<PAGE>
PROSPECTUS
Filed pursuant to Rule 424(b)(1)
Registration No. 333-86787
4,500,000 Shares
[SMARTERKIDS LOGO APPEARS HERE]
Common Stock
This is an initial public offering of common stock by SmarterKids.com, Inc.
We are selling 4,500,000 shares of common stock.
------------
Prior to this offering, there has been no public market for the common
stock. Our common stock has been approved for quotation on the Nasdaq National
Market under the symbol SKDS.
------------
<TABLE>
<CAPTION>
Per Share Total
--------- -----------
<S> <C> <C>
Initial public offering price............................ $14.00 $63,000,000
Underwriting discounts and commissions................... $ 0.98 $ 4,410,000
Proceeds to SmarterKids.com, before expenses............. $13.02 $58,590,000
</TABLE>
SmarterKids.com has granted the underwriters an option for a period of 30
days to purchase up to 658,500 additional shares of common stock. Two selling
stockholders have granted the underwriters options for a period of 30 days to
purchase an aggregate of up to 16,500 additional shares of common stock.
------------
Investing in the common stock involves a high degree of risk.
See "Risk Factors" beginning on page 8.
------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary is
a criminal offense.
Hambrecht & Quist
U.S. Bancorp Piper Jaffray
E*OFFERING
November 23, 1999
<PAGE>
[COMPANY LOGO APPEARS HERE]
HELPING PARENTS HELP THEIR CHILDREN LEARN
[PICTURE OF HAPPY CHILD]
The Destination for Educational Products and Resources
MySmarterKids
Parents can enter information about their child in MySmarterKids to get
product recommendations.
Shop by Brand, Character or Theme
[PICTURE OF SELECTED PRODUCTS]
[PICTURE OF COMPANY WEBSITE SHOWING PRODUCTS, SERVICES AND ADDITIONAL RESOURCES
OFFERED BY THE COMPANY]
[PICTURE OF MOTHER WITH 2 CHILDREN]
Shop by Age/Grade
[PICTURE OF SELECTED PRODUCTS]
Parents Center
Our Parents Resource Center offers educational activities and ideas for the
entire family.
Recommendations
Our Best Sellers, Teachers' Favorites and Parents' Favorites product
categories are just one click away.
Additional Resources
SmarterKids.com offers a number of educational resources.
[PICTURE OF FATHER AND DAUGHTER READING]
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary.................................................... 4
Risk Factors.......................................................... 8
Forward-Looking Statements............................................ 22
Use of Proceeds....................................................... 22
Dividend Policy....................................................... 22
Capitalization........................................................ 23
Dilution.............................................................. 25
Selected Financial Data............................................... 26
Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................ 28
Business.............................................................. 38
Management............................................................ 49
Principal and Selling Stockholders.................................... 58
Shares Eligible for Future Sale....................................... 61
Certain Transactions.................................................. 63
Description of Securities............................................. 64
Underwriting.......................................................... 67
Legal Matters......................................................... 70
Experts............................................................... 70
Where You Can Find More Information................................... 70
Index to Financial Statements......................................... F-1
</TABLE>
----------------
We maintain a World Wide Web site at www.smarterkids.com. Information
contained on our website does not constitute part of this prospectus.
SmarterKids.com, SmarterKids, MySmarterKids and SmartPicks are trademarks of
SmarterKids.com, Inc. All other brand names or trademarks appearing in this
prospectus are the property of their respective holders.
3
<PAGE>
PROSPECTUS SUMMARY
This summary highlights selected information contained elsewhere in this
prospectus. This summary does not contain all of the information that you
should consider before investing in our common stock. You should read the
entire prospectus carefully, including "Risk Factors" and our financial
statements and the notes to those financial statements, before making an
investment decision.
SmarterKids.com
SmarterKids.com is an online retailer focused on children's educational
books, toys and games, and software. We offer a broad assortment of carefully
selected, fun and educational products and an easy-to-use online shopping
environment. We provide educational content, including product reviews,
learning styles surveys and personalized product recommendations, to help
parents and gift givers find quality products and make informed purchase
decisions tailored to a child's individual developmental needs and learning
goals.
We launched our website in November 1998. Among online retailers focusing on
children's products, SmarterKids.com had the second highest number of unique
visitors in September 1999, according to Media Metrix, an independent Internet
research firm.
With thousands of educational products to choose from and few reliable
information sources, it is difficult for parents to identify and buy quality
products and services that fit the particular needs of their children. Parents
need a resource where they can access reliable product information and trusted
educational content to help them make informed purchase decisions and buy
products conveniently. Traditional retailers of educational products, including
mass market retailers, typically lack a focus on education, do not evaluate the
products they offer and may not understand the developmental needs of
individual children. In addition, these retailers often have a narrow product
selection due to physical space limitations, have high facilities and staffing
costs, offer limited service, and lack merchandising flexibility and shopping
convenience. Because of the limitations of the traditional retail distribution
channel, the Internet has emerged as an increasingly popular way to shop.
SmarterKids.com integrates carefully selected products, helpful content and
interactive tools with an intuitive and easy-to-use website to create a
compelling and unique online shopping experience. We only sell products that
our full-time staff of certified educators believe have educational,
developmental or learning value. Our collection of products includes over 2,400
books, toys and games, and software titles from over 300 suppliers. Because we
are focused on education, many of our products, particularly toys and games,
are often not found on many of the other websites that offer children's
products. The MySmarterKids personalization area on our website allows parents
to build a confidential educational profile of their child that can include
information about the child's age and grade, learning styles, learning goals
and performance on standardized tests. Our SmartPicks technology then uses this
profile to make product recommendations from our distinctive assortment of
products tailored to a child's individual developmental profile and goals.
As a result of the following factors and the other factors discussed under
"Risk Factors," investors are cautioned that our business involves a high
degree of risk:
. under our current business plan we have an operating history of less
than one year
. we have a history of significant losses
. we anticipate incurring losses in the foreseeable future, which may be
substantial
. our CD-ROM business, which we have greatly curtailed, historically
provided most of our revenues.
4
<PAGE>
Key elements of our strategy to be the leading online provider of children's
educational products, services and resources for parents include:
. continuing to enhance our customers' experience to build a trusted brand
by offering additional educational content, products and child
assessment tools on our website
. building brand awareness and expanding our customer base by aggressively
marketing and promoting our website
. pursuing additional revenue opportunities, such as adding products for
additional age ranges and introducing online testing services
. leveraging the power of our customer database by targeting product,
service and promotional offerings to customers for whom they are most
relevant
. maintaining scalable and efficient fulfillment operations to ensure
customer satisfaction by maintaining our relationship with J.L. Hammett
Co. while expanding our relationships with our suppliers
Due to our limited operating history, it is uncertain whether these
strategic goals can be achieved or when, if ever, we will be profitable. The
execution and achievement of each of our strategic goals will require
expenditures greatly in excess of amounts spent to date. We expect our spending
to continue to increase and our losses to continue for the foreseeable future.
While we select and own our inventory, take all orders and manage our
customer service, our inventory is held at a warehouse owned and maintained by
J.L. Hammett Co. J.L. Hammett Co. picks, packs and ships all orders and
maintains our warehouse management system. Our relationship with J.L. Hammett
Co. national distributor of educational products, provides us with industry and
supplier relationships, favorable credit and price terms from vendors, and the
ability to scale our warehouse operations.
SmarterKids.com, Inc. was incorporated in Delaware in 1994. From inception
through March 1998, our activities consisted primarily of the conception,
development, publishing, marketing and sales of proprietary educational and
entertainment CD-ROM software. In March 1998, we began transitioning our
business model to online sales of third-party educational products. In November
of 1998, we launched our website, ceased the sale of our proprietary CD-ROM
products through traditional retail channels, and now offer our proprietary CD-
ROM products on a limited basis through our online channel.
Our principal offices are located at 15 Crawford Street, Needham,
Massachusetts 02494, and our telephone number is 781-449-7567. Our website is
located at www.smarterkids.com. The information contained on our website is not
part of this prospectus.
5
<PAGE>
The Offering
Common stock offered by SmarterKids.com... 4,500,000 shares
Common stock to be outstanding after this 19,364,674 shares
offering..................................
Use of proceeds........................... For general corporate purposes
Nasdaq National Market symbol............. SKDS
The number of shares of our common stock that will be outstanding after this
offering, unless otherwise indicated, is based on the number outstanding on
October 15, 1999, with a pro forma adjustment to include an aggregate of
12,732,887 shares of common stock to be issued upon the consummation of the
offering as a result of conversion of all outstanding shares of preferred
stock. It excludes:
. 3,980,201 shares subject to outstanding options at a weighted-average
exercise price of $3.39 per share, of which 655,376 are exercisable as
of October 15, 1999, 35,512 additional shares available for issuance
under our 1995 Stock Plan and 1,800,002 additional shares available for
issuance under stock plans that will be in effect following this
offering
. warrants to purchase 613,091 shares of common stock at a weighted-
average exercise price of $1.88 per share that are currently outstanding
or that we are obligated to issue subject to certain conditions, 500,590
of which are currently exercisable, and 328,091 of which must be
exercised prior to the closing of this offering
----------------
Unless otherwise indicated, all information in this prospectus assumes that
the underwriters' over-allotment option will not be exercised. The term
"SmarterKids.com," "we," "us" and "our" refer to SmarterKids.com, Inc., a
Delaware corporation.
6
<PAGE>
Summary Financial Data
(in thousands, except share and per share data)
The following summary financial data are derived from the financial
statements of SmarterKids.com. The pro forma balance sheet data give effect to
the automatic conversion of all outstanding shares of preferred stock into an
aggregate of 12,732,887 shares of common stock and the automatic elimination of
the redemption right on the redeemable common stock upon the closing of this
offering. The pro forma as adjusted balance sheet data also reflect the pro
forma adjustments and our receipt of the net proceeds of $57.6 million from the
sale of 4,500,000 shares of common stock in this offering at the initial public
offering price of $14.00 per share, after deducting the estimated underwriting
discounts and commissions and offering expenses.
<TABLE>
<CAPTION>
Year Ended Nine Months Ended
December 31, September 30,
---------------------------------------------------------- ----------------------
1994 1995 1996 1997 1998 1998 1999
---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net revenues:
Online retail.......... $ -- $ -- $ -- $ -- $ 22 $ -- $ 1,108
Proprietary CD-ROM(1).. 219 401 1,240 1,416 2,278 1,815 --
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total net revenues.... 219 401 1,240 1,416 2,300 1,815 1,108
---------- ---------- ---------- ---------- ---------- ---------- ----------
Cost of revenues:
Online retail.......... -- -- -- -- 20 -- 795
Proprietary CD-ROM..... 28 319 407 491 908 620 --
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total cost of
revenues............. 28 319 407 491 928 620 795
---------- ---------- ---------- ---------- ---------- ---------- ----------
Gross profit............ $ 191 $ 82 $ 833 $ 925 $ 1,372 $ 1,195 $ 313
========== ========== ========== ========== ========== ========== ==========
Operating expenses...... $ 668 $ 1,553 $ 2,533 $ 1,922 $ 4,733 $ 2,645 $ 14,755
Net loss................ $ (477) $ (1,470) $ (1,649) $ (1,014) $ (3,342) $ (1,461) $ (14,142)
Net loss attributable to
common stockholders.... $ (477) $ (1,470) $ (1,649) $ (1,081) $ (3,596) $ (1,526) $ (14,261)
Basic and diluted net
loss per common share.. $ (.32) $ (.98) $ (1.10) $ (.72) $ (2.34) $ (1.01) $ (8.10)
Shares used to compute
basic and diluted net
loss per common share.. 1,500,000 1,500,000 1,500,606 1,502,148 1,533,524 1,508,665 1,760,106
Pro forma basic and
diluted net loss per
common share........... $ (0.43) $ (0.98)
Shares used to compute
pro forma basic and
diluted net loss per
common share........... 7,840,274 14,492,992
</TABLE>
- --------
(1) From our incorporation in 1994 until November 1998, our business focused on
the development, marketing and sale of our proprietary educational and
entertainment CD-ROM software.
<TABLE>
<CAPTION>
September 30, 1999
-----------------------------
Pro Pro Forma
Actual Forma As Adjusted
-------- ------- -----------
<S> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents...................... $ 13,361 $13,361 $70,953
Working capital................................ 14,357 14,357 71,949
Total assets................................... 23,896 23,896 81,488
Total long-term debt and capital lease
obligations, net of current portion........... 55 55 55
Redeemable stock............................... 35,491 -- --
Stockholders' equity (deficit)................. (19,006) 16,485 74,077
</TABLE>
7
<PAGE>
RISK FACTORS
You should carefully consider the following risk factors and all other
information contained in this prospectus before purchasing our common stock.
Investing in our common stock involves a high degree of risk. Any of the
following risks could harm our business, operating results and financial
condition and could result in a complete loss of your investment.
Risks Related to Our Business
Our business is difficult to evaluate because we have been operating under our
new business model for less than one year. Our market may not develop as
anticipated, and we may not successfully execute our business strategy.
We have a limited operating history upon which you can evaluate our
business. We did not launch the SmarterKids.com website and begin selling
children's educational products online until November 1998. In addition, most
of our management team was hired within the last eighteen months. From
inception through March 1998, our activities consisted primarily of the
conception, development, publishing, marketing and sales of proprietary
educational and entertainment CD-ROM software. In March 1998, we began
transitioning our business model to online sales of third-party educational
products. In November 1998, we launched our website, ceased the sale of our
proprietary CD-ROM products through traditional retail channels and now offer
our proprietary CD-ROM products on a limited basis through our online channel.
You must consider the challenges, risks and difficulties frequently encountered
by early stage companies using new and unproven business models in new and
rapidly evolving markets. Some of these challenges relate to our ability to:
. increase our brand name recognition
. expand our customer base
. manage our supplier/distributor relationships
. upgrade our website, transaction-processing systems, fulfillment
infrastructure and inventory management systems
We cannot be certain that our business strategy will be successful or that
we will successfully address these and other challenges, risks and
uncertainties.
Our limited operating history makes forecasting difficult. We may be unable to
adjust our spending in a timely manner to compensate for any unexpected revenue
shortfall.
As a result of our limited operating history with our current business model
introduced in November 1998, it is difficult to accurately forecast future
revenues. Also, we have limited meaningful historical financial data upon which
to base planned operating expenses. We base our current and future expense
levels on our operating plans and estimates of future revenue. Revenue and
operating results are difficult to forecast because they generally depend on
the volume and timing of the orders we receive. As a result, we may be unable
to adjust our spending in a timely manner to compensate for any unexpected
revenue shortfall, which would result in further substantial losses. We may
also be unable to expand our operations in a timely manner to adequately meet
customer demand to the extent it exceeds our expectations.
We have a history of losses, and we expect to incur substantial net losses in
the future. If we do not achieve profitability, our financial condition and our
stock price could suffer.
Since inception, we have incurred significant losses. As of September 30,
1999, we had an accumulated deficit of $22.5 million. We incurred net losses of
$3.3 million for the year ended December 31, 1998 and $14.1 million for the
nine months ended September 30, 1999.
8
<PAGE>
We expect operating losses and negative cash flow to continue for the
foreseeable future. We anticipate our losses will increase significantly from
current levels because we expect to incur significant additional costs and
expenses related to:
. brand development, advertising, marketing and promotional activities,
including product discounts
. expansion of our supplier/distributor relationships
. expansion of our order fulfillment infrastructure
. continued development of our website, transaction-processing systems,
fulfillment capabilities and network infrastructure
. expansion of our product offerings and website content
. employment of additional personnel as our business expands
Our ability to become profitable depends on our ability to generate and
sustain substantially higher revenue while maintaining reasonable expense
levels. In particular, although we intend to increase significantly our
spending on marketing and promotional activities, these efforts may not be
effective in converting a large number of customers from traditional shopping
methods to online shopping for educational products and services or attracting
online customers to our website. In addition, we are obligated to pay
commissions, based on a percentage of revenue, to companies with which we have
online marketing relationships, and we pay our fulfillment services provider,
J.L. Hammett Co., a fee based on a fixed percentage of the costs of our
products to us. These costs will increase as our revenues and orders increase.
If we do achieve profitability, we cannot be certain that we will be able to
sustain or increase profitability on a quarterly or annual basis in the future.
We have been unable to fund our operations with the cash generated from our
business. If we do not generate cash sufficient to fund our operations, we may
need additional financing to continue our growth or our growth may be limited.
We require substantial working capital to fund our business. Since our
inception, we have experienced negative cash flow from operations and expect to
experience significant negative cash flow from operations for the foreseeable
future. We incurred net losses of $14.1 million in the nine months ended
September 30, 1999 and $6.8 million in the quarter ended September 30, 1999. We
currently anticipate that the net proceeds of this offering, together with our
available funds, will be sufficient to meet our anticipated needs for working
capital and capital expenditures through at least the next 12 months. However,
we may need to raise additional funds prior to or after the expiration of such
period. If we raise additional funds through the issuance of equity or debt
securities, such securities may have rights senior to those of our
stockholders, and our stockholders may experience additional dilution. We
cannot be certain that additional financing will be available to us on
favorable terms when required, or at all.
We expect our quarterly operating results to fluctuate. If we fail to meet the
expectations of public market analysts and investors, the market price of our
common stock will decline.
If our quarterly revenue or operating results fall below investor or
securities analyst expectations, our stock price could fall substantially. The
Company's operating results may fall below investor or analyst expectations
irregardless of the Company's success or profitability. Factors that may cause
our operating results to fluctuate include:
. decreases in the number of visitors to our website or our inability to
convert visitors on our website to customers
. the mix of children's educational books, toys and games, and software
sold by us
. seasonality due to the academic year and Holiday season
. our inability to manage supplier or distributor relationships
9
<PAGE>
. price competition
. an increase in the level of product returns
. increases in the cost of advertising
. the amount and timing of operating costs and capital expenditures
relating to expansion of our operations
. unexpected increases in shipping costs and delivery times, particularly
during the Holiday season
. technical difficulties or system interruptions
In addition, general economic conditions and fluctuations in the demand for
children's educational product, over which we have no control, may also cause
our operating results to fluctuate.
Many of the other risk factors listed in this prospectus may negatively
affect our quarterly operating results and contribute to fluctuations. Our
limited operating history makes it difficult to assess the impact of these
factors on our operating results. Because of this difficulty in predicting
future performance, our operating results will likely fall below the
expectations of securities analysts or investors in some future quarter or
quarters, which would likely adversely affect the market price of our common
stock.
Our market is highly seasonal and may cause our operating results to fluctuate
from quarter to quarter. Our annual results are highly dependent on the success
of our holiday selling season.
The market for children's educational books, toys and games, and software is
highly seasonal due to the holiday season. In addition, Internet usage
generally declines in the summer. Accordingly, we expect to experience seasonal
fluctuations in our revenue. In particular, we expect a disproportionate amount
of our revenue to be realized during the fourth quarter of each calendar year.
If for any reason our revenue is below expectations during the fourth quarter,
our annual operating results would be adversely affected.
Because of our limited operations during last year's holiday season, we do
not have meaningful comparative data indicating the volume or timing of holiday
orders. We may not accurately predict appropriate inventory levels or staffing
needs. In the future, our seasonal sales patterns may become more pronounced,
may strain our personnel and fulfillment relationships and may cause a
shortfall in revenue as compared to expenses in a given period. These seasonal
patterns will cause quarterly fluctuations in our operating results and could
adversely affect our financial performance.
We pay commissions to companies with which we have online marketing
relationships. Our profits as a percentage of revenues will decrease as the
proportion of our revenues from these arrangements increases.
Our relationships with online companies are intended to drive traffic to our
website. Approximately 2% of our revenues in the nine months ended September
30, 1999 were derived from these relationships. We pay commissions to these
companies based on a percentage of the revenues we derive from these
relationships. Although these relationships are intended to increase the number
of our customers and, therefore, our revenues, as revenues derived from these
relationships increases our profit as a percentage of revenues will decrease.
We face significant inventory risks because consumer demand can change for
products that we have in inventory or on order.
The demand for certain products can change what we have in inventory or on
order. As a result, we may own inventory that may become obsolete if customer
orders do not materialize. This risk may be greatest in the first calendar
quarter of each year, after we have increased significantly our inventory
levels for the prior holiday season. This risk will increase as we enter new
product categories due to our lack of
10
<PAGE>
experience in purchasing products for these categories. In addition, to the
extent that demand for our products increases over time, we may be forced to
increase inventory levels. Any such increase would subject us to additional
inventory risks.
We are dependent on J.L. Hammett Co., our sole provider of distribution
services. The inability of J.L. Hammett Co., for any reason, to perform these
functions could lead to interruptions in our operations, lost revenues and
increased expense.
We are highly dependent upon our relationship with J.L. Hammett Co., a
national distributor of educational products, which serves as our exclusive
provider of products and distribution services. J.L. Hammett Co. works closely
with us to determine our projected inventory needs and then orders and
maintains the physical inventory of children's educational books, toys and
games and software necessary to satisfy customer orders. J.L. Hammett Co.
orders and stocks inventory on our behalf, fulfills our customer orders as they
are received, and then packs and ships the orders using our packaging
materials. J.L. Hammett Co. also handles promotional mailings and product
returns as necessary on our behalf. J.L. Hammett Co. is, to a limited extent, a
competitor. The termination of our relationship with J.L. Hammett Co. could
lead to interruptions in our operations, lost revenues and increased expense
necessary to quickly implement an alternative distribution and order
fulfillment infrastructure.
Our success depends on our ability, in conjunction with J.L. Hammett Co., to
rapidly expand fulfillment operations in order to accommodate a significant
increase in customer orders.
Our current fulfillment operations may not be adequate to accommodate
significant increases in customer demand that may occur during the final
quarter of 1999. We plan to take action, including the hiring of additional
personnel to work directly for us at the J.L. Hammett Co. facility and the
funding of additional inventory in the final quarter of 1999, to satisfy such
anticipated increases in product demand. There can be no assurance that the
measures we take will be successful. If we do not successfully expand our
fulfillment operations to accommodate demand generally and, in particular,
increased demand during the final quarter of each calendar year due to the
seasonal nature of our business, our business will be adversely affected.
Our business relies on our ability to obtain sufficient quantities of quality
merchandise on acceptable commercial terms.
Vendors may stop selling merchandise to us and we may not be able to secure
identical or comparable merchandise from alternative vendors in a timely manner
or on acceptable terms. From time to time, we expect to experience difficulty
in obtaining sufficient quantities of certain products. If we cannot supply our
products to consumers at acceptable prices, we may lose sales and market share
as consumers make purchases elsewhere. Further, an increase in supply costs
could increase operating losses beyond current expectations.
Intellectual property claims against us can be costly and result in the loss of
significant rights.
We regard trademarks, copyrights, service marks, trade secrets, patents and
similar intellectual property as important to our success. We rely on trademark
and copyright law, trade secret protection and confidentiality and/or license
agreements with our employees, customers and others to protect our proprietary
rights.
Other parties may assert infringement or unfair competition claims against
us. In the past, other parties have sent us notice of claims of infringement of
proprietary rights, including trademarks, copyrights and patents related to our
business, and we may receive other notices in the future. If we are forced to
defend against any such claims, whether they are with merit or are determined
in our favor, then we may face costly litigation, diversion of technical and
management personnel, and product shipment delays. If there is a
11
<PAGE>
successful claim of infringement against us and we are unable to develop non-
infringing technology or license the infringed or similar technology on a
timely basis, or if we are required to cease using one or more of our business
or product names due to a successful trademark infringement claim against us,
it could adversely affect our business.
In addition, effective trademark, service mark, copyright, trade secret and
patent protection may not be available in every country in which we sell our
products and services online. Therefore, the steps we take to protect our
proprietary rights may be inadequate and our business could be adversely
affected.
If we are unable to retain or acquire the necessary domain names, our brand and
reputation could be damaged and we could lose customers.
We currently hold the Web domain name SmarterKids.com as well as several
other variations of this domain name. The acquisition and maintenance of domain
names generally is regulated by governmental agencies and their designees. In
the United States, the National Science Foundation has appointed Network
Solutions, Inc., and recently several others, as the current registrars for the
".com", ".net" and ".org" generic top-level domains. The regulation of domain
names in the United States and in foreign countries is subject to change in the
near future. As a result, we may be unable to acquire or maintain relevant
domain names in all countries in which we conduct business. Furthermore, the
relationship between regulations governing domain names and laws protecting
trademarks and similar proprietary rights is unclear. Therefore, we may be
unable to prevent third parties from acquiring domain names that are similar
to, infringe upon or otherwise decrease the value of our trademarks and other
proprietary rights. In addition, other parties hold domain names that are
similar to ours and any confusion of our website with another party's could
diminish our brand.
We may fail to compete effectively in our market.
The market for children's educational products online is new, rapidly
evolving and intensely competitive. We expect competition to intensify in the
future. Barriers to entry are minimal, and current and new competitors can
launch new websites at a relatively low cost. In addition, the markets for
children's books, toys and games, and software in general, including those for
children's educational products, are very competitive and highly fragmented,
with no clear dominant leader and increasing public and commercial attention.
Our competitors can be divided into several groups, including:
. mass market retail chains, such as Kmart, Target and Wal-Mart
. mass market book sellers, toy stores and computer hardware and software
stores, such as Barnes & Noble, Toys "R" Us and CompUSA
. traditional regional or local bookstores, toy stores and computer and
software stores
. traditional specialty educational retailers, such as Learning Express,
Learningsmith, Noodle Kidoodle and Zany Brainy
. online book sellers, toy sellers and computer software sellers, such as
Amazon.com, eToys, KBkids.com, toysmart.com and Beyond.com
. educational catalog distributors, such as Scholastic
Many of our current and potential competitors have longer operating
histories, larger customer or user bases, greater brand recognition and
significantly greater financial, marketing and other resources than we do. Many
of these current and potential competitors can devote substantially greater
resources to marketing and promotional campaigns and website and systems
development than we can. Their financial strength could prevent us from
increasing market share. In addition, larger, more well-established and more
well-
12
<PAGE>
financed entities are acquiring, investing in and forming joint ventures with
online competitors and publishers or suppliers of children's educational books,
toys and games, and software as the use of the Internet increases.
Our competitors may be able to secure products from vendors on more
favorable terms, fulfill customer orders more efficiently and adopt more
aggressive pricing or inventory availability policies than we can. Traditional
store-based retailers also enable customers to see and feel products in a
manner that is not possible over the Internet. Some of our competitors have
significantly greater experience in selling children's educational products.
Our online competitors are able to use the Internet as a marketing medium to
reach significant numbers of potential customers. Internet consumers can easily
compare prices among online retailers, which may increase pricing pressures.
New Internet technologies and the expansion of existing technologies, such as
price comparison programs that select specific titles from a variety of
websites and may direct customers to other online educational books, games and
software retailers, may increase pricing pressures and competition.
Increased competition may result in reduced operating margins, loss of
market share and diminished brand awareness.
If we enter new business categories and pursue new product offerings and
services that do not achieve market acceptance, our brand and reputation could
be damaged and we could incur additional financial losses.
We may choose to expand our operations by expanding the breadth and depth of
products and services offered or expanding our market presence through
relationships with third parties. In addition, we may pursue the acquisition of
new or complementary businesses, products, services or technologies, although
we have no present understandings, commitments or agreements with respect to
any material acquisitions or investments. We may not be successful in our
efforts to expand our operations, and potential customers may not react
favorably to these efforts. Furthermore, any new product or service category
that is launched by us but not favorably received by consumers could damage our
brand or reputation. An expansion of our business would also require
significant additional expenses, expose us to additional supplier/distributor
inventory risk and would strain our management, financial and operational
resources. Given our lack of capital resources, any expansion program or new
business category that is not successful could strain our financial resources
and detract capital from otherwise successful operations.
If we are unable to manage our growth and the related expansion in our
operations effectively, our business may be harmed.
Our ability to successfully offer products and services and implement our
business model in a rapidly evolving market requires an effective planning and
management process. We continue to increase the scope of our operations and
have grown our headcount substantially. Excluding part-time employees, we have
grown from 15 employees at December 31, 1997, to 73 employees at September 30,
1999. We will need to add additional personnel in the future. We may be unable
to hire qualified employees as needed. Our growth has placed, and our
anticipated future operations will continue to place, a significant strain on
our management, information systems, network and other resources.
We depend upon United Parcel Service to deliver our products on a timely and
consistent basis. A deterioration in our relationship with United Parcel
Service could decrease our ability to track shipments, cause shipment delays,
and increase our shipping costs and the number of damaged products.
Our supply and distribution system is dependent upon our relationship with
United Parcel Service. If our relationship with United Parcel Service is
terminated or impaired or if United Parcel Service is unable to
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deliver product for us, whether through labor shortage, slow down or stoppage,
deteriorating financial or business condition or for any other reason, we would
be required to use alternative carriers for the shipment of products to our
customers. We may be unable to engage an alternative carrier on a timely basis
or upon terms favorable to us. Potential adverse consequences of changing
carriers include:
. reduced visibility into order status and package tracking
. delays in order processing and product delivery
. increased cost of delivery, resulting in reduced gross margins
. reduced shipment quality which may result in damaged products and
customer dissatisfaction
If we do not successfully maintain and expand our website and the systems that
process customers' orders, we could lose customers and our revenues could be
reduced.
Our success, in particular our ability to successfully receive and fulfill
orders and provide high quality customer service, largely depends on the
efficient and uninterrupted operation of our computer and communications
systems and those systems of J.L. Hammett Co. While we select and own our own
inventory, take all orders and manage our customer service, all our inventory
resides at a warehouse owned and maintained by J.L. Hammett Co. J.L. Hammett
Co. picks, packs and ships all orders, and J.L. Hammett Co. maintains our
warehouse management system. Our success also depends on our ability to rapidly
expand our website, transaction-processing systems and network infrastructure
without systems interruptions in order to accommodate significant increases in
customer traffic and demand. Many of our software systems are custom-developed,
and we rely on our employees and third-party contractors to develop and
maintain these systems. If any of these employees or contractors become
unavailable to us, we may experience difficulty in improving and maintaining
such systems.
In addition, we rely on a third party, Exodus Communications, to host our
website and are thus subject to its ability to provide service when and as we
require.
If we do not respond to rapid technological changes, our services could become
obsolete and we could lose customers.
To remain competitive, we must continue to enhance and improve the
functionality and features of our online store. The Internet and the online
commerce industry are rapidly changing. If competitors introduce new products
and services embodying new technologies, or if new industry standards and
practices emerge, our existing website and proprietary technology and systems
may become obsolete. Our future success will depend on our ability to do the
following:
. both license and internally develop leading technologies useful in our
business
. enhance our existing services
. develop new services and technologies that address the increasingly
sophisticated and varied needs of our prospective customers
. respond to technological advances and emerging industry standards and
practices on a cost-effective and timely basis
Ongoing development of our website and other proprietary technology entails
significant expense and technical risks. We may use new technologies
ineffectively or we may fail to adapt our website, transaction-processing
systems and network infrastructure to customer requirements or emerging
industry standards. If we face material delays in introducing new services,
products and enhancements, our customers may forego the use of our services and
use those of our competitors.
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Our facilities and systems are vulnerable to unexpected problems including
problems relating to system expansion activities or lack of system capacity.
The occurrence of a natural disaster or other unexpected problem could damage
our reputation and brand and reduce our revenues.
Although we expect to periodically enhance and expand our website,
transaction-processing systems and network infrastructure, we may experience
interruptions in our systems. We may be unable to project the rate or timing of
increases, if any, in the use of our website. This would make it difficult for
us to effectively upgrade and expand our transaction-processing systems and to
integrate smoothly any newly developed or purchased modules with our existing
systems. To the extent we are required to outsource any technological
enhancements or become dependent on third party proprietary technology,
expanding and upgrading our systems could become more diffiicult. Due to the
seasonal nature of our business, it is particularly important that we are able
to expand our website, transaction-processing systems and network
infrastructure as necessary in preparation for the holiday season and that we
operate during that period without systems interruptions. Our failure to
achieve or maintain high capacity data transmission without system downtime,
particularly during this period, would adversely affect our business.
Substantially all of our computer and communications hardware systems
related to transaction processing and network infrastructure are hosted at a
third-party facility owned and operated by Exodus Communications in Waltham,
Massachusetts. Our systems and operations, including our fulfillment operation,
which is located at a facility owned and operated by J.L. Hammett Co. are
vulnerable to damage or interruption from fire, flood, power loss,
telecommunications failure, break-ins, earthquake and similar events.
Furthermore, our servers may be vulnerable to computer viruses, physical or
electronic break-ins and similar disruptions. We have no formal disaster
recovery plan, and our business interruption insurance may not adequately
compensate us for losses that may occur. The occurrence of a natural disaster
or unanticipated problems at the J.L. Hammett Co. facility or at the Exodus
facility could cause interruptions or delays in our business, loss of data or
render us unable to accept and fulfill customer orders. The occurrence of any
or all of these events could adversely affect our reputation, brand and
business.
Our computer systems and those of our key suppliers and service providers may
not be year 2000 compliant, which may disrupt our operations.
Many existing computer programs use only two digits to identify a year.
These programs were designed and developed without addressing the impact of the
upcoming change in the century. If not corrected, many computer software
applications could fail or create erroneous results by, at or beyond the year
2000. We use software, computer technology and other services internally
developed and provided by third-party vendors that may fail due to the year
2000 phenomenon. For example, we are dependent on the financial institutions
involved in processing our customers' credit card payments for Internet
services and a third party that hosts our servers. We are also dependent on
telecommunications vendors to maintain our network and UPS and other carriers
to deliver orders to customers.
We have reviewed the proprietary aspects of our internally developed
software and we believe it to be year 2000 compliant. We assessed the year 2000
readiness of our third party supplied software, computer technology and other
services and those of J.L. Hammett Co., our distribution services provider.
Based upon the results of this assessment, we are developing a remediation plan
for the following major risk areas:
. specific network failures that would result in an inability to transmit
data among J.L. Hammett Co., our website, and our headquarters
. specific system failures that would result in an inability to print and
process orders at J.L. Hammett Co.
Any sustained inability of J.L. Hammett Co. to receive and process orders
would result in substantial manual effort and processing delay. The failure of
our software or computer systems or of our third-party suppliers to be year
2000 compliant would have a material adverse effect on our business.
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The year 2000 readiness of the general infrastructure necessary to support
our operations is difficult to assess. For instance, we depend on the integrity
and stability of the Internet to provide our services. We also depend on the
year 2000 compliance of the computer systems and financial services used by
consumers. A significant disruption in the ability of consumers to reliably
access the Internet or portions of it or to use their credit cards would have
an adverse effect on demand for our services and would have a material adverse
effect on our business.
The success of our business depends on the continuing contribution of our key
personnel, including Mr. David A. Blohm, our President and Chief Executive
Officer.
Our future success is dependent on key members of our management team and in
particular David A. Blohm, our President and Chief Executive Officer. The
competition for qualified personnel in the electronic commerce market is
extremely intense, especially in the Northeastern part of the United States.
The loss of service of Mr. Blohm or a significant number of our employees could
have a material adverse effect on our business. In particular, the loss of
several key programmers could inhibit the development and enhancement of our
website and could damage customer relations and our brand. Similarly, the loss
of several marketing and sales personnel could inhibit our ability to
effectively promote our website.
We may be subject to product liability claims.
We face an inherent risk of exposure to product liability claims in the
event that the use of the products we sell results in injury. We may not have
adequate resources in the event of a successful claim against us. Our general
liability insurance may not cover these claims or we may not be indemnified for
any or all of the liabilities that may be imposed. We cannot predict whether
product liability claims will be brought against us in the future or if the
resulting adverse publicity would harm our business.
Risks Related to the Internet Industry
We depend on the Internet and the development of the Internet infrastructure.
Our success will depend in large part on continued growth in, and the use
of, the Internet for commerce. The electronic commerce market is new and
rapidly evolving, and the extent of consumer acceptance is uncertain. The
issues concerning the commercial use of the Internet that we expect to affect
the development of the market for our services include security, reliability,
cost of access, ease of access, ease of use, speed and quality of service.
In addition, popular companies that provide access to Internet transactions
through network access or Web browsers, such as America Online, Yahoo, Lycos
and Microsoft, could promote our competitors or charge us a substantial fee for
connection to our website. Either of these developments could adversely affect
our business.
Our business is subject to government regulation of the Internet and other
legal uncertainties which could negatively impact our operations.
Law and regulations directly applicable to communications or commerce over
the Internet are becoming more prevalent. The United States Congress recently
enacted Internet laws, including laws relating to children's privacy, the
transmission of sexually explicit material and taxation of Internet-based
enterprises. As directed by Congress in the Children's Online Privacy
Protection Act, also known as COPPA, the Federal Trade Commission recently
adopted regulations, effective April 21, 2000, prohibiting unfair and deceptive
acts and practices in connection with the collection and use of personal
information from children under 13 years old on the Internet.
The Child Online Protection Act of 1998, also known as COPA, prohibits
harmful commercial communications over the World Wide Web that are available to
any person under 17 years old. This act,
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however, was declared unconstitutional by a federal district court earlier this
year and that decision is currently on appeal before a federal circuit court.
An oral argument is scheduled for November 4, 1999. If the district court's
decision is overturned and that ruling is upheld upon further appeal, providing
information to minors over the Internet would be greatly limited. However,
because SmarterKids.com's website is not directed at children and we do not
anticipate its widespread use by children, COPPA and the FTC's regulations, as
well as provisions under COPA, should they be enforceable, should not have a
significant effect upon our business. Nevertheless, the FTC has strongly
advocated that even general audience websites establish privacy policies that
include procedures to disclose and notify users of privacy and security
policies, obtain consent from users for collection and use of information, and
provide users with the ability to access, correct and delete personal
information stored by the company. There can be no assurance that we will adopt
policies that conform with regulations adopted or policies advocated by the FTC
or any other governmental entity. In addition, the FTC has already begun
investigations into the privacy practices of companies that collect information
on the Internet. One investigation resulted in a consent decree pursuant to
which an Internet company agreed to establish programs to implement the
principles noted above. We may become subject to a similar investigation, or
the FTC's regulatory and enforcement efforts may adversely affect our ability
to collect demographic and personal information from users, which could
adversely affect our marketing efforts.
In addition, the European Union recently enacted its own privacy regulations.
The European Union Directive on the Protection of Personal Data, which became
effective in October 1998, fosters electronic commerce by establishing a stable
framework to ensure both a high level of protection for private individuals and
the free movement of personal data within the European Union. The EU and the
U.S. Department of Commerce are currently negotiating an agreement under which
the privacy policies of American businesses may be deemed to be adequate under
the EU Directive. Until such time as an agreement is reached, the EU has
voluntarily agreed to a moratorium on enforcement of the EU Directive against
U.S. businesses. Although the Company has received less than 1% of revenues
from outside of the United States in the nine months ended September 30, 1999,
the European legislation and its adoption via any agreement could adversely
affect our ability to expand our sales efforts to Europe by limiting how
information about us can be sent over the Internet in the EU and limiting our
efforts to collect information from European users.
The U.S. Omnibus Appropriations Act of 1998 places a moratorium on taxes
levied on Internet access from October 1, 1998 to October 21, 2001. However,
states may place taxes on Internet access if taxes had already been generally
imposed and actually enforced prior to October 1, 1998. States which can show
they enforced Internet access taxes prior to October 1, 1998 and states after
October 21, 2001 may be able to levy taxes on Internet access resulting in
increased cost to access to the Internet, resulting in a material adverse
effect on our business.
The laws governing the use of the Internet, in general, remain largely
unsettled, even in areas where there has been some legislative action. It may
take years to determine whether and how existing laws such as those governing
intellectual property, privacy, libel and taxation apply to the Internet. In
addition, the growth and development of the market for online commerce may
prompt calls for more stringent consumer protection laws, both in the United
States and abroad. This occurrence may impose additional burdens on companies
conducting business online by limiting how information can flow over the
Internet and the type of information that can flow over the Internet. The
adoption or modification of laws or regulations relating to the Internet could
adversely affect our business. Because we receive a significant amount of
orders as a result of e-mail advertising, new regulations affecting the use of
unsolicited e-mail advertising would impair our marketing efforts.
We may be liable for the content we provide on our website or which is accessed
from our website.
We believe that our future success will depend in part upon our ability to
deliver original and compelling descriptive content about the children's
educational books, toys and games, and software that we
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sell on the Internet. As a publisher of online content, we face potential
liability for defamation, negligence, copyright, patent or trademark
infringement, or other claims based on the nature and content of materials that
we publish or distribute. In the past, plaintiffs have brought such claims and
sometimes successfully litigated them against online services. Although we
carry general liability insurance, our insurance may not cover claims of these
types or may be inadequate to indemnify us for all liability that may be
imposed on us. If we face liability, particularly liability that is not covered
by our insurance or is in excess of our insurance coverage, then our reputation
and our business may suffer.
Our revenues and reputation would be adversely affected if our security
measures fail.
Consumer concerns regarding the security of transactions conducted on the
Internet and users' privacy may inhibit the growth of use of the Internet and
electronic commerce. To securely transmit confidential information, such as
customer credit card numbers, we rely on encryption and authentication
technology that we license from third parties. We cannot predict whether we
will experience compromises of, or breaches in, the technologies we use to
protect customer transaction data.
We may need to expend significant additional capital and other resources to
protect against security breaches or alleviate problems caused by any such
breaches. We cannot guarantee that security breaches will not occur, and if our
security measures fail our business could be harmed. Any penetration of our
network security or misappropriation of our users' personal or credit card
information could subject us to liability. Claims could also be based on other
misuses of personal information, including the use of this information for
unauthorized marketing purposes. These claims could result in litigation.
Our revenues and reputation would be adversely affected if we experience
significant credit card fraud.
Under current credit card practices, merchants are liable for fraudulent
credit card transactions where, as is the case with the transactions we
process, the merchant does not obtain a cardholder's signature. We may be
liable for claims based on unauthorized purchases with credit card information,
impersonation or other similar fraud claims. A failure to adequately control
fraudulent credit card transactions would harm our business.
Privacy concerns and legislation may limit the information we can gather.
When a visitor first arrives at our website, our software creates a profile
for that visitor. If the visitor registers or logs in, the visitor's identity
is added to the profile, preserving any profile information that was gathered
up to that point. We track both explicit user profile data supplied by the user
as well as implicit profile attributes derived from the user's behavior on the
website. We suggest that parents provide us with an educational profile on
their children. This is an important feature of our website. Privacy concerns
relating to children are particularly acute. Privacy concerns may cause
visitors to resist providing the personal data or avoid websites that track the
behavioral information necessary to support this profiling capability. More
importantly, even the perception of security and privacy concerns, whether or
not valid, may indirectly inhibit market acceptance of our products. For
example, the European Union recently adopted a directive addressing data
privacy that may limit the collection and use of certain information regarding
Internet users. This directive may limit our ability to target advertising or
collect and use information in certain European countries. In addition,
legislative or regulatory requirements may heighten these concerns if
businesses must notify website users that the data captured after visiting
websites may be used to direct product promotion and advertising to that user.
Other countries and political entities, such as the European Union, have
adopted such legislation or regulatory requirements. The United States may
adopt similar legislation or regulatory requirements. If privacy legislation is
enacted or consumer privacy concerns are not adequately addressed, our
business, financial condition and operating results could be harmed.
Websites typically place "cookies" on a user's hard drive without the user's
knowledge or consent. We use cookies for a variety of reasons, including the
collection of data derived from the user's Internet activity. Most currently
available Web browsers allow users to remove cookies at any time or to prevent
cookies from
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being stored on their hard drives. In addition, some commentators, privacy
advocates and governmental bodies have suggested limiting or eliminating the
use of cookies. Any reduction or limitation in the use of cookies could limit
the effectiveness of our sales and marketing efforts. The FTC and several
states have investigated the use by certain Internet companies of personal
information. We could incur significant additional expenses if new regulations
regarding the use of personal information are introduced or if our privacy
practices are investigated.
Our revenues could decrease if we became subject to sales and other taxes.
We do not currently collect sales or other similar taxes for physical
shipments of goods into states other than Massachusetts. However, one or more
local, state, federal or foreign jurisdictions may seek to impose sales tax
collection obligations on us. In addition, any new operation in states outside
Massachusetts could subject our shipments in such states to state sales taxes
under current or future laws. A number of legislative proposals have been made
at the federal, state and local level, and by foreign governments, that would
impose additional taxes on the sale of goods and services over the Internet and
certain states have taken measures to tax Internet-related activities. Although
Congress recently placed a three-year moratorium on new state and local taxes
on Internet access or on discriminatory taxes on electronic commerce, existing
state or local laws were expressly excepted from this moratorium. Further, once
this moratorium expires, some type of federal and/or state taxes may be imposed
upon Internet commerce. The moratorium is presently scheduled to expire on
October 20, 2001. Such legislation or other attempts at regulating commerce
over the Internet may substantially impair the growth of commerce on the
Internet and, as a result, adversely affect our opportunity to derive financial
benefit from such activities. If one or more states or any foreign country
successfully asserts that we should collect sales or other taxes on the sale of
our products, it could adversely affect our business and results of operations.
Risks Associated with this Offering
The broad discretion we have in the use of proceeds of this offering increases
the risk that we may not use them effectively or that we may use them in ways
with which you or the market in general may not agree.
Presently, we intend to use the proceeds from this offering for general
corporate purposes, including advertising and other marketing expenses to
promote and enhance our website, purchasing inventory, expanding our
fulfillment capabilities and upgrading our computer systems. We may also use a
portion of the proceeds to expand our business through strategic alliances and
acquisitions. We have not yet determined the amount of net proceeds to be used
specifically for any of the foregoing purposes. As a result, investors in this
offering will be relying on management's judgment with only limited information
about its specific intentions regarding the use of proceeds. Additional
information regarding the ways in which we intend to spend the proceeds of this
offering is included in this prospectus under the heading "Use of Proceeds."
Our officers and directors will exercise significant control over us, which
could delay or prevent someone from acquiring or merging with us.
After this offering, our executive officers and directors (14 persons), and
entities affiliated with them, will control approximately 37.1% of our common
stock. As a result, these stockholders, acting together, would be able to
significantly influence all matters requiring approval by our stockholders,
including the election of directors and the approval of mergers or other
business combination transactions.
Market prices of emerging Internet companies have been highly volatile, and the
market for our stock may be highly volatile as well. Litigation may be
instituted following severe market price volatility.
The stock market has experienced significant price and trading volume
fluctuations, and the market prices of technology companies, particularly
Internet companies, have been highly volatile. A number of
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recent initial public offerings by Internet companies have been accompanied by
exceptional share price and trading volume changes in the first days and weeks
after the securities were released for public trading. Investors may not be
able to resell their shares at or above the initial public offering price. In
the past, following periods of volatility in the market price of a public
company's securities, securities class action litigation has often been
instituted against that company. Such litigation could result in substantial
costs and a diversion of management's attention and resources.
New investors will suffer immediate and substantial dilution in the net
tangible book value of their shares.
The initial public offering price is substantially higher than the net
tangible book value per share of the common stock. Therefore, you will incur
immediate dilution in net tangible book value of $10.20 per share based on the
initial public offering price of $14.00 per share. You may incur additional
dilution if holders of stock options exercise their options or if
warrantholders exercise their warrants to purchase common stock.
A substantial number of our securities may be sold in the market in the future.
This could cause our stock price to decline significantly, even if our business
is doing well.
The market price of our common stock could decline as a result of sales by
our existing stockholders of a large number of shares of our common stock in
the market after this offering (and after a 180-day lockup period in many
cases) or the perception that such sales could occur. These sales also might
make it more difficult for us to sell equity securities in the future at a time
and at a price that we deem appropriate. In addition to the 4,500,000 shares of
common stock to be sold in this offering and assuming the exercise of warrants
to purchase 328,091 shares of common stock which terminate upon the closing of
this offering, the number of shares that will be available for sale in the
public market under the provisions of Rule 144 and 701 based on the number of
shares, options and warrants outstanding as of October 15, 1999 will be as
follows:
. Beginning on the date of this prospectus, only the shares sold in this
offering will be immediately available for sale in the public market.
. Beginning 180 days after the date of this prospectus, approximately
9,838,087 shares will be eligible for sale, including 1,898,266 shares
subject to outstanding vested options and warrants.
. At various times thereafter upon the expiration of applicable holding
periods, 9,619,879 shares will become eligible for sale, including
2,366,935 shares subject to outstanding options and warrants.
Anti-takeover provisions in our charter documents and Delaware law could
prevent or delay a change in control of our company.
Our corporate Charter and By-laws may discourage, delay or prevent a merger
or acquisition that a stockholder may consider favorable by:
. authorizing blank check preferred stock, a type of stock with terms and
conditions set by the Board of Directors alone without further
stockholder approval. Such preferred stock could be issued with more
voting power than the common stock, effectively giving control of the
company to the holders of preferred stock. Such an issuance of preferred
stock could make it more difficult for a third party to acquire, or
discourage a third party from attempting to acquire, a majority of our
outstanding voting stock. The existence of blank check preferred stock
could facilitate the introduction of a poison pill rights distribution
which could discourage or delay a merger or acquisition
. providing for a classified board of directors with staggered, three-year
terms, which generally increases the time required for stockholders to
change the composition of our Board of Directors
. limiting the persons who may call special meetings of stockholders
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. prohibiting stockholder action by written consent
. establishing advance notice requirements for nominations for election to
the board of directors or for proposing matters that can be acted on at
stockholder meetings
Our corporate Charter and By-laws require that a 75% stockholder vote is
required to amend or repeal the foregoing provisions and remove directors for
cause. In addition, Section 203 of the General Corporation Law of Delaware
prohibits us from engaging in a transaction involving a merger or consolidation
of SmarterKids.com with an interested stockholder of SmarterKids.com, or the
sale of assets or securities of SmarterKids.com under certain circumstances to
an interested stockholder of SmarterKids.com for a period of three years after
the date of the transaction in which the person became an interested
stockholder, unless the business combination is approved in a prescribed
manner.
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FORWARD-LOOKING STATEMENTS
Some of the statements under "Prospectus Summary," "Risk Factors," "Use of
Proceeds," "Management's Discussion and Analysis of Financial Condition and
Results of Operations," "Business" and elsewhere in this prospectus constitute
forward-looking statements. These statements involve known and unknown risks,
uncertainties, and other factors that may cause our or our industry's actual
results, levels of activity, performance, or achievements to be materially
different from any future results, levels of activity, performance, or
achievements expressed or implied by such forward-looking statements. Such
factors include, among other things, those listed under "Risk Factors" and
elsewhere in this prospectus. In some cases, you can identify forward-looking
statements by terminology such as "may," "will," "should," "expect," "plan,"
"anticipate," "believe," "estimate," "predict," "potential" or "continue" or
the negative of such terms or other comparable terminology. These statements
are only predictions. Actual events or results may differ materially. In
evaluating these statements, you should specifically consider various factors,
including the risks outlined under "Risk Factors." Although we believe that the
expectations reflected in the forward-looking statements are reasonable, we
cannot guarantee future results, levels of activity, performance or
achievements.
USE OF PROCEEDS
We will receive estimated net proceeds of $57,592,000 from the sale in this
offering of 4,500,000 shares of common stock at the initial public offering
price of $14.00 per share after deducting underwriting discounts and
commissions of $4,410,000 and estimated expenses of $998,000. If the
underwriters' over-allotment option is exercised in full, we will receive net
proceeds of $66,380,500. We will not receive any proceeds from the sale of
common stock by the selling stockholders.
The primary purposes of this offering are to increase our capitalization and
financial flexibility, create a public market for our common stock and
facilitate future access to public markets. We intend to use the proceeds for
working capital and other general corporate purposes.
Although we may use a portion of the net proceeds to acquire technology or
businesses that are complementary to our business, we currently have no
commitments or agreements for such acquisitions and are not involved in
negotiations regarding any acquisitions.
Pending use of the net proceeds for the above purposes, we intend to invest
the net proceeds in short-term, interest-bearing, investment-grade securities.
DIVIDEND POLICY
We currently intend to retain all future earnings, if any, for funding our
growth and, therefore, do not expect to pay any dividends in the foreseeable
future.
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CAPITALIZATION
The following table sets forth our capitalization as of September 30, 1999
on an actual, pro forma and pro forma as adjusted basis. The "actual" column
reflects our capitalization as of September 30, 1999 on a historical basis,
without any adjustments to reflect subsequent events or anticipated events. The
"pro forma" column reflects our actual capitalization as of September 30, 1999
with adjustments for the following:
. the filing prior to the closing of this offering of an Amended and
Restated Certificate of Incorporation authorizing 90,000,000 shares of
common stock and 10,000,000 shares of undesignated preferred stock
. the automatic conversion of all outstanding shares of preferred stock
into an aggregate of 12,732,887 shares of common stock upon the closing
of this offering
. the automatic elimination of the redemption right on the redeemable
common stock upon the closing of this offering
The "pro forma as adjusted" column reflects our capitalization as of
September 30, 1999 with the preceding "pro forma" adjustments plus the receipt
of the estimated net proceeds of $57.6 million from our sale in this offering
of 4,500,000 shares of common stock at the initial public offering price of
$14.00 per share.
None of the columns set forth below reflect as of September 30, 1999:
. warrants to purchase 613,091 shares of our common stock, 328,091 of
which expire upon the closing of this offering
. options to purchase 2,831,451 shares of common stock at an average
exercise price of $0.30 per share, and 2,984,262 shares of common stock
reserved for future issuance under our stock plans
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The information shown in the table below is qualified by, and should be read
in conjunction with, our more detailed financial statements and the related
notes appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
As of September 30, 1999
-------------------------------
Pro Pro Forma
Actual Forma As Adjusted
-------- -------- -----------
(in thousands, except share
data)
<S> <C> <C> <C>
Capital lease obligations, net of current
portion....................................... $ 55 $ 55 $ 55
-------- -------- --------
Redeemable stock:
Series C redeemable convertible preferred
stock, $.01 par value; 4,397,118 shares
authorized and 4,284,091 shares issued and
outstanding, actual; no shares authorized,
issued and outstanding, pro forma and pro
forma as adjusted............................ 24,864 -- --
Series B redeemable convertible preferred
stock, $.01 par value; 3,518 shares
authorized, issued and outstanding, actual;
no shares authorized, issued and outstanding,
pro forma and pro forma as adjusted.......... 7,036 -- --
Series A convertible preferred stock, $.01 par
value; 687 shares authorized, issued and
outstanding; no shares authorized, issued and
outstanding, pro forma and pro forma as
adjusted..................................... 3,251 -- --
Redeemable common stock....................... 340 -- --
-------- -------- --------
Total redeemable stock....................... 35,491 -- --
-------- -------- --------
Stockholders' equity (deficit):
Preferred stock, $.01 par value; no shares
authorized, issued and outstanding, actual;
10,000,000 shares authorized, no shares
issued and outstanding, pro forma and pro
forma as adjusted............................ -- -- --
Common stock, $.01 par value; 13,000,000
shares authorized, 2,131,787 shares issued
and outstanding, actual; 90,000,000 shares
authorized, 14,864,674 shares issued and
outstanding, pro forma; 90,000,000 shares
authorized, 19,364,674 shares issued and
outstanding, pro forma as adjusted........... 21 148 193
Additional paid-in capital.................... 8,572 43,936 101,483
Deferred stock compensation................... (5,065) (5,065) (5,065)
Accumulated deficit........................... (22,534) (22,534) (22,534)
-------- -------- --------
Total stockholders' equity (deficit)......... (19,006) 16,485 74,077
-------- -------- --------
Total capitalization....................... $ 16,540 $ 16,540 $ 74,132
======== ======== ========
</TABLE>
24
<PAGE>
DILUTION
Our pro forma net tangible book value (deficit) as of September 30, 1999 was
$16.0 million, or $1.08 per share of common stock. Pro forma net tangible book
value per share represents the amount of our total tangible assets less total
tangible liabilities, divided by 14,864,674 shares of common stock outstanding
after giving effect to the conversion of all outstanding shares of preferred
stock into an aggregate of 12,732,887 shares of common stock and elimination of
the redemption right on redeemable common stock upon the closing of this
offering. After giving effect to the sale of the 4,500,000 shares of common
stock offered hereby at the initial public offering price of $14.00 per share
and after deducting the underwriting discounts and commissions and estimated
offering expenses, the pro forma net tangible book value as of September 30,
1999 would have been $73.6 million, or approximately $3.80 per share. This
represents an immediate increase in pro forma net tangible book value of $2.72
per share to existing stockholders and an immediate dilution in net tangible
book value of $10.20 per share to new investors of common stock in this
offering. New investors will pay $14.00 per share and the net tangible book
value per share will be $3.80 immediately after the offering. The following
table illustrates this dilution on a per share basis:
<TABLE>
<S> <C> <C>
Initial public offering price per share....................... $14.00
Pro forma net tangible book value (deficit) per share before
this offering, as of September 30, 1999.................... $1.08
Increase in pro forma net tangible book value per share
attributable to new investors in this offering............. 2.72
-----
Pro forma net tangible book value per share after offering.... 3.80
------
Dilution in pro forma tangible book value per share to new
investors.................................................... $10.20
======
</TABLE>
The following table summarizes, on a pro forma basis as of September 30,
1999, the total number of shares of common stock purchased from us, the total
consideration paid and the average price per share paid by existing
stockholders and by the new investors purchasing shares of common stock in this
offering, before deducting estimated underwriting discounts and commissions and
offering expenses payable by SmarterKids.com:
<TABLE>
<CAPTION>
Shares Purchased Total Consideration
------------------ -------------------- Average Price
Number Percent Amount Percent Per Share
---------- ------- ------------ ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders... 14,864,674 76.8% $ 38,100,000 37.7% $ 2.56
New investors........... 4,500,000 23.2 63,000,000 62.3 14.00
---------- ----- ------------ -----
Total................. 19,364,674 100.0% $101,100,000 100.0% $ 5.22
========== ===== ============ =====
</TABLE>
The foregoing discussion and tables assume no exercise of stock options or
warrants outstanding as of September 30, 1999. As of September 30, 1999, there
were outstanding options to purchase 2,831,451 shares of common stock at a
weighted average exercise price of $0.30 per share and 990,000 shares were
reserved for issuance under our stock plan. As of September 30, 1999, there
were also warrants to purchase 613,091 shares of common stock at a weighted
average exercise price of $1.88 per share or that we were obligated to issue
subject to certain conditions. The foregoing discussion and tables also exclude
an additional 2,600,000 shares reserved for issuance under stock plans amended
or adopted in connection with this offering. To the extent that any shares
available for issuance upon exercise of outstanding options or warrants or
pursuant to our stock plans are issued, there will be further dilution to new
public investors.
25
<PAGE>
SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with our
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and financial statements and related notes included elsewhere in
this prospectus. The statement of operations data for the years ended December
31, 1996, 1997 and 1998 and for the nine months ended September 30, 1999 and
the balance sheet data at December 31, 1997 and 1998 and September 30, 1999 are
derived from our audited financial statements appearing elsewhere in this
prospectus. The statement of operations data for the year ended December 31,
1995 and the balance sheet data at December 31, 1995 and 1996 are derived from
our audited financial statements not included in this prospectus. The statement
of operations data for the year ended December 31, 1994 and the balance sheet
data at December 31, 1994 are derived from our unaudited financial statements
not included in this prospectus. The unaudited financial statements, in the
opinion of management, reflect all adjustments necessary for a fair
presentation of that data. Interim results for the nine months ended September
30, 1998 are derived from our unaudited financial statements appearing
elsewhere in this prospectus which, in the opinion of management, reflect all
adjustments necessary for a fair presentation of that data. The pro forma
balance sheet data as of September 30, 1999 reflects the automatic conversion
of all outstanding shares of preferred stock into an aggregate of 12,732,887
shares of common stock and the automatic elimination of the redemption right on
the redeemable common stock upon the closing of this offering. The pro forma as
adjusted balance sheet data as of September 30, 1999 reflects the receipt of
the estimated net proceeds of $57.6 million from our sale in this offering of
4,500,000 shares of common stock at the initial public offering price of $14.00
per share. Historical results are not indicative of the results to be expected
in the future.
<TABLE>
<CAPTION>
Year Ended Nine Months Ended
December 31, September 30,
----------------------------------------------------- ---------------------
1994 1995 1996 1997 1998 1998 1999
--------- --------- --------- --------- --------- --------- ----------
(in thousands, except share and per share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Net revenues:
Online retail.......... $ -- $ -- $ -- $ -- $ 22 $ -- $ 1,108
Proprietary CD-ROM..... 219 401 1,240 1,416 2,278 1,815 --
--------- --------- --------- --------- --------- --------- ----------
Total net revenues.. 219 401 1,240 1,416 2,300 1,815 1,108
--------- --------- --------- --------- --------- --------- ----------
Cost of revenues:
Online retail.......... -- -- -- -- 20 -- 795
Proprietary CD-ROM..... 28 319 407 491 908 620 --
--------- --------- --------- --------- --------- --------- ----------
Total cost of
revenues............ 28 319 407 491 928 620 795
--------- --------- --------- --------- --------- --------- ----------
Gross profit............ 191 82 833 925 1,372 1,195 313
--------- --------- --------- --------- --------- --------- ----------
Operating expenses:
Marketing and sales.... 156 645 1,033 756 2,678 1,411 10,726
Development............ 269 631 887 721 1,378 832 1,149
General and
administrative........ 243 277 611 430 490 330 1,091
Stock compensation..... -- -- 2 15 187 72 1,789
--------- --------- --------- --------- --------- --------- ----------
Total operating
expenses............ 668 1,553 2,533 1,922 4,733 2,645 14,755
--------- --------- --------- --------- --------- --------- ----------
Loss from operations.... (477) (1,471) (1,700) (997) (3,361) (1,450) (14,442)
Interest and other
income (expense), net.. -- 1 51 (17) 19 (11) 300
--------- --------- --------- --------- --------- --------- ----------
Net loss................ (477) (1,470) (1,649) (1,014) (3,342) (1,461) (14,142)
Accretion on redeemable
preferred stock........ -- -- -- (67) (254) (65) (119)
--------- --------- --------- --------- --------- --------- ----------
Net loss attributable to
common stockholders.... $ (477) $ (1,470) $ (1,649) $ (1,081) $ (3,596) $ (1,526) $ (14,261)
========= ========= ========= ========= ========= ========= ==========
Basic and diluted net
loss per common
share (1).............. $ (0.32) $ (0.98) $ (1.10) $ (0.72) $ (2.34) $ (1.01) $ (8.10)
Shares used to compute
basic and diluted net
loss per common share
(1).................... 1,500,000 1,500,000 1,500,606 1,502,148 1,533,524 1,508,665 1,760,106
Pro forma basic and
diluted net loss per
common share (1) ...... $ (0.43) $ (0.98)
Shares used to compute
pro forma basic and
diluted net loss per
common share (1)....... 7,840,274 14,492,992
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
December 31, September 30, 1999
----------------------------------------- -----------------------------
Pro Pro Forma
1994 1995 1996 1997 1998 Actual Forma As Adjusted
----- ------- ------- ------- ------- -------- ------- -----------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash
equivalents............ $ 140 $ 2,307 $ 433 $ 293 $ 4,273 $ 13,361 $13,361 $70,953
Working capital......... 274 1,959 333 110 3,066 14,357 14,357 71,949
Total assets............ 425 2,748 1,470 1,145 5,504 23,896 23,896 81,488
Total long-term debt and
capital lease
obligations, net of
current portion........ -- -- 104 41 -- 55 55 55
Total redeemable stock.. -- 3,251 3,251 4,011 10,287 35,491 -- --
Total stockholders'
equity (deficit)....... (341) (1,144) (2,791) (3,839) (7,162) (19,006) 16,485 74,077
</TABLE>
- --------
(1) For an explanation of the computation of historical and pro forma net loss
per share, see Note 2 in our financial statements.
27
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results
of operations should be read in conjunction with "Risk Factors" and our
financial statements and the notes to those financial statements.
Overview
SmarterKids.com is an online retailer focused exclusively on children's
educational books, toys and games, and software.
From inception through March 1998, our activities consisted primarily of the
conception, development, publishing, marketing and sales of our proprietary
educational and entertainment CD-ROM software. In March 1998, we began
transitioning our business model to online sales of third-party educational
products and commenced development of the SmarterKids.com website. In November
1998, we launched our website, discontinued the sale of our proprietary CD-ROM
products through traditional retail channels and now offer our proprietary CD-
ROM products on a limited basis through our online channel.
Due to the transition of our business model in late 1998, we believe that
period-to-period comparisons prior to 1999 are less meaningful than an analysis
of quarterly results in 1999. While our online retail revenues have grown
rapidly since launching our website, total revenues decreased since the
beginning of 1999 due to the curtailment of our proprietary CD-ROM business.
Over the same period, marketing and sales expenses increased significantly as a
result of our promotional activities. As a result of the ongoing start-up
expenses associated with our new business model, we expect to incur significant
operating losses for the foreseeable future. We also expect that the rate at
which we incur losses will increase significantly from current levels as we
continue to incur additional expenses to advertise and promote our website,
expand our product offerings and website content, enhance and upgrade our
website and other systems, expand our fulfillment capabilities and hire
additional personnel.
Prior to November 1998, revenues consisted solely of sales of our
proprietary CD-ROM products and were recognized upon shipment, net of return
allowances as determined by historical trends of actual returns. Cost of
revenues consisted primarily of production and shipping costs. Marketing and
sales expenses consisted primarily of promotions and advertising of our
products through national computer software retailers. Development costs
consisted primarily of compensation for employees developing our proprietary
CD-ROM software. General and administrative costs consisted primarily of
compensation for employees and professional fees.
Revenues in 1999 consist of online sales of third-party educational products
and our proprietary CD-ROM products and charges to customers for shipping. In
the nine months ended September 30, 1999, we derived less than 1% of our
revenues from outside of the United States. Revenues are recognized upon
shipment to the customer and are net of promotional discounts, coupons and
return allowances, which are determined by historical trends of actual returns.
Under our new business model, our actual returns and therefore our allowance
for returns are lower than the returns from our CD-ROM business which utilized
an indirect sales channel. Cost of revenues consists primarily of the cost of
products sold to customers and our shipping costs. We anticipate that our gross
margins will fluctuate from quarter to quarter depending on consumer
preferences for our mix of products. Marketing and sales expenses consist
primarily of the cost of advertising and promotional activities, fulfillment
service fees to J.L. Hammett Co., commissions to online marketing companies,
and expenses for personnel engaged in marketing, merchandising and customer
service activities. Fulfillment fees paid to J.L. Hammett Co. are based on a
percentage of the cost to us of our products. This percentage is fixed and does
not vary with the prices of our products and, therefore, our net losses will be
greater to the extent our sales prices are reduced. Commissions to on line
marketing companies are based on a percentage of revenues generated through
these relationships. Because we pay
28
<PAGE>
commissions to online marketing companies based on a percentage of revenues
derived from these relationships, we expect our gross margins, as a percentage
of revenues, to decrease if we begin to derive increased revenue from online
marketing relationships. Approximately 2% of our revenues in the nine months
ended September 30, 1999 were derived from these relationships. We intend to
continue to pursue an aggressive branding and marketing campaign to attract new
customers and, therefore, expect marketing and sales expenses to increase
significantly, both in absolute dollars and as a percentage of revenues, in
future periods. In addition, we expect marketing and sales expenses to increase
significantly as we expand fulfillment and customer service capabilities to
accommodate anticipated increases in sales volume. Development expenses consist
primarily of payroll and related costs for personnel performing website design,
development and testing. We believe that continued investment in website
development is critical to attaining our strategic objectives and therefore
anticipate website development expenses to increase significantly. General and
administrative expenses consist primarily of payroll and related costs for
executive and administrative personnel, professional service expenses and other
general corporate expenses. We expect general and administrative expenses to
increase as we expand our staff and incur additional costs related to the
growth of our business infrastructure and costs associated with being a public
company. Subsequent to September 30, 1999, we incurred a one-time cost of
$500,000 in connection with the settlement in November 1999 of a patent
infringement lawsuit, which cost will be included in general and administrative
expenses for our quarter ending on December 31, 1999. Interest and other income
(expense), net consist primarily of interest expense related to short-term
lease obligations and interest earned on the short-term investment of cash.
With respect to our need to attract, retain and motivate qualified employees
and certain marketing and service providers, since September 1995, we have
provided them with equity-based compensation. Stock compensation expenses
represent non-cash charges related to stock options and warrants given to
employees and directors, consultants, J.L. Hammett Co. and NCS. For employee
and director grants, the compensation charge reflects the difference between
the exercise price of the options and the estimated fair value of the
underlying common stock on the date of the grant. This compensation charge is
deferred initially and amortized to expense over the vesting period of the
applicable options. For non-employee grants, the compensation charge reflects
the fair value of the options and warrants on the initial measurement date
(typically the date of grant for those exercisable immediately or with fixed
vesting periods, or the date when vesting becomes fixed for those with variable
vesting periods), as well as subsequent remeasurements of such fair value until
the options and warrants vest. Accordingly, we cannot currently estimate
additional charges related to future remeasurement of unvested non-employee
options and warrants. The Company may, in the future grant additional equity-
based compensation to non-employees to secure marketing or other service
relationships. As of September 30, 1999, $5.1 million of deferred stock
compensation remained to be amortized to expense, generally over the next four
years, for stock options and warrants granted through September 30, 1999.
The market for children's educational books, toys and games, and software is
highly seasonal due to the holiday season. In addition, Internet usage
generally declines in the summer. Accordingly, we expect to experience seasonal
fluctuations in our revenues. In particular, we expect a disproportionate
amount of our revenues to be realized during the fourth quarter of each
calendar year.
J.L. Hammett Co. is our provider of fulfillment services. While we select
and own our inventory, take all orders and manage our customer service, our
inventory is held at a warehouse owned and maintained by J.L. Hammett Co. J.L.
Hammett Co. picks, packs and ships all orders, and J.L. Hammett Co. maintains
our warehouse management system. Our relationship with J.L. Hammett Co., a
national distributor of educational products, provides us with industry and
supplier relationships, favorable credit and price terms from vendors, and the
ability to scale our warehouse operations. In connection with the establishment
of our relationship with J.L. Hammett Co., we issued to it warrants to purchase
57,000 shares of common stock at a price of $1.33 per share in September 1998,
and warrants to purchase an additional 108,000 shares of common stock at a
price of $1.33 per share in September 1999. Such warrants are immediately
exercisable.
29
<PAGE>
Results of Operations
Comparison of Nine Months Ended September 30, 1998 and September 30, 1999
Revenues. Net revenues decreased from $1.8 million in the nine months ended
September 30, 1998 to $1.1 million in the nine months ended September 30, 1999.
This decrease is a result of the discontinuation of our business model focused
on the sales of our proprietary CD-ROM software and the transition of our
business model to online sales of third-party educational products.
Cost of revenues. Cost of revenues increased from $620,000 in the nine
months ended September 30, 1998 to $795,000 in the nine months ended September
30, 1999. Our gross profit margin decreased from 65.8% of net revenues in the
nine months ended September 30, 1998 to 28.2% of net revenues in the nine
months ended September 30, 1999. These changes are attributable to the
transition of our business model to online sales of third-party educational
products.
Marketing and sales. Marketing and sales expenses increased from $1.4
million in the nine months ended September 30, 1998 to $10.7 million in the
nine months ended September 30, 1999. This increase was primarily attributable
to the initiation of our advertising campaigns and promotional activities, fees
to our fulfillment partner, J.L. Hammett Co., as well as to the hire of 20
employees and related expenses required to implement our new Internet business
model.
Development. Development expenses increased from $832,000 in the nine months
ended September 30, 1998 to $1.1 million in the nine months ended September 30,
1999. This increase was attributable primarily to the hire of nine employees
and costs related to enhancing the features, content and functionality of our
website. We expect development expenses to increase as we continue to develop
new promotional programs on our website, as well as add new features and
upgrade technology.
General and administrative. General and administrative expenses increased
from $330,000 in the nine months ended September 30, 1998 to $1.1 million in
the nine months ended September 30, 1999. This increase was attributable
primarily to the hire of seven employees and increased legal and accounting
expenses. We expect general and administrative expenses to increase as we
expand our operations and infrastructure to support future growth and
transition to being a public company.
Stock compensation. We recorded deferred stock compensation of $21,000 in
the nine months ended September 30, 1998 and $4,186,000 in the nine months
ended September 30, 1999. We amortized $14,000 of deferred stock compensation
as an expense in the nine months ended September 30, 1998 and $556,000 in the
nine months ended September 30, 1999 related to stock options and warrants
granted to employees. We recorded additional stock compensation of $58,000 and
$1,233,000 as an expense in the nine months ended September 30, 1998 and 1999
related to warrants and options granted to non-employees. The remaining total
deferred stock compensation is being amortized over the vesting period of the
individual options and warrants or over the period the related services are
performed, as applicable.
Interest and other income (expense), net. Interest and other income
(expense), net increased from $11,000 in other net expense in the nine months
ended September 30, 1998 to $300,000 in other net income in the nine months
ended September 30, 1999. This increase was primarily attributable to an
increase in interest income from invested capital.
Comparison of Years Ended December 31, 1996, 1997 and 1998
Revenues. Revenues increased from $1.2 million in 1996 to $1.4 million in
1997 to $2.3 million in 1998. This increase was primarily attributable to
increased sales of CD-ROM products, which was a result of new product offerings
and expanded marketing and sales efforts through traditional retail channels.
30
<PAGE>
Cost of revenues. Cost of revenues increased from $407,000 in 1996 to
$491,000 in 1997 to $928,000 in 1998. This increase was primarily attributable
to additional costs associated with increased sales of CD-ROM products. Our
gross margin decreased from 67.2% of net revenues in 1996 to 65.3% in 1997, to
59.7% in 1998.
Marketing and sales. Marketing and sales expenses decreased from
$1.0 million in 1996 to $756,000 in 1997. This decrease was primarily
attributable to a decrease in headcount and related expenses as we repositioned
our product line from entertainment CD-ROMs to CD-ROMs for children's skills
assessment. Marketing and sales expenses increased from $756,000 in 1997 to
$2.7 million in 1998. This increase was primarily attributable to additional
costs associated with promotions and advertising for our repositioned
proprietary CD-ROM products and, beginning in November 1998, for the launch of
our website in November 1998.
Development. Development expenses decreased from $887,000 in 1996 to
$721,000 in 1997. This decrease was primarily attributable to a decrease in
headcount and related expenses as we repositioned our CD-ROM product line.
Development expenses increased from $721,000 in 1997 to $1.4 million in 1998.
This increase was primarily attributable to additional costs associated with
development of the SmarterKids.com website which commenced in March 1998.
General and administrative. General and administrative expenses decreased
from $611,000 in 1996 to $430,000 in 1997. This decrease was primarily
attributable to a decrease in headcount and related expenses as we repositioned
our proprietary CD-ROM product line. General and administrative expenses
increased from $430,000 in 1997 to $490,000 in 1998. This increase was
primarily attributable to increased headcount and related expenses of the
repositioning of our CD-ROM product line, which began in late 1997.
Stock compensation. With respect to stock options granted to employees, we
recorded deferred stock compensation of $1.5 million and amortized $81,000 of
stock compensation as an expense in 1998; we recorded deferred stock
compensation of $62,000 and amortized $4,000 of stock compensation as an
expense in 1997. During 1996, stock options were granted with exercise prices
equal to the then fair value of the common stock. Accordingly, no employee
stock compensation was recorded during 1996. We recorded additional stock
compensation of $2,000, $11,000 and $106,000 as an expense in each of the years
ended December 31, 1996, 1997 and 1998 related to options and warrants granted
to non-employees.
Interest and other income (expense), net. Interest and other income
(expense), net decreased from $51,000 in other net income in 1996 to $17,000 in
other net expense in 1997. This decrease was primarily attributable to expenses
associated with our equipment capital lease. Interest and other income
(expense), net increased from $17,000 in other net expense in 1997 to $19,000
in other net income in 1998. This increase was primarily attributable to an
increase in interest income from invested capital.
31
<PAGE>
Selected Quarterly Results of Operations
The following table sets forth selected unaudited statement of operations
data for the seven quarters in the period ended September 30, 1999, both in
dollar amounts and as a percentage of total net revenues. This data was derived
from our unaudited financial statements that, in our opinion, reflect all
adjustments, consisting of only normal recurring adjustments, necessary for a
fair presentation of this quarterly information. This data should be read in
conjunction with the audited financial statements and related notes included
elsewhere in this prospectus.
<TABLE>
<CAPTION>
Quarter Ended
---------------------------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30,
1998 1998 1998 1998 1999 1999 1999
-------- -------- --------- -------- --------- --------- ---------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Net revenues:
Online retail.......... $ -- $ -- $ -- $ 22 $ 94 $ 293 $ 721
Proprietary CD-ROM..... 519 633 663 463 -- -- --
------ ------ ------ ------- --------- --------- -------
Total net revenues... 519 633 663 485 94 293 721
------ ------ ------ ------- --------- --------- -------
Cost of revenues:
Online retail.......... -- -- -- 20 69 210 516
Proprietary CD-ROM..... 171 230 219 288 -- -- --
------ ------ ------ ------- --------- --------- -------
Total cost of
revenues............ 171 230 219 308 69 210 516
------ ------ ------ ------- --------- --------- -------
Gross profit............ 348 403 444 177 25 83 205
------ ------ ------ ------- --------- --------- -------
Operating expenses:
Marketing and sales ... 377 469 565 1,267 2,023 3,690 5,013
Development............ 252 277 303 546 367 396 328
General and
administrative........ 99 114 117 160 155 244 750
Stock compensation..... 9 10 53 115 384 196 1,209
------ ------ ------ ------- --------- --------- -------
Total operating
expenses............ 737 870 1,038 2,088 2,929 4,526 7,300
------ ------ ------ ------- --------- --------- -------
Loss from operations.... (389) (467) (594) (1,911) (2,904) (4,443) (7,095)
Interest and other
income (expense), net.. (5) (10) 4 30 24 28 248
------ ------ ------ ------- --------- --------- -------
Net loss................ $ (394) $ (477) $ (590) $(1,881) $ (2,880) $ (4,415) $(6,847)
====== ====== ====== ======= ========= ========= =======
<CAPTION>
As a Percentage of Total Net Revenues
---------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net revenues:
Online retail.......... --% --% --% 4.5% 100.0% 100.0% 100.0%
Proprietary CD-ROM..... 100.0 100.0 100.0 95.5 -- -- --
------ ------ ------ ------- --------- --------- -------
Total net revenues... 100.0 100.0 100.0 100.0 100.0 100.0 100.0
====== ====== ====== ======= ========= ========= =======
Cost of revenues:
Online retail.......... -- -- -- 4.1 73.4 71.7 71.6
Proprietary CD-ROM..... 32.9 36.3 33.0 59.4 -- -- --
------ ------ ------ ------- --------- --------- -------
Total cost of
revenues............ 32.9 36.3 33.0 63.5 73.4 71.7 71.6
------ ------ ------ ------- --------- --------- -------
Gross profit............ 67.1 63.7 67.0 36.5 26.6 28.3 28.4
------ ------ ------ ------- --------- --------- -------
Operating Expenses:
Marketing and sales ... 72.6 74.1 85.2 261.2 2,152.1 1,259.4 695.3
Development............ 48.6 43.8 45.7 112.6 390.4 135.1 45.5
General and
administrative........ 19.1 18.0 17.7 33.0 164.9 83.3 104.0
Stock compensation..... 1.7 1.6 8.0 23.7 408.5 66.9 167.7
------ ------ ------ ------- --------- --------- -------
Total operating
expenses............ 142.0 137.5 156.6 430.5 3,115.9 1,544.7 1,012.5
------ ------ ------ ------- --------- --------- -------
Loss from operations.... (74.9) (73.8) (89.6) (394.0) (3,089.3) (1,516.4) (984.0)
Interest and other
income (expense), net.. (1.0) (1.6) 0.6 6.2 25.5 9.6 34.4
------ ------ ------ ------- --------- --------- -------
Net loss................ (75.9)% (75.4)% (89.0)% (387.8)% (3,063.8)% (1,506.8)% (949.7)%
====== ====== ====== ======= ========= ========= =======
</TABLE>
32
<PAGE>
Due to the fact that we transitioned to our online business model in
November 1998, we believe that period-to-period comparisons prior to 1999 are
less meaningful than an analysis of quarterly results in 1999.
Revenues increased in the quarter ended September 30, 1999 over the quarter
ended June 30, 1999, which increased over the quarter ended March 31, 1999,
primarily due to increased consumer awareness of our brand and increased number
of customers.
Cost of revenues increased in the quarter ended September 30, 1999 over the
quarter ended June 30, 1999, which increased over the quarter ended March 31,
1999, primarily due to increased revenues. Gross margins in the quarter ended
September 30, 1999 were consistent with margins in the quarter ended June 30,
1999. Gross margins increased in the quarter ended June 30, 1999 over the
quarter ended March 31, 1999 due to a more favorable mix of product sales.
Marketing and sales expenses increased in the quarter ended September 30,
1999 over the quarter ended June 30, 1999, which increased over the quarter
ended March 31, 1999, primarily due to increases in promotional and advertising
activities.
Development expenses decreased in the quarter ended September 30, 1999 over
the quarter ended June 30, 1999 primarily due to reduction in third party
development costs. Development expenses increased in the quarter ended June 30,
1999 over the quarter ended March 31, 1999 primarily due to increased headcount
and related expenses.
General and administrative expenses increased in the quarter ended September
30, 1999 over the quarter ended June 30, 1999, which increased over the quarter
ended March 31, 1999, primarily due to increased headcount and related expenses
and professional fees.
Liquidity and Capital Resources
Since inception, the Company has incurred significant losses. The Company
has met its cash requirements primarily through the sale of capital stock and
the use of capital leases. The Company has received capital from investors in
three private venture capital financings totaling $37.1 million through
July 1999.
Net cash used in operating activities was $9.5 million in the nine months
ended September 30, 1999 as compared to $1.1 million in the nine months ended
September 30, 1998. This increase in cash used in operating activities was
primarily attributable to increased expenses associated with launching and
promoting our new website and retail internet business. Net cash used in
operating activities was $2.0 million in the year ended December 31, 1998, as
compared to $947,000 in the year ended December 31, 1997. In each of these
periods, our principal operating cash requirements were to fund our working
capital needs. In future periods, we expect that operating cash requirements
will increase and that a significant portion of our cash used in operating
activities will be attributable to the purchase of inventory as we anticipate
owning our inventory by the end of 1999.
Net cash used in investing activities has been primarily for purchases of
fixed assets and short-term investments and was $6.7 million in the nine months
ended September 30, 1999 as compared to $15,000 in the nine months ended
September 30, 1998. The increase in cash used in investing activities was
primarily attributable to increased purchases of equipment and the purchase of
short-term investments of $5.0 million. Net cash used in investing activities
was $33,000 in the year ended December 31, 1998, and cash flows from investing
activities was $181,000 in the year ended December 31, 1997. The cash generated
from investing activities in 1997 reflected a release of a restricted cash
deposit related to a prior lease arrangement.
Net cash provided by financing activities was $25.3 million in the nine
months ended September 30, 1999 as compared to $1.2 million in the nine months
ended September 30, 1998. Net cash provided by financing activities in the nine
months ended September 30, 1999 primarily reflects the net proceeds of
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$25.3 million from the issuance of series C redeemable preferred stock. Net
cash provided by financing activities was $6.0 million in the year ended
December 31, 1998, as compared to $626,000 in the year ended December 31, 1997.
Net cash provided by financing activities in the year ended December 31, 1998
consisted primarily of net proceeds of $6.1 million from the issuance of series
B redeemable preferred stock. In the year ended December 31, 1997, net cash
provided by financing activities consisted primarily of proceeds of $710,000
derived from the issuance of series B redeemable preferred stock.
As of September 30, 1999, we had $13.4 million of cash and cash equivalents.
As of that date, our principal commitments consisted of obligations outstanding
under capital leases in the amount of $130,000 and accounts payable of
$5,019,000. Although we currently have no material commitments for capital
expenditures, we anticipate that our business model will require us to commit
significant resources to aggressively promote our brand, expand our product and
service offerings and enhance our infrastructure. Subsequent to September 30,
1999, we incurred a one-time cost of $500,000 in connection with the settlement
in November 1999 of a patent infringement lawsuit, which cost will be included
in general and administrative expenses for our quarter ending on December 31,
1999.
We currently anticipate that the net proceeds of this offering, together
with current cash, cash equivalents and short term investments, will be
sufficient to meet our anticipated needs for working capital and capital
expenditures through at least the next 12 months. We anticipate that we are
likely to need additional financing to execute our business model after such 12
months, or sooner if we need to respond to business contingencies such as
lower-than-anticipated revenues, funding additional advertising expenditures,
developing new or enhancing existing content, features or services, enhancing
our operating infrastructure, responding to competitive pressures, or acquiring
complementary businesses or technologies. If we raise additional funds through
the issuance of equity or convertible debt securities, the percentage ownership
of our stockholders may be reduced, and these newly-issued securities may have
rights, preferences or privileges senior to those of existing stockholders,
including those acquiring shares in this offering. We cannot be certain that
additional financing will be available to us on favorable terms when required,
or at all.
Recent Accounting Pronouncements
In March 1998, the AICPA issued Statement of Position No. 98-1, "Accounting
for the Costs of Computer Software Developed or Obtained for Internal Use". SOP
98-1 provides guidance regarding when software developed or obtained for
internal use should be capitalized. SOP 98-1 is effective for fiscal years
beginning after December 15, 1998. The adoption of SOP 98-1 in the nine months
ended September 30, 1999 did not have a material impact on our financial
position or results of operations.
In April 1998, the AICPA issued Statement of Position No. 98-5, "Reporting
on Costs of Start-up Activities," which requires all costs associated with pre-
opening, pre-operating and organization activities to be expensed as incurred.
The adoption of SOP 98-5 in the nine months ended September 30, 1999 did not
have a material impact on our financial position or results of operations.
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS
133 establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives), and for hedging activities. SFAS
133, as amended by SFAS 137, is effective for all fiscal quarters of all fiscal
years beginning after June 15, 2000, with earlier application encouraged. We do
not currently nor do we intend in the foreseeable future to use derivative
instruments, and therefore, do not expect that adoption of SFAS 133 will have
any impact on our financial position or results of operations.
In December 1998, the AICPA issued Statement of Position No. 98-9,
"Modification of SOP No 97-2, Software Revenue Recognition, with Respect to
Certain Transactions". SOP 98-9 amends SOP 97-2 to require recognition of
revenue using the "residual method" in circumstances outlined in SOP 98-9.
Under the residual method, revenue is recognized as follows: (1) the total fair
value of undelivered elements, as
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indicated by vendor specific objective evidence, is deferred and subsequently
recognized in accordance with the relevant sections of SOP 97-2 and (2) the
difference between the total arrangement fee and the amount deferred for the
undelivered elements is recognized as revenue related to the delivered
elements. SOP 98-9 is effective for transactions entered into in fiscal years
beginning after March 15, 1999. Also, the provisions of SOP 97-2 that were
deferred by SOP 98-4 will continue to be deferred until the date SOP 98-9
becomes effective. We do not expect that the adoption of SOP 98-9 will have a
significant impact on our results of operations or financial position.
Year 2000 Compliance
Our failure or the failure of our key service providers, suppliers,
manufacturers or customers to be year 2000 compliant could have material
adverse consequences on our business and results of operations. Such
consequences could include difficulties in operating our website effectively,
taking product orders, shipping products, delivering products and conducting
other essential and fundamental business operations.
The year 2000 computer issue creates a significant risk for us in at least
four areas:
. potential warranty or other claims arising from our software products or
the software products of others that we sell
. systems we use to run our business
. systems used by our suppliers, vendors, and service providers
. systems used by customers
A failure in any of these areas to be year 2000 compliant may seriously harm
our operations.
Background of year 2000 issues. Many currently installed computer and
communications systems and software and hardware products are unable to
distinguish 21st century dates from 20th century dates. This inability could
result in system failures or miscalculations causing business disruptions. As a
result, many software, computer, communications and other systems need to be
upgraded or replaced to become year 2000 compliant.
Our product testing. We have tested those few proprietary CD-ROM products
that we continue to sell online for year 2000 compliance. We derived our
testing method from our review and analysis of the year 2000 testing practices
of other software vendors, relevant industry year 2000 compliance standards and
the specific functions and operating environments of our products. The tests
were run on all supported platforms for each current release of our products
and included testing for date calculations and internal storage of date
information with test numbers starting in 1999 and going beyond the year 2000.
Based on these tests, we believe our current proprietary CD-ROM products to be
year 2000 compliant with respect to date calculations and internal storage of
date information. We have not done any year 2000 compliance testing on any of
the third-party products that we sell online.
Our website testing. We have reviewed the year 2000 compliance of our
externally and internally developed proprietary software that shapes and
controls a person's experience while they interact with our website. This
review included testing to determine how our systems will function at and
beyond the year 2000. Since inception, we have internally developed or reviewed
the development of most of the systems for the operation of our website. These
systems include the software used to provide our website's search, customer
interaction, and transaction processing. Based upon our assessment to date, we
believe that our internally developed proprietary software is year 2000
compliant.
Our external vendors and third party supplied software. The systems and
software of third parties on which we rely may contain errors or faults with
respect to the year 2000. For example, we depend on J.L. Hammett Co. to process
our orders, financial institutions to process credit card transactions,
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telecommunications vendors to maintain our network, Exodus Communications to
host our website, shipping companies to deliver products to customers,
affiliate networks to allow other websites to sell through SmarterKids.com, and
software, hardware and systems for use in our administrative, communications,
accounting, database, security, network, electronic mail, product development,
website operations, telephone and other systems. Although it has stated that
its systems and software used in our operations are year 2000 compliant, J.L.
Hammett Co., our fulfillment vendor, has not provided us with any written
assurances. All third parties whose systems are material to our operations have
posted their year 2000 compliance statements on their websites, where they have
given assurances that their systems are year 2000 compliant or that they will
be year 2000 compliant by the end of the year. As part of our continuing year
2000 preparation, we intend to pursue year 2000 related corrections or updates
offered by our vendors.
The failure of software and computer systems from J.L. Hammett Co. or our
other third-party suppliers to be year 2000 compliant could have a material
adverse effect on us. Known or unknown errors or defects that affect the
operation of our software and systems and those of third parties could result
in delay or loss of revenue, interruption of services, cancellation of customer
orders, diversion of development resources, damage to our reputation, increased
service and warranty costs and litigation costs.
Our internal systems. We periodically review our internally developed
management information and other systems to identify any products, services or
systems that may not be year 2000 compliant and to take corrective action when
required. To date, we believe we have reviewed all relevant systems. We have
not identified any material year 2000 problems with our internally developed
computer systems.
Costs of addressing year 2000 compliance. Based on our preliminary
evaluations, we do not believe we will incur significant expenses or be
required to invest heavily in computer system improvements to be year 2000
compliant. Through September 30, 1999, we have spent approximately $41,000,
representing approximately 450 person-hours, on year 2000 issues. However,
significant uncertainty exists concerning the potential costs and effects
associated with year 2000 compliance. Any year 2000 compliance problem
experienced by our customers, our vendors, J.L. Hammett Co. or us could reduce
demand for our products, which could have a material adverse effect on our
business.
Customer claims. We may be subject to customer claims to the extent our
software products or the software products of others that we sell fail to
operate properly as a result of the occurrence of the date January 1, 2000.
Liability may result to the extent our products are not able to store, display,
calculate, compute and otherwise process date-related data. We could also be
subject to claims based on the failure of our software products or the software
products of others that we sell to work with software or hardware from other
vendors.
Contingency planning. Our contingency plan is focused on those activities
and functions specifically related to processing customer orders. It addresses
only those types of failures for which contingency operation is possible. For
example, if all communications links between our website and J.L. Hammett Co.
were to fail, but we were still able to accept customer orders at the website,
customer order data would be copied to physical media and transported by
courier to our fulfillment location.
Our contingency plan does not address any types of failures for which
contingency operations would be impossible. For example, any significant
disruption in the Internet would prevent customers from placing orders via the
Internet. The failure of our credit card processor would prevent customers from
making payments.
It is likely that some types of failures were unforeseen, overlooked, or
otherwise omitted from our analysis and were therefore omitted from our
contingency plan. We believe the reasonably likely worst case scenario would
involve year 2000 issues preventing a significant number of users from
accessing our website and the loss of critical services to our business. A
prolonged failure beyond our control or that was unforeseen could prevent us
from operating our business, prevent users from accessing our website, or
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prevent visitors to our website from placing orders. We believe that some of
the business consequences, in the event of such failure, would include:
. lost revenues
. increased operating costs
. loss of customers or visitors to our website
. claims of mismanagement, misrepresentation or breach of contract
Any of these consequences would likely harm our business, operating results
and financial condition.
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BUSINESS
Overview
SmarterKids.com is an online retailer focused on children's educational
books, toys and games, and software. We offer a broad assortment of carefully
selected, fun and educational products and an easy-to-use online shopping
environment. We provide educational content, including product reviews,
learning styles surveys and personalized product recommendations to help
parents and gift givers find quality products and make informed purchase
decisions tailored to a child's individual developmental needs and learning
goals.
SmarterKids.com integrates carefully selected products, helpful content and
interactive tools with an intuitive and easy-to-use website to create a
compelling and unique online shopping experience. We only sell products that
our full-time staff of certified educators believe have educational,
developmental or learning value. Our collection of products includes over 2,400
books, toys and games, and software titles from over 300 suppliers. Because we
are focused on education, many of our products, particularly toys and games,
are often not found on many of the other websites offering children's products.
The MySmarterKids personalization area on our website allows parents to
build an evolving and confidential educational profile of their child that can
include information about the child's age and grade, learning styles, learning
goals and performance on standardized tests. Our SmartPicks technology then
uses this profile to make product recommendations from our distinctive
assortment of products tailored to a child's individual developmental profile
and goals.
We launched our website in November 1998. Among online retailers focusing on
children's products, SmarterKids.com had the second highest number of unique
visitors in September 1999, according to Media Metrix, an independent Internet
research firm.
Industry Background
Our business lies at the intersection of the consumer market for educational
and developmental products for children and the increasing acceptance of
Internet-based commerce.
The Educational Products Market
As a result of a number of societal trends, including constraints on school
budgets and the increasing use of standardized tests, many parents are taking a
more active role in their children's education. In their efforts to help their
children learn, improve their children's standardized test scores and make
learning fun, parents are increasingly purchasing educational books, toys and
games, and software.
Parents are faced with the challenge of finding quality educational products
and selecting the right products for their children. With thousands of
educational products to choose from and few reliable sources of information,
finding the appropriate products for a specific child's needs and goals can be
overwhelming and confusing. Parents seek a resource for comprehensive and
trusted educational content and product information to help them make informed
purchase decisions.
Limitations of the Traditional Retail Channel
The traditional retail channel, including mass-market retailers, has
numerous participants and is highly fragmented. In general, store-based
retailers can face challenges in providing a shopping experience that meets the
needs of parents, including:
. narrow selection of products due to physical space limitations
. high costs from the need to build and operate multiple retail locations
. lack of flexibility in product display and merchandising capabilities
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. lack of convenience due to limited hours of operation and geographic
location
. lack of focus on educational products and limited educational expertise
Specialty educational and creative toy and game retailers that are focused
on education often lack the expertise or time to analyze a child's specific
needs. As a result, the traditional retail channel fails to satisfy parents'
needs for selection, convenience, personalized service, and advice and
information.
Growth of the Internet and Consumer Electronic Commerce
Because of the inherent limitations of traditional retail channels of
distribution, the Internet is dramatically affecting the way consumers and
businesses are buying and selling products and services. According to a
research report dated June 1999 and prepared by International Data Corporation,
there were an estimated 142 million Internet users worldwide at the end of
1998. This number is anticipated to grow to over 500 million users by the end
of 2003. It is also estimated that the worldwide consumer electronic commerce
market will grow from approximately $15 billion in 1998 to approximately $171
billion in 2003. The Internet is well-suited for consumer commerce for a number
of reasons:
. increased convenience due to the ability to access the Internet at any
time from almost any location
. virtually unlimited "shelf" space to allow merchants to offer a wide
selection of products and services
. low facilities and staffing costs
. merchandising flexibility due to the merchant's ability to quickly
update and customize product selection and presentation, editorial
content and prices
. enhanced knowledge of customers' needs from the merchant's ability to
gather, process and store large amounts of customer information
. the ability to provide a large amount of targeted information
In addition consumers are also using the Internet to obtain information and
manage personal needs. Many Internet-based companies have emerged to address
these online opportunities. These companies are focusing on such areas as
consumer goods, travel, personal finance and healthcare.
Limitations of Online Retailers that Offer Educational Products
Although online retailers have a number of advantages, those that offer
educational products as a component of their larger product mix have been
limited in a number of ways because they generally:
. do not evaluate the products they offer
. lack extensive educational and editorial content
. do not assess an individual child's needs to personalize the online
experience
The limitations of traditional and online retailers create a significant
opportunity for an educational resource that combines educational expertise and
assessment tools, a wide range of quality educational products and the power of
the Internet to help parents make informed purchase decisions.
The SmarterKids.com Solution
SmarterKids.com is an online retailer focused on children's educational
books, toys and games, and software. We combine our expertise in children's
education with our sophisticated and proprietary product analysis to help
parents make better purchase decisions. Key features of our solution include:
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Broad Assortment of Carefully Selected and Reviewed Educational
Products. Our collection of educational products includes over 2,400 books,
toys and games, and software titles from over 300 suppliers. We continue to
carefully select and add products to our assortment that meet our quality
standards. We employ on a full-time basis, certified educators who select only
products that have educational, developmental or learning value. Our products
are also selected based on how a child uses the product, and whether the
product is fun. In our KidsLab, children test and review many of our current
and prospective products. Once selected, our review process then determines
product suitability based on the skills taught, effectiveness in addressing
each skill, the appropriate grade level(s), the teaching approach, learning
style and the occasion for use, such as bedtime, travel or group play. Each
product is assigned a rating for "fun," "ease of use" and "reusability" and is
then given an overall "Expert Review." We also provide product reviews prepared
by third parties. Because we are focused on education, many of our products,
particularly toys and games, are not found on many of the other popular
websites that offer children's products.
Compelling Educational Content and Contextual Merchandising. We believe that
SmarterKids.com is an authority on educational products. Each member of our
staff of full-time educators holds a degree in education, has teaching
experience and has designed and implemented developmental and educationally
appropriate curriculum for children. Our staff of educators develops our
content, including educational articles, parenting advice and product reviews,
and we also license educational content from third parties. The benefit we
provide parents comes, first, in our selection of the best educational products
in the marketplace to offer from our website and, second, by providing online
advice and information about specific products to help parents and gift givers
make appropriate selections. Our website also integrates content with access to
relevant products. For example, the Smarter Parents Resource Center suggests
weekly and monthly educational activities parents can do with their children
and then suggests products to expand on these activities. Our Teacher Talk
Glossary helps parents understand commonly used educational terms. Our
SmarterTips helps parents prepare their children for standardized tests. Ask
the Teacher enables parents to submit questions to our staff of teachers
regarding their child's development and review archived answers to previous
questions. Smarter Websites connects parents to other relevant educational
websites.
Convenient and Easy-to-Use Website. We integrate carefully selected
products, helpful content and interactive tools, with an intuitive and easy-to-
use interface. We organize our website around age and grade levels, which is
the way parents typically think about the educational development of their
children. We offer full search and browsing capabilities that enable parents to
find products easily. Furthermore, we notify registered parents when we offer
relevant new products or specials. We provide customers the convenience and
flexibility of shopping 24 hours a day, 7 days a week, with dedicated customer
service and reliable and timely product delivery. Our customer service center,
which is staffed with representatives trained to assist customers with product
selection, order processing and other questions, operates Monday through Friday
from 9:00 a.m. through 9:00 p.m. Eastern Standard Time and on Saturday from
9:00 a.m. through 5:00 p.m. Eastern Standard Time.
Technology That Matches Products With a Child's Unique Educational
Profile. Parents can use our proprietary technology to find products that meet
their child's unique educational needs. The MySmarterKids personalization area
allows parents to build an evolving and confidential educational profile of
their child that can include information about the child's age and grade,
learning goals and results from:
. our Learning Styles Survey that parents can fill out online
. skills check-up assessment tests that children can take online
. CD-ROM based skills tests that parents can order from our website
. scores from state-sponsored standardized tests
Our proprietary SmartPicks technology then uses this developmental profile
to make targeted product recommendations. SmartPicks "reshuffles" our entire
store so that we emphasize those products that our educational team believes
are appropriate for the individual child's unique needs and individual goals.
On
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subsequent visits, our website will recognize registered members and display
products and services tailored to a child's developmental profile and goals. We
believe we are the first and presently the only educational products and
services website to offer this level of personalization.
Strategy
Our objective is to be the leading online provider of children's educational
products, services and resources for parents. To achieve this objective, our
strategy is to:
Continue to Enhance our Customers' Experience to Build a Trusted Brand. We
intend to make the SmarterKids.com brand synonymous with being the trusted
online provider of children's educational products and services. We build
customer loyalty and trust through the quality of the products we offer, the
depth of our educational content and the high level of our customer service. We
intend to enhance these experiences by offering more content, additional
products and child assessment tools, additional customer service features and
technology enhancements. We also intend to offer subscription programs,
publications and incentives for our most loyal customers.
Aggressively Build Brand Awareness and Expand our Customer Base. We plan to
increase our brand awareness through a variety of marketing and promotional
techniques to drive traffic to our website. We advertise on leading parent-
oriented websites and have developed a number of marketing relationships with
online media companies such as Yahoo! and Microsoft's Encarta. We place
banners, buttons and text links on their websites in return for a specified
number of impressions, and we jointly develop content, promotions and e-mail
marketing programs. In addition, we conduct carefully targeted print, radio,
television and direct mail advertising, as well as other consumer-oriented
promotional campaigns.
Pursue Additional Revenue Opportunities. In the future, we intend to
leverage our brand and customer base to develop additional revenue
opportunities. These include:
. increasing product selection in existing categories
. adding new product categories and products for additional age ranges
. introducing private label products
. introducing online learning and testing services
. acquiring or partnering with new or complementary businesses, products,
services or technologies
Leverage the Power of Our Customer Database. Our customer database is
comprised of detailed customer information, buying patterns and educational
profiles. Parents who use MySmarterKids provide us with information about their
children, including demographics, learning goals, learning styles and
standardized or online test scores. This growing database enables us to
accurately target product, service and promotional offerings to customers for
whom they are most relevant. We believe that our customer database will enable
us to optimize our product selection and website design, increase repeat
purchases and maintain long-term, profitable relationships with our customers
while maintaining a strict level of privacy and confidentiality.
Maintain Scalable and Efficient Fulfillment Operations to Ensure Customer
Satisfaction. We intend to maintain an efficient and low-cost inventory and
fulfillment infrastructure that can scale rapidly. Our relationship with J.L.
Hammett Co. provides us with industry and supplier relationships, favorable
credit and pricing terms from suppliers and the ability to scale our warehouse
operations. While we select and own our inventory, take all orders and manage
our customer service, all our inventory is held at a warehouse owned and
maintained by J.L. Hammett Co., and J.L. Hammett Co. picks, packs and ships all
orders, and maintains our warehouse management system.
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Shopping at SmarterKids.com
We have designed the SmarterKids.com website to make it easy and convenient
to use. Our website provides informative reviews of our products and other
useful educational information and is organized in the same way that parents
typically think about the educational development of their kids--by age and
grade level.
Website Design and Utility. The primary means by which our products and
features are organized is by SmarterKids.com's five age and grade ranges--
Toddler, Preschool through Kindergarten, Grades 1-3, Grades 4-6 and Grades 7-9,
each grade range is referred to as an "aisle" on our website. Parents naturally
think about their children in terms of their age and grade, and by organizing
our website in this manner SmarterKids.com is able to emphasize its unique
focus on the individual child.
Within each age and grade range, or "aisle," visitors can browse through
links organized by parents' or teachers' favorites, subject matter, brand,
keyword or theme. Each aisle also has pictures and prices of highlighted
products with links to our teachers' reviews of these products.
From our home page, or within each aisle, customers may access a number of
helpful areas within the website, including:
. product categories such as Parents' Favorites, Teachers' Favorites, Best
Sellers, Monthly Picks, Gift Ideas, Cool and Unique or Twenty Costing
$20 or Less
. product groups, organized by well-known brands or favorite characters
. SmarterKids.com's Learning Styles Survey
. subject links, to find products which address a particular educational
or developmental area
. a keyword search box, where customers can enter a product name,
manufacturer name or descriptive words to find a product
These areas are constantly evaluated and refined to reflect the feedback we
gather from our customers and any seasonal, periodic or promotional
opportunities we choose to pursue.
Products. SmarterKids.com offers three product types--books, toys and games,
and software--ranging in price from under $2.00 to $100.00. These products
range from those based on popular brands and licensed characters to hard-to-
find specialty items. We set our prices on parity with the average prices of
similar products offered by our online competitors. Each product listing has a
picture of the product; narrative review; indication of skills developed,
educational approach utilized, and best application; and ratings for ease of
use, fun, reusability and depth of instruction. With one click, a user can see
all applicable brands, categories and special offers for each product type. For
example, a parent might select a vividly illustrated book that teaches letter
recognition, software that uses an engaging interactive story to develop
creativity, or a puzzle that teaches motor skills and spatial-relationship
awareness.
MySmarterKids offers what we believe to be one of the most personalized
shopping experiences in electronic commerce. Parents enter information related
to their child's education and development to build a personal profile, and
SmarterKids.com uses the information to present an educationally appropriate
assortment of products. The more information that a parent enters, the more
precise will be the product recommendations made by SmartPicks, our proprietary
personalization technology. MySmarterKids incorporates a child's age and grade,
learning goals and results from:
. our Learning Styles Survey that parents fill out online
. a skills check-up assessment test that children can take online
. a CD-ROM-based skills test that parents can order from our website
. scores from state-sponsored standardized tests
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For example, when a parent wishes to focus a first grade child on pre-
reading skills, SmartPicks presents only those products appropriate to that age
and skill goal. Further individual customization can be achieved when a parent
completes our Learning Styles Survey to determine whether a child learns best
through a linguistic, visual, musical, interpersonal, intrapersonal,
mathematical or physical style. If a child's learning style is visual,
SmartPicks will customize this child's shopping area by suggesting products
that teach pre-reading skills to a first grader through visual learning.
SmartPicks retains a child's information for future reference by the parent.
When a parent returns to our website, new products will automatically be
suggested that achieve the learning goals and fit the learning style and age
range of the child.
We protect all information entered into MySmarterKids and elsewhere and
strictly adhere to commonly accepted privacy standards established by TrustE
and the Better Business Bureau, non-profit organizations who are dedicated to
establishing a trusting environment for making purchases and gathering
information on the Internet. Information regarding TrustE and the Better
Business Bureau can be found at www.truste.org and www.bbb.com.
Product Selection, Check-out and Payment functions are easy and intuitive.
We stock each item that we sell and are able to show the customer the
availability for each product. Our credit card approval technology prevents
customers from experiencing delays in check-out. Customers receive e-mail
confirmations of their orders, notification of shipment, and the ability to
track their shipment through UPS.
Website Content is designed and selected to achieve our mission of helping
parents help their children learn. SmarterKids.com's product reviews, which are
prepared by our staff of full-time educators. To promote trust, we encourage
customers to access explanations of our product review methodology. Our Parents
Center suggests weekly learning activities that parents can do with their
children, helps parents prepare their children for standardized tests, and
offers a Teacher Talk Glossary to explain terms used by education
professionals. Ask the Teacher enables parents to submit questions regarding
their child's development and review archived answers to previous questions.
Smarter Links connects parents to relevant and powerful information sources.
Parents who register for MySmarterKids receive twice-monthly e-mailed
newsletters.
Marketing and Promotion
We use an aggressive and multi-faceted advertising and promotional strategy
to build awareness and attract customers to our website. We use a personalized
database marketing approach to build our customer base and encourage repeat
transactions. We emphasize responsive and reliable customer service to earn our
customers' loyalty.
Our Online Marketing efforts primarily consist of relationships with
companies who maintain websites which are important to our customer base. We
place banners, buttons and text links on their websites in return for a
specified number of impressions, and we jointly develop content, promotions and
e-mail marketing programs. For example, we have a persistent search box on the
home page of Microsoft's Encarta encyclopedia website. These relationships
generally include content sharing arrangements and require us to pay a fee for
delivery of traffic. In these relationships we are usually the preferred, if
not exclusive, online retailer of children's educational books, toys and games,
and software. We also advertise on major banner networks such as Burst, 24/7,
Flycast and Adsmart, which distribute our banners to multiple websites for a
fee for delivery of traffic.
The Lightspan Partnership, Inc. creates and sells curriculum-based
educational CD-ROM software and web programs. It recently launched a monthly
subscription online service that offers customized classroom resource pages for
teachers, students and parents. Our relationship with Lightspan includes a co-
branded store, which was launched in October 1999, content sharing and joint
marketing activities. Promotions are intended to encourage teachers to visit
and promote the co-branded store. We have agreed to various content sharing
opportunities, including offering Lightspan content in our ParentCenter and
links to their
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learning activities from various locations on our site, including from the
MySmarterKids location of our site. Lightspan has agreed to link to the co-
branded store from specific learning activities on the Lightspan network. The
agreement with Lightspan provides for us to pay Lightspan a commission based
upon a percentage of net revenue for sales generated within the co-branded
store and expires in December 2000 unless renewed.
National Computer Systems is the largest processor of standardized tests for
kindergarten through grade 12 aged children in the United States. NCS provides
processing and scoring for over 30 million student assessment tests, such as
the Iowa Test of Basic Skills, in all 50 states and for the U.S. Department of
Education. In May 1999, NCS launched its WeHelpKids.com website, offering a
variety of electronic HelpTests and value-added services aimed at providing
assessment and identification of a student's academic strengths and weaknesses.
WeHelpKids.com contains several direct links to our website, which draws
parents eager to support and encourage their children's learning. The links are
promoted through both a banner promotion and the NCS ReportCard service. The
NCS ReportCard service allows parents to enter the results of their children's
state standardized tests on WeHelpKids.com and receive personalized product
recommendations from our SmartPicks system based on those test results.
WeHelpKids has commenced this service as a pilot program for Michigan
standardized tests and intends to add tests and services for tests given in
other states. The agreement with NCS provides for us to pay NCS a commission
based upon a percentage of the gross margin on sales generated by customers
originating from WeHelpKids.com and expires in March 2001 unless renewed. In
connection with the establishment of our promotional services relationship with
NCS, we issued to it 112,500 shares of common stock at an exercise price of
$1.33 per share. These warrants become exercisable on the achievement by NCS of
certain milestones.
Through programs managed by LinkShare and GeoCities, we have relationships
with over 10,000 websites that feature links to SmarterKids.com in return for a
commission based on net sales that result from such referrals. These websites
range from online malls to individuals' websites. LinkShare and GeoCities
recruit affiliates, collect commissions from us and pay the participating
websites. We are currently the exclusive educational products reseller in
GeoCities' Pages That Pay participating websites program.
Offline Marketing is an increasingly important component of
SmarterKids.com's customer acquisition and branding efforts. We advertise in a
variety of parenting-oriented and other magazines and through direct mail and
free-standing inserts. We also run radio and television advertisements and have
significant promotions with a number of traditional, family-oriented companies.
E-Mail is the primary vehicle by which we communicate with our customers and
registered users. We send them periodic newsletters and notify them of private,
customer-only offers. Increasingly, we personalize our information and offers
to specific subsets of our customers, according to the products they have
purchased and the information they have provided in their children's
MySmarterKids profiles, further enhancing the value we add and our relationship
with them.
Operations
J.L. Hammett Co., a national distributor of educational products to schools,
is our provider of fulfillment services. Our relationship with J.L. Hammett Co.
has provided us with access to industry and supplier relationships, favorable
credit and price terms due to its buying power and the ability to scale our
warehouse operations as needed. J.L. Hammett Co. provides us with a well-
trained staff and warehouse capacity to manage seasonal upturns and
unanticipated changes in demand. Our relationship with J.L. Hammett Co. is non-
exclusive, expires on January 31, 2002 and may be terminated by J.L. Hammett
Co. or us upon six months prior notice.
We own and select our own inventory, take all orders and manage our customer
service. All of our inventory resides at a warehouse owned and maintained by
J.L. Hammett Co. and J.L. Hammett Co. picks, packs and ships all orders, and
maintains the warehouse management system. In connection with the
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establishment of our relationship with J.L. Hammett Co., we issued to it
warrants to purchase 57,000 shares of common stock at a price of $1.33 per
share in September 1998, and an additional 108,000 shares of common stock at a
price of $1.33 per share in September 1999. Such warrants are immediately
exercisable.
Customer Service
We seek to provide a customer experience that exceeds customer expectations.
Our goals include:
. prompt shipping
. responding to all e-mail inquiries within the same day
. maintaining a return rate of less than 1%
. maintaining at least 99% of inventory items in stock at any time
We maintain a toll-free telephone customer service center staffed with
customer service representatives trained to assist customers with product
selection, order processing, shipping and billing and any other questions or
problems. We train our representatives to be competent and courteous. We give
representatives wide discretion to ensure that customers are satisfied with
their purchases and their purchasing experience. Our customer service center
operates Monday through Friday from 9:00 a.m. to 9:00 p.m. Eastern Standard
Time and on Saturday from 9:00 a.m. to 5:00 p.m. Eastern Standard Time.
Technology
We have implemented a broad array of scalable systems for website
management, search, customer service, electronic transaction management and
data interchange, e-mail, order processing, payment processing, office
administrative services, and accounting. These systems use a combination of our
own and commercially-available technologies. We focus our internal development
efforts on creating and improving specialized software that is unique and able
to enhance our business. We use a set of applications for:
. evaluating and reviewing products for eligibility in our store
. accepting and validating customer orders
. managing customer telephone and e-mail inquiries and requests for
service
. transmitting order and related information among our website,
headquarters, and fulfillment locations
. profiling customers' order histories and purchasing patterns
. conducting and managing customer payment transactions
. interacting with our fulfillment company
We develop or select systems that are based on industry-standard
architectures that have been designed to minimize downtime in case of outages
or catastrophic occurrences. They provide 24-hours-a-day, 7-days-a-week
availability. Our transaction processing methods and databases are designed
without arbitrary capacity constraints and are scalable to any volume of demand
that we expect to encounter. We have implemented load balancing systems and
redundant servers to provide for fault tolerance.
Since September 1999, our systems infrastructure has been hosted at Exodus
Communications in Waltham, Massachusetts. Exodus provides redundant
communication lines from multiple providers, 24-hour monitoring and engineering
support, its own generators and multiple back-up systems. Exodus also maintains
private peering relationships. Private peering refers to a private network that
Exodus built with major tier-one Internet providers. Customers who connect
through those service providers will be routed faster through the private
network and avoid the unpredictable performance of the public Internet.
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Competition
Our competitors can be divided into several groups including:
. mass market retail chains, such as Kmart, Target and Wal-Mart
. mass market book sellers, toy stores and computer hardware and software
stores, such as Barnes & Noble, Toys "R" Us and CompUSA
. traditional regional or local bookstores, toy stores and computer and
software stores
. traditional and online specialty educational retailers, such as Learning
Express, Learningsmith, Noodle Kidoodle and Zany Brainy
. online book sellers, toy sellers and computer software sellers, such as
Amazon.com, eToys, KBkids.com, toysmart.com and Beyond.com
. educational catalog distributors, such as Scholastic
We believe that the principal competitive factors in our market are:
. brand recognition and trust
. ability to attract and retain consumers
. breadth of product selection
. product pricing
. availability of educational and authoritative information
. quality and responsiveness of customer service
We believe that we compete favorably on these factors. We expect our brand
recognition to increase as a result of current and future strategic
relationships and marketing and advertising campaigns. We will also continue to
expand our product selection.
Intellectual Property
We regard the protection of our intellectual property as critical to our
future success and rely on a combination of copyright, trademark, service mark
and trade secret laws, license agreements and contractual restrictions to
establish and protect our proprietary rights in our website architecture and
technology, products, content and services. We have a pending patent
application relating to the SmartPicks product selection algorithm we use on
our website. We have entered into confidentiality and invention assignment
agreements with our employees and contractors in order to limit disclosure of
our proprietary information and to protect our ownership interest in our
website architecture and technology. We cannot assure you that these
contractual arrangements or the other steps taken by us to protect our
intellectual property will prove sufficient to prevent misappropriation of our
technology or deter independent third-party development of similar
technologies.
We conduct business on the Internet using the trademark SmarterKids.com.
There are a number of other trademarks and domain names similar to ours. An
infringement action could be brought against us at any time by the holders of
these marks. There is a substantial risk that the owner of other marks would
overcome any defenses that we could raise. If the owner of such marks were to
prevail in such an action, we could lose the ability to use the SmarterKids and
SmarterKids.com trademark and domain name and could be subject to substantial
damages. Such outcomes could adversely affect our business. If we are required
to change our company, trademarks or domain name, we could lose customers and
brand equity which would have a material adverse effect on our business and
financial condition. Although we may attempt to acquire or license the right to
use potentially relevant third-party trademarks and domain names, we may not be
successful.
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We have licensed in the past, and expect that we may license in the future,
certain of our intellectual property rights, such as trademarks or copyrighted
material, to third parties. While we attempt to ensure that the quality of the
SmarterKids.com brand is maintained by such licensees, we cannot assure you
that such licensees will not take actions that might materially adversely
affect the value of our intellectual property rights or reputation, which could
harm our business.
Regulatory Environment
In general, existing laws and regulations apply to transactions and other
activities on the Internet. However, the precise applicability of these laws
and regulations to the Internet is sometimes uncertain. The vast majority of
these laws were adopted prior to the advent of the Internet and, as a result,
do not contemplate or address the unique issues of the Internet or electronic
commerce. Nevertheless, numerous federal and state government agencies have
already demonstrated significant activity in promoting consumer protection and
enforcing other regulatory and disclosure statutes on the Internet.
Additionally, due to the increasing use of the Internet as a medium for
commerce and communication, it is likely that new laws and regulations may be
enacted with respect to the Internet and electronic commerce covering issues
such as user privacy, freedom of expression, advertising, pricing, content and
quality of products and services, taxation, intellectual property rights and
information security. The adoption of such laws or regulations and the
applicability of existing laws and regulations to the Internet may adversely
impact our ability to conduct our business and the growth of Internet use,
thereby negatively affecting our business.
Specific laws and regulations concerning the use of the Internet have been
enacted. In particular, as directed by Congress in the Children's Online
Privacy Protection Act, also known as COPPA, the Federal Trade Commission
recently adopted regulations, effective April 21, 2000, prohibiting unfair and
deceptive acts and practices in connection with the collection and use of
personal information from children under 13 years old on the Internet. The
Child Online Protection Act of 1998, also known as COPA, prohibits harmful
commercial communications over the World Wide Web that are available to any
person under 17 years old. This act, however, was declared unconstitutional by
a federal district court earlier this year and that decision is currently on
appeal before a federal circuit court. An oral argument is scheduled for
November 4, 1999. If the district court's decision is overturned and that
ruling is upheld upon further appeal, providing information to minors over the
Internet would be greatly limited. However, because SmarterKids.com's website
is not directed at children and we do not anticipate its widespread use by
children, COPPA and the FTC's regulations, as well as provisions under COPA,
should they be enforceable, should not have a significant effect upon our
business. Nevertheless, the FTC has strongly advocated that even general
audience websites establish privacy policies that include procedures to
disclose and notify users of privacy and security policies, obtain consent from
users for collection and use of information, and provide users with the ability
to access, correct and delete personal information stored by the company. While
we have adopted a privacy policy regarding use of personal user information and
have posted this policy on our website, there can be no assurance that we will
adopt policies that conform with regulations adopted or policies advocated by
the FTC or any other federal or state governmental entity.
The European Union recently enacted its own privacy regulations. The
European Union Directive on the Protection of Personal Data, which became
effective in October 1998, fosters electronic commerce by establishing a stable
framework to ensure both a high level of protection for private individuals and
the free movement of personal data within the European Union. The EU and the
U.S. Department of Commerce are currently negotiating an agreement under which
the privacy policies of American businesses may be deemed to be adequate under
the EU Directive. Until such time as an agreement is reached, the EU has
voluntarily agreed to a moratorium on enforcement of the EU Directive against
U.S. businesses. Although the Company has received less than 1% of revenues
from outside of the United States in the nine months ended September 30, 1999,
the European legislation and its adoption via any agreement could adversely
affect our ability to expand our sales efforts to Europe by limiting how
information about us can be sent over the Internet in the EU and limiting our
efforts to collect information from European users.
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It is also possible that "cookies" may become subject to laws limiting or
prohibiting their use. The term "cookies" refers to information keyed to a
specific server, file pathway or directory location that is stored on a user's
hard drive, possibly without the user's knowledge or consent, which is used to
track demographic information and to target advertising. Certain currently
available Internet browsers allow users to modify their browser settings to
remove cookies at any time or prevent cookies from being stored on their hard
drives. In addition, a number of Internet commentators, advocates and
governmental bodies in the United States and other countries have urged the
passage of laws limiting or abolishing the use of cookies. Limitations on or
elimination of the use of cookies could restrict the effectiveness of our
targeting of advertisements, which could have a material adverse effect on our
ability to generate advertising revenue.
We retain on our website personal information about our users that we obtain
with their consent. We have a stringent privacy policy covering this
information. As a matter of corporate policy, we do not supply customer lists
to third parties. However, if third persons were able to penetrate our network
security and gain access to, or otherwise misappropriate, our users' personal
information, we could be subject to liability and our reputation would be
harmed. Liability could include claims for misuses of personal information,
such as for unauthorized marketing purposes or unauthorized use of credit
cards. These claims could result in litigation, our involvement in which,
regardless of the outcome, could require us to expend significant financial
resources.
Legislative proposals have been made by the federal government that would
afford broader protection to owners of databases of information, such as stock
quotes and sports scores. Such protection already exists in the European Union.
If enacted, this legislation could result in an increase in the price of
services that provide data to websites. In addition, such legislation could
create potential liability for unauthorized use of such data.
Because our services are accessible throughout the United States, a state
may claim that we are required to qualify to do business as a foreign
corporation in that state. We are qualified to do business only in
Massachusetts and Delaware. Our failure to qualify as a foreign corporation in
a state where we are required to do so could subject us to taxes and penalties
and could result in our inability to enforce contracts in such states. Any such
new legislation or regulation, or the application of laws or regulations from
jurisdictions whose laws do not currently apply to our business, could have a
material adverse effect on our business.
Employees
As of September 30, 1999, SmarterKids.com had 73 full-time employees,
including 24 in marketing and sales, 11 in customer service, 7 in editorial and
education review, 18 in development and 13 in general and administrative. From
time to time, we also employ independent contractors to support these
operational areas. Our employees are not represented by a union, and we believe
our employee relations are good.
Facilities
SmarterKids.com is headquartered in Needham, Massachusetts, where we lease
an office with approximately 12,700 square feet under leases expiring in
October 2000. We have executed an additional lease for 39,152 square feet in
Needham, Massachusetts for our new principal offices under a lease expiring in
October 2004. We anticipate that this space will be available for occupancy by
the end of 1999. We believe that these facilities are adequate to meet our
current requirements and that suitable additional or substitute space will be
available as needed.
Legal Proceedings
In November 1999 we settled a patent infringement lawsuit brought against us
in the United States District Court for the Northern District of Illinois
regarding our Smart Picks technology. The lawsuit has been dismissed with
prejudice and we have been granted a non-exclusive license to the plaintiff's
patent. We are not a party to any other material legal proceedings. We may from
time to time become a party to various legal proceedings arising in the
ordinary course of our business.
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MANAGEMENT
Directors, Executive Officers and Key Employees
The following table sets forth certain information about our executive
officers and directors, as well as certain members of our senior management.
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
David Blohm............. 49 President, Chief Executive Officer and Director
Jeff Pucci.............. 39 Co-Founder, Chairman and Director
Richard Viard........... 39 Co-Founder and Senior Vice President, Product Development
Albert Noyes............ 41 Senior Vice President, Marketing and Sales
Robert Cahill........... 33 Vice President, Finance
Mark DeChambeau......... 38 Vice President, Operations
Daniel Davis............ 34 Vice President, Business Development
Joseph Panepinto........ 36 Vice President, Editorial
Richard Secor........... 39 Vice President, MIS and Chief Information Officer
John Zimmermann......... 40 Vice President, Merchandising
Susan Graham............ 29 Director of Education
Pauline O'Keeffe........ 32 Director of Public Relations
Richard Roseman......... 31 Director of Customer Acquisition and Retention
Lisa Tanzer Lewis....... 32 Director of Product Management
Richard D'Amore......... 46 Director
Michael Fitzgerald...... 46 Director
Brian Hickey............ 54 Director
Michael Kolowich........ 47 Director
</TABLE>
- --------
David Blohm has served as SmarterKids.com's President and Chief Executive
Officer since January 1998 and served as President and Chief Operating Officer
from September 1995 to January 1998. Mr. Blohm has served as a member of the
Board of Directors since September 1995. Prior to joining us, Mr. Blohm served
as President of ThinkingWorks, Inc., an educational research company, from June
1994 to September 1995. Mr. Blohm served as the President and Chief Executive
Officer of MathSoft, Inc., a company he co-founded, from August 1985 to May
1994.
Jeff Pucci, our co-founder, has served as SmarterKids.com's Chairman since
August 1995, served as Co-Chief Executive Officer from January 1998 to June
1998 and Chief Executive Officer from August 1995 to January 1998. Mr. Pucci
has served as a member of the Board of Directors since our inception. Mr. Pucci
was President and Chief Executive Officer of SmarterKids.com from May 1994 to
August 1995.
Richard Viard, our co-founder, has served as SmarterKids.com's Senior Vice
President, Product Development since April 1994. Mr. Viard served on our Board
of Directors since our inception to November 1998.
Albert Noyes has served as SmarterKids.com's Senior Vice President,
Marketing and Sales since September 1997. Prior to joining us, Mr. Noyes served
as Vice President of Sales and Marketing of net.Genesis, a developer and
marketer of website usage and performance analysis products, from July 1996 to
May 1997. From November 1995 to May 1996, Mr. Noyes served as Chief Executive
Officer of The Mesa Group, a developer and marketer of messaging and groupware
software, which was subsequently acquired by Microsoft. Mr. Noyes served as
Venture Partner/Entrepreneur-in-Residence for Highland Capital, a venture
capital firm from October 1994 to October 1995.
Robert Cahill has served as SmarterKids.com's Vice President, Finance since
June 1999 and served as Controller from October 1997 to June 1999. Prior to
joining us, Mr. Cahill served as Accounting Manager
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for Gensym Corp., a developer and marketer of software products, from May 1995
to October 1997. Mr. Cahill served as a Senior Accountant for Ernst & Young LLP
from January 1993 to May 1995.
Mark DeChambeau has served as SmarterKids.com's Vice President, Operations
since November 1998. Prior to joining us, Mr. DeChambeau was self-employed as
an operations consultant from March 1997 to October 1998. Mr. DeChambeau served
as Operations Manager for The Fulfillment Center, a full service fulfillment
and distribution center, from October 1993 through January 1997.
Daniel Davis has served as SmarterKids.com's Vice President, Business
Development since October 1999. Prior to joining us, Mr. Davis served as Senior
Vice President and Chief Financial Officer of Biopure Corporation, a developer,
manufacturer and marketer of oxygen therapeutics, from December 1998 to
September 1999. From 1995 to November 1998, Mr. Davis was employed at Knowledge
Universe, a holding company focusing on educational products and services.
Prior to 1995, Mr. Davis attended The Wharton School of Business at the
University of Pennsylvania where he received his M.B.A.
Joseph Panepinto has served as SmarterKids.com's Vice President, Editorial
since April 1999. Prior to joining us, Mr. Panepinto served as Editor of
FamilyPC magazine from August 1997 to February 1999, in a variety of senior
positions for FamilyPC from June 1994 to August 1997 and as a consultant for
FamilyPC from March 1994 to May 1994.
Richard Secor has served as SmarterKids.com's Vice President, MIS and Chief
Information Officer since October 1998. Prior to joining us, Mr. Secor served
as Chief Information Officer for W.A. Wilde Company, a provider of direct mail
advertising services, from February 1996 to October 1998. Mr. Secor served as
Director of Information Services for ResponseNet, a division of W.A. Wilde
Company, from September 1994 to February 1996.
John Zimmermann has served as SmarterKids.com's Vice President,
Merchandising since March 1999. Prior to joining us, Mr. Zimmermann served as
Senior Vice President of Marketing and Merchandising for The Big Party!, a
chain of over 50 party supply super stores, from December 1997 to March 1999.
Mr. Zimmermann served as Merchandise Manager for Bradlees, Inc. a regional
discounter, from June 1995 to December 1997. Mr. Zimmermann also served as
Merchandise Manager of Contempo Casuals, a national specialty store, from June
1994 to June 1995.
Susan Graham has served as SmarterKids.com's Director of Education since
June 1998 and served as Educational Product Manager from July 1998 to February
1999. Ms. Graham served as a kindergarten teacher at the American School in
London from Fall 1995 to Spring 1997 and in the Washington D.C. Public School
District from Fall 1992 to Spring 1994. Ms. Graham has a Masters in Education
from Harvard University, which she attended from September 1994 through June
1995. From Spring 1997 through July 1998, Ms. Graham was self-employed as a
curriculum author and educational researcher.
Pauline O'Keeffe has served as SmarterKids.com's Director of Public
Relations since July 1999. Prior to joining us, Ms. O'Keeffe served in a
variety of capacities, including as Vice President of Public Relations and most
recently as Account Director for The Weber Group, a public relations firm, from
January 1991 to July 1999.
Richard Roseman has served as SmarterKids.com's Director of Customer
Acquisition and Retention since February 1999. Prior to joining us, Mr. Roseman
served as Director of Marketing for Geerlings & Wade, Inc., a marketer of
domestic and imported wine and accessories through the mail and online, from
June 1998 to January 1999. Mr. Roseman served as Marketing Manager for SC
Publishing, Inc., a division of Specialty Catalog Corporation, which markets
educational courses, books and accessories for professionals through catalogs
and online, from June 1995 to May 1998. Mr. Roseman served as Director of
Special
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Projects for ServiSource, a jewelry manufacturer owned by M. Fabrikant & Sons,
from February 1994 to May 1995.
Lisa Tanzer Lewis has served as SmarterKids.com's Director of Product
Management since July 1999. Prior to joining us, Ms. Lewis served as the
Director of Business Development for Staples Inc., an office supply retailer,
from June 1998 through June 1999. Ms. Lewis held several marketing and product
development positions, most recently as Director of U.S. Marketing and Director
of Global Marketing in the Preschool Division, at Hasbro, Inc., a manufacturer
of toys and games, from October 1994 to June 1998.
Richard D'Amore has been a director of SmarterKids.com since November 1998.
In accordance with a voting agreement, Mr. D'Amore was nominated to be a member
of the Board of Directors by NorthBridge Venture Partners III, L.P., a
stockholder of SmarterKids.com. He has served as a general partner at North
Bridge Venture Management Company since March 1994. Previously, Mr. D'Amore
served as a general partner for Hambro International Equity Investors from July
1982 to March 1994.
Michael Fitzgerald has been a director of SmarterKids.com since November
1998. In accordance with a voting agreement, Mr. Fitzgerald was nominated to be
a member of the Board of Directors by Commonwealth Capital Ventures II, L.P., a
stockholder of SmarterKids.com. Mr. Fitzgerald is a founder of and has been a
general partner of Commonwealth Capital Ventures since April 1995. Mr.
Fitzgerald served as a general partner at Palmer Partners, the manager of three
early stage venture capital funds, from June 1981 to April 1995.
Brian Hickey has been a director of SmarterKids.com since July 1999 as a
nominee of Brighter Vision Holdings, Inc. Mr. Hickey has served as the Chairman
of Harlequin Enterprises Limited, a book publishing and printing company, since
December 1997 and its Chief Executive Officer since December 1988. Mr. Hickey
also served as President of Harlequin from December 1988 to December 1997.
Michael Kolowich has been a director of SmarterKids.com since January 1999.
Mr. Kolowich has served as the Vice Chairman and as a Director of NewsEdge
Corporation, a provider of news and information services, since February 1998.
From September 1996 to February 1998, Mr. Kolowich served as the Chairman,
President and Chief Executive Officer of Individual, Inc., which merged with
NewsEdge in February 1998. Mr. Kolowich served as the President of AT&T New
Media Services, a division of AT&T that he founded, from December 1994 to July
1996. Mr. Kolowich also served as President of Ziff-Davis Interactive, a
division of Ziff-Davis Interactive Publishing Company that he founded, from
April 1988 to December 1994.
Election of Officers and Directors
Our Board of Directors consists of six members. Currently, each director is
elected pursuant to our Amended and Restated Stockholders' Voting Agreement
among SmarterKids.com and our stockholders. This agreement will automatically
terminate upon the closing of this offering; provided, however, that for so
long as Brighter Vision Holdings, Inc. owns at least 750,000 shares of our
common stock, we have agreed to nominate a representative of its choice to our
Board of Directors.
Our executive officers are elected by the Board of Directors and serve until
their successors are duly elected and qualified. There are no family
relationships among any of our executive officers or directors.
Upon the closing of this offering, our Board of Directors will be divided
into three classes, with the members of each class of directors serving for
staggered three-year terms. Messrs. Hickey and Kolowich will serve in the class
of directors whose term expires in 2000; Messrs. Fitzgerald and Pucci will
serve in the class of the directors whose term expires in 2001; and Messrs.
Blohm and D'Amore will serve in the class of
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directors whose term expires in 2002. At each annual meeting of stockholders, a
class of directors will be elected for a three-year term to succeed the
directors of the same class whose term is then expiring.
Committees of the Board of Directors
The Compensation Committee consists of Messrs. D'Amore and Kolowich. The
Compensation Committee reviews and evaluates the compensation and benefits of
all of our executive officers, reviews general policy matters relating to
compensation and benefits of our employees and makes recommendations concerning
these matters to the Board of Directors. The Compensation Committee also
administers our stock option and stock purchase plans.
The Audit Committee consists of Messrs. Hickey and Fitzgerald. The Audit
Committee reviews, with our independent auditors, the scope and timing of the
auditors' services, the auditors' report on our financial statements following
completion of their annual audit, and our internal accounting and financial
control policies and procedures. In addition, the Audit Committee will make
annual recommendations to the Board of Directors regarding the appointment of
independent auditors. We are required by the rules and regulations of The
Nasdaq Stock Market to maintain an audit committee, a majority of whose members
must be independent directors. Messrs Hickey and Fitzgerald are considered
independent directors under such rules.
Director Compensation
Neither employee nor non-employee directors receive cash compensation for
services performed in their capacity as directors. We reimburse directors for
reasonable out-of-pocket expenses incurred in attending meetings of the Board
of Directors and any of its committees on which they serve. Directors are also
eligible to participate in our 1995 Stock Plan and our 1999 Stock Option and
Incentive Plan Non-Employee directors are eligible to also participate in our
1999 Non-Employee Director Stock Option Plan. Under our 1995 Stock Plan, non-
employee directors are eligible to receive stock option grants at the
discretion of the Board. In November 1998, each of Messrs. D'Amore and
Fitzgerald was granted an option to purchase 45,000 shares of common stock at
an exercise price of $0.13. In January 1999, Mr. Kolowich was granted an option
to purchase 75,000 shares of common stock at an exercise price of $0.13 per
share and an option to purchase 75,000 shares of common stock at an exercise
price of $1.33 per share. In July 1999, Mr. Hickey was granted an option to
purchase 45,000 shares of common stock at an exercise price of $4.18.
Compensation Committee Interlocks and Insider Participation
The current members of our Compensation Committee are Messrs. D'Amore and
Kolowich. No executive officer has served as a director or member of the
Compensation Committee, or other committee serving an equivalent function, of
any other entity whose executive officers served as a member of the
Compensation Committee of our Board of Directors. For a description of
transactions between us and certain entities affiliated with Messrs. D'Amore
see "Certain Transactions" below.
Executive Compensation
The following summary compensation table sets forth certain information
concerning the compensation of our Chief Executive Officer and our four other
most highly paid executive officers for the fiscal year ended December 31,
1998. Mr. Secor joined us in October 1998 with an annual salary of $121,000.
All other compensation paid to the executive officers named below for the
fiscal year ended December 31, 1998 is comprised of insurance premiums paid by
us for life insurance policies of each executive officer. The five officers
listed in the chart below are sometimes referred to as the named executive
officers.
52
<PAGE>
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Long-Term
Compensation Compensation
-------------------- ------------
Securities All
Underlying Other
Name and Principal Positions Salary ($) Bonus ($) Options (#) Compensation
- ---------------------------- ---------- --------- ------------ ------------
<S> <C> <C> <C> <C>
David Blohm..................... $120,751 $ -- 270,000 $696
President and Chief Executive
Officer
Jeff Pucci...................... 118,643 -- 270,000 696
Co-Founder and Chairman of the
Board
Richard Viard................... 91,892 -- 270,000 696
Co-Founder and Senior Vice
President,
Development
Albert Noyes.................... 105,794 15,073 150,000 696
Senior Vice President,
Marketing and Sales
Richard Secor................... 25,142 -- 75,000 116
Vice President, MIS
and Chief Information Officer
</TABLE>
Option Grants in Last Fiscal Year
The following table provides certain information regarding stock options
granted to the named executive officers during the fiscal year ended December
31, 1998. We granted to our employees options to purchase 1,238,251 shares of
common stock during the 1998 fiscal year. All options were granted with an
exercise price at least equal to the fair market value of the common stock on
the date of the grant, as determined by the Board of Directors. Options may
terminate before their expiration date if the optionee is no longer an employee
or consultant of the company. Please note that for the purposes of calculating
the potential realizable value, we have calculated the gains or "option
spreads" that would exist for the options assuming an annual compound stock
appreciation of 5% and 10% from the date the option was granted over the full
option term. These assumed annual compound rates are mandated by the SEC and do
not represent our estimate or projection of future stock prices.
Option Grants in Last Fiscal Year
<TABLE>
<CAPTION>
Potential
Realizable
Value at Assumed
Annual Rates of
Stock Price
Appreciation for
Individual Grants Option Term ($)
------------------------------------------------ -----------------
Number of
Securities Percent of Total
Underlying Options
Options Granted to Exercise
Granted Employees in Price Per Expiration
Name (#) Fiscal Year (%) Share ($) Date 5% 10%
- ---- ---------- ---------------- --------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
David Blohm............. 270,000 21.80% $.13 11/6/08 $ 22,074 $ 55,940
Jeff Pucci.............. 270,000 21.80 .15 11/6/03 11,189 24,726
Richard Viard........... 270,000 21.80 .15 11/6/03 11,189 24,726
Albert Noyes............ 150,000 12.11 .13 11/6/08 12,263 31,077
Richard Secor........... 75,000 6.06 .13 10/19/08 6,132 15,539
</TABLE>
53
<PAGE>
Year-End Option Table
The following table sets forth information regarding exercisable and
unexercisable stock options held as of December 31, 1998 by each of the named
executive officers. The value realized upon exercise of stock options is
calculated by determining the difference between the exercise price per share
and the fair market value on the date of exercise. There was no public trading
market for our common stock as of December 31, 1998. Accordingly, the value of
unexercised in-the-money options has been calculated by determining the
difference between the exercise price per share and the initial public offering
price of $14.00.
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option
Values
<TABLE>
<CAPTION>
Number of Securities
Shares Underlying Unexercised Value of Unexercised In-
Acquired on Value Options at Fiscal Year End the-Money Options at Fiscal
Exercise Realized (#) Year End ($)
Name (#) ($) (Exercisable/Unexercisable) (Exercisable/Unexercisable)
- ---- ----------- -------- --------------------------- ---------------------------
<S> <C> <C> <C> <C> <C> <C>
David Blohm............. -- -- 375,375 / 395,625 5,238,551 / 5,487,319
Jeff Pucci.............. -- -- -- / 270,000 -- / 3,739,500
Richard Viard........... -- -- -- / 270,000 -- / 3,739,500
Albert Noyes............ 42,000 -- 65,250 / 318,750 905,419 / 4,421,062
Richard Secor........... -- -- -- / 75,000 -- / 1,040,250
</TABLE>
Employment Contracts, Termination of Employment Agreements and Change in
Control Arrangements
Messrs. Pucci and Viard have employment agreements with us each dated
November 6, 1998. If we terminate the employment of Mr. Pucci or Mr. Viard for
any reason during the term of his respective employment agreement, Mr. Pucci or
Mr. Viard, as the case may be, will continue to receive his salary for the
remaining term of the agreement, regardless of whether he obtains other
employment, and his stock options granted in connection with the commencement
of his employment will continue to vest for the remaining term of the
agreement. Pursuant to these employment agreements, each of Messrs. Pucci and
Viard was granted options to purchase 270,000 shares of our common stock on
November 6, 1998 with an exercise price of $.15 per share. The shares vest over
four years with 67,500 shares vesting on November 6, 1999 and 16,875 shares
vesting in equal installments at the end of each calendar quarter beginning
December 31, 1999. These employment agreements expire on November 6, 2000.
Upon the consummation of this offering the following vested options granted
to the following individuals will be exercisable and not subject to a right of
repurchase by SmarterKids.com: David Blohm 636,000 shares, Michael Kolowich
75,000 shares, Albert Noyes 258,000 shares, Jeff Pucci 135,000 shares, Richard
Secor 18,750, and Richard Viard 135,000 shares. See "Principal Stockholders."
Employee Benefit Plans
1995 Stock Plan
The 1995 Stock Plan, as amended, was adopted by the Board of Directors and
approved by our stockholders on September 5, 1995. The aggregate number of
shares of common stock which may be issued under the 1995 Stock Plan is
3,822,000. Under the 1995 Stock Plan, we are authorized to grant incentive
stock options and non-qualified stock options, as well as awards of common
stock and opportunities to make direct purchases of common stock to our
employees, consultants, directors and officers. The 1995 Stock Plan is
administered by the Board of Directors and the Compensation Committee. The 1995
Stock Plan provides that the Board of Directors and the Compensation Committee
each has the authority to select the participants and determine the terms of
the stock options, awards and purchase rights granted under the 1995 Stock
Plan.
54
<PAGE>
An incentive stock option is not transferable by the recipient except by
will or by the laws of descent and distribution. Non-qualified stock options
and other awards are transferable only to the extent provided in the agreement
relating to such option or award or in response to a valid domestic relations
order. Generally, no incentive stock options may be exercised more than three
months following termination of employment, and no stock option may be
exercised following termination of employment for cause. However, in the event
that termination is due to death or disability, the stock option is exercisable
for a maximum of 180 days after such termination.
In September 1999, the Board of Directors voted to terminate the 1995 Stock
Plan effective on the consummation of this offering. As of September 30, 1999,
we had outstanding under the 1995 Stock Plan stock options exercisable for
2,831,451 shares of common stock.
1999 Stock Option and Incentive Plan
The 1999 Stock Option and Incentive Plan was adopted by the Board of
Directors in September 1999 and approved by our stockholders and became
effective in October 1999. The 1999 Stock Option and Incentive Plan provides
for the grant of stock-based awards to our employees, officers and directors,
and consultants or advisors, including incentive stock options and non-
qualified stock options and other equity-based awards. Incentive stock options
may be granted only to our employees. A total of 2,000,000 shares of common
stock may be issued upon the exercise of options or other awards granted under
the 1999 Stock Option and Incentive Plan. The maximum number of shares that may
be granted to any employee under the 1999 Stock Option and Incentive Plan shall
not exceed 500,000 shares of common stock during any calendar year.
The 1999 Stock Option and Incentive Plan is administered by the Board of
Directors and the Compensation Committee. The 1999 Stock Option and Incentive
Plan provides that the Board of Directors and the Compensation Committee each
has the authority to select the persons to whom awards are granted and
determine the terms of each award, including the number of shares of common
stock to be granted. Payment of the exercise price of an award may be made in
cash, shares of common stock, a combination of cash or stock or by any other
method approved by the Board or Compensation Committee, consistent with Section
422 of the Internal Revenue Code and Rule 16b-3 under the Exchange Act. Unless
otherwise permitted by us, awards are not assignable or transferable except by
will or the laws of descent and distribution.
Each of the Board of Directors or Compensation Committee may, in its sole
discretion, amend, modify or terminate any award granted or made under the 1999
Stock Option and Incentive Plan, so long as such amendment, modification or
termination would not materially and adversely affect the participant. Each of
the Board or Compensation Committee may also, in its sole discretion,
accelerate or extend the date or dates on which all or any particular option or
options granted under the 1999 Stock Option and Incentive Plan may be
exercised. Options to purchase 800,000 shares of common stock have been granted
to date under the 1999 Stock Option and Incentive Plan.
1999 Non-Employee Director Stock Option Plan
The 1999 Non-Employee Director Stock Option Plan was adopted by the Board of
Directors in September 1999 and approved by our stockholders in October 1999.
The 1999 Non-Employee Director Stock Option Plan will take effect upon
completion of this offering. The 1999 Non-Employee Director Stock Option Plan
provides for the grant of options to purchase a maximum of 200,000 shares of
Common Stock of the Company to non-employee directors of the Company.
The 1999 Non-Employee Director Stock Option Plan will be administered by a
committee appointed by the Board of Directors. In the event the Board of
Directors does not appoint such a committee, then the Board shall have all
power and authority to administer the 1999 Non-Employee Director Stock Option
Plan.
55
<PAGE>
Under the 1999 Non-Employee Director Stock Option Plan, each director who is
not also an employee or officer of the Company and who is not a director at the
time of this offering shall be automatically granted on the date such person is
first elected to the Board of Directors an option to purchase 45,000 shares of
common stock. Each time a non-employee director is re-elected to the Board,
including current directors, such non-employee director will automatically
receive an option to purchase 2,000 shares of common stock. Provided that the
director continues to serve as a member of the Board of Directors, one-third of
the shares included in each grant will become exercisable on each of the first,
second and third anniversaries of the date of grant. All options granted under
the 1999 Non-Employee Director Stock Option Plan will have an exercise price
equal to the fair market value of the common stock on the date of grant. The
term of each option will be for a period of ten years from the date of grant.
Options may not be assigned or transferred except by will or by the laws of
descent and distribution and are exercisable to the extent vested only while
the optionee is serving as a director or within 90 days after the optionee
ceases to serve as a director (except that if a director dies or becomes
disabled while he or she is serving as a director, the option is exercisable
until the scheduled expiration date of the option). No options have been
granted to date under the 1999 Non-Employee Director Stock Option Plan.
1999 Employee Stock Purchase Plan
The 1999 Employee Stock Purchase Plan was adopted by the Board of Directors
in September 1999 and approved by our stockholders in October 1999. The 1999
Employee Stock Purchase Plan will take effect upon completion of this offering.
The 1999 Employee Stock Purchase Plan provides for the issuance of a maximum of
400,000 shares of common stock. The 1999 Employee Stock Purchase Plan is
administered by the Board of Directors and the Compensation Committee. All
employees whose customary employment is for more than 20 hours per week and for
more than three months in any calendar year and who have completed more than 90
days of employment on or before the first day of any six-month payment period
are eligible to participate in the 1999 Employee Stock Purchase Plan. Outside
directors and employees who would own 5% or more of the total combined voting
power of value of our stock immediately after the grant may not participate in
the 1999 Employee Stock Purchase Plan.
To participate in the 1999 Employee Stock Purchase Plan, an employee must
authorize us to deduct an amount not less than one percent nor more than 10
percent of a participant's total cash compensation from his or her pay during
six-month payment periods. The payment periods will commence on January 1 and
July 1, and end on June 30 and December 31, respectively, of each year. In no
case shall an employee be entitled to purchase more than 1,000 shares in any
one payment period. The exercise price for the option granted in each payment
period is 85% of the lesser of the average market price of the common stock on
the first or last business day of the payment period, in either event rounded
up to the nearest cent. If an employee is not a participant on the last day of
the payment period, such employee is not entitled to exercise his or her
option, and the amount of his or her accumulated payroll deductions will be
refunded.
Options granted under the 1999 Employee Stock Purchase Plan may not be
transferred or assigned. An employee's rights under the 1999 Employee Stock
Purchase Plan terminate upon his or her voluntary withdrawal from the plan at
any time or upon termination of employment. No options or shares have been
granted to date under the 1999 Employee Stock Purchase Plan.
401(k) Plan
We maintain a 401(k) Retirement Savings Plan, which is intended to qualify
under Section 401(a) of the Internal Revenue Code. All employees who are at
least 21 years of age and who have completed six months of service are eligible
to participate in the 401(k) Plan. Under the 401(k) Plan, participants
generally may elect to defer up to 15% of their compensation. In addition, at
the discretion of the Board of Directors, we may make matching contributions to
the 401(k) Plan for all eligible employees. We have not made any matching
contributions to the 401(k) Plan to date.
56
<PAGE>
Limitation of Liability and Indemnification of Officers and Directors
Our Amended and Restated Certificate of Incorporation and Amended and
Restated By-Laws provide that our directors and officers shall be indemnified
by us to the fullest extent permitted by Delaware law, as it now exists or may
in the future be amended, against all expenses and liabilities reasonably
incurred in connection with their service for us or on our behalf. In addition,
our Amended and Restated Certificate of Incorporation provides that our
directors will not be personally liable for monetary damages to us for breaches
of their fiduciary duty as directors, unless they violated their duty of
loyalty to us or our stockholders, acted in bad faith, knowingly or
intentionally violated the law, authorized illegal dividends or redemptions or
derived an improper personal benefit from their action as directors. We intend
to obtain insurance which insures our directors and officers against certain
losses and which insures us against our obligations to indemnify our directors
and officers.
57
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information known to us regarding
beneficial ownership of our common stock as of October 15, 1999 by:
. each of the named executive officers
. each of our directors
. each person known by us to be the beneficial owner of more than 5% of
our common stock
. all executive officers and directors as a group
Unless otherwise noted below, the address of each person listed in the table
is c/o SmarterKids.com, Inc., 15 Crawford Street, Needham, Massachusetts 02494,
and each person has sole voting and investment power over the shares shown as
beneficially owned except to the extent authority is shared by spouses under
applicable law and except as set forth in the footnotes to the table.
We have determined beneficial ownership in accordance with the rules of the
SEC. We have assumed the conversion into common stock of all outstanding shares
of preferred stock. Shares of common stock subject to options that are either
currently exercisable or exercisable within 60 days after October 15, 1999 and
shares of common stock subject to options that are exercisable upon the closing
of this offering are treated as outstanding and beneficially owned by the
option holder for the purpose of computing the percentage ownership of the
option holder. However, these shares are not treated as outstanding for the
purpose of computing the percentage ownership of any other person. The
percentages contained in the "After the Offering" column assume that the
underwriters do not exercise their over-allotment options to purchase up to an
aggregate of 675,000 additional shares, including 658,500 shares from us and
14,850 and 1,650 shares, respectively, from selling stockholders Smart Kids
Company, Inc. and S.K.C., Inc.
58
<PAGE>
<TABLE>
<CAPTION>
Percentage of Common
Shares of Stock Outstanding
Common Stock -------------------------
Beneficially Before the After the
Name and Address of Beneficial Owner Owned (#) Offering (%) Offering (%)
- ------------------------------------ ------------ ------------ ------------
<S> <C> <C> <C>
David Blohm(1)........................ 771,000 4.9% 3.8%
Jeff Pucci(2)......................... 771,000 5.1 3.9
Richard Viard(3)...................... 769,500 5.1 3.9
Albert Noyes(4)....................... 426,000 2.8 2.2
Richard Secor(5)...................... 37,500 * *
Richard D'Amore(6).................... 2,967,817 20.0 15.3
Michael Fitzgerald(7)................. 1,858,908 12.5 9.6
Michael Kolowich(8)................... 150,000 1.0 1.0
Brian Hickey(9)....................... -- -- --
225 Duncan Mill Road
Don Mills, Ontario, Canada M3B 3K9
North Bridge Venture Partners III,
L.P.(6).............................. 2,967,817 20.0 15.4
950 Winter Street, Suite 4600
Waltham, MA 02451
Commonwealth Capital Ventures II,
L.P.(7).............................. 1,858,908 12.6 9.7
20 William Street
Wellesley, MA 02181
Brighter Vision Holdings, Inc......... 1,674,907 11.3 8.7
c/o Torstar Corporation
One Yonge Street
Toronto, Canada M5E IP9
Intel Corporation..................... 1,196,362 8.1 6.2
2200 Mission College Blvd., Mailstop
RN6-46
Santa Clara, CA 95952
Van Wagoner Capital Management........ 957,090 6.4 4.9
245 California Street, Suite 2450
San Francisco, CA 94104
WMUR TV, Inc.(10)..................... 951,000 6.5 4.9
100 Commercial Street
Manchester, NH 02105
All executive officers and directors
as a group (14 persons)(11).......... 7,956,725 47.0 37.1
Selling Stockholders
Entities affiliated with Smart Kids
Company, Inc. (12)................... 33,000 * *
</TABLE>
- --------
* Less than 1%
(1) Consists of 683,060 shares issuable upon the exercise of options
exercisable within 60 days of October 15, 1999 and 87,940 shares which will
become exercisable upon the closing of this offering. As of sixty days
after October 15, 1999, 202,500 shares of the 683,060 shares, if exercised,
will be subject to a right of repurchase by SmarterKids.com. This right of
repurchase will terminate with respect to 67,500 shares upon the closing of
this offering.
(2) Includes 270,000 shares issuable upon the exercise of options exercisable
within 60 days of October 15, 1999. As of sixty days after October 15,
1999, 202,500 shares of the 270,000 shares, if exercised, will be subject
to a right of repurchase by SmarterKids.com. This right of repurchase will
terminate with respect to 67,500 shares upon the closing of this offering.
(3) Includes 270,000 shares issuable upon the exercise of options exercisable
within 60 days of October 15, 1999. As of sixty days after October 15,
1999, 202,500 shares of the 270,000 shares, if exercised, will be subject
to a right of repurchase by SmarterKids.com. This right of repurchase will
terminate with respect to 67,500 shares upon the closing of this offering.
59
<PAGE>
(4) Includes 339,000 shares issuable upon the exercise of options exercisable
within 60 days of October 15, 1999. As of sixty days after October 15,
1999, 236,625 shares of the 339,500 shares, if exercised, will be subject
to a right of repurchase by SmarterKids.com. This right of repurchase will
terminate with respect to 155,625 shares upon the closing of this offering.
(5) Consists of 18,750 shares issuable upon the exercise of options exercisable
within 60 days of October 15, 1999 and 18,750 shares which will become
exercisable upon the closing of this offering.
(6) Consists of 11,250 shares issuable upon the exercise of options exercisable
within 60 days of October 15, 1999 and 2,967,817 shares held by North
Bridge Venture Partners III, L.P. Mr. D'Amore is a general partner of the
general partner of North Bridge Venture Partners III, L.P. and may be
deemed to share voting and investment power with respect to all shares held
by North Bridge Venture Partners III, L.P. Mr. D'Amore disclaims beneficial
ownership of such shares, except to the extent of his pecuniary interest
therein, if any.
(7) Consists of 11,250 shares issuable upon the exercise of options exercisable
within 60 days of October 15, 1999, 1,771,500 shares held by Commonwealth
Capital Ventures II, L.P. and 87,408 shares held by CCV II Associates Fund,
L.P. Mr. Fitzgerald is a general partner of the general partner of
Commonwealth Capital Ventures II, L.P. and the general partner of CCV II
Associates Fund, L.P. and may be deemed to share voting and investment
power with respect to all shares held by Commonwealth Capital Ventures II,
L.P. and CCV II Associates Fund, L.P. Mr. Fitzgerald disclaims beneficial
ownership of such shares, except to the extent of his pecuniary interest
therein, if any.
(8) Includes 75,000 shares which will become exercisable upon the closing of
the offering.
(9) Excludes 1,674,907 shares held by Brighter Vision Holdings, Inc. Mr. Hickey
is the chairman and chief executive officer of Harlequin Enterprises
Limited. Harlequin Enterprises Limited and Brighter Vision Holdings, Inc.
are both wholly-owned subsidiaries of Torstar Corporation. Mr. Hickey
disclaims beneficial ownership of such shares.
(10) Excludes 579,000 shares held by Frank Imes, the President and controlling
shareholder of WMUR TV, Inc. Mr. Imes may be deemed to share voting and
investment power with respect to all shares held by WMUR TV, Inc. Mr. Imes
disclaims beneficial ownership of such shares held by WMUR TV, Inc.,
except to the extent of his pecuniary interest therein, if any.
(11) See footnotes (1) through (9) above. Also includes an aggregate of 105,000
shares issuable upon the exercise of options exercisable within 60 days of
October 15, 1999 or upon the closing of the offering.
(12) Smart Kids Company, Inc. and S.K.C., Inc. are related entities that were
issued an aggregate of 33,000 shares of our common stock in exchange for the
transfer of a registered trademark similar to SmarterKids and certain domain
names. Smart Kids Company and S.K.C. will be selling an aggregate of 16,500
shares if the underwriters exercise their overallotment option.
60
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for our common
stock. Future sales of substantial amounts of common stock in the public market
could lower prevailing market prices. As described below, no shares currently
outstanding will be available for sale immediately after this offering because
of contractual restrictions on resale. Sales of substantial amounts of our
common stock in the public market after the restrictions lapse could harm the
prevailing market price and impair our ability to raise equity capital in the
future.
Upon completion of the offering and based on shares outstanding as of
October 15, 1999, we will have 19,629,764 outstanding shares of common stock
assuming the exercise of warrants to purchase 328,091 shares of common stock
which terminate upon the closing of the offering. Of these shares, the
4,500,000 shares sold in the offering, plus any shares issued upon exercise of
the underwriters' overallotment option, will be freely tradable without
restriction under the Securities Act, unless purchased by our "affiliates" as
that term is defined in Rule 144 under the Securities Act. In general,
affiliates include officers, directors or 10% stockholders.
The remaining 15,192,764 shares outstanding are "restricted securities"
within the meaning of SEC Rule 144. Restricted securities may be sold in the
public market only if registered or if they qualify for an exemption from
registration under Rules 144 or 701 promulgated under the Securities Act, which
are summarized below. Sales of the restricted securities in the public market,
or the availability of such shares for sale, could adversely affect the market
price of the common stock.
The underwriters have required that our directors, officers and
securityholders listed under "Principal Stockholders" enter into lock-up
agreements in connection with this offering generally providing that they will
not offer, sell, contract to sell or grant any option to purchase or otherwise
dispose of our common stock or any securities exercisable for or convertible
into our common stock owned by them for a period of 180 days after the date of
this prospectus without the prior written consent of Hambrecht & Quist LLC.
Based on the number of shares, options and warrants outstanding as of October
15, 1999, taking into account the lock-up agreements, and assuming the
underwriters' overallotment options are not exercised and Hambrecht & Quist LLC
does not release stockholders from these agreements, the number of shares that
will be available for sale in the public market under the provisions of Rule
144 and 701 will be as follows:
. Beginning on the date of this prospectus, only the shares sold in this
offering will be immediately available for sale in the public market.
. Beginning 180 days after the date of this prospectus, approximately
9,838,087 shares will be eligible for sale, including 1,898,266 shares
subject to outstanding vested options and warrants.
. At various times thereafter upon the expiration of applicable holding
periods, 9,619,879 shares will become eligible for sale, including
2,366,935 shares subject to outstanding options and warrants.
In general, under Rule 144, after the expiration of the lock-up agreements,
a person who has beneficially owned restricted securities for at least one year
would be entitled to sell within any three-month period a number of shares that
does not exceed the greater of:
. one percent of the number of shares of common stock then outstanding
which will equal approximately 196,297 shares immediately after the
offering; or
. the average weekly trading volume of the common stock during the four
calendar weeks preceding the sale.
Sales under Rule 144 are also subject to requirements with respect to manner
of sale, notice and the availability of current public information about us.
Under Rule 144(k), a person who is not deemed to have been our affiliate at any
time during the three months preceding a sale and who has beneficially owned
the shares proposed to be sold for at least two years, is entitled to sell such
shares without complying with the manner of sale, public information, volume
limitation or notice provisions of Rule 144.
61
<PAGE>
Rule 701 permits our employees, officers, directors or consultants who
purchased shares pursuant to a written compensatory plan or contract to resell
such shares in reliance upon Rule 144 but without compliance with specific
restrictions. Rule 701 provides that affiliates may sell their Rule 701 shares
under Rule 144 without complying with the holding period requirement and that
non-affiliates may sell such shares in reliance on Rule 144 without complying
with the holding period, public information, volume limitation or notice
provisions of Rule 144.
62
<PAGE>
CERTAIN TRANSACTIONS
Between May 1997 and November 1998, we issued and sold an aggregate of
3,517.5 shares of our series B preferred stock to certain private investors for
an aggregate purchase price of $7,035,000 or $2,000 per share. Each share of
series B preferred stock will convert into 1,500 shares of common stock upon
the closing of this offering. In this financing, North Bridge Venture Partners
III, L.P. purchased 1,500 shares of series B preferred stock for an aggregate
purchase price of $3,000,000, and Commonwealth Capital Ventures II, L.P.
purchased 1,000 shares of series B preferred stock for an aggregate purchase
price of $2,000,000. In July 1999, we issued and sold an aggregate of 4,284,091
shares of our series C preferred stock to certain private investors for an
aggregate purchase price of $26,856,966 or $6.269 per share. Each share of
series C preferred stock will convert into 1.5 shares of common stock upon the
closing of this offering. North Bridge Venture Partners III, L.P. purchased
478,545 shares of series C preferred stock for an aggregate purchase price of
$2,999,998. Commonwealth Capital Ventures II, L.P. and one of its affiliates,
of which Mr. Fitzgerald is a general partner, purchased an aggregate of 239,272
shares of series C preferred stock for an aggregate purchase price of
$1,499,996.
Richard A. D'Amore, a member of the Board of Directors, is general partner
of the general partner of North Bridge Venture Partners III, L.P. which
beneficially owns 20.0% of our common stock. Michael T. Fitzgerald, a member of
the Board of Directors, is general partner of the general partner of
Commonwealth Capital Ventures II, L.P. which beneficially owns 12.5% of our
Common Stock. Pursuant to a Voting Agreement dated November 9, 1998,
NorthBridge and Commonwealth Capital each have the right to appoint a director
to our Board of Directors. The Voting Agreement was amended and restated on
July 12, 1999 and will expire upon the consummation of this offering, with the
exception of the right of Brighter Vision Holdings, Inc. to place in nomination
for director of SmarterKids.com a nominee of its choice so long as it holds at
least 750,000 shares of our common stock.
63
<PAGE>
DESCRIPTION OF SECURITIES
Effective upon the closing of this offering and the filing of our Amended
and Restated Certificate of Incorporation, our authorized capital stock will
consist of 90,000,000 shares of common stock, par value $.01 per share, and
10,000,000 shares of preferred stock, par value $.01 per share. The following
summary description of our capital stock is not intended to be complete and is
qualified by reference to the provisions of applicable law and to our Amended
and Restated Certificate of Incorporation and Amended and Restated By-laws,
filed as exhibits to the registration statement of which this prospectus is a
part.
Common Stock
As of October 15, 1999, there were 2,131,787 shares of common stock
outstanding held by 26 stockholders of record. Based upon the number of shares
outstanding as of that date and giving effect to the issuance of the 4,500,000
shares of common stock offered by us in this offering and the conversion of the
outstanding shares of preferred stock, there will be 19,364,674 shares of
common stock outstanding upon the closing of this offering. In addition, as of
October 15, 1999, there were outstanding stock options to purchase 3,980,201
shares of common stock.
Holders of common stock are entitled to one vote for each share held on all
matters submitted to a vote of stockholders and do not have cumulative voting
rights. Directors are elected by a plurality of the votes of the shares present
in person or by proxy at the meeting and entitled to vote in such election.
Holders of common stock are entitled to receive ratably such dividends, if any,
as may be declared by the Board of Directors out of funds legally available
therefor, after provision has been made for any preferential dividend rights of
outstanding preferred stock. Upon our liquidation, dissolution or winding up,
the holders of common stock are entitled to receive ratably the net assets
available after the payment of all of our debts and other liabilities, and
after the satisfaction of the rights of any outstanding preferred stock.
Holders of the common stock have no preemptive, subscription, redemption or
conversion rights, nor are they entitled to the benefit of any sinking fund.
The outstanding shares of common stock are, and the shares offered by us in
this offering will be, when issued and paid for, validly issued, fully paid and
non-assessable. The rights, powers, preferences and privileges of holders of
common stock are subordinate to, and may be adversely affected by, the rights
of the holders of shares of any series of preferred stock which we may
designate and issue in the future.
Preferred Stock
Upon closing of this offering, all outstanding shares of preferred stock
will automatically convert into an aggregate of 12,732,887 shares of common
stock. Thereafter, the Board of Directors will generally be authorized, without
further stockholder approval, to issue from time to time up to an aggregate of
10,000,000 shares of preferred stock, in one or more series. Each series of
preferred stock shall have such number of shares, designations, preferences,
voting powers, qualifications and special or relative rights or privileges as
shall be determined by the Board of Directors, which may include, among others,
dividend rights, voting rights, redemption and sinking fund provisions,
liquidation preferences, conversion rights and preemptive rights.
Our stockholders have granted the Board of Directors authority to issue the
preferred stock and to determine the rights and preferences of the preferred
stock in order to eliminate delays associated with a stockholder vote on
specific issuances. The rights of the holders of common stock will be
subordinate to the rights of holders of any preferred stock issued in the
future. The issuance of preferred stock, while providing desirable flexibility
in connection with possible acquisitions and other corporate purposes, could
adversely affect the voting power or other rights of the holders of common
stock, and could make it more difficult for a third party to acquire, or
discourage a third party from attempting to acquire, a majority of our
outstanding voting stock. We have not, to date, issued any shares of such
preferred stock, and we have no present plans to issue any shares of preferred
stock.
64
<PAGE>
Warrants
As of October 15, 1999, there were outstanding warrants to purchase:
. 165,000 shares of common stock issued to J.L. Hammett Co. at an exercise
price of $1.33. These warrants expire on September 29, 2003.
. 121,050 shares of common stock issued to Edu Ventures, Inc. at an
exercise price of $.13 and 37,500 shares of common stock issued to Edu
Ventures, Inc. at an exercise price of $1.33. These warrants expire
immediately prior to this offering.
. 112,500 shares of common stock issued to National Computer Systems, Inc.
at an exercise price of $1.33 per share.
. five shares of series B preferred stock issued to Silicon Valley Bank at
an exercise price of $2,000 per share that will expire on March 24,
2003. Upon the closing of this offering, these warrants will convert
into warrants to purchase 7,500 shares of common stock at an exercise
price of $1.33 per share.
. 113,027 shares of series C preferred stock issued to Thomas Weisel
Partners, LLC at an exercise price of $6.269. These warrants expire
immediately prior to this offering.
Registration Rights
Upon the expiration of the contractual lock-up period with the underwriters,
certain stockholders will be entitled to require us to register under the
Securities Act up to a total of 14,000,421 shares of outstanding common stock
under the terms of an investor rights agreement between us and the rights
holders. In addition, a holder of a warrant exercisable for 7,500 shares of
common stock will have certain registration rights. The investor rights
agreement provides that if we propose to register in a firm commitment
underwritten offering any of our securities under the Securities Act at any
time or times, the stockholders having registration rights will generally be
entitled to include shares of common stock held by them in such registration.
However, the managing underwriter of any offering may exclude for marketing
reasons some or all of the shares from the registration. Some of these
stockholders also have the right to require us, on no more than two occasions,
to prepare and file a registration statement under the Securities Act
registering the shares of common stock held by them. We are generally required
to bear the expenses of all such registrations, except underwriting discounts
and commissions. These rights terminate on the fifth anniversary of this
offering.
Anti-Takeover Effects of Delaware Law and Certain Charter and By-Law Provisions
Upon completion of this offering, the provisions of Section 203 of the
General Corporation Law of Delaware will prohibit us from engaging in a
"business combination" with an "interested stockholder" for a period of three
years after the date of the transaction in which the person became an
interested stockholder, unless the business combination is approved in a
prescribed manner. A "business combination" includes mergers, asset sales and
other transactions resulting in a financial benefit to the interested
stockholder. An "interested stockholder" is generally defined as a person who,
together with affiliates and associates, owns, or within three years did own,
15% or more of the corporation's voting stock.
Our Amended and Restated Certificate of Incorporation provides for the
division of the Board of Directors into three classes as nearly equal in size
as possible with staggered three-year terms. In addition, our Amended and
Restated Certificate of Incorporation provides that directors may be removed
only for cause by the affirmative vote of the holders of 75% of the shares of
our capital stock entitled to vote. Under our Amended and Restated Certificate
of Incorporation, any vacancy on the Board of Directors, however occurring,
including a vacancy resulting from an enlargement of the Board, may only be
filled by vote of a majority of the directors then in office. The likely effect
of the classification of the Board of Directors and the limitations on the
removal of directors and filling of vacancies is an increase in the time
required for the
65
<PAGE>
stockholders to change the composition of the Board of Directors. For example,
in general, at least two annual meetings of the stockholders will be necessary
for stockholders to effect a change in a majority of the members of the Board
of Directors.
Our Amended and Restated Certificate of Incorporation also provides that,
after the effective date of the registration statement of which this
prospectus is a part, any action required or permitted to be taken by our
stockholders at an annual meeting or special meeting of stockholders may only
be taken if it is properly brought before the meeting and may not be taken by
written action in lieu of a meeting. Our Amended and Restated By-laws provide
that special meetings of the stockholders may only be called by the Board of
Directors, the Chairman of the Board of Directors, the Chief Executive Officer
or the President. Our Amended and Restated By-laws further provide that in
order for any matter to be considered "properly brought" before a meeting, a
stockholder must comply with requirements regarding advance notice to us. The
foregoing provisions could have the effect of delaying until the next
stockholders meeting stockholder actions which are favored by the holders of a
majority of our outstanding voting securities. These provisions may also
discourage another person or entity from making a tender offer for our common
stock, because such person or entity, even if it acquired a majority of our
outstanding voting securities, would be able to take action as a stockholder,
such as electing new directors or approving a merger, only at a duly called
stockholders meeting, and not by written consent.
The General Corporation Law of Delaware provides generally that the
affirmative vote of a majority of the shares entitled to vote on any matter is
required to amend a corporation's certificate of incorporation or by-laws,
unless a corporation's certificate of incorporation or by-laws, as the case
may be, requires a greater percentage. Our Amended and Restated Certificate of
Incorporation requires the affirmative vote of the holders of at least 75% of
the shares of our capital stock that are issued and outstanding and entitled
to vote to amend or repeal any of the foregoing provisions of the Amended and
Restated Certificate of Incorporation. Our Amended and Restated By-laws may
generally be amended or repealed by a majority vote of the Board of Directors
and may also be amended or repealed by the affirmative vote of the holders of
at least 75% of the shares of our capital stock that are issued and
outstanding and entitled to vote. The 75% stockholder vote would be in
addition to any separate class vote that might in the future be required in
accordance with the terms of any series of preferred stock that might be
outstanding at the time any such amendments are submitted to stockholders.
Transfer Agent and Registrar
The transfer agent and registrar for the common stock is ChaseMellon
Shareholder Services, L.L.C.
66
<PAGE>
UNDERWRITING
The underwriters named below, through their representatives, Hambrecht &
Quist LLC, U.S. Bancorp Piper Jaffray Inc. and E*OFFERING Corp., have severally
agreed to purchase, and we have agreed to sell them, an aggregate of shares of
common stock pursuant to an underwriting agreement. The number of shares of
common stock that each underwriter has agreed to purchase is listed opposite
its name below:
<TABLE>
<CAPTION>
Number of
Name Shares
---- ---------
<S> <C>
Hambrecht & Quist LLC.............................................. 1,980,000
U.S. Bancorp Piper Jaffray Inc..................................... 1,260,000
E*OFFERING Corp.................................................... 360,000
BancBoston Robertson Stephens, Inc. ............................... 120,000
Deutsche Banc Alex. Brown.......................................... 120,000
Donaldson, Lufkin & Jenrette Securities Corporation................ 120,000
Salomon Smith Barney Inc. ......................................... 120,000
Adams Harkness & Hill, Inc. ....................................... 60,000
Advest, Inc. ...................................................... 60,000
Gerard Klauer Mattison & Co., LLC.................................. 60,000
Legg Mason Wood Walker Inc. ....................................... 60,000
Raymond James & Associates Inc. ................................... 60,000
Sands Brothers & Co., Ltd. ........................................ 60,000
Tucker Anthony Cleary Gull......................................... 60,000
---------
Total ............................................................. 4,500,000
=========
</TABLE>
The underwriting agreement provides that the obligations of the underwriters
are conditioned on the absence of any material adverse change in our business
and the receipt of certificates, opinions and letters from us and the selling
stockholders, their counsel and the independent auditors. The nature of the
underwriters' obligation is such that they are committed to purchase all shares
of common stock offered by this prospectus if any of the shares are purchased.
The fee to be paid to the Underwriters by us is equal to the public company
offering price per share of the common stock to be sold in this offering less
the amount paid by us to the underwriters per share of common stock. The
following table shows the per share and total underwriting discounts and
commissions to be paid to the underwriters by SmarterKids.com and the selling
stockholders. The underwriting discount was determined based on an arms' length
negotiation between the representative of the underwriters and SmarterKids.com.
These amounts are shown assuming both no exercise and full exercise of the
underwriters' over-allotment option to purchase additional shares.
<TABLE>
<CAPTION>
Paid by SmarterKids.com
-----------------------
No Full
Exercise Exercise
----------- -----------
<S> <C> <C>
Per share............................................ $ 0.98 $ 0.98
Total................................................ $ 4,410,000 $ 5,055,330
</TABLE>
<TABLE>
<CAPTION>
Paid by Selling
Stockholders
---------------
No Full
Exercise Exercise
-------- --------
<S> <C> <C>
Per share.................................................. -- $ 0.98
Total...................................................... -- $16,170
</TABLE>
The underwriters initially propose to offer part of the shares of common
stock directly to the public at the initial public offering price listed on the
cover page of this prospectus and part to selected dealers, who are typically
members of the National Association of Securities Dealers, Inc. who acquire
shares of common
67
<PAGE>
stock for resale by agreement with the underwriters but are not members of the
underwriting syndicate, at a price that represents a concession not in excess
of $0.58 per share under the public offering price. The underwriters may allow,
and such dealers may reallow a concession not in excess of $0.20 per share to
other underwriters or selected other dealers. After the initial public offering
of the shares of common stock, the offering price and other selling terms may
be changed by the representatives of the underwriters.
E*OFFERING Corp. is the exclusive Internet underwriter for this offering.
E*OFFERING has agreed to allocate a portion of the shares that it purchases to
E*TRADE Securities, Inc., a selected dealer for this offering. E*OFFERING and
E*TRADE will allocate shares to their respective customers in accordance with
usual and customary industry practices. A prospectus in electronic format is
being made available on the website maintained by E*OFFERING Corp.,
www.eoffering.com. Other than the prospectus in electronic format, the
information that is identified as being a part of the prospectus and any other
information that references SmarterKids.com, the information on E*OFFERING
Corp.'s website and any information provided on any other website maintained by
E*OFFERING Corp. is not part of this prospectus and has not been approved or
endorsed by SmarterKids.com or any underwriter other than E*OFFERING and should
not be relied upon by prospective investors.
In the underwriting agreement, SmarterKids.com, and two stockholders, who
together had 33,000 shares, have granted to the underwriters options,
exercisable no later than 30 days after the date of this prospectus, to
purchase up to an aggregate of 675,000 additional shares of common stock at the
initial public offering price, less underwriting discounts and commissions,
listed on the cover page of this prospectus. To the extent that the
underwriters exercise these options, each underwriter will have a firm
commitment to purchase approximately the same percentage which the number of
shares of common stock to be purchased by it shown in the above table bears to
the total number of shares of common stock offered by this prospectus.
At our request, the underwriters have reserved up to 250,000 shares of
common stock to be sold in the offering and offered for sale, at the public
offering price, to our directors, officers, employees, business associates such
as customers and suppliers and persons related to, or affiliated with, the
foregoing persons. The number of shares of common stock available for sale to
the general public will be reduced to the extent these individuals purchase the
reserved shares. Any reserved shares which are not so purchased will be offered
by the underwriters to the general public on the same basis as the other shares
offered by this prospectus.
The offering of the shares is made for delivery when, as and if accepted by
the underwriters and subject to prior sale and to withdrawal, cancellation or
modification of the offering without notice. The underwriters reserve the right
to reject an order for the purchase of shares in whole or in part.
SmarterKids.com and the selling stockholders have agreed to indemnify the
underwriters against liabilities, including liabilities under the Securities
Act, and to contribute to payments the underwriters may be required to make
with respect to these liabilities.
We anticipate that our directors, officers and our significant stockholders
will agree not to directly or indirectly, without the prior written consent of
Hambrecht & Quist LLC on behalf of the underwriters, whether any such
transaction described above is to be settled by delivery of common stock or
such other securities, in cash or otherwise, during the 180-day period
following the date of this prospectus:
. offer, pledge, sell, contract to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option,
right or warrant to purchase, lend or otherwise transfer or dispose of,
directly or indirectly, any shares of common stock or any securities
convertible into or exercisable or exchangeable for common stock
(whether any such shares or any such securities are then owned by such
person or are later acquired directly from us)
. enter into any swap or other arrangement that transfers to another, in
whole or in part, any of the economic consequences of ownership of
common stock
68
<PAGE>
We have also agreed that we will not, without the prior written consent of
Hambrecht & Quist LLC, offer or sell any shares of common stock, options or
warrants to acquire shares of our common stock or securities exchangeable for
or convertible into shares of common stock during the 180-day period following
the date of this prospectus.
The restrictions described in the previous paragraphs do not apply to:
. the sale to the underwriters of the shares of common stock under the
underwriting agreement
. the issuance of shares of our common stock upon the exercise of an
option or warrant or the conversion of a security outstanding on the
date of this prospectus or that we are obligated to issue
. issuance of shares of common stock or options to purchase shares of
common stock pursuant to our employee benefit plans as in existence on
the date of the prospectus
The underwriters participating in this offering may over-allot or effect
transactions which stabilize, maintain or otherwise affect the market price of
the common stock at levels above those which might otherwise prevail in the
open market, including by entering stabilizing bids, effecting syndicate
covering transactions or imposing penalty bids.
. A stabilizing bid means the placing of any bid or effecting of any
purchase, for the purpose of pegging, fixing or maintaining the price of
the common stock.
. A syndicate covering transaction means the placing of any bid on behalf
of the underwriting syndicate or the effecting of any purchase to reduce
a short position created in connection with the offering, which occurs
when the underwriters take a short position in the common stock which
they cover with purchases on the open market to support the stock price.
. A penalty bid means an arrangement that permits the underwriters to
reclaim a selling concession from a syndicate member in connection with
the offering when shares of common stock sold by the syndicate member
are purchased in syndicate covering transactions, where they have been
resold into the market by "flippers" or other purchasers seeking an
immediate gain in the offering.
These transactions may be effected on the Nasdaq National Market, in the over-
the-counter market or otherwise. Stabilizing, if commenced, may be discontinued
at any time.
The representatives of the underwriters have advised us that the
underwriters do not intend to confirm discretionary sales in excess of five
percent of the shares offered hereby.
SmarterKids.com estimates that its share of the total expenses of this
offering, excluding underwiting discounts and commissions, will be
approximately $998,000.
Prior to the offering, there was no public market for the common stock. The
initial public offering price for the common stock was determined by
negotiation among SmarterKids.com, the selling stockholders and the
representatives of the underwriters. The factors that were considered in
determining the initial public offering price were prevailing market and
economic conditions, our revenues and earnings, market valuations of other
companies engaged in activities similar to us, estimates of our business
potential and prospects, the present state of our business operations and our
management.
69
<PAGE>
LEGAL MATTERS
The validity of the shares of common stock to be issued in this offering
will be passed upon for SmarterKids.com by Testa, Hurwitz & Thibeault, LLP,
Boston, Massachusetts. Certain legal matters in connection with this offering
will be passed upon for the underwriters by Hale and Dorr LLP, Boston,
Massachusetts.
EXPERTS
The financial statements of SmarterKids.com, Inc. as of December 31, 1997
and 1998 and September 30, 1999 and for each of the three years in the period
ended December 31, 1998 and for the nine months ended September 30, 1999
included in this prospectus have been so included in reliance upon the report
of PricewaterhouseCoopers LLP, independent accountants, given on the authority
of said firm as experts in auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC a registration statement on Form S-1 under the
Securities Act registering the common stock to be sold in this offering. As
permitted by the rules and regulations of the SEC, this prospectus omits
certain information contained in the registration statement and the exhibits
and schedules filed as a part of the registration statement. For further
information concerning us and the common stock to be sold in this offering, you
should refer to the registration statement and to the exhibits and schedules
filed as part of the registration statement. Statements contained in this
prospectus regarding the contents of any agreement or other document filed as
an exhibit to the registration statement are not necessarily complete, and in
each instance reference is made to the copy of the agreement filed as an
exhibit to the registration statement, each statement being qualified by this
reference. The registration statement, including the exhibits and schedules
filed as a part of the registration statement, may be inspected at the public
reference facilities maintained by the SEC at Room 1024, Judiciary Plaza, 450
Fifth Street, N.W., Washington, D.C. 20549, and at its regional offices located
at Seven World Trade Center, New York, New York 10007 and 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661, and copies of all or any part
thereof may be obtained from such offices upon payment of the prescribed fees.
Upon effectiveness of the Registration Statement, we will become subject to the
reporting requirements of the Exchange Act of 1934, as amended. As a reporting
company, we will be filing quarterly, annual and other periodic and current
reports and proxy statements with the SEC. You may call the SEC at 1-800-SEC-
0330 for further information on the operation of the public reference rooms,
and you can request copies of the documents upon payment of a duplicating fee
by writing to the SEC. In addition, the SEC maintains a website that contains
reports, proxy and information statements and other information regarding
registrants (including us) that file electronically with the SEC which can be
accessed at http://www.sec.gov.
70
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants......................................... F-2
Balance Sheet as of December 31, 1997 and 1998, as of September 30, 1999
and pro forma as of September 30, 1999 (unaudited)....................... F-3
Statement of Operations for the years ended December 31, 1996, 1997 and
1998 and for the nine months ended September 30, 1998 (unaudited) and
1999..................................................................... F-4
Statement of Stockholders' Equity (Deficit) for the years ended December
31, 1996, 1997 and 1998 and for the nine months ended September 30,
1999..................................................................... F-5
Statement of Cash Flows for the years ended December 31, 1996, 1997 and
1998 and for the nine months ended September 30, 1998 (unaudited) and
1999..................................................................... F-6
Notes to Financial Statements............................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of SmarterKids.com, Inc.
In our opinion, the accompanying balance sheet and the related statements of
operations, of stockholders' equity (deficit), and of cash flows present
fairly, in all material respects, the financial position of SmarterKids.com,
Inc. at September 30, 1999, December 31, 1998 and December 31, 1997 and the
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1998 and for the nine months ended September 30,
1999, in conformity with generally accepted accounting principles. 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 of these statements in accordance with
generally accepted auditing standards, which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
Boston, Massachusetts
October 20, 1999, except for the
information contained in the
second paragraph of Note 8 for
which the date is November 22, 1999
F-2
<PAGE>
SMARTERKIDS.COM, INC.
BALANCE SHEET
(In thousands, except share data)
<TABLE>
<CAPTION>
December 31, Pro Forma
---------------- September 30, September 30,
1997 1998 1999 1999
------- ------- ------------- -------------
(unaudited)
ASSETS (Note 2)
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents...... $ 293 $ 4,273 $ 13,361 $ 13,361
Short-term investments......... -- -- 5,000 5,000
Accounts receivable, net of
allowance for doubtful
accounts of $28, $27 and $27
at December 31, 1997 and 1998
and September 30, 1999,
respectively.................. 567 915 207 207
Other receivables.............. -- -- 263 263
Inventories.................... 154 104 -- --
Other current assets........... 28 153 2,882 2,882
------- ------- -------- --------
Total current assets......... 1,042 5,445 21,713 21,713
Property and equipment, net...... 77 44 1,184 1,184
Intangible assets, net........... -- -- 490 490
Restricted cash.................. -- -- 500 500
Other assets..................... 26 15 9 9
------- ------- -------- --------
Total assets................. $ 1,145 $ 5,504 $ 23,896 $ 23,896
======= ======= ======== ========
LIABILITIES, REDEEMABLE STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of long-term
debt.......................... $ 30 $ -- $ -- $ --
Current portion of capital
lease obligations............. 44 41 75 75
Accounts payable............... 312 833 5,019 5,019
Accrued expenses............... 305 787 1,930 1,930
Sales returns allowances....... 241 718 332 332
------- ------- -------- --------
Total current liabilities.... 932 2,379 7,356 7,356
Capital lease obligations, net of
current portion................. 41 -- 55 55
------- ------- -------- --------
Total liabilities............ 973 2,379 7,411 7,411
------- ------- -------- --------
Commitments and contingencies
(Note 14)....................... -- -- -- --
Redeemable stock:
Series C redeemable convertible
preferred stock, $0.01 par
value; 4,397,118 shares
authorized; 4,284,091 shares
issued and outstanding at
September 30, 1999; no shares
authorized, issued and
outstanding at September 30,
1999 on a pro forma basis
(unaudited) (liquidation
preference of $26,857 at
September 30, 1999)........... -- -- 24,864 --
Series B redeemable convertible
preferred stock, $0.01 par
value; 3,518 shares
authorized; 380, 3,518 and
3,518 shares issued and
outstanding at December 31,
1997 and 1998 and September
30, 1999, respectively; no
shares authorized, issued and
outstanding at September 30,
1999 on a pro forma basis
(unaudited)................... 760 7,036 7,036 --
Series A convertible preferred
stock, $0.01 par value; 687
shares authorized, issued and
outstanding at December 31,
1997 and 1998 and September
30, 1999, respectively; no
shares authorized, issued and
outstanding at September 30,
1999 on a pro forma basis
(unaudited)................... 3,251 3,251 3,251 --
Redeemable common stock ....... -- -- 340 --
------- ------- -------- --------
Total redeemable stock......... 4,011 10,287 35,491 --
------- ------- -------- --------
Stockholders' equity (deficit):
Common stock, $0.01 par value;
90,000,000 shares authorized;
1,502,750, 1,628,510,
2,131,787 and 14,864,674
shares issued and outstanding
at December 31, 1997 and 1998,
September 30, 1999 and
September 30, 1999 on a pro
forma basis (unaudited),
respectively.................. 15 16 21 148
Additional paid-in capital..... 881 2,530 8,572 43,936
Deferred stock compensation.... (58) (1,435) (5,065) (5,065)
Accumulated deficit............ (4,677) (8,273) (22,534) (22,534)
------- ------- -------- --------
Total stockholders' equity
(deficit)................... (3,839) (7,162) (19,006) 16,485
------- ------- -------- --------
Total liabilities, redeemable
stock and stockholders'
equity (deficit)............ $ 1,145 $ 5,504 $ 23,896 $ 23,896
======= ======= ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
SMARTERKIDS.COM, INC.
STATEMENT OF OPERATIONS
(In thousands, except per share and share data)
<TABLE>
<CAPTION>
Year Ended Nine Months Ended
December 31, September 30,
------------------------------- -----------------------
1996 1997 1998 1998 1999
--------- --------- --------- ----------- -----------
(unaudited)
<S> <C> <C> <C> <C> <C>
Net revenues:
Online retail......... $ -- $ -- $ 22 $ -- $ 1,108
Proprietary CD-ROM.... 1,240 1,416 2,278 1,815 --
--------- --------- --------- --------- -----------
Total net revenues.. 1,240 1,416 2,300 1,815 1,108
--------- --------- --------- --------- -----------
Cost of revenues:
Online retail......... -- -- 20 -- 795
Proprietary CD-ROM.... 407 491 908 620 --
--------- --------- --------- --------- -----------
Total cost of
revenues........... 407 491 928 620 795
--------- --------- --------- --------- -----------
Gross profit............ 833 925 1,372 1,195 313
--------- --------- --------- --------- -----------
Operating expenses:
Marketing and sales .. 1,033 756 2,678 1,411 10,726
Development........... 887 721 1,378 832 1,149
General and
administrative....... 611 430 490 330 1,091
Stock compensation.... 2 15 187 72 1,789
--------- --------- --------- --------- -----------
Total operating
expenses........... 2,533 1,922 4,733 2,645 14,755
--------- --------- --------- --------- -----------
Loss from operations.... (1,700) (997) (3,361) (1,450) (14,442)
Interest income......... 48 3 41 9 316
Interest expense........ (10) (15) (18) (16) (8)
Other income (expense).. 13 (5) (4) (4) (8)
--------- --------- --------- --------- -----------
Net loss................ (1,649) (1,014) (3,342) (1,461) (14,142)
Accretion of redeemable
preferred stock........ -- (67) (254) (65) (119)
--------- --------- --------- --------- -----------
Net loss attributable to
common stockholders.... $ (1,649) $ (1,081) $ (3,596) $ (1,526) $ (14,261)
========= ========= ========= ========= ===========
Basic and diluted net
loss per common share.. $ (1.10) $ (0.72) $ (2.34) $ (1.01) $ (8.10)
Weighted average shares
used in computing basic
and diluted net loss
per common share....... 1,500,606 1,502,148 1,533,524 1,508,665 1,760,106
Unaudited pro forma
basic and diluted net
loss per common share.. $ (0.43) $ (0.98)
Weighted average shares
used in computing
unaudited pro forma
basic and diluted net
loss per common share.. 7,840,274 14,492,992
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
SMARTERKIDS.COM, INC.
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(In thousands, except share data)
<TABLE>
<CAPTION>
Total
Common Stock Additional Deferred Stockholders'
---------------- Paid-In Stock Accumulated Equity
Shares Amount Capital Compensation Deficit (Deficit)
--------- ------ ---------- ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1995................... 1,500,000 $15 $ 788 $ -- $ (1,947) $ (1,144)
Issuance of common
stock pursuant to
exercise of stock
options............... 1,875 -- --
Issuance of stock
options to
consultants........... 2 2
Net loss............... (1,649) (1,649)
--------- --- ------ ------- -------- --------
Balance at December 31,
1996................... 1,501,875 15 790 -- (3,596) (2,791)
Issuance of common
stock pursuant to
exercise of stock
options............... 875 -- -- --
Accretion of redeemable
preferred stock
related to issuance
costs................. 18 (67) (49)
Issuance of stock
options to
consultants........... 11 11
Deferred stock
compensation related
to employee stock
option grants......... 62 (62) --
Amortization of
deferred stock
compensation.......... 4 4
Net loss............... (1,014) (1,014)
--------- --- ------ ------- -------- --------
Balance at December 31,
1997................... 1,502,750 15 881 (58) (4,677) (3,839)
Issuance of common
stock pursuant to
exercise of stock
options............... 125,760 1 9 10
Accretion of redeemable
preferred stock
related to issuance
costs................. 69 (254) (185)
Issuance of warrants
for amendment of debt
agreement............. 7 7
Issuance and
revaluation of stock
options and warrants
to consultants........ 106 106
Deferred stock
compensation related
to employee stock
option grants......... 1,458 (1,458) --
Amortization of
deferred stock
compensation.......... 81 81
Net loss............... (3,342) (3,342)
--------- --- ------ ------- -------- --------
Balance at December 31,
1998................... 1,628,510 16 2,530 (1,435) (8,273) (7,162)
Issuance of common
stock pursuant to
exercise of stock
options............... 477,777 5 108 113
Issuance of common
stock to acquire
intangible assets .... 25,500 -- --
Issuance of warrants in
connection with
issuance of Series C
preferred stock ...... 515 515
Accretion of redeemable
preferred stock
related to issuance
costs................. (119) (119)
Issuance and
revaluation of stock
options and warrants
to consultants........ 3,507 (2,274) 1,233
Deferred stock
compensation related
to employee stock
option grants......... 1,912 (1,912) --
Amortization of
deferred stock
compensation.......... 556 556
Net loss............... (14,142) (14,142)
--------- --- ------ ------- -------- --------
Balance at September 30,
1999................... 2,131,787 $21 $8,572 $(5,065) $(22,534) $(19,006)
========= === ====== ======= ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
SMARTERKIDS.COM, INC.
STATEMENT OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Year Ended Nine Months Ended
December 31, September 30,
------------------------- --------------------
1996 1997 1998 1998 1999
------- ------- ------- ----------- --------
(unaudited)
<S> <C> <C> <C> <C> <C>
Increase (Decrease) in Cash
Cash flows from operating
activities:
Net loss..................... $(1,649) $(1,014) $(3,342) $(1,461) $(14,142)
Adjustments to reconcile net
loss to net cash used in
operating activities:
Depreciation and
amortization................ 71 60 66 51 49
Compensation expense related
to stock option and warrant
grants...................... 2 15 187 72 1,789
Debt issue costs............. -- -- 7 7 --
Changes in assets and
liabilities:
Accounts receivable.......... (315) (22) (348) (192) 708
Other receivable............. -- -- -- -- (263)
Inventories.................. (90) (1) 50 41 104
Other current assets......... (13) (14) (125) (64) (2,729)
Other assets................. 12 (17) 11 (73) 6
Accounts payable............. 140 (16) 521 83 4,186
Accrued expenses............. 93 54 482 182 1,143
Sales returns allowances..... (62) 8 477 298 (386)
------- ------- ------- ------- --------
Net cash used in operating
activities.................. (1,811) (947) (2,014) (1,056) (9,535)
------- ------- ------- ------- --------
Cash flows from investing
activities:
Short-term investments....... -- -- -- -- (5,000)
Purchases of property and
equipment................... (63) (18) (33) (15) (1,041)
Purchase of intangible
assets...................... -- -- -- -- (150)
(Deposit) release of
restricted cash............. (199) 199 -- -- (500)
------- ------- ------- ------- --------
Net cash provided by (used
in) investing activities.... (262) 181 (33) (15) (6,691)
------- ------- ------- ------- --------
Cash flows from financing
activities:
Proceeds from sale-leaseback
of property and equipment... -- 112 -- -- --
Repayments of long-term debt
and capital lease
obligations................. (5) (196) (74) (59) (59)
Proceeds from issuance of
Series C redeemable
preferred stock, net of
issuance costs.............. -- -- -- -- 25,260
Proceeds from issuance of
Series B redeemable
preferred stock, net of
issuance costs.............. -- 710 6,091 1,211 --
Proceeds from exercise of
common stock options........ -- -- 10 6 113
Proceeds from long-term
debt........................ 204 -- -- -- --
------- ------- ------- ------- --------
Net cash provided by
financing activities........ 199 626 6,027 1,158 25,314
------- ------- ------- ------- --------
Net increase (decrease) in
cash and cash equivalents... (1,874) (140) 3,980 87 9,088
Cash and cash equivalents at
beginning of period......... 2,307 433 293 293 4,273
------- ------- ------- ------- --------
Cash and cash equivalents at
end of period............... $ 433 $ 293 $ 4,273 $ 380 $ 13,361
======= ======= ======= ======= ========
Supplemental disclosure of
cash flow information:
Cash paid during the year for
interest.................... $ 11 $ 15 $ 11 $ 7 $ 8
Supplemental disclosure of
noncash investing and
financing activities:
Capital lease obligations
incurred for property and
equipment................... $ -- $ 112 $ -- $ -- $ 148
Issuance of warrants to
purchase common stock in
exchange for services
related to Series B
redeemable preferred stock
offering.................... -- $ 18 $ 69 -- --
Issuance of common stock in
exchange for purchase of
intangible assets........... -- -- -- -- $ 340
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS
1. Formation and Operations of the Company:
SmarterKids.com, Inc. (the "Company") is an online retailer focused on
children's educational books, toys and games, and software. Prior to 1999, the
Company was engaged in developing, marketing and selling proprietary
educational and entertainment software. The Company primarily sold its products
to national distributors and its principal market was the domestic consumer
market. In March 1998, the Company commenced development of the SmarterKids.com
website. In November 1998, the Company began transitioning its business model
to online sales of third-party educational products. In November 1998, the
Company launched its website, ceased the sale of proprietary CD-ROM products
through traditional retail channels, and now offers its proprietary CD-ROM
products on a limited basis through the online channel. The Company was
incorporated in Delaware on March 28, 1994 and changed its name to Virtual
Knowledge, Inc. effective August 4, 1997. Effective September 1998, the Company
changed its name to SmarterKids.com, Inc.
2. Summary of Significant Accounting Policies:
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. The Company
invested its excess cash primarily in money market funds at major financial
institutions and fixed income notes secured by U.S. Government-backed
securities in 1997, 1998 and the nine months ended September 30, 1999. These
investments are subject to minimal credit and market risks. At December 31,
1997 and 1998 and September 30, 1999, the Company classified its cash
equivalent investments, totaling $201,000, $4,251,000 and $12,738,000,
respectively, as available for sale. The carrying amount in the financial
statements approximates fair value because of the short maturity and holding
period of these instruments. The Company's short-term investments consisted
primarily of fixed income notes secured by U.S. Government-backed securities
with maturities of 123 days.
Financial Instruments
The Company's financial instruments consist of cash and cash equivalents,
short-term investments, accounts receivable, accounts payable, long-term debt
and capital lease obligations. The carrying amounts of these instruments at
December 31, 1997 and 1998 and September 30, 1999 approximate their fair
values.
Inventories
Inventories of proprietary CD-ROM products are stated at the lower of cost
or market, cost being determined on a first-in, first-out basis. All inventory
consists of finished goods.
Property and Equipment
Property and equipment assets are recorded at cost and depreciated using the
straight-line method over their estimated useful lives, generally three years.
Intangible Assets
Costs incurred for acquiring trademarks and domain names are capitalized as
intangible assets and amortized over their estimated useful lives, generally 2
years, using the straight-line method.
The Company evaluates the recoverability of its property and equipment and
intangible assets in accordance with Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets to be
Disposed of" ("SFAS 121"). SFAS 121 requires recognition of impairment of long-
lived assets in the event the net book value of such assets exceeds the
estimated future undiscounted cash flows attributable to such assets or the
business to which such intangible assets relate. No impairments were required
to be recognized during the years ended December 31, 1996, 1997 and 1998 or the
nine months ended September 30, 1999.
F-7
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Concentrations of Credit Risk and Significant Customers
At December 31, 1997 and 1998, accounts receivable from the Company's three
largest customers, all of which are distributors of the Company's proprietary
CD-ROM products, accounted for 80% and 96%, respectively, of total amounts due
to the Company. At September 30, 1999, accounts receivable from two customers,
both of which are distributors of the Company's proprietary CD-ROM products,
accounted for 41% of total amounts due to the Company. Management believes its
credit policies are prudent and reflect normal industry terms and business
risk. The Company does not anticipate non-performance by the counterparties
and, accordingly, does not require collateral.
Sales to three customers accounted for 34%, 30% and 21% of the Company's
total net revenue in 1996. Sales to four customers accounted for 16%, 14%, 16%
and 25% of the Company's total net revenue in 1997. Sales to two customers
accounted for 40% and 35% of the Company's total net revenue in 1998. No
customers accounted for more than 10% of the Company's total net revenue during
the nine months ended September 30, 1999.
Concentrations of Vendor and Distributor Risk
The Company outsourced manufacturing of its proprietary CD-ROM products to
two vendors. As of December 31, 1998 and September 30, 1999, the Company had
only limited product manufacturing. Also, the Company outsources distribution
of its products to one vendor. Although this creates a concentration in sources
of supply and distribution, management believes that other distributors are
available to provide similar products and services on comparable terms. A
failure of or change in the Company's distributor, however, could cause a delay
in the fulfillment of orders and a possible loss of sales, which would
adversely affect operating results.
Revenue Recognition
The Company recognizes revenue from product sales, net of any discounts and
allowances made for estimated product returns, when the products are shipped to
customers, provided that no significant Company obligations remain and
collection of the receivable is probable. Outbound shipping and handling
charges billed to customers are included in net revenues.
Cost of Revenues
Cost of revenues consist of the cost of merchandise sold to customers and
the Company's shipping costs.
Marketing and Sales Expenses
Marketing and sales expenses consist primarily of advertising and
promotional expenditures, as well as payroll and related costs for personnel
engaged in marketing and sales. Fulfillment costs related to online retail
products, including the outsourced cost of operating and staffing distribution
centers and customer service, are also included in marketing and sales
expenses. Advertising costs are charged to operations as incurred. Advertising
expenses for 1996, 1997 and 1998 and the nine months ended September 30, 1999
were $406,000, $276,000, $1,154,000 and $7,388,000, respectively.
Development Expenses
Costs incurred in the development of the Company's proprietary CD-ROM
products through the establishment of technological feasibility, as defined by
Statement of Financial Accounting Standards No. 86, "Accounting for the Costs
of Computer Software to be Sold, Leased, or Otherwise Marketed," are expensed
as incurred. Development costs incurred thereafter and until the products are
first available for release have not been material and, therefore, have not
been capitalized. Development expenses also includes payroll and related costs
for personnel engaged in website design, development and testing.
F-8
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
General and Administrative Expenses
General and administrative expenses consist of payroll and related costs for
executive and administrative personnel, as well as costs for professional fees
and other general corporate expenses.
Stock Compensation
Stock options issued to employees and members of the Company's Board of
Directors are accounted for in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and
related interpretations; accordingly, compensation expense is recorded for
options awarded to employees and directors to the extent that the exercise
prices are less than the common stock's fair market value on the date of grant,
where the number of options and exercise price are fixed. The difference
between the fair value of the Company's common stock and the exercise price of
the stock option is recorded as deferred stock compensation. Deferred stock
compensation is amortized to compensation expense over the vesting period of
the underlying stock option. The Company follows the disclosure requirements of
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-
Based Compensation" ("SFAS 123") (Note 9). All stock-based awards to non-
employees are accounted for at their fair value in accordance with SFAS 123.
Net loss per common share -- Historical
The Company computes net loss per common share in accordance with SFAS No.
128, "Earnings Per Share," ("SFAS 128") and SEC Staff Accounting Bulletin No.
98 ("SAB 98"). Under the provisions of SFAS 128 and SAB 98, basic net loss per
common share is computed by dividing net loss attributable to common
stockholders by the weighted average number of common shares outstanding. The
calculation of diluted net loss per common share for the years ended December
31, 1996, 1997 and 1998 and the nine months ended September 30, 1999 does not
include 1,223,100, 1,547,351, 2,775,141 and 3,444,542 potential shares of
common stock equivalents, respectively, as their inclusion would be
antidilutive.
Net loss per common share -- Pro Forma (Unaudited)
Pro forma net loss per common share is calculated assuming the automatic
conversion of all preferred stock outstanding at December 31, 1998 and
September 30, 1999, which converts automatically into 6,306,750 and 12,732,887,
respectively, shares of common stock upon the completion of the Company's
initial public offering (Note 7). Therefore, accretion of redeemable preferred
stock is excluded from the calculation of pro forma net loss per common share.
The calculation of pro forma net loss per common share for the year ended
December 31, 1998 and the nine months ended September 30, 1999 does not include
2,631,591 and 3,116,451 potential shares of common stock equivalents,
respectively, as their inclusion would be antidilutive.
Unaudited Interim Financial Statements
The financial statements and related notes for the nine months ended
September 30, 1998 are unaudited. In the opinion of the Company's management,
the September 30, 1998 unaudited interim financial statements include all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of the financial position and results of operations for the
interim period.
Unaudited Pro Forma Balance Sheet
Under the terms of the Company's convertible preferred stock (Note 7), all
of such preferred stock will be converted automatically into shares of common
stock prior to the closing of an initial public offering of common stock with
an offering price of at least $10.00 per share and proceeds to the Company of
at least
F-9
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
$15,000,000, or upon the vote of the holders of a majority of the outstanding
shares of preferred stock. The unaudited pro forma balance sheet reflects the
conversion of each share of Series A and Series B preferred stock into 1,500
shares of common stock and each share of Series C preferred stock into 1.5
shares of common stock as if the conversions had occurred on September 30,
1999.
Segment Reporting
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 131, "Disclosures About Segments of an Enterprise and Related Information"
("SFAS 131"). This statement requires companies to report information about
operating segments consistent with management's internal view of the Company.
The Company adopted SFAS 131 effective for its fiscal year ended December 31,
1998. The Company operates in a single segment: retail domestic software and
other product sales. The Company has no organizational structure dictated by
product lines, geography or customer type.
Comprehensive Income
In June 1997, the FASB issued SFAS No. 130, "Comprehensive Income" ("SFAS
130"). SFAS 130 establishes standards for reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. Adoption of SFAS 130 did not impact the Company's
financial statements as the Company had no items of other comprehensive income
during the three year period ended December 31, 1998 or the nine months ended
September 30, 1998 and 1999.
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
disclosures of contingent liabilities at the period end, and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
Recent Accounting Pronouncements
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants ("AICPA") issued Statement of
Position No. 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 provides guidance regarding
when software developed or obtained for internal use should be capitalized. SOP
98-1 is effective for fiscal years beginning after December 15, 1998. The
adoption of SOP 98-1 in the nine months ended September 30, 1999 did not have a
material impact on the Company's financial position or results of operations.
In April 1998, the AICPA issued Statement of Position No. 98-5, "Reporting
on Costs of Start-up Activities" ("SOP 98-5"), which requires all costs
associated with pre-opening, pre-operating and organization activities to be
expensed as incurred. The adoption of SOP 98-5 in the nine months ended
September 30, 1999 did not have a material impact on the Company's financial
position or results of operations.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133").
SFAS 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives), and for hedging
activities. SFAS 133, as amended by SFAS 137, is effective for all fiscal
quarters of all fiscal years beginning after June 15, 2000, with earlier
application encouraged. The Company does not currently nor does it intend in
the foreseeable future to use derivative instruments and, therefore, does not
expect that adoption of SFAS 133 will have any impact on its financial position
or results of operations.
F-10
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
In December 1998, the AICPA issued Statement of Position No. 98-9,
"Modification of SOP No 97-2, Software Revenue Recognition, with Respect to
Certain Transactions" ("SOP 98-9"). SOP 98-9 amends SOP 97-2 to require
recognition of revenue using the "residual method" in circumstances outlined in
SOP 98-9. Under the residual method, revenue is recognized as follows: (1) the
total fair value of undelivered elements, as indicated by vendor specific
objective evidence, is deferred and subsequently recognized in accordance with
the relevant sections of SOP 97-2 and (2) the difference between the total
arrangement fee and the amount deferred for the undelivered elements is
recognized as revenue related to the delivered elements. SOP 98-9 is effective
for transactions entered into in fiscal years beginning after March 15, 1999.
Also, the provisions of SOP 97-2 that were deferred by SOP 98-4 will continue
to be deferred until the date SOP 98-9 becomes effective. The Company does not
expect that the adoption of SOP 98-9 will have a significant impact on the
Company's results of operations or financial position.
3.Allowances for Doubtful Accounts and Sales Returns:
Allowances for doubtful accounts and sales returns consist of the following
(in thousands):
<TABLE>
<CAPTION>
Nine Months
Year Ended December 31, Ended September 30,
------------------------- -------------------
1996 1997 1998 1999
------- ------- ------- ----
<S> <C> <C> <C> <C>
Balance at beginning of
year....................... $ 309 $ 262 $ 269 $ 745
Additions:
Charged against revenues
or expense............... 98 237 601 407
Deductions:
Write-offs and returns.... (145) (230) (125) (793)
------- ------- ------- -----
Balance at end of year...... $ 262 $ 269 $ 745 $ 359
======= ======= ======= =====
</TABLE>
4.Other Current Assets:
Other current assets consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31, September 30,
------------ -------------
1997 1998 1999
------------ ----
<S> <C> <C> <C>
Prepaid advertising.............................. $ -- $ 129 $ 2,685
Prepaid expenses................................. 28 24 64
Other............................................ -- -- 133
----- ------ -------
$ 28 $ 153 $ 2,882
===== ====== =======
</TABLE>
5.Property and Equipment:
Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31, September 30,
------------- -------------
1997 1998 1999
------ ------ ----
<S> <C> <C> <C>
Software....................................... $ 18 $ 28 $ 278
Furniture and fixtures......................... 1 5 38
Computer and office equipment.................. 214 233 1,127
Leasehold improvements......................... -- -- 12
------ ------ ------
233 266 1,455
Less--Accumulated depreciation and amortiza-
tion.......................................... 156 222 271
------ ------ ------
$ 77 $ 44 $1,184
====== ====== ======
</TABLE>
Furniture and fixtures and computer and office equipment includes $214,000
at December 31, 1997 and 1998 and $362,000 at September 30, 1999 related to
assets held under capital leases. Accumulated
F-11
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
depreciation related to assets held under these leases was $152,000, $214,000
and $246,000 at December 31, 1997 and 1998 and September 30, 1999,
respectively. Depreciation and amortization expense for the years ended
December 31, 1996, 1997 and 1998 and the nine months ended September 30, 1999
was $71,000, $60,000, $66,000 and $49,000, respectively.
6. Accrued Expenses:
Accrued expenses consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31, September 30,
------------- -------------
1997 1998 1999
------ ------ -------------
<S> <C> <C> <C>
Marketing........................................ $ 57 $ 268 $ 575
Commissions...................................... 63 94 74
Professional fees................................ 123 172 267
Advertising...................................... -- 159 880
Other............................................ 62 94 134
------ ------ ------
$ 305 $ 787 $1,930
====== ====== ======
</TABLE>
7. Preferred Stock:
In October 1995, the Company authorized 10,000 shares of preferred stock and
designated 687 preferred shares as Series A convertible preferred stock (the
"Series A preferred"). The Company sold 634 shares of Series A preferred to an
entity affiliated with a common stockholder and member of the Board of
Directors of the Company for net proceeds of $3,000,000. In addition, 53 shares
of Series A preferred were issued in connection with the conversion of a
$240,000 note payable, plus accrued interest of $11,000, due to the same common
stockholder.
In 1997, the Company designated and sold 380 shares of Series B redeemable
convertible preferred stock (the "Series B preferred") for net proceeds of
$710,000. Included in this offering, the Company sold 125 shares of the Series
B preferred for net proceeds of $234,000 to an entity with which the Company
subsequently entered a marketing and licensing agreement. The Company also
entered into a stock purchase agreement with this entity allowing for the
purchase of preferred stock having a conversion value of 250,000 common shares,
at the same terms as the Series B preferred. The option expired unexercised in
July 1998. As payment for certain costs associated with the issuance of the
Series B preferred, the Company issued warrants to purchase 66,000 shares of
common stock (Note 10).
In 1998, the Company issued an additional 3,138 shares of the Series B
preferred for net proceeds of $6,091,000. As payment for certain costs
associated with the issuance of the Series B preferred, the Company issued
warrants to purchase 55,050 shares of common stock (Note 10).
In July 1999, the Company designated and sold 4,284,091 shares of Series C
redeemable convertible preferred stock (the "Series C preferred") for net
proceeds of $25.3 million. As payment for certain costs associated with the
issuance of the Series C preferred, the Company issued warrants to purchase
113,027 shares of the Series C preferred (Note 10). The Series C preferred was
recorded upon issuance based on the net proceeds less the $515,000 value of the
warrants related to the issuance. The difference between the total net proceeds
at issuance and the total redemption value is being charged to accumulated
deficit over the period from issuance until redemption first becomes available.
The Series A, Series B and Series C preferred have the following
characteristics:
Voting
Holders of Series A, Series B and Series C preferred are entitled to the
number of votes equal to the number of common shares into which the shares of
preferred stock are convertible.
F-12
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Dividends
Holders of Series A, Series B and Series C preferred are entitled to receive
dividends when and if declared by the Board of Directors.
Liquidation Preference
In the event of any liquidation, dissolution or winding-up of the affairs of
the Company, (including via merger or acquisition) the holders of Series A,
Series B and Series C preferred are entitled to receive, on a pro rata basis,
prior to and in preference to holders of common stock, an amount equal to the
greater of (i) $4,732, $2,000 and $6.27 per share, respectively, plus any
declared but unpaid dividends or (ii) such amount per share as would have been
payable had each preferred share been converted to common stock immediately
prior to such liquidation, dissolution or winding-up. Because this preference
applies to mergers and acquisitions, the Company has classified its Series A
preferred as redeemable preferred stock on its balance sheet.
Conversion
Each Series A and Series B preferred share may be converted at any time, at
the option of the stockholder, into 1,500 shares of common stock, subject to
certain anti-dilution adjustments. Each Series C preferred share may be
converted at any time, at the option of the stockholder, into 1.5 shares of
common stock, subject to certain anti-dilution adjustments.
Each Series A and Series B preferred share is automatically converted into
1,500 shares of common stock and each Series C preferred share is automatically
converted into 1.5 shares of common stock upon the closing of an initial public
offering in which proceeds to the Company equal or exceed $15,000,000 and in
which the price to the public is at least $10.00 per common share.
Redemption
The Series B and Series C preferred is redeemable on or after October 31,
2003 over a three-year period at the option of the holders at redemption prices
of $2,000 and $6.27 per share, respectively, plus any declared but unpaid
dividends. Redemption amounts for Series B and Series C preferred stock,
excluding any declared but unpaid dividends, are as follows:
<TABLE>
<CAPTION>
Series B Series C
Cumulative Redemption Redemption
Year Percentage Amount Amount
---- ---------- ---------- --------------
(in thousands)
<S> <C> <C> <C>
2003.................................... 33% $2,343 $ 8,951
2004.................................... 50% 1,175 4,477
2005.................................... 100% 3,518 13,429
------ -------
$7,036 $26,857
====== =======
</TABLE>
8. Common Stock:
As of September 30, 1999, the Company had reserved 18,561,691 shares of
common stock for issuance upon conversion of the Series A, Series B and Series
C preferred stock (Note 7) and upon exercise of warrants (Note 10) and common
stock options (Note 11).
F-13
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
On September 7, 1999, the Board of Directors authorized a 3-for-2 stock
split of the Company's common stock, to be effective upon the filing of the
Company's Amended and Restated Certificate of Incorporation in connection with
the Company's initial public offering of common stock. As a result, all common
stock share data included in the accompanying financial statements and notes
have been retroactively restated for this split.
9. Redeemable Common Stock:
In connection with the acquisition of intangible assets in September 1999,
the Company issued 25,500 shares of its common stock. In the event that the
Company does not complete an initial public offering on or before August 31,
2000, the holders of this common stock may require the Company to buy back the
common stock at a price of $13.33 per share. In the event that the Company does
not complete an initial public offering on or before August 31, 2000, the
Company may require the stockholders to sell the common stock to the Company at
a price of $13.33 per share. The aggregate carrying value of the redeemable
common stock reflects the fair value of the common stock on the date of
issuance, as well as the redemption value.
10. Warrants:
In 1997 and 1998, in connection with issuance of the Series B preferred
(Note 7), the Company issued warrants to purchase a total of 66,000 and 55,050
shares, respectively, of the Company's common stock with an exercise price of
$0.13 per share. These warrants were exercisable immediately and expire at the
earlier of a change in control of the Company, completion of an initial public
offering, or five years from the date of grant. The fair values ascribed to
these warrants at the time of issuance were estimated by management to be
$18,000 and $69,000 for 1997 and 1998, respectively. The values of these
warrants were recorded as an increase to accumulated deficit and an increase to
additional paid-in capital.
In March 1998, in connection with an amended debt agreement, the Company
granted warrants to purchase 5 shares of Series B preferred with an exercise
price of $2,000 per share. These warrants were exercisable immediately and
expire in five years. The fair value ascribed to these warrants was $7,000 and
was recorded as interest expense in 1998. Upon completion of an initial public
offering, there warrants will convert into warrants to purchase 7,500 shares of
common stock at an exercise price of $1.33 per share.
In September 1998, in connection with a warehousing and fulfillment services
agreement, the Company issued warrants to its distribution partner to purchase
57,000 shares of the Company's common stock with an exercise price of $1.33 per
share. Of these warrants, 15,000 shares vested immediately. Warrants for an
additional 42,000 shares vested in increments of 10,500 every six months,
commencing on March 1, 1999. These warrants expire in five years and were
remeasured at each reporting period until they vested. The fair value ascribed
to these warrants initially was $51,000 which was recorded as compensation
expense in 1998. In September 1999, in connection with amending and further
formalizing the warehouse and fulfillment services agreement, the Company
granted additional warrants to purchase 108,000 shares of the Company's common
stock with an exercise price of $1.33 per share. These warrants expire in five
years and were exercisable immediately. Also, the previously granted warrants
for 57,000 shares were amended to be fully exercisable immediately.
Accordingly, the fair market value of these previously unvested warrants was
determined final upon the amendment. The fair value of the newly issued
warrants was determined final when granted. As of September 30, 1999, deferred
stock compensation related to all of the warrants held by the fulfillment
service provider was $1,448,000, which will be amortized to compensation
expense over the term of the agreement as the services are performed.
Amortization of $60,000 was recorded during the nine months ended September 30,
1999.
F-14
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
In December 1998, in connection with a management consulting services
agreement, the Company granted warrants to a consultant to purchase 22,500
shares of the Company's common stock with an exercise price of $1.33 per share.
These warrants were exercisable immediately and expire at the earlier of a
change in control of the Company, completion of an initial public offering, or
five years from the date of grant. The fair value ascribed to these warrants at
the time of issuance was $22,000 and was recorded as compensation expense in
1998 as this was the period in which the services were provided.
In March 1999, in connection with a promotional services program, the
Company issued warrants to an affiliated party to purchase 112,500 shares of
the Company's common stock with an exercise price of $1.33 per share. These
warrants vest upon the attainment of certain performance targets and expire in
five years. The final value of these warrants will be determined upon the
attainment of these performance targets based on their then-current fair value.
At September 30, 1999, the fair value of this grant was $1,126,000. Related
compensation expense of $788,000 was recorded in the nine months ended
September 30, 1999. The remaining deferred stock compensation is to be
recognized over the period that the services are provided.
In July 1999, in connection with the issuance of the Series C redeemable
convertible preferred stock (Note 7), the Company issued warrants to purchase
113,027 shares of the Company's Series C preferred stock at an exercise price
of $6.27 per share. These warrants are convertible into warrants to purchase
shares of the Company's common stock based on an exchange ratio of 1.5 shares
of common stock for each share of Series C preferred. These warrants were
exercisable immediately and expire at the earlier of a change in control of the
Company, completion of an initial public offering, or four years from the date
of grant. The value ascribed to these warrants was $515,000 based on the fair
value on the date of issuance and was recorded on the date of issuance. The
value ascribed to these warrants was recorded as a discount to the Series C
preferred stock, which will be accreted to the Series C preferred stock balance
over the period from the date of issuance through the mandatory redemption
date.
In September 1999, in connection with a management consulting services
agreement, the Company granted warrants to a consultant to purchase 15,000
shares of the Company's common stock with an exercise price of $1.33 per share.
These warrants were exercisable immediately and expire at the earlier of a
change in control of the Company, completion of an initial public offering, or
five years from the date of grant. The fair value ascribed to these warrants at
the time of issuance was $213,000 and was recorded as compensation expense in
the nine months ended September 30, 1999 as this was the period in which the
services were provided.
F-15
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
A summary of the status of stock warrant activity as of December 31, 1996,
1997 and 1998 and September 30, 1999 and changes in the periods then ended is
presented below:
<TABLE>
<CAPTION>
Weighted-
Number of Average
Shares Exercise Price
--------- --------------
<S> <C> <C>
Outstanding--December 31, 1995..................... -- --
Granted (weighted average fair value of $0.00)... -- --
Exercised........................................ -- --
Forfeited........................................ -- --
-------
Outstanding--December 31, 1996..................... -- --
Granted (weighted average fair value of $0.28)... 66,000 $0.13
Exercised........................................ -- --
Forfeited........................................ -- --
-------
Outstanding--December 31, 1997..................... 66,000 0.13
Granted (weighted average fair value of $0.97)... 142,050 0.87
Exercised........................................ -- --
Forfeited........................................ -- --
-------
Outstanding--December 31, 1998..................... 208,050 0.64
Granted (weighted average fair value of $3.14)... 405,041 2.52
Exercised........................................ -- --
Forfeited........................................ -- --
-------
Outstanding--September 30, 1999.................... 613,091 $1.88
=======
</TABLE>
The fair value of each warrant was estimated on the applicable measurement
dates using the Black-Scholes option pricing model with the following
assumptions for the three years ended December 31, 1998 and the nine months
ended September 30, 1999: 0% dividend yield, 90% volatility, risk-free interest
rates of 6.2%, 6.1%, 5.0% and 4.9% for 1996, 1997, 1998 and 1999, respectively;
and an expected term of five years.
11. Stock Option Plan:
In 1995, the Company adopted the 1995 Stock Plan (the "Plan"). The Plan
provides for issuance of incentive stock options to employees of the Company
and nonqualified stock options, awards of stock, and direct stock purchase
opportunities to directors, officers, employees and consultants of the Company.
The Board of Directors determines the term of each option, option price, number
of shares for which each option is granted and the rate at which each option is
exercisable. The total number of shares which may be issued under the Plan is
3,822,000. For holders of 10% or more of the Company's outstanding common
stock, options may not be granted at less than 110% of the fair market value of
the common stock at the date of grant and the option term may not exceed five
years. The option term for nonqualified stock options may not exceed ten years
from the date of grant.
1999 Stock Option and Incentive Plan
In September 1999, the Board of Directors voted to terminate the 1995 Stock
Option Plan effective on the consummation of the current initial public
offering and approved the adoption of the 1999 Stock Option and Incentive Plan
(the "1999 Plan"). The 1999 Plan provides for the grant of stock-based awards
to employees, officers and directors, and consultants or advisors, including
incentive stock options and non-qualified stock options and other equity-based
awards. A total of 2,000,000 shares of common stock may be issued upon the
exercise of options or other awards granted under the 1999 Plan. As of
September 30, 1999, no stock options were granted under the 1999 Plan.
F-16
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
1999 Non-Employee Director Stock Option Plan
The 1999 Non-Employee Director Stock Option Plan (the "Director Plan") was
adopted by the Board of Directors and approved by stockholders in September
1999 and will take effect upon completion of the current initial public
offering. The Director Plan provides for the grant of options to purchase a
maximum of 200,000 shares of common stock of the Company to non-employee
directors of the Company. The Director Plan will be administered by a committee
appointed by the Board of Directors. Under the Director Plan, each director who
is not an employee or officer of the Company and who is not a director at the
time of the current initial public offering shall be automatically granted on
the date such person is first elected to the Board of Directors an option to
purchase 45,000 shares of common stock. Each time a non-employee director is
re-elected to the Board, such non-employee director will automatically receive
an option to purchase 2,000 shares of common stock. Provided that the director
continues to serve as a member of the Board of Directors, one-third of the
shares included in each grant will become exercisable on each of the first,
second and third anniversaries of the date of grant. All options granted under
the Director Plan will have an exercise price equal to the fair market value of
the common stock on the date of grant. As of September 30, 1999, no options
have been granted under the Director Plan.
1999 Employee Stock Purchase Plan
The 1999 Employee Stock Purchase Plan (the "Stock Purchase Plan") was
adopted by the Board of Directors and approved by stockholders in September
1999 and will take effect upon completion of the current initial public
offering. The Stock Purchase Plan provides for the issuance of a maximum of
400,000 shares of common stock. The Stock Purchase Plan is administered by the
Board of Directors and the Compensation Committee. All employees whose
customary employment is for more than 20 hours per week and for more than three
months in any calendar year and who have completed more than 90 days of
employment on or before the first day of any six-month payment period are
eligible to participate in the Stock Purchase Plan. Outside directors and
employees who would own 5% or more of the total combined voting power or value
of the Company's common stock immediately after the grant may not participate
in the Stock Purchase Plan. As of September 30, 1999, no stock has been issued
under the Stock Purchase Plan.
The Company recorded deferred stock compensation of $62,000, $1,458,000 and
$1,912,000 in 1997, 1998 and the nine months ended September 30, 1999,
respectively, related to employee stock option grants. The Company recognized
$4,000, $81,000 and $556,000 in non-cash stock compensation expense related to
amortization of deferred stock compensation on employee stock option grants
during 1997, 1998 and the nine months ended September 30, 1999, respectively.
During 1996, 1997, 1998 and the nine months ended September 30, 1999, the
Company granted nonqualified stock options under the Plan to non-employees, for
services performed, to purchase 189,000, 30,000, 5,250 and 44,250 shares of
common stock, respectively. Accordingly, the Company recorded stock
compensation expense of $2,000, $11,000, $33,000 and $172,000 in 1996, 1997,
1998 and the nine months ended September 30, 1999, respectively. Such amounts
were determined under the Black-Scholes model based on the fair value of the
options granted, including adjustments for revaluation at each period-end for
unvested options.
F-17
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
A summary of the status of the Plan as of December 31, 1996, 1997 and 1998
and September 30, 1999 and changes for the periods then ended is presented
below:
<TABLE>
<CAPTION>
Weighted-
Average
Number of Exercise
Shares Price
--------- ---------
<S> <C> <C>
Outstanding--December 31, 1995.......................... 986,100 $0.43
Granted (weighted average fair value of $0.02)........ 464,250 0.09
Exercised............................................. (1,875) 0.03
Forfeited............................................. (225,375) 0.06
---------
Outstanding--December 31, 1996.......................... 1,223,100 0.37
Granted (weighted average fair value of $0.15)........ 562,500 0.13
Exercised............................................. (875) 0.10
Forfeited............................................. (303,375) 1.35
---------
Outstanding--December 31, 1997.......................... 1,481,350 0.07
Granted (weighted average fair value of $1.22)........ 1,238,251 0.14
Exercised............................................. (125,760) 0.08
Forfeited............................................. (26,750) 0.13
---------
Outstanding--December 31, 1998.......................... 2,567,091 0.07
Granted (weighted average fair value of $2.76)........ 764,700 0.93
Exercised............................................. (477,777) 0.24
Forfeited............................................. (22,563) 0.12
---------
Outstanding--September 30, 1999......................... 2,831,451 $0.30
=========
</TABLE>
The following table summarizes information about stock options outstanding
at September 30, 1999:
<TABLE>
<CAPTION>
Weighted-
Average
Remaining
Contractual Number
Number Life of Shares
Exercise Price of Shares (years) Exercisable
-------------- --------- ----------- -----------
<S> <C> <C> <C>
$0.02 315,000 5.9 315,000
$0.06-$0.13 1,823,001 8.7 330,927
$0.15-$0.33 546,000 9.1 6,000
$1.33-$4.18 141,900 9.9 --
$11.00 5,550 10.00 --
--------- -------
2,831,451 651,927
========= =======
</TABLE>
In March 1997, the Company's Board of Directors determined that because
certain options held by an employee of the Company had an exercise price
significantly higher than the fair value of the Company's common stock, such
options were not providing the incentive intended. Accordingly, options to
purchase 201,000 shares of common stock with an exercise price of $2.00 per
share were cancelled and reissued at a price of $0.13 per share. The exercise
price of the reissued options equaled the fair market value of the Company's
common stock on the date of repricing.
F-18
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Stock compensation expense has been recognized for options granted under the
Plan pursuant to APB 25. Had stock compensation cost been determined based on
the fair value of the options at the grant date consistent with the provisions
of SFAS 123, the Company's net loss attributable to common stockholders would
have been increased to the pro forma amounts indicated below. Because options
vest over several years and additional option grants are expected to be made in
future years, the pro forma results for 1996, 1997, 1998 and for the nine
months ended September 30, 1999 are not representative of pro forma results for
future years.
<TABLE>
<CAPTION>
Nine Months
Ended
Year Ended December 31, September 30,
------------------------- -------------
1996 1997 1998 1999
------- ------- ------- -------------
(in thousands)
<S> <C> <C> <C> <C>
Net loss attributable to common
stockholders:
As reported.................... $(1,649) $(1,081) $(3,596) $(14,261)
Pro forma...................... (1,654) (1,086) (3,621) (14,264)
Net loss per common share:
As reported.................... $ (1.10) $ (0.72) $ (2.34) $ (8.10)
Pro forma...................... (1.10) (0.72) (2.63) (8.10)
</TABLE>
The fair value of each option grant was estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions for
grants in 1996, 1997, 1998 and the nine months ended September 30, 1999: no
dividend yield; no volatility; risk-free interest rates of 6.2%, 6.1%, 5.0% and
4.9% respectively, and expected option terms of five years.
12. Income Taxes:
Deferred tax assets consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31, September 30,
-------------- -------------
1997 1998 1999
------ ------ -------------
<S> <C> <C> <C>
Net operating loss carryforwards............. $1,229 $2,261 $7,236
Research and development credit
carryforwards............................... 55 90 90
Stock compensation expense................... 6 81 802
Other........................................ 166 404 400
------ ------ ------
Deferred tax assets......................... 1,456 2,836 8,528
Deferred tax asset valuation allowance....... (1,456) (2,836) (8,528)
------ ------ ------
$ -- $ -- $ --
====== ====== ======
</TABLE>
The Company has provided a valuation allowance for the full amount of the
net deferred tax asset at December 31, 1997 and 1998 and September 30, 1999
since the realization of these future benefits is not sufficiently assured. At
September 30, 1999, available net operating loss carryforwards for federal and
state tax purposes were $17,969,000, which expire through 2019. At September
30, 1999, the Company has research and development tax credit carryforwards of
approximately $60,000 and $45,000 available to reduce future federal and state
tax liabilities, respectively, which expire through 2018.
Under the provisions of the Internal Revenue Code, certain substantial
changes in the Company's ownership could result in an annual limitation of the
amount of net operating loss carryforwards and research and development credit
carryforwards which can be utilized in future years.
F-19
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Income taxes computed using the federal statutory income tax rate differ
from the Company's effective tax rate primarily due to the following (in
thousands):
<TABLE>
<CAPTION>
Year Ended Nine Months Ended
December 31, September 30,
--------------------- -----------------
1996 1997 1998 1999
----- ----- ------- -----------------
<S> <C> <C> <C> <C>
Income tax expense (benefit) at
US federal statutory tax rate... $(561) $(345) $(1,136) $(4,808)
State income taxes, net of
federal tax effect.............. (125) (59) (221) (886)
Permanent items.................. 19 1 1 2
Other............................ (20) 13 (24) --
Change in deferred tax asset
valuation allowance............. 687 390 1,380 5,692
----- ----- ------- -------
Provision for income taxes....... $ -- $ -- $ -- $ --
===== ===== ======= =======
</TABLE>
13. Defined Contribution Plan:
In January 1996, the Company adopted a defined contribution plan under
Section 401(k) of the Internal Revenue Code covering substantially all
employees. Under the plan, employees may contribute the lower of up to 15% of
their salaries or a dollar amount prescribed by the Internal Revenue Code. The
Board of Directors may elect to make a discretionary contribution to the plan.
The Company made no contributions during the years ended December 31, 1996,
1997 and 1998 and the nine months ended September 30, 1999.
14. Commitments and Contingencies:
Leases
The Company leases its facilities and certain computer equipment under
noncancelable operating leases. Rental expense under operating leases for the
years ended December 31, 1996, 1997 and 1998 and the nine months ended
September 30, 1999 was $101,000, $101,000, $121,000 and $168,000, respectively.
In April 1997, the Company entered into an agreement for the sale and capital
leaseback of substantially all of the Company's fixed assets. Proceeds from the
sale were $112,000 and the sale did not result in a gain or loss. During the
nine months ended September 30, 1999, the Company entered into capital leases
for the acquisition of certain assets.
Future minimum lease obligations as of September 30, 1999 are as follows (in
thousands):
<TABLE>
<CAPTION>
Operating Capital
Leases Leases
--------- -------
<S> <C> <C>
Year Ending December 31,
1999..................................................... $ 268 $ 27
2000..................................................... 1,360 87
2001..................................................... 1,083 36
2002..................................................... 1,046 --
2003 .................................................... 1,014 --
Thereafter .............................................. 845
------ ----
Total minimum lease payments............................... $5,616 150
======
Less--amount representing interest......................... 20
----
$130
====
</TABLE>
F-20
<PAGE>
On September 9, 1999, the Company entered into a five-year noncancelable
operating lease for a new operating facility. Minimum yearly rental payments
will be $1,014,000, commencing in November 1999. Pursuant to the lease, the
Company entered into a $500,000 irrevocable letter of credit collateralized by
a certificate of deposit.
Restricted Time Deposit
In connection with the facility lease, the Company is required to maintain,
on behalf of the landlord, a certificate of deposit in the amount of $500,000,
which is restricted as to its use.
License Agreements
The Company has entered into agreements with various third parties whereby
the Company is obligated to pay a royalty ranging from 3% to 11% of the
revenues on certain of its software products. Royalty payments in the years
ended December 31, 1996, 1997 and 1998 and the nine months ended September 30,
1999 were not significant.
Legal Matters
On July 15, 1999, a patent infringement suit was filed against the Company.
Specifically, the suit alleges that the SmartPicks technology developed by the
Company in connection with its web-based product line infringes on a patent
held by the plaintiff. This patent purports to disclose and claim a computer
system for matching appropriate educational products with a child's
developmental profile comprising so-called "static and dynamic data." The
complaint seeks temporary and permanent injunctions, as well as unspecified
damages. The hearing for the preliminary injunction motion is scheduled for
November 1999.
Through September 30, 1999, the Company incurred legal expenses of $163,000
pursuant to the above referenced patent litigation. These expenses have been
included in general and administrative expenses in the Company's statement of
operations for the nine months ended September 30, 1999. Management anticipates
that further material expenditures will be incurred in defense of this case at
least through December 1999. Management believes that the suit is without merit
and that the Company has meritorious defenses based on non-infringement and the
invalidity of the subject patent. However, the action has not progressed
sufficiently for the Company to estimate a range of possible loss, if any,
should it not prevail in its defense related to this action.
The Company is party from time to time to certain other litigation matters
and claims which are normal in the course of its operations and, while the
results of litigation and claims cannot be predicted with certainty, management
believes that the final outcome of such matters will not have a materially
adverse effect on the Company's financial position or results from operations.
15. Event Subsequent to Independent Accountant's Report Date (Unaudited)
In November 1999, the Company settled the patent infringement lawsuit
brought against the Company on July 15, 1999, and the lawsuit was dismissed.
This settlement agreement granted the Company a non-exclusive license to the
plaintiff's patent.
F-21
<PAGE>
EDUCATIONAL PRODUCTS MEET E-COMMERCE
[PICTURE OF MOTHER WITH CHILD]
To Shop, click on the appropriate Age/Grade Area
[PICTURE OF AGE/GRADE GROUPS USED BY COMPANY TO ORGANIZE PRODUCTS]
EDUCATIONAL TOYS, GAMES, BOOKS & SOFTWARE
[PICTURE OF SELECTED PRODUCTS]
[COMPANY LOGO]
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
4,500,000 Shares
[SMARTERKIDS LOGO APPEARS HERE]
Common Stock
------------
PROSPECTUS
------------
Hambrecht & Quist
U.S. Bancorp Piper Jaffray
E*OFFERING
----------------
November 23, 1999
----------------
You should rely only on information contained in this prospectus. We have
not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or of any sale of our common stock.
No action is being taken in any jurisdiction outside the United States to
permit a public offering of the common stock or possession or distribution of
this prospectus in any such jurisdiction. Persons who come into possession of
this prospectus in jurisdictions outside the United States are required to
inform themselves about and to observe any restrictions as to this offering and
the distribution of this prospectus applicable to that jurisdiction.
Until December 18, 1999, all dealers that buy, sell or trade in the common
stock, whether or not participating in this offering, may be required to
deliver a prospectus. This is in addition to the dealers' obligation to deliver
a prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
