UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------------
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
-----------------------
Date of Report
(Date of earliest
event reported): March 30, 2000
AppNet, Inc.
(Exact name of registrant as specified in its charter)
Delaware 000-26263 52-2077860
- ----------------- ----------------- ----------------
(State or other
jurisdiction of (Commission File (IRS Employer
incorporation) Number) Identification No.)
6707 Democracy Boulevard
Bethesda, MD 20817
-----------------------------------------------------
(Address of principal executive offices including zip code)
(301) 493-8900
----------------------------
(Registrant's telephone number)
<PAGE>
Item 2. Acquisition or Disposition of Assets.
The audited financial statements of i33 communications corp., Salzinger &
Company, Inc. and Internet Outfitters, Inc., which were acquired by AppNet, Inc.
(the "Company") in 1999, are filed under Item 7 of this Current Report on Form
8-K pursuant to the requirements of Staff Accounting Bulletin No. 80 ("SAB No.
80"). As permitted by SAB No. 80, the audited financial statements for these
corporations for the periods from January 1, 1999 through their respective
acquisition dates were not included in the Company's Registration Statement on
Form S-1 filed in connection with the Company's June 1999 initial public
offering.
Item 7. Financial Statements and Exhibits.
(a) Financial Statements of Business Acquired
i33 communications corp.
Report of Independent Public Accountants
Balance Sheets as of December 31, 1997 and 1998, and January 7,
1999 Statements of Operations for the years ended December 31,
1997 and 1998, and
for the period from January 1, 1999 to January 7, 1999
Statements of Stockholder's Equity for the year ended December
31, 1998, and
for the period from January 1, 1999 to January 7, 1999
Statements of Cash Flows for the years ended December 31, 1997
and 1998,
and for the period from January 1, 1999 to January 7, 1999
Notes to Financial Statements
Salzinger & Company, Inc.
Report of Independent Public Accountants Balance Sheets as of
December 31, 1998 and March 14, 1999 Statements of Operations for
the year ended December 31, 1998, and for the
period from January 1, 1999 to March 14, 1999
Statements of Stockholder's Equity for the year ended December
31, 1998, and for the period from January 1, 1999 to March 14,
1999
Statements of Cash Flows for the year ended December 31, 1998,
and for the period from January 1, 1999 to March 14, 1999
Notes to Financial Statements
Internet Outfitters, Inc.
Report of Independent Public Accountants Balance Sheets as of
December 31, 1998 and March 25, 1999 Statements of Operations for
the year ended December 31, 1998, and for the
period from January 1, 1999 to March 25, 1999
Statements of Stockholders' Equity for the year ended December
31, 1998, and for the period from January 1, 1999 to March 25,
1999
Statements of Cash Flows for the year ended December 31, 1998,
and for the period from January 1, 1999 March 25, 1999
Notes to Financial Statements
-2-
<PAGE>
Report of Independent Public Accountants
To i33 communications corporation:
We have audited the accompanying balance sheets of i33 communications
corporation (a Delaware corporation), as of December 31, 1997 and 1998, and
January 7, 1999, and the related statements of operations, stockholders' equity
(deficit), and cash flows for the years ended December 31, 1997 and 1998, and
the period from January 1, 1999 to January 7, 1999. 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 audits.
We conducted our audits 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 audits provide 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 i33 communications corporation
as of December 31, 1997 and 1998, and January 7, 1999, and the results of its
operations and its cash flows for the years ended December 31, 1997 and 1998,
and the period from January 1, 1999 to January 7, 1999, in conformity with
generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Vienna, Virginia
May 3, 1999
-3-
<PAGE>
<TABLE>
i33 communications corporation
Balance Sheets
As of December 31, 1997 and 1998, and January 7, 1999
Assets
<CAPTION>
December 31, December 31, January 7,
1997 1998 1999
Current assets:
<S> <C> <C> <C>
Cash and cash equivalents $ 23,000 $ 1,000 $ 2,000
Accounts receivable, net of allowance for doubtful
accounts of $86,000, $417,000 and $460,000,
respectively 541,000 1,741,000 1,685,000
Other current assets 1,000 12,000 15,000
----------- ----------- -----------
Total current assets 565,000 1,754,000 1,702,000
Property and equipment, net 262,000 568,000 570,000
Other assets 7,000 12,000 30,000
----------- ----------- -----------
Total assets $ 834,000 $ 2,334,000 $ 2,302,000
=========== =========== ===========
Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Short-term borrowings $ -- $ 500,000 $ 500,000
Accounts payable 250,000 1,076,000 1,081,000
Accrued liabilities 356,000 1,082,000 1,081,000
Current portion of capital lease obligations 24,000 41,000 41,000
----------- ----------- -----------
Total current liabilities 630,000 2,699,000 2,703,000
Capital lease obligations, net of current portion 21,000 15,000 15,000
----------- ----------- -----------
Total liabilities 651,000 2,714,000 2,718,000
----------- ----------- -----------
Commitments and contingencies (Note 6)
Stockholders' equity (deficit):
Common stock, no par value; 100 shares authorized;
issued and outstanding 1,000 1,000 1,000
Retained earnings (accumulated deficit) 182,000 (381,000) (417,000)
----------- ----------- -----------
Total stockholders' equity (deficit) 183,000 (380,000) (416,000)
----------- ----------- -----------
Total liabilities and stockholders'
equity (deficit) $ 834,000 $ 2,334,000 $ 2,302,000
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these balance sheets.
-4-
<PAGE>
<TABLE>
i33 communications corporation
Statements of Operations
For the Years Ended December 31, 1997 and 1998, and
For the Period from January 1, 1999 to January 7, 1999
<CAPTION>
For the
Period from
For the Year For the Year January 1,
Ended Ended 1999 to
December 31, December 31, January 7,
1997 1998 1999
<S> <C> <C> <C>
Revenues $ 2,266,000 $ 4,360,000 $ 103,000
Cost of revenues 982,000 2,251,000 48,000
----------- ----------- -----------
Gross profit 1,284,000 2,109,000 55,000
Operating expenses:
Selling and marketing 471,000 985,000 19,000
General and administrative 550,000 1,343,000 70,000
Depreciation 45,000 114,000 2,000
----------- ----------- -----------
Total operating expenses 1,066,000 2,442,000 91,000
----------- ----------- -----------
Income (loss) from operations 218,000 (333,000) (36,000)
Other expense -- 35,000 --
Interest expense, net 1,000 11,000 --
----------- ----------- -----------
Income (loss) before income taxes 217,000 (379,000) (36,000)
Provision (benefit) for income taxes 159,000 (34,000) --
----------- ----------- -----------
Net income (loss) $ 58,000 $ (345,000) $ (36,000)
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these balance sheets.
-5-
<PAGE>
<TABLE>
i33 communications corporation
Statements of Stockholders' Equity (Deficit)
For the Years Ended December 31, 1997 and 1998, and
For the Period from January 1, 1999 to January 7, 1999
<CAPTION>
Retained Total
Common Earnings Stockholders'
Stock (Accumulated Equity
Shares Amount Deficit) (Deficit)
<S> <C> <C> <C> <C>
Balance, December 31, 1996 100 $ 1,000 $ 124,000 $ 125,000
Net income -- -- 58,000 58,000
--------- --------- --------- ---------
Balance, December 31, 1997 100 1,000 182,000 183,000
Distributions to stockholders -- -- (218,000) (218,000)
Net loss -- -- (345,000) (345,000)
--------- --------- --------- ---------
Balance, December 31, 1998 100 1,000 (381,000) (380,000)
Net loss -- -- (36,000) (36,000)
--------- --------- --------- ---------
Balance, January 7, 1999 100 $ 1,000 $(417,000) $(416,000)
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these balance sheets.
-6-
<PAGE>
<TABLE>
i33 communications corporation
Statements of Cash Flows
For the Years Ended December 31, 1997 and 1998, and
For the Period from January 1, 1999 to January 7, 1999
<CAPTION>
For the
Period From
For the For the January 1,
Year Ended Year Ended 1999 to
December 31, December 31, January 7,
1997 1998 1999
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 58,000 $ (345,000) $ (36,000)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities-
Depreciation 45,000 114,000 2,000
Deferred income taxes 133,000 (45,000) --
Change in assets and liabilities:
Accounts receivable, net (97,000) (1,200,000) 56,000
Other assets (7,000) (16,000) (21,000)
Accounts payable 211,000 826,000 5,000
Accrued liabilities (69,000) 771,000 (1,000)
----------- ----------- -----------
Net cash provided by operating
activities 274,000 105,000 5,000
----------- ----------- -----------
Cash flows used in investing activities:
Purchase of property and equipment, net (140,000) (362,000) (4,000)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from short-term borrowings -- 500,000 --
Payments on capital lease obligations (112,000) (47,000) --
Distributions to stockholders -- (218,000) --
----------- ----------- -----------
Net cash (used in) provided by
financing activities (112,000) 235,000 --
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 22,000 (22,000) 1,000
Cash and cash equivalents, beginning of period 1,000 23,000 1,000
----------- ----------- -----------
Cash and cash equivalents, end of period $ 23,000 $ 1,000 $ 2,000
=========== =========== ===========
Supplementary information:
Cash paid for interest $ 13,000 $ 11,000 $ --
=========== =========== ===========
Cash paid for income taxes $ 1,000 $ 5,000 $ --
=========== =========== ===========
Non-cash financing and investing activities-
Property capital lease additions $ 42,000 $ 59,000 $ --
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these balance sheets.
-7-
<PAGE>
i33 communications corporation
Notes to Financial Statements
As of December 31, 1997 and 1998, and January 7, 1999
1. Business Description:
i33 communications corporation ("i33" or the "Company") was incorporated in
January 1996, under the laws of the state of Delaware. The Company is an
interactive agency specializing in strategy, design, technology and online
advertising management for mid-sized to Fortune 1000 companies. Revenues are
generated from Website design and development, online media buying and planning,
online advertising management, site audits, Web publishing and project
management tools, custom application and database development and hosting
services. i33 is headquartered and operates primarily in New York.
On January 8, 1999, all of the issued and outstanding stock of the Company was
acquired by AppNet Systems, Inc. The Company incurred $35,000 in consulting fees
in connection with the sale to AppNet. This has been classified as other expense
in the accompanying statement of operations.
There are significant risks associated with the Company, including the
subjectivity of the Company's services to rapid technology change.
2. Summary of Significant Accounting Policies and Practices:
Use of 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 and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amount of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of
three months or less to be cash equivalents.
-8-
<PAGE>
Property and Equipment
Property and equipment are stated at cost, net of accumulated depreciation and
amortization. Depreciation and amortization are computed using the straight-line
method over the estimated useful lives of the related assets, as follows:
Computer equipment 5 years
Furniture and fixtures 7 years
Purchased software for internal use is capitalized and amortized principally
over 3 years. Leasehold improvements are amortized over the lesser of the
estimated useful life of the asset or the remaining lease term.
In accordance with Statement of Financial Accounting Standards No. 121 ("SFAS"),
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," the Company reviews its recorded long-lived assets for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable.
Fair Value of Financial Instruments
The Company's financial instruments consist primarily of cash and cash
equivalents, accounts receivable, accounts payable, short-term borrowings, and
capital lease obligations. In management's opinion, the carrying amounts of
these financial instruments approximated their fair values at December 31, 1997
and 1998, and January 7, 1999.
Revenue Recognition
Revenues from time and material contracts are recognized based on fixed hourly
rates for direct labor hours expended. Revenues from fixed-price contracts are
recognized on the percentage-of-completion method, with costs and estimated
profits recorded as work is performed. Revenues from fixed-price advertising
contracts in which the Company delivers advertising impressions for its
customers on third-party websites are recognized ratably over the period the
advertising impressions are delivered. In accordance with industry practice, the
cost of third-party advertising placed by the Company on behalf of its clients
is offset against the related customer reimbursement in the accompanying
statements of operations.
Cost of revenues includes all direct material and labor costs related to
contract performance and does not include any related depreciation expense.
Provisions for estimated losses on uncompleted contracts are made in the period
in which such losses are determined. Changes in contract performance and
estimated profitability, including final contract settlements, may result in
revisions to costs and income and are recognized in the period in which the
revisions are determined. Unbilled receivables on contracts are comprised of
costs, plus earnings on certain contracts in excess of contractual billings, on
such contracts. Cash received in excess of costs incurred is classified as
deferred revenue.
-9-
<PAGE>
Business Concentration and Credit Risk
The following table summarizes the revenues and receivables from clients in
excess of 10 percent of total revenues and receivables:
<TABLE>
<CAPTION>
Revenues
For the Accounts Accounts
Revenues Period Receivable Receivable
For the Years Ended Ended As of As of
December 31, January 7, December 31, January 7,
1997 1998 1999 1997 1998 1999
<S> <C> <C> <C> <C> <C> <C>
Customer A * * 22% * * *
Customer B * * 15% * * *
Customer C * * 10% * * *
Customer D * * 19% * 20% 22%
Customer E * * * * 12% 13%
Customer F * 10% * * 16% 18%
Customer G 14% * * 16% * *
Customer H 13% * * * * *
Customer I 11% * * * * *
Customer J * * * 14% * *
* Represents less than 10 percent of total.
</TABLE>
Income Taxes
In 1996, the Company was taxed as a C corporation. As such, income taxes are
accounted for using an asset and liability approach that requires the
recognition of taxes payable or refundable for the current year and deferred tax
liabilities and assets for the future tax consequences of events that have been
recognized in the Company's financial statements or tax returns. The measurement
of current and deferred tax liabilities and assets are based on provisions of
the enacted tax law; the effects of future changes in tax laws or rates are not
anticipated. The measurement of deferred tax assets is reduced, if necessary, by
the amount of any tax benefits that, based on available evidence, are not
expected to be realized.
In 1997, 1998, and the period from January 1 to January 7, 1999, the Company,
with the consent of its shareholders, has elected to be taxed pursuant to
Subchapter S of the Internal Revenue Code ("an S corporation"). In lieu of
corporation income taxes, the shareholders of an S corporation are taxed on
their proportionate share of the Company's taxable income. Therefore, no
provision for federal income taxes has been included in the accompanying
financial statements. The Company is subject to state and city income taxes
based on the Company's taxable income and alternative minimum tax. The recorded
tax provision (benefit) for 1997 and 1998 relates to these state and city taxes.
There was no recorded tax provision (benefit) as of January 7, 1999. The
significant components of differences between income reported for financial
statement purposes and income reported for tax purposes relates to tax basis
adjustments for accounts receivable, payroll and corporate tax liabilities.
-10-
<PAGE>
3. Accounts Receivable:
Accounts receivable consists of the following:
<TABLE>
<CAPTION>
December 31 January 7,
1997 1998 1999
<S> <C> <C> <C>
Accounts receivable $ 599,000 $ 2,009,000 $ 1,847,000
Unbilled accounts receivable 28,000 149,000 298,000
Allowance for doubtful accounts (86,000) (417,000) (460,000)
----------- ----------- -----------
Accounts receivable, net $ 541,000 $ 1,741,000 $ 1,685,000
=========== =========== ===========
</TABLE>
4. Property and Equipment:
Property and equipment consists of the following:
December 31 January 7,
1997 1998 1999
Computer equipment $ 169,000 $ 474,000 $ 474,000
Furniture and fixtures 112,000 131,000 131,000
Leasehold improvements 38,000 134,000 138,000
--------- --------- ---------
319,000 739,000 743,000
========= ========= =========
Accumulated depreciation and amortization (57,000) (171,000) (173,000)
--------- --------- ---------
Property and equipment, net $ 262,000 $ 568,000 $ 570,000
========= ========= =========
5. Accrued Liabilities:
Accrued liabilities consist of the following:
December 31 January 7,
1997 1998 1999
Deferred revenue $ -- $ -- $ 120,000
Deferred tax liability 239,000 194,000 194,000
Accrued media expense -- 798,000 744,000
Other accrued liabilities 117,000 90,000 23,000
---------- ---------- ----------
Total accrued liabilities $ 356,000 $1,082,000 $1,081,000
========== ========== ==========
6. Leases:
The Company has noncancellable operating leases, primarily for real estate, that
expire over the next three years. Rental expense for operating leases during the
years ended December 31, 1997 and 1998, and the period from January 1, 1999 to
January 7, 1999, was $73,000, $102,000 and $6,000, respectively.
-11-
<PAGE>
The Company leases certain equipment under capital leases.
Future minimum lease payments under capital leases and noncancellable operating
leases are as follows as of January 7, 1999:
Capital Operating
Leases Leases
Year ended December 31, 1999 $ 39,000 $ 93,000
2000 21,000 63,000
2001 5,000 42,000
------- -------
Total minimum lease payments 65,000 $198,000
Less: Amount representing interest (9,000) =======
-------
Present value of capital lease obligations 56,000
Less: Current portion of capital lease obligations 41,000
-------
Long-term portion of capital lease obligation $ 15,000
=======
Equipment under capital leases is summarized as follows:
December 31 January 7,
1997 1998 1999
Computer equipment $54,000 $93,000 $91,000
Accumulated depreciation (7,000) (14,000) (14,000)
------ ------- -------
Total $47,000 $79,000 $77,000
======= ======= =======
7. Income Taxes:
The Company follows the provisions of SFAS No. 109, "Accounting for Income
Taxes," for financial reporting purposes. Deferred tax assets or liabilities at
the end of each period are determined using the currently enacted tax rates to
apply to taxable income in the period in which the deferred tax asset or
liability is expected to be settled or realized.
The components of the net deferred tax liability as of December 31, 1997 and
1998, and January 7, 1999 are as follows:
-12-
<PAGE>
December 31 January 7,
1997 1998 1999
Total deferred tax liabilities $ 242,000 $ 199,000 $ 199,000
Total deferred tax assets (3,000) (5,000) (5,000)
--------- --------- ---------
Net deferred tax liability $ 239,000 $ 194,000 $ 194,000
========= ========= =========
The sources of and differences between the financial accounting and tax basis of
i33's assets and liabilities that give rise to the net deferred tax liability
are as follows:
December 31 January 7,
1997 1998 1999
Deferred tax liabilities:
Differences from accrual to cash basis $ 242,000 $ 199,000 $ 199,000
Deferred tax assets:
Other (3,000) (5,000) (5,000)
--------- --------- ---------
$ 239,000 $ 194,000 $ 194,000
========= ========= =========
The components of the provision (benefit) for income taxes as of December 31,
1997 and 1998, and January 7, 1999 are as follows:
December 31 January 7,
1997 1998 1999
Federal income taxes:
Deferred $ 136,000 $ -- $ --
State taxes:
Current 26,000 11,000 --
Deferred (3,000) (45,000) --
--------- --------- --------
Provisions (benefit) for income taxes $ 159,000 $ (34,000) $ --
========= ========= ========
For the years ended December 31, 1997 and 1998, and the period from January 1,
1999 to January 7, 1999, the provision (benefit) for income taxes differed from
the amounts computed at the statutory rate, as follows:
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<PAGE>
December 31 January 7,
1997 1998 1999
Income tax computed at statutory rate $ -- $ -- $ --
State income taxes, net of federal income
tax benefit 23,000 (34,000) --
C Corporation federal tax 136,000 -- --
---------
Other, net $159,000 $(34,000) $ --
======== ======== =========
8. Related Parties:
The Company shares office space and has purchased equipment from a related party
during the years ended December 31, 1997 and 1998, and the period from January
1, 1999 to January 7, 1999.
The Company has a note with a relative of one of the shareholders, which is
collateralized by substantially all of the assets of the Company and is
personally guaranteed by the Company's President and Chief Technical Officer.
Under the terms of the agreement, the loan was interest free and payment was due
upon the sale of the Company. As of January 7, 1999, the balance due on the note
was $500,000. The note was repaid on January 8, 1999.
During the years ended December 31, 1997 and 1998, the Company wrote off amounts
due from a related party of $5,000 and $18,000, respectively. No amounts were
written off during the period from January 1, 1999 to January 7, 1999.
-14-
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Salzinger & Company:
We have audited the accompanying balance sheets of Salzinger & Company (a
Virginia corporation), as of December 31, 1998 and March 14, 1999, and the
related statements of operations, stockholder's equity, and cash flows for the
year ended December 31, 1998, and the period from January 1, 1999 to March 14,
1999. 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 audits.
We conducted our audits 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 audits provide 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 Salzinger & Company
as of December 31, 1998 and March 14, 1999, and the results of its operations
and its cash flows for the year ended December 31, 1998, and the period from
January 1, 1999 to March 14, 1999, in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
Vienna, Virginia
April 23, 1999
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<PAGE>
<TABLE>
Salzinger & Company
Balance Sheets
As of December 31, 1998 and March 14, 1999
<CAPTION>
December 31, March 14,
1998 1999
<S> <C> <C>
ASSETS
Current assets:
Cash .................................................... $ 193,000 $ 408,000
Accounts receivable ..................................... 1,707,000 804,000
---------- ----------
Total current assets ..................... 1,900,000 1,212,000
Property and equipment, net ................................... 43,000 40,000
Other assets .................................................. 14,000 20,000
---------- ----------
Total assets ............................. $1,957,000 $1,272,000
========== ==========
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities:
Short-term borrowing .................................... $ 130,000 $ --
Accounts payable ........................................ 34,000 16,000
Accrued acquisition costs ............................... -- 472,000
Other accrued liabilities ............................... 177,000 364,000
---------- ----------
Total current liabilities ................ 341,000 852,000
========== ==========
Commitments and contingencies (Note 5)
Stockholder's equity:
Common stock, $1.00 par value; 5,000 shares
authorized; 1,000 shares issued and
outstanding ........................................... 1,000 1,000
Retained earnings ....................................... 1,615,000 419,000
---------- ----------
Total stockholder's equity ............... 1,616,000 420,000
---------- ----------
Total liabilities and stockholder's equity $1,957,000 $1,272,000
========== ==========
The accompanying notes are an integral part of these balance sheets.
</TABLE>
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<PAGE>
Salzinger & Company
Statements of Operations
For the Year Ended December 31, 1998, and
For the Period from January 1, 1999 to March 14, 1999
For the For the Period
Year Ended From January 1,
December 31, 1999 to
1998 March 14,1999
Revenues .................................... $ 3,110,000 $ 417,000
Cost of revenues ............................ 1,738,000 214,000
----------- -----------
Gross profit ........... 1,372,000 203,000
=========== ===========
Operating expenses:
Selling and marketing ................. 2,000 48,000
General and administrative ............ 425,000 172,000
Depreciation and amortization ......... 13,000 3,000
Acquisition - related compensation .... -- 706,000
----------- -----------
Total operating expenses 440,000 929,000
----------- -----------
Income (loss) from operations ............... 932,000 (726,000)
Interest income ............................. 20,000 2,000
Other expense ............................... -- (472,000)
----------- -----------
Net income (loss) ........................... $ 952,000 $(1,196,000)
=========== ===========
The accompanying notes are an integral part of these balance sheets.
-17-
<PAGE>
<TABLE>
Salzinger & Company
Statements of Stockholder's Equity
For the Year Ended December 31, 1998, and
For the Period from January 1, 1999 to March 14, 1999
<CAPTION>
Common Total
Stock Retained Stockholder's
Shares Amount Earnings Equity
<S> <C> <C> <C> <C>
Balance, December 31, 1997 ... 1,000 $ 1,000 $ 663,000 $ 664,000
Net income ............. -- -- 952,000 952,000
----------- ----------- ----------- -----------
Balance, December 31, 1998 ... 1,000 1,000 1,615,000 1,616,000
Net loss ............... -- -- (1,196,000) (1,196,000)
----------- ----------- ----------- -----------
Balance, March 14, 1999 ...... 1,000 $ 1,000 $ 419,000 $ 420,000
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these balance sheets.
-18-
<PAGE>
<TABLE>
Salzinger & Company
Statements of Cash Flows
For the Year Ended December 31, 1998, and
For the Period from January 1, 1999 to March 14, 1999
<CAPTION>
For the For the
Year Ended Period From January 1,
December 31, 1999 to
1998 March 14, 1999
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ............................... $ 952,000 $(1,196,000)
Adjustments to reconcile netincome
(loss) to net cash (used in) provided
by operating activities:
Depreciation and amortization .............. 13,000 3,000
Change in assets and liabilities:
Accounts receivable ................... (1,152,000) 903,000
Other assets .......................... (5,000) (6,000)
Accounts payable ...................... 19,000 (18,000)
Accrued acquisition costs ............. -- 472,000
Other accrued liabilities ............. 11,000 187,000
----------- -----------
Net cash (used in) provided
by in operating activities ..... (162,000) 345,000
----------- -----------
Cash flows from financing activities:
Short-term borrowing (payment) .................. 130,000 (130,000)
----------- -----------
Net (decrease) increase in cash ....................... (32,000) 215,000
Cash beginning of year ................................ 225,000 193,000
----------- -----------
Cash, end of period ................................... $ 193,000 $ 408,000
=========== ===========
</TABLE>
The accompanying notes are an integral part of these balance sheets.
-19-
<PAGE>
1. Business Description:
Salzinger & Company ("Salzinger" or the "Company") was incorporated in 1995,
under the laws of the state of Virginia. Salzinger is a consulting company
providing business-level strategic consulting in website marketing strategy
development, planning and implementation. It is headquartered in Virginia and
operates primarily in the Northeast, with some international clients.
On March 15, 1999, substantially all of the assets of the Company were acquired
by AppNet Systems, Inc. ("AppNet"). The Company incurred $472,000 of expenses in
conjunction with the sale to AppNet primarily for consulting and legal services.
This has been classified in other expenses in the accompanying statements of
operations.
There are significant risks associated with the Company, including the
subjectivity of the Company's services to rapid technological change.
2. Summary of Significant Accounting Policies and Practices:
Use of 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 and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the reporting
period.
Actual results could differ from those estimates.
Property and Equipment
Property and equipment are stated at cost, net of accumulated depreciation
and amortization. Depreciation and amortization are computed using the
straight-line method over the estimated useful lives of the related assets, as
follows:
Computer equipment........................ three years
Furniture and fixtures.................... five years
Automobile................................ five years
Purchased software is capitalized and amortized principally over three
years.
In accordance with Statement of Financial Accounting Standards ("SFAS")
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," the Company reviews its recorded long-lived assets
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable.
-20-
<PAGE>
Fair Value of Financial Instruments
The Company's financial investments consist primarily of cash, accounts
receivable, accounts payable and short-term borrowings. In management's opinion,
the carrying amounts of these financial investments approximated their fair
values at December 31, 1998 and March 14, 1999.
Revenue Recognition
Revenues from time and material contracts are recognized based on fixed hourly
rates for direct labor hours expended. The Company also enters into arrangements
in which a portion of its fee is based on the successful completion of a
transaction. Revenue under these contracts is recognized when the transaction
has closed and the Company is due its success fee. Cost of revenues includes all
direct material and labor costs related to contract performance and does not
include any related depreciation expense. Unbilled receivables on contracts are
comprised of costs, plus earnings on certain contracts in excess of contractual
billings on such contracts. Cash received in excess of costs incurred is
classified as deferred revenue. Business Concentration and Credit Risk
The following table summarizes the revenues and accounts receivable from clients
in excess of 10 percent of total revenues and accounts receivable for the year
ended December 31, 1998, and the period from January 1, 1999 to March 14, 1999:
<TABLE>
<CAPTION>
Revenues Accounts Receivables
For the For the
For the Period From For the Period From
Year Ended January 1, 1999 to Year Ended January 1, 1999 to
December 31, March 14, December 31, March 14,
1998 1999 1998 1999
<S> <C> <C> <C> <C>
Customer A.................... 31% 20% 50% 19%
Customer B ................... 21% * 27% *
Customer C ................... 15% * * 19%
Customer D ................... 15% 26% 13% 13%
Customer E ................... * 20% * 10%
Customer F ................... * * * 24%
* Represents less than 10% of total.
</TABLE>
Income Taxes
The Company, with the consent of its shareholder, has elected to be
taxed pursuant to subchapter S of the Internal Revenue Code (an "S
Corporation"). In lieu of corporation income taxes, the shareholders of an S
corporation are taxed on their proportionate share of
-21-
<PAGE>
the Company's taxable income. Therefore, no provision for federal or state
income taxes has been included in the accompanying financial statements.
3. Accounts Receivable:
Accounts receivable consists of the following as of December 31, 1998, and
March 14, 1999:
December 31, March 14,
1998 1999
Accounts receivable ............. $1,522,000 $ 583,000
Unbilled accounts receivable .... 185,000 221,000
---------- ----------
$1,707,000 $ 804,000
========== ==========
There was no allowance reserved for doubtful accounts as management
believes that all amounts will be collected.
4. Property and Equipment:
Property and equipment consist of the following as of December 31, 1998,
and March 14, 1999:
December 31, March 14,
1998 1999
Computer equipment and software ................ $ 21,000 $ 21,000
Furniture and fixtures ......................... 9,000 9,000
Vehicle ........................................ 35,000 35,000
-------- --------
65,000 65,000
Accumulated depreciation and amortization ...... (22,000) (25,000)
-------- --------
Property and equipment, net $ 43,000 $ 40,000
======== ========
5. Other Accrued Liabilities:
Other accrued liabilities consist of the following:
December 31, March 14,
1998 1999
Accrued compensation and benefits ............ $151,000 $330,000
Deferred revenue ............................. 25,000 25,000
Other ........................................ 1,000 9,000
-------- --------
Other accrued liabilities $177,000 $364,000
======== ========
-22-
<PAGE>
6. Commitments and Contingencies:
Leases
The Company is party to a sublease agreement under which it rents its corporate
office. The sublease is renewable on a month-to-month basis. The Company is also
party to a second lease for office space, which is renewed annually. The Company
leases certain equipment under noncancelable operating leases.
Future minimum lease payments under noncancelable operating leases for office
space and equipment are as follows as of March 14, 1999:
1999.................................................... $48,000
2000.................................................... 13,000
------
Total minimum lease payments.................... $61,000
======
Rent expense under operating leases during the year ended December 31, 1998, and
for the period from January 1, 1999 to March 14, 1999, was $130,000 and $32,000,
respectively.
7. Related Parties:
The Company's sole stockholder loaned $130,000 to the Company in December 1998.
The Company repaid the loan in January 1999.
8. Retirement Plan:
The Company maintains a profit-sharing and retirement plan under the
provisions of the Internal Revenue Code (the "IRC") section 408(p). The Plan
provides for contributions by employees and a discretionary contribution by the
Company. The plan is for the benefit of all employees. Participants may
contribute up to $6,000 annually. Employee contributions are fully vested. The
Company contributes 2 percent of employee's total salary. The Company's
contribution vests immediately. Company contributions totaled $23,000 and $4,000
for the year ended December 31, 1998, and for the period from January 1, 1999 to
March 14, 1999, respectively.
Effective May 1, 1999, Salzinger employees will be covered by the AppNet
401(k) Plan.
9. Acquisition - Related Compensation
In conjunction with AppNet, Inc.'s purchase of Salzinger, Salzinger paid an
unconditional cash bonus of approximately $706,000 to certain employees for past
services.
-23-
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Internet Outfitters, Inc.:
We have audited the accompanying balance sheets of Internet Outfitters, Inc. (a
California corporation), as of December 31, 1998 and March 25, 1999, and the
related statements of operations, stockholders' equity, and cash flows for the
year ended December 31, 1998, and for the period from January 1, 1999 to March
25, 1999. 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 audits.
We conducted our audits 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 audits provide 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 Internet Outfitters as of
December 31, 1998 and March 25, 1999, and the results of its operations and its
cash flows for the year ended December 31, 1998, and for the period from January
1, 1999 to March 25, 1999, in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Vienna, Virginia
May 11, 1999 (except with
respect to the matter
discussed in Note 13, as to
which our date is February 9, 2000)
-24-
<PAGE>
<TABLE>
Internet Outfitters, Inc.
Balance Sheets
As of December 31, 1998 and March 25, 1999
<CAPTION>
December 31, March 25,
1998 1999
ASSETS
<S> <C> <C>
Current assets:
Cash .................................................... $ 70,000 $ 352,000
Accounts receivable, net ................................ 555,000 550,000
Other current assets .................................... 71,000 123,000
----------- -----------
Total current assets ..................... 696,000 961,000
Property and equipment, net ................................... 239,000 276,000
Other assets .................................................. 6,000 6,000
----------- -----------
Total assets ............................. $ 941,000 $ 1,243,000
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................ $ 227,000 $ 205,000
Accrued liabilities ..................................... 184,000 503,000
Current portion of long-term debt ....................... 316,000 100,000
Current portion of capital lease obligations ............ 17,000 13,000
----------- -----------
Total current liabilities ................ 744,000 821,000
Long-term debt, net of current portion ........................ 53,000 53,000
Capital lease obligations, net of current portion ............. 3,000 3,000
Deferred tax liability ........................................ 29,000 31,000
----------- -----------
Total liabilities ........................ 829,000 908,000
----------- -----------
Commitments and contingencies (Note 11)
Stockholders' equity:
Common stock, no par value;
20,000,000 shares authorized;
7,695,641 and 10,031,309
shares issued and outstanding
as of December 31, 1998 and
March 25, 1999, respectively .......................... 8,000 317,000
Additional paid-in capital .............................. 221,000 221,000
Deferred compensation ................................... (164,000) (144,000)
Retained earnings ....................................... 47,000 5,000
----------- -----------
Total stockholders' equity ............... 112,000 399,000
----------- -----------
Total liabilities and
stockholders' equity.................... $ 941,000 $ 1,307,000
=========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
-25-
<PAGE>
<TABLE>
Internet Outfitters, Inc.
Statements of Operations
For the Year Ended December 31, 1998,
and for the period from January 1, 1999 to March 25, 1999
<CAPTION>
Period From
January 1,
December 31, 1999 to March 25,
1998 1999
<S> <C> <C>
Revenues .............................................. $ 2,343,000 $ 663,000
Cost of revenues ...................................... 1,287,000 431,000
----------- -----------
Gross profit ..................... 1,056,000 232,000
----------- -----------
Operating expenses:
Selling and marketing ........................... 47,000 15,000
General and administrative ...................... 859,000 232,000
Stock-based compensation ........................ 57,000 20,000
Depreciation and amortization ................... 57,000 17,000
----------- -----------
Total operating expenses ......... 1,020,000 284,000
----------- -----------
Income (loss) from operations ......................... 36,000 (52,000)
Interest expense, net ................................. 47,000 17,000
----------- -----------
Loss before income taxes (11,000) (69,000)
Provision (benefit) for income taxes .................. 52,000 (27,000)
----------- -----------
Net loss .............................................. $ (63,000) $ (42,000)
=========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
-26-
<PAGE>
<TABLE>
Internet Outfitters, Inc.
Statements of Stockholders' Equity
For the Year Ended December 31, 1998,
and for the period from January 1, 1999 to March 25, 1999
<CAPTION>
Common Additional Total
Stock Paid-In Deferred Accumulated Stockholders'
Shares Amount Capital Compensation Deficit Equity
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 .... 7,695,641 $ 8,000 $ -- $ -- $ 110,000 $ 118,000
Issuance of stock options -- -- 221,000 (221,000) -- --
Stock-based compensation -- -- -- 57,000 -- 57,000
Net loss ................ -- -- -- -- (63,000) (63,000)
---------- ---------- ---------- ---------- ---------- ----------
Balance, December 31, 1998 .... 7,695,641 8,000 221,000 (164,000) 47,000 112,000
Stock-based compensation -- -- -- 20,000 -- 20,000
Exercise of stock options 2,335,668 309,000 -- -- -- 309,000
Net loss ................ -- -- -- -- (42,000) (106,000)
---------- ---------- ---------- ---------- ---------- ----------
Balance, March 25, 1999 ....... 10,031,309 $ 317,000 $ 221,000 $ (144,000) $ 5,000 $ 335,000
========== ========== ========== ========== ========== ==========
</TABLE>
-27-
<PAGE>
<TABLE>
Internet Outfitters, Inc.
Statements of Cash Flows
For the Year Ended December 31, 1998,
and for the period from January 1, 1999 to March 25, 1999
<CAPTION>
For the Period From
January 1, 1999 to
December 31, March 25,
1998 1999
<S> <C> <C>
Cash flows from operating activities:
Net loss ................................................... $ (63,000) $ (42,000)
Adjustments to reconcile net
loss to net cash used in operating
activities:
Deferred income taxes ................................. (29,000) (35,000)
Stock-based compensation .............................. 57,000 20,000
Depreciation and amortization ......................... 57,000 17,000
Change in assets and liabilities:
Accounts receivable, net ......................... (217,000) 5,000
Other assets ..................................... (8,000) (15,000)
Accounts payable ................................. 5,000 (22,000)
Accrued liabilities .............................. 138,000 319,000
--------- ---------
Net cash (used in) provided
by operating activities ................... (60,000) 247,000
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment, net .................... (124,000) (54,000)
--------- ---------
Cash flows from financing activities:
Proceeds from long-term debt ............................... 292,000 --
Repayments of long-term debt ............................... (28,000) (216,000)
Repayments of capital lease obligations .................... (13,000) (4,000)
Proceeds from exercise of stock options .................... -- 309,000
--------- ---------
Net cash provided by financing activities ... 251,000 89,000
--------- ---------
Net increase in cash ............................................. 67,000 282,000
Cash, beginning of period ........................................ 3,000 70,000
--------- ---------
Cash, ending of period ........................................... $ 70,000 $ 352,000
========= =========
Supplementary information:
Cash paid for interest ..................................... $ 45,000 $ 16,800
========= =========
Cash paid for income taxes ................................. $ 63,000 $ 34,000
========= =========
</TABLE>
The accompanying notes are an integral part of these statements.
-28-
<PAGE>
1. Business Description:
Internet Outfitters, Inc. ("IO" or the "Company") was incorporated in
1994, under the laws of the state of California. IO is an information technology
services company providing internet and web-based solutions designed to improve
clients' business processes, including strategy consulting, applications
development, electronic commerce ("E-Commerce"), systems design, technology
development, integration, and operation. The Company is headquartered in Santa
Monica, California and operates primarily in the western region of the United
States.
On March 26, 1999, all of the issued and outstanding stock of the Company
was acquired by AppNet Systems, Inc. ("AppNet").
There are significant risks associated with the Company, including the
subjectivity of the Company's services to rapid technological change and the
Year 2000 issue.
2. Summary of Significant Accounting Policies and Practices:
Use of 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 and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the reporting
period.
Actual results could differ from those estimates.
Property and Equipment
Property and equipment are stated at cost, net of accumulated depreciation
and amortization. Depreciation and amortization are computed using the
straight-line method over the estimated useful lives of the related assets, as
follows:
Computer equipment and software...................... three to five years
Furniture and fixtures............................... seven years
Purchased software and third-party costs incurred to develop software for
internal use are capitalized and amortized principally over three years.
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," the Company reviews its recorded long-lived assets for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable.
-29-
<PAGE>
Fair Value of Financial Instruments
The Company's financial instruments consist primarily of cash, accounts
receivable, accounts payable, long-term debt and capital lease obligations. In
management's opinion, the carrying amounts of these financial instruments
approximated their fair values at December 31, 1998 and March 25, 1999.
Stock-Based Compensation
The Company accounts for stock-based employee compensation arrangements
using the intrinsic value method in accordance with provisions of Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and complies with the disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." Under APB Opinion No. 25,
compensation cost is recognized based on the difference, if any, on the date of
grant between the fair value of the Company's stock and the amount an employee
must pay to acquire the stock.
Revenue Recognition
Revenues from time and material contracts are recognized based on fixed
hourly rates for direct labor hours expended. Revenues from fixed-price
contracts are recognized on the percentage-of-completion method, with costs and
estimated profits recorded as work is performed. Revenues from fixed-price
advertising contracts in which the Company delivers advertising impressions for
its customers on third-party web sites are recognized ratably over the period
the advertising impressions are delivered. In accordance with industry practice,
the cost of third party advertising placed by the Company on behalf of its
clients is offset against the related customer reimbursement in the accompanying
statement of operations. Revenues from cost-plus-fixed-fee contracts are
recognized on the basis of direct costs plus indirect costs incurred plus a
fixed profit percentage.
Costs of revenues includes all direct material and labor costs related to
contract performance and does not include any related depreciation expense.
Provisions for estimated losses on uncompleted contracts are made in the period
in which such losses are determined. Changes in contract performance and
estimated profitability, including final contract settlements, may result in
revisions to costs and income and are recognized in the period in which the
revisions are determined. Unbilled revenues on contracts are comprised of costs,
plus earnings on certain contracts in excess of contractual billings on such
contracts. Cash received in excess of costs incurred is classified as deferred
revenue.
-30-
<PAGE>
Business Concentration and Credit Risk
The following table summarizes the revenues and accounts receivable from
clients in excess of 10 percent of total revenues and accounts receivable as of
December 31, 1998 and March 25, 1999:
<TABLE>
<CAPTION>
December 31, 1998 March 25, 1999
Accounts Accounts
Revenues Receivable Revenues Receivable
<S> <C> <C> <C> <C>
Customer A............................. 42.2% 27.0% 19.3% 25.8%
Customer B............................. 18.1% 33.9% 27.5% 34.5%
Customer C............................. 12.5% * * *
Customer D............................. * * 16.9% *
Customer E............................. * 25.0% 14.6% 10.3%
Customer F............................. * * * 10.9%
* Represents less than 10 percent of total.
</TABLE>
-31-
<PAGE>
Income Taxes
Income taxes are accounted for using an asset and liability approach that
requires the recognition of taxes payable or refundable for the current year and
deferred tax liabilities and assets for the future tax consequences of events
that have been recognized in the Company's financial statements or tax returns.
The measurement of current and deferred tax assets and liabilities are based on
provisions of the enacted tax law; the effects of future changes in tax laws or
rates are not anticipated. The measurement of deferred tax assets is reduced, if
necessary, by the amount of any tax benefits that, based on available evidence,
are not expected to be realized.
3. Accounts Receivable:
Accounts receivable consists of the following as of December 31, 1998 and March
25, 1999:
December 31, March 25,
1998 1999
Commercial clients .............................. $ 560,000 $ 229,000
Unbilled accounts receivable .................... 41,000 367,000
Less: Allowance for doubtful accounts .......... (46,000) (46,000)
--------- ---------
Accounts receivable, net ... $ 555,000 $ 550,000
========= =========
In February 1998, the Company entered into a factoring agreement to sell,
with recourse, on an ongoing basis, certain accounts receivable to a third
party. Collections received on these accounts may be replaced by new receivables
in order to maintain the aggregate outstanding balance. Proceeds from the sale
of receivables are collateralized by substantially all of the assets of the
Company. At no time may the total accounts receivable factored exceed $350,000.
Fees associated with these transactions are included in interest expense in the
accompanying statement of operations. The factoring agreement has an initial
term of one year and is renewed from year to year thereafter unless terminated
by either party.
As of December 31, 1998 and March 25, 1999, accounts receivable totaling
$224,000 and $15,000 had been pledged as collateral against this asset-based
borrowing.
In accordance with SFAS No. 125, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities," the Company's accounts
receivable program will be accounted for as a secured borrowing. The receivables
and the corresponding debt are included as an asset and liability, respectively,
on the accompanying balance sheet.
4. Other Assets:
Other current assets consists of the following as of December 31, 1998 and
March 25, 1999:
-32-
<PAGE>
December 31, March 25,
1998 1999
Deferred tax asset ............... $ 58,000 $ 95,000
Other assets ..................... 13,000 28,000
-------- --------
Total ....... $ 71,000 $123,000
======== ========
5. Property and Equipment:
Property and equipment consists of the following as of December 31, 1998
and March 25, 1999:
December 31, March 25,
1998 1999
Computer equipment and software ..................... $ 332,000 $ 386,000
Furniture and fixtures .............................. 8,000 8,000
--------- ---------
340,000 394,000
Accumulated depreciation and amortization ........... (101,000) (118,000)
--------- ---------
Property and equipment, net .... $ 239,000 $ 276,000
========= =========
6. Accrued Liabilities:
Accrued liabilities consists of the following as of December 31, 1998 and
March 25, 1999:
December 31, March 25,
1998 1999
Accrued compensation and benefits $ 96,000 $132,000
Taxes payable ................... 33,000 --
Deferred revenue ................ 30,000 260,000
Other accrued liabilities ....... 25,000 111,000
-------- --------
Total ...... $184,000 $503,000
======== ========
7. Debt:
In July 1996, the Company issued a $41,000 note payable to an officer of the
Company with a maturity of December 31, 1999. Interest on this note was payable
monthly at a rate of 8 percent. In April 1998, the Company issued a second note
in the amount of $51,000 payable to this officer, which contained a maturity of
June 30, 1999. Interest on this note was payable monthly at a rate of 12
percent.
In December 1998, the Company refinanced the outstanding balances of the above
notes and issued a single $92,000 note payable to this officer. This note bears
interest monthly at a rate of 10 percent and matures on December 31, 2000.
-33-
<PAGE>
The Company issued a $50,000 note payable to a related party in March 1996,
which bears interest monthly at a rate of 8 percent. Principal payments were due
on a quarterly basis with a scheduled maturity of March 1, 1999. In December
1998, the Company rescheduled the payments of the remaining outstanding balance
of $45,000. The amended note has a scheduled maturity of December 31, 1999. All
other terms remained unchanged from the original note.
In 1998, the Company entered into a factoring agreement, the proceeds from which
are treated as a secured borrowing (see Note 3). The outstanding balance at
March 25, 1999 will be repaid through the subsequent sale of additional accounts
receivable from the Company. Finance charges of 2.25 percent are payable monthly
on the average outstanding balance for the respective period. In addition, the
Company is required to pay a monthly administrative fee of 0.75 percent of the
face amount of each purchased receivable during the respective period. The
outstanding balance is secured by substantially all of the assets of the
Company. As of December 31, 1998 and March 25, 1999, $224,000 and $15,000,
respectively, was outstanding related to this agreement.
In March 1998, IO issued a note payable to an employee of the Company in the
amount of $17,000. This note bears interest annually at a rate of 12 percent. At
December 31, 1998, $8,000 was outstanding related to this note. This amount was
repaid in 1999.
As of March 25, 1999, the maturities of short-term and long-term debt were as
follows:
1999 (period ending December 31, 1999)............. $100,000
2000............................................... 53,000
--------
Total $153,000
========
8. Employee Stock Option Plan:
The Company has a stock option plan for key employees. Options expire no
later than ten years from the date of the grant or when employment ceases,
whichever comes first. The maximum number of shares of common stock that may be
issued pursuant to the stock option plan is 5,000,000 shares at December 31,
1998.
The stock option plan is accounted for under APB Opinion No. 25, "Accounting for
Stock Issued to Employees." Had compensation cost for the plan been determined
based on the estimated fair value of the options at the grant dates consistent
with the method of SFAS No. 123, pro forma net loss would have been
approximately $157,000 and $47,000 for the year ended December 31, 1998 and the
period ended March 25, 1999, respectively. The weighted-average fair value of
the options granted during 1998 is estimated to be $0.84 per option assuming the
following: dividend yield of 0 percent, risk-free interest rate of 5.0 percent,
and an expected term of the options of 3.4 years.
The following summarizes option activity during 1998 and for the period from
January 1, 1999 to March 25, 1999:
-34-
<PAGE>
Weighted-
Average
Number of Exercise
Shares Price
Options outstanding, December 31, 1997,
exercise price range of $0.10 to $0.16 ........ 2,441,000 $0.13
Granted in 1998 ............................ 345,000 0.20
--------- -----
Options outstanding, December 31, 1998,
exercise price range of $0.10 to $0.20 ........ 2,786,000 0.14
Exercised in 1999 .......................... 2,335,668 0.13
--------- -----
Options outstanding, March 25, 1999,
exercise price range of $0.12 to $0.20 ........ 450,332 0.17
--------- -----
Options exercisable, March 25, 1999 .............. 15,000 $0.20
========= =====
When AppNet acquired IO (Note 1), the options outstanding under the stock option
plan were assumed as part of the purchase combination and converted to AppNet
options.
9. Income Taxes:
The Company follows the provisions of SFAS No. 109, "Accounting for Income
Taxes," for financial reporting purposes. Deferred tax assets or liabilities at
the end of each period are determined using the currently enacted tax rates to
apply to taxable income in the period in which the deferred tax asset or
liability is expected to be settled or realized.
The sources of and differences between the financial accounting and tax
basis of the Company's assets and liabilities that give rise to the net deferred
tax asset are as follows as of December 31, 1998 and March 25, 1999:
December 31, March 25,
1998 1999
Deferred tax liabilities
Depreciation ............................ $(29,000) $(31,000)
Deferred tax assets
Accrued expenses ........................ 35,000 64,000
Stock-based compensation ................ 23,000 31,000
-------- --------
Net deferred tax asset ... $ 29,000 $ 64,000
======== ========
The components of the provision for income taxes are as follows as of December
31, 1998 and March 25, 1999:
-35-
<PAGE>
December 31, March 25,
1998 1999
Federal income taxes:
Current ........................................... $ 68,000 $ 7,000
Deferred .......................................... (29,000) (35,000)
State taxes ............................................. 13,000 1,000
-------- --------
Provision (benefit) for income taxes ......... $ 52,000 $(27,000)
======== ========
For the year ended December 31, 1998 and the period from January 1, 1999 to
March 25, 1999, the provision for income taxes differed from the amounts
computed at the statutory rate, as follows:
December 31, March 25,
1998 1999
Income tax computed at statutory rates .................. $ (4,000) $(24,000)
State income taxes, net of federal income tax benefit ... ,000 (4,000)
Permanent differences ................................... 48,000 1,000
Other, net .............................................. (1,000) --
-------- --------
$ 52,000 $(27,000)
======== ========
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. Management considers the scheduled
reversal of deferred tax liabilities, projected future taxable income, and tax
planning strategies in making this assessment. For the period January 1, 1999 to
March 25, 1999, management determined that a valuation allowance of $64,000 was
required.
10. Deferred Compensation:
In December 1998, the Company issued stock options to certain employees.
As a result of this grant, the Company recorded deferred compensation of
$221,000. The amount of deferred compensation was based on the difference
between the estimated fair market value of the Company's common stock at the
date of grant, as determined by the most recent third party transaction, and the
stated exercise price. The Company amortized $57,000 and $20,000 of the deferred
compensation for the periods ended December 31, 1998, and March 25, 1999,
respectively.
11. Related Parties:
See Note 7 for a description of certain long-term debt obligations with related
parties.
In 1998, IO entered into a service agreement with a relative of an officer
of the Company. Under this agreement, this individual will act as financial
advisor for any sale, merger or financing transaction entered into by the
Company and, in exchange, will receive a fee equal to 3 percent of the
transaction consideration. No fees were paid in 1998 in connection with this
agreement.
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<PAGE>
12. Commitments and Contingencies:
Leases
The Company has noncancelable operating leases, primarily for real estate, that
expire over the next year. One of the operating leases maintains an escalation
provision that requires annual incremental increases of at least 3 percent.
Rental expense for operating leases during the year ended December 31, 1998 and
the period from January 1, 1999 to March 25, 1999, was $63,000 and $18,000,
respectively.
The Company leases certain equipment under capital leases.
Future minimum lease payments under capital leases and noncancelable operating
leases are as follows as of March 25, 1999:
Capital Operating
Leases Leases
1999 (period ending December 31, 1999) ............ $ 12,000 $ 52,000
2000 .............................................. 5,000 11,000
-------- --------
Total minimum lease payments ............. 17,000 $ 63,000
========
Less: Amount representing interest ............... (1,000)
--------
Present value of capital lease obligations ........ 16,000
Less: Current portion of capital lease obligations 3,000
--------
Long-term portion of capital lease obligations .... $ 13,000
========
Equipment under capital leases is summarized as follows as of December 31, 1998
and March 25, 1999:
December 31, March 25,
1998 1999
Computer equipment............................... $49,000 $49,000
Accumulated depreciation......................... (15,000) (18,000)
------- -------
Total....................... $34,000 $31,000
======= =======
Litigation and Claims
In 1998, one of the Company's suppliers informed IO that it believed the
Company had caused a third party client of the Company to enter into an
incorrect license for a supplier's software. The supplier asserted that the
correct license required additional payments of approximately $2,200,000 in
license fees and technical support fees. The Company denies any liability for
additional licensing fees. While the Company intends to vigorously contest any
claim by the supplier that additional fees are owed in connection with the third
party, the ultimate resolution of this matter cannot be determined at this time.
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<PAGE>
13. Subsequent Events:
As of December 22, 1999, the Company settled the claim by the supplier discussed
in Note 12 with no financial consequences to the Company.
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<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 hereunto duly authorized.
APPNET, INC.
Date: March 30, 2000 By: /s/ Jack Pearlstein
-----------------------------------
Jack Pearlstein
Senior Vice President,
Chief Financial
Officer and Treasurer
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