 1995, be recognized as compensation expense based on
their fair value at the date of grant. Alternatively, a company may account for
granted stock awards under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," (APB No. 25) and disclose pro forma
income amounts which would have resulted from recognizing such awards at their
fair value. The Company has elected to account for stock-based compensation
expense under APB No. 25 and make the required pro forma disclosures for
compensation expense.
<PAGE>
Long-Lived Assets
The Company accounts for long-lived assets in accordance with Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to be Disposed Of" (SFAS No. 121). The
Company reviews for the impairment of long-lived assets and certain identifiable
intangibles whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Under SFAS No. 121, an
impairment loss would be recognized when estimated future cash flows expected to
result from the use of the asset and its eventual disposition is less than its
carrying amount. No such impairment losses have been identified by the Company.
2. Related Party Transactions
Revenue includes $25,000 earned under a software development agreement
between the Company and a Series A Preferred stockholder. This amount is
included in license revenues in the statement of operations.
The Company incurred approximately $112,000 in advertising expenses for
advertising on GoTo's Website. This amount is included in marketing and sales
expense in the statement of operations.
3. Property and Equipment
Property and equipment consists of the following:
<TABLE>
<S> <C>
Computer hardware..................................................... $ 380,000
Computer software..................................................... 95,000
Office furniture and equipment........................................ 125,000
Leasehold improvements................................................ 5,000
---------
605,000
Less accumulated depreciation and amortization........................ (162,000)
---------
$ 443,000
=========
</TABLE>
4. Stockholders' Deficit
During March 1999, the Company's Board of Directors approved a two for one
stock split of all common and Preferred Stock. All share amounts reported in
these financial statements and accompanying notes have been adjusted to reflect
this stock split. The Board of Directors also approved an amendment to the
Company's Articles of Incorporation to authorize the issuance of 40,000,000
shares of common stock and 3,000,000 shares of convertible Preferred Stock,
1,550,000 of which were designated Series A Preferred Stock and 1,450,000 of
which were designated Series B Preferred Stock. The Board of Directors also
authorized 2,750,000 shares of common stock to be reserved for issuance under
its stock option plan.
Holders of Series A Preferred Stock have voting rights equal to the number
of shares of common stock into which such shares may be converted. Holders of
Series A Preferred Stock are entitled when, and if declared by the Board of
Directors, to dividends at stated dividend rates per annum, payable in
preference and priority to any payment of dividends on common stock. Dividends
are noncumulative and no dividends have been declared as of December 31, 1999.
Series A Preferred Stock has liquidation preferences of an amount per share
equal to the original issuance price ($1.00 per share at December 31, 1999),
plus any declared but unpaid dividends. At the option of the holder, each share
of Series A Preferred Stock is convertible into shares of common stock by the
conversion price in effect at the time of conversion ($1.00 per share at
December 31, 1999), subject to adjustment for antidilution. Series A Preferred
Stock will automatically convert into shares of common stock immediately prior
to the closing of an underwritten public offering of common stock under the
Securities Act of 1933, in which the Company receives proceeds of at least
$15,000,000 at a minimum price of $8.375 per share, subject to adjustment for
dilution. In addition, each series of Preferred Stock will automatically convert
upon the approval for conversion by written consent of the holders of two-thirds
of the outstanding shares within a series. Subsequent to year end, all Series A
Preferred Stock was converted to GoTo common stock as discussed in Note 1.
<PAGE>
5. Series B Redeemable Preferred Stock
During March 1999, 1,432,948 shares of Series B Preferred Stock were sold.
The sale of shares included the transfer of rights to the Company to sell
certain software licensed from a Series B Preferred stockholder for an agreed
upon value of $5,000,000. This transfer was accounted for as a non-monetary
transfer of assets from a principal shareholder, at historical cost, in
accordance with the Staff Accounting Bulletin No. 48. Net proceeds from the sale
of shares, excluding the contract value of the license rights, of $6,946,000 was
recorded.
The Company is required to redeem all outstanding shares of Series B
Preferred Stock upon receiving, at any time after five years from the original
Series B Preferred Stock issuance date, a written notice from the holders of at
least two-thirds of the then outstanding shares of Series B Preferred Stock.
Upon receipt of the written notice, the Company will redeem at least 25% of the
Series B Preferred Stock shares outstanding each calendar quarter until all
Series B Preferred Stock shares are redeemed. The redemption price is equal to
the original issuance price of the Series B Preferred Stock shares plus any
declared but unpaid dividends. At December 31, 1999 the aggregate redemption
amount is $12 million. Through December 31, 1999, $758,000, representing the pro
rata portion of the redemption price, has been accreted to the carrying value of
the Series B Preferred Stock.
Holders of Series B Preferred Stock have voting rights equal to the number
of shares of common stock into which such shares may be converted. Holders of
Series B Preferred Stock are entitled when, and if declared by the Board of
Directors, to dividends at stated dividend rates per annum, payable in
preference and priority to any payment of dividends on common stock. Dividends
are noncumulative and no dividends have been declared as of December 31, 1999.
Series B Preferred Stock has liquidation preferences of an amount per share
equal to the original issuance price for each series of Preferred Stock ($8.37
per share at December 31, 1999), plus any declared but unpaid dividends. At the
option of the holder, each share of Series B Preferred Stock is convertible into
shares of common stock by the conversion price in effect at the time of
conversion ($8.37 per share at December 31, 1999), subject to adjustment for
antidilution. Series B Preferred Stock will automatically convert into shares of
common stock immediately prior to the closing of an underwritten public offering
of common stock under the Securities Act of 1933, in which the Company receives
proceeds of at least $15,000,000 at a minimum price of $8.37 per share, subject
to adjustment for dilution. In addition, each series of Preferred Stock will
automatically convert upon the approval for conversion by written consent of the
holders of two-thirds of the outstanding shares within a series. Subsequent to
year end, all Series B Preferred Stock was converted to GoTo common stock as
discussed in Note 1.
6. Stock Option Plan
The Company has a stock option plan (the Plan) under which the Board of
Directors may grant incentive stock options to employees and non-qualified stock
options to employees, directors, and consultants. The Company has reserved
2,750,000 shares of common stock for issuance under the Plan.
Incentive and non-qualified stock options may be granted at a price not
less than fair market value (as determined by the Board of Directors) and 85% of
the fair market value, respectively (110% of fair value to holders of 10% or
more of voting stock). Options are exercisable over periods not to exceed ten
years (five years for incentive stock options granted to holders of 10% or more
of the voting stock) from the date of grant. The Plan gives the Board of
Directors the discretion to determine when options granted will become
exercisable. All granted options vest 25% at the end of one year of service and
ratably over the following thirty-six months. The Company has the right to
repurchase unvested shares issued under the Plan, and retains the right of first
refusal to repurchase vested shares offered for sale to a third party.
<PAGE>
Stock option activity is as follows:
<TABLE>
<CAPTION>
Weighted
Stock Average
Options Exercise Price
----------- --------------
<S> <C> <C>
Options outstanding at December 31, 1998.... 593,500 $ 0.10
Granted................................... 656,000 0.64
Exercised................................. (636,750) 0.20
Forfeited................................. (143,750) (0.10)
--------
Options outstanding at December 31, 1999.... 469,000 $ 0.72
========
</TABLE>
The following table summarizes information regarding options outstanding and
options exercisable:
<TABLE>
<CAPTION>
Weighted
Average
Remaining
Range of Exercise Options Contractual Weighted Average Options Weighted Average
Prices Outstanding Life Exercise Price Exercisable Exercise Price
------------------- ------------- ------------- ---------------- ----------- -----------------
<S> <C> <C> <C> <C> <C>
$0.10 -- $37.17 469,000 9.6 $0.72 469,000 $0.72
</TABLE>
As of December 31, 1999, there were 1,644,250 shares available for future
grant under the Plan. Subsequent to year end, all of the outstanding options
were assumed by GoTo as discussed in Note 1.
The Company applies APB No. 25 and related interpretations in accounting for
its Plan. Accordingly, compensation cost has been recognized for the difference
between the deemed fair value of the stock over the exercise price of the stock
options granted to employees. During 1999, the Company recorded $14,104,000 as
additional-paid-in capital and deferred compensation (as a separate component of
stockholders' deficit) for the activity under the Plan involving employee stock
options. The Company recognized $3,420,000 of the deferred compensation as
expense for the year ended December 31, 1999. Amounts recorded as deferred
compensation are amortized to expense using a graded methodology over the
vesting period.
Under SFAS No. 123, the pro forma net loss would have been $7,354,000 for the
year ended December 31, 1999. For purposes of determining the pro forma net loss
under SFAS No. 123, the fair value of the options granted to employees was
estimated using the Black-Scholes model, with the following assumptions: no
dividend yield, a risk-free interest rate of 4.9%, volatility of 0.80, and an
expected life of four years. The weighted average fair value of the stock
options granted was $19.66 at December 31, 1999.
Applying SFAS No. 123 in the pro forma disclosure may not be representative
of the effects on pro forma net loss for future years as options vest over
several years.
7. Income Taxes
At December 31, 1999, the Company has federal and state of California net
operating loss carryforwards of approximately $3,226,000, which expire beginning
2005 through 2019. Deferred income tax assets of approximately $1,285,000
relating primarily to these net operating losses have been fully reserved, as
their ultimate realization is uncertain.
8. Lease Commitments
The Company leases office facilities under an operating lease in which the
Company is responsible for maintaining liability insurance and paying certain
allocable operating expenses. Rent expense for 1999 was $248,000. Subsequent to
year end, the Company entered into a non-cancellable operating lease for new
facilities which expires in July 2002. In connection with the new lease the
Company is required to maintain a security deposit of $111,000.
<PAGE>
Aggregate future minimum rental payments required under all leases are as
follows:
2000............................... $ 476,000
2001............................... 530,000
2002............................... 313,000
----------
$1,319,000
==========
<PAGE>
Exhibit 99.5
Independent Auditors' Report
Board of Directors
Cadabra Inc.
San Mateo, California
We have audited the accompanying balance sheet of Cadabra Inc. (formerly
Tesserae Information Systems, Inc.) as of December 31, 1998, and the related
statements of operations, stockholders' equity, and cash flows for the year then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Cadabra Inc. as of December 31,
1998, and the results of its operations and its cash flows for the year then
ended in conformity with generally accepted accounting principles.
As discussed in Note 1, in November 1999, the Company's Board of Directors
signed an Agreement and Plan of Reorganization to sell the Company.
/s/ Frank, Rimerman & Co. LLP
December 6, 1999
<PAGE>
Cadabra Inc.
(formerly Tesserae Information Systems, Inc.)
Balance Sheet
As of December 31, 1998
<TABLE>
<CAPTION>
Assets
<S> <C>
Current Assets:
Cash and cash equivalents $ 804,000
Accounts receivable 358,000
Prepaid expenses 16,000
----------
Total current assets 1,178,000
Property and equipment, net 70,000
Other assets, net 1,000
----------
$1,249,000
==========
Liabilities And Stockholders' Equity
Current Liabilities:
Bank borrowings $ 62,000
Accounts payable 24,000
Deferred revenue 95,000
----------
Total current liabilities 181,000
Commitments (Notes 5 and 8)
Stockholders' Equity:
Series A convertible preferred stock at no par value, liquidation preference of
$1.00 per share, authorized--1,550,000; issued--1,537,966 shares at 1,498,000
December 31, 1998
Common stock at no par value, authorized--20,000,000;
issued--3,000,000 shares at December 31, 1998 1,316,000
Deferred compensation (762,000)
Accumulated deficit (984,000)
----------
1,068,000
----------
$1,249,000
==========
</TABLE>
See Notes to Financial Statements.
<PAGE>
Cadabra Inc.
(formerly Tesserae Information Systems, Inc.)
Statement of Operations
For the Year Ended December 31, 1998
<TABLE>
<S> <C>
Revenue:
Related party $ 250,000
Other 9,000
-----------
259,000
Operating expenses:
Marketing and sales 61,000
General and administrative 259,000
Product development 867,000
Deferred compensation 394,000
-----------
1,581,000
-----------
Loss from operations (1,322,000)
Other income (expense):
Government grant 370,000
Interest income (expense), net 29,000
-----------
Net loss before income taxes (923,000)
Income taxes 2,000
-----------
Net loss $ (925,000)
===========
</TABLE>
See Notes to Financial Statements.
<PAGE>
Cadabra Inc.
(formerly Tesserae Information Systems, Inc.)
Statement of Stockholders' Equity
for the Year Ended December 31, 1998
<TABLE>
<CAPTION>
Series A Convertible
Preferred Stock Common Stock Deferred
Shares Amount Shares Amount Compensation
<S> <C> <C> <C> <C> <C>
Balances, December 31, 1997 .................. -- $ -- 2,974,286 $ 9,000 --
Sale of Series A preferred stock, net of
issuance costs of $40,000 ................ 1,537,966 1,498,000 -- -- --
Sale of common stock ....................... -- -- 25,714 2,000 --
Equity compensation for stock options issued
to employees ............................. -- -- -- 1,156,000 (762,000)
Equity compensation for stock options issued
to non-employees ......................... -- -- -- 149,000 --
Net loss ................................... -- -- -- --
----------- ---------- ----------- ----------- -----------
Balances, December 31, 1998 .................. 1,537,966 $1,498,000 3,000,000 $ 1,316,000 $ (762,000)
=========== ========== =========== =========== ============
<CAPTION>
Accumulated
Deficit Total
<S> <C> <C>
Balances, December 31, 1997 .................. $ (59,000) $ (50,000)
Sale of Series A preferred stock, net of
issuance costs of $40,000 ................ -- 1,498,000
Sale of common stock ....................... -- 2,000
Equity compensation for stock options issued
to employees ............................. -- 394,000
Equity compensation for stock options issued
to non-employees ......................... -- 149,000
Net loss ................................... (925,000) (925,000)
----------- -----------
Balances, December 31, 1998 .................. $ (984,000) $1,068,000
============ ===========
</TABLE>
See Notes to Financial Statements.
<PAGE>
Cadabra Inc.
(formerly Tesserae Information Systems, Inc.)
Statement of Cash Flows
For the Year Ended December 31, 1998
<TABLE>
<S> <C>
Cash Flows from Operating Activities:
Net loss $ (925,000)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 20,000
Equity compensation for stock options issued to employees 394,000
Equity compensation for stock options issued to non-employees 149,000
Changes in operating assets and liabilities:
Accounts receivable (315,000)
Prepaid expenses (16,000)
Accounts payable (35,000)
Deferred revenue 85,000
----------
Net cash used in operating activities (643,000)
----------
Cash Flows from Investing Activities-
----------
Purchase of property and equipment (74,000)
----------
Net cash used in investing activities (74,000)
----------
Cash Flows from Financing Activities:
Proceeds from sale of preferred stock, net 1,463,000
Proceeds from sale of common stock 2,000
Proceeds from bank borrowings, net 62,000
Repayment of notes payable to related parties (10,000)
----------
Net cash provided by financing activities 1,517,000
----------
Net Increase in Cash and Cash Equivalents 800,000
Cash and Cash Equivalents, beginning 4,000
----------
Cash and Cash Equivalents, ending $ 804,000
==========
Supplemental Disclosure of Cash Flow Information
Cash paid during the year for:
Interest $ 3,000
==========
Income taxes $ 2,000
==========
Supplemental Disclosure of Non-Cash Financing Activities-
Issuance of Series A convertible preferred stock as
repayment of notes payable $ 35,000
==========
</TABLE>
See Notes to Financial Statements.
<PAGE>
Cadabra Inc.
(formerly Tesserae Information Systems, Inc.)
Notes to Financial Statements
1. Nature of Business and Significant Accounting Policies
Nature of Business and Subsequent Events
General:
Cadabra Inc. (Company) is a California corporation engaged in the business of
developing software for the integration of structured databases into meta-
databases. The Company's 1998 operations consisted principally of $370,000 from
a government grant and $250,000 earned under a software license and development
agreement with one of its Series A preferred stockholders. In 1999 the Company
began developing web-based software which can be used for consumer comparison
shopping through its web site, and through syndicated private-label versions of
the shopping site for its customers. Effective April 12, 1999, the Company
changed its name to Cadabra Inc. from Tesserae Information Systems, Inc.
Subsequent Events:
On November 19, 1999, the Company signed an Agreement and Plan of
Reorganization (Agreement) with GoTo.com, Inc. (GoTo) to convert to GoTo stock,
or the right to receive GoTo stock, all of the Company's issued and outstanding
shares of capital stock, including all outstanding options, warrants or other
rights to acquire or receive shares of capital stock of the Company, for $8.0
million in cash and $242.0 million in GoTo common stock. The number of shares of
GoTo common stock will be determined based on the average of the daily closing
stock price of GoTo for the 30 days prior to closing, but not less than $40.00
per share or greater than $130.00 per share. This transaction is expected to
close during the quarter ending March 31, 2000.
Subsequent to December 31, 1998, the Company's Board of Directors approved
the following:
A two-for-one stock split of the Company's common stock and preferred stock.
All share amounts reported in these financial statements have been adjusted to
reflect this stock split.
Amendment of the Company's Articles of Incorporation to authorize the
issuance of 20,000,000 shares of common stock and 3,000,000 shares of
convertible preferred stock, 1,550,000 of which are designated Series A and
1,450,000 of which are designated Series B.
During March 1999, 1,432,948 shares of Series B preferred stock were sold.
The sale of shares included the transfer of rights to the Company to sell
certain software licensed from a Series B stockholder for an agreed upon value
of $5,000,000. This transfer will be accounted for as a non-monetary transfer of
assets from a principal shareholder at historical cost in accordance with the
Staff Accounting Bulletin No. 48, and net proceeds from the sale of shares,
excluding the value of the license rights, of approximately $7,000,000 will be
recorded.
An increase in the number of shares of common stock reserved for issuance
under its stock option plan to 2,750,000 shares.
Revenue Recognition:
Government Contracts:
The Company recognizes revenue from government grants as expenses are
incurred based on the reimbursement percentage specified in the grant agreement.
Reimbursements are requested (and received) on a monthly basis through
<PAGE>
the end of the contract period (December 31, 1999). Grant revenue is reported
as other income, while the related expenses are included in operating expenses.
License Revenue:
The Company accounts for software license revenue in accordance with the
American Institute of Certified Public Accountants Statement of Position 97-2,
"Software Revenue Recognition" (SOP 97-2). SOP 97-2 requires that revenue
recognized from software arrangements be allocated to each element of the
arrangement based on the relative fair values of the elements, such as software
products, upgrades, enhancements, post contract customer support, installation,
or training. If fair value for each element of the arrangement does not exist,
all revenue from the arrangement is deferred until such time that evidence of
fair value does exist or until all elements of the arrangement are delivered.
The Company recognizes revenue from sales of software licenses to end users
upon persuasive evidence of an arrangement, delivery of the software to a
customer, determination that collection of a fixed and determinable license fee
is considered probable, and there are no remaining commitments or contingencies.
Product Development:
Product development costs are expensed as incurred.
Property and Equipment:
Property and equipment is recorded at cost and depreciated using the
straight- line method over estimated useful lives of three to five years.
Property and equipment purchases which are eligible for reimbursement under
government grants are expensed as incurred.
Income Taxes:
The Company accounts for income taxes using the liability method. Under this
method, deferred income tax assets and liabilities are recorded based on the
estimated future tax effects of differences between the financial statement
basis and income tax basis of existing assets and liabilities. Deferred income
taxes are classified as current or noncurrent, based on the classifications of
the related assets and liabilities giving rise to the temporary difference. A
valuation allowance is provided against the Company's deferred income tax assets
when their realization is not reasonably assured.
Statement of Cash Flows:
For purposes of the statement of cash flows, the Company considers all
highly- liquid investments with original maturities of three months or less to
be cash equivalents.
Estimates:
The preparation of 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, disclosure of contingent
assets and liabilities, and reported amounts of revenue and expenses in the
financial statements and accompanying notes. Actual results could differ from
those estimates.
Concentrations of Credit Risk:
Financial instruments which potentially subject the Company to concentrations
of credit risk consist primarily of cash and accounts receivable. The Company
maintains its cash accounts with one financial institution. Cash balances at
this financial institution are in excess of the $100,000 Federal Deposit
Insurance Corporation insurable limit. Accounts receivable at December 31, 1998
consist of balances due from a Federal government agency (23%) and a stockholder
(77%) (Note 2). Management believes all balances are collectible and no
allowance for potential credit losses is necessary.
<PAGE>
Accounting for Stock-Based Compensation:
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," (SFAS No. 123) requires that stock awards granted
subsequent to January 1, 1995, be recognized as compensation expense based on
their fair value at the date of grant. Alternatively, a company may account for
granted stock awards under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB No. 25), and disclose pro forma
income amounts which would have resulted from recognizing such awards at their
fair value. The Company has elected to account for stock-based compensation
expense under APB No. 25 and make the required pro forma disclosures for
compensation expense.
2. Related Party Transactions
In 1998, revenue includes $250,000 earned under a software development
agreement between the Company and a Series A preferred stockholder. Accounts
receivable at December 31, 1998 includes $275,000 due from this stockholder.
During 1998, the Company issued 37,966 shares of Series A preferred stock to
a related party as repayment of $35,000 in notes payable and $3,000 in accrued
interest.
3. Property and Equipment
Property and equipment consists of the following:
<TABLE>
<S> <C>
Computers and related equipment $ 97,000
Office furniture and equipment 3,000
--------
100,000
Less accumulated depreciation 30,000
--------
$ 70,000
========
</TABLE>
4. Bank Borrowings
The Company has a bank line of credit which provides for borrowings for
equipment purchases of up to $75,000, with interest at the bank's prime rate
(7.75% at December 31, 1998). Borrowings are secured by equipment. All
borrowings were repaid in March 1999.
5. Convertible Preferred Stock
The Company is authorized to issue 3,000,000 shares of convertible preferred
stock, of which 1,550,000 shares are designated Series A and 1,450,000 shares
are designated Series B. The rights and preferences of the Series A and Series B
convertible preferred stock are as follows:
Voting Rights:
Holders of Series A and Series B have voting rights as if their shares were
converted into common stock.
Dividends:
Holders of Series A and Series B are entitled when, as, and if declared by
the Board of Directors, to dividends at stated dividend rates per annum, payable
in preference and priority to any payment of dividends on common stock.
Dividends are not mandatory or cumulative. No dividends have been declared as of
December 31, 1998.
Liquidation Preference:
Preferred stock has liquidation preferences of an amount per share equal to
the original issuance price for each series of preferred stock, plus any
declared but unpaid dividends. Remaining assets, if any, are first distributed
to common stockholders at a rate of $0.50 per share plus any undeclared but
unpaid dividends, and then pro rata based on the number of shares of common
stock, Series A and Series B (on an as converted basis) then issued and
outstanding.
<PAGE>
Conversion:
At the option of the holder, each share of Series A and Series B is
convertible into shares of common stock by the conversion price in effect at the
time of conversion, ($1.00 for Series A at December 31, 1998) subject to
adjustment for antidilution. Series A and Series B will automatically convert
into shares of common stock immediately prior to the closing of an underwritten
public offering of common stock under the Securities Act of 1933, in which the
Company receives proceeds of at least $15,000,000 at a minimum price of $8.375
per share, subject to adjustment for dilution. In addition, each series of
preferred stock will automatically convert upon the approval for conversion by
written consent of the holders of two-thirds of the outstanding shares within a
series.
Mandatory Redemption:
The Company is required to redeem all outstanding shares of Series B upon
receiving, at any time after five years from the original Series B issuance
date, a written notice from the holders of at least two-thirds of the then
outstanding shares of Series B. Upon receipt of the written notice, the Company
will redeem at least 25% of the Series B shares outstanding each calendar
quarter until all Series B shares are redeemed. The redemption price is equal to
the original issuance price of the Series B shares plus any declared but unpaid
dividends.
6. Stock Option Plan
The Company has a stock option plan (the Plan) under which the Board of
Directors may grant incentive stock options to employees and non-qualified stock
options to employees, directors, and consultants. The Company has reserved
2,750,000 shares of common stock for issuance under the Plan.
Incentive and nonqualified stock options may be granted at a price not less
than fair market value (as determined by the Board of Directors) and 85% of the
fair market value, respectively (110% of fair value to holders of 10% or more of
voting stock). Options are exercisable over periods not to exceed ten years
(five years for incentive stock options granted to holders of 10% or more of the
voting stock) from the date of grant. The Plan gives the Board of Directors the
discretion to determine when options granted will become exercisable. All
granted options vest 25% at the end of one year of service and ratably over the
following thirty-six months. The Company has the right to repurchase unvested
shares issued under the Plan, and retains the right of first refusal to
repurchase vested shares offered for sale to a third party.
Stock option activity is as follows:
<TABLE>
<CAPTION>
Weighted-
Stock Average
Options Exercise Price
------------ ------------------
<S> <C> <C>
Options outstanding, December 31, 1997 -- $ --
Granted 659,500 0.10
Cancelled (66,000) 0.10
-------
Options outstanding, December 31, 1998 593,500 $0.10
=======
</TABLE>
The following table summarizes information about stock options outstanding at
December 31, 1998:
<TABLE>
<CAPTION>
Weighted-
Average Weighted- Weighted-
Range of Remaining Average Average
Exercise Options Contractual Exercise Options Exercise
Prices Outstanding Life Price Exercisable Price
---------- ------------- ------------- ----------- ------------- ----------
<S> <C> <C> <C> <C> <C>
$0.10 593,500 9.4 $0.10 30,417 $0.10
</TABLE>
The Company applies APB No. 25 and related interpretations in accounting for
its Plan. Accordingly, compensation cost has been recognized for the difference
between the deemed fair value of the stock over the exercise price of the stock
options granted to employees. During 1998, the Company recorded $1,156,000 as
common stock and deferred compensation (as a separate component of stockholders'
equity) for the activity under the Plan involving employee stock
<PAGE>
options. The Company recognized $394,000 of the deferred compensation as expense
for the year ended December 31, 1998. Amounts recorded as deferred compensation
are amortized to expense using a graded methodology over the vesting period. The
Company also recognized $149,000 for the activity under the Plan involving
non-employee stock options as product development expense for the year ended
December 31, 1998. The fair value of the options to non-employees was estimated
on the date of grant and each successive vesting period (monthly) using the
Black-Scholes model with the following assumptions: no dividend yield, risk-free
interest rate of 4.70%, volatility of 0.80 and an expected life of two years.
Under SFAS No. 123, the pro forma net loss would have been $928,000 for the
year end December 31, 1998. For purposes of determining the pro forma net loss
under SFAS No. 123, the fair value of the options granted to employees was
estimated using the Black-Scholes model, assuming an expected life of four
years, no dividend yield, volatility of 0.80, and a risk-free interest rate of
4.9%. The weighted average fair value of the stock options granted was $2.67 at
December 31, 1998.
As of December 31, 1998, there were 2,156,500 shares available for future
grant under the Plan.
7. Income Taxes
At December 31, 1998 the Company has Federal and State of California net
operating loss carryforwards of approximately $325,000, which expire beginning
in 2113. Deferred income tax assets of approximately $130,000 relating primarily
to these net operating losses have been fully reserved, as their ultimate
realization is uncertain.
Under certain provisions of the 1986 Tax Reform Act, the availability of the
Company's net operating loss carryforwards are subject to limitation if it
should be determined that there has been a change in ownership of more than 50%
of the value of the Company's stock. Such a determination could substantially
limit the eventual tax utilization of these carryforwards.
8. Lease Commitments
The Company leases office facilities under an operating lease in which the
Company is responsible for maintaining liability insurance and paying certain
allocable operating expenses. Rent expense for 1998 was $60,000. Subsequent to
year end, the Company entered into a non-cancelable operating lease for new
facilities which expires in July 2002. In connection with the new lease the
Company is required to maintain prepaid rent and security deposits of $155,000.
Aggregate future minimum rental payments required under all leases are as
follows:
<TABLE>
<S> <C>
1999 $ 202,000
2000 370,000
2001 400,000
2002 235,000
----------
$1,207,000
==========
</TABLE>
