<PAGE>
Exhibit 99.2
SoftAware, Inc.
and Subsidiary
Consolidated Financial Statements for the
Years Ended December 31, 1999, 1998, and 1997, and
Independent Auditors' Report
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
SoftAware, Inc.:
We have audited the accompanying consolidated balance sheets of SoftAware, Inc.
and subsidiary (the Company) as of December 31, 1999 and 1998, and the related
consolidated statements of operations, stockholders' (deficit) equity, and cash
flows for each of the three years in the period ended December 31, 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 auditing standards generally accepted
in the United States of America. 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, such consolidated financial statements present fairly, in all
material respects, the financial position of SoftAware, Inc. and subsidiary as
of December 31, 1999 and 1998, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States of
America.
DELOITTE & TOUCHE LLP
Costa Mesa, California
April 3, 2000
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1999 AND 1998
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $4,977,712 $ 383,635
Accounts receivable, net of allowance for doubtful accounts of
$34,707 (1999) and $15,480 (1998) 520,949 205,498
Other receivables 21,821
Prepaid expenses and other current assets 207,858 104,218
---------- ----------
Total current assets 5,728,340 693,351
PROPERTY AND EQUIPMENT, net (Notes 3 and 4) 2,047,698 866,680
DEFERRED INCOME TAXES (Note 6) 11,361
GOODWILL, net of accumulated amortization of $52,439 (Note 2) 325,124
OTHER ASSETS 73,613 34,728
---------- ----------
$8,174,775 $1,606,120
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements. 2
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1999 AND 1998 (Continued)
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
CURRENT LIABILITIES:
Accounts payable $ 363,813 $ 113,280
Accrued expenses 552,670 98,812
Accrued compensation 186,684 21,740
Income tax payable 43,203 80,129
Current portion of capital lease obligations (Note 4) 347,000 339,446
----------- ------------
Total current liabilities 1,493,370 653,407
CAPITAL LEASE OBLIGATIONS, net of current portion (Note 4) 182,829 347,384
NOTE PAYABLE TO SHAREHOLDER (Note 7)
AND OTHER LIABILITIES 9,422 17,460
COMMITMENTS AND CONTINGENCIES (Notes 4 and 5)
MANDATORILY REDEEMABLE, convertible preferred stock,
no par value; Series A, 4,593,023 shares designated, issued and
outstanding (Note 8) 7,900,000
STOCKHOLDERS' (DEFICIT) EQUITY (Note 8 and 9):
Common stock, no par value; 314,159,265 shares authorized;
17,699,739 (1999) and 17,883,106 (1998) shares issued and outstanding 1,265,708 652,999
Accumulated deficit (2,676,554) (65,130)
----------- ------------
Net stockholders' (deficit) equity (1,410,846) 587,869
----------- -----------
$ 8,174,775 $ 1,606,120
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements. 3
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
REVENUES $6,656,156 $3,690,266 $2,022,870
COSTS OF REVENUES 3,179,008 1,485,658 939,225
---------- ---------- ----------
GROSS PROFIT 3,477,148 2,204,608 1,083,645
OPERATING EXPENSES:
Sales and marketing 942,953 583,298 303,678
General and administrative 2,999,791 1,317,455 588,261
Compensation expense associated with common
stock issuance (Note 8) 320,850 135,742
---------- ---------- ----------
Total operating expenses 4,263,594 1,900,753 1,027,681
---------- ---------- ----------
(LOSS) INCOME FROM OPERATIONS (786,446) 303,855 55,964
OTHER (INCOME) EXPENSE, net:
Interest expense 103,848 111,397 61,726
Interest income (107,386) (12,590)
Other income (94,333)
Loss on disposal of assets 50,599
---------- ---------- ----------
Total other (income) expense, net (97,871) 149,406 61,726
---------- ---------- ----------
(LOSS) INCOME BEFORE PROVISION (BENEFIT)
FOR INCOME TAXES (688,575) 154,449 (5,762)
PROVISION (BENEFIT) FOR INCOME TAXES
(Note 6) (11,224) 57,138 10,830
---------- ---------- ----------
NET (LOSS) INCOME (677,351) 97,311 (16,592)
ACCRETION RELATED TO MANDATORILY
REDEEMABLE SERIES A PREFERRED STOCK (Note 8) (59,729)
---------- ---------- ----------
NET (LOSS) INCOME APPLICABLE TO
COMMON STOCKHOLDERS PER SHARE $ (737,080) $ 97,311 $ (16,592)
========== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Note
receivable Total
for sale of stockholders'
Common stock common Accumulated (deficit)
--------------------
Shares Amount stock deficit equity
<S> <C> <C> <C> <C> <C>
BALANCE, January 1, 1997 15,395,624 $ 88,000 $(27,770) $ (145,849) $ (85,619)
Issuance of common stock 893,304 43,057 43,057
Issuance of common stock for note receivable 156,470 8,200 (8,200)
Compensation expense associated with issuance of
common stock (Note 8) 135,742 135,742
Repayment on note receivable for common stock 27,770 27,770
Net loss (16,592) (16,592)
---------- ----------- ----------- ----------- -----------
BALANCE, December 31, 1997 16,445,398 274,999 (8,200) (162,441) 104,358
Repayment on note receivable for common stock 8,200 8,200
Issuance of common stock 1,437,708 378,000 378,000
Net income 97,311 97,311
---------- ----------- ----------- ----------- -----------
BALANCE, December 31, 1998 17,883,106 652,999 (65,130) 587,869
Issuance of common stock 697,500 320,850 320,850
Issuance of common stock for acquisition (Note 2) 224,647 318,999 318,999
Issuance of Series A preferred stock (Note 8)
Accretion of Series A preferred stock to redemption
value (Note 8) (59,729) (59,729)
Repurchase of common stock (Note 8) (1,105,514) (27,140) (1,874,344) (1,901,484)
Net loss (677,351) (677,351)
---------- ----------- ----------- ----------- -----------
BALANCE, December 31, 1999 17,699,739 $1,265,708 $ - $(2,676,554) $(1,410,846)
========== ========== =========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (677,351) $ 97,311 $ (16,592)
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Compensation expense associated with common stock
issuance 320,850 135,742
Deferred income tax 11,361 (19,316) 7,955
Loss on disposal of property and equipment 50,599
Provision for doubtful accounts receivable 99,761 273,903 50,538
Depreciation and amortization 576,117 232,315 136,659
Changes in operating assets and liabilities,
net of acquisition:
Accounts receivable (376,612) (276,752) (218,920)
Other receivables (21,821)
Prepaid expenses and other current assets (103,640) (91,901) (12,317)
Other assets (46,530) (32,909) (244)
Accounts payable 135,926 60,267 26,799
Accrued expenses and accrued compensation 618,802 23,783 33,358
Income taxes payable (36,926) 76,454 2,875
Other liabilities 6,776
----------- --------- ---------
Net cash provided by operating activities 506,713 393,754 145,853
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (1,470,080) (47,709) (24,603)
Cash acquired for acquisition, less cash paid 12,539
----------- --------- ---------
Net cash used in investing activities (1,457,541) (47,709) (24,603)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease obligations (379,068) (317,813) (117,562)
Net proceeds from issuance of Series A preferred stock 7,840,271
Issuance of common stock 378,000 43,057
Repurchase of common stock (1,901,484)
Payments on note payable to shareholder (14,814) (76,652) (84,000)
Repayments of note receivable for sale of common stock 8,200 27,770
----------- --------- ---------
Net cash provided by (used in) financing activities 5,544,905 (8,265) (130,735)
----------- --------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999 (Continued)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS $ 4,594,077 $ 337,780 $ (9,485)
CASH AND CASH EQUIVALENTS, beginning of year 383,635 45,855 55,340
----------- ---------- ---------
CASH AND CASH EQUIVALENTS, end of year $ 4,977,712 $ 383,635 $ 45,855
=========== ========== =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION - Cash paid during the year for:
Interest $ 111,025 $ 109,864 $ 59,529
=========== ========== =========
Income taxes $ 12,741 $ 20,800 $ 14,200
=========== ========== =========
</TABLE>
SUPPLEMENTAL DISCLOSURES OF NONCASH TRANSACTIONS:
The Company financed $208,371, $592,581, and $326,269 of property and equipment
purchases during the years ended December 31, 1999, 1998, and 1997,
respectively, through capital leases.
In 1997, the Company issued common stock in the amount of $8,200 in exchange for
a note receivable.
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITY:
During the year ended December 31, 1999, the Company issued 224,647 shares of
common stock valued at $318,999 and cash of $50,838 in conjunction with the
purchase of Packet Central, Inc. (Note 2). In conjunction with the acquisition,
certain liabilities were assumed or created as follows:
<TABLE>
<S> <C>
Fair value of assets acquired $ 69,739
Acquired intangible assets 377,563
Total consideration (369,837)
----------
Liabilities assumed or created $ 77,465
==========
</TABLE>
See accompanying notes to consolidated financial statements
7
<PAGE>
SOFTAWARE, INC, AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations and Principles of Consolidation - SoftAware, Inc. (the
Company), formerly Complexity Research, Inc., was organized in California on
January 5, 1994. The accompanying consolidated financial statements of the
Company include the accounts of SoftAware, Inc. and its wholly owned
subsidiary. The Company provides commercial connectivity, including
equipment, to the Internet for content providers and data center services,
including co-location, monitoring, and administration, as well as various
consulting services.
Basis of Presentation - The accompanying consolidated financial statements
have been prepared in accordance with accounting principles generally
accepted in the United States of America.
Cash and Cash Equivalents - Cash and cash equivalents include cash and
certificates of deposit with original maturities of less than 90 days.
Concentration of Credit Risk - Financial instruments which potentially
subject the Company to concentrations of credit risk consist primarily of
temporary cash investments and accounts receivable. The Company places its
temporary investments with one major financial institution.
The Company grants trade credit to its customers. The Company performs
credit evaluations of its customers and generally does not require
collateral. The Company maintains reserves for potential credit losses and
such losses have historically been within management's expectation.
Property and Equipment - Property and equipment are stated at cost and
depreciated over the estimated useful lives, which range from three to seven
years, on a straight-line basis. Leasehold improvements are amortized over
the shorter of the useful life of the improvement or the term of the related
lease.
Long-Lived Assets - The Company accounts for the impairment and disposition
of long-lived assets in accordance with Statement of Financial Accounting
Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets
and Long-Lived Assets to Be Disposed Of. In accordance with SFAS No. 121,
long-lived assets to be held are reviewed for events or changes in
circumstances which indicate that their carrying value may not be
recoverable. The Company periodically reviews the carrying value of long-
lived assets to determine whether or not impairment to such value has
occurred by assessing their net realizable values based on estimated
undiscounted cash flows over their remaining useful lives. Based on its most
recent analysis, the Company believes that no impairment exists at December
31, 1999.
Intangible Assets - The excess of cost over fair market value of net
identifiable assets (goodwill) of acquired companies in the accompanying
balance sheets are amortized on a straight-line basis over three years. The
carrying value of intangible assets is periodically reviewed by the Company
based on
8
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999 (Continued)
--------------------------------------------------------------------------------
the estimated future operating income of each acquired entity on an
undiscounted cash flow basis. Based upon its most recent analysis, the
Company believes that no impairment of intangible assets exists at December
31, 1999.
Income Taxes - The Company accounts for income taxes under SFAS No. 109,
Accounting for Income Taxes, which requires that deferred income taxes be
recognized for the tax consequences in future years of differences between
the tax bases of assets and liabilities and their financial reporting bases
at rates based on enacted tax laws and statutory tax rates applicable to
the periods in which the differences are expected to affect taxable income.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized.
Revenue Recognition - Revenues are comprised primarily of bandwidth
charges, equipment co-location and storage fees, one-time fees for
installation if required to provide services and consulting services.
Bandwidth charges are billed and recognized monthly based on customer
usage. All other revenues are based on flat-rate monthly charges.
Installation fees are typically recognized at the time that installation
occurs. To date, such revenues have not significantly exceeded the direct
costs of installation. Revenue from consulting services are recognized as
services are performed.
Costs of Revenues - Cost of service consists of depreciation of network
equipment used in providing the Company's service, fees paid to network
providers for bandwidth, direct labor, and monthly fees for housing the
Company's servers in third-party network data centers. The Company enters
into contracts for bandwidth with third-party network providers with terms
typically ranging from 24 months to three years. These contracts commit the
Company to minimum monthly fees plus additional fees for bandwidth usage
above the contracted level.
Deferred Revenues - Deferred revenues primarily represent advanced billings
to customers, or prepayments by customers prior to completion of
installation or prior to provision of contractual bandwidth usage.
Deferred Rent - Any defined rental escalations are recorded on the
straight-line basis over the term of the related lease.
Use of Estimates - The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Stock-Based Compensation - The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees.
9
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999 (Continued)
--------------------------------------------------------------------------------
Comprehensive Income - Effective January 1, 1998, the Company has adopted
SFAS No. 130, Reporting Comprehensive Income. This statement establishes
standards for the reporting of comprehensive income and its components.
Comprehensive income, as defined, includes all changes in equity (net
assets) during a period from transactions and other events and
circumstances from nonowner sources. For the years ended December 31, 1999,
1998 and 1997, there was no difference between net income (loss), as
reported, and comprehensive income (loss).
Segment Information - In June 1997, the Financial Accounting Standards
Board issued SFAS No. 131, Disclosures about Segments of an Enterprise and
Related Information. This statement establishes standards for the way
companies report information about operating segments in financial
statements. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers. In accordance
with the provisions of SFAS No. 131, the Company has determined that it
does not currently have any separately reportable operating segments.
Revenues from consulting services have been insignificant.
Risk and Uncertainties - Factors that may materially and adversely affect
the Company's future operating results include: demand for and market
acceptance of the Company's products and services; introductions of
products and services or enhancements by the Company and its competitors;
competitive factors that affect the Company's pricing; capacity utilization
of the applications network; reliable continuity of service and network
availability; the ability and cost of bandwidth and the Company's ability
to increase bandwidth as necessary; the timing of customer installations;
the mix of products and services sold by the Company; customer retention;
the timing and success of marketing efforts and product and service
introductions by the Company; the timing and magnitude of capital
expenditures, including costs relating to the expansion of operations; the
timely expansion of its network infrastructure; fluctuations in bandwidth
used by customers; the retention of key personnel; conditions specific to
the Internet industry and other general economic factors; and new
government legislation and regulation.
Recent Accounting Pronouncements - In June 1998, the Financial Accounting
Standards Board issued SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities. The provisions of SFAS No. 133, as amended by SFAS
No. 137, are effective for all fiscal quarters of all fiscal years
beginning after June 15, 2000. The Company is reviewing the impact of such
pronouncement on its financial statements.
In December 1999, the Securities and Exchange Commission (SEC) staff issued
Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial
Statements. SAB No. 101 summarizes the SEC staff's views in applying
accounting principles generally accepted in the United States of America to
revenue recognition in financial statements. The Company does not expect
its implementation will have an effect on its revenue recognition policy.
10
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999 (Continued)
--------------------------------------------------------------------------------
In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44 of Accounting Principles Board Opinion No. 25,
Accounting for Certain Transactions Involving Stock Compensation, which,
among other things, addressed accounting consequences of a modification
that reduces the exercise price of a fixed stock option award (otherwise
known as repricing). If the exercise price of a fixed stock option award is
reduced, the award must be accounted for as variable price stock plan from
the date of the modification to the date the award is exercised, is
forfeited, or expires unexercised. The exercise price of an option award
has been reduced if the fair value of the consideration required to be paid
by the grantee upon exercise is less than or potentially less than the fair
value of the consideration that was required to be paid pursuant to the
award's original terms. The requirements about modifications to fixed stock
option awards that directly or indirectly reduce the exercise price of an
award apply to modifications made after December 15, 1998, and will be
applied prospectively as of July 1, 2000. The Company does not believe the
adoption of this interpretation would have an impact on the Company's
financial statements.
Reclassifications - Certain reclassifications have been made to prior
year's balances to conform to current year's presentation.
2. ACQUISITION
Effective July 31, 1999, the Company acquired all the outstanding common
stock of Packet Central, Inc., a California Corporation, for 224,647 shares
of the Company's common stock valued at $318,999 and cash of $50,838. The
acquisition was accounted for as a purchase and the purchase price was
allocated to tangible net assets of $69,739 and goodwill of $377,563, which
is being amortized on a straight-line basis over three years. Had the
acquisition occurred at the beginning of the fiscal year in which the
acquisition was completed, or the beginning of the immediately preceding
year, combined pro forma net sales and net income would not have been
materially different from that currently being reported.
11
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999 (Continued)
--------------------------------------------------------------------------------
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Leasehold improvements $ 984,852 $ 61,542
Machinery and equipment 1,737,555 1,070,005
Furniture and fixtures 150,311 71,606
Vehicles 6,379 6,378
Software 81,725 54,240
------------ ------------
2,960,822 1,263,771
Less accumulated depreciation and amortization (913,124) (397,091)
------------ ------------
$ 2,047,698 $ 866,680
============ ============
</TABLE>
4. CAPITAL AND OPERATING LEASE COMMITMENTS
Capital lease obligations are recorded at the present value of future
minimum lease payments. Assets financed under capital leases included in
property and equipment at December 31 are as follows:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Machinery and equipment $ 1,230,816 $ 1,027,664
Furniture and fixtures 87,530 71,606
Software 72,677 54,240
----------- -----------
1,391,023 1,153,510
Less accumulated depreciation (581,136) (326,565)
----------- ----------
$ 809,887 $ 826,945
=========== ===========
</TABLE>
Depreciation of property financed under capital leases was $274,835,
$193,500, and $99,688 for the years ended December 31, 1999, 1998, and 1997,
respectively.
12
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999 (Continued)
--------------------------------------------------------------------------------
Future annual minimum lease payments under capital leases and the present
value of future minimum lease payments as of December 31, 1999 are as
follows:
<TABLE>
<S> <C>
2000 $ 404,795
2001 146,519
2002 54,186
2003 3,176
---------
Total future minimum lease payments 608,676
Less amount representing interest (78,847)
---------
Present value of future minimum lease payments 529,829
Less current portion (347,000)
---------
$ 182,829
=========
</TABLE>
The Company also leases office space and equipment under operating leases
which expire on various dates through the year 2003.
Future annual minimum lease payments under noncancelable operating lease
arrangements at December 31, 1999, are as follows:
<TABLE>
<S> <C>
2000 $1,491,042
2001 1,341,792
2002 1,041,480
2003 582,000
----------
$4,456,314
==========
</TABLE>
Rental expense under operating leases was approximately $373,485, $125,935,
and $126,259 for the years ended December 31, 1999, 1998, and 1997,
respectively.
5. COMMITMENTS AND CONTINGENCIES
Litigation - In the normal course of business, the Company is subject to
various legal matters. In the opinion of management, the resolution of
these matters will not have a material adverse effect on the operations,
cash flows, and financial position of the Company.
13
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999 (Continued)
--------------------------------------------------------------------------------
6. INCOME TAXES
The (benefit) provision for income taxes consisted of the following for the
years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Current:
Federal $ (16,163) $ 55,009 $ 2,075
State (6,422) 21,445 800
--------- -------- --------
(22,585) 76,454 2,875
Deferred:
Federal (238,344) (11,955) 41,836
State (52,146) (7,361) 12,535
--------- -------- --------
(290,490) (19,316) 54,371
Change in valuation allowance 301,851 (46,416)
--------- -------- --------
11,361 (19,316) 7,955
--------- -------- --------
Tax (benefit) provision $ (11,224) $ 57,138 $ 10,830
========= ======== ========
</TABLE>
The difference between the provision for income taxes computed by applying
the federal statutory tax rate to pretax income and the actual provision for
income taxes results primarily from state taxes and nondeductible meals and
entertainment expenses.
14
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999 (Continued)
--------------------------------------------------------------------------------
Major components of the Company's net deferred tax asset and deferred tax
liability are as follows at December 31:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Depreciation $ 53,616 $ 2,851 $ 5,428
Accrual to cash 161,271 9,367 (28,816)
AMT credit 2,075 2,075
State taxes (857) 1,645
Charitable contribution carryforward 366 366
Federal net loss carryforward 74,197 11,163
State net loss carryforward 10,326 184
--------- ------- --------
301,851 11,361 (7,955)
Valuation allowance (301,851)
--------- ------- --------
Net deferred tax asset $ - $11,361 $ (7,955)
========= ======= ========
</TABLE>
The Company has net operating loss carryforwards of approximately $218,000
and $10,000 available to offset federal and state income tax, respectively.
These net operating loss carryforwards will begin expiring in the years 2019
and 2004 for federal and state, respectively. These net operating loss
carryforwards may be subject to annual limitations pursuant to Internal
Revenue Code Section 382.
7. NOTE PAYABLE TO SHAREHOLDER
The note payable to shareholder bears interest at 7% and the balance of
$2,646 is due on January 1, 2001.
8. MANDATORILY REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
Mandatorily Redeemable Convertible Series A Preferred Stock - In September
1999, the Company issued 4,593,023 shares of Series A preferred stock for
$1.72 per share, resulting in net proceeds of $7,840,271.
15
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999 (Continued)
--------------------------------------------------------------------------------
Under the terms of the Series A Convertible Preferred Stock Purchase
Agreement (the Agreement), the holders of the Series A preferred stock are
entitled to dividends in preference to common stockholders, only to the
extent dividends are declared by the Company's Board of Directors. Holders
of Series A preferred stock are entitled to the number of votes equal to the
number of shares of common stock that the Series A shares could be converted
into on the date of the vote. Upon liquidation, the holders of Series A
preferred stock receive, prior and in preference to the holders of common
stock, their liquidation preference of $1.72 per share, subject to certain
adjustments as defined by the Agreement. The holders of Series A preferred
stock may convert their shares into common stock on a one for one basis,
subject to certain adjustments as defined in the Agreement. The Series A
preferred stock automatically converts into common stock upon an initial
public offering yielding at least $30,000,000 in proceeds, a per share price
in excess of $6.00 per share and meeting other factors defined in the
Agreement.
The Series A preferred stock is mandatorily redeemable by the Company at the
earlier of: seven years from the date of issuance (September 10, 1999); the
sale of substantially all of the Company's assets; or upon election of
certain shareholders, as defined in the Agreement. The redemption price is
the greater of the Series A issue price (subject to adjustment as defined in
the Agreement), plus any declared, but unpaid dividends or fair market value
of the Series A preferred stock, as determined by a third-party appraisal,
at the time of redemption. During the year ended December 31, 1999, the
Company recorded accretion of Series A preferred stock to its redemption
value totaling $59,729. In accordance with Emerging Issues Task Force
(EITF) Issue No. 00-7, unless the underlying preferred stock agreement is
modified by December 31, 2000, the fair value of the mandatorily redeemable
Series A preferred stock will be recorded as a liability, with changes in
its fair value recognized in earnings.
Common Stock - The Company's articles of incorporation authorize the
issuance of up to 314,159,265 shares of the Company's common stock. At
December 31, 1999, 17,699,739 shares of common stock were issued and
outstanding. During the year ended December 31, 1999, the Company
repurchased 1,105,514 shares of its common stock for $1,901,484 or $1.72 per
share. In conjunction with this repurchase, the Company recorded an
increase to accumulated deficit of $1,874,344 and a decrease of common stock
of $27,140. During the year ended December 31, 1999, the Company's Board of
Directors authorized the issuance of 697,500 shares of common stock to
certain employees of the Company at no cost. The Company recorded
compensation expense associated with this stock issuance aggregating
$320,850 or $0.46 per share. The majority of this expense would be
classified as general and administrative based on the employees who received
such common stock at no cost.
During the year ended December 31, 1997, the Company's Board of Directors
authorized the issuance of 825,741 shares of common stock to certain
employees and consultants of the Company. The stock was issued at a price
of $0.01 per share. The Company recorded compensation expense associated
with this stock issuance aggregating $135,742 or $0.16 per share. The
majority of this expense would be classified as general and administrative
based on the employees who received such common stock.
16
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999 (Continued)
--------------------------------------------------------------------------------
9. SUBSEQUENT EVENTS
In January 2000, the Company acquired all the outstanding shares of Pacific
Netcom, Inc. for aggregate consideration of $4,639,946, comprising
$1,750,000 in cash and 1,555,201 shares of the Company's common stock valued
at $1.72 per share. The acquisition will be accounted for as a purchase.
In January 2000, the Company acquired certain assets of Subnet, Inc. for
aggregate consideration of $183,747, comprising $109,747 in cash and
forgiveness of amounts owed to the Company of $74,000.
In January 2000, the Company entered into a term credit facility (the
facility) allowing for aggregate borrowings of $10,000,000. The facility is
comprised of a $2,500,000 initial portion which can be utilized by the
Company, upon satisfaction of certain terms and conditions, to fund working
capital and capital expenditure requirements and a $7,500,000 portion, which
can be utilized by the Company, upon satisfaction of certain terms and
conditions, to fund the acquisitions. Advances under the facility are
available through June 30, 2001, at which time the outstanding balance
converts into a term loan with quarterly principle payments due through
October 2004. Outstanding borrowings under the facility will bear interest
at a reference rate plus 1.75%. The facility contains certain restrictive
covenants, including the maintenance of certain financial ratios.
In January 2000, the Company approved the 1999 Stock Option/Stock Issuance
Plan (the 1999 Plan). Under the terms of the 1999 Plan, the Company may
grant options to purchase the Company's common stock or directly issue
common stock to employees, nonemployee members of the Company's Board of
Directors and consultants to the Company. The Company has reserved
6,500,000 shares of its common stock for grant under the 1999 Plan.
* * * * * *
17
<PAGE>
Pacific Netcom, Inc.
(formerly Pacific Netcom partnership)
Financial Statements for the Years
Ended December 31, 1999 and 1998,
and Independent Auditors' Report
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Pacific Netcom, Inc.:
We have audited the accompanying balance sheets of Pacific Netcom, Inc.
(formerly Pacific Netcom partnership) (the Company) as of December 31, 1999 and
1998, and the related statements of operations, stockholders' equity, and cash
flows for each of the three years ended December 31, 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 auditing standards generally accepted
in the United States of America. 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, such financial statements present fairly, in all material
respects, the financial position of Pacific Netcom, Inc. as of December 31, 1999
and 1998, and the results of its operations and its cash flows for each of the
three years ended December 31, 1999, in conformity with accounting principles
generally accepted in the United States of America.
DELOITTE & TOUCHE LLP
Costa Mesa, California
April 20, 2000
<PAGE>
PACIFIC NETCOM, INC.
(formerly Pacific Netcom partnership)
BALANCE SHEETS
AS OF DECEMBER 31, 1999 AND 1998
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 39,897 $ 214,462
Accounts receivable, net of allowance for doubtful accounts of
$9,406 (1999) and $1,000 (1998) 434,585 293,482
Prepaid expenses and other current assets 26,289 20,098
Inventory 113,048 199,235
Due from stockholders (Note 3) 99,754
-------- ----------
Total current assets 613,819 827,031
PROPERTY AND EQUIPMENT, net (Note 2) 52,410 81,424
INTANGIBLE ASSET, net 177,531 193,206
OTHER ASSETS 8,615 4,027
-------- ----------
$852,375 $1,105,688
======== ==========
</TABLE>
See accompanying notes to financial statements.
2
<PAGE>
PACIFIC NETCOM, INC.
(formerly Pacific Netcom partnership)
BALANCE SHEETS
AS OF DECEMBER 31, 1999 AND 1998 (Continued)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $237,916 $ 210,634
Line of credit (Note 7) 246,508
Sales tax payable 36,421 211,369
Note payable to stockholder (Note 3) 29,903 53,405
Accrued expenses 26,714 9,330
Accrued compensation 86,194 50,357
Customer deposits 110,545 123,320
-------- ----------
Total current liabilities 774,201 658,415
COMMITMENTS AND CONTINGENCIES (Note 4)
STOCKHOLDERS' EQUITY (Note 8):
Common stock, $0.01 par value; 1,000 shares authorized; 100 shares
issued and outstanding at December 31, 1999 and 1998 1 1
Additional paid-in capital 49,999 49,999
Retained earnings 28,174 397,273
-------- ----------
Total stockholders' equity 78,174 447,273
-------- ----------
$852,375 $1,105,688
======== ==========
</TABLE>
See accompanying notes to financial statements.
3
<PAGE>
PACIFIC NETCOM, INC.
(formerly Pacific Netcom partnership)
STATEMENTS OF OPERATIONS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
REVENUES (Note 5) $4,337,963 $3,903,172 $4,495,625
COSTS OF REVENUES (Note 5) 3,527,995 2,998,855 3,641,290
---------- ---------- ----------
GROSS PROFIT 809,968 904,317 854,335
OPERATING EXPENSES:
Sales and marketing 445,985 345,855 340,022
General and administrative (Notes 4 and 6) 523,255 386,896 342,381
---------- ---------- ----------
Total operating expenses 969,240 732,751 682,403
---------- ---------- ----------
(LOSS) INCOME FROM OPERATIONS (159,272) 171,566 171,932
OTHER (EXPENSE) INCOME:
Interest expense, net (Notes 3 and 7) (23,554) 3,143 31,201
Other income, net 28,281 (7,470) (13,033)
---------- ---------- ----------
Total other (expense) income, net 4,727 (4,327) 18,168
---------- ---------- ----------
(LOSS) INCOME BEFORE PROVISION FOR
INCOME TAXES (154,545) 167,239 190,100
PROVISION FOR INCOME TAXES 800 2,509 4,364
---------- ---------- ----------
NET (LOSS) INCOME $ (155,345) $ 164,730 $ 185,736
========== ========== ==========
</TABLE>
See accompanying notes to financial statements.
4
<PAGE>
PACIFIC NETCOM, INC.
(formerly Pacific Netcom partnership)
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Additional Total
Common stock paid-in Retained stockholders'
------------------------
Shares Amount capital earnings equity
<S> <C> <C> <C> <C> <C>
BALANCE, January 1, 1997 - $ - $ - $ 252,048 $ 252,048
Distribution of owners' equity of
the former Pacific Netcom
partnership (150,430) (150,430)
Issuance of common stock 100 1 49,999 50,000
Net income 185,736 185,736
--------- ------- ------------- ----------- ---------
BALANCE, December 31, 1997 100 1 49,999 287,354 337,354
Distribution to stockholders (54,811) (54,811)
Net income 164,730 164,730
--------- ------- ------------- ----------- ---------
BALANCE, December 31, 1998 100 1 49,999 397,273 447,273
Distribution to stockholders (Note 3) (213,754) (213,754)
Net loss (155,345) (155,345)
--------- ------- ------------- ----------- ---------
BALANCE, December 31, 1999 100 $ 1 $ 49,999 $ 28,174 $ 78,174
========= ======= ============= =========== =========
</TABLE>
See accompanying notes to financial statements. 5
<PAGE>
PACIFIC NETCOM, INC.
(formerly Pacific Netcom partnership)
STATEMENTS OF CASH FLOWS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $(155,345) $ 164,730 $ 185,736
Adjustments to reconcile net (loss) income to net cash
(used in) provided by operating activities:
Depreciation and amortization 59,966 40,162 23,856
Bad debt provision 25,050 1,000
Changes in operating assets and liabilities:
Accounts receivable (166,153) (38,738) 41,377
Prepaid expenses and other current assets (6,191) 1,354 (19,212)
Inventory 86,187 57,059 (131,979)
Other assets (4,588) (1,771)
Accounts payable 27,282 15,652 65,693
Sales tax payable (174,948) (128,305) 245,285
Accrued expenses and accrued compensation 53,221 (9,085) 54,891
Customer deposits (12,775) (37,983) 161,303
--------- --------- ---------
Net cash (used in) provided by operating activities (268,294) 65,846 625,179
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (15,277) (19,755) (69,974)
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings on line of credit 246,508
Due from stockholders (78,566) (21,188)
Distribution to stockholders (114,000) (54,811)
Payments on note payable to stockholder (23,502) (65,113) (181,406)
--------- --------- ---------
Net cash provided by (used in) financing activities 109,006 (198,490) (202,594)
--------- --------- ---------
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (174,565) (152,399) 352,611
CASH AND CASH EQUIVALENTS, beginning of year 214,462 366,861 14,250
--------- --------- ---------
CASH AND CASH EQUIVALENTS, end of year $ 39,987 $ 214,462 $ 366,861
========= ========= =========
</TABLE>
See accompanying notes to financial statements. 6
<PAGE>
PACIFIC NETCOM, INC.
(formerly Pacific Netcom partnership)
STATEMENTS OF CASH FLOWS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999 (Continued)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION - Cash paid during the year for:
Interest $24,009 $ 5,401 $13,033
======= ======= =======
Income taxes $ 1,982 $ 1,382 $ 1,600
======= ======= =======
</TABLE>
SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING ACTIVITIES:
During 1999, it was determined that the amounts due from stockholders of $99,754
at December 31, 1998, would be recorded as distributions to the stockholders
during 1999.
In February 1997, the owners' equity of the former Pacific Netcom partnership of
$150,430 was distributed to the stockholders in the form of a note payable to
stockholders of $100,430 and 100 shares of common stock valued at $50,000 to the
two founders.
See accompanying notes to financial statements. 7
<PAGE>
PACIFIC NETCOM, INC.
(formerly Pacific Netcom partnership)
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations - Pacific Netcom, Inc. (formerly Pacific Netcom
partnership) (the Company) was incorporated in the State of California on
September 17, 1996. As part of the incorporation, the Company distributed
the owners' capital in the former Pacific Netcom partnership as of February
1, 1997, to the stockholders in the form of notes payable to stockholders in
the aggregate amount of $100,430 and 100 shares of common stock with a par
value of $.01 per share valued at $50,000 to the two founders. The Company
designs and installs computer network systems. The Company also provides
network system integration, local and wide area network management, and
service support of these installed network environments.
Basis of Presentation - The accompanying financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America.
Cash and Cash Equivalents - Cash and cash equivalents include cash and
certificates of deposit with original maturities of less than 90 days.
Accounts Receivable - Accounts receivable arise in the normal course of
granting trade credit to customers. The Company performs credit evaluations
of its customers and generally does not require collateral. The Company
maintains reserves for potential credit losses.
Inventory - Inventory is stated at the lower of cost (first-in, first-out)
or market. All inventory is classified as raw materials.
Property and Equipment - Property and equipment are stated at cost and
depreciated over the estimated useful lives, which range from three to five
years, on a straight-line basis. Leasehold improvements are amortized over
the shorter of the useful life of the improvement or the term of the related
lease.
Long-Lived Assets - The Company accounts for the impairment and disposition
of long-lived assets in accordance with Statement of Financial Accounting
Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets
and Long-Lived Assets to Be Disposed Of. In accordance with SFAS No. 121,
long-lived assets to be held are reviewed for events or changes in
circumstances which indicate that their carrying value may not be
recoverable. The Company periodically reviews the carrying value of long-
lived assets to determine whether or not impairment to such value has
occurred by assessing their net realizable values based on estimated
undiscounted cash flows over their remaining useful lives. Based on its
most recent operating profitability analysis, the Company believes that no
impairment exists at December 31, 1999.
Intangible Asset - Intangible asset consists of the excess of cost over net
assets acquired (goodwill), of $235,000, which arose from an acquisition of
a business in 1996 and is being amortized on a straight-line method over 15
years. Accumulated amortization was $57,469, $41,794, and $26,119 as of
December 31, 1999, 1998, and 1997, respectively.
8
<PAGE>
PACIFIC NETCOM, INC.
(formerly Pacific Netcom partnership)
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999 (Continued)
--------------------------------------------------------------------------------
The Company evaluates the recoverability of its goodwill at each balance
sheet date. The recoverability of goodwill is determined by comparing the
carrying value of the goodwill to the estimated operating income of the
related entity on an undiscounted cash flow basis. Any impairment is
recorded at the date of determination. Based on the Company's most recent
analysis, the Company believes that goodwill is recoverable at December 31,
1999.
Income Taxes - The Company has elected to be taxed for federal and state
purposes under the provision of Subchapter S of the Internal Revenue Code
and similar state statutes. Accordingly, the Company's current taxable
income is treated as if it were allocated to the stockholders, who are
responsible for the payment of taxes thereon. In accordance with the
provisions of the California Revenue and Taxation Code regarding S
corporations, the Company continues to pay income taxes at the rate of 1.5%
of taxable income.
Revenue Recognition - The Company recognizes revenues associated with
services as services are provided to its customers. Revenue associated with
equipment sales is recognized upon shipment.
Use of Estimates - The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Comprehensive Income - Effective January 1, 1998, the Company adopted SFAS
No. 130, Reporting Comprehensive Income. This statement establishes
standards for the reporting of comprehensive income and its components.
Comprehensive income, as defined, includes all changes in equity (net
assets) during a period from transactions and other events and circumstances
from nonowner sources. For each of the years ended December 31, 1999, 1998,
and 1997, there was no difference between net income (loss), as reported,
and comprehensive income (loss).
Recent Accounting Pronouncements - In December 1999, the Securities and
Exchange Commission (SEC) staff issued Staff Accounting Bulletin (SAB) No.
101, Revenue Recognition in Financial Statements. SAB No. 101 summarizes the
SEC staff's views in applying generally accepted accounting principles to
revenue recognition in financial statements. The Company does not expect its
implementation will have an effect on its revenue recognition policy.
9
<PAGE>
PACIFIC NETCOM, INC.
(formerly Pacific Netcom partnership)
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999 (Continued)
--------------------------------------------------------------------------------
2. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
1999 1998
Leasehold improvements $ 2,410 $ 2,410
Furniture and fixtures 43,682 29,255
Computer equipment 80,426 79,576
Vehicles 7,000 7,000
-------- --------
133,518 118,241
Less accumulated depreciation and amortization (81,108) (36,817)
-------- --------
$ 52,410 $ 81,424
======== ========
3. DUE FROM STOCKHOLDERS AND NOTE PAYABLE TO STOCKHOLDER
Amounts due from stockholders at December 31, 1998, arose from advances to
stockholders. During 1999, it was determined that all amounts due from
stockholders would be recorded as distributions to stockholders in 1999.
Note payable to stockholder consists of the following at December 31:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Note payable to stockholder, with interest accruing at a rate
of 8% per annum, due on demand $ 29,903 $ 53,405
Less current portion (29,903) (53,405)
-------- --------
$ - $ -
======== ========
</TABLE>
10
<PAGE>
PACIFIC NETCOM, INC.
(formerly Pacific Netcom partnership)
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999 (Continued)
--------------------------------------------------------------------------------
4. COMMITMENTS AND CONTINGENCIES
Operating Leases - The Company leases its building facility under a
noncancelable operating lease which expires September 2004 with an option to
renew for an additional three years. Future annual minimum lease payments
under this noncancelable operating lease arrangement at December 31, 1999,
are as follows:
Year ending December 31:
2000 $ 85,620
2001 85,620
2002 85,620
2003 85,620
2004 64,215
--------
$406,695
========
Rental expense under operating leases was approximately $65,555, $48,247,
and $34,411 for the fiscal years ended December 31, 1999, 1998, and 1997,
respectively.
Litigation - The Company is involved from time to time in litigation or
claims arising in the ordinary course of business. While the ultimate
liability, if any, arising from these claims cannot be predicted with
certainty, the Company believes that the resolution of these matters will
not likely have a material adverse effect on the Company's financial
statements.
5. MAJOR CUSTOMERS AND SUPPLIERS
Customer Concentration - Sales to one customer represented approximately 19%
and 49% of the Company's total sales for the years ended December 31, 1998
and 1997, respectively. No customers represented more than 10% of the
Company's sales for the year ended 1999. The loss of or reduction in sales
to any such customer could have a material adverse effect on the Company's
business, operating results, and financial condition.
Supplier Concentration - The Company purchased approximately 31%, 58%, and
47% of its products from two vendors for the years ended December 31, 1999,
1998, and 1997, respectively. No other suppliers represented more than 10%
of the Company's purchases for the years ended December 31, 1999, 1998, and
1997. Any inability to obtain products in the amounts needed on a timely
basis could result in delays in product introductions or interruptions in
product shipments, which could have a material adverse effect on the
Company's business, operating results, and financial condition.
11
<PAGE>
PACIFIC NETCOM, INC.
(formerly Pacific Netcom partnership)
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 1999 (Continued)
--------------------------------------------------------------------------------
6. BENEFIT PLAN
In January 1998, the Company established and adopted a 401(k) plan. All
full-time employees of the Company are eligible to participate after
reaching age 21 and after completion of six months of service. Under the
terms of the 401(k) plan, the Company will match 20% of participant
contributions, up to 5% of each participant's elective deferral. Employees
vest in employer contributions to the plan over a five-year period. The
Company recorded expense of $2,267 and $4,285 for plan contributions for the
years ended December 31, 1999 and 1998, respectively.
7. LINE OF CREDIT
In May 1999, the Company entered into a $250,000 Business Ready Credit
agreement with a bank. Borrowings are collateralized by substantially all of
the assets of the Company. Interest and charges (not principal) are due
monthly unless the Company's right to obtain loans under this agreement are
canceled. If canceled, the outstanding principal and interest balance is due
in 24 equal consecutive monthly installments. Interest is payable at the
bank's prime rate (8.50% at December 31, 1999) plus 1.25%. The amounts
outstanding are guaranteed by the two stockholders of the Company. At
December 31, 1999, available borrowings under the facility were $3,492.
8. SUBSEQUENT EVENTS
In January 2000, 100% of the outstanding common stock of the Company was
purchased by SoftAware, Inc., a California corporation, for aggregate
consideration of $4,639,946, comprised primarily of $1,750,000 in cash and
1,555,201 shares of common stock of SoftAware, Inc., a California
corporation, valued at $1.72 per share.
* * * * * *
12
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, 2000 December 31, 1999
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,563,917 $ 4,977,712
Accounts receivable, net of allowance for doubtful accounts of
$74,917 (unaudited) (2000) and $34,707 (1999) 1,311,011 520,949
Other receivables 14,123 21,821
Prepaid expenses and other current assets 168,242 207,858
Inventory 226,966
----------------------------------
Total current assets 6,284,259 5,728,340
PROPERTY AND EQUIPMENT, net 5,499,796 2,047,698
GOODWILL, net of accumulated amortization of
$832,771 (2000) and $66,026 (1999) 4,402,744 335,163
OTHER ASSETS 410,891 63,574
----------------------------------
$16,597,690 $ 8,174,775
=========== ===========
</TABLE>
SOFTAWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)
<TABLE>
<CAPTION>
June 30, 2000 December 31, 1999
(unaudited)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,768,041 $ 363,813
Accrued expenses 512,450 323,163
Accrued Bandwidth 526,920 272,710
Accrued Compensation 37,663 186,684
Current portion of capital lease obligations 309,139 347,000
----------------------------------
Total current liabilities 3,154,213 1,493,370
CAPITAL LEASE OBLIGATIONS, net of current portion 29,597 182,829
NOTE PAYABLE TO STOCKHOLDER AND OTHER LIABILITIES 4,075 9,422
LONG TERM DEBT 4,500,000
COMMITMENTS AND CONTINGENCIES
MANDATORILY REDEEMABLE, convertible preferred stock,
no par value; Series A, 4,593,023 shares designated, issued and
outstanding 7,900,000 7,900,000
STOCKHOLDERS' (DEFICIT) EQUITY:
Common stock, no par value; 314,159,265 shares authorized;
20,471,782 (unaudited) (2000) and 17,699,739 (1999) shares issued
and outstanding 7,012,340 1,265,708
Notes receivable from stockholders (1,018,066)
Accumulated deficit (4,984,469) (2,676,554)
----------------------------------
Net stockholders' (deficit) equity 1,009,805 (1,410,846)
$16,597,690 $ 8,174,775
=========== ===========
</TABLE>
6
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 1999
<TABLE>
<CAPTION>
2000 1999
(unaudited) (unaudited)
<S> <C> <C>
REVENUES $ 7,943,223 $2,782,041
COSTS OF REVENUES 4,613,996 1,244,364
---------------------------------
GROSS PROFIT 3,329,227 1,537,677
OPERATING EXPENSES:
Sales and marketing 959,287 335,164
General and administrative 3,984,176 1,102,522
Research and Development 342,075 0
Compensation expense associated with common 245,911 320,850
stock issuance
---------------------------------
Total operating expenses 5,531,449 1,758,536
LOSS FROM OPERATIONS (2,202,222) (220,859)
OTHER (INCOME) EXPENSE:
Interest expense (280,320) (54,280)
Interest income 177,693 5,355
Other (loss) income (3,066) 70,873
---------------------------------
Total other (expense) income (105,693) 21,948
---------------------------------
NET LOSS $ (2,307,915) $ (198,911)
=================================
</TABLE>
7
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 1999
<TABLE>
<CAPTION>
2000 1999
(unaudited) (unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $(2,307,915) $(198,911)
Adjustments to reconcile net (loss) income to net cash
provided by operating activities, net of the effects of the acquisition:
Issuance of common stock for services performed 171,653
Compensation expense associated with common stock
issuance 74,258 320,850
Deferred Financing Costs 22,877
Interest income on note receivable from sale of common stock (20,289)
Provision for doubtful accounts 123,650 24,378
Depreciation and amortization 1,269,455 142,906
Changes in operating assets and liabilities,
net of acquisition:
Accounts receivable (501,291) (122,803)
Other receivables 7,698 0
Prepaid expenses and other current assets 70,470 26,142
Inventory (116,589) 0
Other assets (362,792) (18,415)
Accounts payable 1,032,491 34,056
Accrued expenses, bandwidth and compensation (214,544) 486,637
Other liabilities (6,776) -
-----------------------------------
Net cash (used in) provided by operating activities (757,644) 694,840
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (3,902,400) (99,758)
Cash paid for acquisition, net of cash acquired (2,064,087) 0
-----------------------------------
Net cash used in investing activities (5,966,487) (99,758)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease obligations (191,093) (184,442)
Issuance of common stock 2,000,000
Payments on note payable to stockholder 1,429 (3,585)
Proceeds from long term debt 4,500,000
-----------------------------------
Net cash provided by (used in) financing activities 6,310,336 (188,027)
NET (DECREASE) INCREASE IN CASH
AND CASH EQUIVALENTS (413,795) 407,055
CASH AND CASH EQUIVALENTS, beginning of year 4,977,712 383,635
-----------------------------------
CASH AND CASH EQUIVALENTS, end of year $ 4,563,917 $ 790,690
============ =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION - Cash paid during the year for:
Interest $ 281,012 $ 64,994
============ =========
Income taxes $ -- $ 12,500
============ =========
SUPPLEMENTAL DISCLOSURES RELATED TO ACQUISITION OF PACIFIC NETCOM
Cash Paid, net of cash acquired (2,064,087)
Fair value of assets acquired 688,676
Goodwill 4,649,365
Common stock issued (2,502,944)
------------
Liabilities Assumed 771,010
============
</TABLE>
In January 2000, the Company acquired certain assets of Subnet, Inc. for
aggregate consideration of $183,747. As a result of this transaction, amounts
due to SoftAware from Subnet, Inc. of $74,000 was forgiven and the remaining
$109,747 was recorded as a current liability included in accounts payable.
In March 2000, the common stock valued at $997,777 was purchased with a note
receivable by which was recorded as contra equity.
8
<PAGE>
SOFTAWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
----------------------------------------------------------
1. General
In the opinion of Management, the unaudited consolidated financial statements of
SoftAware, Inc. and subsidiaries (the Company) reflect all adjustments, which
consist only of normal and recurring adjustments, necessary to present fairly
the financial position at June 30, 2000 and December 31, 1999 and the results of
operations and the changes in financial position for the six month periods ended
June 30, 2000 and 1999, in accordance with accounting principles generally
accepted in the United States.
These financial statements should be read in conjunction with the consolidated
financial statements and notes thereto contained in the SoftAware, Inc. and
subsidiary and Pacific Netcom, Inc.'s financial statements as of December 31,
1999 and 1998 and each of the three years in the period ended December 31, 1999.
Due to the cyclical nature of the business, the results of operations for the
periods presented are not necessarily indicative of the results to be expected
for a full fiscal year.
Certain reclassifications have been made to the December 31, 1999 balances in
order to conform to the June 30, 2000 presentation.
2. Acquisitions and Financing Agreement
In January 2000, the Company acquired all the outstanding shares of Pacific
Netcom, Inc. for aggregate consideration of approximately $4.6 million. The
acquisition will be accounted for as a purchase.
In January 2000, the Company acquired certain assets of Subnet, Inc. for
aggregate consideration of $183,747, comprising $109,747 in cash and forgiveness
of amounts owed to the Company of $74,000.
In January 2000, the Company entered into a term credit facility (the facility)
allowing for aggregate borrowings of $10,000,000. The facility is comprised of a
$2,500,000 initial portion which can be utilized by the Company, upon
satisfaction of certain terms and conditions, to fund working capital and
capital expenditure requirements and a $7,500,000 portion, which can be utilized
by the Company, upon satisfaction of certain terms and conditions, to fund the
acquisitions. Advances under the facility are available through June 30, 2001,
at which time the outstanding balance converts into a term loan with quarterly
principle payments due through October 2004. Outstanding borrowings under the
facility will bear interest at a reference rate plus 1.75%. The facility
contains certain restrictive covenants, including the maintenance of certain
financial ratios.
3. Stockholders' Equity
In March 2000, 580,102 stock options were exercised in accordance with the
Company's 1999 Stock Option/Stock Issuance Plan (1999 Plan) which was adopted in
January 2000. The common stock issued in this transaction is subject to vesting
terms consistent with the four year vesting term of the stock options:
exercisable immediately and vests 25% one year from date of grant and ratably
for the remaining 36 months. Certain employees exercised their stock options
through the issuance of a full recourse note payable to the Company. The notes
payable were issued at a below market interest rate which result in a new
measurement date for financial reporting purposes. Aggregate compensation
expense of $891,096 resulting from the remeasurement will be recorded over the
vesting term of the common stock. Compensation expense related to the six month
period ended June 30, 2000 of $74,258 was recorded in consolidated statements of
operations.
4. Subsequent Event
In September 2000, the Company's outstanding stock was was acquired by Digital
Island, Inc.
9
