<PAGE>
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of
1934
Filed by the Registrant:[X]
Filed by a Party other than the Registrant:[_]
Check the appropriate box:
[X]Preliminary Proxy Statement [_]Confidential, for Use of the
Commission Only (as permitted by
Rule 14a-6(e)(2))
[_]Definitive Proxy Statement
[_]Definitive Additional Materials
[_]Soliciting Material Pursuant to (S)240.14a-11(c) or (S)240.14a-12
SMARTERKIDS.COM, INC.
(Name of Registrant as Specified in Its Charter)
----------------
(Name of Person(s) Filing Proxy Statement)
Payment of Filing Fee (Check the appropriate box):
[_]No fee required.
[X]Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.
(1) Title of each class of securities to which transaction
applies: Common Stock, par value $.01 per share
(2) Aggregate number of securities to which transaction
applies: 20,668,849 shares of SmarterKids.com, Inc. common stock
expected to be acquired
(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (Set forth the amount on which
the filing fee is calculated and state how it was
determined): $0.53125 per share
(4) Proposed maximum aggregate value of transaction: $10,980,326.00
(5) Total fee paid: $2,197.00
[_]Fee paid previously with preliminary materials: ________________________
[_]Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee
was paid previously. Identify the previous filing by registration
statement number, or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid: ____________________________________________
(2) Form, Schedule or Registration Statement no.: ______________________
(3) Filing Party: ______________________________________________________
(4) Date Filed: ________________________________________________________
* The proxy statement-prospectus also constitutes the prospectus of
LearningStar Corp. Accordingly, LearningStar is the Registrant with respect
to the Form S-4 Registration Statement filed under the Securities Act of
1933, as amended, with the Securities and Exchange Commission to register
the shares of common stock of LearningStar which may be issued pursuant to
the Contribution Agreement and Plan of Reorganization and Merger to which
the proxy statement-prospectus relates.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>
PRELIMINARY DRAFT DATED JANUARY 9, 2001
SUBJECT TO COMPLETION
[Graphic]
Combination of
SmarterKids.com, Inc.
and
Earlychildhood LLC
Proxy Statement-Prospectus
----------------
Notice of Special Stockholder Meeting
SmarterKids.com, Inc.
Stockholder Meeting
, 2001
To be held at the
Offices of
Testa, Hurwitz & Thibeault, LLP
High Street Tower
22nd Floor
125 High Street
Boston, Massachusetts
[SmarterKids.com, Inc. Logo]
[Earlychildhood LLC Logo]
<PAGE>
[LOGO OF SMARTERKIDS.COM] [LOGO OF EARLYCHILDHOOD]
To the stockholders of SmarterKids.com, Inc.
A COMBINATION PROPOSAL--YOUR VOTE IS VERY IMPORTANT
SmarterKids.com and Earlychildhood have agreed to combine. We are proposing
the combination and soliciting your proxy to approve it because we believe the
combined strengths of SmarterKids.com and Earlychildhood will enable us to
build a stronger provider of children's educational products, information and
services to both the school and consumer markets and through a variety of
distribution channels. The new combined company will be named LearningStar
Corp. and will be managed by executive officers from both SmarterKids.com and
Earlychildhood.
If the combination is completed, stockholders of SmarterKids.com and members
of Earlychildhood will each receive shares of LearningStar common stock in
exchange for their existing common stock or membership interests, as the case
may be. Each issued and outstanding share of SmarterKids.com common stock will
be converted into the right to receive one newly-issued share of LearningStar
common stock. All of the issued and outstanding membership interests in
Earlychildhood and options therefor will be exchanged for the right to receive
an aggregate of 46,388,575 newly-issued shares of LearningStar common stock.
Following the combination, SmarterKids.com stockholders will own approximately
one-third of the LearningStar capital stock and Earlychildhood members will own
approximately two-thirds of the LearningStar capital stock. It is anticipated
that LearningStar will apply for approval for quotation of its common stock on
the Nasdaq National Market. A new market for trading in the LearningStar common
stock will commence immediately following the effectiveness of the combination,
which we expect to occur in the spring of 2001. No cash is included as
consideration in the combination, except for cash received in lieu of
fractional shares of LearningStar common stock.
The SmarterKids.com board of directors has unanimously determined that the
combination of SmarterKids.com and Earlychildhood is advisable and in the best
interests of its stockholders. The SmarterKids.com board of directors has
unanimously approved the combination agreement and the combination and
unanimously recommends that you vote FOR approval and adoption of the
combination agreement and the transactions contemplated thereby. The management
committee of Earlychildhood and the holders of all outstanding membership
interests in Earlychildhood approved the combination immediately prior to the
signing of the combination agreement. No further action is required by
Earlychildhood's management committee or members to effect the combination.
Information about the combination is contained in this proxy statement-
prospectus. We urge you to read this document carefully, including the section
describing risk factors that begins on page 18.
The special meeting of SmarterKids.com stockholders will be held at the
offices of Testa, Hurwitz & Thibeault, LLP, 125 High Street, High Street Tower,
22nd Floor, Boston, Massachusetts on , 2001 at 10:00 a.m.
Your vote is very important, regardless of the number of shares you own.
Whether or not you plan to attend the special meeting, please vote as soon as
possible to make sure that your shares are represented at the special meeting.
David Blohm
President and Chief Executive
Officer
SmarterKids.com, Inc.
This proxy statement-prospectus is dated , 2001, and is first being
mailed to SmarterKids.com stockholders on or about , 2001. As of ,
2001, there were approximately holders of SmarterKids.com common stock.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of the securities to be issued in
connection with the combination or determined if this proxy statement-
prospectus is accurate or complete. Any representation to the contrary is a
criminal offense.
<PAGE>
ADDITIONAL INFORMATION REGARDING SMARTERKIDS.COM
This proxy statement-prospectus incorporates important business and
financial information about SmarterKids.com and the proposed combination. Other
documents that include important business and financial information about
SmarterKids.com and the proposed combination are available to you without
charge upon your written or oral request. You can obtain the documents
incorporated by reference in this proxy statement-prospectus by requesting them
in writing or by telephone or via e-mail from SmarterKids.com at the following
address:
SmarterKids.com, Inc.
Investor Relations
15 Crawford Street
Needham, Massachusetts 02494
(781) 449-7567
[email protected]
If you would like to request any documents, please do so by , 2001
(five business days prior to the special meeting) in order to receive them
before the special meeting.
Also see the section entitled "Where You Can Find More Information" that
begins on page of this proxy statement-prospectus.
TRADEMARKS
SmarterKids.com(R), SmarterKids(R), Smart Kids'(R) and Virtual Knowledge(R)
are registered trademarks of SmarterKids.com. Earlychildhood NEWS(R),
Flexitemp(R), Little Bit O' Paint(R), Basic Brights(R), First Art(R), The
Imagination Playground(R), BioColor(R), Rainbow(R), Dandi-Li-On(R),
Squeezables(R) and LifeLong Learning Starts Here(R) are registered trademarks
of Earlychildhood. Earlychildhood(TM), Earlychildhood.com(TM) and
SchoolWrapPacks(TM) are trademarks of Earlychildhood. This proxy statement-
prospectus also contains trademarks or tradenames of companies other than
SmarterKids.com and Earlychildhood. All other trademarks and tradenames
referred to in this proxy statement-prospectus are the property of their
respective owners.
<PAGE>
[LOGO OF SMARTERKIDS.COM, INC.]
SMARTERKIDS.COM, INC.
15 Crawford Street
Needham, Massachusetts 02494
Notice of Special Meeting of SmarterKids.com Stockholders
, 2001 at 10:00 a.m.
To the stockholders of SmarterKids.com, Inc.:
Notice is hereby given that a special meeting of stockholders of
SmarterKids.com, Inc. will be held on , 2001 at 10:00 a.m., local time,
at the offices of Testa, Hurwitz & Thibeault, LLP, 125 High Street, High Street
Tower, 22nd Floor, Boston, Massachusetts for the following purposes:
1. To consider and vote upon a proposal to approve and adopt the
Contribution Agreement and Plan of Reorganization and Merger by and
among Earlychildhood, SmarterKids.com, LearningStar and S-E Educational
Merger Corp. pursuant to which, among other things, the combination of
SmarterKids.com and Earlychildhood will be effected by:
. the contribution to LearningStar by the holders of all of
Earlychildhood's outstanding membership interests of their entire
ownership interest in Earlychildhood such that Earlychildhood will
become a wholly-owned subsidiary of LearningStar, and the holders of
Earlychildhood membership interests and options therefor will be
entitled to receive an aggregate of 46,388,575 shares of
LearningStar common stock; and
. the merger of S-E Educational Merger Corp. with and into
SmarterKids.com such that SmarterKids.com will become a wholly-owned
subsidiary of LearningStar and each issued and outstanding share of
SmarterKids.com common stock will be converted into the right to
receive one share of LearningStar common stock.
2. To transact any other business as may properly come before the special
meeting or any adjournment or postponement of the special meeting.
The SmarterKids.com board of directors has unanimously determined that the
combination of SmarterKids.com and Earlychildhood is advisable and in the best
interests of its stockholders. The SmarterKids.com board of directors has
unanimously approved the combination agreement and the combination and
unanimously recommends that you vote FOR approval and adoption of the
combination agreement and the transactions contemplated thereby. We have
described the proposed combination in more detail in the attached proxy
statement-prospectus, which you should read in its entirety before voting. A
copy of the combination agreement is attached as Annex A to the proxy
statement-prospectus.
Only holders of record of SmarterKids.com common stock at the close of
business on , 2001, the record date for the special meeting, are entitled
to notice of, and to vote at, the special meeting and any adjournments or
postponements of the special meeting. On the record date there were
outstanding shares of SmarterKids.com common stock.
SmarterKids.com is a Delaware corporation. Under Delaware law, the
affirmative vote of a majority of the shares of SmarterKids.com common stock
outstanding on the record date is required to approve and adopt the combination
agreement and the transactions contemplated thereby. Your vote is very
important, regardless of
<PAGE>
the number of shares you own. Please vote as soon as possible to make sure that
your shares are represented at the special meeting. To vote your shares, you
may complete and return the enclosed proxy card. If you are a holder of record,
you may also cast your vote in person at the special meeting. If you do not
vote, it will have the effect of a vote against approval and adoption of the
combination agreement and the transactions contemplated thereby. If your shares
are held in an account at a brokerage firm or bank, you must instruct it how to
vote your shares. If you do not instruct your broker or bank on how to vote, it
will have the same effect as voting against approval and adoption of the
combination agreement and the transactions contemplated thereby.
By order of the Board of Directors
of SmarterKids.com, Inc.
David Blohm
Corporate Secretary
Needham, Massachusetts
, 2001
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
QUESTIONS AND ANSWERS ABOUT THE COMBINATION............................... 1
SUMMARY................................................................... 4
RISK FACTORS.............................................................. 18
Risks Related to the Combination........................................ 18
Risks Relating to the Combined Company.................................. 20
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS................ 28
THE SMARTERKIDS.COM SPECIAL MEETING....................................... 30
THE COMBINATION........................................................... 33
General................................................................. 33
Background of the Combination........................................... 34
Joint Reasons for the Combination....................................... 36
SmarterKids.com's Reasons for the Combination........................... 38
Earlychildhood's Reasons for the Combination............................ 38
Opinion of J.P. Morgan H&Q, Financial Advisor to SmarterKids.com........ 39
Recommendation of the SmarterKids.com Board Of Directors................ 43
Interests of Certain Persons in the Combination......................... 46
Securities and Exchange Commission Position on Indemnification for
Securities Act Liabilities............................................. 49
Material United States Federal Income Tax Consequences of the
Combination............................................................ 49
Accounting Treatment of the Combination................................. 53
Dissenters' Rights of Appraisal......................................... 53
Regulatory Matters...................................................... 53
Restrictions on Sales of Shares by Affiliates of SmarterKids.com and
Earlychildhood......................................................... 53
Nasdaq National Market Listing of LearningStar Common Stock to be Issued
in the Combination..................................................... 54
Delisting and Deregistration of SmarterKids.com Common Stock after the
Combination............................................................ 54
</TABLE>
<TABLE>
<CAPTION>
Page
----
<S> <C>
TERMS OF THE COMBINATION AGREEMENT........................................ 55
Structure of the Combination, Conversion of SmarterKids.com Common Stock
and Exchange of Earlychildhood Membership Interests.................... 55
Exchange of SmarterKids.com Stock Certificates for LearningStar Stock
Certificates........................................................... 55
Treatment of Options to Purchase SmarterKids.com Common Stock and
Earlychildhood Membership Interests, SmarterKids.com Warrants and the
SmarterKids.com Employee Stock Purchase Agreement...................... 56
Conditions to the Combination........................................... 57
No Other Transactions Involving SmarterKids.com or Earlychildhood....... 58
Termination............................................................. 60
Termination Fees........................................................ 62
Expenses................................................................ 62
Agreement to Cooperate to Complete the Combination...................... 62
Amendment, Extension and Waiver......................................... 63
Representations and Warranties.......................................... 63
LearningStar Charter and Bylaws......................................... 64
Stockholder Support Agreement........................................... 64
Other Agreements........................................................ 65
Completion and Effectiveness of the Combination......................... 65
No Provision for Unaffiliated Stockholder Access to SmarterKids.com
Corporate Files........................................................ 66
Accountants............................................................. 66
MARKET PRICE INFORMATION.................................................. 67
MARKET DATA............................................................... 67
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION.............. 68
Notes To The Unaudited
Pro Forma Condensed
Combined Balance Sheet................................................. 72
Notes To The Unaudited Pro Forma Condensed Combined Statements
of Operations.......................................................... 73
</TABLE>
i
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
SMARTERKIDS.COM........................................................... 74
Business................................................................ 74
SmarterKids.com Management's Discussion And Analysis Of Financial
Condition And Results Of Operations.................................... 83
SmarterKids.com Quantitative And Qualitative Disclosure About Market
Risk................................................................... 91
Security Ownership of Certain Beneficial Owners and Management of
SmarterKids.com........................................................ 92
EARLYCHILDHOOD............................................................ 94
Business................................................................ 94
Earlychildhood Management's Discussion And Analysis Of Financial
Condition And Results Of Operations.................................... 104
Earlychildhood Quantitative and Qualitative Disclosure About Market
Risk................................................................... 109
Earlychildhood Certain Relationships and Transactions................... 109
Security Ownership of Certain Beneficial Owners and Management of
Earlychildhood......................................................... 110
LEARNINGSTAR.............................................................. 112
The Board of Directors of LearningStar Following the Combination........ 112
Committees of the LearningStar Board of Directors....................... 113
Compensation of the Directors of LearningStar........................... 113
Executive Officers of LearningStar Following the Combination............ 113
Compensation of Executive Officers of LearningStar...................... 114
Option Grants in Last Fiscal Year....................................... 115
Option Exercises and Fiscal Year-End Values............................. 116
Ten Year Option Repricing............................................... 117
Compensation Committee Report on Option Repricing....................... 118
Employment and Change of Control Agreements............................. 118
</TABLE>
<TABLE>
<CAPTION>
Page
----
<S> <C>
Pro Forma Security Ownership of Certain Beneficial Owners and Management
of LearningStar........................................................ 119
DESCRIPTION OF CAPITAL STOCK OF LEARNINGSTAR.............................. 120
Common Stock............................................................ 120
Preferred Stock......................................................... 120
Warrants................................................................ 121
Registration Rights..................................................... 121
Anti-Takeover Effects of Certain Provisions of LearningStar's Charter
and Bylaws and Delaware Law............................................ 121
Transfer Agent and Registrar............................................ 122
COMPARISON OF RIGHTS OF HOLDERS OF LEARNINGSTAR COMMON STOCK,
SMARTERKIDS.COM COMMON STOCK AND EARLYCHILDHOOD MEMBERSHIP INTERESTS...... 123
LEGAL MATTERS............................................................. 132
EXPERTS................................................................... 132
OTHER MATTERS............................................................. 132
STOCKHOLDER PROPOSALS..................................................... 133
WHERE YOU CAN FIND MORE INFORMATION....................................... 134
INDEX TO FINANCIAL STATEMENTS............................................. F-1
</TABLE>
ANNEX A--Contribution Agreement and Plan of Reorganization and Merger
ANNEX B--Stockholder Support Agreement
ANNEX C--Opinion of J.P. Morgan H&Q
ANNEX D--Form of Restated Certificate of Incorporation of LearningStar
ANNEX E--Form of Amended and Restated Bylaws of LearningStar
ii
<PAGE>
QUESTIONS AND ANSWERS ABOUT THE COMBINATION
Q: Why are SmarterKids.com and Earlychildhood proposing to combine?
A: We are proposing the combination because we believe that the combined
strengths of SmarterKids.com and Earlychildhood will enable us to build a
stronger provider of children's educational products to both parents and
educators. The combination will bring together SmarterKids.com's consumer-
focused e-commerce capabilities with Earlychildhood's school-focused
catalog operation, direct sales force, product assortment and fund-raising
programs. We believe that because of the complimentery nature of
SmarterKids.com's and Earlychildhood's businesses, LearningStar has the
potential to achieve stronger operating and financial results than either
company could achieve on its own.
Q: What will I receive as a result of the combination?
A: If we complete the combination, you will receive one share of LearningStar
common stock for each share of SmarterKids.com common stock that you own on
the effective date of the combination. After the combination,
SmarterKids.com stockholders will own, in the aggregate, approximately one-
third of the combined company. We will not issue fractional shares in the
combination. Instead of fractional shares, you will receive cash based on
the market price of LearningStar common stock on the first day it is
traded.
Q: Why did the SmarterKids.com board of directors agree to Earlychildhood
members receiving approximately two-thirds of the LearningStar capital
stock with SmarterKids.com stockholders receiving approximately one-third
of the LearningStar capital stock?
A: We engaged in extensive negotiations with Earlychildhood regarding the
post-combination ownership of the shares of LearningStar common stock to be
issued to SmarterKids.com stockholders and Earlychildhood members in the
combination. After completion of due diligence and based in part upon the
relative size of revenues, operating income and growth prospects of the two
companies and the opinion of SmarterKids.com's financial advisor,
J.P. Morgan H&Q, we agreed that a post-combination ownership of
LearningStar of approximately two-thirds by Earlychildhood members and one-
third by SmarterKids.com stockholders was a fair and equitable division of
the ownership of LearningStar.
Q: What will happen to SmarterKids.com and Earlychildhood after the
combination?
A: Upon completion of the combination, each of SmarterKids.com and
Earlychildhood will be a wholly-owned subsidiary of LearningStar.
Q: What approvals are needed to complete the transaction?
A: The affirmative vote of a majority of the shares of SmarterKids.com common
stock outstanding on the record date is required to approve and adopt the
combination agreement and the transactions contemplated thereby. Each
holder of SmarterKids.com common stock is entitled to one vote per share.
As of the record date, SmarterKids.com directors, executive officers and
their affiliates owned approximately % of the SmarterKids.com common
stock entitled to vote at the special meeting. Each SmarterKids.com
director and executive officer and certain significant stockholders of
SmarterKids.com have entered into a stockholder support agreement with
Earlychildhood. Pursuant to the stockholder support agreement, each of
these directors, executive officers and stockholders have agreed to vote
all of their shares of SmarterKids.com common stock in favor of the
approval and adoption of the combination agreement and the transactions
contemplated thereby at the special meeting. As of the record date, these
directors,
1
<PAGE>
executive officers and stockholders owned, in the aggregate, approximately
% of the voting power of SmarterKids.com common stock entitled to vote at
the special meeting.
The holders of Earlychildhood's outstanding membership interests approved
the combination agreement prior to its signing. No other approvals from the
Earlychildhood members are required to complete the combination.
Q: Will I recognize a taxable gain or loss for U.S. federal income tax purposes
in the combination?
A: We have attempted to structure the combination so that generally you will
not recognize gain or loss for U.S. federal income tax purposes in
connection with the combination, except with respect to any cash received in
lieu of fractional shares. We strongly urge you to consult your own tax
advisor to determine your particular tax consequences. For more information
please see the section entitled "The Combination--Material United States
Federal Income Tax Consequences of the Combination" which begins on page
of this proxy statement-prospectus.
Q: What should I do if my broker holds my shares in "street name"?
A: Please contact your broker to obtain instructions on how to vote your
shares.
Q: Can my broker vote my shares that are held in "street name"?
A: Your broker will vote your shares only if you provide your broker
instructions on how to vote your shares held in "street name" in accordance
with the procedures provided to you by your broker. If you do not instruct
your broker to vote your shares they will become "broker non-votes." Broker
non-votes will be counted in determining whether a quorum is present at the
special meeting, but will not be counted in the number of votes cast.
Because the combination proposal requires the affirmative vote of the
holders of a majority of outstanding shares of SmarterKids.com common stock
eligible to vote at the special meeting, a broker non-vote will have the
same effect as a vote against approval and adoption of the combination
agreement and the transactions contemplated thereby. You should therefore be
sure to provide your broker with instructions on how to vote your shares if
you would like them represented at the special meeting.
Q: What if I do not vote?
A: .If you fail to return your proxy card or attend the special meeting, it
will have the same effect as a vote against the approval and adoption of
the combination agreement and the transactions contemplated thereby.
.
If you return your proxy card and do not indicate how you want to vote,
your proxy will be counted as a vote FOR the approval and adoption of the
combination and the transactions contemplated thereby.
.If you return your proxy card and abstain from voting, it will have the
same effect as a vote against the approval and adoption of the
combination agreement and the transactions contemplated thereby.
Q: Can I change my vote after I have delivered my proxy?
A: Yes. You can change your vote at any time before your proxy is voted at the
special meeting. You can do this in one of three ways. First, you can revoke
your proxy. Second, you can submit a new proxy. If you choose either of
these two methods, you must submit your notice of revocation or your new
proxy to the Secretary of SmarterKids.com before the special meeting. If
your shares are held in an account at a brokerage firm or bank, you should
contact your brokerage firm or bank to change your vote. Third, if you are a
holder of record, you can attend the special meeting and vote in person.
2
<PAGE>
Q: Should I send in my stock certificates now?
A: No. After the combination is completed, SmarterKids.com's exchange agent
will send you written instructions on how to exchange your SmarterKids.com
stock certificates for certificates representing shares of LearningStar
common stock. Please do not send in your stock certificates with your proxy.
Q: Where will my shares of LearningStar common stock be listed?
A: We intend to apply to list the LearningStar common stock on the Nasdaq
National Market under the symbol "LRNS."
Q: Will I receive dividends on my LearningStar shares?
A: LearningStar does not currently intend to pay dividends on its common stock.
Q: When do you expect to complete the transaction?
A: We are working to complete the transaction as quickly as possible. We expect
to complete the transaction during the spring of 2001.
Q: Who can help answer my questions?
A: If you have any questions about the combination or how to submit your proxy,
or if you need additional copies of this proxy statement-prospectus or the
enclosed proxy card, you should contact:
SmarterKids.com, Inc. Investor Relations
15 Crawford Street
Needham, Massachusetts 02494
(781) 449-7567
[email protected]
3
<PAGE>
SUMMARY
This summary highlights selected information in the proxy statement-
prospectus and may not contain all of the information that is important to you.
You should carefully read this entire proxy statement-prospectus and the other
documents we refer to for a more complete understanding of the combination. In
particular, you should read the documents attached to this proxy statement-
prospectus, including the combination agreement and the stockholder support
agreement, which are attached as Annexes A and B. The information contained in
this proxy statement-prospectus about the businesses of each of SmarterKids.com
and Earlychildhood is historical and the information about LearningStar assumes
completion of the combination. The information contained on the websites of
SmarterKids.com, Earlychildhood and LearningStar are not incorporated by
reference into this proxy statement-prospectus and should not be considered a
part of this proxy statement-prospectus.
The Companies
(see pages through )
SmarterKids.com, Inc.
15 Crawford Street
Needham, Massachusetts 02494
(781) 449-7567
www.smarterkids.com
SmarterKids.com, Inc., or SmarterKids.com, is a leading online educational
store dedicated to helping parents help their children learn, develop and grow.
The SmarterKids.com website offers one of the Internet's most personalized
shopping experiences, linking teacher-reviewed toys, games, books, software and
hands-on activities through SmarterKids.com's evaluation and recommendation
process. SmarterKids.com serves as a resource for parents, offering specialty
centers, the Grade Expectations! guide to education standards and thousands of
educational products, including well-known brands and hard-to-find quality
offerings for children from ages infant through 15.
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. SmarterKids.com only sells
products that its full-time staff of certified educators believe have
educational, developmental or learning value. Its collection of products
includes over 4,500 books, toys, games and software titles from over 300
suppliers. Because SmarterKids.com is focused on education, many of its
products, particularly toys and games, are often not found on many of the other
websites that offer children's products. The personalization area on the
SmarterKids.com 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.
The SmarterKids.com SmartPicks technology then uses this profile to make
product recommendations from SmarterKids.com's distinctive assortment of
products tailored to a child's individual developmental profile and goals.
Earlychildhood LLC
2 Lower Ragsdale Drive, Suite 200
Monterey, California 93940
(831) 333-2000
www.earlychildhood.com
Earlychildhood LLC, or Earlychildhood, is a fully integrated, multi-channel
supplier of educational products, services and information to schools,
educational professionals and parents serving the early childhood and
elementary school communities. Through a predecessor entity, Earlychildhood
began operations in 1985.
4
<PAGE>
Earlychildhood manufactures, imports and sells company-developed products as
part of its diverse mix of school supplies and educational toys, while also
distributing and selling a carefully selected range of third-party brands such
as Crayola(R), Lego(R) and Elmer's(R). Earlychildhood utilizes multiple sales,
marketing and distribution channels, including:
. catalogs issued under its tradename Discount School Supply, or DSS;
. sales programs conducted through its wholly-owned subsidiary,
Educational Products, Inc., or EPI;
. the Earlychildhood.com website; and
. Earlychildhood NEWS, a professional content resource published in print
and online.
All of the foregoing are supported by a national sales force which, as of
December 31, 2000, numbered 93 people.
LearningStar Corp.
2 Lower Ragsdale Drive,
Suite 200
Monterey, California
93940
(831) 333-2000
www.learningstarcorp.com
LearningStar Corp., formerly S-E Educational Holdings Corp., is a newly-
formed corporation that has not, to date, conducted any activities other than
those incident to its formation, the matters contemplated by the combination
agreement and the preparation of this proxy statement-prospectus. Upon
completion of the combination, SmarterKids.com and Earlychildhood will each
become a wholly-owned subsidiary of LearningStar. The business of LearningStar
will be the combined businesses currently conducted by SmarterKids.com and
Earlychildhood.
The SmarterKids.com Special Meeting
Record Date for the Special Meeting; Quorum (see page )
SmarterKids.com's board of directors has fixed the close of business on
, 2001 as the record date for determination of the SmarterKids.com
stockholders entitled to notice of, and to vote at, the special meeting.
A majority of the shares of the SmarterKids.com common stock outstanding as
of the record date must be represented either in person or by proxy to
constitute a quorum at the special meeting.
Vote Required for Approval and Adoption of the Combination Agreement (see page
)
The affirmative vote of a majority of the shares of SmarterKids.com common
stock outstanding as of the record date is required to approve and adopt the
combination agreement and the transactions contemplated thereby. Each share of
SmarterKids.com common stock is entitled to one vote on all matters properly
submitted to the SmarterKids.com stockholders.
Recommendation of SmarterKids.com's Board of Directors (see page )
SmarterKids.com's board of directors has unanimously determined that the
combination of SmarterKids.com and Earlychildhood is advisable and in the best
interests of its stockholders. The SmarterKids.com board of directors has
unanimously approved the combination agreement and the combination and
unanimously recommends that you vote FOR approval and adoption of the
combination agreement and the transactions contemplated thereby.
5
<PAGE>
The Combination
The Structure of the Combination (see page )
To accomplish the combination of their businesses, SmarterKids.com and
Earlychildhood jointly formed a new company, LearningStar Corp. LearningStar
has one subsidiary, S-E Educational Merger Corp. The combination will be
effected by:
. the contribution of all of the outstanding membership interests in
Earlychildhood to LearningStar by the holders of those membership
interests; and
. the merger of S-E Educational Merger Corp. into SmarterKids.com, with
SmarterKids.com being the surviving corporation.
As a result of the contribution and the merger, Earlychildhood and
SmarterKids.com will each become a wholly-owned subsidiary of LearningStar.
Approval of the Combination by Earlychildhood (see pages through )
The Earlychildhood management committee and holders of all outstanding
membership interests in Earlychildhood approved the combination agreement prior
to its signing. No other approvals from the Earlychildhood members are required
to complete the combination.
Consideration in the Combination (see page )
SmarterKids.com common stockholders will be entitled to receive one share of
LearningStar common stock for each share of SmarterKids.com common stock held
on the closing date of the combination. The holders of outstanding membership
interests in Earlychildhood will be entitled to receive an aggregate of
46,388,575 shares of LearningStar common stock, which will be allocated among
the holders of those membership interests based on an exchange ratio set forth
in the combination agreement more fully described in the section entitled
"Terms of the Combination Agreement--Structure of the Combination, Conversion
of SmarterKids.com Common Stock and Exchange of Earlychildhood Membership
Interests" which begins on page of this proxy statement-prospectus. As a
result of the combination, former holders of SmarterKids.com common stock will
own approximately one-third, and former holders of Earlychildhood membership
interests will own approximately two-thirds of the capital stock of
LearningStar.
Reasons for the Combination (see pages through )
The SmarterKids.com board of directors and the Earlychildhood management
committee believe that the following mutual benefits will be achieved by
combining the two companies:
. broaden the market of the combined company;
. diversified sales and distribution channels;
. expanded technology capabilities;
. enhanced marketing efforts;
. increased product development capabilities;
. combined management expertise;
. reduced operating costs; and
. enhanced capability to raise funds in the public market.
The SmarterKids.com board of directors had the following additional reasons
for approving the combination agreement and submitting the combination
agreement for approval and adoption by its stockholders:
. the ability to leverage Earlychildhood's operational infrastructure;
6
<PAGE>
. the ability to access Earlychildhood's unique mix of company-developed
and internationally-sourced products;
. the ability to capitalize on Earlychildhood's geographically distributed
warehouse and fulfillment operations; and
. the creation of a greater analyst following for the stock of the
combined company.
Earlychildhood's management committee had the following additional reasons
for approving the combination agreement and submitting the combination
agreement for approval and adoption by the holders of Earlychildhood membership
interests:
. the ability to leverage SmarterKids.com's Internet infrastructure;
. broadened exposure to the consumer market; and
. improved capital availablity of access to the public markets for
Earlychildhood members.
Opinion of SmarterKids.com's Financial Advisor (see pages through )
In deciding to approve the combination, the SmarterKids.com board of
directors considered the opinion of its financial advisor, J.P. Morgan H&Q, a
division of Chase Securities Inc., that, as of the date of its opinion, and
subject to, and based on the considerations referred to in its opinion, the
consideration given to SmarterKids.com stockholders in the transaction is fair,
from a financial point of view, to those stockholders. The full text of the
J.P. Morgan H&Q opinion is attached as Annex C to this proxy statement-
prospectus. We urge you to read the opinion of J.P. Morgan H&Q in its entirety
prior to voting.
Interests of Certain Persons in the Combination (see page )
In considering the recommendation of the SmarterKids.com board of directors,
you should be aware that some of the directors and executive officers of
SmarterKids.com have interests in the combination that are different from, or
are in addition to, your interests as a SmarterKids.com stockholder generally.
These interests include the potential for positions as directors or executive
officers of LearningStar, the acceleration of the vesting of options,
consulting agreements with LearningStar or severance arrangements under
existing agreements with SmarterKids.com or LearningStar and the right to
continued indemnification and insurance coverage by LearningStar for acts or
omissions occurring prior to the combination.
You should also be aware that certain members of the Earlychildhood
management committee and executive officers of Earlychildhood have certain
interests in the combination, including the potential for positions as
directors or executive officers of LearningStar, severance arrangements under
existing agreements with Earlychildhood and the right to continued
indemnification and insurance coverage by LearningStar for acts or omissions
occurring prior to the combination.
Treatment of Outstanding Stock Options and Warrants (see page )
When the combination is completed, each outstanding option to purchase
SmarterKids.com common stock or membership interests in Earlychildhood, as the
case may be, whether vested or unvested, will be converted into an option to
purchase shares of LearningStar common stock. As of December 31, 2000, there
were outstanding options to purchase 5,097,855 shares of SmarterKids.com common
stock and outstanding options to purchase up to 3.33% of total membership
interests in Earlychildhood giving effect to the exchange ratios set forth in
the combination agreement. For more information on the exchange ratios
applicable to the Earlychildhood membership interests, see the section entitled
"Terms of the Combination--Structure of the Combination, Conversion of
SmarterKids.com Common Stock and Earlychildhood Membership Interests." If the
combination is completed and, within a certain period of time thereafter,
certain executive officers of SmarterKids.com are terminated, the vesting of
certain options to purchase shares of SmarterKids.com common
7
<PAGE>
stock owned by those persons may be accelerated in accordance with the terms of
the applicable stock option agreements or change of control agreements between
SmarterKids.com and those executive officers. See the section entitled "The
Combination--Interests of Certain Persons in the Combination" which begins on
page of this proxy statement-prospectus.
Upon completion of the combination, each outstanding warrant to purchase
shares of SmarterKids.com common stock will be converted into the right to
purchase shares of LearningStar common stock on substantially the same terms
and conditions as were applicable to those warrants prior to the combination.
As of December 31, 2000, there were outstanding warrants to purchase an
aggregate of 217,292 shares of SmarterKids.com common stock.
Material United States Federal Income Tax Consequences (see pages through
)
The combination is generally intended to be tax-free to SmarterKids.com's
stockholders for U.S. federal income tax purposes, except with respect to any
cash received in lieu of fractional shares of LearningStar common stock. The
combination is conditioned upon:
. Earlychildhood receiving an opinion from its tax counsel that the
contribution of all of the outstanding membership interests in
Earlychildhood to LearningStar will be treated as a transfer of property
under Section 351 of the Internal Revenue Code; and
. SmarterKids.com receiving an opinion from its tax counsel that the
merger of S-E Educational Merger Corp. into SmarterKids.com will be
treated as a "reorganization" within the meaning of Section 368(a) of
the Internal Revenue Code or, taken together with the contribution of
all of the membership interests in Earlychildhood to LearningStar, as a
transfer of property under Section 351 of the Internal Revenue Code.
For a more complete description of the intended U.S. federal income tax
consequences of the combination and some of the related risks, see the section
entitled "The Combination--Material United States Federal Income Tax
Consequences of the Combination" which begins on page of this proxy
statement-prospectus.
Tax matters can be very complicated and the tax consequences to
SmarterKids.com's stockholders will depend on the facts and circumstances of
each stockholder's situation. Accordingly, SmarterKids.com stockholders should
consult their tax advisors to determine their particular tax consequences.
Accounting Treatment (see page )
We intend to account for the combination of SmarterKids.com with
Earlychildhood under the purchase method of accounting for business
combinations as if Earlychildhood were acquiring SmarterKids.com.
Dissenters' Rights of Appraisal (see page )
Under Delaware law, SmarterKids.com stockholder are entitled to appraisal of
the value of their shares of SmarterKids.com common stock in connection with
the combination.
Overview of the Combination Agreement (see page )
Conditions to the Completion of the Combination. The completion of the
combination depends upon the satisfaction or waiver of a number of specified
conditions, including those listed below:
. the combination agreement must be adopted by the SmarterKids.com
stockholders;
. no law, injunction or order prohibiting the completion of the
combination may be in effect;
. SmarterKids.com and Earlychildhood must obtain regulatory approvals from
governmental entities, such as the Securities and Exchange Commission
and other self-regulatory bodies such as the Nasdaq National Market;
8
<PAGE>
. the shares of LearningStar common stock to be issued in the combination
must have been approved for listing on the Nasdaq National Market;
. both SmarterKids.com and Earlychildhood must have complied with their
respective obligations in the combination agreement;
. the representations and warranties of each of SmarterKids.com and
Earlychildhood in the combination agreement must be true and correct;
. Earlychildhood must receive an opinion from its tax counsel to the
effect that the contribution of all outstanding Earlychildhood
membership interests to LearningStar will be treated for U.S. federal
income tax purposes as a transfer of property qualifying under Section
351 of the Internal Revenue Code;
. SmarterKids.com must receive an opinion from its tax counsel to the
effect that the merger of S-E Educational Merger Corp. into
SmarterKids.com will be treated for U.S. federal income tax purposes as
a "reorganization" within the meaning of Section 368(a) of the Internal
Revenue Code or, taken together with the contribution of all of the
membership interests in Earlychildhood to LearningStar, as a transfer of
property qualifying under Section 351 of the Internal Revenue Code; and
. SmarterKids.com must have Cash on Hand (as defined by U.S. generally
accepted accounting principles) of not less than $18,000,000 after
deducting certain fees and expenses of both SmarterKids.com and
Earlychildhood incurred in connection with the combination, including
costs and expenses resulting from the integration of the two companies
and their technologies.
Termination of the Combination Agreement. SmarterKids.com and Earlychildhood
can jointly agree in writing to terminate the combination agreement at any
time. Either company may also terminate the combination agreement if, among
other things:
. the combination is not completed on or before April 30, 2001, provided,
however, that if the combination is not completed by April 30, 2001 due
to a failure to receive all governmental approvals, the date will be
extended to July 31, 2001;
. if a court of competent jurisdiction or other governmental entity has
issued a non-appealable final order, decree or ruling or taken any other
non-appealable final action having the effect of permanently
restraining, enjoining or otherwise prohibiting the combination; or
. the other party breaches its representations, warranties or covenants in
the combination agreement in a material way, which breach is not cured
within 30 business days following receipt of notice of breach.
The combination agreement may be terminated by SmarterKids.com prior to the
date of the special meeting if the SmarterKids.com board of directors
reasonably determines in good faith and in accordance with the applicable
provisions of the combination agreement:
. after consultation with a financial advisor of nationally recognized
reputation, that an unsolicited bona fide "Acquisition Proposal," is
more favorable or is reasonably likely to lead to an Acquisition
Proposal that is more favorable to the SmarterKids.com stockholders from
a financial point of view than the transactions proposed by the
combination agreement and is made by a third party reasonably believed
by the SmarterKids.com board of directors to be financially capable of
completing the Acquisition Proposal; and
. after consultation with outside counsel, that failure to take action
with respect to an Acquisition Proposal would cause the members of the
SmarterKids.com board of directors to breach their fiduciary duties to
the SmarterKids.com stockholders under applicable law.
9
<PAGE>
An Acquisition Proposal is:
. any transaction pursuant to which a third party, other than
Earlychildhood or its affiliates, acquires more than 20% of the
outstanding shares of SmarterKids.com common stock pursuant to a tender
offer or exchange offer or otherwise;
. a merger or other business combination, recapitalization, restructuring
or similar transaction involving SmarterKids.com;
. any other transaction pursuant to which any third party acquires control
of assets of SmarterKids.com with a fair market value of 20% of the fair
market value of all SmarterKids.com assets immediately prior to the
transaction; or
. any public announcement of a proposal, plan or intention to do any of
the foregoing.
The combination agreement may be terminated by Earlychildhood if any of the
following occurs:
. the requisite vote of the SmarterKids.com stockholders to approve and
adopt the combination agreement is not obtained at a duly held meeting
of the SmarterKids.com stockholders;
. the SmarterKids.com board of directors has withdrawn or modified in any
manner its recommendation that its stockholders vote in favor of the
combination agreement;
. SmarterKids.com fails to include in this proxy statement-prospectus the
recommendation of its board of directors in favor of the approval and
adoption of the combination agreement;
. after the receipt by SmarterKids.com of an Acquisition Proposal,
Earlychildhood requests in writing that the SmarterKids.com board of
directors reconfirm its recommendation of the combination agreement to
the SmarterKids.com stockholders and the SmarterKids.com board of
directors fails to do so within ten business days after receipt of
Earlychildhood's request;
. the SmarterKids.com board of directors or any committee thereof approves
or recommends to the stockholders of SmarterKids.com an Acquisition
Proposal other than the combination;
. a third party, other than Earlychildhood or its affiliates, commences a
tender offer or exchange offer for 20% or more of the outstanding shares
of SmarterKids.com common stock and the SmarterKids.com board of
directors does not oppose the tender or exchange offer;
. SmarterKids.com enters into any letter of intent or similar document or
any agreement, contract or commitment accepting or expressing an intent
to accept an Acquisition Proposal; or
. SmarterKids.com fails to call and hold the SmarterKids.com special
meeting by April 30, 2001.
Termination Fees. The combination agreement provides that, under certain
circumstances, SmarterKids.com will be required to pay Earlychildhood a
termination fee of $1,300,000. The circumstances under which SmarterKids.com
will be obligated to pay the termination fee are described on pages through
of this proxy statement-prospectus.
Expenses. The combination agreement provides that, under certain
circumstances, either party may be required to pay the other party's expenses
incurred in connection with the proposed combination up to a maximum of
$350,000. These circumstances are described on pages through of this
proxy statement-prospectus.
"No Solicitation" and "No Negotiation" Provisions. The combination agreement
contains detailed provisions prohibiting SmarterKids.com and Earlychildhood
from seeking an alternative transaction. These "no solicitation" and "no
negotiation" provisions prohibit SmarterKids.com and Earlychildhood, as well as
their officers, directors, managers, subsidiaries and representatives, from
taking any action to solicit an alternative transaction. The combination
agreement does not, however, prohibit SmarterKids.com or its board of directors
from considering, and potentially recommending an unsolicited bona fide
Acquisition Proposal if:
10
<PAGE>
. the SmarterKids.com board of directors, after consultation with a
financial advisor of nationally recognized reputation, reasonably
determines in good faith that the Acquisition Proposal is more favorable
or reasonably likely to lead to an Acquisition Proposal more favorable
from a financial point of view to the SmarterKids.com stockholders than
the transactions contemplated by the combination agreement and is made
by a third party reasonably believed by the SmarterKids.com board of
directors to be financially capable of completing the Acquisition
Proposal; and
. the SmarterKids.com board of directors, after consultation with outside
counsel, reasonably determines that failure to take action with respect
to the Acquisition Proposal would cause the members of the
SmarterKids.com board of directors to breach their fiduciary duties to
the SmarterKids.com stockholders under applicable law.
The no solicitation and no negotiation provisions of the combination
agreement are described in more detail in the section entitled "Terms of the
Combination Agreement--No Other Transactions Involving SmarterKids.com or
Earlychildhood" which begins on page of this proxy statement-prospectus.
Stockholder Support Agreement. As required by the combination agreement,
Earlychildhood has entered into a stockholder support agreement with each
director and executive officer and certain significant stockholders of
SmarterKids.com pursuant to which these directors, officers and stockholders
have agreed to vote all their shares of SmarterKids.com common stock in favor
of the approval and adoption of the combination agreement and the transactions
contemplated thereby. As of the record date, these stockholders owned shares of
SmarterKids.com common stock representing approximately % of the voting power
of SmarterKids.com common stock entitled to vote at the SmarterKids.com special
meeting. The terms of the stockholder support agreement are described in more
detail in the section entitled "Terms of the Combination--Stockholder Support
Agreement" on pages through of this proxy statement-prospectus.
Consent and Non-Contravention Agreement. Prior to the combination, all of
the holders of membership interests in Earlychildhood executed a consent and
non-contravention agreement pursuant to which, among other things, each member
agreed to accept the applicable number of shares of LearningStar common stock
in exchange for his, her or its membership interests contributed to
LearningStar.
Affiliate Agreements. In connection with the combination, each of the
affiliates of SmarterKids.com (the directors and executive officers of
SmarterKids.com and holders of 5% or more of the outstanding common stock of
SmarterKids.com) and each of the affiliates of Earlychildhood (the members of
the management committee and executive officers of Earlychildhood and holders
of 5% or more of the outstanding membership interests in Earlychildhood) was
required to execute an affiliate agreement pursuant to which each affiliate
agreed to comply with Rule 145 of the Securities Act of 1933 with respect to
the sale of LearningStar common stock acquired by each affiliate in the
combination.
Lock-up Agreements. In connection with the combination, each of the
directors and executive officers and certain significant stockholders of
SmarterKids.com, as well as the members of the Earlychildhood management
committee and the holders of membership interests in Earlychildhood entered
into lock-up agreements with LearningStar. These lock-up agreements restrict
their sale of LearningStar common stock acquired in the transaction for 180
days after the LearningStar registration statement on Form S-4, of which this
proxy statement-prospectus is a part, is declared effective by the Securities
and Exchange Commission.
Registration Rights Agreement. All of the persons or entities who executed a
lock-up agreement in connection with the combination also executed a
registration rights agreement with LearningStar with respect to the shares of
LearningStar common stock they will receive in the combination.
11
<PAGE>
Consulting Agreement. Upon completion of the combination, David Blohm, the
current President and Chief Executive Officer of SmarterKids.com, will enter
into an 18-month consulting agreement with LearningStar. Upon expiration of the
18 month consulting period, LearningStar will provide Mr. Blohm with severance
payments for 24 months.
Each of the foregoing agreements are more fully described in the section
entitled "Terms of the Combination--Other Agreements" which begins on page
of this proxy statement-prospectus.
Completion and Effectiveness of the Combination. We will complete the
combination when all of the conditions to completion of the combination are
satisfied or waived in accordance with the combination agreement. The
combination will become effective when:
. the contribution of all the outstanding membership interests in
Earlychildhood to LearningStar is completed; and
. a certificate of merger is filed with the Secretary of State of the
State of Delaware with respect to the merger of S-E Educational Merger
Corp. with and into SmarterKids.com.
We expect to complete the combination during the spring of 2001.
Nasdaq National Market Listing of LearningStar Common Stock to be Issued in the
Combination (see page )
LearningStar will use its reasonable best efforts to cause the shares of
LearningStar common stock to be issued in connection with the combination to be
approved for listing on the Nasdaq National Market, subject to official notice
of issuance, before the combination is completed.
Delisting and Deregistration of SmarterKids.com Common Stock after the
Combination (see page )
When the combination is completed, the SmarterKids.com common stock will be
delisted from the Nasdaq National Market and will be deregistered under the
Securities Exchange Act of 1934, as amended.
Restrictions on Resales by Affiliates; Affiliate Agreements (see page
through )
Affiliates of both SmarterKids.com and Earlychildhood are subject to Rule
145 of the Securities Act of 1933, as amended, which governs the resale of
shares of LearningStar common stock acquired by those affiliates in the
combination. Each affiliate of SmarterKids.com and Earlychildhood has entered
into an affiliate agreement with LearningStar pursuant to which each affiliate
agreed to comply with Rule 145 of the Securities Act of 1933 with respect to
the sale of LearningStar common stock acquired by each affiliate in the
transaction. The terms of the affiliate agreements are described in the section
entitled "Terms of the Combination--Other Agreements," which begins on page
of this proxy statement-prospectus.
The Board of Directors and Management of LearningStar following the Combination
(see page )
SmarterKids.com and Earlychildhood have agreed that, upon completion of the
combination, the board of directors of LearningStar will be expanded to nine
members, two of whom will be designated by SmarterKids.com, and four of whom
will be designated by Earlychildhood. The remaining three directors will be
independent directors designated jointly by SmarterKids.com and Earlychildhood.
Upon completion of the combination, Al Noyes, currently the Chief Operating
Officer of SmarterKids.com, and Michael Kolowich, currently a director of
SmarterKids.com, will be the two directors of LearningStar designated by
SmarterKids.com. Ronald Elliott, the current President and Chief Executive
Officer of Earlychildhood, Robert MacDonald, Managing Director and President of
the Private Equity Group of William E. Simon & Sons, LLC,
12
<PAGE>
Scott Graves, a Principal of the Private Equity Group of William E. Simon &
Sons, LLC, and Stephen Kaplan, each a current member of Earlychildhood's
management committee, will be the four directors of LearningStar designated by
Earlychildhood.
Upon completion of the combination, Ronald Elliott will serve as Chairman of
the Board of LearningStar and Al Noyes will serve as Chief Executive Officer of
LearningStar. Robert Cahill, currently the Vice President of Finance and Chief
Financial Officer of SmarterKids.com, will serve as the Chief Financial Officer
of LearningStar and Judith McGuinn, currently the Chief Operating Officer of
Earlychildhood, will serve as the Chief Operating Officer of LearningStar.
Ownership of LearningStar following the Combination (see page )
Upon completion of the combination, approximately 20,668,849 shares of
LearningStar common stock will be issued to former holders of SmarterKids.com
common stock, and options to purchase SmarterKids.com common stock will be
converted into the right to purchase an aggregate of approximately 4,774,950
shares of LearningStar common stock. Upon completion of the combination,
warrants to purchase SmarterKids.com common stock will be converted into the
right to purchase approximately 217,292 shares of LearningStar common stock. As
a result of the combination, we estimate that former holders of SmarterKids.com
common stock and options and warrants therefor will own approximately one-third
of the capital stock of LearningStar.
Approximately 44,841,828 shares of LearningStar common stock will be issued
to former holders of Earlychildhood membership interests, and options to
purchase an aggregate of 3.33% of the outstanding membership interests in
Earlychildhood will be converted into the right to purchase an aggregate of
1,546,747 shares of LearningStar common stock. As a result of the combination,
we estimate that the holders of membership interests in Earlychildhood and
options therefor will own approximately two-thirds of the capital stock of
LearningStar.
Immediately prior to the completion of the combination, the directors and
executive officers of SmarterKids.com and their affiliates and the members of
the management committee and executive officers of Earlychildhood and their
affiliates will own, in the aggregate, approximately 9.5% and 62.2%,
respectively, of the fully-diluted outstanding capital stock of LearningStar.
After the combination is completed, North Bridge Venture Partners III, L.P.
and Commonwealth Capital Ventures II, L.P., the two largest stockholders of
SmarterKids.com, will own approximately 4.1% and 2.6%, respectively, of the
capital stock of LearningStar. Educational Simon, L.L.C. and QTL Corporation,
the two largest holders of membership interests in Earlychildhood, will own
approximately 32.7% and 26.6%, respectively, of the fully-diluted capital stock
of LearningStar after the combination is completed.
Comparison of Shareholder Rights (see page )
Upon completion of the combination, stockholders of SmarterKids.com and
members of Earlychildhood will become stockholders of LearningStar. The rights
of the holders of LearningStar capital stock will be governed by Delaware law,
the restated certificate of incorporation and the amended and restated bylaws
of LearningStar. See the section entitled "Comparison of Rights of Holders of
LearningStar Common Stock, SmarterKids.com Common Stock and Earlychildhood
Membership Interests" which begins on page of this proxy statement-
prospectus.
Regulatory Approvals (see page )
SmarterKids.com and Earlychildhood are not aware of any governmental
approvals or actions that are required to complete the combination. Should any
approval or action be required, SmarterKids.com and Earlychildhood currently
plan to seek the approval or take the necessary action.
13
<PAGE>
SUMMARY SELECTED FINANCIAL DATA
We are providing the following summary financial information to aid you in
your analysis of the financial aspects of the combination. This information
should be read in conjunction with the historical financial statements of
SmarterKids.com, Earlychildhood and Educational Products, Inc., or EPI, a
wholly-owned subsidiary of Earlychildhood, included elsewhere in this proxy
statement-prospectus.
SMARTERKIDS.COM SUMMARY SELECTED HISTORICAL FINANCIAL DATA
(in thousands, except per share data)
The following statement of operations data for the years ended December 31,
1997, 1998 and 1999 and the balance sheet data at December 31, 1998 and 1999
are derived from the audited financial statements of SmarterKids.com included
elsewhere in this proxy statement-prospectus. The statement of operations data
for the years ended December 31, 1995 and 1996 and the balance sheet data at
December 31, 1995, 1996 and 1997 are derived from the audited financial
statements of SmarterKids.com not included in this proxy statement-prospectus.
The statement of operations data for the nine months ended September 30, 1999
and 2000 and the balance sheet data at September 30, 2000 are derived from the
unaudited interim financial statements of SmarterKids.com included elsewhere in
this proxy statement-prospectus. The unaudited interim financial statements, in
the opinion of SmarterKids.com management, include all adjustments necessary
for a fair presentation of those financial statements. Historical results are
not indicative of the results to be expected in the future.
<TABLE>
<CAPTION>
Nine Months Ended
Year Ended December 31, September 30,
-------------------------------------------- ----------------------
1995 1996 1997 1998 1999 1999 2000
------- ------- ------- ------- -------- ------------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues........................ $ 401 $ 1,240 $ 1,416 $ 2,300 $ 5,421 $ 1,108 $ 4,504
Income from operations.......... 82 833 925 1,372 1,416 313 1,118
Net loss........................ (1,470) (1,649) (1,014) (3,342) (34,728) (14,142) (23,470)
Net loss attributable to common
stockholders................... (1,470) (1,649) (1,081) (3,596) (34,917) (14,261) (23,470)
Basic and diluted net loss per
common share................... $ (0.98) $ (1.10) $ (0.72) $ (2.34) $ (9.20) $ (8.10) $ (1.15)
Shares used to compute basic and
diluted net loss per common
share.......................... 1,500 1,501 1,502 1,534 3,796 1,760 20,476
<CAPTION>
As of
As of December 31, September 30,
-------------------------------------------- -------------
1995 1996 1997 1998 1999 2000
------- ------- ------- ------- -------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents....... $ 2,307 $ 433 $ 293 $4,273 $ 55,621 $17,754
Short-term investments.......... -- -- -- -- 11,735 15,201
Working capital................. 1,959 333 110 3,066 60,126 33,612
Restricted cash................. -- 199 -- -- 500 1,208
Total assets.................... 2,748 1,470 1,145 5,504 82,335 48,484
Long term debt and capital lease
obligations, net of current
portion........................ -- 104 41 -- 34 806
Redeemable preferred stock...... 3,251 3,251 4,011 10,287 -- --
Stockholders' equity (deficit).. (1,144) (2,791) (3,839) (7,162) 63,634 41,426
</TABLE>
14
<PAGE>
EARLYCHILDHOOD SUMMARY SELECTED HISTORICAL FINANCIAL DATA
(In thousands, except per share data)
The following statement of operations data for the year ended March 31,
1998, the nine months ended December 31, 1998 and the year ended December 31,
1999 and the balance sheet data as of December 31, 1998 and 1999 are derived
from the audited consolidated financial statements of Earlychildhood appearing
elsewhere in this proxy statement-prospectus. The balance sheet data as of
March 31, 1998 is derived from the audited consolidated financial statements of
Earlychildhood not included in this proxy statement-prospectus. The statement
of operations data for the nine months ended September 30, 1999 and 2000 and
the balance sheet data as of September 30, 2000 are derived from the unaudited
consolidated financial statements of Earlychildhood included in this proxy
statement-prospectus. The statement of operations data for the years ended
March 31, 1996 and 1997 and the balance sheet data as of March 31, 1996 and
1997 are derived from the unaudited consolidated financial statements of
Earlychildhood not included in this proxy statement-prospectus. In the opinion
of Earlychildhood's management, the unaudited consolidated financial statements
have been prepared on a basis consistent with the audited consolidated
financial statements which appear elsewhere in this proxy statement-prospectus
and include all adjustments, which are only normal recurring adjustments,
necessary for the fair presentation of the financial position and the results
of operations for the unaudited periods. The historical results presented
herein are not necessarily indicative of future results.
<TABLE>
<CAPTION>
Nine Months Nine Months
Year Ended Ended Year Ended Ended
March 31, December 31, December 31, September 30,
---------------------- ------------ ------------ ---------------
1996 1997 1998 1998(1) 1999(2) 1999 2000
------ ------- ------- ------------ ------------ ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues............... $8,730 $12,698 $18,597 $20,786 $61,034 $49,256 $67,814
Income from
operations............ 539 496 22 2,022 4,224 6,136 2,350
Net income (loss)...... 342 128 (140) 1,649 1,902(3) 4,174 587(3)
Pro forma basic and
diluted net income per
common share(4)....... $ 0.05 $ 0.01
Shares used to compute
pro forma net income
per common share (4)
--Basic............... 35,909 44,738
--Diluted............. 35,909 44,739
</TABLE>
<TABLE>
<CAPTION>
As of As of
As of March 31, December 31, September 30,
----------------- ------------ -------------
1996 1997 1998 1998 1999 2000
----- ----- ----- ----- ------ -------------
<S> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents........ $ 110 $ 92 $ -- $ 29 $ 151 $ --
Working capital.................. 564 554 301 884 7,959 16,941
Total assets..................... 3,583 4,851 6,116 8,443 28,915 39,343
Long term debt, net of current
portion......................... 1,595 1,911 1,986 2,116 9,087 7,750
Members' equity.................. 641 736 590 2,054 10,494 22,265
</TABLE>
(1) Prior to April 1, 1998, the fiscal years of both Earlychildhood and its
affiliate, QTL Corporaton, or QTL, ended March 31. On April 1, 1998, both
Earlychildhood and QTL changed their fiscal years to end on December 31.
Accordingly, the fiscal year ended December 31, 1998 consists of nine
months.
(2) On May 5, 1999, Earlychildhood acquired EPI, a Texas-based wholesaler of
educational products. The financial information reflects the combined
results of Earlychildhood's operations and the operations of EPI
subsequent to May 5, 1999.
(3) Net income for the year ended December 31, 1999 and the nine months ended
September 30, 2000 reflect the pro forma income tax effect of
Earlychildhood's income being subject to federal and state income taxes as
a C corporation. See Note 13 to the consolidated financial statements of
Earlychildhood included elsewhere inthis proxy-statement prospectus.
(4) Assumes the exchange of the weighted average membership interests
outstanding in Earlychildhood for common stock of LearningStar at the
exchange ratios set forth in the combination agreement. See the section
entitled "The Combination--General" in this proxy statement-prospectus.
15
<PAGE>
SUMMARY SELECTED UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL
INFORMATION
(In thousands, except per share data)
Presented below is summary selected unaudited pro forma condensed combined
financial information that is intended to give you a better understanding of
what the SmarterKids.com and Earlychildhood results might have looked like had
they always been combined. The companies would have performed differently had
they been combined, and you should not rely on the pro forma information as
being indicative of the historical results that would have been achieved or the
future results that we will experience after the combination. The information
below does not reflect cost savings that are expected as a result of the
combination or any charges that may be incurred as a result of the combination.
This summary selected unaudited pro forma condensed combined financial
information should be read in conjunction with the Unaudited Pro Forma
Condensed Combined Financial Information included elsewhere in this proxy
statement-prospectus.
<TABLE>
<CAPTION>
Nine Months
Year Ended Ended
December 31, September 30,
1999 2000
------------ -------------
<S> <C> <C>
Unaudited Pro Forma Condensed Combined Statement of
Operations Data:
Revenues......................................... $ 69,162 $ 72,318
Loss from operations............................. (34,309) (24,294)
Net loss attributable to common stockholders..... (34,657) (23,297)
Basic and diluted net loss per share............. $ (0.61) $ (0.36)
Weighted average number of basic and diluted
shares
outstanding..................................... 57,154 65,379
</TABLE>
<TABLE>
<CAPTION>
As of
September 30,
2000
-------------
<S> <C>
Unaudited Pro Forma Condensed Combined Balance Sheet Data:
Cash and cash equivalents...................................... $17,754
Short-term investments......................................... 15,201
Working capital................................................ 47,356
Restricted cash................................................ 1,028
Total assets................................................... 94,139
Long-term debt and capital lease obligations, net of current
portion....................................................... 8,617
Stockholders' equity........................................... 66,806
</TABLE>
16
<PAGE>
COMPARATIVE PER SHARE DATA
The table below summarizes certain per share information of SmarterKids.com
and Earlychildhood. In addition, we have summarized certain per share
information of the combined company on an unaudited pro forma basis assuming
that the combination had been completed at the beginning of the periods
presented. The equivalent pro forma per share information for SmarterKids.com
is the same as the pro forma combined per share information, because
SmarterKids.com common shares convert into shares of the combined company on a
one-for-one basis. Pro forma combined dividends declared are not presented
because LearningStar does not expect to pay dividends. All per share
information relating to Earlychildhood assumes exchange of the membership
interests for common stock of the combined company at the exchange ratios set
forth in the combination agreement. SmarterKids.com paid no dividends during
the periods presented below. This comparative per share information should be
read together with the Unaudited Pro Forma Combined Condensed Financial
Information and the separate historical financial statements of each of
SmarterKids.com, Earlychildhood and EPI and the respective notes thereto,
included elsewhere in this proxy statement-prospectus. The pro forma
information is presented for illustrative purposes only and does not
necessarily indicate what the operating results or financial position of the
combined company would have been if the combination had been completed at the
beginning of the periods presented.
<TABLE>
<CAPTION>
Nine Months
Year Ended Ended
December 31, September 30,
1999 2000
------------ -------------
<S> <C> <C>
SMARTERKIDS.COM--HISTORICAL:
Net loss per share--basic and diluted.............. $(9.20) $(1.15)
Book value per share(1)............................ $(3.13) $(2.01)
EARLYCHILDHOOD--HISTORICAL:
Net income per share--basic and diluted(2)......... $ 0.05 $ 0.01
Book value per share(1)............................ $ 0.24 $ 0.50
Equity distributions............................... $ 0.09 $ 0.01
PRO FORMA COMBINED:
Net loss per share--basic and diluted.............. $(0.61) $(0.36)
Book value per share(3)............................ $ 1.02
</TABLE>
--------
(1) The historical book value per share is computed by dividing total
stockholders' equity (deficit) by the number of common shares assumed to be
outstanding at the end of the period.
(2) See Note 2 to the consolidated financial statements of Earlychildhood
included elsewhere in this proxy statement-prospectus.
(3) The pro forma combined book value per share is computed by dividing total
pro forma stockholders' equity by the pro forma number of shares
outstanding at the end of the period.
17
<PAGE>
RISK FACTORS
In addition to the other information contained in this proxy statement-
prospectus, you should carefully consider the following risk factors in
deciding whether to vote for approval and adoption of the combination agreement
and the transactions contemplated thereby. Actual results could differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including those set forth in the following risk
factors and elsewhere in this proxy statement-prospectus.
Risks Related to the Combination
LearningStar may fail to realize the anticipated benefits of the combination.
The combination involves the integration of two companies that have
previously operated independently. We cannot assure you that the respective
operations of SmarterKids.com and Earlychildhood can be integrated without
encountering difficulties. The success of the combination will depend, in large
part, on the ability of SmarterKids.com, Earlychildhood and LearningStar to
realize the anticipated growth opportunities and synergies from combining the
business of SmarterKids.com with the business of Earlychildhood. To realize the
anticipated benefits of this combination, members of the LearningStar
management team must develop strategies and implement a business plan that
will:
. effectively combine Earlychildhood's children's product catalog and
school fund-raising programs with SmarterKids.com's e-commerce
technology and infrastructure;
. successfully take advantage of the anticipated opportunities for cross-
promoting and cross-selling Earlychildhood's and SmarterKids.com's
products and services and for increasing revenues from the sale of
products, services and information;
. effectively and efficiently integrate SmarterKids.com's and
Earlychildhood's policies, procedures and operations;
. successfully retain and attract key employees, including operating
management and key technical personnel, during a period of transition
and in light of the competitive employment market; and
. while integrating Earlychildhood's and SmarterKids.com's operations and
significant facilities, which are located in California, Florida,
Georgia, Massachusetts, Pennsylvania and Texas, maintain adequate focus
on the core businesses of the combined company in order to take
advantage of competitive opportunities and to respond to competitive
challenges.
If members of the LearningStar management team are not able to develop
strategies and implement a business plan that achieves these objectives, the
anticipated benefits of the combination may not be realized. In particular,
anticipated growth in revenue, earnings before interest, taxes, depreciation
and amortization, or "EBITDA," and cash flow may not be realized, which would
have an adverse impact on LearningStar and the market price of shares of
LearningStar common stock. We cannot assure you whether and to what extent the
integration and consolidation of Earlychildhood and SmarterKids.com will
achieve increased revenues, cost savings or operating synergies.
Fluctuations in market prices may cause the value of the shares of LearningStar
common stock that you receive in the combination to be less than the value of
your shares of SmarterKids.com common stock.
Upon completion of the combination, each outstanding share of
SmarterKids.com common stock will be converted into, and each outstanding
membership interest in Earlychildhood will be exchanged for, shares of
LearningStar common stock. The ratios at which the shares and membership
interests will be converted or exchanged, as applicable, are fixed. There will
be no adjustment for changes in the market price of SmarterKids.com common
stock. As a result, the perceived or actual value of the shares of LearningStar
common stock received by SmarterKids.com stockholders in the combination could
vary depending on
18
<PAGE>
fluctuations in the market price of SmarterKids.com common stock.
SmarterKids.com common stock has historically experienced significant
volatility and its market price has recently fallen below $1.00. Stock price
volatility may result from a variety of factors that are beyond
SmarterKids.com's or LearningStar's control, including changes in its
businesses, operations and prospects, regulatory considerations, general market
and economic conditions and specific conditions in the e-retailing market, the
children's educational products market and the market for stock of Internet
business-to-consumer companies.
Earlychildhood's membership interests are not publicly traded and, as such,
the value of the shares of LearningStar common stock received by holders of
Earlychildhood membership interests in the combination will not vary as a
result of market fluctuations. However, the value attributed to Earlychildhood
and to its membership interests may be impacted by changes in the market price
of SmarterKids.com common stock. Earlychildhood is not permitted to "walk away"
from the combination or resolicit the vote of the holders of its membership
interests solely because of a decrease or successive decreases in the market
price of SmarterKids.com common stock.
The price of SmarterKids.com common stock at the closing of the combination
may vary from its price on the date of this proxy statement-prospectus and on
the date of the special meeting. Because the closing date of the combination
will be later than the date of the special meeting, the price of
SmarterKids.com common stock on the date of the special meeting may not be
indicative of its price on the closing date.
Combining SmarterKids.com and Earlychildhood to form a provider of children's
educational products creates a new business model that the marketplace may have
difficulty valuing.
The market value of shares of common stock generally reflects a "multiple"
of selected measures of financial performance, such as operating profits or
earnings per share. The multiple for shares of LearningStar common stock may be
based on the financial performance of SmarterKids.com, or it may be based on
the financial performance of Earlychildhood, or it may reflect a "blending" of
the two. LearningStar will be a provider of children's educational products and
its business model will include both web-based and traditional catalog sales of
products and services to the school and consumer markets. Financial analysts
and investors may have difficulty identifying and applying measures of
financial performance that reflect the value of the combined company. As a
result, shares of LearningStar common stock may not achieve a valuation in the
public market that fully reflects the true value of the combined company,
including its synergies and benefits.
If we do not complete the combination, it could negatively impact
SmarterKids.com and the price of its common stock.
If the combination is not completed, SmarterKids.com may be subject to a
number of material risks, including the following:
. SmarterKids.com may be required to pay Earlychildhood a termination fee
of $1,300,000 or reimburse Earlychildhood's out-of-pocket expenses
incurred in connection with the combination up to a maximum of $350,000;
. the market price of SmarterKids.com common stock may decline to the
extent that the current market price of SmarterKids.com common stock
reflects a market assumption that the transaction will be completed; and
. SmarterKids.com must pay certain costs related to the transaction, such
as legal and accounting fees and expenses and financial advisor
expenses, even if the combination is not completed.
As a result of the combination, you will experience immediate and substantial
dilution with respect to your shares of SmarterKids.com common stock.
The completion of the combination will result in immediate and substantial
dilution to the SmarterKids.com stockholders because, as a result of the
combination, the ownership of SmarterKids.com
19
<PAGE>
stockholders will decrease from 100% of SmarterKids.com to approximately one-
third of LearningStar. Dilution refers to a decrease in the percentage
ownership interest of a company that a share of stock represents.
Certain SmarterKids.com executive officers and directors have conflicts of
interest that may influence them to support the combination.
A number of executive officers and directors of SmarterKids.com have
employment or severance agreements or benefit arrangements that provide them
with interests in the combination that differ from yours as a stockholder of
SmarterKids.com generally. Following the completion of the combination, Al
Noyes, Chief Operating Officer of SmarterKids.com, will serve as Chief
Executive Officer of LearningStar and Robert Cahill, Vice President of Finance
and Chief Financial Officer of SmarterKids.com, will serve as Chief Financial
Officer of LearningStar. Al Noyes and Michael Kolowich, a current director of
SmarterKids.com, will become directors of LearningStar as the two designees of
SmarterKids.com.
Upon the completion of the combination, David Blohm, President and Chief
Executive Officer of SmarterKids.com, will enter into an 18-month consulting
agreement with LearningStar. Upon expiration of the 18-month consulting period,
LearningStar shall provide Mr. Blohm with severance payments for 24 months. For
more information on this arrangement, please see the section entitled "The
Combination--Interests of Certain Persons in the Combination."
The receipt of compensation or other benefits in the combination, including
the accelerated vesting of stock options, the provision of employment or
consulting arrangements or other severance packages, or the continuation of
indemnification arrangements for current officers and directors of
SmarterKids.com following completion of the combination, may influence
SmarterKids.com's executive officers and directors to support the combination.
See the section entitled "The Combination--Interests of Certain Persons in the
Combination" for a more detailed description of the interests of certain
SmarterKids.com officers and directors.
There may be sales of a substantial amount of LearningStar common stock 180
days after the combination is completed, and these sales could cause the price
of LearningStar common stock to decline.
In connection with the combination agreement, each of the directors and
executive officers and certain significant stockholders of SmarterKids.com, as
well as each of the members of the Earlychildhood management committee,
executive officers and holders of membership interests in Earlychildhood,
entered into lock-up agreements with LearningStar. Pursuant to these lock-up
agreements, all of the shares of LearningStar common stock received by these
persons in connection with the combination may not be sold for a period of 180
days from the date on which the registration statement on Form S-4 of
LearningStar, of which this proxy statement-prospectus is a part, is declared
effective by the Securities and Exchange Commission. Upon the expiration of the
lock-up agreements, these securities may be sold in the future without
registration under the Securities Act to the extent permitted under Rule 144,
Rule 145 or another exemption under the Securities Act. Sales of a substantial
number of shares of LearningStar common stock after the combination is
completed and after the lock-up period has expired could cause the price of
LearningStar's common stock to fall which could have a material adverse effect
on LearningStar.
Risks Relating to the Combined Company
On a pro forma basis, SmarterKids.com's operating losses to date exceed
Earlychildhood's operating profits, and failure to increase SmarterKids.com's
revenues while reducing operating costs could prevent LearningStar from
achieving profitability.
SmarterKids.com has incurred significant losses since its inception and may
incur losses in the future. SmarterKids.com incurred net losses of $23.5
million for the nine months ended September 30, 2000 and has not achieved
profitability on a quarterly or annual basis. Earlychildhood generated net
income of $366,000
20
<PAGE>
for the same nine month period ended September 30, 2000. LearningStar will need
to generate greater revenues and operating profits while significantly reducing
costs and operating expenses to achieve profitability on a combined basis.
SmarterKids.com's revenues may not continue to grow and SmarterKids.com may
never generate sufficient revenues to achieve profitability, which could have a
material adverse effect on LearningStar.
If SmarterKids.com or Earlychildhood fails to obtain all required consents or
waivers, third parties may alter or terminate existing contracts.
Earlychildhood is required to obtain the consent of the lenders under its
existing credit facility to complete the combination. If Earlychildhood is
unable to obtain the lenders' consent, the credit facility could be declared in
default and any borrowings under the credit facility would become due and
payable. In addition, certain other agreements with tenants, suppliers,
customers, landlords or other parties may require Earlychildhood or
SmarterKids.com to obtain the consents or waivers of these parties in
connection with the combination. If Earlychildhood or SmarterKids.com fails to
obtain all of the necessary consents and waivers, third parties may alter or
terminate existing contracts, require accelerated payment of funds, attach
penalties and, potentially, assert other claims with respect thereto. Any one
or more of the foregoing events could materially harm LearningStar's business
following the combination.
Additional financing may not be available when needed or may only be available
on terms that could adversely affect LearningStar's business.
The businesses of SmarterKids.com and Earlychildhood are capital intensive.
The integration and expansion of their businesses will require a significant
commitment of resources. If cash from available sources is insufficient for
these purposes, or if additional cash is necessary for unanticipated needs,
including the prepayment of borrowings under Earlychildhood's existing credit
facility, LearningStar may need to raise additional capital. Additional
financing, if needed, may not be available on satisfactory terms or at all. In
addition, any additional issuance of equity or equity-related securities to
raise capital would be dilutive to existing LearningStar stockholders. Any debt
financing may result in additional restrictions on SmarterKids.com's,
Earlychildhood's or LearningStar's spending ability to pay dividends, which
could have a material adverse effect on LearningStar.
Affiliates of Earlychildhood will have significant influence over LearningStar
which could limit other LearningStar stockholders' ability to influence
corporate decisions.
After completion of the combination two of the largest holders of membership
interests in Earlychildhood will own, in the aggregate, approximately 59.3% of
the common stock of LearningStar on a fully-diluted basis. As a result, these
stockholders, if they act together will be able to control all matters
requiring approval of a majority of the LearningStar stockholders, including
any merger, sale of assets and other significant corporate transactions. This
control could:
. delay or prevent a change of control of LearningStar;
. deprive LearningStar stockholders of an opportunity to receive a premium
for their common stock as a part of a sale of LearningStar or its
assets; and
. affect the market price of the LearningStar common stock.
Each of SmarterKids.com's and Earlychildhood's businesses are highly seasonal.
Seasonal shopping patterns affect SmarterKids.com's business. A significant
portion of SmarterKids.com's sales occurs in the fourth quarter, coinciding
with the holiday shopping season. As such, SmarterKids.com's
21
<PAGE>
results of operations for the entire year depend largely on its fourth quarter
results. Factors that could cause SmarterKids.com's sales and profitability to
suffer include:
. the availability of and customer demand for particular products;
. unfavorable economic conditions;
. the inability to hire adequate temporary personnel;
. the inability to maintain appropriate inventory levels; and
. a late Thanksgiving, which reduces the number of shopping days between
Thanksgiving and the holiday season.
Earlychildhood's business is also subject to seasonality. A significant
portion of Earlychildhood's sales occurs in the third quarter, coinciding with
the start of the school year. As a result, Earlychildhood's results of
operations for the entire year depend largely on its third quarter results.
Factors that could cause Earlychildhood's sales and profitability to suffer
include:
. the availability of and customer demand for particular products;
. unfavorable economic conditions; and
. the inability to maintain appropriate inventory levels.
LearningStar's operations could be disrupted if SmarterKids.com's or
Earlychildhood's information systems fail independently or as part of the
integration.
Both SmarterKids.com's and Earlychildhood's businesses depend on the
efficient and uninterrupted operation of their computer and communications
software and hardware systems. Both companies regularly make investments to
maintain, enhance and replace their individual systems. Each must assess and,
if deemed necessary, appropriately expand the capacity of their information
systems to accommodate the anticipated growth of the combined company or its
operations could suffer.
In addition, continued customer access to both SmarterKids.com's and
Earlychildhood's websites is important to LearningStar's success and the
perception of its brand. Both websites may experience occasional system
interruptions that make their website unavailable or prevent their company from
efficiently fulfilling orders. These interruptions may reduce the volume of
goods sold, the attractiveness of products and services offered and damage
Earlychildhood's, SmarterKid.com's and LearningStar's reputation.
Earlychildhood and SmarterKids.com may require additional software and hardware
to upgrade the systems and network infrastructure of their websites to
accommodate increased traffic and sales volume. Neither SmarterKids.com nor
Earlychildhood can accurately project the rate or timing of any increases in
traffic or sales volume on their individual websites and, therefore, the
integration and timing of these upgrades are uncertain.
Earlychildhood also depends heavily on software which is utilized in its
order-taking, customer service, inventory management, and fulfillment
operations. If problems with this software develop, Earlychildhood's operations
could be slowed or interrupted, reducing the volume of goods sold and shipped
and the attractiveness of products, services and information offered, causing
damage to its reputation.
Neither SmarterKids.com nor Earlychildhood have a formal recovery plan to
prevent delays or other complications arising from information systems failure.
Neither company's business interruption insurance may adequately compensate
them for losses that may occur.
LearningStar's success will be highly dependent upon the successful
integration of each of SmarterKids.com's and Earlychildhood's hardware and
software systems. Failure to successfully integrate these technologies could
result in LearningStar's operations being slowed or interrupted, including the
performance of websites, fulfillment operations and customer service.
22
<PAGE>
Each of SmarterKids.com and Earlychildhood is dependent on executive management
and key technical and sales personnel.
SmarterKids.com's and Earlychildhood's officers have substantial experience
and expertise and make significant contributions to SmarterKids.com's and
Earlychildhood's respective growth and success. Each company believes that the
growth and profitability of LearningStar depends on the continued employment of
certain officers of both SmarterKids.com's and Earlychildhood's management
team. Furthermore, the ultimate successful combination of SmarterKids.com and
Earlychildhood will be largely dependent on the leadership of the combined
management team. If one or more members of LearningStar's management team were
unable or unwilling to serve in positions at LearningStar as contemplated,
LearningStar's profitability could suffer.
In addition the combined company's growth and profitability depends on the
hiring and retention of technical personnel for both SmarterKids.com and
Earlychildhood, as well as a field sales force for Earlychildhood products. If
SmarterKids.com or Earlychildhood are unable to hire and retain technical
personnel or Earlychildhood is unable to hire and retain sales personnel, it
could have a material adverse effect on LearningStar's business, results of
operations and financial condition.
SmarterKids.com and Earlychildhood are subject to intense competition.
Some of SmarterKids.com's direct competitors are specialty educational and
creative toy and game retailers such as Zany Brainy and Learning Express. These
retailers are continuing to expand and could impede SmarterKids.com's ability
to increase its sales. SmarterKids.com is also subject to competition from mass
market retailers and discounters such as Toys "R" Us, WalMart and Target which
have greater brand recognition and greater financial, marketing and other
resources than SmarterKids.com. SmarterKids.com could be at a disadvantage in
responding to these competitors' merchandising and pricing strategies,
advertising campaigns and other initiatives. Several of these competitors,
including Toys "R" Us, have launched successful Internet shopping sites that
compete with SmarterKids.com and educational "boutique" areas within their
retail sites. In addition, an increase in focus on the specialty retail market
or the sale by these competitors of additional products similar to
SmarterKids.com's could cause SmarterKids.com to lose market share.
SmarterKids.com faces growing competition from Internet-only retailers, such as
eToys and Amazon.com, which may have a cost advantage over SmarterKids.com and
reach a broader market, as well as non-toy specialty retailers, which compete
with SmarterKids.com's children's educational product business and could limit
SmarterKids.com's ability to expand in these markets.
SmarterKids.com's sales and profitability could suffer if:
. new competitors enter markets in which SmarterKids.com is currently
operating;
. SmarterKids.com's competitors implement aggressive pricing strategies;
. SmarterKids.com's competitors expand their operations;
. SmarterKids.com's suppliers sell their products directly or enter into
exclusive arrangements with SmarterKids.com's competitors; or
. SmarterKids.com's competitors adopt innovative merchandising strategies
that are similar to those of SmarterKids.com.
Earlychildhood's direct competitors are educational supply companies such as
School Specialty, Inc., Lakeshore Learning Materials, The Kaplan Companies, ABC
School Supply, Inc., Beckley Cardy Co., U.S. Toy Company, Childcraft Education
Corp., and J.L. Hammett Co.'s Earlychildhood Division.
There has been consolidation among these competitors over the last several
years; specifically, Beckley Cardy and Childcraft Education have all been
purchased by School Specialty, Inc. This consolidation could continue and
result in one company's dominance in the marketplace and Earlychildhood's loss
of market share. Some of Earlychildhood's competitors, such as The Kaplan
Companies and School Specialty, Inc., have
23
<PAGE>
launched successful websites which offer both products and information that
compete with Earlychildhood's website.
Earlychildhood manufactures products domestically and develops products
internationally to offer low-cost, higher margin company-developed products. If
one of its competitors pursued an aggressive manufacturing program, a competing
line of similar company-developed products could cause Earlychildhood to lose
market share.
In addition, capital requirements in the school supply distribution industry
are low, and there are few barriers to entry. A number of industry participants
(including Discount School Supply and EPI) have grown consistently, buoyed by
strong industry fundamentals. Attracted by this growth, entrants could
potentially re-create Earlychildhood's successful operating strategies, which
could materially adversely affect LearningStar.
Earlychildhood's sales and profitability could suffer if:
. new competitors enter markets in which Earlychildhood is currently
operating;
. Earlychildhood's competitors implement aggressive pricing strategies;
. Earlychildhood's competitors expand their operations; or
. Earlychildhood's competitors recreate its operating strategies,
specifically the importation and manufacture of company-developed
products.
If LearningStar's suppliers and distributors do not provide sufficient
quantities of products, LearningStar's sales and profitability will suffer.
LearningStar's dependence on its principal suppliers and distributors
involves risk, and if there is a disruption in supply from a principal supplier
or distributor, LearningStar may be unable to obtain the merchandise it desires
to sell. LearningStar's sales also could decline if key specialty suppliers
sell more products through mass-market retailers. Many of SmarterKids.com's and
Earlychildhood's suppliers currently provide them with incentives, such as
return privileges, volume purchasing allowances and cooperative advertising. A
reduction or discontinuation of these incentives could adversly affect
LearningStar's financial performance.
If a shipment of products that LearningStar imports is interrupted or delayed,
inventory levels and sales could decline.
LearningStar will import some of its product offerings. LearningStar will be
subject to the following risks inherent in relying on foreign manufacturers:
. the inability to return products;
. fluctuations in currency exchange rates;
. economic and political instability;
. transportation delays;
. trade restrictive actions by foreign governments;
. the laws and policies of the United States affecting importation of
goods, including duties, quotas and taxes;
. foreign trade and tax laws;
. foreign labor practices;
24
<PAGE>
. trade infringement claims; and
. increased liability as importer of record.
Interruptions or delays in LearningStar's imports could cause shortages in
product inventory and a decline in LearningStar's sales unless it secures
alternative supply arrangements. Even if LearningStar could locate alternative
sources, these alternative products may be of lesser quality or more expensive.
LearningStar's sales could also suffer if its suppliers experience similar
problems with foreign manufacturers.
If LearningStar is unable to predict or react to changes in customer demand, it
may lose customers and sales may decline.
LearningStar's success will depend on its ability to anticipate and respond
in a timely manner to changing consumer demand and preferences. LearningStar's
products must appeal to a broad range of consumers whose preferences cannot be
predicted with certainty and are subject to change. If LearningStar incorrectly
forecasts the demand for its merchandise, it may overstock certain products and
be forced to take significant inventory markdowns, which may have a negative
impact on LearningStar's profitability, or return overstocked products to
vendors, which may have a negative impact on LearningStar's relationships with
its vendors.
If LearningStar is unable to identify new products that will enjoy strong
consumer demand, it may lose customers and sales may decline. The introduction
of new products may also depress sales of existing products. Moreover, because
LearningStar will sell only those products that conform to its product mission,
LearningStar may choose not to sell some products that its customers desire and
thus lose potential sales.
SmarterKids.com, Earlychildhood and LearningStar may be exposed to product
liability lawsuits and other claims if they fail to comply with government and
toy industry safety standards.
Children can sustain injuries from educational products. Each of
SmarterKids.com, Earlychildhood and LearningStar may be subject to claims or
lawsuits resulting from such injuries. There is a risk that claims or
liabilities may exceed all of SmarterKids.com's, Earlychildhood's and
LearningStar's insurance coverage. Moreover, each of SmarterKids.com,
Earlychildhood and LearningStar may be unable to retain adequate liability
insurance in the future. SmarterKids.com, Earlychildhood and LearningStar are
subject to regulation by the Consumer Product Safety Commission and similar
state regulatory authorities.
SmarterKids.com, Earlychildhood and LearningStar may be unable to protect their
respective intellectual property, which could impair brand and reputation.
Efforts by SmarterKids.com, Earlychildhood and LearningStar to protect their
proprietary rights may be inadequate. Each company regards its intellectual
property as important to the marketing strategy of the combined company. To
protect their proprietary rights, SmarterKids.com, Earlychildhood and
LearningStar generally rely on copyright, trademark and trade secret laws,
confidentiality agreements with employees and third parties and license
agreements with consultants and suppliers. However, a third party could,
without authorization, copy or otherwise appropriate information from any of
the companies. Employees, consultants and others who participate in development
activities could breach their confidentiality agreements, and the companies may
not have adequate remedies for any such breach. Each of the companies' failure
or inability to protect its proprietary rights could materially decrease their
value, and each of the company's individual, as well as the combined company's
brand and reputation could be impaired.
The cost of materials used to manufacture products is subject to volatility
which could adversely effect LearningStar's results of operations.
Currently, Earlychildhood manufactures certain products, including non-toxic
tempera paints, finger paints, glues and other water-based art mediums. The raw
materials used in the manufacture process for these products may not be
available from regular commercial sources of supply or may only be available
from a single
25
<PAGE>
supplier. Earlychildhood may, from time to time, experience difficulty in
obtaining adequate raw material requirements at competitive prices, and
experience shortages of raw materials used in its manufacturing process. The
unavailability of raw materials or a substantial increase in their prices would
have an adverse affect on Earlychildhood's, and ultimately LearningStar's,
business, results of operations and financial condition.
Earlychildhood is subject to regulation by federal and state environmental
authorities and may be subject to environmental claims relating to its
manufacturing processes.
Earlychildhood's manufacturing operations are subject to numerous federal,
state, and local environmental and occupational health and safety laws and
regulations, which include laws and regulations governing waste disposal, air
and water emissions, the handling of hazardous substances, workplace exposure,
and other matters. If Earlychildhood fails to comply with these environmental
laws and regulations, it may incur material liabilities in the form of
administrative, civil, or criminal enforcement by government agencies or other
parties which would adversely affect Earlychildhood's, and ultimately
LearningStar's business, results of operations and financial condition.
Earlychildhood and/or LearningStar may be required to make material capital
expenditures to remain in compliance with applicable environmental laws and
regulations. In addition, the adoption of new environmental laws and
regulations, changes in existing laws and regulations, or their interpretation,
stricter enforcement of existing laws and regulations, or governmental or
private claims for damage to persons, property, or the environment resulting
from Earlychildhood's current or former operations, may have a material adverse
effect on Earlychildhood's business by forcing it to expend additional capital
and resources on environmental compliance.
Provisions of LearningStar's charter and bylaws and Delaware law may have anti-
takeover effects that could prevent a change in control of LearningStar.
The LearningStar restated certificate of incorporation authorizes the
LearningStar board of directors to issue, without shareholder approval
shares of preferred stock with voting, conversion and other rights and
preferences that could adversely affect the voting power or other rights of the
holders of LearningStar common stock. The issuance of LearningStar preferred
stock or of rights to purchase preferred stock could be used to discourage an
unsolicited acquisition proposal. In addition, the possible issuance of
preferred stock could discourage a proxy contest, make more difficult the
acquisition of a substantial block of LearningStar's common stock or limit the
price that investors might be willing to pay in the future for shares of
LearningStar's common stock. The LearningStar restated certificate of
incorporation and amended and restated bylaws also provide that:
. the LearningStar board of directors may adopt, amend or repeal the
bylaws or any provision of the restated certificate of incorporation of
LearningStar, however, the affirmative vote of the holders of at least
75% of the voting power of all outstanding shares of the capital stock
of LearningStar voting as a single class is required to adopt, amend or
repeal the amended and restated bylaws or any provision of the
LearningStar restated certificate of incorporation or;
. LearningStar stockholders may not take any action by written consent;
. special meetings of LearningStar stockholders may be called only by the
chairman of the board of directors or a majority of the LearningStar
board of directors and business transacted at any special meeting shall
be limited to matters relating to the purposes set forth in the notice
of the special meeting; and
. the LearningStar board of directors will be divided into three classes
serving staggered three-year terms.
In addition, following the completion of the combination, LearningStar will
be subject to certain "anti-takeover" provisions of the Delaware General
Corporation Law which, subject to certain exceptions, restrict certain
transactions and business combinations between a corporation and a shareholder
owning 15% or more
26
<PAGE>
of the corporation's outstanding voting stock (an "interested shareholder") for
a period of three years from the date the shareholder becomes an interested
shareholder.
These provisions of the LearningStar restated certificate of incorporation,
the amended and restated bylaws and Delaware law may have the effect of
delaying or preventing a change of control of LearningStar and, therefore,
could adversely affect the price of the LearningStar common stock. For more
information, please see the section entitled "Description of Capital Stock of
LearningStar--Anti-Takeover Effects of Certain Provisions of LearningStar's
Charter and Bylaws and Delaware Law."
The imposition of state sales tax and other tax obligations on e-commerce could
affect LearningStar's financial performance and limit SmarterKids.com's and
Earlychildhood's growth.
Neither SmarterKids.com nor Earlychildhood currently collects state sales
and use taxes or other similar taxes with respect to its marketing of products
to customers in states where it does not have a tax "nexus." It is possible
that the combination and potential changes in the way that SmarterKids.com and
Earlychildhood do business after the combination could result in LearningStar
being more broadly subject to sales and use tax collection responsibilities or
to state income taxes.
A number of proposals have been made at the federal, state, local and
international levels that would impose taxes on the sale of goods and services
through the Internet in circumstances where no tax or tax collection
responsibility is presently thought to be imposed. These proposals, if adopted,
could substantially impair the growth of e-commerce and could adversely affect
the combined companies' future results of operations and financial condition.
There is currently in effect in the United States a three-year moratorium
expiring on October 20, 2001 on new state and local taxes on Internet access
and "multiple or discriminatory" taxes on e-commerce. Sales or use taxes
imposed on those buying or selling products or services over the Internet are
not generally affected by this moratorium. The full effect of this moratorium
on SmarterKids.com's and Earlychildhood's business is not clear. To the extent
that the moratorium provides a material benefit, its expiration on October 20,
2001 could adversely affect LearningStar's business, results of operations and
financial condition.
In addition, for a discussion of certain state tax and other tax
considerations applicable to the Earlychildhood business, please see the
section entitled "Earlychildhood -- Business."
27
<PAGE>
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
This proxy statement-prospectus and the documents incorporated by reference
in this proxy-statement prospectus contain forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. These
forward-looking statements are subject to risks and uncertainties. Actual
results could differ materially from those projected in the forward-looking
statements as a result of certain factors, including those set forth in the
section entitled "Risk Factors." Reference is made to the particular
discussions set forth under the sections entitled "SmarterKids.com's
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Earlychildhood's Management's Discussion and Analysis of
Financial Condition and Results of Operations." Forward-looking statements
include information regarding:
. synergies;
. efficiencies;
. cost-savings;
. revenue enhancements;
. projected funds from operations; and
. the timetable for completion of the combination.
The sections of this proxy statement-prospectus which contain forward-
looking statements include, among others:
. "Questions and Answers About the Combination";
. "Summary";
. "Summary Selected Unaudited Pro Forma Condensed Combined Financial
Information";
. "The Combination--Background of the Combination";
. "The Combination--Joint Reasons for the Combination";
. "The Combination--SmarterKids.com's Reasons for the Combination";
. "The Combination--Earlychildhood's Reasons for the Combination";
. "Opinion of J.P. Morgan H&Q, Financial Advisor to SmarterKids.com"; and
. "Unaudited Pro Forma Condensed Combined Financial Information."
Forward-looking statements in this document or those documents incorporated
by reference also include, among other things, statements regarding the intent,
belief or expectations of SmarterKids.com, Earlychildhood or LearningStar and
can be identified by the use of words such as "may," "will," "should,"
"believes," "expects," "anticipates," "intends," "estimates" and other
comparable terms. For those statements, we claim the protection of the safe
harbor for forward-looking statements contained in the Private Securities
Litigation Reform Act of 1995.
You should understand that the following important factors, in addition to
those discussed elsewhere in this document could affect the future results of
SmarterKids.com, Earlychildhood, and LearningStar after completion of the
combination, and could cause actual results or other outcomes to differ
materially from those expressed in the forward-looking statements:
. inability to manage growth, diversify product offerings and expand in
new and existing markets;
. inability to integrate the operations, brands, personnel and information
systems of Earlychildhood and SmarterKids.com or realize the business
synergies expected from the combination;
28
<PAGE>
. changes in general economic and business conditions and in the e-
retailing or educational children's products industry in particular;
. actions by SmarterKids.com competitors;
. unanticipated costs of the combination;
. the level of demand for products of Earlychildhood and SmarterKids.com;
. changes in SmarterKids.com business strategies; and
. other factors discussed under "Risk Factors."
We urge you not to place undue reliance on forward-looking statements, which
speak only as of the date of this document.
All subsequent written and oral forward-looking statements attributable to
SmarterKids.com, Earlychildhood or LearningStar or any person acting on their
behalf are expressly qualified in their entirety by the cautionary statements
contained or referred to in this section. None of SmarterKids.com,
Earlychildhood or LearningStar undertakes any obligation to release publicly
any revisions to the forward-looking statements in this proxy statement-
prospectus to reflect events or circumstances after the date of this proxy
statement-prospectus or to reflect the occurrence of unanticipated events.
29
<PAGE>
THE SMARTERKIDS.COM SPECIAL MEETING
Proxy Statement-Prospectus; Date, Time and Place of Special Meeting
This proxy statement-prospectus is being furnished to you in connection with
the solicitation of proxies from holders of SmarterKids.com common stock by the
SmarterKids.com board of directors for use at the special meeting to be held at
the offices of Testa, Hurwitz & Thibeault, LLP, 125 High Street, High Street
Tower, 20th Floor, Boston, Massachusetts 02110 on , 2001 at 10:00 a.m.,
local time and at any and all adjournments or postponements of the special
meeting.
This proxy statement-prospectus is first being furnished to SmarterKids.com
stockholders on or about , 2001. The information concerning
SmarterKids.com has been furnished by SmarterKids.com and the information set
forth herein concerning Earlychildhood has been furnished by Earlychildhood.
The information concerning LearningStar has been jointly furnished by
SmarterKids.com and Earlychildhood.
Purpose of the Special Meeting--Approval and Adoption of the Combination
Agreement
The special meeting is being held so that stockholders of SmarterKids.com
may consider and vote upon a proposal to approve and adopt the combination
agreement pursuant to which SmarterKids.com and Earlychildhood will each become
a wholly-owned subsidiary of LearningStar. SmarterKids.com stockholders will
consider and vote upon any other business that properly comes before the
special meeting or any adjournment or postponement of the special meeting.
Approval and adoption of the combination agreement will also constitute
approval of the combination and the other transactions contemplated by the
combination agreement.
If the stockholders of SmarterKids.com approve and adopt the combination
agreement and the transactions contemplated thereby, upon completion of the
combination, each outstanding share of SmarterKids.com common stock will be
converted into the right to receive one share of LearningStar common stock.
Recommendation of the SmarterKids.com Board of Directors
The SmarterKids.com board of directors has unanimously determined that the
combination of SmarterKids.com and Earlychildhood is advisable and in the best
interests of its stockholders. The SmarterKids.com board of directors has
unanimously approved the combination agreement and the combination and
unanimously recommends that you vote FOR approval and adoption of the
combination agreement and the transactions contemplated thereby.
Record Date for the SmarterKids.com Special Meeting; Quorum
SmarterKids.com's board of directors has fixed the close of business on
, 2001 as the record date for determination of SmarterKids.com
stockholders entitled to notice of, and to vote at, the special meeting. On the
record date, there were shares of SmarterKids.com common stock outstanding,
held by approximately holders of record.
A majority of the outstanding shares of the SmarterKids.com common stock
must be represented either in person or by proxy to constitute a quorum at the
SmarterKids.com special meeting.
30
<PAGE>
Vote Required for Approval and Adoption of the Combination Agreement
The affirmative vote of a majority of the shares of SmarterKids.com common
stock outstanding on the record date for the special meeting is required to
approve and adopt the combination agreement and the transactions contemplated
thereby. Each share of SmarterKids.com common stock is entitled to one vote on
all matters properly submitted to the SmarterKids.com stockholders at the
special meeting.
Each of SmarterKids.com's directors, executive officers and certain
significant stockholders of SmarterKids.com who owned, in the aggregate,
approximately % of the shares of SmarterKids.com common stock outstanding on
the record date for the special meeting have entered into a stockholder support
agreement with Earlychildhood pursuant to which, among other things, they have
agreed to vote all their shares of SmarterKids.com common stock in favor of the
approval and adoption of the combination agreement and the transactions
contemplated thereby.
Proxies
All shares of SmarterKids.com common stock represented by properly executed
proxies at the special meeting will, unless the proxies are subsequently
revoked, be voted in accordance with the instructions indicated on those
proxies. If no instructions are indicated on a properly executed proxy card,
the shares will be voted FOR approval and adoption of the combination
agreement. You are urged to mark the box on the proxy card to indicate how to
vote your shares.
If a properly executed proxy card is returned and the stockholder has
abstained from voting, the SmarterKids.com common stock represented by that
proxy will be considered present at the special meeting for purposes of
determining a quorum, but will not be considered to have been voted in favor of
approval and adoption of the combination agreement. If your shares are held in
an account at a brokerage firm or bank, you must instruct them on how to vote
your shares. If an executed proxy card is returned by a broker or bank holding
shares which indicates that the broker or bank does not have discretionary
authority to vote on approval and adoption of the combination agreement, the
shares will be considered present at the meeting for purposes of determining
the presence of a quorum, but will have the same effect as a vote against the
approval and adoption of the combination agreement and the transactions
contemplated thereby. Your broker or bank will vote your shares only if you
provide instructions on how to vote by following the information provided to
you by your broker.
Because approval and adoption of the combination agreement requires the
affirmative vote of at least a majority of the shares of SmarterKids.com's
common stock outstanding on the record date for the special meeting, failures
to vote will also have the same effect as a vote against the approval and
adoption of the combination agreement and the transactions contemplated
thereby.
The SmarterKids.com special meeting may be adjourned or postponed, including
by its chairman, in order to permit further solicitation of proxies. No proxy
voted against the proposal to approve the combination agreement will be voted
on any proposal to adjourn or postpone the special meeting that is submitted to
the stockholders for a vote.
SmarterKids.com does not expect that any matter other than approval and
adoption of the combination agreement and the transactions contemplated thereby
will be brought before the special meeting. If, however, other matters are
properly presented, the persons named as proxies on the proxy card will vote in
accordance with their judgment with respect to those matters, unless authority
to do so is specifically withheld on the proxy card.
31
<PAGE>
Revocability of Proxies
A SmarterKids.com stockholder may revoke his or her proxy at any time before
it is voted by:
. filing a written notice of revocation of proxy with SmarterKids.com at
or prior to the taking of the vote at the special meeting;
. executing a later dated proxy and delivering it to SmarterKids.com prior
to the special meeting; or
. if the stockholder is a holder of record, appearing in person and voting
at the special meeting.
All written notices of revocation and other communications regarding
revocation of proxies should be addressed to SmarterKids.com, 15 Crawford
Street, Needham, Massachusetts 02494, Attention: Secretary.
Attendance at the special meeting will not, in and of itself, constitute
revocation of a proxy.
Solicitation of Proxies
SmarterKids.com will bear the expenses incurred in connection with the
printing and mailing of this proxy statement-prospectus. SmarterKids.com will
request banks, brokers and other intermediaries holding shares of
SmarterKids.com common stock beneficially owned by others to send this proxy
statement-prospectus to, and obtain proxies from, the beneficial owners and
will reimburse the holders for their reasonable expenses in so doing.
Solicitation of proxies by mail may be supplemented by telephone, telegram and
other electronic means, advertisements and personal solicitation by the
directors, officers or employees of SmarterKids.com. No additional compensation
will be paid to directors, officers or employees for this solicitation.
YOU SHOULD NOT SEND IN ANY STOCK CERTIFICATES WITH YOUR PROXY CARD.
A TRANSMITTAL LETTER WITH INSTRUCTIONS FOR THE SURRENDER OF STOCK
CERTIFICATES WILL BE MAILED TO YOU AS SOON AS PRACTICABLE AFTER
COMPLETION OF THE COMBINATION.
32
<PAGE>
THE COMBINATION
The following discussion summarizes the material aspects of the proposed
combination. Detailed terms of, and conditions to, the combination are
contained in the combination agreement, a copy of which is attached to this
proxy statement-prospectus as Annex A and incorporated herein by reference.
Statements made in this proxy statement-prospectus with respect to the terms of
the combination are qualified in their entirety by reference to the more
detailed information set forth in the combination agreement and the other
annexes hereto, each of which is incorporated herein by reference. While we
believe that the following description covers the material aspects of the
combination, this summary may not contain all of the information that is
important to you. You should read this entire proxy statement-prospectus and
the other documents we refer to carefully for a more complete understanding of
the combination.
General
The combination will become effective upon:
. the contribution of all of the outstanding membership interests of
Earlychildhood to LearningStar by the holders of those membership
interests; and
. the filing of a certificate of merger with the Secretary of State of
Delaware with respect to the merger of S-E Educational Merger Corp., a
wholly-owned subsidiary of LearningStar, with and into SmarterKids.com.
We are working toward completing the combination as quickly as possible. We
expect to complete the combination during the spring of 2001.
At the effective time of the combination, each share of SmarterKids.com
common stock outstanding immediately prior to the effective time will be
converted into the right to receive one share of LearningStar common stock.
Shares of SmarterKids.com common stock, if any, held in the treasury of
SmarterKids.com will be cancelled.
The outstanding membership interests of Earlychildhood currently consist of
Class A interests, Class B interests and Class C interests. Upon the completion
of the combination, each class of the outstanding membership interests of
Earlychildhood will be exchanged for shares of LearningStar common stock
according to the following exchange ratios:
. each .00001% of a Class A membership interest will be exchanged for
4.9951 shares of LearningStar common stock;
. each .00001% of a Class B membership interest will be exchanged for
4.6781 shares of LearningStar common stock; and
. each .00001% of a Class C membership interest will be exchanged for
2.3365 shares of LearningStar common stock.
LearningStar will pay cash with respect to any fractional shares of
LearningStar common stock to which a SmarterKids.com stockholder or
Earlychildhood member would otherwise be entitled based on the market price of
the LearningStar common stock on its first trading day.
As a result of the combination, former holders of SmarterKids.com common
stock and options and warrants therefor will own approximately one-third of the
capital stock of LearningStar and former holders of membership interests in
Earlychildhood and options therefor will own approximately two-thirds of the
capital stock of LearningStar.
33
<PAGE>
Background of the Combination
In early December 1999, SmarterKids.com received an unsolicited letter from
Thomas Weisel Partners, LLP acting on behalf of its client Earlychildhood,
regarding a potential transaction between SmarterKids.com and Earlychildhood.
The market addressed by Earlychildhood, and its complementary distribution
channels, were appealing to SmarterKids.com management. In early January 2000,
Dan Davis, Vice President of Business Development for SmarterKids.com,
telephoned Thomas Weisel Partners, LLP to preliminarily discuss the matters
described in its letter.
By the middle of January 2000, additional discussions had been initiated
directly between principals of SmarterKids.com and Earlychildhood relating to
the strategic rationale for a merger of the two companies. On January 19, 2000,
Mr. Davis visited the offices of Earlychildhood in Monterey, California to meet
with Robert Healy, a member of the Earlychildhood management committee and, at
that time, a Principal of the Private Equity Group of William E. Simon & Sons,
LLC, an affiliate of the largest equity holder of Earlychildhood, and Ronald
Elliott, the President and Chief Executive Officer of Earlychildhood. On
January 21, 2000, in order to facilitate additional discussions and the
exchange of confidential information between the parties, SmarterKids.com,
Earlychildhood and Thomas Weisel Partners, LLP entered into a nondisclosure and
confidentiality agreement.
In February 2000, SmarterKids.com senior management met to discuss the
structure and implementation of a stock-for-stock merger of SmarterKids.com and
Earlychildhood. In early March, 2000, Mr. Davis and David Blohm, President and
Chief Executive Officer of SmarterKids.com, met in San Francisco, California
with Mr. Healy and Scott Graves, a member of the Earlychildhood management
committee and a Principal of the Private Equity Group of William E. Simon &
Sons, LLC, to discuss material terms of a possible transaction. In conjunction
with these discussions, the companies began consulting with their respective
financial and legal advisors regarding the possible transaction. On March 14,
2000, SmarterKids.com engaged J.P. Morgan H&Q to assist in the merger
negotiations with Earlychildhood. At the same time, in response to a continuing
decline in the market price of SmarterKids.com common stock, which closed at
$4.31 per share on March 14, 2000 down from its initial public offering price
of $14.00 per share on November 23, 1999, the widespread decline in market
value of Internet-based retail or "dot.com" stocks in general, as well as the
deteriorating cash position of SmarterKids.com, SmarterKids.com entered into a
separate engagement letter with J.P. Morgan H&Q engaging J.P. Morgan H&Q to
identify other potential strategic partners for SmarterKids.com.
Working with their advisors, SmarterKids.com and Earlychildhood conducted
due diligence investigations using publicly available materials and non-public
materials provided pursuant to the nondisclosure and confidentiality agreement
and began analyses of a possible merger. On March 24, 2000, SmarterKids.com
presented an offer letter to Earlychildhood containing specific proposed terms
and conditions of a merger of the two companies.
In April, 2000, senior managers of SmarterKids.com met with principals of
Earlychildhood.com to discuss the specific terms of SmarterKids.com's offer
letter, including the valuation of the two companies, and issues surrounding
the structure of the merger and post-merger corporate governance. Thereafter,
on April 20, 2000, Messrs. Elliott and Graves, and Judith McGuinn, Chief
Operating Officer of Earlychildhood visited the SmarterKids.com management team
at the offices of SmarterKids.com in Needham, Massachusetts. At the meeting,
the parties were unable to agree on a valuation of the respective companies,
and decided to suspend further negotiations. On May 3, 2000, Earlychildhood
sent SmarterKids.com an additional letter containing a new valuation proposal
for the respective companies to which SmarterKids.com did not reply. All
discussions and due diligence efforts were terminated after the parties
suspended their negotiations.
34
<PAGE>
In July 2000, SmarterKids.com initiated a telephone call to Earlychildhood
to discuss re-opening negotiations relating to a business combination of the
two companies. Shortly thereafter, Mr. Healy and Mr. Blohm had a telephone
discussion focusing on the possible management configuration for the combined
company. Mr. Healy indicated that a change in chief executive officer might be
appropriate and they discussed possible candidates. Following discussion
between Mr. Blohm and Al Noyes, at that time SmarterKids.com's Executive Vice
President of Sales and Marketing, Mr. Blohm advised Mr. Healy that Mr. Noyes
was prepared to accept the position of chief executive officer of the combined
company. Discussions between representatives of the two companies continued
during September 2000.
Throughout the course of the summer and early fall of 2000, J.P. Morgan H&Q
continued its process to seek out other potential strategic partners for
SmarterKids.com. During this time, J.P. Morgan H&Q contacted a variety of
companies which it believed could provide an interesting strategic fit with
SmarterKids.com, including various conventional retailers, Internet-based
retailers and content providers, companies focused on educational products and
services, and others. Seven of the companies contacted executed confidentiality
agreements and reviewed confidential information relating to SmarterKids.com,
and six engaged in discussions with J.P. Morgan H&Q representatives.
On September 29, 2000, Earlychildhood sent SmarterKids.com a proposal
outlining the terms of a possible combination of the two companies whereby the
members of Earlychildhood and SmarterKids.com would receive approximately two-
thirds and one-third, respectively, of the post-combination equity of the
combined company. The outline also contemplated that Al Noyes would become
Chief Executive Officer of the combined company.
On September 30, 2000, the SmarterKids.com board of directors met to discuss
the proposal. Also in attendance were Mr. Davis and Robert Cahill, Chief
Financial Officer of SmarterKids.com.
On October 3, 2000, the SmarterKids.com board of directors was convened via
conference call to discuss the terms of the proposed combination with
Earlychildhood.com. The SmarterKids.com board of directors questioned Messrs.
Blohm, Noyes and Cahill about the valuation of SmarterKids.com, the proposed
equity allocation and the strategic value of a combination with Earlychildhood.
The board of directors reviewed information provided by Messrs. Blohm, Noyes
and Cahill about the relative revenues, operating income and other financial
and operating aspects of the two companies, and discussed other alternatives to
a transaction with Earlychildhood. Representatives of J.P. Morgan H&Q reviewed
relative advantages and disadvantages of the combination, various pro forma
financial aspects of the proposed combination, and operating statistics of
comparable companies. Following the board meeting, SmarterKids.com and
Earlychildhood and their respective advisors intensified due diligence
activities, communications coordination and preparation of successive drafts of
definitive documentation.
On October 4, 2000, an alternative preliminary acquisition proposal was
received by SmarterKids.com. Thereafter, representatives of SmarterKids.com
engaged in telephone discussions with the party submitting the proposal.
On October 11, 2000, the SmarterKids.com board of directors met.
Representatives of J.P. Morgan H&Q and Gordon Hayes of Testa, Hurwitz and
Thibeault, LLP also attended the meeting at the invitation of the
SmarterKids.com board. Discussion ensued regarding the two pending acquisition
proposals.
On October 12, 2000, the SmarterKids.com board directors reconvened to
discuss the progress of negotiations and the relative strengths and weaknesses
of the two acquisition proposals received. After extended consideration and
discussion, the SmarterKids.com board of directors decided to pursue a
combination with Earlychildhood as the best means to enhance shareholder value
for SmarterKids.com's stockholders.
After the SmarterKids.com board of directors meeting on October 12, 2000,
Robert MacDonald, Managing Director and President of the Private Equity Group
of William E. Simon & Sons, LLC and a member of the
35
<PAGE>
management committee of Earlychildhood, had a telephone conversation with Mr.
Blohm to discuss the proposed composition of senior management and the board of
directors of the combined company in the post-combination period. Mr. MacDonald
expressed his desire that, while Al Noyes would become Chief Executive Officer
of the combined company, that Mr. Blohm would agree to lend his active support
and leadership through an initial transition period and make himself available
to provide guidance on a consulting basis going forward. Initially, discussion
focused on having Mr. Blohm serve as Chairman of the Board of LearningStar for
a number of months following the closing of the combination, to be followed by
a consulting period. Subsequent to that date, Mr. MacDonald and Mr. Blohm
agreed instead that Mr. Blohm would perform consulting services for an extended
period following the combination. These discussions led to the preparation of a
consulting agreement to be entered into by the combined company and Mr. Blohm
following the effective date of the combination.
On October 23, 2000, the SmarterKids.com board of directors met again to
discuss the terms of the proposed combination and the status of the
negotiations. The SmarterKids.com board of directors listened to the report of
the senior managers and directed that they continue to attempt to arrive at a
definitive agreement.
On November 8, 2000, the SmarterKids.com board of directors met a final time
to consider the proposed transaction and review drafts of the definitive
agreements. In attendance at this meeting by the invitation of the
SmarterKids.com board of directors were Messrs. Cahill and Noyes,
representatives of Testa, Hurwitz & Thibeault, LLP and representatives of J.P.
Morgan H&Q. At this meeting, Mr. Blohm and other members of management reviewed
the transaction with the board of directors, including the strategic reasons
for the proposed transaction, the principal terms of the proposed transaction,
a financial review of the proposed transaction, a review of Earlychildhood's
financial condition and business operations and the results of
SmarterKids.com's due diligence review of Earlychildhood and its subsidiaries.
Representatives of Testa, Hurwitz & Thibeault, LLP, SmarterKids.com's
outside legal counsel, discussed the board of director's fiduciary duties in
considering a strategic business combination and further discussed the terms of
the combination agreement and related documents. Representatives of J.P. Morgan
H&Q presented to SmarterKids.com's board of directors a summary of its analyses
on the strategic rationale for, and financial analyses related to the proposed
transaction. In addition, J.P. Morgan H&Q delivered a draft of its opinion that
the consideration to be given SmarterKids.com stockholders of an aggregate of
approximately one-third of the capital stock of LearningStar pursuant to the
combination agreement was fair, from a financial point of view, to the
SmarterKids.com stockholders. Upon completing its deliberations, the board of
directors of SmarterKids.com unanimously approved and adopted the combination
agreement and the combination and the related agreements and the transactions
contemplated by those agreements, and declared them advisable and in the best
interests of the SmarterKids.com stockholders.
After the November 8, 2000 meeting of the SmarterKids.com board of
directors, respective counsel for SmarterKids.com and Earlychildhood worked to
finalize the definitive agreement and related agreements. On November 14, 2000,
representatives of SmarterKids.com and representatives of Earlychildhood
executed the combination agreement and additional ancillary agreements,
including the stockholder support agreement. On the morning of November 15,
2000, SmarterKids.com and Earlychildhood issued a joint press release
announcing the proposed combination of SmarterKids.com and Earlychildhood.
Joint Reasons for the Combination
The board of directors of SmarterKids.com and the management committee of
Earlychildhood have identified potential mutual benefits of the combination
that they believe will contribute to the success of LearningStar. These
potential benefits include the following:
. Broadened End Markets. Combining the existing and targeted customer
bases of Earlychildhood and SmarterKids.com provides the opportunity to
broaden the market exposure of the combined company beyond that of
either company on a standalone basis. Earlychildhood's business model
focuses primarily on providing children's educational products, services
and information
36
<PAGE>
to schools, educational professionals, and secondarily, to parents.
SmarterKids.com's business model focuses on providing goods and services
to the parent market.
. Diversified Sales and Distribution Channels. Combining the sales and
distribution capabilities and strategies of Earlychildhood and
SmarterKids.com is anticipated to expand the number of methods through
which the combined company is able to reach and interact with its
customers. On a standalone basis, Earlychildhood maintains sales and
distribution capabilities through its catalogs, fund-raising programs,
direct sales force and, to a limited extent, its website.
SmarterKids.com sells and distributes exclusively through its online
retail store.
. Expanded Technology Capabilities. The combination of internally-
developed technology and information system capabilities of
SmarterKids.com and Earlychildhood will result in stronger online and
traditional operations for the combined company. Earlychildhood
maintains specialized technology systems to procure, fulfill and measure
operating efficiencies across its traditional catalog, direct sales and
other business channels. SmarterKids.com possesses an internally-
developed, patent pending technology that optimizes a customer's ability
to evaluate and identify children's learning capabilities, strengths and
weaknesses relative to age, and then matches those characteristics with
recommended product and content purchases.
. Enhanced Marketing Efforts. The combination of Earlychildhood and
SmarterKids.com provides the combined company the opportunity to enhance
its marketing efforts and enables it to influence customers over a
broadened variety of marketing media. Existing marketing efforts are
anticipated to become more efficient and new marketing methodologies are
anticipated to become available that could not exist in each of the
standalone entities. Specifically, marketing of online operations is
anticipated to be executed at reduced costs through the use of
Earlychildhood's traditional marketing strategies:
. the Discount School Supply catalogs;
. Earlychildhood NEWS magazine;
. EPI SchoolWrapPacks; and
. its direct sales force.
Additionally, Earlychildhood's traditional business is anticipated to
benefit from the targeted marketing opportunities associated with
SmarterKids.com's online presence and database marketing capabilities.
. Increased Product Development Capabilities. The combination of
Earlychildhood and SmarterKids.com joins two well-developed in-house
product development operations. Earlychildhood researches, develops,
manufactures its own company-developed children's paint and other
educational art materials, as well as a variety of school supplies and
educational toys. SmarterKids.com views its primary product to be unique
web and systems technologies that create a user experience which gives
SmarterKids.com a competitive advantage in the marketplace. The product
development operations of the two companies will enable the combined
company to leverage its company-developed products into an effective way
to differentiate itself from its competitors in the educational market.
. Combined Management Expertise. Combining the management expertise of
SmarterKids.com and Earlychildhood will enable the combined company to
further leverage the individual strengths and assets of each company to
become a stronger combined entity.
. Reduced Operating Costs. Elimination of operating redundancies of the
two companies is expected to provide greater revenue-generating
opportunities and the potential to reduce operating costs in marketing,
payroll, warehouse, general operating overhead and other areas as it
deems appropriate.
37
<PAGE>
. Enhanced Capability to Raise Funds in the Public Market. LearningStar's
ability to raise capital in the private and public markets will be
greater than either SmarterKids.com's or Earlychildhood's ability alone.
SmarterKids.com's Reasons for the Combination
In addition to the anticipated joint benefits of the combination described
above, SmarterKids.com's board of directors believes that the following are
additional reasons the combination will be beneficial to SmarterKids.com and in
the best interests of its stockholders:
. Ability to Leverage Earlychildhood's Operational Infrastructure. As a
result of the combination, SmarterKids.com will be able to leverage the
operating infrastructure that Earlychildhood has created over its 15-
year operating history. This infrastructure includes all facets of
business operations such as sales, marketing, inventory procurement,
product fulfillment, operational reporting and management expertise.
. Access to Unique Products. Earlychildhood possesses a unique mix of
company-developed and internationally sourced products, as well as
established long-term vendor relationships. Leveraging these assets is
anticipated to provide a more unique, higher gross margin product base
than SmarterKids.com could achieve on a standalone basis.
. Diversified Fulfillment Expertise. Combining with Earlychildhood will
allow SmarterKids.com to capitalize on Earlychildhood's distribution
facilities and fulfillment operations which are located to optimize
shipping and delivery efficiencies. Access to these facilities and
operations will provide SmarterKids.com the opportunity to deliver its
products to customers faster and more cost effectively.
. Create Greater Analyst Following. A public company the size of
LearningStar with the added revenue streams of Earlychildhood may be a
more attractive investment than SmarterKids.com alone and may more
likely be followed by analysts and investors.
Earlychildhood's Reasons for the Combination
In addition to the anticipated joint benefits for the combination described
above, the Earlychildhood management committee believes that the following are
additional reasons the combination will be beneficial to Earlychildhood and in
the best interests of its equity holders:
. Ability to Leverage SmarterKids.com's Internet Infrastructure. The
combination will allow Earlychildhood to leverage SmarterKids.com's
Internet technologies, web engineering resources and overall technology
expertise. The SmarterKids.com website has received multiple accolades,
and SmarterKids.com's technology-centric focus has been a business
differentiator since inception. Earlychildhood anticipates augmenting
its traditional catalog and marketing expertise with SmarterKids.com's
Internet specific technology capabilities. This integration of
capabilities is anticipated to expand Earlychildhood's successful track
record of developing competitive advantages into both the combined
company and the individual business divisions.
. Broadened Customer Exposure. The combination will provide Earlychildhood
with an immediate and established entry into the consumer portion of the
early childhood market. Historically, Earlychildhood has focused
primarily on providing children's educational products, services and
information to schools, educational professionals and secondarily, to
parents. The combination with SmarterKids.com provides Earlychildhood
the opportunity to diversify its customer base into the parents and
individual consumer market.
. Improved Capital Availability and Access to Public Markets. The
combination will provide Earlychildhood with immediate access to the
public markets. Because Earlychildhood is currently a privately-held
limited liability company, it has limited access to new sources of
capital. Upon completion of the combination, LearningStar's common stock
will be publicly traded. Earlychildhood will also have access to
SmarterKids.com's cash, cash equivalents, restricted cash and short-term
38
<PAGE>
investments which were approximately $34.0 million as of September 30,
2000, and to additional financial resources to accelerate its growth.
Opinion of J.P. Morgan H&Q, Financial Advisor to SmarterKids.com
The board of directors of SmarterKids.com retained J.P. Morgan H&Q to
deliver an opinion in connection with a possible business combination
transaction with Earlychildhood. J.P. Morgan H&Q was selected by
SmarterKids.com's board of directors to provide an opinion based on J.P.
Morgan H&Q's qualifications as a nationally-known investment bank of
unquestioned expertise and reputation and its ongoing relationship with
SmarterKids.com. In connection with its engagement, SmarterKids.com instructed
J.P. Morgan H&Q to evaluate the fairness, from a financial point of view, of
the consideration to be received by the holders of the SmarterKids.com common
stock in the combination.
At the meeting of the SmarterKids.com board of directors on November 8,
2000, J.P. Morgan H&Q rendered its preliminary opinion that as of November 8,
2000, based upon and subject to the various considerations set forth in the
J.P. Morgan H&Q opinion, the consideration to be received by the
SmarterKids.com stockholders in the combination is fair from a financial point
of view. On November 14, 2000, SmarterKids.com's board of directors received
J.P. Morgan H&Q's definitive written opinion dated the same date and
reaffirming that the consideration to be received by the SmarterKids.com
stockholders in the combination is fair from a financial point of view. The
consideration to be given to SmarterKids.com stockholders was the result of
arms-length negotiations between SmarterKids.com and Earlychildhood.
The full text of the definitive written J.P. Morgan H&Q opinion, dated
November 14, 2000, which sets forth the assumptions made, the procedures
followed, the matters considered and the limitations on the scope of the
review undertaken by J.P. Morgan H&Q in rendering its opinion is attached as
Annex C to this proxy statement-prospectus. SmarterKids.com stockholders are
urged to read the J.P. Morgan H&Q opinion carefully and in its entirety. J.P.
Morgan H&Q was not asked to consider, and its opinion does not address the
relative merits of the combination as compared to any alternative business
strategy that might exist for SmarterKids.com or of the effect of any other
business combinations in which SmarterKids.com might engage. The J.P. Morgan
H&Q opinion only addresses the fairness of the financial terms from a
financial point of view to the SmarterKids.com stockholders as of the date of
the J.P. Morgan H&Q opinion, and does not constitute a recommendation to any
stockholder of SmarterKids.com as to how the stockholder should vote at the
special meeting. The summary of the J.P. Morgan H&Q opinion set forth in this
proxy statement-prospectus is qualified in its entirety by reference to the
full text of the opinion.
In reviewing the proposed transaction, and in arriving at its opinion, J.P.
Morgan H&Q, among other things:
. reviewed the publicly available consolidated financial statements of
SmarterKids.com for recent years and interim periods to date and certain
other relevant financial and operating data of SmarterKids.com made
available to J.P. Morgan H&Q from published sources, including Wall
Street analysts' research reports, and from the internal records of
SmarterKids.com;
. reviewed the financial statements of Earlychildhood for recent years and
interim periods to date and certain other relevant financial and
operating data of Earlychildhood made available to J.P. Morgan H&Q from
the internal records of Earlychildhood;
. reviewed certain internal financial and operating information relating
to SmarterKids.com and Earlychildhood prepared by the senior management
of SmarterKids.com and Earlychildhood;
. discussed the business, financial condition and prospects of
SmarterKids.com, Earlychildhood and LearningStar with certain members of
the senior management of SmarterKids.com and Earlychildhood;
. reviewed the recent reported prices and trading activity for the common
stock of SmarterKids.com and compared such information and certain
financial information for SmarterKids.com with similar
39
<PAGE>
information for certain other companies engaged in businesses J.P.
Morgan H&Q considered comparable;
. reviewed the financial terms, to the extent publicly available, of
certain comparable merger and acquisition transactions;
. reviewed a draft of the combination agreement dated November 8, 2000;
. reviewed the final version of the combination agreement dated November
14, 2000; and
. performed such other analyses and examinations and considered such other
information, financial studies, analyses and investigations and
financial, economic and market data as J.P. Morgan H&Q deemed relevant.
J.P. Morgan H&Q did not assume responsibility for independent verification
of, and did not independently verify, any of the information concerning
SmarterKids.com considered in connection with its review of the proposed
transactions, including without limitation any financial information, forecasts
or projections, considered in connection with the rendering of its opinion.
Accordingly, for purposes of its opinion, J.P. Morgan H&Q assumed and relied
upon the accuracy and completeness of all such information. In connection with
its opinion, J.P. Morgan H&Q did not prepare or obtain any independent
valuation or appraisal of any of the assets or liabilities of SmarterKids.com,
and it did not conduct a physical inspection of the properties and facilities
of SmarterKids.com or Earlychildhood. With respect to the financial forecasts
and projections used in its analysis, J.P. Morgan H&Q assumed that they
reflected the best currently available estimates and judgments of the expected
future financial performance of SmarterKids.com, and J.P. Morgan H&Q expressed
no view as to the reasonableness of such forecasts and projections or the
assumptions on which such forecasts or projections were based. For the purposes
of its opinion, J.P. Morgan H&Q also assumed that neither SmarterKids.com nor
Earlychildhood was a party to any pending transactions, including without
limitation external financings, recapitalizations or material merger or
acquisition discussions, other than the proposed combination and transactions
in the ordinary course of conducting their respective businesses.
SmarterKids.com advised J.P. Morgan H&Q that it may assume for purposes of its
opinion and J.P. Morgan H&Q did assume, that the proposed merger of S-E
Educational Merger Corp. into SmarterKids.com will be treated for U.S. federal
income tax purposes as a reorganization under Section 368(a) of the Internal
Revenue Code or, taken together with the contribution of all of the outstanding
membership interests in Earlychildhood to LearningStar, as a transfer of
property to LearningStar qualifying under Section 351 of the Internal Revenue
Code.
In performing its analyses, J.P. Morgan H&Q used published Wall Street
estimates of calendar year 2000 and 2001 financial performance of
SmarterKids.com. J.P. Morgan H&Q also made numerous assumptions with respect to
industry performance, general business and economic conditions and other
matters, many of which are beyond the control of SmarterKids.com,
Earlychildhood or J.P. Morgan H&Q. The analyses performed by J.P. Morgan H&Q
and summarized below are not necessarily indicative of actual values or actual
future results, which may be significantly more or less favorable than
suggested by such analyses. Because such analyses are inherently subject to
uncertainty, being based upon numerous factors or events beyond the control of
SmarterKids.com, Earlychildhood or their respective advisors, neither
SmarterKids.com, J.P. Morgan H&Q nor any other person assumes responsibility if
future results or actual values are materially different from the results of
analyses based on forecasts or assumptions. Additionally, analyses relating to
the values of businesses do not purport to be appraisals or to reflect the
prices at which businesses or securities actually may be acquired or bought or
sold.
J.P. Morgan H&Q's opinion is necessarily based upon market, economic,
financial and other conditions as they existed and can be evaluated as of the
date of the opinion and any subsequent change in such conditions would require
a reevaluation of such opinion. J.P. Morgan H&Q expressed no opinion as to the
price at which LearningStar common stock will trade. In rendering its opinion,
J.P. Morgan H&Q assumed that the proposed combination would be completed
substantially on the terms contained in the combination agreement, without any
waiver of any material terms or conditions by any party thereto.
40
<PAGE>
The preparation of a fairness opinion is a complex process and is not
necessarily susceptible to summary description. The summary of J.P. Morgan
H&Q's analyses set forth below summarizes the material analyses presented to
the SmarterKids.com board of directors but is not a complete description of the
presentation by J.P. Morgan H&Q to the SmarterKids.com board of directors or
the analysis performed by J.P. Morgan H&Q in connection with preparing its
opinion. In arriving at its opinion, J.P. Morgan H&Q did not attribute any
particular weight to any analyses or factors considered by it, but rather made
subjective, qualitative judgments as to the significance and relevance of each
analysis and factor. Accordingly, J.P. Morgan H&Q believes that its analyses
and the summary set forth below must be considered as a whole and that
selecting portions of its analyses, without considering all analyses, or of the
following summary, without considering all factors and analyses, could create
an incomplete view of the processes underlying the analyses set forth in the
J.P. Morgan H&Q presentation to the SmarterKids.com board of directors and J.P.
Morgan H&Q's opinion.
The terms of the proposed combination were determined through arms-length
negotiations between SmarterKids.com and Earlychildhood and were approved by
the SmarterKids.com board of directors. Although J.P. Morgan H&Q provided
advice to SmarterKids.com during the course of these negotiations, the decision
to enter into the combination agreement was solely that of the SmarterKids.com
board of directors. As described in the section entitled "--Recommendation of
the SmarterKids.com Board of Directors," the opinion of J.P. Morgan H&Q and its
presentation to the SmarterKids.com board of directors was only one of a number
of factors taken into consideration by the SmarterKids.com board of directors
in making its determination to approve the proposed combination.
The following is a brief summary of the material financial analyses
performed by J.P. Morgan H&Q in connection with providing its preliminary
opinion to the SmarterKids.com board of directors on November 8, 2000 and the
definitive written opinion provided to the SmarterKids.com board of directors
and dated November 14, 2000.
Valuation Analysis of SmarterKids.com
Analysis of Publicly Traded Companies Considered Comparable to
SmarterKids.com. This analysis reviews a business' operating performance and
outlook relative to a group of peer companies to determine an implied value.
Using published Wall Street estimates, J.P. Morgan H&Q compared, among other
things, the enterprise values and projected revenues and EBITDA for calendar
years 2000 and 2001 for SmarterKids.com to corresponding measures for certain
publicly traded education technology and electronic commerce companies that
J.P. Morgan H&Q considered comparable to SmarterKids.com. J.P. Morgan H&Q used
revenues and price to EBITDA when making its comparisons, because valuations
based on revenues and EBITDA are generally accepted in the analysis of
education product distribution and information technology companies. The
companies that J.P. Morgan H&Q considered comparable to SmarterKids.com were:
<TABLE>
<CAPTION>
EV/CY00E EV/CY01E P/E P/E
Revenues Revenues Multiples Multiples
Company Multiples Multiples CY00E CY01E
------- --------- --------- --------- ---------
<S> <C> <C> <C> <C>
School Specialty........................ 0.7 0.6 14.8 13.2
ZapMe................................... 1.9 0.7 N/A N/A
Riverdeep............................... 50.1 13.7 N/A N/A
Amazon.com.............................. 5.4 3.6 29.3 62.0
Barnes and Noble.com.................... 1.9 1.0 N/A N/A
eToys................................... 1.6 0.9 N/A N/A
</TABLE>
J.P. Morgan H&Q determined mean and median enterprise value-to-revenue and
price-to-earnings multiples for these companies. These multiples were used in
analyses discussed below.
41
<PAGE>
Furthermore, J.P. Morgan H&Q reviewed the relative common stock price
performance of certain publicly traded education technology and electronic
commerce companies that J.P. Morgan H&Q considered comparable to
SmarterKids.com from January 3, 2000 to October 31, 2000 and compared such
performance to the Nasdaq Composite Index and the Dow Jones Industrial Average.
J.P. Morgan H&Q noted that the Dow Jones Industrial Average had declined 4.8%
during that period, the Nasdaq Composite Index had declined 16.4%, the index of
education technology companies had declined 70.1% and the index of electronic
commerce companies had declined 79.2%.
Pro Forma Contribution Analysis. J.P. Morgan H&Q determined the implied pro
forma ownership of the combined company, assuming an exchange ratio in the
combination of one share of common stock of LearningStar per share of
SmarterKids.com common stock. J.P. Morgan H&Q then computed the portion of the
combined company's pro forma calendar year 2000 and 2001 revenues contributed
by SmarterKids.com, based on estimates provided by the companies' management.
J.P. Morgan H&Q noted that stockholders of SmarterKids.com would own
approximately 33.3% of the capital stock of the combined company on a pro forma
basis, and that SmarterKids.com would account for 10.7% of the combined
company's estimated consolidated calendar year 2001 revenues.
Also, J.P. Morgan H&Q determined the relative contribution to the equity
value of the combined company by Earlychildhood and SmarterKids.com. In the
case of Earlychildhood, calendar year 2001 estimated revenues and EBITDA were
converted into equity values using revenue and EBITDA multiples from comparable
companies. An equity value for SmarterKids.com was determined by reference to
total market capitalization of its common stock as of November 14, 2000,
adjusted for any anticipated free cash balance as of the completion of the
combination. J.P. Morgan H&Q noted that stockholders of SmarterKids.com would
own approximately 33.3% of the capital stock of the combined company on a pro
forma basis, and that SmarterKids.com would account for as low as 26.6% and as
high as 41.6% of the combined company's equity value.
Pro Forma Trading Value Analysis. Based upon forecasts provided by the
management of SmarterKids.com and Earlychildhood, which reflected the
consummation of the proposed combination, J.P. Morgan H&Q estimated the pro
forma trading value per share of LearningStar using a variety of enterprise
value to revenue multiples from the above analysis of publicly traded companies
considered comparable to SmarterKids.com. J.P. Morgan H&Q then used a variety
of equity values derived from the multiples to calculate the value of each
share of LearningStar common stock. J.P. Morgan H&Q then performed a
sensitivity analysis that derived a range of hypothetical pro forma share
prices based on these pro forma financials and noted that each share could have
a pro forma trading value of between $1.41 and $2.17. The hypothetical pro
forma trading value analysis does not take into account qualitative factors
such as market conditions, potential investor reaction to the transaction or
any other factors not mentioned above. J.P. Morgan H&Q indicated the
hypothetical valuation range which results from this analysis does not
represent J.P. Morgan H&Q's opinion regarding the price at which LearningStar
will trade subsequent to consummation of the transaction. J.P. Morgan H&Q did
not, in any of its verbal or written communications to the board of directors
of SmarterKids.com, provide such an opinion or estimate.
Other Considerations. J.P. Morgan H&Q also took into account many factors
relating to the negotiation of the transaction. J.P. Morgan H&Q and
SmarterKids.com first initiated discussions regarding strategic alternatives in
January 2000. SmarterKids.com engaged J.P. Morgan H&Q to contact organizations
regarding potential interest in a strategic transaction which led to the
execution of seven nondisclosure agreements and preliminary discussions with
six parties. Following the submission of two indications of interest, the
SmarterKids.com board of directors decided to pursue a transaction with
Earlychildhood and terminate discussions with all other parties.
J.P. Morgan H&Q also observed that no company used in the above analyses is
identical to SmarterKids.com or the proposed combination, and the reasons for
and circumstances surrounding each of the analyzed transactions are inherently
different. Accordingly, an analysis of the results of the foregoing is not
42
<PAGE>
mathematical; rather it involves complex, qualitative considerations and
judgments, reflected in J.P. Morgan H&Q's opinion, concerning differences in
the financial and operating characteristics of the compared companies, the
characteristics of the selected transactions and other factors that could
affect the public trading values of the comparable companies and
SmarterKids.com.
J.P. Morgan H&Q, as part of its investment banking services, is regularly
engaged in the valuation of businesses and their securities in connection with
mergers and acquisitions, strategic transactions, corporate restructurings,
negotiated underwritings, secondary distributions of listed and unlisted
securities, private placements and valuations for corporate and other purposes.
J.P. Morgan H&Q has previously provided investment banking and other financial
advisory services to SmarterKids.com, and has received fees for rendering these
services. In the ordinary course of business, J.P. Morgan H&Q acts as a market
maker and broker in the publicly traded securities of SmarterKids.com and
receives customary compensation in connection therewith and has provided
research coverage of SmarterKids.com in the past. In the ordinary course of
business, J.P. Morgan H&Q actively trades in the equity and derivative
securities of SmarterKids.com for its own account and for the accounts of its
customers and, accordingly, may at any time hold a long or short position in
these securities. J.P. Morgan H&Q may in the future provide investment banking
or other financial advisory services to SmarterKids.com, Earlychildhood or
LearningStar.
SmarterKids.com has agreed to pay J.P. Morgan H&Q a financial advisory fee
of $350,000 upon execution of the combination agreement and, upon completion of
the combination an additional $650,000. SmarterKids.com has also agreed to
reimburse J.P. Morgan H&Q for its expenses incurred in performing its services
and to indemnify J.P. Morgan H&Q and its affiliates, their respective
directors, officers, agents and employees and each person, if any, controlling
J.P. Morgan H&Q or any of its affiliates against certain liabilities and
expenses, including certain liabilities under federal securities laws, related
to or arising out of J.P. Morgan H&Q's engagement and any related transactions.
Recommendation of the SmarterKids.com Board Of Directors
The SmarterKids.com board of directors has unanimously determined that the
combination of SmarterKids.com and Earlychildhood is advisable and in the best
interests of its stockholders. The SmarterKids.com board of directors has
unanimously approved the combination agreement and the combination and
unanimously recommends that you vote FOR approval and adoption of the
combination agreement and the transactions contemplated thereby.
In making its recommendation, in addition to the reasons for the combination
set forth above, the SmarterKids.com board of directors took into account the
following:
. Expected Impact of the Combination. The board of directors of
SmarterKids.com noted that the combination of SmarterKids.com and
Earlychildhood is expected to strengthen the financial condition of both
SmarterKids.com and Earlychildhood. The SmarterKids.com board of
directors also noted that the combination of SmarterKids.com and
Earlychildhood would be accounted for as a purchase transaction.
. Opinion of J.P. Morgan H&Q, SmarterKids.com's Financial
Advisor. SmarterKids.com retained J.P. Morgan H&Q to act as its
financial advisor in connection with a possible business combination
transaction with Earlychildhood. In connection with its engagement,
SmarterKids.com instructed J.P. Morgan H&Q to evaluate the fairness,
from a financial point of view of the proposed combination. At the
November 8, 2000 meeting of the board of directors of SmarterKids.com,
J.P. Morgan H&Q delivered its preliminary opinion to the board of
directors of SmarterKids.com to the effect that, as of the date of such
opinion and based upon the various qualifications and assumptions set
forth therein, the consideration to be received by the SmarterKids.com
stockholders
43
<PAGE>
in the combination is fair, from a financial point of view. The J.P.
Morgan H&Q opinion was reaffirmed in a definitive, written opinion dated
November 14, 2000.
. Continuing Equity Interest of SmarterKids.com. The board of directors of
SmarterKids.com considered the fact that by providing for the conversion
of shares of common stock of SmarterKids.com into shares of common stock
of LearningStar, the combination agreement allows holders of
SmarterKid.com common stock to participate in the value generated by the
combination of SmarterKids.com and Earlychildhood. The board of
directors of SmarterKids.com also noted that the proposed ratio of
converting shares of SmarterKids.com into shares of common stock of
LearningStar would result in holders of SmarterKids.com common stock
receiving a significant equity stake in LearningStar, equal to
approximately one-third of the capital stock of LearningStar on a fully-
diluted basis after completion of the combination.
. Corporate Governance Arrangements. The board of directors of
SmarterKids.com noted that pursuant to, and in accordance with, the
combination agreement, the board of directors of LearningStar will
initially consist of nine individuals, two of whom will be designated by
SmarterKids.com, four of whom will be designated by Earlychildhood and
three of whom will be independent directors designated by the
Earlychildhood and SmarterKids.com jointly. In addition, the
SmarterKids.com board of directors noted that the combination agreement
provides that Al Noyes, currently the Chief Operating Officer of
SmarterKids.com, will initially serve as Chief Executive Officer and a
director of LearningStar; Robert Cahill, currently the Chief Financial
Officer of SmarterKids.com, will initially serve as Chief Financial
Officer of LearningStar; and Michael Kolowich, a current director of
SmarterKids.com, will serve as a director of LearningStar. The
SmarterKids.com board of directors concluded that these arrangements
would allow a strong management team drawn from both Earlychildhood and
SmarterKids.com to work together to integrate the two companies.
. Alternatives to the Combination. The board of directors of
SmarterKids.com considered information presented by senior members of
the SmarterKids.com management team that, in seeking the re-positioning
of SmarterKids.com, they had explored alternatives to the proposed
combination of Earlychildhood and SmarterKids.com, including alternative
merger transactions. The SmarterKids.com board of directors considered
management's view that the combination of Earlychildhood and
SmarterKids.com provides significant cost savings and synergies with
greater distribution capabilities, opportunities for cross-marketing
products and potential to offer consumers new and innovative products.
. Integration of Earlychildhood and SmarterKids.com. The board of
directors of SmarterKids.com considered the fact that the combination of
the businesses of Earlychildhood and SmarterKids.com would be
challenging, and the success of the combination is not certain. The
SmarterKids.com board of directors noted, however, that the management
teams of Earlychildhood and SmarterKids.com have a shared vision of the
potential created by the combination of traditional and new commerce
methods. The SmarterKids.com board of directors further noted that the
businesses of both Earlychildhood and SmarterKids.com are based, in
part, on the acquisition and retention of customers. In addition, the
SmarterKids.com board of directors noted that both management teams
share a marketing focus and a service orientation. The SmarterKids.com
board of directors then noted that these similarities in experiences and
views are likely to facilitate the efforts of the management teams of
Earlychildhood and SmarterKids.com to integrate their businesses
effectively and efficiently.
. Conditions; Termination Provisions; Termination Fee. The board of
directors of SmarterKids.com reviewed the conditions to the completion
of the combination and the circumstances under which either party would
have the right to terminate the combination agreement. In addition, the
SmarterKids.com board of directors reviewed the provisions of the
combination agreement that prohibit each of Earlychildhood and
SmarterKids.com from soliciting any third-party proposal or offer
regarding any acquisition of Earlychildhood or SmarterKids.com, as the
case may be. The board
44
<PAGE>
of directors of SmarterKids.com also reviewed the provisions of the
combination agreement that require the board of directors of
SmarterKids.com to recommend the approval and adoption of the
combination agreement and the transactions contemplated thereby to the
stockholders of SmarterKids.com and prohibit the board of directors of
SmarterKids.com from withdrawing or modifying its recommendation unless,
subject to specified conditions, it has received an unsolicited
acquisition proposal which would, if completed, result in a transaction
that is more favorable to the SmarterKids.com stockholders from a
financial point of view than the proposed combination. The
SmarterKids.com board of directors also reviewed the termination fee and
expenses that might be payable in the event the combination agreement is
terminated under specified circumstances. The SmarterKids.com board of
directors noted that while these provisions could have an impact on a
third party considering an unsolicited acquisition proposal for
SmarterKids.com, the provisions were reasonably necessary to protect
Earlychildhood's interests in the context of the proposed combination.
In addition, the SmarterKids.com board of directors found reasonable the
views of its legal and financial advisors that the fees were within the
range of fees payable in comparable transactions and would not be
expected to preclude an unsolicited acquisition proposal for
SmarterKids.com.
. Stockholder Support Agreement. The board of directors of SmarterKids.com
considered the terms of the stockholder support agreement entered into
by each of the SmarterKids.com directors and executive officers and
certain significant stockholders of SmarterKids.com in connection with
the combination. The SmarterKids.com board of directors noted that,
under the stockholder support agreement, these stockholders have agreed
to vote all of their shares of SmarterKids.com's common stock,
representing approximately % of the voting power of the
SmarterKids.com common stock entitled to vote at the special meeting, in
favor of approval and adoption of the combination agreement and the
transactions contemplated thereby.
. Potential Adverse Consequences of the Combination. The board of
directors of SmarterKids.com considered several risks associated with
the combination of Earlychildhood and SmarterKids.com that have the
potential to create adverse consequences for SmarterKids.com. In
particular, the SmarterKids.com board of directors considered the risk
that the attention and efforts of senior members of SmarterKids.com's
management team may be diverted from SmarterKids.com's businesses while
they are working to implement the combination and that valuable
strategic opportunities may be lost. The SmarterKids.com board of
directors also considered the risk that the combination of
SmarterKids.com and Earlychildhood may not be completed.
This summary of the factors considered by the board of directors of
SmarterKids.com in evaluating the merits of the combination of SmarterKids.com
and Earlychildhood is not intended to be exhaustive, but is believed to include
all material factors considered by the SmarterKids.com board of directors. Due
to the wide variety of factors that the SmarterKids.com board of directors
considered in evaluating the merits of the combination of SmarterKids.com and
Earlychildhood, the SmarterKids.com board of directors did not find it
practicable to, and did not attempt to, quantify or otherwise assign relative
weights to the specific factors considered in its evaluation. In addition, the
SmarterKids.com board of directors did not undertake to make any specific
determination as to whether any particular factor, or any aspect of any
particular factor, should be regarded as favorable or unfavorable; instead the
SmarterKids.com board of directors analyzed all of the factors as a whole and
determined that, overall, the factors support its unanimous conclusion that the
combination of SmarterKids.com and Earlychildhood is advisable and in the best
interests of SmarterKids.com and its stockholders. Individual members of the
SmarterKids.com board of directors may have considered some factors to be more
important than other factors and may have considered some factors, or aspects
of some factors, to be favorable while other members considered them to be
unfavorable.
In considering the recommendation of the board of directors of
SmarterKids.com that you to vote for the approval and adoption of the
combination agreement and the transactions contemplated thereby, you should be
aware that certain members of the SmarterKids.com board of directors and
certain members of SmarterKids.com's management team have agreements or
arrangements that provide them with interests in the
45
<PAGE>
transaction that differ from yours generally as a stockholder of
SmarterKids.com. Please see the section entitled "--Interests of Certain
Persons in the Combination" that follows.
Interests of Certain Persons in the Combination
In considering the recommendation of the board of directors of
SmarterKids.com that you to vote for the approval and adoption of the
combination agreement and the transactions contemplated thereby, you should be
aware that certain SmarterKids.com directors and executive officers and their
affiliates, certain Earlychildhood executive officers and members of
Earlychildhood's management committee and their affiliates have agreements or
arrangements that provide them with interests in the transaction that differ
from yours generally as a stockholder of SmarterKids.com. The SmarterKids.com
board of directors was aware of these agreements and arrangements during its
deliberations of the merits of the combination and in determining unanimously
that the combination of SmarterKids.com and Earlychildhood is advisable, and in
the best interest of its stockholders and to unanimously recommend that you
vote to approve and adopt the combination agreement and the transactions
contemplated thereby.
Ownership and Voting Stock. As of December 31, 2000, the directors,
executive officers of SmarterKids.com and their affiliates beneficially owned
8,089,789 shares of SmarterKids.com common stock, including stock options to
purchase 1,860,562 shares of SmarterKids.com common stock, exercisable within
60 days of December 31, 2000, representing in the aggregate approximately 38.7%
of the outstanding shares of SmarterKids.com common stock.
As of December 31, 2000, members of Earlychildhood's management committee,
executive officers of Earlychildhood and their affiliates beneficially owned
95.9% of the outstanding membership interests in Earlychildhood and options to
purchase 3.33% of Earlychildhood membership interests giving effect to the
exchange ratios set forth in the combination agreement.
Stock Options and Accelerated Vesting. Assuming the completion of the
combination as of March 30, 2001, 1,049,242 options to purchase shares of
SmarterKids.com common stock will vest and become exercisable upon the
completion of the combination, including options to purchase SmarterKids.com
common stock that will vest upon the termination without cause or constructive
termination of certain optionholders within 12 months of the completion of the
combination. As of March 30, 2001, the number of unvested stock options held by
executive officers and directors of SmarterKids.com is expected to total
695,832. Assuming the combination is completed on March 30, 2001, the number of
stock options held by executive officers and directors of SmarterKids.com that
would vest by that date is expected to total 616,667 pursuant to the
acceleration of the vesting of options triggered by stock option agreements and
change of control agreements upon completion of the combination.
None of the Earlychildhood options are subject to accelerated vesting. As of
December 31, 2000, the number of unvested stock options held by members of the
Earlychildhood management committee and Earlychildhood executive officers is
expected to total 3.33% of the membership interests in Earlychildhood giving
effect to the exchange ratios set forth in the combination agreement.
Employment, Consulting and Severance Agreements. Upon completion of the
combination, David Blohm, the current President and Chief Executive Officer of
SmarterKids.com, will execute an 18-month consulting agreement with
LearningStar pursuant to which he will be paid $18,750 per month. The
consulting agreement also provides that at the end of the consulting period,
LearningStar will provide Mr. Blohm severance payments of $4,166.67 per month
for 24 months.
Ronald Elliott, the current President and Chief Executive Officer of
Earlychildhood and Judith McGuinn, Earlychildhood's Chief Operating Officer,
both have employment agreements with Earlychildhood. Ms. McGuinn's employment
agreement provides that if at any time Ronald Elliott is not President or
Chairman of the Board of Earlychildhood or any successor entity, Ms. McGuinn
may resign from her position and be entitled to severance payments from
Earlychildhood for the time remaining under her employment agreement.
46
<PAGE>
At this time, it is not anticipated that any member of the Earlychildhood
management committee or Earlychildhood executive officer will enter into a
consulting or severance agreement with LearningStar in connection with the
combination.
Stock Option Agreements. Each of the following SmarterKids.com officers:
David Blohm, Al Noyes, Chief Operating Officer, Jeff Pucci, Co-Chief Executive
Officer, Robert Cahill, Vice President of Finance and Chief Financial Officer,
Richard Viard, Vice President of Product Development, and Richard Secor, Vice
President of MIS and Chief Information Officer, has a stock option agreement
with SmarterKids.com which provides that in the event of a change of control of
SmarterKids.com, a portion of the options held by these executive officers will
be subject to accelerated vesting. Pursuant to these stock option agreements
and as a result of the combination, options held by these executive officers to
purchase an aggregate of 541,667 shares of SmarterKids.com common stock will
immediately vest and become exercisable, assuming the combination is completed
on March 30, 2001.
Earlychildhood does not have any option agreements that are affected by a
change of control of Earlychildhood.
Change of Control Agreements. In September 2000, each of Al Noyes, Robert
Cahill, Richard Viard, Richard Secor, and several key employees (Lisa Tanzer,
Dan Davis, Mark DeChambeau, Joe Panepinto, Evelyn Somers, and John Zimmerman),
each referred to in this section as an "Executive" and SmarterKids.com executed
a change of control agreement pursuant to which, if the Executive is terminated
by SmarterKids.com as a result of a change of control (as defined in the change
of control agreements) within three years from the date of such agreement,
SmarterKids.com would:
. pay the Executive's base salary until the earlier of six months and the
date the Executive is employed by a subsequent employer or is engaged as
a consultant;
. pay the Executive's monthly premium for continued medical and dental
insurance coverage if the Executive elects to continue such coverage
under the Consolidated Omnibus Budget Reconciliation Act of 1985, or
COBRA, until the earlier of six months and the date of the Executive's
COBRA coverage would terminate in accordance with the provisions of
COBRA; and
. accelerate the vesting of the Executive's incentive and non-qualified
options by six months.
Pursuant to these change of control agreements, assuming the combination is
completed on March 30, 2001, options to purchase an aggregate of 124,688 shares
of SmarterKids.com common stock will vest and become exercisable.
In September 2000, each of David Blohm and Jeff Pucci, each referred to in
this section as a "Senior Executive," and SmarterKids.com executed a change of
control agreement pursuant to which, if the Senior Executive is terminated by
SmarterKids.com as a result of a change of control (as defined in the change of
control agreements) within three years from the date of such agreement,
SmarterKids.com will:
. pay the Senior Executive's base salary until the earlier of 12 months
and the date the Senior Executive is employed by a subsequent employer
or is engaged as a consultant;
. pay the Senior Executive's monthly premium for continued medical and
dental insurance coverage if the Senior Executive elects to continue
such coverage under COBRA until the earlier of 12 months and the date
the Senior Executive's COBRA coverage would terminate in accordance with
the provisions of COBRA; and
. accelerate the vesting of the Senior Executive officers incentive and
non-qualified options by 12 months.
47
<PAGE>
Pursuant to these change of control agreements, assuming the combination is
completed on March 30, 2001 and the termination of both Messrs. Blohm and Pucci
immediately thereafter, options to purchase an additional 75,000 shares of
SmarterKids.com common stock will vest and become exercisable, exclusive of
Mr. Blohm's options pursuant to his change of control agreement which will be
superceded by the consulting agreement between Mr. Blohm and LearningStar to be
executed after completion of the combination.
Earlychildhood does not have any change of control agreements.
Governance Structure and Management Positions. Pursuant to the terms of the
combination agreement, upon completion of the combination the board of
directors of LearningStar will be fixed at nine; two members of the
LearningStar board of directors will be designated by SmarterKids.com; four
members of the LearningStar board of directors will be designated by
Earlychildhood; and the remaining three members of the LearningStar board of
directors will be independent directors designated jointly by Earlychildhood
and SmarterKids.com.
Al Noyes, Chief Operating Officer of SmarterKids.com, and Michael Kolowich,
a current director of SmarterKids.com, will serve on the LearningStar board of
directors as the two designees of SmarterKids.com. Ronald Elliott, President
and Chief Executive Officer of Earlychildhood, Robert MacDonald, Managing
Director and President of the Private Equity Group of William E. Simon & Sons,
LLC, an affiliate of Educational Simon, L.L.C., the largest stockholder of
Earlychildhood, Scott Graves, a Principal of the Private Equity Group of
William E. Simon & Sons, LLC, and Stephen Kaplan, each a current member of the
management committee of Earlychildhood will serve on the LearningStar board of
directors as the four designees of Earlychildhood.
The combination agreement also provides that, upon completion of the
combination:
. Al Noyes will serve as Chief Executive Officer of LearningStar;
. Robert Cahill, Vice President of Finance and Chief Financial Officer of
SmarterKids.com, will serve as Chief Financial Officer of LearningStar;
. Ronald Elliott will serve as Chairman of the Board of LearningStar; and
. Judith McGuinn, the Chief Operating Officer of Earlychildhood, will
serve as Chief Operating Officer of LearningStar.
Please see the section entitled "LearningStar" for additional information
regarding the governance structure and executive management positions of
LearningStar following the combination.
Indemnification and Insurance. The combination agreement provides that, upon
completion of the combination, LearningStar will indemnify and hold harmless,
and provide advancement of expenses to, all past and present directors and
officers of SmarterKids.com and members of the Earlychildhood management
committee and Earlychildhood officers incurred in connection with any claim,
action suit or legal proceeding arising out of or pertaining to matters
existing or occurring prior to completion of the combination:
. to the fullest extent they were indemnified or had the right to
advancement of expenses as of November 14, 2000, which is the date of
the combination agreement, pursuant to SmarterKids.com's restated
certificate of incorporation, restated bylaws and indemnification
agreements with any directors and officers of SmarterKids.com; or the
Earlychildhood operating agreement, bylaws and indemnification
agreements with any members of the Earlychildhood management committee
and Earlychildhood officers, as the case may be; and
. to the fullest extent permitted by law.
The combination agreement also provides that, upon completion of the
combination, LearningStar will cause to be maintained, for a period of six
years after completion of the combination, the current policies of directors'
and officers' liability insurance and fiduciary liability insurance maintained
by SmarterKids.com and Earlychildhood, or policies of at least the same amount
and scope containing terms and conditions which are at
48
<PAGE>
least as favorable as SmarterKids.com's and Earlychildhood's existing coverage
with respect to claims arising from facts or events that occurred on or before
the completion of the combination, although LearningStar will not be required
to expend in any one year an amount in excess of 200% of the higher of annual
premiums currently paid by either SmarterKids.com or Earlychildhood, as
applicable, for directors' and officers' liability insurance and fiduciary
liability insurance.
Securities and Exchange Commission Position on Indemnification for Securities
Act Liabilities
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers or persons controlling
SmarterKids.com pursuant to the combination agreement, LearningStar has been
informed that, in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the Securities Act
and is therefore unenforceable.
Material United States Federal Income Tax Consequences of the Combination
The following summary discusses the material U.S. federal income tax
consequences of the combination to U.S. Holders of SmarterKids.com common
stock.
For purposes of this discussion, a U.S. Holder means:
. a citizen or resident of the United States;
. a corporation or other entity taxable as a corporation created or
organized under the laws of the United States, any state thereof or the
District of Columbia;
. a trust, if a U.S. court is able to exercise primary supervision over
the administration of the trust and one or more U.S. persons have the
authority to control all substantial decisions of the trust; or
. an estate that is subject to U.S. federal income tax on its income
regardless of its source.
This discussion is based upon the Internal Revenue Code of 1986, as
amended, Treasury regulations, administrative rulings and judicial decisions
currently in effect, all of which are subject to change, possibly with
retroactive effect. The discussion assumes that SmarterKids.com stockholders
hold their SmarterKids.com common stock and will hold their LearningStar
common stock as a capital asset within the meaning of Section 1221 of the
Internal Revenue Code. Further, the discussion does not address all aspects of
U.S. federal income taxation that may be relevant to a particular stockholder
in light of his, her or its personal investment circumstances or to
stockholders subject to special treatment under the U.S. federal income tax
laws, including:
. insurance companies;
. tax-exempt organizations;
. dealers in securities or foreign currency;
. banks or trusts;
. persons that hold their SmarterKids.com common stock as part of a
straddle, a hedge against currency risk or a constructive sale or
conversion transaction;
. persons that have a functional currency other than the U.S. dollar;
. investors in partnerships, limited liability companies, and other pass-
through entities;
. stockholders who acquired their SmarterKids.com common stock through the
exercise of options or otherwise as compensation or through a tax-
qualified retirement plan; or
. holders of options granted under any SmarterKids.com option or benefit
plan.
Furthermore, this discussion does not consider the potential effects of any
state, local or foreign tax laws.
49
<PAGE>
All SmarterKids.com stockholders are urged to consult their tax advisors
regarding the tax consequences of the combination to them in their particular
situations, including the effects of U.S. federal, state, local, foreign and
other tax laws.
In connection with the filing of the registration statement on Form S-4, of
which this proxy statement- prospectus is a part, Testa, Hurwitz & Thibeault,
LLP, counsel to SmarterKids.com, has delivered to SmarterKids.com, an opinion
dated on or about the effective date of this proxy statement-prospectus to the
effect that this discussion is a fair and adequate summary of the material
anticipated U.S. federal income tax consequences of the combination to the
SmarterKids.com stockholders. Counsel to SmarterKids.com has rendered its
opinion on the basis of certain assumptions and representations described in
such opinion, unverified by counsel, including factual representations
contained in certificates from SmarterKids.com, Earlychildhood, LearningStar,
S-E Educational Merger Corp. and certain of their officers.
The obligation of Earlychildhood to consummate the combination is subject to
the condition that it receive at the closing date an opinion from its counsel,
Latham & Watkins, to the effect that the contribution to LearningStar of all of
the membership interests in Earlychildhood will be treated for U.S. federal
income tax purposes as a transfer of property to LearningStar qualifying under
Section 351 of the Internal Revenue Code. The obligation of SmarterKids.com to
consummate the combination is subject to the condition that it receive at the
closing date an opinion from its counsel, Testa, Hurwitz & Thibeault, LLP, to
the effect that the merger of S-E Educational Merger Corp. into SmarterKids.com
will be treated for U.S. federal income tax purposes as a reorganization within
the meaning of Section 368(a) of the Internal Revenue Code, or, taken together
with the contribution of all of the outstanding membership interests of
Earlychildhood, as a transfer of property to LearningStar qualifying under
Section 351 of the Internal Revenue Code. In rendering those opinions, such
counsel may make certain assumptions and require and rely on representations,
unverified by counsel, including factual representations contained in
certificates from SmarterKids.com, Earlychildhood, LearningStar, S-E
Educational Merger Corp. and certain of their officers.
Both SmarterKids.com and Earlychildhood (for itself and its subsidiaries)
have represented in the combination agreement that they will not incur any tax
liability in connection with the combination.
In the combination agreement, Earlychildhood has also represented, to its
knowledge that:
. none of Earlychildhood, any of its subsidiaries or other affiliates, and
any holders of the equity interests of Earlychildhood have taken or
agreed to take any action (or failed to take or agreed not to take any
action) which such action or inaction, as the case may be, would
prevent:
. the contribution of the equity interests of Earlychildhood to
LearningStar from constituting a transaction qualifying as a
transfer of property to LearningStar by the holders of such equity
interests under Section 351 of the Internal Revenue Code; and
. the merger of S-E Educational Merger Corp. into SmarterKids.com from
qualifying as a "reorganization" described in Section 368(a) of the
Internal Revenue Code; and
. that the holders of such equity interests have no present plan,
intention or arrangement to sell or otherwise dispose of any of the
LearningStar common stock received in exchange for the contribution of
the membership interests of Earlychildhood that would cause the
contribution of such membership interests and the merger of S-E
Educational Merger Corp. into SmarterKids.com to fail to qualify as
transfers under Section 351 of the Internal Revenue Code.
In the combination agreement, SmarterKids.com has also represented, to its
knowledge:
. that none of SmarterKids.com, its affiliates, and any of
SmarterKids.com's stockholders have taken or agreed to take any action
(or failed to take or agreed not to take any action) which such action
or inaction, as the case may be, would prevent the merger of S-E
Educational Merger Corp. into SmarterKids.com from qualifying:
50
<PAGE>
. as a reorganization described in Section 368(a) of the Internal
Revenue Code; and
. taken together with the contribution of the equity interests of
Earlychildhood, as a transfer of property to LearningStar covered by
Section 351 of the Internal Revenue Code; and
. that the stockholders of SmarterKids.com have no present plan, intention
or arrangement to sell or otherwise dispose of any of the LearningStar
common stock received in the merger of S-E Educational Merger Corp. into
SmarterKids.com that would cause the contribution of the membership
interests of Earlychildhood and the merger of S-E Educational Merger
Corp. into SmarterKids.com to fail to qualify as transfers under Section
351 of the Internal Revenue Code.
Earlychildhood, SmarterKids.com, and LearningStar have also agreed in the
combination agreement that neither they nor any of their subsidiaries or other
affiliates will knowingly take any action, or knowingly fail to take any
action, that is reasonably likely to jeopardize the treatment of the merger of
S-E Educational Merger Corp. into SmarterKids.com and the contribution of
membership interests in Earlychildhood to LearningStar as transfers of property
described in Section 351 of the Internal Revenue Code or the merger of S-E
Educational Merger Corp. into SmarterKids.com as a reorganization described in
Section 368(a) of the Internal Revenue Code.
Assuming that the merger of S-E Educational Merger Corp. into
SmarterKids.com qualifies as a "reorganization" within the meaning of Section
368(a) of the Internal Revenue Code, or, taken together with the contribution
of all of the outstanding equity interests in Earlychildhood, as a transfer of
property to LearningStar qualifying under Section 351 of the Internal Revenue
Code, the material U.S. federal income tax consequences to the SmarterKids.com
stockholders are expected to be as follows:
. no gain or loss will be recognized, as the result of the merger of S-E
Educational Merger Corp. into SmarterKids.com, by LearningStar, S-E
Educational Merger Corp. or SmarterKids.com;
. no gain or loss will be recognized by U.S. Holders of SmarterKids.com
common stock on the exchange of their SmarterKids.com common stock for
LearningStar common stock, except with respect to cash received in lieu
of any fractional share of LearningStar common stock;
. the aggregate adjusted basis of the LearningStar common stock received
by a U.S. Holder in exchange for his, her or its SmarterKids.com common
stock, including any fractional share deemed received and redeemed as
described below, will be equal to the aggregate adjusted basis of the
U.S. Holder's SmarterKids.com common stock exchanged for LearningStar
common stock; and
. the holding period of the LearningStar common stock received in exchange
for a U.S. Holder's SmarterKids.com common stock will include the
holding period of the U.S. Holder's SmarterKids.com common stock,
provided that the U.S. Holder held the SmarterKids.com common stock as a
capital asset.
None of the opinions to be delivered to the parties in connection with the
combination as described in this summary is binding on the Internal Revenue
Service or the courts, and the parties do not intend to request a ruling from
the Internal Revenue Service with respect to the combination. Accordingly,
there is no assurance that the Internal Revenue Service will not challenge the
conclusions reflected in those opinions or that a court will not sustain such a
challenge.
If the Internal Revenue Service were successfully to challenge both:
. the "reorganization" status of the merger of S-E Educational Merger
Corp. into SmarterKids.com; and
. the treatment of the merger, taken together with the contribution of all
of the outstanding membership interests in Earlychildhood, as a transfer
of property under Section 351 of the Code;
51
<PAGE>
each U.S. Holder of SmarterKids.com common stock would recognize taxable gain
or loss with respect to the SmarterKids.com common stock surrendered, measured
by the difference between:
. the fair market value, as of the time of the combination, of the
LearningStar common stock received in the combination; and
. the tax basis of the SmarterKids.com common stock surrendered in the
combination.
In that event, a stockholder's aggregate basis in the LearningStar common
stock so received would equal its fair market value as of the time of the
combination and the holding period for that stock would begin the day after the
combination.
Any change in currently applicable law, which change may or may not be
retroactive, or any failure of any factual representations or assumptions to be
true, correct and complete in all material respects, could affect the validity
of the opinions discussed in this summary.
Cash Instead of Fractional Shares. The receipt of cash instead of fractional
shares of LearningStar common stock by a U.S. Holder of SmarterKids.com common
stock will result in taxable gain or loss to the U.S. Holder for U.S. federal
income tax purposes based upon the difference between the amount of cash
received by the U.S. Holder and the U.S. Holder's adjusted tax basis in the
fractional shares as set forth above. The gain or loss is expected to
constitute capital gain or loss and to constitute long-term capital gain or
loss if the U.S. Holder's holding period is more than one year as of the
effective date of the combination. For non-corporate U.S. Holders, this long-
term capital gain generally will be taxed at a maximum U.S. federal income tax
rate of 20%. The deductibility of capital losses is subject to limitations.
Backup Withholding. Certain non-corporate SmarterKids.com stockholders may
be subject to backup withholding at a 31% rate on cash payments received
instead of fractional shares of LearningStar common stock. Backup withholding
will not apply, however, to a SmarterKids.com stockholder who:
. furnishes a correct taxpayer identification number and certifies that
he, she or it is not subject to backup withholding on the substitute
Form W-9 or successor form included in the letter of transmittal to be
delivered to SmarterKids.com stockholders following the date of
completion of the combination;
. provides a certification of foreign status on Form W-BEN; or
. is otherwise exempt from backup withholding.
Reporting Requirements. A U.S. Holder of SmarterKids.com common stock
receiving LearningStar common stock as a result of the combination will be
required to retain certain records for U.S. federal income tax purposes and to
file with its U.S. federal income tax return a statement setting forth facts
relating to the combination. SmarterKids.com stockholders are urged to consult
their tax advisors with respect to these record keeping, filing, and any other
tax reporting requirements.
Tax Attributes. SmarterKids.com has substantial accumulated net operating
loss carryovers, which are available (subject to complex rules and limitations)
to reduce U.S. federal income tax liabilities in future taxable years. Sections
382 and 383 of the Internal Revenue Code impose significant limitations on the
use of carryovers of net operating losses and other items following an
"ownership change" as defined in Section 382 of the Internal Revenue Code.
SmarterKids.com will likely undergo an ownership change for purposes of these
tax rules at the time of the combination. The impact of an ownership change on
the ability of a corporation to utilize carryovers involves inherently factual
questions, some of which cannot be currently known (including future
profitability). In any event, however, while the extent to which the ownership
change occurring as a result of the combination will materially affect the
utilization of any carryovers cannot be predicted with certainty, this
utilization is likely to be significantly limited. SmarterKids.com's
stockholders and their advisers should evaluate the combination with the
expectation that net operating loss carryovers and all other carryover items of
SmarterKids.com will not be materially available to offset future income tax.
52
<PAGE>
This discussion is intended to provide only a summary of the material U.S.
federal income tax consequences of the combination to the SmarterKids.com
stockholders. It does not purport to be a complete analysis or description of
all potential U.S. federal income tax consequences of the combination. It does
not address certain categories of stockholders, and it does not address state,
local or foreign tax consequences. In addition, as noted above, this summary
does not address tax consequences that may vary with, or be contingent upon,
the individual circumstances of stockholders. The summary does not address the
tax consequences of any transaction other than the combination. Accordingly,
SmarterKids.com stockholders should consult their individual tax advisor(s) to
determine their particular U.S. federal, state, local or foreign income or
other tax consequences resulting from the combination, in light of their
individual circumstances.
Accounting Treatment of the Combination
We intend to account for the combination under the purchase method of
accounting for business combinations as if Earlychildhood were acquiring
SmarterKids.com. For more information on the accounting treatment of the
combination, please see the section entitled "Unaudited Pro Forma Condensed
Combined Financial Information."
Dissenters' Rights of Appraisal
Under Delaware law, SmarterKids.com stockholders are not entitled to
appraisal rights in connection with the combination.
Regulatory Matters
Neither SmarterKids.com nor Earlychildhood are required to file any
information with the Federal Trade Commission or the Antitrust Division of the
Department of Justice under the provisions of the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended, in connection with the combination and
the transactions contemplated by the combination agreement.
SmarterKids.com and Earlychildhood are not aware of any of governmental
approvals or actions that are required to complete the combination. Should any
approval or action be required, SmarterKids.com and Earlychildhood currently
plan to seek the approval or take any necessary action. Failure to obtain the
approval or take any necessary action is not anticipated to have a material
effect on the combination or on LearningStar.
Restrictions on Sales of Shares by Affiliates of SmarterKids.com and
Earlychildhood
The shares of LearningStar common stock to be issued in connection with the
combination will be freely transferable under the Securities Act, except for
shares of LearningStar common stock issued to any person who is deemed to be an
"affiliate" of either SmarterKids.com or Earlychildhood at the time of the
special meeting. Persons who may be deemed to be affiliates include individuals
or entities that control, are controlled by, or are under the common control of
either SmarterKids.com or Earlychildhood and include SmarterKids.com directors
and executive officers, significant stockholders of SmarterKids.com (greater
than 5%), members of the Earlychildhood management committee, Earlychildhood
executive officers and significant equity holders of Earlychildhood (greater
than 5%). Affiliates may not sell their shares of LearningStar common stock
acquired in connection with the combination except pursuant to:
. an effective registration statement under the Securities Act covering
the resale of those shares;
. an exemption under paragraph (d) of Rule 145 under the Securities Act;
or
. any other applicable exemption under the Securities Act.
LearningStar's registration statement on Form S-4, of which this proxy
statement-prospectus forms a part, does not cover the resale of shares of
LearningStar common stock to be received by affiliates in the
53
<PAGE>
combination. Each of the affiliates of SmarterKids.com and Earlychildhood also
entered into agreements with LearningStar pursuant to which each affiliate
agreed to comply with Rule 145 of the Securities Act of 1933 in connection with
the sale of any common stock of LearningStar acquired in the combination. For
more information on restrictions on the sale of LearningStar common stock
acquired by affiliates and the affiliate agreements please see the section
entitled "Terms of the Combination--Other Agreements."
Nasdaq National Market Listing of LearningStar Common Stock to be Issued in the
Combination
LearningStar will use its reasonable best efforts to cause the shares of
LearningStar common stock to be issued in connection with the combination to be
approved for listing on the Nasdaq National Market, subject to official notice
of issuance, before the completion of the combination.
Delisting and Deregistration of SmarterKids.com Common Stock following the
Combination
When the combination is completed, SmarterKids.com common stock will be
delisted from the Nasdaq National Market and will be deregistered under the
Securities Exchange Act of 1934.
54
<PAGE>
TERMS OF THE COMBINATION AGREEMENT
The following is a brief summary of the material provisions of the
combination agreement, a copy of which is attached hereto as Annex A and is
incorporated by reference in this proxy statement-prospectus. The summary is
qualified in its entirety by reference to the combination agreement. We urge
you to read the combination agreement in its entirety for a more complete
description of the terms and conditions of the combination.
Structure of the Combination, Conversion of SmarterKids.com Common Stock and
Exchange of Earlychildhood Membership Interests
Structure. To accomplish the combination of their businesses,
SmarterKids.com and Earlychildhood jointly formed a new company, LearningStar,
with one wholly-owned subsidiary, S-E Educational Merger Corp. In order to
effect the combination:
. all outstanding membership interests of Earlychildhood will be
contributed to LearningStar; and
. S-E Educational Merger Corp. will be merged with and into
SmarterKids.com, with SmarterKids.com as the surviving corporation.
As a result of the contribution and the merger, SmarterKids.com and
Earlychildhood will each become a wholly-owned subsidiary of LearningStar.
Conversion of SmarterKids.com Common Stock and Exchange of Earlychildhood
Membership Interests. In the combination:
. Earlychildhood members will receive shares of LearningStar common stock
according to the following exchange ratio applicable to the class of
each outstanding Earlychildhood membership interest they own as of the
closing date of the combination:
. each .00001% of a Class A membership interest will be exchanged for
4.9951 shares of LearningStar common stock;
. each .00001% of a Class B membership interest will be exchanged for
4.6781 shares of LearningStar common stock;
. each .00001% of a Class C membership interest will be exchanged for
2.3365 shares of LearningStar common stock; and
. SmarterKids.com common stockholders will receive one share of
LearningStar common stock for each share of SmarterKids.com common stock
owned as of the effective date of the combination.
As a result of the combination, former holders of SmarterKids.com common
stock and options and warrants therefor will own approximately one-third of the
capital stock of LearningStar and former holders of membership interests in
Earlychildhood and options therefor will own approximately two-thirds of the
capital stock of LearningStar. The number of shares of LearningStar common
stock issuable in the combination will be proportionately adjusted for any
stock split, stock dividend or similar event with respect to the
SmarterKids.com common stock or Earlychildhood membership interests effected
between the date of the combination agreement and the date the combination is
completed.
Exchange of SmarterKids.com Stock Certificates for LearningStar Stock
Certificates
When the combination is completed, the exchange agent will deliver a letter
of transmittal and instructions for surrendering SmarterKids.com stock
certificates and certificates representing Earlychildhood membership interests,
if any, for LearningStar stock certificates. When you deliver your
SmarterKids.com stock certificates to the exchange agent, along with a properly
executed letter of transmittal and any other required documents, your
SmarterKids.com stock certificates will be cancelled and you will receive stock
certificates representing
55
<PAGE>
the number of full shares of LearningStar common stock to which you are
entitled under the combination agreement. SmarterKids.com stockholders and
Earlychildhood members will receive payment in cash, without interest, in lieu
of any fractional shares of LearningStar common stock to which they would have
been otherwise entitled as a result of the combination. You should not submit
your SmarterKids.com stock certificates for exchange until you receive the
transmittal instructions and a form of letter of transmittal from the exchange
agent.
You are not entitled to receive any dividends or other distributions on
LearningStar common stock until the combination is completed and you have
surrendered your SmarterKids.com stock certificates in exchange for
LearningStar stock certificates.
If there is any dividend or other distribution on LearningStar common stock
with a record date after the date on which the combination is completed and a
payment date before the date you surrender your SmarterKids.com stock
certificates in exchange for LearningStar stock certificates, you will receive
the dividend or distribution with respect to the whole shares of LearningStar
common stock issued to you promptly after the dividend or distribution is
issued. If there is any dividend or other distribution on LearningStar common
stock with a record date after the date on which the combination is completed
and a payment date after the date you surrender your SmarterKids.com stock
certificates in exchange for LearningStar stock certificates, you will receive
the dividend or distribution with respect to the whole shares of LearningStar
common stock issued to you promptly after the payment date.
LearningStar will issue a LearningStar stock certificate and/or a check in
lieu of a fractional share in a name other than the name in which a surrendered
SmarterKids.com stock certificate is registered only if the exchange agent is
presented with all documents required to effect the unrecorded transfer of
ownership and show payment of any applicable stock transfer taxes.
Treatment of Options to Purchase SmarterKids.com Common Stock and
Earlychildhood Membership Interests, SmarterKids.com Warrants and the
SmarterKids.com Employee Stock Purchase Agreement
Options to Purchase SmarterKids.com Common Stock and Earlychildhood
Membership Interests. When the combination is completed, each option to
purchase SmarterKids.com common stock or Earlychildhood membership interests,
as the case may be, will be converted into an option to purchase the same
number of shares of LearningStar common stock (rounded down to the nearest
whole number) as the holder of the option would have been entitled to receive
had the optionholder exercised the option in full immediately prior to the
effective date of the combination, at an exercise price equal to:
. the aggregate exercise price for the shares of SmarterKids.com common
stock or Earlychildhood membership interests, as the case may be,
purchasable pursuant to the option, divided by
. the number of full shares of LearningStar common stock deemed
purchasable pursuant to the option in accordance with the combination
agreement (rounded up to nearest whole cent).
LearningStar intends to file a registration statement on Form S-8 covering
the issuance of the shares of LearningStar common stock subject to each
SmarterKids.com and Earlychildhood option and intends to maintain the
effectiveness of that registration statement for as long as any of the options
remain outstanding.
SmarterKids.com Warrants. Upon consummation of the combination, each
outstanding warrant for SmarterKids.com common stock will be converted into the
right to acquire the same number of shares of LearningStar common stock
(rounded down to the nearest whole number) as the holder of the warrants would
have been entitled to purchase had the warrantholder exercised the warrants
immediately prior to the effective date of the combination, at an exercise
price equal to:
. the aggregate exercise price for the shares of SmarterKids.com common
stock purchasable pursuant to the warrant, divided by
56
<PAGE>
. the number of full shares of LearningStar common stock deemed
purchasable pursuant to the warrant in accordance with the combination
agreement (rounded up to the nearest whole cent).
Employee Stock Purchase Plan. When the combination is completed, it is
intended that SmarterKids.com employees and Earlychildhood employees will be
able to participate in the LearningStar employee stock purchase plan, and the
SmarterKids.com 1999 employee stock purchase plan will be terminated.
Conditions to the Combination
Each of SmarterKids.com's and Earlychildhood's obligations to complete the
combination are subject to the satisfaction or written waiver of specified
conditions, including the following:
. the receipt of all approvals and consents of, and the completion of
filings with, or notices to, any governmental authority necessary for
completion of the combination, the failure of which to obtain,
individually or in the aggregate, would reasonably be likely to have a
material adverse effect, individually or in the aggregate, on
SmarterKids.com, Earlychildhood or LearningStar;
. the declaration of effectiveness of the registration statement on Form
S-4, of which this proxy statement-prospectus is a part, by the
Securities and Exchange Commission, and the absence of any stop order or
proceedings seeking a stop order;
. the absence of any order, executive order, stay, decree, judgment or
injunction prohibiting completion of the combination issued by any
governmental entity;
. the approval for listing on a national securities exchange or for
quotation on the Nasdaq National Market of the shares of LearningStar
common stock to be issued, or to be reserved for issuance, in connection
with the combination, subject to official notice of issuance;
. the receipt by both parties of the respective required consents of any
person whose consent is required in order to complete the combination,
except those consents that, if not obtained, would not, individually or
in the aggregate, have a material adverse effect on SmarterKids.com or
Earlychildhood, as applicable, or a material adverse effect on
LearningStar;
. the taking of all necessary actions by both parties to amend the
certificate of incorporation and bylaws of LearningStar and to compose
the board of directors of LearningStar as required by the combination
agreement; and
. each of the transaction documents must have been executed and be in full
force and effect and no material breach by any party shall have occurred
thereunder.
The term "material adverse effect" when used in this section in reference to
any entity means any event, change, circumstance or effect that is or is
reasonably likely to be materially adverse to the business, assets, properties,
financial condition or results of operations of the entity and its
subsidiaries, if any, taken as a whole. However, with respect to
SmarterKids.com no decrease or successive decreases in the market price of
SmarterKids.com common stock will, in and of itself, constitute a material
adverse effect.
SmarterKids.com's obligation to complete the combination is subject to the
satisfaction or waiver of the following additional conditions:
. Earlychildhood's representations and warranties must be true and correct
as of the date of the combination agreement and as of the date of
completion of the combination, except for:
. changes contemplated by the combination agreement; and
. inaccuracies which, individually or in the aggregate, have not had
and are not reasonably likely to have a material adverse effect on
Earlychildhood or LearningStar or a material adverse effect on the
consummation of the transactions contemplated by the combination
agreement;
57
<PAGE>
. Earlychildhood must have performed in all material respects all material
obligations required to be performed by it under the combination
agreement; and
. no material adverse effect or material adverse change with respect to
Earlychildhood shall have occurred since the date of the combination
agreement and be continuing;
. SmarterKids.com must have received from Testa, Hurwitz & Thibeault, LLP,
a written opinion to the effect that the merger of S-E Educational
Merger Corp. with and into SmarterKids.com will be treated for U.S.
federal income tax purposes as either a "reorganization" within the
meaning of Section 368(a) of the Internal Revenue Code or, when taken
together with the contribution of all of the outstanding membership
interests in Earlychildhood to LearningStar, as a transfer of property
qualifying under Section 351 of the Internal Revenue Code; and
. Earlychildhood must have executed each of the transaction documents to
which it is a party, which agreements must be in full force and effect
and no material breach by Earlychildhood may have occurred thereunder.
Earlychildhood's obligation to complete the combination is subject to the
satisfaction or waiver of the following additional conditions:
. the adoption of the combination agreement by the affirmative vote of the
holders of a majority of the outstanding shares of SmarterKids.com
common stock;
. SmarterKids.com's representations and warranties, must be true and
correct as of the date of the combination agreement and as of the date
of completion of the combination, except for:
. changes contemplated by the combination agreement; and
. inaccuracies which, individually or in the aggregate, have not had
and are not reasonably likely to have a material adverse effect on
SmarterKids.com or LearningStar or a material adverse effect on the
consummation of the transactions contemplated by the combination
agreement;
. SmarterKids.com must have performed or complied with all material
obligations required to be performed by it under the combination
agreement;
. no material adverse effect or material adverse change with respect to
SmarterKids.com shall have occurred since the date of the combination
agreement and be continuing;
. SmarterKids.com shall have Cash on Hand (as defined by U.S. generally
accepted accounting principles) of not less than $18,000,000 after
deducting certain fees and expenses of both parties incurred in
connection with the combination, including costs relating to the
integration of the two businesses and their technologies; and
. Earlychildhood must have received from Latham & Watkins a written
opinion to the effect that for U.S. federal income tax purposes, the
contribution of all the outstanding membership interests of
Earlychildhood to LearningStar will be treated as a transfer of property
qualifying under Section 351 of the Internal Revenue Code.
No Other Transactions Involving SmarterKids.com or Earlychildhood
The combination agreement contains detailed provisions prohibiting
SmarterKids.com and Earlychildhood from seeking an alternative transaction.
Under these "no solicitation" and "no negotiation" provisions, each of
SmarterKids.com and Earlychildhood has agreed that neither it nor any of its
subsidiaries, officers, directors, employees, financial advisors, attorneys,
accountants or other agents or representatives will, directly or indirectly:
. solicit, initiate, facilitate or encourage any inquires, offers or
proposals by any third party with respect to an Acquisition Proposal, as
described below;
58
<PAGE>
. enter into or execute any agreement with respect to an Acquisition
Proposal;
. engage in or continue any discussion with, or otherwise communicate any
non-public information to any third party relating to an Acquisition
Proposal, except pursuant to a governmental request for information;
. make or authorize any public statement, recommendation or solicitation
in support of any Acquisition Proposal; or
. take any other action inconsistent with its non-solicitation obligations
or commitments.
The term "Acquisition Proposal" means, with respect to any entity:
. any transaction pursuant to which any third party acquires more than 20%
of the outstanding equity securities of that entity pursuant to a tender
offer or exchange offer or otherwise;
. a merger or other business combination, recapitalization, restructuring
or similar transaction involving that entity;
. any other transaction pursuant to which any third party acquires more
than 20% of the fair market value of all assets of the entity, including
stock of its subsidiaries, taken as a whole; or
. any public announcement of a proposal, plan or intention to do any of
the foregoing.
However, the combination agreement does not prevent SmarterKids.com and its
board of directors from, with respect to a bona fide written unsolicited
Acquisition Proposal:
. furnishing non-public information to the third party;
. otherwise facilitating any effort or attempt by the third party to make
an Acquisition Proposal;
. agreeing to recommend or endorse the Acquisition Proposal by the third
party;
. withdrawing, modifying or proposing to withdraw or modify its approval
and recommendation of the combination agreement and the transactions
contemplated thereby;
. participating in any discussions or negotiations with the third party
relating to the Acquisition Proposal; and
. entering into an agreement implementing the Acquisition Proposal, if
SmarterKids.com at the same time terminates the combination agreement
and pays Earlychildhood the termination fee described below.
However, SmarterKids.com may take the foregoing actions if and only to the
extent that:
. the SmarterKids.com board of directors, after consultation with a
financial advisor of nationally recognized reputation, reasonably
determines in good faith that the unsolicited Acquisition Proposal is
more favorable or reasonably likely to lead to an Acquisition Proposal
more favorable to the SmarterKids.com stockholders from a financial
point of view than the transactions contemplated by the combination
agreement and is made by a third party reasonably believed by the
SmarterKids.com board of directors to be financially capable of
completing the Acquisition Proposal;
. the SmarterKids.com board of directors, after consultation with outside
counsel, reasonably determines in good faith that the failure to take
such action would cause the members of the SmarterKids.com board of
directors to breach their fiduciary duties to the SmarterKids.com
stockholders under applicable law;
59
<PAGE>
. before providing any non-public information to, or entering into
discussions or negotiations with, the third party in connection with an
unsolicited Acquisition Proposal by that person, the SmarterKids.com
board of directors receives from that third party an executed
confidentiality agreement with terms no less favorable than those
contained in the confidentiality agreement among SmarterKids.com,
Earlychildhood and Thomas Weisel Partners, LLP and provided that the
confidentiality agreement does not contain any exclusive right to
negotiate with SmarterKids.com or any payments by SmarterKids.com; and
. before providing any information to any person or entering into
discussions or negotiations with the third party with respect to the
Acquisition Proposal, it promptly notifies Earlychildhood of:
. inquiries, proposals or offers received with respect to the
Acquisition Proposal, any non-public information requested from, or
any discussions or negotiations sought to be initiated or continued
with, any of its representatives;
. the name of the third party making the Acquisition Proposal and the
terms and conditions of any proposal or offer; and
. SmarterKids.com does not accept or enter into any agreement
concerning an Acquisition Proposal for at least three business days
after Earlychildhood's receipt of notice of the terms of the
Acquisition Proposal.
In addition, the combination agreement does not prevent SmarterKids.com from
complying with Rule 14e-2 promulgated under the Securities Exchange Act of 1934
with regard to an Acquisition Proposal.
The SmarterKids.com board of directors may only change its recommendation
that the SmarterKids.com stockholders vote in favor of the approval and
adoption of the combination agreement and the transactions contemplated thereby
as provided in the "no solicitation" provision of the combination agreement.
Each of SmarterKids.com and Earlychildhood has agreed under the provisions
of the combination agreement that:
. it will promptly keep the other party informed of the status and terms
of any proposals, offers, discussions or negotiations covered by the "no
solicitation" and "no negotiation" provisions of the combination
agreement;
. it will, and its officers, directors, managers and representatives will,
immediately cease and terminate any activities, discussions or
negotiations existing as of November 14, 2000, the date of the execution
of the combination agreement, with any parties conducted before that
date with respect to any Acquisition Proposal; and
. it will use reasonable best efforts to promptly inform its directors,
officers, key employees, agents and representatives of the obligations
of the "no solicitation" provision of the combination agreement, in the
case of SmarterKids.com, and "no negotiation" provision of the
combination agreement, in the case of Earlychildhood.
Nothing contained in the "no solicitation" or "no negotiation" provisions of
the combination agreement will:
. permit SmarterKids.com or Earlychildhood to terminate the combination
agreement, except as specifically provided in the combination agreement;
or
. affect any other obligation of SmarterKids.com or Earlychildhood under
the combination agreement.
Termination
The combination agreement may be terminated at any time prior to the
completion of the combination, whether before or after SmarterKids.com
stockholder approval has been obtained:
60
<PAGE>
. by mutual written consent of SmarterKids.com and Earlychildhood;
. by either SmarterKids.com or Earlychildhood if the combination is not
completed by April 30, 2001, except that if the combination has not been
completed by April 30, 2001 due to failure to obtain any governmental
approval, the date for completion of the combination will be extended to
July 31, 2001;
. by either SmarterKids.com or Earlychildhood if any court of competent
jurisdiction issues an non-appealable final order, decree or ruling or
takes any other non-appealable, final action permanently restraining,
enjoining or otherwise prohibiting the combination;
. by either SmarterKids.com or Earlychildhood if there has been a breach
of any representation, warranty, covenant or agreement on the part of
the other party that is material and not cured within 30 business days
following receipt by the breaching party of written notice of the
breach;
. by Earlychildhood, if:
. at the SmarterKids.com special meeting of stockholders (including
any adjournment or postponement of the special meeting), the
requisite vote of the stockholders of SmarterKids.com in favor of
the approval and adoption of this combination agreement and the
transactions contemplated thereby is not obtained;
. the SmarterKids.com board of directors has withdrawn or modified in
any manner its recommendation that its stockholders vote in favor of
approval and adoption of the combination agreement and the
transactions contemplated thereby;
. SmarterKids.com fails to include in this proxy statement-prospectus
the recommendation of its board of directors in favor of the
approval of the combination agreement and the transactions
contemplated thereby;
. after the receipt by SmarterKids.com of an Acquisition Proposal,
Earlychildhood requests in writing that the SmarterKids.com board of
directors reconfirm its recommendation that the SmarterKids.com
stockholders are in favor of approval and adoption of the
combination agreement and the transactions contemplated thereby and
the SmarterKids.com board of directors fails to do so within ten
business days after its receipt of Earlychildhood's request;
. the SmarterKids.com board of directors or any committee thereof
approves or recommends to the stockholders of SmarterKids.com an
Acquisition Proposal other than the proposed combination;
. a tender offer or exchange offer for 20% or more of the outstanding
shares of SmarterKids.com common stock is commenced (other than by
Earlychildhood or an affiliate of Earlychildhood) and the
SmarterKids.com board of directors does not oppose the tender or
exchange offer;
. SmarterKids.com enters into any letter of intent or similar document
or any agreement, contract or commitment accepting or expressing an
intent to accept an Acquisition Proposal;
. SmarterKids.com fails to call and hold the special meeting of
SmarterKids.com stockholders by April 30, 2001; or
. by SmarterKids.com, prior to the approval and adoption by its
stockholders of the combination agreement, if SmarterKids.com receives a
bona fide written unsolicited Acquisition Proposal and:
. the SmarterKids.com board of directors reasonably determines in good
faith (after consultation with a financial advisor of nationally
recognized reputation) that the Acquisition Proposal is more
favorable or is reasonably likely to lead to an Acquisition Proposal
that is more favorable to the SmarterKids.com stockholders from a
financial point of view than the proposed combination and is made by
a third party reasonably believed by the SmarterKids.com board of
directors to be financially capable of completing the Acquisition
Proposal; and
61
<PAGE>
. the SmarterKids.com board of directors reasonably determines in good
faith (after having consulted with and considered the advice of its
outside legal counsel) that the failure to take actions in
connection with the Acquisition Proposal would cause the members of
the SmarterKids.com board of directors to breach their fiduciary
duties to the SmarterKids.com stockholders under applicable law;
provided, that SmarterKids.com must have given Earlychildhood three
business days' notice before the termination, otherwise complied
with the "no solicitation" provisions and paid Earlychildhood the
termination fee described below.
Termination Fees
As set forth in more detail below, the combination agreement requires
SmarterKids.com to pay a termination fee of $1,300,000 to Earlychildhood if:
. Earlychildhood terminates the combination agreement due to the failure
of SmarterKids.com to receive the requisite vote of its stockholders to
approve the combination agreement; and:
. at the time of this termination, a definitive proposal for an
Acquisition Proposal has been provided to SmarterKids.com by a third
party; and
. within 12 months of this termination, either SmarterKids.com shall
have entered into a definitive agreement with respect to, or have
completed, a transaction in connection with the Acquisition
Proposal;
. SmarterKids.com terminates the combination agreement and at that time
Earlychildhood would have been permitted to terminate the combination
agreement as a result of the actions of the SmarterKids.com board of
directors in connection with approval and adoption of the combination
agreement and the transactions contemplated thereby by SmarterKids.com
stockholders or an Acquisition Proposal;
. Earlychildhood terminates the combination agreement due to
SmarterKids.com's actions in connection with approval and adoption of
the combination agreement and the transactions contemplated thereby by
SmarterKids.com stockholders or an Acquisition Proposal; or
. SmarterKids.com terminates the combination agreement having determined
in good faith that an Acquisition Proposal:
. is more favorable or is reasonably likely to lead to an Acquisition
Proposal that is more favorable to the SmarterKids.com stockholders
from a financial point of view than the combination and is made by a
third party reasonably believed by the SmarterKids.com board of
directors to be financially capable of completing the Acquisition
Proposal; and
. the failure to take alternative actions in connection with the
Acquisition Proposal would cause the members of the SmarterKids.com
board of directors to breach their fiduciary duties to the
SmarterKids.com stockholders under applicable law.
Expenses
If the combination agreement is terminated by SmarterKids.com or
Earlychildhood due to a breach by the other party of its representations,
warranties, covenants and agreements, then the breaching party is required to
pay the expenses incurred by the non-breaching party in connection with the
combination, up to a maximum of $350,000 and subject to certain exceptions
described in the combination agreement. A portion of the termination fee, if
applicable, may be deemed to include reimbursement of termination expenses.
Agreement to Cooperate to Complete the Combination
Each of SmarterKids.com and Earlychildhood has agreed to cooperate with the
other and to use its reasonable best efforts to take all actions and do all
things necessary, proper and advisable under the
62
<PAGE>
combination agreement and applicable laws to complete the combination as soon
as practicable after November 14, 2000, which is the date of the combination
agreement. Accordingly, each has agreed to use its reasonable best efforts to:
. as promptly as practicable, prepare and file all applications, notices,
petitions, filings, and other documents, and to obtain all waivers,
licenses, orders, registrations, permits, rulings, authorizations and
clearances from any third party or any domestic or foreign governmental
entity necessary to complete the combination; and
. take all reasonable steps to obtain all necessary consents and required
approvals, including those required under applicable antitrust laws.
The combination agreement also contains covenants relating to the
cooperation between SmarterKids.com and Earlychildhood in the preparation of
this proxy statement-prospectus and additional agreements between them relating
to, among other things, access to information, mutual notice of specified
matters and public announcements.
Amendment, Extension and Waiver
The combination agreement may be amended by SmarterKids.com and
Earlychildhood, by action taken or authorized by their board of directors or
management committee, as the case may be, at any time before or after approval
of the combination agreement by the stockholders of SmarterKids.com has been
obtained. After the approval has been obtained, no amendment may be made which
by law requires further approval by the stockholders of SmarterKids.com,
without their further approval. All amendments to the combination agreement
must be in writing signed by SmarterKids.com and Earlychildhood.
At any time before the effective date of the combination, SmarterKids.com
and Earlychildhood may, by action taken or authorized by their board of
directors or management committee, as the case may be, to the extent legally
allowed:
. extend the time for the performance of any of the obligations or other
acts of the other parties to the combination agreement;
. waive any inaccuracies in the representations and warranties of the
other party contained in the combination agreement or in any document
delivered pursuant to the combination agreement; and
. waive compliance with any of the agreements or conditions of the other
party contained in the combination agreement.
All extensions and waivers must be in writing and signed by the party making
the waiver.
Representations and Warranties
The combination agreement contains customary representations and warranties
of SmarterKids.com and Earlychildhood relating to, among other things:
. corporate organization and similar corporate matters;
. subsidiaries and capital structure;
. taxes;
. properties;
. intellectual property;
. product warranty and liability;
. material contracts;
63
<PAGE>
. litigation;
. environmental matters;
. employee benefit plans and labor matters;
. compliance with laws;
. insurance;
. no existing discussions with third parties;
. authorization, absence of conflicts, required filings and consents;
. absence of certain changes or events;
. information supplied in connection with this proxy statement-prospectus
and the registration statement of which it is a part;
. board of directors and management committee approval, as the case may
be, and applicable state takeover laws;
. in the case of SmarterKids.com, the vote required to approve and adopt
the combination agreement and the transactions contemplated thereby; and
. in the case of SmarterKids.com, documents filed with the Securities and
Exchange Commission and financial statements included in those
documents.
LearningStar Charter and Bylaws
Upon completion of the combination, the restated certificate of
incorporation of LearningStar will be in substantially the form set forth in
Annex D to this proxy statement-prospectus and the amended and restated bylaws
of LearningStar will be substantially in the form set forth in Annex E to this
proxy statement-prospectus. For a summary of the material provisions of the
restated certificate of incorporation and amended and restated bylaws of
LearningStar, and the rights of stockholders of LearningStar under the restated
certificate of incorporation and amended and restated bylaws, see the section
entitled "Description of Capital Stock of LearningStar."
Stockholder Support Agreement
The following is a brief summary of the material provisions of the
stockholder support agreement, a copy of which is attached as Annex B to this
proxy statement-prospectus and is incorporated herein by reference. The summary
is qualified in its entirety by reference to the stockholder support agreement.
We urge you to read the stockholder support agreement in its entirety for a
more complete description of its terms and conditions.
In connection with the execution and delivery of the combination agreement,
Earlychildhood entered into a stockholder support agreement with each of the
directors and executive officers and certain significant stockholders of
SmarterKids.com, pursuant to which these directors, executive officers and
stockholders agreed to vote all their shares of SmarterKids.com common stock in
favor of the approval and adoption of the combination agreement and the
transactions contemplated thereby. As of the record date for the special
meeting, these directors, executive officers and stockholders owned shares of
SmarterKids.com common stock representing approximately % of the total voting
power of the outstanding shares of the SmarterKids.com common stock.
The stockholder support agreement prohibits, subject to limited exceptions,
these stockholders from selling, transferring, pledging, encumbering, assigning
or otherwise disposing of any shares of SmarterKids.com capital stock, except
to a person who agrees in writing to be bound by the terms of the stockholder
support agreement.
64
<PAGE>
The stockholder support agreement terminates upon the earlier to occur of
the completion of the combination and the termination of the combination
agreement in accordance with its terms.
Other Agreements
The following is a brief summary of the material provisions of the other
agreements entered into in connection with the combination agreement.
Consent and Non-Contravention Agreement. In connection with the combination,
each of the holders of membership interests in Earlychildhood entered into a
consent and non-contravention agreement with SmarterKids.com pursuant to which
the members agreed that they would, at the closing of the combination,
contribute all of their membership interests in Earlychildhood to LearningStar
and in exchange therefor accept the number of shares of LearningStar common
stock in accordance with the exchange ratio applicable to the class of
membership interests held.
The consent and non-contravention agreement prohibits, subject to limited
exceptions, the Earlychildhood members from selling, transferring, pledging,
encumbering, assigning or otherwise disposing of any membership interests in
Earlychildhood, except to a person who agrees in writing to be bound by the
terms of the consent and non-contravention agreement.
The consent and non-contravention agreement terminates upon the earlier to
occur of the completion of the combination and the termination of the
combination agreement in accordance with its terms.
Affiliate Agreements. In connection with the combination, each of the
affiliates of SmarterKids.com (the directors and executive officers and holders
of 5% or more of the outstanding common stock of SmarterKids.com) and each of
the affiliates of Earlychildhood (the management committee members, executive
officers and holders of 5% or more of the outstanding membership interests in
Earlychildhood) executed affiliate agreements pursuant to which each affiliate
agreed to comply with Rule 145 of the Securities Act of 1933 in connection with
the sale of any common stock of LearningStar acquired in the combination. For
more information on the requirements of Rule 145 of the Securities Act of 1933,
please see the section entitled "The Combination--Restrictions on Sales of
Shares by Affiliates of SmarterKids.com and Earlychildhood."
Lock-up Agreements. In connection with the combination, each of the
directors and executive officers and certain significant stockholders of
SmarterKids.com, as well as each of the holders of membership interests in
Earlychildhood, entered into a lock-up agreement with LearningStar pursuant to
which each agreed not to sell any shares of LearningStar common stock received
in connection with the combination for a period of 180 days from the date on
which the LearningStar registration statement on Form S-4, of which this proxy
statement-prospectus is a part, is declared effective by the Securities and
Exchange Commission.
Registration Rights Agreements. Each of the persons or entities who executed
a lock-up agreement in connection with the combination also entered into a
registration rights agreement with LearningStar pursuant to which, under
certain circumstances, LearningStar will be required to register the shares of
LearningStar common stock acquired in the combination by these persons or
entities.
Consulting Agreement. Upon completion of the combination, David Blohm, the
current President and Chief Executive Officer of SmarterKids.com, will enter
into an 18-month consulting agreement with LearningStar and will be paid a fee
of $18,750 per month for his services. Upon expiration of the 18-month
consulting period, LearningStar shall provide Mr. Blohm with severance payments
of $4,166.67 per month for 24 months.
Completion and Effectiveness of the Combination
The combination will be completed when all of the conditions to completion
of the combination are satisfied or waived, including the approval and adoption
of the combination agreement by the stockholders of SmarterKids.com. The
combination will become effective upon:
65
<PAGE>
. the contribution of all of the outstanding membership interests in
Earlychildhood to LearningStar; and
. the filing of a certificate of merger with the Secretary of State of the
State of Delaware with respect to the merger of S-E Educational Merger
Corp. with and into SmarterKids.com.
We are working toward completing the combination as quickly as possible. We
expect to complete the combination during the spring of 2001.
No Provision for Unaffiliated Stockholder Access to SmarterKids.com Corporate
Files
No provision has been made by SmarterKids.com in connection with the
combination to grant unaffiliated security holders access to the corporate
files of SmarterKids.com or to obtain counsel or appraisal services at the
expense of SmarterKids.com.
Accountants
The firms of PricewaterhouseCoopers, LLP, independent accountants and
auditors of SmarterKids.com, and KPMG LLP, independent accountants and auditors
of Earlychildhood, have each been invited to attend the SmarterKids.com special
meeting and will have an opportunity to make a statement and respond to
appropriate questions.
66
<PAGE>
MARKET PRICE INFORMATION
SmarterKids.com common stock is traded on the Nasdaq National Market under
the symbol "SKDS." As of the record date for the special meeting, there were
approximately holders of record of SmarterKids.com common stock. The
following table sets forth the high and low closing prices per share of
SmarterKids.com common stock as reported by the Nasdaq National Market for each
quarter during the fiscal year ended December 31, 2000 and for the portion of
the fourth quarter during the fiscal year ended December 31, 1999 following
completion of SmarterKids.com's initial public offering on November 23, 1999.
SmarterKids.com has not paid cash dividends on its common stock during these
periods and SmarterKids.com does not presently intend to declare cash dividends
on its common stock in the foreseeable future.
Earlychildhood's membership interests are not publicly traded and, as such,
no market price information is available regarding its membership interests. As
of , 2001, the record date for the SmarterKids.com special meeting, there
were approximately holders of outstanding membership interests in
Earlychildhood.
<TABLE>
<CAPTION>
SmarterKids.com
Common Stock
----------------
High Low
-------- -------
<S> <C> <C>
1999
Fourth Quarter (November 23-December 31, 1999)............... $15.3125 $6.5625
2000
First Quarter................................................ $ 8.3750 $3.9375
Second Quarter............................................... $ 4.0625 $1.5000
Third Quarter................................................ $ 2.3125 $1.0625
Fourth Quarter............................................... $ 2.1250 $0.5312
</TABLE>
MARKET DATA
The table below presents trading information for SmarterKids.com common
stock for November 13, 2000 and , 2001. November 13, 2000 was the last
full trading date prior to the public announcement of the proposed combination.
, 2001 was the last practicable trading day for which information was
available prior to the date of the first mailing of this proxy statement-
prospectus.
<TABLE>
<CAPTION>
SmarterKids.com
Common Stock
---------------
High Low
---------------
<S> <C> <C>
November 13, 2000............................................... $ 2.125 $ 1.875
, 2001...................................................
</TABLE>
The market price of SmarterKids.com common stock fluctuates. As a result, we
urge you to obtain current market quotations for SmarterKids.com common stock.
67
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION
On November 14, 2000, SmarterKids.com, Inc. entered into a Contribution
Agreement and Plan of Reorganization and Merger, with Earlychildhood LLC, S-E
Educational Holdings Corp. (subsequently renamed LearningStar Corp.) and S-E
Educational Merger Corp. Pursuant to the combination agreement, each of
Earlychildhood and SmarterKids.com will become a wholly-owned subsidiary of
LearningStar. Upon completion of the combination, each issued and outstanding
share of common stock of SmarterKids.com will be converted into the right to
receive one newly-issued share of LearningStar common stock, and holders of
outstanding common stock of SmarterKids.com and options and warrants therefor
will acquire an aggregate of approximately one-third of the capital stock of
LearningStar. In addition, in the combination, all of the issued and
outstanding membership interests of Earlychildhood will be exchanged for newly-
issued shares of LearningStar common stock in accordance with the exchange
ratios set forth in the combination agreement, and holders of outstanding
membership interests in Earlychildhood and options therefor will acquire
approximately two-thirds of the capital stock of LearningStar.
The following unaudited pro forma condensed combined financial information
gives effect to the combination of Earlychildhood and SmarterKids.com by
application of the pro forma adjustments described in the accompanying notes.
The unaudited pro forma condensed combined balance sheet gives effect to the
combination as if it had occurred on September 30, 2000. The unaudited pro
forma condensed combined statement of operations for the nine month period
ended September 30, 2000 gives effect to the combination as if it had occurred
on January 1, 2000. The unaudited pro forma condensed combined statement of
operations for the year ended December 31, 1999 gives effect to the combination
and the acquisition of Educational Products, Inc., or EPI, by Earlychildhood in
1999 as if both had occurred on January 1, 1999.
The combination will be accounted for under the purchase method, with
Earlychildhood as the acquirer and SmarterKids.com as the acquired company.
Under the purchase method of accounting, the purchase price will be allocated
to the assets acquired and liabilities assumed of SmarterKids.com based upon
management's estimates of fair values, with the excess of the fair value of the
net assets over the purchase price being allocated to reduce ratably the
recorded fair values of property and equipment and identifiable intangible
assets. The pro forma adjustments related to the purchase price allocation
represent management's best estimate of the effects of the pending combination
and are subject to adjustment upon completion of a final independent valuation
analysis to be obtained in connection with the closing of the combination. The
pro forma adjustments are based upon estimates, currently available information
and certain assumptions that management deems appropriate; management believes
that finalization of the purchase accounting upon consummation of the
combination will not significantly change the pro forma adjustments.
On May 5, 1999, Earlychildhood acquired EPI, a Texas-based wholesaler of
educational products, for approximately $8.6 million, including direct
acquisition costs of approximately $217,000. The purchase price consisted of
$6.8 million in cash and membership interests in Earlychildhood valued at $1.6
million. Earlychildhood accounted for this acquisition under the purchase
method. Accordingly, the total cost of the business acquired is allocated to
the underlying tangible and intangible assets acquired and liabilities assumed
based on their respective fair values. The excess of the purchase price over
the fair value of the net assets acquired, amounting to approximately $5.5
million, was treated as goodwill and is being amortized over ten years.
The unaudited pro forma condensed combined financial information presented
herein is not necessarily indicative of the results of operations or financial
position of the combined companies had the transactions assumed therein
occurred, nor are they necessarily indicative of the results of operations
which may be expected to occur in the future. The unaudited pro forma condensed
combined financial information should be read in conjunction with the audited
financial statements and notes thereto of each of Earlychildhood, EPI and
SmarterKids.com included elsewhere in this proxy statement-prospectus.
68
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
As of September 30, 2000
(In thousands)
<TABLE>
<CAPTION>
Pro Forma
-----------------------
Earlychildhood SmarterKids.com Adjustments Total
-------------- --------------- ----------- -------
<S> <C> <C> <C> <C>
Assets
Current assets:
Cash and cash
equivalents........... $ -- $ 17,754 $ -- $17,754
Short-term
investments........... -- 15,201 -- 15,201
Accounts receivable,
net................... 10,032 175 -- 10,207
Inventories............ 14,023 4,161 -- 18,184
Prepaid expenses and
other current assets.. 2,153 2,573 -- 4,726
------- -------- --------- -------
Total current assets... 26,208 39,864 -- 66,072
Receivable from member.. 139 -- 139
Property and equipment,
net.................... 4,495 5,469 (1,582)(b) 7,452
(930)(e)
Other assets............ 1,086 1,761 2,847
Goodwill and other
intangible assets,
net.................... 7,415 362 (362)(c) 16,601
12,077 (d)
(2,891)(e)
Restricted cash......... -- 1,028 -- 1,028
------- -------- --------- -------
Total assets........... $39,343 $ 48,484 $ 6,312 $94,139
======= ======== ========= =======
Liabilities and
Stockholders' Equity
Current liabilities:
Current portion of long
term debt and capital
lease obligations..... $ 1,383 $ 541 $ -- $ 1,924
Accounts payable....... 4,991 2,123 -- 7,114
Accrued expenses....... 1,240 2,983 630 (f) 7,953
3,100 (k)
Deferred revenue....... -- 533 (533)(g) --
Income taxes payable... 1,015 -- -- 1,015
Deferred income taxes.. 475 -- -- 475
Other current
liabilities........... 163 72 -- 235
------- -------- --------- -------
Total current
liabilities........... 9,267 6,252 3,197 18,716
Long term debt and
capital lease
obligations, net of
current portion........ 7,811 806 -- 8,617
------- -------- --------- -------
Total liabilities...... 17,078 7,058 3,197 27,333
------- -------- --------- -------
Stockholders' equity:
Members' equity......... 24,980 -- (24,980)(i) --
Common stock............ -- 206 (206)(h) 655
206 (a)
449 (i)
Additional paid in-
capital................ -- 112,374 (112,374)(h) 69,636
48,205 (a)
24,531 (i)
(3,100)(k)
Deferred stock
compensation........... (2,715) (4,494) 4,494 (h) (3,485)
(770)(j)
Accumulated deficit..... -- (66,660) 66,660 (h) --
------- -------- --------- -------
Total stockholders'
equity................ 22,265 41,426 3,115 66,806
------- -------- --------- -------
Total liabilities and
stockholders' equity.. $39,343 $ 48,484 $ 6,312 $94,139
======= ======== ========= =======
</TABLE>
69
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
For the year ended December 31, 1999
(In thousands, except per share data)
<TABLE>
<CAPTION>
Pro Forma Pro Forma
-------------------- ----------------------
Early Sub- Smarter
childhood EPI (1) Adjustments total Kids.com Adjustments Total
--------- ------- ----------- ------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Net revenues............ $61,034 $ 2,707 $-- $63,741 $ 5,421 $ -- $ 69,162
Cost of goods sold...... 37,226 1,961 -- 39,187 4,005 -- 43,192
------- ------- ---- ------- -------- ------ --------
Gross profit........... 23,808 746 -- 24,554 1,416 -- 25,970
------- ------- ---- ------- -------- ------ --------
Operating expenses:
Selling, general and
administrative,
excluding stock-based
compensation.......... 18,931 2,051 -- 20,982 33,491 (837)(p) 53,636
Stock-based
compensation.......... -- -- -- -- 3,405 308 (q) 3,713
Amortization of
goodwill and other
intangibles........... 653 -- 232(m) 885 -- 2,045 (r) 2,930
------- ------- ---- ------- -------- ------ --------
Total operating
expenses.............. 19,584 2,051 232 21,867 36,896 1,516 60,279
------- ------- ---- ------- -------- ------ --------
Income (loss) from
operations............. 4,224 (1,305) (232) 2,687 (35,480) (1,516) (34,309)
Interest and other
(income) expense, net.. 829 63 208(n) 1,100 (752) -- 348
------- ------- ---- ------- -------- ------ --------
Income (loss) before
income taxes.......... 3,395 (1,368) (440) 1,587 (34,728) (1,516) (34,657)
Income tax expense
(benefit).............. 982 46 (538)(o) 490 -- (490)(s) --
------- ------- ---- ------- -------- ------ --------
Net income (loss)...... 2,413 (1,414) 98 1,097 (34,728) (1,026) (34,657)
Accretion of redeemable
preferred stock........ -- -- -- -- (189) 189 --
------- ------- ---- ------- -------- ------ --------
Net income (loss)
attributable to common
stockholders ......... $ 2,413 $(1,414) $ 98 $ 1,097 $(34,917) $ (837) $(34,657)
======= ======= ==== ======= ======== ====== ========
Basic and diluted net
income (loss) per
common share........... $ 0.05(t) $ 0.03(t) $ (9.20) $ (0.61)(u)
Weighted average number
of basic and diluted
shares outstanding..... 35,909(t) 36,513(t) 3,796 57,154 (u)
</TABLE>
70
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
For the nine months ended September 30, 2000
(In thousands, except per share data)
<TABLE>
<CAPTION>
Pro Forma
----------------------
Early Smarter
childhood Kids.com Adjustments Total
--------- -------- ----------- --------
<S> <C> <C> <C> <C>
Net revenues................... $67,814 $ 4,504 $ -- $ 72,318
Cost of goods sold............. 42,585 3,386 -- 45,971
------- -------- ------ --------
Gross profit............... 25,229 1,118 -- 26,347
------- -------- ------ --------
Operating expenses:
Selling, general and
administrative, excluding
stock-based compensation.... 21,648 25,251 (628)(p) 46,271
Stock-based compensation..... 467 1,374 231 (q) 2,072
Amortization of goodwill and
other intangibles........... 764 -- 1,534 (r) 2,298
------- -------- ------ --------
Total operating expenses... 22,879 26,625 1,137 50,641
------- -------- ------ --------
Income (loss) from
operations.............. 2,350 (25,507) (1,137) (24,294)
Interest and other (income)
expense, net.................. 1,040 (2,037) -- (997)
------- -------- ------ --------
Income (loss) before income
taxes..................... 1,310 (23,470) (1,137) (23,297)
Income tax expense (benefit)... 944 -- (944)(s) --
------- -------- ------ --------
Net income (loss).......... $ 366 $(23,470) $ (193) $(23,297)
======= ======== ====== ========
Basic and diluted net income
(loss) per common share....... $ 0.01(t) $ (1.15) $ (0.36)(u)
Weighted average number of
shares outstanding:
Basic...................... 44,738(t) 20,476 65,379 (u)
Diluted.................... 44,739(t) 20,476 65,379 (u)
</TABLE>
71
<PAGE>
1. Notes to the Unaudited Pro Forma Condensed Combined Balance Sheet
The following represents the components of the purchase price of
SmarterKids.com as of September 30, 2000 for financial accounting purposes (in
thousands):
<TABLE>
<S> <C>
Fair value of 20,641,040 shares of LearningStar Corp. common stock
exchanged for outstanding SmarterKids.com common stock........... $37,228
Fair value of stock options exchanged............................. 7,746
Fair value of warrants exchanged.................................. 337
Direct acquisition costs of Earlychildhood........................ 3,100
-------
Total purchase price............................................ $48,411
=======
</TABLE>
The fair value of the common stock issued in the combination of $1.80 per
share was based on the average market value of SmarterKids.com common stock
during the period commencing three days before and ending three days after the
announcement date of the combination. The following represents the preliminary
allocation of the total purchase price to the estimated fair values of acquired
assets and liabilities of SmarterKids.com at September 30, 2000 and is for
illustrative purposes only. Assuming the transaction occurred on September 30,
2000, the purchase accounting allocation would have been as follows (in
thousands):
<TABLE>
<S> <C>
Working capital..................................................... $33,515
Property and equipment.............................................. 2,957
Other assets........................................................ 2,789
Other intangible assets............................................. 9,186
Long-term liabilities............................................... (806)
Deferred compensation............................................... 770
-------
Total purchase price.............................................. $48,411
=======
</TABLE>
The purchase accounting allocation summarized above is reflected in the
following pro forma adjustments to the unaudited pro forma condensed combined
balance sheet at September 30, 2000:
(a) To record Earlychildhood's investment in SmarterKids.com equal to the
total purchase price summarized above.
(b) To reflect the fair value of the SmarterKids.com property and
equipment acquired.
(c) To eliminate the previously recorded value of intangible assets of
SmarterKids.com.
(d) To record the identifiable intangible assets at their fair values
based on a preliminary independent appraisal. Upon completion of the
combination, Earlychildhood will obtain a final independent
professional valuation of the identifiable intangible assets acquired.
Preliminarily, Earlychildhood expects such identifiable intangible
assets to include primarily trade names, completed technology under
patents and its customer lists. To a lesser extent, Earlychildhood
also expects the identifiable intangible assets to include existing
website technology, customer profiles, remaining workforce in-place,
and content ratings.
(e) To record a pro rated amount of negative goodwill resulting from the
difference between the fair value of the net assets acquired and the
total purchase price.
(f) To record a liability for exit costs related to SmarterKids.com
facilities to be closed in connection with the combination.
72
<PAGE>
(g) To eliminate the previously recorded value of deferred revenue since
there are no expected related post-combination performance costs.
(h) To eliminate the historical stockholders' equity accounts of
SmarterKids.com.
(i) To reflect the recapitalization of Earlychildhood in connection with
the combination whereby the Earlychildhood membership interests will
be exchanged for common stock of LearningStar.
(j) To record deferred compensation related to the intrinsic value of the
unvested portion of SmarterKids.com employee stock options exchanged
in the combination.
(k) To record Earlychildhood's direct costs related to the combination.
2. Notes to the Unaudited Pro Forma Condensed Combined Statements of Operations
(l) To record the results of EPI for the period January 1, 1999 through
May 5, 1999, the pre-acquisition period for which EPI results were not
consolidated with the results of operations of Earlychildhood.
(m) To record additional goodwill amortization expense related to the
acquisition of EPI for the period from January 1, 1999 through May 5,
1999. The goodwill is being amortized over ten years.
(n) To reflect interest expense for the period January 1, 1999 through May
5, 1999 on the debt incurred by Earlychildhood to finance the
acquisition of EPI.
(o) To record an adjustment to tax expense relating to the inclusion of
the pre-acquisition results of EPI for the period January 1, 1999
through May 5, 1999.
(p) To reflect reduced depreciation expense resulting from negative
goodwill allocated in the purchase accounting to reduce the recorded
fair value of property and equipment.
(q) To reflect amortization of the deferred stock compensation of $770,000
recorded in connection with the combination.
(r) To reflect amortization of identifiable intangible assets of
SmarterKids.com recorded in the purchase accounting for the
combination, based on their expected useful lives ranging from three
to six years.
(s) To adjust the tax provision of the combined companies to reflect the
net operating losses generated by SmarterKids.com in the periods
presented. As of December 31, 1999, SmarterKids.com had net operating
loss carryforwards for federal and state tax purposes of approximately
$38 million, which expire through 2019, and has generated significant
additional net operating losses in 2000. Utilization of these tax
benefits in future years by the combined company will be subject to
annual limitations.
(t) Assumes exchange of the weighted average membership interests into
common stock of LearningStar Corp. at the exchange ratios as stated in
the combination agreement and includes a pro forma adjustment to
income tax expense to reflect the effect of Earlychildhood's income
being subject to federal and state income taxes.
(u) Since the pro forma statement of operations results in a loss from
continuing operations, the pro forma basic and diluted net loss per
common share is computed by dividing the net loss by the weighted
average number of common shares outstanding. The calculation of the
pro forma weighted average number of common shares outstanding assumes
that 20,641,040 shares of the combined company have been issued to
acquire SmarterKids.com in the combination and 1,763,498 shares issued
in the EPI acquisition were outstanding at the beginning of the
periods presented.
(v) To remove accretion relating to the preferred stock of SmarterKids.com
as the preferred stock does not continue to be outstanding after the
combination.
73
<PAGE>
SMARTERKIDS.COM
The information in this section describes the business of SmarterKids.com as
it has historically been conducted, without giving effect to the combination.
For a more detailed discussion of SmarterKids.com's business, you should read
its most recent annual report on Form 10-K, which was filed by SmarterKids.com
on March 30, 2000.
Business
Overview
SmarterKids.com was incorporated in Delaware in March 1994. SmarterKids.com
is a leading online educational store, launched in November 1998, dedicated to
helping parents help their children learn, develop, and grow. The site offers
one of the Internet's most personalized shopping experiences, linking teacher-
reviewed toys, games, books, software, and hands-on activities through
SmarterKids.com's patent-pending evaluation and recommendation process.
SmarterKids.com provides 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 serves as a resource for parents, offering specialty
centers, the Grade Expectations! guide to education standards and thousands of
educational products, including both well-known brands and hard-to-find quality
offerings, for children ages infant through 15.
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. SmarterKids.com only sells
products that its full-time staff of certified educators believes have
educational, developmental or learning value. SmarterKids.com's collection of
products includes over 4,500 books, toys and games, and software titles from
over 300 suppliers. Because SmarterKids.com is focused on education, many of
its products, particularly toys and games, are often not found on many of the
other websites that offer children's products. The MySmarterKids.com
personalization area on the SmarterKids.com 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. The SmarterKids.com SmartPicks technology
then uses this profile to make product recommendations from SmarterKids.com's
distinctive assortment of products tailored to a child's individual
developmental profile and goals.
SmarterKids.com's principal executive offices are located at 15 Crawford
Street Needham, Massachusetts 02494. SmarterKids.com's telephone number is
(781) 449-7567, and its website is www.smarterkids.com.
Industry Background
SmarterKids.com's business lies at the intersection of the consumer market
for educational and developmental products for children and 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
74
<PAGE>
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 face challenges in
providing a shopping experience that meets the needs of parents, including:
. narrow selection of products due to physical space limitations;
. high costs from the need to build and operate multiple retail locations;
. lack of flexibility in product display and merchandising capabilities;
. lack of convenience due to limited hours of operation and geographic
location; and
. lack of focus on educational products and limited educational expertise.
Specialty educational retailers and creative toy and game retailers that are
focused on education often lack the sales 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 has dramatically affected the way consumers and businesses are buying
and selling products and services. The Internet is well suited for consumer
commerce for a number of reasons, including:
. 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; and
. 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.
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; and
. 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.
75
<PAGE>
The SmarterKids.com Solution
SmarterKids.com is an online retailer focused on children's educational
books, toys and games, and software. SmarterKids.com combines expertise in
children's education with sophisticated product analysis to help parents make
better purchase decisions. Key features of the SmarterKids.com solution
include:
Broad Assortment of Carefully Selected and Reviewed Educational
Products. SmarterKids.com's collection of educational products includes over
4,500 books, toys and games, and software titles from over 300 suppliers.
SmarterKids.com continues to carefully select and add products to its
assortment that meet its quality standards. SmarterKids.com employs certified
educators who select only products that have educational, developmental or
learning value. SmarterKids.com products are also selected based on how a child
uses the product, and whether the product is fun. Once selected, the
SmarterKids.com 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."
SmarterKids.com also provides product reviews prepared by third parties.
Because it is focused on education, many of SmarterKids.com's 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. SmarterKids.com
believes that it is an authority on educational products. Each member of the
SmarterKids.com 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. This staff of educators
develops SmarterKids.com content, including educational articles, parenting
advice and product reviews, and licenses educational content from third
parties. The benefit SmarterKids.com provides parents comes, first, by
selecting the best educational products in the marketplace to offer from the
SmarterKids.com website and, second, by providing online advice and information
about specific products to help parents and gift givers make appropriate
selections. The SmarterKids.com 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. The SmarterKids.com
Teacher Talk Glossary helps parents understand commonly used educational terms.
SmarterTips helps parents prepare their children for standardized tests. Ask
the Teacher enables parents to submit questions to SmarterKids.com's staff of
teachers regarding their child's development and review archived answers to
previous questions. SmarterSites connects parents to other relevant educational
websites. SmarterKids.com's exclusive monthly columns, "TotTime" by Jean Warren
and "Raising Smarter Kids" by Dr. Dorothy Rubin, are authored by education
experts with more than 100 published books to their credit. In addition,
parents can get daily education news headlines from the world's top news
sources in Today's Headlines. In addition, SmarterKids.com launched specialty
centers focused on the individual product and informational needs of Gifted &
Talented and Special Needs children, furthering its mission to help all
children learn, develop, and grow.
Convenient and Easy-to-Use Website. SmarterKids.com integrates carefully
selected products, helpful content and interactive tools with an intuitive and
easy-to-use interface. SmarterKids.com organizes its website around age and
grade levels, which is the way parents typically think about the educational
development of their children. SmarterKids.com offers full search and browsing
capabilities that enable parents to find products easily. Furthermore,
SmarterKids.com notifies registered parents when it offers relevant new
products or specials. SmarterKids.com provides customers the convenience and
flexibility of shopping 24 hours a day, seven days a week, with dedicated
customer service and reliable and timely product delivery.
76
<PAGE>
Technology That Matches Products With a Child's Unique Educational
Profile. Parents can use SmarterKids.com's proprietary technology to find
products that meet their child's unique educational needs. The
MySmarterKids.com 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:
. the Learning Styles Survey that parents can fill out online;
. skills check-up assessment tests that children can take online;
. CD-ROM based skills tests that parents can order from the
SmarterKids.com website; and
. scores from state-sponsored standardized tests.
SmarterKids.com's proprietary SmartPicks technology then uses this
developmental profile to make targeted product recommendations. SmartPicks
"reshuffles" the entire store so that it emphasizes those products that the
SmarterKids.com educational team believes are appropriate for the individual
child's unique needs and individual goals. On subsequent visits, the
SmarterKids.com website will recognize registered members and display products
and services tailored to a child's developmental profile and goals.
SmarterKids.com believes it is the first and presently the only educational
products and services website to offer this level of personalization.
Shopping at SmarterKids.com
The SmarterKids.com website is designed to be easy and convenient to use.
The SmarterKids.com 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 SmarterKids.com's
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 the
SmarterKids.com website. Parents naturally think about their children in terms
of their age and grade, and, by organizing its 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' favorite, subject matter, brand,
keyword or theme. Each aisle also has pictures and prices of highlighted
products with links to teachers' reviews of these products.
From the SmarterKids.com 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, Great Gift Ideas, Kids' Favorites or Twenty
under $20;
. 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; and
. 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
SmarterKids.com gathers from its customers and any seasonal, periodic or
promotional opportunities SmarterKids.com pursues.
Products. SmarterKids.com offers three product types--books, toys and games,
and software--ranging in price from under $2.00 to $799.00. These products
range from those based on popular brands and licensed
77
<PAGE>
characters to hard-to-find specialty items. SmarterKids.com sets its prices on
parity with the average prices of similar products offered by its 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.
The Grade Expectations! section of the SmarterKids.com website allows
parents to select products aligned to educational grade standards based on an
interpretation of widely accepted national, state, and local curriculum
guidelines.
MySmarterKids.com offers what SmarterKids.com believes 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, SmarterKids.com's proprietary personalization technology.
MySmarterKids.com incorporates a child's age and grade, learning goals and
results from:
. the 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 the
SmarterKids.com website; and
. 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 a 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 the SmarterKids.com website, new products will
automatically be suggested that achieve the learning goals and fit the learning
style and age range of the child.
SmarterKids.com protects all information entered into MySmarterKids.com and
elsewhere and strictly adheres 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.
SmarterKids.com stocks each item that it sells and is able to show the customer
the availability for each product. SmarterKids.com's 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 the United Parcel Service.
Website content is designed and selected to achieve SmarterKids.com's
mission of helping parents help their children learn. SmarterKids.com's product
reviews are prepared by a staff of full-time educators. To promote trust,
SmarterKids.com encourages customers to access explanations of product review
methodology. SmarterKids.com's 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. SmarterSites connects parents to relevant and
78
<PAGE>
powerful information sources. Parents who register for MySmarterKids.com
receive twice-monthly e-mailed newsletters.
Marketing and Sales
SmarterKids.com uses an aggressive and multi-faceted advertising and
promotional strategy to build awareness and attract customers to its website.
SmarterKids.com uses a personalized database marketing approach to build its
customer base and encourage repeat transactions. SmarterKids.com emphasizes
responsive and reliable customer service to earn customer loyalty.
E-mail is the primary vehicle by which SmarterKids.com communicates with its
customers and registered users. SmarterKids.com sends customers periodic
newsletters and notification of private, customer-only offers. SmarterKids.com
personalizes its information and offers to specific subsets of its customers,
according to the products they have purchased and the information they have
provided in their children's MySmarterKids.com profiles, enhancing the value
added and SmarterKids.com's relationship with them.
SmarterKids.com's online marketing efforts include relationships with
companies who maintain websites that have a large, existing customer base.
SmarterKids.com places banners, buttons and text links on its websites in
return for a specified number of impressions, and jointly develops content,
promotions and e-mail marketing programs. For example, SmarterKids.com has a
persistent search box on the home page of Microsoft's Encarta encyclopedia
website. These relationships generally include content sharing arrangements and
require SmarterKids.com to pay a fee for delivery of Internet traffic. In these
relationships, SmarterKids.com is usually the preferred, if not exclusive,
online retailer of children's educational books, toys and games, and software.
National Computer Systems, or NCS, is the largest processor of standardized
tests for children in kindergarten through grade 12 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 the SmarterKids.com
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 SmarterKids.com's 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 that
SmarterKids.com 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
its promotional services relationship with NCS, SmarterKids.com issued to NCS
warrants to purchase 112,500 shares of SmarterKids.com common stock at an
exercise price of $1.33 per share. With the consent of NCS, SmarterKids.com
cancelled warrants to purchase 84,375 shares of SmarterKids.com common stock in
November 2000. The remaining 28,125 warrants became exercisable upon the
achievement by NCS of certain milestones.
Through programs managed by LinkShare, SmarterKids.com has 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 recruits
affiliates, collect commissions from SmarterKids.com and pays the participating
websites.
Offline marketing is an increasingly important component of
SmarterKids.com's customer acquisition and branding efforts. SmarterKids.com
advertises in a variety of parenting-oriented and other magazines and through
direct mail and free-standing inserts.
79
<PAGE>
SmarterKids.com obtains products from a network of large and small vendors,
manufacturers and distributors. SmarterKids.com carries inventory of the
products available for sale on its website. SmarterKids.com currently conducts
its distribution operations through one facility operated by SmarterKids.com,
consisting of approximately 139,000 square foot facility in Mansfield,
Massachusetts.
SmarterKids.com sends orders from its website to its distribution facilities
over secure connections and warehouse management systems that optimize the
pick, pack and ship process. The warehouse management system provides the
website with data on inventory quantities, which enables SmarterKids.com to
display information about the availability of the products on its website. The
management system also enables SmarterKids.com to offer a variety of gift wrap
choices, custom gift cards and custom to/from labels for each individual gift.
In addition, SmarterKids.com offers an order tracking service for its customers
on its website.
SmarterKids.com offers three levels of shipping service in the United
States: standard, premium and express. SmarterKids.com has developed strong
relationships with United Parcel Service, the United States Postal Service and
Federal Express to maximize its overall service level to all 50 states.
Customer Service
SmarterKids.com seeks to provide a customer experience that exceeds customer
expectations. Its goals include:
. prompt shipping;
. responding to all e-mail inquiries within the same day;
. maintaining a return rate of less than 1%; and
. maintaining at least 99% of inventory items in stock at any time.
SmarterKids.com maintains 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. SmarterKids.com trains its representatives to be
competent and courteous. SmarterKids.com gives representatives wide discretion
to ensure that customers are satisfied with their purchases and their
purchasing experience.
Technology
SmarterKids.com has 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
proprietary and commercially-available technologies. SmarterKids.com focuses
its internal development efforts on creating and improving specialized software
that is unique and able to enhance its business. SmarterKids.com uses a set of
applications for:
. evaluating and reviewing products for eligibility in its 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; and
. interacting with its fulfillment center.
80
<PAGE>
SmarterKids.com develops or selects 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, seven-days-a-
week availability. The SmarterKids.com transaction processing methods and
databases are designed without arbitrary capacity constraints and are scalable
to any volume of demand that it expects to encounter. SmarterKids.com has
implemented load balancing systems and redundant servers to provide for fault
tolerance.
Since September 1999, SmarterKids.com's 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
SmarterKids.com's 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 and Zany Brainy;
. online book sellers, toy sellers and computer software sellers, such as
Amazon.com, eToys, KBkids.com, and Beyond.com; and
. educational catalog distributors, such as Scholastic.
SmarterKids.com believes that the principal competitive factors in its
market are:
. brand recognition and trust;
. ability to attract and retain consumers;
. breadth of product selection;
. product pricing;
. availability of educational and authoritative information; and
. quality and responsiveness of customer service.
SmarterKids.com believes that it competes favorably on these factors.
SmarterKids.com expects its brand recognition to increase as a result of
current and future strategic relationships and marketing and advertising
campaigns. SmarterKids.com will also continue to expand its product selection.
Intellectual Property Rights
SmarterKids.com regards the protection of its intellectual property as
critical to its future success and relies on a combination of copyright,
trademark, service mark and trade secret laws, license agreements and
contractual restrictions to establish and protect its proprietary rights in
SmarterKids.com website architecture and technology, products, content and
services. SmarterKids.com has a pending patent application relating to the
SmartPicks product selection algorithm it uses on its website. SmarterKids.com
has entered into confidentiality and invention assignment agreements with its
employees and contractors in order to limit disclosure of proprietary
information and to protect SmarterKids.com's ownership interest in its website
81
<PAGE>
architecture and technology. SmarterKids.com cannot assure you that these
contractual arrangements or the other steps taken by it to protect its
intellectual property will prove sufficient to prevent misappropriation of its
technology or deter independent third-party development of similar
technologies.
Employees
As of December 31, 2000, SmarterKids.com had 98 full-time employees,
including 35 in marketing and sales, 16 in customer service, two in editorial
and education review, 20 in development and 25 in general and administrative.
From time to time, SmarterKids.com also employs independent contractors to
support these operational areas. The employees of SmarterKids.com are not
represented by a union, and it believes that its employee relations are good.
Property
SmarterKids.com is headquartered in Needham, Massachusetts, where it leases
an office with approximately 39,152 square feet under a lease expiring in
October 2004. SmarterKids.com believes that these facilities are adequate to
meet its current requirements and that suitable additional or substitute space
will be available as needed. In addition, during the second quarter of 2000,
SmarterKids.com entered into a lease agreement for a 139,000 square foot
distribution center in Mansfield, Massachusetts that expires in March 2005. The
distribution center allows SmarterKids.com to better manage its fulfillment
process.
Legal Proceedings
SmarterKids.com is not a party to any material legal proceedings, though it
from time to time may become a party to various legal proceedings arising in
the ordinary course of its business.
82
<PAGE>
SmarterKids.com Management's Discussion and Analysis of Financial Condition and
Results of Operations
SmarterKids.com's Management's Discussion and Analysis of Financial
Condition and Results of Operations should be read in conjunction with the
accompanying financial statements and related notes of SmarterKids.com for the
periods specified, included elsewhere in this proxy statement-prospectus. The
following discussion contains forward-looking statements which involve risks
and uncertainties. SmarterKids.com makes such forward-looking statements under
the provision of the "Safe Harbor" section of the Private Securities Litigation
Reform Act of 1995. Any forward-looking statements should be considered in
light of the factors described. Actual results may vary materially from those
projected, anticipated or indicated in any forward-looking statements. In this
section, the words "anticipates," "believes," "expects," "intends," "future,"
"could," and similar words or expressions (as well as other words or
expressions referencing future events, conditions, or circumstances) identify
forward-looking 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, SmarterKids.com's activities consisted
primarily of the conception, development, publishing, marketing and sales of
its proprietary educational and entertainment CD-ROM software. In March 1998,
SmarterKids.com began transitioning its business model to online sales of
third-party educational products and commenced development of the
SmarterKids.com website. In November1998, SmarterKids.com launched its website,
discontinued the sale of its proprietary CD-ROM products through traditional
retail channels and began offering its proprietary CD-ROM products on a limited
basis through SmarterKids.com online channel.
While SmarterKids.com's online retail revenues have grown rapidly since
launching its website, total revenues decreased since the beginning of 1999 due
to the curtailment of SmarterKids.com's proprietary CD-ROM business. Over the
same period, marketing and sales expenses increased significantly as a result
of SmarterKids.com's promotional activities. SmarterKids.com expects that the
rate at which it incurs losses will depend on the extent it continues to incur
additional expenses to advertise and promote its website, expand its product
offerings and website content, enhance and upgrade its website and other
systems, expand its fulfillment capabilities and hire additional personnel.
Prior to November 1998, revenues consisted solely of sales of
SmarterKids.com's 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 SmarterKids.com's products through national computer software retailers.
Development costs consisted primarily of compensation for employees developing
SmarterKids.com's proprietary CD-ROM software. General and administrative costs
consisted primarily of compensation for employees and professional fees.
Revenues in 1999 and 2000 consisted of online sales of third-party
educational products and charges to customers for shipping. In the year ended
December 31, 1999, and the nine months ended September 30, 2000,
SmarterKids.com derived less than 2% of its 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 SmarterKids.com's online retail
business model, its actual returns and therefore its allowance for returns are
lower than the returns from its historical CD-ROM business which utilized an
indirect sales channel. Cost of revenues consisted primarily of the cost of
products sold to customers and SmarterKids.com's shipping costs.
SmarterKids.com anticipates that its gross margins will fluctuate from quarter
to quarter depending on consumer preferences for its mix of products. Marketing
and sales expenses consisted primarily of the cost of advertising and
promotional activities, fulfillment services fees to J.L. Hammett Co. through
July 1, 2000 and costs to operate SmarterKids.com's own distribution facility
thereafter, commissions to online marketing companies, and expenses for
personnel engaged in marketing, merchandising and customer service activities.
Fulfillment fees
83
<PAGE>
paid to J.L. Hammett Co. were based on a percentage of the cost to
SmarterKids.com's of its products. This percentage was fixed and did not vary
with the prices of SmarterKids.com's products. Commissions to online marketing
companies are based on a percentage of revenues generated through these
relationships. Because SmarterKids.com pays commissions to online marketing
companies based on a percentage of revenues derived from these relationships,
SmarterKids.com expects SmarterKids.com's gross margins, as a percentage of
revenues, to decrease if SmarterKids.com begins to derive increased revenue
from online marketing relationships. Approximately 4% and 5% of
SmarterKids.com's revenues in the year ended December 31, 1999 and the nine
months ended September 30, 2000, respectively, were derived from these
relationships. Development expenses consisted primarily of payroll and related
costs for personnel performing website design, development and testing.
SmarterKids.com believes that continued investment in website development is
critical to attaining its strategic objectives. General and administrative
expenses consisted primarily of payroll and related costs for executive and
administrative personnel, professional service expenses and other general
corporate expenses. In November 1999, SmarterKids.com incurred a one-time cost
of $861,000 in connection with the settlement and legal expenses of a patent
infringement lawsuit, which cost was included in general and administrative
expenses for the quarter ended on December 31, 1999. Interest and other income
(expense), net consisted primarily of interest expense related to short-term
lease obligations and interest earned on the short-term investment of cash.
With respect to SmarterKids.com's need to attract, retain and motivate
qualified employees and certain marketing and service providers, since
September 1995, SmarterKids.com has 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 re-
measurements of such fair value until the options and warrants vest.
Accordingly, SmarterKids.com cannot currently estimate additional charges
related to future re-measurement of unvested non-employee options and warrants.
SmarterKids.com may in the future grant additional equity-based compensation to
non-employees to secure marketing or other service relationships. As of
September 30, 2000, $4.5 million of deferred stock compensation remained to be
amortized to expense, generally over the next three years, for stock options
and warrants granted through September 30, 2000.
The market for children's educational books, toys and games, and software is
highly seasonal. Accordingly, SmarterKids.com expects to experience seasonal
fluctuations in its revenues. In particular, SmarterKids.com expects a
disproportionate amount of its revenues to be realized during the fourth
quarter of each calendar year.
84
<PAGE>
Results of Operations
<TABLE>
<CAPTION>
Twelve Months Ended Nine Months Ended
December 31, September 30,
-------------------------- ------------------
1997 1998 1999 1999 2000
------- ------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C>
Net Revenues:
Online retail................ $ -- $ 22 $ 5,421 $ 1,108 $ 4,504
Proprietary CD-Rom........... 1,416 2,278 -- -- --
------- ------- -------- -------- --------
Total net revenues......... 1,416 2,300 5,421 1,108 4,504
------- ------- -------- -------- --------
Cost of revenues:
Online retail................ -- 20 4,005 795 3,386
Proprietary CD-Rom........... 491 908 -- -- --
------- ------- -------- -------- --------
Total cost of revenues..... 491 928 4,005 795 3,386
------- ------- -------- -------- --------
Gross profit................. 925 1,372 1,416 313 1,118
------- ------- -------- -------- --------
Operating expenses:
Marketing and sales.......... 756 2,678 28,916 10,726 20,215
Development.................. 721 1,378 1,721 1,149 2,546
General and administrative... 430 490 2,854 1,091 2,490
Stock compensation........... 15 187 3,405 1,789 1,374
------- ------- -------- -------- --------
Total operating expenses... 1,922 4,733 36,896 14,755 26,625
------- ------- -------- -------- --------
Loss from operations......... (997) (3,361) (35,480) (14,442) (25,507)
Interest and other income
(expense), net.............. (17) 19 752 300 2,037
------- ------- -------- -------- --------
Net loss..................... $(1,014) $(3,342) $(34,728) $(14,142) $(23,470)
======= ======= ======== ======== ========
</TABLE>
Nine Months Ended September 30, 1999 and 2000
Revenues. Revenues primarily consist of online sales of third-party
educational products and charges to customers for shipping. In the nine months
ended September 30, 1999 and 2000, SmarterKids.com continued to derive
substantially all of its revenues from sales within 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.
Revenues were $1.1 million and $4.5 million in the nine months ended
September 30, 1999 and 2000, respectively. In the nine months ended September
30, 2000, SmarterKids.com recognized $228,000 of previously deferred gift
certificate revenue on gift certificates expiring unused. The increase in
revenue from the nine months ended September 30, 1999 to the nine months ended
September 30, 2000 resulted from increased marketing efforts and brand-building
during the more recent period as well as revenue recognized from expired gift
certificates.
Cost of revenues. Cost of revenues consists primarily of the cost of
products sold to customers and the cost of shipping products to SmarterKids.com
customers. SmarterKids.com anticipates that its gross margins will fluctuate
from quarter to quarter depending on consumer preferences for its mix of
products. The cost of revenues was $795,000 and $3.4 million in the nine months
ended September 30, 1999 and 2000, respectively. During the nine months ended
September 30, 2000, SmarterKids.com recorded an inventory obsolescence charge
of $209,000 for software products held in inventory. SmarterKids.com's gross
margin decreased from 28% in the nine months ended September 30, 1999 to 25% in
the same nine month period in 2000, due to slightly lower gross margins on new
products introduced, obsolescence charges and increased freight charges.
Marketing and sales. Marketing and sales expenses consist primarily of the
cost of advertising and promotional activities, fulfillment costs, commissions
to online marketing companies, expenses for personnel
85
<PAGE>
engaged in marketing, and merchandising activities. Fulfillment costs represent
costs incurred in operating and staffing the distribution center and the
customer service department, picking and packing customers' orders for
shipment, responding to inquires from customers, credit card fees, as well as
fees paid to J.L. Hammett Co., a fulfillment partner during the first six
months of 2000 and all nine months of 1999. As of July 1, 2000, SmarterKids.com
discontinued using J.L. Hammett Co. as a third party fulfillment partner due to
the opening of its own distribution facility.
Marketing and sales expenses were $10.7 million and $20.2 million in the
nine months ended September 30, 1999 and 2000, respectively. The increase in
the nine months ended September 30, 2000 was primarily attributable to
increased advertising and promotional activities, fees to SmarterKids.com
previous fulfillment partner, J.L. Hammett Co., as well as the hiring of
employees to staff SmarterKids.com's distribution center which opened for
operations on July 1, 2000.
Fulfillment costs included in marketing and sales expense were $340,000 and
$1,538,000 for the nine months ended September 30, 1999 and 2000, respectively.
In September 2000, the Emerging Issues Task Force, or EITF, reached a final
consensus on EITF Issue 00-10, "Accounting for Shipping and Handling Fees and
Costs." This consensus states that all amounts billed to a customer in a sale
transaction related to shipping and handling, if any, represent revenue and
should be classified as revenue. SmarterKids.com already classifies shipping
charges to customers as revenue. With respect to the classification of costs
related to shipping and handling incurred by the seller, including fulfillment
costs, the EITF determined that the classification and amount of such costs is
an accounting policy decision that should be disclosed. SmarterKids.com
classifies fulfillment costs in marketing and sales expenses. These costs are
primarily composed of distribution facility expenses, including equipment and
supplies, payroll and travel expenses for personnel engaged in distribution
activities, third party fulfillment fees, credit card fees and the costs of
customer support. These costs represent facility costs necessary for
warehousing inventory, as well as costs incurred to pick and pack a customer
order and the related packaging supplies.
Development. Development expenses consist primarily of payroll and related
costs for personnel performing website design, development, maintenance and
testing. Development expenses were $1.1 million and $2.5 million in the nine
months ended September 30, 1999 and 2000, respectively. The increase in
development costs from the nine months ended September 30, 1999 to the nine
months ended September 30, 2000 was attributable primarily to costs related to
maintaining, testing and enhancing the features, content and functionality of
SmarterKids.com's website, as well as the hiring of additional employees.
General and administrative. General and administrative expenses consist
primarily of payroll and related costs for executive and administrative
personnel, professional service expenses and other general corporate expenses.
General and administrative expenses were $1.1 million and $2.5 million in the
nine months ended September 30, 1999 and 2000, respectively. The increase in
general and administrative expenses from the nine months ended September 30,
1999 to the nine months ended September 30, 2000 was attributable primarily to
the costs related to the expansion of SmarterKids.com's operations and
infrastructure, as well as the hiring of additional employees.
Stock compensation. SmarterKids.com recorded non-cash stock compensation
expense of $1.8 million and $1.4 million in the nine months ended September 30,
1999 and 2000, respectively, related to amortization of deferred stock
compensation for options and warrants granted to employees and non-employees.
Included in the nine months ended September 30, 2000 was stock compensation of
$242,000 recorded in connection with the acceleration of J.L. Hammett Co.
warrants and $110,000 recorded in connection with the repricing of certain of
SmarterKids.com's employee stock options.
On September 7, 2000, SmarterKids.com completed a direct repricing of
certain employee stock option grants. As part of the repricing, SmarterKids.com
reduced the exercise price of all outstanding options with exercise prices of
greater than $1.50 per share. The new exercise price of these repriced options
was reset to
86
<PAGE>
$1.50 per share, which was equal to the market value of the common stock on
September 7, 2000. Options to purchase 2,325,574 shares of SmarterKids.com
common stock were repriced. SmarterKids.com is accounting for the repriced
options as a variable award.
Interest and other income (expense), net. Interest and other income
(expense), net consists primarily of interest income earned on
SmarterKids.com's short-term investments offset by interest expense related to
short-term lease obligations and borrowings under its equipment line of credit.
Interest and other income (expense), net increased from $300,000 in the nine
months ended September 30, 1999 to $2.0 million in the nine months ended
September 30, 2000. The increase was primarily attributable to an increase in
interest income generated from higher balances of capital invested in
commercial paper, corporate and treasury notes and auction rates. The higher
balances of capital were generated from SmarterKids.com's initial public
offering.
Years Ended December 31, 1997, 1998 and 1999
Revenues. Revenues in 1999 consisted of online sales of third-party
educational products and SmarterKids.com's proprietary CD-ROM products and
charges to customers for shipping. In the year ended December 31, 1999,
SmarterKids.com derived less than 2% of its 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 SmarterKids.com's new
online retail business model, its actual returns and therefore its allowance
for returns are lower than the returns from its CD-ROM business which utilized
an indirect sales channel. From inception through March 1998, SmarterKids.com's
activities consisted primarily of the conception, development, publishing,
marketing and sales of its proprietary educational and entertainment CD-ROM
software. In March 1998, SmarterKids.com began transitioning its business model
to online sales of third-party educational products.
Revenues were $1.4 million, $2.3 million and $5.4 million in the years ended
December 31, 1997, 1998 and 1999, respectively. The increase in revenue from
1997 to 1998 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. The increase in revenue from 1998
to 1999 was primarily attributable to the transition of SmarterKids.com's
business model to online sales of third-party educational products and
reflected the results of its significant marketing efforts.
Cost of revenues. Cost of revenues consists primarily of the cost of
products sold to customers and SmarterKids.com's shipping costs. The cost of
revenues were $491,000, $928,000 and $4.0 million in the years ended December
31, 1997, 1998 and 1999, respectively. The increase from 1997 to 1998 was
primarily attributable to additional costs associated with increased sales of
CD-ROM products. The increase from 1998 to 1999 was attributable to the
increase in online sales of third-party educational products. SmarterKids.com's
gross margin decreased from 65.3% in 1997 to 59.7% in 1998 to 26.1% in 1999 as
a result of the new online retail business model.
Marketing and sales. 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.
Marketing and sales expenses were $756,000 $2.7 million and $28.9 million in
the years ended December 31, 1997, 1998 and 1999, respectively. The increase
from 1997 to 1998 was primarily attributable to additional costs associated
with promotions and advertising for SmarterKids.com's repositioned proprietary
CD-ROM products and the launch of its website in November 1998. The increase
from 1998 to 1999 was primarily attributable to the initiation of
SmarterKids.com's advertising campaigns and promotional activities, fees to its
fulfillment partner, J.L. Hammett Co., as well as the hiring of 22 employees
and related expenses required to implement its Internet business model.
Development. Development expenses consist primarily of payroll and related
costs for personnel performing website design, development and testing.
Development expenses were $721,000, $1.4 million and
87
<PAGE>
$1.7 million in the years ended December 31, 1997, 1998 and 1999, respectively.
The increase from 1997 to 1998 was primarily attributable to additional costs
associated with development of the SmarterKids.com website. The increase from
1998 to 1999 was attributable primarily to the hiring of 17 employees and costs
related to enhancing the features, content and functionality of
SmarterKids.com's website.
General and administrative. General and administrative expenses consist
primarily of payroll and related costs for executive and administrative
personnel, professional service expenses and other general corporate expenses.
General and administrative expenses were $430,000, $490,000 and $2.9 million in
the years ended December 31, 1997, 1998 and 1999, respectively. The increase
from 1997 to 1998 was primarily attributable to increased headcount and related
expenses of repositioning of SmarterKids.com's CD-ROM product line, which began
in late 1997. The increase from 1998 to 1999 was attributable primarily to the
hiring of nine employees as SmarterKids.com expanded its operations and
infrastructure to support future growth and transition to being a public
company. SmarterKids.com incurred a one-time cost of $861,000 in connection
with the settlement and related legal expenses in November 1999 of a patent
infringement lawsuit, which cost was included in general and administrative
expenses in the quarter ending December 31, 1999.
Stock compensation. With respect to stock options granted to employees,
SmarterKids.com recorded deferred stock compensation of $62,000 and amortized
$4,000 of stock compensation as an expense in 1997. SmarterKids.com recorded
deferred stock compensation of $1.5 million and $5.7 million and amortized
$81,000 and $2.2 million and of stock compensation as an expense in 1998 and
1999, respectively. SmarterKids.com recorded additional stock compensation of
$11,000, $106,000 and $1.2 million as an expense in each of the years ended
December 31, 1997, 1998 and 1999, respectively, related to options and warrants
granted to non-employees.
Interest and other income (expense), net. Interest and other income
(expense), net consists primarily of interest expense related to short-term
lease obligations and interest earned on the short-term investments. In 1998,
interest and other income, net increased from net expense of $17,000 in 1997.
Interest and other income, net increased to from $19,000 in 1998 to $752,000 in
1999. Both of the increases were primarily attributable to an increase in
interest income from higher balances of invested capital.
88
<PAGE>
Selected Quarterly Results of Operations
The following table sets forth selected unaudited statement of operation
data for the eight quarters in the period ended September 30, 2000.
This data was derived from unaudited interim financial statements that, in
SmarterKids.com's management's opinion, reflect all adjustments, consisting
only of 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 of SmarterKids.com included elsewhere in
this proxy statement-prospectus.
<TABLE>
<CAPTION>
Quarter Ended (in thousands)
----------------------------------------------------------------------------------
Dec. 31, Mar. 31, June 30, Sept. Dec. 31, Mar. 31, June 30, Sept. 30,
1998 1999 1999 30, 1999 1999 2000 2000 2000
-------- -------- -------- -------- --------- --------- --------- ---------
(unaudited)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net Revenues:
Online retail.......... $ 22 $ 94 $ 293 $ 721 $ 4,313 $ 1,469 $ 1,528 $ 1,507
Proprietary CD-Rom..... 463 -- -- --
-------- ------- -------- -------- --------- --------- --------- ---------
Total net revenues..... 485 94 293 721 4,313 1,469 1,528 1,507
-------- ------- -------- -------- --------- --------- --------- ---------
Cost of revenues:
Online retail.......... 20 69 210 516 3,210 1,101 1,149 1,136
Proprietary CD-Rom..... 288 -- -- --
-------- ------- -------- -------- --------- --------- --------- ---------
Total cost of
revenues.............. 308 69 210 516 3,210 1,101 1,149 1,136
-------- ------- -------- -------- --------- --------- --------- ---------
Gross profit............ 177 25 83 205 1,103 368 379 371
-------- ------- -------- -------- --------- --------- --------- ---------
Operating expenses:
Marketing and sales.... 1,267 2,023 3,690 5,013 18,190 7,300 7,144 5,771
Development............ 546 367 396 328 572 943 821 782
General and
administrative........ 160 155 244 750 1,763 906 816 768
Stock compensation..... 115 384 196 1,209 1,616 178 336 860
-------- ------- -------- -------- --------- --------- --------- ---------
Total operating
expenses.............. 2,088 2,929 4,526 7,300 22,141 9,327 9,117 8,181
-------- ------- -------- -------- --------- --------- --------- ---------
Loss from operations.... (1,911) (2,904) (4,443) (7,095) (21,038) (8,959) (8,738) (7,810)
Interest and other
income (expense), net.. 30 24 28 248 452 828 654 555
-------- ------- -------- -------- --------- --------- --------- ---------
Net loss............... $ (1,881) $(2,880) $ (4,415) $ (6,847) $ (20,586) $ (8,131) $ (8,084) $ (7,255)
======== ======= ======== ======== ========= ========= ========= =========
Basic and diluted net
loss attributable to
common stockholders... (1.32) (1.77) (2.66) (3.52) (2.10) (0.40) (0.39) (0.35)
</TABLE>
Since SmarterKids.com's inception, it has incurred significant losses.
SmarterKids.com has met its cash requirements primarily through the sale of
capital stock and the use of capital leases. SmarterKids.com received capital
from investors in three private venture capital financings totaling $37.0
million through July 1999. On November 23, 1999, SmarterKids.com completed an
initial public offering of 4,500,000 shares of common stock resulting in net
proceeds of $65.9 million. The primary purposes of the initial public offering
were to increase SmarterKids.com's capitalization and financial flexibility,
create a public market for its common stock, and facilitate future access to
public markets. As of September 30, 2000, SmarterKids.com has used $32.9
million of the offering proceeds for working capital.
Net cash used in operating activities was $9.5 million and $30.8 million in
the nine months ended September 30, 1999 and 2000, respectively. The increase
in net cash used in operating activities from the nine months ended September
30, 1999 to the nine months ended September 30, 2000 was primarily attributable
to a larger net loss and payments to vendors for inventory, advertising
expenses and the build out of SmarterKids.com's new distribution center.
SmarterKids.com expects that operating cash requirements will increase and that
a significant portion of its cash used in operating activities will be
attributable to investments in inventory and advertising.
89
<PAGE>
Net cash used in operating activities was $947,000, $2.0 million and $25.0
million in the years ended December 31, 1997, 1998 and 1999, respectively. The
increase in cash used in operating activities from 1998 to 1999 was primarily
attributable to increased expense associated with launching and promoting
SmarterKids.com's new website and retail Internet business.
Net cash used in investing activities has been primarily for purchases of
fixed assets and short-term investments. Cash used in investing activities was
$6.7 million and $8.2 million in the nine months ended September 30, 1999 and
2000, respectively. The increase in cash used in investing activities was
primarily attributable to increased purchases of equipment for the build-out of
SmarterKids.com's new distribution facility and the purchase of short-term
investments.
Net cash provided by investing activities was $181,000 in the year ended
December 31, 1997. The cash generated from investing activities in 1997
reflected the release of a restricted cash deposit related to a prior lease
arrangement. Net cash used in investing activities has been primarily for
purchases of fixed assets and short-term investments and was $33,000 and $14.9
million in the years ended December 31, 1998 and 1999, respectively. The
increase in cash used in investing activities was primarily attributable to
increased purchases of equipment and the purchase of short-term investment of
$11.7 million.
Net cash provided by financing activities was $25.3 million and $1.1 million
in the nine months ended September 30, 1999 and 2000, respectively. Net cash
provided by financing activities in the nine months ended September 30, 1999
consisted of proceeds from the exercise of stock options. Net cash provided by
financing activities in the nine months ended September 30, 2000 primarily
reflects the net proceeds of $1.6 million from an equipment line of credit.
Net cash provided by financing activities was $626,000, $6.0 million and
$91.3 million in the years ended December 31, 1997, 1998 and 1999,
respectively. 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. 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. Net cash provided by financing activities in the year ended December 31,
1999 primarily reflects the net proceeds of $65.9 million from
SmarterKids.com's initial public offering and $25.3 million from the issuance
of Series C Redeemable Preferred Stock.
During the first quarter of 2000, SmarterKids.com entered into a $1.5
million three-year equipment line of credit facility. Equipment collateralized
under this agreement approximates $1.5 million at September 30, 2000. The
interest on the agreement is equal to the three-year U.S. Treasury rate plus
3.5%. SmarterKids.com is making payments on this credit facility of $45,000 per
month.
During the second quarter of 2000, SmarterKids.com entered into a lease
agreement for a 140,000 square foot distribution center in Mansfield,
Massachusetts. The distribution center allows it to better manage its
fulfillment process. As a result, SmarterKids.com discontinued using J.L.
Hammett Co. as its fulfillment partner during the second quarter of 2000. The
five-year operating lease for the warehouse will require minimum payments of
approximately $900,000 per year.
As of September 30, 2000, SmarterKids.com had $17.8 million of cash and cash
equivalents, $15.2 million of short-term investments, $1.0 million of
restricted cash. As of that date, SmarterKids.com's principal commitments
consisted of obligations outstanding under an equipment line of credit and
capital leases in the amount of $1.3 million, commitments for annual facility
lease obligations of $2.0 million, and accounts payable of $2.1 million.
SmarterKids.com anticipates that its business model will require it to commit
significant resources to aggressively promote its brand, expand its product and
service offerings and enhance its infrastructure.
90
<PAGE>
SmarterKids.com currently anticipates that current cash, cash equivalents
and short-term investments will be sufficient to meet its anticipated needs for
working capital and capital expenditures through the next twelve months.
SmarterKids.com anticipates that it is likely to need additional financing to
execute its business model after the twelve months, or sooner if it needs 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 its operating infrastructure,
responding to competitive pressures, or acquiring complementary businesses or
technologies. SmarterKids.com has transitioned customer order fulfillment to
its own distribution facility during the second quarter in 2000. In conjunction
with this transaction, SmarterKids.com invested capital for the infrastructure
to support these fulfillment activities at the new distribution facility. If
SmarterKids.com raises additional funds through the issuance of equity or
convertible debt securities, the percentage ownership of SmarterKids.com's
stockholders may be reduced, and these newly issued securities may have rights,
preferences or privileges senior to those of existing stockholders.
SmarterKids.com cannot be certain that additional financing will be available
to it on favorable terms when required, or at all.
SmarterKids.com Quantitative And Qualitative Disclosure About Market Risk
The following discussion of the SmarterKids.com's market risk includes
"forward-looking statements" that involve risks and uncertainties. Actual
results could differ materially from those projected in the forward-looking
statements. SmarterKids.com does not use derivative financial instruments for
speculative or trading purposes.
Interest Rate Risk
SmarterKids.com is exposed to market risk from changes in interest rates
primarily through its investing activities. In addition, SmarterKids.com's
ability to finance future acquisition transactions may be impacted if
SmarterKids.com is unable to obtain appropriate financing at acceptable rates.
SmarterKids.com's investment portfolio consists solely of held-to-maturity
investments in high-grade, commercial bank money market accounts and
certificates of deposit. As of September 30, 2000, SmarterKids.com had
securities classified as held-to maturity investments with an amortized cost
value of $29.6 million. SmarterKids.com also had $3.3 million in commercial
bank money markets and $1.0 million of restricted cash in certificates of
deposit.
Credit Risk
Financial instruments which potentially subject SmarterKids.com to
concentrations of credit risk consist primarily of cash, cash equivalents,
short-term investments and accounts receivable. SmarterKids.com does not
believe that it is subject to any unusual credit risk beyond the normal credit
risk associated with commercial banking relationships.
91
<PAGE>
Security Ownership of Certain Beneficial Owners and Management of
SmarterKids.com
The following table sets forth certain information as to the number of
shares of SmarterKids.com common stock held by the following persons as of
December 31, 2000:
. each person or entity known by SmarterKids.com to beneficially own 5% of
more of its common stock;
. each director of SmarterKids.com;
. each executive officer of SmarterKids.com; and
. all SmarterKids.com directors and executive officers as a group.
Except as otherwise indicated, SmarterKids.com believes that persons
expected to be the beneficial owners of its common stock listed below, based on
information furnished by such owners, have sole voting and investment power
with respect to such shares. Unless otherwise indicated, the address of the
following persons is c/o SmarterKids.com 15 Crawford Street, Needham,
Massachusetts 02494.
<TABLE>
<CAPTION>
Amount and
Nature of Percent of
Name and Address of Beneficial Owner Ownership(1) Common Stock
------------------------------------ ------------ ------------
<S> <C> <C>
Executive Officers
David Blohm(2).................................... 795,375 3.7%
Jeff Pucci(3)..................................... 795,375 3.7
Richard Viard(4).................................. 793,875 3.7
Albert Noyes(5)................................... 461,875 2.2
Richard Secor(6).................................. 102,188 *
Robert Cahill(7).................................. 91,875 *
Directors
Richard D'Amore(8)................................ 2,993,130 14.5
Michael Fitzgerald(9)............................. 1,884,221 9.1
Michael Kolowich.................................. 155,000 *
Brian Hickey(10).................................. 16,875 *
225 Duncan Mill Road
Don Mills, Ontario, Canada M3B 3K9
5% Holders
North Bridge Venture Partners III, L.P.(8)........ 2,967,817 14.4
950 Winter Street, Suite 4600
Waltham, MA 02451
Commonwealth Capital Ventures II, L.P.(9)......... 1,858,908 9.0
20 William Street
Wellesley, MA 02181
Brighter Vision Holdings, Inc. ................... 1,674,907 8.1
c/o Torstar Corporation
One Yonge Street
Toronto, Canada M5E IP9
All executive officers and directors as a group
(10 persons)(11)................................. 8,089,789 35.9
</TABLE>
--------
* Less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. Shares of common stock issuable by
SmarterKids.com to a person or entity named below pursuant to options which
may be exercised within 60 days after December 31, 2000 are deemed to be
beneficially owned by that person or entity. However, these shares are not
deemed to be outstanding for purposes of computing the percentage
beneficially owned by any other person or entity.
92
<PAGE>
(2) Consists of 795,375 shares issuable upon the exercise of options
exercisable on December 31, 2000 or within 60 days thereafter. Mr. Blohm
is also a director of SmarterKids.com.
(3) Includes 294,375 shares issuable upon the exercise of options exercisable
on December 31, 2000 or within 60 days thereafter. Mr. Pucci is also a
director of SmarterKids.com.
(4) Includes 294,375 shares issuable upon the exercise of options exercisable
on the December 31, 2000 or within 60 days thereafter.
(5) Includes 214,875 shares issuable upon the exercise of options exercisable
on December 31, 2000 or within 60 days thereafter.
(6) Consists of 102,188 shares issuable upon the exercise of options
exercisable on December 31, 2000 or within 60 days thereafter.
(7) Consists of 91,875 shares issuable upon the exercise of option exercisable
on December 31, 2000 or within 60 days thereafter.
(8) Includes of 25,313 shares issuable upon the exercise of options
exercisable on December 31, 2000 or within 60 days thereafter 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.
(9) Includes of 25,313 shares issuable upon the exercise of options
exercisable on December 31, 2000 or within 60 days thereafter, 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.
(10) Includes 16,875 shares issuable upon the exercise of options exercisable
on December 31, 2000 or within 60 days thereafter. 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 except to the extent of his pecuniary
interest therein, if any.
(11) See footnotes (1) through (10) above. Includes options to purchase an
aggregate of 1,860,564 shares of SmarterKids.com common stock issuable
upon the exercise of options exercisable on December 31, 2000 or within 60
days thereafter.
93
<PAGE>
EARLYCHILDHOOD
Business
Overview
Earlychildhood LLC is a fully integrated, multi-channel supplier of
educational products, services and information to schools, educational
professionals and parents serving the early childhood and elementary school
communities. Through a predecessor entity, Earlychildhood LLC, a California
limited liability company, began operations in 1985. Earlychildhood
manufactures, imports and sells company-developed products as part of its
diverse mix of school supplies and educational toys, while also distributing
and selling a carefully selected range of third party brands such as
Crayola(R), Lego(R) and Elmer's(R). Earlychildhood utilizes multiple sales,
marketing and distribution channels, including:
. catalogs issued under its tradename Discount School Supply, or DSS;
. sales programs conducted through its wholly-owned subsidiary, Educational
Products, Inc., or EPI;
. the Earlychildhood website; and
. Earlychildhood NEWS, a professional content resource published in print and
online.
All of the foregoing are supported by a national sales force which, as of
December 31, 2000, numbered 93 people.
Earlychildhood's principal executive offices are located at 2 Lower Ragsdale
Drive, Suite 200, Monterey, California 93940. Earlychildhood has five warehouse
distribution facilities located to optimize shipping and delivery efficiencies.
These facilities are located in Salinas, California; Harrisburg, Pennsylvania;
Jacksonville, Florida; Dallas, Texas; and Houston, Texas. Additionally,
Earlychildhood maintains two facilities dedicated to the manufacturing of
children's art products located in Jacksonville, Florida and Salinas,
California.
Discount School Supply
Under the trade name "Discount School Supply," Earlychildhood manufactures,
imports and sells company-developed and third party products within the
following categories:
. arts & crafts; . manipulatives;
. active play; . math;
. carpets; . music;
. dramatic play; . puzzles;
. furniture; . sand & water;
. infant & toddler; . science; and
. language; . teacher resources.
Discount School Supply began operations in 1985 and was one of the first
companies to focus on offering discounted school supplies to the early
childhood market.
The Discount School Supply catalog has been the primary vehicle for customer
acquisition and sales by DSS. Earlychildhood mails out three DSS catalogs
annually to a growing customer base of educational professionals, schools and
parents. A refresher version of each of these catalogs is typically
redistributed 45 to 75 days after the initial distribution. The distribution of
three catalogs enables Earlychildhood to adjust pricing
94
<PAGE>
and product strategies faster than competitors mailing catalogs less
frequently. For the year ended December 31, 2000, over 1.9 million catalogs
were mailed. Included within the catalog are projects and curriculum ideas for
using Discount School Supply products targeted to assist customers in educating
and fostering the learning process. This educational content enables
Earlychildhood to position the Discount School Supply catalog not only as a
sales tool, but also as a learning resource for educational professionals,
teachers and parents. It also fosters an extended useful life for the catalog
that competing catalogs exclusively selling products might not be able to
attain.
As of December 31, 2000, 57 members of Earlychildhood's national sales force
were educational consultants dedicated to DSS operations and were located in
major metropolitan areas throughout the United States. Most educational
consultants are former teachers, familiar with the preschool environment and
the demands on each early childhood educator's time and available resources.
Their job is to help educational professionals, teachers and parents optimize
their time spent in and out of the classroom by giving workshops intended to
offer potential options and ideas for using Discount School Supply products.
These programs result in increased sales, retention of the customer and
competitive margins, as many of the products demonstrated are company-developed
and exclusively distributed by Earlychildhood. The programs also provide a
"human face" to Discount School Supply that a catalog alone cannot reproduce.
Earlychildhood has warehouses across the United States located to optimize
shipping and delivery efficiencies to permit Earlychildhood to deliver an order
within 48 hours to over 90% of the U.S. population at regular UPS ground rates.
During the year ended December 31, 2000, Discount School Supply achieved a
greater than 99% success rate in sending out orders on the same day that were
placed by 2 p.m., customer's local time. Earlychildhood's ability to ship and
deliver effectively has been a consistent competitive differentiator throughout
its operating history.
Educational Products, Inc.
Earlychildhood sells school supplies to elementary schools, teachers and
organizations through its subsidiary, Educational Products, Inc. These supplies
are specifically targeted for use by children in first through sixth grades.
Products purchased from EPI provide these schools, teachers and educational
organizations the opportunity to implement fund-raising programs which can
benefit particular schools or other community or student programs by providing
them with a percentage of the proceeds from the sale of the products. Through
its acquisition of EPI in May 1999, Earlychildhood expanded its presence in the
elementary school market and expanded its geographic reach by doubling its
direct sales force.
As of December 31, 2000, 36 members of Earlychildhood's sales force were
dedicated to EPI and located primarily in Texas. EPI offers products and
programs to support several different fund-raising alternatives, including
traditional school-based sales programs of gift wrap or candy and EPI's
company-developed innovation, the "SchoolWrapPacks." SchoolWrapPacks are school
supply sets individually packaged to meet the specifications of individual
teachers for their classrooms. EPI typically sells SchoolWrapPacks to PTAs,
which then resell the product to parents at a small mark-up as a fund-raising
activity. This program provides parents and teachers with a convenient and
cost-effective way to purchase school supplies, while simultaneously supporting
the school's fund-raising efforts. During the back-to-school season of 1999,
Earlychildhood sold nearly one million SchoolWrapPacks.
Earlychildhood News
Earlychildhood NEWS is a print- and web-based content resource connecting
the commerce segments of Earlychildhood and offering information and services
to early childhood professionals, elementary school teachers and parents.
Earlychildhood NEWS exists in print form as Earlychildhood NEWS magazine,
published six times annually, with the most recently published version mailed
to approximately 50,000 readers. Earlychildhood NEWS is also published
continually online at www.earlychildhoodnews.com. Earlychildhood NEWS contains
articles about:
. issues facing teachers and parents, as well as pre-school and school-age
children;
. illustrated arts and crafts;
95
<PAGE>
. developmentally appropriate activities;
. news and information; and
. expert perspectives on a variety of topics.
Readers may participate in sharing boards, browse a reading room of selected
articles, and ask questions or participate in opinion polls. The objective of
Earlychildhood NEWS is to bring together parents and teachers to share
information, ideas and products, thereby creating a continuum of care for young
children across their homes and schools.
Earlychildhood NEWS also sponsors Newslink, a weekly opt-in e-mail program
that brings its subscribers a collection of topical articles gathered from an
array of news media. In addition, Newslink includes seasonal crafts and product
specials linked to the Earlychildhood NEWS website.
Earlychildhood NEWS sponsors a respected Professional Development Program
through the University of Wisconsin-Stout, home of the nation's second largest
early childhood education program. The Professional Development Program enables
early childhood educators to improve their professionalism and to keep their
credentials current. Since the Professional Development Program started in
1995, over 10,000 teachers have participated in the program. Program materials
are available to interested parents as auditors. The Professional Development
Program reinforces Earlychildhood's position as an educational resource for
information and products.
The Early Childhood Market
The market for educational school supplies and furniture (excluding
textbooks) is currently estimated at approximately $6.1 billion annually. The
child-care segment of the overall educational and training market is estimated
to grow at a five year compound annual growth rate of 8.3% from 2000 to 2005.
Propelling this growth are multiple forces that are currently prevalent in the
early childhood market and that are likely to continue for the foreseeable
future.
Political support in education is gaining momentum. The federal government
has responded to industry research, cultural pressure and recent decreases in
welfare by spending more on early learning. Specifically, the Head Start
program, a multi-billion dollar governmental early learning initiative, has
been receiving accelerating political attention and support, both financial and
otherwise. Under this program, early education has been provided to nearly
950,000 children and since 1993, this type of educational funding has increased
at an annual rate of 9.6%, reaching an estimated $5.3 billion in the 1999-2000
school year.
The demand for early childhood learning centers is growing at an increasing
rate. The growing population of children ages five years and younger and the
growth in two income families is creating economic imperatives and sociological
change. The Bureau of Labor Statistics anticipates the zero to five year-old
age group will grow by over one million children domestically and will reach 24
million in 2010. Additionally, the National Child Care Information Center
estimates that only 7% of families have a parent at home while the other spouse
works, 62% of women with children under the age of six are in the workforce,
and that 78% of women with school-age children are working. As a result of
these trends, the demand for outsourced childcare and learning environments is
increasing. The nature and quality of early learning within outsourced
environments is under tremendous evaluation and scrutiny. Pre-primary school
enrollment rates in center-based programs have steadily risen over the last few
decades from 6% in 1965 to well over 50% in 1999 and, in 1998, $34 billion was
spent on the child-care segment of the overall educational and training market.
A transformational shift in the traditional early learning education
distribution channel is occurring. Historically, preschools, daycares and
regulated child care centers have been largely dependent on paper-based
procurement of educational tools and materials through retail, field sales and
catalogs. Today, new technology is making learning materials easier to deliver.
Specifically, the e-commerce channel is emerging at a rapid pace, cutting costs
and promoting best practices, to make the delivery of early childhood learning
and educational materials easier and more efficient.
96
<PAGE>
The market is undergoing significant parental pressure. Academic research
continues to highlight the importance of learning in the early age groups, i.e.
ages one through seven, and the media is increasingly focusing on the
importance of parental involvement during this critical stage of growth and
brain development. As such, parental responsibility is causing parents to take
an increasing amount of ownership in educational standards and their child's
development.
Consolidation. The highly fragmented nature of the early childhood market
has given way to growing consolidation. Currently, there are an estimated 3,400
distributors in the market for school supplies and furniture dominated by a
preponderance of regional small businesses, usually family-owned. To remain
competitive, smaller distribution companies in the sector must consolidate in
order to meet customers' increasing demands for more comprehensive product
offerings, higher quality service and sophisticated support, while concurrently
maintaining a low fixed-cost structure.
While these forces apply to the entire K-12 market, they are particularly
powerful in the early childhood market because it has been recognized that
effective early education for children is an essential factor in ensuring
continued and accelerated learning in the higher grades. Specifically, a recent
study conducted at the Frank Porter Graham Child Development Center suggests
that high-quality child care programs have considerable long-term effects on
such areas as school achievement, cognition skills, language ability, math
skills, grade retention and social adjustment.
Further driving the growth of the educational supply industry is the
increase both in enrollment levels and expenditures per student. School
enrollment is projected to increase steadily to more than 54 million by 2008.
Further, a study conducted at the Lucille Packard Foundation found that on
average, parents spend $4,000-$6,000 per year on child care, with some spending
as much as $10,000 per annum. Earlychildhood believes these factors will
continue to spur growth of the early childhood market.
The Earlychildhood Solution
Earlychildhood combines its expertise in children's education with the sale
of company-developed products and a diverse selection array of third party
products to help bring together educational professionals and parents to share
information, ideas and products.
One of Earlychildhood's advantages is its manufacturing, sale and exclusive
distribution of company-developed products. Through the research, development
and marketing of its own brands, Earlychildhood is able to monitor and control
the quality of its products, as well as offer high quality items at competitive
prices while realizing favorable profit margins. As an example, Earlychildhood
has realized success with its line of BioColor products, a complete variety of
paints and accessories based on Earlychildhood's company-developed children's
art materials.
97
<PAGE>
In addition to its company-manufactured and company-developed products,
Earlychildhood also offers a broad assortment of carefully reviewed and
selected third-party educational products. These products enhance
Earlychildhood's product offerings to customers looking for a diverse range of
products to fulfill their educational needs. Earlychildhood satisfies those
needs by offering quality products in the following categories:
. arts & crafts;
. math;
. active play;
. music;
. carpets;
. puzzles;
. dramatic play;
. sand & water;
. furniture;
. science; and
. infant & toddler;
. teacher resources.
. language;
. manipulatives;
Furthermore, Earlychildhood merchandises its products in an effort to
maximize the educational benefit to each of its customers. For example,
Earlychildhood's sales representatives are trained to understand which products
are relevant to pre-kindergarten children and which products are more
educationally appropriate for children in kindergarten or above. This tailored,
or "contextual," merchandising has helped to foster a long-term bond between
Earlychildhood's sales representatives and its customers, who view their sales
representatives as knowledgeable and discerning advocates for children.
Earlychildhood has created a streamlined chain of merchandising and
distribution tools to make sure that customers can access Earlychildhood's
offerings conveniently and effectively. To promote and sell its offerings,
Earlychildhood has traditionally relied on its wide-scale distribution of the
DSS catalogs, its ongoing presence at industry trade gatherings, and its
dedicated sales force. Recently, to augment its traditional distribution
channels, Earlychildhood created a convenient and easy-to-use website,
www.earlychildhood.com, targeted at enhancing visibility and accessibility. In
fact, web access to Earlychildhood is anticipated to be a critical component to
the company's competitive growth strategy in the years to come.
Earlychildhood's Strategy
The early childhood educational community has traditionally lacked a means
to adequately communicate and interact among different constituencies.
Teachers, administrators and parents are conveying a desire to educate one
another and to share ideas, opinions, and learning tools. To meet this demand,
Earlychildhood is in the process of leveraging its existing assets and the
Internet to become an end-to-end provider of educational products, services and
resources to educational professionals and parents.
Earlychildhood will address the needs of its educational community by
leveraging the Internet to blend its product offerings with an array of
information and services across multiple distribution channels and customer
touch points. For example, Earlychildhood's print and online publication of
informative articles in Earlychildhood NEWS, as well as its online sharing
boards provide an opportunity for teachers and parents to obtain and share
information about products and learning experiences critical to advancing the
quality of early childhood education. As customers increasingly interact with
and become aware of Earlychildhood's multiple distribution methods and customer
touch points, including the catalog, direct sales force, fund-raising programs
and website, Earlychildhood seeks to become synonymous with convenience,
quality and value.
98
<PAGE>
Shopping at Earlychildhood
Customers may shop at Earlychildhood in four ways:
. by telephone to Earlychildhood's customer service department;
. by mail or fax of an order form;
. online at the Earlychildhood website; and
. through its sales force.
Additionally, over 99% of Earlychildhood's orders ship out of the warehouse
on the same day, as long as the order is placed by 2:00 p.m. in the customer's
time zone. Earlychildhood uses recycled boxes and biodegradable foam to pack
and ship its products.
Earlychildhood's Customers
Earlychildhood sells to institutions such as public and private schools,
school districts, early learning centers, child care programs and PTAs as well
as parents and educational professionals such as school teachers,
administrators, purchasing directors, and supervisors. Earlychildhood is not
dependent on any single customer or group of customers and in the year ended
December 31, 2000, Earlychildhood's largest customer account amounted to
approximately 1% of sales. Earlychildhood strives to strengthen customer
relationships and has attained its high rate of catalog reorder by having a
highly responsive customer service department and direct sales force.
Earlychildhood's Marketing and Promotion Channels
Earlychildhood has four primary marketing and promotion channels:
Catalogs: Catalogs represent DSS's primary outreach channel. Unlike its
principal competitors who send out only one catalog per year, Earlychildhood
sends out three different catalogs per year (with a re-mail of the same catalog
with a different cover in between new catalogs) under its Discount School
Supply trade name. Mailing three different catalogs provides Earlychildhood
with flexibility to change prices and calibrate pricing to its response rate.
These catalogs are mailed in the months of January (edition re-mailed in
March), May (edition re-mailed in July) and August (edition re-mailed in
September) to coincide with the periods when school purchasing decisions are
made. In the year ended December 31, 2000, over 1.9 million copies of
Earlychildhood's catalogs were distributed.
Direct Sales Representatives: Earlychildhood's sales force consisted of 93
sales representatives as of December 31, 2000. 57 members of the sales force
acted as educational consultants focused on catalog sales through DSS, and the
other 36 focused on direct sales through EPI. Sales representatives promote
company-developed products such as BioColor and Colorations, and programs such
as "SchoolWrapPacks" to teachers and administrators through in-school
demonstrations and workshops, designed to elicit higher response and better
retention rates. Within EPI, sales representatives educate PTAs and teachers
about the benefits and convenience associated with the SchoolWrapPack program
and other products. The sale of SchoolWrapPacks generated substantially all of
EPI's consolidated sales for the year ended December 31, 2000.
Web-based Sales: Earlychildhood's website has been designed to become one of
the principal vehicles used by the company to reach customers and provide them
with an array of information and services attendant to the sale of items from
Earlychildhood's product line.
Earlychildhood NEWS: Earlychildhood NEWS is a content resource published in
both print and web formats. The print magazine is published six times annually
and the web version is published continually at www.earlychildhoodnews.com.
Earlychildhood NEWS offers a professional development program for early
99
<PAGE>
childhood educators and provides a forum in which parents and educators can
share news, ideas and information. Earlychildhood NEWS also publishes Newslink,
a weekly opt-in email program that brings subscribers news, information and
product specials.
Earlychildhood's Products and Services.
Discount School Supply: The principal component of Earlychildhood's Discount
School Supply product line is the company's comprehensive arts and crafts
product offerings. Anchored by Earlychildhood's company-developed and
exclusively distributed children's lines of art materials, "BioColor," and
"Colorations," Earlychildhood provides a wide variety of arts and crafts, art
materials and accessories to children throughout the early childhood market. In
addition, Earlychildhood offers products within the following categories:
. active play;
. math;
. carpets;
. music;
. dramatic play;
. puzzles;
. furniture;
. sand & water;
. infant & toddlers;
. science; and
. language;
. teacher resources.
. manipulatives;
Earlychildhood also distributes third-party products including brand names such
as Crayola(R), Lego(R), and Elmer's(R). Regardless of origin, however, each of
Earlychildhood's products has been thoroughly reviewed by its merchandisers for
quality and educational value. Earlychildhood is continually updating its
product line based on customer responses and sales feedback monitored by its
merchandising department.
Educational Products, Inc.: Through EPI, Earlychildhood sells its products
to the lower elementary market. In addition to SchoolWrapPacks, EPI offers a
selection of science fair supplies, including display boards, individual medals
and awards.
Earlychildhood Suppliers
Earlychildhood purchases services, products and materials from over 650
suppliers and therefore does not experience significant supplier concentration.
In addition, Earlychildhood performs significant product sourcing overseas,
primarily in Southeast Asia (accounting for approximately a quarter of its
sales). Earlychildhood experiences little or no supplier risk, as most of the
product sources are standard and obtainable from multiple vendors.
Earlychildhood's Strategic Relationships
Earlychildhood has entered into a number of strategic business relationships
with third parties that have enhanced its visibility and sales reach:
Turn the Page Press: Earlychildhood has secured an exclusive distribution
agreement for all "Turn the Page" products. These products, which include
children's books and music, are chosen or created by Bev Boss, a well-known and
respected educator in the early childhood field.
Early Learning Centre: Earlychildhood has been chosen as the exclusive
United States educational distributor of the products of Early Learning Centre,
a prominent United Kingdom-based company known for its high-quality,
proprietary, educational toys and school supplies.
100
<PAGE>
The Jane Goodall Institute: Earlychildhood has partnered with the Jane
Goodall Institute to create an early childhood component for Jane Goodall's
successful "Roots and Shoots" program. Through this partnership, early
childhood educators may join the program, and, in turn, receive information,
curriculum-based activities and special product offers.
University of Wisconsin-Stout: Earlychildhood NEWS offers a professional
development program in cooperation with the University of Wisconsin-Stout,
which has the nation's second largest early childhood education program.
Registrants may earn continuing education units and certificates from the
University of Wisconsin-Stout by reading articles in print or online in
Earlychildhood NEWS and by taking tests which are graded by the University of
Wisconsin-Stout.
Operations
Earlychildhood maintains manufacturing locations in Jacksonville, Florida
and Salinas, California, totaling approximately 55,000 square feet of space
dedicated to manufacturing non-toxic paints and other art materials. As of
December 31, 2000, the manufacturing department had 21 full-time employees.
Earlychildhood's innovation and quality control laboratory is located in
Suwanee, Georgia. Earlychildhood is a member of the Arts & Creative Materials
Institute, or ACMI, and has a representative who sits on ACMI's technical
committee. All art materials produced by Earlychildhood are evaluated and
certified as non-toxic by the Duke University Department of Occupational and
Environmental Health. These products are packaged in accordance with federal
labeling standards for art materials.
Earlychildhood has warehouse and distribution centers in Salinas,
California; Jacksonville, Florida; Dallas, Texas; Houston, Texas; and
Harrisburg, Pennsylvania.
Customer Service
Earlychildhood seeks to provide a customer experience that exceeds customer
expectations. Its goals include:
. Prompt shipping;
. Responding to all customer inquiries within the same day;
. Maintaining a low return rate; and
. Maintaining at least 98% of inventory items in stock at any time.
Earlychildhood maintains a toll-free customer service department staffed
with customer service representatives trained to assist customers with product
selection, order processing, shipping and billing and any other questions or
problems. Earlychildhood trains its representatives to be competent and
courteous. Representatives are given wide discretion to ensure that customers
are satisfied with their purchases and their purchasing experience.
Competition
The educational supply industry is highly fragmented. Of the estimated
3,400 school-supply distributors, the majority are small- to medium-sized
companies that are regionally focused. Competition is based on price, timely
service, product selection and the nature of the products. The major companies
competing in the school-supply market are School Specialty, Inc., Lakeshore
Learning Materials, The Kaplan Companies, ABC School Supply, Inc., U.S. Toy
Company and The J.L. Hammett Early Childhood Division.
Currently, School Specialty, Inc. is the only publicly owned competitor in
the educational supply market.
101
<PAGE>
Intellectual Property
Earlychildhood regards the protection of its intellectual property as
critical to its future success and relies on a combination of copyright,
trademark, service mark and trade secret laws, license agreements and
contractual restrictions to establish and protect its proprietary rights in its
products, content and services. The company has entered into confidentiality
and invention assignment agreements with certain employees and contractors in
order to limit disclosure of our proprietary information. However,
Earlychildhood cannot ensure that these contractual arrangements or the other
steps taken by it to protect its intellectual property will prove sufficient to
prevent misappropriation of its technology or deter independent third-party
development of similar items.
Earlychildhood conducts business on the Internet principally using its
trademark Earlychildhood.com. There are a number of other trademarks and domain
names similar to Earlychildhood's. An infringement action could be brought
against Earlychildhood at any time by the holders of these marks and names.
There is a risk that the owner of other marks would overcome any defenses that
Earlychildhood could raise. If the owner of such marks were to prevail in such
an action, Earlychildhood could lose the ability to use the Earlychildhood and
Earlychildhood.com trademark and domain name and could be subject to
substantial damages. Such outcomes could adversely affect Earlychildhood's
business. If Earlychildhood is required to change its company or domain name,
or trademarks, it could lose customers and brand equity which would have a
material adverse effect on Earlychildhood's and LearningStar's business and
financial condition. Although Earlychildhood may attempt to acquire or license
the right to use potentially relevant third-party trademarks and domain names,
it may not be successful.
Regulatory Environment
Earlychildhood's products are subject to the provisions of the Consumer
Product Safety Act which enables the Consumer Product Safety Commission to
exclude from the market consumer products that fail to comply with applicable
product safety regulations or otherwise create a substantial risk of injury.
The Consumer Product Safety Commission may also require the repurchase by the
manufacturer of articles that are banned. Similar laws exist in some states.
Earlychildhood's manufacturing operations are subject to numerous federal,
state and local environmental and occupational health and safety laws and
regulations, which include laws and regulations governing waste disposal, air
and water emissions, workplace exposure and other matters. Earlychildhood's
business, and the catalog industry in general, is subject to regulation by a
variety of state and federal laws relating to, among other things, advertising
and sales taxes. The Federal Trade Commission regulates Earlychildhood's
advertising and trade practices and the Consumer Product Safety Commission has
issued regulations governing the safety of the products which Earlychildhood
sells through its catalogs. Under current law, catalog retailers are permitted
to make sales in states where they do not have a physical presence without
collecting sales tax. Earlychildhood believes that it collects sales taxes in
states where it is required to do so. However, since 1987, legislation has been
introduced periodically in the U.S. Congress which would permit states to
require sales tax collection by mail order companies. To date, this proposed
legislation has not been passed. Should Congress, however, pass such
legislation in the future, most states could be expected to require sales tax
collection by out-of-state mail order companies. This would increase the cost
of purchasing Earlychildhood's products in those states and eliminate whatever
competitive advantage that Earlychildhood may currently enjoy with respect to
in-state competitors in terms of sales taxation, as well as increasing the
administrative and overhead costs to Earlychildhood in connection with the
collection of such sales tax. There can be no assurances given that these state
sales tax laws will not be changed in the future to the detriment of
Earlychildhood. Earlychildhood is subject to various other federal,
102
<PAGE>
state and local laws and regulations applicable to its business. Earlychildhood
believes that it is in substantial compliance with these laws and regulations.
Earlychildhood has no claims or regulatory matters in process or pending as of
December 31, 2000
Earlychildhood is a member in good standing of ACMI. As such,
Earlychildhood's paints and other art material formulations are evaluated and
to date certified non-toxic by the Department of Occupational Health at Duke
University. Furthermore, Earlychildhood's paints and other art materials
formulations conform to the Labeling of Hazardous Art Materials Act and ASTM
Standard D-4236-88 under the auspices of the Consumer Product Safety
Commission.
Employees
As of December 31, 2000, Earlychildhood employed 420 full-time personnel,
including 93 in direct sales, 160 in warehouse operations, 33 in customer
service, 21 in manufacturing and 12 merchandising, and 101 at the
administrative and corporate level. Earlychildhood has not experienced any work
stoppage and continues to maintain good relations with its employees. None of
Earlychildhood's employees belong to a collective bargaining unit.
Facilities
Earlychildhood's headquarters are located at 2 Lower Ragsdale Drive,
Monterey, California. The 27,000 square foot office houses customer service,
finance, operations, purchasing, marketing, graphic design, merchandising and
product development, as well as the magazine, Earlychildhood NEWS.
Earlychildhood also maintains warehouses and sales offices in Salinas,
California; Harrisburg, Pennsylvania; Jacksonville, Florida; Dallas, Texas; and
Houston, Texas totaling over 589,000 square feet. Each location was selected
based on customer shipping characteristics such as delivery times and shipping
zones. Business-to-business orders to schools are routed to the appropriate
warehouse based on the customer's destination zip code, providing the customer
with fastest possible ship time while providing Earlychildhood with the lowest
shipping cost available. Business-to-consumer orders to homes or individuals
are shipped from Salinas, California.
Earlychildhood does not own real property. Instead, it leases its facilities
under non-cancelable lease agreements expiring in one to ten years.
Earlychildhood believes that these facilities are adequate to meet its current
requirements and that suitable additional or substitute space will be available
as needed.
Legal Proceedings
In a demand letter dated July 13, 1999, Showboard, Inc. claimed that EPI's
display boards infringed on Showboard's display board patents (U.S. Patent Nos.
4,794,712, 5,293,705, and 5,911,522). By letter dated March 6, 2000, counsel to
Earlychildhood responded that Earlychildhood did not believe that such patents
were infringed. No response has been received from Showboard. No complaint has
been filed, nor is any litigation pending over this issue.
103
<PAGE>
Earlychildhood Management's Discussion and Analysis of Financial Condition
and Results of Operations
Earlychildhood Management's Discussion and Analysis of Financial Condition
and Results of Operations should be read in conjunction with the accompanying
financial statements for the periods specified and the associated notes. The
following discussion contains forward-looking statements which involve risks
and uncertainties. Earlychildhood makes such forward-looking statements under
the provision of the "Safe Harbor" section of the Private Securities Litigation
Reform Act of 1995. Any forward-looking statements should be considered in
light of the factors described. Actual results may vary materially from those
projected, anticipated or indicated in any forward-looking statements. In this
section, the words "anticipates," "believes," "expects," "intends," "future,"
"could," and similar words or expressions (as well as other words or
expressions referencing future events, conditions, or circumstances) identify
forward-looking statements. The following discussion and analysis should be
read in conjunction with the accompanying financial statements and related
notes included elsewhere in this proxy statement-prospectus.
Overview
Earlychildhood LLC is a fully integrated, multi-channel supplier of
educational products, services and information to schools, educational
professionals and parents serving the early childhood and elementary school
communities. Through a predecessor entity, Earlychildhood began operations in
1985. Earlychildhood manufactures, imports and sells company-developed products
as part of its diverse mix of school supplies and educational toys, while also
distributing and selling a carefully selected range of third party brands such
as Crayola(R), Lego(R) and Elmer's(R). Earlychildhood utilizes multiple sales,
marketing and distribution channels, including:
. its catalogs issued under its tradename, Discount School Supply, or DSS;
. sales programs conducted through its wholly-owned subsidiary,
Educational Products, Inc., or EPI;
. the Earlychildhood website; and
. Earlychildhood NEWS, a professional content resource published in print
and online.
All of the foregoing are supported by a national sales force which, as of
December 31, 2000, numbered 93 people.
Earlychildhood's predecessor operating company was QTL Corporation, or QTL.
As part of the recapitalization that occurred on May 5, 1999, QTL transferred
significantly all of its assets and liabilities to Earlychildhood in exchange
for membership interests. The transfer of assets and liabilities was considered
a combination of entities under common control and accounted for on an "as if
pooling" basis and accordingly, the basis of accounting did not change.
The acquisition of EPI on May 5, 1999 was accounted for as a purchase and
accordingly, Earlychildhood's consolidated results of operations only include
the results of EPI subsequent to May 5, 1999. All results of EPI prior to May
5, 1999 are excluded from consolidated results of operations accordingly, the
comparability of Earlychildhood's historical operating results is affected by
the May 5, 1999 acquisition of EPI. Earlychildhood presently operates in two
segments: Discount School Supply, or DSS, and EPI. DSS includes the brand names
Discount School Supply, Earlychildhood NEWS and Earlychildhood.com. DSS
supplies educational products and information through multiple channels to
early childhood professionals and parents. EPI sells school supplies to
elementary schools, teachers and other educational organizations.
104
<PAGE>
Results Of Operations
Earlychildhood's predecessor company, QTL, changed its fiscal year-end in
1998 from March 31 to December 31. The historical audited consolidated
financial statements for Earlychildhood reflect the operating results of the
nine months ended December 31, 1998. However, for purposes of comparability,
the following discussion compares the twelve months ended December 31, 1999
operating results to the unaudited results of the twelve month period ended
December 31, 1998.
Information regarding the results of operations of Earlychildhood is
presented below and should be read in conjunction with the following discussion
and analysis.
<TABLE>
<CAPTION>
Nine Months
Twelve Months Ended Ended September
December 31, 30,
------------------- ---------------
1998 1999 1999 2000
----------- ------- ------- -------
(in thousands) (in thousands)
(unaudited) (unaudited)
----------- ------- ---------------
<S> <C> <C> <C> <C>
Revenues.................................. $25,149 $61,034 $49,256 $67,814
Gross profit.............................. 10,276 23,808 18,882 25,229
Selling, general and administrative
expenses (includes equity based
compensation)............................ 8,968 18,931 12,345 22,115
Amortization of goodwill and other
intangible assets........................ 39 653 401 764
Interest expense, net..................... 257 829 513 1,040
------- ------- ------- -------
Income (loss) before income taxes......... 1,012 3,395 5,623 1,310
Income tax expense........................ 160 982 1,449 944
------- ------- ------- -------
Net income................................ $ 852 $ 2,413 $ 4,174 $ 366
======= ======= ======= =======
</TABLE>
Nine Months Ended September 30, 1999 and 2000
Revenues. Revenues increased 37.5% from $49.3 million for the nine months
ended September 30, 1999 to $67.8 million for the same period in 2000. This
increase was primarily due to internal growth in the existing Earlychildhood
business and the inclusion of revenues from EPI for the nine months ended
September 30, 2000. DSS's contribution to the $18.5 million revenue increase
amounted to approximately $12.3 million and is attributed to an increase in its
customer base, an increase in the number of pages per catalog, an increase in
the number of catalogs sent and an increase in the number of products offered.
EPI revenues accounted for $20.7 million and $26.9 million, or 42.0% and 39.7%
of total revenues for the nine months ended September 30, 1999 and 2000,
respectively.
Gross Profit. Gross profit increased 33.6% from $18.9 million, or 38.3% of
revenues, for the nine months ended September 30, 1999 to $25.2 million, or
37.2% of revenues, for the same period in 2000. The increase in gross profit
was primarily related to the increase in revenues. The decrease in gross profit
as a percentage of sales was driven by the inclusion of EPI, which generally
generates lower gross profit percentage than DSS, for the full nine months
ended September 30, 2000. EPI's gross profit margin for the nine months ended
September 30, 2000 was approximately 29% of sales. EPI's lower gross profit
percentage was partially offset by an increase in the gross profit percentage
at DSS relating to the increased sales of company-developed, company-
manufactured and imported products, which have historically maintained higher
gross margins.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses include wages and commissions, catalog costs,
operations expenses (which include customer service and certain warehouse
costs), administrative costs (which include information systems, accounting,
and human resources), e-business costs and depreciation and amortization of
property and equipment.
105
<PAGE>
Selling, general and administrative expenses increased 79.1% from $12.3
million, or 25.1% of revenues, for the nine months ended September 30, 1999 to
$22.1 million, or 32.6% of revenues, for the same period in 2000. The increase
in selling, general and administrative expense was attributable to costs
associated with Earlychildhood's e-business strategy which commenced in
November 1999, the inclusion of EPI for the full nine months of 2000, and
increased investment in personnel and facilities.
For the nine months ended September 30, 2000, approximately $2.9 million of
the total $9.8 million increase in selling, general and administrative expenses
related to planning and executing Earlychildhood's e-business strategy. Such
costs were net of $812,000 of capitalized website developments costs.
Earlychildhood considers its e-business strategy to be an emerging line of
business that has and will continue to require significant fixed expenditures
until enough revenues can be generated to cover recurring e-business strategy
start-up expenses.
The inclusion of EPI in the full nine months of 2000 accounted for $2.6
million of the total increase. EPI's selling, general and administrative
expenses were $3.1 million and $5.7 million for the nine months ended September
30, 1999 and 2000, respectively. The remainder of the cost increase was
primarily due to the increase in personnel and facility costs related to the
growth of the Earlychildhood's infrastructure. Earlychildhood's results of
operations for the nine months ended September 30, 2000 also include a one-time
charge for approximately $421,000 relating to equity-based compensation to
Earlychildhood's management committee members.
Amortization of Goodwill and Other Intangible Assets. Amortization of
goodwill and other intangible assets increased 90.5% from approximately
$401,000 for the nine months ended September 30, 1999 to approximately $764,000
for the nine months ended September 30, 2000. The increase in amortization of
goodwill and other intangible is primarily due to the inclusion of the
amortization of goodwill and other intangible assets associated with the
acquisition of EPI for the full nine months ended September 2000.
Interest Expense. Interest expense increased 103% from approximately
$513,000 for the nine months ended September 30, 1999 to approximately $1.0
million, for the nine months ended September 30, 2000. The interest expense for
both 1999 and 2000 is primarily related to the $10 million term loan, which was
entered into on May 5, 1999 in conjunction with the acquisition of EPI and in
order to fund general working capital needs.
Income Tax Expense. Earlychildhood LLC is a limited liability company and is
not subject to income taxes; however its wholly-owned subsidiary, EPI, is a C
corporation, and is therefore subject to federal and state income taxes. Prior
to May 5, 1999, Earlychildhood was combined with QTL. QTL was subject to
federal and state income taxes as a C corporation until April 1, 1998 when it
elected S corporation status.
Income tax expense decreased 34.8% from $1.4 million for the nine months
ended September 30, 1999 to $0.9 million for the nine months ended September
30, 2000. Offsetting the decrease was an increase in the effective tax rate
from 25.8% for the nine months ended September 30, 1999 to 72.1% for the nine
months ended September 30, 2000. The increase in the effective tax rate is due
to the change in the composition of taxable income (losses) between DSS and
EPI. DSS generated nontaxable income in the nine months ended September 30,
1999. For the nine months ended September 30, 2000, DSS generated nontaxable
losses, largely due to its spending on its e-business strategy. Due to
Earlychildhood LLC's limited liability company status, such losses were not
available to offset taxable income generated by EPI for the nine months ended
September 30, 2000.
Twelve Months Ended December 31, 1999 and 1998
Revenues. Revenues increased 143% from $25.1 million for the twelve months
ended December 31, 1998 to $61.0 million for 1999. This increase is primarily
due to internal growth of the existing DSS business and the acquisition of EPI.
EPI revenues accounted for $22.9 million, or 37.5% of total revenues in fiscal
year
106
<PAGE>
1999. DSS's contribution to the $35.9 million revenue increase amounted to $13
million and is attributed to increases in its customer base, in the number of
pages per catalog, in the number of catalogs sent and in the number of products
offered.
Gross Profit. Gross profit increased 132% from $10.3 million, or 40.9% of
revenues, for the twelve months ended December 31, 1998 to $23.8 million, or
39.0% of revenues, for 1999. The increase in gross profit was primarily related
to the increase in revenues. The decrease in gross profit as a percentage of
sales was driven by the inclusion of EPI in 1999. EPI's gross profit margins
for 1999 were approximately 32% of sales.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses include wages and commissions, catalog costs,
operations expenses (which include customer service and certain warehouse
costs), administrative costs (which include information systems, accounting and
human resources), and depreciation and amortization of property and equipment.
Selling, general and administrative expenses increased 109% from $9.0
million, or 35.7% of revenues, for the twelve months ended December 31, 1998 to
$18.9 million, or 31.0% of revenues, for the same period in 1999. The increase
in selling, general and administrative expense was partially attributable to
the acquisition of EPI, which accounted for $5.3 million of the total increase
in selling, general and administrative expenses. The remainder of the cost
increase was primarily due to an increase in personnel and an increase in
catalog production, distribution and general and administrative costs.
Amortization of Goodwill and Other Intangible Assets. Amortization of
goodwill and other intangible assets increased significantly from approximately
$39,000 for the twelve months ended December 31, 1998 to approximately $653,000
for 1999. The increase in amortization of goodwill and other intangible assets
is primarily due to the acquisition of EPI, which resulted in $0.5 million of
incremental amortization expense subsequent to the May 5, 1999 acquisition.
Interest Expense. Interest expense increased 223% from $257,000 for the
twelve months ended December 31, 1998 to $829,000, for 1999. The increase in
interest expense is primarily related to the $10 million term loan which was
entered into on May 5, 1999 in conjunction with the acquisition of EPI and in
order to fund general working capital needs. The interest expense in 1998 was
principally related to Earlychildhood's line of credit facility which was
replaced in conjunction with the May 5, 1999 recapitalization and acquisition.
Income Tax Expense. As a limited liability company, Earlychildhood is not
subject to income taxes; however its wholly-owned subsidiary, EPI, is a C
corporation, and is therefore subject to federal and state income taxes. Prior
to May 5, 1999, Earlychildhood was combined with QTL. QTL was subject to
federal and state income taxes as a C corporation until April 1, 1998 when it
elected S corporation status.
Income tax expense increased 514% from $160,000 for the twelve months ended
December 31, 1999 to $982,000 for the year ended December 31, 1999. The
effective tax rate increased from 15.8% for the twelve months ended December
31, 1998 to 28.9% for 1999. The increase in the effective tax rate is due to
the inclusion of EPI taxable income in 1999. The proportion of Earlychildhood's
1998 income which was related to taxable C corporation entities was lower in
1998 than in 1999.
Liquidity and Capital Resources
Earlychildhood's primary cash needs have been for working capital, capital
expenditures and acquisitions to fund its growth. The primary sources of
liquidity have been the credit facility with BNP Paribas (Paribas Credit
Facility) and capital contributions from its members. As of September 30, 2000,
Earlychildhood had net working capital of $16.9 million. Capitalization
consisted of limited liability company membership interests of $22.3 million
and long-term debt obligations of $7.8 million.
The Paribas Credit Facility is a $20 million credit facility which matures
on May 5, 2004. The credit facility includes a $10 million revolving credit
facility which includes a $2.5 million letter of credit sublimit.
107
<PAGE>
The revolver is subject to a cleandown provision, which requires that
Earlychildhood limit the outstanding principal balance drawn on the revolver to
a maximum of $3.5 million for 15 consecutive days each year. Additionally, the
revolving credit facility is subject to a maximum borrowing base equal to the
sum of 80% of the aggregate face amount of eligible accounts receivable plus
50% of eligible inventory. As of September 30, 2000, Earlychildhood had no
amount outstanding under the revolving credit facility and $9.5 million of
available borrowing capacity under the revolving credit facility.
The Paribas Credit Facility also includes a $10 million term loan component
with a final maturity of May 5, 2004. The term loan, which was fully drawn on
May 5, 1999, is payable in 16 consecutive quarterly installments commencing
March 31, 2000 and continuing until December 31, 2003, with a final payment on
the maturity date. As of September 30, 2000, the outstanding balance of the
term loan was $9.1 million. Interest on both the term loan and the revolving
facility will accrue at a rate of either the lender's base rate plus 2% or the
adjusted LIBOR rate plus 3.25% at the option of Earlychildhood.
In 1999 and 2000, Earlychildhood raised $19.1 million of capital, net of
issuance costs, from issuing limited liability company membership interests to,
and receiving additional capital contributions from Educational Simon, L.L.C.
The capital was used for investments in working capital, acquisitions and e-
business operations. Earlychildhood does not anticipate the need to raise
additional funding in the near future.
During the nine months ended September 30, 2000, Earlychildhood's operating
activities used $4.2 million in cash. The use of cash was primarily related to
the increases in accounts receivable and inventories. Earlychildhood used $2.9
million of cash for investing activities in the nine months ended September 30,
2000, primarily related to capital expenditures. Earlychildhood generated $7.0
million in cash from financing activities. The cash generated from financing
activities was primarily related to capital contributions by Educational Simon,
L.L.C., partially offset by repayments made on long-term debt obligations.
Earlychildhood used $3.3 million in cash from its operating activities
during the fiscal year ended December 31, 1999. The use of cash was primarily
related to reductions in accounts payable. For the year ended December 31,
1999, Earlychildhood used $9.3 million of cash in investing activities. The
majority of the cash was used in the acquisition of EPI. Earlychildhood raised
$12.7 million of cash from financing activities during 1999. The funds were
provided through capital contributions from Educational Simon, L.L.C. and
borrowings under the Paribas Credit Facility.
Management believes that availability under the Paribas Credit Facility and
cash flow from operations will provide adequate funds for Earlychildhood's
foreseeable working capital needs, planned capital expenditures and debt
service obligations. Earlychildhood's ability to fund its operations, make
scheduled debt payments and make planned capital expenditures and to remain in
compliance with its financial covenants under its credit facility depends on
its future operating performance and cash flow, which in turn, are subject to
prevailing economic conditions and to financial, business and other factors,
some of which are beyond its control.
Seasonality
Earlychildhood's seasonal sales trends coincide with the start of each
school year. Accordingly, the majority of revenues are generated in the second
and third calendar quarter, with a particular emphasis on the third quarter
which generally represents 40% to 50% of Earlychildhood's annual sales.
Earlychildhood's working capital needs are greatest during the second calendar
quarter as inventory levels are increased to meet seasonal demands.
Inflation
Inflation has and is expected to have only a minor effect on
Earlychildhood's results of operations and sources of liquidity.
Recent Accounting Pronouncements
In December 1999, the Securities and Exchange Commission staff released
Staff Accounting Bulletin, or SAB, 101, "Revenue Recognition in Financial
Statements," which provides guidance on the recognition,
108
<PAGE>
presentation and disclosure of revenue in financial statements. Subsequently,
SAB 101 A and B have been released which direct the application of the guidance
in SAB 101 to be required in Earlychildhood's fourth quarter of 2000. Given
that Earlychildhood's accounting policy for revenue recognition is in
accordance with SAB 101, management does not expect the adoption of SAB 101 to
have a material effect on Earlychildhood's consolidated financial statements.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" as amended by SFAS No. 137, which was
issued in July 1999, delayed the adoption date for SFAS No. 133 until annual
periods beginning after June 15, 2000. SFAS No. 133 established standards for
recognition and measurement of derivatives and hedging activities.
Earlychildhood will adopt SFAS No. 133 beginning January 1, 2001. Management
does not believe the adoption of SFAS No. 133 will have a material effect on
the financial position or operations of Earlychildhood.
In July 2000 the Emerging Issues Task Force, or EITF, of the FASB concluded
on Issue 1 of EITF issue No. 00-10 "Accounting for Shipping and Handling Fees
and Costs," which provides guidance on the presentation of shipping and
handling revenue and costs in the statement of operations. Earlychildhood's
accounting policies are in accordance with the requirements of this EITF issue
and accordingly the adoption of this new accounting pronouncement will have no
effect on Earlychildhood's consolidated financial statements.
In March 2000, the EITF of the FASB reached a consensus on EITF Issue 00-2,
"Accounting for Web Site Development Costs." This consensus provided guidance
on what types of costs incurred to develop websites should be capitalized or
expensed. Earlychildhood adopted this consensus effective January 1, 2000 and
capitalized $812,000 of website development costs in the nine months ended
September 30, 2000. No website development costs were capitalized prior to
2000.
Earlychildhood Quantitative and Qualitative Disclosure About Market Risk
The following discussion of the Earlychildhood's market risk includes
"forward-looking statements" that involve risks and uncertainties. Actual
results could differ materially from those projected in the forward-looking
statements. Earlychildhood does not use derivative financial instruments for
speculative or trading purposes.
Interest Rate Risk
Earlychildhood's financial instruments include cash and cash equivalents,
accounts receivable, accounts payable, a revolving line of credit and long-term
debt. Market risks relating to operations result primarily from changes in
interest rates. Earlychildhood's borrowings are primarily dependent upon LIBOR
rates. The estimated fair value of long-term debt approximates its carrying
value at September 30, 2000. To manage interest rate risk on the variable rate
long-term borrowings under Earlychildhood's credit facility, Earlychildhood
entered into an interest rate cap agreement during fiscal 1999. This interest
rate cap agreement effectively limits the level to which the variable rate can
rise on the notional principal amount established in the cap agreement which
approximates 55% of the aggregate long-term balance at September 30, 2000. As a
result, this hedging arrangement is designed to reduce Earlychildhood's
exposure to increases in interest rates.
Credit Risk
Financial instruments which potentially subject Earlychildhood to
concentrations of credit risk consist primarily of cash, cash equivalents,
accounts receivable, a revolving line of credit and long-term debt.
Earlychildhood does not believe that it is subject to any unusual credit risk
beyond the normal credit risk associated with commercial banking relationships.
In addition, Earlychildhood's ability to finance future acquisition
transactions may be impacted if Earlychildhood is unable to obtain appropriate
financing at acceptable rates.
109
<PAGE>
Earlychildhood Certain Relationships and Transactions
In connection with the May 5, 1999 acquisition of assets from QTL
Corporation, or QTL, and recapitalization of Earlychildhood, Earlychildhood
leased 36,000 square feet of combined warehouse and office space located in
Salinas, California from Elliott-Mair Salinas, LLC, an affiliate of QTL. The
current lease agreement is effective August 9, 2000 and runs for five years.
Ronald Elliott who will become LearningStar's Chairman of the Board and who is
the current President, Chief Executive Officer and a member of the management
committee of Earlychildhood, holds 62% of the membership interests in Elliott-
Mair Salinas, LLC. Mr. Elliott is also the largest shareholder of QTL, which in
turn, owns an approximate 41.1% membership interest in Earlychildhood on a
fully-diluted basis.
In conjunction with the May 5, 1999 recapitalization of Earlychildhood, and
the transfer by QTL of significantly all of its assets and liabilities to
Earlychildhood QTL retained inventory and accounts receivable having a book
value of $2,168,000. Because Earlychildhood continued QTL's principal business
functions, Earlychildhood subsequently collected on those accounts receivables
and sold the exempted inventory and then forwarded the revenue directly to QTL.
All amounts from the exempted assets were collected and forwarded to QTL by the
end of the 1999 calendar year.
Pursuant to a promissory note and pledge agreement between QTL and
Earlychildhood effective May 5, 1999, Earlychildhood effected a loan to QTL to
finance QTL's litigation expenses related to a lawsuit with Lakeshore Learning
Materials. The litigation concluded in 1999, and the principal balance on the
loan effective December 31, 2000 was $139,000. The note bears interest at 8%
and matures no later than May 5, 2004 and earlier under certain circumstances.
On May 5, 1999, Earlychildhood entered into a seven-year executive
management agreement with William E. Simon & Sons, LLC. William E. Simon &
Sons, LLC is an affiliate of Educational Simon, L.L.C., the largest equity
holder of Earlychildhood which owns approximately 47.1% of the outstanding
membership interests of Earlychildhood on a fully-diluted basis and, after the
completion of the combination, will own approximately 32.7% of the capital
stock of LearningStar on a fully-diluted basis. Pursuant to the terms of this
executive management agreement, William E. Simon & Sons, LLC received an
initial fee of $400,000, and an aggregate base fee of $300,000 per year. The
base fee is subject to revision upon approval of a supermajority of the
Earlychildhood management committee provided that it does not exceed $600,000
at any time. In addition, if mutually agreed upon by a supermajority of the
management committee, William E. Simon & Sons, LLC is entitled to receive an
acquisition fee for services provided in connection with an acquisition of
Earlychildhood. William E. Simon & Sons, LLC did not receive an acquisition fee
in connection with the combination. The executive management agreement will be
terminated upon the closing of this combination.
Pursuant to the amended and restated operating agreement of Earlychildhood,
Educational Simon, L.L.C. is entitled to select three of the six members of the
management committee of Earlychildhood. All three of the Educational Simon,
L.L.C. designees who serve on the Earlychildhood management committee, Robert
MacDonald, Scott Graves and Stephen Kaplan, will join the LearningStar board of
directors as three of the four designees of Earlychildhood.
Security Ownership of Certain Beneficial Owners and Management of
Earlychildhood
The following table sets forth certain information as of December 31, 2000
with respect to the class and percentage of the Earlychildhood membership
interests held by the following persons:
. each person or entity known by Earlychildhood to beneficially own 5% of
more of the Earlychildhood membership interests;
. each member of the management committee of Earlychildhood;
. each executive officer of Earlychildhood; and
. all members of the Earlychildhood management committee and
Earlychildhood executive officers as a group.
110
<PAGE>
Except as otherwise indicated, Earlychildhood believes that persons listed
as the beneficial owners of the Earlychildhood membership interests have sole
voting and investment power with respect to such membership interests. Unless
otherwise indicated, the address of the following persons is c/o Earlychildhood
2 Lower Ragsdale Drive, Suite 200, Monterey, California 93940.
<TABLE>
<CAPTION>
Percent of
Equity
Membership
Percent of on a
Class of Beneficial fully-
Interests of Ownership diluted
Name and Address of Beneficial Owner Ownership (1) basis (2)
------------------------------------ ------------ ---------- ----------
<S> <C> <C> <C>
Executive Officers
Ronald Elliott(3).......................... Class B 44.0 41.1%
Judith McGuinn............................. Class C -- --
Richard Phelan............................. Class B 2.7 2.5
Ronald Phelan.............................. Class B 1.4 1.3
Members of the Management Committee
Randy Dean(4).............................. Class C * *
Scott Graves(5)............................ Class A 50.5 47.1
Robert Healy............................... Class C * *
Dr. Judith Herr............................ Class C * *
Stephen Kaplan............................. Class C * *
Robert MacDonald(4)........................ Class A 50.5 47.1
5% Members
Educational Simon, L.L.C................... Class A 50.5 47.1
QTL Corporation............................ Class B 44.0 41.1
All members of the management committee and
executive officers as a group............. 99.6 92.9
</TABLE>
--------
* Less than 1%.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. Membership interests issuable by
Earlychildhood to a person or entity named below pursuant to options which
may be exercised within 60 days after December 31, 2000 are deemed to be
beneficially owned by that person or entity, after giving effect to the
exchange ratios set forth in the combination agreements. However, these
shares are not deemed to be outstanding for purposes of computing the
percentage beneficially owned by any other person or entity.
(2) Beneficial ownership as shown under this column is determined by
calculating the percentage interest of a person or entity owned by that
person or entity, as compared to the fully-diluted total of membership
interests outstanding on December 31, 2000.
(3) Includes a 44.0% membership interest in Earlychildhood held by QTL
Corporation computed in accordance with the formula set forth in footnote 1
(or a 41.1% membership interest in Earlychildhood computed in accordance
with the formula set forth in footnote 2). Mr. Elliott, also a member of
the Earlychildhood management committee, disclaims beneficial ownership of
these membership interests, except to the extent of his pecuniary interest
in the membership interests.
(4) Mr. Dean resigned as a member of the Earlychildhood management committee in
the spring of 2000.
(5) Includes a 50.5% membership interest in Earlychildhood held by Educational
Simon, L.L.C. computed in accordance with the formula set forth in footnote
1 (or a 47.1% membership interest in Earlychildhood computed in accordance
with the formula set forth in footnote 2). Mr. Graves disclaims beneficial
ownership of these membership interests, except to the extent of his
pecuniary interest in the membership interests.
(6) Includes a 50.5% membership interest in Earlychildhood held by Educational
Simon, L.L.C. computed in accordance with the formula set forth in footnote
1 (or a 47.1% membership interest in Earlychildhood computed in accordance
with the formula set forth in footnote 2). Mr. MacDonald disclaims
beneficial ownership of these membership interests, except to the extent of
his pecuniary interest in the membership interests.
111
<PAGE>
LEARNINGSTAR
The Board of Directors of LearningStar Following the Combination
Upon completion of the combination, the board of directors of LearningStar
will be comprised of nine individuals; four of whom will be designated by
Earlychildhood; two of whom will be designated by SmarterKids.com; and three of
whom will be independent directors jointly designated by Earlychildhood and
SmarterKids.com.
SmarterKids.com and Earlychildhood expect to designate the independent
directors of LearningStar prior to the mailing of this proxy statement-
prospectus. To date, Earlychildhood and SmarterKids.com have designated the
individuals set forth below to be directors of LearningStar upon completion of
the combination:
<TABLE>
<CAPTION>
Name Age Designee of:
---- --- ------------
<S> <C> <C>
Ronald Elliott.............................................. 45 Earlychildhood
Al Noyes.................................................... 43 SmarterKids.com
Scott Graves................................................ 30 Earlychildhood
Stephen Kaplan.............................................. 42 Earlychildhood
Michael Kolowich............................................ 47 SmarterKids.com
Robert MacDonald............................................ 53 Earlychildhood
</TABLE>
Ronald Elliott is the founder of Earlychildhood and has been an executive
officer of Earlychildhood since 1984. Prior thereto, Mr. Elliott served as the
President of QTL Corporation, the predecessor to Earlychildhood, from 1985 to
1999.
Al Noyes has served as SmarterKids.com's Chief Operating Officer since
November 2000 and before that served as its Executive Vice President, Sales and
Marketing from February 2000 to July 2000. Mr. Noyes also served as Senior Vice
President, Sales and Marketing of SmarterKids.com from September 1997 to
February 2000. Prior to joining SmarterKids.com, 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.
Scott Graves has been a member of the Earlychildhood management committee
since July 2000. Mr. Graves joined William E. Simon & Sons, LLC, a private
investment firm and merchant bank, in 1998 and is currently a Principal of its
Private Equity Group. From 1996 through 1997, Mr. Graves worked in the Mergers
and Acquisitions Group of Merrill Lynch & Company, an international investment
banking firm. Prior thereto, Mr. Graves worked in the Audit and Business
Services Division of PricewaterhouseCoopers LLP, an international professional
services firm from 1993 through 1995. Mr. Graves is a Certified Public
Accountant in the State of California and serves on the board of directors of
SF Interactive.
Stephen Kaplan has been a Principal of Oaktree Capital Management, LLC since
1995. Oaktree provides investment management services 62 pursuant to a sub-
advisory agreement with TCW Asset Management Company, the general partner of
TCW Special Credits Fund V--The Principal Fund. Mr. Kaplan was a Managing
Director of Trust Company of the West from 1993 to 1995. Prior to that time,
Mr. Kaplan was a partner with the law firm of Gibson, Dunn & Crutcher. Mr.
Kaplan is also a director of Acorn Products, Inc., GeoLogistics Corporation,
KinderCare Learning Centers, Inc. and Roller Bearing Holding Co.
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
112
<PAGE>
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.
Robert MacDonald joined the Earlychildhood management committee in May 1999.
Mr. MacDonald joined William E. Simon & Sons, LLC, a private investment firm
and merchant bank in 1993 and is currently Managing Director and President of
its Private Equity Group. From 1988 through 1992, Mr. MacDonald provided
private investment and financial services to a variety of clients, including
William E. Simon & Sons, LLC, through East Rock Partners, a firm he co-founded.
In 1981, Mr. MacDonald co-founded Catalyst Energy Corporation, a leading
developer of independent power facilities throughout the United States. Mr.
MacDonald serves on the boards of directors of PBOC Holdings, Corporate
Staffing Resources, and Do+Able Products.
Committees of the LearningStar Board of Directors
Upon completion of the combination, the board of directors of LearningStar
initially will have a compensation committee and an audit committee.
The compensation committee, of which Messrs. , and
are members, will determine the compensation (including stock option grants) of
LearningStar's senior management. The audit committee, of which Messrs. ,
and are members, will oversee financial results and internal
controls of LearningStar, including matters relating to the appointment and
activities of LearningStar's independent auditors. Each of Messrs. ,
and are "independent directors" as defined by the Nasdaq Stock Market
Rule 4200(a)(14).
Compensation of Directors of LearningStar
It is expected that neither employee nor non-employee directors will receive
cash compensation for services performed in their capacity as directors of
LearningStar. SmarterKids.com will 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 will be eligible to
participate in the LearningStar 2001 Stock Plan. Under the LearningStar 2001
stock option and incentive plan, non-employee directors will be eligible to
receive stock option grants at the discretion of the board of directors. In
addition, each director who is not also an employee or officer of LearningStar
will be entitled to participate in the LearningStar 2001 Non-Employee Director
Stock Option Plan.
Executive Officers of LearningStar Following the Combination
The executive officers of LearningStar upon completion of the combination
will be as follows:
<TABLE>
<CAPTION>
Name Age Title
---- --- -----
<S> <C> <C>
Ronald Elliott........................... 45 Chairman of the Board of Directors
Al Noyes................................. 43 Chief Executive Officer
Robert Cahill............................ 34 Chief Financial Officer
Judith McGuinn........................... 51 Chief Operating Officer
</TABLE>
Robert Cahill has served as SmarterKids.com's Vice President, Finance and
Administration and Chief Financial Officer since April 2000 and served as Vice
President, Finance from June 1999 and served as Controller from October 1997 to
June 1999. Prior to joining SmarterKids.com, Mr. Cahill served as Accounting
Manager for Gensym Corp., a developer and marketer of software products, from
May 1995 to October 1997. Mr. Cahill is a Certified Public Accountant in the
Commonwealth of Massachusetts and served as a Senior Accountant for Ernst &
Young LLP from January 1993 to May 1995.
113
<PAGE>
Judith McGuinn has served as Earlychildhood's Senior Vice President and
Chief Operating Officer since December 1999. Prior to joining Earlychildhood
Ms. McGuinn served as Vice President/Director of Time Warner Audio Books, a
division of Time Warner Trade Publishing in New York, from July 1994 to
December 1999.
For information regarding Messrs. Elliott and Noyes, please see their
biographies in the section entitled "--The Board of Directors of LearningStar
Following the Combination."
Compensation of Executive Officers of LearningStar
LearningStar has not yet paid any compensation to the persons expected to
become executive officers of LearningStar. The form and amount of compensation
to be paid to each of LearningStar's executive officers in any future period
will be determined by the compensation committee of the LearningStar board of
directors.
The following table sets forth the compensation paid by SmarterKids.com to
its executive officers in fiscal year ended December 31, 2000 who will become
executive officers and/or directors of LearningStar:
<TABLE>
<CAPTION>
Annual Compensation Long-Term
--------------------- Compensation on
Name and Principal Fiscal Salary Bonus Securities Underlying All Other
Positions Year ($) ($)(2) Options (#) Compensation ($)(1)
------------------ ------ ------- ------ --------------------- -------------------
<S> <C> <C> <C> <C> <C>
Al Noyes................. 1998 105,794 15,073 150,000 696
Chief Operating Officer 1999 120,000 27,200 200,000 696
2000 145,750 15,000 60,000 385
Robert Cahill............ 1998 80,278 -- 15,000 696
Vice President, Finance 1999 101,729 -- 105,000 696
and Chief
Financial Officer 2000 155,750 -- 95,000 414
</TABLE>
--------
(1) Excludes prerequisites and other personal benefits, the aggregate annual
amount of which for each officer was less than the lesser of $50,000 or 10%
of the total salary and bonus reported.
(2)Bonuses are reported in the year earned, even if actually paid in a
subsequent year.
The following table sets forth the compensation paid by Earlychildhood in
fiscal year ended December 31, 2000 to the executive officers of Earlychildhood
who will become executive officers of LearningStar:
<TABLE>
<CAPTION>
Annual Compensation Long-Term
------------------------- Compensation on
Name and Principal Fiscal Salary Bonus Securities Underlying All Other
Positions Year ($) ($) Options (#) Compensation
------------------ ------ ------- ------- --------------------- -------------
<S> <C> <C> <C> <C> <C>
Ronald Elliott........... 1998 268,573 700,000 -- --
Founder, President and 1999 242,752 -- -- --
Chief
Executive Officer 2000 231,341 -- -- --
Judith McGuinn(1)........ 1998 -- -- -- --
Chief Operating Officer 1999 8,750(1) -- -- --
2000 156,923 28,854 140,182(2) --
</TABLE>
--------
(1) Judith McGuinn joined Earlychildhood on December 6, 1999.
(2) Ms. McGuinn was granted options for 0.6% of Earlychildhood membership
interests which will be exchanged for the right to purchase 140,182 shares
of LearningStar common stock upon completion of the combination.
114
<PAGE>
Option Grants in Last Fiscal Year
The following table sets forth grants of stock options pursuant to
SmarterKids.com's 1995 stock plan and 1999 stock option and incentive plan
granted during the fiscal year ended December 31, 2000 to the SmarterKids.com
executive officers and directors who will become executive officers and/or
directors of LearningStar:
<TABLE>
<CAPTION>
Option Grants In Last Fiscal Year Individual Grants
----------------------------------------------------------
Potential
Realizable
Value at
Assumed Annual
Rates of Stock
Percent of Price
Total Options Appreciation
Number of Granted to for Option Term
Securities Employees in ($)(3)
Underlying Options Fiscal Exercise Price Expiration ---------------
Name Granted (#)(1) Year (%)(2) Per Share ($) Date 5% 10%
---- ------------------ ------------- -------------- ---------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Al Noyes................ 60,000 3.6% 1.50 9/7/10 56,601 143,437
200,000(4) -- (6) 1.50 10/1/09 188,668 478,123
Robert Cahill........... 60,000(5) 3.6% 1.50 4/1/10 56,601 143,437
10,000(5) .6% 1.50 1/12/10 9,433 23,906
25,000 1.5% 1.50 9/7/10 23,584 59,765
75,000(5) -- 1.50 10/1/09 70,751 179,296
Michael Kolowich........ -- -- -- -- -- --
</TABLE>
--------
(1) No stock appreciation rights ("SARs") were granted by SmarterKids.com in
the fiscal year ended December 31, 2000.
(2) Represents all options granted to the individual during 2000 as a
percentage of all options granted to employees during 2000.
(3) Amounts reported in these columns represent amounts that may be realized
upon exercise of the options immediately prior to the expiration of their
term assuming the specified compounded rates of appreciation (5% and 10%)
on the market value of SmarterKids.com's common stock on the date of option
grant over the term of the options. These numbers are calculated based on
rules promulgated by the Securities and Exchange Commission and do not
reflect SmarterKids.com's estimate of future stock price growth. Actual
gains, if any, on stock option exercises and common stock holdings are
dependent on the timing of such exercise and the future performance of
SmarterKids.com's common stock. There can be no assurance that the rates of
appreciation assumed in this table can be achieved or that the amounts
reflected will be received by the individuals.
(4) On September 7, 2000, certain of Mr. Noye's options were amended by the
board of directors of SmarterKids.com to reduce the exercise price to
$1.50, the current market value on that date. See the description under the
caption "--Ten Year Option Repricing."
(5) On September 7, 2000, certain of Mr. Cahill's options were amended by the
board of directors of SmarterKids.com to reduce the exercise price to
$1.50, the current market value on that date. See the description under the
caption "--Ten Year Option Repricing."
(6) For purposes of calculating the percentage, the repriced options described
in footnotes (4) and (5) are not deemed to be options granted to employees
in the fiscal year.
115
<PAGE>
The following table sets forth grants of membership interests granted during
the fiscal year ended December 31, 2000 to members of the Earlychildhood
management committee and Earlychildhood executive officers will become
executive officers and/or directors of LearningStar.
<TABLE>
<CAPTION>
Option Grants In Last Fiscal Year Individual Grants
----------------------------------------------------------
Potential Realizable
Value at Assumed
Percent of Annual Rates of
Total Options Stock Price
Number of Granted to Appreciation for
Securities Employees in Option Term ($)(3)
Underlying Options Fiscal Exercise Price Expiration ---------------------
Name Granted (#)(1) Year (%)(2) Per Share ($) Date 5% 10%
---- ------------------ ------------- -------------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Ronald Elliott.......... -- -- -- -- -- --
Judy McGuinn............ 140,182 9% .018 9/01/10 408,492 651,950
</TABLE>
--------
(1) No SARs were granted by Earlychildhood in the fiscal year ended
December 31, 2000.
(2) Represents all options granted to the individual during 2000 as a
percentage of all options granted to employees during 2000.
(3) Amounts reported in these columns represent amounts that may be realized
upon exercise of the options immediately prior to the expiration of their
term assuming the specified compounded rates of appreciation (5% and 10%)
on the market value of Earlychildhood's membership interests on the date of
option grant over the term of the options. These numbers are calculated
based on rules promulgated by the Securities and Exchange Commission and do
not reflect Earlychildhood's estimate of future stock price growth. Actual
gains, if any, on option exercises and membership interests holdings are
dependent on the timing of such exercise and the future performance of
Earlychildhood's membership interests. There can be no assurance that the
rates of appreciation assumed in this table can be achieved or that the
amounts reflected will be received by the individuals.
Option Exercises and Fiscal Year-End Values
The following table sets forth information with respect to options to
purchase SmarterKids.com's common stock granted under SmarterKids.com's 1995
Stock Plan and 1999 Stock Option and Incentive Plan to the SmarterKids.com
executive officers and directors who will become directors and/or executive
officers of LearningStar, including:
. the number of shares of common stock purchased upon exercise of options
in the fiscal year ended December 31, 2000;
. the net value realized upon such exercise;
. the number of unexercised options outstanding at December 31, 2000; and
. the value of such unexercised options at December 31, 2000.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL
YEAR AND FISCAL YEAR-END OPTION/SAR VALUES
<TABLE>
<CAPTION>
Number of Securities
Underlying Unexercised Value of Unexercised
Value Options at In-the-Money Options at
Shares Acquired Realized Fiscal Year End (#) Fiscal Year End ($)(1)
Name on Exercise (#) ($) (Exercisable/Unexercisable) (Exercisable/Unexercisable)
---- --------------- -------- --------------------------- ---------------------------
<S> <C> <C> <C> <C>
Al Noyes................ 160,000 653,667 220,875/218,125 60,423/11,184
Robert Cahill........... -- -- 89,375/155,625 24,978/4,847
Michael Kolowich........ 75,000 125,900 0/0 0/0
</TABLE>
--------
(1) Value is based on the difference between the option exercise price and the
fair market value of SmarterKids.com common stock at December 31, 1999, the
fiscal year-end ($.531 per share as quoted on the Nasdaq National Market,
multiplied by the number of shares underlying the option).
116
<PAGE>
The following table sets forth information with respect to options to
purchase Earlychildhood membership interests granted under the Earlychildhood
management incentive option plan to the Earlychildhood executive officers and
members of the Earlychildhood management committee who will become directors
and/or executive officers of LearningStar including:
. the number of membership interests of common stock purchased upon
exercise of options in the fiscal year ended December 31, 2000;
. the net value realized upon such exercise;
. the number of unexercised options outstanding at December 31, 2000; and
. the value of such unexercised options at December 31, 2000.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL
YEAR AND FISCAL YEAR-END OPTION/SAR VALUES
<TABLE>
<CAPTION>
Number of Membership
Membership Interests Underlying Value of Unexercised
Interests Unexercised Options at In-the-Money Options at
Acquired on Value Fiscal Year End % Fiscal Year End ($)(1)
Name Exercise (#)% Realized ($) (Exercisable/Unexercisable) (Exercisable/Unexercisable)
---- ------------- ------------ --------------------------- ---------------------------
<S> <C> <C> <C> <C>
Ronald Elliott.......... -- -- -- --
Judith McGuinn.......... -- -- 0.0%/0.6% 0/71,914
Scott Graves............ -- -- -- --/--
Stephen Kaplan.......... -- -- -- --/--
Robert MacDonald........ -- -- -- --/--
</TABLE>
--------
(1) Value is based on the difference between the option exercise price and the
fair market value of Earlychildhood membership interests at December 31,
2000, the fiscal year-end ($1,198.57 per .0001 Class C membership
interest). The fair market value was determined by multiplying the number
of options of LearningStar to be received in the combination using the
exchange ratios set forth in the combination agreement by the closing
price.
Ten Year Option Repricing
On September 7, 2000, SmarterKids.com completed a direct repricing of
certain employee stock option grants. As part of the repricing, SmarterKids.com
reduced the exercise price of all outstanding options with exercise prices of
greater than $1.50 per share. The new exercise price of these repriced options
was reset to $1.50 per share, which was equal to the market value of
SmarterKids.com's common stock on September 7, 2000. The number of options
repriced totaled 2,325,574. SmarterKids.com is accounting for the repriced
options as a variable award. In the quarter ending September 30, 2000,
SmarterKids.com recorded an incremental non-cash stock compensation charge of
$110,000 as a result of the repricing. The following chart presents information
about the consequences of the repricing for the SmarterKids.com executive
officers and directors who will become directors and/or executive officers of
LearningStar:
<TABLE>
<CAPTION>
Original
Exercise Option Term
Price at Exercise Remaining at
Date of # Mkt Price at Prior to Price Post time of
Repricing Securities Repricing($) Repricing($) Repricing($) Repricing(yrs)
--------- ---------- ------------ ------------ ------------ --------------
<S> <C> <C> <C> <C> <C> <C>
Al Noyes................ 9/7/00 200,000 1.50 11.00 1.50 3.21
Robert Cahill........... 9/7/00 10,000 1.50 6.44 1.50 3.38
9/7/00 60,000 1.50 2.50 1.50 3.58
9/7/00 75,000 1.50 11.00 1.50 3.06
Michael Kolowich........ -- -- -- -- -- --
</TABLE>
117
<PAGE>
Compensation Committee Report on Option Repricing
On August 30, 1999, the compensation committee of SmarterKids.com board of
directors (the "compensation committee") approved a reduction, effective
September 7, 2000, in the exercise price of certain outstanding stock options
held by executive officers and employees of SmarterKids.com to $1.50 per share,
the fair market value of SmarterKids.com's common stock on September 7, 2000.
These options were granted between July 1999 and April 2000 at exercise prices
ranging from $1.50 to $14.00 per share.
As set forth in SmarterKids.com 1995 stock plan and 1999 stock option and
incentive plan, stock options are intended to provide incentives to
SmarterKids.com's executive officers and employees. The SmarterKids.com
compensation committee believed that such equity incentives are a significant
factor in SmarterKids.com's ability to attract, retain and motivate key
employees who are critical to the SmarterKids.com long-term success. The
SmarterKids.com compensation committee believed that, at their original
exercise prices, the disparity between the exercise price of these options and
recent market prices for SmarterKids.com's common stock did not provide
meaningful incentive to the executive officers and employees holding these
options to perform to their maximum potential and to work towards the success
of SmarterKids.com. Inquiries conducted indicated that other comparable
companies in the Internet education product industry sector have been
confronted with this problem and have made similar adjustments in option prices
to motivate their executive officers and employees. The SmarterKids.com
compensation committee approved the repricing of these options as a means of
ensuring that the optionees will continue to have meaningful equity incentives
to work toward the success of SmarterKids.com. The adjustment was deemed by the
SmarterKids.com compensation committee to be in the best interest of
SmarterKids.com and its stockholders.
Respectfully submitted by the
Compensation Committee:
Richard D'Amore and Michael Kolowich
Earlychildhood has never repriced its options to purchase membership
interests in Earlychildhood.
Employment and Change of Control Agreements
Currently, none of the executive officers or directors of LearningStar have
employment agreements or change of control agreements with LearningStar. For
more information on the employment agreements and change of control agreements
of the SmarterKids.com directors and executive officers, the members of the
Earlychildhood management committee and the Earlychildhood executive officers,
see the section entitled "The Combination--Interests of Certain Persons in the
Combination."
118
<PAGE>
Pro Forma Security Ownership of Certain Beneficial Owners and Management of
LearningStar
The following table sets forth certain pro forma information as to the
number of shares of LearningStar common stock to be held by the following
persons upon completion of the combination:
. each person or entity expected by LearningStar to beneficially own 5% of
more of the LearningStar common stock;
. each director of LearningStar;
. each executive officer of LearningStar; and
. all LearningStar directors and executive officers as a group.
Except as otherwise indicated, LearningStar believes that persons expected
to be the beneficial owners of the LearningStar common stock listed below,
based on information furnished by such owners, have sole voting and investment
power with respect to such shares. Unless otherwise indicated the address of
the following persons is c/o LearningStar, 15 Crawford Street, Needham,
Massachusetts 02494.
<TABLE>
<CAPTION>
Amount and
Nature of Percent of
Name and Address of Beneficial Owner Ownership(1) Common Stock
------------------------------------ ------------ ------------
<S> <C> <C>
Executive Officers
Ronald Elliott(2).................................... 19,205,598 29.3%
Al Noyes(3).......................................... 461,875 *
Robert Cahill(4)..................................... 91,875 *
Judith McGuinn....................................... -- --
Directors
Scott Graves(5)...................................... 23,537,465 35.9
Stephen Kaplan....................................... 77,882 *
Michael Kolowich..................................... 155,000 *
Robert MacDonald(6).................................. 23,537,465 35.9
5% Holders
Educational Simon, L.L.C............................. 23,537,465 35.9
QTL Corporation...................................... 19,205,598 29.3
All executive officers and directors as group(7)..... 43,529,659 66.4
</TABLE>
--------
* Less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. Membership interests issuable by
Earlychildhood to a person or entity named below pursuant to options which
may be exercised within 60 days after December 31, 2000 are deemed to be
beneficially owned by that person or entity. However, these shares are not
deemed to be outstanding for purposes of computing the percentage
beneficially owned by any other person or entity.
(2) Include 19,205,598 shares of LearningStar common stock to be held by QTL
Corporation. Mr. Elliott, who will also become a director of LearningStar,
disclaims beneficial ownership of these shares except to the extent of his
pecuniary interest therein.
(3) Includes 214,875 shares of LearningStar common stock issuable upon the
exercise of options exercisable on December 31, 2000 or within 60 days
thereafter. Mr. Noyes will also become a director of LearningStar.
(4) Consists of 91,875 shares of LearningStar common stock issuable upon the
exercise of options exercisable on December 31, 2000 or within 60 days
thereafter.
(5) Include 23,537,465 shares of LearningStar common stock to be held by
Educational Simon, L.L.C. Mr. Graves disclaims beneficial ownership of
these shares except to the extent of his pecuniary interest therein.
(6) Include 23,537,465 shares of LearningStar common stock to be held by
Educational Simon, L.L.C. Mr. MacDonald disclaims beneficial ownership of
these shares except to the extent of his pecuniary interest therein.
(7) See footnotes (1) through (6) above. Includes options to purchase an
aggregate of 306,750 shares of LearningStar common stock issuable upon the
exercise of options exercisable on December 31, 2000 or within 60 days
thereafter.
119
<PAGE>
DESCRIPTION OF CAPITAL STOCK OF LEARNINGSTAR
Effective upon the closing of this combination and the filing of the
LearningStar restated certificate of incorporation, the LearningStar authorized
capital stock will consist of shares of common stock, par value $.01 per
share, and shares of preferred stock, par value $.01 per share. The
following summary description of the LearningStar capital stock is not intended
to be complete and is qualified by reference to the provisions of applicable
law and to the LearningStar restated certificate of incorporation attached as
Annex D to this proxy statement-prospectus and the LearningStar amended and
restated bylaws attached as Annex E to this proxy statement-prospectus.
Common Stock
Upon the completion of the combination, there will be shares of
LearningStar common stock outstanding held by stockholders of record. In
addition, upon completion of the combination, there will be stock options
outstanding to purchase an aggregate of shares of LearningStar common stock
due to the conversion of outstanding options to purchase SmarterKids.com common
stock and the conversion of outstanding options to purchase Earlychildhood
membership interests. In addition, following the completion of the combination,
there will be outstanding warrants to purchase 217,292 shares of LearningStar
common stock due to the conversion of warrants to purchase shares of
SmarterKids.com common stock.
Holders of LearningStar 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
the election. Holders of LearningStar common stock are entitled to receive
ratably dividends, if any, as may be declared by the LearningStar board of
directors out of funds legally available therefor, after provision has been
made for any preferential dividend rights of outstanding preferred stock, if
any. Upon liquidation, dissolution or winding up of LearningStar, the holders
of LearningStar common stock are entitled to receive ratably the net assets
available after the payment of all of its debts and other liabilities, and
after the satisfaction of the rights of any outstanding preferred stock.
Holders of LearningStar 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 LearningStar common stock will be, when validly
issued, fully paid and non-assessable. The rights, powers, preferences and
privileges of holders of LearningStar common stock are subordinate to, and may
be adversely affected by, the rights of the holders of shares of any series of
preferred stock that LearningStar may designate and issue in the future.
Preferred Stock
The LearningStar board of directors will be authorized, without further
stockholder approval, to issue from time to time up to an aggregate of
shares of preferred stock, in one or more series. Each series of preferred
stock shall have the number of shares, designations, preferences, voting
powers, qualifications and special or relative rights or privileges as shall be
determined by the LearningStar board of directors, which may include, among
others, dividend rights, voting rights, redemption and sinking fund provisions,
liquidation preferences, conversion rights and preemptive rights. The rights of
the holders of LearningStar 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 LearningStar's outstanding voting stock.
LearningStar has not, to date, issued any shares of preferred stock, and has no
present plans to issue any shares of preferred stock.
120
<PAGE>
Warrants
As of the completion of the combination, the following warrants to purchase
an aggregate of 217,292 shares of LearningStar common stock will be
outstanding:
. J.L. Hammett Co. will have a warrant to purchase 165,000 shares of
LearningStar common stock at an exercise price of $1.33 per share;
. Silicon Valley Bank will have a warrant to purchase 7,500 shares of
LearningStar common stock at an exercise price of $1.33 per share;
. TLP Leasing Programs, Inc. will have a warrant to purchase 16,667 shares
of LearningStar common stock at an exercise price of $3.00 per share;
and
. National Computer Systems will have warrants to purchase an aggregate of
28,125 shares of LearningStar common stock at an exercise price of $1.33
per share.
Registration Rights
Upon the expiration of the contractual lock-up period in accordance with the
lock-up agreements between LearningStar and each of the directors and executive
officers and certain significant stockholders of SmarterKids.com and all of the
holders of membership interests in Earlychildhood, collectively referred to
herein as the "Rightsholders," will be entitled to require LearningStar to
register under the Securities Act of 1933 up to an aggregate of shares of
LearningStar common stock held by the Rightsholders pursuant to the
registration rights agreement among LearningStar and the Rightsholders.
The registration rights agreement provides that if LearningStar proposes to
register in a firm commitment underwritten offering any of its securities under
the Securities Act at any time or times, the Rightsholders will generally be
entitled to include shares of common stock held by them in the registration.
However, the managing underwriter of any offering may exclude for marketing
reasons some or all of the shares from the registration. The Rightsholders also
have the right to require LearningStar, on no more than two occasions 180 days
after the closing date of the combination, to prepare and file a registration
statement under the Securities Act registering the shares of LearningStar
common stock held by them. LearningStar is generally required to bear the
expenses of all these registrations, except underwriting discounts and
commissions. These rights will terminate on the fifth anniversary of the
closing date of the combination.
In addition, holders of warrants to purchase an aggregate of 24,167 shares
of LearningStar common stock will have certain registration rights.
Anti-Takeover Effects of Certain Provisions of LearningStar's Charter and
Bylaws and Delaware Law
Upon completion of the combination, the provisions of Section 203 of the
Delaware General Corporation Law will prohibit LearningStar 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 a corporation's voting stock.
The LearningStar and restated certificate of incorporation provides for the
division of the LearningStar board of directors into three classes as nearly
equal in size as possible with staggered three-year terms. In addition, the
LearningStar 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 the LearningStar
121
<PAGE>
capital stock entitled to vote generally in the election of directors, voting
as a single class. Under the LearningStar restated certificate of
incorporation, any vacancy on the LearningStar board of directors, however
occurring, including a vacancy resulting from an enlargement of the board of
directors, may only be filled by vote of a majority of the directors then in
office. The likely effect of the classification of the LearningStar board of
directors and the limitations on the removal of directors and filling of
vacancies is an increase in the time required for the stockholders to change
the composition of the LearningStar 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
LearningStar board of directors.
The LearningStar restated certificate of incorporation also provides that,
after the effective date of the LearningStar registration statement on Form S-4
of which this proxy statement-prospectus is a part, any action required or
permitted to be taken by LearningStar 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.
The LearningStar amended and restated bylaws provide that special meetings of
the stockholders may only be called by the LearningStar board of directors, the
chairman of the board or by the board of directors. The LearningStar amended
and restated bylaws further provide that in order for any matter to be
considered "properly brought" before a meeting, a stockholder must comply with
requirements regarding timely notice to LearningStar. The foregoing provisions
could have the effect of delaying until the next LearningStar stockholders
meeting stockholder actions which are favored by the holders of a majority of
the LearningStar outstanding voting securities. These provisions may also
discourage another person or entity from making a tender offer for
SmarterKids.com common stock, because such person or entity, even if it
acquired a majority of SmarterKids.com 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 Delaware General Corporation Law 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 bylaws, unless a
corporation's certificate of incorporation or bylaws, as the case may be,
requires a greater percentage. The LearningStar restated certificate of
incorporation requires the affirmative vote of the holders of at least 75% of
the shares of LearningStar capital stock that are issued and outstanding and
entitled to vote to amend or repeal any of the foregoing provisions of the
LearningStar restated certificate of incorporation. The LearningStar amended
and restated bylaws may generally be amended or repealed by a majority vote of
the LearningStar 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 LearningStar
capital stock that are issued and outstanding and entitled to vote and voting
as a single class. 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 LearningStar common stock is
ChaseMellon Shareholder Services, L.L.C.
122
<PAGE>
COMPARISON OF RIGHTS OF HOLDERS OF LEARNINGSTAR COMMON STOCK, SMARTERKIDS.COM
COMMON STOCK AND EARLYCHILDHOOD MEMBERSHIP INTERESTS
The following is a summary of the material differences between the rights of
holders of SmarterKids.com common stock and holders of membership interests in
Earlychildhood before the combination and the rights of holders of LearningStar
capital stock after the combination. Because SmarterKids.com and LearningStar
are both corporations organized under the laws of the State of Delaware, the
differences arise solely from differences between various provisions of their
respective certificates of incorporation and bylaws. However, because
Earlychildhood is organized under the laws of the State of California as a
limited liability company and LearningStar is organized under the laws of the
State of Delaware as a corporation, the differences arise both from differences
between various provisions of their respective organizational documents and
California and Delaware law. The discussion of the comparative rights of the
stockholders of SmarterKids.com, the members of Earlychildhood and the holders
of LearningStar common stock set forth below does not purport to be complete
and is subject to and qualified in its entirety by reference to the
certificates of incorporation and bylaws of SmarterKids.com and LearningStar,
the operating agreement of Earlychildhood and California and Delaware law.
Authorized Capital Stock
The total number of shares LearningStar will have the authority to issue
will be consisting of shares of common stock, par value $.01 per
share, and shares of LearningStar preferred stock.
The total number of shares of capital stock which SmarterKids.com has
authority to issue is 100,000,000, consisting of 90,000,000 shares of common
stock, par value $0.01 per share, 20,668,849 shares of which are issued and
outstanding as of December 31, 2000 and 10,000,000 shares of preferred stock,
par value $0.01 per share, none of which are issued and outstanding as of the
date hereof.
Number of Directors or Members of Management Committee
The Delaware General Corporation Law provides that the board of directors of
a Delaware corporation will consist of one or more directors as fixed by the
certificate of incorporation or bylaws. LearningStar's restated certificate of
incorporation provides for a board of directors of not less than three nor more
than 15 directors, as fixed by LearningStar's amended and restated bylaws.
LearningStar's amended and restated bylaws and the combination agreement
provide for a LearningStar board of directors consisting of nine members; two
of whom will be designated by SmarterKids.com and referred to herein as the
"SmarterKids.com Designated Directors" four of whom will be designated by
Earlychildhood and referred to herein as the "Earlychildhood Designated
Directors"; and three of whom will be jointly designated by SmarterKids.com and
Earlychildhood. The LearningStar restated certificate of incorporation provides
that the board of directors will be divided into three classes each consisting
of three directors and designated Class I, Class II, and Class III. Class I
directors will be initially elected for a term expiring at the first annual
meeting of LearningStar stockholders. Class II directors will be initially
elected for a term expiring at the second annual meeting of LearningStar
stockholders. Class III directors will be initially elected for a term expiring
at the third annual meeting of LearningStar stockholders. The LearningStar
restated certificate of incorporation provides that at each annual meeting of
the LearningStar stockholders, successors to the class of directors whose term
expires at that annual meeting will be elected for a three-year term. The
combination agreement provides that the SmarterKids.com Designated Directors
and the Earlychildhood Designated Directors will be allocated as evenly as
possible among LearningStar's three classes of directors.
SmarterKids.com's bylaws provide for a board of directors consisting of not
less than three directors as fixed by the SmarterKids.com board of directors or
by the SmarterKids.com stockholders at an annual or special meeting.
SmarterKids.com's bylaws provide for a classified board of directors consisting
of three classes. Currently, SmarterKids.com has a board of directors
consisting of six directors with two directors in each class.
123
<PAGE>
The Beverly-Killea Limited Liability Company Act, or the California Limited
Liability Company Act, provides that the business and affairs of a California
limited liability company be managed by one or more managers and not by all its
members if the articles of organization so provides. The number and
qualifications of managers are dictated by provisions of the articles of
organization or operating agreement of the limited liability company.
Earlychildhood's amended articles of organization provides that Earlychildhood
will be managed by more than one manager. Earlychildhood's amended and restated
operating agreement provides that the business and affairs of Earlychildhood
will be managed by the members acting through a management committee initially
composed of five representatives and currently composed of six representatives.
Committees of the Board of Directors or Management Committee
LearningStar's amended and restated bylaws provide that the board of
directors may by resolution designate an Executive Committee to exercise all of
the powers of the LearningStar board of directors in the management of the
business and affairs of LearningStar when the board is not in session and may
also adopt one or more other committees. It is intended that LearningStar will
designate an audit committee and a compensation committee. The audit committee
will be initially comprised of and , each an Earlychildhood
Designated Director, and , a SmarterKids.com Designated
Director. The members of the LearningStar audit committee meet the independence
and audit committee composition requirements under the rules of the Nasdaq
National Market. The audit committee will assist the board of directors in
fulfilling its responsibilities by reviewing:
. the financial reports provided by LearningStar to the Securities and
Exchange Commission; and
. LearningStar's internal financial and accounting controls.
The LearningStar compensation committee will be initially comprised of
and , each an Earlychildhood Designated Director, and , a
SmarterKids.com Designated Director, each of whom will meet the requirements of
independence as established by Nasdaq National Market and required by the
Securities and Exchange Commission pursuant to Section 16 of the Securities
Exchange Act. The LearningStar compensation committee will have responsibility
for:
. reviewing the compensation and employee benefit policies of
LearningStar;
. recommending to the LearningStar board of directors the base salary
amounts and incentive awards for all elected officers of LearningStar
and setting guidelines for the administration of all salaries;
. administering incentive compensation and awarding stock options to
employees under any stock option or compensation plan of LearningStar
and amending or modifying any provisions of such stock option or
compensation plan that may be amended or modified without stockholder
approval; and
. supervising all administrative matters with respect to the foregoing.
SmarterKids.com's bylaws provide that its board of directors by a majority
vote may establish one or more committees, each committee consisting of one or
more of the directors of SmarterKids.com. Any committee so established to the
extent provided in the resolution of the board of directors, will have and may
exercise all the powers of the board of directors in the management of the
business and affairs of SmarterKids.com. SmarterKids.com has established two
committees, an audit committee and a compensation committee.
Neither Earlychildhood's amended articles of organization nor its amended
and restated operating agreement specifically provides for the establishment of
committees, although Earlychildhood's amended and restated operating agreement
states that its provisions do not bar Earlychildhood's management committee
from delegating responsibility for any of the management committee's management
decisions to any member, officer, or other representative or agent of
Earlychildhood.
124
<PAGE>
Removal of Directors or Member of the Management Committee
The Delaware General Corporation Law provides that a director or the entire
board of directors may be removed, with or without cause, by the holders of a
majority of the shares then entitled to vote at an election of directors,
except that:
. in the case of a corporation whose board is classified, directors may be
removed only for cause unless the certificate of incorporation provides
otherwise; or
. if the corporation has cumulative voting, in which event if less than
the entire board is to be removed, no director may be removed without
cause if the votes cast against the director's removal would be
sufficient to elect that director if voted cumulatively either at an
election of the entire board of directors or for classes of the board.
LearningStar's restated certificate of incorporation provides that directors
may be removed only for cause and in addition to any other vote required by
law, by the affirmative vote of the holders of at least 75% of the voting power
of the shares of LearningStar capital stock entitled to vote generally in the
election of directors, voting together as a single class.
SmarterKids.com's bylaws allow the removal with cause of a director by the
affirmative vote of the holders of at least 75% the shares entitled to vote at
an election of directors.
The California Limited Liability Company Act provides that any or all
managers of a limited liability company may be removed, with or without cause,
by the vote of a majority in interest of the members at a meeting called
expressly for that purpose. Neither Earlychildhood's amended articles of
organization nor its amended and restated operating agreement provide any
further guidance with respect to the removal of members of Earlychildhood's
management committee.
Amendment to the Bylaws or Operating Agreement
Under the Delaware General Corporation Law, bylaws may be altered, amended,
supplemented or repealed, or new bylaws adopted, by the stockholders entitled
to vote, by the board of directors, or by any other manner as may be authorized
by the certificate of incorporation.
LearningStar's amended and restated bylaws provide that the board of
directors may amend, alter, or repeal any provision of LearningStar's amended
and restated bylaws with an affirmative vote of a majority of LearningStar's
board of directors, provided that notice of the proposed change is given to the
board of directors not later than two days prior to the meeting of the board of
directors to effect such change. In addition to any other vote required by law,
LearningStar's amended and restated bylaws provide that any amendment,
alteration or repeal of any provision of the LearningStar amended and restated
bylaws requires the affirmative vote of 75% of the voting power of all
outstanding shares of LearningStar then entitled to vote generally in the
election of directors, voting together as a single class.
SmarterKids.com's bylaws may be altered, amended or repealed, or new bylaws
may be adopted by a majority of the board of directors. In addition to an
amendment made by the board of directors, the shareholder may amend or repeal
any provision of the SmarterKids.com bylaws with a vote of 75% of the shares of
capital stock that are issued, outstanding and entitled to vote at any regular
or special meeting of stockholders.
The California Limited Liability Company Act gives the members of a
California limited liability company the power to amend the limited liability
company's operating agreement. The manner in which the operating agreement may
be amended may be prescribed by the articles of organization or the operating
agreement. Earlychildhood's amended and restated operating agreement provides
that it may be amended only upon receipt of the written consent of the
management committee, which may be given, withheld or made subject to such
conditions as are determined by each member of the management committee in its
sole and
125
<PAGE>
absolute discretion. In addition, amendment of certain provisions of
Earlychildhood's amended and restated operating agreement requires the approval
of a supermajority of the representatives on Earlychildhood's management
committee.
Amendments to the Certificates of Incorporation or Articles of Organization
Under the Delaware General Corporation Law amendment of the certificate of
incorporation of a corporation will be made by a resolution of the board of
directors setting forth the amendment, declaring its advisability, and either
calling a special meeting of the stockholders entitled to vote or directing
that the amendment proposed be considered at the next annual meeting of the
stockholders. At the stockholder's meeting, a majority of the outstanding
shares entitled to vote is required to approve the amendment. If an amendment
would increase or decrease the number of authorized shares of such class,
increase or decrease the par value of the shares of such class or alter or
change the powers, preferences or other special rights of a class of
outstanding shares so as to affect the class adversely, then a majority of
shares of that class must approve the amendment as well. The Delaware General
Corporation Law also permits a corporation to make provision in its certificate
requiring a greater proportion of voting power to approve a specified
amendment.
LearningStar's amended and restated bylaws provide that the board of
directors may amend, alter, or repeal any provision of LearningStar's restated
certificate of incorporation as provided by Delaware statute.
SmarterKids.com's certificate of incorporation may be altered, amended or
repealed, or new bylaws may be adopted by a majority of the board of directors.
In addition to a vote of the SmarterKids.com board of directors, to amend or
repeal any provision of the SmarterKids.com certificate of incorporation the
vote of 75% of the shares of capital stock that are issued, outstanding and
entitled to vote is required.
The California Limited Liability Company Act provides that the articles of
organization of a limited liability company may be amended at any time and in
any manner as the members may determine, as long as the articles of
organization, as amended, contain only those provisions as would be lawful if
inserted in the original articles of organization. In order to affect an
amendment to the articles of organization, a certificate of amendment must be
filed with the Secretary of State of the State of California setting forth the
name and Secretary of State's file number of the limited liability company and
the text of the amendment to the articles of organization.
Action by Written Consent of Stockholders or Members.
The Delaware General Corporation Law contains provisions permitting actions
by holders of common stock without providing notice and convening a meeting of
such holders if consents setting for the action to be taken are signed by
holders of outstanding stock having not less than the minimum number of votes
that would be necessary to authorize or take such action at a meeting of
stockholders unless prohibited by the corporation's bylaws.
LearningStar's amended and restated bylaws do not permit any actions to be
taken by written consent of its stockholders.
SmarterKids.com's bylaws permit any actions to be taken by stockholders
without a meeting, by written consent, provided such written consent sets forth
the actions taken and is signed by the holders of the minimum number of shares
required to take such actions at a meeting at which all shares entitled to vote
are present and voted and the consents delivered to SmarterKids.com within 60
days of the earliest consent date.
The California Limited Liability Company Act provides that any action that
may be taken at any meeting of the members of a limited liability company may
be taken without a meeting if a consent in writing setting forth the action is
signed and delivered to the limited liability company, within 60 days of the
record date for the action, by members having not less than the minimum number
of votes necessary to authorize to take the
126
<PAGE>
action at a meeting at which all members entitled to vote on the action were
present and voted. Members, or their proxyholders, may revoke their consent in
a writing received by the limited liability company prior to the time that
written consents of members having the minimum number of votes that would be
required to authorize the proposed action have been filed with the limited
liability company, but may not be revoked after that time. Neither
Earlychildhood's amended articles of organization nor its amended and restated
operating agreement has any provisions respecting actions taken by written
consent of its members.
Indemnification
The Delaware General Corporation Law contains provisions setting forth
conditions under which a corporation may indemnify its directors, officers and
employees; however, indemnification is permitted only if certain statutory
standards of conduct are met. The Delaware General Corporation Law requires
that the indemnified officer or director acted in good faith and in a manner
that the officer or director reasonably believed to be in, or not opposed to,
the best interests of the corporation and, with respect to any criminal action
or proceeding, had no reasonable cause to believe the conduct was unlawful.
Indemnification is not mandatory only permissible under the Delaware General
Corporation Law; however, the Delaware General Corporation Law requires that a
corporation indemnify an officer or director who is successful on the merits,
or otherwise, in the defense of certain specified actions, suits or proceedings
for expenses and attorneys' fees actually and reasonably incurred in connection
therewith. Although indemnification is permissible in Delaware, the Delaware
General Corporation Law allows a corporation, through its certificate of
incorporation, bylaws, or other intracorporate agreements, to make
indemnification mandatory.
Pursuant to this authority, LearningStar's restated certificate of
incorporation and amended and restated bylaws provide that LearningStar will
indemnify its directors, officers and employees to the fullest extent permitted
by law. LearningStar's restated certificate of incorporation specifically
requires indemnification of costs, charges and expenses, judgments, fines,
settlements actually or reasonably incurred in connection with a third-party
actions, suit or proceeding for any person who was or is a party, or is
threatened to be a party, by reason of the fact that such person is or was or
agreed to be a director, officer or employee of LearningStar or because such
person was serving another legal entity as a director, officer or employee at
the request of LearningStar while a director, officer or employee of
LearningStar.
SmarterKids.com's bylaws provide similar indemnification protections and
provide that SmarterKids.com shall indemnify to the fullest extent of the law
any director, officer, employee or agent whom it may indemnify pursuant
thereto. SmarterKids.com's amended and restated bylaws specifically require
indemnification of judgments, fines, settlements and expenses of third-party
actions for any director, officer, employee or agent who is or was a party, or
is threatened to be a party, by reason of the fact that such person is or was a
director, officer, employee or agent of SmarterKids.com or because such person
was serving another legal entity as a director, officer, employee or agent at
the request of SmarterKids.com.
The Delaware General Corporation Law differentiates between third-party
actions and claims by or in the right of the corporation (i.e., stockholder
derivative suits). Indemnification under the Delaware General Corporation Law
varies depending on whether the action is brought by a third party or by
stockholders in a derivative suit. Unlike a third-party action, in which
indemnification is permissive under the statute and mandatory under both
LearningStar's restated certificate of incorporation and SmarterKids.com's
amended and restated bylaws, the Delaware General Corporation Law does not
permit indemnification in a stockholder derivative suit if the person is found
liable to the corporation, unless and only to the extent that, the Delaware
Court of Chancery or the court in which such action or suit was brought
determines that the person is fairly and reasonably entitled to
indemnification. Further, the corporation may indemnify such persons only for
attorneys' fees and other expenses.
127
<PAGE>
The advancement of expenses is permissible under the Delaware General
Corporation Law. LearningStar's restated certificate of incorporation provides
for the advancement of expenses incurred by a director or officer, subject to
an undertaking that the director or officer will repay such amount if it is
ultimately determined that such director or officer is not entitled to
indemnification. LearningStar's restated certificate of incorporation also
provides that no advance will be made if a determination is reasonably and
promptly made by:
. a majority vote of a quorum of disinterested directors of LearningStar;
. a quorum of disinterested directors so directed by independent legal
counsel in a written opinion that, based upon the facts known to the
board of directors and the counsel at the time, the director, officer or
employee acted in bad faith and in a manner that the persons did not
believe to be in the best interests of LearningStar; or
. with respect to a criminal proceeding, that such director, officer or
employee believed or had reasonable cause to believe that his or her
conduct was unlawful.
In no event will expenses by advanced to any director, officer or employee
if the board of directors or independent legal counsel reasonably determines
that such person breached his or her duty to LearningStar.
SmarterKids.com's bylaws provides that expenses may be advanced; however,
advanced expenses must be repaid if it is ultimately determined that such
person is not entitled to be indemnified.
The California Limited Liability Company Act provides that, except for a
breach of the fiduciary duty a manager owes to a limited liability company and
to its members, the articles of organization or operating agreement of a
limited liability company may provide for indemnification of any person,
including, without limitation, any manager, member, officer, employee, or agent
of the limited liability company, against judgments, settlements, penalties,
fines or expenses of any kind incurred as a result of the person's acting
within that capacity.
Earlychildhood's amended and restated operating agreement provides that, to
the greatest extent permitted by law, Earlychildhood will defend, indemnify and
hold harmless
. its members (in their capacity as members);
. representatives on its management committee;
. its affiliates, agents, officers, partners, employees, representatives,
directors, members or shareholders of any of its members (which is not
an individual); or
. itself, against any liability or loss as a result of any claim or legal
proceeding by any person (including by or through Earlychildhood and/or
any of its members) relating to the performance or nonperformance of
any act concerning the activities of Earlychildhood if:
. the act or failure to act of the person to be indemnified was in
good faith, within the scope of that person's authority and in a
manner he or she reasonably believed to be in, or not inconsistent
with, the best interest of Earlychildhood; and
. the conduct of the person did not constitute fraud, willful
misconduct, gross negligence or a material breach of a material
provision of Earlychildhood's amended and restated operating
agreement.
The indemnification authorized by Earlychildhood's amended and restated
operating agreement includes any judgment, award, settlement, the payment of
reasonable attorneys' fees and other expenses (not limited to taxable costs)
incurred in settling or defending any claims, threatened action or finally
adjudicated legal proceeding. If Earlychildhood's management committee finds
that the person to be indemnified has met the two standards described above,
the attorneys' fees and other expenses will be advanced by Earlychildhood prior
to the final disposition of such claims, actions or proceedings upon receipt by
Earlychildhood of an undertaking, reasonably acceptable to the management
committee, by or on behalf of the person to be indemnified to repay such
amounts if it shall be determined that the person is not entitled to be
indemnified as authorized under Earlychildhood's amended and restated operating
agreement.
128
<PAGE>
Liability of Directors or Members of the Management Committee
Under the Delaware General Corporation Law, a corporation's certificate of
incorporation may contain a provision limiting or eliminating a director's
personal liability to the corporation or its stockholders for monetary damages
for a director's breach of fiduciary duty subject to certain limitations.
Neither LearningStar's nor SmarterKids.com's certificates of incorporation or
bylaws contains a provision limiting the liability of directors.
The California Limited Liability Company Act provides that no person that is
a manager of a limited liability company shall be personally liable under any
judgment of a court, or in any other manner, for any debt, obligation or
liability of the limited liability company solely by reason of being a manager
of the limited liability company.
Earlychildhood's amended and restated operating agreement provides that, to
the fullest extent permitted by law, none of
. its members (in their capacity as members);
. the representatives on its management committee;
. its affiliates, agents, officers, partners, employees, representatives,
directors, members or shareholders of any of its members (which is not
an individual); or
. itself acting in accordance with its amended and restated operating
agreement will be liable, responsible or accountable, in damages or
otherwise, to Earlychildhood or any of its members for doing any act or
failing to do any act, the effect of which may cause or result in loss
or damage to Earlychildhood or the member if:
. the act or failure to act of the person or entity was in good faith,
within the scope of its authority and in a manner it reasonably
believed to be in, or not inconsistent with, the best interest of
Earlychildhood; and
. the conduct of the person or entity did not constitute fraud,
willful misconduct, gross negligence or a material breach of a
material provision of Earlychildhood's amended and restated
operating agreement.
Stockholder or Member Meetings
The Delaware General Corporation Law requires that meetings of the
stockholders be held in the place designated in the corporation's certificate
of incorporation or bylaws or, if not designated therein, as determined by the
corporation's board of directors. Special meetings of a corporation's
stockholders may be called by the board of directors or such persons designated
in the corporation's certificate of incorporation. In order to determine the
stockholders entitled to vote in any annual or special meeting, the Delaware
General Corporation Law requires a corporation's board of directors to set a
record date of not more than 60 nor less than ten days from the date of the
meeting.
In accordance with LearningStar's amended and restated bylaws, annual and
special meetings of stockholders will be held on such date as may be fixed by
LearningStar's board of directors, and special meetings of stockholders may be
called only by the chairman of the board or a majority of LearningStar's board
of directors. LearningStar's amended and restated bylaws require notice of any
meeting of stockholders to be given to each stockholder not less than ten nor
more than 60 days before the date of the meeting.
Pursuant to SmarterKids.com's bylaws, annual meetings of stockholders will
be held March 31 of each year, or at such other date and time as designated by
the board of directors or the chief executive officer of SmarterKids.com. The
SmarterKids.com bylaws provide that a special meeting of stockholders may be
called by the board of directors or the chief executive officer or by the chief
executive officer at the request in writing of a majority of the
SmarterKids.com board of directors or at the request in writing of
SmarterKids.com stockholders owning a majority in amount of the entire capital
stock of SmarterKids.com.
129
<PAGE>
The Delaware General Corporation Law, SmarterKids.com's bylaws and
LearningStar's bylaws require that whenever stockholders are required or
permitted to take action at a meeting, a written notice stating the place, time
and date of the meeting and, in the case of a special meeting, the purpose or
purposes for which the meeting is called, must be sent to all stockholders of
record entitled to vote thereon not less than ten nor more than 60 days before
the meeting. The Delaware General Corporation Law further requires that notice
of a meeting to consider an agreement of merger must be sent at least 20 days
prior to the date of the meeting.
The California Limited Liability Company Act code provides that meetings of
members of a limited liability company may be held at any place, within or
without the State of California, selected by the person(s) calling the meetings
or as may be stated or fixed in accordance with the articles of organization or
operating agreement. If no place is stated or fixed in these documents, the
California Limited Liability Company Act provides that all meetings are to be
held at the principal executive office of the limited liability company. A
meeting of the members of a limited liability company may be called by any
manager or by any member(s) representing more than 10% of the interests of
members for the purpose of addressing any matters on which the members may
vote. The California Limited Liability Company Act requires that written notice
of a meeting of the members of a limited liability company be given not less
than ten days nor more than 60 days before the date of the meeting to each
stockholder entitled to vote at the meeting. Neither Earlychildhood's amended
articles of organization nor its amended and restated operating agreement
addresses meetings of Earlychildhood members.
Mergers and Consolidations
In order to effect a merger under the Delaware General Corporation Law, a
corporation's board of directors must adopt an agreement of merger and
recommend it to the stockholders. The agreement must be adopted by holders of a
majority of the outstanding shares of the corporation entitled to vote thereon.
The California Limited Liability Company Act Code provides that, in order to
effect the merger of a limited liability company, the agreement of merger must
be approved by the vote of a majority in interest of the members of the limited
liability company, or such greater percentage of the voting interests of the
members as may be specified in the articles of organization or the operating
agreement. The amended and restated operating agreement does not address the
voting rights of members of Earlychildhood.com.
Business Combinations
The Delaware General Corporation Law bars a corporation which has securities
traded on an exchange, designated on the Nasdaq National Market or held of
record by more than 2,000 stockholders from engaging in certain business
combinations, including a merger, sale of substantial assets, loan or
substantial issuance of stock, with an interested stockholder, or an interest
stockholder's affiliates and associates, for a three-year period beginning on
the date the interested stockholder acquires 15% or more of the outstanding
voting stock of the corporation. The restrictions on business combinations do
not apply if:
. the board of directors gives prior approval to the transaction in which
the 15% ownership level is exceeded;
. the interested stockholder acquires at one time at least 85% of the
corporation's stock (excluding those shares owned by persons who are
directors and also officers as well as employee stock plans in which
employees do not have a confidential right to vote); or
. the business combination is approved by the board of directors and
authorized at a meeting of stockholders by the holders of at least two-
thirds of the outstanding voting stock, excluding shares owned by the
interested stockholder.
Although a Delaware corporation may elect, pursuant to its certificate or
bylaws, not to be governed by this provision, none of LearningStar's restated
certificate of incorporation, amended and restated bylaws, SmarterKids.com's
amended and restated certificate of incorporation or amended and restated
bylaws contain such an election or other limitation on the applicability of
this provision.
130
<PAGE>
The California Limited Liability Company Act does not provide any similar
business combination provisions with respect to limited liability companies.
Other Anti-Takeover Provisions
The Delaware General Corporation Law does not contain a control share
acquisition statute which restricts the voting rights of a person who acquires
a controlling interest in the corporation to those voting rights which are
conferred by the stockholders at a meeting.
The California Limited Liability Company Act does not provide any similar
control share acquisition statutes.
Dissenter's Appraisal Rights
Under the Delaware General Corporation Law, stockholders may exercise a
right of dissent from certain corporate actions and obtain payment of the fair
value of their shares. This remedy is an exclusive remedy, except where the
corporate action involves fraud or illegality. Under the Delaware General
Corporation Law, dissenters' rights are limited. Appraisal rights are available
only in connection with certain statutory mergers or consolidations, amendments
to the certificate of incorporation (if so provided in the certificate of
incorporation), any merger or consolidation in which the corporation is a
constituent corporation, or sales of all or substantially all of the assets of
a corporation.
The California Limited Liability Company Act provides that, if the approval
of outstanding membership interests is required for a limited liability company
to participate in certain corporate reorganizations, pursuant to the operating
agreement of the limited liability company or otherwise, then each member of
the limited liability company holding the membership interests may require the
limited liability company to purchase for cash, at its fair market value, the
interest owned by the member in the limited liability company. The fair market
value of the dissenting membership interest is determined as of the day before
the first announcement of the terms of the proposed corporate reorganization.
In order to obtain this right, a dissenting member's interest must:
. have been outstanding on the date for the determination of members
entitled to vote on the reorganization; and
. not have been voted in favor of the reorganization or have been voted
against the reorganization;
and the dissenting member must:
. have demanded that the limited liability company purchase at its fair
market value; and
. have submitted for endorsement, if necessary.
Neither Earlychildhood's amended articles of organization nor its amended
and restated operating agreement addresses the rights of dissenting members,
except to state that Earlychildhood's members must waive any dissenters' rights
that they may have by law under certain circumstances in which the company is
sold.
131
<PAGE>
LEGAL MATTERS
The validity of the shares of LearningStar common stock to be issued in
connection with the combination will be passed upon by Testa, Hurwitz &
Thibeault, LLP, Boston, Massachusetts.
Testa, Hurwitz & Thibeault, LLP, counsel to SmarterKids.com, and Latham &
Watkins, counsel to Earlychildhood, will pass upon certain U.S. federal income
tax consequences of the combination for SmarterKids.com and Earlychildhood,
respectively.
EXPERTS
The financial statements of SmarterKids.com as of December 31, 1998 and 1999
and for each of the three years in the period ended December 31, 1999 included
in this proxy statement-prospectus have been so included in reliance on the
report of PricewaterhouseCoopers LLP, independent accountants, given on the
authority of said firm as experts in auditing and accounting.
The consolidated financial statements of Earlychildhood LLC and subsidiary
as of December 31, 1998 and 1999 and for the year ended March 31, 1998, the
nine months ended December 31, 1998 and the year ended December 31, 1999, have
been included herein in reliance on the report of KPMG LLP, independent
accountants, appearing elsewhere herein, and upon authority of said firm as
experts in accounting and auditing.
The financial statements of Educational Products, Inc. as of March 31, 1999
and May 5, 1999 and the year ended March 31, 1999 and the 35-day period ended
May 5, 1999 have been included herein in reliance on the report of KPMG LLP,
independent accountants, appearing elsewhere herein, and upon authority of said
firm as experts in auditing and accounting.
OTHER MATTERS
As of the date of this proxy statement-prospectus, the SmarterKids.com board
of directors know of no matters that will be presented for consideration at the
SmarterKids.com special meeting other than as described in this proxy
statement-prospectus. If any other matters shall properly come before the
special meeting or any adjournments or postponements of the special meeting and
are to be voted upon, the enclosed proxy will be deemed to confer discretionary
authority on the individuals named as proxies therein to vote the shares
represented by such proxy as to any such matters, unless such authority is
specifically withheld. The persons named as proxies intend to vote or not vote
in accordance with the recommendation of the management of SmarterKids.com.
132
<PAGE>
STOCKHOLDER PROPOSALS
If the combination is completed, the first annual meeting of stockholders of
LearningStar is expected to be held on or about , 2002. If the
combination is not completed, the next annual meeting of SmarterKids.com
stockholders is expected to be held on or about June , 2001.
Subject to the foregoing, if any LearningStar stockholder intends to present
a proposal at LearningStar's first annual meeting and wishes to have the
proposal considered for inclusion in the proxy materials for that meeting, the
holder must submit the proposal to the secretary of LearningStar in writing so
as to be received at the executive offices of LearningStar no sooner than
, 2001 and no later than , 2001. These proposals must also meet the
other requirements of the rules of the Securities and Exchange Commission
relating to stockholders' proposals.
In addition to other applicable requirements, the amended and restated
bylaws of LearningStar require that for business to be properly brought before
an annual meeting by a stockholder, the stockholder must have given timely
notice thereof, containing the information required by the LearningStar amended
and restated bylaws and in writing to the Secretary of LearningStar. To be
timely, a stockholder's notice containing the information required by the
LearningStar bylaws must be delivered to or mailed and received at the
principal executive offices of LearningStar not less than days nor more
than days prior to the meeting; provided, however, that in the event less
than days notice or prior disclosure of the date of the annual meeting is
given or is made to stockholders, notice by a stockholder to be timely must be
received no later than the close of business on the day following the day
on which such notice of the date of the annual meeting was mailed or such
public disclosure was made, whichever occurs first.
In the event the combination is not completed, the only stockholder
proposals eligible to be considered in the proxy materials for the next annual
meeting of SmarterKids.com will be those which were duly submitted to the
Secretary of SmarterKids.com by , 2001, as provided in the next annual
meeting proxy statement of SmarterKids.com.
133
<PAGE>
WHERE YOU CAN FIND MORE INFORMATION
SmarterKids.com files annual, quarterly and special reports and other
information with the Securities and Exchange Commission. You may read and copy
any reports, statements or other information filed by SmarterKids.com at the
Securities and Exchange Commission's public reference rooms in Washington,
D.C., New York, New York and Chicago, Illinois. Please call the Securities and
Exchange Commission at 1-800-SEC-0330 for further information on the public
reference rooms. SmarterKids.com's Securities and Exchange Commission filings
are also available to the public from commercial document retrieval services
and at the website maintained by the Securities and Exchange Commission at
www.sec.gov.
Learning Star filed with the Securities and Exchange Commission a
registration statement on Form S-4 under the Securities Act of 1933, as
amended, to register with the Securities and Exchange Commission the
LearningStar common stock issuable pursuant to the combination agreement. This
proxy statement-prospectus does not contain all the information you can find in
the registration statement or the exhibits and schedules to the registration
statement. For further information with respect to SmarterKids.com,
Earlychildhood and the LearningStar common stock, please refer to the
registration statement, including the exhibits and schedules. You may inspect
and copy the registration statement, including the exhibits and schedules, as
described above. Statements contained in this proxy statement-prospectus about
the contents of any contract or other document are not necessarily complete,
and we refer you, in each case, to the copy of such contract or other document
filed as an exhibit to the registration statement.
If you would like to request documents from SmarterKids.com, please do so by
, 2001 to receive them before the special meeting.
You should rely only on the information contained in this proxy statement-
prospectus to vote on the combination. SmarterKids.com has not authorized
anyone to provide you with information that is different from what is contained
in this proxy statement-prospectus. This proxy statement-prospectus is dated
, 2001. You should not assume that the information contained in this
proxy statement-prospectus is accurate as of any date other than ,
2001, and neither the mailing of this proxy statement-prospectus to
SmarterKids.com stockholders nor the issuance of LearningStar common stock in
the combination shall create any implication to the contrary.
134
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
SMARTERKIDS.COM, INC.:
Report of Independent Accountants......................................... F-2
Balance Sheet as of December 31, 1998 and 1999............................ F-3
Statement of Operations for the years ended December 31, 1997, 1998 and
1999..................................................................... F-4
Statement of Stockholders' Equity (Deficit) for the years ended December
31, 1997, 1998 and 1999.................................................. F-5
Statement of Cash Flows for the years ended December 31, 1997, 1998 and
1999..................................................................... F-6
Notes to Financial Statements............................................. F-7
Unaudited Interim Balance Sheet as of December 31, 1999 and September 30,
2000..................................................................... F-20
Unaudited Interim Statement of Operations for the nine months ended
September 30, 1999 and 2000.............................................. F-21
Unaudited Interim Statement of Cash Flows for the nine months ended
September 30, 1999 and 2000.............................................. F-22
Unaudited Notes to Interim Financial Statements........................... F-23
EARLYCHILDHOOD LLC AND SUBSIDIARY
Independent Auditors' Report.............................................. F-26
Consolidated Balance Sheets as of December 31, 1998, 1999 and September
30, 2000 (Unaudited)..................................................... F-27
Consolidated Statements of Operations for the year ended March 31, 1998,
the nine months ended December 31, 1998, the year ended December 31, 1999
and the nine months ended September 30, 1999 (Unaudited) and 2000
(Unaudited).............................................................. F-28
Consolidated Statements of Members' Equity for the year ended March 31,
1998, the nine months ended December 31, 1998, the year ended December
31, 1999, and the nine months ended September 30, 2000 (Unaudited)....... F-29
Consolidated Statements of Cash Flows for the year ended March 31, 1998,
the nine months ended December 31, 1998, the year ended December 31, 1999
and the nine months ended September 30, 1999 (Unaudited) and 2000
(Unaudited).............................................................. F-30
Notes to Consolidated Financial Statements................................ F-31
EDUCATIONAL PRODUCTS, INC.
Independent Auditors' Report.............................................. F-49
Balance Sheets as of March 31, 1999 and May 5, 1999....................... F-50
Statements of Operations for the year ended March 31, 1999 and for the
thirty-five-day period ended May 5, 1999................................. F-51
Statements of Stockholders' Equity for the year ended March 31, 1999 and
for the thirty-five-day period ended May 5, 1999......................... F-52
Statements of Cash Flows for the year ended March 31, 1999 and for the
thirty-five-day period ended May 5, 1999................................. F-53
Notes to Financial Statements............................................. F-54
</TABLE>
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of SmarterKids.com, Inc.:
In our opinion, the accompanying balance sheet and the related statements of
operations, of stockholders' equity (deficit), and of cash flows present
fairly, in all material respects, the financial position of SmarterKids.com,
Inc. at December 31, 1998 and 1999, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1999 in
conformity with accounting principles generally accepted in the United States
of America. 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 auditing standards generally accepted in the United States of
America, 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 our opinion.
PricewaterhouseCoopers LLP
Boston, Massachusetts
February 15, 2000
F-2
<PAGE>
SMARTERKIDS.COM, INC.
BALANCE SHEET
(In thousands, except share data)
<TABLE>
<CAPTION>
December 31,
-----------------
1998 1999
------- --------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents..................................... $ 4,273 $ 55,621
Short-term investments........................................ -- 11,735
Accounts receivable, net of allowance for doubtful accounts of
$27 at December 31, 1998 and 1999............................ 915 132
Other receivable.............................................. -- 486
Inventories................................................... 104 8,902
Other current assets.......................................... 153 1,917
------- --------
Total current assets........................................ 5,445 78,793
Property and equipment, net..................................... 44 2,421
Intangible assets, net.......................................... -- 621
Restricted cash................................................. -- 500
Other assets.................................................... 15 --
------- --------
Total assets................................................ $ 5,504 $ 82,335
======= ========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of long term debt and capital lease
obligations.................................................. $ 41 $ 74
Accounts payable.............................................. 833 10,996
Accrued expenses.............................................. 787 6,699
Deferred revenue.............................................. -- 811
Sales returns allowances...................................... 718 87
------- --------
Total current liabilities................................... 2,379 18,667
Long term debt and capital lease obligations, net of current
portion........................................................ -- 34
------- --------
Total liabilities........................................... 2,379 18,701
------- --------
Commitments and contingencies (Note 12)......................... -- --
Redeemable preferred stock:
Series B redeemable convertible preferred stock, $0.01 par
value; 3,518 shares authorized, issued and outstanding at
December 31, 1998; no shares authorized, issued and
outstanding at December 31, 1999 ............................ 7,036 --
Series A convertible preferred stock, $0.01 par value; 687
shares authorized, issued and outstanding at December 31,
1998; no shares authorized, issued and outstanding at
December 31, 1999............................................ 3,251 --
------- --------
Total redeemable preferred stock............................ 10,287 --
------- --------
Stockholders' equity (deficit):
Preferred stock, $0.01 par value; no and 10,000,000 shares
authorized; no shares issued or outstanding, at December 31,
1998 and 1999, respectively.................................. -- --
Common stock, $0.01 par value; 10,000,000 and 90,000,000
shares authorized; 1,628,510 and 20,301,770 shares issued and
outstanding, at December 31, 1998 and 1999, respectively..... 16 203
Additional paid-in capital.................................... 2,530 112,907
Deferred stock compensation................................... (1,435) (6,286)
Accumulated deficit........................................... (8,273) (43,190)
------- --------
Total stockholders' equity (deficit)........................ (7,162) 63,634
------- --------
Total liabilities, redeemable preferred stock and
stockholders' equity (deficit)............................. $ 5,504 $ 82,335
======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
SMARTERKIDS.COM, INC.
STATEMENT OF OPERATIONS
(In thousands, except share data)
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------
1997 1998 1999
--------- --------- ---------
<S> <C> <C> <C>
Net revenues:
Online retail............................... $ -- $ 22 $ 5,421
Proprietary CD-ROM.......................... 1,416 2,278 --
--------- --------- ---------
Total net revenues........................ 1,416 2,300 5,421
--------- --------- ---------
Cost of revenues:
Online retail............................... -- 20 4,005
Proprietary CD-ROM.......................... 491 908 --
--------- --------- ---------
Total cost of revenues.................... 491 928 4,005
--------- --------- ---------
Gross profit.................................. 925 1,372 1,416
--------- --------- ---------
Operating expenses:
Marketing and sales (excluding stock
compensation of $15, $91 and $1,216 for
1997, 1998 and 1999, respectively)......... 756 2,678 28,916
Development (excluding stock compensation of
$0, $60 and $1,143 for 1997, 1998 and 1999,
respectively).............................. 721 1,378 1,721
General and administrative (excluding stock
compensation of $0, $36 and $1,046 for
1997, 1998 and 1999, respectively)......... 430 490 2,854
Stock compensation.......................... 15 187 3,405
--------- --------- ---------
Total operating expenses.................. 1,922 4,733 36,896
--------- --------- ---------
Loss from operations.......................... (997) (3,361) (35,480)
Interest income............................... 3 41 732
Interest expense.............................. (15) (18) (16)
Other income (expense), net................... (5) (4) 36
--------- --------- ---------
Net loss...................................... (1,014) (3,342) (34,728)
Accretion of redeemable preferred stock....... (67) (254) (189)
--------- --------- ---------
Net loss attributable to common stockholders.. $ (1,081) $ (3,596) $ (34,917)
========= ========= =========
Basic and diluted net loss per common share... $ (0.72) $ (2.34) $ (9.20)
Weighted average shares-basic and diluted..... 1,502,148 1,533,524 3,795,967
</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, 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................................... 497,028 5 110 115
Issuance of common stock to acquire intangible
assets.......................................... 33,000 -- 445 445
Issuance of common stock warrants in connection
with issuance of Series C redeemable preferred
stock........................................... 515 515
Conversion of redeemable preferred stock to
common stock.................................... 12,732,887 127 35,096 35,223
Accretion of redeemable preferred stock related
to issuance costs............................... (189) (189)
Issuance and revaluation of stock options and
warrants to consultants......................... 2,758 (1,550) 1,208
Issuance of common stock pursuant to the exercise
of warrants..................................... 251,845 3 63 66
Issuance of common stock in initial public
offering........................................ 5,158,500 52 65,892 65,944
Deferred stock compensation related to employee
stock option grants............................. 5,734 (5,734) --
Cancellation of unvested employee stock options.. (236) 236 --
Amortization of deferred stock compensation
related to employee stock options............... 2,197 2,197
Net loss......................................... (34,728) (34,728)
---------- ---- -------- ------- -------- --------
Balance at December 31, 1999....................... 20,301,770 $203 $112,907 $(6,286) $(43,190) $ 63,634
========== ==== ======== ======= ======== ========
</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 December 31,
--------------------------
1997 1998 1999
------- ------- --------
<S> <C> <C> <C>
Increase (Decrease) in Cash and Cash Equivalents
Cash flows from operating activities:
Net loss......................................... $(1,014) $(3,342) $(34,728)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization.................. 60 66 296
Compensation expense related to stock option
and warrant grants............................ 15 187 3,405
Debt issue costs............................... -- 7 --
Changes in assets and liabilities:
Accounts receivable............................ (22) (348) 783
Other receivable............................... -- -- (486)
Inventories.................................... (1) 50 (8,798)
Other assets................................... (31) (114) (1,749)
Accounts payable............................... (16) 521 10,163
Accrued expenses............................... 54 482 5,912
Deferred revenue............................... -- -- 811
Sales return allowance......................... 8 477 (631)
------- ------- --------
Net cash used in operating activities.............. (947) (2,014) (25,022)
------- ------- --------
Cash flows from investing activities:
Purchase of short-term investments............... -- -- (11,735)
Purchases of property and equipment.............. (18) (33) (2,451)
Purchase of intangible assets.................... -- -- (250)
(Deposit) release of restricted cash............. 199 -- (500)
------- ------- --------
Net cash provided by (used in) investing
activities........................................ 181 (33) (14,936)
------- ------- --------
Cash flows from financing activities:
Net proceeds from issuance of common stock....... -- -- 65,944
Net proceeds from issuance of Series C redeemable
preferred stock................................. -- -- 25,262
Net proceeds from issuance of Series B redeemable
preferred stock................................. 710 6,091 --
Net proceeds from sale-leaseback of property and
equipment....................................... 112 --
Repayments of long-term debt and capital lease
obligations..................................... (196) (74) (81)
Proceeds from exercise of common stock options... -- 10 115
Proceeds from exercise of common stock warrants.. -- -- 66
------- ------- --------
Net cash provided by financing activities.......... 626 6,027 91,306
------- ------- --------
Net increase (decrease) in cash and cash
equivalents....................................... (140) 3,980 51,348
Cash and cash equivalents at beginning of year..... 433 293 4,273
------- ------- --------
Cash and cash equivalents at end of year........... $ 293 $ 4,273 $ 55,621
======= ======= ========
Supplemental disclosure of cash flow information:
Cash paid during the year for interest........... $ 15 $ 11 $ 28
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 offerings............ $ 18 $ 69 $ 515
Issuance of common stock in exchange for purchase
of intangible assets............................ $ -- $ -- $ 445
</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 uses its proprietary CD-ROM
products on a limited basis for promotional events. 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 1998 and 1999. These investments are subject to minimal credit
and market risks. At December 31, 1998 and 1999, total cash and cash
equivalents were $4,273,000 and $55,621,000, respectively. The cash equivalent
investments were stated at amortized cost plus accrued interest, which
approximates market value.
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, 1998 and 1999 approximate their fair values.
The Company's short-term investments consist of short-term debt securities,
which are classified at the date of purchase as held to maturity. Investments
with remaining maturities of less than twelve months from the balance sheet
date are classified as short-term. At December 31, 1999, these investments were
stated at amortized cost plus accrued interest, which approximates market
value.
Inventories
Inventories are stated at the lower of cost or market value, 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
two years, using the straight-line method. Amortization expense related to
intangibles assets for the year ended December 31, 1999 was $74,000.
F-7
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Long-Lived Assets
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, 1997, 1998 or 1999.
Concentrations of Credit Risk and Significant Customers
Management believes its credit policies are prudent and reflect normal
industry terms and business risk. The Company does not anticipate non-
performance by counter parties and, accordingly, does not require collateral.
At December 31, 1998, the Company's three largest customers, all of which were
distributors of the Company's proprietary CD-ROM products, accounted for 96%
of total amounts due to the Company. At December 31, 1999 no customer
accounted for more than 10% of total amounts due to the Company.
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 in 1999.
Concentrations of Vendor and Distributor Risk
The Company outsources all of its receiving, handling and warehousing of
inventory as well as its fulfillment of customer orders to one distributor.
Although this creates a concentration in sources of distribution, management
believes that other distributors are available to provide similar services on
comparable terms. A failure of or a change in the Company's distributor who
provides these services could cause a delay in the receiving and movement of
inventory, as well as the fulfillment of orders. Such delays could result in
the possible loss of sales, which would adversely affect operating results.
Purchases of inventory from the Company's two largest vendors accounted for
approximately 15% and 13% of total inventory purchases in 1999. Although this
creates a concentration in sources of supply, management believes that other
vendors are available to provide similar products on comparable terms. A
failure of or change in the Company's vendor, 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
F-8
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
products, including the outsourced cost of operating and staffing warehousing
and distribution centers as well as customer service, are also included in
marketing and sales expenses. Advertising costs are charged to operations as
incurred. Advertising expenses for 1997, 1998 and 1999 were $276,000,
$1,154,000 and $21,314,000, respectively.
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
The Company computes net loss per common share in accordance with SFAS No.
128, "Earnings Per Share," and SEC Staff Accounting Bulletin No. 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, 1997, 1998 and 1999 does
not include 1,547,351, 2,775,141 and 3,017,400 potential shares of common stock
equivalents, respectively, as their inclusion would be antidilutive.
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, 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
F-9
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
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 December 1999, the SEC staff released Staff Accounting Bulletin ("SAB")
101, "Revenue Recognition in Financial Statements", which provides guidance on
the recognition, presentation and disclosure of revenue in financial
statements. Subsequently, SAB 101 A and B have been released which direct the
application of the guidance in SAB 101 to be required in the Company's fourth
quarter of 2000. The effects of applying this guidance, if any, will be
reported as a cumulative effect adjustment resulting from a change in
accounting principle. The Company is evaluating the impact of SAB 101 adoption
on its financial statements.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities" as amended by SFAS No. 138,
which was issued in June 2000. The Company will adopt SFAS No. 133 on January
1, 2001. SFAS No. 133 requires that all derivative instruments be reported on
the balance sheet at their fair value. Changes in the fair value of derivatives
are recorded each period in current earnings or other comprehensive income,
depending on whether a derivative is designated as part of a hedge transaction
and, if it is, the type of hedge transaction. The Company has not yet
determined the impact of the adoption of SFAS No. 133 on its financial
condition, results of operations, or business practices.
3. Allowances for Doubtful Accounts and Sales Returns:
Allowances for doubtful accounts and sales returns consist of the following
(in thousands):
<TABLE>
<CAPTION>
December 31,
-------------------
1997 1998 1999
----- ----- -----
<S> <C> <C> <C>
Balance at beginning of year............................... $ 262 $ 269 $ 745
Additions:
Charged against revenues or expense...................... 237 601 360
Deductions:
Write-offs and returns................................... (230) (125) (991)
----- ----- -----
Balance at end of year..................................... $ 269 $ 745 $ 114
===== ===== =====
</TABLE>
4. Property and Equipment:
Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
December
31,
-----------
1998 1999
---- ------
<S> <C> <C>
Software........................................................ $ 28 $ 377
Furniture and fixtures.......................................... 5 207
Computer and office equipment................................... 233 1,774
Leasehold improvements.......................................... -- 507
---- ------
266 2,865
Less--Accumulated depreciation and amortization................. 222 444
---- ------
$ 44 $2,421
==== ======
</TABLE>
F-10
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Furniture and fixtures and computer and office equipment includes $214,000
at December 31, 1998 and $362,000 at December 31, 1999 related to assets held
under capital leases. Accumulated depreciation related to assets held under
these leases was $214,000 and $265,000 at December 31, 1998 and 1999,
respectively. Depreciation and amortization expense for the years ended
December 31, 1997, 1998 and 1999 was $60,000, $66,000 and $222,000,
respectively.
5. Accrued Expenses:
Accrued expenses consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
-------------
1998 1999
-------------
<S> <C> <C>
Marketing...................................................... $ 268 $ 261
Commissions.................................................... 94 171
Professional fees.............................................. 172 105
Advertising.................................................... 159 5,724
Other.......................................................... 94 438
----- -------
$ 787 $ 6,699
===== =======
</TABLE>
6. 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 8).
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 8).
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 8). 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 was being charged to accumulated
deficit over the period from issuance until redemption first became available.
F-11
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
In November 1999, each Series A and Series B preferred share automatically
converted into 1,500 shares of common stock and each Series C preferred share
automatically converted into 1.5 shares of common stock upon the closing of the
Company's initial public offering of common stock (Note 7).
7. Common Stock:
On September 7, 1999, the Board of Directors authorized a 3-for-2 stock
split of the Company's common stock, which was effective upon the filing of the
Company's Amended and Restated Certificate of Incorporation in connection with
the Company's initial public offering of common stock. As a result, all common
stock share data included in the accompanying financial statements and notes
were retroactively restated for this split.
In September 1999, the Company issued 25,500 shares of common stock valued
at $340,000 in connection with the acquisition of intangible assets.
In November 1999, the Company issued 7,500 shares of common stock valued at
$105,000 in connection with the acquisition of intangible assets.
On November 23, 1999, the Company completed its initial public offering of
5,158,500 shares of common stock resulting in net proceeds of $65,944,000. In
connection with the closing of the offering, all outstanding convertible
preferred stock was converted into an aggregate 12,732,887 shares of common
stock. Additionally, all warrants for the purchase of preferred stock were
converted into warrants for the purchase of shares of common stock. The
redemption rights of the 25,500 shares of redeemable common stock were
automatically eliminated upon the Company's initial public offering of common
stock.
8. Warrants:
In 1997 and 1998, in connection with issuance of the Series B preferred
(Note 6), 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 October 1999, these warrants were exercised for
121,050 shares of common stock at $0.13 per share.
In March 1998, in connection with an amended debt agreement, the Company
granted warrants to purchase 5 shares of Series B preferred stock 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 the Company's
initial public offering in November 1999, these warrants converted 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
F-12
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
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. The final value of all of these
warrants was determined to be $1,448,000. As of December 31, 1999, deferred
stock compensation related to all of the warrants held by the fulfillment
service provider was $1,207,000, which is being amortized to compensation
expense over the term of the service agreement as the services are performed.
Amortization expense related to these warrants of $241,000 was recorded during
the year ended December 31, 1999.
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 were set to 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 October 1999, these warrants were exercised for 22,500 shares of
common stock.
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.
As of December 31, 1999, the fair value of this grant was $741,000. Related
compensation expense of $520,000 was recorded in the year ended December 31,
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 were 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 were set to 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. The value ascribed to these
warrants was recorded as a discount to the Series C preferred stock upon
issuance. The discount was being accreted to the Series C preferred stock
balance over the period from the date of issuance through the expected
mandatory redemption date until the conversion of the preferred stock into
common stock at the initial public offering date. On November 22, 1999, a
portion of these warrants were exercised for 93,295 shares of common stock.
Consideration for the exercise price of these warrants was not cash, but the
forfeiture of the warrants for the remaining 76,246 shares, which had an
aggregate value on the exercise date equal to the exercise price for the
warrants.
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
during 1999, the period in which the services were provided. In October 1999,
these warrants were exercised for 15,000 shares of common stock.
F-13
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
A summary of the status of stock warrants for the three years ended December
31, 1999 is presented below:
<TABLE>
<CAPTION>
Number of Weighted-
Shares Average
of Common Exercise
Stock Price
--------- ---------
<S> <C> <C>
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............................................. (251,845) 1.81
Forfeited............................................. (76,246) 4.18
--------
Outstanding--December 31, 1999.......................... 285,000 1.33
======== =====
</TABLE>
The fair value of each warrant during 1999, 1998 and 1997 was estimated on
the applicable measurement dates using the Black-Scholes option pricing model
with the following assumptions:
<TABLE>
<CAPTION>
1997 1998 1999
---- ---- -----
<S> <C> <C> <C>
Dividend yield............................................ 0.0% 0.0% 0.0%
Expected volatility....................................... 90.0% 90.0% 90.0%
Risk-free interest rate................................... 6.1% 5.0% 5.4%
Expected life (years)..................................... 5 5 4 to 5
</TABLE>
9. 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 of common stock that 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. During the years ended December
31, 1998 and 1999, 1,238,251 and 1,207,501 options were granted under the 1995
Plan, respectively.
1999 Stock Option and Incentive Plan
In September 1999, the Board of Directors voted to terminate the 1995 Stock
Option Plan effective on November 23, 1999, the date of the consummation of the
Company's 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
F-14
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
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 December 31, 1999,
994,348 options were granted under the 1999 Plan.
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 became effective on November 23, 1999. 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. A committee appointed by
the Board of Directors will administer the Director Plan. Under the Director
Plan, each director who is not an employee or officer of the Company and who
was not a director at the time of the Company's initial public offering will 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
December 31, 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 became effective upon completion of the Company's initial public
offering in November 1999. The Stock Purchase Plan provides for the issuance of
a maximum of 400,000 shares of common stock. The Board of Directors and the
Compensation Committee administer the Stock Purchase Plan. 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 1 day 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 December 31, 1999, no shares have been issued
under the Stock Purchase Plan.
The Company recorded deferred stock compensation of $62,000, $1,458,000 and
$5,734,000 in 1997, 1998 and 1999, respectively, related to employee stock
option grants. The Company recognized $4,000, $81,000 and $2,197,000 in non-
cash stock compensation expense related to amortization of deferred stock
compensation on employee stock option grants during 1997, 1998 and 1999,
respectively.
During 1997, 1998 and 1999, the Company granted nonqualified stock options
under the Plan to non-employees, for services performed, to purchase 30,000,
5,250 and 44,250 shares of common stock, respectively. Accordingly, the Company
recorded stock compensation expense of $11,000, $33,000 and $234,000 in 1997,
1998 and 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-15
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
A summary of the activity under the Company's Plan for the three years ended
December 31, 1999 is presented below:
<TABLE>
<CAPTION>
Weighted-
Average
Number of Exercise
Shares Price
--------- ---------
<S> <C> <C>
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 $7.96)........ 2,201,849 7.72
Exercised............................................. (497,028) 0.23
Forfeited............................................. (97,713) 0.85
---------
Outstanding--December 31, 1999.......................... 4,174,199 4.09
=========
</TABLE>
At December 31, 1997, 1998, and 1999, the Company maintained options
available for future grants of 87,900, 1,126,400, and 1,082,263, respectively.
The following table summarizes information about stock options outstanding
at December 31, 1999:
<TABLE>
<CAPTION>
Weighted-
Average Weighted -
Remaining Weighted- Average
Contractual Average Number Exercise Price
Exercise Number Life Exercise of Shares for Exercisable
Price of Shares (years) Price Exercisable Options
-------- --------- ----------- --------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
$ 0.02 315,000 5.7 $ 0.02 315,000 $0.02
0.06- 0.13 1,744,500 8.4 0.13 1,228,470 0.13
0.15- 0.33 546,000 8.8 0.15 546,000 0.15
1.33- 4.18 126,900 9.6 3.25 -- --
11.00- 14.00 1,441,799 9.8 11.34 -- --
--------- ---------
4,174,199 2,089,470
========= =========
</TABLE>
At December 31, 1997 and 1998, of the options outstanding, 771,606 and
988,515, respectively, were exercisable.
The fair value of each option grant during 1997, 1998 and 1999 is estimated
on the date of grant using the Black-Scholes option pricing model with the
following assumptions:
<TABLE>
<CAPTION>
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Dividend yield............................................. 0.0% 0.0% 0.0%
Expected volatility........................................ 0.0% 0.0% 90.0%
Risk-free interest rate.................................... 6.1% 5.0% 5.4%
Expected life (years)...................................... 5 5 5
</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
F-16
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
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.
Stock compensation expense has been recognized for options granted to
employees 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 1997, 1998 and
1999 are not representative of pro forma results for future years.
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1997 1998 1999
------- ------- --------
<S> <C> <C> <C>
Net loss attributable to common stockholders
(in thousands):
As reported................................. $(1,081) $(3,596) $(34,917)
Pro forma................................... (1,086) (3,621) (36,639)
Net loss per common share:
As reported................................. $ (0.72) $ (2.34) $ (9.20)
Pro forma................................... (0.72) (2.63) (9.65)
</TABLE>
10. Income Taxes:
Deferred tax assets consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
-----------------
1998 1999
------- --------
<S> <C> <C>
Net operating loss carryforwards.......................... $ 2,261 $ 15,322
Research and development credit carryforwards............. 90 136
Stock compensation expense................................ 81 495
Other..................................................... 404 64
------- --------
Deferred tax assets..................................... 2,836 16,017
Deferred tax asset valuation allowance.................... (2,836) (16,017)
------- --------
Net deferred tax assets................................. $ -- $ --
======= ========
</TABLE>
At December 31, 1999, available net operating loss carryforwards for federal
and state tax purposes were approximately $38,000,000, which expire through
2019. At December 31, 1999, the Company has research and development tax credit
carryforwards of approximately $99,000 and $37,000 available to reduce future
federal and state tax liabilities, respectively, which expire through 2019.
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-17
<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 December
31,
------------------------
1997 1998 1999
----- ------- --------
<S> <C> <C> <C>
Income tax expense (benefit) at US federal
statutory tax rate............................. $(345) $(1,136) $(11,807)
State income taxes, net of federal tax effect... (59) (221) (2,050)
Permanent items................................. 1 1 751
Other........................................... 13 (24) 75
Change in deferred tax asset valuation
allowance...................................... 390 1,380 13,031
----- ------- --------
Provision for income taxes...................... $ -- $ -- $ --
===== ======= ========
</TABLE>
11. 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, 1997,
1998 and 1999.
12. 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, 1997, 1998 and 1999 was $101,000, $121,000 and
$499,000, 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 1999, the Company entered into capital leases for the
acquisition of certain assets.
Future minimum lease obligations as of December 31, 1999 are as follows (in
thousands):
<TABLE>
<CAPTION>
Operating Capital
Leases Leases
--------- -------
<S> <C> <C>
Year Ending December 31,
2000..................................................... $1,498 $ 87
2001..................................................... 1,171 36
2002..................................................... 1,111 --
2003..................................................... 1,017 --
2004..................................................... 848 --
------ ----
Total minimum lease payments........................... $5,645 123
======
Less--amount representing interest..................... 15
----
Total.................................................. $108
====
</TABLE>
F-18
<PAGE>
SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Restricted Time Deposit
In connection with a facility lease entered into in 1999, 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 expenses in the years
ended December 31, 1997, 1998 and 1999 were not significant.
Legal Matters
On July 15, 1999, a patent infringement suit was filed against the Company.
Specifically, the suit alleged 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." In
November 1999, the Company settled the patent infringement lawsuit, and the
lawsuit was dismissed. The settlement agreement granted the Company a non-
exclusive license to the plaintiff's patent. Through December 31, 1999, the
Company incurred legal expenses and settlement costs of $861,000 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 year ended December 31, 1999.
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.
13. Events Subsequent to Independent Accountant's Report Date--Unaudited
Proposed Combination
On November 14, 2000, the Company entered into an agreement to combine with
Earlychildhood LLC. In the proposed transaction, the Company's stockholders
will convert their outstanding shares of common stock and Earlychildhood's
members will exchange their membership interests for shares of common stock of
LearningStar Corp., a newly-formed company. Also, the Company's outstanding
stock options and warrants will be converted to options and warrants to receive
common stock of LearningStar. After the conversion, holders of the Company's
common stock, stock options and warrants will own approximately one-third of
LearningStar's shares on a diluted basis. The completion of the combination is
subject to certain conditions, including approval by the Company's
stockholders.
Option Repricing
On September 7, 2000, the Company completed a direct repricing of certain
employee stock option grants. As part of the repricing, the Company reduced the
exercise price of all outstanding options with exercise prices of greater than
$1.50 per share. The new exercise price of these repriced options was reset to
$1.50 per share, which was equal to the market value of the Company's common
stock on September 7, 2000. Options to purchase 2,325,574 shares of the
Company's common stock were repriced. The Company is accounting for the
repriced options as variable awards. In the nine months ended September 30,
2000, the Company recorded an incremental non-cash stock compensation charge of
$110,000 as a result of the repricing.
F-19
<PAGE>
SMARTERKIDS.COM, INC.
UNAUDITED INTERIM BALANCE SHEET
<TABLE>
<CAPTION>
December 31, September 30,
1999 2000
------------ -------------
(in thousands, except
share data)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents......................... $ 55,621 $ 17,754
Short-term investments............................ 11,735 15,201
Accounts receivable, net of allowance for doubtful
accounts of $27 and $22 at December 31, 1999 and
September 30, 2000, respectively................. 132 175
Inventories....................................... 8,902 4,161
Other current assets.............................. 2,403 2,573
-------- --------
Total current assets............................ 78,793 39,864
Property and equipment, net......................... 2,421 5,469
Other assets........................................ -- 1,761
Intangible assets, net.............................. 621 362
Restricted cash..................................... 500 1,028
-------- --------
Total assets.................................... $ 82,335 $ 48,484
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long term debt and capital
lease obligations................................ $ 74 $ 541
Accounts payable.................................. 10,996 2,123
Accrued expenses.................................. 6,699 2,983
Deferred revenue.................................. 811 533
Other current liabilities......................... 87 72
-------- --------
Total current liabilities....................... 18,667 6,252
Long term debt and capital lease obligations, net of
current portion.................................... 34 806
-------- --------
Total liabilities............................... 18,701 7,058
-------- --------
Commitments and contingencies (Note 4).............. -- --
Stockholders' equity:
Common stock, $0.01 par value; 90,000,000 shares
authorized; 20,301,770 and 20,641,040 shares
issued and outstanding at December 31, 1999 and
September 30, 2000, respectively................. 203 206
Additional paid-in capital........................ 112,907 112,374
Deferred stock compensation....................... (6,286) (4,494)
Accumulated deficit............................... (43,190) (66,660)
-------- --------
Total stockholders' equity...................... 63,634 41,426
-------- --------
Total liabilities and stockholders' equity...... $ 82,335 $ 48,484
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-20
<PAGE>
SMARTERKIDS.COM, INC.
UNAUDITED INTERIM STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
For the
Nine Months Ended
September 30,
------------------
1999 2000
-------- --------
(in thousands,
except per share
data)
<S> <C> <C>
Net revenues............................................... $ 1,108 $ 4,504
Cost of revenues........................................... 795 3,386
-------- --------
Gross profit............................................... 313 1,118
-------- --------
Operating expenses:
Marketing and sales (excluding stock compensation of $327
and $1,157 for 1999 and 2000, respectively)............. 10,726 20,215
Development (excluding stock compensation of $1,141 and
$(238) for 1999 and 2000, respectively)................. 1,149 2,546
General and administrative (excluding stock compensation
of $321 and $455 for 1999 and 2000, respectively)....... 1,091 2,490
Stock compensation....................................... 1,789 1,374
-------- --------
Total operating expenses............................... 14,755 26,625
-------- --------
Loss from operations....................................... (14,442) (25,507)
Interest and other income (expense), net................... 300 2,037
-------- --------
Net loss................................................... (14,142) (23,470)
Accretion of redeemable preferred stock.................... (119) --
-------- --------
Net loss attributable to common stockholders............... $(14,261) $(23,470)
======== ========
Basic and diluted net loss per common share................ $ (8.10) $ (1.15)
Weighted average shares outstanding--basic and diluted..... 1,760 20,476
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-21
<PAGE>
SMARTERKIDS.COM, INC.
UNAUDITED INTERIM STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
For the
Nine Months Ended
September 30,
------------------
1999 2000
-------- --------
(in thousands)
<S> <C> <C>
Cash flows from operating activities:
Net loss................................................. $(14,142) $(23,470)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................ 49 1,368
Stock compensation expense............................... 1,789 1,374
Changes in assets and liabilities:
Accounts receivable.................................... 708 (43)
Inventories............................................ 104 4,741
Other assets........................................... (2,986) (170)
Other long-term assets................................. -- (1,761)
Accounts payable....................................... 4,186 (8,873)
Accrued expenses....................................... 1,143 (3,716)
Other current liabilities.............................. (386) (293)
-------- --------
Net cash used in operating activities...................... (9,535) (30,843)
-------- --------
Cash flows from investing activities:
Purchase of short-term investments....................... (5,000) (3,466)
Purchases of property and equipment...................... (1,041) (4,157)
Purchase of intangible assets............................ (150) --
Deposit of restricted cash............................... (500) (528)
-------- --------
Net cash used in investing activities...................... (6,691) (8,151)
-------- --------
Cash flows from financing activities:
Proceeds from long-term borrowings....................... -- 1,601
Repayments of long-term borrowings....................... (59) (362)
Proceeds from issuance of Series C redeemable preferred
stock, net of issuance costs............................ 25,260 --
Proceeds from exercise of common stock options........... 113 25
Proceeds from exercise of common stock warrants.......... -- 15
Proceeds from the purchase of common stock under the
Employee Stock Purchase Plan............................ -- 52
Increase from estimated IPO costs........................ -- (204)
-------- --------
Net cash provided by financing activities.................. 25,314 1,127
-------- --------
Net decrease in cash and cash equivalents.................. 9,088 (37,867)
Cash and cash equivalents at beginning of period........... 4,273 55,621
-------- --------
Cash and cash equivalents at end of period................. $ 13,361 $ 17,754
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-22
<PAGE>
SMARTERKIDS.COM, INC.
UNAUDITED NOTES TO INTERIM FINANCIAL STATEMENTS
1. Basis of Presentation:
The interim financial statements as of September 30, 2000 and for the nine
months ended September 30, 1999 and 2000 have been prepared by SmarterKids.com,
Inc. ("SmarterKids.com" or the "Company") pursuant to the rules and regulations
of the Securities and Exchange Commission (the "SEC") for interim financial
reporting. These statements are unaudited and, in the opinion of management,
include all adjustments (consisting only of normal recurring adjustments and
accruals) necessary to present fairly the balance sheet and the statement of
operations and cash flows for the periods presented. Operating results for the
nine months ended September 30, 2000 may not be indicative of the results for
the year ending December 31, 2000. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been omitted in accordance with the rules
and regulations of the SEC. These financial statements should be read in
conjunction with the audited financial statements and accompanying notes of
SmarterKids.com for the year ended December 31, 1999 included elsewhere in this
proxy statement-prospectus.
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
disclosures of contingencies at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from the estimates.
Marketing and Sales Expenses
Marketing and sales expenses consist primarily of the cost of advertising
and promotional activities, fulfillment costs including service fees to J.L.
Hammett Co., commissions to online marketing companies and expenses for
personnel engaged in marketing and merchandising. Fulfillment costs represent
costs incurred in operating and staffing the distribution center and the
customer service department, picking and packing customers' orders for
shipment, responding to inquires from customers, credit card fees, as well as
fees paid to J.L. Hammett Co., a fulfillment partner during the first six
months of 2000. As of July 1, 2000, the Company discontinued using J.L. Hammett
Co. as a third party fulfillment partner due to the opening of its own
distribution facility. Fulfillment costs were $340,000 and $1,538,000 for the
nine months ended September 30, 1999 and 2000, respectively. Advertising costs
are charged to operations as incurred. Advertising expenses were $8,040,000 and
$10,610,000 for the nine months ended September 30, 1999 and 2000,
respectively.
Recent Accounting Pronouncements
In December 1999, the SEC staff released Staff Accounting Bulletin ("SAB")
101, "Revenue Recognition in Financial Statements", which provides guidance on
the recognition, presentation and disclosure of revenue in financial
statements. Subsequently, SAB 101 A and B have been released which direct the
application of the guidance in SAB 101 to be required in the Company's fourth
quarter of 2000. The effects of applying this guidance, if any, will be
reported as a cumulative effect adjustment resulting from a change in
accounting principle. The Company is evaluating the impact of SAB 101 adoption
on its financial statements.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities"as amended by SFAS No. 138, which
was issued in June 2000. The Company will adopt SFAS No. 133 on January 1,
2001. SFAS No. 133 requires that all derivative instruments be reported on the
balance sheet at their fair value. Changes in the fair value of derivatives are
recorded each period in current earnings or other
F-23
<PAGE>
SMARTERKIDS.COM, INC.
UNAUDITED NOTES TO INTERIM FINANCIAL STATEMENTS--(Continued)
comprehensive income, depending on whether a derivative is designated as part
of a hedge transaction and, if it is, the type of hedge transaction. The
Company has not yet determined the impact of the adoption of SFAS No. 133 on
its financial condition, results of operations, or business practices.
In March 2000, the Emerging Issues Task Force ("EITF") of the FASB reached a
consensus on EITF Issue 00-2, "Accounting for Web Site Development Costs." This
consensus provided guidance on what types of costs incurred to develop web
sites should be capitalized or expensed. The Company adopted this consensus on
July 1, 2000. The adoption of this consensus had no material impact on the
Company's financial statements.
2. Property and Equipment:
Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31, September 30,
1999 2000
------------ -------------
<S> <C> <C>
Software................ $ 377 $1,769
Furniture and fixtures.. 207 230
Computer and office
equipment.............. 1,774 3,928
Leasehold improvements.. 507 1,095
------ ------
2,865 7,022
Less--Accumulated
depreciation and
amortization........... 444 1,553
------ ------
$2,421 $5,469
====== ======
</TABLE>
During April 2000, the Company entered into a lease agreement for a new
distribution facility. As of September 30, 2000, there were $3,114,000 of
capital costs associated with the opening of the new distribution facility held
in fixed assets. The five-year lease requires minimum annual payments of
approximately $900,000.
3. Equipment Line of Credit:
During the quarter ended March 31, 2000, the Company secured a three-year
equipment line of credit facility. Through September 30, 2000, borrowings and
equipment collateralized under this agreement were $1.5 million. The interest
on the agreement is the three-year U.S. Treasury rate plus 3.5%. In accordance
with the agreement, the balance under the line of credit was converted to a 36-
month term loan at the time of funding. Accordingly, the Company is making
payments of approximately $45,000 per month over the term of the loan. At
September 30, 2000, a total balance of $1.2 million remains outstanding and no
additional amounts are available under the line.
During the quarter ended June 30, 2000, the Company secured additional
borrowing capacity of $1.0 million under another three-year equipment line of
credit facility. Through September 30, 2000, borrowings and equipment
collateralized under this agreement were $149,000. The interest on the
borrowings is 9% per annum. The Company issued warrants for the purchase of
16,667 shares of common stock with an exercise price of $3.00 per share in
connection with obtaining the facility. The warrants have been valued and a
discount of $8,645 has been recorded on the lease obligation. The discount is
being amortized to interest expense over the life of the line of credit. At
September 30, 2000, a balance of $131,000 remains outstanding.
F-24
<PAGE>
SMARTERKIDS.COM, INC.
UNAUDITED NOTES TO INTERIM FINANCIAL STATEMENTS--(Continued)
4. Commitments and Contingencies:
Restricted Time Deposit
In connection with a facility lease entered into in 1999, 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. In connection with
the warehouse facility lease entered into in the second quarter of 2000, the
Company was required to maintain, on behalf of the landlord, $500,000 in an
interest-bearing account, which will be restricted as to its use.
5. Stockholders' Equity:
In March 2000, the Financial Accounting Standard Board ("FASB") issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation--an interpretation of APB Opinion No. 25" ("FIN 44"). FIN 44
clarifies the application of Accounting Policy Bulletin ("APB") Opinion No. 25
and among other issues clarifies the following: the definition of an employee
for purposes of applying APB Opinion No. 25, the criteria for determining
whether a plan qualifies as a noncompensatory plan, the accounting consequence
of various modifications to the terms of previously issued fixed stock options
or awards, and the accounting for an exchange of stock compensation awards in a
business combination. FIN 44 was effective July 1, 2000, but certain
conclusions in FIN 44 cover specific events that occurred after either December
15, 1998 or January 12, 2000.
On September 7, 2000, the Company completed a direct repricing of certain
employee stock option grants. As part of the repricing, the Company reduced the
exercise price of all outstanding options with exercise prices of greater than
$1.50 per share. The new exercise price of these repriced options was reset to
$1.50 per share, which was equal to the market value of the Company's common
stock on September 7, 2000. Options to purchase 2,325,574 shares of the
Company's common stock were repriced. The Company is accounting for the
repriced options as variable awards. In the nine months ended September 30,
2000, the Company recorded an incremental non-cash stock compensation charge of
$110,000 as a result of the repricing.
6. Subsequent Events:
Proposed Combination
On November 14, 2000, the Company entered into an agreement to combine with
Earlychildhood LLC. In the proposed transaction, the Company's stockholders
will convert their outstanding shares of common stock and Earlychildhood's
members will exchange their membership interests for shares of common stock of
LearningStar, Corp., a newly-formed company. Also, the Company's outstanding
stock options and warrants will be converted to options and warrants to receive
common stock of LearningStar. After the conversion, holders of the Company's
common stock, stock options and warrants will own approximately one-third of
LearningStar's shares on a diluted basis. The completion of the combination is
subject to certain condition, including approval by the Company's stockholders.
F-25
<PAGE>
Independent Auditors' Report
The Board of Directors
Earlychildhood LLC:
We have audited the accompanying consolidated balance sheets of
Earlychildhood LLC and subsidiary (the "Company") as of December 31, 1998 and
1999, and the related consolidated statements of operations, members' equity
and cash flows for the year ended March 31, 1998, the nine months ended
December 31, 1998 and the year ended December 31, 1999. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
Earlychildhood LLC and subsidiary as of December 31, 1998 and 1999, and the
results of their operations and their cash flows for the year ended March 31,
1998, the nine months ended December 31, 1998 and the year ended December 31,
1999 in conformity with generally accepted accounting principles.
KPMG LLP
San Francisco, California
December 22, 2000, except for Note 1,
which is as of January 8, 2001
F-26
<PAGE>
EARLYCHILDHOOD LLC
Consolidated Balance Sheets
(In thousands)
<TABLE>
<CAPTION>
December 31, December 31, September 30,
1998 1999 2000
------------ ------------ -------------
(Unaudited)
<S> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents............ $ 29 $ 151 $ --
Accounts receivable, net............. 1,421 4,188 10,032
Inventories.......................... 3,324 11,227 14,023
Prepaid expenses and other current
assets.............................. 383 1,679 2,153
------ ------- -------
Total current assets............... 5,157 17,245 26,208
Receivable from member................. 405 137 139
Property and equipment, net............ 1,898 2,169 4,495
Deferred income taxes.................. 47 -- --
Other assets........................... 40 1,233 1,086
Goodwill, net.......................... -- 5,772 5,306
Other intangible assets, net........... 896 2,359 2,109
------ ------- -------
Total assets....................... $8,443 $28,915 $39,343
====== ======= =======
Liabilities and Members' Equity
Current liabilities:
Bank overdraft....................... $ -- $ 407 $ 8
Short-term debt...................... 2,203 3,608 1,375
Accounts payable..................... 1,497 2,238 4,991
Accrued expenses..................... 403 1,128 1,240
Income taxes payable................. -- 920 1,015
Deferred income taxes................ 33 577 475
Other liabilities.................... 137 408 163
------ ------- -------
Total current liabilities.......... 4,273 9,286 9,267
Deferred income taxes.................. -- 48 61
Notes payable to member................ 591 -- --
Notes payable.......................... 1,525 9,087 7,750
------ ------- -------
Total liabilities.................. 6,389 18,421 17,078
------ ------- -------
Members' equity........................ 2,054 10,494 24,980
Deferred compensation.................. -- -- (2,715)
------ ------- -------
Total members' equity.............. 2,054 10,494 22,265
------ ------- -------
Total liabilities and members'
equity............................ $8,443 $28,915 $39,343
====== ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-27
<PAGE>
EARLYCHILDHOOD LLC
Consolidated Statements of Operations
(In thousands, except per share data)
<TABLE>
<CAPTION>
Nine Months Fiscal Year Nine Months Nine Months
Fiscal Year Ended Ended Ended Ended
Ended March December 31, December 31, September 30, September 30,
31, 1998 1998 1999 1999 2000
----------- ------------ ------------ ------------- -------------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C>
Revenues................ $18,597 $20,786 $ 61,034 $49,256 $ 67,814
Cost of goods sold...... 10,789 12,154 37,226 30,374 42,585
------- ------- ----------- ------- -----------
Gross profit........ 7,808 8,632 23,808 18,882 25,229
------- ------- ----------- ------- -----------
Operating expenses:
Selling, general and
administrative
(includes equity
based compensation of
$467 for nine months
ended September 30,
2000)................ 7,774 6,574 18,931 12,345 22,115
Amortization of
goodwill and other
intangible assets.... 12 36 653 401 764
------- ------- ----------- ------- -----------
7,786 6,610 19,584 12,746 22,879
------- ------- ----------- ------- -----------
Operating income.... 22 2,022 4,224 6,136 2,350
------- ------- ----------- ------- -----------
Other (income) expense:
Interest expense...... 265 194 875 536 1,075
Interest income....... -- (3) (46) (23) (35)
------- ------- ----------- ------- -----------
265 191 829 513 1,040
------- ------- ----------- ------- -----------
Income (loss) before
income taxes....... (243) 1,831 3,395 5,623 1,310
Income tax (benefit)
expense................ (103) 182 982 1,449 944
------- ------- ----------- ------- -----------
Net income (loss)... $ (140) $ 1,649 $ 2,413 $ 4,174 $ 366
======= ======= =========== ======= ===========
Pro forma income tax
expense (unaudited).... $ 1,493 $ 723
----------- -----------
Pro forma net income
(unaudited)............ $ 1,902 $ 587
=========== ===========
Pro forma net income per
share--basic
(unaudited)............ $ 0.05 $ 0.01
=========== ===========
Pro forma net income per
share--diluted
(unaudited)............ $ 0.05 $ 0.01
=========== ===========
Shares used in pro forma
per share calculation--
basic (unaudited)...... 35,908,666 44,737,985
=========== ===========
Shares used in pro forma
per share calculation--
diluted (unaudited).... 35,908,666 44,738,777
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-28
<PAGE>
EARLYCHILDHOOD LLC
Consolidated Statements of Members' Equity
(In thousands)
<TABLE>
<CAPTION>
Earlychildhood LLC
Membership Interest
Elliott Mair LLC -----------------------
Membership Class Class Deferred
Interest Class A B C Compensation Total
---------------- ------- ------ ------ ------------ -------
<S> <C> <C> <C> <C> <C> <C>
Balance at April 1,
1997................... $ 736 $ -- $ -- $ -- $ -- $ 736
Net loss................ (140) -- -- -- -- (140)
Distributions to
members................ (5) -- -- -- -- (5)
------- ------- ------ ------ ------- -------
Balance at March 31,
1998................... $ 591 $ -- $ -- $ -- $ -- $ 591
Net income.............. 1,649 -- -- -- -- 1,649
Distributions to
members................ (186) -- -- -- -- (186)
------- ------- ------ ------ ------- -------
Balance at December 31,
1998................... $ 2,054 $ -- $ -- $ -- $ -- $ 2,054
Net income January 1,
1999 through May 5,
1999................... 505 -- -- -- -- 505
Distribution to
members................ (1,150) -- -- -- -- (1,150)
Recapitalization:
Transfer of net assets
to Elliott Mair
Salinas LLC.......... (160) -- -- -- -- (160)
Distributions to
members.............. (2,168) -- -- -- -- (2,168)
Recapitalization of
existing membership
interests............ 919 -- (919) -- -- --
Issuance of new
membership interests,
net of fees.......... -- 7,240 -- 165 -- 7,405
Acquisition of
Educational Products,
Inc.................... -- -- 1,600 -- -- 1,600
Capital contribution.... -- 500 -- -- -- 500
Net income May 6, 1999
to December 31, 1999... -- 1,277 625 6 -- 1,908
------- ------- ------ ------ ------- -------
Balance at December 31,
1999................... $ -- $ 9,017 $1,306 $ 171 $ -- $10,494
Capital contributions
(unaudited)............ -- 11,328 -- -- -- 11,328
Net income (unaudited).. -- 366 -- -- -- 366
Issuance of new
membership interests
(unaudited)............ -- -- -- 421 -- 421
Issuance of options to
purchase membership
interests (unaudited).. -- -- -- 2,761 (2,761) --
Amortization of deferred
compensation
(unaudited)............ -- 46 46
Distributions to members
(unaudited)............ -- (314) (76) -- -- (390)
------- ------- ------ ------ ------- -------
Balance at September 30,
2000 (unaudited)....... $ -- $20,397 $1,230 $3,353 $(2,715) $22,265
======= ======= ====== ====== ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-29
<PAGE>
EARLYCHILDHOOD LLC
Consolidated Statements of Cash Flows
(In thousands)
<TABLE>
<CAPTION>
Fiscal Nine Fiscal Nine Nine
Year Ended Months Ended Year Ended Months Ended Months Ended
March 31, December 31, December 31, September September 30,
1998 1998 1999 30, 1999 2000
---------- ------------ ------------ ------------ -------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)................................... $ (140) $1,649 $2,413 $4,174 $ 366
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization....................... 222 234 963 631 1,263
Equity based compensation........................... -- -- -- -- 467
Deferred income taxes............................... (16) 50 (207) (137) (89)
Changes in operating assets and liabilities, net of
acquisitions:
Accounts receivable................................. 95 (282) (3,870) (7,028) (5,844)
Inventories......................................... (1,424) (743) 2,225 3,139 (2,796)
Prepaid expenses and other current assets........... 155 (202) (1,296) (821) (474)
Other assets........................................ 72 (16) 254 205 147
Accounts payable.................................... 802 54 (5,393) 448 2,753
Accrued expenses.................................... 311 (42) 355 370 112
Income taxes payable................................ (227) 68 1,123 1,483 95
Other liabilities................................... 84 60 153 33 (245)
------- ------ ------ ------ ------
Net cash provided by (used in) operating
activities........................................ (66) 830 (3,280) 2,497 (4,245)
------- ------ ------ ------ ------
Cash flows from investing activities:
Purchase of plant and equipment..................... (191) (285) (1,581) (1,156) (2,825)
Purchase of other intangible assets................. -- (216) (327) (282) (48)
Acquisitions, net of cash acquired.................. -- (638) (7,372) (6,872) --
------- ------ ------ ------ ------
Net cash used in investing activities.............. (191) (1,139) (9,280) (8,310) (2,873)
------- ------ ------ ------ ------
Cash flows from financing activities:
Bank overdraft...................................... 9 (9) 407 -- (399)
Net borrowings (principal payments) on line of
credit............................................. 95 746 (1,639) (3,160) (2,233)
Net borrowings on long-term liabilities............. 75 130 7,482 7,696 (1,337)
Issuance of membership interests, net of fees....... -- -- 7,905 7,405 11,328
Member distributions................................ (5) (186) (1,150) (1,150) (390)
Member loans........................................ -- -- (591) (591) (2)
Member (advances) payments.......................... (9) (343) 268 105 --
------- ------ ------ ------ ------
Net cash provided by financing activities.......... 165 338 12,682 10,305 6,967
------- ------ ------ ------ ------
Net increase (decrease) in cash and cash
equivalents......................................... (92) 29 122 4,492 (151)
Cash and cash equivalents at beginning of period..... 92 -- 29 29 151
------- ------ ------ ------ ------
Cash and cash equivalents at end of period........... $ -- $ 29 $ 151 $4,521 $ --
======= ====== ====== ====== ======
Supplemental disclosures of cash flow information:
Cash payments during the period:
Cash paid for interest.............................. $ 265 $ 194 $ 875 $ 536 $1,075
Cash paid for taxes................................. $ 333 $ -- $1,506 $ 271 $ 938
Non-cash investing and financing activities:
Membership interests issued in acquisition of
business........................................... $ -- $ -- $1,600 $1,600 $ --
Transfer of net assets to Elliott Mair Salinas LLC.. $ -- $ -- $ 160 $ 160 $ --
Distribution of assets to members................... $ -- $ -- $2,168 $2,168 $ --
Issuance of membership interests.................... $ -- $ -- $ -- $ -- $ 421
</TABLE>
See accompanying notes to consolidated financial statements.
F-30
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements
(1) The Business
Earlychildhood LLC ("Earlychildhood") and its wholly-owned subsidiary,
Educational Products, Inc. (collectively, the "Company") is a fully integrated,
multi-channel supplier of educational products, services and information to
schools, educational professionals and parents serving the early childhood and
elementary school communities. A predecessor company, QTL Corporation ("QTL"),
commenced operations in 1985 and was incorporated in 1986. Earlychildhood
itself was formed in 1995, and was originally named Elliott-Mair LLC. QTL and
Elliott-Mair LLC had the same ownership. On May 5, 1999, Elliott-Mair LLC
changed its name to Earlychildhood.com LLC. On January 8, 2001
Earlychildhood.com LLC changed its name to Earlychildhood LLC.
On May 5, 1999, QTL transferred significantly all of its assets and
liabilities to Earlychildhood in exchange for membership interests. The
acquisition constituted a combination of entities under common control for
financial accounting purposes and a tax-free reorganization for tax purposes.
The transaction was accounted for as an "as if pooling of interests" under
Accounting Principles Board Opinion 16 and related AICPA Accounting
Interpretations. Accordingly, the consolidated financial statements present the
combined results of operations, financial position and cash flows of the
Company as if QTL had been part of Earlychildhood LLC prior to May 5, 1999.
(2) Summary of Significant Accounting Policies
(a) Principles of Consolidation
The consolidated financial statements include the accounts of Earlychildhood
and its wholly-owned subsidiary. All material intercompany transactions have
been eliminated in consolidation.
(b) Fiscal Year
On April 1, 1998, QTL changed their fiscal year to end on December 31. Prior
to April 1, 1998, Earlychildhood and QTL's fiscal year ended on March 31.
Accordingly, the fiscal year ended December 31, 1998 consists of nine months.
(c) Cash and Cash Equivalents
The Company considers all highly liquid investments with a remaining
maturity of three months or less at the date of the acquisition to be cash
equivalents.
(d) Concentration of Credit Risk
The Company has no customer comprising greater than 10% of their revenues.
However, receivables arising from sales to customers are not collateralized and
management continually monitors the financial condition of its customers to
reduce the risk of loss.
(e) Inventories
The Company values inventories at the lower of cost or market, using the
first-in, first-out method.
(f) Deferred Catalog Costs
Deferred catalog costs are considered direct response advertising and are
capitalized and amortized in amounts proportionate to revenues over the lives
of each catalog, generally five to six months. Such costs are included in
prepaid expenses and other current assets. Amortization expense related to
deferred catalog costs is
F-31
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements--Continued
included in the statements of operations as a component of selling, general and
administrative expenses. Such amortization expense was $887,000 for the year
ended March 31, 1998, $749,000 for the nine months ended December 31, 1998,
$2,083,000 for the year ended December 31, 1999 and $1,537,000 and $2,235,000
for the nine months ended September 30, 1999 and 2000, respectively.
(g) Property and Equipment
Property and equipment are stated at cost less accumulated depreciation.
Leasehold improvements are capitalized and amortized over the lesser of the
remaining life of the asset or the remaining term of the lease. Maintenance and
repairs are expensed as incurred. Depreciation of property and equipment is
calculated using the straight-line method over the estimated useful lives of
the respective assets. The estimated useful lives range from five to thirteen
years for leasehold improvements and three to seven years for furniture,
fixtures and equipment.
Depreciation of property and equipment amounted to $210,000 for the year
ended March 31, 1998, $198,000 for the nine months ended December 31, 1998,
$310,000 for the year ended December 31, 1999 and $230,000 and $499,000 for the
nine months ended September 30, 1999 and 2000, respectively.
(h) Web Site Development
The Company does not produce software to be sold or marketed. However, in
connection with building its new web site, the Company has capitalized certain
web site development costs during the nine months ended September 30, 2000.
Capitalized costs of $812,000 are included in property and equipment on the
Company's balance sheet at September 30, 2000. No depreciation of capitalized
website development costs was recognized during the nine months ended September
30, 2000 as the Company's new website was not launched as of September 30,
2000.
(i) Goodwill and Other Intangible Assets
Trademarks and other intangible assets are stated at cost, and are being
amortized on the straight-line basis over their estimated useful lives, which
range from five to ten years. Goodwill, which represents the excess of cost
over fair market value of net assets acquired, is being amortized on the
straight-line basis over an estimated useful life of ten years.
Amortization expense amounted to $12,000 for the year ended March 31, 1998,
$36,000 for the nine months ended December 31, 1998, $653,000 for the year
ended December 31, 1999 and $401,000 and $764,000 for the nine months ended
September 30, 1999 and 2000, respectively.
(j) Accounting for Impairment of Long-Lived Assets
The Company assesses the need to record impairment losses on long-lived
assets used in operations when indicators of impairment are present. On an on-
going basis, management reviews the value and period of amortization or
depreciation of long-lived assets. Additionally, in accordance with Statement
of Financial Accounting Standards (SFAS) No. 121, "Accounting for Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," the Company's
policy is to review the estimated undiscounted future cash flows for its
operations on an annual basis and to compare it to the remaining net book value
to ascertain if a provision for impairment is necessary.
(k) Income Taxes
The Company has elected to be taxed as a limited liability company (a
partnership) for federal and state income tax purposes. As a partnership, the
Company's income and deductions are reported by its members who are taxed on
such income or loss. Educational Products, Inc. ("EPI"), a wholly-owned
subsidiary of Earlychildhood, is a C corporation and therefore is subject to
federal and state income taxes.
F-32
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements--Continued
QTL was a C corporation until April 1, 1998, when it elected S corporation
status. As an S corporation, QTL's income and deductions were reported by the
Company's shareholders who were taxed on such income or loss. While QTL's
income generally was not subject to federal income tax, it was subject to
certain state income taxes.
The consolidated financial statements reflect actual income taxes based on
the income tax status of the Company and its subsidiary combined with QTL for
the respective periods. In addition, the statement of operations for the year
ended December 31, 1999 and the nine months ended September 30, 2000 reflect
pro forma income taxes as if the Company had elected to be taxed as a C
corporation for federal and state income tax purposes during those periods.
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
(l) Revenue Recognition
The Company recognizes revenue from product sales upon the delivery of
products. Provisions for estimated returns and allowances are recorded as a
reduction to sales and cost of sales. The Company records revenue related to
these arrangements once the products are sold through to the end user. Shipping
and handling revenues and costs are included in revenues and cost of goods
sold, respectively.
(m) Equity--Based Compensation
The Company has adopted SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"). As permitted by SFAS 123, the Company measures
compensation cost in accordance with Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25"), and related
interpretations. Accordingly, no accounting recognition is given to stock
options granted at fair market value until they are exercised. Upon exercise,
net proceeds, including income tax benefits realized, are credited to equity.
Compensation cost for stock options granted with exercise prices below
estimated fair market value is recognized over the period which certain Company
repurchase provisions lapse (see Note 16). The pro forma impact on earnings has
been disclosed in the notes to the financial statements as allowed by SFAS 123
(see Note 16).
(n) Comprehensive Income
SFAS No. 130, "Reporting Comprehensive Income", requires that the Company
report comprehensive income, which includes net income as well as other changes
in assets and liabilities recorded in members' equity (deficit) in the
financial statements. There were no components of comprehensive income other
than net income for all periods presented.
(o) Unaudited Pro Forma Basic and Diluted Net Income per Share
The unaudited pro forma basic and diluted net income per share information
included in the accompanying statements of operations for the year ended
December 31, 1999 and the nine months ended September 30, 2000
F-33
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements--Continued
reflects the impact of the conversion of all membership interests into common
shares of LearningStar Corp. ("LearningStar") in conjunction with the proposed
combination transaction with SmarterKids.com (see Note 22) as of the beginning
of each period or date of issuance, if later. Common equivalent shares of 792
have been included in the computation of diluted net income per share for the
nine months ended September 30, 2000. Common equivalent shares consist of
membership interests issuable upon the exercise of options.
Historical basic and diluted net income per share have not been presented
because they are irrelevant due to the significant change in the Company's
capital structure and resultant basic and diluted net income per share that
will result upon conversion of all membership interests into common shares of
LearningStar (see Note 22).
The following table sets forth the computation of pro forma basic and
diluted net income per share:
<TABLE>
<CAPTION>
Nine Months
Year Ended Ended
December 31, September 30,
1999 2000
------------ -------------
<S> <C> <C>
Pro forma net income............................ $ 1,902,000 $ 587,000
=========== ==========
Weighted average shares outstanding assuming
conversion of membership interests to
LearningStar common stock:
Class A membership interests.................. 15,476,689 23,537,465
Class B membership interests.................. 20,365,158 20,969,096
Class C membership interests.................. 66,819 231,424
----------- ----------
Shares used in pro forma per share calculation
basic.......................................... 35,908,666 44,737,985
----------- ----------
Options to purchase membership interests
assuming conversion to LearningStar stock
options...................................... -- 792
----------- ----------
Shares used in pro forma per share calculation--
diluted........................................ 35,908,666 44,738,777
=========== ==========
Pro forma net income per share--basic........... $ 0.05 $ 0.01
=========== ==========
Pro forma net income per share--diluted......... $ 0.05 $ 0.01
=========== ==========
</TABLE>
(p) Fair Value of Financial Instruments
The carrying value for cash and cash equivalents, accounts receivable,
short-term debt, accounts payable and notes payable approximates fair value
because of the short term nature of these instruments. The carrying value of
notes payable approximates their fair values due to variable interest rates.
(q) Use of Estimates in Preparation of Financial Statements
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
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(r) Unaudited Interim Financial Information
The consolidated financial statements, including footnote disclosures as of
September 30, 2000 and for the nine months ended September 30, 1999 and 2000
are unaudited; however, in the opinion of management, all
F-34
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements--Continued
adjustments (consisting of normal recurring adjustments) necessary for a fair
presentation of the financial statements for the interim periods have been
included. Results of operations for the interim periods presented are not
necessarily indicative of the results that may be expected for the full fiscal
year or any future periods.
(s) Recent Accounting Pronouncements
In December 1999, the SEC staff released Staff Accounting Bulletin ("SAB")
101, "Revenue Recognition in Financial Statements", which provides guidance on
the recognition, presentation and disclosure of revenue in financial
statements. Subsequently, SAB 101 A and B have been released which direct the
application of the guidance in SAB 101 to be required in our fourth quarter of
2000. Given that the Company's accounting policy for revenue recognition is in
accordance with SAB 101, the management does not expect the adoption of SAB 101
to have a material effect on the Company's financial statements.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" as amended by SFAS No. 137, which was
issued in July 1999, delayed the adoption date for SFAS
No. 133 until annual periods beginning after June 15, 2000. SFAS No. 133
established standards for recognition and measurement of derivatives and
hedging activities. The Company will adopt SFAS No. 133 beginning January 1,
2001. Management does not believe the adoption of SFAS No. 133 will have a
material effect on the financial position or operations of the Company.
In July 2000 the Emerging Issues Task Force ("EITF") of the FASB concluded
on Issue 1 of EITF issue No. 00-10 "Accounting for Shipping and Handling Fees
and Costs," which provides guidance on the presentation of shipping and
handling revenue and costs in the statement of operations. The Company's
accounting policies are in accordance with the requirements of this EITF issue
and accordingly the adoption of this new accounting pronouncement will have no
effect on the Company's consolidated financial statements.
In March 2000, the EITF of the FASB reached a consensus on EITF Issue 00-2,
"Accounting for Web Site Development Costs." This consensus provided guidance
on what types of costs incurred to develop web sites should be capitalized or
expensed. The Company adopted this consensus effective January 1, 2000 and
capitalized $812,000 of web site development costs in the nine months ended
September 30, 2000. No significant web site development costs were incurred
prior to 2000.
(3) Recapitalization
The recapitalization of Earlychildhood took effect on May 5, 1999. The net
assets of the former Elliott Mair LLC in the amount of $160,000, which
consisted primarily of property and notes payable, were initially transferred
out of Earlychildhood into an affiliated company, Elliott-Mair Salinas LLC.
Thereafter, the following events occurred:
. QTL transferred significantly all of its assets and liabilities to
Earlychildhood in exchange for Class B membership interests in
Earlychildhood. The net book value of the assets transferred by QTL was
$1,409,000. As a result of the transfer, QTL received a 43.7% Class B
membership interest in Earlychildhood.
. In conjunction with the transaction, a portion of QTL's assets consisting
of inventory and receivables having a book value of $2,168,000 were
retained by QTL.
. Educational Simon, L.L.C. contributed $8,172,000 in cash. As a result of
its capital contribution, Educational Simon, L.L.C. received a 51.7%
Class A membership interest in Earlychildhood (Note 15).
. The Company incurred $932,000 in professional fees associated with the
issuance of Class A membership interests; $767,000 of the fees were paid
in cash of which $165,000 were paid in the form of a 0.4% Class C
membership interest in Earlychildhood.
F-35
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements--Continued
. The Company borrowed $10,000,000 in the form of a term loan with BNP
Paribas. The proceeds were used to pay down existing debt, fund
acquisitions and provide for future working capital needs of the Company.
(4) Acquisitions
On May 5, 1999, after the recapitalization, Earlychildhood acquired all of
the stock of EPI, a company which sells school supplies to elementary schools,
teachers and other educational organizations, for $6,800,000 in cash and 4.1%
in Class B membership interests in Earlychildhood, valued at $1,600,000. In
conjunction with the acquisition, EPI's existing notes payable of $1,193,000
and amounts outstanding under the existing line of credit of $1,500,000 were
repaid. Transaction fees amounted to $217,000.
The EPI acquisition was accounted for as a purchase with the excess of the
purchase price over the estimated fair value of the net assets recorded as
goodwill. The purchase price was allocated based on the fair values of the
assets and liabilities acquired as follows (in thousands):
<TABLE>
<S> <C>
Cash............................................................... $ 131
Other current assets............................................... 11,193
Property and equipment............................................. 277
Other intangible assets............................................ 1,410
Goodwill........................................................... 5,545
Other assets....................................................... 250
Current liabilities................................................ (10,191)
--------
$ 8,615
========
</TABLE>
The unaudited pro forma financial information in the following table
illustrates the combined results of the Company's operations and the operations
of EPI for the nine months ended December 31, 1998 and year ended December 31,
1999 and as if the acquisition of EPI had occurred as of April 1, 1998 and
January 1, 1999, respectively. The pro forma financial information is presented
for informational purposes and is not necessarily indicative of the results of
operations which would have occurred had the Company constituted a single
entity as of April 1, 1998 and January 1, 1999, respectively. The pro forma
information also is not necessarily indicative of the future results of
operations of the combined Company.
<TABLE>
<CAPTION>
Nine months Year
ended ended
December 31, December
1998 31, 1999
------------ --------
(in thousands)
<S> <C> <C>
Net sales............................................ $40,034 $63,741
Operating income..................................... $ 3,149 $ 2,687
Pro forma net income................................. $ 1,655 $ 1,097
Pro forma basic and diluted net income per share..... $ 0.03
Shares used in pro forma basic and diluted net income
per share calculation............................... 36,513
</TABLE>
The Company also concluded two less significant acquisitions. In December
1998 the Company acquired the stock of Colorations, Inc. a manufacturer and
distributor of non-toxic arts materials for $638,000. The net fair value of the
tangible assets acquired was insignificant and the majority of the purchase
price was allocated to trademarks, tradenames and formulas and amortized over
five years. In November 1999, the Company acquired certain assets and
liabilities relating to the Earlychildhood NEWS magazine for $500,000. The net
fair value of the tangible assets and liabilities acquired was insignificant
and the majority of the purchase price for the acquisition was allocated to
goodwill and amortized over ten years.
F-36
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements--Continued
The results of each acquired operation have been included in the
consolidated financial results of the Company from the date of acquisition.
(5) Accounts Receivable
Accounts receivable consists of the following amounts (in thousands):
<TABLE>
<CAPTION>
December 31, December 31, September 30,
1998 1999 2000
------------ ------------ -------------
<S> <C> <C> <C>
Accounts receivable................ $1,490 $4,331 $10,273
Less: allowance for doubtful
accounts.......................... (69) (143) (241)
------ ------ -------
$1,421 $4,188 $10,032
====== ====== =======
</TABLE>
(6) Inventories
Inventories, stated at lower of cost or market, consist of the following
amounts (in thousands):
<TABLE>
<CAPTION>
December 31, December 31, September 30,
1998 1999 2000
------------ ------------ -------------
<S> <C> <C> <C>
Raw materials and work in
progress......................... $ 155 $ 658 $ 997
Finished goods.................... 3,169 10,569 13,026
------ ------- -------
$3,324 $11,227 $14,023
====== ======= =======
(7) Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consist of the following amounts
(in thousands):
<CAPTION>
December 31, December 31, September 30,
1998 1999 2000
------------ ------------ -------------
<S> <C> <C> <C>
Prepaid catalog costs............. $ 224 $ 353 $ 565
Prepaid inventory................. 75 555 861
Non trade receivables............. 84 207 --
Other prepaid expenses............ -- 329 554
Other............................. -- 235 173
------ ------- -------
$ 383 $ 1,679 $ 2,153
====== ======= =======
</TABLE>
F-37
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements--Continued
(8) Property and Equipment
A summary of property and equipment is as follows (in thousands):
<TABLE>
<CAPTION>
December 31, December 31, September 30,
1998 1999 2000
------------ ------------ -------------
<S> <C> <C> <C>
Land................................. $ 250 $ -- $ --
Building............................. 1,127 -- --
Furniture & fixtures................. 64 248 372
Leasehold improvements............... 97 819 1,472
Machinery & equipment................ 1,109 2,571 3,807
Website development costs............ -- -- 812
------ ------ ------
2,647 3,638 6,463
Accumulated depreciation............. (749) (1,469) (1,968)
------ ------ ------
$1,898 $2,169 $4,495
====== ====== ======
</TABLE>
(9) Goodwill and Other Intangible Assets
Goodwill is presented net of accumulated amortization of $0, $379,000 and
$844,000 as of December 31, 1998, December 31, 1999 and September 30, 2000,
respectively. Other intangible assets consist of the following amounts (in
thousands):
<TABLE>
<CAPTION>
December 31, December 31, September 30,
1998 1999 2000
------------ ------------ -------------
<S> <C> <C> <C>
Trademarks, tradenames and
formulas......................... $964 $1,292 $1,340
Customer lists.................... -- 1,410 1,410
---- ------ ------
964 2,702 2,750
Less accumulated amortization..... (68) (343) (641)
---- ------ ------
$896 $2,359 $2,109
==== ====== ======
</TABLE>
(10) Accrued Expenses
Accrued expenses consist of the following amounts (in thousands):
<TABLE>
<CAPTION>
December 31, December 31, September 30,
1998 1999 2000
------------ ------------ -------------
<S> <C> <C> <C>
Payroll and commissions.............. $ 3 $ 282 $ 338
Vacation............................. 84 367 167
Professional services................ 40 107 327
Sales tax............................ 78 151 235
Other................................ 198 221 173
---- ------ ------
$403 $1,128 $1,240
==== ====== ======
</TABLE>
(11) Related Party Transactions
The Company has a note receivable from QTL amounting to $137,000 and
$139,000 as of December 31, 1999 and September 30, 2000, respectively. The
note bears interest at 8% and matures no later than May 5, 2004 or earlier
under certain circumstances. The note agreement was entered into effective May
5, 1999 to finance QTL's expenses related to a litigation matter which was
settled later in 1999.
F-38
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements--Continued
As of December 31, 1998, the Company had accounts receivable from a
shareholder of QTL in the amount of $405,000. The accounts receivable were
unsecured and bore no interest. In addition, as of December 31, 1998,
Earlychildhood had an unsecured note payable from a shareholder of QTL of
$591,000. The interest rate on this borrowing was 7.0% per annum. The note was
subsequently paid in full on May 5, 1999 as part of the recapitalization.
On May 5, 1999, Earlychildhood entered into a seven-year executive
management agreement with William E. Simon & Sons, LLC, an affiliate of
Educational Simon, L.L.C. Pursuant to the agreement, Earlychildhood paid
William E. Simon & Sons, LLC an initial fee of $400,000 and it pays a quarterly
fee of $75,000. The initial fee was allocated between costs of the
recapitalization and the EPI acquisition, whereas the quarterly fee is included
in selling, general and administrative expenses in the consolidated statement
of operations.
Beginning on May 5, 1999, Earlychildhood leased its distribution center from
Elliott Mair-Salinas LLC, a related company. Monthly payments are $13,000. The
lease term is indefinite and is renewed on a monthly basis. Earlychildhood also
utilizes a distribution center, which is owned by a related party for storage
and distribution of certain inventory. Earlychildhood recorded expenses of
$1,300 for the year ended March 31, 1998, $24,000 for the nine months ended
December 31, 1998, $96,000 for the year ended December 31, 1999 and $80,000 and
$14,000 for the nine months ended September 30, 1999 and September 30, 2000,
respectively.
(12) Credit Facilities
(a) Short-Term Debt
Short-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
December 31, December 31, September 30,
1998 1999 2000
------------ ------------ -------------
<S> <C> <C> <C>
Outstanding revolver line under:
Paribas Credit Facility............. $ -- $2,800 $ --
Bank of Salinas Credit Facility..... 1,918 -- --
Current portion of long-term debt..... 285 808 1,375
------ ------ ------
Total short-term debt............. $2,203 $3,608 $1,375
====== ====== ======
(b) Notes Payable Less Current Installments
Notes payable less current installments consist of the following (in
thousands):
<CAPTION>
December 31, December 31, September 30,
1998 1999 2000
------------ ------------ -------------
<S> <C> <C> <C>
Term loan under the Paribas Credit Fa-
cility............................... $ -- $9,625 $9,125
Notes payable secured by land and
building............................. 1,228 -- --
Other obligations..................... 582 270 --
------ ------ ------
1,810 9,895 9,125
Less current portion of long-term
debt................................. 285 808 1,375
------ ------ ------
Total long-term debt................ $1,525 $9,087 $7,750
====== ====== ======
</TABLE>
On May 5, 1999, the Company entered into a Senior Secured Credit Facility
with BNP Paribas, hereinafter, the Paribas Credit Facility. The Paribas
Credit Facility consisted of the following components:
Revolving Line of Credit--The Paribas Credit Facility included a $10
million Senior Secured Revolving Credit Facility, hereinafter, the
Revolver, maturing on May 5, 2004. The Revolver is subject to
F-39
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements--Continued
a clean-down provision, which requires that the Company limit the
outstanding principal balance drawn on the Revolver to a maximum of $3.5
million for 15 consecutive days each year. Additionally, the terms of the
Revolver include a $2.5 million letter of credit sublimit. At the option of
the Company, interest on principal borrowings outstanding on the Revolver
will accrue at a rate of either lender's base rate plus 2.0% per annum or
the adjusted LIBOR rate plus 3.25% per annum. The average annual interest
rate charged to the Company on the outstanding principal balance drawn on
the Revolver, as of December 31, 1999 was 8.94%. Indebtedness is secured by
substantially all of the assets of the Company. The credit facility is
available for working capital and general corporate purposes in the
ordinary course of business.
Term Loan--The Paribas Credit Facility included a $10 million term loan
component with a final maturity of May 5, 2004. The term loan, which was
fully drawn on May 5, 1999, is payable in 16 consecutive quarterly
installments commencing March 31, 2000 and continuing until December 31,
2003, with a final payment due on the maturity date. At the option of the
Company, interest on principal borrowings outstanding on the term loan will
accrue at a rate of either lender's base rate plus 2.0% per annum or the
adjusted LIBOR rate plus 3.25% per annum. The average annual interest rate
charged to the Company on the outstanding principal balance drawn on the
term loan, as of December 31, 1999 was 9.0%.
Acquisition Line--The Paribas Credit Facility included a $20 million
acquisition line with a maturity date of May 5, 2004. Principal balances
drawn on the acquisition line are governed by a defined set of covenants.
As of January 31, 2000, the Senior Secured Credit Facility was amended and
restated as follows:
Revolving Line of Credit--The terms of the Revolver were amended to
include the calculation of a collateralized borrowing base. The borrowing
base equals the sum of 80% of the aggregate face amount of eligible
accounts receivables due and owing; plus 50% of eligible inventory
(calculated at the lower of cost or market, on a first in, first out
basis).
Term Loan--Unchanged.
Acquisition Line--Terminated and removed.
As of September 30, 2000 the Company has $9,450,000 in borrowing capacity
under the Paribas Credit Facility. The Company's credit facilities include
certain restrictive covenants, which require maintenance of minimum amounts of
tangible net worth and EBITDA. The Company was in compliance with such
covenants at September 30, 2000.
From 1998 through May 5, 1999 the Company had a revolving line of credit
agreement with Bank of Salinas which allowed for borrowings of up to $2.5
million at an interest rate based on the bank's prime rate plus 0.75%. Notes
payable which were secured by land and building were transferred, along with
the related land and building and other assets and liabilities to Elliott Mair
Salinas LLC in conjunction with the recapitalization. Other obligations consist
of various notes in relation to the equipment of the Company. Their interest
rates range from 8.5% to 15.0% as of December 31, 1999. Certain assets of the
Company were pledged as collateral for the notes.
Maturities as of September 30, 2000 are as follows (in thousands):
<TABLE>
<S> <C>
2001................................................................. $1,375
2002................................................................. 2,500
2003................................................................. 3,375
2004................................................................. 1,875
Thereafter........................................................... --
------
Total maturities of debt........................................... $9,125
======
</TABLE>
F-40
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements--Continued
(13) Income Taxes
As a limited liability company, the Company is not subject to income taxes;
however its wholly-owned subsidiary, EPI, is a C corporation and therefore is
subject to federal and state income taxes. QTL was a C corporation until April
1, 1998 when it elected S corporation status. As an S corporation, QTL's income
and deductions were reported by the Company's shareholders who are taxed on
such income or loss. While QTL's income generally was not subject to federal
income tax, it was subject to certain state income taxes.
The following table reflects actual income taxes based on the income tax
status of the Company and its subsidiary combined with QTL for the respective
periods (in thousands):
<TABLE>
<CAPTION>
Nine Months Nine Months Nine Months
Year ended Ended Year ended Ended Ended
March 31, December 31, December 31, September 30, September 30,
1998 1998 1999 1999 2000
---------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Federal:
Current............... $ (71) $ 46 $1,068 $1,431 $ 937
Deferred.............. (10) 14 (192) (129) (80)
----- ---- ------ ------ ------
Total................. $ (81) $ 60 $ 876 $1,302 $ 858
===== ==== ====== ====== ======
State:
Current............... $ (16) $ 86 $ 121 $ 155 $ 96
Deferred.............. (6) 36 (15) (8) (9)
----- ---- ------ ------ ------
Total................. $ (22) $122 $ 106 $ 147 $ 87
===== ==== ====== ====== ======
Total income tax expense
(benefit):
Current............... $ (87) $132 $1,189 $1,586 $1,033
Deferred.............. (16) 50 (207) (137) (89)
----- ---- ------ ------ ------
Total................. $(103) $182 $ 982 $1,449 $ 945
===== ==== ====== ====== ======
</TABLE>
The Company's actual tax expense (benefit) differs from the statutory
federal income tax rate of 34% as shown in the following schedule (in
thousands):
<TABLE>
<CAPTION>
Nine months Nine months Nine months
Year ended Ended Year ended Ended Ended
March 31, December 31, December 31, September 30, September 30,
1998 1998 1999 1999 2000
---------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Income tax expense
(benefit) at statutory
rate................... $ (83) $623 $1,154 $1,912 $445
Effect of (income) loss
not subject to federal
taxes.................. (5) (623) (389) (626) 257
State income taxes...... (15) 108 50 81 57
Nondeductible
amortization of
goodwill............... -- -- 173 108 185
Effect of change in tax
status................. -- 74 9 9 --
Other................... (15) (35) --
----- ---- ------ ------ ----
Actual tax expense
(benefit).............. $(103) $182 $ 982 $1,449 $944
===== ==== ====== ====== ====
</TABLE>
F-41
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements--Continued
The following table displays the tax effects of temporary differences,
which, except for 1998, are primarily related to EPI and give rise to
significant portions of the deferred tax liabilities (in thousands):
<TABLE>
<CAPTION>
December 31, December 31, September 30,
1998 1999 2000
------------ ------------ -------------
<S> <C> <C> <C>
Deferred tax assets:
Inventory............................ $ 9 $ -- $ --
Allowance for bad debts.............. 3 13 39
Accrued expenses..................... 11 60 --
State taxes.......................... -- 62 50
---- ----- -----
23 135 89
Deferred tax liabilities:
Property and equipment............... (9) (37) (61)
Inventory............................ -- (723) (564)
---- ----- -----
Net deferred tax asset (liability)..... $ 14 $(625) $(536)
==== ===== =====
</TABLE>
Due to the nontaxable status of Earlychildhood, no deferred tax assets or
liabilities have been established relating to the differences between book and
tax basis of LLC assets and liabilities. As of September 30, 2000 the net tax
basis of Earlychildhood's assets and liabilities exceeded the net book basis by
$3,375,000.
The Company has presented unaudited pro forma income tax expense for the
year ended December 31, 1999 and the nine months ended September 30, 2000, on
the consolidated statements of operations as if Earlychildhood was subject to
federal and state income taxes as a C corporation. Such pro forma income tax
expense differs from the statutory rate primarily due to the effect of state
income taxes and the amortization of goodwill and certain intangible assets,
which are not deductible for tax purposes and the effect of state income taxes.
(14) Retirement Savings Plans
Employees of the Company are eligible to participate in the Earlychildhood
Retirement Savings Plan ("the Plan") amended and restated as of September 9,
1999. The Plan is a defined contribution plan operating under section 401(k) of
the Internal Revenue Service Code. Under the Plan, employees are eligible to
participate after completing one year of service. Participants may defer up to
15% of their compensation to a maximum of $10,500 as a contribution to the
Plan. The Company matches 50% of the employee contributions to the Plan up to a
maximum of 6% of participant contributions.
Participant contributions are 100% vested immediately. Employer
contributions are subject to the following vesting schedule:
<TABLE>
<S> <C>
Year 3 of service....................................................... 20%
Year 4 of service....................................................... 40%
Year 5 of service....................................................... 60%
Year 6 of service....................................................... 80%
Year 7 of service....................................................... 100%
</TABLE>
The Company's expense was $13,000 for the year ended March 31, 1998, $25,000
for the nine months ended December 31, 1998, $48,000 for the year ending
December 31, 1999 and $9,000 and $94,000 for the nine months ended September
30, 1999 and 2000, respectively.
F-42
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements--Continued
(15) Members' Equity
Upon formation of Earlychildhood under its former name Elliott Mair LLC in
1995, membership interests were established at 62% and 38% between the two then
existing members, based upon their respective capital contributions. These two
members were also the owners of QTL. Net income of Earlychildhood was allocated
based upon each member's percentage interest.
Per the amended and restated Operating Agreement of Earlychildhood (the
"Operating Agreement") entered into as of May 5, 1999 and as a result of the
Company's recapitalization, four classes of membership interests were
established: Classes A, B, C, and D. No Class D interests have ever been
issued. The following table sets forth the relative membership interests for
each outstanding class of interests as of December 31, 1999 and September 30,
2000:
<TABLE>
<CAPTION>
Membership Interests
---------------------------------
December 31,
Class 1999 September 30, 2000
----- ------------- ------------------
<C> <S> <C>
A 51.7% 50.5%
B 47.9% 48.1%
C 0.4% 1.4%
</TABLE>
Upon execution of the Operating Agreement, Educational Simon, L.L.C. made a
capital contribution of $8,172,000. To the extent that Educational Simon,
L.L.C. did not make a cumulative capital contribution of $20,000,000, gross of
transaction fees by July 31, 2000, the Operating Agreement provided that a
proportionate share of membership interests would be reallocated as Class B
membership interests to the Class B members. Educational Simon, L.L.C. made
such $11,828,000 additional capital contributions during the period from May 5,
1999 through July 31, 2000.
In addition, the Operating Agreement provides that if Earlychildhood met
certain targeted operating results for the twelve month period ended March 31,
2000, QTL Corporation would receive additional Class B membership interests.
Based on those provisions, after meeting certain of the targets, QTL received
additional Class B membership interests of 0.67% in April 2000, which ratably
diluted certain of the other members. Such reallocations of membership
interests were not contingent on the continued employment of any QTL employees
and have been reflected as a reallocation between the respective classes of
members' equity.
Net income is allocated to the members as follows:
. First, to the Class A member in an amount equal to their preferred
return amount. The preferred return is calculated as a 10% annual return
on the amount of its unreturned capital contributions taking into
account the amount and timing of the capital contributions.
. Second, to the Class A, B and C members, pro rata in accordance with
their relative percentage interests until the Class A member receives at
least a 25% internal rate of return, as defined by the Operating
Agreement.
. Thereafter, to the members, pro rata in accordance with their relative
percentage interest.
The management committee is comprised of six members, three of whom are
designated by Educational Simon, L.L.C., two of whom are designated by QTL and
one who is appointed upon the mutual agreement of Educational Simon, L.L.C. and
QTL.
F-43
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements--Continued
In May 2000, the Company issued Class C membership interests of 1% to
certain members of its management committee. Such members were not employees of
the Company or affiliates of Educational Simon, L.L.C. or QTL. The membership
interests were fully vested upon issuance. The fair value of the Class C
membership interests of $421,000 has been recorded in selling, general and
administrative expense during the nine months ended September 30, 2000.
(16) Options to Purchase Membership Interests
Effective June 20, 2000, the Company adopted the 2000 Management Equity
Incentive Option Plan (the "2000 Plan"), pursuant to which the Company's
management committee may grant options to eligible employees and consultants to
purchase Class C membership interests. A total of approximately 9% of
Earlychildhood's membership interests were available for issue under the 2000
Plan. The interests issued under the 2000 Plan will dilute the Class A and B
members on a pro-rata basis.
Options issued in 2000 become exercisable at a rate of 33.3% per year on the
anniversary date of grant and expire ten years from the date of grant. The
membership interests which are acquired by virtue of exercise of the options,
are subject to repurchase by the Company at cost in the event of employee
termination for any reason other than for cause. Such repurchase provisions
lapse at an annual rate of 20% each year, measured from the grant date. On
September 1, 2000 the initial option grant under the 2000 Plan was made to
Company employees. The grant represented 6.6% of the Company's membership
interests at an exercise price of $42.50 per .01% interest.
The Company recorded deferred compensation of $2,761,000 as of September 30,
2000, representing the difference between the exercise price and the implied
fair value of the related membership interests at the date of grant. The
implied fair value was calculated upon conversion to shares of LearningStar in
conjunction with the proposed combination of the Company with SmarterKids.com,
Inc. ("SmarterKids.com") (see Note 22). Such implied fair value was based upon
the fair market value of SmarterKids.com at the announcement date of the
proposed combination. The deferred compensation reflected in membership
interests is being amortized over five years, which represents the period over
which the repurchase provisions ratably lapse. Of the total deferred
compensation amount, $46,000 has been amortized as of September 30, 2000.
As of September 30, 2000, all of the options issued, representing 6.6% of
Earlychildhood's membership interests, are outstanding. None of the options are
exercisable at September 30, 2000.
The fair value of each option grant is established on the date of grant
using the Black-Scholes option pricing model with the following weighted
average assumptions for grants for the nine months ended September 30, 2000:
volatility of 60%, risk-free rate of 5.75%, expected life of options of ten
years and no dividend yield. The weighted average fair value of options granted
during the nine months ended September 30, 2000 was approximately $420,000 per
1% Class C membership interest.
Had compensation expense for these awards been determined based on the fair
value at the date of grant consistent with the method prescribed by SFAS No.
123, the Company's pro forma net income would have been $365,000 for the nine
months ended September 30, 2000.
F-44
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements--Continued
(17) Lease Commitments
The Company leases its facilities and certain equipment under noncancelable
lease agreements, which expire at various dates. Future minimum lease payments
as of September 30, 2000 under operating leases are as follows (in thousands):
<TABLE>
<CAPTION>
Operating
Leases
---------
<S> <C>
2000............................................................... $ 679
2001............................................................... 2,767
2002............................................................... 2,727
2003............................................................... 2,687
2004............................................................... 2,233
2005............................................................... 1,893
Thereafter......................................................... 3,847
-------
$16,833
=======
</TABLE>
Total rental expense under operating leases was $227,000 for the nine months
ended December 31, 1998, $685,000 for the year ended December 31, 1999 and
$389,000 and $902,000 for the nine months ended September 30, 1999 and 2000,
respectively.
As stated in Note 11, the Company leases one of its warehouse facilities
from an affiliate of one of its members.
(18) Segment Information
The Company has adopted the provisions of SFAS No. 131, "Disclosure About
Segments of an Enterprise and Related Information." SFAS No. 131 establishes
standards for the reporting by public business enterprises of information about
operating segments, products and services, geographic areas and major
customers. The method for determining the Company's operating segments is based
on the internal organization that is used by management for making operating
decisions and assessing performance.
The Company's chief operating decision maker is considered to be the
Company's Chief Executive Officer ("CEO"). The CEO reviews financial
information presented on a consolidated basis accompanied by disaggregated
information by operating segment for purposes of making operating decisions and
assessing financial performance. The Company presently operates in two
segments, DSS and EPI. DSS includes the brand names Discount School Supply,
Earlychildhood NEWS and Earlychildhood.com. DSS supplies educational products
and information through multiple channels to early childhood professionals and
parents. EPI sells school supplies to elementary schools, teachers and other
educational organizations.
F-45
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements--Continued
The accounting policies of the reportable segments are the same as those
described in the summary of significant accounting policies. There were no
intersegment sales. Segment identifiable assets are those which are directly
used in or identified to segment operations. The Company's profit measure of
EBITDA represents net income adding back depreciation and amortization,
interest and income taxes. Information regarding DSS and EPI is as follows:
<TABLE>
<CAPTION>
DSS EPI Total
------- ------- -------
(in thousands)
<S> <C> <C> <C>
Year ended December 31, 1999:
Revenues............................................ $38,111 $22,923 $61,034
EBITDA.............................................. 2,387 2,800 5,187
Amortization and depreciation....................... 424 539 963
Interest expense.................................... 864 11 875
Net income.......................................... 986 1,427 2,413
Assets.............................................. 13,537 15,378 28,915
Capital expenditures................................ $ 1,387 $ 194 $ 1,581
Nine months ended September 30, 1999:
Revenues............................................ $28,514 $20,742 $49,256
EBITDA.............................................. 2,641 4,126 6,767
Amortization and depreciation....................... 298 333 631
Interest expense.................................... 525 11 536
Net income.......................................... 2,097 2,077 4,174
Assets.............................................. 14,599 19,912 34,511
Capital expenditures................................ $ 1,010 $ 146 $ 1,156
Nine months ended September 30, 2000:
Revenues............................................ $40,890 $26,924 $67,814
EBITDA.............................................. 935 2,678 3,613
Amortization and depreciation....................... 650 613 1,263
Interest expense.................................... 1,075 -- 1,075
Net income (loss)................................... (1,698) 2,064 366
Assets.............................................. 22,333 17,010 39,343
Capital expenditures................................ $ 2,469 $ 356 $ 2,825
</TABLE>
Prior to the May 5, 1999 acquisition of EPI, the Company operated in only
one segment, DSS. DSS performs limited administrative activities, including
certain accounting and information system functions on behalf of EPI. DSS
charges EPI based on estimates of its actual costs for such activities.
Intersegment charges amounted to $108,000, $68,000 and $81,000 for the year
ended December 31, 1999, the nine months ended September 30, 1999 and the nine
months ended September 30, 2000, respectively.
F-46
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements--Continued
(19) Quarterly Financial Information (Unaudited)
<TABLE>
<CAPTION>
Quarter Ended (in thousands)
-------------------------------------------
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
<S> <C> <C> <C> <C>
1998:
Revenues................ $ 5,670 $ 9,128 $ 5,988
Gross profit............ 2,407 3,803 2,422
Operating income........ 746 1,428 (152)
Income (loss) before
income taxes........... 693 1,383 (245)
Net income (loss)....... $ 578 $ 1,301 $ (230)
1999:
Revenues................ $ 7,049 $12,557 $29,650 $11,778
Gross profit............ 3,037 4,961 10,884 4,926
Operating income........ 469 1,073 4,594 (1,912)
Income (loss) before
income taxes........... 406 898 4,319 (2,228)
Net income (loss)....... $ 399 $ 605 $ 3,170 $(1,761)
2000:
Revenues................ $ 12,503 $18,459 $36,852
Gross profit............ 4,577 7,211 13,441
Operating income........ (2,152) (545) 5,047
Income (loss) before
income taxes........... (2,454) (990) 4,754
Net income (loss)....... $ (1,941) $ (793) $ 3,100
</TABLE>
(20) Legal Proceedings
The Company is involved in litigation arising in the ordinary course of
business. While the ultimate results of such proceedings cannot be predicted
with certainty, management expects that these matters will not have a material
adverse effect on the Company's financial position or results of operations.
(21) Combining Financial Information
The recapitalization of Earlychildhood has been accounted for as an "as-if-
pooling" and accordingly, the historical consolidated financial statements have
been restated to include the accounts and results of operations of
Earlychildhood and QTL back to the beginning of the fiscal year ended March 31,
1998. The results of operations previously reported by the separate businesses
and the combined amounts presented in the accompanying consolidated financial
statements are presented below.
<TABLE>
<CAPTION>
Nine Months Nine Months Nine Months
Year Ended Ended Year Ended Ended Ended
March 31, December 31, December 31, September 30, September 30,
1998 1998 1999 1999 2000
---------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Revenue
Earlychildhood.......... $ 203 $ 148 $51,871 $40,093 $67,814
QTL..................... 18,586 20,782 9,163 9,163 --
Eliminations............ (192) (144) -- -- --
------- ------- ------- ------- -------
$18,597 $20,786 $61,034 $49,256 $67,814
======= ======= ======= ======= =======
Net income
Earlychildhood.......... $ 16 $ 11 $ 1,908 $ 3,669 $ 366
QTL..................... (156) 1,638 505 505 --
------- ------- ------- ------- -------
$ (140) $ 1,649 $ 2,413 $ 4,174 $ 366
======= ======= ======= ======= =======
</TABLE>
F-47
<PAGE>
EARLYCHILDHOOD LLC
Notes to the Consolidated Financial Statements--Continued
Rental income from the Earlychildhood's distribution center lease to QTL,
which ended on May 5, 1999 has been eliminated in the consolidated financial
statements. There were no other transactions between Earlychildhood and QTL
prior to the recapitalization.
(22) Proposed Combination
On November 14, 2000, the Company entered into an agreement to combine with
SmarterKids.com. In the proposed transaction, the Company's members will
exchange their membership interests and SmarterKids.com's shareholders will
convert their shares for shares of common stock of LearningStar, a newly-
formed company. In addition, holders of options to purchase Earlychildhood
membership interests will exchange their Earlychildhood options for options to
purchase common stock of LearningStar. After the exchange, the Company's
members and option holders will own approximately two-thirds of LearningStar's
shares on a diluted basis.
The combination agreement provides that each of the outstanding classes of
LLC members will receive shares of LearningStar at the following exchange
ratios:
<TABLE>
<CAPTION>
LearningStar
shares received
per .00001%
Membership
interest
----------------
<S> <C>
Class A Members............................................. 4.9951
Class B Members............................................. 4.6781
Class C Members............................................. 2.3365
</TABLE>
The Company is required to obtain the consent of the lenders under the
Paribas Credit Facility to complete the combination. If the Company is unable
to obtain the lenders' consent, the credit facility could be declared in
default and any borrowings under the credit facility would become due and
payable. In addition, the completion of the combination is subject to certain
conditions including approval by the SmarterKids.com stockholders.
F-48
<PAGE>
Independent Auditors' Report
The Board of Directors
Educational Products, Inc.:
We have audited the accompanying balance sheets of Educational Products,
Inc. ("the Company") as of March 31, 1999 and May 5, 1999 and the related
statements of operations, stockholders' equity and cash flows for the year
ended March 31, 1999 and the 35-day period ended May 5, 1999. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Educational Products, Inc.
as of March 31, 1999 and May 5, 1999, and the results of its operations and its
cash flows for the year ended March 31, 1999 and the 35-day period ended May 5,
1999 in conformity with generally accepted accounting principles.
KPMG LLP
San Francisco, California
December 3, 1999
F-49
<PAGE>
EDUCATIONAL PRODUCTS, INC.
Balance Sheets
(In thousands)
<TABLE>
<CAPTION>
March 31, May 5,
1999 1999
--------- -------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.................................. $ -- $ 1,631
Accounts receivable, less allowance for doubtful accounts
of $50,000 as of March 31, 1999 and May 5, 1999........... 944 629
Inventories................................................ 8,820 10,565
Prepaid income taxes....................................... 14 10
Other current assets....................................... 164 157
------- -------
Total current assets..................................... 9,942 12,992
Property and equipment, net................................ 276 277
Other assets............................................... 51 84
------- -------
Total assets............................................. $10,269 13,353
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Bank overdraft............................................. $ 379 $ --
Line of credit............................................. 270 1,500
Note payable to stockholders............................... 1,125 1,125
Note payable Earlychildhood................................ -- 1,850
Accounts payable........................................... 5,173 6,134
Accrued expenses........................................... 660 439
Deferred income taxes...................................... 744 594
------- -------
Total current liabilities................................ 8,351 11,642
Deferred income taxes...................................... 51 49
------- -------
Total liabilities........................................ 8,402 11,691
------- -------
Stockholders' equity:
Common stock, no par value, 10,000 shares authorized; 1,000
shares issued and outstanding............................. 1 1
Retained earnings.......................................... 1,866 1,661
------- -------
Total stockholders' equity............................... 1,867 1,662
------- -------
$10,269 $13,353
======= =======
</TABLE>
See accompanying notes to financial statements.
F-50
<PAGE>
EDUCATIONAL PRODUCTS, INC.
Statements of Operations
(In thousands)
<TABLE>
<CAPTION>
Year ended Thirty-five-day
March 31, period ended
1999 May 5, 1999
---------- ---------------
<S> <C> <C>
Net sales............................................ $21,304 $ 422
Cost of goods sold................................... 14,011 296
------- -----
Gross profit..................................... 7,293 126
------- -----
Operating expenses:
Selling............................................ 228 12
General and administrative......................... 6,523 452
------- -----
6,751 464
------- -----
Operating income (loss).......................... 542 (338)
------- -----
Other income (expense):
Interest income.................................... 49 --
Interest expense................................... (112) (15)
------- -----
Total other expense.............................. (63) (15)
------- -----
Income (loss) before income taxes.................... 479 (353)
Income tax expense (benefit)......................... 184 (148)
------- -----
Net income (loss)................................ $ 295 $(205)
======= =====
</TABLE>
See accompanying notes to financial statements.
F-51
<PAGE>
EDUCATIONAL PRODUCTS, INC.
Statements of Stockholders' Equity
Year ended March 31, 1999 and thirty-five-day period ended May 5, 1999
(In thousands, except per share data)
<TABLE>
<CAPTION>
Total
Number Retained stockholders'
of shares Amount earnings equity
--------- ------ -------- -------------
<S> <C> <C> <C> <C>
Balances, April 1, 1998................. 1,000 $ 1 $1,571 $1,572
Net income.............................. -- -- 295 295
----- --- ------ ------
Balances, March 31, 1999................ 1,000 1 1,866 1,867
Net loss................................ -- -- (205) (205)
----- --- ------ ------
Balances, May 5, 1999................... 1,000 $ 1 $1,661 $1,662
===== === ====== ======
</TABLE>
See accompanying notes to financial statements.
F-52
<PAGE>
EDUCATIONAL PRODUCTS, INC.
Statements of Cash Flows
(In thousands)
<TABLE>
<CAPTION>
Year ended Thirty-five-day
March 31, period ended
1999 May 5, 1999
---------- ---------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)................................. $ 295 $ (205)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization................... 100 8
Deferred income taxes........................... 245 (152)
Gain on disposal of property and equipment...... (4) --
Changes in operating assets and liabilities:
Accounts receivable........................... (272) 315
Inventories................................... (1,992) (1,745)
Other current assets.......................... (200) 7
Prepaid income taxes.......................... -- 4
Other assets.................................. 21 (33)
Accounts payable.............................. 1,858 962
Accrued expenses.............................. 76 (222)
------- -------
Net cash provided by (used in) operating
activities................................. 127 (1,061)
------- -------
Cash flows from investing activities:
Proceeds from sale of property and equipment...... 4 --
Purchase of property and equipment................ (106) (9)
------- -------
Net cash used in investing activities....... (102) (9)
------- -------
Cash flows from financing activities:
Drawdowns on line of credit....................... 20 1,230
Repayments on notes payable to stockholders....... (1,275) --
Proceeds from notes payable to stockholders....... 1,250 --
Proceeds from note payable to Earlychildhood...... -- 1,850
------- -------
Net cash (used in) provided by financing
activities................................. (5) 3,080
------- -------
Net increase in cash and cash equivalents........... 20 2,010
Cash and cash (overdraft) equivalents beginning of
period............................................. (399) (379)
------- -------
Cash and cash (overdraft) equivalents end of
period............................................. $ (379) $ 1,631
======= =======
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest........................................ $ 112 $ 6
======= =======
Income taxes.................................... $ 28 $ --
======= =======
</TABLE>
See accompanying notes to financial statements.
F-53
<PAGE>
EDUCATIONAL PRODUCTS, INC.
Notes to Financial Statements
(1) Organization of the Company
Educational Products, Inc. (the "Company"), a Texas corporation, was
incorporated on February 13, 1980.
The Company sells school supplies to elementary schools, teachers and other
educational organizations. The Company's business cycle is highly seasonal.
Substantially all sales activity occurs during the period from May through
August, with a need to draw upon financial resources to fund working capital
in advance of the peak of the Company's business cycle.
On May 5, 1999, 100% of the common stock of the Company was acquired by
Earlychildhood LLC, or Earlychildhood, a fully integrated, multi-channel
supplier of educational products, services and information to parents, as well
as educational professionals and schools serving the early childhood and
elementary age communities. The consideration for the acquisition was $6.8
million in cash and membership interests in Earlychildhood valued at $1.6
million. In conjunction with the acquisition, the notes payable to
stockholders and amounts outstanding under the line of credit were repaid.
Financial statements reflect the financial position and the operating results
on a historical cost basis immediately prior to the acquisition of EPI by
Earlychildhood.
(2) Summary of Significant Accounting Policies
(a) Cash and Cash Equivalents
The Company considers all highly liquid investments with a remaining
maturity of three months or less at the date of the acquisition to be cash
equivalents.
(b) Inventories
The Company values inventories at the lower of cost or market, using the
average cost method.
(c) Deferred Catalog Costs
Deferred catalog costs reflected with other current assets, which include
paper, production, printing and postage, are reflected with other current
assets and are amortized in amounts proportionate to revenues over the life of
the catalog, which is approximately one year. Amortization expense related to
deferred catalog costs is included in the statements of income as a component
of selling expenses. Such amortization expense for the year ended March 31,
1999 and the 35-day period ended May 5, 1999 was $25,000 and $1,000,
respectively.
(d) Property and Equipment
Property and equipment are stated at cost less accumulated depreciation.
Maintenance and repairs are expensed as incurred. Depreciation of property and
equipment is calculated using the straight-line method over the estimated
useful lives of the respective assets. The estimated useful lives range from
five to seven years for furniture, fixtures and equipment.
(e) Other Current Assets and Other Assets
Other assets consist of security deposits and prepaid expenses.
(f) Income Taxes
Income taxes are accounted for using the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying
F-54
<PAGE>
EDUCATIONAL PRODUCTS, INC.
Notes to Financial Statements--(Continued)
amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
(g) Revenue Recognition
The Company recognizes revenue from product sales upon the delivery of
products. Provisions for estimated returns and allowances are recorded as a
reduction to sales and cost of sales. The Company has arrangements with certain
customers under which it delivers products on a consignment basis. The Company
records revenue related to these arrangements once the products are sold
through to the end user.
(h) Fair Value of Financial Instruments
The carrying value for cash and cash equivalents, accounts receivable,
short-term debt, accounts payable and notes payable approximate fair value
because of the short-term nature of these instruments. The carrying value of
notes payable approximates their fair values due to variable interest rates.
(i) Use of Estimates in Preparation of Financial Statements
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
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(3) Other Current Assets
Other current assets consist of the following as of March 31, 1999 and May
5, 1999 (in thousands):
<TABLE>
<CAPTION>
March 31, May 5,
1999 1999
--------- ------
<S> <C> <C>
Deferred catalog costs.................................... $135 $134
Other..................................................... 29 23
---- ----
$164 $157
==== ====
</TABLE>
(4) Property and Equipment
A summary of property and equipment as of March 31, 1999 and May 5, 1999 is
as follows (in thousands):
<TABLE>
<CAPTION>
March 31, May 5,
1999 1999
--------- ------
<S> <C> <C>
Machinery and equipment..................................... $ 726 $735
Furniture and fixtures...................................... 87 87
----- ----
813 822
Less accumulated depreciation............................... (537) (545)
----- ----
$ 276 $277
===== ====
</TABLE>
F-55
<PAGE>
EDUCATIONAL PRODUCTS, INC.
Notes to Financial Statements--(Continued)
(5) Accrued Expenses
Accrued expenses consist of the following as of March 31, 1999 and May 5,
1999 (in thousands):
<TABLE>
<CAPTION>
March 31, May 5,
1999 1999
--------- ------
<S> <C> <C>
Employee stock ownership plan payable....................... $310 $--
Employee related accruals................................... 290 274
Other....................................................... 60 165
---- ----
$660 $439
==== ====
</TABLE>
As of May 5, 1999, the Company had established an employee stock ownership
plan ("ESOP"), but it did not own any of the Company's stock. The ESOP was
terminated in conjunction with the acquisition by Earlychildhood.
(6) Line of Credit
The Company has an available a revolving line of credit of $1.5 million.
Borrowings under the line of credit bear interest at the bank's index rate
(currently 8%) plus 0.75%. Borrowings outstanding were $270,000 and $1,500,000
as of March 31, 1999 and May 5, 1999, respectively. The credit facility is
secured by certain assets of the Company. All outstanding borrowings were
repaid on May 5, 1999 in conjunction with the acquisition by Earlychildhood
(Note 1).
(7) Notes Payable
Notes payable consist of the following as of March 31, 1999 and May 5, 1999
(in thousands):
<TABLE>
<CAPTION>
March 31, May 5,
1999 1999
--------- ------
<S> <C> <C>
Note payable to stockholders at prime rate plus 1% (8.75%
at May 5, 1999)......................................... $1,125 $1,125
Note payable to Earlychildhood........................... -- 1,850
------ ------
$1,125 $2,975
====== ======
</TABLE>
The notes to stockholders are considered current as of March 31, 1999 and
May 5, 1999 as they were repaid subsequent to year end (Note 1). The fair value
of the notes approximates the carrying value as of March 31, 1999 and May 5,
1999.
The note payable to Earlychildhood represents amounts advanced to the
Company to be used to pay off the note payable to stockholders (Note 1).
(8) Employee Stock Ownership Plan
The Company has an employee stock ownership program ("ESOP") in which
eligible employees are allowed to participate. Contributions are determined at
the Company's discretion. Contributions during the year ended March 31, 1999
and the 35-day period ended May 5, 1999 amounted to $290,000 and $310,000,
respectively. As of March 31, 1999, no shares were held by the ESOP. The value
of the assets held by the plan amounted to $947,000 and $214,000 as of March
31, 1999 and May 5, 1999, respectively.
F-56
<PAGE>
EDUCATIONAL PRODUCTS, INC.
Notes to Financial Statements--(Continued)
(9) Income Taxes
Income tax expense (benefit) consisted of the following for the year ended
March 31, 1999 and the period ended May 5, 1999 (in thousands):
<TABLE>
<CAPTION>
Current Deferred Total
------- -------- -----
<S> <C> <C> <C>
Year ended March 31, 1999:
Federal.......................................... $(68) $ 217 $ 149
State............................................ 7 29 35
---- ----- -----
$(61) $ 246 $ 184
==== ===== =====
Period ended May 5, 1999:
Federal.......................................... $-- $(142) $(142)
State............................................ 4 (10) (6)
---- ----- -----
$ 4 $(152) $(148)
==== ===== =====
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities as of March
31, 1999 and May 5, 1999 are presented below (in thousands):
<TABLE>
<CAPTION>
Year ended Thirty-five-day
March 31, period ended
1999 May 5, 1999
---------- ---------------
<S> <C> <C>
Deferred income tax assets:
Net operating loss............................ $ 45 $ 222
Allowance for doubtful accounts............... 19 18
Accrued vacation.............................. 31 34
State taxes................................... 32 --
Other......................................... 15 6
----- -----
Deferred tax assets......................... 142 280
Deferred income tax liabilities:
Property and equipment, principally due to
differences in depreciation.................. (51) (49)
Inventory..................................... (886) (874)
----- -----
Net deferred tax asset (liability).......... $(795) $(643)
===== =====
</TABLE>
The Company's management believes that it is more likely than not that its
deferred tax amount will be realized. Accordingly, no valuation allowance has
been established.
The actual income tax expense differs from the "expected" income tax
expense, computed by applying the U.S. federal income statutory tax rate of 34%
to income before income taxes as follows (in thousands):
<TABLE>
<CAPTION>
Year ended Thirty-five-day
March 31, period ended
1999 May 5, 1999
---------- ---------------
<S> <C> <C>
Computed "expected" tax (benefit) expense....... $163 $(120)
Increase resulting from:
State income tax, net of federal income tax
benefit...................................... 23 (4)
Other permanent differences................... (2) (24)
---- -----
$184 $(148)
==== =====
</TABLE>
F-57
<PAGE>
EDUCATIONAL PRODUCTS, INC.
Notes to Financial Statements
The net operating loss represents an interim period loss which will be
offset against taxable income generated by the Company subsequent to the
acquisition by Earlychildhood. The utilization of such interim net operating
losses will not be impacted by the aquisition due to the acquirer's limited
liability company status.
(10) Lease Commitments
The Company leases its facilities and certain equipment under noncancelable
lease agreements which expire at various dates. Future minimum lease payments
under noncancelable operating leases are as follows (in thousands):
<TABLE>
<CAPTION>
Year ended Thirty-five-day
March 31, period ended
1999 May 5, 1999
---------- ---------------
<S> <C> <C>
2000............................................. $ 586 $ 529
2001............................................. 242 242
2002............................................. 242 242
2003............................................. 230 230
2004............................................. 164 164
Thereafter....................................... -- --
------ ------
Total future minimum lease payments under
operating leases.............................. $1,464 $1,407
====== ======
</TABLE>
Total rental expense under operating leases was $605,000 and $39,000 for the
year ended March 31, 1999 and the 35-day period ended May 5, 1999,
respectively.
(11) Legal Proceedings
The Company is involved in litigation arising in the ordinary course of its
business. While the ultimate results of such proceedings cannot be predicted
with certainty, management expects that these matters will not have a material
adverse effect on the Company's financial position or results of operations.
F-58
<PAGE>
ANNEX A
EXECUTION COPY
CONTRIBUTION AGREEMENT AND PLAN OF REORGANIZATION AND
MERGER
BY AND AMONG
EARLYCHILDHOOD.COM, LLC,
SMARTERKIDS.COM, INC.,
S-E EDUCATIONAL HOLDINGS CORP.
AND
S-E EDUCATIONAL MERGER CORP.
----------------
DATED AS OF NOVEMBER 14, 2000
----------------
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<C> <S> <C>
ARTICLE I. THE CONTRIBUTION AND THE MERGER.............................. A-2
Section 1.1 Certificate of Incorporation and Bylaws of Holdings.... A-2
Section 1.2 The Contribution....................................... A-2
Section 1.3 The SmarterKids Merger................................. A-3
Section 1.4 Effective Time......................................... A-3
Section 1.5 Closing................................................ A-3
Section 1.6 Effect of the Contribution............................. A-3
Section 1.7 Effect of the SmarterKids Merger....................... A-3
Section 1.8 Organizational Documents of Earlychildhood............. A-3
Section 1.9 Certificate of Incorporation and Bylaws of the
Surviving Corporation.................................. A-3
Section 1.10 Management of Earlychildhood Following the
Contribution; Directors and Officers of the Surviving
Corporation............................................ A-4
Section 1.11 Earlychildhood Employees............................... A-4
ARTICLE II. EXCHANGE AND CONVERSION OF SECURITIES....................... A-4
Section 2.1 Exchange of LLC Interests of Earlychildhood............ A-4
Section 2.2 Conversion of SmarterKids Capital Stock................ A-4
Section 2.3 Treatment of Outstanding Options, SmarterKids Warrants,
and SmarterKids Employee Stock Purchase Plan........... A-5
Section 2.4 Cancellation of Holdings Common Stock.................. A-6
Section 2.5 Exchange of Certificates............................... A-6
ARTICLE III. REPRESENTATIONS AND WARRANTIES OF EARLYCHILDHOOD........... A-9
Section 3.1 Organization of Earlychildhood......................... A-9
Section 3.2 Earlychildhood Capital Structure....................... A-10
Section 3.3 Authority; No Conflict; Required Filings and Consents.. A-11
Section 3.4 Books and Records...................................... A-12
Section 3.5 Financial Information.................................. A-12
Section 3.6 No Undisclosed Liabilities............................. A-12
Section 3.7 Absence of Certain Changes or Events................... A-12
Section 3.8 Taxes.................................................. A-14
Section 3.9 Properties............................................. A-15
Section 3.10 Intellectual Property.................................. A-15
Section 3.11 Product Warranty and Liability......................... A-17
Section 3.12 Material Contracts..................................... A-17
Section 3.13 Litigation............................................. A-18
Section 3.14 Environmental Matters.................................. A-18
Section 3.15 Employee Benefit Plans................................. A-19
Section 3.16 Compliance With Laws................................... A-21
Section 3.17 Tax Matters............................................ A-21
Section 3.18 Registration Statement; Proxy Statement/Prospectus..... A-21
Section 3.19 Labor Matters.......................................... A-22
Section 3.20 Insurance.............................................. A-22
Section 3.21 No Existing Discussions................................ A-22
Section 3.22 Consent................................................ A-22
Section 3.23 Management Committee Approval.......................... A-22
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Page
----
<C> <S> <C>
ARTICLE IV. REPRESENTATIONS AND WARRANTIES OF SMARTERKIDS................ A-23
Section 4.1 Organization of SmarterKids............................. A-23
Section 4.2 SmarterKids Capital Structure........................... A-23
Section 4.3 Authority; No Conflict; Required Filings and Consents... A-24
Section 4.4 SEC Filings; Financial Statements....................... A-25
Section 4.5 No Undisclosed Liabilities.............................. A-25
Section 4.6 Absence of Certain Changes or Events.................... A-26
Section 4.7 Taxes................................................... A-27
Section 4.8 Properties.............................................. A-28
Section 4.9 Intellectual Property................................... A-28
Section 4.10 Product Warranties and Liability........................ A-29
Section 4.11 Agreements, Contracts and Commitments................... A-30
Section 4.12 Litigation.............................................. A-31
Section 4.13 Environmental Matters................................... A-31
Section 4.14 Employee Benefit Plans.................................. A-31
Section 4.15 Compliance With Laws.................................... A-33
Section 4.16 Tax Matters............................................. A-33
Section 4.17 Registration Statement; Proxy Statement/Prospectus...... A-34
Section 4.18 Labor Matters........................................... A-34
Section 4.19 Insurance............................................... A-34
Section 4.20 Opinion of Financial Advisor............................ A-34
Section 4.21 No Existing Discussions................................. A-34
Section 4.22 Board Recommendation.................................... A-34
Section 4.23 Voting Requirements..................................... A-34
Section 4.24 Section 203 of the DGCL Not Applicable.................. A-35
ARTICLE V. COVENANTS..................................................... A-35
Section 5.1 Conduct of Business..................................... A-35
Section 5.2 Cooperation; Notice; Cure............................... A-37
Section 5.3 No Solicitation......................................... A-37
Section 5.4 No Negotiation.......................................... A-39
Section 5.5 Proxy Statement/Prospectus; Registration Statement...... A-40
Section 5.6 Nasdaq Quotation........................................ A-40
Section 5.7 Access to Information................................... A-40
Section 5.8 SmarterKids Stockholders' Meeting....................... A-41
Section 5.9 Legal Conditions to Merger.............................. A-41
Section 5.10 Earlychildhood Financial Statements..................... A-42
Section 5.11 Public Disclosure....................................... A-42
Section 5.12 Non-recognition Exchange................................ A-42
Section 5.13 Affiliate Agreements.................................... A-42
Section 5.14 Nasdaq Quotation........................................ A-42
Section 5.15 Stock Plans............................................. A-42
Section 5.16 Employee Stock Purchase Plan............................ A-44
Section 5.17 Non-Employee Director Plan.............................. A-44
Section 5.18 Brokers or Finders...................................... A-44
Section 5.19 Indemnification......................................... A-44
Section 5.20 Letter of SmarterKids' Accountants...................... A-45
Section 5.21 Letter of Earlychildhood's Accountants.................. A-45
Section 5.22 Post-Transaction Corporate Governance of Holdings....... A-45
Section 5.23 Name of Holdings........................................ A-46
Section 5.24 Conveyance Taxes........................................ A-46
Section 5.25 SmarterKids Minimum Closing Cash........................ A-46
Section 5.26 Blohm Consulting Agreement.............................. A-46
</TABLE>
- ii -
<PAGE>
<TABLE>
<CAPTION>
Page
----
<C> <S> <C>
ARTICLE VI. CONDITIONS TO THE TRANSACTIONS.............................. A-46
Section 6.1 Conditions to Each Party's Obligation to Effect the
Transactions............................................ A-46
Section 6.2 Additional Conditions to Obligations of Earlychildhood.. A-47
Section 6.3 Additional Conditions to Obligations of SmarterKids..... A-48
ARTICLE VII. TERMINATION AND AMENDMENT.................................. A-49
Section 7.1 Termination............................................. A-49
Section 7.2 Effect of Termination................................... A-50
Section 7.3 Fees and Expenses....................................... A-50
Section 7.4 Amendment............................................... A-51
Section 7.5 Extension; Waiver....................................... A-51
ARTICLE VIII. MISCELLANEOUS A-52
Section 8.1 Nonsurvival of Representations, Warranties and
Agreements.............................................. A-52
Section 8.2 Notices................................................. A-52
Section 8.3 Interpretation.......................................... A-53
Section 8.4 Counterparts............................................ A-53
Section 8.5 Entire Agreement; No Third Party Beneficiaries. A-53
Section 8.6 Governing Law........................................... A-53
Section 8.7 Assignment.............................................. A-53
</TABLE>
- iii -
<PAGE>
EXHIBITS
<TABLE>
<C> <S>
Exhibit A Form of Stockholder Support Agreement
Exhibit B Form of Consent and Non-Contravention Agreement
Exhibit C Form of Lockup Agreement
Exhibit D Form of Registration Rights Agreement
Exhibit E Form of Restated Certificate of Incorporation of Holdings
Exhibit F Form of Amended and Restated Bylaws of Holdings
Exhibit G Form of Second Amended and Restated Operating Agreement
Form of Restated Certificate of Incorporation of Surviving
Exhibit H Corporation
Exhibit I Form of Amended and Restated Bylaws of Surviving Corporation
Exhibit J Form of Affiliate Agreement
Exhibit K Form of Holdings Stock Plan
Exhibit L Form of Holdings Employee Stock Purchase Plan
Exhibit M Form of Holdings Director Plan
Exhibit N Form of Blohm Consulting Agreement
</TABLE>
- iv -
<PAGE>
TABLE OF DEFINED TERMS
<TABLE>
<CAPTION>
Cross Reference in
Terms Agreement
----- ------------------
<S> <C>
Acquisition Proposal......................................... Section 5.3(a)
Affiliate.................................................... Section 5.13
Affiliate Agreement.......................................... Section 5.13
Agreement.................................................... Preamble
Bankruptcy and Equity Exception.............................. Section 3.3(a)
Benefit Arrangements......................................... Section 3.15(a)
Breaching Party.............................................. Section 7.3(b)
Certificates................................................. Section 2.5(b)(ii)
Class A Exchange Ratio....................................... Section 2.1
Class B Exchange Ratio....................................... Section 2.1
Class C Exchange Ratio....................................... Section 2.1
Closing...................................................... Section 1.5
Closing Date................................................. Section 1.5
Code......................................................... Recitals
Confidentiality Agreements................................... Section 5.7
Consent Agreement............................................ Recitals
Contribution................................................. Recitals
Conveyance Taxes............................................. Section 5.24
Costs........................................................ Section 5.19(a)
Current Premium.............................................. Section 5.19(b)
DGCL......................................................... Recitals
Earlychildhood............................................... Preamble
Earlychildhood Acquisition Proposal.......................... Section 5.4(a)
Earlychildhood Balance Sheet................................. Section 3.5
Earlychildhood Change of Control Arrangements................ Section 3.15(f)
Earlychildhood Confidentiality Agreement..................... Section 5.3(b)
Earlychildhood Director...................................... Section 5.22(a)
Earlychildhood Disclosure Schedule........................... ARTICLE III
Earlychildhood Employee Plans................................ Section 3.15(a)
Earlychildhood ERISA Affiliate............................... Section 3.15(c)(i)
Earlychildhood Exchange Ratio................................ Section 2.1
Earlychildhood Financial Information......................... Section 3.5
Earlychildhood Intellectual Property......................... Section 3.10(a)
Earlychildhood Lease Agreements.............................. Section 3.9(a)
Earlychildhood Material Adverse Change....................... Section 3.7
Earlychildhood Material Adverse Effect....................... Section 3.1
Earlychildhood Material Contracts............................ Section 3.12(b)
Earlychildhood Option........................................ Section 2.3(a)
Earlychildhood Option Plans.................................. Section 2.3(a)
Earlychildhood Organizational Documents...................... Section 3.3(b)
Earlychildhood Owned Real Property........................... Section 3.9(a)
Earlychildhood Permitted Encumbrances........................ Section 3.9(a)
Earlychildhood Third Party Rights............................ Section 3.10(e)
Effective Time............................................... Section 1.4
Employee Benefit Plans....................................... Section 3.15(a)
Encumbrance ................................................. Section 3.2(a)
Environmental Law ........................................... Section 3.14(b)
ERISA ....................................................... Section 3.15(a)
</TABLE>
- v-
<PAGE>
<TABLE>
<CAPTION>
Cross Reference in
Terms Agreement
----- ------------------
<S> <C>
ESPP Termiation Date ........................................ Section 2.3(d)
Exchange Act ................................................ Section 4.3(c)
Exchange Agent .............................................. Section 2.5(a)
Exchange Fund ............................................... Section 2.5(a)
Executive Management Agreement .............................. Section 3.12(e)
Expenses .................................................... Section 7.3(b)
Final SmarterKids Purchase Date ............................. Section 2.3(d)
Fund ........................................................ Section 3.3(c)
GAAP ........................................................ Section 3.5
Governmental Entity ......................................... Section 3.3(c)
Hazardous Substance ......................................... Section 3.14(c)
Holdings..................................................... Preamble
Holdings Common Stock........................................ Recitals
Holdings Director Plan....................................... Section 5.17
Holdings Employee Stock Purchase Plan........................ Section 5.16(a)
Holdings Material Adverse Effect............................. Section 6.1(f)
Holdings Stock Plan.......................................... Section 5.15(f)
HSR Act...................................................... Section 3.3(c)
Indemnified Parties.......................................... Section 5.19(a)
Independent Director......................................... Section 5.22(a)
IRS.......................................................... Section 3.8(b)
LLC Certificates............................................. Section 2.5(b)(i)
LLC Interests................................................ Section 1.2
Lockup Agreement............................................. Recitals
Members...................................................... Section 3.2(a)
Merger Sub................................................... Preamble
Minimum Closing Cash......................................... Section 5.25
Operating Agreement.......................................... Section 1.2
Order........................................................ Section 5.9(b)
Other Party.................................................. Section 5.4(a)
Outside Date................................................. Section 7.1(b)
Proxy Statement/Prospectus................................... Section 3.18
Registration Rights Agreement................................ Recitals
Registration Statement....................................... Section 3.18
Rule 145..................................................... Section 5.13
SEC.......................................................... Section 3.18
Second Amended and Restated Operating Agreement.............. Section 1.8
Stockholder Support Agreement................................ Recitals
Subsidiary................................................... Section 3.1
Superior Proposal............................................ Section 5.3(b)
Surviving Corporation........................................ Section 1.7
SmarterKids.................................................. Preamble
SmarterKids Balance Sheet.................................... Section 4.4(c)
SmarterKids Certificate of Merger............................ Section 1.4
SmarterKids Certificates..................................... Section 2.5(b)(ii)
SmarterKids Change of Control Agreements..................... Section 4.14(f)
SmarterKids Common Stock..................................... Section 1.3
SmarterKids Confidentiality Agreement........................ Section 5.7
SmarterKids Director......................................... Section 5.22(a)
SmarterKids Disclosure Schedule.............................. ARTICLE IV
</TABLE>
- vi -
<PAGE>
<TABLE>
<CAPTION>
Cross Reference in
Terms Agreement
----- ------------------
<S> <C>
SmarterKids Employee Plans................................... Section 4.14(a)
SmarterKids Employee Stock Purchase Plan..................... Section 2.3(d)
SmarterKids ERISA Affiliate.................................. Section 4.14(c)(i)
SmarterKids Exchange Ratio................................... Section 2.2(c)
SmarterKids Intellectual Property............................ Section 4.9(a)
SmarterKids Lease Agreements................................. Section 4.8(a)
SmarterKids Material Adverse Change.......................... Section 4.6
SmarterKids Material Adverse Effect.......................... Section 4.1
SmarterKids Material Contracts............................... Section 4.11(b)
SmarterKids Merger........................................... Recitals
SmarterKids Organizational Documents......................... Section 4.3(b)
SmarterKids Permitted Encumbrances........................... Section 4.8(a)
SmarterKids Preferred Stock.................................. Section 4.2(a)
SmarterKids SEC Reports...................................... Section 4.4(a)
SmarterKids Stock Option..................................... Section 2.3(b)
SmarterKids Stock Plans...................................... Section 4.2(a)
SmarterKids Stockholders' Meeting............................ Section 3.18
SmarterKids Third Party Rights............................... Section 4.9(e)
SmarterKids Warrants......................................... Section 4.2(a)
Tax.......................................................... Section 3.8(a)
Taxes........................................................ Section 3.8(a)
Termination Fee.............................................. Section 7.3(c)
Third Party.................................................. Section 5.3(a)
Transaction Documents........................................ Section 3.3(a)
Transactions................................................. Section 1.3
Transfer Documents........................................... Section 2.5(b)(i)
</TABLE>
- vii -
<PAGE>
CONTRIBUTION AGREEMENT AND PLAN OF REORGANIZATION AND MERGER
CONTRIBUTION AGREEMENT AND PLAN OF REORGANIZATION AND MERGER (the
"Agreement"), dated as of November 14, 2000 by and among EARLYCHILDHOOD.COM,
LLC, a California limited liability corporation ("Earlychildhood"),
SMARTERKIDS.COM, INC., a Delaware corporation ("SmarterKids"), S-E EDUCATIONAL
HOLDINGS CORP., a newly-formed Delaware corporation, one-half of the issued and
outstanding capital stock of which is owned by each of Earlychildhood and
SmarterKids ("Holdings") and S-E EDUCATIONAL MERGER CORP., a newly-formed
Delaware corporation and a wholly-owned subsidiary of Holdings ("Merger Sub").
WHEREAS, the Management Committee of Earlychildhood and the Board of
Directors of SmarterKids deem it advisable and in the best interests of each
corporation and its members or stockholders, as the case may be, in order to
advance the long-term business interests of Earlychildhood and SmarterKids,
that Earlychildhood and SmarterKids combine;
WHEREAS, the combination of Earlychildhood and SmarterKids shall be effected
through (i) the contribution to Holdings by the holders of all outstanding LLC
Interests (as defined in Section 1.2) of all of the right, title and interest
in and to their entire ownership interest in Earlychildhood (the
"Contribution") such that Earlychildhood will become a wholly-owned subsidiary
of Holdings and the holders of LLC Interests in Earlychildhood will become
stockholders of Holdings, and (ii) the merger of Merger Sub with and into
SmarterKids (the "SmarterKids Merger") such that SmarterKids becomes a wholly-
owned subsidiary of Holdings and the holders of capital stock of SmarterKids
become stockholders of Holdings;
WHEREAS, concurrently with the execution and delivery of this Agreement and
as a condition and inducement to Earlychildhood's willingness to enter into
this Agreement, certain stockholders of SmarterKids have entered into a
Stockholder Support Agreement with Earlychildhood, dated as of the date hereof,
substantially in the form attached hereto as Exhibit A (the "Stockholder
Support Agreement"), pursuant to which such stockholders have agreed, among
other things, to vote all voting securities of SmarterKids beneficially owned
by them in favor of approval and adoption of this Agreement and the SmarterKids
Merger;
WHEREAS, concurrently with the execution and delivery of this Agreement and
as a condition and inducement to SmarterKids' willingness to enter into this
Agreement, the holders of all outstanding LLC Interests in Earlychildhood have
entered into a Consent and Non-Contravention Agreement, dated as of the date
hereof, substantially in the form attached hereto as Exhibit B (the "Consent
Agreement"), pursuant to which such persons have agreed, among other things, to
(i) effect the Contribution upon the terms and subject to the conditions set
forth herein and (ii) take no action, directly or indirectly, to contravene,
supersede or modify their consent in favor of this Agreement and the
Contribution or to cause Earlychildhood to take any action in contravention of
this Agreement or the transactions contemplated hereby;
WHEREAS, concurrently with the execution and delivery of this Agreement and
as a condition and inducement to Earlychildhood's and SmarterKids' willingness
to enter into this Agreement, certain holders of LLC Interests in
Earlychildhood and certain stockholders of SmarterKids have entered into a
Lockup Agreement, dated as of the date hereof, substantially in the form
attached hereto as Exhibit C (the "Lockup Agreement"), pursuant to which such
persons have agreed, among other things, not to sell the shares of Holdings
Common Stock (as defined below) such persons receive in connection with the
Transactions (as defined in Section 1.3) until the earlier to occur of (i) 180
days from the Effective Time (as defined in Section 1.4) and (ii) the date upon
which a secondary offering of Holdings Common Stock for the purposes of
effecting the orderly sale of such shares has been consummated;
WHEREAS, concurrently with the execution and delivery of this Agreement and
as a condition and inducement to Earlychildhood's and SmarterKids' willingness
to enter into this Agreement, Holdings has entered into a Registration Rights
Agreement, dated as of the date hereof, substantially in the form attached
hereto as Exhibit D (the "Registration Rights Agreement") with certain Holders
(as defined in the Registration
A-1
<PAGE>
Rights Agreement) of common stock, par value $0.01 per share of Holdings (the
"Holdings Common Stock"), which Registration Rights Agreement will govern the
resale registration by Holdings, for the benefit of the Holders, of shares of
Holdings Common Stock received by such Holders in the Transactions;
WHEREAS, for Federal income tax purposes, it is intended that (i) the
Contribution shall qualify as a transfer of property to Holdings by holders of
LLC Interests described in Section 351 of the Internal Revenue Code of 1986, as
amended (the "Code"), and (ii) the SmarterKids Merger shall qualify as a
reorganization described in Section 368(a) of the Code and, taken together with
the Contribution, as a transfer of property to Holdings by holders of
SmarterKids capital stock described in Section 351 of the Code; and
WHEREAS, the Management Committee of Earlychildhood and the Board of
Directors of SmarterKids have approved this Agreement and each of the
Transaction Documents (as defined in Section 3.3(a)) to which its company is a
party;
WHEREAS, no further action on the part of the Management Committee of
Earlychildhood is required to effect the transactions contemplated hereby;
WHEREAS, the holders of LLC Interests have approved this Agreement and the
Contribution and no further action on the part of the holders of LLC Interests
is required to effect the transactions contemplated hereby;
WHEREAS, under the Delaware General Corporation Law (the "DGCL"), in order
to effect the SmarterKids Merger, SmarterKids is required to obtain the vote of
the holders of a majority of the outstanding shares of SmarterKids capital
stock to approve this Agreement; and
WHEREAS, Earlychildhood, SmarterKids and Holdings desire to make certain
representations, warranties, covenants and agreements in connection with the
combination and also to prescribe various conditions to the combination.
NOW, THEREFORE, in consideration of the foregoing and the respective
representations, warranties, covenants and agreements set forth below, the
parties agree as follows:
ARTICLE I.
THE CONTRIBUTION AND THE MERGER
Section 1.1 Certificate of Incorporation and Bylaws of Holdings. The
Certificate of Incorporation and Bylaws of Holdings shall be amended prior to
the Effective Time to be substantially in the form of Exhibit E and Exhibit F
attached hereto, respectively. From the date hereof until the Effective Time,
Earlychildhood and SmarterKids shall consult with each other prior to causing
or permitting Holdings to take any action and neither shall cause or permit
Holdings to take any action inconsistent with the provisions of this Agreement
without the written consent of the other.
Section 1.2 The Contribution. Upon the terms and subject to the provisions
of this Agreement, at the Effective Time, each holder of an outstanding
membership interest in Earlychildhood (such membership interests (other than
Earlychildhood Options (as defined below) and membership interests issuable
upon conversion of Earlychildhood Options) being collectively referred to
herein as the "LLC Interests") shall contribute to Holdings all of the right,
title and interest in and to such holder's entire ownership interest in
Earlychildhood, which ownership interest, in each case, is set forth next to
the name of such person in the Earlychildhood Disclosure Schedule (as defined
in Article III), and in exchange therefor (as described in Section 2.1), (i)
each holder of LLC Interests which is a Class A Member (as defined in that
certain Amended and Restated Operating Agreement of Earlychildhood dated as of
May 5, 1999 (the "Operating Agreement")) shall be entitled to receive 4.9951
shares of Holdings Common Stock for each .00001% of an LLC Interest
A-2
<PAGE>
held in such capacity, (ii) each holder of an LLC Interest which is a Class B
Member (as defined in the Operating Agreement) shall be entitled to receive
4.6781 shares of Holdings Common Stock for each .00001% of an LLC Interest held
in such capacity, and (iii) each holder of an LLC Interest which is a Class C
Member (as defined in the Operating Agreement) shall be entitled to receive
2.3365 shares of Holdings Common Stock for each .00001% of an LLC Interest held
in such capacity. At the Effective Time, the Operating Agreement shall be
amended and restated to provide that Holdings shall be the sole member of
Earlychildhood, holding a single class of membership interests.
Section 1.3 The SmarterKids Merger. Earlychildhood and SmarterKids shall
cause Holdings to form Merger Sub under the laws of the State of Delaware.
Earlychildhood and SmarterKids shall cause Holdings to cause Merger Sub to
execute and deliver this Agreement. Upon the terms and subject to the
provisions of this Agreement, and in accordance with the DGCL, Merger Sub shall
merge with and into SmarterKids at the Effective Time, and each outstanding
share of common stock, par value $.01 per share, of SmarterKids ("SmarterKids
Common Stock") shall be converted into the right to receive one (1) share of
Holdings Common Stock (as described in Section 2.2(c)). Merger Sub will be
formed solely to facilitate the SmarterKids Merger and will conduct no business
or activity other than in connection with the SmarterKids Merger. The
SmarterKids Merger, together with the Contribution, collectively constitute the
"Transactions."
Section 1.4 Effective Time. Subject to, and consistent with, the provisions
of this Agreement, a certificate of merger (the "SmarterKids Certificate of
Merger") with respect to the SmarterKids Merger in such form as is required by
the relevant provisions of the DGCL shall be duly prepared, executed and
acknowledged and thereafter delivered to the Secretary of State of the State of
Delaware for filing, as provided in the DGCL, as early as practicable on the
Closing Date. The SmarterKids Merger shall become effective upon the filing of
the SmarterKids Certificate of Merger with the Secretary of State of the State
of Delaware or such later time as may be specified therein. The time at which
the Contribution has been consummated and the SmarterKids Merger has become
fully effective is hereinafter referred to as the "Effective Time."
Section 1.5 Closing. The closing of the Transactions (the "Closing") will
take place at 10:00 a.m., Eastern Standard Time, on a date to be specified by
SmarterKids and Earlychildhood, which shall be no later than the third business
day after satisfaction or, if permissible, waiver of the conditions set forth
in Article VI (the "Closing Date"), at the offices of Latham & Watkins, 633
West Fifth Street, Suite 4000 Los Angeles, California 90071, unless another
date, place or time is agreed to in writing by SmarterKids and Earlychildhood.
Section 1.6 Effect of the Contribution. As a result of the Contribution, (i)
Holdings shall become the sole member of Earlychildhood and shall have all of
the rights, benefits and obligations set forth in the Second Amended and
Restated Operating Agreement (as defined in Section 1.8) and (ii)
Earlychildhood will become a wholly-owned subsidiary of Holdings.
Section 1.7 Effect of the SmarterKids Merger. As a result of the SmarterKids
Merger, the separate corporate existence of Merger Sub shall cease and
SmarterKids shall continue as the surviving corporation (the "Surviving
Corporation"). Upon becoming effective, the SmarterKids Merger shall have the
effects set forth in the DGCL. Without limiting the generality of the
foregoing, and subject thereto, at the Effective Time, all properties, rights,
privileges, powers and franchises of SmarterKids and Merger Sub shall vest in
the Surviving Corporation, and all debts, liabilities and duties of SmarterKids
and Merger Sub shall become the debts, liabilities and duties of the Surviving
Corporation.
Section 1.8 Organizational Documents of Earlychildhood. At the Effective
Time, the Operating Agreement shall be amended and restated in substantially
the form attached hereto as Exhibit G to provide that Holdings shall be the
sole member of Earlychildhood upon consummation of the Contribution holding a
single class of membership interests (as so amended and restated, the "Second
Amended and Restated Operating Agreement").
Section 1.9 Certificate of Incorporation and Bylaws of the Surviving
Corporation. At the Effective Time, the Certificate of Incorporation and Bylaws
of the Surviving Corporation shall be amended and restated
A-3
<PAGE>
as set forth in Exhibit H and Exhibit I attached hereto, respectively, in each
case until duly amended in accordance with applicable law.
Section 1.10 Management of Earlychildhood Following the Contribution;
Directors and Officers of the Surviving Corporation.
(a) Management of Earlychildhood. At the Effective Time (after giving effect
to the Contribution), Earlychildhood shall be managed in accordance with the
provisions of the Second Amended and Restated Operating Agreement.
(b) Directors and Officers of the Surviving Corporation. The directors and
officers of SmarterKids immediately prior to the Effective Time shall be the
initial directors and officers of the Surviving Corporation, each to hold
office in accordance with the Certificate of Incorporation and Bylaws of the
Surviving Corporation.
Section 1.11 Earlychildhood Employees. At the Effective Time, all of the
employees of Earlychildhood shall be transferred to Holdings and, from and
after the Effective Time, shall be employees of Holdings. Such transferred
employees shall serve Holdings in the same capacity or capacities as they
served Earlychildhood prior to the Effective Time. Each of the parties hereto
shall take all actions necessary to effect the provisions of this Section 1.11.
ARTICLE II.
EXCHANGE AND CONVERSION OF SECURITIES
Section 2.1 Exchange of LLC Interests of Earlychildhood. At the Effective
Time, subject to Section 2.5(e), (i) each .00001% of an LLC Interest then
outstanding and owned by a holder of LLC Interests which is a Class A Member in
such capacity shall, by virtue of the Contribution, be exchanged for 4.9951
shares of Holdings Common Stock (the "Class A Exchange Ratio"), (ii) each
.00001% of an LLC Interest then outstanding and owned by a holder of LLC
Interests which is a Class B Member in such capacity shall, by virtue of the
Contribution, be exchanged for 4.6781 shares of Holdings Common Stock (the
"Class B Exchange Ratio"), and (iii) each .00001% of an LLC Interest then
outstanding and owned by a holder of LLC Interests which is a Class C Member in
such capacity shall, by virtue of the Contribution, be exchanged for 2.3365
shares of Holdings Common Stock (the "Class C Exchange Ratio" and, collectively
with the Class A Exchange Ratio and the Class B Exchange Ratio, the
"Earlychildhood Exchange Ratio"). Upon such Contribution, all such LLC
Interests shall be transferred in full, together with all right, title and
interest in and to such LLC Interests, to Holdings and each person who was
formerly a holder of an LLC Interest shall cease to have any rights with
respect thereto, except the right to receive the shares of Holdings Common
Stock and any cash in lieu of fractional shares of Holdings Common Stock to be
issued or paid in consideration therefor, without interest thereon.
Section 2.2 Conversion of SmarterKids Capital Stock. At the Effective Time,
by virtue of the SmarterKids Merger and without any action on the part of any
of the parties hereto or the holders of any shares of SmarterKids Common Stock
or capital stock of Merger Sub:
(a) Capital Stock of Merger Sub. Each issued and outstanding share of
the capital stock of Merger Sub shall be converted into and become one
fully paid and nonassessable share of common stock, par value $.01 per
share, of the Surviving Corporation.
(b) Cancellation of Treasury Stock. All shares of SmarterKids Common
Stock that are owned by SmarterKids (including treasury stock) shall be
canceled and retired and shall cease to exist and no shares of Holdings
Common Stock or other consideration shall be delivered in exchange
therefor.
(c) Exchange Ratio for SmarterKids Common Stock. Subject to Section
2.5(e), each issued and outstanding share of SmarterKids Common Stock
(other than shares to be canceled in accordance with
A-4
<PAGE>
Section 2.2(b)) shall be converted into the right to receive one (1) share
of Holdings Common Stock (the "SmarterKids Exchange Ratio"). All such
shares of SmarterKids Common Stock, when so converted, shall no longer be
outstanding and shall automatically be cancelled and retired and shall
cease to exist, and each holder of a certificate representing any such
shares shall cease to have any rights with respect thereto, except the
right to receive the shares of Holdings Common Stock and any cash in lieu
of fractional shares of Holdings Common Stock to be issued or paid in
consideration therefor, in each case upon the surrender of such certificate
in accordance with Section 2.5 and without interest thereon.
Section 2.3 Treatment of Outstanding Options, SmarterKids Warrants, and
SmarterKids Employee Stock Purchase Plan.
(a) Earlychildhood Options. At the Effective Time, each outstanding option
to purchase LLC Interests (an "Earlychildhood Option") under any option plans
of Earlychildhood in effect on the date hereof (the "Earlychildhood Option
Plans"), whether vested or unvested, shall be deemed to constitute an option to
acquire, on substantially the same terms and conditions as were applicable
under such Earlychildhood Option the same number of shares of Holdings Common
Stock as the holder of such Earlychildhood Option would have been entitled to
receive pursuant to the Contribution had such holder exercised such option in
full immediately prior to the Effective Time (rounded down to the nearest whole
number), at a price per share (rounded up to the nearest whole cent) equal to
(x) the aggregate exercise price for the LLC Interests purchasable pursuant to
such Earlychildhood Option immediately prior to the Effective Time divided by
(y) the number of full shares of Holdings Common Stock deemed purchasable
pursuant to such Earlychildhood Option in accordance with the foregoing. Prior
to the Effective Time, Earlychildhood shall make any such amendments to the
terms of the Earlychildhood Option Plans that are necessary to give effect to
the transactions contemplated by this Section 2.3(a) and to make such
Earlychildhood Option Plans and the provisions thereof consistent with option
plans customary for public companies.
(b) SmarterKids Stock Options. At the Effective Time, each outstanding
option to purchase shares of SmarterKids Common Stock (a "SmarterKids Stock
Option") under the SmarterKids Stock Plans (as defined in Section 4.2(a)),
whether vested or unvested, shall be deemed to constitute an option to acquire,
on the same terms and conditions as were applicable under such SmarterKids
Stock Option the same number of shares of Holdings Common Stock as the holder
of such SmarterKids Stock Option would have been entitled to receive pursuant
to the SmarterKids Merger had such holder exercised such option in full
immediately prior to the Effective Time (rounded down to the nearest whole
number), at a price per share (rounded up to the nearest whole cent) equal to
(x) the aggregate exercise price for the shares of SmarterKids Common Stock
purchasable pursuant to such SmarterKids Stock Option immediately prior to the
Effective Time divided by (y) the number of full shares of Holdings Common
Stock deemed purchasable pursuant to such SmarterKids Stock Option in
accordance with the foregoing. Prior to the Effective Time, SmarterKids shall
make any such amendments to the terms of the SmarterKids Stock Plans that are
necessary to give effect to the transactions contemplated by this Section
2.3(b). It is the intention of the parties that any SmarterKids Stock Options
that are "incentive stock options" within the meaning of Section 422 of the
Code and which are converted into options to acquire Holdings Common Stock
pursuant to this Section 2.3(b) qualify following the Effective Time as
incentive stock options. Such adjustments pursuant to this Section 2.3(b) are
intended to be effective in a manner which is consistent with Section 424(a) of
the Code.
(c) SmarterKids Warrants. At the Effective Time, each SmarterKids Warrant
(as defined in Section 4.2(a)) shall thereafter represent solely the right to
acquire, on substantially the terms and conditions as are currently applicable
under the SmarterKids Warrants, the same number of shares of Holdings Common
Stock as a holder of the SmarterKids Warrants would have been entitled to
receive pursuant to the SmarterKids Merger had such holder exercised such
SmarterKids Warrants in full immediately prior to the Effective Time (rounded
down to the nearest whole number), at the price per share (rounded up to the
nearest whole cent) equal to (x) the aggregate exercise price for the shares of
SmarterKids Common Stock purchasable pursuant to the SmarterKids Warrants
immediately prior to the Effective Time divided by (y) the number of full
shares of Holdings Common Stock deemed purchasable pursuant to the SmarterKids
Warrants in accordance with the
A-5
<PAGE>
foregoing. Prior to the Effective Time, SmarterKids shall make any such
amendments to the terms of the SmarterKids Warrants that are necessary to give
effect to the transactions contemplated by this Section 2.3(c).
(d) SmarterKids Employee Stock Purchase Plan.
(i) In the event that the current "payment period" (as such term is used
in the 1999 Employee Stock Purchase Plan of SmarterKids (the "SmarterKids
Employee Stock Purchase Plan")), in effect as of the date of this
Agreement, ends prior to the Effective Time, SmarterKids shall use its
reasonable best efforts to terminate the SmarterKids Employee Stock
Purchase Plan, subject to Section 2.3(d)(iii) below, as of the date that
the current payment period ends (the "ESPP Termination Date").
(ii) In the event that the Effective Time occurs on or prior to the end
of the current payment period in effect as of the date of this Agreement,
SmarterKids shall use its reasonable best efforts, to the extent permitted
by law and the provisions of the SmarterKids Employee Stock Purchase Plan,
including any amendment provisions thereof, to cause the exercise date
applicable to the current payment period to be the last trading day on
which the shares of SmarterKids Common Stock are traded on Nasdaq
immediately prior to the Effective Time (the "Final SmarterKids Purchase
Date"); provided, that, such change in the Final SmarterKids Purchase Date
will be conditioned upon the consummation of the SmarterKids Merger.
Subject to Section 2.3(d)(iii) below, SmarterKids shall use its reasonable
best efforts to terminate the SmarterKids Employee Stock Purchase Plan
immediately after the Final SmarterKids Purchase Date and prior to the
Effective Time.
(iii) On the occurrence of either the ESPP Termination Date or the Final
SmarterKids Purchase Date, as the case may be, SmarterKids shall apply the
funds credited as of such date under the SmarterKids Employee Stock
Purchase Plan within each participant's payroll withholdings account to the
purchase of whole shares of SmarterKids Common Stock in accordance with the
terms of the SmarterKids Employee Stock Purchase Plan. The cost to each
participant in the SmarterKids Employee Stock Purchase Plan for shares of
SmarterKids Common Stock will be the lower of 85% of the average market
price of SmarterKids Common Stock on Nasdaq on (A) the first day of the
then current offering period or (B) the ESPP Termination Date or the Final
SmarterKids Purchase Date, as the case may be. No fractional shares of
SmarterKids Common Stock shall be issued and any payroll withholdings not
used to purchase fractional shares of SmarterKids Common Stock will be
refunded, without interest to the participant.
(iv) It is the intention of the parties that notwithstanding anything
contained in this Agreement, the exercise price, the number of shares
purchasable and the terms and conditions applicable to any adjustments to
the SmarterKids Employee Stock Purchase Plan and any employee stock
purchase plan maintained by Holdings will be determined so as to comply
with Sections 423 and 424 of the Code and the regulations promulgated
thereunder such that the arrangement implemented under the SmarterKids
Employee Stock Purchase Plan by reason of the SmarterKids Merger not
constitute a "modification."
Section 2.4 Cancellation of Holdings Common Stock. At the Effective Time, by
virtue of the Transactions and without any action on the part of any holder of
any LLC Interest or any holder of capital stock of SmarterKids or Holdings,
each share of Holdings Common Stock issued and outstanding immediately prior to
the Effective Time shall be canceled, and no consideration shall be delivered
in exchange therefor.
Section 2.5 Exchange of Certificates. The procedures for exchanging LLC
Interests and shares of SmarterKids Common Stock outstanding immediately prior
to the Effective Time for shares of Holdings Common Stock in the Transactions
are as follows:
(a) Exchange Agent. As of the Effective Time, Holdings shall deposit
with a bank or trust company designated by SmarterKids and Earlychildhood
(the "Exchange Agent"), for the benefit of the holders of LLC Interests
outstanding immediately prior to the Effective Time and the holders of
shares of SmarterKids Common Stock outstanding immediately prior to the
Effective Time, for exchange in accordance with this Section 2.5, through
the Exchange Agent, certificates representing the shares of Holdings Common
Stock issuable pursuant to Sections 2.1 and 2.2 in exchange for outstanding
LLC
A-6
<PAGE>
Interests and outstanding shares of SmarterKids Common Stock, respectively
(such shares of Holdings Common Stock, together with any dividends or
distributions with respect thereto, and any cash in lieu of fractional
shares of Holdings Common Stock being hereinafter referred to as the
"Exchange Fund").
(b) Exchange Procedures.
(i) At the Effective Time, each holder of an LLC Interest shall deliver
to the Exchange Agent, or to such other agent or agents (including
Holdings) as may be appointed by Holdings, (A) documentation reasonably
satisfactory to the Exchange Agent or Holdings evidencing the transfer of
the LLC Interests to Holdings (the "Transfer Documents"), which Transfer
Documents shall include, to the extent previously issued by Earlychildhood,
certificates evidencing the LLC Interests (the "LLC Certificates") and
(B) instructions for effecting the exchange of such LLC Interests for
certificates evidencing shares of Holdings Common Stock (plus cash in lieu
of fractional shares, if any, of Holdings Common Stock as provided below)
in accordance with Section 2.1. Upon delivery of the Transfer Documents,
duly endorsed, to the Exchange Agent or to such other agent or agents
(including Holdings) as may be appointed by Holdings, such holders of LLC
Interests shall be entitled to receive in exchange therefor, certificates
representing the number of whole shares of Holdings Common Stock which such
holder has the right to receive pursuant to the provisions of this Article
II and any cash in lieu of fractional shares, if any, of Holdings Common
Stock.
(ii) As soon as reasonably practicable after the Effective Time, the
Exchange Agent shall mail to each holder of record of a certificate or
certificates which immediately prior to the Effective Time represented
outstanding shares of SmarterKids Common Stock (the "SmarterKids
Certificates" and, together with the LLC Certificates, the "Certificates")
whose shares were converted pursuant to Section 2.2 into the right to
receive shares of Holdings Common Stock, (A) a letter of transmittal (which
shall specify that delivery shall be effected, and risk of loss and title
to the SmarterKids Certificates shall pass, only upon delivery of the
SmarterKids Certificates to the Exchange Agent and shall be in such form
and have such other provisions as Earlychildhood and SmarterKids may
reasonably specify), and (B) instructions for effecting the surrender of
the SmarterKids Certificates in exchange for certificates representing
shares of Holdings Common Stock (plus cash in lieu of fractional shares, if
any, of Holdings Common Stock as provided below). Upon surrender of a
SmarterKids Certificate for cancellation to the Exchange Agent or to such
other agent or agents (including Holdings) as may be appointed by Holdings,
together with such letter of transmittal, duly executed, the holder of such
SmarterKids Certificate shall be entitled to receive in exchange therefor a
certificate representing that number of whole shares of Holdings Common
Stock which such holder has the right to receive pursuant to the provisions
of this Article II, and any cash in lieu of fractional shares, if any, of
Holdings Common Stock, and the SmarterKids Certificate so surrendered shall
immediately be canceled.
(iii) In the event of a transfer of ownership of LLC Interests or
SmarterKids Common Stock prior to the Effective Time which is not
registered in the transfer records of Earlychildhood or SmarterKids,
respectively, a certificate representing the proper number of shares of
Holdings Common Stock may be issued to a transferee if the Transfer
Documents for such LLC Interests or the SmarterKids Certificate
representing such SmarterKids Common Stock, as applicable, is presented to
the Exchange Agent, or such other agent or agents as may be appointed by
Holdings (including Holdings), accompanied by all documents required to
evidence and effect such transfer and by evidence that any applicable stock
transfer taxes have been paid.
(iv) Immediately after the Effective Time, (A) all LLC Interests shall
have been delivered (or, in the absence of certificated LLC Interests,
shall be deemed to have been delivered) to the Exchange Agent (or to such
other agent or agents (including Holdings) as may be appointed by Holdings,
and exchanged for shares of Holdings Common Stock in accordance with the
provisions set forth in subsection (i) above and (B) each outstanding
SmarterKids Certificate which theretofore represented shares of SmarterKids
Common Stock shall represent only the right to receive shares of Holdings
Common Stock pursuant to the terms hereof and shall not be deemed to
evidence ownership of the number of shares of Holdings
A-7
<PAGE>
Common Stock into which such shares of SmarterKids Common Stock would be or
were, as the case may be, converted until the SmarterKids Certificate
therefor shall have been surrendered in accordance with this Section 2.5.
(c) Distributions With Respect to Unexchanged Interests or Shares. No
dividends or other distributions declared or made after the Effective Time with
respect to Holdings Common Stock with a record date after the Effective Time
shall be paid to the holder of any uncontributed LLC Interest or unsurrendered
SmarterKids Certificate with respect to the shares of Holdings Common Stock the
holder thereof is entitled to receive in respect thereof and no cash payment in
lieu of fractional shares shall be paid to any such holder pursuant to
subsection (e) below until the holder of record of such LLC Interests or
SmarterKids Certificate shall contribute such LLC Interest as described in
subsection (b)(i) above or surrender such SmarterKids Certificate as described
in subsection (b)(ii) above, as applicable. Subject to the effect of applicable
laws, following the contribution of any such LLC Interest or surrender of any
such SmarterKids Certificate, there shall be paid to the record holder of the
certificates representing whole shares of Holdings Common Stock issued in
exchange therefor, without interest, (i) at the time of such contribution or
surrender, as applicable, the amount of any cash payable in lieu of a
fractional share of Holdings Common Stock to which such holder is entitled
pursuant to subsection (e) below and the amount of dividends or other
distributions with a record date after the Effective Time previously paid with
respect to such whole shares of Holdings Common Stock, and (ii) at the
appropriate payment date, the amount of dividends or other distributions with a
record date after the Effective Time but prior to surrender and a payment date
subsequent to surrender payable with respect to such whole shares of Holdings
Common Stock.
(d) No Further Ownership Rights in LLC Interests and SmarterKids Common
Stock. All shares of Holdings Common Stock issued upon the delivery of the
Transfer Documents and/or surrender for exchange of the SmarterKids
Certificates, as applicable, in accordance with the terms hereof (including any
cash paid pursuant to subsection (c) or (e) of this Section 2.5) shall be
deemed to have been issued in full satisfaction of all rights pertaining to the
LLC Interests so contributed or to the shares of SmarterKids Common Stock
theretofore represented by such SmarterKids Certificates, as applicable, and
from and after the Effective Time there shall be no further registration of
transfers on the stock transfer books of the Surviving Corporation of the
shares of SmarterKids Common Stock which were outstanding immediately prior to
the Effective Time or registration of transfers on the ownership records of
Earlychildhood of LLC Interests held by holders thereof immediately prior to
the Effective Time. If, after the Effective Time, SmarterKids Certificates are
presented to the Surviving Corporation or Holdings for any reason, such
SmarterKids Certificates shall be canceled and exchanged as provided in this
Section 2.5. If, after the Effective Time, Transfer Documents with respect to
valid LLC Interests are presented to Holdings for any reason, such LLC
Interests shall be deemed contributed to Holdings in accordance with the
provisions of this Agreement, effective as of the Effective Time and the
holders thereof, in exchange therefor, shall receive such number of shares of
Holdings Common Stock as may be calculated pursuant to the applicable
Earlychildhood Exchange Ratio, together, without interest, with cash in lieu of
fractional shares as described in Section 2.5(e).
(e) No Fractional Shares. No certificate or scrip representing fractional
shares of Holdings Common Stock shall be issued upon the contribution or
surrender for exchange, as applicable, of LLC Interests or SmarterKids
Certificates, and such fractional share interests will not entitle the owner
thereof to vote or to any other rights of a stockholder of Holdings.
Notwithstanding any other provision of this Agreement, each holder of LLC
Interests or shares of SmarterKids Common Stock outstanding immediately prior
to the Effective Time exchanged pursuant to the Contribution or the SmarterKids
Merger who would otherwise have been entitled to receive a fraction of a share
of Holdings Common Stock (after taking into account the entire LLC Interest
exchanged by such holder or all SmarterKids Certificates delivered by such
holder, as applicable) shall receive, in lieu thereof, cash (without interest)
in an amount equal to such fractional part of a share of Holdings Common Stock
multiplied by the per share opening sales price of Holdings Common Stock (as
reported by the national securities exchange or market on which such Holdings
Common Stock is traded or quoted) on the first day of trading of Holdings
Common Stock on such exchange or market after the Effective Time.
A-8
<PAGE>
(f) Termination of Exchange Fund. Any portion of the Exchange Fund which
remains undistributed to the former holders of LLC Interests or the former
stockholders of SmarterKids on the 180th day after the Effective Time shall be
delivered to Holdings upon demand, and any former holder or stockholder, as the
case may be, who has not previously complied with Section 1.2 or this Section
2.5 shall thereafter look only to Holdings for payment of such holder's or
stockholder's claim for Holdings Common Stock, any cash in lieu of fractional
shares of Holdings Common Stock and any dividends or distributions with respect
to Holdings Common Stock.
(g) No Liability. None of Earlychildhood, SmarterKids or Holdings shall be
liable to any holder of LLC Interests or shares of SmarterKids Common Stock, as
the case may be, for any shares of Holdings Common Stock (or cash in lieu of
fractional shares of Holdings Common Stock or any dividends or distributions
with respect thereto) delivered to a public official pursuant to any applicable
abandoned property, escheat or similar law.
(h) Withholding Rights. Holdings and the Surviving Corporation shall be
entitled to deduct and withhold from the consideration otherwise payable
pursuant to this Agreement to any holder of LLC Interests or shares of
SmarterKids Common Stock such amounts as it is required to deduct and withhold
with respect to the making of such payment under the Code, or any provision of
state, local or foreign tax law. To the extent that amounts are so withheld by
Holdings or the Surviving Corporation, as the case may be, such withheld
amounts shall be treated for all purposes of this Agreement as having been paid
to the holder of LLC Interests or shares of SmarterKids Common Stock, as the
case may be, in respect of which such deduction and withholding was made.
(i) Lost Certificates. If any Certificate shall have been lost, stolen or
destroyed, upon the making of an affidavit of that fact by the person claiming
such Certificate to be lost, stolen or destroyed and, if required by Holdings
or the Surviving Corporation, the posting by such person of a bond in such
reasonable amount as Holdings or the Surviving Corporation may direct as
indemnity against any claim that may be made against it with respect to such
Certificate, the Exchange Agent will issue in exchange for such lost, stolen or
destroyed Certificate, the shares of Holdings Common Stock, any cash in lieu of
fractional shares, and any unpaid dividends and distributions on shares of
Holdings Common Stock deliverable in respect thereof pursuant to this
Agreement.
(j) Affiliates. Notwithstanding anything herein to the contrary, neither LLC
Interests nor SmarterKids Certificates surrendered for exchange by any
Affiliate (as defined in Section 5.13) of Earlychildhood or SmarterKids shall
be exchanged until Holdings has received an Affiliate Agreement (as defined in
Section 5.13) substantially in the form of Exhibit J attached hereto from such
Affiliate.
ARTICLE III.
REPRESENTATIONS AND WARRANTIES OF EARLYCHILDHOOD
Earlychildhood represents and warrants to SmarterKids that the statements
contained in this Article III are true and correct, except as set forth herein
and in the disclosure schedules delivered by Earlychildhood to SmarterKids on
or before the date of this Agreement (the "Earlychildhood Disclosure
Schedule"). The Earlychildhood Disclosure Schedule shall be arranged in
paragraphs corresponding to the numbered and lettered paragraphs contained in
this Article III and the disclosure in any paragraph shall qualify other
paragraphs in this Article III only to the extent that it is reasonably
apparent from a reading of such disclosure that it also qualifies or applies to
such other paragraphs.
Section 3.1 Organization of Earlychildhood. Each of Earlychildhood and its
Subsidiaries (as defined below) is duly organized, validly existing and in good
standing under the laws of the jurisdiction of its organization, has all
requisite corporate power to own, lease and operate its property and to carry
on its business as now being conducted and as proposed to be conducted, and is
duly qualified to do business and is in good standing as a foreign limited
liability company or corporation, as the case may be, in each jurisdiction
A-9
<PAGE>
in which the failure to be so qualified would have a material adverse effect on
the business, assets, properties, financial condition or results of operations
of Earlychildhood and its Subsidiaries, taken as a whole (an "Earlychildhood
Material Adverse Effect"). Except as set forth on the Earlychildhood Disclosure
Schedule, neither Earlychildhood nor any of its Subsidiaries, directly or
indirectly owns (other than ownership interests in Earlychildhood or in one or
more of its Subsidiaries) any equity or similar interest in, or any interest
that is mandatorily convertible into or exchangeable or exercisable for, any
corporation, partnership, joint venture or other business association or
entity. A true, correct and complete copy of the organizational documents of
Earlychildhood and each of its Subsidiaries has been delivered to SmarterKids.
As used in this Agreement, the word "Subsidiary" means, with respect to any
party, any corporation or other organization, whether incorporated or
unincorporated, of which (i) such party or any other Subsidiary of such party
is a general partner (excluding partnerships the general partnership interests
of which held by such party or any Subsidiary of such party do not have a
majority of the voting interest in such partnership) or (ii) at least a
majority of the securities or other interests having by their terms ordinary
voting power to elect a majority of the board of directors or others performing
similar functions with respect to such corporation or other organization is
directly or indirectly owned or controlled by such party or by any one or more
of its Subsidiaries, or by such party and one or more of its Subsidiaries.
Section 3.2 Earlychildhood Capital Structure.
(a) The outstanding LLC Interests currently consist, and will consist on the
Closing Date, of the LLC Interests set forth in the Earlychildhood Disclosure
Schedule, which LLC Interests, subject to LLC Interests represented by options
granted under the Earlychildhood Option Plans, represent one hundred percent
(100%) of the membership and other equity interests in Earlychildhood. Other
than the persons set forth in the Earlychildhood Disclosure Schedule (the
"Members"), no other person owns or holds any LLC Interest or portion of an LLC
Interest, including, without limitation, an economic interest in
Earlychildhood, an interest in the profits or losses of Earlychildhood, an
interest in the right to affect the management of Earlychildhood or an interest
in the right to receive distributions from Earlychildhood. With respect to each
Member, the Earlychildhood Disclosure Schedule sets forth such Member's
designation as a Class A Member, Class B Member or Class C Member, as
applicable. Set forth on the Earlychildhood Disclosure Schedule is the
aggregate amount of LLC Interests issuable pursuant to options granted and
outstanding under the Earlychildhood Option Plans as of the date hereof, and
the entities or persons to whom such options were granted. Except as may exist
under the Earlychildhood Option Plan or as otherwise set forth on the
Earlychildhood Disclosure Schedule, there are no outstanding subscriptions,
calls, commitments, warrants or options for the purchase of LLC Interests, or
any securities convertible into or exchangeable for LLC Interests, or any other
commitments of any kind for the granting of additional LLC Interests or other
equity interests or securities issued by Earlychildhood. All of the outstanding
LLC Interests are duly authorized, fully paid and nonassessable securities of
Earlychildhood, free and clear of all Encumbrances (as defined below). Except
as set forth on the Earlychildhood Disclosure Schedule, there are no contracts
relating to the issuance, sale, or transfer of any LLC Interests, or any
portions of any LLC Interests. To the knowledge of Earlychildhood, there are no
voting trusts, proxies or other voting agreements or understandings with
respect to the outstanding LLC Interests. For purposes of this Agreement,
"Encumbrance" shall mean any charge, claim, condition, equitable interest,
lien, option, pledge, security interest, right of first refusal or restriction
of any kind, including any restriction on use, voting, transfer, receipt of
income or exercise of any other attribute of ownership.
(b) All of the outstanding shares of capital stock or other equity interests
of each of Earlychildhood's Subsidiaries are duly authorized, validly issued,
fully paid and nonassessable and all such shares are owned by Earlychildhood or
another Subsidiary free and clear of all Encumbrances. There are no outstanding
subscriptions, calls, commitments, warrants or options for the purchase of
shares of capital stock or equity interests, as the case may be, or any
securities convertible into or exchangeable for shares of capital stock or
equity interests, as the case may be, or any other commitments of any kind for
the granting of additional shares of capital stock, other equity interests or
securities issued by any of Earlychildhood's Subsidiaries. There are no
contracts relating to the issuance, sale, or transfer of any shares of capital
stock or equity interests, as the case may be, of any of Earlychildhood's
Subsidiaries.
A-10
<PAGE>
Section 3.3 Authority; No Conflict; Required Filings and Consents.
(a) Earlychildhood has all requisite corporate power and authority to enter
into this Agreement and each of the Transaction Documents (as defined below) to
which it is a party and to consummate the Transactions contemplated by this
Agreement and each of the Transaction Documents to which it is a party. The
execution and delivery of this Agreement and each of the Transaction Documents
to which it is a party and the consummation of the transactions contemplated by
this Agreement and each of the Transaction Documents to which it is a party by
Earlychildhood have been duly authorized by all necessary action on the part of
Earlychildhood, its Management Committee and its Members. Each holder of an LLC
Interest outstanding on the date hereof has executed and delivered a Consent
Agreement in the form of Exhibit B attached hereto and, assuming the due
authorization and execution of the Consent Agreement by each such Member, the
Consent Agreements constitute the valid and binding obligations of such
Members, enforceable in accordance with their terms, subject to the Bankruptcy
and Equity Exception (as hereafter defined). This Agreement and each of the
Transaction Documents to which it is a party have been duly executed and
delivered by Earlychildhood and constitute the valid and binding obligations of
Earlychildhood, enforceable in accordance with their terms, subject to
bankruptcy, insolvency, fraudulent transfer, reorganization, moratorium and
similar laws of general applicability relating to or affecting creditors'
rights and to general equitable principles (the "Bankruptcy and Equity
Exception"). "Transaction Documents" means the Stockholder Support Agreement,
the Registration Rights Agreement, the Consent Agreement, the Affiliate
Agreement and the Lockup Agreement.
(b) Except as set forth on the Earlychildhood Disclosure Schedule, the
execution and delivery of this Agreement and each of the Transaction Documents
to which it is a party by Earlychildhood does not, and the consummation of the
Transactions contemplated by this Agreement, and each of the Transaction
Documents to which Earlychildhood is a party will not, (i) conflict with, or
result in any violation or breach of, any provision of the organizational
documents of Earlychildhood (including the Operating Agreement) or any of the
organizational documents of any of Earlychildhood's Subsidiaries (collectively,
the "Earlychildhood Organizational Documents"), (ii) result in any violation or
breach of, or constitute (with or without notice or lapse of time, or both) a
default (or give rise to a right of termination, cancellation or acceleration
of any obligation or loss of any material benefit) under, or require a consent
or waiver under, any of the terms, conditions or provisions of any note, bond,
mortgage, indenture, lease, contract or other agreement, instrument or
obligation to which Earlychildhood or any of its Subsidiaries is a party or by
which any of them or any of their respective properties or assets may be bound,
or (iii) conflict with or violate any permit, concession, franchise, license,
judgment, order, decree, statute, law, ordinance, rule or regulation applicable
to Earlychildhood or any of its Subsidiaries or any of its or their properties
or assets, except in the case of (ii) and (iii) for any such conflicts,
violations, defaults, terminations, cancellations or accelerations which are
not, individually or in the aggregate, reasonably likely to have an
Earlychildhood Material Adverse Effect. The execution and delivery of each
Consent Agreement by the holders of all outstanding LLC Interests does not
conflict with, and will not result in any violation or breach of any provision
of, the Earlychildhood Organizational Documents.
(c) No consent, approval, order or authorization of, or registration,
declaration or filing with, any court, administrative agency or commission or
other governmental authority or instrumentality ("Governmental Entity") is
required by or with respect to Earlychildhood or any of its Subsidiaries in
connection with the execution and delivery of this Agreement and each of the
Transaction Documents to which it is a party or the consummation of the
transactions contemplated hereby or thereby, except for (i) the filing of the
pre-merger notification report under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended (the "HSR Act"), if applicable, (ii) such
consents, approvals, orders, authorizations, registrations, declarations and
filings as may be required under applicable state securities laws, and
(iii) such other consents, authorizations, filings, approvals and registrations
which, if not obtained or made, would not be reasonably likely to have an
Earlychildhood Material Adverse Effect. Earlychildhood is not a "$100 Million
Person" within the meaning of the HSR Act (and the Regulations thereunder) and
William E. Simon & Sons Private Equity Fund, L.P. (the "Fund"), to the extent
the Fund is the "ultimate parent entity" of Earlychildhood (as such term is
used in the HSR Act and the Regulations thereunder), is not, together, with all
the entities that it controls, directly and indirectly, a "$100 million Person"
within the meaning of the HSR Act (and the Regulations thereunder).
A-11
<PAGE>
Section 3.4 Books and Records. The books of account, minute books (or any
other books containing records of member or manager action) and record books
and other records which are material to the business of Earlychildhood and its
Subsidiaries, all of which have been made available to SmarterKids, are
complete and correct in all material respects and have been maintained in
accordance with sound business practices. The minute books (or any other books
containing records of member or manager action) of Earlychildhood and its
Subsidiaries contain, in all material respects, accurate records of all
meetings held of, and corporate or other action taken by, the Members, or the
Management Committee of Earlychildhood, or the stockholders or owners or board
of directors or other similar bodies of any of its Subsidiaries and no meeting
has been held for which minutes have not been prepared and are not contained in
such minute books. At the Closing, all of the books and records of
Earlychildhood and its Subsidiaries will be in the possession of
Earlychildhood.
Section 3.5 Financial Information. Earlychildhood has delivered to
SmarterKids: (i) an audited consolidated balance sheet of Earlychildhood and
its Subsidiaries as of December 31, 1999 and the related audited consolidated
statements of income, changes in members' equity and cash flows of
Earlychildhood and its Subsidiaries for the fiscal year then ended, together
with the report thereon of KPMG, LLP, its independent certified public
accountants; (ii) an audited consolidated balance sheet of QTL Corporation and
its Subsidiaries as of December 31, 1998 and the related audited consolidated
statements of income, stockholders' equity and cash flows of QTL Corporation
for the nine months then ended, together with the report thereon of KPMG LLP,
its independent certified public accountants; (iii) an audited balance sheet of
Educational Products, Inc. as of March 31, 1999 and the related audited
statements of income, stockholders' equity and cash flows of Educational
Products, Inc. for the fiscal year then ended, together with the report thereon
of KPMG LLP, its independent certified public accountants and (iv) an unaudited
consolidated balance sheet of Earlychildhood and its Subsidiaries as of
September 30, 2000 (the "Earlychildhood Balance Sheet") and the related
unaudited consolidated statements of income, changes in members' equity, and
cash flows, including, in each case, the notes thereto (together with the
Earlychildhood Balance Sheet, the "Earlychildhood Financial Information"). The
Earlychildhood Financial Information has been prepared in accordance with
generally accepted accounting principles ("GAAP") applied on a consistent basis
(except as may be noted therein), and presents fairly, in all material
respects, the financial position of Earlychildhood and its Subsidiaries on a
consolidated basis as of the respective dates and for the periods referred to
in such Earlychildhood Financial Information, except that the Earlychildhood
Financial Information is subject to normal and recurring year-end adjustments
and subject, in each case, to the notes regarding the matters reflected
therein. Except set forth on the Earlychildhood Disclosure Schedule, no
financial information of any entity are required to be included in the
financial statements of Earlychildhood under GAAP.
Section 3.6 No Undisclosed Liabilities. Except as set forth on the
Earlychildhood Disclosure Schedule or the Earlychildhood Balance Sheet and
except for normal or recurring liabilities incurred since the date of the
Earlychildhood Balance Sheet in the ordinary course of business consistent with
past practices, Earlychildhood and its Subsidiaries do not have any
liabilities, either accrued, contingent or otherwise (whether or not required
to be reflected in the Earlychildhood Financial Information in accordance with
GAAP), and whether due or to become due, which, individually or in the
aggregate, are reasonably likely to have an Earlychildhood Material Adverse
Effect.
Section 3.7 Absence of Certain Changes or Events. Except as expressly
contemplated by this Agreement and the Transaction Documents or as set forth on
the Earlychildhood Disclosure Schedule, since the date of the Earlychildhood
Balance Sheet, Earlychildhood has conducted its businesses only in the ordinary
course and in a manner consistent with past practice, and, since such date,
there has been no material adverse change in the financial condition, results
of operations, business, assets or properties of Earlychildhood or any of its
Subsidiaries, taken as a whole (an "Earlychildhood Material Adverse Change") or
any development or combination of developments of which the management of
Earlychildhood is aware that, individually or in the aggregate, has had, or is
reasonably likely to have, an Earlychildhood Material Adverse Effect, and,
since such date, there has not been any:
(a) (i) issuance of LLC Interests, or options or rights therefor, other
than pursuant to the Earlychildhood Option Plans through the date hereof;
(ii) purchase, redemption, retirement or other
A-12
<PAGE>
acquisition by Earlychildhood of any LLC Interest, parts of any LLC
Interest or other rights or equity interests in Earlychildhood or any of
its Subsidiaries; or (iii) declaration or payment of any dividend or other
distribution or payment in respect of any LLC Interest, parts of any LLC
Interest or other rights or equity interests in Earlychildhood or any of
its Subsidiaries, other than tax distributions made in the ordinary course
of business;
(b) amendment to the organizational documents of Earlychildhood or any
of its Subsidiaries (including the Operating Agreement);
(c) payment by Earlychildhood or any of its Subsidiaries of any bonuses,
salaries or other compensation (including management or other similar fees
but excluding tax distributions) to any shareholder or member, as
applicable, managing member, member of the Management Committee or
executive officer (except for payments of salary, bonuses and other
compensation payable for employment services rendered in the ordinary
course of business (in which case there has been no increase in such
payments)) or entry into any employment, severance or similar contract with
any such person;
(d) adoption of any new Employee Benefit Plan or Benefit Arrangement
(each as defined below) for or with any employees of Earlychildhood or any
Earlychildhood ERISA Affiliate or any increase in the payment to or
benefits under any Earlychildhood Plan or other benefit obligations for or
with any employees of Earlychildhood or any Earlychildhood ERISA Affiliate
or change any actuarial or other assumption used to calculate funding
obligations with respect to any Earlychildhood Employee Benefit Plans or
Benefit Arrangements, or any change in the manner in which contributions to
any Earlychildhood Employee Benefit Plans or Benefit Arrangements are made
or the basis on which such contributions are determined;
(e) damage to or destruction or loss of any asset or property of
Earlychildhood or any of its Subsidiaries, whether or not covered by
insurance, that would have an Earlychildhood Material Adverse Effect;
(f) sale, lease or other disposition of any material asset or property
of Earlychildhood or any of its Subsidiaries (other than sales of inventory
in the ordinary course of business);
(g) accrual of any expenses except for such accruals in the ordinary
course of business;
(h) cancellation or waiver of any claims or rights by Earlychildhood or
any of its Subsidiaries that would have an Earlychildhood Material Adverse
Effect;
(i) assumption, guarantee or endorsement or other agreement to become
responsible for the obligations of any other individual, firm or
corporation (other than intercompany obligations) or making of any loans or
advances to, any employee of Earlychildhood or any of its Subsidiaries,
other than in the ordinary course of business;
(j) material change by Earlychildhood or its Subsidiaries in their
respective accounting methods, principles or practices to which SmarterKids
has not previously consented in writing, except insofar as may be
appropriate for changes required by applicable law or GAAP;
(k) revaluations by Earlychildhood or its Subsidiaries of any of their
respective assets having an Earlychildhood Material Adverse Effect;
(l) agreement, whether oral or written, by Earlychildhood or any of its
Subsidiaries, with respect to or to do any of the foregoing; or
(m) other action or event that would have required the consent of
SmarterKids pursuant to Section 5.1 of this Agreement had such action or
event occurred after the date of this Agreement, and that, individually or
in the aggregate, has had, or is reasonably likely to have, an
Earlychildhood Material Adverse Effect.
A-13
<PAGE>
Section 3.8 Taxes.
(a) For the purposes of this Agreement, a "Tax" or, collectively, "Taxes,"
means any and all federal, state, local and foreign taxes, assessments and
other governmental charges, duties, impositions and liabilities, including
taxes based upon or measured by gross receipts, income, profits, sales, use and
occupation, and value added, ad valorem, transfer, gains, franchise,
withholding, payroll, recapture, employment, excise, unemployment insurance,
social security, business license, occupation, business organization, stamp,
environmental and property taxes, together with all interest, penalties and
additions imposed with respect to such amounts. For purposes of this Agreement,
"Taxes" also includes any obligations under any agreements or arrangements with
any other person or any provision of law with respect to Taxes of such other
person (including pursuant to Treas. Reg. (S) 1.1502-6 or comparable provisions
of state, local or foreign tax law) and including any liability for Taxes of
any predecessor entity.
(b) Except as set forth on the Earlychildhood Disclosure Schedule,
Earlychildhood and each of its Subsidiaries have (i) timely filed all federal,
state, local and foreign Tax returns and reports required to be filed by them
prior to the date of this Agreement (taking into account all applicable
extensions) and such Tax returns are accurate and complete in all material
respects, (ii) timely paid or accrued all Taxes owed (whether or not shown on
any Tax return), and (iii) paid all Taxes for which a notice of assessment or
collection has been received (other than amounts being contested in good faith
by appropriate proceedings). None of the Tax returns filed or Taxes payable by
either Earlychildhood or any of its Subsidiaries (or, to the knowledge of
Earlychildhood, by the holders of the LLC Interests as they relate to the items
of income, deductions, etc. of Earlychildhood) have been the subject of an
audit, action, suit, proceeding, claim, examination, deficiency or assessment
by the Internal Revenue Service (the "IRS") or any other governmental
authority, and no such audit, action, suit, proceeding, claim, examination,
deficiency or assessment is currently pending or, to the knowledge of
Earlychildhood or any of its Subsidiaries, contemplated or threatened. The
unpaid Taxes of Earlychildhood and each of its Subsidiaries (whether or not yet
payable) attributable to any period (or portion thereof) ending on or before
the Closing Date did not, as of September 30, 2000, exceed the reserve for
actual Taxes (as opposed to any reserve for deferred Taxes established to
reflect timing differences between book and Tax income) as shown on the
Earlychildhood Balance Sheet, and will not exceed such reserve as adjusted for
the passage of time through the Closing Date in accordance with the reasonable
past custom and practice of Earlychildhood and its Subsidiaries in filing their
Tax returns. Earlychildhood and each of its Subsidiaries will not incur any
liability for Taxes from September 30, 2000 through the Closing Date other than
in the ordinary course of business and consistent with reasonable past
practice, and will not incur any Tax liability in connection with the
transactions contemplated by this Agreement. Except as set forth on the
Earlychildhood Disclosure Schedule, neither Earlychildhood nor any of its
Subsidiaries has agreed to make any adjustment under Section 481(a) of the Code
(or any corresponding provision of state, local or foreign Tax law) by reason
of a change in accounting method or otherwise, and neither Earlychildhood nor
any of its Subsidiaries will be required to make any such adjustment as a
result of the transactions contemplated by this Agreement. Earlychildhood and
each of its Subsidiaries have timely withheld or collected and paid over to the
appropriate governmental authorities (or are properly holding for such timely
payment) all Taxes required by law to be withheld or collected. None of the
Subsidiaries of Earlychildhood which is a corporation has made an election
under Section 341(f) of the Code. There are no liens for Taxes upon the assets
of Earlychildhood or any of its Subsidiaries (other than liens for Taxes that
are not yet due or that are being contested in good faith by appropriate
proceedings). No extension of a statute of limitations relating to any Taxes is
in effect with respect to Earlychildhood and its Subsidiaries.
(c) Earlychildhood and any non-corporate Subsidiaries of Earlychildhood have
at all times during their existence been properly treated as a partnership or a
disregarded entity for U.S. federal, state and local income tax purposes. No
Subsidiary of Earlychildhood which is a corporation has been a member of an
affiliated group of corporations filing a consolidated federal income tax
return (or a group of corporations filing a consolidated, combined or unitary
income tax return under comparable provisions of state, local or foreign tax
law) for any taxable period. Neither Earlychildhood nor any of its Subsidiaries
has been or is a party to or member of any joint venture, partnership, limited
liability company, or other arrangement or contract which could be treated as
A-14
<PAGE>
a partnership for federal income tax purposes. None of the LLC Interests nor
any assets transferred from Earlychildhood to Holdings, whether an actual
transfer or a deemed transfer of assets, pursuant to the Contribution is a U.S.
real property interest (as that term is defined in Section 897(c)(1) of the
Code).
(d) Neither Earlychildhood nor any of its Subsidiaries has any obligation
under any agreement or arrangement with any other person or any provision of
law with respect to Taxes of such other person (including pursuant to Treas.
Reg. (S) 1.1502-6 or comparable provisions of state, local or foreign tax law)
and including any liability for Taxes of any predecessor entity.
Section 3.9 Properties.
(a) The Earlychildhood Disclosure Schedule sets forth a list of (i) all
material leases to which Earlychildhood or any of its Subsidiaries is a party
as a lessee as of the date hereof (the "Earlychildhood Lease Agreements"),
setting forth in the case of any such lease covering real property, the
location of such real property, and (ii) all material real properties owned by
Earlychildhood or any of its Subsidiaries as of the date hereof (the
"Earlychildhood Owned Real Property"). To the knowledge of Earlychildhood, each
of Earlychildhood and its Subsidiaries has good and marketable titled to the
Earlychildhood Owned Real Property and a valid and binding leasehold interest
in each of the properties that is the subject of an Earlychildhood Lease
Agreement, free and clear of all Encumbrances, except for (i) any Encumbrances
reflected in the Earlychildhood Financial Information and the Earlychildhood
Disclosure Schedule; (ii) any Encumbrances which, individually or in the
aggregate, are not reasonably likely to have an Earlychildhood Material Adverse
Effect; (iii) zoning laws and other land use restrictions that do not impair
the present or anticipated use or occupancy of the property subject thereto,
(iv) any Encumbrances for taxes, assessments and other governmental charges not
yet due and payable or due but not delinquent or due and being contested in
good faith; (v) any mechanics' workmen's, repairmen's, warehousemen's,
carrier's or other similar liens and encumbrances arising in the ordinary
course of business consistent with past practice or being contested in good
faith and (vi) any Encumbrances which are matters of public record or are shown
by a current title report and reflected on the Earlychildhood Disclosure
Schedule (clauses (i) through (vi) above collectively referred to herein as
"Earlychildhood Permitted Encumbrances").
(b) None of Earlychildhood and its Subsidiaries is in default under any of
the Earlychildhood Lease Agreements, except for such defaults which have not
had and are not reasonably likely to have an Earlychildhood Material Adverse
Effect.
Section 3.10 Intellectual Property.
(a) Each of Earlychildhood and its Subsidiaries owns free and clear of all
Encumbrances or is licensed or otherwise possesses legally enforceable rights
to use all patents, trademarks, trade names, service marks, copyrights, and any
applications for such patents, trademarks, trade names, service marks,
copyrights, know-how, computer software programs or applications and tangible
or intangible proprietary information or material that are necessary to conduct
the business of each of Earlychildhood and its Subsidiaries as currently
conducted (the "Earlychildhood Intellectual Property"), subject to such
exceptions that would not be reasonably likely to have an Earlychildhood
Material Adverse Effect. The Earlychildhood Disclosure Schedule contains a list
of all of the following that are material within the Earlychildhood
Intellectual Property: (i) patents and patent applications; (ii) trademarks,
trade names and service marks and registrations thereof and applications
therefor; and (iii) registered copyrights and applications therefor. The
Earlychildhood Disclosure Schedule identifies the owner of each item listed
thereon and, in the case of registrations and applications, the application or
registration number and date.
(b) To the knowledge of Earlychildhood, Earlychildhood or a Subsidiary
thereof is the sole and exclusive owner or a licensee of all of the material
Earlychildhood Intellectual Property. All of the material Earlychildhood
Intellectual Property will be owned or available for use by Earlychildhood or
its Subsidiaries on terms and conditions immediately following the Effective
Time identical to the terms and conditions pertaining to Earlychildhood or a
Subsidiary thereof immediately prior to the Effective Time. Earlychildhood or a
A-15
<PAGE>
Subsidiary thereof has taken reasonable measures to protect the proprietary
nature of the Earlychildhood Intellectual Property and to maintain in
confidence the trade secrets and confidential information that they own or
use. No other person has any rights to any material item of the Earlychildhood
Intellectual Property or has any rights to any of the material Earlychildhood
Intellectual Property, except that the items of the Earlychildhood
Intellectual Property identified on the Earlychildhood Disclosure Schedule as
licensed to Earlychildhood or a Subsidiary thereof are owned by the respective
owners identified on the Earlychildhood Disclosure Schedule, and, to the
knowledge of Earlychildhood, no person is infringing, violating or
misappropriating any of the material Earlychildhood Intellectual Property.
(c) To the knowledge of Earlychildhood, none of the activities or business
presently conducted by Earlychildhood or any of its Subsidiaries infringes or
violates, or constitutes a misappropriation of, any intellectual property of
any other person, and, if without the knowledge of Earlychildhood, such
activities or business presently conducted by Earlychildhood or any of its
Subsidiaries does infringe, violate or constitute a misappropriation of any
intellectual property of any other person, no such infringement, violation or
misappropriation, individually or in the aggregate, is reasonably likely to
have an Earlychildhood Material Adverse Effect. None of Earlychildhood, any
Subsidiary or any Affiliate of Earlychildhood has received any complaint,
claim or notice alleging any such infringement, violation or misappropriation.
(d) With respect to each item of the Earlychildhood Intellectual Property:
(i) Earlychildhood or a Subsidiary thereof possesses all right, title
and interest in and to such item, except for any Earlychildhood Third Party
Rights (as defined below);
(ii) such item is not subject to any outstanding judgment, order,
decree, stipulation or injunction; and
(iii) neither Earlychildhood nor any of its Subsidiaries has agreed,
except in the ordinary course of business consistent with past practice or
in conjunction with product or service sales or licenses, to indemnify any
person for or against any infringement, misappropriation or other conflict
with respect to such item.
(e) The Earlychildhood Disclosure Schedule identifies each item of the
intellectual property used by Earlychildhood or any Subsidiary that is owned
by a party other than Earlychildhood ("Earlychildhood Third Party Rights"),
and all licenses or other agreements pursuant to which Earlychildhood or any
Subsidiary uses such items are listed on the Earlychildhood Disclosure
Schedule. With respect to each such item:
(i) the license or other agreement covering any such material item is
valid, binding, enforceable and in full force and effect with respect to
Earlychildhood or a Subsidiary thereof and, to the knowledge of
Earlychildhood, with respect to every other party thereto;
(ii) each such license or other agreement, including licenses to all
third-party software listed in the Earlychildhood Disclosure Schedule other
than generally commercially available software, to which Earlychildhood or
a Subsidiary thereof is a party, is assignable by Earlychildhood or such
Subsidiary without the consent or approval of, or any payment to, any party
except as set forth on the Earlychildhood Disclosure Schedule, and, except
as set forth on the Earlychildhood Disclosure Schedule, all such licenses
and other agreements will continue to be valid, binding, enforceable and in
full force and effect immediately following the Effective Time in
accordance with the terms thereof as in effect immediately prior to the
Effective Time, and the consummation of the transactions will not conflict
with, result in a violation or breach of or constitute a default under
(with notice or lapse of time or both) any such license or other agreement;
and
(iii) neither Earlychildhood, any Subsidiary thereof nor, to the
knowledge of Earlychildhood, any other party to any such license or other
agreement, is in breach or default under any such license or other
agreement and, to the knowledge of Earlychildhood, no event has occurred
that, with notice or lapse of time or both, would constitute such a breach
or default or permit termination, modification or acceleration thereunder.
A-16
<PAGE>
Section 3.11 Product Warranty and Liability.
(a) No reserves have been provided for by Earlychildhood to cover potential
claims under existing customer indemnification agreements.
(b) Except as to claims, actions, proceedings or investigations which have
been asserted but as to which no notice has been given to Earlychildhood or any
of its Subsidiaries, and except as set forth on the Earlychildhood Disclosure
Schedule, there are no product liability claims, actions, proceedings or
investigations pending or, to the knowledge of Earlychildhood, threatened
against Earlychildhood or any of its Subsidiaries or their respective assets,
or, to the knowledge of Earlychildhood, any state of facts existing which could
give rise to any such product liability claim, action, proceeding or
investigation.
(c) To the knowledge of Earlychildhood, no claims have been made that the
products sold by Earlychildhood or any of its Subsidiaries are not effective
for the uses such products purport to serve. To the knowledge of
Earlychildhood, neither Earlychildhood nor any of its Subsidiary has received
any written notice that any product manufactured or distributed by
Earlychildhood or any of its Subsidiaries has not been manufactured in
accordance with "current Good Manufacturing Practices" (as such term is
commonly understood within Earlychildhood's industry) or has not been properly
labeled for its approved use.
Section 3.12 Material Contracts.
(a) The Earlychildhood Disclosure Schedule sets forth a complete and
accurate list, and Earlychildhood has made available to SmarterKids, true and
complete copies of:
(i) each contract that provides for annual payments to or by
Earlychildhood or any of its Subsidiaries in excess of $150,000;
(ii) each contract of Earlychildhood or any of its Subsidiaries that was
not entered into in the ordinary course of business;
(iii) any contract under which Earlychildhood or any of its Subsidiaries
has or may, except by way of endorsement of negotiable instruments for
collection in the ordinary course of business and consistent with past
practice, become absolutely or contingently or otherwise liable for (x) the
performance under any contract of any other person, firm or corporation or
(y) the whole or any part of the indebtedness or liabilities of any other
person, firm or corporation, in all cases, individually in excess of
$1,000,000 and in the aggregate in excess of $5,000,000;
(iv) all employment agreements, consulting agreements, contracts or
commitments with any employee or member of Earlychildhood's Management
Committee, other than those which are terminable by Earlychildhood or any
of its Subsidiaries on not more than thirty days notice without liability
or financial obligation, and within each such category of agreements,
contracts or commitments, which are individually in excess of $150,000;
(v) any agreements or plans, including, without limitation, any stock
option, stock or equity appreciation right or stock or equity purchase
plans or agreements, any of the benefits of which will be increased, or the
vesting of benefits of which will be accelerated, by the occurrence of any
of the transactions contemplated by this Agreement or the value of any of
the benefits of which will be calculated on the basis of any of the
transactions contemplated by this Agreement;
(vi) any contract with any Member, managing member or member of the
Management Committee of Earlychildhood, other than in such person's
capacity as a Member, managing member or member of the Management
Committee, or any contract with any entity in which, to the knowledge of
Earlychildhood, any Member, managing member or member of the Management
Committee or any family member of any such person has a material economic
interest;
(vii) any contract that limits or restricts in any material respect
where Earlychildhood or any of its Subsidiaries may conduct its or their
business or the type or line of business that Earlychildhood or any of its
Subsidiaries may engage in;
A-17
<PAGE>
(viii) any powers of attorney outstanding (other than those issued in
the ordinary course of business with respect to Tax matters), or material
obligations or liabilities (absolute or contingent) as guarantor, surety,
cosigner, endorser, co-maker, indemnitor, or otherwise respecting the
obligations or liabilities of any person.
(ix) any material contract containing any agreement with respect to any
change of control; and
(x) each material amendment, supplement, and modification (whether oral
or written) in respect of any of the foregoing.
(b) Neither Earlychildhood nor any of its Subsidiaries have breached, or
received in writing any claim or notice that it has breached, any of the terms
or conditions of any material agreement, contract or commitment set forth or
required to be set forth in Section 3.12 of the Earlychildhood Disclosure
Schedule ("Earlychildhood Material Contracts") in such a manner as,
individually or in the aggregate, is reasonably likely to have an
Earlychildhood Material Adverse Effect. Except as set forth in the
Earlychildhood Disclosure Schedule, each Earlychildhood Material Contract that
has not expired by its terms is in full force and effect, except for those
contracts, the ineffectiveness of which would not reasonably be likely to have
an Earlychildhood Material Adverse Effect and, if all of the consents,
approvals, authorizations, filings, notifications and other actions listed with
respect to such contract in the Earlychildhood Disclosure Schedule are
obtained, taken or made, as applicable, such contract will continue, after the
Effective Time, to be in full force and effect on identical terms.
(c) To the knowledge of Earlychildhood or its Subsidiaries, none of the
parties to any Earlychildhood Material Contract have terminated, or notified
Earlychildhood or any of its Subsidiaries in writing of its intent to
materially reduce or terminate its business relationship with Earlychildhood or
any of its Subsidiaries in the future.
(d) Neither of Earlychildhood nor any of its Subsidiaries have received
written notice from any customer, or group of customers, that are under common
ownership or control, and that accounted for a material percentage of the
aggregate products and services furnished by Earlychildhood or any of its
Subsidiaries since January 1, 1999 that such customer or group of customers has
stopped or intends to stop purchasing Earlychildhood's or any of its
Subsidiaries' products or services, nor has Earlychildhood or any of its
Subsidiaries lost any supplier, or group of suppliers that are under common
ownership or control, that accounted for a material percentage of the aggregate
supplies purchased by Earlychildhood or any of its Subsidiaries since January
1, 1999.
(e) As of the Effective Time, Earlychildhood will have terminated the
Executive Management Agreement, dated as of May 5, 1999 by and between
Earlychildhood and William E. Simon and Sons, L.L.C., a Delaware limited
liability company (the "Executive Management Agreement"), and, from and after
the Effective Time, there will be no further obligations or liabilities,
including payment obligations, outstanding or due thereunder. The fees payable
to William E. Simon and Sons, L.L.C. between the date hereof and the Effective
Time pursuant to the Executive Management Agreement shall not exceed $25,000
per month.
Section 3.13 Litigation. Except as disclosed in the Earlychildhood Financial
Information or in the Earlychildhood Disclosure Schedule, there is no (i)
action, suit or proceeding, claim, arbitration or investigation against
Earlychildhood or any of its Subsidiaries pending or, to the knowledge of
Earlychildhood, threatened, against Earlychildhood or any of its Subsidiaries
or (ii) outstanding order, judgment, writ, injunction or decree of any court,
governmental agency or arbitration tribunal in a proceeding to which
Earlychildhood or any of its Subsidiaries is a party, except, in the case of
each of clauses (i) and (ii) above, those that, individually or in the
aggregate, are not reasonably likely to have an Earlychildhood Material Adverse
Effect or a material adverse effect on the ability of Earlychildhood to
consummate the transactions contemplated by this Agreement.
Section 3.14 Environmental Matters. (a) To the knowledge of Earlychildhood,
except as disclosed on the Earlychildhood Disclosure Schedule and except, with
or without the knowledge of Earlychildhood, for such matters that, individually
or in the aggregate, are not reasonably likely to have an Earlychildhood
Material
A-18
<PAGE>
Adverse Effect: (i) Earlychildhood and its Subsidiaries are in material
compliance with all applicable Environmental Laws (as defined in Section
3.14(b)); (ii) the properties currently owned or operated by Earlychildhood and
its Subsidiaries (including soils, groundwater, surface water, buildings or
other structures) are not contaminated with any Hazardous Substances (as
defined in Section 3.14(c)); (iii) the properties formerly owned or operated by
Earlychildhood or any of its Subsidiaries were not contaminated with Hazardous
Substances during the period of ownership or operation by Earlychildhood or any
of its Subsidiaries; (iv) neither Earlychildhood nor its Subsidiaries are
subject to liability for any Hazardous Substance disposal or contamination on
any third party property; (v) neither Earlychildhood nor any of its
Subsidiaries has been associated with any release or threat of release of any
Hazardous Substance; (vi) neither Earlychildhood nor any of its Subsidiaries
has received any written notice, demand, letter, claim or request for
information alleging that Earlychildhood or any of its Subsidiaries may be in
violation of or liable under any Environmental Law; and (vii) neither
Earlychildhood nor any of its Subsidiaries is subject to any orders, decrees,
injunctions or other arrangements with any Governmental Entity or is subject to
any indemnity or other agreement with any third party relating to liability
under any Environmental Law or relating to Hazardous Substances.
(b) As used in this Agreement, the term "Environmental Law" means any
federal, state, local or foreign law, regulation, order, decree, permit,
authorization, common law or agency requirement relating to: (A) the
protection, investigation or restoration of the environment, health and safety,
or natural resources, (B) the handling, use, presence, disposal, release or
threatened release of any Hazardous Substance or (C) noise, odor, wetlands,
pollution, contamination or any injury or threat of injury to persons or
property.
(c) As used in this Agreement, the term "Hazardous Substance" means any
substance that is: (A) listed, classified or regulated pursuant to any
Environmental Law; (B) any petroleum product or by-product, asbestos-containing
material, lead-containing paint or plumbing, polychlorinated biphenyls,
radioactive materials or radon; or (C) any other substance which is the subject
of regulatory action by any Governmental Entity pursuant to any Environmental
Law.
Section 3.15 Employee Benefit Plans.
(a) The Earlychildhood Disclosure Schedule sets forth all employee benefit
plans ("Employee Benefit Plans"), as defined in Section 3(3) of the Employee
Retirement Income Security Act of 1974, as amended ("ERISA"), and all other
material employee benefit arrangements that are not Employee Benefit Plans,
including, but not limited to any employment or consulting agreement, any
arrangement providing insurance benefits, any incentive bonus or deferred bonus
arrangement, any arrangement providing termination allowance, severance or
similar benefits, any equity compensation plan, any deferred compensation plan,
and any compensation policy or practice (collectively "Benefit Arrangements"),
which are maintained, contributed to or required to be contributed to by
Earlychildhood or any of its Subsidiaries ("Earlychildhood Employee Plans").
(b) A true and complete copy of each written Earlychildhood Employee Plan,
including, if applicable, each amendment thereto and any trust agreement,
insurance contract, collective bargaining agreement, or other funding or
investment arrangements for the benefits under such Earlychildhood Employee
Plan, has been made available to SmarterKids. In addition, with respect to each
such Earlychildhood Employee Plan to the extent applicable, Earlychildhood has
made available to SmarterKids the most recently filed Federal Forms 5500, the
most recent summary plan description (including any summaries of material
modifications), the most recent IRS determination letter, if applicable, the
most recent actuarial report or valuation, if applicable, and all material
employee communications with respect to each such Earlychildhood Employee Plan.
(c) Except as set forth on the Earlychildhood Disclosure Schedule:
(i) neither Earlychildhood nor any entity that, together with
Earlychildhood is required to be treated as a single employer under Section
414 of the Code ("Earlychildhood ERISA Affiliate"), sponsors or has
previously sponsored, maintained, contributed to or incurred an obligation
to contribute to any Employee Benefit Plan regulated under Title IV of
ERISA, including any "multiemployer plan," as defined in Sections 3(37) and
4001(a)(3) of ERISA and neither Earlychildhood nor any Earlychildhood ERISA
A-19
<PAGE>
Affiliate has incurred nor reasonably expects to incur any liability under
Title IV of ERISA arising in connection with the termination of any plan
covered or previously covered by Title IV of ERISA. Neither Earlychildhood
nor any ERISA Affiliate participates in or has employees covered by an
Employee Plan sponsored by a professional employer organization or similar
entity;
(ii) neither Earlychildhood nor any of its Subsidiaries sponsors or has
previously sponsored, maintained, contributed to or incurred an obligation
to contribute to any Employee Benefit Plan that provides or will provide
benefits described in Section 3(1) of ERISA to any former employee or
retiree of Earlychildhood or any of its Subsidiaries, except as required
under Part 6 of Title I of ERISA and Section 4980B of the Code or
applicable state law;
(iii) all Earlychildhood Employee Plans and Benefit Arrangements have
been maintained and operated, and currently are, in compliance in all
material respects with their terms, the requirements prescribed by any and
all applicable laws (including ERISA and the Code), orders, or governmental
rules and regulations in effect with respect thereto, and Earlychildhood
and its Subsidiaries have performed all material obligations required to be
performed by them under, are not in any material respect in default under
or in violation of, and have no knowledge of any default or violation by
any other party to, any of the Earlychildhood Employee Plans;
(iv) each Earlychildhood Employee Plan that is intended to qualify under
Section 401(a) of the Code and each trust established pursuant to each such
Earlychildhood Employee Plan that is intended to qualify under Section
501(a) of the Code is the subject of a favorable determination letter from
the IRS, a copy of which has been made available to SmarterKids, and, to
Earlychildhood's knowledge, nothing has occurred which may reasonably be
expected to impair such determination or otherwise adversely affect the
tax-qualified status of such Earlychildhood Employee Plan;
(v) Earlychildhood and its Subsidiaries have made full and timely
payment of all amounts required to be contributed under the terms of each
Earlychildhood Employee Plan and applicable law or required to be paid as
expenses under such Earlychildhood Employee Plan and there has been no
amendment to, written interpretation of or announcement (whether or not
written) by Earlychildhood or any Earlychildhood ERISA Affiliates relating
to, or change in employee participation or coverage under, any Employee
Benefit Plan or Benefit Arrangement that would increase materially the
expense of maintaining such Employee Benefit Plan or Benefit Arrangement
above the level of the expense incurred in respect thereof for the fiscal
year ended prior to the date hereof; and
(vi) other than claims for benefits in the ordinary course, there is no
claim, suit, action, dispute, arbitration or legal, administrative or other
proceeding or governmental investigation or audit pending, or, to the
knowledge of Earlychildhood, threatened, alleging any breach of the terms
of any Earlychildhood Employee Plan or of any fiduciary duty thereunder or
violation of any applicable law with respect to any such Earlychildhood
Employee Plan.
(d) With respect to the Earlychildhood Employee Plans, individually and in
the aggregate, no event has occurred, and to the knowledge of Earlychildhood,
there exists no condition or set of circumstances in connection with which
Earlychildhood could be subject to any liability that is reasonably likely to
have an Earlychildhood Material Adverse Effect under ERISA, the Code or any
other applicable law.
(e) Earlychildhood is not a party to any written or oral contract,
agreement, plan or arrangement pursuant to which Earlychildhood has any
obligation to "gross up," indemnify or otherwise compensate or hold harmless
any person with respect to any portion of any excise tax (or interest or
penalties with respect thereto) which such person may become subject to under
Section 4999 of the Code or any similar state tax law, and there is no
contract, agreement, plan or arrangement covering any person that, individually
or collectively, would constitute compensation in excess of the limitation set
forth in Section 162(m) of the Code.
(f) Except as set forth on the Earlychildhood Disclosure Schedule, and
except as provided for in this Agreement, neither Earlychildhood nor any of its
Subsidiaries is a party to any oral or written (i) agreement with any officer
or other key employee of Earlychildhood or any of its Subsidiaries, the
benefits of which are contingent, or the terms of which are materially altered,
upon the occurrence of a transaction involving
A-20
<PAGE>
Earlychildhood of the nature contemplated by this Agreement, (ii) agreement
with any officer of Earlychildhood providing any term of employment or
compensation guarantee extending for a period longer than one year from the
date hereof and for the payment of compensation in excess of $100,000 per
annum, or (iii) agreement or plan, including any stock option plan, stock
appreciation right plan, restricted stock plan or stock purchase plan, any of
the benefits of which will be increased, or the vesting of the benefits of
which will be accelerated, by the occurrence of any of the transactions
contemplated by this Agreement or the value of any of the benefits of which
will be calculated on the basis of any of the transactions contemplated by this
Agreement. None of the execution and delivery of this Agreement or any of the
Transaction Documents or the consummation of the transactions contemplated
hereunder or thereunder will trigger any "change of control" or similar
provisions resulting in the acceleration of benefits or compensation with
respect to any agreements with any officer or other key employee of
Earlychildhood or any of its Subsidiaries except for such applicable agreements
as set forth on the Earlychildhood Disclosure Schedule (the "Earlychildhood
Change of Control Agreements").
Section 3.16 Compliance With Laws.
(a) Neither Earlychildhood nor any of its Subsidiaries has violated or
failed to comply with any statute, law, ordinance, regulation, rule or order of
any Governmental Entity, or any judgment, decree or order of any court,
applicable to it, its business or operations or by which it, its business or
operations are bound, except for any such violations or failures to comply
that, individually or in the aggregate have not had and are not reasonably
likely to have an Earlychildhood Material Adverse Effect;
(b) No investigation or review by any Governmental Entity is pending or, to
the knowledge of Earlychildhood, has been threatened against Earlychildhood or
any of its Subsidiaries, nor, to the knowledge of Earlychildhood, has any
Governmental Entity indicated by written notice or otherwise, an intention to
conduct an investigation of Earlychildhood or any of its Subsidiaries; and
(c) There is no agreement, judgment, injunction, order or decree binding
upon Earlychildhood or any of its Subsidiaries which has had or is reasonably
likely to have the effect of prohibiting or materially impairing the conduct of
Earlychildhood's business as currently conducted or the transactions
contemplated by this Agreement.
Section 3.17 Tax Matters.
(a) To the knowledge of Earlychildhood, none of Earlychildhood, any of its
Subsidiaries or other Affiliates (as defined in Section 5.13) and any holders
of LLC Interests have taken or agreed to take any action (or failed to take or
agreed not to take any action) which such action or inaction, as the case may
be, would prevent (i) the Contribution from constituting a transaction
qualifying as a transfer of property to Holdings by the holders of LLC
Interests under Section 351 of the Code or (ii) the SmarterKids Merger as
qualifying as a reorganization described in Section 368(a) of the Code.
(b) To the knowledge of Earlychildhood, the holders of LLC Interests have no
present plan, intention or arrangement to sell or otherwise dispose of any of
the Holdings Common Stock received in the Contribution that would cause the
Contribution and the SmarterKids Merger to fail to qualify as transfers under
Section 351 of the Code.
Section 3.18 Registration Statement; Proxy Statement/Prospectus. The
information to be supplied by Earlychildhood or its Subsidiaries or about
Earlychildhood or its Subsidiaries by Earlychildhood's agents for inclusion in
the registration statement on Form S-4 pursuant to which shares of Holdings
Common Stock issued in the Transactions will be registered under the Securities
Act (the "Registration Statement"), shall not at the time the Registration
Statement is declared effective by the Securities and Exchange Commission (the
"SEC") contain any untrue statement of a material fact or omit to state any
material fact required to be stated in the Registration Statement or necessary
in order to make the statements in the Registration Statement, in light of the
circumstances under which they were made, not misleading. The information
supplied by Earlychildhood or
A-21
<PAGE>
its Subsidiaries for inclusion in the proxy statement/prospectus to be sent to
the stockholders of SmarterKids in connection with the meeting of SmarterKids'
stockholders (the "SmarterKids Stockholders' Meeting") to consider this
Agreement and the SmarterKids Merger (the "Proxy Statement/Prospectus") shall
not, on the date the Proxy Statement/Prospectus is first mailed to the
stockholders of SmarterKids, at the time of the SmarterKids Stockholders'
Meeting and at the Effective Time, contain any statement which, at such time
and in light of the circumstances under which it shall be made, is false or
misleading with respect to any material fact, omit to state any material fact
necessary in order to make the statements made in the Proxy
Statement/Prospectus not false or misleading, or omit to state any material
fact necessary to correct any statement in any earlier communication with
respect to the solicitation of proxies for the SmarterKids Stockholders'
Meeting which has become false or misleading. If at any time prior to the
Effective Time any event relating to Earlychildhood or any of its Affiliates,
should be discovered by Earlychildhood which should be set forth in an
amendment to the Registration Statement or a supplement to the Proxy
Statement/Prospectus, Earlychildhood shall promptly inform SmarterKids.
Section 3.19 Labor Matters. Neither Earlychildhood nor any of its
Subsidiaries is a party to or otherwise bound by any collective bargaining
agreement, contract or other agreement or understanding with a labor union or
labor organization, nor, as of the date hereof, is Earlychildhood or any of its
Subsidiaries the subject of any material proceeding asserting that
Earlychildhood or any of its Subsidiaries has committed an unfair labor
practice or seeking to compel it to bargain with any labor union or labor
organization nor, as of the date of this Agreement, is there pending or, to the
knowledge of Earlychildhood, threatened, any material labor strike, dispute,
walkout, work stoppage, slow-down or lockout involving Earlychildhood or any of
its Subsidiaries.
Section 3.20 Insurance. All material fire and casualty, general liability,
business interruption, product liability, and sprinkler and water damage
insurance policies maintained by Earlychildhood or any of its Subsidiaries are
with reputable insurance carriers, provide full and adequate coverage for all
normal risks incident to the business of Earlychildhood and its Subsidiaries
and their respective properties and assets, and are in character and amount at
least equivalent to that carried by persons engaged in similar businesses and
subject to the same or similar perils or hazards, except for any such failures
to maintain insurance policies that, individually or in the aggregate, are not
reasonably likely to have an Earlychildhood Material Adverse Effect. All
premiums and other payments due from Earlychildhood or any Subsidiary with
respect to any such contracts of insurance or indemnity have been paid. Neither
Earlychildhood nor any of its Subsidiaries have received written notice of any
threatened termination of, or premium increase with respect to, any of such
policies or bonds.
Section 3.21 No Existing Discussions. As of the date hereof, other than the
Transactions, neither Earlychildhood nor any of its Affiliates is engaged,
directly or indirectly, in any discussions or negotiations with any other party
with respect to any Earlychildhood Acquisition Proposal (as defined in Section
5.4).
Section 3.22 Consent. The Contribution has been approved by the unanimous
consent of all holders of LLC Interests and such holders have taken all actions
necessary under the California Limited Liability Company Act required for the
approval of the Transactions. No separate approval by the holders of any class
or series of LLC Interests or other equity interests in Earlychildhood is
necessary to approve this Agreement, the Contribution, the Transaction
Documents to which Earlychildhood is a party or any of the other transactions
contemplated hereby.
Section 3.23 Management Committee Approval. The Management Committee of
Earlychildhood has taken all actions necessary under the California Limited
Liability Company Act required for the approval of the Transactions and no
other approval under any California anti-takeover statute or regulation
applicable to Earlychildhood is required in connection with the consummation of
the Transactions. No "fair price," "moratorium," "control share acquisitions"
or other similar anti-takeover statute or regulation is applicable to
Earlychildhood or (by reason of Earlychildhood's participation therein) this
Agreement, the Contribution or the Transactions.
A-22
<PAGE>
ARTICLE IV.
REPRESENTATIONS AND WARRANTIES OF SMARTERKIDS
SmarterKids represents and warrants to Earlychildhood that the statements
contained in this Article IV are true and correct, except as set forth herein
and in the disclosure schedules delivered by SmarterKids to Earlychildhood on
or before the date of this Agreement (the "SmarterKids Disclosure Schedule").
The SmarterKids Disclosure Schedule shall be arranged in paragraphs
corresponding to the numbered and lettered paragraphs contained in this Article
IV and the disclosure in any paragraph shall qualify other paragraphs in this
Article IV only to the extent that it is reasonably apparent from a reading of
such disclosure that it also qualifies or applies to such other paragraphs.
Section 4.1 Organization of SmarterKids. SmarterKids is a corporation duly
organized, validly existing and in good standing under the laws of the State of
Delaware, has all requisite corporate power to own, lease and operate its
property and to carry on its business as now being conducted and as proposed to
be conducted, and is duly qualified to do business and is in good standing as a
foreign corporation in each jurisdiction in which the failure to be so
qualified would have a SmarterKids Material Adverse Effect (as defined below).
SmarterKids does not have, and, since the date of its incorporation, has not
had any Subsidiaries. Except as set forth on the SmarterKids Disclosure
Schedule or in the SmarterKids SEC Reports (as defined in Section 4.4) filed
prior to the date hereof, SmarterKids does not directly or indirectly own any
equity or similar interest in, or any interest that is mandatorily convertible
into or exchangeable or exercisable for, any corporation, partnership, joint
venture or other business association or entity. A true, correct and complete
copy of the Certificate of Incorporation and other similar organizational
documents of SmarterKids has been delivered to Earlychildhood. For purposes of
this Agreement "SmarterKids Material Adverse Effect" shall mean a material
adverse effect on the business, assets, properties, financial condition or
results of operations of SmarterKids, provided, that a decrease or successive
decreases in the market price of the SmarterKids Common Stock prior to the
Effective Time shall not, in and of itself, constitute a SmarterKids Material
Adverse Effect (it being understood that any decrease or successive decreases
in market price may be indicative of other factors which, in and of themselves
(without giving effect to such decrease(s) in market price), would and, to the
extent applicable, shall constitute a SmarterKids Material Adverse Effect).
Section 4.2 SmarterKids Capital Structure.
(a) The authorized capital stock of SmarterKids consists of 90,000,000
shares of SmarterKids Common Stock and 10,000,000 shares of Preferred Stock,
$.01 par value ("SmarterKids Preferred Stock"). As of the date hereof, (i)
20,651,115 shares of SmarterKids Common Stock were issued and outstanding, all
of which are validly issued, fully paid and nonassessable, (ii) no shares of
SmarterKids Common Stock were held in the treasury of SmarterKids and (iii) no
shares of SmarterKids Preferred Stock were issued and outstanding. The
SmarterKids Disclosure Schedule shows the number of shares of SmarterKids
Common Stock reserved for future issuance pursuant to stock options granted and
outstanding as of the date hereof, the plans under which such options were
granted and award agreements pursuant to which "non-plan" options were granted
(collectively, the "SmarterKids Stock Plans"), and the entities or persons to
whom such options were granted. As of the date hereof, warrants to purchase an
aggregate of 217,292 shares of SmarterKids Common Stock were issued and
outstanding the ("SmarterKids Warrants"). The SmarterKids Disclosure Schedule
sets forth the SmarterKids agreements under which the SmarterKids Warrants were
issued and to whom such warrants were granted. Except as set forth on the
SmarterKids Disclosure Schedule, there are no obligations, contingent or
otherwise, of SmarterKids to repurchase, redeem or otherwise acquire any shares
of SmarterKids Common Stock or make any material investment (in the form of a
loan, capital contribution or otherwise) in any other entity. A maximum of
400,000 shares of SmarterKids Common Stock is authorized for issuance under the
SmarterKids Employee Stock Purchase Plan, of which 40,666 shares have been
purchased pursuant thereto as of the date hereof.
A-23
<PAGE>
(b) Except as set forth in this Section 4.2 or as reserved for future grants
of options under the SmarterKids Stock Plans or as disclosed on the SmarterKids
Disclosure Schedule, (i) there are no equity securities of any class of
SmarterKids, or any security exchangeable into or exercisable for such equity
securities, issued, reserved for issuance or outstanding; (ii) there are no
options, warrants, equity securities, calls, rights, commitments or agreements
of any character to which SmarterKids is a party or by which it is bound
obligating SmarterKids to issue, deliver or sell, or cause to be issued,
delivered or sold, additional shares of capital stock of SmarterKids or
obligating SmarterKids to grant, extend, accelerate the vesting of or enter
into any such option, warrant, equity security, call, right, commitment or
agreement; and (iii) to the knowledge of SmarterKids, there are no voting
trusts, proxies or other voting agreements or understandings with respect to
the shares of capital stock of SmarterKids.
Section 4.3 Authority; No Conflict; Required Filings and Consents.
(a) SmarterKids has all requisite corporate power and authority to enter
into this Agreement and each of the Transaction Documents to which it is a
party and to consummate the Transactions contemplated by this Agreement and
each of the Transaction Documents to which it is a party. The execution and
delivery of this Agreement and each of the Transactions Documents to which it
is a party and the consummation of the transactions contemplated by this
Agreement and each of the Transaction Documents to which it is a party by
SmarterKids have been duly authorized by all necessary corporate action on the
part of SmarterKids, subject only to the approval and adoption of this
Agreement by SmarterKids' stockholders under the DGCL. The stockholders of
SmarterKids identified on the SmarterKids Disclosure Schedule have each
executed and delivered the Stockholder Support Agreement in the form of Exhibit
A attached hereto and assuming the due authorization and execution of the
Stockholder Support Agreement by each such stockholder, the Stockholder Support
Agreement constitutes a valid and binding obligation of such stockholders,
enforceable in accordance with its terms, subject to the Bankruptcy and Equity
Exception. This Agreement and each of the Transaction Documents to which
SmarterKids is a party have been duly executed and delivered by SmarterKids and
constitute the valid and binding obligations of SmarterKids, enforceable in
accordance with their terms, subject to the Bankruptcy and Equity Exception.
(b) Except as set forth on the SmarterKids Disclosure Schedule, the
execution and delivery of this Agreement and each of the Transaction Documents
to which it is a party by SmarterKids does not, and the consummation of the
Transactions contemplated by this Agreement and each of the Transaction
Documents to which it is a party will not, (i) conflict with, or result in any
violation or breach of, any provision of the Certificate of Incorporation or
Bylaws of SmarterKids (the "SmarterKids Organizational Documents"), (ii) result
in any violation or breach of, or constitute (with or without notice or lapse
of time, or both) a default (or give rise to a right of termination,
cancellation or acceleration of any obligation or loss of any material benefit)
under, or require a consent or waiver under, any of the terms, conditions or
provisions of any note, bond, mortgage, indenture, lease, contract or other
agreement, instrument or obligation to which SmarterKids is a party or by which
it or any of its properties or assets may be bound, or (iii) conflict with or
violate any permit, concession, franchise, license, judgment, order, decree,
statute, law, ordinance, rule or regulation applicable to SmarterKids or any of
its properties or assets, except in the case of (ii) and (iii) for any such
conflicts, violations, defaults, terminations, cancellations or accelerations
which are not, individually or in the aggregate, reasonably likely to have a
SmarterKids Material Adverse Effect. The execution and delivery of the
Stockholder Support Agreement by the stockholders of SmarterKids party thereto
does not conflict with, and will not result in any violation or breach of, any
provision of SmarterKids Organizational Documents.
(c) No consent, approval, order or authorization of, or registration,
declaration or filing with, any Governmental Entity is required by or with
respect to SmarterKids in connection with the execution and delivery of this
Agreement and each of the Transaction Documents to which it is a party or the
consummation of the Transactions contemplated hereby or thereby, except for (i)
the filing of the pre-merger notification report under the HSR Act, if
applicable, (ii) the filing of a Certificate of Merger with respect to the
SmarterKids Merger with the Delaware Secretary of State, (iii) the filing of
the Proxy Statement/Prospectus with the SEC in accordance with the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), (iv) such consents,
A-24
<PAGE>
approvals, orders, authorizations, registrations, declarations and filings as
may be required under applicable state or foreign securities laws, and (v) such
other consents, authorizations, filings, approvals and registrations which, if
not obtained or made, would not be reasonably likely to have a SmarterKids
Material Adverse Effect. SmarterKids is its own "ultimate parent entity" (as
such term is used in the HSR Act and the Regulations thereunder) and is not a
"$100 million Person" within the meaning of the HSR Act and the Regulations
thereunder.
Section 4.4 SEC Filings; Financial Statements.
(a) SmarterKids has timely filed and made available to Earlychildhood all
forms, reports and documents filed or required to be filed by SmarterKids with
the SEC since the date of its initial public offering (collectively, the
"SmarterKids SEC Reports"). The SmarterKids SEC Reports (including all exhibits
and schedules thereto and documents incorporated by reference therein) (i) at
the time filed, complied in all material respects with the applicable
requirements of the Securities Act and the Exchange Act, as the case may be,
and (ii) did not at the time they were filed (or if amended or superseded by a
filing prior to the date of this Agreement, then on the date of such filing)
contain any untrue statement of a material fact or omit to state a material
fact required to be stated in such SmarterKids SEC Reports or necessary in
order to make the statements in such SmarterKids SEC Reports, in the light of
the circumstances under which they were made, not misleading.
(b) SmarterKids will deliver to Earlychildhood as soon as they become
available true and complete copies of any report or statement mailed by
SmarterKids to its security holders generally or filed by it with the SEC, in
each case subsequent to the date hereof and prior to the Effective Time. As of
their respective dates, such reports and statements (excluding any information
therein provided by Earlychildhood, as to which SmarterKids makes no
representation) will not contain any untrue statement of a material fact or
omit to state a material fact required to be stated therein or necessary to
make the statements therein, in the light of the circumstances under which they
are made, not misleading and will comply in all material respects with all
applicable requirements of law. The audited financial statements and unaudited
interim financial statements of SmarterKids to be included or incorporated by
reference in such reports and statements will be prepared in accordance with
GAAP and regulations of the SEC applicable to public companies and will fairly
present the financial position of SmarterKids as of the dates thereof and the
results of operations and consolidated cash flows for the periods then ended
(subject, in the case of any unaudited interim financial statements, to normal
year-end adjustments and to the extent they may not include footnotes or may be
condensed or summary statements).
(c) Each of the financial statements (including, in each case, any related
notes) contained in the SmarterKids SEC Reports complied as to form in all
material respects with the applicable published rules and regulations of the
SEC with respect thereto, was prepared in accordance with GAAP and regulations
of the SEC applicable to public companies applied on a consistent basis
throughout the periods involved (except as may be indicated in the notes to
such financial statements or, in the case of unaudited statements, in
conformity with the requirements of Form 10-Q under the Exchange Act) and
fairly presented in all material respects the financial position of SmarterKids
as of the respective dates and the results of its operations and cash flows for
the periods indicated, except that the unaudited interim financial statements
were or are subject to normal and recurring year-end adjustments which were not
or are not expected to be material in amount. The unaudited balance sheet of
SmarterKids as of September 30, 2000 is referred to herein as the "SmarterKids
Balance Sheet." No financial statements of any other entity are required to be
included in the financial statements of SmarterKids under GAAP.
Section 4.5 No Undisclosed Liabilities. Except as disclosed in the
SmarterKids SEC Reports filed prior to the date hereof or on the SmarterKids
Disclosure Schedule, and except for normal or recurring liabilities incurred
since the date of the SmarterKids Balance Sheet in the ordinary course of
business consistent with past practices, SmarterKids does not have any
liabilities, either accrued, contingent or otherwise (whether
A-25
<PAGE>
or not required to be reflected in financial statements in accordance with
GAAP), and whether due or to become due, which individually or in the
aggregate, are reasonably likely to have a SmarterKids Material Adverse Effect.
Section 4.6 Absence of Certain Changes or Events. Except as expressly
contemplated by this Agreement and the Transaction Documents or as disclosed in
the SmarterKids SEC Reports filed prior to the date hereof or as set forth on
the SmarterKids Disclosure Schedule, since the date of the SmarterKids Balance
Sheet, SmarterKids has conducted its businesses only in the ordinary course and
in a manner consistent with past practice and, since such date, there has been
no material adverse change in the financial condition, results of operations,
business, assets or properties of SmarterKids (a "SmarterKids Material Adverse
Change") or any development or combination of developments of which the
management of SmarterKids is aware that, individually or in the aggregate, has
had, or is reasonably likely to have, a SmarterKids Material Adverse Effect,
and since such date, there has not been any:
(a) issuances of any capital stock, other than pursuant to the SmarterKids
Stock Plans through the date hereof, or purchases, redemptions or other
acquisitions, or agreements to purchase, redeem or otherwise acquire, any
shares of capital stock of SmarterKids, or issuances or purchases of any
options, warrants or other equity securities, debt securities or evidence of
indebtedness of SmarterKids, or declarations or payments of any dividends or
any distributions (whether in cash, stock or property or any combination
thereof) in respect of SmarterKids' capital stock;
(b) amendment to the organizational documents of SmarterKids;
(c) payment by SmarterKids of any bonuses, salaries or other compensation to
any director or executive officer (except for payments of salary, bonuses and
other compensation payable for employment services rendered in the ordinary
course of business (in which case there has been no increase in such payments))
or entry into any employment, severance or similar contract with any such
person;
(d) adoption of any Employee Benefit Plan or Benefit Arrangement for or with
any employees of SmarterKids or any SmarterKids ERISA Affiliate or any increase
in the payment to or benefits under any SmarterKids Plan or other benefit
obligations for or with any employees of SmarterKids or any SmarterKids ERISA
Affiliate or change in any actuarial or other assumption used to calculate
funding obligations with respect to any SmarterKids Employee Benefit Plan or
Benefit Arrangements, or any change in the manner in which contributions to any
SmarterKids Employee Benefit Plan or Benefit Arrangements are made or the basis
on which such contributions are determined;
(e) damage to or destruction or loss of any asset or property of
SmarterKids, whether or not covered by insurance, that would have a SmarterKids
Material Adverse Effect;
(f) sale, lease or other disposition of any material asset or property of
SmarterKids (other than sales of inventory in the ordinary course of business);
(g) accrual of any expenses except for such accruals in the ordinary course
of business;
(h) cancellation or waiver of any claims or rights by SmarterKids that would
have a SmarterKids Material Adverse Effect;
(i) assumption, guarantee or endorsement or other agreement to become
responsible for the obligations of any other individual, firm or corporation
(other than intercompany obligations) or making of any loans or advances to,
any employee of SmarterKids, other than in the ordinary course of business;
(j) material change by SmarterKids in its accounting methods, principles or
practices to which Earlychildhood has not previously consented in writing,
except insofar as may be appropriate for changes required by applicable law or
GAAP;
A-26
<PAGE>
(k) revaluation by SmarterKids of any of its assets having a SmarterKids
Material Adverse Effect;
(l) agreement, whether oral or written, by SmarterKids with respect to or to
do any of the foregoing;
(m) other action or event that would have required the consent of
Earlychildhood pursuant to Section 5.1 of this Agreement had such action or
event occurred after the date of this Agreement and that, individually or in
the aggregate, has had or is reasonably likely to have a SmarterKids Material
Adverse Effect.
Section 4.7 Taxes.
(a) SmarterKids has (i) timely filed all federal, state, local and foreign
Tax returns and reports required to be filed by it prior to the date of this
Agreement (taking into account all applicable extensions) and such Tax returns
are accurate and complete in all material respects, (ii) timely paid or accrued
all Taxes owed (whether or not shown on any Tax returns), and (iii) paid or
accrued all Taxes for which a notice of assessment or collection has been
received (other than amounts being contested in good faith by appropriate
proceedings). None of the Tax returns filed or Taxes payable by SmarterKids
have been the subject of an audit, action, suit, proceeding, claim,
examination, deficiency or assessment by the IRS or any other governmental
authority, and no such audit, action, suit, proceeding, claim, examination,
deficiency or assessment is currently pending or, to the knowledge of
SmarterKids, contemplated or threatened. The unpaid Taxes of SmarterKids
(whether or not yet payable) attributable to any period (or portion thereof)
ending on or before the Closing Date did not, as of September 30, 2000, exceed
the reserve for actual Taxes (as opposed to any reserve for deferred Taxes
established to reflect timing differences between book and Tax income) as shown
on the SmarterKids Balance Sheet, and will not exceed such reserve as adjusted
for the passage of time through the Closing Date in accordance with the
reasonable past custom and practice of SmarterKids in filing its Tax returns.
SmarterKids will not incur any liability for Taxes from September 30, 2000
through the Closing Date other than in the ordinary course of business and
consistent with reasonable past practice, and will not incur any Tax liability
in connection with the transactions contemplated by this Agreement. SmarterKids
has not agreed to make any adjustment under Section 481(a) of the Code (or any
corresponding provision of state, local or foreign Tax law) by reason of a
change in accounting method or otherwise, and SmarterKids will not be required
to make any such adjustment as a result of the transactions contemplated by
this Agreement. SmarterKids has timely withheld or collected and paid over to
the appropriate governmental authorities (or is properly holding for such
timely payment) all Taxes required by law to be withheld or collected.
SmarterKids has not made an election under Section 341(f) of the Code. There
are no liens for Taxes upon the assets of SmarterKids (other than liens for
Taxes that are not yet due or that are being contested in good faith by
appropriate proceedings). No extension of a statute of limitations relating to
any Taxes is in effect with respect to SmarterKids.
(b) SmarterKids has not been a member of an affiliated group of corporations
filing a consolidated federal income tax return (or a group of corporations
filing a consolidated, combined or unitary income tax return under comparable
provisions of state, local or foreign tax law) for any taxable period, other
than a group the common parent of which is or was SmarterKids. SmarterKids has
not been and is not a party to or member of any joint venture, partnership,
limited liability company, or other arrangement or contract which could be
treated as a partnership for federal income tax purposes. SmarterKids is not,
and has not been, a U.S. real property holding corporation (as defined in
Section 897(c)(2) of the Code) during the applicable period specified in
Section 897(c)(1)(A)(ii) of the Code.
(c) SmarterKids has no obligation under any agreement or arrangement with
any other person or any provision of law with respect to Taxes of such other
person (including pursuant to Treas. Reg. (S) 1.1502-6 or comparable provisions
of state, local or foreign tax law) and including any liability for Taxes of
any predecessor entity.
A-27
<PAGE>
Section 4.8 Properties.
(a) The SmarterKids Disclosure Schedule sets forth a list of all material
leases to which SmarterKids is a party as a lessee as of the date hereof (the
"SmarterKids Lease Agreements"), setting forth in the case of any such lease
covering real property, the location of such real property. To the knowledge of
SmarterKids, SmarterKids has a valid and binding leasehold interest in each of
the properties that is the subject of a SmarterKids Lease Agreement free and
clear of all Encumbrances except for (i) any Encumbrances reflected in the
financial statements included in the SmarterKids SEC Reports and the
SmarterKids Disclosure Schedule; (ii) any Encumbrances which, individually or
in the aggregate, are not reasonably likely to have a SmarterKids Material
Adverse Effect; (iii) zoning laws and other land use restrictions that do not
impair the present or anticipated use or occupancy of the property subject
thereto, (iv) any Encumbrances for taxes, assessments and other governmental
charges not yet due and payable or due but not delinquent or due and being
contested in good faith; (v) any mechanics' workmen's, repairmen's,
warehousemen's, carrier's or other similar liens and encumbrances arising in
the ordinary course of business consistent with past practice or being
contested in good faith and (vi) any Encumbrances which are matters of public
record or are shown by a current title report and reflected on the SmarterKids
Disclosure Schedule (clauses (i) through (vi) above collectively referred to
herein as "SmarterKids Permitted Encumbrances").
(b) SmarterKids is not in default under any SmarterKids Lease Agreement
except where the existence of such defaults, individually or in the aggregate,
has not had and is not reasonably likely to have a SmarterKids Material Adverse
Effect.
(c) SmarterKids does not own any real property.
Section 4.9 Intellectual Property.
(a) SmarterKids owns free and clear of all Encumbrances or is licensed or
otherwise possesses legally enforceable rights to use all patents, trademarks,
trade names, service marks, copyrights, and any applications for such patents,
trademarks, trade names, service marks, copyrights, know-how, computer software
programs or applications and tangible or intangible proprietary information or
material that are necessary to conduct the business of SmarterKids as currently
conducted (the "SmarterKids Intellectual Property"), subject to such exceptions
that would not be reasonably likely to have an SmarterKids Material Adverse
Effect. The SmarterKids Disclosure Schedule contains a list of all of the
following that are included in the material within the SmarterKids Intellectual
Property: (i) patents and patent applications; (ii) trademarks, trade names and
service marks and registrations thereof and applications therefor; and (iii)
registered copyrights and applications therefor. The SmarterKids Disclosure
Schedule identifies the owner of each item listed thereon and, in the case of
registrations and applications, the application or registration number and
date.
(b) To the knowledge of SmarterKids, SmarterKids is the sole and exclusive
owner or a licensee of all of the material SmarterKids Intellectual Property.
All of the material SmarterKids Intellectual Property will be owned or
available for use by SmarterKids on terms and conditions immediately following
the Effective Time identical to the terms and conditions pertaining to
SmarterKids immediately prior to the Effective Time. SmarterKids has taken
reasonable measures to protect the proprietary nature of the SmarterKids
Intellectual Property and to maintain in confidence the trade secrets and
confidential information that they own or use. No other person has any rights
to any material item of the SmarterKids Intellectual Property or has any rights
to any of the material SmarterKids Intellectual Property, except that the items
of the SmarterKids Intellectual Property identified on the SmarterKids
Disclosure Schedule as licensed to SmarterKids are owned by the respective
owners identified on the SmarterKids Disclosure Schedule, and, to the knowledge
of SmarterKids, no person is infringing, violating or misappropriating any of
the material SmarterKids Intellectual Property.
(c) To the knowledge of SmarterKids, none of the activities or business
presently conducted by SmarterKids infringes or violates, or constitutes a
misappropriation of, any intellectual property of any other person, and, if
without the knowledge of SmarterKids, such activities or business presently
conducted by
A-28
<PAGE>
SmarterKids does infringe, violate or constitute a misappropriation of any
intellectual property of any other person, no such infringement, violation or
misappropriation, individually or in the aggregate, is reasonably likely to
have a SmarterKids Material Adverse Effect. Neither SmarterKids nor any
Affiliate of SmarterKids has received any complaint, claim or notice alleging
any such infringement, violation or misappropriation.
(d) With respect to each item of the SmarterKids Intellectual Property:
(i) SmarterKids possesses all right, title and interest in and to such
item, except for any SmarterKids Third Party Rights (as defined below;)
(ii) such item is not subject to any outstanding judgment, order,
decree, stipulation or injunction; and
(iii) SmarterKids has not agreed, except in the ordinary course of
business consistent with past practice or in conjunction with product or
service sales or licenses, to indemnify any person for or against any
infringement, misappropriation or other conflict with respect to such item.
(e) The SmarterKids Disclosure Schedule identifies each item of the
intellectual property used by SmarterKids that is owned by a party other than
SmarterKids ("SmarterKids Third Party Rights"), and all licenses or other
agreements pursuant to which SmarterKids uses such items are listed on the
SmarterKids Disclosure Schedule. With respect to each such item:
(i) the license or other agreement covering any such material item is
valid, binding, enforceable and in full force and effect with respect to
SmarterKids and, to the knowledge of SmarterKids, with respect to every
other party thereto;
(ii) each such license or other agreement, including licenses to all
third-party software listed in the SmarterKids Disclosure Schedule other
than generally commercially available software, to which SmarterKids is a
party, is assignable by SmarterKids without the consent or approval of, or
any payment to, any party except as set forth on the SmarterKids Disclosure
Schedule, and, except as set forth on the SmarterKids Disclosure Schedule,
all such licenses and other agreements will continue to be valid, binding,
enforceable and in full force and effect immediately following the
Effective Time in accordance with the terms thereof as in effect
immediately prior to the Effective Time, and the consummation of the
transactions will not conflict with, result in a violation or breach of or
constitute a default under (with notice or lapse of time or both) any such
license or other agreement; and
(iii) neither SmarterKids nor, to the knowledge of SmarterKids, any
other party to any such license or other agreement, is in breach or default
under any such license or other agreement and, to the knowledge of
SmarterKids, no event has occurred that, with notice or lapse of time or
both, would constitute such a breach or default or permit termination,
modification or acceleration thereunder.
(g) The systems and web architecture currently associated with SmarterKids'
web site are capable of supporting revenue of $40 million on an annual basis
at present performance standards and consistent with the seasonality of
SmarterKids' business.
Section 4.10 Product Warranties and Liability.
(a) No reserves have been provided for by SmarterKids to cover potential
claims under existing customer indemnification agreements.
(b) Except as to claims, actions, proceedings or investigations which have
been asserted but as to which no notice has been given to SmarterKids and
except as set forth on SmarterKids Disclosure Schedule, there are no product
liability claims, actions, proceedings or investigations pending or, to the
knowledge of SmarterKids, threatened against SmarterKids or its assets or, to
the knowledge of SmarterKids, any state of facts existing which could give
rise to any such product liability claim, action, proceeding or investigation.
A-29
<PAGE>
(c) To the knowledge of SmarterKids, no claims have been made that the
products sold by SmarterKids are not effective for the uses such products
purport to serve. To its knowledge, SmarterKids has not received any written
notice that any product manufactured by it has not been manufactured in
accordance with "current Good Manufacturing Practices" (as such term is
commonly understood within SmarterKids' industry) or has not been properly
labeled for its approved use.
Section 4.11 Agreements, Contracts and Commitments.
(a) As of the date hereof, SmarterKids is not a party to any existing
contract, obligation or commitment (including amendments, supplements or
modifications thereof (whether orally or in writing)) of any type in any of the
following categories except for contracts filed as exhibits to the SmarterKids
SEC Reports or set forth in the SmarterKids Disclosure Schedule (true and
complete copies of which contracts have been delivered to or made available to
Earlychildhood):
(i) contracts that provide for annual payments to or by SmarterKids
aggregating in excess of $150,000;
(ii) each contract of SmarterKids that was not entered into in the
ordinary course of business;
(iii) contracts under which SmarterKids has or may, except by way of
endorsement of negotiable instruments for collection in the ordinary course
of business and consistent with past practice, become absolutely or
contingently or otherwise liable for (x) the performance under a contract
of any other person, firm or corporation or (y) the whole or any part of
the indebtedness or liabilities of any other person, firm or corporation,
in all cases, individually in excess of $1,000,000 and in the aggregate in
excess of $5,000,000;
(iv) employment agreements, consulting agreements, contracts or
commitments with any employee or member of SmarterKids' Board of Directors,
other than those which are terminable by SmarterKids on not more than
thirty days notice without liability or financial obligation, and within
each such category of agreements, contracts or commitments, which are
individually in excess of $150,000;
(v) any agreements or plans, including, without limitation, any stock
option, stock appreciation right or stock purchase plans or agreements, any
of the benefits of which will be increased, or the vesting of benefits of
which will be accelerated, by the occurrence of any of the transactions
contemplated by this Agreement or the value of any of the benefits of which
will be calculated on the basis of any of the transactions contemplated by
this Agreement;
(vi) any contract with any director, officer or more than 5% stockholder
of SmarterKids, other than in such person's capacity as a director or
officer of SmarterKids, or any contract with any entity in which, to the
knowledge of SmarterKids, any director, officer or more than 5% stockholder
or any family member of any director, officer or stockholder has a material
economic interest;
(vii) any contract that limits or restricts in any material respect
where SmarterKids may conduct its business or the type or line of business
that Earlychildhood may engage in;
(viii) any powers of attorney outstanding (other than those issued in
the ordinary course of business with respect to Tax matters), or material
obligations or liabilities (absolute or contingent) as guarantor, surety,
cosigner, endorser, co-maker, indemnitor, or otherwise respecting the
obligations or liabilities of any person;
(ix) any material contract containing any agreement with respect to any
change of control; and
(x) each material amendment, supplement and modification (whether oral
or written) in respect of any of the foregoing.
(b) SmarterKids has not breached, or received in writing any claim or notice
that it has breached, any of the terms or conditions of any material agreement,
contract or commitment filed or required to be filed as an exhibit to the
SmarterKids SEC Reports or set forth or required to be set forth in Section
4.11 of the
A-30
<PAGE>
SmarterKids Disclosure Schedule ("SmarterKids Material Contracts") in such a
manner as, individually or in the aggregate, is reasonably likely to have a
SmarterKids Material Adverse Effect. Each SmarterKids Material Contract that
has not expired by its terms is in full force and effect, except for those
contracts the ineffectiveness of which would not reasonably be likely to have a
SmarterKids Material Adverse Effect, and, if all of the consents, approvals,
authorizations, filings, notifications and other actions listed with respect to
such contract in the SmarterKids Disclosure Schedule are obtained, taken or
made, as applicable, such contract will continue, after the Effective Time, to
be in full force and effect on identical terms.
(c) To SmarterKids' knowledge, none of the parties to any SmarterKids
Material Contract have terminated, or notified SmarterKids in writing of its
intent to materially reduce or terminate its business relationship with
SmarterKids in the future.
(d) SmarterKids has not received written notice from any customer, or group
of customers, that are under common ownership or control, and that accounted
for a material percentage of the aggregate products and services furnished by
SmarterKids since January 1, 1999 that such customer or group of customers has
stopped or intends to stop purchasing SmarterKids' products or services, nor
has SmarterKids lost any supplier, or group of suppliers that are under common
ownership or control, that accounted for a material percentage of the aggregate
supplies purchased by SmarterKids since January 1, 1999.
Section 4.12 Litigation. Except as disclosed in the SmarterKids SEC Reports
or in the SmarterKids Disclosure Schedule, there is no (i) action, suit or
proceeding, claim, arbitration or investigation against SmarterKids pending or,
to the knowledge of SmarterKids, threatened, against SmarterKids or (ii)
outstanding order, judgment, writ, injunction or decree of any court,
governmental agency or arbitration tribunal in a proceeding to which
SmarterKids is a party, except, in the case of each of clauses (i) and (ii)
above, those that, individually or in the aggregate, are not reasonably likely
to have a SmarterKids Material Adverse Effect or a material adverse effect on
the ability of SmarterKids to consummate the transactions contemplated by this
Agreement.
Section 4.13 Environmental Matters. To the knowledge of SmarterKids, except
as disclosed in the SmarterKids SEC Reports filed prior to the date hereof and
except, with or without the knowledge of SmarterKids, for such matters that,
individually or in the aggregate, are not reasonably likely to have a
SmarterKids Material Adverse Effect: (i) SmarterKids is in material compliance
with all applicable Environmental Laws; (ii) the properties currently owned or
operated by SmarterKids (including soils, groundwater, surface water, buildings
or other structures) are not contaminated with any Hazardous Substances; (iii)
the properties formerly owned or operated by SmarterKids were not contaminated
with Hazardous Substances during the period of ownership or operation by
SmarterKids; (iv) SmarterKids is not subject to liability for any Hazardous
Substance disposal or contamination on any third party property; (v)
SmarterKids has not been associated with any release or threat of release of
any Hazardous Substance; (vi) SmarterKids has not received any written notice,
demand, letter, claim or request for information alleging that SmarterKids may
be in violation of or liable under any Environmental Law; and (vii) SmarterKids
is not subject to any orders, decrees, injunctions or other arrangements with
any Governmental Entity or subject to any indemnity or other agreement with any
third party relating to liability under any Environmental Law or relating to
Hazardous Substances.
Section 4.14 Employee Benefit Plans.
(a) The SmarterKids Disclosure Schedule sets forth all Employee Benefit
Plans, as defined in Section 3(3) of ERISA, and all other material Benefit
Arrangements, (i) which are maintained, contributed to or required to be
contributed to by SmarterKids ("SmarterKids Employee Plans").
(b) A true and complete copy of each written SmarterKids Employee Plan,
including, if applicable, each amendment thereto and any trust agreement,
insurance contract, collective bargaining agreement, or other funding or
investment arrangements for the benefits under such SmarterKids Employee Plan,
has been made
A-31
<PAGE>
available to Earlychildhood. In addition, with respect to each such SmarterKids
Employee Plan to the extent applicable, SmarterKids has made available to
Earlychildhood the most recently filed Federal Forms 5500, the most recent
summary plan description (including any summaries of material modifications),
the most recent IRS determination letter, if applicable, the most recent
actuarial report or valuation, if applicable, and all material employee
communications with respect to each such SmarterKids Employee Plan.
(c) Except as set forth on the SmarterKids Disclosure Schedule:
(i) neither SmarterKids nor any entity that, together with SmarterKids
is required to be treated as a single employer under Section 414 of the
Code ("SmarterKids ERISA Affiliate") sponsors or has previously sponsored,
maintained, contributed to or incurred an obligation to contribute to any
Employee Benefit Plan regulated under Title IV of ERISA, including any
"multiemployer plan," as defined in Sections 3(37) and 4001(a)(3) of ERISA
and neither SmarterKids nor any SmarterKids ERISA Affiliate has incurred
nor reasonably expects to incur any liability under Title IV of ERISA
arising in connection with the termination of any plan covered or
previously covered by Title IV or ERISA. Neither SmarterKids nor any ERISA
Affiliate participates in or has employees covered by an Employee Plan
sponsored by a professional employer organization or similar entity;
(ii) SmarterKids does not and has not previously sponsored, maintained,
contributed to or incurred an obligation to contribute to any Employee
Benefit Plan that provides or will provide benefits described in Section
3(1) of ERISA to any former employee or retiree of SmarterKids, except as
required under Part 6 of Title I of ERISA and Section 4980B of the Code or
applicable state law;
(iii) all SmarterKids Employee Plans and Benefit Arrangements have been
maintained and operated, and currently are, in compliance in all material
respects with their terms, the requirements prescribed by any and all
applicable laws (including ERISA and the Code), orders, or governmental
rules and regulations in effect with respect thereto, and SmarterKids has
performed all material obligations required to be performed by it under, is
not in any material respect in default under or in violation of, and has no
knowledge of any default or violation by any other party to, any of the
SmarterKids Employee Plans;
(iv) each SmarterKids Employee Plan that is intended to qualify under
Section 401(a) of the Code and each trust established pursuant to each such
SmarterKids Employee Plan that is intended to qualify under Section 501(a)
of the Code is the subject of a favorable determination letter from the
IRS, a copy of which has been made available to Earlychildhood, and, to
SmarterKids' knowledge, nothing has occurred which may reasonably be
expected to impair such determination or otherwise adversely affect the
tax-qualified status of such SmarterKids Employee Plan;
(v) SmarterKids has made full and timely payment of all amounts required
to be contributed under the terms of each SmarterKids Employee Plan and
applicable law or required to be paid as expenses under such SmarterKids
Employee Plan and there has been no amendment to, written interpretation of
or announcement (whether or not written) by SmarterKids or any SmarterKids
ERISA Affiliates relating to, or change in employee participation or
coverage under, any Employee Benefit Plan or Benefit Arrangement that would
increase materially the expense of maintaining such Employee Benefit Plan
or Benefit Arrangement above the level of the expense incurred in respect
thereof for the fiscal year ended prior to the date hereof; and
(vi) other than claims for benefits in the ordinary course, there is no
claim, suit, action, dispute, arbitration or legal, administrative or other
proceeding or governmental investigation or audit pending, or, to the
knowledge of SmarterKids, threatened, alleging any breach of the terms of
any SmarterKids Employee Plan or of any fiduciary duty thereunder or
violation of any applicable law with respect to any such SmarterKids
Employee Plan.
(d) With respect to the SmarterKids Employee Plans, individually and in the
aggregate, no event has occurred, and to the knowledge of SmarterKids, there
exists no condition or set of circumstances in connection with which
SmarterKids could be subject to any liability that is reasonably likely to have
a SmarterKids Material Adverse Effect under ERISA, the Code or any other
applicable law.
A-32
<PAGE>
(e) SmarterKids is not a party to any written or oral contract, agreement,
plan or arrangement pursuant to which SmarterKids has any obligation to "gross
up," indemnify or otherwise compensate or hold harmless any person with respect
to any portion of any excise tax (or interest or penalties with respect
thereto) which such person may become subject to under Section 4999 of the Code
or any similar state tax law, and there is no contract, agreement, plan or
arrangement covering any person that, individually or collectively, would
constitute compensation in excess of the limitation set forth in Section 162(m)
of the Code.
(f) Except as set forth on the SmarterKids Disclosure Schedule, and except
as provided for in this Agreement, SmarterKids is not a party to any oral or
written (i) agreement with any officer or other key employee of SmarterKids,
the benefits of which are contingent, or the terms of which are materially
altered, upon the occurrence of a transaction involving SmarterKids of the
nature contemplated by this Agreement, (ii) agreement with any officer of
SmarterKids providing any term of employment or compensation guarantee
extending for a period longer than one year from the date hereof and for the
payment of compensation in excess of $100,000 per annum, or (iii) agreement or
plan, including any stock option plan, stock appreciation right plan,
restricted stock plan or stock purchase plan, any of the benefits of which will
be increased, or the vesting of the benefits of which will be accelerated, by
the occurrence of any of the transactions contemplated by this Agreement or the
value of any of the benefits of which will be calculated on the basis of any of
the transactions contemplated by this Agreement. None of the execution and
delivery of this Agreement or any of the Transaction Documents or the
consummation of the transactions contemplated hereunder or thereunder will
trigger any "change of control" or similar provisions resulting in the
acceleration of benefits or compensation with respect to any agreements with
any officer or other key employee of SmarterKids except for such applicable
agreements as set forth on the SmarterKids Disclosure Schedule (the
"SmarterKids Change of Control Agreements").
Section 4.15 Compliance With Laws.
(a) SmarterKids has not violated or failed to comply with any statute, law,
ordinance, regulation, rule or order of any Governmental Entity, or any
judgment, decree or order of any court, applicable to it, its business or
operations or by which it, its business or operations are bound, except for any
such violations or failures to comply that, individually or in the aggregate
have not had and are not reasonably likely to have a SmarterKids Material
Adverse Effect;
(b) No investigation or review by any Governmental Entity is pending or, to
the knowledge of SmarterKids, has been threatened against SmarterKids, nor, to
the knowledge of SmarterKids, has any Governmental Entity indicated by written
notice or otherwise, an intention to conduct an investigation of SmarterKids;
and
(c) There is no agreement, judgment, injunction, order or decree binding
upon SmarterKids which has had or is reasonably likely to have the effect of
prohibiting or materially impairing the conduct of SmarterKids' business as
currently conducted or the transactions contemplated by this Agreement.
Section 4.16 Tax Matters.
(a) To the knowledge of SmarterKids, none of SmarterKids, its Affiliates (as
defined in Section 5.13) and any of SmarterKids' stockholders have taken or
agreed to take any action (or failed to take or agreed not to take any action)
which such action or inaction, as the case may be, would prevent the
SmarterKids Merger from (i) qualifying as a reorganization described in Section
368(a) of the Code and, (ii) taken together with the Contribution, as a
transfer of property to Holdings qualifying under Section 351 of the Code.
(b) To the knowledge of SmarterKids, the stockholders of SmarterKids have no
present plan, intention or arrangement to sell or otherwise dispose of any of
the Holdings Common Stock received in the SmarterKids Merger that would cause
the Contribution and the SmarterKids Merger to fail to qualify as transfers
under Section 351 of the Code.
A-33
<PAGE>
Section 4.17 Registration Statement; Proxy Statement/Prospectus. The
information to be supplied by SmarterKids or about SmarterKids to be supplied
by SmarterKids' agents for inclusion in the Registration Statement shall not at
the time the Registration Statement is declared effective by the SEC contain
any untrue statement of a material fact or omit to state any material fact
required to be stated in the Registration Statement or necessary in order to
make the statements in the Registration Statement, in light of the
circumstances under which they were made, not misleading. The information to be
supplied by SmarterKids or about SmarterKids by SmarterKids' agents for
inclusion in the Proxy Statement/Prospectus shall not, on the date the Proxy
Statement/Prospectus is first mailed to stockholders of SmarterKids, at the
time of the SmarterKids Stockholders' Meeting and at the Effective Time,
contain any statement which, at such time and in light of the circumstances
under which it shall be made, is false or misleading with respect to any
material fact, omit to state any material fact necessary in order to make the
statements made in the Proxy Statement/Prospectus not false or misleading, or
omit to state any material fact necessary to correct any statement in any
earlier communication with respect to the solicitation of proxies for the
SmarterKids Stockholders' Meeting which has become false or misleading. If at
any time prior to the Effective Time any event relating to SmarterKids or any
of its Affiliates, officers or directors should be discovered by SmarterKids
which should be set forth in an amendment to the Registration Statement or a
supplement to the Proxy Statement/Prospectus, SmarterKids shall promptly inform
Earlychildhood.
Section 4.18 Labor Matters. SmarterKids is not a party to or otherwise bound
by any collective bargaining agreement, contract or other agreement or
understanding with a labor union or labor organization, nor, as of the date
hereof, is SmarterKids the subject of any material proceeding asserting that
SmarterKids has committed an unfair labor practice or seeking to compel it to
bargain with any labor union or labor organization nor, as of the date of this
Agreement, is there pending or, to the knowledge of SmarterKids, threatened,
any material labor strike, dispute, walkout, work stoppage, slow-down or
lockout involving SmarterKids.
Section 4.19 Insurance. All material fire and casualty, general liability,
business interruption, product liability, and sprinkler and water damage
insurance policies maintained by SmarterKids are with reputable insurance
carriers, provide full and adequate coverage for all normal risks incident to
the business of SmarterKids and its respective properties and assets, and are
in character and amount at least equivalent to that carried by persons engaged
in similar businesses and subject to the same or similar perils or hazards,
except for any such failures to maintain insurance policies that, individually
or in the aggregate, are not reasonably likely to have a SmarterKids Material
Adverse Effect. All premiums and other payments due from SmarterKids with
respect to any such contracts of insurance or indemnity have been paid.
SmarterKids has not received written notice of any threatened termination of,
or premium increase with respect to, any of such policies or bonds.
Section 4.20 Opinion of Financial Advisor. The financial advisor of
SmarterKids, Chase H&Q, has delivered to SmarterKids an opinion dated the date
of this Agreement to the effect that the SmarterKids Exchange Ratio is fair to
the holders of SmarterKids Common Stock from a financial point of view.
Section 4.21 No Existing Discussions. As of the date hereof, neither
SmarterKids nor any of its Affiliates is engaged, directly or indirectly, in
any discussions or negotiations with any other party with respect to a
SmarterKids Alternative Transaction or any proposal therefor.
Section 4.22 Board Recommendation. The Board of Directors of SmarterKids
has, by a unanimous vote at a meeting of such board duly held on November 8,
2000, approved and adopted this Agreement, the SmarterKids Merger and the other
transactions contemplated hereby and thereby, and determined that this
Agreement, the SmarterKids Merger, and the other transactions contemplated
hereby and thereby, taken together, are in the best interest of the
stockholders of SmarterKids, and prior to the date hereof resolved to recommend
that the holders of SmarterKids Common Stock approve and adopt this Agreement,
the SmarterKids Merger and the other transactions contemplated hereby.
Section 4.23 Voting Requirements. The approval by a majority of the voting
power represented by the outstanding shares of SmarterKids Common Stock
entitled to vote thereon is the only vote of the holders of
A-34
<PAGE>
any class of SmarterKids' capital stock necessary to approve this Agreement,
the SmarterKids Merger and the other transactions contemplated hereby. No
separate approval by the holders of any other class or series of capital stock
of SmarterKids is necessary to approve this Agreement, the SmarterKids Merger
or any of the other transactions contemplated hereby.
Section 4.24 Section 203 of the DGCL Not Applicable. The Board of Directors
of SmarterKids has taken all actions necessary under the DGCL, including
approving the transactions contemplated by this Agreement and each of the
Transaction Documents to which it is a party, to ensure that Section 203 of the
DGCL applicable to a "business combination" (as defined in Section 203 of the
DGCL) do not, and will not, apply to the transactions contemplated hereunder
and thereunder. No other "fair price," "moratorium," "control share
acquisition" or other similar anti-takeover statute or regulation is applicable
to SmarterKids or (by reason of SmarterKids' participation therein) the
SmarterKids Merger or the other transactions contemplated by this Agreement or
the other Transaction Documents to which it is a party.
ARTICLE V.
COVENANTS
Section 5.1 Conduct of Business. Except as set forth in the Earlychildhood
Disclosure Schedule or the SmarterKids Disclosure Schedule, during the period
from the date of this Agreement and continuing until the earlier of the
termination of this Agreement or the Effective Time, Earlychildhood and
SmarterKids each agrees as to itself and, in the case of Earlychildhood, its
Subsidiaries (except to the extent that the other party shall otherwise consent
in writing) to carry on its business in the usual, regular and ordinary course
in substantially the same manner as previously conducted, to pay its debts and
taxes when due subject to good faith disputes over such debts or taxes, to pay
or perform its other obligations when due, and, to the extent consistent with
such business, use all reasonable efforts consistent with past practices and
policies to (i) preserve intact its present business organization, (ii) keep
available the services of its present officers, key employees and/or managers
and (iii) preserve its relationships with customers, suppliers, distributors,
and others having business dealings with it. Except as expressly contemplated
by this Agreement (including the Exhibits attached hereto) or as set forth in
the Earlychildhood Disclosure Schedule or the SmarterKids Disclosure Schedule,
during the period from the date of this Agreement and continuing until the
earlier of the termination of this Agreement or the Effective Time,
Earlychildhood and SmarterKids each shall not (and Earlychildhood shall not
permit its Subsidiaries to), without the written consent of the other party:
(a) Split, combine or reclassify any shares of its capital stock or
equity interests, as applicable, declare, set aside or pay any dividend or
other distribution (whether in cash, stock or property or any combination
thereof) in respect of its capital stock, LLC Interests or other equity
interests (as applicable) or, except pursuant to agreements in effect on
the date of execution of this Agreement which have been disclosed in the
Earlychildhood Disclosure Schedule or the SmarterKids Disclosure Schedule,
as the case may be, purchase, prepay, redeem or otherwise acquire any
shares of its own capital stock, LLC Interests or any other equity
interests (as applicable) or any indebtedness or debt security; provided,
however, that Earlychildhood (and to the extent necessary, its
Subsidiaries) may effect tax distributions to its equity holders in the
ordinary course of business up to the maximum amounts permitted under the
Operating Agreement;
(b) Accelerate, amend or change the period of exercisability of options
or restricted stock granted under any employee stock or equity plan of such
party or authorize cash payments in exchange for any options granted under
any of such plans, except as required by the terms of such plans or any
related agreements in effect as of the date of this Agreement;
(c) Issue, deliver or sell, or authorize or propose the issuance,
delivery or sale of, any shares of its capital stock or other equity
interests (as applicable) or securities convertible into or exchangeable
for shares of its capital stock or other equity interests (as applicable)
or subscriptions, rights, warrants or
A-35
<PAGE>
options to acquire, or other agreements or commitments of any character
obligating it to issue any such shares or equity interests, as applicable,
or other convertible securities, other than the issuance of LLC Interests
or SmarterKids Common Stock, as the case may be, pursuant to the exercise
of options or the SmarterKids Warrants outstanding on the date of this
Agreement;
(d) Acquire or agree to acquire by merging or consolidating with, or by
purchasing an equity interest in or portion of the assets of, or by any
other manner, any business or any corporation, partnership or other
business organization or division, or otherwise acquire or agree to acquire
any assets (other than inventory and other items in the ordinary course of
business), except for any such acquisitions involving aggregate
consideration of not more than $250,000;
(e) Consolidate, merge or amalgamate with or into any other person, or
sell, lease, license or otherwise dispose of (in one or more transactions)
any of its material properties or assets;
(f) (i) Increase or agree to increase the compensation payable or to
become payable to its directors or management committee members (as
applicable), officers, managers, employees or consultants, except for
increases in salary or wages of employees (other than officers) in
accordance with past practices, (ii) grant any additional severance or
termination pay to, or enter into any employment or severance agreements
with, any consultants, employees, officers, directors or management
committee members (as applicable), (iii) terminate any officers, employees
or consultants, (iv) enter into any collective bargaining agreement (other
than as required by law), or (v) establish, adopt, enter into or amend any
Employee Benefit Plan or Benefit Arrangement or other plan, trust, fund,
policy or arrangement for the benefit of any directors, officers, employees
or consultants; provided, however, that SmarterKids may make bonus payments
to its senior officers, up to an aggregate maximum of $200,000, after the
date of this Agreement and prior to January 31, 2001, so long as such
payments are made in the ordinary course of business consistent with past
practice and approved by the compensation committee of SmarterKids' Board
of Directors.
(g) Amend or propose to amend its organizational documents (including,
in the case of Earlychildhood, the Operating Agreement), except as
contemplated by this Agreement and in any event pursuant to draft
amendments sent for review and comment to the other party;
(h) (A) Incur any indebtedness for borrowed money other than in the
ordinary course of business, (B) assume, guarantee, endorse or otherwise
become liable or responsible for the obligations of any other individual,
firm or corporation or make any loans or advances, except advances to
employees for expense reimbursement made in the ordinary course of business
consistent with past practice, (C) enter into any commitment or transaction
material to SmarterKids or material to Earlychildhood and its Subsidiaries,
taken as a whole (as applicable) outside of product sales in the ordinary
course of business, or (D) incur any liabilities, except for liabilities
that, individually or in the aggregate, would not have an Earlychildhood
Material Adverse Effect or a SmarterKids Material Adverse Effect, as the
case may be;
(i) Take any action that would or is reasonably likely to result in (A)
a material breach of any provision of this Agreement or any of the
Transaction Documents to which it is a party or (B) any of its
representations and warranties set forth in this Agreement or any of the
Transaction Documents to which it is a party being untrue on and as of the
Closing Date;
(j) Institute any significant change in accounting methods, principles
or practices affecting its assets, liabilities, reserve or expense
recognition, reserves, amortization or accruals, except insofar as may be
appropriate to conform to changes in law or GAAP;
(k) Revalue any of its respective assets, including without limitation,
writing down the value of inventory or notes or accounts receivables, in
each case, except in the ordinary course of business consistent with past
practice and except insofar as may be appropriate to conform to changes in
law or GAAP;
(l) Make or rescind any material express or deemed election relating to
Taxes, settle or compromise any material claim, action, suit, litigation,
proceeding, arbitration, investigation, audit or controversy
A-36
<PAGE>
relating to Taxes, or change any of its methods of reporting income or
deductions for federal income Tax purposes from those employed in the
preparation of its federal income tax return for the taxable year ending
December 31, 1999, except as may be required by applicable law;
(m) Settle any litigation relating to the transactions contemplated
hereby or any other litigation if the cost of the settlement would exceed
$250,000;
(n) Permit any material insurance policy naming it as a beneficiary or a
loss payee to be cancelled, terminated or materially altered, unless such
policy is replaced with a comparable policy for comparable cost;
(o) Take, or agree in writing or otherwise to take, any of the actions
described in Sections (a) through (n) above.
Section 5.2 Cooperation; Notice; Cure. Each of Earlychildhood, SmarterKids
and Holdings will use commercially reasonable efforts to effectuate the
transactions contemplated hereby and to fulfill and cause to be fulfilled the
conditions to Closing under this Agreement. Subject to compliance with
applicable law, from the date hereof until the Effective Time, each of
Earlychildhood and SmarterKids shall confer on a regular and frequent basis
with one or more representatives of the other party to report on the general
status of ongoing operations and shall promptly provide the other party or its
counsel with copies of all filings made by such party with any Governmental
Entity and, in the case of SmarterKids, with the SEC, in connection with this
Agreement, the Transactions and the transactions contemplated hereby and
thereby. Each of Earlychildhood and SmarterKids shall notify the other of, and
will use all commercially reasonable efforts to cure before the Closing Date,
any event, transaction or circumstance, as soon as practical after it becomes
known to such party, that causes or will cause any covenant or agreement of
Earlychildhood or SmarterKids under this Agreement to be breached or that
renders or will render untrue any representation or warranty of Earlychildhood
or SmarterKids contained in this Agreement. Each of Earlychildhood and
SmarterKids shall notify the other in writing of, and will use all commercially
reasonable efforts to cure, before the Closing Date, any violation or breach,
as soon as practical after it becomes known to such party, of any
representation, warranty, covenant or agreement made by Earlychildhood or
SmarterKids. No notice given pursuant to this paragraph shall have any effect
on the representations, warranties, covenants or agreements contained in this
Agreement for purposes of determining satisfaction of any condition contained
herein.
Section 5.3 No Solicitation.
(a) Subject to Section 5.3(b), unless and until this Agreement shall have
been terminated by SmarterKids or Earlychildhood pursuant to and in compliance
with Article VII hereof, SmarterKids shall not, nor will it authorize or permit
any of its officers, directors, employees, financial advisors, attorneys,
accountants, or other representatives or agents to, directly or indirectly
through another person (i) solicit, initiate, facilitate or encourage any
inquiries, offers or proposals by or from any Third Party (as defined below)
that constitute, or could reasonably be expected to lead to, any Acquisition
Proposal (as defined below), (ii) enter into or execute any agreement with
respect to an Acquisition Proposal, (iii) engage in or continue negotiations or
discussions with any Third Party concerning, or, except pursuant to a
governmental request for information, otherwise communicate or provide any non-
public information to any Third Party relating to any Acquisition Proposal,
(iv) make or authorize any public statement, recommendation or solicitation in
support of any Acquisition Proposal, or (v) take any other action inconsistent
with its obligations or commitments under this Section 5.3. As used in this
Agreement, "Acquisition Proposal" means any (i) transaction pursuant to which
any corporation, partnership, trust, person or other entity or group other than
Earlychildhood or its Affiliates (a "Third Party"), acquires more than 20% of
the outstanding shares of SmarterKids Common Stock pursuant to a tender offer
or exchange offer or otherwise, (ii) merger or other business combination,
recapitalization, restructuring or similar transaction involving SmarterKids,
(iii) other transaction pursuant to which any Third Party acquires control of
assets of SmarterKids having a fair market value equal to more than 20% of the
fair market value of all the assets of SmarterKids immediately prior to such
transaction, or (iv) any public announcement of a proposal, plan or intention
to do any of the foregoing or any agreement to engage in any of the foregoing.
A-37
<PAGE>
(b) Notwithstanding the foregoing, SmarterKids may, and may authorize and
permit its officers, directors, employees, financial advisors, attorneys,
accountants and other representatives or agents, in response to a bona fide,
written, unsolicited Acquisition Proposal from a Third Party which did not
otherwise result from a breach of this Section 5.3, to (i) furnish non-public
information to such Third Party; (ii) otherwise facilitate any effort or
attempt by such Third Party to make or implement an Acquisition Proposal; (iii)
agree to or recommend or endorse any such Acquisition Proposal with or by any
Third Party; (iv) withdraw or modify, or propose publicly to withdraw or
modify, in a manner adverse to Earlychildhood, its approval and recommendation
of the SmarterKids Merger and this Agreement; (v) participate in discussions
and negotiations with such Third Party relating to such Acquisition Proposal;
and (vi) cause SmarterKids to enter into an agreement implementing an
Acquisition Proposal, provided that SmarterKids simultaneously terminates this
Agreement pursuant to Section 7.1(f) and pays the Termination Fee (as defined
in Section 7.3); provided, however, that SmarterKids shall be permitted to take
any one or more of the actions enumerated in clauses (i)-(vi) above if and only
to the extent that (A) the Board of Directors of SmarterKids reasonably
determines in good faith (after consultation with a financial advisor of
nationally recognized reputation) that (X) the Acquisition Proposal is more
favorable or is reasonably likely to lead to an Acquisition Proposal that is
more favorable to the SmarterKids stockholders from a financial point of view
than the Transactions, and (Y) is made by a Third Party reasonably believed by
the SmarterKids Board of Directors to be financially capable of completing such
Acquisition Proposal, (B) the SmarterKids Board of Directors reasonably
determines in good faith (after having consulted with and considered the advice
of its outside legal counsel) that the failure to take such actions would cause
the members of the SmarterKids Board of Directors to breach their fiduciary
duties to the SmarterKids stockholders under applicable law, and (C) prior to
furnishing or disclosing any non-public information to, or entering into
discussions or negotiations with, such Third Party, it receives from such Third
Party an executed confidentiality agreement with respect to the information to
be furnished with terms no less favorable in the aggregate to it than those
contained in the Confidentiality Agreement dated as of January 19, 2000 by and
between Earlychildhood and SmarterKids (the "Earlychildhood Confidentiality
Agreement"), but which confidentiality agreement shall not (nor shall any other
agreement or arrangement between SmarterKids, on the one hand, and such Third
Party, on the other hand, or any of their respective representatives or agents)
provide for any exclusive right to negotiate with SmarterKids or any payments
by SmarterKids. Without limiting the foregoing, it is understood that any
violation of the restrictions set forth in this Section 5.3(b) by any officer,
director or employee of SmarterKids or any investment banker, attorney,
accountant or other advisor, representative or agent of SmarterKids shall be
deemed to be a breach of this Section 5.3 by SmarterKids.
(c) SmarterKids shall (i) immediately cease and cause to be terminated any
existing activities, discussions or negotiations with any parties conducted
heretofore with respect to any Acquisition Proposal or similar transaction, and
take all necessary steps to inform such individuals or entities of the
obligations undertaken in this Section 5.3, (ii) as promptly as practicable
(and in any event within twenty-four (24) hours) notify Earlychildhood in
writing of any Acquisition Proposal or receipt of any inquiries, proposals or
offers with respect to an Acquisition Proposal or any request for non-public
information relating to it in connection with an Acquisition Proposal or for
access to its properties, books or records by any Third Party that informs
SmarterKids' Board of Directors or any representative thereof that it is
considering making, or has made (or which SmarterKids' Board of Directors
reasonably believes may be considering making or has made) a proposal or offer
with respect to an Acquisition Proposal, (iii) in such written notice, indicate
in reasonable detail the identity of such Third Party (including the name of
such Third Party and a copy of any offer or proposal and any supporting
documentation) and the terms and conditions of such proposal or offer, all of
which information shall be held in confidence by Earlychildhood, and (iv) as
promptly as practicable (and in any event within twenty-four (24) hours) notify
Earlychildhood in writing of any determination by its Board of Directors to
furnish information or engage in discussions or negotiations with any Third
Party. SmarterKids shall promptly furnish to Earlychildhood copies of any
written information (and advise it orally of any non-written information)
provided to or by any Third Party relating to an Acquisition Proposal to the
extent such information has not previously been provided to Earlychildhood. If
any notice is given or required to be given in accordance with the second
preceding sentence, then SmarterKids shall thereafter continue to keep
Earlychildhood informed, on a current basis, of the status of any such
discussions or negotiations and the terms
A-38
<PAGE>
being discussed or negotiated. Notwithstanding the foregoing, SmarterKids shall
not accept or enter into any agreement concerning an Acquisition Proposal for a
period of at least three business days after Earlychildhood's receipt of the
notification of the terms thereof pursuant to the third preceding sentence (and
only in compliance with the terms of Article VII hereof).
(d) Nothing contained in this Section 5.3 shall prohibit SmarterKids from
taking and disclosing to its stockholders a position contemplated by Rule 14e-2
promulgated under the Exchange Act or from making any disclosure to its
stockholders if the SmarterKids Board of Directors reasonably determines in
good faith after receiving the advice of its outside legal counsel (who may be
its regularly engaged outside counsel) that the failure to do so would cause
the members of the SmarterKids Board of Directors to breach of their fiduciary
duties to the SmarterKids stockholders under any applicable law, provided,
however, that neither SmarterKids nor the SmarterKids Board of Directors nor
any committee thereof may, except as expressly permitted by Section 5.3(b) or
required by Rule 14e-2 promulgated under the Exchange Act, withdraw or modify,
or propose publicly to withdraw or modify, its position with respect to this
Agreement or the SmarterKids Merger or approve or recommend, or propose
publicly to approve or recommend, an Acquisition Proposal.
Section 5.4 No Negotiation.
(a) From the date hereof until the Effective Time, or unless this Agreement
is earlier terminated by SmarterKids or Earlychildhood pursuant to and in
compliance with Article VII, Earlychildhood shall not and shall not permit its
Subsidiaries nor any of its Members or any of their respective Affiliates, nor
will Earlychildhood authorize or permit any of its employees, financial
advisors, attorneys, accountants, or other representatives or agents to,
directly or indirectly through another person, (i) solicit, initiate,
facilitate or encourage any inquiries, offers or proposals by or from any Other
Party (as defined below) that constitute, or could reasonably be expected to
lead to, any Earlychildhood Acquisition Proposal (as defined below), (ii) enter
into or execute any agreement with respect to an Earlychildhood Acquisition
Proposal, (iii) engage in or continue negotiations or discussions with any
Other Party concerning, or, except pursuant to a governmental request for
information, otherwise communicate or provide any non-public information to any
Other Party relating to, any Earlychildhood Acquisition Proposal, (iv) make or
authorize any public statement, recommendation or solicitation in support of
any Earlychildhood Acquisition Proposal, or (v) take any other action
inconsistent with its obligations or commitments under this Section 5.4. As
used in this Agreement, "Earlychildhood Acquisition Proposal" means any (i)
transaction pursuant to which any corporation, partnership, trust, person or
other entity or group other than SmarterKids or its Affiliates (an "Other
Party"), acquires more than 20% of the outstanding LLC Interests, (ii) merger
or other business combination, recapitalization, restructuring or similar
transaction involving Earlychildhood, (iii) other transaction pursuant to which
any Other Party acquires control of assets of Earlychildhood having a fair
market value equal to more than 20% of the fair market value of all the assets
of Earlychildhood immediately prior to such transaction, or (iv) any public
announcement of a proposal, plan or intention to do any of the foregoing or any
agreement to engage in any of the foregoing.
(b) Earlychildhood shall (i) immediately cease and cause to be terminated
any existing activities, discussions or negotiations with any parties conducted
heretofore with respect to any Earlychildhood Acquisition Proposal or similar
transaction, and take all necessary steps to inform such individuals or
entities of the obligations undertaken in this Section 5.4, (ii) as promptly as
practicable (and in any event within twenty-four (24) hours) notify SmarterKids
in writing of receipt of any Earlychildhood Acquisition Proposal or any
inquiries, proposals or offers with respect to an Earlychildhood Acquisition
Proposal or any request for nonpublic information relating to it in connection
with an Earlychildhood Acquisition Proposal or for access to its properties,
books or records by any Other Party that informs Earlychildhood's Management
Committee or any officer of Earlychildhood that is its considering making, or
has made (or which Earlychildhood's Management Committee reasonably believes
may be considering making or has made) a proposal or offer with respect to an
Earlychildhood Acquisition Proposal, (iii) in such written notice indicate in
reasonable detail the identity of such Other Party (including the name of such
Other Party and a copy of any offer or proposal and any supporting
documentation) and the terms and conditions of such proposal or offer, all of
which information
A-39
<PAGE>
shall be held in confidence by SmarterKids, and (iv) as promptly as practicable
(and in any event within twenty-four (24) hours) notify SmarterKids in writing
of any determination by Earlychildhood's Management Committee or its officers
or Affiliates to furnish information or engage in discussions or negotiations
with any Other Party, it being understood that if Earlychildhood furnishes such
information or engages in discussions or negotiations without SmarterKids'
prior written consent, it shall constitute a breach of this Agreement. During
such period, neither the Earlychildhood Management Committee nor any
subcommittee thereof will approve or enter into any agreement to initiate,
facilitate, encourage or implement an Earlychildhood Acquisition Proposal, or
take any other action to contravene, supersede or modify their approval of this
Agreement, the Transaction Documents, the Contribution or the other
transactions contemplated hereby.
Section 5.5 Proxy Statement/Prospectus; Registration Statement.
(a) As promptly as practicable after the execution of this Agreement,
SmarterKids shall prepare and file with the SEC the Proxy Statement/Prospectus
and Earlychildhood and SmarterKids will cause Holdings to prepare and file with
the SEC the Registration Statement on Form S-4 in which the Proxy
Statement/Prospectus will be included as a prospectus. Holdings shall use all
reasonable efforts to cause the Registration Statement to become effective as
soon after such filing as practical and to keep such Registration Statement
effective for so long as is necessary to consummate the Contribution and the
SmarterKids Merger. The Proxy Statement/Prospectus shall include the
recommendation of the Board of Directors of SmarterKids in favor of this
Agreement and the SmarterKids Merger; provided that the Board of Directors of
SmarterKids may modify or withdraw such recommendation in accordance with the
terms of Section 5.3.
(b) SmarterKids and Earlychildhood shall make all necessary filings with
respect to the SmarterKids Merger and the Contribution, respectively, under the
Securities Act, the Exchange Act, applicable state blue sky laws and the rules
and regulations thereunder.
(c) Earlychildhood and SmarterKids shall use their best efforts to furnish
to each other all information required for any application or other filing to
be made pursuant to the rules and regulations of any applicable law (including
all information required to be included in the Proxy Statement/Prospectus and
the Registration Statement) in connection with the transactions contemplated by
this Agreement.
Section 5.6 Nasdaq Quotation.
SmarterKids agrees to use its reasonable best efforts to continue the
quotation and listing of SmarterKids Common Stock on Nasdaq during the term of
this Agreement.
Section 5.7 Access to Information. Upon reasonable notice, Earlychildhood
and SmarterKids shall each (and Earlychildhood shall cause its Subsidiaries to)
afford to the officers, managers, employees, accountants, counsel and other
authorized representatives of the other, access, during normal business hours
during the period prior to the Effective Time, to all its personnel,
properties, books, contracts, commitments and records and, during such period,
each of Earlychildhood and SmarterKids shall (and Earlychildhood shall cause
its Subsidiaries to) furnish promptly to the other (a) a copy of each report,
schedule, registration statement and other document filed or received by it
during such period pursuant to the requirements of federal securities laws and
(b) all other information concerning its business, properties and personnel as
such other party may reasonably request. The parties will hold any such
information which is nonpublic in confidence in accordance with the
Earlychildhood Confidentiality Agreement and the Confidentiality Agreement
dated as of January 19, 2000 between SmarterKids, Earlychildhood and Thomas
Weisel Partners (the "SmarterKids Confidentiality Agreement", and together with
the Earlychildhood Confidentiality Agreement, the "Confidentiality
Agreements"). No information or knowledge obtained in any investigation
pursuant to this Section 5.7 shall affect or be deemed to modify any
representation or warranty contained in this Agreement or the conditions to the
obligations of the parties to consummate the Contribution or the SmarterKids
Merger.
A-40
<PAGE>
Section 5.8 SmarterKids Stockholders' Meeting. SmarterKids shall call a
meeting of its stockholders to be held as promptly as practicable for the
purpose of voting upon this Agreement and the SmarterKids Merger. Subject to
Section 5.3, SmarterKids shall, through its Board of Directors, recommend to
its stockholders approval of such matters and shall coordinate and cooperate
with Earlychildhood with respect to the timing of such meeting and shall use
its best efforts to hold such meeting as soon as practicable after the date
hereof. The only matters SmarterKids shall propose to be acted on by its
stockholders at the stockholders' meeting shall be the approval of this
Agreement and the SmarterKids Merger and related matters incidental to the
consummation of the SmarterKids Merger. Unless otherwise required to comply
with the fiduciary duties of SmarterKids' Board of Directors, as determined by
such directors in good faith after consultation with outside legal counsel,
SmarterKids shall use commercially reasonable efforts to solicit from its
stockholders proxies in favor of such matters including the retention of a
proxy solicitation firm. SmarterKids shall not require any vote greater than a
majority of the votes entitled to be cast by the holders of the issued and
outstanding shares of SmarterKids Common Stock for approval of this Agreement
and the SmarterKids Merger.
Section 5.9 Legal Conditions to Merger.
(a) Earlychildhood and SmarterKids shall each use all reasonable efforts to
(i) take, or cause to be taken, all appropriate action, and do, or cause to be
done, all things necessary and proper under applicable law to consummate and
make effective the transactions contemplated hereby as promptly as practicable,
(ii) obtain from any Governmental Entity or any other third party any consents,
licenses, permits, waivers, approvals, authorizations, or orders required to be
obtained or made by Earlychildhood or SmarterKids (and in the case of
Earlychildhood, its Subsidiaries) in connection with the authorization,
execution and delivery of this Agreement and the consummation of the
transactions contemplated hereby including, without limitation, the
Contribution and the SmarterKids Merger, (iii) as promptly as practicable, make
all necessary filings, and thereafter make any other required submissions, with
respect to this Agreement, the Contribution and the SmarterKids Merger required
under (A) the Securities Act and the Exchange Act, and any other applicable
federal or state securities laws, (B) the HSR Act, if applicable, and (C) any
other applicable law, and (iv) refrain from taking any actions (other than as
expressly permitted under Sections 5.3 or 5.4) which would reasonably be likely
to delay, hinder or interfere with the transactions contemplated hereby.
Earlychildhood and SmarterKids shall cooperate with each other in connection
with the making of all such filings, including providing copies of all such
documents to the non-filing party and its advisors prior to filing and, if
requested, to accept all reasonable additions, deletions or changes suggested
in connection therewith.
(b) Earlychildhood and SmarterKids agree, and Earlychildhood shall cause
each of its Subsidiaries, to cooperate and to use their respective best efforts
to obtain any government clearances required for Closing (including through
compliance with the HSR Act), to respond to any government requests for
information, and to contest and resist any action, including any legislative,
administrative or judicial action, and to have vacated, lifted, reversed or
overturned any decree, judgment, injunction or other order (whether temporary,
preliminary or permanent) (an "Order") that restricts, prevents or prohibits
the consummation of the Transactions or any other transactions contemplated by
this Agreement. The parties hereto will consult and cooperate with one another,
and consider in good faith the views of one another, in connection with any
analyses, appearances, presentations, memoranda, briefs, arguments, opinions
and proposals made or submitted by or on behalf of any party hereto in
connection with proceedings under or relating to the HSR Act or any other
federal, state or foreign antitrust or fair trade law. Earlychildhood and
SmarterKids shall cooperate and work together in any proceedings or
negotiations with any Governmental Entity relating to any of the foregoing.
Notwithstanding anything to the contrary in this Section 5.9, neither
Earlychildhood nor SmarterKids shall be required to take any action that would
reasonably be expected to substantially impair the overall benefits expected,
as of the date hereof, to be realized from the consummation of the
Transactions.
(c) Each of Earlychildhood and SmarterKids shall give any notices to third
parties, and shall use all reasonable efforts to obtain any third party
consents related to or required in connection with the Transactions.
A-41
<PAGE>
(d) Prior to the Effective Time, unless the parties hereto otherwise agree
in writing, SmarterKids and Earlychildhood shall take all action necessary to
terminate, as of immediately prior to the Effective Time, the respective
Employee Benefit Plan subject to Section 401(k) of the Code maintained by
Earlychildhood and each ERISA Affiliate.
Section 5.10 Earlychildhood Financial Statements. Earlychildhood shall
provide both audited and unaudited financial statements required to be included
in the Proxy Statement/Prospectus in compliance with applicable SEC reporting
requirements.
Section 5.11 Public Disclosure. Earlychildhood and SmarterKids shall agree
on the form and content of the initial press release regarding the transactions
contemplated hereby and thereafter shall consult with each other before
issuing, and use all reasonable efforts to agree upon, any press release or
other public statement with respect to any of the transactions contemplated
hereby and shall not issue any such press release or make any such public
statement prior to such consultation, except as may be required by law.
Section 5.12 Non-recognition Exchange. Whether before or after the Effective
Time, none of Earlychildhood, SmarterKids, their respective Subsidiaries or
Affiliates and Holdings shall knowingly take any action, or knowingly fail to
take any action, that is reasonably likely to jeopardize the treatment of the
SmarterKids Merger and the Contribution as transfers of property described in
Section 351 of the Code or the SmarterKids Merger as a reorganization described
in Section 368(a) of the Code.
Section 5.13 Affiliate Agreements. Upon the execution of this Agreement,
Earlychildhood and SmarterKids will provide each other with a list of those
persons who are, in Earlychildhood's or SmarterKids' respective reasonable
judgment, "affiliates" of Earlychildhood or SmarterKids, as the case may be,
within the meaning of Rule 145 (each such person who is an "affiliate" of
Earlychildhood or SmarterKids within the meaning of Rule 145 is referred to as
an "Affiliate") promulgated under the Securities Act ("Rule 145").
Earlychildhood and SmarterKids shall provide each other such information and
documents as the other party shall reasonably request for purposes of reviewing
such list and shall notify the other party in writing regarding any change in
the identity of its Affiliates prior to the Closing Date. Earlychildhood and
SmarterKids shall each use all reasonable efforts to deliver or cause to be
delivered to each other by November 30, 2000 (and in any case prior to the
Effective Time) from each of its Affiliates, an executed Affiliate Agreement,
substantially similar to the form attached hereto as Exhibit J, by which each
Affiliate of Earlychildhood and each Affiliate of SmarterKids agrees to comply
with the applicable requirements of Rule 145 (an "Affiliate Agreement").
Holdings shall be entitled to place appropriate legends on the certificates
evidencing any Holdings Common Stock to be received by such Affiliates of
Earlychildhood or SmarterKids pursuant to the terms of this Agreement, and to
issue appropriate stop transfer instructions to the transfer agent for Holdings
Common Stock, consistent with the terms of the Affiliate Agreements (provided
that such legends or stop transfer instructions shall be removed, when such
shares of Holdings Common Stock are generally transferable without any
restrictions imposed by Rule 145, upon the request of any stockholder that is
not then an Affiliate of Holdings).
Section 5.14 Nasdaq Quotation. Earlychildhood and SmarterKids shall cause
Holdings to promptly prepare and submit an application to Nasdaq to quote the
shares of Holdings Common Stock to be issued in the Transactions and upon
exercise or conversion of the Earlychildhood Options, the SmarterKids Stock
Options and the SmarterKids Warrants, and shall use all reasonable efforts to
cause such shares to be approved for quotation on Nasdaq, prior to the
Effective Time, subject to official notice of issuance.
Section 5.15 Stock Plans.
(a) At the Effective Time, each outstanding Earlychildhood Option under the
Earlychildhood Option Plans and each outstanding SmarterKids Stock Option under
the SmarterKids Stock Plans, in each case whether vested or unvested, shall be
deemed to constitute an option to acquire, in the case of Earlychildhood, on
substantially the same terms and conditions as were applicable under such
Earlychildhood Option and, in the
A-42
<PAGE>
case of SmarterKids, on the same terms and conditions as were applicable under
such SmarterKids Stock Option, the same number of shares of Holdings Common
Stock as the holder of such Earlychildhood Option or SmarterKids Stock Option,
as the case may be, would have been entitled to receive pursuant to the
Contribution or the SmarterKids Merger, respectively, had such holder exercised
such option in full immediately prior to the Effective Time (rounded down to
the nearest whole number), at a price per share (rounded up to the nearest
whole cent) equal to (y) the aggregate exercise price for the LLC Interests or
shares of SmarterKids Common Stock, as the case may be, purchasable pursuant to
such Earlychildhood Option or such SmarterKids Stock Option immediately prior
to the Effective Time divided by (z) the number of full shares of Holdings
Common Stock deemed purchasable pursuant to such Earlychildhood Option or
SmarterKids Stock Option, as the case may be, in accordance with the foregoing.
Prior to the Effective Time, each of Earlychildhood and SmarterKids shall make
any such adjustments to the terms of the Earlychildhood Option Plans or
SmarterKids Stock Plans as may be necessary to give effect to the provisions of
this Section 5.15.
(b) As soon as practicable after the Effective Time, Holdings shall deliver
to the participants in the Earlychildhood Option Plans and the SmarterKids
Stock Plans appropriate notice setting forth such participants' rights pursuant
thereto and the grants pursuant to Earlychildhood Option Plans or SmarterKids
Stock Plans, as the case may be, shall continue in effect on the same terms and
conditions (subject to the adjustments required by this Section 5.15 after
giving effect to the Transactions).
(c) Holdings shall take all corporate action necessary to reserve for
issuance a sufficient number of shares of Holdings Common Stock for delivery
under Earlychildhood Option Plans and SmarterKids Stock Plans in accordance
with this Section 5.15. As soon as practicable after the Effective Time,
Holdings shall file a registration statement on Form S-8 (or any successor or
other appropriate forms), or another appropriate form with respect to the
shares of Holdings Common Stock subject to such options and shall use its best
efforts to maintain the effectiveness of such registration statement or
registration statements (and maintain the current status of the prospectus or
prospectuses contained therein) for so long as such options remain outstanding.
(d) The Management Committee or Board of Directors, as the case may be, of
Earlychildhood and SmarterKids shall, prior to or as of the Effective Time,
take all necessary actions, pursuant to and in accordance with the terms of the
Earlychildhood Option Plans and the instruments evidencing the Earlychildhood
Options, or the SmarterKids Stock Plans and the instruments evidencing the
SmarterKids Stock Options, as the case may be, to provide for the conversion of
the Earlychildhood Options and the SmarterKids Stock Options into options to
acquire Holdings Common Stock in accordance with this Section 5.14, and to the
extent required, obtain the consent of the holders of the Earlychildhood
Options or SmarterKids Stock Options in connection with such conversion.
(e) The Board of Directors of SmarterKids shall, prior to or as of the
Effective Time, take appropriate action to approve the deemed disposition of
the SmarterKids Stock Options, as the case may be, for purposes of excepting
such disposition under Rule 16b-3(e) promulgated under the Exchange Act. The
Board of Directors of Holdings shall, prior to or as of the Effective Time,
take appropriate action to approve the deemed grant of options to purchase
Holdings Common Stock under the Earlychildhood Options and the SmarterKids
Stock Options (as converted pursuant to this Section 5.14) for purposes of
excepting such grant under Rule 16b-3(d) promulgated under the Exchange Act.
(f) Prior to the Effective Time, Holdings shall adopt the stock plan (the
"Holdings Stock Plan") substantially in the form attached hereto as Exhibit K,
which Holdings Stock Plan shall become effective as of the Effective Time.
A-43
<PAGE>
Section 5.16 Employee Stock Purchase Plan.
(a) Prior to the Effective Time, Holdings shall adopt an Employee Stock
Purchase Plan (the "Holdings Employee Stock Purchase Plan") substantially in
the form attached hereto as Exhibit L, which Holdings Employee Stock Purchase
Plan shall be effective as of the Effective Time, so that employees of
Earlychildhood and SmarterKids as of the Effective Time will be permitted to
participate in Holdings' Employee Stock Purchase Plan commencing on the first
enrollment date following the Effective Time, subject to compliance with the
eligibility provisions of such plan (with employees receiving credit, to the
extent permissible, for purposes of such eligibility provisions, for service
with SmarterKids).
(b) Holdings shall take all corporate action necessary to reserve for
issuance a sufficient number of shares of Holdings Common Stock for purchase
under the Holdings Employee Stock Purchase Plan assumed in accordance with this
Section 5.16.
Section 5.17 Non-Employee Director Plan. Prior to the Effective Time,
Holdings shall adopt a Non-Employee Director Plan (the "Holdings Director
Plan") substantially in the form attached hereto as Exhibit M, which Holdings
Director Plan shall become effective as of the Effective Time.
Section 5.18 Brokers or Finders. Each of SmarterKids and Earlychildhood
represents, as to itself, its Subsidiaries and its Affiliates, that no agent,
broker, investment banker, financial advisor or other firm or person is or will
be entitled to any broker's or finder's fee or any other commission or similar
fee in connection with any of the transactions contemplated by this Agreement,
except Thomas Weisel Partners, whose fees and expenses will be paid by
Earlychildhood in accordance with Earlychildhood's agreement with such firm (a
copy of which has been delivered by Earlychildhood to SmarterKids prior to the
date of this Agreement), and Chase H&Q, whose fees and expenses will be paid by
SmarterKids in accordance with SmarterKids' agreement with such firm (a copy of
which has been delivered by SmarterKids to Earlychildhood prior to the date of
this Agreement). Each of SmarterKids and Earlychildhood agrees to indemnify and
hold the other harmless from and against any and all claims, liabilities or
obligations with respect to any such fees, commissions or expenses asserted by
any person on the basis of any act or statement alleged to have been made by
such party or any of its Affiliates.
Section 5.19 Indemnification.
(a) From and after the Effective Time, Holdings agrees that it will, and
will cause Earlychildhood and the Surviving Corporation to, indemnify and hold
harmless each present and former director, Management Committee member and
officer of Earlychildhood and SmarterKids (the "Indemnified Parties"), against
any costs or expenses (including attorneys' fees), judgments, fines, losses,
claims, damages, liabilities or amounts paid in settlement (collectively,
"Costs") incurred in connection with any claim, action, suit, proceeding or
investigation, whether civil, criminal, administrative or investigative,
arising out of or pertaining to matters existing or occurring at or prior to
the Effective Time, whether asserted or claimed prior to, at or after the
Effective Time, to the fullest extent that Earlychildhood or SmarterKids, as
the case may be, would have been permitted under applicable law and its
organizational documents (including, in the case of Earlychildhood, the
Operating Agreement) in effect on the date hereof to indemnify such Indemnified
Party (and Holdings, Earlychildhood and the Surviving Corporation, as
applicable, shall also advance expenses as incurred to the fullest extent
permitted under applicable law; provided the Indemnified Party to whom expenses
are advanced provides an undertaking to repay such advances if it is ultimately
determined that such Indemnified Party is not entitled to indemnification).
(b) For a period of six years after the Effective Time, Holdings shall
maintain (to the extent available in the market) in effect a directors' and
officers' liability insurance policy covering those persons who are currently
covered by Earlychildhood's and SmarterKids' directors' and officers' liability
insurance policies (copies of which have been heretofore delivered by
SmarterKids to Earlychildhood and vice versa) with coverage in amount and scope
at least as favorable as Earlychildhood's and SmarterKids' existing coverage;
A-44
<PAGE>
provided that in no event shall Holdings be required to expend in excess of
200% of the higher annual premium currently paid by Earlychildhood or
SmarterKids, as applicable, for such coverage (in either case, the "Current
Premium"); and if such premium would at any time exceed 200% of the Current
Premium, then Holdings shall maintain insurance policies which provide the
maximum and best coverage available at an annual premium equal to 200% of the
Current Premium.
(c) The provisions of this Section 5.19 are intended to be in addition to
the rights otherwise available to the current officers, directors or members of
the Management Committee of Earlychildhood and SmarterKids, as applicable, by
law, charter, statute, bylaw or agreement, and shall operate for the benefit
of, and shall be enforceable by, each of the Indemnified Parties, their heirs
and their representatives.
Section 5.20 Letter of SmarterKids' Accountants. SmarterKids shall use all
reasonable efforts to cause to be delivered to Earlychildhood and SmarterKids a
comfort letter of PricewaterhouseCoopers LLP, SmarterKids' independent
accountants, dated a date within two business days before the date on which the
Registration Statement shall become effective and addressed to Holdings, in
form reasonably satisfactory to Earlychildhood and customary in scope and
substance for letters delivered by independent public accountants in connection
with registration statements similar to the Registration Statement.
Section 5.21 Letter of Earlychildhood's Accountants. Earlychildhood shall
use all reasonable efforts to cause to be delivered to SmarterKids and
Earlychildhood a comfort letter of KPMG, LLP, Earlychildhood's independent
accountants, dated a date within two business days before the date on which the
Registration Statement shall become effective and addressed to Holdings, in
form reasonably satisfactory to SmarterKids and customary in scope and
substance for letters delivered by independent public accountants in connection
with registration statements similar to the Registration Statement.
Section 5.22 Post-Transaction Corporate Governance of Holdings. At the
Effective Time, the total number of persons serving on the Board of Directors
of Holdings shall be nine (9) (unless otherwise agreed in writing by
Earlychildhood and SmarterKids prior to the Effective Time), four (4) of whom
shall be Earlychildhood Directors, two (2) of whom shall be SmarterKids
Directors and three (3) of whom shall be Independent Directors (as such terms
are defined below), all of which Earlychildhood Directors, SmarterKids
Directors and Independent Directors shall be spread proportionately among
Holdings' three classes of Directors; provided, however, that one SmarterKids
Director shall be required to stand for election at the first annual meeting of
stockholders of Holdings after the Effective Time and one SmarterKids Director
shall be required to stand for election at the third annual meeting of
stockholders of Holdings after the Effective Time; the persons to serve
initially on the Board of Directors of Holdings at the Effective Time who are
Earlychildhood Directors shall be selected solely by and at the absolute
discretion of Earlychildhood's Management Committee prior to the Effective
Time; the persons to serve initially on the Board of Directors of Holdings at
the Effective Time who are SmarterKids Directors shall be selected solely by
and at the absolute discretion of the Board of Directors of SmarterKids prior
to the Effective Time; and the persons to serve initially on the Board of
Directors of Holdings at the Effective Time who are Independent Directors shall
be mutually agreed upon by Earlychildhood and SmarterKids prior to the
Effective Time. In the event that, prior to the Effective Time, any person so
selected to serve on the Board of Directors of Holdings after the Effective
Time is unable or unwilling to serve in such position, the Management Committee
or Board of Directors which selected such person shall designate another of its
members or another person to serve in such person's stead in accordance with
the provisions of the immediately preceding sentence. The term "Earlychildhood
Director" means any person serving on the Management Committee of
Earlychildhood on the date hereof or any other person so designated who becomes
a Director of Holdings at the Effective Time and any successor director
appointed or elected pursuant to the Bylaws of Holdings; the term "SmarterKids
Director" means any person serving as a Director of SmarterKids on the date
hereof or any other person so designated who becomes a Director of Holdings at
the Effective Time and any successor director appointed or elected pursuant to
the Bylaws of Holdings and the term "Independent Director" means any person who
becomes a Director of Holdings at the Effective Time and is not an employee of
Earlychildhood, SmarterKids or Holdings at any time during the term in which
they serve as an Independent Director, and any successor director appointed or
elected pursuant to the Bylaws of Holdings.
A-45
<PAGE>
(b) Subject to Section 8.5, at the Effective Time, (i) Ronald Elliott, shall
hold the position of Chairman of the Board of Holdings, (ii) Al Noyes, shall
hold the position of Chief Executive Officer of Holdings, (iii) Judy McGuinn
shall hold the position of Chief Operating Officer of Holdings and (iv) Bob
Cahill shall hold the position of Chief Financial Officer of Holdings. If any
of the persons identified in the preceding sentence is unable or unwilling to
hold such offices as set forth above, his successor shall be selected by the
Board of Directors of Holdings in accordance with the Bylaws of Holdings.
Section 5.23 Name of Holdings. Prior to the Effective Time, Earlychildhood
and SmarterKids shall use reasonable efforts to decide on a new corporate name
for Holdings.
Section 5.24 Conveyance Taxes. Earlychildhood and SmarterKids shall
cooperate in the preparation, execution and filing of all returns,
questionnaires, applications or other documents regarding any real property
transfer or gains, sales, use, transfer, value added, stock transfer and stamp
taxes, any transfer, recording, registration and other fees or any similar
taxes (together, "Conveyance Taxes") which become payable in connection with
the transactions contemplated by this Agreement that are required or permitted
to be filed on or before the Effective Time. Earlychildhood shall pay with
respect to the Contribution, and SmarterKids shall pay with respect to the
SmarterKids Merger, without deduction or withholding from any amount payable to
the holders of LLC Interests or SmarterKids Common Stock, as the case may be,
any such Conveyance Taxes imposed by any Governmental Entity (and any penalties
and interest with respect to such Conveyance Taxes), which become payable in
connection with the transactions contemplated by this Agreement, on behalf of
their stockholders or holders of LLC interests, as the case may be.
Section 5.25 SmarterKids Minimum Closing Cash. As of the Effective Time,
SmarterKids covenants, agrees and commits that it shall have Cash on Hand (as
defined by GAAP) of not less than $18,000,000 after deducting (a) all of the
fees, costs and expenses incurred in connection with the Transactions
(including, without limitation, (i) attorney, accounting and other professional
fees and expenses incurred in the negotiation and performance of the
Transaction Documents, the preparation, filing and effectiveness of the Proxy
Statement/Prospectus and the Registration Statement and the consummation of the
Transactions and (ii) all fees of financial advisors incurred in connection
with the Transactions) and (b) all of the fees, costs and expenses incurred or
reasonably likely to be incurred in connection with realizing all contemplated
cost savings resulting from the integration of the businesses (including,
without limitation, costs associated with the integration of the respective
technologies) of Earlychildhood and SmarterKids (the "Minimum Closing Cash").
Prior to the Effective Time, SmarterKids shall provide Earlychildhood with
written verification satisfactory to Earlychildhood evidencing the Minimum
Closing Cash, and Earlychildhood shall have the right to investigate and
confirm the existence thereof in such manner as it deems necessary.
Section 5.26 Blohm Consulting Agreement. At the Effective Time, Holdings
shall enter into a consulting agreement with David Blohm, substantially in the
form attached hereto as Exhibit N.
ARTICLE VI.
CONDITIONS TO THE TRANSACTIONS
Section 6.1 Conditions to Each Party's Obligation to Effect the
Transactions. The respective obligations of each party to this Agreement to
effect the Transactions shall be subject to the satisfaction or waiver in
writing by each of SmarterKids and Earlychildhood prior to the Effective Time
of the following conditions:
(a) HSR Act. The waiting period applicable, if any, to the consummation
of the Transactions under the HSR Act shall have expired or been
terminated.
(b) Approvals. All authorizations, consents, orders or approvals of, or
declarations or filings with, or expirations of waiting periods imposed by,
any Governmental Entity (including, without limitation, an SEC order of
effectiveness with respect to the Proxy Statement/Prospectus) the failure
of which to file,
A-46
<PAGE>
obtain or occur is reasonably likely to have an Earlychildhood Material
Adverse Effect, a SmarterKids Material Adverse Effect or a Holdings
Material Adverse Effect (as defined below) shall have been filed, obtained
or occurred.
(c) Registration Statement. The Registration Statement shall have become
effective under the Securities Act and shall not be the subject of any stop
order or proceedings seeking a stop order.
(d) No Injunctions. No Governmental Entity shall have enacted, issued,
promulgated, enforced or entered any order, executive order, stay, decree,
judgment or injunction or statute, rule, regulation which is in effect and
which has the effect of making the Transactions illegal or otherwise
prohibiting consummation of the Transactions.
(e) National Listing or Nasdaq Quotation. The shares of Holdings Common
Stock to be issued in the Transactions shall have been approved for listing
on a national securities exchange or for quotation on The Nasdaq Stock
Market, subject to official notice of issuance.
(f) Consents Under Earlychildhood Agreements. Earlychildhood shall have
obtained the consent or approval of any person whose consent or approval
shall be required under any agreement or instrument in order to permit the
consummation of the transactions contemplated hereby, except those of
which, if not obtained, would not, individually or in the aggregate, have
(i) an Earlychildhood Material Adverse Effect or (ii) a material adverse
effect on the business, assets, properties, financial condition or results
of operations of Holdings after giving effect to the Transactions (a
"Holdings Material Adverse Effect").
(g) Consents Under SmarterKids Agreements. SmarterKids shall have
obtained the consent or approval of any person whose consent or approval
shall be required under any agreement or instrument in order to permit the
consummation of the transactions contemplated hereby, except those which,
if not obtained, would not, individually or in the aggregate, have (i) a
SmarterKids Material Adverse Effect or (ii) a Holdings Material Adverse
Effect.
(h) Corporate Governance. Earlychildhood and SmarterKids shall have
taken all actions necessary so that (i) not later than the Effective Time,
the Certificate of Incorporation and Bylaws of Holdings shall have been
amended to be substantially in the form of Exhibit E and Exhibit F attached
hereto; and (ii) at the Effective Time, the composition of the Board of
Directors of Holdings shall comply with Section 5.20 hereof (assuming
Earlychildhood has designated the Earlychildhood Directors and SmarterKids
has designated the SmarterKids Directors, in each case as contemplated by
Section 5.20(a) hereof).
(i) Transaction Documents. Each of the Transaction Documents shall have
been executed by each of the parties thereto and shall be in full force and
effect and legally binding against the parties thereto and no material
breach by any party shall have occurred thereunder as of the Closing Date.
Section 6.2 Additional Conditions to Obligations of Earlychildhood. The
obligation of Earlychildhood to effect the Contribution is subject to the
satisfaction of each of the following conditions prior to the Effective Time,
any of which may be waived in writing exclusively by Earlychildhood:
(a) Stockholder Approval. This Agreement and the SmarterKids Merger
shall have been approved in the manner required under the DGCL by the
holders of the issued and outstanding shares of SmarterKids Common Stock.
(b) Representations and Warranties. The representations and warranties
of SmarterKids set forth in this Agreement shall be true and correct as of
the date of this Agreement and (except to the extent such representations
and warranties speak as of an earlier date) as of the Closing Date as
though made on and as of the Closing Date, except for, (i) changes
contemplated by this Agreement and (ii) inaccuracies which, individually or
in the aggregate, have not had and are not reasonably likely to have a
SmarterKids Material Adverse Effect or a Holdings Material Adverse Effect
(without regard to any materiality limitations contained in any such
representation or warranty), or a material adverse effect upon the
consummation of the transactions contemplated hereby; and Earlychildhood
shall have received a certificate signed on behalf of SmarterKids by the
chief executive officer and the chief financial officer of SmarterKids to
such effect.
A-47
<PAGE>
(c) Performance of Obligations of SmarterKids. SmarterKids shall have
performed in all material respects all material obligations required to be
performed by it under this Agreement at or prior to the Closing Date, and
Earlychildhood shall have received a certificate signed on behalf of
SmarterKids by the chief executive officer and the chief financial officer
of SmarterKids to such effect.
(d) SmarterKids Material Adverse Effect. No SmarterKids Material Adverse
Effect or SmarterKids Material Adverse Change shall have occurred since the
date of this Agreement and be continuing.
(e) Minimum Closing Cash. SmarterKids shall have Cash on Hand (as
defined by GAAP) of not less than the amount of the Minimum Closing Cash,
verified as set forth in Section 5.24.
(f) Tax Opinion. Earlychildhood shall have received a written opinion
from Latham & Watkins, counsel to Earlychildhood, to the effect that the
Contribution will be treated for Federal income tax purposes as a transfer
of property to Holdings qualifying under Section 351 of the Code (it being
agreed that Earlychildhood, Holdings and SmarterKids shall provide
reasonable cooperation, including the delivery of such certifications as
shall be reasonably requested, to Latham & Watkins to enable it to render
such opinion).
Section 6.3 Additional Conditions to Obligations of SmarterKids. The
obligations of SmarterKids to effect the SmarterKids Merger are subject to the
satisfaction of each of the following conditions prior to the Effective Time,
any of which may be waived in writing exclusively by SmarterKids:
(a) Representations and Warranties. The representations and warranties
of Earlychildhood set forth in this Agreement shall be true and correct as
of the date of this Agreement and (except to the extent such
representations and warranties speak as of an earlier date) as of the
Closing Date as though made on and as of the Closing Date, except for, (i)
changes contemplated by this Agreement, and (ii) inaccuracies which,
individually or in the aggregate, have not had and are not reasonably
likely to have an Earlychildhood Material Adverse Effect or Holdings
Material Adverse Effect (without regard to any materiality limitations
contained in any such representation or warranty), or a material adverse
effect upon the consummation of the transactions contemplated hereby; and
SmarterKids shall have received a certificate signed on behalf of
Earlychildhood by its chief executive officer or chief financial officer to
such effect.
(b) Performance of Obligations of Earlychildhood. Earlychildhood shall
have performed in all material respects all material obligations required
to be performed by it under this Agreement at or prior to the Closing Date;
and SmarterKids shall have received a certificate signed on behalf of
Earlychildhood by its chief executive officer or chief financial officer to
such effect.
(c) Earlychildhood Material Adverse Effect. No Earlychildhood Material
Adverse Effect or Earlychildhood Material Adverse Change shall have
occurred since the date of this Agreement and be continuing.
(d) Tax Opinion. SmarterKids shall have received a written opinion from
Testa, Hurwitz & Thibeault, counsel to SmarterKids, to the effect that the
SmarterKids Merger will be treated for Federal income tax purposes as a
reorganization under Section 368(a) of the Code or, taken together with the
Contribution, as a transfer of property to Holdings qualifying under
Section 351 of the Code (it being agreed that Earlychildhood, Holdings and
SmarterKids shall provide reasonable cooperation, including the delivery of
such certifications as shall be reasonably requested, to Testa, Hurwitz &
Thibeault to enable it to render such opinion).
(e) Transaction Documents. Earlychildhood shall have duly executed each
of the Transaction Documents to which it is a party, and such Transaction
Documents shall be in full force and effect and legally binding against
Earlychildhood and no material breach by Earlychildhood shall have occurred
thereunder as of the Closing Date.
A-48
<PAGE>
ARTICLE VII.
TERMINATION AND AMENDMENT
Section 7.1 Termination. This Agreement may be terminated at any time prior
to the Effective Time (with respect to Sections 7.1(b) through 7.1(f), by
written notice by the terminating party to the other party), whether before or
after approval of the matters presented in connection with the Transactions by
the stockholders of SmarterKids:
(a) by mutual written consent of Earlychildhood and SmarterKids; or
(b) by either Earlychildhood or SmarterKids if the Transactions shall
not have been consummated by April 30, 2001 (the "Outside Date"); provided,
however, that if the Transactions shall have not been consummated by the
Outside Date due to the failure of the condition set forth in Section
6.1(b), the Outside Date shall be extended to July 31, 2001; and provided,
further, however, that the right to terminate this Agreement under this
Section 7.1(b) shall not be available to any party whose failure to fulfill
any obligation under this Agreement has been the cause of or resulted in
the failure of the Transactions to occur on or before such date; or
(c) by either Earlychildhood or SmarterKids if a court of competent
jurisdiction or other Governmental Entity shall have issued a nonappealable
final order, decree or ruling or taken any other nonappealable final
action, in each case having the effect of permanently restraining,
enjoining or otherwise prohibiting the Transactions; or
(d) by Earlychildhood, if, at the SmarterKids Stockholders' Meeting
(including any adjournment or postponement thereof), the requisite vote of
the stockholders of SmarterKids in favor of the approval and adoption of
this Agreement and the SmarterKids Merger shall not have been obtained; or
(e) by Earlychildhood, if (i) the SmarterKids Board of Directors shall
have withdrawn or modified in any manner its recommendation that its
stockholders vote in favor of this Agreement or the SmarterKids Merger;
(ii) SmarterKids shall have failed to include in the Proxy
Statement/Prospectus the recommendation of its Board of Directors in favor
of the approval of this Agreement and the SmarterKids Merger; (iii) after
the receipt by SmarterKids of an Acquisition Proposal, Earlychildhood
requests in writing that the SmarterKids Board of Directors reconfirm its
recommendation of this Agreement and the SmarterKids Merger to the
stockholders of SmarterKids and the SmarterKids Board of Directors fails to
do so within ten (10) business days after its receipt of Earlychildhood's
request; (iv) the SmarterKids Board of Directors or any committee thereof
shall have approved or recommended to the stockholders of SmarterKids an
Acquisition Proposal, other than the Transactions; (v) a tender offer or
exchange offer for 20% or more of the outstanding shares of SmarterKids
Common Stock is commenced (other than by Earlychildhood or an Affiliate of
Earlychildhood) and the SmarterKids Board of Directors does not oppose such
tender or exchange offer; (vi) SmarterKids shall have entered into any
letter of intent or similar document or any agreement, contract or
commitment accepting or expressing an intent to accept an Acquisition
Proposal; or (vii) SmarterKids fails to call and hold the SmarterKids
Stockholders' Meeting by the Outside Date (provided that Earlychildhood's
right to terminate this Agreement under this clause (vii) shall not be
available if at such time SmarterKids would be entitled to terminate this
Agreement under Section 7.1(f));
(f) by SmarterKids, prior to the approval by its stockholders of the
SmarterKids Merger, if (i) the SmarterKids Board of Directors reasonably
determines in good faith (after consultation with a financial advisor of
nationally recognized reputation) that (X) the Acquisition Proposal is more
favorable or is reasonably likely to lead to an Acquisition Proposal that
is more favorable to the SmarterKids stockholders from a financial point of
view than the Transactions, and (Y) is made by a Third Party reasonably
believed by the SmarterKids Board of Directors to be financially capable of
completing such Acquisition Proposal, and (ii) the SmarterKids Board of
Directors reasonably determines in good faith (after having consulted with
and considered the advice of its outside legal counsel) that the failure to
take such actions would cause the members of the SmarterKids Board of
Directors to breach their fiduciary duties to the
A-49
<PAGE>
SmarterKids stockholders under applicable law; provided, that SmarterKids
shall have given Earlychildhood three (3) business days' notice prior to
such termination and otherwise complied with the provisions of Section 5.3;
and, provided further, that such termination shall not be effective until
the fee specified in Section 7.3(b) has been paid to Earlychildhood; or
(g) by Earlychildhood or SmarterKids, if there has been a breach of any
representation, warranty, covenant or agreement on the part of the other
party set forth in this Agreement, which breach (i) will cause the
conditions set forth in Section 6.2(b) or (c) (in the case of termination
by Earlychildhood) or 6.3(a) or (b) (in the case of termination by
SmarterKids) not to be satisfied, and (ii) shall not have been cured within
thirty (30) business days following receipt by the breaching party of
written notice of such breach from the other party.
Section 7.2 Effect of Termination. In the event of termination of this
Agreement as provided in Section 7.1, written notice shall be given to the
other party hereto and this Agreement shall, subject to the provisions of
Section 7.1(f), immediately become void and there shall be no liability or
obligation on the part of Earlychildhood, SmarterKids, Holdings or their
respective officers, directors, members, stockholders or Affiliates, except as
set forth in Sections 5.19 and 7.3 and except that such termination shall not
limit liability for a willful breach of this Agreement; provided that, the
provisions of Sections 5.19 and 7.3 of this Agreement and the Confidentiality
Agreements shall remain in full force and effect and survive any termination of
this Agreement.
Section 7.3 Fees and Expenses.
(a) Except as set forth in this Section 7.3, if the Transactions are
terminated, all fees and expenses incurred in connection with this Agreement
and the transactions contemplated hereby shall be paid by the party incurring
such expenses.
(b) If this Agreement is terminated by either party pursuant to Section
7.1(g) hereof, then the non-terminating party (the "Breaching Party") shall pay
the Expenses (as defined below) incurred by the non-Breaching Party up to a
maximum of $350,000; provided, however, that if this Agreement is terminated by
SmarterKids pursuant to Section 7.1(g) and, at the time of such termination,
Earlychildhood is permitted to terminate this Agreement pursuant to Section
7.1(e), Earlychildhood shall not be required to pay any of SmarterKids'
Expenses pursuant to this Section 7.3(b). As used in this Agreement "Expenses"
shall include all reasonable out-of-pocket fees and expenses (including without
limitation, all reasonable fees and expenses of counsel, accountants,
investment bankers, experts and consultants to a party hereto) incurred by a
party or on its behalf in connection with or related to the authorization,
preparation, negotiation, execution and performance of this Agreement and the
transactions contemplated hereby, including the preparation, printing, filing
and mailing of the Proxy Statement/Prospectus and the solicitation of
stockholder approvals and all other matters related to the transactions
contemplated hereby.
SmarterKids' payment of the Expenses incurred by Earlychildhood pursuant to
this subsection shall be the sole and exclusive remedy of Earlychildhood
against SmarterKids and its directors, officers, employees, agents, advisory or
other representatives with respect to the occurrences giving rise to such
payment, except for liabilities or damages caused by the willful breach of any
representations, warranties, covenants or agreements herein by SmarterKids.
Earlychildhood's payment of the Expenses incurred by SmarterKids pursuant to
this subsection shall be the sole and exclusive remedy of SmarterKids against
Earlychildhood and any of its Subsidiaries and their respective managers,
directors, officers, employees, agents, advisors or other representatives with
respect to the occurrences giving rise to such payment, except for liabilities
or damages caused by the willful breach of any representations, warranties,
covenants or agreements herein by Earlychildhood.
A-50
<PAGE>
(c) SmarterKids shall pay Earlychildhood a termination fee (the "Termination
Fee") of $1,300,000 (a portion of which may be deemed to include the
reimbursement of Expenses) in cash if any of the following events occurs:
(i) the termination of this Agreement by Earlychildhood pursuant to
Section 7.1(d), and (x) at the time of such termination a definitive
proposal for an Acquisition Proposal has been provided to SmarterKids by a
Third Party and (y) within twelve (12) months of such termination, either
SmarterKids shall have entered into a definitive agreement with respect to,
or consummated, a transaction in connection with such Acquisition Proposal;
(ii) the termination of this Agreement by SmarterKids pursuant to
Section 7.1 hereof and at such time Earlychildhood shall have been
permitted to terminate this Agreement under Section 7.1(e);
(iii) the termination of this Agreement by Earlychildhood pursuant to
Section 7.1(e); or
(iv) the termination of this Agreement by SmarterKids pursuant to
Section 7.1(f).
(d) In the event of a termination pursuant to clause (i) above, the
Termination Fee shall be paid upon the earlier of the consummation or entering
into of a definitive agreement for an Acquisition Proposal, and in the event of
a termination pursuant to clause (ii), (iii) or (iv) above, the Termination Fee
shall be paid concurrently with such termination.
(e) SmarterKids' payment of the Termination Fee pursuant to subsection (b)
above shall be the sole and exclusive remedy of Earlychildhood against
SmarterKids and its directors, officers, employees, agents, advisors or other
representatives with respect to the occurrences giving rise to such payment;
provided that this limitation shall not apply in the event of a willful breach
of this Agreement by SmarterKids.
Section 7.4 Amendment. This Agreement may be amended by the parties hereto,
by action taken or authorized by their Management Committee or Board of
Directors, as the case may be, at any time before or after approval of the
matters presented in connection with the SmarterKids Merger by the stockholders
of SmarterKids, but, after any such approval, no amendment shall be made which
by law requires further approval by such stockholders without such further
approval. This Agreement may not be amended except by an instrument in writing
signed on behalf of each of the parties hereto.
Section 7.5 Extension; Waiver. At any time prior to the Effective Time, the
parties hereto, by action taken or authorized by their Management Committee or
Board of Directors, as the case may be, may, to the extent legally allowed, (i)
extend the time for the performance of any of the obligations or other acts of
the other parties hereto, (ii) waive any inaccuracies in the representations
and warranties of the other parties hereto contained herein or in any document
delivered pursuant hereto and (iii) waive compliance with any of the agreements
or conditions of the other parties hereto contained herein. Any agreement on
the part of a party hereto to any such extension or waiver shall be valid only
if set forth in a written instrument signed on behalf of such party. Any waiver
or failure to insist on strict compliance with any obligation, covenant,
agreement or condition contained in this Agreement shall not operate as a
waiver of, or estoppel with respect to, any subsequent or other failure.
A-51
<PAGE>
ARTICLE VIII.
MISCELLANEOUS
Section 8.1 Nonsurvival of Representations, Warranties and Agreements. None
of the representations, warranties and agreements in this Agreement or in any
instrument delivered pursuant to this Agreement shall survive the Effective
Time, except for the agreements contained in Sections 1.6, 1.7, 1.8, 2.1, 2.2,
2.4, 2.5, 5.12, 5.15, 5.16, 5.17, 5.18, 5.19, 5.22, 5.24, and this Article
VIII, and the agreements of the Affiliates delivered pursuant to Section 5.13.
The Confidentiality Agreement shall survive the execution and delivery of this
Agreement.
Section 8.2 Notices. All notices and other communications hereunder shall be
in writing and shall be deemed given if delivered personally, telecopied (which
is confirmed) or mailed by registered or certified mail (return receipt
requested) to the parties at the following addresses (or at such other address
for a party as shall be specified by like notice):
(a) if to Earlychildhood, to
Earlychildhood.com, LLC
2 Lower Ragsdale Drive
Suite 200
Monterey, CA 93940
Attention: Ronald Elliott
Telecopy: (831) 771-5587
with a copy to
Latham & Watkins
633 West Fifth Street, Suite 4000
Los Angeles, CA 90071-2007
Attention: Jeffrey L. Kateman, Esq.
Telecopy: (213) 891-8763
(b) if to SmarterKids, to
SmarterKids.com, Inc.
15 Crawford Street
Needham, MA 02494
Attention: Robert Cahill
Telecopy: (781) 449-4887
with a copy to:
Testa, Hurwitz & Thibeault
125 High Street Boston, MA 02110
Attention: Gordon Hayes, Esq.
Telecopy: (617) 248-7100
A-52
<PAGE>
Section 8.3 Interpretation. When a reference is made in this Agreement to
Sections, such reference shall be to a Section of this Agreement unless
otherwise indicated. The table of contents and headings contained in this
Agreement are for reference purposes only and shall not affect in any way the
meaning or interpretation of this Agreement. Whenever the words "include,"
"includes" or "including" are used in this Agreement they shall be deemed to be
followed by the words "without limitation." The phrase "made available" in this
Agreement shall mean that the information referred to has been made available
if requested by the party to whom such information is to be made available. The
phrases "the date of this Agreement", "the date hereof," and terms of similar
import, unless the context otherwise requires, shall be deemed to refer to
November 14, 2000.
Section 8.4 Counterparts. This Agreement may be executed in two or more
counterparts, all of which shall be considered one and the same agreement and
shall become effective when two or more counterparts have been signed by each
of the parties and delivered to the other parties, it being understood that all
parties need not sign the same counterpart.
Section 8.5 Entire Agreement; No Third Party Beneficiaries. This Agreement
and all documents and instruments referred to herein (a) constitute the entire
agreement and supersedes all prior agreements and understandings, both written
and oral, among the parties with respect to the subject matter hereof and
thereof, and (b) except as provided in Section 5.19, are not intended to confer
upon any person (including, without limitation, the individuals identified in
Section 5.19 and 5.22) other than the parties hereto any rights or remedies
hereunder; provided that the Confidentiality Agreement shall remain in full
force and effect until the Effective Time. Each party hereto agrees that,
except for the representations and warranties contained in this Agreement,
neither Earlychildhood nor SmarterKids makes any other representations or
warranties, and each hereby disclaims any other representations and warranties
made by itself or any of its officers, directors, managers, members, employees,
agents, financial and legal advisors or other representatives, with respect to
the execution and delivery of this Agreement or the transactions contemplated
hereby, notwithstanding the delivery or disclosure to the other or the other's
representatives of any documentation or other information with respect to any
one or more of the foregoing.
Section 8.6 Governing Law. This Agreement shall be governed and construed in
accordance with the laws of the State of Delaware without regard to any
applicable conflicts of law.
Section 8.7 Assignment. Neither this Agreement nor any of the rights,
interests or obligations hereunder shall be assigned by any of the parties
hereto (whether by operation of law or otherwise) without the prior written
consent of the other parties. Subject to the preceding sentence, this Agreement
will be binding upon, inure to the benefit of and be enforceable by the parties
and their respective successors and assigns.
[Signature Page Follows]
A-53
<PAGE>
IN WITNESS WHEREOF, Earlychildhood, SmarterKids, Holdings and Merger Sub
have caused this Agreement to be signed by their respective duly authorized
officers as of the date first written above.
EARLYCHILDHOOD.COM, LLC
/s/ Ronald C. Elliott
-------------------------------------
By: Ronald C. Elliott
Its: Chief Executive Officer
SMARTERKIDS.COM, INC.
/s/ David A. Blohm
-------------------------------------
By: David A. Blohm
Its: Chief Executive Officer
S-E EDUCATIONAL HOLDINGS CORP.
/s/ Ronald C. Elliott
-------------------------------------
By: Ronald C. Elliott
Its: Chairman of the Board
S-E EDUCATIONAL MERGER CORP.
/s/ Ronald C. Elliott
-------------------------------------
By: Ronald C. Elliott
Its: Chairman of the Board
A-54
<PAGE>
ANNEX B
STOCKHOLDER SUPPORT AGREEMENT
This STOCKHOLDER SUPPORT AGREEMENT, dated as of November 14, 2000 (the
"Agreement"), is by and among Earlychildhood.com, LLC, a California limited
liability company ("Earlychildhood") and the stockholders of SmarterKids.com,
Inc., a Delaware corporation ("SmarterKids") listed on the signature page(s)
hereto (collectively, the "Stockholders" and, individually, a "Stockholder").
Capitalized terms used in this Agreement, unless specifically defined herein,
shall have the meanings given to them in the Contribution Agreement and Plan of
Reorganization and Merger, dated as of the date hereof (the "Merger
Agreement"), by and among Earlychildhood, SmarterKids, S-E Educational Holdings
Corp., a newly-formed Delaware corporation, one-half of the issued and
outstanding capital stock of which is owned by each of Earlychildhood and
SmarterKids ("Holdings") and S-E Educational Merger Corp., a newly-formed
Delaware corporation and a wholly-owned subsidiary of Holdings ("Merger Sub").
WHEREAS, as of the date hereof, each of the Stockholders own of record and
beneficially (i) the shares of common stock, $.01 par value per share (the
"Common Stock"), of SmarterKids as is set forth next to the name of such
Stockholder in Column II of Annex A hereto and (ii) the options to acquire
shares of Common Stock as is set forth next to the name of such Stockholder on
Schedule 1.1(c) hereto (collectively, the "Shares");
WHEREAS, concurrently with the execution of this Agreement, Earlychildhood
and SmarterKids have entered into the Merger Agreement pursuant to which, and
upon the terms and subject to the conditions set forth therein, the combination
of Earlychildhood and SmarterKids shall be effected through (i) the
contribution to Holdings by the holders of LLC Interests of all of the right,
title and interest in and to their entire ownership interest in Earlychildhood
(the "Contribution") and (ii) the merger of Merger Sub with and into
SmarterKids such that SmarterKids becomes a wholly-owned subsidiary of Holdings
(the "Merger" and, collectively with the Contribution, the "Transactions");
WHEREAS, as a condition to the willingness of Earlychildhood and SmarterKids
to enter into the Merger Agreement, Earlychildhood has required that the
Stockholders agree, and in order to induce Earlychildhood to enter into the
Merger Agreement, the Stockholders have agreed, to enter into this Agreement;
and
WHEREAS, prior to the date hereof, Earlychildhood and the Stockholders had
no agreement, arrangement or understanding (as such terms are used in Section
203 of the DGCL) for the purpose of acquiring, holding, voting or disposing of
the Shares.
NOW, THEREFORE, in consideration of the foregoing premises and the
representations, warranties, covenants and agreements set forth herein, and
other good and valuable consideration, the receipt and sufficiency of which are
hereby acknowledged, and subject to the terms and conditions set forth herein,
the parties hereto hereby agree as follows:
ARTICLE I.
Section 1.1 Representations and Warranties of the Stockholders. As of the
date hereof and as of the date of the Closing under the Merger Agreement, each
Stockholder on its own behalf hereby represents and warrants to Earlychildhood
with respect to itself and its ownership of the Shares as follows:
(a) Stockholder is the sole owner of record and beneficial owner (as
defined in Rule 13d-3 under the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), which meaning will apply for all purposes of this
Agreement) of, and has good title to, all of the Shares set forth adjacent
to such Stockholder's name on Annex A, free and clear of any mortgage,
pledge, hypothecation, rights of others, claim, security interest, charge,
encumbrance, title defect, title retention agreement, voting trust
agreement,
B-1
<PAGE>
interest, option, lien, charge or similar restriction (including any
restriction on the right to vote, sell or otherwise dispose of the Shares)
or limitation (each, a "Lien") except for immaterial Liens which shall not
materially affect such Stockholder's ability to perform its obligations
under this Agreement.
(b) The Shares constitute all of the securities (as defined in Section
3(10) of the Exchange Act, which definition will apply for all purposes of
this Agreement) of SmarterKids beneficially owned, directly or indirectly,
by Stockholder, excluding any securities beneficially owned by any of its
affiliates or associates (as such terms are defined in Rule 12b-2 under the
Exchange Act, which definitions will apply for all purposes of this
Agreement), as to which it does not have voting or investment power.
(c) Except as set forth on Schedule 1.1(c), and except for the Shares,
Stockholder does not, directly or indirectly, beneficially own or have any
option, warrant or other right to acquire any securities of SmarterKids
that are or may by their terms become entitled to vote or any securities
that are convertible or exchangeable into or exercisable for any securities
of SmarterKids that are or may by their terms become entitled to vote, nor
is Stockholder subject to any contract, commitment, arrangement,
understanding or relationship (whether or not legally enforceable), other
than this Agreement, that allows or obligates it to vote or acquire any
securities of SmarterKids. Stockholder has the exclusive power to vote the
Shares set forth adjacent to such Stockholder's name on Annex A and has not
granted a proxy to any other individual, corporation, partnership (general
or limited), limited liability company, joint venture, association, trust,
unincorporated organization or other entity (collectively, a "Person") to
vote such Shares, subject to the limitations set forth in this Agreement.
(d) Each Stockholder that is a corporation or partnership, as the case
may be, is duly organized, validly existing and in good standing under the
laws of its jurisdiction of organization and has the power and authority to
execute and deliver this Agreement and to consummate the transactions
contemplated hereby, and has taken all necessary action to authorize the
execution, delivery and performance of this Agreement.
(e) This Agreement and each Transaction Document to which Stockholder is
a party has been duly executed and delivered by Stockholder and, assuming
due authorization, execution and delivery of this Agreement by
Earlychildhood and SmarterKids, constitute a valid and binding obligation
of Stockholder enforceable against Stockholder in accordance with their
terms, except that (i) the enforceability hereof or thereof may be subject
to applicable bankruptcy, insolvency or other similar laws, now or
hereinafter in effect, affecting creditors' rights generally and (ii) the
availability of the remedy of specific performance or injunctive or other
forms of equitable relief may be subject to equitable defenses and would be
subject to the discretion of the court before which any proceeding therefor
may be brought.
(f) Neither the execution and delivery of this Agreement and each of the
Transaction Documents to which Stockholder is a party, nor the performance
by Stockholder of its obligations hereunder or thereunder will, nor will
the consummation of the transactions contemplated by this Agreement and the
Merger Agreement, conflict with, result in a violation or breach of, or
constitute a default (or an event that, with notice or lapse of time or
both, would result in a default) or give rise to any right of termination,
amendment, cancellation, or acceleration or result in the creation of any
Lien on any Shares under, or require a consent or waiver under
(collectively, a "Conflict"), (i) its organizational documents, (ii) any
note, bond, mortgage, indenture lease, contract, commitment, agreement,
understanding, arrangement or restriction of any kind to which Stockholder
is a party or by which Stockholder is bound, to the extent such Conflict
would materially affect Stockholder's ability to consummate the
transactions contemplated hereby or (iii) any permit, franchise, license,
statute, injunction, judgment, writ, decree, order, ruling, rule or
regulation applicable to Stockholder, to the extent such Conflict would
materially affect Stockholder's ability to consummate the transactions
contemplated hereby.
(g) Neither the execution and delivery of this Agreement nor the
performance by Stockholder of its obligations hereunder will violate any
law, decree, statute, rule or regulation applicable to Stockholder or
require any order, consent, authorization or approval of, filing or
registration with, or declaration or notice
B-2
<PAGE>
to, any corporation, Person, firm, Governmental Entity or public or
judicial authority, other than any required notices or filings pursuant to
the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and
the rules and regulations promulgated thereunder or the federal securities
laws. There is no beneficiary or holder of a voting trust certificate or
other interest of any trust of which any of the Stockholders is a trustee
whose consent is required for the execution and delivery of this Agreement
or the compliance by the Stockholders with the terms hereof.
ARTICLE II.
Section 2.1 Transfer of the Shares; Non-Interference.
(a) During the term of this Agreement, no Stockholder shall (i) tender into
any tender or exchange offer or otherwise offer to sell, sell, transfer,
pledge, assign, hypothecate or otherwise dispose of, or encumber with any Lien,
any of the Shares, (ii) other than in connection with this Agreement, deposit
the Shares into a voting trust, enter into any voting agreement or similar
arrangement with respect to the Shares or grant any proxy or power of attorney
with respect to the Shares, or take any action inconsistent with this Agreement
or the Merger Agreement without having obtained the prior written consent of
Earlychildhood, (iii) other than this Agreement enter into any contract, option
or other arrangement or undertaking with respect to the direct or indirect
sale, transfer, pledge, assignment, hypothecation or other disposition of any
interest in or the voting of any shares of Common Stock or any other securities
of SmarterKids, (iv) take any action that would make any representation of such
Stockholder contained herein untrue or incorrect or would result in a breach by
such Stockholder of its obligations under this Agreement or a breach by
SmarterKids of its obligations under the Merger Agreement or (v) take any
action that would have the effect of preventing or disabling such Stockholder
from performing its obligations under this Agreement or SmarterKids from
performing its obligations under the Merger Agreement.
(b) Nothing herein shall prevent a Stockholder from transferring Shares by
gift, transfer to a trust or distribution, provided that (i) any such gift,
transfer or distribution is permissible under the form of Lock-Up Agreement
attached as Exhibit C to the Merger Agreement and (ii) each donee, transferee
or distributee, as applicable, executes, concurrently with such gift, transfer
or distribution, a counterpart signature page hereto and agrees to be bound
hereby.
Section 2.2 Adjustments.
(a) In the event (i) of any stock dividend, stock split, recapitalization,
reclassification, combination or exchange of shares of capital stock or other
securities of SmarterKids on, of or affecting the Shares or the like or any
other action that would have the effect of changing any of the Stockholders'
ownership of SmarterKids's capital stock or other securities or (ii) any of the
Stockholders becomes the beneficial owner of any additional shares of Common
Stock or other securities of SmarterKids, then the terms of this Agreement will
apply to the shares of capital stock held by any such Stockholder immediately
following the effectiveness of the events described in clause (i) or any such
Stockholder becoming the beneficial owner thereof, as described in clause (ii),
as though they were Shares hereunder and the term Shares shall be deemed to
refer to and include such shares of Common Stock and other securities.
(b) Each Stockholder hereby agrees, while this Agreement is in effect,
promptly to notify Earlychildhood of the number of any new shares of the Common
Stock acquired by Stockholder, if any, after the date hereof and to update
Annex A hereof, as applicable, to increase the number of Shares set forth
therein to reflect any changes resulting from the events discussed in Section
2.2(a) above. To the extent required under the Merger Agreement, each of the
events described in Section 2.2(a) shall require the prior written consent of
Earlychildhood.
Section 2.3 Stop Transfer. Each Stockholder hereby agrees with, and
covenants to, each other party hereto, that such Stockholder shall not request
that SmarterKids register the transfer (book entry or otherwise) of any
certificate or uncertificated interest representing any of its Shares, unless
such transfer is made in
B-3
<PAGE>
compliance with this Agreement (including the provisions of Section 2.1
hereof). SmarterKids agrees with, and covenants to, each other party hereto
that SmarterKids shall not register the transfer (book entry or otherwise) of
any certificate or uncertificated interest representing any of the Shares,
unless such transfer is made in compliance with this Agreement (including the
provisions of Section 2.1 hereof).
ARTICLE III.
Section 3.1 Voting of Shares; No Inconsistent Agreement.
(a) Until the termination of this Agreement in accordance with the terms
hereof, each Stockholder hereby agrees that, at any meeting (whether annual or
special and whether or not an adjourned or postponed meeting) of the
stockholders of SmarterKids, however called, and in any action by written
consent of the stockholders of SmarterKids, such Stockholder will vote (or
cause to be voted) all of its Shares (i) in favor of the Merger, the approval
and adoption of the Merger Agreement and the other transactions contemplated by
the Merger Agreement or any amendment thereto; (ii) in favor of any other
matter necessary to the consummation of the Merger and the transactions
contemplated by the Merger Agreement and considered and voted upon by the
stockholders of SmarterKids; and (iii) against any Alternative Transaction and
against any action or agreement that would result in a breach in any respect of
any covenant, representation or warranty or any other obligation or agreement
under this Agreement or the Merger Agreement or which is intended to, or could
reasonably be expected to, impede, interfere with, delay, postpone or
materially adversely effect this Agreement, the Merger Agreement, the Merger,
the other transactions contemplated by this Agreement and the Merger Agreement
or the benefits to Earlychildhood resulting herefrom or therefrom. In addition,
no Stockholder will take any action, directly or indirectly, until the
termination of this Agreement in contravention of this Agreement or the Merger
Agreement or to cause SmarterKids to take any action in contravention of the
Merger Agreement or the transactions contemplated thereby. Stockholder also
agrees that it will, upon request by Earlychildhood, furnish written
confirmation, in form and substance reasonably satisfactory to Earlychildhood,
of such Stockholder's support for the Merger Agreement. Each Stockholder
acknowledges receipt and review of a copy of the Merger Agreement and the
opportunity to consult its own legal counsel in regard to the Merger Agreement
and this Agreement.
(b) Each Stockholder agrees that it shall not enter into any agreement or
understanding with any Person the effect of which would be inconsistent with or
violative of the provisions and agreements contained herein, including in this
Section 3.1.
Section 3.2 No Solicitation. Prior to the termination of this Agreement in
accordance with its terms, each Stockholder agrees (a) that it will not, nor
will it authorize or permit any of its officers, directors, employees,
financial advisors, attorneys, accountants and other representatives or agents,
directly or indirectly through another person, to (i) solicit, initiate,
facilitate or encourage any inquiries, offers or proposals by or from a Third
Party that constitute, or could reasonably be expected to lead to, any
Acquisition Proposal, (ii) enter into or execute any agreement with respect to
an Acquisition Proposal, (iii) engage in or continue negotiations or
discussions with any Third Party concerning, or, except pursuant to a
governmental request for information, otherwise communicate or provide any non-
public information to any Third Party relating to any Acquisition Proposal,
(iv) make or authorize any public statement, recommendation or solicitation in
support of any Acquisition Proposal or (v) take, or consent to take, any other
action inconsistent with its obligations under this Section 3.2 or
SmarterKids's obligations under Section 5.3 of the Merger Agreement; and (b)
that it will notify Earlychildhood in writing as promptly as practicable (and
in any event within 24 hours) if any Acquisition Proposal is received or any
inquiries, proposals or offers with respect to an Acquisition Proposal are
received by or any information or documents are requested from or any
negotiations or discussions are sought to be initiated or continued with, it or
any of its Affiliates, such written notice to contain the identity of the other
party (including the name of such other party and a copy of any offer or
proposal and any supporting documentation), and the terms and conditions of
such proposal or offer.
B-4
<PAGE>
ARTICLE IV.
Section 4.1 Termination. This Agreement shall become effective on the date
hereof and shall continue in effect until the earlier of (i) the termination of
the Merger Agreement in accordance with its terms and (ii) the consummation of
the Transactions.
Section 4.2 Expenses. Except as otherwise expressly provided in the Merger
Agreement, all costs and expenses incurred by any of the parties hereto will be
borne by the party incurring such costs and expenses. Earlychildhood, on the
one hand, and the Stockholders, on the other hand, will indemnify and hold
harmless the other from and against any and all claims or liabilities for
finder's fees or brokerage commissions or other like payments incurred by
reason of action taken by him, it or any of them, as the case may be.
Section 4.3 Reliance. Each Stockholder agrees and acknowledges that
Earlychildhood is entering into the Merger Agreement in reliance upon each
Stockholder's execution and delivery of this Agreement.
Section 4.4 Further Assurances. Each party hereto will execute and deliver
all such further documents and instruments and take all such further action as
may be necessary in order to consummate the transactions contemplated hereby.
In addition to the foregoing, each Stockholder agrees that, if requested by
Earlychildhood, it will appoint Earlychildhood, or any nominee thereof, with
full power of substitution during the term of this Agreement, as its attorney-
in-fact and proxy for purposes of voting (or causing the voting of) all Shares
beneficially owned by such Stockholder in accordance with Section 3.1 hereof
and taking all such other action as may be required to give effect to this
Agreement. Such proxy and power of attorney will be coupled with an interest
and shall be irrevocable during and for the term of this Agreement.
Section 4.5 Enforcement of the Agreement. The Stockholders acknowledge that
irreparable damage would occur in the event that any of the provisions of this
Agreement were not performed in accordance with their specific terms or were
otherwise breached. It is accordingly agreed that the parties hereto will be
entitled to an injunction or injunctions to prevent breaches of this Agreement
and to enforce specifically the terms and provisions hereof in any court of the
United States or any state having jurisdiction, this being in addition to any
other remedy to which they are entitled at law or in equity.
Section 4.6 Miscellaneous.
(a) All representations and warranties contained herein will terminate upon
the termination of this Agreement. The covenants and agreements made herein
will survive the Closing Date in accordance with their respective terms.
(b) Any provision of this Agreement may be waived at any time by the party
that is entitled to the benefits thereof. No such waiver, amendment or
supplement will be effective unless in writing and signed by the party or
parties sought to be bound thereby. Any waiver by any party of a breach of any
provision of this Agreement will not operate as or be construed to be a waiver
of any other breach of such provision or of any breach of any other provision
of this Agreement. The failure of a party to insist upon strict adherence to
any term of this Agreement or one or more sections hereof will not be
considered a waiver or deprive that party of the right thereafter to insist
upon strict adherence to that term or any other term of this Agreement.
(c) This Agreement constitutes the entire agreement among the parties hereto
with respect to the subject matter hereof, and supersedes all prior agreements
among such parties with respect to such matters. This Agreement may not be
amended, changed, supplemented, waived or otherwise modified, except upon the
delivery of a written agreement executed by the parties hereto.
(d) This Agreement will be governed by and construed in accordance with the
laws of the State of Delaware, without regard to the conflicts of laws
principles thereof.
(e) With respect to any suit, action or proceeding initiated by a party to
this Agreement arising out of, under or in connection with this Agreement, each
Stockholder and Earlychildhood hereby submit to the
B-5
<PAGE>
exclusive jurisdiction of any state or federal court sitting in the State of
Delaware and irrevocably waive, to the fullest extent permitted by law, any
objection that they may now have or hereafter obtain to the laying of venue in
any such court in any such suit, action or proceeding.
(f) The descriptive headings contained herein are for convenience and
reference only and will not affect in any way the meaning or interpretation of
this Agreement.
(g) All notices and other communications hereunder will be in writing and
will be given (and will be deemed to have been duly given upon receipt) by
delivery in person, by facsimile, or by registered or certified mail, postage
prepaid, return receipt requested, addressed as follows:
If to Earlychildhood:
Earlychildhood.com, LLC
2 Lower Ragsdale Drive
Suite 200
Monterey, CA 93940
Attention: Ronald Elliott
Facsimile: (831) 771-5587
With a copy to:
Latham & Watkins
633 W. Fifth St., Suite 4000
Los Angeles, CA 90071
Attention: Jeffrey L. Kateman, Esq.
Facsimile: (213) 891-8763
If to SmarterKids:
SmarterKids.com, Inc.
15 Crawford Street
Needham, MA 02494
Attention: Bob Cahill
Facsimile: (781) 449-4887
With a copy to:
Testa, Hurwitz & Thibeault, LLP
125 High Street
Boston, MA 02110
Attention: Gordon H. Hayes, Jr., Esq.
Facsimile: (617) 248-7100
If to a Stockholder:
At the address(es) beneath such Stockholder's name on Annex A to this
Agreement.
or to such other address as any party may have furnished to the other parties
in writing in accordance herewith.
(h) This Agreement may be executed in any number of counterparts, each
of which will be deemed to be an original, but all of which together will
constitute one agreement.
(i) This Agreement shall be executed at the same time as the Merger
Agreement and at such time shall be valid and binding obligations of each
of the parties and signatories thereto.
(j) Neither this Agreement nor any of the rights or obligations of any
party hereto may be assigned without the prior written consent of the other
parties hereto, except that Earlychildhood may, without such
B-6
<PAGE>
consent, assign this Agreement and any of such rights and obligations to
one or more of its affiliates. Any such assignment shall not, however, act
as a release of the assigning Person. Subject to the foregoing, this
Agreement shall inure to the benefit of and be binding upon the successors
and assigns of each of the parties, and no other Person shall have any
right, benefit or obligation hereunder.
(k) If any term or provision of this Agreement is determined to be
invalid, illegal or incapable of being enforced by any rule of law or
public policy, all other terms and provisions of this Agreement will
nevertheless remain in full force and effect so long as the economic or
legal substance of the transactions contemplated hereby is not affected in
any manner adverse to any party hereto. Upon any such determination that
any term or other provision is invalid, illegal or incapable of being
enforced, the parties hereto will negotiate in good faith to modify this
Agreement so as to effect the original intent of the parties as closely as
possible in an acceptable manner to the end that the transactions
contemplated by this Agreement are consummated to the extent possible.
(l) All rights, powers and remedies provided under this Agreement or
otherwise available in respect hereof at law or in equity will be
cumulative and not alternative, and the exercise of any thereof by either
party will not preclude the simultaneous or later exercise of any other
such right, power or remedy by such party.
[Signature pages follow]
B-7
<PAGE>
IN WITNESS WHEREOF, the parties hereto have duly executed this Stockholder
Support Agreement on the date first above written.
EARLYCHILDHOOD.COM, LLC
/s/ Ronald C. Elliott
By: _________________________________
Name:Ronald C. Elliott
Title:Chief Executive Officer
STOCKHOLDERS:
NORTH BRIDGE VENTURE PARTNERS III,
L.P.
By: NORTH BRIDGE VENTURE
MANAGEMENT III, L.P., its
General Partner
/s/ Richard D'Amore
By: _________________________________
Name:Richard D'Amore
Title:General Partner
COMMONWEALTH CAPITAL VENTURES II,
L.P.
By: COMMONWEALTH CAPITAL
VENTURES II, L.P., its General
Partner
/s/ Michael T. Fitzgerald
By: _________________________________
Name:Michael T. Fitzgerald
Title:General Partner
DAVID BLOHM, an Individual
/s/ David Blohm
_____________________________________
David Blohm
JEFF PUCCI, an Individual
/s/ Jeff Pucci
_____________________________________
Jeff Pucci
RICHARD VIARD, an Individual
/s/ Richard Viard
_____________________________________
Richard Viard
B-8
<PAGE>
ALBERT NOYES, an Individual
/s/ Albert Noyes
_____________________________________
Albert Noyes
RICHARD SECOR, an Individual
/s/ Richard Secor
_____________________________________
Richard Secor
RICHARD D'AMORE, an Individual
/s/ Richard D'Amore
_____________________________________
Richard D'Amore
MICHAEL FITZGERALD, an Individual
/s/ Michael Fitzgerald
_____________________________________
Michael Fitzgerald
MICHAEL KOLOWICH, an Individual
/s/ Michael Kolowich
_____________________________________
Michael Kolowich
BRIAN HICKEY, an Individual
/s/ Brian Hickey
_____________________________________
Brian Hickey
ROBERT CAHILL, an Individual
/s/ Robert Cahill
_____________________________________
Robert Cahill
B-9
<PAGE>
ANNEX A TO STOCKHOLDER SUPPORT AGREEMENT
SHARES OWNED BY STOCKHOLDERS
<TABLE>
<CAPTION>
Shares
held as
of the
date
Stockholder hereof
----------- ---------
<S> <C>
North Bridge Venture Partners III, L.P................................ 2,967,817
Commonwealth Capital Ventures II, L.P................................. 1,858,908
Jeff Pucci............................................................ 501,000
Richard Viard......................................................... 499,500
Albert Noyes.......................................................... 247,000
Michael Kolowich...................................................... 155,000
</TABLE>
SCHEDULE 1.1(c)
CONVERTIBLE SECURITIES BENEFICIALLY OWNED BY STOCKHOLDERS
<TABLE>
<CAPTION>
Outstanding
Optionee Options
-------- -----------
<S> <C>
David Blohm......................................................... 1,072,000
Robert Cahill....................................................... 245,000
Richard D'Amore..................................................... 45,000
Michael Fitzgerald.................................................. 45,000
Brian Hickey........................................................ 45,000
Michael Kolowich.................................................... 75,000
Albert Noyes........................................................ 439,000
Jeff Pucci.......................................................... 570,000
Richard Secor....................................................... 310,000
Richard Viard....................................................... 570,000
</TABLE>
B-10
<PAGE>
ANNEX C
[LOGO of Chase H&Q]
One Bush Street
San Francisco, CA 94104
Tel 415-371-3000
November 14, 2000
Confidential
The Board of Directors
SmarterKids.com
15 Crawford Street
Needham, MA 02494
Ladies and Gentlemen:
You have requested our opinion as to the fairness from a financial point of
view to the holders of the outstanding shares of common stock (the "Common
Stock") of SmarterKids.com, Inc. ("SmarterKids.com" or the "Company") of the
consideration to be received by such stockholders in connection with the
proposed merger of S-E Merger Corp. ("Merger Sub"), a subsidiary of S-E
Holdings Corp. ("Holdings"), with and into SmarterKids.com (the "Proposed
Transaction") pursuant to the Contribution Agreement and Plan of Reorganization
and Merger to be dated as of November 14, 2000, by and among Earlychildhood.com
LLC, SmarterKids.com, Holdings and Merger Sub (the "Agreement").
We understand that the terms of the Agreement provide, among other things,
that each issued and outstanding share of Common Stock of the Company shall be
cancelled and shall be converted automatically into the right to receive [x/y]
of one share of Common Stock of Holdings (the "Exchange Ratio"), as more fully
set forth in the Agreement. For purposes of this opinion, we have assumed that
the Contribution (as such term is defined in the Agreement) will be treated for
Federal income tax purposes as a transfer of property to Holdings qualifying
under Section 351 of the Internal Revenue Code of 1986, as amended (the
"Code"), and that the Proposed Transaction will be treated for Federal income
tax purposes as a reorganization under Section 368(a) of the Code or, taken
together with the Contribution, as a transfer of property to Holdings
qualifying under Section 351 of the Code.
Chase H&Q, a division of Chase Securities Inc. ("Chase H&Q"), as part of its
investment banking services, is regularly engaged in the valuation of
businesses and their securities in connection with mergers and acquisitions,
strategic transactions, corporate restructurings, negotiated underwritings,
secondary distributions of listed and unlisted securities, private placements
and valuations for corporate and other purposes. We have acted as a financial
advisor to the Board of Directors of SmarterKids.com in connection with the
Proposed Transaction, and we will receive a fee, a substantial portion of which
is conditioned on the consummation of the Proposed Transaction, for our
services, which include the rendering of this opinion.
In the past, we have provided investment banking and other financial
advisory services to SmarterKids.com, including as lead manager in
SmarterKids.com's initial public offering in November 1999, and have received
fees for rendering these services. In the ordinary course of business, Chase
H&Q acts as a market maker and broker in the publicly traded securities of
SmarterKids.com and receives customary
<PAGE>
compensation in connection therewith, and has in the past provided research
coverage for SmarterKids.com. In the ordinary course of business, Chase H&Q
also actively trades in the equity and derivative securities of SmarterKids.com
for its own account and for the accounts of its customers and, accordingly, may
at any time hold a long or short position in such securities. Chase H&Q may in
the future provide additional investment banking or other financial advisory
services to SmarterKids.com or Earlychildhood.
In connection with our review of the Proposed Transaction, and in arriving
at our opinion, we have, among other things:
(i) reviewed the publicly available consolidated financial statements of
SmarterKids.com for recent years and interim period to date and certain
other relevant financial and operating data of SmarterKids.com made
available to us from published sources, including Wall Street analysts'
research reports, and from the internal records of SmarterKids.com and
reviewed the financial statements of Earlychildhood for recent years
and interim periods to date and certain other relevant financial and
operating data of Earlychildhood made available to us from the internal
records of Earlychildhood;
(ii) reviewed certain internal financial and operating information relating
to SmarterKids.com and Earlychildhood prepared by the senior
management of SmarterKids.com and Earlychildhood;
(iii) discussed the business, financial condition and prospects of
SmarterKids.com, Earlychildhood and Holdings with certain members of
senior management SmarterKids.com and Earlychildhood;
(iv) reviewed the recent reported prices and trading activity for the
common stock of SmarterKids.com and compared such information and
certain financial information for SmarterKids.com with similar
information for certain other companies engaged in businesses we
consider comparable;
(v) reviewed the financial terms, to the extent publicly available, of
certain comparable merger and acquisition transactions;
(vi) reviewed a draft of the Agreement, dated as of November 13, 2000; and
(vii) performed such other analyses and examinations and considered such
other information, financial studies, analyses and investigations and
financial, economic and market data as we deemed relevant.
In rendering our opinion, we have assumed and relied upon the accuracy and
completeness of all of the information concerning SmarterKids.com,
Earlychildhood and Holdings considered in connection with our review of the
Proposed Transaction, and we have not assumed any responsibility for
independent verification of, and did not independently verify, such
information. We have not prepared any independent valuation or appraisal of any
of the assets or liabilities of SmarterKids.com, Earlychildhood or Holdings,
nor have we conducted a physical inspection of the properties, facilities or
other asses of SmarterKids.com or Earlychildhood. With respect to the financial
forecasts and projections made available to us and in our analysis, we have
assumed that they reflect the best currently available estimates and judgments
of the expected future financial performance of SmarterKids.com, Earlychildhood
and Holdings. In rendering our opinion, we express no view as to the
reasonableness of such forecasts and projections or the assumptions on which
they are based. For purposes of this opinion, we have assumed that neither
Earlychildhood, Holdings nor SmarterKids.com is a party to any pending
transactions, including external financings, recapitalizations or material
merger discussions, other than the Proposed Transaction and those activities
undertaken in the ordinary course of conducting their respective businesses.
Our opinion is necessarily based upon market, economic, financial and other
conditions as they exist and can be evaluated as of the date of this letter and
any change in such conditions would require a reevaluation of this opinion. We
express no opinion as to the price at which the Common Stock will trade. In
rendering this opinion, we have assumed that the proposed merger will be
consummated substantially on the terms discussed in the Agreement, without any
waiver of any material terms or conditions by any party thereto.
C-2
<PAGE>
It is understood that this letter is for the information of the Board of
Directors and may not by used for any other purpose without our prior written
consent; provided, however, that this letter may be reproduced in full in any
proxy statement filed by SmarterKids.com in connection with the Proposed
Transaction. This letter does not constitute a recommendation to any
stockholder of SmarterKids.com as to how such stockholder should vote on the
Proposed Transaction.
Based upon and subject to the foregoing and after considering such other
matters as we deem relevant, we are of the opinion that as of the date hereof
the Exchange Ratio is fair to holders of the Common Stock from a financial
point of view.
Very truly yours,
[LOGO]
/s/ James Secretarski
By __________________________________
Managing Director
<PAGE>
ANNEX D
FORM OF
RESTATED
CERTIFICATE OF INCORPORATION
OF
LEARNINGSTAR CORP.
The present name of the Corporation is LearningStar Corp. The Corporation
was incorporated by the filing of its original Certificate of Incorporation
with the Secretary of State of the State of Delaware on November 6, 2000. This
Restated Certificate of Incorporation of the Corporation, which both restates
and further amends the provisions of the Corporation's Certificate of
Incorporation, was duly adopted in accordance with the provisions of Sections
242 and 245 of the General Corporation Law of the State of Delaware (the
"DGCL") and by the unanimous written consent of its stockholders in accordance
with Section 228 of the DGCL. The Certificate of Incorporation of the
Corporation is hereby amended and restated to read in its entirety as follows:
FIRST: The name of the Corporation is LearningStar Corp.
SECOND: The address of the registered office of the Corporation in the State
of Delaware is Corporation Service Company, 2711 Centerville Road, Suite 400,
in the City of Wilmington, County of New Castle, State of Delaware. The name of
its registered agent at that address is Corporation Service Company.
THIRD: The purpose of the Corporation is to engage in any lawful act or
activity for which a corporation may be organized under the DGCL.
FOURTH: A. Capital Stock. The total number of shares of capital stock which
the Corporation shall have authority to issue shares (the "Capital Stock"),
consisting of shares of Common Stock, par value $.01 per share (the "Common
Stock"), and shares of Preferred Stock, par value of $.01 per share (the
"Preferred Stock").
B. Common Stock. The shares of authorized Common Stock of the Corporation
shall be identical in all respects and shall have equal rights and privileges.
C. Preferred Stock. Shares of Preferred Stock may be issued from time to
time in one or more series, as provided for herein or as provided for by the
Board of Directors as permitted hereby. All shares of Preferred Stock shall be
of equal rank and shall be identical, except in respect of the terms fixed
herein for the series provided for herein or fixed by the Board of Directors
for any series provided for by the Board of Directors as permitted hereby.
The Board of Directors is hereby authorized, by resolution or resolutions,
to establish, out of the unissued shares of Preferred Stock not then allocated
to any series of Preferred Stock, additional series of Preferred Stock. Before
any shares of any such additional series are issued, the Board of Directors
shall fix and determine, and is hereby expressly empowered to fix and
determine, by resolution or resolutions, the number of shares constituting such
series and the distinguishing characteristics and the relative voting powers,
rights, preferences, privileges and immunities, if any, and any qualifications,
limitations or restrictions thereof, of the shares thereof, so far as not
inconsistent with the provisions of this Article FOURTH and a certificate of
said resolution or resolutions (a "Certificate of Designation") shall be filed
in accordance with the DGCL. Without limiting the generality of the foregoing,
the Board of Directors may fix and determine:
1. The designation of such series and the number of shares which shall
constitute such series of such shares, which number the Board of Directors may
thereafter (except where otherwise provided in the Certificate of Designation)
increase or decrease (but not below the number of shares thereof then
outstanding);
D-1
<PAGE>
2. The rate of dividend, if any, payable on shares of such series;
3. Whether the shares of such series shall be cumulative, non-cumulative or
partially cumulative as to dividends, and the dates from which any cumulative
dividends are to accumulate;
4. Whether the shares of such series may be redeemed, and, if so, the price
or prices at which and the terms and conditions on which shares of such series
may be redeemed;
5. The amount payable upon shares of such series in the event of the
voluntary or involuntary dissolution, liquidation or winding up of the affairs
of the Corporation;
6. The sinking fund provisions, if any, for the redemption of shares of such
series;
7. The voting rights, if any, of the shares of such series;
8. Whether the shares of the series shall be convertible into or
exchangeable for shares of any other class or series, or any other security, of
the Corporation or any other corporation, and, if so, the specifications of
such other class or series or such other security, the conversion or exchange
price or prices or rate or rates, and adjustments thereof, the date or dates at
which such shares shall be convertible or exchangeable and all other terms and
conditions upon which such conversion or exchange may be made;
9. The terms and conditions, if any, on which shares of such series may be
converted into shares of capital stock of the Corporation of any other class or
series;
10. Whether the shares of such series are to be preferred over shares of
capital stock of the Corporation of any other class or series as to dividends,
or upon the voluntary or involuntary dissolution, liquidation, or winding up of
the affairs of the Corporation, or otherwise;
11. Restrictions on the issuance of shares of the same series or of any
other class or series; and
12. Any other characteristics, preferences, limitations, rights, privileges,
immunities or terms not inconsistent with the provisions of this Article
FOURTH.
D. Voting Power for Holders of Common and Preferred Stock. Except as
otherwise provided in this Restated Certificate of Incorporation, each holder
of Common Stock shall be entitled to one vote for each share of Common Stock
held by such holder on all matters submitted to stockholders for a vote and
each holder of any series of Preferred Stock shall be entitled to such number
of votes for each share held by such holder as may be specified herein or in
the Certificate of Designation in respect thereof.
Except as otherwise provided by law, the presence, in person or by proxy, of
the holders of record of issued and outstanding shares of Capital Stock
entitling the holders thereof to cast a majority of the votes entitled to be
cast by the holders of issued and outstanding shares of Capital Stock entitled
to vote shall constitute a quorum at all meetings of the stockholders.
FIFTH: The Board of Directors shall have the power to make, adopt, alter,
amend, change or repeal the bylaws of the Corporation (as may be amended from
time to time, the "Bylaws") by resolution adopted by the affirmative vote of a
majority of the entire Board of Directors, subject to any law or Bylaw
provision requiring the affirmative vote of a larger percentage of the members
of the Board of Directors. In addition to any other vote required by law, the
affirmative vote of the holders of at least 75% of the voting power of all
outstanding shares of the Corporation then entitled to vote generally in the
election of directors, voting together as a single class shall be required to
make, adopt, alter, amend, change or repeal the Bylaws of the Corporation or
any provision of this Restated Certificate of Incorporation.
SIXTH: A. Number; Election and Terms of Directors. Subject to Section C of
this Article SIXTH, the number of directors of the Corporation which shall
constitute the entire Board shall be not less than three nor
D-2
<PAGE>
more than fifteen directors. Within such limits, the exact number of directors
constituting the entire Board shall be fixed from time to time pursuant to a
resolution adopted by a majority of the total number of directors which the
Corporation would have if there were no vacancies. Subject to Section C of this
Article SIXTH, the Board of Directors shall be divided into three classes,
designated Class I, Class II and Class III. Class I, Class II and Class III
shall each initially consist of three directors. Class I directors shall be
initially elected for a term expiring at the first annual meeting of
stockholders of the Corporation following the date hereof, Class II directors
shall be initially elected for a term expiring at the second annual meeting of
stockholders of the Corporation following the date hereof, and Class III
directors shall be initially elected for a term expiring at the third annual
meeting of stockholders of the Corporation following the date hereof. At each
annual meeting of stockholders, beginning in 2001, successors to the class of
directors whose term expires at that annual meeting shall be elected for a
three-year term A director shall hold office until the annual meeting for the
year in which his term expires and until his successor shall be elected and
shall qualify, subject, however, to such director's prior death, resignation,
retirement, disqualification or removal from office. Unless and except to the
extent that the Bylaws of the Corporation shall so require, the election of
directors of the Corporation need not be by written ballot.
B. Vacancies and Newly Created Directorships. Subject to Section C of this
Article SIXTH unless the Board of Directors otherwise determines, vacancies
resulting from death, resignation, retirement, disqualification, removal from
office or other cause, and newly-created directorships resulting from any
increase in the authorized number of directors, may be filled only by the
affirmative vote of a majority of the remaining directors, though less than a
quorum of the Board of Directors. Any director so chosen pursuant to the
preceding sentence shall hold office for the remainder of the full term
expiring at the annual meeting of the stockholders at which the term of office
of the class to which such director has been elected expires and until such
director's successor shall have been duly elected and qualified. If the number
of directors is changed, any increase or decrease shall be apportioned among
the classes so as to maintain the number of directors in each class as nearly
equal as possible, and any additional director of any class elected to fill a
vacancy resulting from an increase in such class shall hold office for a term
that shall coincide with the remaining term of that class. In no case will a
decrease in the number of authorized directors constituting the Board of
Directors shorten the term of any incumbent director.
C. Removal. Any director may be removed from office, but only for cause, and
any such removal shall require, in addition to any other vote required by law,
the affirmative vote of the holders of at least 75% of the voting power of all
shares of Capital Stock of the Corporation entitled to vote generally in the
election of directors, voting together as a single class.
D. Rights of Holders of Preferred Stock. Notwithstanding the foregoing,
whenever the holders of any one or more series of Preferred Stock issued by the
Corporation shall have the right, voting separately as a class or series, to
elect directors at an annual or special meeting of stockholders, the election,
term of office, removal, filling of vacancies and other features of such
directorships shall be governed by the terms of this Restated Certificate of
Incorporation and the Certificate of Designation applicable thereto, and such
directors so elected shall not be divided into classes pursuant to this Article
SIXTH unless expressly provided by such terms.
SEVENTH: Special meetings of the stockholders of the Corporation, for any
purpose or purposes, may only be called at any time by a majority of the entire
Board of Directors or by either the Chairman or the Chief Executive Officer of
the Corporation.
EIGHTH: No stockholder action may be taken except at a duly called annual or
special meeting of stockholders of the Corporation and stockholders of the
Corporation may not take any action by written consent in lieu of a meeting of
stockholders.
NINTH: A. Indemnification. The Corporation shall indemnify (A) its directors
and officers, whether serving the Corporation or, at its request, any other
entity, to the fullest extent required or permitted by the DGCL now or
hereafter in force, and shall advance expenses to the fullest extent permitted
by law and (B)
D-3
<PAGE>
other employees and agents to such extent as shall be expressly authorized by
the Board of Directors or the Bylaws and as permitted by law. The foregoing
rights of indemnification shall not be exclusive of any other rights to which
those seeking indemnification may be entitled. The Board of Directors may take
such action as is necessary to carry out these indemnification provisions and
is expressly empowered to adopt, approve and amend from time to time such
bylaws, resolutions or contracts implementing such provisions or such further
indemnification arrangements as may be permitted by law. No amendment of this
Restated Certificate of Incorporation or repeal of any of its provisions shall
limit or eliminate the right to indemnification provided under this Article
NINTH with respect to any acts or omissions occurring prior to such amendment
or repeal.
TENTH: To the fullest extent permitted by the DGCL, as the same exists or
may hereafter be amended, no director of this Corporation shall be personally
liable to the Corporation or its stockholders for monetary damages for breach
of fiduciary duty as a director. No amendment of this Restated Certificate of
Incorporation or repeal of any of its provisions shall limit or eliminate any
right or protection of any director of this Corporation under this Article
TENTH for or with respect to any acts or omissions of such director occurring
prior to such amendment for repeal.
ELEVENTH: The Corporation reserves the right to amend, alter, change or
repeal any provision contained in this Restated Certificate of Incorporation
and other provisions authorized by the laws of the State of Delaware in force
at that time may be added or inserted, in the manner now or thereafter
prescribed by statute, and all rights, preferences and privileges of whatsoever
nature conferred upon stockholders, directors or any other persons whomsoever
by and pursuant to this Restated Certificate of Incorporation in its present
form or as hereafter amended are granted subject to this reservation.
D-4
<PAGE>
IN WITNESS WHEREOF, said Corporation has caused this Restated Certificate of
Incorporation to be signed by Albert Noyes, its Chief Executive Officer on this
day of , 2001.
LEARNINGSTAR CORP.
-------------------------------------
Name: Albert Noyes
Title: Chief Executive Officer
D-5
<PAGE>
ANNEX E
FORM OF
AMENDED AND RESTATED BYLAWS
OF
LEARNINGSTAR CORP.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<C> <S> <C>
ARTICLE I. OFFICES...................... E-1
Section 1. REGISTERED OFFICES...... E-1
Section 2. OTHER OFFICES........... E-1
Section 3. BOOKS AND RECORDS....... E-1
ARTICLE II. MEETINGS OF STOCKHOLDERS.... E-1
Section 1. ANNUAL MEETINGS......... E-1
Section 2. SPECIAL MEETINGS........ E-1
Section 3. PLACE OF MEETINGS....... E-1
Section 4. NOTICE OF MEETING....... E-1
Section 5. LIST OF STOCKHOLDERS
ENTITLED TO VOTE........ E-2
Section 6. QUORUM AND ADJOURNMENT.. E-2
Section 7. PROXIES................. E-2
Section 8. NOTICE OF STOCKHOLDERS
BUSINESS AND
NOMINATIONS............. E-2
Section 9. VOTING.................. E-5
Section 10. STOCK LEDGER............ E-5
Section 11. NO STOCKHOLDER ACTION BY
WRITTEN CONSENT......... E-5
Section 12. ORGANIZATION............ E-5
Section 13. FIXING DATE FOR
DETERMINATION OF
STOCKHOLDERS OF RECORD.. E-5
Section 14. INSPECTORS OF ELECTION.. E-5
Section 15. CONDUCT OF MEETINGS..... E-6
ARTICLE III. BOARD OF DIRECTORS......... E-6
Section 1. GENERAL POWERS.......... E-6
Section 2. NUMBER OF DIRECTORS;
TENURE AND
QUALIFICATIONS.......... E-6
Section 3. MEETINGS................ E-7
Section 4. QUORUM.................. E-7
Section 5. VACANCIES AND NEWLY
CREATED DIRECTORSHIPS... E-7
Section 6. ACTIONS OF BOARD OF
DIRECTORS............... E-7
Section 7. MEETINGS BY MEANS OF
CONFERENCE TELEPHONE.... E-7
Section 8. EXECUTIVE AND OTHER
COMMITTEES.............. E-7
Section 9. REMOVAL................. E-8
Section 10. COMPENSATION............ E-8
Section 11. INTERESTED DIRECTORS.... E-8
Section 12. ORGANIZATION............ E-8
ARTICLE IV. OFFICERS.................... E-9
Section 1. GENERAL................. E-9
Section 2. ELECTION AND TERM OF
OFFICERS................ E-9
Section 3. CHAIRMAN OF THE BOARD... E-9
Section 4. CHIEF EXECUTIVE
OFFICER................. E-9
Section 5. VICE CHAIRMAN........... E-9
Section 6. PRESIDENT............... E-9
Section 7. CHIEF OPERATING
OFFICER................. E-10
Section 8. CHIEF FINANCIAL
OFFICER................. E-10
Section 9. EXECUTIVE VICE
PRESIDENTS AND SENIOR
VICE PRESIDENTS......... E-10
Section 10. VICE PRESIDENTS......... E-10
Section 11. TREASURER AND ASSISTANT
TREASURERS.............. E-10
Section 12. SECRETARY AND ASSISTANT
SECRETARIES............. E-10
Section 13. OTHER OFFICERS.......... E-11
</TABLE>
i
<PAGE>
<TABLE>
<CAPTION>
Page
----
<C> <S> <C>
ARTICLE V. STOCK....................................................... E-11
Section 1. STOCK CERTIFICATES..................................... E-11
Section 2. LOST, STOLEN OR DESTROYED CERTIFICATES................. E-11
Section 3. TRANSFERS.............................................. E-11
ARTICLE VI. INDEMNIFICATION AND INSURANCE.............................. E-11
ACTION OTHER THAN BY OR IN THE RIGHT OF THE
Section 1. CORPORATION............................................ E-11
Section 2. ACTION BY OTHER OR IN THE RIGHT OF THE CORPORATION..... E-12
Section 3. DETERMINATION OF RIGHT OF INDEMNIFICATION.............. E-12
Section 4. INDEMNIFICATION AGAINST EXPENSES OF SUCCESSFUL PARTY... E-12
Section 5. ADVANCES OF EXPENSES................................... E-12
RIGHT OF AGENT TO INDEMNIFICATION UPON APPLICATION;
Section 6. PROCEDURE UPON APPLICATION............................. E-12
Section 7. OTHER RIGHTS AND REMEDIES.............................. E-13
Section 8. INSURANCE.............................................. E-13
Section 9. PRESUMPTIONS AND EFFECT OF CERTAIN PROCEEDINGS......... E-13
Section 10. OTHER ENTERPRISES, FINES, AND SERVING AT CORPORATION'S
REQUEST................................................ E-14
Section 11. SAVINGS CLAUSE......................................... E-14
Section 12. CERTAIN DEFINITIONS.................................... E-14
ARTICLE VII. MISCELLANEOUS PROVISIONS.................................. E-15
Section 1. FISCAL YEAR............................................ E-15
Section 2. DIVIDENDS.............................................. E-15
Section 3. SEAL................................................... E-15
Section 4. AUDITS................................................. E-15
Section 5. RESIGNATIONS........................................... E-15
Section 6. CONTRACTS.............................................. E-15
Section 7. PROXIES................................................ E-15
Section 8. WAIVER OF NOTICE OF MEETINGS OF STOCKHOLDERS, DIRECTORS
AND COMMITTEES......................................... E-15
ARTICLE VIII. AMENDMENTS............................................... E-16
Section 1. AMENDMENTS............................................. E-16
</TABLE>
ii
<PAGE>
FORM OF
AMENDED AND RESTATED BYLAWS
OF
LEARNINGSTAR CORP.
ARTICLE I.
Offices
Section 1. Registered Office. The registered office of LearningStar Corp.
(the "Corporation") in the State of Delaware shall be located at Corporation
Service Company, 2711 Centerville Road, Suite 400, in the City of Wilmington,
County of New Castle, State of Delaware.
Section 2. Other Offices. The Corporation may also have offices at such
other places both within and without the State of Delaware as the Board of
Directors of the Corporation (the "Board of Directors") may from time to time
designate or the business of the Corporation may require.
Section 3. Books and Records. The books and records of the Corporation may
be kept outside the State of Delaware at such place or places as may from time
to time be designated by the Board of Directors.
ARTICLE II.
Meetings of Stockholders
Section 1. Annual Meetings. The annual meeting of stockholders shall be held
on such date and at such time as may be fixed by resolution of the Board of
Directors.
Section 2. Special Meetings. Unless otherwise prescribed by law or by the
Restated Certificate of Incorporation of the Corporation (as may be amended
from time to time, the "Certificate of Incorporation"), special meetings of
stockholders, for any purpose or purposes, may only be called by the Chairman
of the Board or by the Board of Directors pursuant to a resolution adopted by a
majority of the entire Board of Directors.
Section 3. Place of Meetings. Meetings of the stockholders for the election
of directors or for any other purpose shall be held at such time and place,
either within or without the State of Delaware as shall be designated by the
Board of Directors or the Chairman of the Board. If no such designation is
made, the place of meeting shall be the principal office of the Corporation.
Notwithstanding the foregoing, the board of directors may determine that the
meeting shall not be held at any place, but instead may be held solely by means
of remote communication in accordance with applicable law.
Section 4. Notice of Meeting. Notice of an annual or special meeting stating
the place, if any, date and hour of the meeting, the means of remote
communications, if any, by which the stockholders and proxy holders may be
deemed to be present in person and vote at such meeting, and in the case of a
special meeting, the purpose or purposes for which the meeting is being called,
shall be given to each stockholder entitled to vote at such meeting not less
than ten (10) nor more than sixty (60) days before the date of the meeting. If
mailed, such notice shall be deemed to be delivered when deposited in the
United States mail with postage thereon prepaid, addressed to the stockholder
at his address as it appears on the stock books of the Corporation. Only such
business shall be conducted at a special meeting of stockholders as shall have
been brought before the meeting pursuant to the Corporation's notice of
meeting. Any previously scheduled meeting of the stockholders may be postponed,
and (unless the Certificate of Incorporation otherwise provides) any special
meeting of the stockholders may be canceled, by resolution of the Board of
Directors upon public notice given prior to the date previously scheduled for
such meeting of stockholders.
E-1
<PAGE>
Section 5. List of Stockholders Entitled to Vote. The officer of the
Corporation who has charge of the stock ledger of the Corporation shall prepare
and make, at least ten (10) days before every meeting of stockholders, a
complete list of the stockholders entitled to vote at the meeting, arranged in
alphabetical order, and showing the address of each stockholder and the number
of shares registered in the name of each stockholder. Such list shall be open
to the examination of any stockholder, for any purpose germane to the meeting,
as required by applicable law. The list shall also be produced and kept at the
time and place of the meeting during the whole time thereof, and may be
inspected by any stockholder of the Corporation who is present.
Section 6. Quorum and Adjournment. Except as otherwise provided by law or by
the Certificate of Incorporation, the holders of a majority of the capital
stock issued and outstanding and entitled to vote generally in the election of
directors (the "Voting Stock"), present in person or represented by proxy,
shall constitute a quorum at all meetings of the stockholders for the
transaction of business, except that when specified business is to be voted on
by a class or series of stock voting as a class, the holders of a majority of
the shares of such class or series shall constitute a quorum of such class or
series for the transaction of such business. Shares of its own capital stock
belonging to the Corporation or to a subsidiary of the Corporation, if a
majority of the shares entitled to vote in the election of directors of such
subsidiary is held, directly or indirectly, by the Corporation, shall neither
be entitled to vote nor be counted for quorum purposes; provided, however, that
the foregoing shall not limit the right of the Corporation or any subsidiary of
the Corporation to vote stock, including but not limited to its own stock, held
by it in a fiduciary capacity. The Chairman of the meeting may adjourn the
meeting from time to time if a quorum shall not be present or represented by
proxy at any meeting of the stockholders. The meeting may be adjourned without
notice other than announcement at the meeting, until a quorum shall be present
or represented by proxy. At such adjourned meeting at which a quorum shall be
present or represented, any business may be transacted which might have been
transacted at the meeting as originally noticed. If the adjournment is for more
than thirty (30) days, or if after the adjournment a new record date is fixed
for the adjourned meeting, a notice of the adjourned meeting shall be given to
each stockholder entitled to vote at the meeting.
Section 7. Proxies. At all meetings of stockholders, a stockholder entitled
to vote may vote by proxy (or in such manner permitted by the General
Corporation Law of the State of Delaware (the "DGCL") by the stockholder, or by
his duly authorized attorney in fact. A proxy shall be irrevocable if it states
that it is irrevocable and if, and only so long as, it is coupled with an
interest sufficient in law to support an irrevocable power. A stockholder may
revoke any proxy which is not irrevocable by attending the meeting and voting
in person or by filing an instrument in writing revoking the proxy or by
delivering a proxy in accordance with applicable law bearing a later date to
the Secretary of the Corporation.
Section 8. Notice of Stockholder Business and Nominations.
(A) Annual Meetings of Stockholders.
(1)Nominations of persons for election to the Board of Directors of
the Corporation and the proposal of business to be considered by the
stockholders may be made at an annual meeting of stockholders (a) pursuant to
the Corporation's notice of meeting (or any supplement thereto), (b) by or at
the direction of a majority of the Board of Directors or (c) by any stockholder
of the Corporation who was a stockholder of record at the time the notice
provided for in this Bylaw is delivered to the Secretary of the Corporation,
who is entitled to vote at the meeting and who complies with the notice
procedures set forth in this Bylaw.
(2) For nominations or other business to be properly brought before
an annual meeting by a stockholder pursuant to clause (c) of paragraph (A)(1)
of this Bylaw, the stockholder must have given timely notice thereof in writing
to the Secretary of the Corporation and such other business must otherwise be a
proper matter for stockholder action. To be timely, a stockholder's notice
shall be delivered to the Secretary at the principal executive offices of the
Corporation not later than the close of business on the 70th day nor earlier
than the close of business on the 90th day prior to the first anniversary of
the preceding year's annual meeting;
E-2
<PAGE>
provided, however, that in the event that the date of the annual meeting is
more than 30 days before or more than 60 days after such anniversary date,
notice by the stockholder to be timely must be so delivered not earlier than
the close of business on the 90th day prior to such annual meeting nor later
than the close of business on the later of the 70th day prior to such annual
meeting or the 10th day following the day on which public announcement of the
date of such meeting is first made by the Corporation. In no event shall the
public announcement of an adjournment or postponement of an annual meeting
commence a new time period (or extend any time period) for the giving of a
stockholder's notice as described above. Such stockholder's notice shall set
forth (a) as to each person whom the stockholder proposes to nominate for
election or re-election as a director all information relating to such person
that is required to be disclosed in solicitations of proxies for election of
directors in an election contest, or is otherwise required, in each case
pursuant to Regulation 14A under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), including, but not limited to, information
required to be disclosed by Items 4(b) and 6 of Schedule 14A under the Exchange
Act and information which would be required to be filed on Schedule 14C under
the Exchange Act, and Rule 14a-11 thereunder (including such person's written
consent to being named in the proxy statement as a nominee and to serving as a
director if elected); (b) as to any other business that the stockholder
proposes to bring before the meeting, a brief description of the business
desired to be brought before the meeting, the text of the proposal or business
(including the text of any resolutions proposed for consideration and in the
event that such business includes a proposal to amend the Bylaws of the
Corporation, the language of the proposed amendment), the reasons for
conducting such business at the meeting and any material interest in such
business of such stockholder and the beneficial owner, if any, on whose behalf
the proposal is made; and (c) as to the stockholder giving the notice and the
beneficial owner, if any, on whose behalf the nomination or proposal is made
(i) the name and address, as they appear on the Corporation's books, of such
stockholder and any other stockholders known by such stockholder to be
supporting such nominees or proposal, and of any such beneficial owner, (ii)
the class and number of shares of the Corporation which are owned beneficially
and of record by such stockholder and, to the extent known, by any other
stockholders known by such stockholder to be supporting such nominees or
proposal and such beneficial owner, (iii) a representation that the stockholder
is a holder of record of stock of the Corporation entitled to vote at such
meeting and intends to appear in person or by proxy at the meeting to propose
such business or nomination, and (iv) a representation whether the stockholder
or the beneficial owner, if any, intends or is a part of a group which intends
to (a) deliver a proxy statement and a form of proxy to holders of at least the
percentage of the Corporation's outstanding common stock required to approve or
adopt the proposal or elect the nominee and/or (b) otherwise solicit proxies
from stockholders in support of such proposal or nomination. The foregoing
notice requirements shall be deemed satisfied by a stockholder if the
stockholder has notified the Corporation of his or her intention to present a
proposal at an annual meeting in compliance with Rule 14a-8 (or any successor
thereof) promulgated under the Exchange Act and such stockholder's proposal has
been included in a proxy statement that has been prepared by the Corporation to
solicit proxies for such annual meeting. The Corporation may require any
proposed nominee to furnish such other information as it may reasonably require
to determine the eligibility of such proposed nominee to serve as a director of
the Corporation.
(3) Notwithstanding anything in the second sentence of paragraph
(A)(2) of this Bylaw to the contrary, in the event that the number of directors
to be elected to the Board of Directors of the Corporation is increased and
there is no public announcement by the Corporation naming all of the nominees
for director or specifying the size of the increased Board of Directors at
least 70 days prior to the first anniversary of the preceding year's annual
meeting, a stockholder's notice required by this Bylaw shall also be considered
timely, but only with respect to nominees for any new positions created by such
increase, if it shall be delivered to the Secretary at the principal executive
offices of the Corporation by not later than the close of business on the 10th
day following the day on which such public announcement is first made by the
Corporation.
(B) Special Meetings of Stockholders. Only such business shall be
conducted at a special meeting of stockholders as shall have been brought
before the meeting pursuant to the Corporation's notice of meeting. Nominations
of persons for election to the Board of Directors may be made at a special
meeting of stockholders at which directors are to be elected pursuant to the
Corporation's notice of meeting (a) by or at the
E-3
<PAGE>
direction of the Board of Directors or (b) provided that the Board of Directors
has determined that the directors shall be elected at such meeting, by any
stockholder of the Corporation who was a stockholder of record at the time the
notice provided for in this Bylaw is delivered to the Secretary of the
Corporation, who is entitled to vote at the meeting and who complies with the
notice procedures set forth in this Bylaw. In the event the Corporation calls a
special meeting of stockholders for the purpose of electing one or more
directors to the Board of Directors, any such stockholder may nominate a person
or persons (as the case may be), for election to such position(s) as specified
in the Corporation's notice of meeting, if the stockholder's notice required by
paragraph (A)(2) of this Bylaw shall be delivered to the Secretary at the
principal executive offices of the Corporation not earlier than the close of
business on the 90th day prior to such special meeting and not later than the
close of business on the 70th day prior to such special meeting or the 10th day
following the day on which public announcement is first made of the date of the
special meeting and of the nominees proposed by the Board of Directors to be
elected at such meeting. In no event shall the public announcement of an
adjournment of a special meeting commence a new time period (or extend any time
period) for the giving of a stockholder's notice as described above.
(C) General.
(1)Only such persons who are nominated in accordance with the
procedures set forth in this Bylaw shall be eligible to be elected at an annual
or special meeting of stockholders of the Corporation to serve as directors and
only such business shall be conducted at a meeting of stockholders as shall
have been brought before the meeting in accordance with the procedures set
forth in this Bylaw. Except as otherwise provided by law, the Chairman of the
meeting shall have the exclusive power and duty to (i) determine whether a
nomination or any business proposed to be brought before the meeting was made
or proposed, as the case may be, in accordance with the procedures set forth in
this Bylaw (including whether the stockholder or beneficial owner, if any, on
whose behalf the nomination or proposal is made, solicited (or is part of a
group which solicited) or did not so solicit, as the case may be, proxies in
support of such stockholder's nominee or proposal in compliance with such
stockholder's representation as required by clause (A)(2)(c)(iv) of this Bylaw)
and (ii) if any proposed nomination or business is not in compliance with this
Bylaw, including if the stockholder solicits or is part of a group which
solicits proxies in support of such stockholder's proposal without such
stockholder having made the representation required by either clause (c)(iii)
or (c)(iv) of paragraph (A)(2) of this Bylaw, to declare that such defective
proposal or nomination shall be disregarded or that such proposed business
shall not be transacted. Notwithstanding the foregoing provisions of this
Bylaw, if the stockholder (or a qualified representative of the stockholder)
does not appear at the annual or special meeting of stockholders of the
Corporation to present a nomination or business, such nomination shall be
disregarded and such proposed business shall not be transacted, notwithstanding
that proxies in respect of such vote may have been received by the Corporation.
(2)For purposes of this Bylaw, "public announcement" shall mean
disclosure in a press release reported by the Dow Jones News Services,
Associated Press or comparable national news service or in a document publicly
filed by the Corporation with the Securities and Exchange Commission pursuant
to Section 13, 14 or 15(d) of the Exchange Act.
(3) Notwithstanding the foregoing provisions of this Bylaw, a
stockholder shall also comply with all applicable requirements of the Exchange
Act and the rules and regulations thereunder with respect to the matters set
forth in this Bylaw. Nothing in this Bylaw shall be deemed to affect any rights
(i) of stockholders to request inclusion of proposals in the Corporation's
proxy statement pursuant to Rule 14a-8 of the Exchange Act or (ii) of the
holders of any series of Preferred Stock to elect directors under specified
circumstances.
Section 9. Voting. Unless otherwise required by law, the Certificate of
Incorporation, the rules or regulations of any stock exchange applicable to the
Corporation or these Bylaws, any question (other than the election of
directors) brought before any meeting of stockholders shall be decided by the
vote of the holders of a majority of the stock represented and entitled to vote
thereat. Subject to the rights of the holders of any series of Preferred Stock
to elect directors under specified circumstances, at all meetings of
stockholders for the
E-4
<PAGE>
election of directors, a plurality of the votes cast shall be sufficient to
elect. Each stockholder represented at a meeting of stockholders shall be
entitled to cast one vote for each share of the capital stock entitled to vote
thereat held by such stockholder, unless otherwise provided by the Certificate
of Incorporation. Such votes may be cast in person or by proxy but no proxy
shall be voted after three years from its date, unless such proxy provides for
a longer period. The Board of Directors, in its discretion, or the officer of
the Corporation presiding at a meeting of stockholders, in his or her
discretion, may require that any votes cast at such meeting be cast by written
ballot.
Section 10. Stock Ledger. The stock ledger of the Corporation shall be the
only evidence as to who are the stockholders entitled to examine the stock
ledger, the list required by Section 5 of this Article II or the books of the
Corporation, or to vote in person or by proxy at any meeting of stockholders.
Section 11. No Stockholder Action by Written Consent. Any action required or
permitted to be taken by the stockholders of the Corporation must be effected
at a duly called annual or special meeting of such holders and may not be
effected by any consent in writing by such holders.
Section 12. Organization. Meetings of stockholders shall be presided over by
the Chairman of the Board, if any, or in his or her absence by the Vice
Chairman of the Board, if any, or in his or her absence by the Chief Executive
Officer or the President, or in their absence by a Vice President, or in the
absence of the foregoing persons by a chairman designated by the Board of
Directors, or in the absence of such designation by a chairman chosen at the
meeting. The Secretary shall act as secretary of the meeting, but in his or her
absence the chairman of the meeting may appoint any person to act as secretary
of the meeting.
Section 13. Fixing Date for Determination of Stockholders of Record. In
order that the Corporation may determine the stockholders entitled to notice of
or to vote at any meeting of stockholders or any adjournment thereof, or
entitled to receive payment of any dividend or other distribution or allotment
of any rights, or entitled to exercise any rights in respect of any change,
conversion or exchange of stock or for the purpose of any other lawful action,
the Board of Directors may fix a record date, which record date shall not
precede the date upon which the resolution fixing the record date is adopted by
the Board of Directors, and which record date: (1) in the case of determination
of stockholders entitled to vote at any meeting of stockholders or adjournment
thereof, shall, unless otherwise required by law, not be more than sixty (60)
nor less than ten (10) days before the date of such meeting; and (2) in the
case of any other action, shall not be more than sixty (60) days prior to such
other action. If no record date is fixed: (1) the record date for determining
stockholders entitled to notice of or to vote at a meeting of stockholders
shall be at the close of business on the date next preceding the day on which
notice is given, or, if notice is waived, at the close of business on the day
next preceding the day on which the meeting is held; and (2) the record date
for determining stockholders for any other purpose shall be at the close of
business on the day on which the Board of Directors adopts the resolution
relating thereto. A determination of stockholders of record entitled to notice
of or to vote at a meeting of stockholders shall apply to any adjournment of
the meeting; provided, however, that the Board of Directors may fix a new
record date for the adjourned meeting.
Section 14. Inspectors of Election. The Corporation may, and shall if
required by law, in advance of any meeting of stockholders, appoint one or more
inspectors of election, who may be employees of the Corporation, to act at the
meeting or any adjournment thereof and to make a written report thereof. The
Corporation may designate one or more persons as alternate inspectors to
replace any inspector who fails to act. In the event that no inspector so
appointed or designated is able to act at a meeting of stockholders, the person
presiding at the meeting shall appoint one or more inspectors to act at the
meeting. Each inspector, before entering upon the discharge of his or her
duties, shall take and sign an oath to execute faithfully the duties of
inspector with strict impartiality and according to the best of his or her
ability. The inspector or inspectors so appointed or designated shall (i)
ascertain the number of shares of capital stock of the Corporation outstanding
and the voting power of each such share, (ii) determine the shares of capital
stock of the corporation represented at the meeting and the validity of proxies
and ballots, (iii) count all votes and ballots, (iv) determine and retain for a
reasonable period a record of the disposition of any challenges made to any
determination by the inspectors,
E-5
<PAGE>
and (v) certify their determination of the number of shares of capital stock of
the Corporation represented at the meeting and such inspectors' count of all
votes and ballots. Such certification and report shall specify such other
information as may be required by law. In determining the validity and counting
of proxies and ballots cast at any meeting of stockholders of the Corporation,
the inspectors may consider such information as is permitted by applicable law.
No person who is a candidate for an office at an election may serve as an
inspector at such election.
Section 15. Conduct of Meetings. The date and time of the opening and the
closing of the polls for each matter upon which the stockholders will vote at a
meeting shall be announced at the meeting by the person presiding over the
meeting. The Board of Directors may adopt by resolution such rules and
regulations for the conduct of the meeting of stockholders as it shall deem
appropriate. Except to the extent inconsistent with such rules and regulations
as adopted by the Board of Directors, the person presiding over any meeting of
stockholders shall have the right and authority to convene and to adjourn the
meeting, to prescribe such rules, regulations and procedures and to do all such
acts as, in the judgment of such chairman, are appropriate for the proper
conduct of the meeting. Such rules, regulations or procedures, whether adopted
by the Board of Directors or prescribed by the presiding officer of the
meeting, may include, without limitation, the following: (i) the establishment
of an agenda or order of business for the meeting; (ii) rules and procedures
for maintaining order at the meeting and the safety of those present; (iii)
limitations on attendance at or participation in the meeting to stockholders of
record of the Corporation, their duly authorized and constituted proxies or
such other persons as the chairman of the meeting shall determine; (iv)
restrictions on entry to the meeting after the time fixed for the commencement
thereof; and (v) limitations on the time allotted to questions or comments by
participants. The presiding officer at any meeting of stockholders, in addition
to making any other determinations that may be appropriate to the conduct of
the meeting, shall, if the facts warrant, determine and declare to the meeting
that a matter or business was not properly brought before the meeting and any
such matter or business not properly brought before the meeting shall not be
transacted or considered. Unless and to the extent determined by the Board of
Directors or the person presiding over the meeting, meetings of stockholders
shall not be required to be held in accordance with the rules of parliamentary
procedure.
ARTICLE III.
BOARD OF DIRECTORS
Section 1. General Powers. The business and affairs of the Corporation shall
be managed under the direction of the Board of Directors. In addition to the
powers and authorities by these Bylaws expressly conferred upon them, the Board
of Directors may exercise all such powers of the Corporation and do all such
lawful acts and things as are not by statute or by the Certificate of
Incorporation or by these Bylaws required to be exercised or done by the
stockholders.
Section 2. Number of Directors; Tenure and Qualifications. Subject to the
rights of the holders of any series of Preferred stock to elect directors under
specified circumstances, the number of directors of the Corporation which shall
constitute the entire board shall be fixed from time to time as provided in the
Certificate of Incorporation. Directors need not be stockholders. The
directors, other than those who may be elected by the holders of any series of
Preferred Stock under specified circumstances, shall be divided, with respect
to the time for which they severally hold office, into three classes, as nearly
equal in number as is reasonably possible, with the term of office of the first
class to expire at the [first annual meeting of stockholders following the
Effective Time], the term of office of the second class to expire at the
[second annual meeting of stockholders following the Effective Time] and the
term of office of the third class to expire at the [third annual meeting of
stockholders following the Effective Time], with each director to hold office
until his or her successor shall have been duly elected and qualified. At each
annual meeting of stockholders commencing with the [first annual meeting of
stockholders following the Effective Time], (i) directors elected to succeed
those directors whose terms then expire shall be elected for a term of office
to expire at the third
E-6
<PAGE>
succeeding annual meeting of stockholders after their election, with each
director to hold office until his or her successor shall have been duly elected
and qualified, and (ii) if authorized by a resolution of the Board of
Directors, directors may be elected to fill any vacancy on the Board of
Directors, regardless of how such vacancy shall have been created. Any director
may resign at any time upon notice given in writing or by electronic
transmission.
Section 3. Meetings. The Board of Directors of the Corporation may hold
meetings, both regular and special, either within or without the State of
Delaware. Regular meetings of the Board of Directors may be held without notice
at such time and at such place as may from time to time be determined by the
Board of Directors. Special meetings of the Board of Directors may be called by
the Chairman of the Board, the Chief Executive Officer or a majority of the
entire Board of Directors. Notice thereof stating the place, date and hour of
the meeting shall be given to each director either by mail not less than forty-
eight (48) hours before the date of the meeting, by telephone or telegram on
twenty-four (24) hours notice, or on such shorter notice as the person or
persons calling such meeting may deem necessary or appropriate in the
circumstances.
Section 4. Quorum. Subject to Section 5 of this Article III and except as
may be otherwise specifically provided by law, the Certificate of Incorporation
or these Bylaws, at all meetings of the Board of Directors or any committee
thereof, a majority of the entire Board of Directors or such committee, as the
case may be, shall constitute a quorum for the transaction of business and the
act of a majority of the directors present at any meeting at which there is a
quorum shall be the act of the Board of Directors or such committee, as the
case may be. If a quorum shall not be present at any meeting of the Board of
Directors or of any committee thereof, a majority of the directors present
thereat may adjourn the meeting from time to time, without notice other than
announcement at the meeting, until a quorum shall be present.
Section 5. Vacancies and Newly Created Directorships. Except as otherwise
provided in the Certificate of Incorporation and subject to applicable law and
the rights of the holders of any series of Preferred Stock, and unless the
Board of Directors otherwise determines, vacancies resulting from death,
resignation, retirement, disqualification, removal from office or other cause,
and newly created directorships resulting from any increase in the authorized
number of directors, may be filled only by the affirmative vote of a majority
of the remaining directors, though less than a quorum of the Board of
Directors. Any director so chosen pursuant to the foregoing sentence shall hold
office for the remainder of the full term expiring at the annual meeting of
stockholders at which the term of office of the class to which they have been
elected expires and until such director's successor shall have been duly
elected and qualified. No decrease in the number of authorized directors
constituting the Board of Directors shall shorten the term of any incumbent
director.
Section 6. Actions of Board of Directors. Unless otherwise provided by the
Certificate of Incorporation or these Bylaws, any action required or permitted
to be taken at any meeting of the Board of Directors or of any committee
thereof may be taken without a meeting, if all the members of the Board of
Directors or committee, as the case may be, consent thereto in writing or by
electronic transmission, and the writing or writings or electronic transmission
or transmissions are filed with the minutes of proceedings of the Board of
Directors or committee, as applicable. Such filing shall be in paper form if
the minutes are maintained in paper form and shall be in electronic form if the
minutes are maintained in electronic form.
Section 7. Meetings by Means of Conference Telephone. Unless otherwise
provided by the Certificate of Incorporation or these Bylaws, members of the
Board of Directors of the Corporation, or any committee designated by the Board
of Directors, may participate in a meeting of the Board of Directors or such
committee by means of a conference telephone or other communications equipment
by means of which all persons participating in the meeting can hear each other,
and participation in a meeting pursuant to this Article III, Section 7 shall
constitute presence in person at such meeting.
Section 8. Executive and Other Committees. The Board of Directors may, by
resolution designate an Executive Committee to exercise, subject to applicable
provisions of law, all of the powers of the Board of Directors in the
management of the business and affairs of the Corporation when the Board of
Directors is not
E-7
<PAGE>
in session, including, without limitation, the power to declare dividends, to
authorize the issuance of the Corporation's capital stock and to adopt a
certificate of ownership and merger pursuant to Section 253 of the DGCL, and
may, by resolution similarly adopted, designate one or more other committees.
The Executive Committee and each such other committee shall consist of two or
more directors of the Corporation. The Board of Directors may designate one or
more directors as alternate members of any committee, who may replace any
absent or disqualified member at any meeting of any such committee. In the
absence or disqualification of a member of a committee, and in the absence of a
designation by the Board of Directors of an alternate member to replace the
absent or disqualified member, the member or members thereof present at any
meeting and not disqualified from voting, whether or not he, she or they
constitute a quorum, may unanimously appoint another member of the Board of
Directors to act at the meeting in the place of any absent or disqualified
member. Any committee, other than the Executive Committee (the powers of which
are expressly provided for herein), may to the extent permitted by law exercise
such powers and shall have such responsibilities as shall be specified in the
designating resolution. Each committee shall keep regular minutes and report to
the Board of Directors when required.
Section 9. Removal. Subject to the rights of holders of any series of
Preferred Stock to elect directors under specified circumstances, any director
may be removed from office, but only for cause, and only by the affirmative
vote of the holders of at least 75% of the voting power of all the then
outstanding shares of Voting Stock, voting together as a single class.
Section 10. Compensation. The directors may be paid their expenses, if any,
of attendance at each meeting of the Board of Directors and may be paid a fixed
sum for attendance at each meeting of the Board of Directors or a stated salary
as director. No such payment shall preclude any director from serving the
Corporation in any other capacity and receiving compensation therefor. Members
of special or standing committees may be allowed like compensation for
attending committee meetings.
Section 11. Interested Directors. No contract or transaction between the
Corporation and one or more of its directors or officers, or between the
Corporation and any other corporation, partnership, association, or other
organization in which one or more of its directors or officers are directors or
officers, or have a financial interest, shall be void or voidable solely for
this reason, or solely because the director or officer is present at or
participates in the meeting of the Board of Directors or committee thereof
which authorizes the contract or transaction, or solely because his, her or
their votes are counted for such purpose if (i) the material facts as to his,
her or their relationship or interest and as to the contract or transaction are
disclosed or are known to the Board of Directors or the committee, and the
Board of Directors or committee in good faith authorizes the contract or
transaction by the affirmative votes of a majority of the disinterested
directors, even though the disinterested directors may be less than a quorum;
or (ii) the material facts as to his, her or their relationship or interest and
as to the contract or transaction are disclosed or are known to the
stockholders entitled to vote thereon, and the contract or transaction is
specifically approved in good faith by vote of the stockholders; or (iii) the
contract or transaction is fair as to the Corporation as of the time it is
authorized, approved or ratified, by the Board of Directors, a committee
thereof or the stockholders. Common or interested directors may be counted in
determining the presence of a quorum at a meeting of the Board of Directors or
of a committee which authorizes the contract or transaction.
Section 12. Organization. Meetings of the Board of Directors shall be
presided over by the Chairman of the Board, if any, or in his or her absence by
the Vice Chairman of the Board, if any, or in his or her absence by the Chief
Executive Officer, or in his or her absence by a chairman chosen at the
meeting. The Secretary shall act as secretary of the meeting, but in his
absence the chairman of the meeting may appoint any person to act as secretary
of the meeting.
E-8
<PAGE>
ARTICLE IV.
OFFICERS
Section 1. General. The officers of the Corporation shall be elected by the
Board of Directors and shall consist of: a Chairman of the Board; a Chief
Executive Officer; a Vice Chairman; a President; a Chief Operating Officer; a
Chief Financial Officer; a Secretary; and a Treasurer. The Board of Directors,
in its discretion, may also elect one or more Executive Vice Presidents, Senior
Vice Presidents, Vice Presidents, Assistant Secretaries, Assistant Treasurers,
a Controller and such other officers as in the judgment of the Board of
Directors may be necessary or desirable. Any number of offices may be held by
the same person and more than one person may hold the same office, unless
otherwise prohibited by law, the Certificate of Incorporation or these Bylaws.
The officers of the Corporation need not be stockholders of the Corporation
nor, need such officers be directors of the Corporation.
Section 2. Election and Term of Office. The Board of Directors at its first
meeting held after each annual meeting of stockholders shall elect the officers
of the Corporation who shall hold their offices for such terms and shall
exercise such powers and perform such duties as shall be determined from time
to time by the Board of Directors; and all officers of the Corporation shall
hold office until their successors are chosen and qualified, or until their
earlier resignation or removal. Except as otherwise provided in this Article
IV, any officer elected by the Board of Directors may be removed with or
without cause at any time by the affirmative vote of a majority of the Board of
Directors. Any vacancy occurring in any office of the Corporation shall be
filled by the Board of Directors. The salaries of all officers who are
directors of the Corporation shall be fixed by the Board of Directors.
Section 3. Chairman of the Board. The Chairman of the Board shall be a
member of the Board of Directors, shall serve at the discretion of the Board of
Directors and shall exercise and perform such duties and have such powers as
may be prescribed by the Board of Directors or these Bylaws, all in accordance
with basic policies as established by and subject to the oversight of the Board
of Directors.
Section 4. Chief Executive Officer. The Chief Executive Officer of the
Corporation shall serve at the discretion of the Board of Directors and shall
supervise, coordinate and manage the Corporation's business and activities and
supervise, coordinate and manage its operating expenses and capital allocation,
shall have general authority to exercise all the powers necessary for the Chief
Executive Officer of the Corporation and shall perform such other duties and
have such other powers as may be prescribed by the Board of Directors or these
Bylaws, all in accordance with basic policies as established by and subject to
the oversight of the Board of Directors.
Section 5. Vice Chairman. The Vice Chairman shall be a member of the Board
of Directors and shall serve at the discretion of the Board of Directors. The
Vice Chairman shall exercise and perform such duties and have such powers as
may be prescribed by the Board of Directors or these Bylaws, all in accordance
with basic policies as established by and subject to the oversight of the Board
of Directors. In the absence or disability of the Chairman of the Board, the
duties of the Chairman of the Board shall be performed, and the Chairman of the
Board's authority may be exercised by the Vice Chairman and, in the event the
Vice Chairman is absent or disabled, such duties shall be performed and such
authority may be exercised by a director designated for such purpose by the
Board of Directors.
Section 6. President. The President shall serve at the discretion of the
Board of Directors and shall supervise, coordinate and manage the Corporation's
business and activities and supervise, coordinate and manage its operating
expenses and capital allocation, shall have general authority to exercise all
the powers necessary for the President of the Corporation and shall perform
such other duties and have such other powers as may be prescribed by the Board
of Directors or these, all in accordance with basic policies as established by
and subject to the oversight of the Board of Directors, the Chairman of the
Board and the Chief Executive Officer.
E-9
<PAGE>
Section 7. Chief Operating Officer. The Chief Operating Officer shall report
to the President, and shall supervise, coordinate and manage the Corporation's
business and activities and supervise, coordinate and manage its operating
expenses and capital allocation, shall have general authority to exercise all
the powers necessary for the Chief Operating Officer of the Corporation and
shall perform such other duties and have such other powers as may be prescribed
by the Board of Directors or these Bylaws, all in accordance with basic
policies as established by and subject to the oversight of the Board of
Directors, the Chairman of the Board and the Chief Executive Officer.
Section 8. Chief Financial Officer. The Chief Financial Officer shall report
to the President, and be an Executive Vice President, a Senior Vice President
or a Vice President and shall act in an executive financial capacity. The Chief
Financial Officer shall establish and maintain the accounting records of the
Corporation in accordance with generally accepted accounting principles applied
on a consistent basis, maintain proper internal control of the assets of the
Corporation and shall perform such other duties as the Board of Directors, the
Chairman of the Board, the Chief Executive Officer, or the Vice Chairman and
President may prescribe.
Section 9. Executive Vice Presidents and Senior Vice Presidents. The
Executive Vice Presidents and the Senior Vice Presidents shall report to the
President, and perform such duties as may be delegated or prescribed by the
Board of Directors, Chief Executive Officer or Vice Chairman and President of
the Corporation.
Section 10. Vice Presidents. Each Vice President shall report to the
President, and perform such duties and have such powers as the Board of
Directors from time to time may prescribe or as delegated by the Vice Chairman
and President.
Section 11. Treasurer and Assistant Treasurers. The Treasurer shall report
to the President, and have the custody of the corporate funds and securities
and shall keep full and accurate accounts of receipts and disbursements in
books belonging to the Corporation and shall deposit all moneys and other
valuable effects in the name and to the credit of the Corporation in such
depositories as may be designated by the Board of Directors. The Treasurer
shall disburse the funds of the Corporation as may be ordered by the Board of
Directors, taking proper vouchers for such disbursements, and shall render to
the Vice Chairman and President and the Board of Directors, at its regular
meetings, or when the Board of Directors so requires, an account of all his or
her transactions as Treasurer and of the financial condition of the
Corporation. If required by the Board of Directors, the Treasurer shall give
the Corporation a bond (which shall be renewed every six years) in such sum and
with such surety or sureties as shall be satisfactory to the Board of Directors
for the faithful performance of the duties of his or her office and for the
restoration to the Corporation, in case of his or her death, resignation,
retirement or removal from office, of all books, papers, vouchers, money and
other property of whatever kind in his or her possession or under his or her
control belonging to the Corporation.
The Assistant Treasurers in the order of their seniority shall, in the
absence or disability of the Treasurer, perform the duties and exercise the
powers of the Treasurer and shall perform such other duties as the Board of
Directors shall prescribe.
Section 12. Secretary and Assistant Secretaries. The Secretary shall report
to the President, and shall attend all meetings of the Board of Directors and
all meetings of stockholders and record all votes and proceedings thereat in a
book or books to be kept for that purpose; the Secretary shall also perform
like duties for the standing committees when required. The Secretary shall
give, or cause to be given, notice of all meetings of the stockholders and
special meetings of the Board of Directors, and shall perform such other duties
as may be prescribed by the Board of Directors, the Chairman of the Board or
Vice Chairman and President, who shall supervise the Secretary. The Secretary
shall have custody of the seal of the Corporation and the Secretary or any
Assistant Secretary, if there be one, shall have authority to affix the same to
any instrument requiring it and when so affixed, it may be attested by the
signature of the Secretary or by the signature of any Assistant Secretary. The
Board of Directors may give general authority to any other officer to affix the
seal of the Corporation and to attest the affixing by his or her signature. The
Secretary shall see that all books, reports, statements, certificates and other
documents and records required by law to be kept or filed are properly kept or
filed, as the case may be.
E-10
<PAGE>
The Assistant Corporate Secretary or the Assistant Secretaries in order of
their seniority, shall, in the absence or disability of the Secretary, perform
the duties and exercise the powers of the Secretary and shall perform such
other duties as the Board of Directors shall prescribe.
Section 13. Other Officers. Such other officers as the Board of Directors
may choose shall perform such duties and have such powers as from time to time
may be assigned to them by the Board of Directors. The Board of Directors may
delegate to any other officer of the Corporation the power to choose such other
officers and to prescribe their respective duties and powers.
ARTICLE V.
STOCK
Section 1. Stock Certificates. The interest of each stockholder of the
Corporation shall be evidenced by certificates for shares of stock or shall be
uncertificated. The certificate for shares of stock of the Corporation shall be
in such form, not inconsistent with the Certificate of Incorporation, as the
appropriate officers of the Corporation may from time to time prescribe. The
certificates of stock shall be signed, countersigned and registered in such
manner as the Board of Directors may by resolution prescribe, which resolution
may permit all or any of the signatures on such certificates to be in
facsimile. In case any officer, transfer agent or registrar who has signed or
whose facsimile signature has been placed upon a certificate shall have ceased
to be such officer, transfer agent or registrar before such certificate is
issued, it may be issued by the Corporation with the same effect as if he or
she were such officer, transfer agent or registrar at the date of issue.
Section 2. Lost, Stolen or Destroyed Certificates. The Board of Directors
may direct new certificate(s) to be issued in place of any certificate(s)
theretofore issued by the Corporation alleged to have been lost, stolen or
destroyed, upon the making of an affidavit of that fact by the person claiming
the certificate of stock to be lost, stolen or destroyed. When authorizing such
issue of new certificate(s), the Board of Directors may, in its discretion and
as a condition precedent to the issuance thereof, require the owner of such
lost, stolen or destroyed certificate(s), or such owner's legal representative,
to advertise the same in such manner as the Board of Directors shall require
and/or to give the Corporation a bond in such sum as it may direct as indemnity
against any claim that may be made against the Corporation with respect to the
certificate(s) alleged to have been lost, stolen or destroyed.
Section 3. Transfers. Stock of the Corporation shall be transferable in the
manner prescribed by law and in these Bylaws. Transfers of stock shall be made
on the books of the Corporation only by the person named in the certificate or
by such person's attorney lawfully constituted in writing and upon the
surrender of the certificate therefor, which shall be canceled before a new
certificate shall be issued.
ARTICLE VI.
INDEMNIFICATION AND INSURANCE
Section 1. Action Other Than By or In The Right of The Corporation. The
Corporation shall indemnify and hold harmless, to the fullest extent permitted
by applicable law as it presently exists or may hereafter be amended, an Agent
(as hereinafter defined) against costs, charges and Expenses (as hereinafter
defined), judgments, fines and amounts paid in settlement actually and
reasonably incurred by an Agent in connection with an action, suit or
proceeding (of the type referenced in the definition of "Agent"), and any
appeal therefrom, if the Agent acted in good faith and in a manner the Agent
reasonably believed to be in or not opposed to the best interests of the
Corporation, and with respect to any criminal action or proceeding, had no
reasonable cause to believe such conduct was unlawful. The termination of any
action, suit or proceeding (whether by judgment, order, settlement, conviction,
or upon a plea of nolo contendere or its equivalent) shall
E-11
<PAGE>
not, of itself, create a presumption that the Agent did not act in good faith
and in a manner which the Agent reasonably believed to be in or not opposed to
the best interests of the Corporation, and, with respect to any criminal action
or proceeding, that such person had reasonable cause to believe that the
Agent's conduct was unlawful.
Section 2. Action By Or In The Right Of The Corporation. The Corporation
shall indemnify any person who was or is a party or is threatened to be made a
party to any threatened, pending or completed judicial action or suit brought
by or in the right of the Corporation to procure a judgment in its favor by
reason of the fact that such person is or was an Agent, against costs, charges
and Expenses actually and reasonably incurred by an Agent in connection with
the defense or settlement of such action or suit and any appeal therefrom if
the Agent acted in good faith and in a manner such person reasonably believed
to be in or not opposed to the best interests of the Corporation, except that
no indemnification shall be made in respect of any claim, issue or matter as to
which such person shall have been adjudged to be liable for gross negligence or
willful misconduct in the performance of the Agent's duty to the Corporation
unless and only to the extent that the Court of Chancery or the court in which
such action or suit was brought shall determine upon application that, despite
the adjudication of liability but in view of all the circumstances of the case,
such person is fairly and reasonably entitled to indemnity for such costs,
charges and Expenses which the Court of Chancery or other such court shall deem
proper.
Section 3. Determination of Right of Indemnification. Any indemnification
under Section 1 or 2 of this Article VI (unless ordered by a court) shall be
paid by the Corporation if a determination is reasonably and promptly made (i)
by the Board of Directors by a majority vote of Disinterested Directors (as
hereinafter defined) even though less than a quorum, or (ii) by a committee of
Disinterested Directors designated by majority vote of such directors, even
though less than a quorum, or (iii) if such a quorum is not obtainable, or,
even if obtainable, if a quorum of Disinterested Directors so directs, by
Independent Counsel in a written opinion, or (iv) by the stockholders, that
such person has met the applicable standard of conduct set forth in Section 1
and 2 of Article VI.
Section 4. Indemnification Against Expenses of Successful Party.
Notwithstanding the other provisions of this Article VI, to the extent that an
Agent has been successful on the merits or otherwise, including, without
limitation, the dismissal of an action without prejudice, the settlement of an
action without admission of liability, or the defense of any claim, issue or
matter therein, or on appeal from any such proceeding, action, claim or matter,
such Agent shall be indemnified against all costs, charges and Expenses
incurred in connection therewith.
Section 5. Advances of Expenses. Except as limited by Section 6 of this
Article VI, costs, charges, and Expenses incurred by an Agent in any action,
suit, proceeding or investigation or any appeal therefrom shall be paid by the
Corporation in advance of the final disposition of such matter, if the Agent
shall undertake to repay such amount in the event that it is ultimately
determined, as provided herein, that such person is not entitled to
indemnification. Notwithstanding the foregoing, no advance shall be made by the
Corporation if a determination is reasonably and promptly made (i) by the Board
of Directors by a majority vote of a quorum of Disinterested Directors, (ii) if
such a quorum is not obtainable or, even if obtainable, a quorum of
Disinterested Directors so directs, by Independent Counsel in a written
opinion, that, based upon the facts known to the Board of Directors or counsel
at the time such determination is made, the Agent acted in bad faith and in a
manner that such person did not believe to be in the best interests of the
Corporation, or (iii) with respect to any criminal proceeding, that such person
believed or had reasonable cause to believe his or her conduct was unlawful. In
no event shall any advance be made in instances where the Board of Directors or
Independent Counsel reasonably determines that the Agent deliberately breached
such person's duty to the Corporation or its stockholders.
Section 6. Right of Agent to Indemnification Upon Application; Procedure
Upon Application. Any indemnification under Section 1, 2 or 4 or advance under
Section 5 of this Article VI, shall be made promptly, and in any event within
60 days, upon the written request of the Agent, unless with respect to
applications
E-12
<PAGE>
under Section 1, 2 or 5, a determination is reasonably and promptly made by the
Board of Directors by a majority vote of a quorum of Disinterested Directors
that such Agent acted in a manner set forth in such Sections as to justify the
Corporation's not indemnifying or making an advance to the Agent. In the event
no quorum of Disinterested Directors is obtainable, the Board of Directors
shall promptly direct that Independent Counsel shall decide whether the Agent
acted in the manner set forth in such Sections as to justify the Corporation's
not indemnifying or making an advance to the Agent. The right to
indemnification or advances as granted by this Article shall be enforceable by
the Agent in any court of competent jurisdiction, if the Board of Directors or
Independent Counsel denies the claim in whole or in part, or if no disposition
of such claim is made within 60 days. The Agent's costs, charges and Expenses
incurred in connection with successfully establishing such person's right to
indemnification, in whole or in part, in any such proceeding shall also be
indemnified by the Corporation.
Section 7. Other Rights and Remedies. The indemnification provided by this
Article VI shall not be deemed exclusive of, and shall not affect, any other
rights to which an Agent seeking indemnification may be entitled under any law,
Bylaw, or charter provision, agreement, vote of stockholders or Disinterested
Directors or otherwise, both as to action in such person's official capacity
and as to action in another capacity while holding such office, and shall
continue as to a person who has ceased to be an Agent and shall inure to the
benefit of the heirs, executors and administrators of such a person. All rights
to indemnification under this Article VI shall be deemed to be a contract
between the Corporation and the Agent who serves in such capacity at any time
while the Certificate of Incorporation and other relevant provisions of the
DGCL and other applicable law, if any, are in effect. Any repeal or
modification thereof shall not affect any rights or obligations then existing.
Section 8. Insurance. The Corporation may purchase and maintain insurance on
behalf of any person who is or was an Agent against any liability asserted
against such person and incurred by him or her in any such capacity, or arising
out of such person's status as such, whether or not the Corporation would have
the power to indemnify such person against such liability under the provisions
of this Article VI. The Corporation may create a trust fund, grant a security
interest or use other means (including, without limitation, a letter of credit)
to ensure the payment of such sums as may become necessary to effect
indemnification as provided herein.
Section 9. Presumptions and Effect of Certain Proceedings. If a Change of
Control (as hereinafter defined) shall have occurred, in making a determination
with respect to entitlement to indemnification hereunder, the person, persons
or entity making such determination shall presume that the Agent is entitled to
indemnification under this Article if the Agent has submitted a request for
indemnification in accordance with Section 6 of this Article VI, and the
Corporation shall have the burden of proof to overcome that presumption in
connection with the making by any person, persons or entity of any
determination contrary to that presumption.
If the person, persons or entity empowered or selected under Section 6 of
this Article VI to determine whether the Agent is entitled to indemnification
shall not have made such determination within 60 days after receipt by the
Corporation of the request therefor, the requisite determination of entitlement
to indemnification shall be deemed to have been made and the Agent shall be
entitled to such indemnification, absent (i) a misstatement by the Agent of a
material fact, or an omission of a material fact necessary to make the Agent's
statement not materially misleading, in connection with the request for
indemnification, or (ii) a prohibition of such indemnification under applicable
law; provided, however, that such 60-day period may be extended for a
reasonable time, not to exceed an additional 30 days, if the person, persons or
entity making the determination with respect to entitlement to indemnification
in good faith requires such additional time for the obtaining or evaluating of
documentation and/or information relating thereto; and provided, further, that
the foregoing provisions of this Section 9 shall not apply (a) if the
determination of entitlement to indemnification is to be made by the
stockholders pursuant to Section 6 and if (A) within 15 days after receipt by
the Corporation of the request for such determination the Board of Directors
has resolved to submit such determination to the stockholders for their
consideration at an annual meeting thereof to be held within 75 days after such
receipt
E-13
<PAGE>
and such determination is made thereat, or (B) a special meeting of the
stockholders is called within 15 days after such receipt for the purpose of
making such determination, such meeting is held for such purpose within 60 days
after having been so called and such determination is made thereat, or (b) if
the determination of entitlement to indemnification is to be made by
Independent Counsel pursuant to Section 5 of this Article VI.
The termination of any proceeding or of any claim, issue or matter therein
by judgment, order, settlement or conviction, or upon a plea of nolo contendere
or its equivalent, shall not (except as otherwise expressly provided in this
Article VI) of itself adversely affect the right of the Agent to
indemnification or create a presumption that the Agent did not act in good
faith and in a manner which such person reasonably believed to be in or not
opposed to the best interests of the Corporation, or, with respect to any
criminal proceeding, that the Agent had reasonable cause to believe that such
person's conduct was unlawful.
Section 10. Other Enterprises, Fines, and Serving at Corporation's Request.
For the purposes of this Article VI, references to "other enterprise" in
Section 12(A) below shall include employee benefit plans; references to "fines"
shall include any excise taxes assessed on a person with respect to any
employee benefit plan; and references to "serving at the request of the
Corporation" shall include any service by the Agent as a director, officer or
employee of the Corporation which imposes duties on, or involves services by,
such Agent with respect to any employee benefit plan, its participants, or
beneficiaries; and a person who acted in good faith and in a manner such person
reasonably believed to be in the interest of the participants and beneficiaries
of an employee benefit plan shall be deemed to have acted in a manner "not
opposed to the best interests of the Corporation" as referred to in this
Article VI.
Section 11. Savings Clause. If this Article or any portion thereof shall be
invalidated on any ground by any court of competent jurisdiction, then the
Corporation shall nevertheless indemnify each Agent as to costs, charges and
Expenses, judgments, fines and amounts paid in settlement with respect to any
action, suit, proceeding or investigation, and any appeal therefrom, whether
civil, criminal or administrative, and whether internal or external, including
a grand jury proceeding and an action or suit brought by or in the right of the
Corporation, to the full extent permitted by any applicable portion of this
Article that shall not have been invalidated, and to the fullest extent
permitted by applicable law.
Section 12. Certain Definitions. For the purposes of this Article VI:
"Agent" means any person who was or is a party or is threatened to be made a
party to any threatened, pending or completed action, suit or proceeding or
investigation, whether civil, criminal or administrative, and whether external
or internal to the Corporation (other than a judicial action or suit brought by
or in the right of the Corporation) by reason of the fact that he or she is or
was or has agreed to be a director, officer or employee of the Corporation, or
that, being or having been such a director, officer or employee, he or she is
or was serving at the request of the Corporation as a director, officer or
employee of another corporation, partnership, joint venture, trust or other
enterprise.
"Change of Control" means a change in control of the Corporation of a nature
that would be required to be reported in response to Item 5(f) of Schedule 14A
of Regulation 14A (or in response to any similar item on any similar schedule
or form) promulgated under the Exchange Act, whether or not the Corporation is
then subject to such reporting requirement; provided, however, that, without
limitation, such a Change in Control shall be deemed to have occurred if: (i)
any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange
Act) is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the
Exchange Act), directly or indirectly, of securities of the Corporation
representing 25% or more of the combined voting power of the Corporation's then
outstanding securities without the prior approval of at least two-thirds of the
members of the Board of Directors in office immediately prior to such person
attaining such percentage interest; (ii) the Corporation is a party to a
merger, consolidation, sale of assets or other reorganization, or a proxy
contest, as a consequence of which members of the Board of Directors in office
immediately prior to such transaction or event constitute less than a majority
of the Board of Directors thereafter; or (iii) during any period of three
consecutive years, individuals who at the beginning of such period constituted
the Board of Directors
E-14
<PAGE>
(including for this purpose any new director whose election or nomination for
election by the Corporation's stockholders was approved by a vote of at least
two-thirds of the directors then still in office who were directors at the
beginning of such period) cease for any reason to constitute at least a
majority of the Board of Directors.
"Disinterested Director" means a director of the Corporation who is not and
was not a party to the matter in respect of which indemnification is sought by
the claimant.
"Expenses" shall include all reasonable attorneys' fees, retainers, court
costs, transcript costs, fees of experts, witness fees, travel expenses,
duplicating costs, printing and binding costs, telephone charges, postage,
delivery service fees, and all other disbursements or expenses of the types
customarily incurred in connection with prosecuting, defending, preparing to
prosecute or defend, investigating, or being or preparing to be a witness in a
proceeding.
"Independent Counsel" means a law firm, a member of a law firm, or an
independent practitioner, that is experienced in matters of corporation law and
shall include any person who, under the applicable standards of professional
conduct then prevailing, would not have a conflict of interest in representing
either the Corporation or the claimant in an action to determine the claimant's
rights under this Article VI.
ARTICLE VII.
MISCELLANEOUS PROVISIONS
Section 1. Fiscal Year. The fiscal year of the Corporation shall begin on
the first day of January and end of the thirty-first day of December each year.
Section 2. Dividends. The Board of Directors may from time to time declare,
and the Corporation may pay, dividends on its outstanding shares in the manner
and upon the terms and conditions provided by law and the Certificate of
Incorporation. Dividends may be paid in cash, in property, or in shares of the
capital stock of the Corporation. Before payment of any dividend, there may be
set aside out of any funds of the Corporation available for dividends, such sum
or sums as the directors may, from time to time in their absolute discretion,
think proper as a reserve fund to meeting contingencies, or for equalizing
dividends, or for repairing or maintaining any property of the Corporation, or
for such other purpose as the directors shall think conducive to the interest
of the Corporation, and the directors may abolish any such reserve in the
manner in which it was created.
Section 3. Seal. The corporate seal shall have inscribed thereon the name of
the Corporation, the year of incorporation and the words "Corporation Seal,
Delaware." Said seal may be used by causing it or a facsimile thereof to be
impressed or affixed or reproduced or otherwise.
Section 4. Audits. The accounts, books and records of the Corporation shall
be audited upon the conclusion of each fiscal year by an independent certified
public accountant selected by the Board of Directors, and it shall be the duty
of the Board of Directors to cause such audit to be done annually.
Section 5. Resignations. Any officer, whether elected or appointed, may
resign at any time by giving written notice of such resignation to the Chairman
of the Board, the Chief Executive Officer or the Secretary, and such
resignation shall be deemed to be effective as of the close of business on the
date said notice is received by the Chairman of the Board, Chief Executive
Officer or Secretary, or at such later time as is specified therein. No formal
action shall be required of the Board of Directors or the stockholders to make
any such resignation effective.
Section 6. Contracts. Except as otherwise required by law, the Certificate
of Incorporation or these Bylaws, any contracts or other instruments may be
executed and delivered in the name and on behalf of the Corporation by such
officer or officers of the Corporation as the Board of Directors may from time
to time
E-15
<PAGE>
direct. Such authority may be general or confined to specific instances as the
Board may determine. The Chairman of the Board, Chief Executive Officer, Vice
Chairman and President, or any Executive Vice President, Senior Vice President
or Vice President may execute bonds, contracts, deeds, leases and other
instruments to be made or executed for or on behalf of the Corporation.
Section 7. Proxies. Unless otherwise provided by resolution adopted by the
Board of Directors, the Chairman of the Board, Chief Executive Officer, Vice
Chairman and President, any Executive Vice President, Senior Vice President or
Vice President may from time to time appoint an attorney or attorneys or agent
or agents of the Corporation, in the name and on behalf of the Corporation, to
case the votes which the Corporation may be entitled to case as the holder of
stock or other securities in any other corporation, any of whose stock or other
securities may be held by the Corporation, at meetings of the holders of stock
or other securities or such other corporation, or to consent in writing, in the
name of the Corporation as such holder, to any action by such other
corporation, and may instruct the person or persons so appointed as to the
manner of casting such votes or giving such consent, and may execute or cause
to be executed in the name and on behalf of the Corporation and under its
corporate seal or otherwise, all such written proxies or other instruments as
he may deem necessary or proper in the premises.
Section 8. Waiver of Notice of Meetings of Stockholders, Directors and
Committees. Any waiver of notice, whether before or after the time stated
therein, shall be deemed equivalent to notice. Attendance of a person at a
meeting shall constitute a waiver of notice of such meeting, except when the
person attends a meeting for the express purpose of objecting, at the beginning
of the meeting, to the transaction of any business because the meeting is not
lawfully called or convened. Neither the business to be transacted at nor the
purpose of any regular or special meeting of the stockholders, directors, or
members of a committee of directors need be specified in any waiver of notice.
ARTICLE VIII.
AMENDMENTS
Section 1. Amendments. These Bylaws may be altered, amended, or repealed at
any meeting of the Board of Directors or of the stockholders, provided that
notice of the proposed change was given in the notice of the meeting and, in
the case of a meeting of the Board of Directors, in a notice given not less
than two days prior to the meeting; provided, however, that, in the case of
amendments by stockholders, notwithstanding any other provisions of these
Bylaws or any provision of law which might otherwise permit a lesser vote or no
vote, but in addition to any affirmative vote of the holders of any particular
class or series of the capital stock of the Corporation required by law, the
Certificate of Incorporation or these Bylaws, the affirmative vote of the
holders of at least 75% of the voting power of all the then outstanding shares
of the Voting Stock, voting together as a single class, shall be required to
alter, amend or repeal any provision of these Bylaws.
E-16
