<PAGE>
As filed with the Securities and Exchange Commission on November 17, 1999
Registration No. 333-86787
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
--------------
Amendment No. 4
to
FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
--------------
SmarterKids.com, Inc.
(Exact name of registrant as specified in its charter)
--------------
Delaware 5945 04-3226127
(State or other (Primary Standard Industrial (I.R.S. Employer
jurisdiction Classification Code Number)Identification Number)
of incorporation or
organization)
--------------
15 Crawford Street
Needham, MA 02494
(781) 449-7567
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
--------------
David A. Blohm
President and Chief Executive Officer
SmarterKids.com, Inc.
15 Crawford Street
Needham, MA 02494
(781) 449-7567
(Name, address including zip code, and telephone
number, including area code, of agent for service)
--------------
Copies to:
<TABLE>
<S> <C>
Gordon H. Hayes, Esq. John A. Burgess, Esq.
Edwin L. Miller, Jr., Esq. William S. Gehrke, Esq.
Testa, Hurwitz & Thibeault, LLP Hale and Dorr LLP
125 High Street 60 State Street
Boston, Massachusetts 02110 Boston, Massachusetts 02109
Tel: (617) 248-7000 Tel: (617) 526-6000
Fax: (617) 248-7100 Fax: (617) 526-5000
</TABLE>
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date hereof.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [_]
--------------
The registrant hereby amends this registration statement on such date or
dates as may be necessary to delay its effective date until the registrant
shall file a further amendment which specifically states that this
registration statement shall thereafter become effective in accordance with
Section 8(a) of the Securities Act of 1933 or until this registration
statement shall become effective on such date as the Commission, acting
pursuant to said Section 8(a), may determine.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus is not complete and may be changed. +
+Underwriters may not confirm sales of these securities until the registration +
+statement filed with the Securities and Exchange Commission becomes +
+effective. This prospectus is not an offer to sell these securities and it is +
+not soliciting offers to buy these securities in any jurisdiction where the +
+offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED NOVEMBER 17, 1999
PROSPECTUS
4,500,000 Shares
[SMARTERKIDS LOGO APPEARS HERE]
Common Stock
This is an initial public offering of common stock by SmarterKids.com, Inc.
The estimated initial public offering price will be between $13.00 and $15.00
per share.
---------
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................................... $ $
Underwriting discounts and commissions.......................... $ $
Proceeds to SmarterKids.com, before expenses.................... $ $
</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
, 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> <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.......................................................... 37
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
offering..................................
19,364,674 shares
Use of proceeds...........................
For general corporate purposes
Proposed 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 $1.89 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 and reflects a
three-for-two stock split of our outstanding shares of common stock anticipated
to occur immediately prior to this offering. 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 an assumed 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-
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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.
We expect the initial public offering price to be 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,
assuming an 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 an assumed initial public
offering price of $14.00 per share after deducting estimated 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.
22
<PAGE>
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 an assumed 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
23
<PAGE>
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; 10,000,000
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 an assumed initial public offering price of $14.00 per
share and after deducting the estimated 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. Based upon the midpoint of the offering price range, new
investors will pay $14.00 per share and the net tangible book value per share
is expected to be $3.80 immediately after the offering. The following table
illustrates this dilution on a per share basis:
<TABLE>
<S> <C> <C>
Assumed 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 $1.89 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 an assumed 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 1,091
General and
administrative........ 243 277 611 430 490 330 1,149
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. 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 $4,546,000 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>
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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 $37.0 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.
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 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
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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,
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
35
<PAGE>
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
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.
36
<PAGE>
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
37
<PAGE>
. lack of flexibility in product display and merchandising capabilities
. 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.
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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:
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
39
<PAGE>
. 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 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.
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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.
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.
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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
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
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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 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.
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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 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
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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.
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
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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.
We are presently a party to one patent infringement lawsuit. See "Legal
Proceedings."
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
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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.
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.
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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
51
<PAGE>
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 21.88% $.13 11/6/08 $ 22,074 $ 55,940
Jeff Pucci.............. 270,000 21.88 .15 11/6/03 11,189 24,726
Richard Viard........... 270,000 21.88 .15 11/6/03 11,189 24,726
Albert Noyes............ 150,000 12.15 .13 11/6/08 12,263 31,077
Richard Secor........... 75,000 6.08 .13 10/19/08 6,132 15,539
</TABLE>
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<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 an assumed 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 SmartKids
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.
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<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.
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<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.
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<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.
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<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.
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<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..............................................
U.S. Bancorp Piper Jaffray Inc.....................................
E*OFFERING Corp....................................................
---------
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........................................ $ $
Total............................................ $ $
</TABLE>
<TABLE>
<CAPTION>
Paid by Selling
Stockholders
---------------
No Full
Exercise Exercise
-------- --------
<S> <C> <C>
Per share.................................................. -- $
Total...................................................... -- $
</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 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 $ per share under the public offering price. The
underwriters may allow, and such dealers may reallow a concession not in excess
of $ 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
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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 25,500 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 225,000 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
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
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. 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 in connection with acquisitions of
businesses or assets or strategic relationships, provided that such
shares may not be sold without the prior written consent of Hambrecht &
Quist LLC during the 180-day period following the date of this
prospectus
. 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 has been no public market for the common stock.
The initial public offering price for the common stock will be determined by
negotiation among SmarterKids.com, the selling stockholders and the
representatives of the underwriters. The factors that will be considered in
determining the initial public offering price are 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. The estimated initial public offering price range on the cover of
this preliminary prospectus is subject to change as a result of market
conditions or other factors.
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<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.
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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.
The 3-for-2 stock split approved on September 7, 1999 described in Note 8 to
the financial statements has not been consummated at November 17, 1999. When it
has been consummated, we will be in a position to furnish the following report:
"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
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 closing of 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>
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EDUCATIONAL TOYS, GAMES, BOOKS & SOFTWARE
[PICTURE OF SELECTED PRODUCTS]
[COMPANY LOGO]
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4,500,000 Shares
[SMARTERKIDS LOGO APPEARS HERE]
Common Stock
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PROSPECTUS
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Hambrecht & Quist
U.S. Bancorp Piper Jaffray
E*OFFERING
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, 1999
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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 , 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.
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PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution.
Estimated expenses, other than underwriting discounts and commissions,
payable by us in connection with the sale of the common stock being registered
under this registration statement are as follows:
<TABLE>
<S> <C>
SEC registration fee............................................ $ 25,986
NASD filing fee................................................. 9,815
Nasdaq National Market listing fee.............................. 95,000
Printing and engraving expenses................................. 150,000
Legal fees and expenses......................................... 350,000
Accounting fees and expenses.................................... 350,000
Transfer agent and registrar fees and expenses.................. 5,000
Miscellaneous................................................... 12,199
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Total......................................................... $998,000
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</TABLE>
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* To be filed by amendment.
Item 14. Indemnification of Directors and Officers.
The Delaware General Corporation Law and our charter and by-laws provide for
indemnification of our directors and officers for liabilities and expenses that
they may incur in such capacities. In general, directors and officers are
indemnified with respect to actions taken in good faith in a manner reasonably
believed to be in, or not opposed to, our best interests and, with respect to
any criminal action or proceeding, actions that the indemnitee had no
reasonable cause to believe were unlawful. Reference is made to our charter and
bylaws filed as Exhibits 3.2 and 3.3 to this registration statement,
respectively.
The underwriting agreement provides that the underwriters are obligated,
under certain circumstances, to indemnify our directors, officers and
controlling persons against certain liabilities, including liabilities under
the Securities Act. Reference is made to the form of underwriting agreement
filed as Exhibit 1.1 to this registration statement.
In addition, we intend to apply for directors and officers liability
insurance policy.
Item 15. Recent Sales of Unregistered Securities.
In the three years preceding the filing of this registration statement, we
have issued the following securities that were not registered under the
Securities Act:
(a) Issuances of Capital Stock.
Between May 15, 1997 and November 6, 1998, we issued and sold an aggregate
of 3,517.5 shares of Series B Preferred Stock in a private financing for an
aggregate price of $7,035,000.
On July 12, 1999, we issued and sold an aggregate of 4,284,091 shares of
series C preferred stock to 10 institutional investors and to 5 individual
investors in a private financing for an aggregate price of $26,856,966.
On September 7, 1999, we issued an aggregate of 25,500 shares of our common
stock to two related companies in exchange for the transfer of a registered
trademark similar to SmarterKids.
With the exception of the sales of securities in July 1999, no underwriters
were used in the foregoing transactions. All sales of securities described
above were made in reliance upon the exemption from registration provided by
Section 4(2) of the Securities Act for transactions by an issuer not involving
a public offering.
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(b) Issuances of Warrants.
On December 31, 1997 and November 6, 1998, we issued warrants to Edu
Ventures, Inc. to purchase 66,000 and 55,050 shares of common stock,
respectively, each at an exercise price of $0.13. On December 31, 1998 and
September 1, 1999, we issued warrants to Edu Ventures, Inc. to purchase 22,500
and 15,000 shares of common stock, respectively, each at an exercise price of
$1.33. These warrants expire immediately prior to the offering.
On March 8, 1999, we issued a warrant to National Computer Systems, Inc. to
purchase 112,500 shares of common stock at an exercise price of $1.33. The
issuance of shares pursuant to this warrant depends on the achievement of
specific milestones.
On March 25, 1998, we issued a warrant to Silicon Valley Bank for five
shares of series B preferred stock at an exercise price of $2,000 per share
that will expire on March 24, 2003.
On September 29, 1998, we issued a warrant to J.L. Hammett Co. to purchase
57,000 shares of common stock at an exercise price of $1.33 that will expire on
September 29, 2003. On September 7, 1999, we issued an additional 108,000
shares of common stock at an exercise price of $1.33 that will expire on
September 7, 2004
In connection with its services rendered to us in our private placement in
July 1999, on July, 12, 1999, we issued a warrant to Thomas Weisel Partners LLC
for 113,027 shares of series C preferred stock at an exercise price of $6.269.
This warrant is convertible into a warrant to purchase 169,541 shares of common
stock and expires immediately prior to this offering.
(c) Grants and Exercises of Stock Options.
Since September 30, 1996, we have granted stock options to purchase
3,597,200 shares of common stock with exercise prices ranging from $0.13 to
$11.00 per share, to employees, directors and consultants pursuant to our 1995
Stock Plan. Of these options, 198,000 have been exercised for a weighted
average exercise price of $0.59 as of October 15, 1999. The issuance of common
stock upon exercise of the options was exempt either pursuant to Rule 701, as a
transaction pursuant to a compensatory benefit plan, or pursuant to
Section 4(2), as a transaction by an issuer not involving a public offering.
Item 16. Exhibits and Financial Statement Schedules.
(a) Exhibits:
<TABLE>
<CAPTION>
Exhibit No. Description
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<C> <S>
1.1(Delta) Form of Underwriting Agreement
3.1 Amended and Restated Certificate of Incorporation, as amended, of
SmarterKids.com currently in effect
3.2 Form of Second Amended and Restated Certificate of Incorporation
of SmarterKids.com to be filed with the Secretary of State of
Delaware and effective upon the effectiveness of the registration
statement
3.3 Form of Amendment to the Second Amended and Restated Certificate
of Incorporation of SmarterKids.com to be filed with the Secretary
of State of Delaware and effective upon the closing of the
offering
3.4 Amended and Restated By-laws of SmarterKids.com currently in
effect
3.5 Form of Second Amended and Restated By-laws of SmarterKids.com to
be effective upon the effectiveness of the offering
4.4 Specimen certificate for shares of SmarterKids.com's common stock
5.1(Delta) Legal opinion of Testa, Hurwitz & Thibeault, LLP
</TABLE>
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<TABLE>
<CAPTION>
Exhibit No. Description
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<C> <S>
10.1 1995 Stock Plan, as amended
10.2 1999 Stock Option and Incentive Plan
10.3 1999 Non-Employee Director Stock Option Plan
10.4 1999 Employee Stock Purchase Plan
10.5 Amended and Restated Investor Rights Agreement dated as of July
12, 1999 by and among SmarterKids.com, Inc., certain stockholders
of SmarterKids.com, Inc. and certain senior management of
SmarterKids.com, Inc.
10.6 Amended and Restated Stockholders Voting Agreement dated as of
July 12, 1999 among SmarterKids.com, Inc., certain stockholders of
SmarterKids.com, Inc. and certain senior management of
SmarterKids.com, Inc.
10.7 Lease Agreements dated as of September 1, 1998 and April 16, 1999
between SmarterKids.com, Inc. and McFarland FLP
+10.8 Agreement for Product Distribution Services dated as of October 8,
1999 between SmarterKids.com, Inc. and J.L. Hammett Co.
10.9 Letter Agreement dated November 6, 1998 between SmarterKids.com,
Inc. and Jeff Pucci
10.10 Letter Agreement dated November 6, 1998 between SmarterKids.com,
Inc. and Richard Viard
10.11 Office Lease dated September 8, 1999 by and between BHX, LLC, as
Trustee of Crawford Realty Trust and SmarterKids.com, Inc.
+10.12(Delta) Business Agreement dated as of March 9, 1999 between National
Computer Systems and SmarterKids.com, Inc.
11.1 Statement re: Computation of Per Share Earnings (This exhibit has
been omitted because the information is shown in the financial
statements or notes thereto.)
23.1 Consent of Testa, Hurwitz & Thibeault, LLP (contained in Exhibit
5.1)
23.2(Delta) Consent of PricewaterhouseCoopers LLP
24.1 Power of Attorney
27.1 Financial Data Schedule (This exhibit has been omitted because the
information is shown in the financial statements or notes
thereto.)
</TABLE>
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+ Confidential materials omitted and filed separately with the SEC
(Delta) Filed herewith
* To be filed by amendment
(b) Financial Statement Schedules.
No financial statement schedules for which provision is made in the
applicable accounting regulations of the SEC are included here since the
required information is disclosed in the notes to the financial statements or
the schedules are inapplicable and therefore have been omitted.
Item 17. Undertakings.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
registrant pursuant to the provisions described in Item 14 above, or otherwise,
the registrant has been advised that in the opinion of the SEC such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by
such director, officer or controlling person in connection with the securities
being registered, the registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed
by the final adjudication of such issue.
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The undersigned registrant hereby undertakes (1) to provide to the
underwriters at the closing specified in the underwriting agreement,
certificates in such denominations and registered in such names as required by
the underwriters to permit prompt delivery to each purchaser; (2) that for
purposes of determining any liability under the Securities Act, the information
omitted from the form of prospectus filed as part of this registration
statement in reliance upon Rule 430A and contained in a form of prospectus
filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the
Securities Act shall be deemed to be part of this registration statement as of
the time it was declared effective; and (3) that for the purpose of determining
any liability under the Securities Act, each post-effective amendment that
contains a form of prospectus shall be deemed to be a new registration
statement relating to the securities offered therein, and the offering of such
securities at that time shall be deemed to be the initial bona fide offering
thereof.
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, SmarterKids.com,
Inc. has duly caused this registration statement to be signed on its behalf by
the undersigned, thereunto duly authorized, in Boston, Massachusetts, on
November 17, 1999.
SmarterKids.com, Inc.
By: /s/ Robert Cahill
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Robert Cahill
Vice President, Finance
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed below by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title(s) Date
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<S> <C> <C>
* President, Chief Executive November 17, 1999
______________________________________ Officer and Director
David Blohm (principal executive
officer)
/s/ Robert Cahill Vice President, Finance November 17, 1999
______________________________________ (principal financial and
Robert Cahill accounting officer)
* Co-Founder, Chairman and November 17, 1999
______________________________________ Director
Jeff Pucci
* Director November 17, 1999
______________________________________
Richard D'Amore
* Director November 17, 1999
______________________________________
Michael Fitzgerald
* Director November 17, 1999
______________________________________
Michael Kolowich
* Director November 17, 1999
______________________________________
Brian Hickey
</TABLE>
*By: /s/ Robert Cahill
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Robert Cahill
Attorney-in-Fact
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EXHIBITS
<TABLE>
<CAPTION>
Exhibit No. Description
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<C> <S>
1.1(Delta)Form of Underwriting Agreement
3.1 Amended and Restated Certificate of Incorporation, as amended, of
SmarterKids.com currently in effect
3.2 Form of Second Amended and Restated Certificate of Incorporation
of SmarterKids.com to be filed with the Secretary of State of
Delaware and effective upon the effectiveness of the registration
statement
3.3 Form of Amendment to the Second Amended and Restated Certificate
of Incorporation of SmarterKids.com to be filed with the Secretary
of State of Delaware and effective upon the closing of the
offering
3.4 Amended and Restated By-laws of SmarterKids.com currently in
effect
3.5 Form of Second Amended and Restated By-laws of SmarterKids.com to
be effective upon the effectiveness of the offering
4.4 Specimen certificate for shares of SmarterKids.com's common stock
5.1(Delta) Legal opinion of Testa, Hurwitz & Thibeault, LLP
10.1 1995 Stock Plan, as amended
10.2 1999 Stock Option and Incentive Plan
10.3 1999 Non-Employee Director Stock Option Plan
10.4 1999 Employee Stock Purchase Plan
10.5 Amended and Restated Investor Rights Agreement dated as of July
12, 1999 by and among SmarterKids.com, Inc., certain stockholders
of SmarterKids.com, Inc. and certain senior management of
SmarterKids.com, Inc.
10.6 Amended and Restated Stockholders Voting Agreement dated as of
July 12, 1999 among SmarterKids.com, Inc., certain stockholders of
SmarterKids.com, Inc. and certain senior management of
SmarterKids.com, Inc.
10.7 Lease Agreements dated as of September 1, 1998 and April 16, 1999
between SmarterKids.com, Inc. and McFarland FLP
+10.8 Agreement for Product Distribution Services dated as of October 8,
1999 between SmarterKids.com, Inc. and J.L. Hammett Co.
10.9 Letter Agreement dated November 6, 1998 between SmarterKids.com,
Inc. and Jeff Pucci
10.10 Letter Agreement dated November 6, 1998 between SmarterKids.com,
Inc. and Richard Viard
10.11 Office Lease dated September 8, 1999 by and between BHX, LLC, as
Trustee of Crawford Realty Trust and SmarterKids.com, Inc.
+10.12(Delta) Business Agreement dated as of March 9, 1999 between National
Computer Systems and SmarterKids.com, Inc.
11.1 Statement re: Computation of Per Share Earnings (This exhibit has
been omitted because the information is shown in the financial
statements or notes thereto.)
23.1 Consent of Testa, Hurwitz & Thibeault, LLP (contained in Exhibit
5.1)
23.2(Delta) Consent of PricewaterhouseCoopers LLP
24.1 Power of Attorney
27.1 Financial Data Schedule (This exhibit has been omitted because the
information is shown in the financial statements or notes
thereto.)
</TABLE>
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+ Confidential materials omitted and filed separately with the SEC
(Delta) Filed herewith
* To be filed by amendment
<PAGE>
EXHIBIT 1.1
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SmarterKids.com, Inc.
4,500,000 SHARES/1/
COMMON STOCK
UNDERWRITING AGREEMENT
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_____________, 1999
HAMBRECHT & QUIST LLC
U.S. BANCORP PIPER JAFFRAY INC.
E*OFFERING CORP.
c/o Hambrecht & Quist LLC
One Bush Street
San Francisco, CA 94104
Ladies and Gentlemen:
Smarterkids.com, Inc., a Delaware corporation (herein called the Company),
proposes to issue and sell 4,500,000 shares of its authorized but unissued
Common Stock, $0.01 par value (herein called the Common Stock), (said 4,500,000
shares of Common Stock being herein called the Underwritten Stock). The Company
and the stockholders of the Company named in Schedule II hereto (herein
collectively called the Selling Securityholders) propose to grant to the
Underwriters (as hereinafter defined) an option to purchase up to 675,000
additional shares of Common Stock (herein called the Option Stock and with the
Underwritten Stock herein collectively called the Stock). The Common Stock is
more fully described in the Registration Statement and the Prospectus
hereinafter mentioned.
The Company and the Selling Securityholders severally hereby confirm the
agreements made with respect to the purchase of the Stock by the several
underwriters, for whom you are acting, named in Schedule I hereto (herein
collectively called the Underwriters, which term shall also include any
underwriter purchasing Stock pursuant to Section 3(b) hereof). You represent
and warrant that you have been authorized by each of the other Underwriters to
enter into this Agreement on its behalf and to act for it in the manner herein
provided.
1. REGISTRATION STATEMENT. The Company has filed with the Securities and
Exchange Commission (herein called the Commission) a registration statement on
Form S-1 (No. 333-86787), including the related preliminary prospectus, for the
registration under the Securities Act of 1933, as amended (herein called the
Securities Act) of the Stock. Copies of such registration statement and of each
amendment thereto, if any, including the related preliminary prospectus (meeting
the requirements of Rule 430A of the rules and regulations of the Commission)
heretofore filed by the Company with the Commission have been delivered to you.
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/1/ Plus an option to purchase from the Company and the Selling Securityholders
up to 675,000 additional shares to cover over-allotments.
<PAGE>
The term Registration Statement as used in this agreement shall mean such
registration statement, all exhibits and financial statements, the "Meet the
Management" presentation included in E*OFFERING Corp.'s website, all information
omitted therefrom in reliance upon Rule 430A and contained in the Prospectus
referred to below, in the form in which it became effective, and any
registration statement filed pursuant to Rule 462(b) of the rules and
regulations of the Commission with respect to the Stock (herein called a Rule
462(b) registration statement), and, in the event of any amendment thereto after
the effective date of such registration statement (herein called the Effective
Date), shall also mean (from and after the effectiveness of such amendment) such
registration statement as so amended (including any Rule 462(b) registration
statement). The term Prospectus as used in this Agreement shall mean the
prospectus relating to the Stock first filed with the Commission pursuant to
Rule 424(b) and Rule 430A (or if no such filing is required, as included in the
Registration Statement) and, in the event of any supplement or amendment to such
prospectus after the Effective Date, shall also mean (from and after the filing
with the Commission of such supplement or the effectiveness of such amendment)
such prospectus as so supplemented or amended. The term Preliminary Prospectus
as used in this Agreement shall mean each preliminary prospectus, including the
documents incorporated by reference therein, included in such registration
statement prior to the time it becomes effective.
The Registration Statement has been declared effective under the Securities
Act, and no post-effective amendment to the Registration Statement has been
filed as of the date of this Agreement. The Company has caused to be delivered
to you copies of each Preliminary Prospectus and has consented to the use of
such copies for the purposes permitted by the Securities Act.
2. REPRESENTATIONS AND WARRANTIES OF THE COMPANY AND THE SELLING
SECURITYHOLDERS.
a) The Company hereby represents and warrants as follows:
(i) The Company has been duly incorporated and is validly existing as
a corporation in good standing under the laws of the jurisdiction of its
incorporation, has full corporate power and authority to own or lease its
properties and conduct its business as described in the Registration
Statement and the Prospectus and as being conducted, and is duly qualified
as a foreign corporation and in good standing in all jurisdictions in which
the character of the property owned or leased or the nature of the business
transacted by it makes qualification necessary (except where the failure to
be so qualified would not have a material adverse effect on the business,
properties, financial condition or results of operations of the Company and
its subsidiaries, taken as a whole).
(ii) Since the respective dates as of which information is given in
the Registration Statement and the Prospectus, there has not been any
materially adverse change in the properties, financial condition or results
of operations of the Company, whether or not arising from transactions in
the ordinary course of business, other than as set forth in the
Registration Statement and the Prospectus, and since such dates, except in
the ordinary course of business, the Company has not entered into any
material transaction not referred to in the Registration Statement and the
Prospectus.
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(iii) The Commission has not issued any order preventing or suspending
the use of any Preliminary Prospectus or the Prospectus, nor instituted
proceedings for that purpose. The Registration Statement and the Prospectus
comply, and on the Closing Date (as hereinafter defined) and any later date
on which Option Stock is to be purchased, the Prospectus will comply, in
all material respects, with the provisions of the Securities Act and the
Securities Exchange Act of 1934, as amended (herein called the Exchange
Act) and the rules and regulations of the Commission thereunder; on the
Effective Date, the Registration Statement did not contain any untrue
statement of a material fact and did not omit to state any material fact
required to be stated therein or necessary in order to make the statements
therein not misleading; and, on the Effective Date the Prospectus did not
and, on the Closing Date and any later date on which Option Stock is to be
purchased, will not contain any untrue statement of a material fact or omit
to state any material fact necessary in order to make the statements
therein, in the light of the circumstances under which they were made, not
misleading; provided, however, that none of the representations and
warranties in this subparagraph (iii) shall apply to statements in, or
omissions from, the Registration Statement or the Prospectus made in
reliance upon and in conformity with information herein or otherwise
furnished in writing to the Company by or on behalf of the Underwriters for
use in the Registration Statement or the Prospectus. There are no contracts
or documents of the Company which would be required by the Securities Act
or by the rules and regulations of the Commission to be filed as exhibits
to the Registration Statement which have not been filed.
(iv) The capitalization of the Company as of September 30, 1999, was
as set forth in the Prospectus under the caption "Capitalization"; the
outstanding shares of Common Stock of the Company have been duly authorized
and validly issued and are fully paid and non-assessable; the capital stock
of the Company conforms to the description thereof in the Registration
Statement under the caption "Description of Securities"; the Stock is duly
and validly authorized, is (or, in the case of shares of the Stock to be
sold by the Company, will be, when issued and sold to the Underwriters as
provided herein) duly and validly issued, fully paid, nonassessable, free
of pre-emptive rights and conforms to the description thereof in the
Prospectus. As of September 30, 1999, there were no outstanding options,
warrants or other rights granted to or by the Company to purchase shares of
Common Stock or other securities of the Company other than as described in
the Registration Statement; and no such option, warrant or other right has
been granted to any person, the exercise of which would cause such person
to own more than five percent of the Common Stock outstanding immediately
after the offering other than as described in the Prospectus. No person or
entity holds a right to require or participate in the registration under
the Securities Act of shares of Common Stock of the Company which right has
not been waived by the holder thereof as of the date hereof with respect to
the registration of shares pursuant to the Registration Statement, and
except as described in the Prospectus, no person holds a right to require
registration under the Securities Act of shares of Common Stock of the
Company at any other time. No person or entity has a right of participation
with respect to the sale of shares of the Stock by the Company. No further
approval or authority of the stockholders or the Board of Directors of the
Company will be required for the issuance and sale of the Stock as
contemplated herein. The Stock is duly and validly authorized, is (or, in
the case of shares of the Stock to be sold by the Company, will be, when
issued
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<PAGE>
and sold to the Underwriters as provided herein) duly and validly issued,
fully paid and nonassessable and conforms to the description thereof in the
Prospectus. No further approval or authority of the stockholders or the
Board of Directors of the Company will be required for the transfer and
sale of the Stock to be sold by the Selling Securityholders or the issuance
and sale of the Stock as contemplated herein.
(v) The Company now holds, and at the Closing Date (as defined in
Section 5(a) hereof) will hold, all material licenses, certificates and
permits from state, federal and other regulatory authorities which are
necessary for the conduct of the business of the Company; the Company is
not in violation of its corporate charter or by-laws, or in default in the
performance or observance of any material provision of any obligation,
agreement, covenant or condition contained in any bond, debenture or in any
contract, indenture, mortgage, loan agreement, joint venture or other
agreement or instrument to which the Company is a party or by which it or
any of its properties is bound or, to the best of the Company's knowledge,
is in material violation of any law, order, rule, regulation, writ,
injunction or decree of any government, governmental instrumentality or
court, domestic or foreign.
(vi) To its knowledge and except as described in the Prospectus, the
Company owns, or possesses adequate rights to use or sublicense, all
patents, patent rights, inventions, trade secrets, licenses, know-how,
proprietary techniques, including processes, trademarks, service marks,
trade names, copyrights and other intellectual property described or
referred to in the Registration Statement and the Prospectus as owned or
used by it or which are necessary for the conduct of its business as now
conducted and as described in the Registration Statement and the
Prospectus. Except as described in the Prospectus, all such patents, patent
rights, licenses, trademarks, service marks and copyrights are (i) valid
and enforceable and (ii) not being infringed by any third parties which
infringement could, whether singly or in the aggregate, materially and
adversely affect the business, properties, operations, condition (financial
or otherwise), results of operations, income or business prospects or the
Company, as presently being conducted or as proposed to be conducted in the
Prospectus. Except as described in the Prospectus, the Company has no
knowledge of, nor has it received any notice of, infringement of or
conflict with asserted rights of others with respect to any patents, patent
rights, inventions, trade secrets, licenses, know-how, proprietary
techniques, including processes and substances, trademarks, service marks,
trade names, copyrights or other intellectual property which, singly or in
the aggregate, is, or is reasonably likely to be, the subject of an
unfavorable decision, ruling or finding that could materially and adversely
affect the business, properties, operations, condition (financial or
otherwise), results of operations, income or business prospects of the
Company, as now conducted or as proposed to be conducted in the
Registration Statement and the Prospectus.
(vii) This Agreement has been duly authorized, executed and delivered
by the Company; the performance of this Agreement and the consummation of
the transactions herein contemplated will not result in a breach or
violation of any of the terms and provisions of, or constitute a material
default under, (A) any indenture, mortgage, deed of trust, loan agreement
or other material agreement or instrument to which the Company is a party
or by which the property of the Company is bound, (B) the
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<PAGE>
corporate charter or by-laws of the Company or (C) (assuming the making of
all filings required under Rule 424(b) or Rule 430A and the due
qualification of the Stock for public offering by the Underwriters under
state and foreign securities laws) any statute or any order, rule or
regulation of any court or governmental agency or body having jurisdiction
over the Company or over the properties of the Company.
(viii) Except as described in the Prospectus, there is not any action,
suit or proceeding, at law or in equity, pending against the Company before
any court or administrative agency, which, if determined adversely to the
Company, would materially adversely affect the business, operations,
financial condition, income or business prospects of the Company taken as a
whole, or prevent consummation of the transactions contemplated hereby.
(ix) The consolidated financial statements of the Company, together
with the related notes and schedules as set forth in the Registration
Statement, present fairly the consolidated financial position and the
results of operations of the Company, at the indicated dates and for the
indicated periods. Such financial statements have been prepared in
accordance with generally accepted accounting principles consistently
applied throughout the periods involved, and all adjustments necessary for
a fair presentation of results for such periods have been made. The summary
financial and statistical data included in the Registration Statement
present fairly the information shown therein and have been compiled on a
basis consistent with the financial statements presented therein.
(x) The Company has filed all federal, state and foreign income tax
returns which have been required to be filed (or have filed extensions
therefor or obtained any required extensions in connection therewith), and
have paid all taxes indicated by said returns and all assessments received
by it to the extent that such taxes have become due and are not being
contested in good faith.
(xi) Each approval, consent, order, authorization, designation,
declaration or filing by or with any United States regulatory,
administrative or other governmental body necessary in connection with the
execution and delivery by the Company of this Agreement and the
consummation by the Company of the transactions herein contemplated (except
(A) such additional steps as may be required by the National Association of
Securities Dealers, Inc. (the "NASD"), (B) as may be necessary to make the
Registration Statement effective (and to maintain such effectiveness) and
to qualify the Stock for public offering by the Underwriters under state
and foreign securities laws or (C) filings required under Rule 424(b) or
Rule 430(A)) has been obtained or made and is in full force and effect.
(xii) PricewaterhouseCoopers LLP, who have certified the financial
statements filed with the Commission as part of the Registration Statement,
are independent public accountants as required by the Securities Act and
the rules and regulations thereunder.
(xiii) The Company has good and marketable title to all of the
properties and assets reflected in the financial statements (or as
described in the Registration
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Statement) described as owned by it, subject to no lien, mortgage, pledge,
charge or encumbrance of any kind except those reflected in such financial
statements (or as described in the Registration Statement) or which are not
material in amount.
(xiv) The Company is not involved in any material labor dispute nor,
to the knowledge of the Company, is any such dispute threatened.
(xv) The Common Stock is registered pursuant to Section 12(g) of the
Securities Exchange Act of 1934, as amended (hereinafter the Exchange Act),
and is listed on the Nasdaq National Market, and the Company has taken no
action designed to, or likely to have the effect of, terminating the
registration of the Common Stock under the Exchange Act or delisting the
Common Stock from the Nasdaq National Market, nor has the Company received
any notification that the Commission or the NASD is contemplating
terminating such registration or listing has been approved, subject to
notice of issuance of the Stock.
(xvi) Neither the Company nor, to its knowledge, any of its officers,
directors or affiliates have taken, and at the Closing Date and at each
purchase of the Option Stock, neither the Company nor, to its knowledge,
any of its officers, directors or affiliates will have taken, directly or
indirectly, any action which has constituted, or might reasonably be
expected to constitute, the stabilization or manipulation of the price of
sale or resale of the Stock.
(xvii) The Stock to be sold by the Selling Securityholders is listed
and duly admitted to trading on the Nasdaq National Market, and prior to
the Closing Date the Stock to be issued and sold by the Company will be
authorized for listing by the Nasdaq National Market upon official notice
of issuance.
b) Each of the Selling Securityholders hereby represents and warrants as
follows:
(i) Such Selling Securityholder has good and marketable title to all
the shares of Stock to be sold by such Selling Securityholder hereunder,
free and clear of all liens, encumbrances, equities, security interests and
claims whatsoever, with full right and authority to deliver the same
hereunder, subject, in the case of each Selling Securityholder, to the
rights of the Company, as Custodian (herein called the Custodian), and that
upon the delivery of and payment for such shares of the Stock hereunder,
the several Underwriters will receive good and marketable title thereto,
free and clear of all liens, encumbrances, equities, security interests and
claims whatsoever.
(ii) Certificates in negotiable form for the shares of the Stock to be
sold by such Selling Securityholder have been placed in custody under a
Custody Agreement for delivery under this Agreement with the Custodian;
such Selling Securityholder specifically agrees that the shares of the
Stock represented by the certificates so held in custody for such Selling
Securityholder are subject to the interests of the several Underwriters and
the Company, that the arrangements made by such Selling Securityholder for
such custody, including the Power of Attorney provided for in such Custody
Agreement, are to that extent irrevocable, and that the obligations of such
Selling Securityholder shall not be terminated by any act of such Selling
Securityholder
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or by operation of law, whether by the death or incapacity of such Selling
Securityholder (or, in the case of a Selling Securityholder that is not an
individual, the dissolution or liquidation of such Selling Securityholder)
or the occurrence of any other event; if any such death, incapacity,
dissolution, liquidation or other such event should occur before the
delivery of such shares of the Stock hereunder, certificates for such
shares of the Stock shall be delivered by the Custodian in accordance with
the terms and conditions of this Agreement as if such death, incapacity,
dissolution, liquidation or other event had not occurred, regardless of
whether the Custodian shall have received notice of such death, incapacity,
dissolution, liquidation or other event.
3. PURCHASE OF THE STOCK BY THE UNDERWRITERS.
a) On the basis of the representations and warranties and subject to the
terms and conditions herein set forth, the Company agrees to issue and sell
4,500,000 shares of the Underwritten Stock to the several Underwriters, and each
of the Underwriters agrees to purchase from the Company the respective aggregate
number of shares of Underwritten Stock set forth opposite its name in Schedule
I. The price at which such shares of Underwritten Stock shall be sold by the
Company and purchased by the several Underwriters shall be $___ per share. The
obligation of each Underwriter to the Company shall be to purchase from the
Company that number of shares of the Underwritten Stock which represents the
same proportion of the total number of shares of the Underwritten Stock to be
sold by each of the Company pursuant to this Agreement as the number of shares
of the Underwritten Stock set forth opposite the name of such Underwriter in
Schedule I hereto represents of the total number of shares of the Underwritten
Stock to be purchased by all Underwriters pursuant to this Agreement, as
adjusted by you in such manner as you deem advisable to avoid fractional shares.
In making this Agreement, each Underwriter is contracting severally and not
jointly; except as provided in paragraphs (b) and (c) of this Section 3, the
agreement of each Underwriter is to purchase only the respective number of
shares of the Underwritten Stock specified in Schedule I.
b) If for any reason one or more of the Underwriters shall fail or refuse
(otherwise than for a reason sufficient to justify the termination of this
Agreement under the provisions of Section 8 or 9 hereof) to purchase and pay for
the number of shares of the Stock agreed to be purchased by such Underwriter or
Underwriters, the Company or the Selling Securityholders shall immediately give
notice thereof to you, and the non-defaulting Underwriters shall have the right
within 24 hours after the receipt by you of such notice to purchase, or procure
one or more other Underwriters to purchase, in such proportions as may be agreed
upon between you and such purchasing Underwriter or Underwriters and upon the
terms herein set forth, all or any part of the shares of the Stock which such
defaulting Underwriter or Underwriters agreed to purchase. If the non-
defaulting Underwriters fail so to make such arrangements with respect to all
such shares and portion, the number of shares of the Stock which each non-
defaulting Underwriter is otherwise obligated to purchase under this Agreement
shall be automatically increased on a pro rata basis to absorb the remaining
shares and portion which the defaulting Underwriter or Underwriters agreed to
purchase; provided, however, that the non-defaulting Underwriters shall not be
obligated to purchase the shares and portion which the defaulting Underwriter or
Underwriters agreed to purchase if the aggregate number of such shares of the
Stock exceeds 10% of the total number of shares of the Stock which all
Underwriters agreed to purchase hereunder. If the total number of shares of the
Stock which the defaulting
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Underwriter or Underwriters agreed to purchase shall not be purchased or
absorbed in accordance with the two preceding sentences, the Company and the
Selling Securityholders shall have the right, within 24 hours next succeeding
the 24-hour period above referred to, to make arrangements with other
underwriters or purchasers satisfactory to you for purchase of such shares and
portion on the terms herein set forth. In any such case, either you or the
Company and the Selling Securityholders shall have the right to postpone the
Closing Date determined as provided in Section 5 hereof for not more than seven
business days after the date originally fixed as the Closing Date pursuant to
said Section 5 in order that any necessary changes in the Registration
Statement, the Prospectus or any other documents or arrangements may be made. If
neither the non-defaulting Underwriters nor the Company and the Selling
Securityholders shall make arrangements within the 24-hour periods stated above
for the purchase of all the shares of the Stock which the defaulting Underwriter
or Underwriters agreed to purchase hereunder, this Agreement shall be terminated
without further act or deed and without any liability on the part of the Company
or the Selling Securityholders to any non-defaulting Underwriter and without any
liability on the part of any non-defaulting Underwriter to the Company or the
Selling Securityholders. Nothing in this paragraph (b), and no action taken
hereunder, shall relieve any defaulting Underwriter from liability in respect of
any default of such Underwriter under this Agreement.
c) On the basis of the representations, warranties and covenants herein
contained, and subject to the terms and conditions herein set forth, the Company
and each Selling Securityholder grant an option to the several Underwriters to
purchase, severally and not jointly, up to the number of shares of Option Stock
set forth in Schedule II opposite the name of the Company and such Selling
Securityholder, at the same price per share as the Underwriters shall pay for
the Underwritten Stock. Said option may be exercised only to cover over-
allotments in the sale of the Underwritten Stock by the Underwriters and may be
exercised in whole or in part at any time (but not more than once) on or before
the thirtieth day after the date of this Agreement upon written or telegraphic
notice by you to the Company setting forth the aggregate number of shares of the
Option Stock as to which the several Underwriters are exercising the option.
Delivery of certificates for the shares of Option Stock, and payment therefor,
shall be made as provided in Section 5 hereof. The number of shares of the
Option Stock to be purchased by each Underwriter shall be the same percentage of
the total number of shares of the Option Stock to be purchased by the several
Underwriters as such Underwriter is purchasing of the Underwritten Stock, as
adjusted by you in such manner as you deem advisable to avoid fractional shares.
4. OFFERING BY UNDERWRITERS.
a) The terms of the initial public offering by the Underwriters of the
Stock to be purchased by them shall be as set forth in the Prospectus. The
Underwriters may from time to time change the public offering price after the
closing of the initial public offering and increase or decrease the concessions
and discounts to dealers as they may determine.
b) The information set forth under "Underwriting" in the Registration
Statement, any Preliminary Prospectus and the Prospectus relating to the Stock
filed by the Company (insofar as such information relates to the Underwriters)
constitutes the only information furnished by the Underwriters to the Company
for inclusion in the Registration Statement (including without limitation the
"Meet the Management" presentation on the E*OFFERING
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website), any Preliminary Prospectus, and the Prospectus, and you on behalf of
the respective Underwriters represent and warrant to the Company that the
statements made therein are correct.
5. DELIVERY OF AND PAYMENT FOR THE STOCK.
a) Delivery of certificates for the shares of the Underwritten Stock and
the Option Stock (if the option granted by Section 3(c) hereof shall have been
exercised not later than 7:00 A.M., San Francisco time, on the date two business
days preceding the Closing Date), and payment therefor, shall be made at the
office of Hale and Dorr LLP, 60 State Street, Boston, Massachusetts 02109, at
7:00 a.m., San Francisco time, on the fourth business day after the date of this
Agreement, or at such time on such other day, not later than seven full business
days after such fourth business day, as shall be agreed upon in writing by the
Company and you. The date and hour of such delivery and payment (which may be
postponed as provided in Section 3(b) hereof) are herein called the Closing
Date.
b) If the option granted by Section 3(c) hereof shall be exercised after
7:00 a.m., San Francisco time, on the date two business days preceding the
Closing Date, delivery of certificates for the shares of Option Stock, and
payment therefor, shall be made at the office of, Hale and Dorr LLP, 60 State
Street, Boston, Massachusetts 02109 at 7:00 a.m., San Francisco time, on the
third business day after the exercise of such option.
c) Payment for the Stock purchased from the Company shall be made to the
Company or its order, and payment for the Stock purchased from the Selling
Securityholders shall be made to the Custodian, for the account of the Selling
Securityholders, in each case by one or more wire transfers or one or more
certified or official bank check or checks in same day funds. Such payment shall
be made upon delivery of certificates for the Stock to you for the respective
accounts of the several Underwriters against receipt therefor signed by you.
Certificates for the Stock to be delivered to you shall be registered in such
name or names and shall be in such denominations as you may request at least one
business day before the Closing Date, in the case of Underwritten Stock, and at
least one business day prior to the purchase thereof, in the case of the Option
Stock. Such certificates will be made available to the Underwriters for
inspection, checking and packaging at the offices of Lewco Securities
Corporation, 2 Broadway, New York, New York 10004 on the business day prior to
the Closing Date or, in the case of the Option Stock, by 3:00 p.m., New York
time, on the business day preceding the date of purchase.
It is understood that you, individually and not on behalf of the
Underwriters, may (but shall not be obligated to) make payment to the Company
and the Selling Securityholders for shares to be purchased by any Underwriter
whose check shall not have been received by you on the Closing Date or any later
date on which Option Stock is purchased for the account of such Underwriter.
Any such payment by you shall not relieve such Underwriter from any of its
obligations hereunder.
6. FURTHER AGREEMENTS OF THE COMPANY. The Company covenants and agrees as
follows:
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a) The Company will (i) prepare and timely file with the Commission under
Rule 424(b) a Prospectus containing information previously omitted at the time
of effectiveness of the Registration Statement in reliance on Rule 430A and (ii)
not file any amendment to the Registration Statement or supplement to the
Prospectus of which you shall not previously have been advised and furnished
with a copy or to which you shall have reasonably objected in writing or which
is not in compliance with the Securities Act or the rules and regulations of the
Commission.
b) The Company will promptly notify each Underwriter in the event of (i)
the request by the Commission for amendment of the Registration Statement or for
supplement to the Prospectus or for any additional information, (ii) the
issuance by the Commission of any stop order suspending the effectiveness of the
Registration Statement, (iii) the institution or notice of intended institution
of any action or proceeding for that purpose, (iv) the receipt by the Company of
any notification with respect to the suspension of the qualification of the
Stock for sale in any jurisdiction, or (v) the receipt by it of notice of the
initiation or threatening of any proceeding for such purpose. The Company will
make every reasonable effort to prevent the issuance of such a stop order and,
if such an order shall at any time be issued, to obtain the withdrawal thereof
at the earliest possible moment.
c) The Company will (i) on or before the Closing Date, deliver to you a
signed copy of the Registration Statement as originally filed and of each
amendment thereto filed prior to the time the Registration Statement becomes
effective and, promptly upon the filing thereof, a signed copy of each
post-effective amendment, if any, to the Registration Statement (together with,
in each case, all exhibits thereto unless previously furnished to you) and will
also deliver to you, for distribution to the Underwriters, a sufficient number
of additional conformed copies of each of the foregoing (but without exhibits)
so that one copy of each may be distributed to each Underwriter, (ii) as
promptly as possible deliver to you and send to the several Underwriters, at
such office or offices as you may designate, as many copies of the Prospectus as
you may reasonably request, and (iii) thereafter from time to time during the
period in which a prospectus is required by law to be delivered by an
Underwriter or dealer, likewise send to the Underwriters as many additional
copies of the Prospectus and as many copies of any supplement to the Prospectus
and of any amended prospectus, filed by the Company with the Commission, as you
may reasonably request for the purposes contemplated by the Securities Act.
d) If at any time during the period in which a prospectus is required by
law to be delivered by an Underwriter or dealer any event relating to or
affecting the Company, or of which the Company shall be advised in writing by
you, shall occur as a result of which it is necessary, in the opinion of counsel
for the Company or of counsel for the Underwriters, to supplement or amend the
Prospectus in order to make the Prospectus not misleading in the light of the
circumstances existing at the time it is delivered to a purchaser of the Stock,
the Company will forthwith prepare and file with the Commission a supplement to
the Prospectus or an amended prospectus so that the Prospectus as so
supplemented or amended will not contain any untrue statement of a material fact
or omit to state any material fact necessary in order to make the statements
therein, in the light of the circumstances existing at the time such Prospectus
is delivered to such purchaser, not misleading. If, after the initial public
offering of the Stock by the Underwriters and during such period, the
Underwriters shall propose to vary the terms of offering thereof by reason of
changes in general market conditions or otherwise,
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you will advise the Company in writing of the proposed variation, and, if in the
opinion of counsel for the Company after entertaining in good faith the views of
counsel for the Underwriters, such proposed variation requires that the
Prospectus be supplemented or amended, the Company will forthwith prepare and
file with the Commission a supplement to the Prospectus or an amended prospectus
setting forth such variation. The Company authorizes the Underwriters and all
dealers to whom any of the Stock may be sold by the several Underwriters to use
the Prospectus, as from time to time amended or supplemented, in connection with
the sale of the Stock in accordance with the applicable provisions of the
Securities Act and the applicable rules and regulations thereunder for such
period.
e) Prior to the filing thereof with the Commission, the Company will submit
to you, for your information, a copy of any post-effective amendment to the
Registration Statement and any supplement to the Prospectus or any amended
prospectus proposed to be filed.
f) The Company will cooperate, when and as requested by you, in the
qualification of the Stock for offer and sale under the securities or blue sky
laws of such jurisdictions as you may designate and, during the period in which
a prospectus is required by law to be delivered by an Underwriter or dealer, in
keeping such qualifications in good standing under said securities or blue sky
laws; provided, however, that the Company shall not be obligated to file any
general consent to service of process or to qualify as a foreign corporation in
any jurisdiction in which it is not so qualified. The Company will, from time to
time, prepare and file such statements, reports, and other documents as are or
may be required to continue such qualifications in effect for so long a period
as you may reasonably request for distribution of the Stock.
g) During a period of five years commencing with the date hereof, the
Company will furnish to you, and to each Underwriter who may so request in
writing, copies of all periodic and special reports furnished to stockholders of
the Company.
h) Not later than the 45th day following the end of the fiscal quarter
first occurring after the first anniversary of the Effective Date, the Company
will make generally available to its security holders an earnings statement in
accordance with Section 11(a) of the Securities Act and Rule 158 thereunder.
i) The Company agrees to pay all costs and expenses incident to the
performance of the Company's and the Selling Stockholders obligations under this
Agreement, including all costs and expenses incident to (i) the preparation,
printing and filing with the Commission and the National Association of
Securities Dealers, Inc. ("NASD") of the Registration Statement, any Preliminary
Prospectus and the Prospectus, (ii) the furnishing to the Underwriters of copies
of any Preliminary Prospectus and of the several documents required by paragraph
(c) of this Section 6 to be so furnished, (iii) the printing of this Agreement
and related documents delivered to the Underwriters, (iv) the preparation,
printing and filing of all supplements and amendments to the Prospectus referred
to in paragraph (d) of this Section 6, (v) the furnishing to you and the
Underwriters of the reports and information referred to in paragraph (g) of this
Section 6 and (vi) the printing and issuance of stock certificates, including
the transfer agent's fees. The Selling Securityholders will pay any transfer
taxes incident to the transfer to the Underwriters of the shares of Stock being
sold by the Selling Securityholders.
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j) The Company agrees to reimburse you, for the account of the several
Underwriters, for blue sky fees and related disbursements (including counsel
fees and disbursements and cost of printing memoranda for the Underwriters) paid
by or for the account of the Underwriters or their counsel in qualifying the
Stock under state securities or blue sky laws and the filing fees incident to
the review of the offering by the NASD.
k) The provisions of paragraphs (i) and (j) of this Section are intended to
relieve the Underwriters from the payment of the expenses and costs which the
Company and the Selling Securityholders hereby agree to pay and shall not affect
any agreement which the Company and the Selling Securityholders may make, or may
have made, for the sharing of any such expenses and costs.
l) The Company and each of the Selling Securityholders hereby agrees that,
without the prior written consent of Hambrecht & Quist LLC on behalf of the
Underwriters, the Company or such Selling Securityholder, as the case may be,
will not, for a period of 180 days following the commencement of the public
offering of the Stock by the Underwriters, directly or indirectly, (i) sell,
offer, contract to sell, make any short sale, pledge, sell any option or
contract to purchase, purchase any option or contract to sell, grant any option,
right or warrant to purchase or otherwise transfer or dispose of any shares of
Common Stock or any securities convertible into or exchangeable or exercisable
for or any rights to purchase or acquire Common Stock or (ii) enter into any
swap or other agreement that transfers, in whole or in part, any of the economic
consequences or ownership of Common Stock, whether any such transaction
described in clause (i) or (ii) above is to be settled by delivery of Common
Stock or such other securities, in cash or otherwise. The foregoing sentence
shall not apply to (a) the Stock to be sold to the Underwriters pursuant to this
Agreement, (b) the issuance by the Company of Common Stock upon the exercise of
an option or warrant, the conversion of a security, or any other contractual
obligation, in each case outstanding on the date hereof and described in the
Prospectus, (c) the issuance by the Company of options to purchase Common Stock
pursuant to any employee benefit plan of the Company that is in existence on the
date hereof and described in the Prospectus, (d) the issuance by the Company of
Common Stock pursuant to any employee benefit plan of the Company that is in
existence on the date hereof and described in the Prospectus, provided that the
recipient of such shares agrees to be bound by the provisions of the foregoing
sentence, (e) the transfer of securities by a Selling Securityholder by gift,
will, intestate succession or partnership distribution for no consideration,
provided that the recipient of such securities agrees to be bound by the
provisions of the foregoing sentence, (g) the transfer of securities by a
Selling Securityholder to his or her immediate family (meaning spouse, lineal
descendent, father, mother, brother, or sister) or to a trust the beneficiaries
of which are exclusively such Selling Stockholders or a member or members of his
or her immediate family, provided that the recipient of such securities (except
for the recipient of securities issued as described in clause (a) above) agrees
to be bound by the provisions of the foregoing sentence.
m) If at any time during the 25-day period after the Registration Statement
becomes effective any rumor, publication or event relating to or affecting the
Company shall occur as a result of which in your opinion the market price for
the Stock has been or is likely to be materially affected (regardless of whether
such rumor, publication or event necessitates a supplement to or amendment of
the Prospectus), the Company will, after written notice from you advising the
Company to the effect set forth above, forthwith prepare, consult with you
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concerning the substance of, and disseminate a press release or other public
statement, reasonably satisfactory to you, responding to or commenting on such
rumor, publication or event.
n) The Company is familiar with the Investment Company Act of 1940, as
amended, and has in the past conducted its affairs, and will in the future
conduct its affairs, in such a manner to ensure that the Company was not and
will not be an "investment company" or a company "controlled" by an "investment
company" within the meaning of the Investment Company Act of 1940, as amended,
and the rules and regulations thereunder.
7. INDEMNIFICATION AND CONTRIBUTION.
a) The Company and the Selling Securityholders jointly and severally agree
to indemnify and hold harmless each Underwriter and each person (including each
partner or officer thereof) who controls any Underwriter within the meaning of
Section 15 of the Securities Act from and against any and all losses, claims,
damages or liabilities, joint or several, to which such indemnified parties or
any of them may become subject under the Securities Act, the Exchange Act, or
the common law or otherwise, and the Company and the Selling Securityholders
jointly and severally agree to reimburse each such Underwriter and controlling
person for any legal or other expenses (including, except as otherwise
hereinafter provided, reasonable fees and disbursements of counsel) incurred by
the respective indemnified parties in connection with defending against any such
losses, claims, damages or liabilities or in connection with any investigation
or inquiry of, or other proceeding which may be brought against, the respective
indemnified parties, in each case arising out of or based upon (i) any untrue
statement or alleged untrue statement of a material fact contained in the
Registration Statement (including the Prospectus as part thereof and any Rule
462(b) registration statement) or any post-effective amendment thereto
(including any Rule 462(b) registration statement), or the omission or alleged
omission to state therein a material fact required to be stated therein or
necessary to make the statements therein not misleading, or (ii) any untrue
statement or alleged untrue statement of a material fact contained in any
Preliminary Prospectus or the Prospectus (as amended or as supplemented if the
Company shall have filed with the Commission any amendment thereof or supplement
thereto) or the omission or alleged omission to state therein a material fact
necessary in order to make the statements therein, in the light of the
circumstances under which they were made, not misleading; provided, however,
that (1) the indemnity agreements of the Company and the Selling Securityholders
contained in this paragraph (a) shall not apply to any such losses, claims,
damages, liabilities or expenses if such statement or omission was made in
reliance upon and in conformity with information furnished as herein stated or
otherwise furnished in writing to the Company by or on behalf of any Underwriter
for use in any Preliminary Prospectus or the Registration Statement or the
Prospectus or any such amendment thereof or supplement thereto, (2) the
indemnity agreement contained in this paragraph (a) with respect to any
Preliminary Prospectus shall not inure to the benefit of any Underwriter from
whom the person asserting any such losses, claims, damages, liabilities or
expenses purchased the Stock which is the subject thereof (or to the benefit of
any person controlling such Underwriter) if at or prior to the written
confirmation of the sale of such Stock a copy of the Prospectus (or the
Prospectus as amended or supplemented) was not sent or delivered to such person
and the untrue statement or omission of a material fact contained in such
Preliminary Prospectus was corrected in the Prospectus (or the Prospectus as
amended or supplemented) unless the failure is the result of noncompliance by
the Company with paragraph
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(c) of Section 6 hereof, and (3) each Selling Securityholder shall only be
liable under this paragraph with respect to (A) information pertaining to such
Selling Securityholder furnished by or on behalf of such Selling Securityholder
expressly for use in any Preliminary Prospectus or the Registration Statement or
the Prospectus or any such amendment thereof or supplement thereto or (B) facts
that would constitute a breach of any representation or warranty of such Selling
Securityholder set forth in Section 2(b) hereof; and further provided that each
Selling Securityholder's aggregate liability under this Agreement shall be
limited to an amount equal to the net proceeds (after deducting the underwriting
discount, but before deducting expenses), if any, received by such Selling
Securityholder from the sale of the stock. The indemnity agreements of the
Company and the Selling Securityholders contained in this paragraph (a) and the
representations and warranties of the Company and the Selling Securityholders
contained in Section 2 hereof shall remain operative and in full force and
effect regardless of any investigation made by or on behalf of any indemnified
party and shall survive the delivery of and payment for the Stock.
b) Each Underwriter severally agrees to indemnify and hold harmless the
Company, each of its officers who signs the Registration Statement on his own
behalf or pursuant to a power of attorney, each of its directors, each other
Underwriter and each person (including each partner or officer thereof) who
controls the Company or any such other Underwriter within the meaning of Section
15 of the Securities Act, and the Selling Securityholders from and against any
and all losses, claims, damages or liabilities, joint or several, to which such
indemnified parties or any of them may become subject under the Securities Act,
the Exchange Act, or the common law or otherwise and to reimburse each of them
for any legal or other expenses (including, except as otherwise hereinafter
provided, reasonable fees and disbursements of counsel) incurred by the
respective indemnified parties in connection with defending against any such
losses, claims, damages or liabilities or in connection with any investigation
or inquiry of, or other proceeding which may be brought against, the respective
indemnified parties, in each case arising out of or based upon (i) any untrue
statement or alleged untrue statement of a material fact contained in the
Registration Statement (including the Prospectus as part thereof and any Rule
462(b) registration statement) or any post-effective amendment thereto
(including any Rule 462(b) registration statement) or the omission or alleged
omission to state therein a material fact required to be stated therein or
necessary to make the statements therein not misleading or (ii) any untrue
statement or alleged untrue statement of a material fact contained in the
Prospectus (as amended or as supplemented if the Company shall have filed with
the Commission any amendment thereof or supplement thereto) or the omission or
alleged omission to state therein a material fact necessary in order to make the
statements therein, in the light of the circumstances under which they were
made, not misleading, if such statement or omission was made in reliance upon
and in conformity with information furnished as herein stated or otherwise
furnished in writing to the Company by or on behalf of such indemnifying
Underwriter for use in the Registration Statement or the Prospectus or any such
amendment thereof or supplement thereto. The indemnity agreement of each
Underwriter contained in this paragraph (b) shall remain operative and in full
force and effect regardless of any investigation made by or on behalf of any
indemnified party and shall survive the delivery of and payment for the Stock.
c) Each party indemnified under the provision of paragraphs (a) and (b) of
this Section 7 agrees that, upon the service of a summons or other initial legal
process upon it in any action or suit instituted against it or upon its receipt
of written notification of the
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commencement of any investigation or inquiry of, or proceeding against, it in
respect of which indemnity may be sought on account of any indemnity agreement
contained in such paragraphs, it will promptly give written notice (herein
called the Notice) of such service or notification to the party or parties from
whom indemnification may be sought hereunder. No indemnification provided for in
such paragraphs shall be available to any party who shall fail so to give the
Notice if the party to whom such Notice was not given was unaware of the action,
suit, investigation, inquiry or proceeding to which the Notice would have
related and was prejudiced by the failure to give the Notice, but the omission
so to notify such indemnifying party or parties of any such service or
notification shall not relieve such indemnifying party or parties from any
liability which it or they may have to the indemnified party for contribution or
otherwise than on account of such indemnity agreement. It is understood that the
indemnifying party shall not, in connection with any proceeding or related
proceedings in the same jurisdiction, be liable for the reasonable fees and
expenses of more than one separate firm for all such indemnified parties. Such
firm shall be designated by you in the case of parties indemnified pursuant to
Section 7(a) and by the Company and the Selling Securityholders in the case of
parties indemnified pursuant to Section 7(b). Any indemnifying party shall be
entitled at its own expense to participate in the defense of any action, suit or
proceeding against, or investigation or inquiry of, an indemnified party. Any
indemnifying party shall be entitled, if it so elects within a reasonable time
after receipt of the Notice by giving written notice (herein called the Notice
of Defense) to the indemnified party, to assume (alone or in conjunction with
any other indemnifying party or parties) the entire defense of such action,
suit, investigation, inquiry or proceeding, in which event such defense shall be
conducted, at the expense of the indemnifying party or parties, by counsel
chosen by such indemnifying party or parties and reasonably satisfactory to the
indemnified party or parties; provided, however, that (i) if the indemnified
party or parties reasonably determine that there may be a conflict between the
positions of the indemnifying party or parties and of the indemnified party or
parties in conducting the defense of such action, suit, investigation, inquiry
or proceeding or that there may be legal defenses available to such indemnified
party or parties different from or in addition to those available to the
indemnifying party or parties, then counsel for the indemnified party or parties
shall be entitled to conduct the defense to the extent reasonably determined by
such counsel to be necessary to protect the interests of the indemnified party
or parties and (ii) in any event, the indemnified party or parties shall be
entitled to have counsel chosen by such indemnified party or parties participate
in, but not conduct, the defense. If, within a reasonable time after receipt of
the Notice, an indemnifying party gives a Notice of Defense and the counsel
chosen by the indemnifying party or parties is reasonably satisfactory to the
indemnified party or parties, the indemnifying party or parties will not be
liable under paragraphs (a) through (c) of this Section 7 for any legal or other
expenses subsequently incurred by the indemnified party or parties in connection
with the defense of the action, suit, investigation, inquiry or proceeding,
except that (A) the indemnifying party or parties shall bear the legal and other
expenses incurred in connection with the conduct of the defense as referred to
in clause (i) of the proviso to the preceding sentence and (B) the indemnifying
party or parties shall bear such other expenses as it or they have authorized to
be incurred by the indemnified party or parties. If, within a reasonable time
after receipt of the Notice, no Notice of Defense has been given, the
indemnifying party or parties shall be responsible for any legal or other
expenses incurred by the indemnified party or parties in connection with the
defense of the action, suit, investigation, inquiry or proceeding.
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d) If the indemnification provided for in this Section 7 is unavailable or
insufficient to hold harmless an indemnified party under paragraph (a) or (b) of
this Section 7, then each indemnifying party, in lieu of indemnifying such
indemnified party, shall contribute to the amount paid or payable by such
indemnified party as a result of the losses, claims, damages or liabilities
referred to in paragraph (a) or (b) of this Section 7 (i) in such proportion as
is appropriate to reflect the relative benefits received by each indemnifying
party from the offering of the Stock or (ii) if the allocation provided by
clause (i) above is not permitted by applicable law, in such proportion as is
appropriate to reflect not only the relative benefits referred to in clause (i)
above but also the relative fault of each indemnifying party in connection with
the statements or omissions that resulted in such losses, claims, damages or
liabilities, or actions in respect thereof, as well as any other relevant
equitable considerations. The relative benefits received by the Company and the
Selling Securityholders on the one hand and the Underwriters on the other shall
be deemed to be in the same respective proportions as the total net proceeds
from the offering of the Stock received by the Company and the Selling
Securityholders and the total underwriting discount received by the
Underwriters, as set forth in the table on the cover page of the Prospectus,
bear to the aggregate public offering price of the Stock. Relative fault shall
be determined by reference to, among other things, whether the untrue or alleged
untrue statement of a material fact or the omission or alleged omission to state
a material fact relates to information supplied by each indemnifying party and
the parties' relative intent, knowledge, access to information and opportunity
to correct or prevent such untrue statement or omission.
The parties agree that it would not be just and equitable if contributions
pursuant to this paragraph (d) were to be determined by pro rata allocation
(even if the Underwriters were treated as one entity for such purpose) or by any
other method of allocation which does not take into account the equitable
considerations referred to in the first sentence of this paragraph (d). The
amount paid by an indemnified party as a result of the losses, claims, damages
or liabilities, or actions in respect thereof, referred to in the first sentence
of this paragraph (d) shall be deemed to include any legal or other expenses
reasonably incurred by such indemnified party in connection with investigation,
preparing to defend or defending against any action or claim which is the
subject of this paragraph (d). Notwithstanding the provisions of this paragraph
(d), no Underwriter shall be required to contribute any amount in excess of the
underwriting discount applicable to the Stock purchased by such Underwriter. No
person guilty of fraudulent misrepresentation (within the meaning of Section
11(f) of the Securities Act) shall be entitled to contribution from any person
who was not guilty of such fraudulent misrepresentation. The Underwriters'
obligations in this paragraph (d) to contribute are several in proportion to
their respective underwriting obligations and not joint.
Each party entitled to contribution agrees that upon the service of a
summons or other initial legal process upon it in any action instituted against
it in respect of which contribution may be sought, it will promptly give written
notice of such service to the party or parties from whom contribution may be
sought, but the omission so to notify such party or parties of any such service
shall not relieve the party from whom contribution may be sought from any
obligation it may have hereunder or otherwise (except as specifically provided
in paragraph (c) of this Section 7).
e) Neither the Company nor the Selling Securityholders will, without the
prior written consent of each Underwriter, settle or compromise or consent to
the entry of any judgment in any pending or threatened claim, action, suit or
proceeding in respect of which
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<PAGE>
indemnification may be sought hereunder (whether or not such Underwriter or any
person who controls such Underwriter within the meaning of Section 15 of the
Securities Act or Section 20 of the Exchange Act is a party to such claim,
action, suit or proceeding) unless such settlement, compromise or consent
includes an unconditional release of such Underwriter and each such controlling
person from all liability arising out of such claim, action, suit or proceeding.
8. TERMINATION. This Agreement may be terminated by you at any time prior
to the Closing Date by giving written notice to the Company and the Selling
Securityholders if after the date of this Agreement trading in the Common Stock
shall have been suspended, or if there shall have occurred (i) the engagement in
hostilities or an escalation of major hostilities by the United States or the
declaration of war or a national emergency by the United States on or after the
date hereof, (ii) any outbreak of hostilities or other national or international
calamity or crisis or change in economic or political conditions if the effect
of such outbreak, calamity, crisis or change in economic or political conditions
in the financial markets of the United States would, in the Underwriters'
reasonable judgment, make the offering or delivery of the Stock impracticable,
(iii) suspension of trading in securities generally or a material adverse
decline in value of securities generally on the New York Stock Exchange, the
American Stock Exchange, or The Nasdaq Stock Market, or limitations on prices
(other than limitations on hours or numbers of days of trading) for securities
on either such exchange or system, (iv) the enactment, publication, decree or
other promulgation of any federal or state statute, regulation, rule or order
of, or commencement of any proceeding or investigation by, any court,
legislative body, agency or other governmental authority which in the
Underwriters' reasonable opinion materially and adversely affects or will
materially or adversely affect the business or operations of the Company, (v)
declaration of a banking moratorium by either federal or New York State
authorities or (vi) the taking of any action by any federal, state or local
government or agency in respect of its monetary or fiscal affairs which in the
Underwriters' reasonable opinion has a material adverse effect on the securities
markets in the United States. If this Agreement shall be terminated pursuant to
this Section 8, there shall be no liability of the Company or the Selling
Securityholders to the Underwriters and no liability of the Underwriters to the
Company or the Selling Securityholders; except for the costs and expenses
referred to in paragraphs (i) and (j) of Section 6 hereof.
9. CONDITIONS OF UNDERWRITERS' OBLIGATIONS. The obligations of the several
Underwriters to purchase and pay for the Stock shall be subject to the
performance by the Company and by the Selling Securityholders of all their
respective obligations to be performed hereunder at or prior to the Closing Date
or any later date on which Option Stock is to be purchased, as the case may be,
and to the following further conditions:
a) The Registration Statement shall have become effective; and no stop
order suspending the effectiveness thereof shall have been issued and no
proceedings therefor shall be pending or threatened by the Commission.
b) The legality and sufficiency of the sale of the Stock hereunder and the
validity and form of the certificates representing the Stock, all corporate
proceedings and other legal matters incident to the foregoing, shall have been
approved at or prior to the Closing Date by Hale and Dorr LLP, counsel for the
Underwriters.
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c) You shall have received from Testa, Hurwitz & Thibeault, LLP, counsel
for the Company and the Selling Securityholders, and from Fish & Richardson,
P.C., patent counsel to the Company, opinions, addressed to the Underwriters and
dated the Closing Date, covering the matters set forth in Annex A and Annex B
hereto, respectively, and if Option Stock is purchased at any date after the
Closing Date, an additional opinion from each such counsel, addressed to the
Underwriters and dated such later date, confirming that the statements expressed
as of the Closing Date in such opinions remain valid as of such later date.
d) You shall be satisfied that (i) as of the Effective Date, the statements
made in the Registration Statement and the Prospectus were true and correct and
neither the Registration Statement nor the Prospectus omitted to state any
material fact required to be stated therein or necessary in order to make the
statements therein, respectively, not misleading, (ii) since the Effective Date,
no event has occurred which should have been set forth in a supplement or
amendment to the Prospectus which has not been set forth in such a supplement or
amendment, (iii) since the respective dates as of which information is given in
the Registration Statement in the form in which it originally became effective
and the Prospectus contained therein, there has not been any material adverse
change or any development involving a prospective material adverse change in or
affecting the business, properties, financial condition or results of operations
of the Company, whether or not arising from transactions in the ordinary course
of business, and, since such dates, except in the ordinary course of business,
the Company has not entered into any material transaction not referred to in the
Registration Statement in the form in which it originally became effective and
the Prospectus contained therein, (iv) the Company does not have any material
contingent obligations which are not disclosed in the Registration Statement and
the Prospectus, (v) there are not any pending or known threatened legal
proceedings to which the Company is a party or of which property of the Company
or any of its subsidiaries is the subject which are material and which are not
disclosed in the Registration Statement and the Prospectus, (vi) there are not
any franchises, contracts, leases or other documents which are required to be
filed as exhibits to the Registration Statement which have not been filed as
required, (vii) the representations and warranties of the Company herein are
true and correct in all material respects as of the Closing Date or any later
date on which Option Stock is to be purchased, as the case may be, and (viii)
there has not been any material change in the market for securities in general
or in political, financial or economic conditions from those reasonably
foreseeable as to render it impracticable in your reasonable judgment to make a
public offering of the Stock, or a material adverse change in market levels for
securities in general (or those of companies in particular) or financial or
economic conditions which render it inadvisable in your reasonable judgment to
proceed.
e) You shall have received on the Closing Date and on any later date on
which Option Stock is purchased a certificate, dated the Closing Date or such
later date, as the case may be, and signed by the President and the Chief
Financial Officer of the Company, stating that the respective signers of said
certificate have carefully examined the Registration Statement in the form in
which it originally became effective and the Prospectus contained therein and
any supplements or amendments thereto, and that the statements included in
clauses (i) through (vii) of paragraph (d) of this Section 9 are true and
correct.
f) You shall have received from PricewaterhouseCoopers LLP, a letter or
letters, addressed to the Underwriters and dated the Closing Date and any later
date on which Option Stock is purchased, confirming that they are independent
public accountants with respect to the
18
<PAGE>
Company within the meaning of the Securities Act and the applicable published
rules and regulations thereunder and based upon the procedures described in
their letter delivered to you concurrently with the execution of this Agreement
(herein called the Original Letter), but carried out to a date not more than
three business days prior to the Closing Date or such later date on which Option
Stock is purchased (i) confirming, to the extent true, that the statements and
conclusions set forth in the Original Letter are accurate as of the Closing Date
or such later date, as the case may be, and (ii) setting forth any revisions and
additions to the statements and conclusions set forth in the Original Letter
which are necessary to reflect any changes in the facts described in the
Original Letter since the date of the Original Letter or to reflect the
availability of more recent financial statements, data or information. The
letters shall not disclose any change, or any development involving a
prospective change, in or affecting the business or properties of the Company
which, in your sole judgment, makes it impractical or inadvisable to proceed
with the public offering of the Stock or the purchase of the Option Stock as
contemplated by the Prospectus.
g) You shall have been furnished evidence in usual written or telegraphic
form from the appropriate authorities of the several jurisdictions, or other
evidence satisfactory to you, of the qualification referred to in paragraph (f)
of Section 6 hereof.
h) Prior to the Closing Date, the Stock to be issued and sold by the
Company shall have been duly authorized for listing by the Nasdaq National
Market upon official notice of issuance.
i) On or prior to the Closing Date, you shall have received from all
directors, officers, and stockholders listed on Schedule III hereto, agreements,
in form reasonably satisfactory to Hambrecht & Quist LLC, stating that without
the prior written consent of Hambrecht & Quist LLC on behalf of the
Underwriters, such person or entity will not, for a period of 180 days following
the commencement of the public offering of the Stock by the Underwriters,
directly or indirectly, (i) sell, offer, contract to sell, make any short sale,
pledge, sell any option or contract to purchase, purchase any option or contract
to sell, grant any option, right or warrant to purchase or otherwise transfer or
dispose of any shares of Common Stock or any securities convertible into or
exchangeable or exercisable for or any rights to purchase or acquire Common
Stock or (ii) enter into any swap or other agreement that transfers, in whole or
in part, any of the economic consequences or ownership of Common Stock, whether
any such transaction described in clause (i) or (ii) above is to be settled by
delivery of Common Stock or such other securities, in cash or otherwise.
All the agreements, opinions, certificates and letters mentioned above or
elsewhere in this Agreement shall be deemed to be in compliance with the
provisions hereof only if Hale and Dorr LLP, counsel for the Underwriters, shall
be satisfied that they comply in form and scope.
In case any of the conditions specified in this Section 9 shall not be
fulfilled, this Agreement may be terminated by you by giving notice to the
Company, on behalf of itself and the Selling Securityholders. Any such
termination shall be without liability of the Company or the Selling
Securityholders to the Underwriters and without liability of the Underwriters to
the Company or the Selling Securityholders; provided, however, that (i) in the
event of such termination, the Company and the Selling Securityholders agree to
reimburse the Underwriters for all costs and expenses referred to in paragraphs
(i) and (j) of Section 6 hereof, and (ii) if this Agreement is terminated by you
because of any refusal, inability or failure on the part of the
19
<PAGE>
Company or the Selling Securityholders to perform any agreement herein, to
fulfill any of the conditions herein, or to comply with any provision hereof
other than by reason of a default by any of the Underwriters, the Company will
reimburse the Underwriters severally upon demand for all out-of-pocket expenses
(including reasonable fees and disbursements of counsel) that shall have been
incurred by them in connection with the transactions contemplated hereby.
10. CONDITIONS OF THE OBLIGATION OF THE COMPANY AND THE SELLING
SECURITYHOLDERS. The obligation of the Company and the Selling Securityholders
to deliver the Stock shall be subject to the conditions that (a) the
Registration Statement shall have become effective and (b) no stop order
suspending the effectiveness thereof shall be in effect and no proceedings
therefor shall be pending or threatened by the Commission.
In case either of the conditions specified in this Section 10 shall not be
fulfilled, this Agreement may be terminated by the Company and the Selling
Securityholders by giving notice to you. Any such termination shall be without
liability of the Company and the Selling Securityholders to the Underwriters and
without liability of the Underwriters to the Company or the Selling
Securityholders; provided, however, that in the event of any such termination
the Company and the Selling Securityholders jointly and severally agree to
indemnify and hold harmless the Underwriters from all costs or expenses incident
to the performance of the obligations of the Company and the Selling
Securityholders under this Agreement, including all costs and expenses referred
to in paragraphs (i) and (j) of Section 6 hereof.
11. PERSONS ENTITLED TO BENEFIT OF AGREEMENT. This Agreement shall inure to
the benefit of the Company, the Selling Securityholders and the several
Underwriters and, with respect to the provisions of Section 7 hereof, the
several parties (in addition to the Company, the Selling Securityholders and the
several Underwriters) indemnified under the provisions of said Section 7, and
their respective personal representatives, successors and assigns. Nothing in
this Agreement is intended or shall be construed to give to any other person,
firm or corporation any legal or equitable remedy or claim under or in respect
of this Agreement or any provision herein contained. The term "successors and
assigns" as herein used shall not include any purchaser, as such purchaser, of
any of the Stock from any of the several Underwriters.
12. Notices. Except as otherwise provided herein, all communications
hereunder shall be in writing or by telegraph and, if to the Underwriters, shall
be mailed, telegraphed or delivered to Hambrecht & Quist LLC, One Bush Street,
San Francisco, California 94104; and if to the Company, shall be mailed,
telegraphed or delivered to it at its office, 200 Highland Avenue, Needham, MA
02494, Attention: David A. Blohm, President and Chief Executive Officer; and if
to the Selling Securityholders, shall be mailed, telegraphed or delivered to the
Selling Securityholders in care of the Company, 200 Highland Avenue, Needham, MA
02494, Attention: David A. Blohm, President and Chief Executive Officer, Inc.
All notices given by telegraph shall be promptly confirmed by letter.
13. Miscellaneous. The reimbursement, indemnification and contribution
agreements contained in this Agreement and the representations, warranties and
covenants in this Agreement shall remain in full force and effect regardless of
(a) any termination of this Agreement, (b) any investigation made by or on
behalf of any Underwriter or controlling person thereof, or by or on behalf of
the Company or the Selling Securityholders or their respective directors or
officers, and (c) delivery and payment for the Stock under this Agreement;
20
<PAGE>
provided, however, that if this Agreement is terminated prior to the Closing
- -----------------
Date, the provisions of paragraphs (l) and (n) of Section 6 hereof shall be of
no further force or effect.
This Agreement may be executed in two or more counterparts, each of which
shall be deemed an original, but all of which together shall constitute one and
the same instrument.
This Agreement shall be governed by, and construed in accordance with, the
laws of the State of California.
21
<PAGE>
Please sign and return to the Company and to the Selling Securityholders in
care of the Company the enclosed duplicates of this letter, whereupon this
letter will become a binding agreement among the Company, the Selling
Securityholders and the several Underwriters in accordance with its terms.
Very truly yours,
SMARTERKIDS.COM, INC.
By __________________________
David A. Blohm
President and Chief Financial Officer
SELLING SECURITYHOLDERS:
By _____________________________
Name: David A. Blohm
Attorney-in-Fact
The foregoing Agreement is hereby confirmed
and accepted as of the date first above written.
HAMBRECHT & QUIST LLC
U.S. BANCORP PIPER JAFFRAY INC.
E*OFFERING CORP.
By Hambrecht & Quist LLC
By __________________________
__________________________, Managing Director
Acting on behalf of the several Underwriters,
including themselves, named in Schedule I hereto.
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<PAGE>
SCHEDULE I
UNDERWRITERS
NUMBER OF
SHARES TO BE
UNDERWRITERS PURCHASED
- ------------
Hambrecht & Quist LLC . . . . . . . . . . . . . . . . . . . . .
U.S. Bancorp Piper Jaffray Inc. . . . . . . . . . . . . . . . .
E*OFFERING Corp . . . . . . . . . . . . . . . . . . . . . . . .
Total. . . . . . . . . . . . . . . . . . . . . . . . . . . _______________
23
<PAGE>
SCHEDULE II
SELLING SECURITYHOLDERS
NAME AND ADDRESS NUMBER OF SHARES
OF SELLING SECURITYHOLDERS TO BE SOLD
Total. . . . . . . . . . . . . . . . . . . ________________
24
<PAGE>
SCHEDULE III
STOCKHOLDERS SIGNING LOCK-UP AGREEMENT
25
<PAGE>
ANNEX A
MATTERS TO BE COVERED IN THE OPINION OF
COUNSEL FOR THE COMPANY
AND THE SELLING SECURITYHOLDERS
(i) The Company has been duly incorporated and is validly existing as
a corporation in good standing under the laws of Delaware, is duly
qualified as a foreign corporation and in good standing in Massachusetts
and has full corporate power and authority to own or lease its properties
and conduct its business as described in the Registration Statement;
(ii) Following the closing of the sale of the Stock under the
Underwriting Agreement, the authorized capital stock of the Company
consists of _________ shares of Preferred Stock, of which there are
outstanding _______ shares, and ________ shares of Common Stock, $____ par
value, of which there are outstanding ____________ shares (including the
Underwritten Stock plus the number of shares of Option Stock issued on the
date hereof); proper corporate proceedings have been taken validly to
authorize such authorized capital stock; all of the outstanding shares of
such capital stock (including the Underwritten Stock and the shares of
Option Stock issued, if any) have been duly and validly issued and are
fully paid and nonassessable; any Option Stock purchased after the Closing
Date, when issued and delivered to and paid for by the Underwriters as
provided in the Underwriting Agreement, will have been duly and validly
issued and be fully paid and nonassessable; and no preemptive rights of, or
rights of refusal in favor of, stockholders exist with respect to the
Stock, or the issue and sale thereof, pursuant to the Certificate of
Incorporation or Bylaws (each as amended and restated to date) of the
Company that have not been waived and, to the knowledge of such counsel,
there are no contractual preemptive rights, rights of first refusal or
rights of co-sale which exist with respect to the Stock being sold by the
Selling Securityholders or the issue and sale of the Stock that have not
been waived;
(iii) the Registration Statement has become effective under the
Securities Act and, to such counsel's knowledge, no stop order suspending
the effectiveness of the Registration Statement or suspending or preventing
the use of the Prospectus is in effect and to such counsel's knowledge no
proceedings for that purpose have been instituted or are pending or
contemplated by the Commission;
(iv) the Registration Statement and the Prospectus (except as to the
financial statements and schedules and other financial data contained
therein, as to which such counsel need express no opinion) comply as to
form in all material respects with the requirements of the Securities Act,
the Exchange Act and with the rules and regulations of the Commission
thereunder;
(v) the information required to be set forth in the Registration
Statement in answer to Items 9 and 10 (insofar as it relates to such
counsel) and 11(c) (except with respect to intellectual property issues) of
Form S-1 is to the best of such counsel's knowledge accurately and
adequately set forth therein in all material respects or no
26
<PAGE>
response is required with respect to such Items; and the description of the
Company's stock option plans and the options granted and which may be
granted thereunder and the options granted otherwise than under such plans
set forth in the Prospectus accurately and fairly presents the information
required to be shown with respect to said plans and options to the extent
required by the Securities Act and the rules and regulations of the
Commission thereunder;
(vi) such counsel do not know of any franchises, contracts, leases,
documents or legal proceedings, pending or threatened, which in the opinion
of such counsel are of a character required to be described in the
Registration Statement or the Prospectus or to be filed as exhibits to the
Registration Statement, which are not described and filed as required;
(vii) the Underwriting Agreement has been duly authorized, executed
and delivered by the Company;
OR
(viii) based insofar as factual matters are concerned solely upon
certificates of the Selling Securityholders, the accuracy of which we have
no reason to question, (A) the Underwriting Agreement has been duly
executed and delivered by or on behalf of each of the Selling
Securityholders; (B) the Custody Agreement between the Selling
Securityholders and the Company, as Custodian, and the Power of Attorney
referred to in such Custody Agreement have been duly executed and delivered
by such Selling Securityholder; (C) the Custody Agreement entered into by,
and the Power of Attorney given by, such Selling Securityholder is valid
and binding on such Selling Securityholder; and (D) each Selling
Securityholder has full legal right and authority to enter into the
Underwriting Agreement;
(ix) the issue and sale by the Company of the shares of Stock sold by
the Company as contemplated by the Underwriting Agreement will not conflict
with, or result in a breach of, the Certificate of Incorporation or Bylaws
of the Company or any agreement or instrument set forth on the Exhibit
Index to the Registration Statement to which the Company is a party or any
applicable law or regulation, or so far as is known to such counsel, any
order, writ, injunction or decree, of any jurisdiction, court or
governmental instrumentality;
(x) all holders of securities of the Company having rights to the
registration of shares of Common Stock, or other securities known to such
counsel, because of the filing of the Registration Statement by the Company
have waived such rights or such rights have expired by reason of lapse of
time following notification of the Company's intent to file the
Registration Statement;
(xi) Upon the Underwriters obtaining control of the Stock sold by the
Selling Stockholders, and assuming that the Underwriters acquired such
Stock for value and without notice of any adverse claim to such Stock
within the meaning of Section 8-102 of the Uniform Commercial Code as in
effect in the Commonwealth of Massachusetts,
27
<PAGE>
the Underwriters will have acquired all rights of the Selling Stockholders
in such Stock free of any adverse claim;
(xii) no consent, approval, authorization or order of any court or
governmental agency or body is required for the consummation of the
transactions contemplated in the Underwriting Agreement, except such as
have been obtained under the Securities Act and such as may be required
under state securities or blue sky laws in connection with the purchase and
distribution of the Stock by the Underwriters; and
(xiii) the Stock sold by the Selling Securityholders is listed and
duly admitted to trading on the Nasdaq National Market, and the Stock
issued and sold by the Company will been duly authorized for listing by the
Nasdaq National Market, upon official notice of issuance.
During the course of the preparation of the Registration Statement, we
participated in conferences with officials and representatives of the
Company, representatives of the Underwriters, counsel for the Underwriters
and PricewaterhouseCoopers LLP, the independent certified public
accountants of the Company, at which the contents of the Registration
Statements and Prospectus and related matters were discussed. Although we
have not verified the accuracy or completeness of the statements contained
in the Registration Statement or the Prospectus or passed upon or assumed
any responsibility for the accuracy or completeness of the statements
contained in the Registration Statement or the Prospectus, no facts have
come to our attention that lead us to believe that, at the time the
Registration Statement became effective and at the Closing Date, the
Registration Statement (except as to the financial statements and schedules
and other financial data contained or incorporated by reference therein, as
to which such counsel need not express any opinion or belief) at the
Effective Date contained any untrue statement of a material fact or omitted
to state a material fact required to be stated therein or necessary to make
the statements therein not misleading, or that the Prospectus (except as to
the financial statements and schedules and other financial data contained
or incorporated by reference therein, as to which such counsel need not
express any opinion or belief) as of its date or at the Closing Date (or
any later date on which Option Stock is purchased), contained any untrue
statement of a material fact or omitted or omits to state a material fact
necessary in order to make the statements therein, in light of the
circumstances under which they were made, not misleading.
____________________________________
Counsel rendering the foregoing opinion may rely as to questions of law not
involving the laws of the United States or of the State of Delaware or of the
Commonwealth of Massachusetts, upon opinions of local counsel satisfactory in
form and scope to counsel for the Underwriters. Copies of any opinions so
relied upon shall be delivered to the Underwriters and to counsel for the
Underwriters and the foregoing opinion shall also state that counsel knows of no
reason the Underwriters are not entitled to rely upon the opinions of such local
counsel.
28
<PAGE>
ANNEX B
MATTERS TO BE COVERED IN THE OPINION OF
PATENT COUNSEL FOR THE COMPANY
Such counsel are familiar with the technology used by the Company in its
business and the manner of its use thereof and have read the Registration
Statement and the Prospectus, including particularly the portions of the
Registration Statement and the Prospectus referring to patents, trade secrets,
trademarks, service marks or other proprietary information or materials and:
(i) The statements in the Registration Statement and the Prospectus under
the captions "Risk Factors A third party has claimed that our SmartPicks
technology infringes his intellectual property," "Risk Factors
Intellectual property claims against us can be costly and result in the
loss of significant rights," "Business Intellectual Property" and
"Business Legal Proceedings," to the best of such counsel's knowledge and
belief, are accurate and complete statements or summaries of the matters
therein set forth, and nothing has come to such counsel's attention that
causes such counsel to believe that the above-described portions of the
Registration Statement and the Prospectus contain any untrue statement of a
material fact or omit to state a material fact required to be stated
therein or necessary in order to make the statements therein, in light of
the circumstances under which they were made, not misleading; and
(ii) to the best of such counsel's knowledge and except as set forth in
the Prospectus under the caption "Business Legal Proceedings," there are
no legal or governmental proceedings pending relating to patent rights,
trade secrets, trademarks, service marks or other proprietary information
or materials of the Company, and to the best of such counsel's knowledge no
such proceedings are threatened or contemplated by governmental authorities
or others.
29
<PAGE>
Exhibit 5.1
-----------
Testa, Hurwitz & Thibeault, LLP
November 17, 1999
SmarterKids.com, Inc.
200 Highland Avenue
Needham, MA 02494
RE: Registration Statement on Form S-1
(File No. 333-86787)
----------------------------------
Ladies and Gentlemen:
This opinion relates to an aggregate of 5,175,000 shares of common stock,
par value $.01 per share ("common stock"), of SmarterKids.com, Inc. (the
"Company"), which are the subject matter of a Registration Statement on Form S-1
as filed with the Securities and Exchange Commission (the "Commission") on
September 9, 1999, as amended (the "Registration Statement").
The 5,175,000 shares of common stock covered by the Registration Statement
consist of 5,158,500 shares being sold by the Company, of which 658,500 shares
are subject to an over-allotment option granted by the Company to the
underwriters (the "Underwriters") named in the prospectus (the "Prospectus")
incorporated by reference in the Registration Statement and 16,500 shares
subject to an over-allotment option granted by certain stockholders of the
Company to the Underwriters.
Based upon such investigation as we have deemed necessary, we are of the
opinion that when the 5,158,500 shares of common stock to be sold by the Company
pursuant to the Prospectus have been issued and paid for in accordance with the
terms described in the Prospectus, such shares of common stock will have been
validly issued and will be fully paid and nonassessable. Further, we are of the
opinion that the 16,500 shares of common stock to be sold by the stockholders of
the Company pursuant to the Prospectus have been validly issued and are fully
paid and nonassessable.
We hereby consent to the filing of this opinion as Exhibit 5.1 to the
Registration Statement and to the reference to our firm in the Prospectus under
the caption "Legal Matters."
Very truly yours,
/S/ Testa, Hurwitz & Thibeault, LLP
TESTA, HURWITZ & THIBEAULT, LLP
<PAGE>
EXHIBIT 10.12
-------------
SmarterKids.com(TM)
NCS and SmarterKids.com
Business Agreement
Version 1.0
March 9, 1999
<PAGE>
Overview
1.1 NCS:
National Computer Systems, a global information services company providing
software, services and systems for the collection, management and interpretation
of data. NCS http://www.ncs.com serves important segments of the education,
------------------
testing, assessment and complex data management markets.
NCS is the world's largest commercial processor of educational measurement
instruments, processing and scoring over 30 million student assessment tests.
Additionally, National Computer Systems is the nation's single largest provider
of financial management, student information, and instructional management
software and services to the K-12 education market. Across all of these markets,
NCS supports its customers by providing service solutions that include
consulting, training, network administration, system support and outsourcing.
1.2 SmarterKids.com:
SmarterKids.com is an Internet reseller of children's educational products, and
is the fastest growing publisher of children's educational software in the US.
SmarterKids.com features a comprehensive database of 1000 plus educational
products including books, software, and games for children in Preschool through
Ninth Grade. Each product is characterized using a unique combination of over
100 educational attributes, making it easy to select products based on the
individual education goals of parents/teachers.
SmarterKids.com's mission is to empower parents, teachers and educational
professionals to play a more productive role in the education of children. The
Company's approach is to understand a child's academic strengths and weaknesses,
using assessment tools and technology, and to apply that understanding in
identifying products and services to enhance a child's learning and to use the
Internet to enable customers to purchase those products and services
conveniently at http://www.smarterkids.com.
--------------------------
2
<PAGE>
Goals and Objectives
2.1 General:
The business relationship between NCS and SmarterKids.com is a focused priority
on providing value-added electronic testing and educational products and
services to our clients and their constituents in the K-12 market. The theme of
the business proposition is to augment state assessment programs by offering a
variety of HelpTests for users to access on-line. These tests will provide
feedback on student skill proficiency and performance. Using this skill data,
NCS will refer parents/teachers to recommended web sites where they may find
educationally relevant information, services, and products (SmarterKids.com).
2.2 On-line HelpTests:
The purpose of the NCS web site is to provide HelpTests aligned specifically to
individual state assessment standards and curriculum requirements. Additionally
off-grade tests and national tests (e.g., NAEP items) will also be provided
online. These tests will promote confidence in test taking skills, provide an
early assessment of student strengths and areas for improvement, an electronic
workbook for repeat test takers working to pass state matriculation standards,
and provide educational product recommendations for skill proficiency
improvement (SmarterKids.com). Additionally, the site will accommodate direct
entry of individual student report data for parents/teachers whose children have
already taken a state assessment test.
It is not planned that a paper-based HelpTest would be provided as part of this
project.
[CONFIDENTIAL TREATMENT REQUESTED]**
2.3 Link To SmarterKids.com:
At the completion of a HelpTest, the student scores and results are provided on-
line. The user will be referred to options, including "Would You Like To See
Products and Services Tailored To: 1) Concentration On Strengths 2)
Concentration On Areas For Improvement." After a selection, a Notice page will
advise the user of linking to SmarterKids.com for product recommendations.
The user will arrive at the SmarterKids.com web site, with special co-site
branding of NCS and SmarterKids.com and navigation button(s) back to NCS. This
will promote intersite navigation and will build the brand recognition,
confidence, and quality of our relationship.
[CONFIDENTIAL TREATMENT REQUESTED]**
**[CONFIDENTIAL TREATMENT REQUESTED] INDICATES MATERIAL THAT HAS BEEN OMITTED
AND FOR WHICH CONFIDENTIAL TREATMENT HAS BEEN REQUESTED. ALL SUCH OMITTED
MATERIAL HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO
RULE 406 PROMULGATED UNDER THE SECURITIES ACT OF 1933, AS AMENDED.
3
<PAGE>
Project Plans
3.1 Pilot Projects:
NCS has identified two state pilot projects to kickoff the initiative. One
pilot will be a statewide initiative for Michigan and the [CONFIDENTIAL
TREATMENT REQUESTED]**. For participating in the pilot projects, NCS will
provide a special promotional offer of [CONFIDENTIAL TREATMENT REQUESTED]** and
a [CONFIDENTIAL TREATMENT REQUESTED]** merchandise credit at the SmarterKids.com
web store. This discount could be applied to teacher accounts and/or Title I
district funds. Participation by states in the pilot projects is subject to
their approval.
3.2 Project Phases:
This project will be divided into three phases.
Phase 1 will involve the generation of a PC based demonstration tool and
marketing materials to initiate discussions with customers to promote support
for hosting a pilot project. This system will include an alpha release of the
WeHelpKids.com web site including menus and links, (1) 30Q Math Grade 4
HelpTest, test skill results mapping to SmarterKids.com skill sets, and the
process of linking to the SmarterKids.com web site for product recommendations.
Phase 2 will involve the active deployment of a beta WeHelpKids.com web site to
support both the Michigan and [CONFIDENTIAL TREATMENT REQUESTED]** pilots. NCS
will provide a subset of HelpTests and ReportCard entry forms for inputting
state test results. Skill results from the HelpTest and ReportCard will be
completely mapped to SmarterKids.com skill sets. The user will then be windowed
to the SmarterKids.com site for product recommendations.
Phase 3 will involve a postmortem analysis of the pilot projects and their
contribution to the NCS/SmarterKids.com value proposition. Collected
information such as demographics, purchasing profile, adoption rates, revenue
models, customer reactions, and other meaningful market data will be assessed to
help refine the parameters of the business relationship. At the conclusion of
this phase, a Go/No Go decision will be made on a nationwide deployment of this
initiative.
3.3 Project Tasks and Schedule:
The project tasks and planned schedule associated with completion of the Phases
1 through 3 are shown in the attached project schedule:
Picture of ICON
** [CONFIDENTIAL TREATMENT REQUESTED] INDICATES MATERIAL THAT HAS BEEN OMITTED
AND FOR WHICH CONFIDENTIAL TREATMENT HAS BEEN REQUESTED. ALL SUCH OMITTED
MATERIAL HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO
RULE 406 PROMULGATED UNDER THE SECURITIES ACT OF 1933, AS AMENDED.
4
<PAGE>
Business Agreement NCS/SmarterKids.com Schedule
- ------------------------ ------------- ---------------------------------
[CONFIDENTIAL TREATMENT [CONFIDENTIAL [CONFIDENTIAL TREATMENT
REQUESTED]** TREATMENT REQUESTED]**
- ------------------------ REQUESTED]**
WeHelpKids.com Site
Development
- ------------------------
[CONFIDENTIAL
TREATMENT
REQUESTED]**
- ------------------------
Marketing and Promotion
- ------------------------
[CONFIDENTIAL
TREATMENT
REQUESTED]**
- ------------------------
Business Development
- ------------------------
[CONFIDENTIAL
TREATMENT
REQUESTED]**
- ------------------------
Live Pilot
- ------------------------
[CONFIDENTIAL
TREATMENT
REQUESTED]**
- ------------------------ ------------- ---------------------------------
**[CONFIDENTIAL TREATMENT REQUESTED] indicates material that has been omitted
and for which confidential treatment has been requested. All such omitted
material has been filed with the Securities and Exchange Commission pursuant to
Rule 406 promulgated under the Securities Act of 1933, as amended.
<PAGE>
Terms and Conditions
4.1 General:
This is the entire agreement between the parties and it, together with the Non-
Disclosure Agreement referred to herein, replaces and supersedes all other
agreements written or oral. This Agreement may only be modified by a written
instrument signed by authorized representatives of both parties. This Agreement
and the performance and relationship provided for herein shall be governed by
the laws of and subject to the exclusive jurisdictions of the courts of and
Federal courts in, the State of Minnesota.
4.2 Exclusivity:
SmarterKids.com and NCS agree to work on an exclusive basis for the Term of this
Agreement. This means that NCS will be SmarterKids.com's exclusive partner for
the purpose of establishing the state initiatives. SmarterKids.com would be
precluded from a similar relationship with a book/test publisher or NCS
competitor in assessment administration and processing. NCS would be precluded
from a similar relationship with another PreK-9 children's educational products
company reseller (not precluded are companies marketing their own products and
any products offered by National Computer Systems) who competes with
Smarterkids.com.
4.3 Term:
The term of this Agreement ("Term") shall be [CONFIDENTIAL TREATMENT
REQUESTED]** years from the date set forth above. This agreement shall expire at
the end of the last day of the Term unless extended by mutual agreement of the
parties.
4.4 Database And Rights:
There are three databases that are anticipated to result from these state
initiatives.
[CONFIDENTIAL TREATMENT REQUESTED]**
** [CONFIDENTIAL TREATMENT REQUESTED] INDICATES MATERIAL THAT HAS BEEN OMITTED
AND FOR WHICH CONFIDENTIAL TREATMENT HAS BEEN REQUESTED. ALL SUCH OMITTED
MATERIAL HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO
RULE 406 PROMULGATED UNDER THE SECURITIES ACT OF 1933, AS AMENDED.
<PAGE>
Terms and Conditions (Cont.)
4.5 Mutual Responsibilities:
The parties will contribute the following assets and responsibilities to this
initiative:
NCS will provide:
. Knowledge of state assessment practices; institutional marketing
. Test item bank development; build on-line HelpTests
. Web site for hosting, administering, scoring HelpTests
SmarterKids.com will provide:
. Expertise in consumer and on-line marketing
. Knowledge of leading edge computer-based assessment technology
. E-commerce, order processing, and fulfillment
. Web site for product recommendations and expert reviews
4.6 Assignment:
Neither party shall assign this business agreement in whole or in part without
the prior written approval of the other party, which shall not be unreasonably
withheld.
4.7 Liability:
Each party will, at its expense but subject to the limitations set forth in this
paragraph, defend, indemnify and hold harmless the other (the party from whom
indemnification is sought hereinafter the "Indemnifying Party") against, and pay
any costs, expenses and damages in connection therewith, an action or claim,
based upon material on the Indemnifying Party's web site, or based on material
(including, without limitation intellectual property) owned or provided by the
indemnifying party, including without limitation an action or claim for
infringement or misappropriation of a third party's trademark, trade secret or
copyrighted material, or based upon the products or operation of the
Indemnifying Party or the negligence or willful misconduct of Indemnifying Party
or its employees or agents or anyone acting on its behalf or under its direction
or control; provided that: (a) the party seeking indemnification promptly
notifies the Indemnifying Party of the claim; and (b) subject to evidence
reasonably satisfactory to the party seeking indemnification of the financial
responsibility of the Indemnifying party and selection of reputable and
appropriate counsel by the Indemnifying Party, the Indemnifying Party may, in
full satisfaction of its obligations under this section, assume the defense
and/or settlement of any such action or claim and payment of any award or
settlement amount, all at its own expense. The party seeking indemnification may
be represented in such action by counsel of its selection at its own expense.
The Indemnifying Party shall not have liability to the other party regarding any
claim to the extent arising from the negligence or willful misconduct of the
party seeking indemnification or its employees or agents or anyone acting on its
behalf or under its direction or control or arising from web site content
provided by the party seeking indemnification.
<PAGE>
Terms and Conditions (Cont.)
EXCLUDING LIABILITY ARISING UNDER OBLIGATIONS OF NON-DISCLOSURE (AS SET FORTH IN
SECTION 4.8 BELOW), OR ARISING FROM THE INDEMNITY SET FORTH ABOVE: NEITHER PARTY
SHALL BE LIABLE TO THE OTHER FOR ANY INDIRECT, CONSEQUENTIAL, OR INCIDENTAL
DAMAGES (INCLUDING DAMAGES FOR LOSS OF BUSINESS PROFITS, BUSINESS INTERRUPTION,
LOSS OF BUSINESS INFORMATION, AND THE LIKE) ARISING OUT OF THIS AGREEMENT, EVEN
IF SUCH PARTY HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES, NOR SHALL
EITHER PARTY'S AGGREGATE LIABILITY (EXCLUDING LIABILITY TO MAKE PAYMENTS DUE
HEREUNDER) FOR MATTERS ARISING OUT OF THE SUBJECT MATTER OF THIS AGREEMENT,
WHETHER IN CONTRACT, TORT OR OTHERWISE, EXCEED THE AMOUNT PAID OR PAYABLE TO NCS
BY SMARTERKIDS.COM DURING THE 12 MONTHS PRECEDING THE OCCURRENCE GIVING RISE TO
THE CLAIM OF LIABILITY.
4.8 Confidentiality:
The parties acknowledge and agree that performance of this Agreement shall from
time to time require disclosure of confidential information by each party to the
other. The exchange and disclosure of such information shall be governed by the
terms of that certain Non-Disclosure Agreement entered into by and between the
parties and executed on September 9, 1998.
4.9 Warranty:
UNLESS EXPRESSLY SET FORTH AND PROVIDED FOR IN THIS AGREEMENT OR AN AMENDMENT
HERETO, BOTH PARTIES DISCLAIM ALL WARRANTIES, EXPRESS AND IMPLIED, INCLUDING BUT
NOT LIMITED TO THE IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A
PARTICULAR PURPOSE. NO ORAL OR WRITTEN INFORMATION OR ADVICE GIVEN BY EITHER
PARTY, THEIR AGENTS OR EMPLOYEES SHALL CREATE A WARRANTY OR IN ANY WAY INCREASE
THE SCOPE OF THE WARRANTIES IN THIS AGREEMENT. Neither party shall make any
warranty or representation concerning the products or services of the other
party or other material information concerning the other party, unless with the
express, prior written consent of that party.
<PAGE>
Value Proposition
5.1 Revenue Model:
The revenue from this initiative will result from the purchase of products and
services at SmarterKids.com by parents/teachers. For state participation in the
pilot projects, NCS will provide a special promotional offer of [CONFIDENTIAL
TREATMENT REQUESTED]**, and a [CONFIDENTIAL TREATMENT REQUESTED]** merchandise
credit at the SmarterKids.com web store. This discount will be applied to
special teacher accounts and/or donations to Title/district funds, as
applicable.
It is envisioned that providing the HelpTest service for free will maximize
traffic to the NCS web site, and ultimately maximize the exposure and adoption
rate of products on the SmarterKids.com site. However, these pilot projects may
validate the possibility of ultimately charging a registration fee for the
HelpTest on the NCS web site.
5.2 Financial Model:
1. Standard Affiliate Program: Revenue generated from clients linking
from the NCS web site to the SmarterKids.com store. Each and every time
a client links from NCS to SmarterKids.com and purchases products, NCS
will receives [CONFIDENTIAL TREATMENT REQUESTED]** of the gross margin
of all SmarterKids.com sales to that client.
2. Special Affiliate Program: Revenue generated from clients returning
directly to the SmarterKids.com store through a special SmarterKids.com
homepage especially designed for NCS and its customers. (e.g.,
http://www.smarterkids. com/whk). Each and every time a client enters
this homepage and subsequently purchases products, NCS receives
[CONFIDENTIAL TREATMENT REQUESTED]** of the gross margin of all
SmarterKids.com sales to that client.
3. Special Coupon Program: Revenue generated from clients returning
directly to the SmarterKids.com store and purchasing products using
special NCS incentive codes. Each and every time a client purchases
products and enters a special NCS code, NCS receives [CONFIDENTIAL
TREATMENT REQUESTED]** of the gross margin of all SmarterKids.com sales
to that client.
**[CONFIDENTIAL TREATMENT REQUESTED] INDICATES MATERIAL THAT HAS BEEN OMITTED
AND FOR WHICH CONFIDENTIAL TREATMENT HAS BEEN REQUESTED. ALL SUCH OMITTED
MATERIAL HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO
RULE 406 PROMULGATED UNDER THE SECURITIES ACT OF 1933, AS AMENDED.
<PAGE>
Value Proposition (Cont.)
5.3 Margin Calculation:
Gross margin will be defined as the net revenue of the sale of products less the
cost of goods sold for those products:
Net revenue shall be defined as the gross revenue on the sale of all products
less any discounts, applicable promotions, merchandise incentive program
discounts or other programs that reduce the cost of the product to the customer.
Shipping and sales tax are excluded from the calculation.
Cost of Goods shall be defined as the cost of the product to SmarterKids.com, as
charged by our 3/rd/ party fulfillment partner. These costs consist of the
purchase cost from the product manufacturer plus handling and fulfillment fees
incurred by our fulfillment partner. Additionally, royalties to the content
providers of proprietary SmarterKids.com products (the Children's Skills Test
line) shall be an additional cost of goods on those items only. Freight-out
costs are excluded from the calculation.
5.4 Terms of Payment:
Payment to NCS under this agreement shall occur quarterly, 30 days following the
close of each calendar quarter.
5.5 Audit:
NCS shall have the right to perform (or have performed on its behalf) an audit
of the books and records (including business records and web site activity
records regardless of media) of SmarterKids.com, relating to the performance of
SmarterKids.com's obligations under this Agreement and the calculation of all
payments due to be paid to NCS hereunder. Such audits shall be conducted at
reasonable times and frequencies, with a minimum advanced notice of 10 business
days, during regular business hours and subject to the terms and condition of
the Non-Disclosure Agreement referred to in Section 4.8.
5.6 Purchase Incentives:
SmarterKids.com offers NCS, on a nonexclusive basis, a merchandise incentive
program. This incentive program allows NCS to offer merchandise credits to its
clients for purchasing products at the SmarterKids.com web store using methods
described in Section 5.2. These credits may be applied to teacher or other
special accounts at the rate of [CONFIDENTIAL TREATMENT REQUESTED]** of sales
price. NCS and SmarterKids.com shall equally share the cost burden of a client
exercising a merchandise credit.
**[CONFIDENTIAL TREATMENT REQUESTED] INDICATES MATERIAL THAT HAS BEEN OMITTED
AND FOR WHICH CONFIDENTIAL TREATMENT HAS BEEN REQUESTED. ALL SUCH OMITTED
MATERIAL HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO
RULE 406 PROMULGATED UNDER THE SECURITIES ACT OF 1933, AS AMENDED.
<PAGE>
Value Proposition (Cont.)
5.7 Stock Warrants:
Smarterkids.com will grant to NCS, with the approval of the SmarterKids.com
Board Of Directors, warrants to purchase 75,000 shares (approximately 1.00% of
the company post financing) of the Company's common stock at an exercise price
of $2.00/share. These shares would be exercisable in four equal increments based
on completion of the planned rollout to states (to be mutually agreed upon). One
fourth would be immediately exercisable upon completion of phase three and a
"Go" decision on large scale deployment of the state initiatives. The remaining
warrants would be exercisable as completion of the rollout occurs.
<PAGE>
This agreement ("Agreement") is entered into effective March 9, 1999 between
SmarterKids.com, Inc., a Delaware Corporation, with offices at 200 Highland
Avenue, Needham, Massachusetts and National Computer Systems, Inc. a Minnesota
Corporation with offices at 2510 N. Dodge Street, Iowa City, Iowa 52245. The
abbreviation "NCS" as used herein refers to the State Assessment business unit
of the Measurement Services Division of National Computer Systems, Inc. In
consideration of the mutual promises, obligations and rights set forth in this
Agreement, the sufficiency of which is hereby acknowledged by both parties, and
intending to be bound by this Agreement, the parties agree as follows:
National Computer Systems, Inc.
By: /s/ Gary A. Mainor
---------------------------
Authorized Signature
Name: Gary A. Mainor
------------------------
Title: General Manager
------------------------
Date: 3/10/99
------------------------
SmarterKids.com, Inc.
By: /s/ David A. Blohm
--------------------------
Authorized Signature
Name: David A. Blohm
------------------------
Title: President/CEO
------------------------
Date: 3/15/99
------------------------
<PAGE>
Exhibit 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in this registration statement on Form S-1 of
our report dated October 15, 1999, relating to the financial statements of
SmarterKids.com, Inc., which appears in such registration statement. We also
consent to the reference to us under the heading "Experts" in such registration
statement.
PRICEWATERHOUSECOOPERS LLP
Boston, Massachusetts
November 17, 1999
