<PAGE> 1
Filed Pursuant to Rule 424(b)(1)
Registration No. 333-87257
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4,000,000 shares of common stock $18.00 per share
[Andover.Net LOGO]
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This is our initial public offering and no public market currently Andover.Net, Inc.
exists for our shares. The initial public offering price is $18.00 per 50 Nagog Park
share. This price may not reflect the market price of our shares after Acton, MA 01720
this offering.
Nasdaq National Market
Symbol: ANDN
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<TABLE>
<CAPTION>
THE OFFERING PER SHARE TOTAL
<S> <C> <C> <C>
Public Offering Price........................ $18.00 $72,000,000
Underwriting Discount........................ $ 1.17 $ 4,680,000
Proceeds to Andover.Net...................... $16.83 $67,320,000
We have granted the underwriters the right to purchase up to 600,000
additional shares within 30 days to cover any over-allotments. The
underwriters expect to deliver shares of common stock to purchasers on
December 13, 1999.
The method of distribution being used by the underwriters in this
offering differs somewhat from that traditionally employed in firm
commitment underwritten public offerings. In particular, the public
offering price and allocation of shares were determined primarily by
an auction process conducted by the underwriters and other securities
dealers participating in the offering. A more detailed description of
this process is included in "Plan of Distribution."
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THIS OFFERING INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD PURCHASE SHARES ONLY
IF YOU CAN AFFORD A COMPLETE LOSS OF YOUR INVESTMENT. SEE "RISK FACTORS"
BEGINNING ON PAGE 4.
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Neither the Securities and Exchange Commission nor any state OPEN IPO WR HAMBRECHT & CO [LOGO]
securities commission has approved or disapproved of these se-
curities or determined if this prospectus is truthful or complete. Any
representation to the contrary is a criminal offense.
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WR HAMBRECHT & CO [LOGO]
ADVEST, INC.
DLJdirect INC.
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The date of this prospectus is December 8, 1999
<PAGE> 2
[ANDOVER.NET LOGO]
ANDOVER.NET PAGE VIEWS -
45.9 MILLION, September, 1999
[PIE CHART]
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Linux/Open Source Sites................................. 61.2%
Slashdot.............................................. 46.3%
Freshmeat.net......................................... 12.3%
FreeCode.............................................. 2.6%
Cross-Platform Sites.................................... 37.4%
Windows Site............................................ 1.4%
[SLASHDOT LOGO]
[FREECODE LOGO]
[FRESHMEAT.NET LOGO]
</TABLE>
Source: ABC Interactive, Audit Bureau of Verification Services, Inc. a
subsidiary of Audit Bureau of Circulations, September 1999.
Percentages are based on total number of audited page views for one month
ended September 30, 1999.
<PAGE> 3
LINUX/OPEN SOURCE SITES
SLASHDOT.ORG
News for Nerds. Stuff that Matters. A leading
voice for the Open Source community.
[Screen Shot] http://www.andover.net
FRESHMEAT.NET FREECODE
One of the largest downloadable Linux A comprehensive archive
software application repositories. of free source code.
[Screen Shot] [Screen Shot]
THINKGEEK
An online retailer of Linux/Open Source gifts, [Screen Shot]
books and paraphernalia.
<PAGE> 4
[ANDOVER.NET LOGO]
CROSS-PLATFORM SITES
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DAVECENTRAL MEDIABUILDER ANDOVER NEWS
Over 10,000 downloadable Complete online multimedia Searchable computer-industry news
products for both Linux resource center, including and editorials.
and Windows. online tools.
[Screen Shot] [Screen Shot] [Screen Shot]
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IT MANAGER'S JOURNAL INTERNET TRAFFIC REPORT
Editorials and summaries for Monitors the flow of data around
IT managers. the world.
[Screen Shot] [Screen Shot]
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WINDOWS SITE
SLAUGHTERHOUSE
Free Windows applications and news.
[Screen Shot]
<PAGE> 5
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of our common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or of any sale of our common stock.
------------------------
TABLE OF CONTENTS
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PAGE
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Prospectus Summary.......................................... 1
The Offering................................................ 2
Summary Financial Data...................................... 3
Risk Factors................................................ 4
Special Note Regarding Forward Looking Statements........... 13
Use of Proceeds............................................. 14
Dividend Policy............................................. 14
Capitalization.............................................. 15
Dilution.................................................... 16
Selected Financial Data..................................... 18
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 20
Business.................................................... 31
Management.................................................. 43
Principal Stockholders...................................... 50
Relationships with Andover.Net and Related Transactions..... 53
Description of Capital Stock................................ 56
Shares Eligible for Future Sale............................. 59
Plan of Distribution........................................ 60
Legal Matters............................................... 65
Experts..................................................... 65
Where You Can Find More Information......................... 66
Index to Financial Statements............................... F-1
</TABLE>
------------------------
Andover.Net and the Andover.Net logo are trademarks of Andover.Net, Inc.
All other trademarks, tradenames or copyrights referred to in this prospectus
are the property of their respective owners.
<PAGE> 6
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE> 7
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PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and the financial statements and notes appearing elsewhere in this
prospectus. This summary may not contain all of the information that you should
consider before investing in our common stock. You should read the entire
prospectus carefully.
Our Business: Andover.Net owns and operates a network of web sites, including
Slashdot.org, Freshmeat.net and Mediabuilder.com, that provides
news, online user forums, downloadable software, information and
online web site development tools. Our network has a strong focus
on the Linux operating system in particular and, more generally,
on Open Source software. Visitors to our network are primarily
software programmers, web site developers and other technology
professionals. In September 1999, we had over two million
individuals, or unique visitors, visit our web sites. These
visitors viewed over 45 million individual web pages, or page
views. The demographics of our technology-oriented visitors
provide an attractive medium for advertising on our network, and
consequently our primary source of revenue is advertising. For
the year ended September 30, 1999, Andover.Net had over 130
advertisers on our network of web sites. Our top five advertisers
based on total revenues for the year ended September 30, 1999
were EarthWeb, IBM, CNET, Broadcast.com and Silicon Graphics.
While most of our revenue since 1996 has come from advertising,
we also generate revenues from our electronic commerce, or
e-commerce, offerings, which currently consist primarily of the
online sale of compact discs of animated graphics and of Linux
and Open Source related gifts, books and paraphernalia.
The Marketplace:
The Open Source movement is a collaborative approach to the
development, testing and modification of software and has emerged
as an alternative to traditional proprietary software
development. In contrast to proprietary software, Open Source
software may be easily modified by users so that they may
customize it to meet their needs. Additionally, Open Source
software is either free or available for less than $100. The
growth of the Internet has greatly increased the scale and
efficiency of Open Source development by enabling large
communities of independent developers to collaborate online. The
viability of the Open Source movement is evidenced in part by the
announcements of major technology industry leaders, including
IBM, Intel and Hewlett-Packard, that they are developing products
that will incorporate and interface with Linux. Linux, an
operating system developed by Linus Torvalds in 1991, is probably
the most well-known Open Source software product. The ability of
programmers to modify Linux and share those modifications with
the public has proven to be so effective in the marketplace that
according to International Data Corporation, Linux based
operating systems accounted for approximately 17% of all newly
licensed shipments of server operating systems in 1998, an
increase of 212% from the previous year. Andover.Net participates
in this marketplace by providing an online resource for
developers and programmers to gather and exchange information,
download new and updated versions of software programs and
retrieve free programming code.
Our Network: We combine our Linux and, more generally, Open Source web sites
with our other web sites to provide programmers and developers
with online resources. The majority of these online resources,
including news and online tools, are generated by us. At our
community web site, Slashdot.org, our visitors create content by
commenting on various news stories that are posted throughout the
day. Third parties develop most of the downloadable software that
visitors can access through our network. Our network is
integrated by multiple links and cross-references which simplify
navigation between web sites. Some of our web sites provide
information and news solely about Linux or Open Source software.
Our Cross-Platform web sites provide information, online
resources and free software that are helpful to users of Linux,
Windows, Unix and other operating systems. The web sites which we
own and maintain include:
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<S> <C> <C> <C>
LINUX/OPEN SOURCE CROSS-PLATFORM WINDOWS
- slashdot.org - davecentral.com - slaughterhouse.com
- freshmeat.net - mediabuilder.com
- freecode.com - andovernews.com
- thinkgeek.com - itmanagersjournal.com
- internettrafficreport.com
</TABLE>
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1
<PAGE> 8
Our History: Andover.Net was incorporated in Massachusetts in 1992 as Andover
Advanced Technologies, Inc. Originally, as a software publisher,
we licensed, developed, marketed and distributed packaged
software. Beginning in March 1997, we significantly changed our
business model to focus on providing technology-related content
on the World Wide Web, or web, and we shifted to an
advertising-based revenue model. Between June and August of 1999,
we acquired Slashdot.org, Freshmeat.net and Animation Factory to
help further that strategy. In September 1999, we changed our
name to Andover.Net, Inc. and reincorporated in Delaware. Despite
our growing number of page views and unique visitors, we have a
limited operating history and a history of significant losses.
For the fiscal year ended September 30, 1999, we incurred a loss
of $5.4 million and $11.0 million on a pro forma basis.
Additionally, as of September 30, 1999, we had accumulated a
deficit of approximately $8.2 million and $20.4 million on a pro
forma basis. The pro forma results assume that our acquisitions
of Slashdot.org and Animation Factory occurred on October 1,
1998. We anticipate incurring losses for the foreseeable future.
Finally, we operate in a highly competitive market where barriers
to entry are low, additional competitors may emerge quickly and
numerous companies compete for a limited supply of potential
advertising customers.
THE OFFERING
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Type of Security............................. Common stock
Common stock offered......................... 4,000,000 shares
Common stock to be outstanding after the
offering................................... 15,000,000 shares
Use of proceeds.............................. For redemption of redeemable preferred stock,
potential strategic acquisitions and general
corporate purposes, including working
capital. See "Use of Proceeds."
Proposed Nasdaq National Market symbol....... ANDN
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References to "we," "us" or "Andover.Net" shall refer to Andover.Net, Inc.
and all predecessor entities.
Except as otherwise noted, all information in this prospectus assumes:
- no exercise of the underwriters' over-allotment option;
- no exercise of those options to purchase shares of common stock remaining
outstanding after the completion of this offering;
- that the 111,111, 6,172 and 11,111 shares of common stock to be issued
upon the closing of this offering, based on an offering price of $18.00
per share, in connection with our recent acquisitions of Slashdot.org,
Freshmeat.net and Animation Factory, respectively, have not been issued
because the issuance of these shares is contingent on the completion of
this offering and our continued employment of the key employees of
Slashdot.org, Freshmeat.net and Animation Factory;
- the conversion of all outstanding shares of Series B convertible
preferred stock into 3,017,133 shares of our common stock immediately
prior to the closing of this offering;
- the redemption of all outstanding shares of Series A redeemable preferred
stock immediately prior to the closing of this offering;
- the completion of a 5.0238 for 1 stock split effective immediately prior
to the effectiveness of the registration statement of which this
prospectus forms a part; and
- an increase in our authorized common stock to 100,000,000 shares and the
authorization of 1,000,000 shares of undesignated preferred stock
effective immediately prior to the closing of this offering.
Our headquarters are located at 50 Nagog Park, Acton, Massachusetts, 01720,
and our telephone number is (978) 635-5300. Information about Andover.Net is
available at www.andover.net.
2
<PAGE> 9
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SUMMARY FINANCIAL DATA
The following table summarizes the financial data of our business. The pro
forma 1999 statements of operations data give effect to the automatic conversion
of the Series B convertible preferred stock, issued to a group of accredited
investors in September 1999, into common stock and the effects of the
acquisition of Slashdot.org and Animation Factory. See Note 2(j) of the
Financial Statements and Notes thereto for discussion of pro forma basic and
diluted net loss per share.
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<CAPTION>
YEAR ENDED SEPTEMBER 30,
----------------------------------------------
PRO FORMA
1996 1997 1998 1999 1999
------ ------ ------ ------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenues....................................... $ 316 $ 741 $1,290 $ 2,121 $ 2,629
Gross profit................................... 287 438 963 1,388 1,623
Loss from operations........................... (573) (590) (445) (5,055) (8,376)
Net loss....................................... (654) (664) (474) (5,433) (11,027)
Net loss attributable to common stockholders... (654) (705) (608) (5,787) (11,381)
Basic and diluted net loss per share
attributable to common stockholders.......... $(0.38) $(0.29) $(0.12) $ (0.78) $ (1.51)
Basic and diluted weighted average common
shares outstanding........................... 1,763 2,468 5,110 7,419 7,564
Pro forma basic and diluted net loss per share
attributable to common stockholders.......... $ (0.75) $ (1.45)
Pro forma basic and diluted weighted average
common shares outstanding.................... 7,703 7,848
</TABLE>
The following table summarizes our balance sheet data as of September 30,
1999. The pro forma column gives effect to the automatic conversion of the
Series B convertible preferred stock into 3,017,133 shares of common stock
including the non recurring interest charge of $12.2 million related to the
beneficial conversion feature of the Series B convertible preferred stock and
the classification as a current liability of the dividend payable of $447,000
for the Series A redeemable preferred stock. The effects of the Slashdot.org and
Animation Factory acquisitions are included in the actual September 30, 1999
balance sheet data below, as such acquisitions were consummated before September
30, 1999. The pro forma as adjusted column reflects the sale of 4,000,000 shares
of common stock offered by Andover.Net at an initial public offering price of
$18.00 per share, after deducting the underwriting discount and assumed offering
expenses and the automatic redemption of all outstanding shares of Series A
redeemable preferred stock, including $447,000 of accrued dividends, for $4.8
million which will occur upon the closing of this offering. See "Use of
Proceeds" and "Capitalization."
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AS OF SEPTEMBER 30, 1999
----------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
------- --------- -----------
(IN THOUSANDS)
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BALANCE SHEET DATA:
Cash and cash equivalents................................. $ 9,871 $ 9,871 $71,391
Working capital........................................... 8,014 7,567 70,019
Total assets.............................................. 14,440 14,440 74,575
Long-term obligations, less current portion............... 762 762 762
Redeemable preferred stock................................ 4,800 4,353 --
Redeemable convertible preferred stock.................... 12,669 -- --
Stockholders' equity (deficit)............................ (6,313) 6,356 72,676
</TABLE>
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3
<PAGE> 10
RISK FACTORS
You should carefully consider the following risks and all other information
contained in this prospectus before you decide to buy our common stock. We have
included a discussion of each material risk that we have identified as of the
date of this prospectus. However, additional risks and uncertainties not
presently known to us or that we currently deem immaterial may also impair our
business operations. If any of the following risks actually occur, our business,
financial condition or operating results could suffer. If this occurs, the
trading price of our common stock could decline, and you could lose all or part
of the money you paid to buy our common stock.
RISKS RELATED TO ANDOVER.NET
WE HAVE ONLY BEEN OPERATING AS AN INTERNET COMPANY SINCE MARCH 1997.
Although we began operating in May 1992, we only commenced our Internet
focus in March 1997. Prior to that time we were engaged in the business of
software publishing and derived our revenue from sales of packaged software
products. We discontinued this aspect of our business during the second quarter
of fiscal 1997 and commenced our current business which generates revenues
primarily from advertising sales. Thus, we have a limited operating history in
our current market upon which you can evaluate our business. The limited amount
of information about us makes it difficult for you to predict whether we will be
successful. We are subject to the risks, expenses and uncertainties frequently
encountered by companies in the new and rapidly evolving markets for Internet
products and services.
We might not be successful in addressing these risks or other risks we may
face. If we are unable to address these risks adequately, our business, results
of operations and financial condition may suffer.
WE EXPECT TO INCUR SUBSTANTIAL LOSSES IN THE FUTURE.
We have incurred operating losses since our inception in 1992. We had net
losses of approximately $474,000 for the year ended September 30, 1998 and $5.4
million for the year ended September 30, 1999. As of September 30, 1999, we had
an accumulated deficit of $8.2 million. We expect to incur significant losses in
the near term as we substantially increase our sales and marketing, general and
administrative, and research and development expenses. In addition, we are
investing considerable resources in our expansion strategies. As a result, we
cannot be certain when or if we will achieve sustained profitability. Failure to
become and remain profitable may materially and adversely affect the market
price of our common stock and our ability to raise capital and continue
operations.
ATTEMPTS TO EXPAND BY MEANS OF ACQUISITIONS AND STRATEGIC ALLIANCES MAY NOT BE
SUCCESSFUL.
We intend to expand our operations or market presence by entering into
business combinations, investments, joint ventures or other strategic alliances
both in the United States and internationally. We may not, however, be able to
enter into such combinations and alliances. Furthermore, any such expansion may
harm our operational efficiency, financial performance and relationships with
employees and third parties. Our ability to expand in this way may be limited
due to the many financial and operational risks accompanying these transactions.
For example:
- we may have difficulty assimilating the operations, technology and
personnel of any acquired companies;
- the allocation of resources to consummate these transactions may disrupt
our business;
- we may have problems retaining key technical and managerial personnel
from acquired companies;
- we may experience one-time, in-process research and development charges
as well as ongoing expenses associated with deferred compensation and
amortization of goodwill and other purchased intangible assets;
- our stockholders will be diluted if we issue equity to fund these
transactions;
4
<PAGE> 11
- acquired businesses may initially be unprofitable resulting in our
assumption of operating losses and increased expenses;
- our reputation may be harmed if the Linux, and more generally Open
Source, or Linux/Open Source, communities do not approve of these
transactions; and
- our relationships with existing employees, customers and business
partners may be weakened or terminated as a result of these
transactions.
Furthermore, we have acquired and intend to continue to acquire
complementary web sites, companies, technologies, services and products as
appropriate opportunities arise. If we identify an appropriate acquisition
opportunity, we might not be able to negotiate the terms of that acquisition
successfully, obtain financing or integrate the acquired company's personnel and
operations. We may also have difficulty continuing to acquire web sites and
other Internet media properties at the prices historically paid due to the
escalation of Internet media valuations. If we make acquisitions outside of our
core business, assimilating the acquired technology, services or products into
our operations could be difficult. This may cause a disruption in our ongoing
business, distract management and make it difficult to maintain standards,
controls and procedures. In addition, we might be required to incur debt or
issue equity securities to pay for any future acquisitions. If the market price
for acquisition targets increases substantially, our business, results of
operations and financial condition could suffer.
WE RELY ON THE GROWTH OF THE LINUX/OPEN SOURCE MOVEMENT.
Our business relies on growth in the use of Linux and other Open Source
operating systems. Generally, this software is provided for free or for less
than $100. If the Open Source community of third-party software developers does
not continue to improve the functionality of the Linux operating system, or
fails to introduce new Open Source software or software enhancements, or
develops predominantly expensive, proprietary software, the use of these
operating systems may not increase and our business, results of operations and
financial condition will suffer.
NEGATIVE REACTION WITHIN THE OPEN SOURCE COMMUNITY TO OUR BUSINESS STRATEGY
COULD HARM OUR REPUTATION AND BUSINESS.
Some members of the Open Source community have criticized the
commercialization of the Open Source movement through activities such as
licensing proprietary versions of Open Source software, providing services to
the users of Open Source software and selling advertisements to companies that
seek access to the user group that visits web sites dedicated to Open Source
software. We provide services to the users of Open Source software and sell
advertisements on our web sites. This type of negative reaction, if widely
shared by our visitors or the rest of the Open Source community, could harm our
reputation and diminish the Andover.Net brand. Our business, results of
operations and financial condition could suffer accordingly.
WE HAVE A SIGNIFICANT AMOUNT OF NET INTANGIBLE ASSETS.
We had approximately $3.2 million of net intangible assets as of September
30, 1999. Of these intangible assets $2.8 million relates to goodwill. If we are
unable to recover the recorded amounts of our intangible assets, our business,
results of operations and financial condition will suffer.
HISTORICALLY WE HAVE GRANTED OPTIONS TO PURCHASE COMMON STOCK AT LOW EXERCISE
PRICES.
Historically we have granted employees options to purchase our common stock
at exercise prices less than fair market value. During the year ended September
30, 1999, we granted options to purchase 912,698 shares of common stock to
employees and non-employee directors with exercise prices ranging from $0.03 to
$1.07 per share. We have recognized additional compensation expense of
$1,023,000 for the year ending September 30, 1999 relating to the difference
between the exercise price of the options and the fair value of our common
stock. We will recognize additional compensation expenses of $5.2 million as the
options vest over the next four years which will dilute any earnings that we may
achieve.
5
<PAGE> 12
OUR HEAVY RELIANCE ON ADVERTISING REVENUES, WHICH ACCOUNTED FOR 95% OF OUR
REVENUES FOR THE YEAR ENDED SEPTEMBER 30, 1999, COULD IMPACT OUR OPERATING
RESULTS.
Advertising revenues accounted for 95% of our revenues for the year ended
September 30, 1999. As we execute our Internet strategy, we expect to continue
to derive a majority of our revenue from advertising on our network for the
foreseeable future. We may not generate these revenues if advertisers do not
maintain or increase their current levels of Internet advertising. Advertisers
that currently advertise on the Internet may reduce or eliminate this form of
advertising, and advertisers that have traditionally relied upon other
advertising media may be reluctant to begin to advertise on the Internet.
Moreover, widespread adoption of currently available software programs that
limit or prevent advertisements from being delivered to an Internet user's
computer would negatively affect the commercial viability of Internet
advertising and would further deter advertisers from increasing or maintaining
current levels of Internet advertising. Our ability to execute our Internet
strategy successfully will suffer if the market for Internet advertising fails
to develop or develops more slowly than expected.
Different pricing models are used to sell advertising on the Internet. It
is difficult to predict which, if any, will emerge as the industry standard. We
currently use two different models to sell advertising. We sell advertisements
such as large and small banner advertisements and display advertisements to
customers on a month to month basis. Additionally, we enter into sponsorship
arrangements with some customers that include four to six month agreements, more
complex advertisements and preferential placement on our network. If we cannot
quickly and successfully respond to changes in pricing models for Internet
advertising, or identify and adopt any industry standards that may emerge, we
will not be able to attract a sufficient number of advertising customers, and
our Internet advertising strategy will fail.
We expect that it will be important to our advertisers that we accurately
measure the demographics of the visitors to our network. If we are unable to
provide this demographic data for any reason, or if it becomes costly to do so,
then companies may choose not to advertise on our network or may pay less for
advertising on our network.
While we currently engage in limited e-commerce through our online sales of
animation compact discs and Linux and Open Source related gifts, books and
paraphernalia and subscriptions to animation archives, we intend to expand the
scope of our e-commerce offerings through a combination of internal development
and strategic acquisitions. If our e-commerce strategy does not generate a
significant amount of revenue, then we expect to depend primarily on advertising
revenues for the foreseeable future. As a result, the level of advertising
revenues in each quarter is likely to significantly affect our quarterly
revenues and operating results. Our selling and marketing, general and
administrative, research and development, barter advertising, amortization of
deferred compensation, amortization of intangible assets and compensation
related to acquisitions expenses are based on expectations of future revenues
and are relatively fixed in the short term. Operating expenses totaled
approximately $6.4 million during the year ended September 30, 1999. If our
advertising and other revenues are lower than expected, we might not be able to
reduce spending quickly. In addition, we intend to significantly increase
operating expenses to expand our business. Any shortfall in revenues would have
a direct impact on operating results for a particular quarter, and these
fluctuations could affect the market price of our common stock.
48% OF OUR CASH ADVERTISING REVENUES COMES FROM OUR TOP 10 ADVERTISERS.
We have derived our revenues to date from a limited number of advertising
customers, and we expect that a limited number of advertisers will continue to
account for a significant portion of our revenues. For the year ended September
30, 1999, cash revenues represented 73% of our total revenue, and barter
revenues of approximately $570,000 represented the remaining 27% of our total
revenue. In particular, IBM accounted for approximately 14% of our cash
advertising revenues for the year ended September 30, 1999, and our top ten
advertisers accounted for an aggregate of approximately 48% of our cash
advertising revenues for the year ended September 30, 1999. Moreover, we
generally sell advertising through the use of insertion order agreements, which
are short-term orders to place advertisements on our web sites. These agreements
are subject to cancellation with no minimum notice requirement. Current
advertisers may not continue to
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<PAGE> 13
purchase advertising from us, or we may not be able to attract additional
advertisers. If we lose one or more of the advertisers that represent a material
portion of our revenues, or if we experience the non-payment or late payment of
amounts due by a significant advertiser, our business, results of operations and
financial condition could suffer.
WE MAY FAIL TO DEVELOP AND PROMOTE OUR NETWORK EFFECTIVELY, WHICH MAY PREVENT US
FROM ATTRACTING NEW VISITORS AND ADVERTISERS TO OUR NETWORK.
Enhancing our network is critical to our ability to increase our revenue
because we deliver services and content to users through our network, and we
display advertisements on our network. We intend to enhance our network by
internally creating and externally acquiring additional complementary web sites.
Some of the content currently on our web sites is developed by us. Other content
is developed by third parties and posted on our network. In order to attract and
retain Internet users and advertisers, we intend to substantially increase our
expenditures to further promote and develop our network. Our success in
developing and promoting the Andover.Net network will also depend on our ability
to provide high quality content, features and functionality. If we fail to
promote our network successfully or if visitors to our network or advertisers do
not perceive our services to be useful, current or of high quality, our
business, results of operations and financial condition will suffer.
WE DEPEND ON AN EFFECTIVE DIRECT SALES FORCE.
We depend on our direct sales force of 13 people to sell advertising on our
network. This dependence involves the following risks:
- the need to increase the size of our direct sales force;
- the need to hire, retain, integrate and motivate additional sales and
sales support personnel;
- lack of experience of our two new sales personnel; and
- competition from other companies in hiring and retaining sales
personnel.
Our business, results of operations and financial condition may suffer if
we do not maintain an effective direct sales force.
WE FACE INTENSE COMPETITION IN OUR INDUSTRY.
The market for Internet-based content offerings and services is relatively
new, intensely competitive and rapidly changing. Since the advent of commercial
services on the Internet, the number of online services competing for users'
attention and spending has proliferated. We expect that competition will
continue to intensify. We compete with other web sites which are aimed
specifically at Linux/Open Source users as well as other companies that direct
some of their overall web content and services at the Internet professional
community. We also compete for circulation with general interest portal and
destination web sites as well as traditional media.
In addition, the competition in the sale of advertising on the Internet,
including competition from Internet portals and other high-traffic sites, is
intense. Advertising rates are primarily based on the amount of traffic on a web
site and the demographics of the visitors to the web site. This competition has
resulted in a wide range of rates quoted by different vendors for a variety of
advertising services. As a result, we cannot accurately predict the future
levels of Internet advertising revenues that we will realize. Most of the
advertisements on our network are large or small banner advertisements or
larger, more complex display advertisements which are viewed by visitors to our
web sites. The prices for Internet advertising may also be affected by
competition among current and future suppliers of Internet navigational services
or web sites and advertising networks. This, together with competition with
other traditional media for advertising placements, could result in significant
price competition, reduced pricing for Internet advertising and reductions in
our advertising revenues.
7
<PAGE> 14
An important part of our strategy is to develop and increase the reputation
of our brand names. If we are unable to do so, or if our competitors develop
their brand names more successfully than we do, our future growth, business,
results of operations and financial condition would suffer.
Many of our current and potential competitors have longer operating
histories, larger customer bases, greater brand recognition and significantly
greater financial, marketing and other resources than we have. These competitors
may be able to respond more quickly to new or emerging technologies and changes
in customer requirements and to devote greater resources to the development,
promotion and sale of their products and services than we can. We might not be
able to compete successfully against our current or future competitors.
WE MIGHT NOT BE ABLE TO ADEQUATELY MANAGE OUR GROWTH.
Our network's page views have increased from approximately 6.5 million for
the month ended September 30, 1998 to approximately 45 million for the month
ended September 30, 1999. In connection with that growth, we have increased the
number of our employees from 11 to 49 over the same period. Our recent growth
has placed, and will continue to place, a significant strain on our managerial,
operational and financial resources. We must continue to implement and improve
our operational and financial systems and expand, train and manage our employee
base to manage this future growth. We also intend to establish or acquire
additional web sites which will create additional operational and management
complexities. In addition, we expect that our operational and management systems
will face increased strain as a result of the expansion of our content offerings
and services. We might not be able to manage effectively the expansion of our
operations and systems, and our procedures and controls might not be adequate to
support our operations. In addition, our management might not be able to make
and execute decisions rapidly enough to exploit market opportunities for the
expansion of our content offerings and services. If we are unable to manage our
growth effectively, our business, results of operations and financial condition
would suffer.
WE DEPEND ON THE CONTINUED SERVICE OF OUR KEY OFFICERS.
Our future success depends on the continued services of a number of key
officers including Bruce A. Twickler, President, Chief Executive Officer and
Chairman, Adam B. Green, Chief Technology Officer and Peter A. Phelps, Chief
Financial Officer. The loss of the technical knowledge and industry expertise of
any of these officers could seriously impede our success. If we lose one or a
group of our key employees, particularly to a competitor, our business,
financial condition and results of operations could suffer.
WE ARE VULNERABLE TO UNEXPECTED NETWORK INTERRUPTIONS CAUSED BY SYSTEM
FAILURES, WHICH MAY RESULT IN REDUCED VISITOR TRAFFIC ON OUR NETWORK, DECREASED
REVENUE AND HARM TO OUR REPUTATION.
Substantially all of our communications hardware and other hardware related
to our web sites is located at one location. Fire, floods, hurricanes,
tornadoes, earthquakes, power loss, telecommunications failures, break-ins and
similar events could damage these systems. In addition, our servers are
vulnerable to computer viruses, electronic break-ins, human error and other
similar disruptive problems which could adversely affect our systems and web
sites. We could lose revenue and suffer damage to our reputation if any of these
occurrences affected our systems because we would have decreased visitor traffic
on our network. Our insurance policies may not adequately compensate us for any
losses that may occur due to failures or interruptions in our systems.
OUR SYSTEMS MAY FAIL OR EXPERIENCE A SLOWDOWN AND OUR USERS DEPEND ON OTHERS FOR
ACCESS TO OUR NETWORK.
Our network must accommodate a high volume of traffic and deliver
frequently updated information. Our network has in the past, and may in the
future, experience slower response times or decreased traffic for a variety of
reasons. Slower response times can result from general Internet problems,
routing and equipment problems by third-party Internet access providers,
problems with third-party advertising servers and increased traffic to our
servers. Our network could experience interruptions in service due to the
failure or delay in the transmission or receipt of this information. In
addition, our community of Internet users depends on Internet
8
<PAGE> 15
service providers, online service providers and other web sites' operators for
access to our network. Those providers have experienced outages in the past, and
may experience outages or delays in the future. Moreover, our Internet
infrastructure might not be able to support continued growth of our network. If
we experience any of these problems, our reputation and brand name could suffer,
users might perceive our network as not functioning properly and our business,
results of operations and financial condition could suffer.
OUR COMPUTER SYSTEMS, AS WELL AS THOSE OF OUR CUSTOMERS AND SUPPLIERS, COULD
FAIL AS A RESULT OF THE YEAR 2000 PROBLEM.
Our business will suffer if the computer systems we use, as well as the
computer systems used by our Internet users, advertisers and vendors, do not
correctly process the change in year from "99" to "00" on January 1, 2000. There
may be parts of our computer systems and aspects of the year 2000 issue,
including the potential cost of addressing the year 2000 issue, that we have
failed to consider. If our efforts and the efforts of our users, advertisers,
vendors and other service providers to address the year 2000 issue are not
successful, our business, results of operations and financial condition could
suffer.
OUR FAILURE TO UPDATE AND MODERNIZE OUR INTERNAL SYSTEMS, PROCEDURES AND
CONTROLS MAY PREVENT THE IMPLEMENTATION OF OUR BUSINESS STRATEGIES IN A RAPIDLY
EVOLVING MARKET AND MAY LIMIT OUR FUTURE GROWTH.
Our operational and financial systems, procedures and controls, which are
adequate for a small private company, may become outdated as we grow. Our
business could suffer if we fail to improve our transaction processing and
reporting systems and procedures, or to expand and train our expanding workforce
quickly enough to maintain a competitive position in our markets. In addition,
failure to quickly replace obsolete systems, procedures and controls could
impede our management's decision-making abilities. This, in turn, may impair our
ability to pursue business opportunities and may hamper future growth.
THE AVAILABILITY OF BARTER TRANSACTIONS MAY BE LIMITED WHICH COULD INCREASE OUR
MARKETING COSTS.
We engage in barter transactions, which reduce cash expenditures in
marketing. Barter is the exchange by us of advertising space on our network for
reciprocal advertising space on other web sites. During the year ended September
30, 1999, 26% of our viewable pages contained bartered advertisements, and we
recognized $570,000 of advertising revenues from barter transactions. In the
future, our ability to barter may be limited due to a lack of availability or
willingness of other web sites to enter into barter transactions. This could
increase our expenses which could harm our business.
OUR EFFORTS TO PROTECT OUR TRADEMARKS MAY NOT BE ADEQUATE TO PREVENT THIRD
PARTIES FROM MISAPPROPRIATING OUR INTELLECTUAL PROPERTY RIGHTS.
We use a number of trademarks which contribute to drawing visitors to our
web sites. We are uncertain as to whether a trademark owner in the United States
or another country will have superior rights that will result in our inability
to continue to use one or more of our trademarks. The protective steps we have
taken in the past have been, and may in the future continue to be, inadequate to
deter misappropriation of our trademark rights. We may be unable to detect the
unauthorized use of, or take appropriate steps to enforce, our trademark rights.
Effective trademark protection may not be available in every country in which we
offer or intend to offer our products and services. Failure to protect our
trademark rights adequately could damage or even destroy the Andover.Net brand
and impair our ability to compete effectively. Furthermore, defending or
enforcing our trademark rights could result in the expenditure of significant
financial and managerial resources.
THERE ARE A NUMBER OF RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS THAT COULD
HARM OUR BUSINESS.
Although we have historically received an insubstantial amount of revenue
from advertisers in foreign countries, in the future we may expand into
international markets in order to diversify our advertising revenues. While we
have only one employee located in Europe, our content offerings are viewed
9
<PAGE> 16
internationally. The markets in which we may undertake international expansion
generally have technology and online industries that are less developed than
those in the United States.
There are risks inherent in doing business in international markets, such
as the following:
- uncertainty of product acceptance by different cultures;
- unforeseen changes in regulatory requirements impacting the use of the
Internet and online content;
- difficulties in staffing and managing multinational operations;
- government imposed restrictions on the repatriation of funds; and
- potentially adverse tax consequences.
These factors could harm our ability to successfully operate
internationally and could harm our business.
RISKS RELATED TO OUR INTERNET STRATEGY
OUR FUTURE RESULTS DEPEND ON CONTINUED GROWTH IN THE USE OF THE INTERNET.
Our market is new and rapidly evolving. Our business could suffer if
Internet usage does not continue to grow. Internet usage may be inhibited for a
number of reasons, including:
- inadequate network infrastructure;
- security concerns;
- inconsistent quality of service;
- lack of availability of cost-effective and high-speed service; and
- changes in government regulation of the Internet.
If Internet usage grows, the Internet infrastructure might not be able to
support the demands placed on it by this growth or its performance and
reliability may decline. In addition, future outages and other interruptions
occurring throughout the Internet could lead to decreased use of our network and
would therefore harm our business.
WE ARE VULNERABLE TO CLAIMS THAT OUR CONTENT INFRINGES THIRD PARTY INTELLECTUAL
PROPERTY RIGHTS PARTICULARLY BECAUSE OUR CONTENT IS COMPRISED OF MANY DISTINCT
SOFTWARE COMPONENTS DEVELOPED BY THOUSANDS OF INDEPENDENT PARTIES.
We may be exposed to future litigation based on claims that our content
infringes on the intellectual property rights of others. This risk is
exacerbated by the fact that independent parties over whom we exercise no
supervision or control develop most of the code in applications on our network.
Claims of infringement could require us to obtain licenses from third parties in
order to continue offering our content. In addition, an adverse legal decision
affecting our intellectual property, or the use of significant resources to
defend against this type of claim, could place a significant strain on our
financial resources and harm our reputation.
WE MAY BE SUED AS A RESULT OF INFORMATION PUBLISHED OR POSTED ON OR ACCESSIBLE
FROM OUR NETWORK.
We may be subjected to claims for defamation, negligence, copyright or
trademark infringement or other claims relating to the information we publish on
our network. These types of claims have been brought, sometimes successfully,
against online services in the past, and can be costly to defend. We may also be
subjected to claims based on content that is accessible from our network through
links to other web sites or through content and materials that visitors to our
network may post. The scope and amount of our commercial and general liability
insurance may not adequately protect us against these types of claims.
GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES COULD ADD ADDITIONAL COSTS AND
RISKS TO DOING BUSINESS ON THE INTERNET.
There are currently few laws or regulations that specifically regulate
communications or commerce on the Internet. However, laws and regulations may be
adopted in the future that address issues such as user privacy, pricing and the
characteristics and quality of products and services. For example, although it
was
10
<PAGE> 17
held unconstitutional, the Telecommunications Act of 1996 prohibited certain
types of information and content from being transmitted over the Internet.
Several other nations have taken actions to restrict the free flow of material
deemed to be objectionable on the Internet. In addition, local telephone
carriers have argued before the Federal Communications Commission that Internet
service providers and online service providers should be required to pay fees
for access to local telephone networks in a manner similar to long distance
telephone carriers. If these efforts are successful, costs for Internet access
could increase sharply. Moreover, it may take years to determine the extent to
which existing laws relating to issues such as property ownership, libel and
personal privacy are applicable to the Internet. New laws or regulations
relating to various aspects of the Internet including online content, access
charges, product quality and taxes could harm our business.
REGULATION COULD REDUCE THE VALUE OF OUR DOMAIN NAMES WHICH WOULD HARM OUR BRAND
RECOGNITION.
We own the Internet domain name "andover.net" as well as numerous other
domain names both in the United States and internationally. Our domain names are
important because they allow visitors to locate our web sites and build brand
recognition. Internet regulatory bodies regulate domain names. The regulation of
domain names in the United States and in foreign countries is subject to change.
Regulatory bodies could establish additional top-level domains, appoint
additional domain name registrars or modify the requirements for holding domain
names. As a result, we might not acquire or maintain the "andover.net" or
comparable domain names in all the countries in which we conduct business, which
could harm our business. Furthermore, the relationship between regulations
governing domain names and laws protecting trademarks and similar proprietary
rights is unclear and still evolving. Therefore, we might be unable to prevent
third parties from acquiring domain names that infringe or otherwise decrease
the value of our trademarks and other proprietary rights. If this occurs, our
business, results of operations and financial condition would suffer.
THE INTERNET INDUSTRY IS CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE.
Rapid technological developments, evolving industry standards and user
demands, and frequent new product introductions and enhancements characterize
the market for Internet products and services. These market characteristics are
exacerbated by the emerging nature of the market and the fact that many
companies are expected to introduce new Internet products and services in the
near future. Our future success will depend on our ability to continually
improve our content offerings and services. In addition, the widespread adoption
of developing technologies could require fundamental and costly changes in our
technology and could adversely affect the nature, viability and measurability of
Internet-based advertising, which could harm our business.
RISKS RELATED TO THIS OFFERING
OWNERSHIP OF APPROXIMATELY 61% OF OUR OUTSTANDING COMMON STOCK BY 16
STOCKHOLDERS WILL LIMIT YOUR ABILITY TO INFLUENCE CORPORATE MATTERS.
Immediately following this offering, 16 stockholders including our
directors, executive officers and greater than 5% stockholders and their
affiliates will beneficially own approximately 61% of our outstanding common
stock, including options to purchase common stock exercisable within 60 days of
September 30, 1999. These stockholders could significantly influence the outcome
of actions taken by us that require stockholder approval. For example, these
stockholders could significantly influence the election of our directors, delay
or prevent a transaction in which stockholders might receive a premium over the
prevailing market price for their shares and control changes in management.
11
<PAGE> 18
PROVISIONS OF OUR CHARTER AND BY-LAWS MAY DELAY OR PREVENT TRANSACTIONS THAT
MANY STOCKHOLDERS MAY FAVOR.
Provisions of our certificate of incorporation and by-laws may discourage,
delay or prevent a merger or acquisition that stockholders may consider
favorable, including transactions in which you might otherwise receive a premium
for your shares. These provisions include:
- authorizing the issuance of "blank check" preferred stock, which may
have rights and preferences that are superior to our common stock,
without any need for action by stockholders;
- providing for a classified board of directors with staggered three-year
terms which could discourage or delay a merger because a potential
acquiror could not acquire board control at any one annual stockholders
meeting;
- eliminating the ability of stockholders to call special meetings of
stockholders;
- prohibiting stockholder action other than by unanimous written consent;
and
- establishing advance notice requirements for nominations for election to
the board of directors or for proposing matters that can be acted on by
stockholders at stockholder meetings.
Section 203 of Delaware law may also discourage, delay or prevent someone
from acquiring us or merging with us in a transaction that might benefit our
stockholders by prohibiting or delaying potential acquisitions by existing
stockholders.
OUR STOCK PRICE MAY BE EXTREMELY VOLATILE AND YOU MAY NOT BE ABLE TO RESELL YOUR
SHARES AT OR ABOVE THE INITIAL OFFERING PRICE.
Following this offering, the price at which our common stock will trade may
be extremely volatile and may fluctuate significantly. The public market may not
agree with or accept the valuation determined in connection with this offering.
In addition, the stock market has from time to time experienced significant
price and volume fluctuations that have affected the market prices for the
securities of technology companies, particularly software and Internet
companies. After this offering, therefore, you might not be able to resell your
shares at or above the initial public offering price.
APPROXIMATELY THREE MILLION SHARES OF OUR COMMON STOCK COULD BE SOLD INTO THE
PUBLIC MARKET WITHIN SIX MONTHS FROM THE DATE OF THIS OFFERING, WHICH COULD
DEPRESS OUR STOCK PRICE.
Once a trading market develops for our common stock, many of our
stockholders will have an opportunity to sell their stock for the first time.
Approximately three million shares will become eligible for sale in the public
market within six months from the date of this prospectus. Sales of a
substantial number of shares of common stock in the public market, or the threat
that substantial sales might occur, could cause the market price of our stock to
decrease significantly. These factors could also make it difficult for us to
raise additional capital by selling stock.
YOU WILL INCUR IMMEDIATE AND SUBSTANTIAL DILUTION IN THIS OFFERING.
The initial public offering price of our common stock is substantially
higher than the net tangible book value per share of the outstanding common
stock immediately after this offering. Therefore, if you purchase our common
stock in this offering, you will incur immediate dilution of $13.39 in the net
tangible book value per share of common stock from the price you pay for such
common stock (based upon an initial public offering price of $18.00 per share).
Investors will incur additional dilution upon the exercise of outstanding stock
options.
12
<PAGE> 19
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
This prospectus contains "forward looking statements." These statements may
include statements regarding:
- our business strategy;
- plans for hiring additional personnel;
- entering into business combinations strategic alliances;
- adequacy of anticipated sources of funds, including the proceeds from
this offering; and
- other statements about our plans, objectives, expectations and
intentions contained in this prospectus that are not historical facts.
When used in this prospectus, the words "expects," "anticipates,"
"intends," "plans," "believes," "seeks," "estimates" and similar expressions are
generally intended to identify forward looking statements. Because these forward
looking statements involve risks and uncertainties, actual results could differ
materially from those express or implied by these forward looking statements for
a number of reasons, including those discussed under "Risk Factors" and
elsewhere in this prospectus. Following this offering, we assume no obligation
to update any forward looking statements contained in this prospectus.
13
<PAGE> 20
USE OF PROCEEDS
We estimate the net proceeds from the sale of the 4,000,000 shares of
common stock offered by us will be $66,320,000, after deducting the underwriting
discount and assumed offering expenses. We intend to use $4,800,000 of the net
proceeds of this offering to redeem our outstanding Series A redeemable
preferred stock in full. We expect to use the remainder of the net proceeds for
potential strategic acquisitions and general corporate purposes, including
working capital and expansion of sales and marketing and research and
development activities. The amounts actually expended for such working capital
purposes may vary significantly and will depend on a number of factors,
including the amount of our future revenues and the other factors described
under "Risk Factors." Accordingly, our management will retain broad discretion
in the allocation of the net proceeds of this offering. Pending these uses, we
intend to invest the proceeds in short-term, investment-grade, interest-bearing
investments.
DIVIDEND POLICY
We have never declared or paid cash dividends on our capital stock. We
currently anticipate that we will retain all available funds for use in our
business and do not anticipate paying any cash dividends in the foreseeable
future. Any determination to pay dividends in the future will be at the
discretion of our board of directors and will depend upon our financial
condition, results of operations and capital requirements.
14
<PAGE> 21
CAPITALIZATION
The following table sets forth our capitalization as of September 30, 1999.
Our capitalization is presented:
- on an actual basis;
- on a pro forma basis to give effect to (a) the automatic conversion of
the Series B convertible preferred stock into 3,017,133 shares of common
stock including the non recurring interest charge of $12.2 million
related to the beneficial conversion feature of the Series B convertible
preferred stock and (b) the classification as a current liability of the
dividend payable of $447,000 for the Series A redeemable preferred
stock; and
- on a pro forma as adjusted basis to reflect (a) our receipt of the net
proceeds from the sale of 4.0 million shares of common stock in this
offering at an initial public offering price of $18.00 per share after
deducting the underwriting discount and assumed offering expenses and
(b) the automatic redemption of all outstanding shares of Series A
redeemable preferred stock, including accrued dividends, for $4.8
million upon the closing of this offering.
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1999
--------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
-------- ---------- ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Current portion of long-term debt.......................... $ 654 $ 654 $ 654
Long-term debt, less current portion....................... 762 762 762
Series A redeemable preferred stock, 900 shares authorized;
322 shares issued and outstanding, actual and pro
forma; no shares issued and outstanding, pro forma as
adjusted.............................................. 4,800 4,353 --
Series B convertible redeemable preferred stock, 700 shares
authorized; 601 shares issued and outstanding, actual;
no shares issued and outstanding, pro forma and pro
forma as adjusted..................................... 12,669 -- --
Stockholders' equity (deficit):
Common Stock, $.01 par value 100,000 shares authorized;
7,983 issued and outstanding, actual; 11,000 shares
issued and outstanding, pro forma; 15,000 shares
issued and outstanding, pro forma as adjusted......... 80 110 150
Additional paid in capital................................. 6,934 31,787 98,067
Deferred compensation...................................... (5,156) (5,156) (5,156)
Accumulated deficit........................................ (8,171) (20,385) (20,385)
------- -------- --------
Total stockholders' equity (deficit)............. (6,313) 6,356 72,676
------- -------- --------
Total capitalization............................. $12,572 $ 12,125 $ 74,092
======= ======== ========
</TABLE>
Common stock outstanding after this offering excludes 1,410,000 shares
issuable upon exercise of stock options outstanding as of September 30, 1999.
See "Selected Financial Data," "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the Financial Statements and
Notes thereto included in this prospectus.
15
<PAGE> 22
DILUTION
The pro forma net tangible book value of the common stock as of September
30, 1999 was $2,705,000, or $0.25 per share, after giving effect to the
automatic conversion of the Series B convertible preferred stock into 3,017,133
shares of common stock and the classification as a current liability of the
dividend payable of $447,000 for the Series A redeemable preferred stock.
After giving effect to the sale of the common stock in this offering at an
initial public offering price of $18.00 per share and after deducting the
underwriting discount and assumed expenses of this offering, the adjusted pro
forma net tangible book value at September 30, 1999, would have been
$69,025,000, or $4.61 per share.
Pro forma net tangible book value per share before this offering has been
determined by dividing our pro forma net tangible book value (total tangible
assets less total liabilities) by the pro forma number of shares of common stock
outstanding at September 30, 1999. This offering will result in an increase in
pro forma net tangible book value per share of $4.36 to existing stockholders
and dilution in pro forma net tangible book value per share of $13.39 to new
investors who purchase common stock in this offering. Dilution is determined by
subtracting pro forma net tangible book value per share from the initial public
offering price of $18.00. The following table illustrates this dilution.
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share............. $18.00
Pro forma net tangible book value per share at September
30, 1999............................................... $0.25
Increase attributable to sale of common stock in this
offering (1)........................................... 4.36
-----
Pro forma net tangible book value per share after this
offering.................................................. 4.61
------
Dilution of net tangible book value per share to persons who
purchase shares in this offering.......................... $13.39
======
</TABLE>
- ---------------
(1) After deduction of the underwriting discount and assumed expenses totaling
$5,680,000.
If the underwriters' over-allotment option were exercised in full, the pro
forma net tangible book value per share after this offering would be $5.07 per
share, the increase in net tangible book value per share to existing
stockholders would be $4.82 per share and the dilution to persons who purchase
common stock in this offering would be $12.93 per share.
The table below summarizes, on a pro forma basis, as of September 30, 1999,
the following differences between our existing stockholders and new investors
purchasing our common stock in this offering:
- the number of shares purchased from Andover.Net;
- the aggregate cash consideration paid; and
- the average price per share paid.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
---------------------- ---------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
----------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders............. 11,000,000 73% $13,028,000 15% $ 1.18
New investors..................... 4,000,000 27 72,000,000 85 18.00
----------- --- ----------- ---
Total........................ 15,000,000 100% $85,028,000 100%
=========== === =========== ===
</TABLE>
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<PAGE> 23
This information is based on pro forma shares outstanding as of September
30, 1999 and excludes:
- 1,410,000 shares of common stock reserved for issuance pursuant to
outstanding options granted under our 1995 stock option plan and our 1999
stock option plan;
- 1,295,882 shares of common stock reserved for issuance pursuant to future
grants under our 1999 stock option plan; and
- 440,737 shares of common stock reserved for issuance as consideration for
recent acquisitions based on an initial public offering price of $18.00,
of which 128,394 shares will be issued immediately following this
offering provided that the key employees of the companies that we
acquired are still employed by us at the closing of this offering.
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<PAGE> 24
SELECTED FINANCIAL DATA
The selected financial data of Andover.Net set forth below as of September
30, 1998 and 1999 and for each of the years ended September 30, 1997, 1998 and
1999 are derived from financial statements of Andover.Net audited by Arthur
Andersen LLP, independent public accountants, which are included elsewhere in
this prospectus. The selected financial data as of September 30, 1996 and 1997,
and for the year ended September 30, 1996 are derived from audited financial
statements of Andover.Net which are not included in this prospectus. The
selected financial data as of September 30, 1995 and the year ended September
30, 1995 are derived from unaudited financial statements of Andover.Net which
are not included in this prospectus and which include, in the opinion of
Andover.Net, all adjustments (consisting only of normal recurring adjustments)
that are necessary for a fair presentation of its financial position and the
results of its operations for those periods. Pro forma statements of operations
data gives effect to the automatic conversion of the Series B convertible
preferred stock into common stock and the effects of the acquisitions of
Slashdot.org and Animation Factory. The pro forma statements of operations does
not include the non-recurring interest charge of $12.2 million related to the
beneficial conversion feature of the Series B convertible preferred stock. See
Note 2 (j) of the Financial Statements or Notes thereto for discussion of the
pro forma basis and diluted net loss per share. The pro forma balance sheet data
as of September 30, 1999 reflects the automatic conversion of the Series B
convertible preferred stock into common stock including the non recurring
interest charge of $12.2 million related to the beneficial conversion feature of
the Series B convertible preferred stock and the classification as a current
liability of the dividend payable of $447,000 for the Series A redeemable
preferred stock. The effects of the Slashdot.org and Animation Factory
acquisitions are included in the actual September 30, 1999 balance sheet data
below, as such acquisitions were consummated before September 30, 1999. The data
should be read in conjunction with the Financial Statements and the Notes
thereto and with Management's Discussion and Analysis of Financial Condition and
Results of Operations appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------------------------------------
PRO FORMA
1995 1996 1997 1998 1999 1999
------ ------ ------ ------ ------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenues:
Advertising............................................... $ -- $ -- $ 469 $1,290 $ 2,021 $ 2,314
Software.................................................. 989 316 272 -- 100 315
------ ------ ------ ------ ------- --------
Total revenues.......................................... 989 316 741 1,290 2,121 2,629
Cost of revenues:
Editorial content and related............................. -- -- 136 327 731 849
Software.................................................. 376 29 167 -- 2 157
------ ------ ------ ------ ------- --------
Total cost of revenues.................................. 376 29 303 327 733 1,006
------ ------ ------ ------ ------- --------
Gross profit................................................ 613 287 438 963 1,388 1,623
Operating expenses:
Sales and marketing....................................... 301 339 496 744 1,952 1,952
General and administrative................................ 311 521 338 360 1,480 1,603
Research and development.................................. -- -- 194 304 770 770
Amortization of deferred compensation..................... -- -- -- -- 1,023 1,023
Amortization of intangible assets......................... -- -- -- -- 405 1,399
Compensation related to acquisitions...................... -- -- -- -- 813 3,252
------ ------ ------ ------ ------- --------
Total operating expenses................................ 612 860 1,028 1,408 6,443 9,999
------ ------ ------ ------ ------- --------
Loss from operations........................................ 1 (573) (590) (445) (5,055) (8,376)
Interest income............................................. 3 1 20 88 111
Interest expense............................................ (35) (84) (75) (49) (466) (2,762)
------ ------ ------ ------ ------- --------
Net loss................................................ $ (34) $ (654) $ (664) $ (474) $(5,433) $(11,027)
====== ====== ====== ====== ======= ========
Accrued dividends on redeemable preferred stock............. -- -- 41 134 354 354
------ ------ ------ ------ ------- --------
Net loss attributable to common stockholders............ $ (34) $ (654) $ (705) $ (608) $(5,787) $(11,381)
====== ====== ====== ====== ======= ========
Basic and diluted net loss per share........................ $(1.70) $(0.38) $(0.29) $(0.12) $ (0.78) $ (1.51)
====== ====== ====== ====== ======= ========
Basic and diluted weighted average common shares
outstanding............................................... 20 1,763 2,468 5,110 7,419 7,564
====== ====== ====== ====== ======= ========
Pro forma basic and diluted net loss per share.............. $ (0.75) $ (1.45)
======= ========
Pro forma basic and diluted weighted average common shares
outstanding............................................... 7,703 7,848
======= ========
</TABLE>
18
<PAGE> 25
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30,
-----------------------------------------------------------
1995 1996 1997 1998 1999 PRO FORMA
------- ------- ------- ------- ------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................. $ 2 $ 128 $ 837 $ 196 $ 9,871 $ 9,871
Working capital........................................... (72) 155 710 230 8,014 7,567
Total assets.............................................. 142 404 1,099 533 14,440 14,440
Long-term obligations, less current portion............... -- 51 -- -- 762 762
Redeemable preferred stock................................ -- 988 2,228 2,362 4,800 4,353
Redeemable convertible preferred stock.................... -- -- -- -- 12,669 --
Stockholders' equity (deficit)............................ (64) (870) (1,503) (2,109) (6,313) 6,356
</TABLE>
19
<PAGE> 26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction with
the financial statements and related notes included elsewhere in this
prospectus. Except for historical information, the discussion in this prospectus
contains certain forward looking statements that involve risks and
uncertainties. The principal factors that could cause or contribute to
differences in our actual results are discussed in the section titled "Risk
Factors."
OVERVIEW
Andover.Net is a network of web sites that provides an independent,
unbiased source for content, community and commerce for the Linux and, more
generally, the Open Source communities. We provide products, online tools, news
and other services for programmers, software developers, web site designers,
technology managers and corporate buyers.
We were incorporated in Massachusetts in 1992 as Andover Advanced
Technologies, Inc. In September 1999, Andover Advanced Technologies, Inc. was
merged into its wholly-owned subsidiary, Andover.Net, Inc., a Delaware
corporation, and we changed our fiscal year end from September 30 to December
31.
Prior to fiscal 1996, we were a software publisher of multimedia and web
authoring tools. We derived revenues from licensing, developing, marketing and
distributing packaged multimedia software, primarily to large distributors and
retailers. In fiscal 1996, we launched our first web site, DaveCentral.com.
During fiscal 1997, we transitioned from a software publisher to a web site
publisher to participate in the commercial opportunities emerging on the
Internet. Since March 1997, all of our activities have been focused on expanding
our Internet business.
We currently generate substantially all of our revenue from advertisements
on our network of web sites. Our current advertising products include standard
banner advertising, display advertisements, megabanners and web site and
newsletter sponsorships. We recognize advertising revenue in the period that the
advertising is displayed, provided that we deem the collectibility of the
resulting receivable as probable. We sell advertising through our nationwide
direct sales force. During the quarter ended September 30, 1999, we also
generated e-commerce revenues related to the online sale of compact discs of
aminated graphics sold through the MediaBuilder.com web site and subscriptions
to animation archives which collectively represented 9.9% of our total revenues
for such quarter. We intend to generate increased e-commerce revenue, including
through acquisitions such as our October 1999 acquisition of ThinkGeek.com, and
to expand our subscription based revenues from other web sites within our
network.
We enter into barter transactions with other web sites in order to increase
traffic to our network of web sites and to strengthen the Andover.Net brand. A
barter transaction is the exchange by us of advertising space on our web sites
for reciprocal advertising space on the web sites of others. We record revenues
only on the portion of our barter transactions for which we are able to
determine fair value and for which the advertiser has the financial ability to
pay cash. To date, we have only recorded revenues from barter transactions
involving public companies. Otherwise, we do not recognize barter revenue. To
make the determination of whether the advertiser could pay cash, Andover.Net
reviews the current liquidity of the advertiser based on recent public
disclosures. Only advertisers with exceptional liquidity positions are
considered when recognizing barter revenue. We record revenue from these barter
transactions, and the corresponding advertising expense, based upon the fair
market value of the advertising space exchanged. Revenues from barter
transactions, representing advertising space given, is recognized as income when
advertisements are delivered on our network. Barter expense, representing
advertising space received, is recognized when our advertisements are run on
other companies' web sites, which is typically in the same period when the
related barter revenue is recognized. For the year ended September 30, 1999, we
recognized $570,000 in barter revenue, which represented 26.9% of revenues, and
$570,000 in barter expense, which represented 29.2% of sales and marketing
expenses. We did not recognize any barter revenues or expenses for the year
ended September 30, 1998.
20
<PAGE> 27
Revenue from the online sale of compact discs of aminated graphics, for
which no technical support is provided, are generally recognized upon shipment
of the products, net of estimated returns.
We have incurred losses since our inception. As of September 30, 1999, we
had an accumulated deficit of $8.2 million and tax net operating loss
carryforwards which may be used to offset future taxable income, if any, in the
amount of $4.5 million. U.S. tax rules impose annual limitations on the use of
net operating losses following substantial changes in ownership. Andover.Net has
completed several financings since its inception and has incurred an ownership
change as defined by the U.S. tax rules. Andover.Net believes that this change
in ownership will not have a material impact on its ability to utilize its net
operating loss carryforwards. We anticipate incurring additional expenses to
increase our product development and sales and marketing efforts, to pursue
additional strategic acquisitions and to support the growth of the organization.
As a result, we believe that we will incur additional losses in the foreseeable
future.
RECENT DEVELOPMENTS
Sale of Series B Convertible Preferred Stock. Andover.Net issued 600,568
shares of Series B convertible preferred stock on September 15, 1999. Of these
shares, 480,354 shares were issued and sold for consideration of $10.1 million
and 120,214 shares were issued to holders of convertible notes in consideration
for the conversion of approximately $2.1 million of principal and interest. The
price per share in the private placement was $21.03. The Series B convertible
preferred stock is convertible into common stock immediately upon issuance at
the option of the holder and will convert into 3,017,133 shares of common stock
upon the closing of this offering. This conversion will result in an effective
purchase price of $4.05 per share of common stock. The difference between the
offering price and the deemed effective purchase price resulted in a beneficial
conversion feature of approximately $12.2 million. This expense will be recorded
as interest expense in the statement of operations in the period in which this
offering occurs.
Acquisition of Slashdot.org. In June 1999, we acquired substantially all of
the assets and assumed certain liabilities relating to the Slashdot.org web site
from BlockStackers, Inc. Slashdot.org is the largest online community for
Linux/Open Source developers providing news, commentary, information and
reviews. Consideration for the transaction consists of a $1.5 million cash
payment made at the closing, and contingent payments of $2.0 million of stock
valued at the initial public offering price issuable upon the closing of this
offering, up to $3.5 million in cash and up to $5.0 million in stock valued at
the initial public offering price and payable during the two years following
this offering. All consideration paid or payable in connection with this
acquisition has been paid or will be paid to BlockStackers, Inc. The amount of
cash and stock consideration that is contingent solely on the continued
employment of the key employees of Slashdot.org by Andover.Net in the amount of
$6.3 million will be recorded as a compensation charge ratably over the period
of the payments. The amount of stock consideration that is contingent on the
achievement of performance milestones relating to traffic on the Slashdot.org
web site and the continued employment of the key employees of Slashdot.org will
be recognized upon the achievement of these milestones. To the extent any stock
consideration is issued, we will record a non-cash compensation charge based on
the fair value of the shares issued at such time.
Acquisition of Animation Factory. In June 1999, we acquired substantially
all of the assets and assumed certain liabilities of Eclipse Digital Imaging,
Inc., including the graphical and artistic web site known as Animation Factory.
Animation Factory contains over 100,000 downloadable images and graphic, or GIF,
animations. Consideration for this transaction consists of a $250,000 cash
payment made at the closing, $200,000 of stock valued at the initial offering
price issuable upon the closing of this offering and payments of up to $1.25
million in cash and contingent payments of up to $400,000 in stock valued at the
initial public offering price, all of which are payable during the two years
following this offering. All consideration paid or payable in connection with
this acquisition has been paid or will be paid to Eclipse Digital Imaging, Inc.
The amount of the stock consideration that is contingent solely on the continued
employment of the key employees of Animation Factory by Andover.Net in the
amount of $200,000 will be recorded as a compensation charge ratably over the
period of the payments. The amount of the stock consideration that is contingent
on the achievement of performance milestones related to the creation of new
animation images and the continued employment of the key employees of Animation
Factory will be recognized upon the
21
<PAGE> 28
achievement of these milestones. To the extent any stock consideration is
issued, we will record a non-cash compensation charge based on the fair value of
the shares issued at such time.
Acquisition of Freshmeat.net. In August 1999, we acquired substantially
all of the assets and assumed the liabilities relating to the Freshmeat.net web
site from a business owned by Patrick Lenz. Freshmeat.net is one of the largest
Linux software application repositories and also contains application news and a
community section. Consideration for this transaction consists of a $367,000
cash payment made at the closing, $300,000 payable in 15 monthly non-contingent
installments of $20,000 through November 2000, $111,111 of stock valued at the
initial public offering price issuable upon the closing of this offering and
contingent payments of up to $222,222 in stock valued at the initial public
offering price and payable during the two year period following this offering.
All of the stock payments are contingent on the continued services provided by
Mr. Lenz. As the stock payments relate to the compensation of Mr. Lenz for his
services, a compensation charge of $333,333 will be recognized ratably over the
payment period of two years. To the extent any stock consideration is issued, we
will record a non-cash compensation charge based on the fair value of the shares
issued at such time.
Acquisition of ThinkGeek.com. In October 1999, we acquired all of the
assets relating to the web site known as ThinkGeek.com from ThinkGeek, LLC.
ThinkGeek.com is an online retailer of Linux/Open Source related gifts, books
and paraphernalia. Consideration for this transaction consists of a $200,000
cash payment made at the closing and $200,000 payable in eight equal quarterly
contingent installments beginning in January 2000. These payments are contingent
on the continued employment of the key employees of ThinkGeek.com.
Our recent acquisitions have resulted in increased page views on our
network of web sites and we anticipate that our network's page views, and
therefore our advertising revenues on an absolute dollar basis, will continue to
increase as a result of these and future acquisitions.
In October 1999, we entered into a licensing agreement with Lycos, Inc. to
release GIFWorks 3.0, an online software application, on Tripod.com. The
agreement enables us to provide online tools for the Angelfire.com and the
Tripod.com community web sites in exchange for a monthly fee and a percentage of
the advertising revenue earned on the licensed web pages.
AMORTIZATION OF DEFERRED COMPENSATION
In the year ended September 30, 1999, we recorded total deferred stock
compensation of $6.2 million in connection with stock option grants totaling
914,000 options. This amount represents the difference between the exercise
price of stock option grants and the deemed fair value of our common stock at
the time of such grants. Should the actual offering price of this offering
increase, we may record additional deferred compensation expense. We are
amortizing this amount over the vesting periods of the stock options. These
vesting periods range from zero to four years. The amortization of the deferred
compensation resulted in a compensation expense of $1.0 million for the year
ended September 30, 1999, and will result in charges of $1.1 million in 2000,
$1.4 million in 2001, $1.4 million in 2002, $1.0 million in 2003 and $300,000 in
2004. There is no stock compensation expense for any other historical periods
presented. In addition, we anticipate recording additional deferred compensation
of approximately $482,000 related to 75,000 options granted in October 1999
which will be recognized as an expense over the vesting period of these options.
There are currently 260,459 options that vest in full upon an initial
public offering. Upon the closing of this offering, additional compensation
expense of approximately $800,000 relating to these 260,459 options will be
recorded as compensation expense in the quarter in which this offering occurs.
The remaining deferred compensation will be amortized over the remaining vesting
period.
NET OPERATING LOSS CARRYFORWARDS
As of September 30, 1999, we had net operating loss carryforwards of $4.5
million. Net operating loss carryforwards can be used to offset taxable income
in future periods. The net operating loss carryforwards will expire at various
dates through 2019, if not utilized. The Tax Reform Act of 1986 imposes
substantial restrictions on the utilization of net operating loss carryforwards
in the event of an "ownership change" of a
22
<PAGE> 29
corporation. Our ability to utilize net operating loss and tax credit
carryforwards on an annual basis would be limited as a result of an "ownership
change" as defined by Section 382 of the Internal Revenue Code. We have
completed several financings since inception and believe that we have incurred
ownership changes. We do not believe the ownership changes to date will have a
material impact on our ability to utilize our net operating loss and tax credit
carryforwards. There can be no assurance that our future acquisitions, if any,
will not result in an ownership change that would limit our ability to utilize
our net operating losses and tax credit carryforwards.
RESULTS OF OPERATIONS
The following table sets forth certain statements of operations data as a
percentage of revenues for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------------------------
1995 1996 1997 1998 1999
----- ------ ----- ----- ------
(AS A PERCENTAGE OF REVENUES)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenues........................................ 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues................................ 38.0 9.2 40.9 25.3 34.6
----- ------ ----- ----- ------
Gross profit.................................... 62.0 90.8 59.1 74.7 65.4
Operating expenses:
Sales and marketing........................ 30.4 107.3 66.9 57.7 92.0
General and administrative................. 31.4 164.9 45.6 27.9 69.8
Research and development................... -- -- 26.2 23.6 36.3
Amortization of deferred compensation...... -- -- -- -- 48.2
Amortization of intangible assets.......... -- -- -- -- 19.1
Compensation related to acquisitions....... -- -- -- -- 38.3
----- ------ ----- ----- ------
Total operating expenses.............. 61.8 272.2 138.7 109.2 303.7
----- ------ ----- ----- ------
Loss from operations............................ 0.2 (181.4) (79.6) (34.5) 238.3
Interest income................................. -- 0.9 0.1 1.6 4.1
Interest expense................................ (3.5) (26.6) (10.1) (3.8) (22.0)
----- ------ ----- ----- ------
Net loss........................................ (3.3)% (207.1)% (89.6)% (36.7)% (256.2)%
===== ====== ===== ===== ======
</TABLE>
FISCAL YEARS ENDED SEPTEMBER 30, 1998 AND 1999
Revenues. Substantially all of the revenues for the year ended September
30, 1998 and year ended September 30, 1999 were from advertisements on our
network of web sites. In 1999, our revenues also included $100,000 of software
product revenues related to the online sale of compact discs of animated
graphics. Revenues increased 61.5% from $1.3 million in the year ended September
30, 1998 to $2.1 million in the year ended September 30, 1999. The increase was
primarily due to an increase in banner advertising and sponsorships on our
network of web sites and the advertising revenue attributed to the acquisitions
of Slashdot.org, Animation Factory and Freshmeat.net. There were no barter
revenues in the year ended September 30, 1998. In the year ended September 30,
1999, revenues from barter transactions were $570,000, or 26.9% of revenues.
Cost of Revenues. Cost of revenues primarily consists of expenses
associated with editorial content, communications infrastructure, and web site
hosting. Our web site hosting expenses include expenses associated with our
ownership of two servers, our lease of 17 servers and media fees. Cost of
revenues increased from $327,000, or 25.3% of revenues, in the year ended
September 30, 1998 to $733,000, or 34.6% of revenues, in the year ended
September 30, 1999. The increase in cost of revenues reflects additional
operations personnel and expenses for freelance contributors for editorial
content, as well as higher costs for hosting our network of web sites which
includes expenses for our server leases. We anticipate that cost of revenues
will continue to increase in absolute dollars as we continue to enhance our
content offerings and services and expand the number of data centers hosting our
web sites.
23
<PAGE> 30
Sales and Marketing Expenses. Sales and marketing expenses primarily
consist of advertising and promotional expenditures and payroll, sales
commissions and related expenses for personnel engaged in sales and marketing
activities. Sales and marketing expenses increased from $744,000, or 57.7% of
revenues, in the year ended September 30, 1998 to $2.0 million, or 92.0% of
revenues, in the year ended September 30, 1999. The increase in expenses relates
to added sales personnel and an increase in advertising and promotional
expenses. In January 1999, we began to transition to a direct sales force.
Previously, we had relied primarily on a limited number of independent,
non-exclusive sales representatives to sell advertising for us. Between January
and September of 1999, we expanded our direct sales personnel from three to 15.
In addition to the increase in sales personnel, we substantially increased our
advertising and promotional expenditures in the year ended September 30, 1999.
We anticipate our sales and marketing expenses will substantially increase in
the future as we continue to expand our direct sales force and invest in
advertising and promotions to strengthen the Andover.Net brand.
General and Administrative Expenses. General and administrative expenses
primarily consist of payroll and related costs of management and administrative
personnel, as well as professional fees and facility costs. General and
administrative expenses increased from $360,000, or 27.9% of revenues, in the
year ended September 30, 1998 to $1.5 million, or 69.8% of revenues, in the year
ended September 30, 1999. The increase in expenses largely reflects the hiring
of additional management and administrative personnel increasing our headcount
from one to nine, employee recruiting costs and an increase in facility costs
due to our move to larger, leased office space in May 1999. We anticipate that
our general and administrative expenses will continue to increase in absolute
dollars as we plan on hiring additional personnel and will incur costs
associated with being a public company, including directors' and officers'
liability insurance and higher professional service fees.
Research and Development Expenses. Research and development expenses
primarily consist of payroll and related costs for developing our web sites,
including our internal banner advertising and page statistic systems, as well as
developing our e-Tools, our free software products that help our web site
visitors build their own web sites. Research and development expenses increased
from $304,000, or 23.6% of revenues, in the year ended September 30, 1998 to
$800,000, or 36.3% of revenues, in the year ended September 30, 1999. The
increase in research and development expenses largely reflects additions to our
research and development staff of direct and contract personnel increasing our
headcount from six to 19. We anticipate that these expenses will increase
significantly as we continue to expand our technical staff to handle the
integration of future acquisitions and development of new internal systems and
e-Tools.
Barter Advertising Expenses. For the year ended September 30, 1999, there
were non-cash advertising costs of $570,000 from barter transactions. There were
no barter advertising costs in the year ended September 30, 1998.
Amortization of Deferred Compensation -- Amortization expense of deferred
compensation represents the vested portion of stock options which were granted
to certain employees at exercise prices below the estimated fair valve.
Amortization of Intangible Assets -- Amortization expense of intangible
assets relates to the intangible assets acquired of Slashdot.org, Animation
Factory and Freshmeat.net. This amortization was $405,000, or 19.1% of revenues,
for the year ended September 30, 1999 and was recorded in the fourth quarter of
the fiscal year as the acquisitions were consummated on or after June 30, 1999.
Compensation Related to Acquisitions -- Compensation related to
acquisitions consists of the cash and stock payments related to the
Slashdot.org, Animation Factory and Freshmeat.net acquisitions that are
contingent solely on the continued employment of key employees of those
acquisitions. These payments are considered by Andover.Net for accounting
purposes to be compensation for services performed by these key individuals.
This compensation was $813,000, or 38.3% of revenues, for the year ended
September 30, 1999 and was recorded in the fourth quarter of the fiscal year as
the service provided related solely to the post-acquisition period.
Interest Income and Expense. Interest income increased from $20,000 in the
year ended September 30, 1998 to $88,000 in the year ended September 30, 1999.
The increase in interest income reflects the higher average cash balances
resulting from the private sale of equity securities during the year ended
September 30,
24
<PAGE> 31
1999. Interest expense increased from $49,000 in the year ended September 30,
1998 to $466,000 in the year ended September 30, 1999. Net interest expense
increased from $29,000 for the year ended September 30, 1998 to $378,000 for the
year ended September 30, 1999. This increase is primarily attributable to the
interest charge relating to the beneficial conversion of notes payable into
Series B redeemable convertible preferred stock.
Provision for Income Taxes. We had no provision for income taxes for the
year ended September 30, 1998 and 1999 because we incurred losses during these
periods.
FISCAL YEARS ENDED SEPTEMBER 30, 1997 AND 1998
Revenues. Revenues increased 74.1% from $741,000 in the fiscal year ended
September 30, 1997 to $1.3 million in the fiscal year ended September 30, 1998.
In fiscal 1997, we transitioned our business activities from software publishing
to web site publishing. Revenues derived from sales of packaged goods software
products in fiscal 1997 were $272,000 and initial advertising revenues on our
web sites were $469,000. In fiscal 1998, substantially all of our revenues of
$1.3 million represent advertising on our network of web sites. The increase in
advertising revenues in fiscal 1998 was a result of increased sales of banner
advertising and sponsorships from our expanding base of customers.
Cost of Revenues. Cost of revenues increased from $303,000, or 40.9% of
revenues, in the fiscal year ended September 30, 1997 to $327,000, or 25.3% of
revenues, in the fiscal year ended September 30, 1998. In fiscal 1997, costs of
advertising revenues were $136,000, or 29.0% of advertising revenues, and costs
of software publishing revenues were $167,000, or 61.4% of software publishing
revenues. In fiscal 1998, costs of revenues related entirely to advertising
revenues. The lower costs of advertising revenues, as a percentage of
advertising revenues, in fiscal 1998 was due to lower proportionate fixed costs
on the higher year-to-year revenues.
Sales and Marketing Expenses. Sales and marketing expenses increased from
$496,000, or 66.9% of revenues, in the fiscal year ended September 30, 1997 to
$744,000, or 57.7% of revenues, in the fiscal year ended September 30, 1998. The
increase in absolute dollars in sales and marketing expenses relates primarily
to higher variable sales commissions on the year-to-year increases in revenues.
During fiscal 1997 and 1998, we primarily relied on independent, non-exclusive
sales representatives to sell our advertising. During this period, we increased
our sales and marketing staff from two to three persons.
General and Administrative Expenses. General and administrative expenses
increased from $338,000, or 45.6% of revenues, in the fiscal year ended
September 30, 1997 to $360,000, or 27.9% of revenues, in the fiscal year ended
September 30, 1998. The increase in general and administrative expenses, in
absolute dollars, relates primarily to administrative support from contract
employees and other non-payroll administrative costs. For this period, our
headcount decreased from two for the year ended September 30, 1997 to one for
the year ended September 30,1998.
Research and Development Expenses. Research and development expenses
increased from $194,000, or 26.2% of revenues, in the fiscal year ended
September 30, 1997 to $304,000, or 23.6% of revenues, in the fiscal year ended
September 30, 1998. The increase in research and development expenses, in
absolute dollars, relates primarily to personnel additions to our development
staff which increased our headcount from four to six.
Interest Income and Expense. Interest income increased from $1,000 in the
year ended September 30, 1997 to $20,000 in the fiscal year ended September 30,
1998. Interest expense decreased from $75,000 in the fiscal year ended September
30, 1997 to $49,000 in the fiscal year ended September 30, 1998. Net interest
expense decreased from $74,000 for the year ended September 30, 1999 to $29,000
for the year ended September 30, 1998. The increase in interest income in fiscal
1998 over fiscal 1997 relates to higher average cash balances during fiscal
1998. The interest expense over this two-year period relates to a secured loan
we received from two of our stockholders in fiscal 1993. This loan was repaid in
early fiscal 1998.
Provision for Income Taxes. We had no provision for income taxes for
fiscal years ended September 30, 1997 or 1998 because we incurred losses during
these periods.
25
<PAGE> 32
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain unaudited statements of operations
data for each quarter of fiscal 1998 and 1999, as well as such data expressed as
a percentage of Andover.Net's revenues for each quarter. This information has
been presented on the same basis as the audited Financial Statements appearing
elsewhere in this prospectus and, in the opinion of management, includes all
adjustments, consisting only of normal recurring adjustments, that Andover.Net
considers necessary to present fairly the unaudited quarterly results. This
information should be read in conjunction with Andover.Net's audited Financial
Statements and Notes thereto appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------------------------------------------
DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30,
1997 1998 1998 1998 1998 1999 1999 1999
-------- --------- -------- --------- -------- --------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues.............................. $ 333 $ 364 $ 289 $ 304 $ 373 $ 253 $ 483 $ 1,012
Cost of revenues...................... 53 99 103 72 107 147 176 303
----- ----- ----- ----- ----- ----- ----- -------
Gross profit...................... 280 265 186 232 266 106 307 709
Operating expenses:
Sales and marketing................. 235 189 157 163 213 369 536 834
General and administrative.......... 90 115 85 70 145 236 297 802
Research and development............ 50 69 81 104 127 160 185 298
Amortization of deferred
compensation...................... -- -- -- -- 577 16 127 303
Amortization of intangible assets... -- -- -- -- -- -- -- 405
Compensation related to
acquisitions...................... 813
----- ----- ----- ----- ----- ----- ----- -------
Total operating expenses.......... 375 373 323 337 1,062 781 1,145 3,455
----- ----- ----- ----- ----- ----- ----- -------
Loss from operations.................. (95) (108) (137) (105) (796) (675) (838) (2,746)
Interest income....................... 4 7 5 4 12 28 19 29
Interest expense...................... (49) -- -- -- -- -- -- (466)
----- ----- ----- ----- ----- ----- ----- -------
Net loss.......................... $(140) $(101) $(132) $(101) $(784) $(647) $(819) $(3,183)
===== ===== ===== ===== ===== ===== ===== =======
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------------------------------------------
DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30,
1997 1998 1998 1998 1998 1999 1999 1999
-------- --------- -------- --------- -------- --------- -------- ---------
(AS A PERCENTAGE OF REVENUES)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues.............................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues...................... 15.9 27.2 35.6 23.7 28.7 58.1 36.4 29.9
----- ----- ----- ----- ------ ------ ------ ------
Gross profit...................... 84.1 72.8 64.4 76.3 71.3 41.9 63.6 70.1
Operating expenses:
Sales and marketing................. 70.6 51.9 54.3 53.6 57.1 145.8 111.0 82.4
General and administrative.......... 27.0 31.6 29.4 23.0 38.9 93.3 61.5 79.3
Research and development............ 15.0 19.0 28.0 34.2 34.0 63.2 38.3 29.5
Amortization of deferred
compensation...................... -- -- -- -- 154.7 6.3 26.3 29.9
Amortization of intangible assets... -- -- -- -- -- -- -- 40.0
Compensation related to
acquisitions...................... 80.3
----- ----- ----- ----- ------ ------ ------ ------
Total operating expenses.......... 112.6 102.5 111.7 110.8 284.7 308.6 237.1 341.4
----- ----- ----- ----- ------ ------ ------ ------
Loss from operations.................. (28.5) (29.7) (47.4) (34.5) (213.4) (266.8) (173.5) (271.3)
Interest income....................... 1.2 1.9 1.7 1.3 3.2 11.1 3.9 2.9
Interest expense...................... (14.7) -- -- -- -- -- -- (46.1)
----- ----- ----- ----- ------ ------ ------ ------
Net loss.......................... (42.0)% (27.7)% (45.7)% (33.2)% (210.2)% (255.7)% (169.6)% (314.5)%
===== ===== ===== ===== ====== ====== ====== ======
</TABLE>
The operating results for any quarter are not necessarily indicative of the
operating results for any future period. In particular, due to our limited
operating history as an Internet company and the unpredictability of our
industry, our revenues may fluctuate from quarter to quarter and are difficult
to forecast. Accordingly, a revenue shortfall in a particular quarter would have
a disproportionate adverse effect on our operating results for that quarter.
During the three months ended March 31, 1999, our revenues declined from the
prior quarter as we transitioned from using independent sales representatives to
a direct media sales force. During the second half of fiscal 1998, our quarterly
revenues were lower than the first half of fiscal 1998. We believe this was
primarily related to a reduction in advertising spending by technology companies
who were adversely affected by the Asian economic crisis.
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LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have funded operations primarily through the private
sales of common and preferred stock and short-term loans, which are convertible
into equity securities, together with cash flow from operations. As of September
30, 1999, we had $9.9 million in cash and cash equivalents, total current assets
of $10.5 million and working capital of $8.0 million. In September 1999, we
issued 600,568 shares of Series B convertible preferred stock. We received
proceeds of $10.1 million from the issuance of the 480,354 shares of Series B
convertible preferred stock to a new investor. In addition, we issued 120,214
shares of Series B convertible preferred stock upon conversion of approximately
$2.1 million of principal and interest under convertible notes which were issued
to existing shareholders in June 1999. These notes were due December 31, 1999
and bore interest at the prime rate.
Net cash used in operating activities was $529,000 in fiscal 1997, $574,000
in fiscal 1998 and $2.5 million in fiscal 1999. The net cash used in operating
activities for all of these periods was primarily a result of our operating
losses before non-cash expenses.
Cash used for additions to property and equipment was $8,000 in fiscal
1997, $17,000 in fiscal 1998 and 242,000 in fiscal 1999. For the year ended
September 30, 1999, the additions to property and equipment consisted of
leasehold improvements, furniture and office equipment for our new leased office
space, as well as computer equipment necessary to support personnel additions.
In June 1999, we paid $1.75 million in cash at closing for our acquisitions
of Slashdot.org ($1.5 million) and Animation Factory ($250,000). Under the terms
of the Slashdot.org acquisition, there are additional contingent cash payments
of up to $1.5 million in January 2000, $1.0 million in June 2000 and $1.0
million in June 2001. The amount of each of these cash payments is dependent on
the continued employment of two key employees of Slashdot.org. In addition, the
acquisition price of Slashdot.org includes the issuance of $2.0 million of stock
valued at the initial public offering price upon the closing of this offering
and contingent payments of up to an additional $5.0 million of stock valued at
the initial public offering price and payable in installments over a two-year
period, following this offering. The payment of this stock consideration is
contingent upon the continued employment of the key employees of Slashdot.org
and the achievement of certain performance milestones relating to traffic on the
web site over the two-year period. Under the terms of the Animation Factory
acquisition, there are additional cash payments totaling $1.25 million, payable
in 15 equal monthly installments beginning October 1999. This amount payable of
$1.2 million as of September 30, 1999, representing future cash payments less
interest, is reflected in current liabilities for $910,000 and in long-term
liabilities for $244,000. In addition, the acquisition price of Animation
Factory includes the issuance of $200,000 of stock valued at the initial public
offering price upon the closing of this offering and contingent payments of up
to an additional $400,000 of stock valued at the initial public offering price
and payable in installments over a two-year period following this offering. The
payment of this stock consideration is contingent upon the continued employment
of the two key employees of Animation Factory and the achievement of certain
performance milestones relating to sales and traffic on the web site over the
two-year period.
We have intangible assets of $3.2 million, consisting primarily of
goodwill, as of September 30, 1999 relating to the acquisitions of Slashdot.org
and Animation Factory. The purchase price for these acquisitions represents the
up-front cash payment for both acquisitions, as well as the installment cash
payments due under the Animation Factory acquisition. The intangible assets will
be amortized over a three-year period on a straight-line basis. The future
contingent cash payments under the Slashdot.org acquisition, as well as the
future contingent stock payments under both acquisitions that are directly based
on continued employment, will be charged to operations over the period the
payments are made. The future contingent stock payments that are based on the
achievement of future milestones and the continued employment of the key
employees will be recognized upon the achievement of these milestones.
In August 1999, we paid $367,000 in cash at closing for our acquisition of
Freshmeat.net. Under the terms of the Freshmeat.net acquisition, there are
additional cash payments totaling $300,000, payable in 15 equal monthly
installments beginning September 1999. This amount payable of $265,000 as of
September 30, 1999, representing future cash payments less interest, is
reflected in current liabilities for $225,000 and in
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long term liabilities for $40,000. In addition, the purchase agreement also
includes the issuance of $111,111 of stock valued at the initial public offering
price upon the closing of this offering and contingent payments of up to an
additional $222,222 of stock valued at the initial public offering price and
payable over a two-year period following this offering. The payment of this
stock consideration is contingent upon the continued services provided by the
principal of Freshmeat.net in accordance with a service agreement. These future
contingent stock payments will be charged to operations over the period the
payments are made.
During fiscal 1997, we received net proceeds of $1.3 million from sales of
Series B convertible preferred stock, Series A redeemable preferred stock and
common stock. We then changed our capital structure and issued Series C
redeemable preferred stock and common stock in exchange for our outstanding
Series A convertible preferred stock and Series B convertible preferred stock.
Between November 1998 and January 1999, we received net proceeds of $2.8 million
for the issuance of Series C redeemable preferred stock and common stock. In
connection with our merger in September 1999 with a wholly-owned subsidiary to
effect our reincorporation in Delaware, the Series C redeemable preferred stock
was converted into Series A redeemable preferred stock. The holders of the
Series A redeemable preferred stock accrue dividends at an 8.0% annual rate. As
of September 30, 1999, $447,000 of dividends have been accrued and not paid. The
Series A redeemable preferred stock will be redeemed upon the completion of this
offering at the redemption price of $13.50 per share, or a total of $4.4
million, plus accrued dividends.
We currently anticipate that available funds as of September 30, 1999, will
be sufficient to meet our anticipated cash requirements for working capital and
capital expenditures through at least December 31, 2000. Should this offering
not close, Andover.Net could alter its expenditures appropriately such that its
current available funds would be sufficient for the Company to continue as a
going concern over the next twelve months. However, we may need to raise
additional funds sooner if, for example, we pursue business or technology
acquisitions or experience operating losses that exceed our current
expectations. If we raise additional funds through the issuance of equity,
equity related or debt securities, such securities may have rights, preferences
or privileges senior to those of the rights of our common stock, and our
stockholders may experience additional dilution. We cannot be certain that such
additional financing will be available to us on favorable terms, or at all. If
additional financing is not available when required or is not available on
acceptable terms, we may be unable to develop or enhance our products or
services. In addition, we may be unable to take advantage of business
opportunities or to respond to competitive pressures. Any of these events could
harm our business, financial condition or results of operations.
YEAR 2000
Many existing computer programs use only two digits to identify a year and
cannot reliably distinguish dates beginning on January 1, 2000 from dates prior
to the year 2000. If not corrected, many computer software applications could
fail or create erroneous results by, on or after the year 2000. We use software,
computer technology and other services provided by third parties that may fail
due to the year 2000 phenomenon.
State of Readiness
We have made a preliminary assessment of the year 2000 readiness of our
information technology systems and we are currently conducting a more thorough
examination. This assessment includes but is not limited to the hardware and
software necessary to provide and deliver our services. We are also performing
assessments of our non-information technology systems, which include many of the
building and office equipment systems.
Our year 2000 readiness plan consists of the following steps:
- quality assurance testing of our internally developed software;
- contacting third-party vendors of hardware, software and services that
we utilize and obtaining certification from those vendors as to the
year 2000 readiness of their products;
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- contacting material non-information technology systems and service
providers that we utilize and obtaining certification from those
providers as to the year 2000 readiness of their products;
- developing and implementing necessary remedial measures as we discern
them throughout our assessment process; and
- creating contingency plans in the event of year 2000 failures.
Our year 2000 task force, which is being directed by our Chief Technology
Officer, is currently conducting an inventory of and developing and implementing
testing procedures for all software and other systems that might be affected by
year 2000 issues. Because third parties developed and currently support many of
the systems we use, a significant portion of this effort involves ensuring that
these third-party systems are year 2000 ready. We have contacted our third-party
vendors and obtained representations regarding their year 2000 readiness and we
have completed testing of those third-party systems. We plan to complete our
evaluation and testing of internally developed software and third-party vendors
of hardware, software and services by November 10, 1999 and plan to complete all
necessary remedial measures by November 30, 1999. However, until our evaluation
and testing is completed, we will not be able to completely evaluate whether our
systems will need to be revised or replaced and the time and costs involved to
do so.
Costs
To date, we have spent $27,000 on year 2000 readiness issues. We expect to
incur an additional $15,000 in the future in connection with identifying,
evaluating and addressing year 2000 readiness issues. Most of our expenses to
date have related to, and are expected to continue to relate to, the time spent
by employees in the evaluation process and developing and implementing necessary
remedial measures. If these expenses are significantly higher than expected our
business, results of operations and financial condition could suffer.
Risks
We are not currently aware of any year 2000 readiness problems relating to
our internally developed software or third-party supplied hardware, software and
services that would have a material adverse affect on our business. However, as
we complete our evaluation and testing, we may discover year 2000 readiness
problems. These problems may require us to substantially revise our systems or
revise or replace third-party hardware, software or services, all of which could
be time-consuming and expensive. Our failure to fix or replace our internally
developed software or third-party hardware, software or services on a timely
basis could result in interruptions. These interruptions could harm our
business, results of operations and financial condition.
We are dependent on a number of third-party vendors to provide network
services and equipment. A significant year 2000-related disruption of the
services or equipment that third-party vendors provide to us could cause our
users, advertisers or sponsors to consider seeking alternate content providers
or cause a significant burden on our technical support, which could adversely
affect our business. In addition, a systematic failure beyond our control, such
as a prolonged Internet, telecommunications or electrical failure, which could
prevent us from delivering services or prevent users from accessing our network,
could harm our business, results of operations and financial condition.
Contingency Plan
As discussed above, we are currently engaged in an ongoing year 2000
readiness assessment and have not yet developed any contingency plans. The
results of our evaluation and testing, together with the certification and
testing results from third-party vendors and service providers, will be
considered in determining the nature and extent of any contingency plans we
develop.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
We have no derivative financial instruments or derivative commodity
instruments in our cash and cash equivalents and investments. We invest our cash
and cash equivalents and investments in short-term, interest-
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bearing, investment grade securities. We anticipate investing our net proceeds
from this offering in similar investment grade investments pending their use as
described in this prospectus. See "Use of Proceeds." Our transactions are
conducted, and our accounts are denominated, in United States dollars.
Accordingly, we are not exposed to significant foreign currency risk.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities in the
balance sheet and measure those instruments at fair value. Pursuant to SFAS No.
137, Accounting for Derivative Instruments and Hedging Activities -- Deferral of
the Effective Date of FASB Statement No. 133, SFAS No. 133 is effective for all
fiscal quarters of fiscal years beginning after June 15, 2000. SFAS No. 133 is
not expected to have a material impact on Andover.Net's financial statements.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position (SOP) 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. SOP 98-1 requires computer
software costs associated with internal use software to be charged to operations
as incurred until certain capitalization criteria are met. SOP 98-1 is effective
beginning January 1, 1999. The adoption of this statement did not have a
material impact on Andover.Net's financial position or consolidated results of
operations.
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BUSINESS
INTRODUCTION
Andover.Net's network of web sites, including Slashdot.org, the leading
Linux/Open Source destination on the Internet, provides products, online tools,
news and other services for programmers, software developers, web site
designers, technology managers and corporate buyers. Our network of web sites
provides an independent, unbiased source for content, community and commerce for
the Linux and, more generally, the Open Source communities of information
technology, or IT, professionals, including programmers and developers.
Our network generates over 45 million page views with over two million
unique visitors monthly. With our recent acquisitions of Slashdot.org and
Freshmeat.net, we believe that traffic on our network represents over 50% of the
visits to Linux resource sites on the web. This leading position in the Linux
market allows us to provide advertisers targeted access to the Linux/Open Source
communities of IT professionals, including programmers and developers. For the
year ended September 30, 1999, we had over 130 advertisers on our network and
our top five advertisers based on total revenues were EarthWeb, IBM, CNET,
Broadcast.com and Silicon Graphics.
The Internet has accelerated the growth of the Open Source movement. The
Open Source movement is a collaborative approach to the development and
distribution of software and has emerged as an alternative to traditional
proprietary software development. The growth of the Internet has greatly
increased the scale and efficiency of Open Source development by enabling large
communities of independent developers to collaborate online. The best-known
example of Open Source is the Linux operating system created by Linus Torvalds
in 1991. Due to the growing number of Linux/Open Source operating systems and
related applications, a number of major technology industry leaders, including
IBM, Intel and Hewlett-Packard, have recently announced support for Linux-based
operating systems by stating plans to develop Linux related products. According
to International Data Corporation, or IDC, Linux-based operating systems
represented 17% of all new licensed shipments of server operating systems in
1998, which was an increase of 212% from the previous year.
INDUSTRY OVERVIEW
Growth and impact of the Internet
The Internet has emerged as a global communications medium, enabling
millions of people to gather information, communicate and conduct business
electronically. IDC estimates that there were approximately 142 million users of
the Internet at the end of 1998 and that number will grow to over 500 million
users by the end of 2003.
The Internet is an attractive medium for advertisers because it allows
flexibility, interactivity and measurement capabilities and provides users with
immediate access to information about advertisers and their products. For
example, the Internet allows advertisers to change messages frequently in
response to market developments or current events. The Internet also allows
advertisers to gather demographic information about users and to deliver
targeted messages to specific consumer groups. According to Jupiter
Communications, total Internet advertising revenues were $2.1 billion in 1998
and are expected to grow to $11.5 billion in 2003, representing an average
annual compounded growth rate of approximately 41% from 1998 to 2003. The
growing popularity of the Internet also represents a substantial opportunity for
companies to take advantage of the potential for conducting transactions online,
commonly known as e-commerce. IDC estimates that worldwide e-commerce revenue
will increase from approximately $50 billion in 1998 to more than $1 trillion in
2003.
Growth of the information technology profession
As the pace and complexity of technological change has increased,
professionals in the IT industry have become more specialized and grown in
number. IT professionals, including programmers and developers, play
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a central role in many companies because of their ability to deploy and
integrate new information technologies. Organizations are increasingly adopting
technologies such as client/server architectures, data warehousing,
Internet/intranet applications and software development to execute business
strategies and maintain competitiveness. These and other technologies have
continued to fuel the growth in the worldwide market for IT products and
services, which is forecasted by IDC to grow from an estimated $781 billion in
1998 to $1.1 trillion in 2002.
IT professionals devote considerable time, effort and financial resources
researching new technologies, seeking answers to technical questions and
developing and implementing IT solutions. These professionals need to stay
abreast of rapid technological developments in a marketplace where vendors
continually introduce new products with a variety of standards and short life
cycles. They have historically relied on resources provided by IT publishers,
software vendors, hardware vendors, training service providers and fellow
professionals to follow the latest trends in the industry. We do not believe
that any of these sources provides a comprehensive solution for IT
professionals' need for continuous education, access to new products and a
medium in which professionals can exchange ideas. Due to the rapid rate of
change, technical information, training materials and software become dated and
obsolete relatively quickly. Therefore, IT professionals, including programmers
and developers, have the following common needs:
- Content -- News and other resources that keep them informed of changes
within the industry;
- Community -- The exchange of ideas and collaboration through a central
medium by which they can share their experiences to increase their
personal knowledge as well as grow the industry and technology; and
- Commerce -- An efficient, comprehensive source for products and services
which meet their purchasing needs.
Growth of the Linux and Open Source movement
The Internet has accelerated the growth of the Open Source movement. The
Open Source movement is a collaborative approach to the development and
distribution of software and has emerged as a viable alternative to traditional
proprietary software development. The growth of the Internet has greatly
increased the scale and efficiency of Open Source development by enabling large
communities of independent developers to collaborate online.
The growth of the Open Source movement is principally based on access to
software source code. Developers write programs in source code. This source code
is then translated into object code, which is read by the computer. Under the
proprietary model of software development, a software developer generally
licenses only the object code, not the source code, to the user. The source code
is always controlled and maintained by the proprietary software developer. By
contrast, under the Open Source development model, the software developer
provides the user access to the source code which allows the software to be
easily modified by the user to meet their specific needs. This code is often
provided for free or for a minimal cost and is adaptable by the user for a wide
variety of applications, including running web servers and low cost computer
products known as electronic "appliances." These appliances are designed to
provide basic computer applications such as Internet access, word processing and
e-mail at a much lower cost than traditional personal computers. As a result,
manufacturers can create products that are unique, but which can be sold at a
lower cost because they are not required to license a proprietary operating
system such as Windows for their products.
Due to the collaborative nature of Open Source software, many new, Open
Source-based operating systems have emerged. The best known Open Source-based
operating system is the Linux operating system, or Linux, which was created by
Linus Torvalds in 1991. Since 1991, many distributions or varieties of Linux
have emerged. Due to the growing number of Linux/Open Source operating systems
and related applications, a number of major technology industry leaders,
including IBM, Intel and Hewlett-Packard, have recently announced support for
Linux-based operating systems. According to IDC, Linux-based operating systems
represented 17% of all new licensed shipments of server operating systems in
1998, which was an increase of 212% from the previous year. Further, because
most versions of the Linux operating system are either free or sold for less
than $100 and allow the user to customize the code to meet its needs, many
Linux/Open Source
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applications have emerged. Although the code is free, companies are able to
charge a license fee for their software products which both aid in the
installation of the Linux operating system and provide extensive documentation
and support services.
A necessary element to the continued success of the Open Source movement is
the continued ability of software developers to communicate, share and develop
software in a collaborative manner. For technology developers, locating and
fostering a community within which one can share information is of critical
importance. Despite a strong continued focus on open software development and
continued support for Open Source products, a number of obstacles to widespread
adoption of Open Source products within the technology industry exist including
the lack of:
- a highly-visible transition path from proprietary based operating systems
to Linux/Open Source;
- an independent, trusted intermediary, not biased toward a single
operating system, to communicate the multiple Linux/Open Source products,
developments and services to diverse user communities;
- a comprehensive and efficient support infrastructure providing product
and service guides, technical information, and development resources; and
- an open marketplace to facilitate the flow of Linux/Open Source products
and services.
We believe that a Linux/Open Source leader must broadly promote the
adoption of Linux/Open Source, provide a trusted, responsive, industry-focused
information resource that offers support and collaboration at a consistently
high level, and enable a market for Linux/Open Source products and services.
THE ANDOVER.NET SOLUTION
Through our network of web sites, we provide a solution designed to meet
the needs of the Linux/Open Source community and its developing markets. As an
extensive provider of Cross-Platform content, or information and software that
is helpful to users of Linux as well as other operating systems, Andover.Net is
a natural place to begin the transition to Linux/Open Source from other
operating systems. As the Internet's leading Linux/Open Source destination, our
Slashdot.org, Freshmeat.net and FreeCode.com web sites provide for the exchange
of information about Linux/Open Source, and access to downloadable resources
through links to other web sites. We generate advertising revenues on each of
these web sites, and the information that we provide to our users is free. The
majority of these resources, including news and online tools, are generated by
Andover.Net. At our community web site, Slashdot.org, our visitors generate
content by commenting on various news stories that are posted throughout the
day. Some of our web sites contain archives of free downloadable software
products developed by various third parties.
Transition path. We believe the best way for people to discover and
understand Linux/Open Source is for them to visit Slashdot.org, a leading hub
for community, news and information. To make Slashdot.org highly visible to
non-Linux developers, we include links, banners and buttons throughout
Andover.Net's Cross-Platform web sites that contain content useful for both
Linux and Windows. We believe that as sophisticated IT professionals and
technology hobbyists move to Linux and other Open Source-based operating
systems, our network, including our Cross-Platform web sites, will become an
important resource in this transition. In addition, millions of banner
advertisements per month and millions of links to Linux/Open Source web sites
outside our network promote the possibilities of Linux to IT professionals,
including developers and programmers.
Trusted content. We provide an independent, unbiased source for content,
much of which comes from the Linux/Open Source community itself. Moreover, the
comprehensive information we provide covers a broad range of Open Source topics
rather than a single version of Linux or a single hardware platform.
Freshmeat.net comprehensively rates and categorizes the latest in Linux products
regardless of developer or distribution. Further, FreeCode.com has hundreds of
code modules that can run on, or be easily adapted to run on, any Linux/Open
Source system. Through broad, unbiased coverage in editorials, community
comments and comprehensive software listings, Andover.Net is the largest
independent intermediary for Linux/Open Source.
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Comprehensive support. Support for Linux/Open Source on our network comes
in many forms. The community itself offers advice and counsel on Slashdot.org.
Further, Freshmeat.net is one of five sites within our network providing
descriptions and free downloadable software resources. Other sites provide
tutorials, reviews, screenshots of products, links to these products and market
information.
Open marketplace. We provide the largest Internet media channel through
which Linux/Open Source vendors can promote and advertise their goods and
services and on which purchasers can identify, evaluate and buy the products and
services they need. In addition, we promote application development through our
discussion forums, provide free advertising for Linux based products that are
free, and broadly support promising new business models to encourage growth in
the market.
The benefits of our solution accrue to both members of the Linux/Open
Source community as well as to vendors who are targeting that community.
Benefits for our community. We have established our network as both the
most popular and most visited meeting place for the Linux/Open Source community
as well as one of the largest Cross-Platform transition networks. We provide
editorials, community, commentary, reviews, products, tools, news, information
and services for programmers, software developers, system engineers, web site
designers, web site managers and corporate technology buyers.
Benefits for vendors. We provide vendors with targeted channels to reach
our highly focused technology community. As our network has grown to become a
central site for members of the Linux/Open Source community, it has likewise
evolved as a unique selling opportunity for advertisers. We believe that our
users represent a large and targeted online community of Internet industry and
IT professionals, web developers, programmers and experienced Internet users. As
a result, our vendors can enhance the effectiveness of their advertising by
customizing advertisements and placing them on targeted pages on our network.
OUR STRATEGY
Our goal is to maintain and enhance our position as the leading destination
for Linux and, more generally, the Open Source movement. Key elements of our
strategy are:
Grow the size and share of our dominant Linux/Open Source position
We are the leading Linux/Open Source destination on the Internet. To grow
this dominant position, we intend to increase our traffic by offering more
viewable pages, high quality content and additional services. In particular, we
are committed to augmenting Slashdot.org, Freshmeat.net and FreeCode.com, our
leading web sites. We also intend to support the overall growth in the Linux and
Open Source communities. An important distinction between Andover.Net and other
major Linux/Open Source companies is that we support Open Source and all
versions of Linux rather than a single version of that operating system. We
intend to support Linux/Open Source communities through free web site hosting,
contributions of advertising and trade show space to promote free Linux products
and the acceptance of the Linux/Open Source movement, funding of application
development and benchmark testing for developers of free products, supporting
new business models and expanding our Linux/Open Source partnership programs.
Facilitate and guide the transition of Windows developers to Linux/Open Source
Unique among all major Linux/Open Source companies, our network includes
high-traffic, Cross-Platform sites for IT professionals, including programmers,
software developers, web designers and web site managers, many of whom have not
yet adopted Linux. Our Cross-Platform web sites offer products, online tools,
news and other services which are usable with virtually all major operating
systems including Linux, Windows and Macintosh. To accelerate the growth of our
Linux/Open Source web sites, we intend to educate visitors on these
Cross-Platform web sites and inform, guide and encourage developers to adopt and
support Linux.
Expand our e-commerce offerings to our targeted, high volume traffic
Our network currently provides content and community to over two million
targeted unique visitors on a monthly basis, and we believe this represents a
significant e-commerce opportunity. We currently sell compact
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discs of animated graphics, Linux/Open Source related gifts, books and
paraphernalia and subscriptions to our animations archives online. We intend to
expand our e-commerce offerings by selling various additional Linux products
such as computer hardware, books and compact discs as well as services such as
installation and support. Moreover, we believe that our e-commerce offerings
will generate increased traffic and encourage longer time spent on our network.
Acquire complementary Linux/Open Source web sites
We have already acquired and integrated leading Linux/Open Source web sites
such as Slashdot.org and Freshmeat.net. We expect to continue to pursue
strategic acquisitions to strengthen our content offerings and services. We may
also acquire complementary web sites to obtain valuable brands, expertise or
access to new users, advertisers and vendors. We believe that by acquiring
complementary web sites, we can efficiently integrate them into our network, and
thereby improve their traffic and revenue results as well as our own.
Expand the number and participation of major advertisers
We intend to increase the number of major advertisers on our network by
expanding our direct sales force and by increasing our sales promotion to
Linux/Open Source vendors. With our recent Linux/Open Source acquisitions, we
believe that traffic on our network represents over 50% of the visits to Linux
resource sites on the web. This leading position in the Linux/Open Source market
allows us to provide advertisers targeted access to the Linux/Open Source
communities. We believe that Linux/Open Source related vendors will
significantly increase their online advertising in this rapidly growing market.
We also intend to broaden the participation of our major advertisers by offering
several innovative advertising products. Many advertisers have indicated to us
that these advertising products are more effective for branding and sales than
standard banner advertisements.
Strengthen the Andover.Net brand
We intend to strengthen the Andover.Net brand through a combination of
online and offline advertising, sales promotion, trade shows, direct mail,
public relations, syndicated content and events to promote the use of our
network to the technical community, advertisers and vendors. We currently place
over eight million banner advertisements each month on complementary sites and
expect to significantly increase both online and other media advertising in the
future. We also intend to promote the Andover.Net brand with licensing programs
such as our licensing agreement with Lycos, Inc. to provide online tools for the
Angelfire.com and the Tripod.com community web sites in exchange for a monthly
fee and a percentage of the advertising revenue earned on the licensed web
pages. We also have contractual arrangements with more than 15 web sites that
put our logo on over four million web pages and link directly to our network
which generates traffic at no cost to us.
THE ANDOVER.NET NETWORK
Our closely integrated network consists of web sites that are deep in
content and provide programmers and developers with leading online resources. We
believe that as sophisticated IT professionals and technology hobbyists move to
Linux and other Open Source-based operating systems, our network, which includes
news and tools for the Windows operating system, will become an important
component of this transition. Our network will introduce Linux and other similar
operating systems to many of our technology oriented customers who have not yet
migrated to these systems.
The Andover.Net network consists of three categories of web sites:
- Our Linux/Open Source sites attract sophisticated Linux users and
developers who seek cutting-edge Open Source content;
- Our Cross-Platform sites offer visitors a wide range of content including
news, products and online software applications or e-Tools; and
- Our Windows site features daily reviews and updates of Windows software
downloads.
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Each of our main web sites and product offerings are summarized below.
LINUX/OPEN SOURCE SITES
<TABLE>
<S> <C>
LOGO slashdot.org -- Slashdot.org is the largest online community for Linux/Open
Source developers providing news, commentary, information and reviews on a
wide range of subjects. Slashdot.org focuses on issues of importance to the
Open Source community allowing individuals to post comments and debate news
items and technical issues.
LOGO freshmeat.net -- Freshmeat.net is one of the largest Linux software
application repositories and also contains application news and a community
section. At Freshmeat.net, Linux/Open Source developers and users can
exchange information online to collaborate on Linux/Open Source software
projects. One feature of this web site shows the number of hits each
application has received which allows us to determine which Linux product is
the most popular.
LOGO freecode.com -- FreeCode.com is a comprehensive online resource for
programming source code which offers a constantly updated and expanded
database of free, Internet-related programs. FreeCode.com contains programs
written in Perl, C++, Java and Visual Basic.
LOGO thinkgeek.com -- ThinkGeek.com is an online retailer of Linux/Open Source
related gifts, books and paraphernalia. ThinkGeek.com's product offerings
include items branded with logos of other Andover.Net web sites and
hard-to-find novelty products that are pertinent to individuals who identify
with the Linux/Open Source community.
</TABLE>
CROSS-PLATFORM SITES
<TABLE>
<S> <C>
LOGO davecentral.com -- DaveCentral.com has two components, one for Linux and one
for Windows. The site archives over 10,000 free software downloads and
reviews. Both the Linux and Windows web sites group the software by category
which facilitates searches. The site also has a ticker showing recent
updates in all sections of the web site as well as keyword search
capabilities.
LOGO andovernews.com -- Andover News provides free, timely and searchable
computer-industry news from multiple sources. IT professionals visit Andover
News for information and editorials about a broad range of technologies and
technology companies.
LOGO itmanagersjournal.com -- IT Manager's Journal provides IT news and advice
for professionals and managers. The site features daily editorial articles
on a wide variety of IT topics, survey questions with live results and
discussions about a broad range of IT issues.
</TABLE>
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<PAGE> 43
<TABLE>
<S> <C>
LOGO mediabuilder.com -- MediaBuilder.com is an online multimedia resource center
which contains multimedia software; online tools; GIF animations, the most
popular file format for animations on the web; the largest collection of
free images on the Internet; and a font library with over 1,000 free fonts.
With our acquisition of Animation Factory, users can also access and
download over 100,000 images. Some of the more popular web tools found
within MediaBuilder.com are summarized below:
LOGO - gifworks.com -- GIFWorks.com is a free on-line software application.
With easy-to-use pull down menus, GIFWorks.com allows user to resize
any GIF animation.
LOGO - htmlworks.com -- HTMLWorks.com is an online application that enables
users to quickly and easily create, edit and improve their web pages
through their web browser.
LOGO techmailings.com -- TechMailings.com offers the largest collection of
technology mailing lists on the Internet with fifteen categories covering
everything from cyber-culture to Internet marketing.
LOGO techsightings.com -- TechSightings.com searches the Internet for technology
sites and presents informative daily reviews of the best high-tech sites for
IT professionals. Chosen sites include targeted information on topics such
as hardware, software, programming and web building.
LOGO internettrafficreport.com -- Internet Traffic Report monitors the flow of
Internet data around the world. The Internet Traffic Report analyzes the
data and displays a value ranging from zero to 100 with higher values
indicating faster, more reliable connections.
</TABLE>
WINDOWS SITE
<TABLE>
<S> <C>
LOGO slaughterhouse.com -- Slaughter House ranks and updates a wide variety of
Windows software, including Internet applications, multimedia tools,
utilities and games. Slaughter House also offers daily news updates and a
"Product of the Day Review."
</TABLE>
By combining our Linux/Open Source, Cross-Platform and Windows web sites
into our network, Andover.Net provides IT professionals with a leading online
resource.
VISITORS
According to an independent survey we commissioned in February 1999 from
the Laredo Group, the typical Andover.Net visitor spends an average of 15.8
hours per week online, excluding time spent corresponding by e-mail, two hours
of which are spent visiting Andover.Net sites. Our visitors, who have an annual
average household income of $61,000, include corporate executives, web
developers and designers, programmers and IT professionals. Over 60% of our
visitors visit our web sites at least once a week.
Furthermore, 68% of our visitors are personally involved in the purchasing
of computer products for their companies. The study also reveals that 74% of our
visitors have already made online purchases compared to an industry average of
35% in 1998, as estimated by Jupiter Communications. In addition, 77% of our
visitors said they are likely to make online purchases within the next year. We
believe that these buying patterns of our user base make our network well suited
for e-commerce.
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The main reasons cited in the survey for visiting our network were
up-to-date technology news, including the latest developments in Linux and Open
Source systems, buying information and product downloads for evaluation, how-to
information and the ability to search for computer products and services.
MARKETING AND SALES
Marketing
We employ a combination of online and offline advertising, sales promotion,
trade shows, direct mail, public relations, syndicated content and events to
promote the use of our network to the technical community, advertisers and
vendors. We currently place banner advertisements on over eight million pages
online each month, usually on complementary programmer and developer sites. We
use barter, content licensing and partnerships to extend our online presence to
offline media including technical trade magazines and Internet marketing guides.
Our sales promotion includes seminars at major online media agencies and
forums for presenting our Linux/Open Source marketing opportunities to major
product vendors. We focus our trade show marketing on Linux-related shows, such
as LinuxWorld, and online media planning conferences, such as @d:tech. We
announce and promote major events and advertising opportunities to media
planners and vendors through direct mail, as well as with advertising campaigns
on the major online web-marketing sites. We also promote our network to over
150,000 users who subscribe to Andover Update, Autopsy Report and our other
online newsletters for free and to the over two million unique visitors who
visit our network on a monthly basis.
Andover.Net has received extensive press coverage in both online and print
publications including the Wall Street Journal, Business Week-on-Line, Time
Digital, Rolling Stone, Red Herring and USA Today. Slashdot.org also produces an
online radio show "Geeks in Space" hosted by The Sync, an online radio
syndicator. The show generally occurs once a week or, as the introduction
relates, "Whenever we feel like it."
We use online tools, including the Internet Traffic Report, GIFWorks.com
and HTMLWorks.com, to attract technology-oriented visitors. We believe that this
encourages long and repeat visits, adding to our "stickiness." The significance
of these e-Tools extends beyond attracting a large core of users to our own
network. We also use them in a variety of licensing and partnership programs to
extend our promotional frequency and reach. For example, GIFWorks.com has over
four million links from companies with whom we have contractual arrangements
where we provide public relations and promotion to the partners' sites, and they
provide links to GIFWorks.com. In addition, with a recent agreement with Lycos
with respect to their Angelfire.com and Tripod.com web sites, we estimate that
we will have links to GIFWorks.com from over 150 million pages per month and
share in the advertising revenue.
Sales
The core of Andover.Net's online advertising business is a professional
direct sales force that makes sales calls on computer product vendors and media
planners at major agencies. We have built and are expanding our nationwide
direct sales force with representatives currently in San Francisco, New York,
Los Angeles and Boston. As of September 30, 1999, our direct sales force had 13
members. Our direct sales force is dedicated to increasing the sales of banner
advertising, sponsorships, email newsletters, display advertisements and
megabanners and recruitment advertising. We sell our advertising services to
high technology companies, consumer goods companies, independent software
developers, advertising agencies, high technology recruitment agencies, and
other marketers interested in reaching our highly focused technology community.
We successfully market banner advertising on our web sites because we provide an
efficient medium for advertisers to reach a worldwide audience of Internet
developers. In addition, because of the unique role our visitors play as Linux
and web site developers, they represent an affluent and highly sought after
target audience for high technology and high-end consumer products.
We believe that our competitive advantage is our leading Linux/Open Source
position. We estimate that our Linux/Open Source web sites represent 50% to 60%
of the advertisable online pages in the Linux/Open
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Source category. Linux/Open Source computer product vendors must advertise to
establish their share of this early stage but rapidly growing market. We believe
that our network is the most effective channel for that communication due to our
category-leading quality and depth of our web sites.
We have been generating advertising revenue since our DaveCentral.com web
site went online and accepted advertisements in 1996. In addition to
conventional banner advertisements, Andover.Net has developed several innovative
advertising products, or beyond-the-banner products.
Our current offering of innovative advertising products is shown below:
- Display Advertisements -- Appear in the navigation bar on most
Andover.Net web sites and combine visually appealing animations with
text. They are approximately two inches wide and six inches long and
generally contain 100 words of copy and extend down the right hand side
of our web pages. They can be rotated throughout the network to pages
and web sites specified by advertisers just as a regular banner
advertisements.
- Megabanners -- Combine a display advertisement with a large top-of-page
banner resulting in sixteen square inches filled with animations and
text in the top right hand corner of our web page.
- e-Tools -- Online tools that allow advertisers to communicate directly
to users of GIFWorks.com and HTMLWorks.com who typically spend ten to 15
minutes per visit on this web site.
- Sponsorships -- Include banners, display advertisements and logo/slogan
design elements on targeted web sites, e-Tools, home pages and
newsletters.
We believe that our advertisers can customize their advertising campaigns
and deliver their message in a highly targeted fashion by choosing specific
placements, or channels, on our network. Because of this ability to target and
deliver a specific audience, we believe that we command higher advertising
rates.
We believe that we enable advertisers to efficiently and effectively reach
targeted Linux/Open Source programmers, developers, engineers, web site
designers and managers, and other buyers of technical products and services. In
addition, since this demographic group has premium income and purchasing power,
it allows us to offer significant advertising opportunities to premium
non-technology advertisers. Based on the Laredo Group survey, 68% of our
visitors are personally involved in purchasing computer products for their
company. They buy for departments or sections with an average of 150 people. As
a result, based on publicly available banner advertisement rate cards, we
believe that our rates are approximately two to three times higher than the
rates of well-known portals that target a more general audience.
Andover.Net's Advertisers
Our customers include high technology and consumer advertisers. Our base of
advertisers has been increasing steadily and, for the year ended September 30,
1999, we had over 130 advertisers on our network who account for total revenues
from zero to $358,781, which includes barter arrangements. Only two of our
customers accounted for over ten percent of total revenues for the year ended
September 30, 1999: EarthWeb and IBM at 18% and 10%, respectively. Based on
percentage of total revenues, our five largest advertisers who accounted for 43%
of our total revenues for the year ended September 30, 1999, were EarthWeb, IBM,
CNET, Broadcast.com and Silicon Graphics.
SOFTWARE ENGINEERING AND DEVELOPMENT
We have invested, and intend to continue to invest, significant resources
in product and technology development. We focus and modify our product
development efforts based on the needs of users and changes in the marketplace.
Our software development efforts are focused on four key areas.
Advertisement and statistics systems. We have created and continually
enhance two software systems necessary for the efficient operation of our web
sites: a banner advertisement system and a page traffic statistics system. Using
an internally developed advertising system has allowed us to create unique
advertising products, such as our megabanner product, and to rapidly adjust to
requests from advertising clients.
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Database generated web sites. All of our web sites are created and managed
through centralized, online databases. This allows data entry operators working
both in-house and off-site to enter new content and update existing content for
our sites using password protected web forms. At regular intervals, ranging from
one to 24 hours, a completely new copy of each web site is automatically
generated from these databases using internally developed programs. These web
pages are automatically uploaded to our web servers, providing our visitors with
continually updated versions of each site. This database driven model of web
site creation provides a higher level of efficiency than traditional publishing
models, where large numbers of people are required to write each web page by
hand. Therefore, we believe that we are able to provide a high level of content
at minimal incremental cost with a much smaller staff.
Online web applications, or e-Tools. A unique, and highly popular,
component of our network is our e-Tools which are part of our MediaBuilder.com
site and include GIFWorks.com and HTMLWorks.com. These server-based applications
are usable through any web browser, and provide a high level of functionality,
without requiring the user to download or install any additional software. All
of our e-Tools have been developed and are continually enhanced internally.
e-Tools are another way that we achieve a high level of efficiency, because they
provide web site content that is continually new and relevant to a visitor,
without requiring any on-going editorial effort.
Technical integration of acquired web sites. We continue to integrate new
acquisitions into our network. All of our web sites are linked into our network
and share traffic as visitors follow links from one of our web sites to another.
Acquired web sites are modified to utilize our statistics and advertising
systems. Some acquired web sites are completely redesigned if necessary to
increase their quality and performance.
All of our software systems have been written in the C++ and Perl
programming languages. These languages are commonly used for Internet
applications and are understood and used by a wide number of software engineers.
As of September 30, 1999, we employed 12 software engineers, nine web
design professionals, and two network operations engineers. We intend to
increase our development staff significantly to accommodate the increased
technical demands of acquisitions, new internal systems and additional e-Tools.
SYSTEM TECHNOLOGY AND DATA CENTER ARCHITECTURE
Maintaining a high level of performance and reliability while accommodating
rapid growth in visitors to our web sites is a major focus of our network
operations engineers. To that end we have developed an expandable and
fault-tolerant data center architecture for delivering content and
advertisements on our web sites.
Our web sites are maintained on 16 high-speed, industry-standard Pentium
servers that run on the Linux operating system. These servers are equipped with
a Redundant Array of Interdependent Disks, or RAID, for increased reliability.
Web site requests are distributed among the servers by a pair of Alteon load
balancing switches that allow for maximum throughput and fault tolerance. This
architecture allows us to respond quickly to increased traffic on our web sites
by incorporating additional machines without having to shut down or otherwise
interfere with the existing servers. We lease our servers which provides us with
the flexibility needed to increase the number of machines used or update our
machines quickly and inexpensively.
Our current data center is located on the East coast of the United States.
We intend to add three additional data centers using the same software and
hardware architecture. These will be located on the West coast of the United
States, Europe and Asia. Load balancing routers will be employed to
automatically allocate web site traffic to the closest geographic location,
ensuring our visitors the best possible performance. This multiple data center
architecture will increase the fault tolerance of our network, and insulate us
from localized interruptions of service on the Internet.
We maintain and continually enhance a quality assurance process to monitor
our servers, processes and network connectivity. This process involves both
internal staff and external contractors who run regular system and security
audits of our servers. We currently run automatic monitoring programs which
immediately notify our network operations engineers by email and pager in the
case of any current or
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potential interruptions in service. We intend to develop a distributed network
of engineers who will personally monitor our data centers on a 24-hour basis and
be prepared to perform any necessary adjustments to the servers.
INTELLECTUAL PROPERTY
Andover.Net seeks to protect its intellectual property through a
combination of license agreements, service mark, copyright, trade secret laws
and other methods of restricting disclosure and transferring title. We obtain
the majority of our content under license agreements with publishers, through
work for hire arrangements with third parties and from internal staff
development. We have no patents or patents pending for our current online
services and do not anticipate that patents will become a significant part of
our intellectual property in the foreseeable future. Where appropriate, we also
enter into confidentiality agreements with our employees, consultants, vendors
and customers. We generally seek to control access to and distribution of our
technology, documentation and other proprietary information. We pursue the
registration of our trademarks in the United States and internationally, and
have submitted trademark registration applications for our Andover.net,
Slashdot.org and Freshmeat.net trademarks. Content created or acquired by us is
protected by copyright. The proprietary software that we use to run our business
is protected generally by restricting third party access, entering into
confidentiality agreements with third parties who do have access and relying on
copyright law.
COMPETITION
Competition within the Internet is intense and is expected to increase
significantly in the future. Specifically, the market is rapidly evolving and
barriers to entry are low, enabling newcomers to launch competitive web sites at
relatively low costs.
We believe that we compete on the basis of brand recognition, quality and
quantity of content, product and resource selection, convenience and
reliability. We believe that we are differentiated from our competitors due to:
- our focus on the Linux/Open Source operating systems;
- the fact that we are independent of a particular version of the
Linux/Open Source operating systems; and
- our vertical focus of providing content, community and commerce to
technology professionals.
We compete for advertisers, merchants, users and strategic partners with:
- web sites specifically targeting the Linux/Open Source communities;
- web sites specializing in technology information;
- Internet portals, search sites and content aggregators; and
- traditional media content businesses such as newspapers, magazines,
radio and television.
Increased competition could result in advertising price reductions, reduced
margins or loss of market share, any of which could harm our business.
Competition is likely to increase significantly as new companies enter the
market and current competitors expand their services. Many of our current and
potential competitors have longer operating histories, larger customer bases,
greater brand recognition and significantly greater financial, marketing and
other resources than we have. These competitors may be able to respond more
quickly to new or emerging technologies and changes in customer requirements and
to devote greater resources to the development, promotion and sale of their
products and services than we can.
Additionally, our success is in large part dependant on the success of
Linux which is in competition with other operating systems. In the market for
operating systems, Linux competes with a number of large and well-established
companies that have significantly greater financial resources, larger
development staffs and more extensive marketing and distribution capabilities.
While we do not directly compete with these
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companies, our future success may depend on the ability of Linux to effectively
compete with these other more established operating systems.
EMPLOYEES
As of September 30, 1999, we had a total of 49 employees. Of the total
employees, 25 were in engineering and content development, 15 in sales and
marketing and nine in finance and administration. Our future success will depend
in part on our ability to attract, retain and motivate highly qualified
technical and management personnel, for whom competition is intense. From time
to time we also employ independent contractors to support our professional
services, product development, sales, marketing and business development
organizations. Our employees are not represented by any labor union and are not
organized under a collective bargaining agreement, and we have never experienced
work stoppage. We believe our relations with our employees are good.
FACILITIES
Our headquarters are currently located in a leased facility in Acton,
Massachusetts, consisting of approximately 11,700 square feet under a five year
lease that will expire on April 30, 2004. The current annual rental expense
under this lease is approximately $205,000. We have an option to extend the term
of this lease for another five years at the end of the initial five year term.
We believe that additional space will be required as our business expands and
will be available on acceptable terms.
LEGAL PROCEEDINGS
We are not currently a party to any legal proceedings.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Our directors and executive officers and their respective ages and
positions are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Bruce A. Twickler.......................... 53 President, Chief Executive Officer and
Chairman
Peter A. Phelps............................ 42 Chief Financial Officer
Adam B. Green.............................. 43 Chief Technology Officer
James E. Patterson......................... 61 Executive Vice President
William M. Dwyer........................... 47 Vice President, Publishing
Derek V. Carroll........................... 43 Vice President, Business Development
Janet F. Holian............................ 39 Vice President, Communications
Walter M. Bird, III........................ 41 Director
Jonathan M. Goldstein...................... 39 Director
James D. Logan............................. 47 Director
Robert Malda............................... 23 Director
Louis Page................................. 33 Director
Thomas R. Shepherd......................... 69 Director
John E. Trombly............................ 52 Director
</TABLE>
- ---------------
Bruce A. Twickler. Mr. Twickler founded Andover.Net in 1992, has been a
director, President and Chief Executive Officer since its formation and was
elected Chairman of the Board in September 1999. From 1988 to 1991, Mr. Twickler
was Vice President of Microcom. From 1987 to 1988, Mr. Twickler was President of
Shiva Corporation, and from 1983 to 1986 he was President of Hayden Software.
Prior to that time, Mr. Twickler was Vice President of Marketing of Pioneer
Electronics USA.
Peter A. Phelps. Mr. Phelps joined Andover.Net in October 1999 as Chief
Financial Officer. In 1998 Mr. Phelps co-founded Marathon Investment Partners,
LP, a Small Business Investment Company that provides capital for middle market
operating companies. From 1998 to October 1999, Mr. Phelps was the Chief
Financial Officer and a Partner of Marathon Investment Partners. From 1987 to
1998, Mr. Phelps was the Chief Financial Officer of Rosse Enterprises Limited, a
private equity firm. Mr. Phelps was also previously a Manager at
PricewaterhouseCoopers LLP and Audit Supervisor at Ernst & Young LLP. Mr. Phelps
is a Certified Public Accountant.
Adam B. Green. Mr. Green has been Chief Technology Officer of Andover.Net
since July 1996. From 1995 to 1996, Mr. Green was Vice President of Internet
Products at Clear Software, Inc. In 1994, Mr. Green was a consultant and
contract trainer for Alpha Software, Inc. In 1993, Mr. Green was a consultant
and contract trainer for Powersoft.
James E. Patterson. Mr. Patterson has been an Executive Vice President of
Andover.Net since May 1999. He is responsible for implementing our e-commerce
strategy. From February 1997 to May 1999, he was Andover.Net's Vice President,
Sales and Marketing, and from November 1995 to February 1997, he was our Vice
President, Sales. From May 1991 to November 1995, Mr. Patterson was Director of
the IBM Business Unit of Wang Global.
William M. Dwyer. Mr. Dwyer has been Vice President, Publishing of
Andover.Net since May 1999. He is responsible for sales and marketing. From 1994
to 1999, Mr. Dwyer was self-employed. Through his companies The InterMedia Group
and IT/World Inc., he provided publishing and media sales consulting services to
companies such as PennWell Publishing and Skinner James Publishing. As
Publisher, Mr. Dwyer created and launched "BackOffice Magazine" for PennWell
Publishing. Prior to founding IT/World, Inc., Mr. Dwyer was Vice President of
Sales for BYTE Magazine at McGraw-Hill, Inc. Previously, Mr. Dwyer held a
variety of positions at Ziff-Davis over a 10 year period including Director of
the Ziff-Davis Magazine Network.
Derek V. Carroll. Mr. Carroll has been Vice President, Business
Development of Andover.Net since February 1999. From 1995 to 1999, Mr. Carroll
was Vice-President of Sales and Marketing of Silent
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Systems, Inc. From 1985 to 1995, Mr. Carroll was Director of Business
Development of MicroTouch Systems, Inc.
Janet F. Holian. Ms. Holian has been Vice President, Communications of
Andover.Net since August 1999. Ms. Holian joined Andover.Net in February 1999 as
Director of Marketing. From 1996 to 1998, Ms. Holian was Vice President of
Marketing of PersonalAudio, Inc. From 1993 to 1996, Ms. Holian was Director of
Marketing of MicroTouch Systems, Inc.
Walter M. Bird, III. Mr. Bird has been a director of Andover.Net since
July 1997. Since 1996, Mr. Bird has been Vice President of Claflin Capital
Management, Inc., a venture capital investment management firm. From 1990 to
1996, Mr. Bird was a Vice President of BankBoston, N.A.
Jonathan M. Goldstein. Mr. Goldstein has been a director of Andover.Net
since September 1999. Since 1986, he has been associated with TA Associates,
Inc., a venture capital firm, a Vice President from 1990 to 1996 and as a
Principal from January 1997 to date.
James D. Logan. Mr. Logan has been a director of Andover.Net since January
1999. Mr. Logan is the President and Chief Executive Officer of Gotuit Media,
Inc. which he founded in 1999. From 1996 to 1998, Mr. Logan was President and
Chief Executive Officer of PersonalAudio, Inc. which he founded. From 1982 to
1996, Mr. Logan was the Chief Executive Officer and President of MicroTouch
Systems Inc. Mr. Logan is currently Chairman of the Board of Directors of
MicroTouch Systems Inc.
Robert Malda. Mr. Malda has been a director of Andover.Net since July
1999, joining the Board following our acquisition of Slashdot.org from
BlockStackers, Inc. He is currently the editor of the Slashdot.org web site. Mr.
Malda is President of BlockStackers which he co-founded in 1996. Mr. Malda
served as a web site developer for The Image Group from 1996 to 1998. From 1994
to 1996, Mr. Malda was a personal computer technician at the Donnelly
Corporation.
Louis Page, CFA. Mr. Page has been a director of Andover.Net since October
1995. Mr. Page is and has been since 1994 the President and founder of Window to
Wall Street, Inc., a company that serves as the general partner of a number of
venture capital investment firms.
Thomas R. Shepherd. Mr. Shepherd has been a director of Andover.Net since
July 1999. Mr. Shepherd is a co-founder and has been the Chairman of The
Shepherd Group, LLC, a private equity investment firm, since 1996. Additionally,
Mr. Shepherd is a Special Partner, and until 1998 was a Managing Director, of
the Thomas H. Lee Company, a private equity investment firm. Prior to joining
the Thomas H. Lee Company in 1986, Mr. Shepherd was President of the GTE
Lighting Products Group of GTE Sylvania from 1983 to 1986, and was President of
North American Philips Commercial Electronics Corporation from 1981 to 1983. Mr.
Shepherd is also a director of Rayovac Corporation and The Vermont Teddy Bear
Co., Inc.
John E. Trombly. Mr. Trombly has been a director of Andover.Net since
October 1995. Since 1992, Mr. Trombly has been an Executive Vice President of
Royalty Capital Management, Inc., a venture capital management firm, and a
General Partner of Royalty Capital Fund L.P. I, a venture capital investment
fund. Prior to co-founding Royal Capital Fund, Mr. Trombly was President of
Foxboro/Octek from 1978 to 1988.
Pursuant to contractual arrangements between Andover.Net and several of our
stockholders which will terminate at the closing of this offering, our directors
were nominated as follows: Jonathan M. Goldstein is the nominee of the Series B
stockholders; Louis Page is the nominee of Windows to Wall Street, Inc; Thomas
R. Shepherd is the nominee of The Shepherd Venture Fund I, L.P. and The Shepherd
Group, LLC, Bruce A. Twickler is nominated as the Chief Executive Officer and
the other directors are not nominated by a particular stockholder group, but
have contractually agreed to be directors.
BOARD COMMITTEES
Following the completion of this offering, the compensation committee of
the board of directors of Andover.Net will be comprised of Walter H. Bird, III,
James D. Logan and Jonathan Goldstein. The compensation committee reviews and
evaluates the compensation and benefits of all of Andover.Net's officers,
reviews general policy matters relating to compensation and employee benefits
and makes recommendations
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concerning these matters to the board of directors. The compensation committee
also administers Andover.Net's stock options and stock purchase plans. See
"--Employee Benefits Plans". The audit committee of the board of directors of
Andover.Net will be comprised of Louis Page, Thomas R. Shepherd and Jonathan
Goldstein. The audit committee reviews, with Andover.Net's independent auditors,
the scope and timing of the auditors' services, the auditors report on
Andover.Net's financial statements following completion of the auditors' audit,
and Andover.Net's internal accounting and financial control policies and
procedures. In addition, the audit committee will make annual recommendations to
the board of directors for the appointment of independent auditors for the
ensuing year.
ELECTION AND COMPENSATION OF DIRECTORS
Our certificate of incorporation provides for a classified board of
directors divided into three classes. Class I will expire at the annual meeting
of stockholders to be held in 2000, Class II will expire at the annual meeting
of stockholders to be held in 2001 and Class III will expire at the annual
meeting of stockholders to be held in 2002. Messrs. Bird and Trombly will
initially serve as Class I Directors; Messrs. Logan, Shepherd and Page will
initially serve as Class II Directors; and Messrs. Twickler, Goldstein and Malda
will initially serve as Class III Directors. At each annual meeting of
stockholders, beginning with the 2000 annual meeting, the successors to
directors whose terms will then expire will be elected to serve from the time of
election and qualification until the third annual meeting following election and
until their successors have been duly elected and qualified, or until their
earlier resignation or removal, if any. To the extent there is an increase or
reduction in the number of directors, increase or decrease in directorships
resulting therefrom will be distributed among the classes so that, as nearly as
possible, each class will consist of an equal number of directors. Two directors
will be independent, as required by the rules of the Nasdaq National Market,
Inc. All of the directors were appointed pursuant to contractual rights of
certain stockholders. Upon the closing of this offering, however, no individual
stockholder will have a contractual right to designate a director.
Our current directors receive no compensation for serving as directors;
however, they may be reimbursed for the expenses they incur in attending
meetings of the board or board committees. Although our directors are not
entitled to any specified number of options as a result of their positions as
directors, we have granted in the past, and intend to grant in the future,
non-qualified stock options to our non-employee directors.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
None of our directors serves as a member of the board of directors or
compensation committee of any other company that has one or more executive
officers serving as a member of our board of directors or compensation
committee.
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<PAGE> 52
EXECUTIVE COMPENSATION
The following table sets forth the compensation earned by our Chief
Executive Officer and each of our other most highly compensated executive
officers (collectively, the "Named Executive Officers") during the year ended
September 30, 1999:
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION LONG-TERM COMPENSATION AWARDS
----------------------------------------- ----------------------------------------
OTHER
ANNUAL SECURITIES UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION SALARY ($) BONUS ($) COMPENSATION ($) OPTIONS/SARS (#) COMPENSATION ($)
--------------------------- ---------- --------- ---------------- --------------------- ----------------
<S> <C> <C> <C> <C> <C>
Bruce Twickler................... 116,500 15,000 -- 147,760 --
President, Chief Executive
Officer and Chairman
Adam Green....................... 125,000 19,500 -- 124,048 --
Chief Technology Officer
James Patterson.................. 105,450 13,500 25,551 10,108 --
Executive Vice President
Derek Carroll.................... 71,355 19,500 -- 160,762 --
Vice President, Business
Development
(commenced employment with
Andover.Net in February 1999)
William Dwyer.................... 47,920 11,500 -- 80,381 --
Vice President, Publishing
(commenced employment with
Andover.Net in May 1999)
</TABLE>
The following table sets forth certain information regarding the option
grants made during the year ended September 30, 1999 to each of the Company's
named executive officers in the Summary Compensation Table above. The Company
issued no stock appreciation rights in year ended September 30, 1999.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES OF STOCK
PRICE APPRECIATION
INDIVIDUAL GRANTS FOR OPTION TERM(1)
--------------------------------------------------------- ------------------------------------
NUMBER OF
SECURITIES PERCENT OF TOTAL
UNDERLYING OPTIONS GRANTED EXERCISE OR
OPTIONS TO EMPLOYEES IN BASE PRICE EXPIRATION
NAME GRANTED(#) FISCAL YEAR(%) ($/SHARE) DATE 0%($) 5%($) 10%($)
---- ----------- ---------------- ----------- ---------- ----- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Bruce Twickler....... 147,760 9.4 $0.02 12/2/08 $2,656,725 $4,324,570 $6,887,905
Adam Green........... 23,572 1.5 $0.02 12/2/08 $ 423,825 $ 689,894 $1,098,820
100,476 6.4 $0.26 9/1/09 $1,782,444 $2,877,290 $4,597,078
James Patterson...... 10,108 .6 $0.02 12/2/08 $ 181,742 $ 295,836 $ 471,189
Derek Carroll........ 80,381 5.1 $0.02 9/1/09 $1,445,250 $2,352,553 $3,747,000
20,095 1.3 $0.22 9/1/09 $ 357,289 $ 577,565 $ 922,295
60,286 3.8 $0.26 9/1/09 $1,069,474 $1,726,386 $2,758,265
William Dwyer........ 80,381 5.1 $0.02 9/1/09 $1,445,250 $2,352,553 $3,747,000
</TABLE>
- ---------------
(1) In accordance with the rules of the SEC, shown are the gains or "option
spreads" that would exist for the respective options granted. These gains
are based on the assumed rates of annual compound stock price appreciation
of 5% and 10% from the date the option was granted over the full option
term. These assumed annual compound rates of stock price appreciation are
mandated by the rules of the SEC and do not represent the Company's estimate
or projection of future common stock prices.
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<PAGE> 53
Year End Option Table. The following table sets forth information
regarding exercise of options and the number and value of options held at
September 30, 1999, by each of the Company's named executive officers in the
Summary Compensation Table above:
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND
YEAR-END OPTION/SAR VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
FISCAL YEAR END FISCAL YEAR END (1)
SHARES ACQUIRED VALUE --------------------------------- ----------------------------------
NAME ON EXERCISE(#) REALIZED($) EXERCISABLE(#) UNEXERCISABLE(#) EXERCISABLE($) UNEXERCISABLE($)
---- --------------- ----------- -------------- ---------------- -------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Bruce Twickler....... -- -- 147,760 -- $2,655,990 --
Adam Green........... -- -- 205,545 199,835 $3,694,677 $3,592,039
James Patterson...... 30,203 479,595 54,094 46,382 $ 972,341 $ 833,718
Derek Carroll........ -- -- 25,731 135,031 $ 446,051 $2,355,848
William Dwyer........ -- -- 8,628 71,753 $ 154,068 $1,281,233
</TABLE>
- ---------------
(1) Value is based on the difference between the option exercise price and the
initial public offering price of the common stock multiplied by the number
of shares of common stock underlying the option. No market existed for the
common stock prior to this offering. Offering price of $18.00 per share;
exercise prices vary and are noted in the Option Grants in Last Fiscal Year
table.
BENEFIT PLANS
1995 Stock Option Plan.
The 1995 Stock Option Plan, or the 1995 plan, provides for the granting of
incentive stock options and non-qualified options defined in Section 422 of the
Internal Revenue Code to Andover.Net's employees, consultants and directors. The
1995 plan may be administered by the board of directors or by a committee. The
board has the authority to take the following actions:
(a) interpret and apply the 1995 plan; and
(b) determine the eligibility of an individual to participate in the
1995 plan.
No incentive stock options may be granted to an employee who, at the time
of the grant, owns more than 10% of the voting power or greater than 10% of each
class of Andover.Net's outstanding stock, unless the purchase price of the stock
is not less than 110% of the stock's fair market value on the date of the grant
and the option, by its terms, shall not be exercisable more than five years from
the date it is granted.
Vested options may be exercised in full at one time or in part from time to
time. The payment of the exercise price may be made by delivery of one of the
following: (a) cash or a check; (b) at the discretion of the board, shares of
Andover.Net's common stock owned by the optionholder having a fair market value
equal in amount to the exercise price of the options being exercised; (c) at the
discretion of the board, by delivery of the optionholder's personal recourse
note; or (d) at the discretion of the board, any combination of (a), (b) and
(c).
The term of any option granted under the 1995 plan is limited to either
five or 10 years, depending on the nature of the option holder. Upon the
termination of an optionholder's employment with Andover.Net, his or her options
will terminate between 60 and 180 days after that optionholder leaves the employ
of Andover.Net.
As of September 30, 1999, 969,453 options were outstanding under the 1995
plan. No additional shares will be granted under the plan. Options granted vest
over a term established by the board of directors or committee at the date of
grant. The outstanding options have exercise prices ranging from $.02 to $1.06
per share.
\ 1999 Stock Option Plan.
The 1999 Stock Option Plan, or 1999 plan, provides for the granting of
incentive stock options and non-qualified options defined in Section 422 of the
Internal Revenue Code to Andover.Net's employees, directors,
47
<PAGE> 54
advisors or consultants. The 1999 plan may be administered by Andover.Net's
board of directors or by a committee. The board has the authority to take the
following actions:
(a) interpret and apply the 1999 plan;
(b) determine the eligibility of an individual to participate in the
1999 plan;
(c) approve the assignment of options immediately prior to the
registration of Andover.Net's stock pursuant to the Securities Exchange Act
of 1934, as amended, if such assignment would increase the number of common
stockholders; and
(d) determine and allocate the cancellation or exchange of outstanding
options in the case of a recapitalization, acquisition, merger or change in
control.
No incentive stock options may be granted to an employee who, at the time
of the grant, owns more than 10% of the voting power or greater than 10% of each
class of Andover.Net's outstanding stock, unless the purchase price of the stock
is not less than 110% of the stock's fair market value on the date of the grant
and the option, by its terms, shall not be exercisable more than five years from
the date it is granted.
Vested options may be exercised in full at one time or in part from time to
time in amounts of 50 shares or more. The payment of the exercise price may be
made as determined by the board, and set forth in the option agreement, by
delivery of one of the following: (a) cash or a check; (b) shares of
Andover.Net's common stock owned by the optionholder having a fair market value
equal in amount to the exercise price of the options being exercised; (c) any
combination of (a) and (b); provided, however, that payment of the exercise
price by delivery of shares of common stock owned by such option holder may be
made if the payment does not result in a charge to earnings for financial
accounting purposes as determined by the board; or (d) a properly executed
exercise notice to Andover.Net, together with a copy of irrevocable instruments
to a broker to deliver promptly to Andover.Net the amount of sale or loan
proceeds to pay the exercise price. Andover.Net may delay the issuance of shares
covered by the exercise of an option until the shares for which the option has
been exercised have been registered or qualified under the applicable federal or
state securities laws, or counsel for Andover.Net has opined that the shares are
exempt from the registration requirements of applicable federal or state
securities laws.
The term of any option granted under the 1999 plan is limited to either
five or 10 years, depending on the nature of the option holder. Upon the
termination of an optionholder's employment with Andover.Net, his or her options
will terminate between 60 days and 12 months after that optionholder leaves the
employ of Andover.Net.
The number of shares reserved for issuance upon the exercise of options
under the 1999 Plan is 1,736,225. As of September 30, 1999, 440,343 options were
outstanding under the 1999 plan. Options granted vest over a term established by
the board of directors at the date of grant. The outstanding options have an
exercise price ranging from $.10 to $1.06 per share.
LIMITATION OF LIABILITY; INDEMNIFICATION OF DIRECTORS AND OFFICERS
As permitted by the Delaware General Corporation Law, we have included in
our certificate of incorporation a provision to eliminate the personal liability
of our directors for monetary damages for breach or alleged breach of their
fiduciary duties as directors, other than breaches of their duty of loyalty,
actions not in good faith or which involve intentional misconduct, or
transactions from which they derive improper personal benefit. In addition, our
bylaws provide that we are required to indemnify our officers and directors
under certain circumstances, including those circumstances in which
indemnification would otherwise be discretionary, and we are required to advance
expenses to its officers and directors as incurred in connection with
proceedings against them for which they may be indemnified. At present, we are
not aware of any pending or threatened litigation or proceeding involving our
directors, officers, employees or agents in which indemnification would be
required or permitted. We believe that our certificate of incorporation
provisions and indemnification agreements are necessary to attract and retain
qualified persons as directors and officers.
48
<PAGE> 55
In addition to indemnification provisions in our certificate of
incorporation and bylaws, upon the closing of this offering we will have entered
into agreements to indemnify our non-employee directors. These agreements will
provide for indemnification for some types of expenses, including attorneys'
fees, judgments, fines and settlement amounts incurred by persons in any action
or proceeding, including any action by or in the right of Andover.Net, arising
out of their services as a director of Andover.Net.
49
<PAGE> 56
PRINCIPAL STOCKHOLDERS
The following table sets forth information regarding the beneficial
ownership of our common stock as of October 31, 1999, and as adjusted to reflect
the sale of the common stock offered hereby by:
- each person who is known by us to own beneficially more than 5% of the
outstanding shares of our capital stock;
- each of our directors;
- the named executive officers; and
- all directors and executive officers as a group.
Percentage of ownership is calculated as required by the Securities and
Exchange Commission, or SEC. Except as indicated in the footnotes to this table,
the persons named in the table have sole voting and investment power with
respect to all shares of common stock shown as beneficially owned by them. The
table below includes the number of shares underlying options which are
exercisable within 60 days from October 31, 1999. For purposes of calculating
each person's or group's percentage ownership, stock options exercisable within
60 days after October 31, 1999 are included for that person or group, but not
the stock options of any other person or group. Unless otherwise indicated, the
address of each of the beneficial owners identified is 50 Nagog Park, Acton,
Massachusetts 01720.
<TABLE>
<CAPTION>
PERCENTAGE OF
SHARES OUTSTANDING
----------------------
NUMBER OF SHARES BEFORE THE AFTER THE
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED OFFERING OFFERING
------------------------------------ ------------------ ---------- ---------
<S> <C> <C> <C>
NAMED EXECUTIVE OFFICERS AND DIRECTORS
Bruce A. Twickler(1)....................................... 1,763,354 17.1% 12.6%
Peter A. Phelps............................................ -- -- --
Adam B. Green(2)........................................... 304,904 2.7 2.0
James E. Patterson(3)...................................... 109,921 1.0 *
William M. Dwyer(4)........................................ 80,381 * *
Derek V. Carroll(5)........................................ 100,476 * *
Janet F. Holian(6)......................................... 30,143 * *
Walter M. Bird III(7)...................................... 792,690 7.2 5.3
Jonathan M. Goldstein(8)................................... 2,381,341 21.6 15.9
James D. Logan(9).......................................... 203,504 1.8 1.4
Robert Malda(10)........................................... -- -- --
Louis Page(11)............................................. 1,327,178 12.1 8.8
Thomas R. Shepherd(12)..................................... 199,605 1.8 1.3
John E. Trombly(13)........................................ 517,452 4.7 3.4
All Directors and Executive Officers as a Group
(14 persons, including the above)........................ 7,199,994 67.7 50.5
5% STOCKHOLDERS
Massachusetts Technology Development Corp.................. 684,141 6.2 4.6
148 State Street
Boston, MA 02109
James S. Mulhullond, Jr.................................... 926,329 8.4 6.2
One East 66th Street
New York, NY 10021
TA/Advent VIII L.P.(14) ................................... 1,592,871 14.5 10.6
High Street Tower
125 High Street
Boston, MA 02110
</TABLE>
50
<PAGE> 57
<TABLE>
<CAPTION>
PERCENTAGE OF
SHARES OUTSTANDING
----------------------
NUMBER OF SHARES BEFORE THE AFTER THE
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED OFFERING OFFERING
------------------------------------ ------------------ ---------- ---------
<S> <C> <C> <C>
TA/Atlantic and Pacific IV, L.P.(14) ...................... 726,351 6.6% 4.8%
High Street Tower
125 High Street
Boston, MA 02110
Window to Wall Street, Inc.(15)............................ 561,480 5.1 3.7
39 Cedar Hill Road
Dover, MA 02030
Window to Wall Street Limited Partnership(15).............. 569,197 5.2 3.8
39 Cedar Hill Road
Dover, MA 02030
</TABLE>
- ---------------
* Less than one percent
(1) Shares listed as held by Bruce A. Twickler include 617,184 shares which are
currently held by Barbara Twickler, his wife, as to which Mr. Twickler
maintains full voting power. Mr. Twickler disclaims beneficial ownership of
these shares. Shares listed as held by Mr. Twickler also include options to
purchase 147,760 shares Mr. Twickler has the right to acquire within 60
days of October 31, 1999.
(2) Shares listed as held by Adam B. Green include options to purchase 304,904
shares Mr. Green has the right to acquire within 60 days of October 31,
1999.
(3) Shares listed as held by James E. Patterson include options to purchase
79,718 shares Mr. Patterson has the right to acquire within 60 days of
October 31, 1999.
(4) Shares listed as held by William M. Dwyer include options to purchase
80,381 shares Mr. Dwyer has the right to acquire within 60 days of October
31, 1999.
(5) Shares listed as held by Derek V. Carroll include options to purchase
100,476 shares Mr. Carroll has the right to acquire within 60 days of
October 31, 1999.
(6) Shares listed as held by Janet F. Holian include options to purchase 30,143
shares Ms. Holian has the right to acquire within 60 days of October 31,
1999.
(7) Shares listed as held by Walter M. Bird III include 461,009 shares held by
Claflin Capital VI, L.P. and 331,681 Claflin Capital VII, L.P. of which Mr.
Bird is the general partner. Mr. Bird disclaims beneficial ownership of
these shares.
(8) Shares listed as held by Jonathan M. Goldstein include an aggregate of
1,592,871 shares held by TA/Advent VIII L.P., 726,351 shares held by
TA/Atlantic and Pacific IV, L.P., 30,263 shares held by TA Executives Fund
LLC, and 31,856 shares held by TA Investors LLC. Mr. Goldstein has
beneficial ownership of 6,636 of such shares. Mr. Goldstein disclaims
beneficial ownership of the remaining shares.
(9) Shares listed as held by James D. Logan include 188,171 shares held by the
James D. and Kerry M. Logan Family Trust U/A/D 12/31/98 of which his mother
Bernice C. Logan is a trustee. Mr. Logan disclaims beneficial ownership of
these shares. Shares listed as held by Mr. Logan also include 15,333
options for shares Mr. Logan has the right to acquire within 60 days of
October 31, 1999.
(10) Mr. Malda, a substantial stockholder of BlockStackers, will beneficially
own a certain number of shares of common stock upon the closing of this
offering based upon the initial public offering price. See "Relationships
with Andover.Net and Related Transactions -- Other Transactions with
Management -- Slashdot.org Purchase Agreement."
(11) Shares listed as held by Louis Page include 561,480 shares held by Window
to Wall Street, Inc. of which Mr. Page is the president, 569,197 shares
held by Window to Wall Street Limited Partnership of which Window to Wall
Street Inc. is the general partner and 196,501 shares held by Window to
Wall Street II Limited Partnership of which Window to Wall Street, Inc. is
the general partner. Mr. Page
51
<PAGE> 58
disclaims beneficial ownership of the shares held by Window to Wall Street
Limited Partnership and Window to Wall Street II Limited Partnership.
(12) Shares listed as held by Thomas R. Shepherd include an aggregate of 10,188
shares held by The Shepherd Group, LLC of which Mr. Shepherd is the
Chairman and 80,883 shares held by The Shepherd Venture Fund I, L.P. of
which The Shepherd Group, LLC is the general partner. Mr. Shepherd
disclaims beneficial ownership of these shares.
(13) Shares listed as held by John E. Trombly include 334,927 shares held by
Royalty Capital Fund L.P. I, of which Royalty Capital Management, Inc. is
the general partner. Mr. Trombly is the Executive Vice President of Royalty
Capital Management, Inc. Mr. Trombly disclaims beneficial ownership of
these shares.
(14) TA/Advent VIII L.P., TA/Atlantic and Pacific IV, L.P., TA Executives Fund
LLC and TA Investors LLC are under common control. Collectively these
entities own 2,381,341 shares of Andover.Net.
(15) Window to Wall Street, Inc. is the general partner of Window to Wall Street
Limited Partnership and Window to Wall Street II Limited Partnership.
Collectively, these entities own 1,327,178 shares of Andover.Net.
52
<PAGE> 59
RELATIONSHIPS WITH ANDOVER.NET AND RELATED TRANSACTIONS
SALE OF SERIES B PREFERRED STOCK
Andover.Net issued and sold 600,568 shares of Series B convertible
preferred stock on September 15, 1999. 480,354 shares were sold and issued to
affiliates of TA Associates, Inc. and others and 120,214 shares, in the
aggregate, were issued to holders of convertible promissory notes in exchange
for the cancellation of their notes. The total aggregate proceeds to Andover.Net
in the private placement was approximately $10,100,000. The Series B convertible
preferred stock is immediately convertible into common stock at the option of
the holder and will convert into 3,017,133 shares of common stock upon the
closing of this offering.
EMPLOYMENT AGREEMENTS
Robert Malda
In connection with its acquisition of Slashdot.org, Andover.Net entered
into an employment agreement with Robert Malda, a director of Andover.Net, on
June 28, 1999, for a term of three years. The agreement provides that Mr. Malda
is entitled to a base salary of $90,000 per year. In addition, Mr. Malda is
entitled to customary employee benefits. Mr. Malda's employment agreement may be
terminated by Andover.Net at any time for "cause," which is defined as (a) the
conviction of or plea of no contest to any felony, (b) continued, uncured
insubordination, (c) breach of the non-competition provisions of the employment
agreement or (d) commission of any fraud, embezzlement or similar acts of
dishonesty against Andover.Net. This agreement may also be terminated by
Andover.Net without cause or by Mr. Malda for "good reason," which is defined as
(a) the assignment of any duties inconsistent with those set forth in the
employment agreement, (b) any material reduction in Mr. Malda's salary or
benefits, (c) breach of the employment agreement by Andover.Net or (d) the
requirement by Andover.Net that Mr. Malda perform his duties from any specific
location for a prolonged period of time. If Mr. Malda is terminated without
cause or terminates for "good reason" then Mr. Malda is entitled to continue to
receive his existing base salary and benefits for a period of 12 months and is
entitled to receive the payments set forth in the Slashdot.org purchase
agreement without reduction. See "Other Transactions with Management -
Slashdot.org Purchase Agreement."
Under the terms of the employment agreement, Mr. Malda has agreed that
during the term of the agreement he will not participate in the management of
any entity which is in competition with Andover.Net. In the event that
Andover.Net terminates Mr. Malda without cause or if Mr. Malda terminates for
good reason, this non-competition period will terminate concurrently with the
termination of employment.
OTHER TRANSACTIONS WITH MANAGEMENT
Compensation and Benefits.
Our executive officers receive compensation, bonuses and other benefits
under various employee benefit plan arrangements maintained by us and its
subsidiaries. The executive officers participated in such benefit plans under
the same terms generally made available to our similarly situated employees with
similar responsibilities and levels of compensation.
Our executive officers are eligible for performance bonuses under our
Executive Officer Incentive Plan. Under this plan, each officer is eligible for
a bonus of up to $9,000 per quarter. The amount of each bonus is based on a
consideration of our quarterly revenues and quarterly traffic as well as the
achievement of specific corporate objectives.
Slashdot.org Purchase Agreement
Under the terms of the Asset Purchase Agreement between BlockStackers, Inc.
and Andover.Net, dated as of June 18, 1999, Andover.Net purchased those assets
of BlockStackers relating to the Slashdot.org web site for 1.5 million in cash
paid at closing and maximum future cash payments of $3.5 million payable over
the next two years contingent on the continued employment of two key employees.
Maximum future stock consideration of $7.0 million is payable over a period of
two years following this offering. For the purposes of these issuances, the
number of shares of common stock to be issued is determined using an initial
public offering price of $18.00 per share. Thus, the total consideration that
will be paid is valued at $8.5 million and
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<PAGE> 60
the maximum contingent consideration payable is $3.5 million. All consideration
has been or will be paid to BlockStackers. The number of shares paid is
contingent on the continued employment of two key employees and the achievement
of performance milestones relating to traffic on the web site.
- 111,111 shares issuable upon the closing of this offering;
- 55,555 shares issuable seven months after the closing of this offering;
- 37,037 shares issuable 12 months after the closing of this offering;
- 74,074 shares issuable 12 months after the closing of this offering
provided that the milestones in the agreement have been met;
- 37,037 shares issuable 24 months after the closing of this offering; and
- 74,074 shares issuable 24 months after the closing of this offering
provided that the milestones in the agreement have been met.
Pursuant to this purchase agreement, BlockStackers also agreed not to
compete with Andover.Net or to solicit its personnel, customers or suppliers.
Specifically, BlockStackers may not compete with Andover.Net, its subsidiaries
or affiliates by engaging in any business that involves a real-time or
contemporaneous news web site until June 28, 2004. Prior to June 28, 2001,
BlockStackers may not solicit personnel, customers or suppliers from
Andover.Net, its subsidiaries or affiliates. Mr. Malda, a director of
Andover.Net, owns 25% of BlockStackers. Mr. Malda, the President and co-founder
of BlockStackers, was a web site manager of BlockStackers, running Slashdot.org.
Mr. Malda continues to run Slashdot.org as a web site manager and editor of
Andover.Net.
Freshmeat.net Purchase Agreement
Under the terms of the Asset Purchase Agreement between Patrick Lenz (the
owner of Freshmeat.net) and Andover.Net, dated August 6, 1999, Andover.Net
purchased those assets relating to the Freshmeat.net web site for consideration
with a maximum total value of $1.0 million. Of the $667,000 cash portion of the
purchase price, $367,000 was paid on the closing of the acquisition and $300,000
will be paid in 15 non-contingent monthly installments beginning September 1999.
The stock consideration portion of the purchase price is payable over two years
contingent on the continuation of the consulting agreement between Mr. Lenz and
Andover.Net. Pursuant to the consulting agreement, Mr. Lenz will provide
maintenance for the Freshmeat.net web site. The agreement automatically
terminates on September 1, 2002 unless the parties extend its term prior to that
date. For purposes of these issuances, the number of shares of common stock to
be issued is determined using an initial public offering price of $18.00 per
share.
- 6,172 shares issuable upon the closing of this offering;
- 6,172 shares issuable 12 months after the closing of this offering; and
- 6,172 shares issuable 24 months after the closing of this offering.
Mr. Lenz is presently an independent contractor of Andover.Net.
Animation Factory Purchase Agreement
Under the terms of the Asset Purchase Agreement between Eclipse Digital
Imaging, Inc. and Andover.Net, dated as of June 18, 1999, Andover.Net purchased
certain assets of Eclipse Digital Imaging including certain graphical and
artistic web sites known as Animation Factory for consideration with a maximum
total value of $2.1 million. Of the $1.5 million cash portion of purchase price,
$250,000 was paid on the closing of the acquisition and $1.25 million will be
paid in 15 equal monthly installments beginning October 1999. The $600,000 stock
consideration portion of the purchase price is payable over two years contingent
on the continued employment of the two key employees of Eclipse Digital Imaging
and the achievement of performance milestones relating to the creation of new
animation images. All consideration has been or will be paid to Eclipse Digital
Imaging. For the purposes of these issuances, the number of shares of common
stock to be issued is determined using an initial public offering price of
$18.00 per share.
- 11,111 shares issuable upon the closing of this offering;
- 11,111 shares issuable 12 months after the closing of this offering; and
- 11,111 shares issuable 24 months after the closing of this offering.
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<PAGE> 61
In addition, the two key employees of Animation Factory have entered into
employment and non-competition agreements with Andover.Net pursuant to which
they will provide services in a managerial capacity. These agreements may be
terminated by either party upon written notice.
James Maloney and Art Holden, employees of Andover.Net, each own 25% of
Eclipse Digital Imaging.
We intend to enter into indemnification agreements with each of our
non-employee directors. These indemnification agreements will require us to
indemnify such individuals to the fullest extent permitted by Delaware law.
55
<PAGE> 62
DESCRIPTION OF CAPITAL STOCK
Upon completion of the offering, our authorized capital stock will consist
of 100,000,000 shares of common stock, $.01 par value per share, of which
15,000,000 shares will be outstanding, and 1,000,000 shares of preferred stock,
$.01 par value per share, none of which will be outstanding. The following
description of our capital stock and certain provisions of our restated
certificate of incorporation, or the certificate of incorporation, and bylaws is
a summary and is qualified in its entirety by the provisions of the certificate
of incorporation and bylaws, copies of which have been filed as exhibits to this
registration Statement of which this prospectus is a part.
COMMON STOCK
Holders of common stock are entitled to one vote for each share held on all
matters submitted to a vote of the stockholders, including the election of
directors. Accordingly, holders of a majority of the shares of common stock
entitled to vote in any election of directors may elect all of the directors
standing for election if they choose to do so. The certificate of incorporation
does not provide for cumulative voting for the election of directors. Holders of
common stock are entitled to receive ratably such dividends, if any, as may be
declared from time to time by the board of directors out of funds legally
available therefor, and shall be entitled to receive, pro rata, all assets of
Andover.Net available for distribution to such holders upon liquidation. Holders
of common stock have no preemptive, subscription or redemption rights.
PREFERRED STOCK
We are authorized to issue "blank check" preferred stock, which may be
issued from time to time in one or more series upon authorization by our board
of directors. The board of directors, without further approval of the
stockholders, is authorized to fix the dividend rights and terms, conversion
rights, voting rights, redemption rights and terms, liquidation preferences and
any other rights, preferences, privileges and restrictions applicable to each
series of the preferred stock. The issuance of preferred stock, while providing
flexibility in connection with possible acquisitions and other corporate
purposes, could, among other things, adversely affect the voting power of the
holders of common stock and, under certain circumstances, make it more difficult
for a third party to gain control of Andover.Net, discourage bids for our common
stock at a premium or otherwise adversely affect the market price of our common
stock. We currently have no plans to issue any preferred stock.
CERTAIN CERTIFICATE OF INCORPORATION, BYLAW AND STATUTORY ANTI-TAKEOVER
PROVISIONS AFFECTING STOCKHOLDERS
Classified Board. Our board of directors is divided into three classes.
Initially Class I will serve until the annual meeting of stockholders in 2000,
Class II will serve until the annual meeting of stockholders in 2001 and Class
III will serve until the annual meeting of stockholders in 2002. Following this
initial transition period, each class will serve for three years, with one class
being elected each year. Removal of a member of the board of directors with or
without cause requires a majority vote of the board of directors or of the
stockholders. A majority of the remaining directors then in office, though less
than a quorum, and the stockholders, are empowered to fill any vacancy on the
board of directors. A majority vote of the stockholders is required to alter,
amend or repeal the foregoing provisions.
Section 203 of Delaware Law. We are subject to the "business combination"
statute of the Delaware General Corporation Law. In general, this statute
prohibits a publicly held Delaware corporation from engaging in various
"business combination" transactions with any "interested stockholder" for a
period of three years after the date of the transaction in which the person
became an "interested stockholder," unless (a) the transaction is approved by
the board of directors prior to the date the interested stockholder obtained
such status, (b) upon consummation of the transaction which resulted in the
shareholder becoming an "interested stockholder," the "interested stockholder"
owned at least 85% of the voting stock of the corporation outstanding at the
time the transaction commenced, excluding for purposes of determining the number
of shares outstanding those shares owned by (x) persons who are directors and
also officers and
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(y) employee stock plans in which employee participants do not have the right to
determine confidentially whether shares held subject to the plan will be
tendered in a tender or exchange offer, or (c) on or subsequent to such date the
"business combination" is approved by the board of directors and authorized at
an annual or special meeting of stockholders by the affirmative vote of at least
66 2/3% of the outstanding voting stock which is not owned by the "interested
stockholder." A "business combination" includes mergers, asset sales and other
transactions resulting in a financial benefit to a stockholder. An "interested
stockholder" is a person who, together with affiliates and associates, owns (or
within three years, did own) 15% or more of a corporation's voting stock. By
virtue of our decision not to elect out of the statute's provisions, the statute
applies to us. None of our current stockholders is an "interested stockholder"
because their acquisition of shares was approved by our board of directors. The
statute could prohibit or delay the accomplishment of mergers or other takeover
or change in control attempts with respect to us and, accordingly, may
discourage attempts to acquire us.
Directors Liability. The certificate of incorporation provides that no
director shall be personally liable to us or our stockholders for monetary
damages for breach of fiduciary duty as a director notwithstanding any provision
of law imposing such liability, provided that, to the extent provided by
applicable law, the certificate of incorporation shall not eliminate the
liability of a director for (a) any breach of the director's duty of loyalty to
us or our stockholders, (b) acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law, (c) acts or omissions in
respect of certain unlawful dividend payments or stock redemptions or
repurchases or (d) any transaction from which such director derives improper
personal benefit. The effect of this provision is to eliminate the rights of
Andover.Net and our stockholders (through stockholders' derivative suits against
Andover.Net) to recover monetary damages against a director for breach of the
fiduciary duty of care as a director (including breaches resulting from
negligent or grossly negligent behavior) except in the situations described in
clauses (a) through (d) above. The limitations summarized above, however, do not
affect the ability of Andover.Net or our stockholders to seek non-monetary based
remedies, such as an injunction or rescission, against a director for breach of
his fiduciary duty nor would such limitations limit liability under the Federal
securities laws. Our bylaws provide that we shall, to the extent permitted by
Delaware law, as amended from time to time, indemnify and advance expenses to
the currently acting and former directors, officers, employees and agents of
Andover.Net or of another corporation, partnership, joint venture, trust or
other enterprise if serving at our request arising in connection with their
acting in such capacities.
Certain provisions described above may also have the effect of delaying
stockholder actions with respect to certain business combinations and the
election of new members to our board of directors. As such, the provisions could
have the effect of discouraging open market purchases of our common stock
because they may be considered disadvantageous by a stockholder who desires to
participate in a business combination with us or elect a new director to our
board.
REGISTRATION RIGHTS OF CERTAIN HOLDERS
Following this offering and the expiration of the lockup periods of 180
days for directors, officers and greater than 5% shareholders and 90 days for
other security holders, as described in "Plan of Distribution" and "Shares
Eligible for Future Sale," the holders of approximately 9,497,433 shares of
common stock will have certain rights to register those shares under the
Securities Act of 1933, as amended, pursuant to a third amended and restated
registration rights agreement. Subject to certain limitations in the agreement,
the holders of at least 50% of:
- the shares issued upon conversion of the Series B convertible preferred
stock; or
- the shares of common stock held by former holders of Series A redeemable
preferred stock
may require, on a total of three occasions, Andover.Net to use its best efforts
to register all such shares for resale to the public. These holders are
entitled, if Andover.Net registers any of its common stock for its own account
or for the account of other security holders, to include their shares of common
stock in such registration. These holders may also require Andover.Net to
register all or a portion of their shares of common stock in a registration
statement on Form S-3 when Andover.Net is eligible to use that form,
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provided that the proposed aggregate price to the public of any offering is at
least $1,000,000. Andover.Net will bear all fees, costs and expenses of these
registrations, other than underwriting discounts and commissions.
All of the registration rights described above are subject to conditions
and limitations, among them the right of the underwriters in any underwritten
offering to limit the number of shares of common stock to be included in a
registration. Registrations of any shares of common stock held by holders with
registration rights would result in these shares being freely tradable without
restriction under the Securities Act upon the effective date of the
registration. Under the agreement, Andover.Net has also agreed to indemnify the
holders of registration rights.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the common stock is BankBoston, N.A.
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SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, Andover.Net will have outstanding
15,000,000 shares of common stock. Of these shares, the 4,000,000 shares offered
hereby (4,600,000 shares if the Underwriters' over-allotment option is exercised
in full) will be freely tradable without restriction or further registration
under the Securities Act, unless purchased by "affiliates" of Andover.Net as
that term defined in Rule 144 described below. The remaining 11,000,000 shares
of common stock outstanding upon closing of the offering are "restricted
securities" as that term is defined in Rule 144.
In general, under Rule 144, as amended, a person who has beneficially owned
shares for at least one year is entitled to sell in "brokers' transactions" or
to market makers, within any three-month period commencing 90 days after the
date of this Prospectus, a number of shares that does not exceed the greater of
(i) one percent of the number of shares of common stock then outstanding,
approximately 150,000 shares immediately after the completion of this offering
or (ii) generally, the average weekly trading volume in our common stock during
the four calendar weeks preceding the required filing of a Form 144 with respect
to such sale. Sales under Rule 144 are generally subject to the availability of
current public information about Andover.Net. Under Rule 144(k), a person who is
not deemed to have been an affiliate of Andover.Net at any time during the 90
days preceding a sale, and who has beneficially owned the shares proposed to be
sold for at least two years, is entitled to sell such shares without having to
comply with the manner of sale, public information, volume limitation or notice
provisions of Rule 144. Under Rule 701, persons who purchase shares upon
exercise of options granted prior to the effective date of this offering are
entitled to sell such shares 90 days after the effective date of this offering
in reliance on Rule 144, without having to comply with the holding period
requirements of Rule 144 and, in the case of non-affiliates, without having to
comply with the public information, volume limitation or notice provisions of
Rule 144.
- Shares eligible for sale 90 days after the commencement of this offering
subject to the requirements of Rule 144 or Rule 701, not including those
shares subject to 180 day lockup agreements: 2,943,153
- Shares eligible for sale 90 days after the commencement of this offering,
pursuant to Rule 144(k): 2,590,404
- Additional shares of common stock subject to outstanding vested stock
options eligible for sale January 1, 2000, subject in some cases to
volume limitations: 913,869
Each of our directors, executive officers and holders of 5% or more of our
outstanding capital stock has agreed to certain restrictions on their ability to
sell, offer, contract or grant any option to sell, pledge, transfer or otherwise
dispose of shares of our common stock for a period of 180 days after the date of
this prospectus, without the prior written consent of WR Hambrecht + Co. Each of
the holders of less than 5% of our outstanding capital stock has agreed to
identical restrictions covering a period of 90 days from the date of this
prospectus.
- Shares subject to 180-day lockup agreements: 5,008,626
- Shares eligible for sale 180 days after commencement of this offering
subject to the requirements of Rule 144: 7,951,779
The holders of an aggregate of 9,497,433 shares of common stock or their
transferees are entitled to rights with respect to the registration of these
shares under the Securities Act. See "Description of Capital Stock-Registration
Rights of Certain Holders."
Prior to this offering, there has not been any public market for our common
stock. Future sales of substantial amounts of our common stock in the public
market could adversely affect the prevailing market prices and impair
Andover.Net's ability to raise capital through the sale of equity securities.
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PLAN OF DISTRIBUTION
In accordance with the terms of an underwriting agreement, WR Hambrecht +
Co., LLC, Advest, Inc. and DLJdirect Inc., as underwriters, will purchase from
Andover.Net the following respective number of shares of common stock at the
public offering price less the underwriting discounts and commissions described
on the cover page of this prospectus.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
- ----------- ---------
<S> <C>
WR Hambrecht + Co., LLC..................................... 1,333,334
Advest, Inc. ............................................... 1,333,333
DLJdirect Inc............................................... 1,333,333
---------
Total............................................. 4,000,000
=========
</TABLE>
The underwriting agreement provides that the obligations of the
underwriters are subject to conditions, including the absence of any material
adverse change in Andover.Net's business, and the receipt of certificates,
opinions and letters from Andover.Net and its counsel and independent
accountants. Subject to those conditions, the underwriters are committed to
purchase all shares of common stock offered if any of the shares are purchased.
The underwriters propose to offer the shares of common stock directly to
the public at the offering price set forth on the cover page of this prospectus,
as this price is determined by the process described below, and to certain
dealers at this price less a concession not in excess of $0.45 per share. Any
dealers that participate in the distribution of the common stock may be deemed
to be underwriters within the meaning of the Securities Act, and any discounts,
commissions or concessions received by them and any provided by the sale of the
shares by them might be deemed to be underwriting discounts and commissions
under the Securities Act. After the completion of the initial public offering of
the shares, the public offering price and other selling terms may be changed by
the underwriters. The underwriters have informed Andover.Net that they do not
intend to confirm discretionary sales in excess of 5% of the shares of common
stock offered by this prospectus.
The following tables show the per share and total underwriting discount to
be paid to the underwriters by Andover.Net in connection with this offering.
These amounts are shown assuming both no exercise and full exercise of the
over-allotment option.
<TABLE>
<CAPTION>
PAID BY ANDOVER.NET NO EXERCISE FULL EXERCISE
- ------------------- ----------- -------------
<S> <C> <C>
Per share................................................... $ 1.17 $ 1.17
Total....................................................... $4,680,000 $5,382,000
</TABLE>
The underwriting discount is an amount equal to the offering price per
share to the public of the common stock, less the amount paid by the
underwriters to Andover.Net per share of common stock. The underwriting discount
will be determined by a negotiation between Andover.Net and the underwriters
based on their agreement that the auction process described below should result
in lower distribution costs than traditional underwritings. These lower costs,
in turn, will be shared between Andover.Net and the underwriters. The
underwriting discount is 6.5%.
The expenses of the offering, exclusive of the underwriting discount,
include the Securities and Exchange Commission registration fee, the National
Association of Securities Dealers filing fee, the Nasdaq National Market listing
fee, printing expenses, legal fees and expenses, accounting fees and expenses,
road show expenses, Blue Sky fees and expenses, transfer agent and registrar
fees, and other miscellaneous fees. We estimate that these fees and expenses
will be an aggregate of approximately $1,000,000. These fees and expense are
payable entirely by us.
The public offering price described on the cover page of this prospectus
will be based on the results of an auction process, rather than solely through
negotiations between Andover.Net and the underwriters.
The method of distribution being used by the underwriters in this offering
differs from that traditionally employed in firm commitment underwritten public
offerings. In particular, the public offering price and
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allocation of shares will be determined primarily by an auction process
conducted by the underwriters and other securities dealers participating in this
offering.
The following describes how the auction process works:
BEFORE THE REGISTRATION STATEMENT BECOMES EFFECTIVE
- Before the registration statement relating to this offering becomes
effective, the underwriters and participating dealers will solicit
conditional offers to purchase from prospective investors through the
Internet, telephone and facsimile. The conditional offers to purchase
will specify the number of shares the potential investor proposes to
purchase and the price the potential investor is willing to pay for the
shares.
- At least one business day and not more than seven days before the
registration statement relating to this offering is expected to become
effective, the underwriters and participating dealers will contact
potential investors who have submitted conditional offers by one of the
following means of communication selected by WR Hambrecht + Co unless a
specific means of communication is expressly requested by a potential
investor: e-mail, telephone, voice mail or facsimile. This notice will:
- advise potential investors that the registration statement for this
offering may be declared effective shortly,
- suggest that they should carefully consider the conditional offer
that they have previously made, and
- request that they affirmatively confirm their previous conditional
offer to purchase the shares made prior to effectiveness of the
registration statement and indicate that if they do not confirm their
previous conditional offer, then their conditional offer will be
deemed withdrawn.
- Once a potential investor affirmatively confirms its previous
conditional offer to purchase, the confirmation will remain valid for
seven days from the time the request for confirmation was sent by the
underwriters unless subsequently withdrawn by the potential investor.
- If WR Hambrecht + Co anticipates that the registration statement will
not become effective and conditional offers will not be accepted within
the seven day period described above, the underwriters and participating
dealers will send out another confirmation e-mail, or otherwise contact
potential investors by another means of communication if expressly
requested by a potential investor, before the revised time that WR
Hambrecht + Co expects the registration statement to become effective.
This confirmation will indicate that more than seven days are expected
to pass before the registration statement is expected to become
effective and conditional offers are expected to be accepted, and will
offer potential investors the opportunity to enter a new conditional
offer to purchase or to re-affirm existing conditional offers to
purchase.
- All conditional offers to purchase that are not confirmed before the
time specified by the underwriters, or, if the time is not specified, by
the close of the auction, will be deemed withdrawn.
- If the expected price range for the public offering price is changed,
then each potential investor will receive a notice of the change and a
request that they affirmatively re-confirm their previous conditional
offer to purchase the shares made prior to effectiveness of the
registration statement and indicating that if they do not re-confirm
their previous conditional offer, then their conditional offer will be
deemed withdrawn.
- The auction will close following effectiveness of the registration
statement, at which time the underwriters and participating dealers will
no longer take new or revised conditional offers to purchase. Following
the closing of the auction, the clearing price will be set based on the
results of all bids made prior to closing of the auction. The clearing
price will not necessarily be the public offering price, which will be
determined as described in "Determination of public offering price"
below. The clearing price as determined by the auction will determine
the allocation of shares to potential investors, regardless of the
public offering price.
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- Potential investors will receive advance notice of the closing of the
auction in the notice of effectiveness described below in "After the
Registration Statement becomes effective."
- A conditional offer to purchase, even if re-confirmed after originally
made by a potential investor, is not binding on a potential investor
until, and can be withdrawn by a potential investor at any time prior
to, the potential investor is notified that the conditional offer has
been accepted.
- The closing of the auction may be later than the time specified in the
notification of effectiveness of the registration statement.
- Potential investors may at any time expressly request that all, or any
specific, communications between them and the underwriters and
participating dealers be made by a specific means of communication.
AFTER THE REGISTRATION STATEMENT BECOMES EFFECTIVE
- After the registration statement becomes effective, the underwriters
will contact by e-mail, telephone, voice mail or facsimile all bidders
who have affirmatively confirmed their conditional offers. This notice
will inform these bidders that the registration statement has become
effective and that WR Hambrecht + Co can accept his or her confirmed
conditional offer to purchase once the auction has closed and the
offering has been priced by the underwriters and Andover.Net.
- The auction will close after the registration statement becomes
effective at a time agreed to by Andover.Net and WR Hambrecht + Co, but
not before at least one hour has elapsed from the time the notice
informing investors that the registration statement has become effective
has been sent.
- The actual time following the one hour notification period described
above at which the auction closes will be determined by Andover.Net and
WR Hambrecht + Co based on general market conditions during the period
after the registration statement becomes effective.
- Potential investors will be able to withdraw their conditional offers at
any time after the registration statement has become effective but
before the conditional offer has been accepted by notifying WR Hambrecht
+ Co or a participating dealer.
- New conditional offers to purchase may be placed at any time before the
auction closes, including following the effectiveness of the
registration statement. Any conditional offer to purchase which is
within the public offering price range will be deemed valid without
requiring any reconfirmation by the potential investor. If the public
offering price range were changed, then reconfirmation by the potential
investor would be required.
- WR Hambrecht + Co or a participating dealer will notify successful
bidders that their confirmed conditional offers to purchase have been
accepted.
- Once the auction closes and a clearing price is set as described below,
WR Hambrecht + Co will accept the conditional offers to purchase from
those bidders whose bid is at or above the clearing price but may accept
a lesser number of shares than the number included in the conditional
offers to purchase submitted by potential investors.
- If the public offering price range is changed after a potential investor
affirmatively confirms an offer to purchase, or if the public offering
price is outside the public offering range previously provided to the
potential investor in the prospectus, the underwriters and participating
dealers will notify potential investors of the change and that
conditional offers will not be accepted until the potential investor has
again re-confirmed its conditional offer regardless of whether the
potential investor's initial conditional offer to purchase was above,
below or at the public offering price.
DETERMINATION OF PUBLIC OFFERING PRICE
The public offering price for this offering will ultimately be determined
by negotiation between the underwriters and Andover.Net after the auction closes
and will not necessarily bear any direct relationship to Andover.Net's assets,
current earnings or book value or to any other established criteria of value,
although these factors were considered in establishing the initial public
offering price range. Prior to the offering, there has been no public market for
Andover.Net's common stock. The principal factor in establishing the public
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offering price will be the clearing price resulting from the auction that equals
the highest price contained in valid conditional offers at which all of the
shares contained in valid conditional offers, not to exceed 4,600,000 shares,
which includes shares that may be purchased by the underwriters to cover any
overallotments, may be sold to potential investors. For example, if the
underwriters receive valid conditional offers to purchase 6,000,000 shares, the
clearing price will be determined by the highest price at which 4,600,000 shares
can be sold. Alternatively, if the underwriters receive valid conditional offers
to purchase 4,300,000 shares, the clearing price will be determined by the
highest price at which all 4,300,000 shares can be sold. Finally, if the
underwriters receive valid conditional offers to purchase 4,000,000 shares, the
clearing price will be determined by the highest price at which all 4,000,000
shares can be sold.
Factors considered in determining the public offering price range include:
- market conditions;
- the industry in which Andover.Net operates;
- an assessment of Andover.Net's management;
- Andover.Net's operating results;
- Andover.Net's capital structure;
- the business potential of Andover.Net; and
- the demand for similar securities of comparable companies.
The public offering price may be lower, but will not be higher, than the
clearing price based on negotiations between the underwriters and Andover.Net.
However, the clearing price will always determine the allocation of shares to
potential investors. Therefore, if the public offering price is below the
clearing price, all conditional offers that are below the clearing price will be
rejected even if they are higher than the public offering price. If sufficient
conditional offers are not received, or if Andover.Net does not consider the
clearing price to be adequate, or if the underwriters and Andover.Net are not
able to reach agreement on the public offering price, then Andover.Net and the
underwriters will either postpone or cancel this offering. Alternatively,
Andover.Net and the underwriters may file a post-effective amendment to the
registration statement in order to conduct a new auction.
The following simplified example illustrates how the clearing price will be
determined through the auction process:
- Company X offers to sell 100 shares in its public offering through the
auction process. WR Hambrecht + Co, on behalf of Company X, receives
five conditional offers to purchase, all of which are kept confidential
until the auction closes.
- The first conditional offer to purchase is to pay $10 per share for 10
shares. The second conditional offer to purchase is to pay $9 per share
for 30 shares. The third conditional offer to purchase is to pay $8 per
share for 60 shares. The fourth conditional offer to purchase is to pay
$8 per share for 40 shares. The fifth conditional offer to purchase is
to pay $7 per share for 80 shares.
- Assuming that all of these conditional offers to purchase are confirmed
and not withdrawn or modified before the auction closes, and assuming
that no additional conditional offers to purchase are received, the
clearing price used to determine the public offering price would be $8
per share which equals the highest price at which all 100 shares offered
may be sold to potential investors who have submitted valid bids.
However, the shares may be sold at a price below $8 per share based on
negotiations between the underwriters and Andover.Net.
- If the public offering price is $8 per share, the underwriters will only
confirm conditional offers to purchase that were made at or above $8 per
share. If the clearing price is $8 per share but the public offering
price is less than $8 per share, no conditional offers to purchase made
at a price of less than $8 per share will be accepted.
- The two potential investors with the highest conditional offers to
purchase would receive all of the shares they requested, totaling 40
shares. The next two potential investors would receive the remaining 60
shares in proportion to the amounts for which they bid, or 36 and 24
shares each. The
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potential investor with the lowest conditional offer to purchase would
not receive any shares in this example.
REQUIREMENTS FOR VALID CONDITIONAL OFFERS TO PURCHASE
Valid conditional offers to purchase are those that meet the requirements,
including eligibility, account status and size, established by the underwriters
or participating dealers. In order to open a brokerage account with WR Hambrecht
+ Co, potential investors must deposit $2,000 in their account. In addition,
once the registration statement becomes effective and the auction closes, a
prospective investor submitting a conditional offer to purchase through a WR
Hambrecht + Co brokerage account must have an account balance equal to or in
excess of the amount of its conditional offer to purchase or its conditional
offer will not be accepted by WR Hambrecht + Co. No funds will be transferred to
the underwriters, however, until the acceptance of the conditional offer to
purchase and the subsequent closing of this offering. Conditions for valid
conditional offers to purchase, including eligibility standards and account
funding requirements of other underwriters or participating dealers other than
WR Hambrecht + Co, may vary.
THE CLOSING OF THE AUCTION AND ALLOCATION OF SHARES
The auction will close on a date estimated and publicly disclosed in
advance by the underwriters on the web site of WR Hambrecht + Co at
www.wrhambrecht.com or www.openipo.com. The 4,000,000 shares offered hereby, or
4,600,000 shares if the underwriters' overallotment option is exercised in full,
will be purchased from Andover.Net by the underwriters and sold through the
underwriters and participating dealers to investors who have submitted offers to
purchase at or higher than the clearing price. These investors will be notified
by e-mail, telephone, voice mail, facsimile or mail as soon as practicable
following the closing of the auction that their conditional offers to purchase
have been accepted.
The number of shares sold to an investor submitting a conditional offer to
purchase precisely at the clearing price may be subject to a pro rata reduction
depending on the number of other investors submitting identical bids.
Each participating dealer has agreed with the underwriters to sell shares
they purchase from the underwriters in accordance with the auction process
described above, unless the underwriters otherwise consent. The underwriters
reserve the right to reject bids that they deem manipulative or disruptive in
order to facilitate the orderly completion of this offering, and they reserve
the right, in exceptional circumstances, to alter this method of allocation as
they deem necessary to ensure a fair and orderly distribution of Andover.Net's
shares. For example, large orders may be reduced to ensure a public distribution
and conditional offers to purchase may be rejected by the underwriters or
participating dealers based on eligibility or creditworthiness criteria.
Price and volume volatility in the market for Andover.Net's common stock
may result from the somewhat unique nature of the proposed plan of distribution.
Price and volume volatility in the market for Andover.Net's common stock after
the completion of this offering may adversely affect the market price of
Andover.Net's common stock.
Andover.Net has granted to the underwriters an option, exercisable no later
than 30 days after the date of this prospectus, to purchase up to an aggregate
of 600,000 additional shares of common stock at the offering price, less the
underwriting discount, set forth on the cover page of this prospectus. To the
extent that the underwriters exercise this option, the underwriters will have a
firm commitment to purchase the additional shares, and Andover.Net will be
obligated to sell the additional shares to the underwriters. The underwriters
may exercise the option only to cover over-allotments made in connection with
the sale of shares offered. The underwriting agreement provides that Andover.Net
will indemnify the underwriters against specified liabilities, including
liabilities under the Securities Act, or contribute to payments that the
underwriters may be required to make.
Andover.Net has agreed not to offer, sell, contract to sell, or otherwise
dispose of any shares of common stock, or any options or warrants to purchase
common stock other than the shares of common stock or options to acquire common
stock issued under Andover.Net's stock option plan(s), for a period of 90 days
after the date of this prospectus, except with the prior written consent of WR
Hambrecht + Co. Each of our directors, executive officers and holders of 5% or
more of our outstanding capital stock has agreed to certain
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restrictions on their ability to sell, offer, contract or grant any option to
sell, pledge, transfer or otherwise dispose of shares of our common stock for a
period of 180 days after the date of this prospectus, without the prior written
consent of WR Hambrecht + Co. Each of the holders of less than 5% of our
outstanding capital stock has agreed to identical restrictions covering a period
of 90 days from the date of this prospectus.
In connection with the offering, persons participating in the offering may
purchase and sell shares of common stock on the open market. These transactions
may include short sales, stabilizing transactions in accordance with Rule 104 of
Regulation M under the Securities Exchange Act of 1934, as amended, the Exchange
Act, and purchases to cover positions created by short sales. Short sales
involve the sale by the underwriters of a greater number of shares than they are
required to purchase in the offering which creates a syndicate short position.
Stabilizing transactions consist of certain bids or purchases made for the
purpose of preventing or retarding a decline in the market price of the common
stock. The underwriters also may impose a penalty bid. This occurs when a
particular underwriter repays to the underwriters a portion of the underwriting
discount received by it because the representative has repurchased shares sold
by or for the account of such underwriter in stabilizing or short covering
transactions. These activities by the underwriters may stabilize, maintain or
otherwise affect the market price of the common stock. As a result, the price of
the common stock may be higher than the price that otherwise might exist in the
open market. If these activities are commenced, they may be discontinued by the
underwriters at any time. These transactions may be effected on the Nasdaq
National Market, in the over-the-counter market or otherwise.
Persons participating in this offering may also engage in passive market
making transactions in the common stock on the Nasdaq National Market. Passive
market making consists of displaying bids on the Nasdaq National Market limited
by the prices of independent market makers and affecting purchases limited by
such prices and in response to order flow. Rule 103 of Regulation M promulgated
by the SEC limits the amount of net purchases that each passive market maker may
make and the displayed size of each bid.
Passive market making may stabilize the market price of the common stock at
a level above that which might otherwise prevail in the open market and, if
commenced, may be discontinued at any time.
WR Hambrecht + Co currently intends to act as a market maker for the common
stock following this offering. However, WR Hambrecht + Co is not obligated to do
so and may discontinue any market making at any time.
WR Hambrecht + Co is an investment banking firm formed as a limited
liability company in February 1998. In addition to this offering, WR Hambrecht +
Co has engaged in the business of public and private equity investing and
financial advisory services since its inception. The manager of WR Hambrecht +
Co, William R. Hambrecht, has 40 years of experience in the securities industry.
LEGAL MATTERS
The validity of the shares of common stock offered hereby will be passed
upon for Andover.Net by Hutchins, Wheeler & Dittmar, A Professional Corporation,
Boston, Massachusetts. Certain members of Hutchins, Wheeler & Dittmar may be
deemed to have a beneficial interest in an aggregate of 5,747 shares of common
stock. David P. Kreisler, a member of Hutchins, Wheeler and Dittmar, is also the
Secretary of Andover.Net. Certain legal matters in connection with the offering
will be passed upon for the underwriters by Willkie Farr & Gallagher, New York,
New York.
EXPERTS
The financial statements of (a) Andover.Net, Inc. as of September 30, 1998
and 1999, and for each of the three years ending September 30, 1997, 1998 and
1999, (b) the financial statements of BlockStackers, Inc. as of December 31,
1998 and for the period from Inception (August 24, 1998) through December 31,
1998 and (c) the financial statements of Eclipse Digital Imaging, Inc. as of
December 31, 1998 and for the year then ended, included in the registration
statement of which this prospectus forms a part have been audited by
65
<PAGE> 72
Arthur Andersen LLP, independent public accountants, as indicated in their
reports with respect thereto, and are included herein in reliance upon the
authority of said firm as experts in giving said reports.
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement on Form S-1 with the Securities and
Exchange Commission, or SEC, for the common stock we are offering by this
prospectus. This prospectus does not contain all of the information set forth in
the registration statement and the exhibits and schedules thereto. For further
information with respect to us and our common stock, we make reference to the
registration statement and to the exhibits and schedules filed therewith.
Statements contained in this prospectus as to the contents of any contract or
any other document referred to are not necessarily complete, and in each
instance, reference is made to the copy of such contract or other document filed
as an exhibit to the registration statement, each such statement being qualified
in all respects by such reference. A copy of the registration statement may be
inspected by anyone without charge at the SEC's principal office in Washington,
D.C., and copies of all or any part of the registration statement may be
obtained from the Public Reference Section of the SEC, 450 Fifth Street, N.W.,
Washington, D.C. 20549, upon payment of certain fees prescribed by the SEC.
Please call the SEC at 1-800-SEC-0330 for further information on the operation
of the public reference rooms. The SEC maintains a web site that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the SEC. The address of the web site
is http://www.sec.gov. Upon completion of the offering, we will be subject to
the information reporting requirements of the Securities Exchange Act of 1934,
as amended and, in accordance therewith, will file reports, proxy statements and
other information with the SEC.
We intend to furnish our stockholders with annual reports containing
financial statements audited by our independent public accountants and quarterly
reports for the first three fiscal quarters of each fiscal year containing
unaudited interim financial information.
66
<PAGE> 73
ANDOVER.NET, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
ANDOVER.NET, INC.
Report of Independent Public Accountants.................... F-2
Balance Sheets as of September 30, 1998 and 1999............ F-3
Statements of Operations for the Years Ended September 30,
1997, 1998 and 1999....................................... F-4
Statements of Stockholders' Equity (Deficit) for the Years
Ended September 30, 1997, 1998 and 1999................... F-5
Statements of Cash Flows for the Years Ended September 30,
1997, 1998 and 1999....................................... F-6
Notes to Financial Statements............................... F-7
ANDOVER.NET, INC. PRO FORMA UNAUDITED FINANCIAL INFORMATION
Introduction to Pro Forma Financial Information............. F-22
Pro Forma Combined Statement of Operations for the Year
Ended September 30, 1999.................................. F-23
BLOCKSTACKERS, INC.
Report of Independent Public Accountants.................... F-25
Balance Sheets as of December 31, 1998...................... F-26
Statements of Operations for the Period from Inception
(August 24, 1998) through December 31, 1998............... F-27
Statements of Stockholders' Equity (Deficit) from Inception
(August 24, 1998) through December 31, 1998............... F-28
Statements of Cash Flows for the Period from Inception
(August 24, 1998) through December 31, 1998............... F-29
Notes to Financial Statements............................... F-30
ECLIPSE DIGITAL IMAGING, INC.
Report of Independent Public Accountants.................... F-33
Balance Sheets as of December 31, 1998...................... F-34
Statements of Operations for the Year Ended December 31,
1998...................................................... F-35
Statements of Stockholders' Equity.......................... F-36
Statements of Cash Flows for the Year Ended December 31,
1998...................................................... F-37
Notes to Financial Statements............................... F-38
</TABLE>
F-1
<PAGE> 74
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Andover.Net, Inc.:
We have audited the accompanying balance sheets of Andover.Net, Inc. (a Delaware
corporation) as of September 30, 1998 and 1999 and the related statements of
operations, stockholders' equity (deficit) and cash flows for the three years
ended September 30, 1997, 1998 and 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 Andover.Net, Inc. as of
September 30, 1998 and 1999 and the results of its operations and cash flows for
the three years ended September 30, 1997, 1998 and 1999, in conformity with
generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
October 22, 1999
F-2
<PAGE> 75
ANDOVER.NET, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30,
---------------------------------------
1998 1999 PRO FORMA
------------- ------- -----------
(NOTE 2(b))
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.............................. $ 196 $ 9,871 $ 9,871
Accounts receivable, net of allowance of $13 and $100
as of September 30, 1998 and 1999, respectively..... 308 539 539
Other current assets................................... 6 126 126
------- ------- --------
Total current assets........................... 510 10,536 10,536
Property and equipment, net.............................. 23 218 218
Other assets:
Intangible assets...................................... -- 3,166 3,166
Deferred offering costs................................ -- 485 485
Other.................................................. -- 35 35
------- ------- --------
-- 3,686 3,686
------- ------- --------
$ 533 $14,440 $ 14,440
======= ======= ========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable....................................... $ 121 $ 301 $ 301
Accrued expenses....................................... 159 1,567 2,014
Long-term debt -- current portion...................... -- 654 654
------- ------- --------
Total current liabilities...................... 280 2,522 2,969
Long-term debt........................................... -- 762 762
Commitments and contingencies (Note 8)
Series A redeemable preferred stock, at redemption value
(Note 9(b))............................................ 2,362 4,800 4,353
Series B redeemable convertible preferred stock at
redemption value (Note 9(c))........................... -- 12,669 --
Stockholders' equity (deficit):
Common stock, $0.01 par value -- authorized -- 100,000
shares; issued and outstanding -- 5,119 shares at
September 30, 1998, 7,983 shares at September 30,
1999 and 11,000 pro forma at September 30, 1999..... 51 80 110
Additional paid in capital............................. 105 6,934 31,787
Deferred compensation.................................. -- (5,156) (5,156)
Accumulated deficit.................................... (2,265) (8,171) (20,385)
------- ------- --------
Total stockholders' equity (deficit)........... (2,109) (6,313) 6,356
------- ------- --------
$ 533 $14,440 $ 14,440
======= ======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE> 76
ANDOVER.NET, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
-----------------------------------
1997 1998 1999
--------- --------- ---------
<S> <C> <C> <C>
Net revenues:
Advertising............................................. $ 469 $ 1,290 $ 1,451
Barter advertising...................................... -- -- 570
Software product........................................ 272 -- 100
--------- --------- ---------
Total revenues.................................. 741 1,290 2,121
--------- --------- ---------
Cost of revenues:
Editorial content and related........................... 136 327 731
Software product........................................ 167 -- 2
--------- --------- ---------
Total cost of revenues.......................... 303 327 733
--------- --------- ---------
Gross profit.............................................. 438 963 1,388
Operating expenses:
Sales and marketing..................................... 496 744 1,382
General and administrative.............................. 338 360 1,480
Research and development................................ 194 304 770
Barter advertising...................................... -- -- 570
Amortization of deferred compensation................... -- -- 1,023
Amortization of intangible assets....................... -- -- 405
Compensation expense related to acquisitions............ -- -- 813
--------- --------- ---------
Total operating expenses........................ 1,028 1,408 6,443
--------- --------- ---------
Loss from operations............................ (590) (445) (5,055)
Interest income........................................... 1 20 88
Interest expense.......................................... (75) (49) (466)
--------- --------- ---------
Net loss........................................ $ (664) $ (474) $ (5,433)
--------- --------- ---------
Accrued dividends on redeemable preferred stock........... 41 134 354
--------- --------- ---------
Net loss attributable to common stockholders.... $ (705) $ (608) $ (5,787)
========= ========= =========
Basic and diluted net loss per share applicable to common
stockholders (Note 2(j))................................ $ (0.29) $ (0.12) $ (0.78)
========= ========= =========
Basic and diluted weighted average shares
outstanding............................................. 2,468 5,110 7,419
========= ========= =========
Pro forma net loss per share (Note 2(j)).................. $ (0.12) $ (0.75)
========= =========
Pro forma basic and diluted weighted average shares
outstanding............................................. 5,110 7,703
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 77
ANDOVER.NET, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
COMMON STOCK
.01 PAR VALUE
------------------ ADDITIONAL TOTAL
NUMBER OF DEFERRED PAID-IN ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT COMPENSATION CAPITAL DEFICIT EQUITY (DEFICIT)
--------- ------ ------------ ---------- ----------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Balance, September 30, 1996.................. 1,763 $ 18 $ -- $ -- $ (813) $ (795)
Recapitalization of preferred stock........ 1,709 17 -- -- (139) (122)
Issuance of common stock................... 1,206 12 -- 78 -- 90
Issuance costs related to Series A
redeemable preferred stock............... -- -- -- -- (41) (41)
Conversion of convertible promissory notes
to Series A redeemable preferred stock
and common stock......................... 402 4 -- 27 -- 31
Exercise of stock options.................. 15 -- -- -- -- --
Net loss................................... -- -- -- -- (664) (664)
------ ---- ------- ------- -------- -------
Balance, September 30, 1997.................. 5,095 51 -- 105 (1,657) (1,501)
Accrued dividends on Series A redeemable
preferred stock.......................... -- -- -- -- (134) (134)
Exercise of stock options.................. 24 -- -- -- -- --
Net loss................................... -- -- -- -- (474) (474)
------ ---- ------- ------- -------- -------
Balance, September 30, 1998.................. 5,119 51 -- 105 (2,265) (2,119)
Accrued dividends on Series A redeemable
preferred stock.......................... -- -- -- -- (313) (313)
Issuance of common stock................... 2,636 26 -- 650 -- 676
Issuance costs related to Series A
redeemable preferred stock............... -- -- -- -- (34) (34)
Issuance costs related to Series B
redeemable convertible preferred stock... -- -- -- -- (85) (85)
Accrued dividends on Series B redeemable
convertible preferred stock.............. -- -- -- -- (41) (41)
Exercise of stock options.................. 228 3 -- -- -- 3
Deferred compensation related to stock
options.................................. -- -- (6,179) 6,179 -- --
Amortization of deferred compensation...... -- -- 1,023 -- -- 1,023
Net loss................................... -- -- -- -- (5,433) (5,433)
------ ---- ------- ------- -------- -------
Balance, September 30, 1999.................. 7,983 $ 80 $(5,156) $ 6,934 $ (8,171) $(6,313)
------ ---- ------- ------- -------- -------
Conversion of Series B redeemable
convertible preferred stock to common
stock (unaudited)........................ 3,017 30 -- 24,853 (12,214) 12,669
------ ---- ------- ------- -------- -------
Pro forma balance, September 30, 1999
(unaudited) (Note 2(b)).................... 11,000 $110 $(5,156) $31,787 $(20,385) $ 6,356
====== ==== ======= ======= ======== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 78
ANDOVER.NET, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30
--------------------------
1997 1998 1999
------ ----- -------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $ (664) $(474) $(5,433)
Adjustments to reconcile net loss to net cash used in
operating activities --
Depreciation and amortization.......................... 6 9 432
Amortization of deferred compensation.................. -- -- 1,023
Interest expense of beneficial conversion of
convertible notes payable to stockholders............. -- -- 438
Changes in operating assets and liabilities --
Accounts receivable.................................. (91) (136) (231)
Other current assets................................. 107 69 (38)
Accounts payable..................................... 45 (120) 180
Accrued expenses..................................... 68 78 1,091
------ ----- -------
Net cash used in operating activities............. (529) (574) (2,538)
------ ----- -------
Cash flows from investing activities:
Cash paid for acquisitions................................ -- -- (2,117)
Purchases of property and equipment....................... (8) (17) (242)
Increase in other assets.................................. -- -- (285)
------ ----- -------
Net cash used in investing activities............. (8) (17) (2,644)
------ ----- -------
Cash flows from financing activities:
Proceeds from the issuance of Series B redeemable
convertible preferred stock............................ -- -- 10,015
Proceeds from the issuance of AAT Series B convertible
preferred stock........................................ 10 -- --
Proceeds from the issuance of Series A redeemable
preferred stock, net of issuance costs................. 769 -- 2,091
Proceeds from issuance of common stock.................... 90 -- 679
Proceeds from exercise of ATT Series B warrants........... 103 -- --
Payments on related party notes payable to stockholders... (26) (50) (18)
Proceeds from convertible notes payable to stockholders... -- -- 2,090
Proceeds from convertible notes payable to stockholders
and issuance of Series A redeemable preferred stock and
common stock........................................... 300 -- --
------ ----- -------
Net cash provided by (used in) financing
activities..................................... 1,246 (50) 14,857
------ ----- -------
Net increase (decrease) in cash and cash equivalents........ 709 (641) 9,675
Cash and cash equivalents, beginning of period.............. 128 837 196
------ ----- -------
Cash and cash equivalents, end of period.................... $ 837 $ 196 $ 9,871
====== ===== =======
Supplemental disclosure of cash flow information:
Cash paid for interest.................................... $ 48 $ 27 $ 2
====== ===== =======
Supplemental disclosure of noncash financing transactions:
Conversion of notes payable to Series A redeemable
preferred stock and common stock....................... $ 100 $ -- $ --
====== ===== =======
Conversion of convertible notes payable to stockholders
and accrued interest to Series B redeemable convertible
preferred stock........................................ $ -- $ -- $ 2,124
Notes payable and accrued interest recorded in connection
with acquisitions...................................... $ -- $ -- $ 1,463
====== ===== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE> 79
ANDOVER.NET, INC.
NOTES TO FINANCIAL STATEMENTS
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(1) OPERATIONS
Andover.Net, Inc. (Andover.Net) (formerly Andover Advanced Technologies,
Inc.) is a commercial internet web site designer and developer. Andover.Net has
developed a network of web sites providing news, information, products and
services to technology-oriented users. Andover.Net sells advertising to
companies whose products and services target these users. Prior to September 30,
1996, Andover.Net was a software publisher of multimedia and Internet tools. In
fiscal 1997, Andover.Net made the transition from a software publisher to web
site publisher, focusing all development and sales efforts on Web publishing
after March 31, 1997. The Company was originally incorporated in Massachusetts
in 1992. In September 1999, Andover Advanced Technologies, Inc. (AAT) was merged
into its wholly owned subsidiary, Andover.Net and changed its fiscal year-end to
December 31.
Since its inception, Andover.Net has incurred a significant accumulated
deficit and is devoting substantially all of its efforts toward marketing its
web sites and products. Andover.Net is subject to the risks associated with
emerging, technology-oriented companies with a limited operating history,
including a developing business model, limited history of commerce on the
Internet, initial and continued market acceptance of Andover.Net's web sites,
competition, the ability to successfully market its current web sites, and the
continued ability to manage and fund Andover.Net's future operations.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying financial statements reflect the application of certain
significant accounting policies as described in this note and elsewhere in the
notes to financial statements.
(a) Use of Estimates in the 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 net revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
(b) Unaudited Pro Forma Presentation
The unaudited pro forma balance sheet as of September 30, 1999 and the pro
forma net loss per share for the year ended September 30, 1999 gives effect to
the automatic conversion of the Series B convertible preferred stock into
3,017,133 shares of common stock upon the closing of the initial public
offering, the non recurring interest charge of $12.2 million (which has not been
reflected in the pro forma statement of operations) related to the beneficial
conversion feature of the Series B preferred stock and the classification of the
dividend payable of $447,000 for the Series A redeemable preferred stock as a
current liability. The effects of the Slashdot.org, Animation Factory and
Freshmeat.net acquisitions are included in the actual September 30, 1999 balance
sheet data below, as such acquisitions were consummated before September 30,
1999.
(c) Revenue Recognition
Advertising revenues are derived from the sale of advertising space on
Andover.Net's various online services. Advertising revenues are recognized over
the period in which the advertisements are displayed, provided that no
significant obligations remain and collection of the receivable is reasonably
assured. Andover.Net obligations typically include guarantees of a minimum
number of "impressions" (times that an advertisement is viewed by users of
Andover.Net's online services over a specified period of time). To the extent
that minimum guaranteed impressions are not met, Andover.Net does not recognize
the corresponding revenues until the guaranteed impressions are achieved.
Revenues from barter transactions are recorded at the lower of the
estimated fair value of the advertisements, goods or services received or the
estimated fair value of the advertisements given.
F-7
<PAGE> 80
ANDOVER.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Andover.Net records barter revenues only on the portion of the barter
transactions which, Andover.Net is able to determine fair value based on
comparable cash transactions and for which the advertiser has the financial
ability to pay cash. Otherwise, barter revenue is not recognized. Revenues from
barter transactions, representing advertising space given, is recognized as
income when advertisements are delivered on Andover.Net's web site. Barter
expense, representing advertising space received, is recognized when our
advertisements are run on other companies' web sites, which is typically in the
same period when the related barter revenue is recognized. Andover.Net did not
recognize any barter revenue for the years ended September 30, 1997 and 1998 and
recognized $570,000 of barter revenue for the year ended September 30, 1999.
Revenue from the sale of software animation products, are recognized upon
shipment of the products, net of estimated returns. There is no technical
support provided for any animation products.
Andover.Net derived revenue from web related software products during 1997
for use on desktop computers. Revenue from the licensing of software products
was recognized when the products were shipped, as there were no significant post
delivery obligations. Andover.Net provided for estimated returns and warranty
costs at the time of sale. Andover.Net did not offer maintenance and support on
its products. There were no significant software sales after fiscal 1997.
(d) Cost of Revenues
Cost of revenues includes expenses associated with editorial content,
communication infrastructure, including servers equipped with a redundant array
of interdependent dishes and local balancing switches for our web site data
center and website hosting.
(e) Sales and Marketing Expenses
Sales and marketing expenses consist primarily of costs, including salaries
and sales commissions, of all personnel involved in the sales process and
related expenses. All costs of advertising are expensed as incurred. Advertising
expense totaled approximately $241,000, $546,000 and $794,000 for the years
ended September 30, 1997, 1998 and 1999, respectively.
(f) Research and Development
Research and development expenses include all research and development
related direct costs, primarily salaries for Andover.Net research and
development personnel and outside contractors related to the development of new
web sites, improved design of existing web sites and related infrastructure.
(g) Cash and Cash Equivalents
Cash equivalents are stated at cost, which approximates fair market value.
Andover.Net considers highly liquid investments with original maturities of
ninety days or less to be cash equivalents and includes money market accounts
and commercial paper that are readily convertible to cash.
(h) Property and Equipment
Andover.Net provides for depreciation using the straight-line method, by
charges to operations in amounts estimated to allocate the cost of property and
equipment over their estimated useful lives.
<TABLE>
<CAPTION>
ESTIMATED
ASSET CLASSIFICATION USEFUL LIFE
- -------------------- -------------
<S> <C>
Computer equipment..................................... 3 years
Furniture and fixtures................................. 7 years
Office equipment....................................... 5 years
Leasehold improvements................................. Life of lease
</TABLE>
F-8
<PAGE> 81
ANDOVER.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Property and equipment consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30,
-------------------------
1998 1999
------------- --------
(IN THOUSANDS)
<S> <C> <C>
Computer equipment.................................... $ 43 $180
Furniture and fixtures................................ 13 51
Office equipment...................................... -- 23
Leasehold improvements................................ -- 44
---- ----
56 298
Less -- Accumulated depreciation...................... (33) (80)
---- ----
$ 23 $218
==== ====
</TABLE>
(i) Concentration of Credit Risk
Andover.Net has no significant off-balance sheet concentration of credit
risks such as foreign exchange contracts, options contracts or other foreign
hedging arrangements. Financial instruments that potentially expose Andover.Net
to concentrations of credit risk consist primarily of cash equivalents, accounts
receivable, accounts payable, notes payable and redeemable preferred stock.
Concentrated credit risk with respect to accounts receivable is limited to
certain customers to whom Andover.Net makes substantial sales. Andover.Net
performs periodic evaluations of its customers and generally does not require
collateral.
The following table summarizes the number of customers that individually
comprise greater than 10% of total accounts receivable and total net revenue for
the periods presented:
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
-------------------------
1997 1998 1999
----- ----- -----
<S> <C> <C> <C>
Revenue --
Customer A................................................ * 26% *
Customer B................................................ * 20% *
Customer C................................................ 21% 10% *
Customer D................................................ * * *
Customer E................................................ * * 17%
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Accounts Receivable --
Customer A.................................................. 17% 21% 13%
Customer B................................................ * * *
Customer C................................................ * 35% *
Customer D................................................ 42% * *
Customer E................................................ * * *
</TABLE>
- ------------------------------
* Less than 10%
(j) Net Loss Per Share
Basic and diluted net loss per common share is computed using the weighted
average number of shares of common stock outstanding during the period.
Potentially dilutive shares outstanding have been excluded because their effect
would be antidilutive.
F-9
<PAGE> 82
ANDOVER.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Pro forma net loss per share is computed using the weighted average number
of common shares outstanding, including the pro forma effects of:
- the automatic conversion of the Series B redeemable convertible preferred
stock into shares of Andover.Net's common stock, effective upon the
closing of Andover.Net's proposed initial public offering as if such
conversion occurred on the date of the original issuance, and
- shares to be issued in the proposed initial public offering the proceeds
of which will be used to repay the accrued dividends of the Series A
redeemable preferred stock.
The weighted average common shares outstanding, the pro forma weighted
average number of common shares outstanding and the shares under option plans
and convertible notes payable which were antidilutive for all periods presented
are as follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED
SEPTEMBER 30,
-----------------
1998 1999
------ -------
<S> <C> <C>
Net loss attributable to common stockholders used in basic
and diluted net loss per share calculation................ $ (608) $(5,787)
====== =======
Weighted average common shares used in basic and diluted EPS
calculation................................................. 5,110 7,419
Weighted average Series B redeemable convertible preferred
stock assumed to convert to common shares................. -- 251
Weighted average accrued dividends assumed to convert to
common shares............................................. -- 33
------ -------
Weighted average common shares used in pro forma basic and
diluted EPS calculations.................................. 5,110 7,703
====== =======
Shares under option plans excluded in computation of diluted
earnings per share due to antidilutive effects............ 723 1,410
====== =======
</TABLE>
(k) Stock-Based Compensation for Employees
Andover.Net has adopted Statement of Financial Accounting Standards (SFAS)
No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 defines a
fair-value-based method of accounting for employee stock options and other
stock-based compensation. The compensation expense related to employee stock
based compensation arising from this method of accounting can be included in the
statements of operations or, alternatively, the pro forma net loss and loss per
share effect of the fair-value-based accounting can be disclosed in the
financial statement footnotes. Andover.Net has elected the disclosure-only
alternative (see Note 11b).
(l) Comprehensive Income
In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS
No. 130, Reporting Comprehensive Income. Under SFAS No. 130, companies are
required to report comprehensive income as a measure of overall performance.
Comprehensive income includes all changes in equity during a period, except
those resulting from investments by owners and distributions to owners. For the
years ended September 30, 1997, 1998 and 1999, Andover.Net's comprehensive loss
is the same as its reported net loss.
(m) Segment and Geographic Information
SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information, establishes standards for reporting information regarding operating
segments in annual financial statements and requires selected information for
those segments to be presented in interim financial reports issued to
stockholders. SFAS No. 131 also establishes standards for related disclosures
about products and services and geographic areas. Operating segments are
identified as components of an enterprise about which separate discrete
F-10
<PAGE> 83
ANDOVER.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
financial information is available for evaluation by the chief operating
decision maker, or decision making group, in making decisions how to allocate
resources and assess performance. Andover.Net's chief decision-maker, as defined
under SFAS No. 131, is the Chief Executive Officer. At September 30, 1999,
Andover.Net views its operations and its business as principally one segment,
Internet publishing. For all periods presented, Andover.Net did not have
international sales greater than 10% of total net revenues.
(n) Fair Value of Financial Instruments
Financial instruments consist principally of cash equivalents, accounts
receivable, accounts payable, notes payable and preferred stock. The estimated
fair value of these instruments approximates their carrying value.
(o) Impairment of Long-Lived Assets
Andover.Net applies SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets To Be Disposed Of. SFAS No. 121
requires Andover.Net to continually evaluate whether events or circumstances
have occurred that indicate that the estimated remaining useful life of
long-lived assets and certain identifiable intangibles and goodwill may warrant
revision or that the carrying value of these assets may be impaired. To compute
whether assets have been impaired, the estimated gross cash flows for the
estimated remaining useful life of the assets are compared to the carrying
value. To the extent that the gross cash flows are less than the carrying value,
the assets are written down to the estimated fair value of the asset.
Andover.Net does not believe that its long-lived assets have been impaired.
(p) New Accounting Standards
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities in the
balance sheet and measure those instruments at fair value. Pursuant to SFAS No.
137, Accounting for Derivative Instruments and Hedging Activities -- Deferral of
the Effective Date of FASB Statement No. 133, SFAS No. 133 is effective for all
fiscal quarters of fiscal years beginning after June 15, 2000. SFAS No. 133 is
not expected to have a material impact on Andover.Net's financial statements.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position (SOP) 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. SOP 98-1 requires computer
software costs associated with internal use software to be charged to operations
as incurred until certain capitalization criteria are met. SOP 98-1 is effective
beginning January 1, 1999. The adoption of this statement did not have a
material impact on Andover.Net's financial position or consolidated results of
operations.
(3) ACQUISITIONS
(a) Slashdot.org
On June 28, 1999, Andover.Net entered in an asset purchase agreement (the
Purchase) to acquire the web site www.slashdot.org, the assets required to run
the web site, and all trademarks from BlockStackers, Inc. (BlockStackers or
Seller). The web site and related assets essentially made up the entire business
of BlockStackers. The web site provides a forum among programmers to discuss
current issues regarding the Linux operating system.
Andover.Net paid $1,500,000 in cash on June 28, 1999 for the assets
described above. The purchase agreement also contains additional cash payments
and common stock consideration contingent upon certain future events. Maximum
future cash payments are $3,500,000 payable over the next two years contingent
on two key employees continued employment. Maximum future stock consideration of
$7,000,000 is payable over
F-11
<PAGE> 84
ANDOVER.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
two years, contingent upon the closing of an initial public offering by
Andover.Net in the next two years as defined in the Purchase. The number of
shares paid will be calculated based on the price per share offered in the
public offering and are contingent upon the continued employment of two key
employees and other performance milestones relating to the web site.
In the event that an initial public stock offering does not occur within 18
months of the closing of the acquisition, the Seller has the one time option, to
accept cash consideration instead of the stock consideration as follows:
$1,500,000 five days following the election of cash payment, $1,500,000
twenty-four months after the acquisition closing and $1,500,000 thirty months
after the acquisition closing. This cash election is subject to the same
employment requirement and milestones of the stock election. This option expires
21 months from the closing of the acquisition.
The acquisition has been accounted for under the purchase method of
accounting in accordance with Accounting Principles Board Opinion No. 16 (APB
16) Business Combinations and Emerging Issues Task Force Issue 95-08, (EITF
95-08) Accounting for Contingent Consideration Paid to the Shareholders of an
Acquired Enterprise in a Purchase Business Combination. The purchase price of
$1,500,000 was allocated to the acquired assets based on the fair value of
assets acquired as determined by a valuation performed by an independent
appraiser. Of the purchase price, $242,000 was allocated to the covenant not to
compete, $23,000 was allocated to trademarks and $1,235,000 was allocated to
goodwill. The goodwill can primarily be attributed to the value of the work
force acquired. Trademarks and goodwill will be amortized over two years which
is their estimated useful life. The covenant not to compete will be amortized
over five years, which is the life of the agreement. There was $179,000 of
amortization expense recorded in the statement of operations for the year ended
September 30, 1999. The future cash and stock payments which are contingent
solely on future employment in the amount of $6.3 million will be recognized as
compensation expense ratably over the term of the payments as they are directly
linked to the continued employment of the two key employees. The remaining
contingent payments, which are based on performance milestones, will be
recognized as expense once those milestones are reached. To the extent that
there is any appreciation in the market value, the compensation charges could be
materially higher than as disclosed.
(b) Animation Factory
Concurrently on June 28, 1999, Andover.Net acquired certain assets and
assumed certain liabilities related to the web site Animation Factory from
Eclipse Digital Imaging, Inc. (Eclipse). Eclipse develops, markets and sells
computer animation via its web site.
The purchase price was $1,500,000 in cash for the net assets acquired, of
which $250,000 was paid on the closing of the acquisition and $1,250,000 will be
paid in 15 equal monthly installments beginning in October 1999. The future
payments have been discounted to their present value using an imputed interest
rate of prime (8% at June 28, 1999) plus 1% for a present value of $1,151,000.
The discount will be amortized as interest expense over the term of the
payments. The purchase agreement also contains stock consideration of $600,000
payable over two years contingent upon: continued employment of the two
principals of Eclipse, Andover.Net completing an initial public offering and
other milestones relating to the creation of new animation images. Any stock
consideration given, when the contingencies are resolved, will be accounted for
as compensation expense over the period earned as they are directly related to
the continued employment and performance of these two key employees. The number
of shares paid will be calculated based on the price per share offered in the
initial public offering.
In the event that an initial public stock offering does not occur within 18
months of the closing of the acquisition, the seller has the one time option to
accept cash consideration instead of the stock consideration as follows:
$200,000 five days following the election of cash payment, $200,000 twenty-four
months after the acquisition closing and $200,000 thirty-six months after the
acquisition closing. This option expires 19 months from the closing of the
acquisition.
F-12
<PAGE> 85
ANDOVER.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The acquisition has been accounted for under APB 16 and EITF 95-08 and the
purchase price of $1,421,000 was allocated to the acquired assets based on the
fair value of the assets acquired as determined by a valuation performed by an
independent appraiser. Of the purchase price, $177,000 was allocated to the
covenant not to compete, $213,000 was allocated to the animation library,
$15,000 was allocated to trademarks and $1,017,000 was allocated to goodwill.
The animation library, the trademarks and the goodwill will be amortized over
two years, which is the estimated useful life. The covenant not to compete will
be amortized over five years, which is the life of the agreement. There was
$174,000 of amortization expense for the year ended September 30, 1999. The
future cash and stock payments which are contingent solely on future employment
in the amount of $200,000 will be recognized as compensation expense ratably
over the term of the payments as they are directly linked to the continued
employment of the two key employees. The remaining contingent payments, which
are based on performance milestones, will be recognized as expense once those
milestones are reached. To the extent that there is any appreciation in the
market value, the compensation charges could be materially higher than as
disclosed.
The unaudited pro forma results below assume the two acquisitions occurred
on October 1 of each period and therefore have been considered with
Andover.Net's historical results.
<TABLE>
<CAPTION>
YEARS ENDED
SEPTEMBER 30,
---------------------
1998 1999
-------- ---------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
Revenues.............................................. $ 1,539 $ 2,629
Operating loss........................................ (4,892) (8,376)
Net loss applicable to common shareholders............ $(6,315) $(11,381)
======= ========
Net loss per share applicable to common
shareholders -- basic and diluted................... $ (1.19) $ (1.51)
======= ========
</TABLE>
(c) Freshmeat
In August 1999, Andover.Net purchased certain assets related to the web
site Freshmeat. Andover.Net paid $367,000 of cash at the closing and has
guaranteed future payments aggregating $300,000 payable monthly through November
2000. The future payments have been discounted to their present value using an
imputed interest rate of prime (8% at August 6, 1999) plus 1% for a present
value of $650,000. The discount will be amortized as interest expense over the
terms of the payments. Future stock consideration of $333,000 is contingent upon
meeting certain milestones as defined in the asset purchase agreement. No pro
forma information has been presented as the acquisition is not material to
Andover.Net.
In the event that an initial public stock offering does not occur within 18
months of the closing of the acquisition, the Seller has the one time option, to
accept cash consideration instead of the stock consideration as follows:
$100,000 five days following the election of cash payment, $100,000 twelve
months thereafter and $100,000 twenty-four months after the acquisition closing.
This cash election is subject to the same employment requirement and milestones
of the stock election. This option expires 19 months from the closing of the
acquisition.
The acquisition has been accounted for under the purchase method of
accounting in accordance with APB 16 EITF 95-08. The purchase price of $650,000
was allocated to the acquired assets based on the fair value of assets acquired
as determined by a valuation performed by an independent appraiser. Of the
purchase price, $107,000 was allocated to the covenant not to compete, $8,000
was allocated to trademarks and $535,000 was allocated to goodwill. The goodwill
can primarily be attributed to the value of the work force acquired. Trademarks
and goodwill will be amortized over two years which is their estimated useful
life. The covenant not to compete will be amortized over five years, which is
the life of the agreement. There was
F-13
<PAGE> 86
ANDOVER.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
$52,000 of amortization expense recorded in the statement of operations for the
year ended September 30, 1999. The future cash and stock payments which are
contingent solely on future employment in the amount of $283,000 will be
recognized as compensation expense ratably over the term of the payments as they
are directly linked to the continued employment of the two key employees. The
remaining contingent payments, which are based on performance milestones, will
be recognized as expense once those milestones are reached. To the extent that
there is any appreciation in the market value, the compensation charges could be
material higher than as disclosed.
(4) ACCOUNTS RECEIVABLE
Accounts receivable, which result primarily from advertising sales, are
presented net of an allowance for doubtful accounts. The activity in
Andover.Net's allowance for doubtful accounts for the years ended September 30,
1997, 1998 and 1999 is presented in the following table:
<TABLE>
<CAPTION>
BALANCE AT BALANCE AT
BEGINNING OF CHARGED TO END OF
PERIOD EXPENSE DEDUCTIONS(a) PERIOD
------------ ---------- ------------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Year ended September 30, 1997....... $ -- $ -- $ -- $ --
Year ended September 30, 1998....... -- 13 -- 13
Year ended September 30, 1999....... 13 93 6 100
</TABLE>
- ------------------------------
(a) Represents amounts written off as uncollectable accounts receivable
(5) ACCRUED EXPENSES
Accrued expenses consist of the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------
1998 1999
---- ------
<S> <C> <C>
Accrued compensation........................................ $ -- $ 841
Accrued vendor commissions.................................. 80 --
Other....................................................... 79 726
---- ------
$159 $1,567
==== ======
</TABLE>
(6) CONVERTIBLE NOTES PAYABLE TO STOCKHOLDERS
On June 30, 1999, Andover.Net received proceeds of $2,090,000 from the
issuance of convertible notes payable in a private placement to various
investors, some of whom are Andover.Net stockholders and certain outsiders (the
Notes). The Notes bear interest at the prime rate (8% at June 30, 1999) per
annum and are due on December 31, 1999. Upon the closing of this financing by
Andover.Net in September 1999 these Notes converted into 120,214 shares of
Series B Redeemable Convertible Preferred Stock issued under the new capital
structure of Andover.Net (See Note 9c). Upon the closing of an initial public
offering, this Series B Convertible Preferred Stock automatically converts into
603,931 shares of common stock.
The original terms of the Notes provided for a formula based conversion
price. Pursuant to the conversion terms, whereby the holders of the Notes were
guaranteed beneficial conversion features depending on the amount of time the
Notes were held before conversion, Andover.Net recorded an original discount of
$403,000, which represents the difference between the proceeds from the notes
payable and the value of the Series B preferred stock. This discount will be
amortized to interest expense over 76 days, which is the period from issuance of
the Notes to the period in which the Series B Redeemable preferred stock
offering occurs. In addition, Andover.Net will recognize an additional interest
expense of $2,124,000 which represents
F-14
<PAGE> 87
ANDOVER.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
the beneficial conversion feature of the 120,214 shares of Series B Redeemable
Convertible Preferred Stock into 603,931 shares of common stock. This expense
will be recognized in the statement of operations in the period that the initial
public offering closes. (See Note 9(c))
(7) INCOME TAXES
Andover.Net accounts for income taxes using the liability method which
requires the recognition of the amount of current and deferred income taxes at
the date of the financial statements as a result of all differences in the tax
basis and financial statement carrying amounts of assets and liabilities, as
measured by enacted tax laws.
No provision for federal or state income taxes has been recorded, as
Andover.Net has incurred net operating losses for all periods presented. As of
September 30, 1999, Andover.Net had net operating loss carryforwards for federal
and state income tax purposes of approximately $4,530,000 available to reduce
future federal and state income taxes, if any. These carryforwards expire at
various dates through 2019 and are subject to review and possible adjustment by
the Internal Revenue Service. Due to the uncertainty surrounding the realization
of the net deferred tax asset, Andover.Net has provided a full valuation
allowance against this amount.
U.S. tax rules impose annual limitations on the use of net operating losses
following substantial changes in ownership. Andover.Net has completed several
financings since its inception and has incurred an ownership change as defined
by the U.S. tax rules. Andover.Net believes that this change in ownership will
not have a material impact on its ability to utilize its net operating loss
carryforwards.
The approximate income tax effect of each type of temporary difference and
carryforward is as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
-------------------------
1997 1998 1999
----- ----- -------
<S> <C> <C> <C>
Net operating loss carryforwards.......................... $ 530 $ 674 $ 1,824
Non-deductible expenses and reserves...................... 20 37 512
Valuation allowance....................................... (550) (711) (2,336)
----- ----- -------
Net deferred tax asset.......................... $ -- $ -- $ --
===== ===== =======
</TABLE>
(8) COMMITMENTS AND CONTINGENCIES
(a) Operating Leases
Andover.Net leases its office facility and equipment under operating leases
that expire at various dates through April 30, 2004.
Future minimum lease payments at September 30, 1999 are as follows (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
- ------------------------
<S> <C>
2000........................................................ $ 209
2001........................................................ 205
2002........................................................ 215
2003........................................................ 229
2004........................................................ 134
------
$ 992
======
</TABLE>
Rent expense included in the accompanying statements of operations was
approximately $33,000, $20,000 and $122,000 for the years ended September 30,
1997, 1998 and 1999, respectively.
F-15
<PAGE> 88
ANDOVER.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(b) Litigation
Currently, Andover.Net is not a party to any litigation.
(9) REDEEMABLE PREFERRED STOCK
Redeemable preferred stock consists of the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
-----------------
1998 1999
------ -------
<S> <C> <C>
Series A redeemable preferred stock (Series A) -- $13.50
redemption value plus accrued dividends; authorized -- 900
shares, issued and outstanding -- 165 and 322 shares at
September 30, 1998 and 1999, respectively (at redemption
value)..................................................... $2,228 $ 4,353
Accrued dividends on Series A (see Dividends)............... 134 447
------ -------
$2,362 $ 4,800
====== =======
Series B redeemable convertible preferred stock (Series B)
-- $21.03 redemption value plus accrued dividends;
authorized -- 700 shares, issued and outstanding -- none
and 601 shares at September 30, 1998 and 1999,
respectively (at redemption value)........................ $ -- $12,628
Accrued dividends on Series B (see Dividends)............... -- 41
------ -------
$ -- $12,669
====== =======
</TABLE>
(a) Recapitalization
In September 1999, Andover Advanced Technologies, Inc. was merged into its
wholly owned subsidiary, Andover.Net. All information presented assumes an
authorized 2 million shares of Preferred Stock, of which 900,000 shares will be
designated as Series A redeemable preferred stock, 700,000 shares will be
designated as Series B redeemable convertible preferred stock and 400,000 shares
will remain undesignated effective immediately prior to the closing of the
initial public offering.
(b) Series A Redeemable Preferred Stock
In connection with the recapitalization of Andover.Net in September 1999,
all the Series C redeemable preferred stock of AAT was converted to Series A
redeemable preferred stock of Andover.Net. This new Series A redeemable
preferred stock has all of the same rights, privileges and preferences of the
AAT Series C redeemable preferred stock. The following reflects that conversion
on a retroactive basis.
During fiscal 1997, Andover.Net amended its bylaws to change its capital
structure and to authorize Series A redeemable preferred stock. Each stockholder
of AAT Series A convertible preferred stock and AAT Series B convertible
preferred stock received one share of Series A redeemable preferred stock and
one share of common stock in a recapitalization. The Series A redeemable
preferred stock has been stated at the redemption value of $13.50 plus accrued
dividends. An adjustment to accumulated deficit of approximately $122,000 is
reflected in the accompanying statements of stockholders' equity (deficit) to
account for the issuance of the Series A redeemable preferred stock at
redemption value.
In fiscal 1997, Andover.Net sold an additional 80,001 shares of Series A
redeemable preferred stock at a price of $13.50 per share, less stock issuance
costs of approximately $41,000, for aggregate net proceeds of approximately
$1,039,000. During fiscal 1999, Andover.Net sold 157,438 shares of Series A
redeemable preferred stock, and 2,634,436 shares of common stock at a price of
$0.26 per share, less stock issuance costs of approximately $33,000, for
aggregate net proceeds of approximately $2,770,000.
F-16
<PAGE> 89
ANDOVER.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The Series A redeemable preferred stock (Series A Preferred Stock) holders
have the following rights, preferences and privileges:
Voting Rights
The Series A Preferred Stock does not entitle the holder to any voting
rights on any action taken by the stockholders of Andover.Net.
Dividends
Beginning January 1, 1998, the holders of Series A Preferred Stock are
entitled to receive cumulative dividends, which will accrue and will be due and
payable at an annual rate, or portion thereof for partial periods, in an amount
equal to the greater of (i) the applicable percentage, as defined, of
Andover.Net's pre-tax earnings or (ii) 8.0% of the original purchase price paid
for the number of shares of Series A Preferred Stock outstanding on the last day
of the applicable year. Dividends are not payable until approved by the Board of
Directors and do not accrue interest. As of September 30, 1999, approximately
$447,000 of dividends have been accrued.
Liquidation Preference
In certain events, including liquidation, dissolution or winding up of
Andover.Net, the holders of Series A Preferred Stock are entitled to $13.50 per
share plus all accumulated and unpaid dividends due before any distribution may
be made to common stockholders. If the assets of Andover.Net shall be
insufficient to permit payment in full to the holders of preferred stock, then
the entire assets of Andover.Net that are available for distribution shall be
distributed ratably.
Redemption
At any time on or after June 2003, at the election of the holders of 70% of
the shares of Series A Preferred Stock, Andover.Net may be required to redeem
the Series A Preferred Stock at a redemption price in an amount equal to the
liquidation payment for the Series A Preferred Stock and shall be paid in cash.
Andover.Net is required to redeem all shares of the Series A Preferred
Stock outstanding upon the closing of an initial public offering in which the
valuation of Andover.Net is at least $20 million or a qualified acquisition, as
defined.
(c) Series B Redeemable Convertible Preferred Stock
On September 15, 1999, Andover.Net issued 600,568 shares of Series B
redeemable convertible preferred stock at $21.03 per share to private investors
for total consideration of $12,224,000. This includes $10,100,000 of originally
issued shares and the conversion of $2,124,000 of principal and accrued interest
from the June 1999 convertible notes into 120,214 shares of Series B redeemable
convertible preferred stock of which 19,195 shares were issued pursuant to a
beneficial conversion feature (See Note 6).
The Series B redeemable convertible preferred stock (Series B Preferred
Stock) holders have the following rights, preferences and privileges:
Voting Rights
The Series B Preferred Stock entitles the holder to voting rights on all
actions taken by the stockholders of Andover.Net.
F-17
<PAGE> 90
ANDOVER.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Dividends
Dividends accrue annually and are cumulative at a rate of 8% of the
original purchase price of $21.03 per share, on a per share basis. Dividends
must be paid before any other dividends can be declared or paid on any common
stock or Series A Redeemable Preferred Stock. As of September 30, 1999,
approximately $41,000 of dividends have been accrued.
Liquidation Preference
In certain events, including liquidation, dissolution or winding up of
Andover.Net, the holders of Series B Preferred Stock are entitled to $21.03 per
share plus all accumulated and unpaid dividends due before any distribution may
be made to common stockholders or Series A Redeemable Preferred Stockholders. If
the assets of Andover.Net shall be insufficient to permit payment in full to the
holders of preferred stock, then the entire assets of Andover.Net that are
available for distribution shall be distributed ratably.
Conversion
The Series B Preferred Stock is convertible at any time by the holders, at
the then applicable conversion rate as adjusted from time to time. Upon the
closing of this offering, all outstanding shares of Series B Preferred Stock
will automatically convert into 3,017,133 shares of common stock, resulting in
an effective purchase price of $4.05 per common share. The difference between
the fair value of Andover.Net's common stock on the date of issuance and the
deemed effective purchase price resulted in a beneficial conversion feature of
$12.2 million, which will be reflected as interest expense in the statement of
operations in the period in which this offering occurs. Of the $12.2 million
interest expense charge, $10.1 relates to the originally issued shares of Series
B Preferred Stock and $2.1 relates to the converted notes payable (see Note 6).
Redemption
At any time on or after September 2003, if Andover.Net has not made a
qualified public offering of its common stock of at least $20 million, at the
election of the holders of the shares of Series B Preferred Stock, Andover.Net
may be required to redeem the Series B Preferred Stock at a redemption price in
an amount equal to the liquidation payment for the Series A Preferred Stock and
shall be paid in cash.
The following table summarizes the activity for the AAT Series A, AAT
Series B and Andover.Net Series A and Series B Preferred Stock (in thousands,
except for share data):
<TABLE>
<CAPTION>
ANDOVER.NET
AAT AAT ANDOVER.NET SERIES B REDEEMABLE
SERIES A CONVERTIBLE SERIES B CONVERTIBLE SERIES A REDEEMABLE CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK
---------------------- ---------------------- ---------------------- ----------------------
NUMBER OF REDEMPTION NUMBER OF REDEMPTION NUMBER OF REDEMPTION NUMBER OF REDEMPTION
SHARES VALUE SHARES VALUE SHARES VALUE SHARES VALUE
--------- ---------- --------- ---------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, September 30,
1996......................... 50,000 $ 500 27,500 $ 413 -- $ -- -- $ --
Exercise of AAT Series B
warrants.................. -- -- 6,875 103 -- -- -- --
Issuance AAT Series B
convertible preferred
stock..................... -- -- 666 10 -- -- -- --
Recapitalization of
preferred stock........... (50,000) (500) (35,041) (526) 85,041 1,148 -- --
Issuance of Series A
Redeemable preferred
stock..................... -- -- -- -- 60,001 810 -- --
Conversion of convertible
promissory notes and
issuance of Series A
redeemable preferred stock
and common stock.......... -- -- -- -- 20,000 270 -- --
------- ----- ------- ----- -------- ------ -------- ------
<CAPTION>
TOTAL
REDEMPTION
VALUE
----------
<S> <C>
Balance, September 30,
1996......................... $ 913
Exercise of AAT Series B
warrants.................. 103
Issuance AAT Series B
convertible preferred
stock..................... 10
Recapitalization of
preferred stock........... 122
Issuance of Series A
Redeemable preferred
stock..................... 810
Conversion of convertible
promissory notes and
issuance of Series A
redeemable preferred stock
and common stock.......... 270
------
</TABLE>
F-18
<PAGE> 91
ANDOVER.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
ANDOVER.NET
AAT AAT ANDOVER.NET SERIES B REDEEMABLE
SERIES A CONVERTIBLE SERIES B CONVERTIBLE SERIES A REDEEMABLE CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK
---------------------- ---------------------- ---------------------- ----------------------
NUMBER OF REDEMPTION NUMBER OF REDEMPTION NUMBER OF REDEMPTION NUMBER OF REDEMPTION
SHARES VALUE SHARES VALUE SHARES VALUE SHARES VALUE
--------- ---------- --------- ---------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, September 30,
1997......................... -- -- -- -- 165,042 2,228 -- --
Accrued dividends on Series
A redeemable preferred
stock..................... -- -- -- -- -- 134 -- --
------- ----- ------- ----- -------- ------ -------- ------
Balance, September 30,
1998........................ -- -- -- -- 165,042 2,362 -- --
Accrued dividends on Series
A Redeemable preferred
stock..................... -- -- -- -- -- 313 -- --
Issuance of Series A
Redeemable preferred
stock..................... -- -- -- -- 157,438 2,125 -- --
------- ----- ------- ----- -------- ------ -------- ------
Balance, September 30,
1999........................ -- $ -- -- $ -- 322,480 $4,800 -- $ --
======= ===== ======= ===== ======== ====== ======== ======
<CAPTION>
TOTAL
REDEMPTION
VALUE
----------
<S> <C>
Balance, September 30,
1997......................... 2,228
Accrued dividends on Series
A redeemable preferred
stock..................... 134
------
Balance, September 30,
1998........................ 2,362
Accrued dividends on Series
A Redeemable preferred
stock..................... 313
Issuance of Series A
Redeemable preferred
stock..................... 2,125
------
Balance, September 30,
1999........................ $4,800
======
</TABLE>
(10) STOCKHOLDERS' EQUITY
(a) Common Stock
In November 1998, the board of directors authorized an additional 3,697,523
shares of Andover.Net's no par value common stock for an aggregate authorization
of 10,987,069 shares. The board of directors also authorized an additional
184,000 shares of preferred stock for an aggregate authorization of 409,000
shares.
Also in November 1998, the board of directors approved an increase in the
number of authorized options under the Andover.Net 1995 Stock Option Plan to
1,507,142 options.
In September 1999, the board of directors approved a 4-for-1 stock split of
Andover.Net's $0.01 par value common stock. All information presented assumes an
authorized 100 million shares of Andover.Net, $.01 par value common stock and
the completion of a 5.0238 for 1 stock split effective immediately prior to the
effectiveness of the registration statement. All references to the number of
shares in the accompanying financial statements have been adjusted to reflect
both stock splits on a retroactive basis.
(b) Stock Warrants
During the fiscal year 1996, Andover.Net issued warrants to the
stockholders of the previously issued Series B Redeemable Convertible preferred
stock. A total of 6,875 warrants were issued to purchase Series B Redeemable
Convertible preferred stock at an exercise price of $15.00 share. The value of
the warrants when issued was determined to be immaterial. The warrants were
exercised during fiscal 1997 for total proceeds of approximately $103,000.
(c) Convertible Notes Payable to Stockholders
In May 1997, Andover.Net issued convertible promissory notes to certain
stockholders (the Notes) in the sum of $100,000. The Notes were mandatorily
convertible upon the additional financing of $200,000 (the conversion financing)
which was completed during fiscal 1997. The Notes were converted into shares
identical to the shares sold in the conversion financing. The investors received
a total of 401,905 common shares and 20,000 Series C Preferred shares in
exchange for the notes and an additional $200,000 in cash.
(11) STOCK OPTION PLAN
(a) 1995 Stock Option Plan
On October 12, 1995, Andover.Net's board of directors (the Board) approved
the adoption of the 1995 Stock Option Plan (the 1995 Plan), as amended, which
provides for a maximum of 1,507,140 shares of common stock to be issued as
incentive stock option (ISOs) and nonqualified options. The options under the
Plan may be granted to directors, officers, employees, consultants and related
corporations. ISOs may be
F-19
<PAGE> 92
ANDOVER.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
granted at no less then fair market value (FMV) on the date of grant, as
determined by the Board (no less than 110% of FMV on the date of grant for 10%
or greater stockholders). Options under the Plan expire between 5 to 10 years
from the date of grant. Vesting is determined by the Board and can be fully
exercisable on the date of grant or in installments, as approved.
(b) 1999 Stock Option Plan
In August 1999, Andover.Net approved the adoption of the 1999 Stock Option
Plan (the 1999 Plan), which provides for a maximum of 1,736,225 shares of common
stock to be issued as ISOs and nonqualified options. The options under the Plan
may be granted to directors, officers, employees, consultants and related
corporations. ISOs may be granted at no less than fair market value (FMV) on the
date of grant, as determined by the Board (no less than 110% of FMV on the date
of grant for 10% or greater stockholders). Options under the Plan expire no more
than 10 years from the date of grant. Vesting is determined by the Board and can
be fully exercisable on the date of grant or in installments as approved.
Stock option activity for the years ended September 30, 1997, 1998 and 1999
is as follows (in thousands, except per share data):
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
EXERCISE
EXERCISE PRICE
NUMBER OF PRICE PER PER
SHARES SHARE SHARE
--------- --------------- --------
<S> <C> <C> <C>
Outstanding, September 30, 1996........................ 196 $ $0.005 $0.005
Granted.............................................. 482 0.025 0.025
Exercised............................................ (15) 0.025 0.025
Canceled............................................. (25) 0.025 0.025
----- --------------- ------
Outstanding, September 30, 1997 638 0.005 - 0.025 0.019
Granted.............................................. 165 0.025 0.025
Exercised............................................ (24) 0.025 0.025
Canceled............................................. (56) 0.025 0.025
----- --------------- ------
Outstanding, September 30, 1998 723 0.005 - 0.025 0.019
Granted.............................................. 914 0.025 - 1.066 0.201
Exercised............................................ (227) 0.025 0.008
----- --------------- ------
Outstanding, September 30, 1999........................ 1,410 $0.005 - 1.066 $0.139
===== =============== ======
Exercisable, September 30, 1999........................ 559 $0.005 - 1.066 $0.067
===== =============== ======
</TABLE>
At September 30, 1999, 2,370,611 options to purchase shares of common stock
were available for future grants under the Plan.
F-20
<PAGE> 93
ANDOVER.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
SFAS No. 123, Accounting for Stock-Based Compensation, requires the
measurement of the fair value of stock options to be included in the statements
of operations or disclosed in the notes to the financial statements. Andover.Net
has determined that it will continue to account for stock-based compensation for
employees under the Accounting Principles Board Opinion No. 25 and elect the
disclosure-only alternative under SFAS No. 123. Fair value of each option grant
is estimated on the date of grant using the Black-Scholes option pricing model
with the following assumptions:
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
--------------------------------------
1997 1998 1999
---------- ---------- ----------
<S> <C> <C> <C>
Risk free interest rate.............................. 6.18%-6.53% 5.62%-6.11% 4.45%-6.14%
Expected dividend yield.............................. -- -- --
Expected lives (years)............................... 5.00 5.00 5.00
Expected volatility.................................. 70% 70% 70%
Weighted average fair value per share of options
granted............................................ $1.48 $2.91 $6.95
Weighted average remaining contractual life of
options outstanding (years)........................ 6.12 8.25 8.96
</TABLE>
Had compensation expense for the options been determined consistent with
SFAS No. 123, Andover.Net's net loss and net loss per share would have been
affected as follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
---------------------------
1997 1998 1999
------ ------ -------
<S> <C> <C> <C>
Net loss applicable to common shareholders --
As reported............................................... $ (705) $ (608) $(5,787)
Pro forma................................................. $ (884) $ (902) $(7,068)
Basic and diluted net loss per share applicable to common
shareholders --
As reported............................................... $(0.29) $(0.12) $ (0.78)
Pro forma................................................. $(0.36) $(0.18) $ (0.95)
</TABLE>
In connection with certain stock option grants during the year ended
September 30, 1999, Andover.Net recorded deferred compensation of approximately
$6.2 million in connection with stock option grants of approximately 914,000,
which represents the aggregate difference between the exercise price and the
fair market value of the common stock as determined for accounting purposes. The
deferred compensation will be recognized as an expense over the vesting period
of the underlying stock options. These vesting periods range from 0 to 4 years.
Andover.Net recorded compensation expense of approximately $1.0 million for the
year ended September 30, 1999 related to these options.
Certain options contain provisions that accelerate the vesting to 100% upon
an initial public offering. Upon this event, additional compensation expense of
approximately $800,000 relating to 260,459 options will be recorded as
compensation expense. The remaining deferred compensation will be amortized over
the remaining vesting period.
F-21
<PAGE> 94
INTRODUCTION TO PRO FORMA FINANCIAL INFORMATION
The following unaudited Pro Forma Combined Statements of Operations for the year
ended September 30, 1999 give effect to the acquisitions by Andover.Net, Inc. of
Slashdot.org and Animation Factory as if each had occurred at the beginning of
the period presented. The unaudited Pro Forma Combined Statement of Operations
does not include the effects of the Andover.Net, Inc. acquisition of the assets
related to Freshmeat as of August 6, 1999 as Andover.Net, Inc. has determined
that its effects are immaterial. The unaudited Pro Forma Combined Statement of
Operations gives effect to the issuance of the convertible notes payable and
their subsequent conversion into Series B Redeemable Convertible Preferred Stock
as these notes were used to finance the acquisitions. These statements do not
take into effect the issuance of the Series B Redeemable Convertible Preferred
Stock in September 1999.
The unaudited Pro Forma Combined Statements of Operations have been prepared
using the purchase method of accounting for the Acquisitions whereby the total
cost of each acquisition is allocated to the tangible and intangible assets
acquired and liabilities assumed based upon their respective fair values at the
effective dates of such acquisitions. Such allocations have been made based upon
currently available information and management's estimates. Final allocations
will be determined upon completion of the analysis of the assets acquired and
liabilities assumed.
The unaudited Pro Forma Combined Statement of Operations for the year ended
September 30, 1999 is based on the audited financial statements for the year
ended September 30, 1999 of Andover.Net, Inc. and the unaudited operating
results for the nine months ended June 30, 1999 of Slashdot.org and Animation
Factory. The unaudited financial statements reflect all adjustments, consisting
of normal recurring adjustments, which in the opinion of management are
necessary for a presentation of results for the respective periods in accordance
with the basis of presentation described in Note 2 of the Notes to Andover.Net,
Inc.'s Financial Statements and similar statements found in the other entities'
financial statements.
The unaudited Pro Forma Combined Statements of Operations do not purport to
represent what the results of operations or financial position of Andover.Net,
Inc. would actually have been if any of the transactions had occurred on such
dates or to project the results of operations or financial positions of
Andover.Net, Inc. for any future date or period. The unaudited Pro Forma
Combined Statements of Operations set forth below should be read in conjunction
with the respective Financial Statements and Notes thereto of the Andover.Net,
Inc. included elsewhere in this Prospectus, and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
F-22
<PAGE> 95
ANDOVER.NET, INC.
PRO FORMA COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
HISTORICAL
----------------------------------------- PRO FORMA
ANIMATION COMBINED FOR THE
ANDOVER.NET SLASHDOT.ORG(a) FACTORY ADJUSTMENTS(e) ACQUISITIONS
----------- --------------- --------- -------------- ----------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Revenues:
Advertising.................................. $ 2,021 $293 $ -- $ -- $ 2,314
Software product........................... 100 -- 215 -- 315
------- ---- ---- ------- --------
Total revenues...................... 2,121 293 215 -- 2,629
Cost of revenues:
Editorial content and related.............. 731 118 -- 849
Software product........................... 2 -- 155 157
------- ---- ---- ------- --------
Total cost of revenues.............. 733 118 155 -- 1,006
------- ---- ---- ------- --------
Gross profit................................. 1,388 175 60 -- 1,623
------- ---- ---- ------- --------
Operating expenses........................... 6,443 55 68 994(b)
2,439(c) 9,999
------- ---- ---- ------- --------
Operating income (loss)...................... (5,055) 120 (8) (3,433) (8,376)
Interest income (expense).................... (378) -- -- (172)(e)
(2,124)(f) (2,674)
Other (expense) income....................... -- -- 23 -- 23
------- ---- ---- ------- --------
Income (loss) before taxes................... (5,433) 120 15 (5,729) (11,027)
Income tax benefit
(expense).................................. -- -- -- -- --
------- ---- ---- ------- --------
Net income (loss)............................ $(5,433) $120 $ 15 $(5,729) $(11,027)
======= ==== ==== ======= ========
Accretion on preferred stock................. 354 -- -- -- 354
Net income (loss) applicable to common
shareholders............................... $(5,787) $120 $ 15 $(5,729) $(11,381)
======= ==== ==== ======= ========
Basic and diluted net loss per share
applicable to common stockholders.......... $ (0.78) $ (1.51)
======= ========
Basic and diluted weighted average shares
outstanding................................ 7,419 145(d) 7,564
======= ======= ========
Other operating data:
Depreciation and amortization.............. $ 432 $ -- $ -- $ -- $ 432
======= ==== ==== ======= ========
</TABLE>
- ------------------------------
(a) Includes the results of operations of the acquired businesses from the
beginning of the period reporting through the respective dates of
acquisition by Andover.Net (both entities on June 28, 1999).
(b) Reflects the amortization of goodwill and intangible assets associated with
the acquisition of Slashdot.org and Animation Factory. The intangible
assets and goodwill of Slashdot.org and Animation Factory are as follows:
<TABLE>
<CAPTION>
ASSET LIFE SLASHDOT.ORG ANIMATION FACTORY AMORTIZATION
----- ------- ------------ ----------------- ------------
<S> <C> <C> <C> <C>
Covenant not to compete........ 5 years $ 242,000 $ 177,000 $ 63,000
Trademarks..................... 2 years 23,000 15,000 14,000
Animation library.............. 2 years -- 213,000 80,000
Goodwill....................... 2 years 1,235,000 1,017,000 837,000
---------- ---------- --------
$1,500,000 $1,422,000 $994,000
========== ========== ========
</TABLE>
(c) Reflects additional compensation payments required with the purchase
agreements. These payments, which are solely contingent upon the continued
employment of two key employees, are payable over two years and are
comprised of $3.5 million of cash and $3.0 million in stock compensation.
Andover.Net is recognizing this compensation expense ratably over the two
year period. The remaining contingent payments of $4.6 million in stock
compensation are not reflected as they are contingent upon performance
milestones. At this time, it is uncertain if or when these milestones will
be met.
F-23
<PAGE> 96
Included in the pro forma adjustments is nine months of this compensation
expense as the Andover.Net results include three months of compensation
charges. The nine month compensation expense was computed by dividing the
$3.5 million cash contingent payments and the $3.0 million stock contingent
payments by the 24 month payment period and multiplying by nine months.
(d) Reflects weighted shares to be issued as compensation associated with the
acquisitions of Slashdot.org and Animation Factory at an offering price of
$18.00. These shares are to be issued within the first nine months after
the offering.
(e) Reflects interest expense on debt used to finance the acquisitions
calculated using an assumed interest rate of 8.25% per annum on the
convertible notes payable.
(f) Reflects the additional charge recorded as interest expense for the
beneficial conversion effect of the convertible notes payable. The charge
was computed assuming the issuance of the convertible notes payable at the
beginning of the period presented and the conversion at September 16, 1999,
which is a period of 11.5 months. Therefore, the entire charge of
$2,124,000 is recognized.
F-24
<PAGE> 97
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To BlockStackers, Inc.:
We have audited the accompanying balance sheet of BlockStackers, Inc. (a
Michigan corporation) as of December 31, 1998, and the related statements of
operations, stockholders' deficit and cash flows for the period from inception
(August 24, 1998) to December 31, 1998. 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 audit.
We conducted our audit 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 audit provides 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 BlockStackers, Inc. as of
December 31, 1998, and the results of its operations and its cash flows for the
period from inception (August 24, 1998) to December 31, 1998, in conformity with
generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
September 16, 1999
F-25
<PAGE> 98
BLOCKSTACKERS, INC.
BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
------------ ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash...................................................... $ 3 $--
Accounts receivable....................................... -- 32
Other current assets...................................... 1 2
---- ---
Total current assets.............................. 4 34
---- ---
$ 4 $34
==== ===
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 5 $ 4
Accrued expenses.......................................... 4 1
---- ---
Total current liabilities......................... 9 5
Stockholders' deficit:
Common stock, no par value --
Authorized -- 60 shares
Issued -- 3 shares
Outstanding -- 2 shares................................ 5 5
Retained earnings (deficit)............................... (10) 24
---- ---
Total stockholders' equity (deficit).............. (5) 29
---- ---
$ 4 $34
==== ===
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-26
<PAGE> 99
BLOCKSTACKERS, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
PERIOD FROM INCEPTION
(AUGUST 24, 1998) THREE MONTHS
THROUGH ENDED
DECEMBER 31, 1998 MARCH 31, 1999
--------------------- --------------
(UNAUDITED)
<S> <C> <C>
Net revenues................................................ $ 18 $68
Cost of revenues............................................ 17 21
---- ---
Gross profit...................................... 1 47
Operating expenses:
Selling expenses.......................................... 6 1
General and administrative expenses....................... 5 12
---- ---
Total operating expenses.......................... 11 13
==== ===
Net income (loss)................................. $(10) $34
==== ===
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-27
<PAGE> 100
BLOCKSTACKERS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK
----------------- TOTAL
NO RETAINED STOCKHOLDERS'
NUMBER OF PAR EARNINGS EQUITY
SHARES VALUE (DEFICIT) (DEFICIT)
--------- ----- ----------- -------------
<S> <C> <C> <C> <C>
August 24, 1998 (Inception)........................ -- $-- $ -- $ --
Contributed capital.............................. 3 5 -- 5
Repurchase and retirement of common stock........ (1) -- -- --
Net loss......................................... -- -- (10) (10)
--- --- ---- ----
Balance, December 31, 1998......................... 2 $ 5 $(10) $ (5)
--- --- ---- ----
Net income (unaudited)........................... -- -- 34 34
--- --- ---- ----
Balance, March 31, 1999 (unaudited)................ 2 $ 5 $ 24 $ 29
=== === ==== ====
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-28
<PAGE> 101
BLOCKSTACKERS, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
PERIOD FROM INCEPTION
(AUGUST 24, 1998) THREE MONTHS
THROUGH ENDED
DECEMBER 31, 1998 MARCH 31, 1999
--------------------- --------------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)........................................... $(10) $ 34
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities --
Donated services....................................... 4 --
Changes in operating assets and liabilities --
Accounts receivable.................................. -- (32)
Other current assets................................. (1) (1)
Accounts payable..................................... 5 (1)
Accrued expense...................................... 4 (3)
---- ----
Net cash provided by (used in) operating
activities...................................... 2 (3)
---- ----
Cash flows from financing activities:
Contributed capital....................................... 1 --
---- ----
Net cash provided by financing activities......... 1 --
---- ----
Net increase (decrease) in cash............................. 3 (3)
Cash, beginning of period................................... -- 3
---- ----
Cash, end of period......................................... $ 3 $ --
==== ====
</TABLE>
The accompanying notes are an integral part of these financial statements
F-29
<PAGE> 102
BLOCKSTACKERS, INC.
NOTES TO FINANCIAL STATEMENTS
(1) OPERATIONS
BlockStackers, Inc. (BlockStackers) was incorporated in Michigan on August
24, 1998 as an S Corporation. BlockStackers creates and hosts a web site,
Slashdot.org that acts as a forum for Linux software users to discuss
developments and events. Revenues are generated through advertising banners
placed on BlockStackers' web site and through consulting work.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying financial statements reflect the application of certain
significant accounting policies described in this note and elsewhere in the
notes to financial statements.
(a) Use of Estimates in the 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.
(b) Revenue Recognition
Revenues are recognized ratably in the period in which the advertisement is
displayed providing BlockStackers has no remaining obligations.
(c) Concentrations of Credit Risk
BlockStackers has no significant off-balance sheet concentration of credit
risks such as foreign exchange contracts, options contracts or other foreign
hedging arrangements. Financial instruments that substantially expose
BlockStackers to concentrations of credit risk consist primarily of cash.
BlockStackers maintains its cash balances with a financial institution.
BlockStackers operates in one industry segment and derives substantially all of
its revenues from U.S. customers.
The following table summarizes the number of customers that individually
comprise greater than 10% of total revenues for the period from inception
(August 24, 1998) to December 31, 1998 presented:
<TABLE>
<S> <C>
Revenue --
Customer A................................................ 33%
Customer B................................................ 23%
</TABLE>
(d) Comprehensive Income (Loss)
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 130, Reporting
Comprehensive Income. Under SFAS No. 130, companies are required to report
comprehensive income as a measure of overall performance. Comprehensive income
includes all changes in equity during a period, except those resulting from
investments by owners and distributions to owners. For the period ended December
31, 1998, BlockStackers' comprehensive loss is the same as its reported net
loss.
(e) Fair Value of Financial Instruments
Financial instruments consist principally of cash and accounts payable. The
estimated fair value of these instruments approximates their carrying value.
F-30
<PAGE> 103
BLOCKSTACKERS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(f) New Accounting Standards
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities in the
balance sheet and measure those instruments at fair value. Pursuant to SFAS No.
137, Accounting for Derivative Instruments and Hedging Activities -- Deferral of
the Effective Date of FASB Statement No. 133, SFAS No. 133 is effective for all
fiscal quarters of fiscal years beginning after June 15, 2000. SFAS No. 133 is
not expected to have a material impact on BlockStackers' financial statements.
In March 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 98-1, Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use. SOP 98-1 requires
computer software costs associated with internal use software to be charged to
operations as incurred until certain capitalization criteria are met. SOP 98-1
is effective for financial statements for fiscal years beginning after December
15, 1998. The adoption of this statement did not have a material impact on
BlockStackers' financial statements.
In April 1998, AICPA issued Statement of Position 98-5, Reporting on the
Costs of Start-up Activities (SOP 98-5). SOP 98-5 provides guidance on the
financial reporting of start-up activities and organization costs to be expensed
as incurred. SOP 98-5 did not have a material impact on BlockStackers' financial
statements.
(3) INCOME TAXES
BlockStackers has elected to be taxed as an S corporation for federal
income tax purposes, which results in taxable income of BlockStackers being
reported on the individual tax returns of its stockholders for federal income
taxes.
(4) STOCKHOLDERS' DEFICIT
(a) Common Stock
At December 31, 1998, BlockStackers has authorized 60,000 shares of common
stock at no par value.
(b) Retired Common Stock
In December 1998, BlockStackers acquired and retired 500 shares of its
common stock at a purchase price of $.10 per share.
(c) Donated Services
During 1998, certain shareholders provided services valued at approximately
$4,000 for no charge. This amount was recorded as a contribution to capital in
the accompanying statement of stockholders' equity (deficit).
(5) RELATED PARTY TRANSACTIONS
During 1998, BlockStackers operated its business from one of the
shareholders' homes. Therefore, BlockStackers did not incur rent and utilities
expenses.
F-31
<PAGE> 104
BLOCKSTACKERS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(6) SUBSEQUENT EVENT
(a) Operating Lease
On May 1, 1999, BlockStackers entered into an operating lease for its
headquarters. The approximate future minimum lease payments due under the
operating lease agreement are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
- ------------------------
<S> <C>
1999........................................................ $ 7
2000........................................................ 4
---
$11
===
</TABLE>
(b) Sale of Assets
On June 28, 1999, BlockStackers sold all its business assets relating to
the Web site www.slashdot.org and all related trademarks, software code and
hardware required to run the Web site for $1,500,000. The purchase agreement
contains additional cash payments of $3,500,000 and stock consideration of
$7,000,000 contingent upon certain events, as defined.
F-32
<PAGE> 105
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Eclipse Digital Imaging, Inc.:
We have audited the accompanying balance sheet of Eclipse Digital Imaging, Inc.
(a South Dakota corporation) as of December 31, 1998, and the related statements
of operations, stockholders equity and cash flows for the year then ended. These
financial statements are the responsibility of Eclipse Digital Imaging, Inc.'s
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit 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 audit provides 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 Eclipse Digital Imaging, Inc.
as of December 31, 1998, and the results of its operations and its cash flows
for the year then ended, in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
September 16, 1999
F-33
<PAGE> 106
ECLIPSE DIGITAL IMAGING, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
------------ -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash...................................................... $ 10 $ 15
Accounts receivable....................................... 27 1
---- ----
Total current assets.............................. 37 16
Property and equipment, at cost:
Office equipment.......................................... 3 3
Computer equipment........................................ 51 51
---- ----
54 54
Less -- accumulated depreciation.......................... (20) (26)
---- ----
34 28
---- ----
$ 71 $ 44
==== ====
LIABILITIES AND STOCKHOLDERS EQUITY
Current liabilities:
Accounts payable.......................................... $ 6 $ 3
Line of credit............................................ 5 8
Accrued expenses.......................................... 1 4
---- ----
Total current liabilities......................... 12 15
Stockholders' equity
Common stock, $100 par value -- authorized -- 10,000
shares; issued and outstanding -- 400 shares at March
31, 1999............................................... 40 40
Additional paid-in capital................................ 19 19
Accumulated deficit....................................... -- (30)
---- ----
Total stockholders' equity........................ 59 29
---- ----
$ 71 $ 44
==== ====
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-34
<PAGE> 107
ECLIPSE DIGITAL IMAGING, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS
DECEMBER 31, ENDED
1998 MARCH 31, 1999
------------ --------------
(UNAUDITED)
<S> <C> <C>
Net revenue................................................. $291 $ 60
Cost of revenue............................................. 100 (71)
---- ----
Gross profit...................................... 191 (11)
Operating expenses:
Sales and marketing expenses.............................. 14 13
General and administrative expenses....................... 36 14
---- ----
Income (loss) from operations..................... 141 (38)
Other income................................................ 10 8
---- ----
Net income (loss)................................. $151 $(30)
==== ====
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-35
<PAGE> 108
ECLIPSE DIGITAL IMAGING, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK
$100 PAR VALUE
------------------ ADDITIONAL TOTAL
NUMBER OF PAID-IN ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT EQUITY
--------- ------ ---------- ----------- -------------
<S> <C> <C> <C> <C> <C>
December 31, 1997 (Unaudited).......... 400 $40 $11 $ -- $ 51
Contributed capital.................. -- -- 8 -- 8
Stockholder distribution............. -- -- -- (151) (151)
Net income........................... -- -- -- 151 151
---- --- --- ---- ----
December 31, 1998...................... 400 40 19 -- 59
Net loss............................. -- -- -- (30) (30)
---- --- --- ---- ----
March 31, 1999 (Unaudited)............. 400 $40 $19 $(30) $ 29
==== === === ==== ====
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-36
<PAGE> 109
ECLIPSE DIGITAL IMAGING, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, 1998 MARCH 31, 1999
----------------- --------------
(UNAUDITED)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)......................................... $ 151 $ (30)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities --
Depreciation and amortization.......................... 13 7
Changes in operating assets and liabilities --
Accounts receivable.................................. (15) 26
Accounts payable..................................... 3 (3)
Accrued expenses..................................... 1 3
----- -----
Net cash provided by operating activities......... 153 3
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of equipment..................................... (13) (1)
----- -----
CASH FLOWS FROM FINANCING ACTIVITIES:
Stockholder distributions................................. (151) --
Borrowings under line of credit........................... 5 3
----- -----
Net cash provided by (used in) financing
activities...................................... (146) 3
----- -----
NET INCREASE (DECREASE) IN CASH............................. (6) 5
CASH, BEGINNING OF YEAR..................................... 16 10
----- -----
CASH, END OF YEAR........................................... $ 10 $ 15
===== =====
SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING TRANSACTIONS:
Contributed capital....................................... $ 8 $ --
===== =====
</TABLE>
The accompanying notes are an integral part of these financial statements
F-37
<PAGE> 110
ECLIPSE DIGITAL IMAGING, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
(1) OPERATIONS
Eclipse Digital Imaging, Inc. (Eclipse Digital Imaging) was incorporated on
November 25, 1998. From September 1996 through December 1998, Eclipse Digital
Imaging operated was organized as four individual sole proprietors, who were
operating the business. On January 1, 1999, the Company reorganized by issuing
400 shares of stock to the four proprietors at $100 per share in exchange for
assets of Eclipse Digital Imaging, Inc. All periods presented reflect the entity
as a corporation. Eclipse Digital Imaging develops and sells animated graphics
software through its Web site.
Eclipse Digital Imaging, Inc. is subject to risks common to rapidly growing
technology-based companies, including a limited operating history, dependence on
key personnel, and the need for successful development and marketing of
services.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying financial statements reflect the application of certain
significant accounting policies, described in this note and elsewhere in the
notes to financial statements.
(a) Use of Estimates in the 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.
(b) Revenue Recognition
Revenue from the sale of software animation products, for which no
technical support is provided, are generally recognized upon shipment of the
products, net of estimated returns.
(c) Property and Equipment
Eclipse Digital Imaging, Inc. provides for depreciation using the
straight-line method, by charges to operations in amounts estimated to allocate
the cost of property and equipment over their estimated useful lives.
<TABLE>
<CAPTION>
ESTIMATED
ASSET CLASSIFICATION USEFUL LIFE
- -------------------- -----------
<S> <C>
Office equipment.................................. 5 years
Computer equipment/software....................... 3 years
</TABLE>
(d) Concentrations of Credit Risk
Eclipse Digital Imaging has no significant off-balance sheet concentration
of credit risks such as foreign exchange contracts, options contracts, or other
foreign hedging arrangements. Financial instruments that potentially expose
Eclipse Digital Imaging to concentrations of credit risk consist primarily of
cash and accounts receivable. Eclipse Digital Imaging maintains the majority of
its cash balances with financial institutions. Concentrated credit risk with
respect to accounts receivable is limited to certain customers to whom Eclipse
Digital Imaging makes substantial sales. To reduce risk, Eclipse Digital Imaging
routinely assesses the financial strength of its customers and, as a
consequence, believes that its accounts receivable
F-38
<PAGE> 111
ECLIPSE DIGITAL IMAGING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
credit risk exposure is limited. Eclipse Digital Imaging, Inc. operates in one
industry segment and derives substantially all of its revenues from U.S.
customers.
During the year ended December 31, 1998, one customer accounted for
approximately 52% of net sales. This customer's accounts receivable balance
represented approximately 98% of accounts receivable as of December 31, 1998.
(e) Fair Value of Financial Instruments
Financial instruments consist principally of cash, accounts receivable and
accounts payable. The estimated fair value of these instruments approximates
their carrying value.
(f) New Accounting Standards
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. This statement establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the balance sheet and measure those instruments at fair value.
Pursuant to SFAS No. 137, Deferral of the Effective Date, SFAS No. 133,
Accounting For Derivative Instruments and Hedging Activities, this statement is
effective for all fiscal quarters of fiscal years beginning after June 15, 2000.
SFAS No. 133 is not expected to have a material impact on Eclipse Digital
Imaging's financial statements.
In March 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 98-1, Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use. SOP 98-1 requires
computer software costs associated with internal use software to be charged to
operations as incurred until certain capitalization criteria are met. SOP 98-1
is effective for financial statements for fiscal years beginning after December
15, 1998. The adoption of this statement did not have a material impact on
Eclipse Digital Imaging's financial statements.
In April 1998, AICPA issued Statement of Position 98-5, Reporting on the
Costs of Start-Up Activities (SOP 98-5). SOP 98-5 provides guidance on the
financial reporting of start-up activities and organization costs to be expensed
as incurred. SOP 98-5 did not have a material impact on Eclipse Digital
Imaging's financial statements.
(3) INCOME TAXES
Eclipse Digital Imaging is treated as a partnership for Federal and State
income tax purposes, whereby the individual members are taxed on their
proportionate share of Eclipse Digital Imaging, Inc.'s income. As a result,
Eclipse Digital Imaging, Inc. does not provide for Federal or State income
taxes.
(4) COMMITMENTS
(a) Operating Leases
Eclipse Digital Imaging leased certain office space from a related party.
Included in the accompanying statements of operations for the year ended
December 31, 1998 is rent expense of approximately $5,460.
The approximate future minimum annual rent due under the operating lease
agreement as of December 31, 1998 is $4,000 for the year ending December 31,
1999.
F-39
<PAGE> 112
ECLIPSE DIGITAL IMAGING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(b) Litigation
In the ordinary course of business, Eclipse Digital Imaging is party to
various types of litigation. Eclipse Digital Imaging believes it has meritorious
defenses to all claims and, in its opinion, all litigation currently pending or
threatening will not have a material adverse effect on Eclipse Digital Imaging's
financial position or results of operations.
(5) LINE OF CREDIT
On October 2, 1998, Eclipse Digital Imaging entered into a $20,000 line of
credit with the bank secured by substantially all of its business assets. The
line bears interest at 9.5%. At December 31, 1998, approximately $5,000 was
outstanding under the line. The line of credit expires on October 2, 1999. There
are no financial, negative or affirmative covenants.
(6) SUBSEQUENT EVENT
On June 28, 1999, Eclipse Digital Imaging sold substantially all the assets
and assumed certain liabilities for $1,500,000. The purchase agreement contains
additional stock consideration of $1,000,000 contingent upon certain events, as
defined.
F-40
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