<PAGE> 1
EXHIBIT 99.2
DIGITAL ARCHAEOLOGY CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
Report of Independent Auditors.................................................1
Audited Financial Statements
Balance Sheets.................................................................2
Statements of Operations.......................................................4
Statements of Stockholders' Equity (Deficit)...................................5
Statements of Cash Flows.......................................................6
Notes to Financial Statements..................................................8
</TABLE>
<PAGE> 2
Report of Independent Auditors
The Board of Directors
Digital Archaeology Corporation
We have audited the accompanying balance sheets of Digital Archaeology
Corporation (the Company) as of December 31, 1999 and 1998, and the related
statements of operations, stockholders' equity (deficit) and cash flows for the
years then ended. 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 Digital Archaeology Corporation
at December 31, 1999 and 1998, and the results of its operations and its cash
flows for the years then ended in conformity with generally accepted accounting
principles.
[Ernst & Young LLP Signature]
March 1, 2000
1
<PAGE> 3
Digital Archaeology Corporation
Balance Sheets
<TABLE>
<CAPTION>
DECEMBER 31 JUNE 30
1998 1999 2000
(UNAUDITED)
---------- ----------- -----------
<S> <C> <C> <C>
ASSETS (NOTES 6 AND 7)
Current assets:
Cash $3,123,924 $ 132,452 $4,819,062
Accounts receivable 59,277 213,928 646,701
Inventory 9,396 2,612 2,929
Prepaid expenses 2,646 57,024 455,398
---------- ----------- ----------
Total current assets 3,195,243 406,016 5,924,090
Computer equipment 320,573 468,766 579,625
Furniture and fixtures 17,712 148,343 150,770
Office equipment 36,334 47,259 55,223
Software 22,895 142,624 300,358
Leasehold improvements -- 42,486 60,171
---------- ----------- ----------
397,514 849,478 1,146,147
Less accumulated depreciation 95,092 264,050 388,908
---------- ----------- ----------
Net property and equipment 302,422 585,428 757,239
Patent costs 56,854 95,059 124,334
Deposits 18,951 9,951 44,951
---------- ----------- ----------
Total other assets 75,805 105,010 169,285
---------- ----------- ----------
Total assets $3,573,470 $1,096,454 $6,850,614
========== =========== ==========
</TABLE>
2
<PAGE> 4
Digital Archaeology Corporation
Balance Sheets (continued)
<TABLE>
<CAPTION>
DECEMBER 31 JUNE 30
1998 1999 2000
(UNAUDITED)
---------- ------------ -----------
<S> <C> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Notes payable to stockholders (Note 7) $ -- $ 490,000 $ --
Note payable to bank (Note 7) -- 596,588 --
Accounts payable 189,753 427,459 708,943
Accrued expenses 190,357 427,226 296,285
Deferred revenue -- 124,957 144,386
Current portion of capital lease obligations (Note 2) -- 77,235 45,944
---------- ------------ -----------
Total current liabilities 380,110 2,143,465 1,195,558
Capital lease obligations, less current portion (Note 2) -- 8,335 22
Convertible notes payable to stockholders (Note 6) -- 1,110,235 --
Stockholders' equity (deficit) (Notes 4 and 5):
Common stock, $.01 par value:
Authorized shares -- 5,472,467 and 33,000,000 at
December 31, 1999 and June 30, 2000, respectively
Issued and outstanding shares -- 502,000 and
526,776 at December 31, 1999 and June 30,
2000, respectively 5,020 5,020 5,268
Redeemable, convertible preferred
stock, $.01 par value:
Series A:
Authorized shares -- 1,000,000
Issued and outstanding shares --
1,000,000 10,000 10,000 10,000
Liquidation preference -- $1,000,000
Series B:
Authorized shares -- 2,238,537
Issued and outstanding shares -- 2,238,537 22,384 22,384 22,384
Liquidation preference -- $4,589,000
Series C:
Authorized shares -- 833,334
Issued and outstanding shares -- 833,334 8,333 8,333 8,333
Liquidation preference -- $3,200,000
Series D:
Authorized shares -- 50,000
Issued and outstanding shares -- 13,190 -- -- 132
Liquidation preference -- $13,190,000
Additional paid-in capital 8,642,094 8,702,094 21,838,283
Accumulated deficit (5,494,471) (10,913,412) (16,229,366)
---------- ------------ -----------
Total stockholders' equity (deficit) 3,193,360 (2,165,581) 5,655,034
---------- ------------ -----------
Total liabilities and stockholders' equity (deficit) $3,573,470 $ 1,096,454 $ 6,850,614
========== ============ ===========
</TABLE>
See accompanying notes.
3
<PAGE> 5
Digital Archaeology Corporation
Statements of Operations
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31 JUNE 30
1998 1999 1999 2000
----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED)
Revenues:
<S> <C> <C> <C> <C>
Licenses $ 94,825 $ 717,183 $ 265,875 $ 518,777
Services 175 139,830 10,681 174,796
----------- ----------- ----------- -----------
Total revenues 95,000 857,013 276,556 693,573
Cost of revenues:
Licenses -- 13,376 3,494 4,554
Services -- 139,890 41,359 137,109
----------- ----------- ----------- -----------
Total cost of revenues -- 153,266 44,853 141,663
Gross margin 95,000 703,747 231,703 551,910
Operating expenses:
Sales and marketing 919,142 2,296,330 1,149,673 3,932,310
Research and development 1,577,442 2,249,025 1,069,613 1,282,425
General and administrative 821,265 1,482,341 710,615 735,319
----------- ----------- ----------- -----------
Total operating expenses 3,317,849 6,027,696 2,929,901 5,950,054
----------- ----------- ----------- -----------
Operating loss (3,222,849) (5,323,162) (2,698,198) (5,398,144)
Interest expense (23,662) (131,497) (13,012) (113,655)
Interest income 47,643 35,718 32,241 195,845
----------- ----------- ----------- -----------
Net loss $(3,198,868) $(5,418,941) $(2,678,969) $(5,315,954)
=========== =========== =========== ===========
</TABLE>
See accompanying notes.
4
<PAGE> 6
Digital Archaeology Corporation
Statements of Stockholders' Equity (Deficit)
<TABLE>
<CAPTION>
SERIES A SERIES B SERIES C
COMMON PREFERRED PREFERRED PREFERRED
STOCK STOCK STOCK STOCK
------ -------- --------- --------
<S> <C> <C> <C> <C>
Balance at December 31, 1997 $5,000 $10,000 $ -- $ --
Issuance of 2,000 shares of common stock
as compensation for services 20 -- -- --
Issuance of 1,390,244 shares of Series B
preferred stock for cash, net of
offering costs of $50,000 -- -- 13,902 --
Issuance of 775,122 shares of Series B
preferred stock upon conversion of
demand notes payable -- -- 7,751 --
Issuance of 73,171 shares of Series B
preferred stock upon exercise of
Series B preferred stock warrants -- -- 731 --
Issuance of 833,334 shares of Series C
preferred stock for cash, net of
offering costs of $11,000 -- -- -- 8,333
Net loss -- -- -- --
------ ------- ------- ------
Balance at December 31, 1998 5,020 10,000 22,384 8,333
Common stock warrants issued in
conjunction with notes payable -- -- -- --
Net loss -- -- -- --
------ ------- ------- ------
Balance at December 31, 1999 5,020 10,000 22,384 8,333
Issuance of 13,190 shares of Series
D preferred stock for cash, net of
offering costs of $108,689
(unaudited) -- -- -- --
Grant and exercise of common stock
options as compensation for
services (unaudited) 248 -- -- --
Net loss (unaudited) -- -- -- --
------ ------- ------- ------
Balance at June 30, 2000 (unaudited) $5,268 $10,000 $22,384 $8,333
====== ======= ======= ======
</TABLE>
<TABLE>
<CAPTION>
SERIES D ADDITIONAL
PREFERRED PAID-IN ACCUMULATED
STOCK CAPITAL DEFICIT TOTAL
--------- ---------- ----------- -------
<S> <C> <C>
Balance at December 31, 1997 $ -- $ 1,090,000 $ (2,295,603) $(1,190,603)
Issuance of 2,000 shares of common stock
as compensation for services -- 4,080 -- 4,100
Issuance of 1,390,244 shares of Series B
preferred stock for cash, net of
offering costs of $50,000 -- 2,786,098 -- 2,800,000
Issuance of 775,122 shares of Series B
preferred stock upon conversion of
demand notes payable -- 1,581,249 -- 1,589,000
Issuance of 73,171 shares of Series B
preferred stock upon exercise of
Series B preferred stock warrants -- -- -- 731
Issuance of 833,334 shares of Series C
preferred stock for cash, net of
offering costs of $11,000 -- 3,180,667 -- 3,189,000
Net loss -- -- (3,198,868) (3,198,868)
---- ----------- ------------ -----------
Balance at December 31, 1998 8,642,094 (5,494,471) 3,193,360
Common stock warrants issued in
conjunction with notes payable -- 60,000 -- 60,000
Net loss -- -- (5,418,941) (5,418,941)
---- ----------- ------------ -----------
Balance at December 31, 1999 -- 8,702,094 (10,913,412) (2,165,581)
Issuance of 13,190 shares of Series
D preferred stock for cash, net of
offering costs of $108,689
(unaudited) 132 13,081,179 -- 13,081,311
Grant and exercise of common stock
options as compensation for
services (unaudited) -- 55,010 -- 55,258
Net loss (unaudited) -- -- (5,315,954) (5,315,954)
---- ----------- ------------ -----------
Balance at June 30, 2000 (unaudited) $132 $21,838,283 $(16,229,366) $ 5,655,034
==== =========== ============ ===========
</TABLE>
See accompanying notes.
5
<PAGE> 7
Digital Archaeology Corporation
Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31 JUNE 30
1998 1999 1999 2000
(UNAUDITED) (UNAUDITED)
----------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss $(3,198,868) $ (5,418,941) $(2,678,969) $(5,315,954)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation 56,160 168,958 70,729 124,858
Amortization of debt discount to
interest expense -- 51,823 -- 8,177
Compensatory stock issuance 4,100 -- -- 55,000
Changes in operating assets and
liabilities:
Accounts receivable (50,824) (154,651) (199,770) (432,773)
Inventory (9,396) 6,784 (1,827) (317)
Prepaid expenses 289 (54,378) (42,881) (398,374)
Deposits (6,000) 9,000 (32,000) (35,000)
Accounts payable 177,129 237,706 (68,244) 281,484
Accrued expenses 182,280 236,869 77,923 (130,941)
Deferred revenue -- 124,957 70,055 19,429
----------- ------------ ----------- -----------
Net cash used in operating activities (2,845,130) (4,791,873) (2,804,984) (5,824,411)
----------- ------------ ----------- -----------
INVESTING ACTIVITIES
Purchases of property and equipment (209,789) (297,495) (319,927) (296,669)
Patent costs incurred (56,206) (38,205) (3,523) (29,275)
----------- ------------ ----------- -----------
Net cash used in investing activities (265,995) (335,700) (323,450) (325,944)
----------- ------------ ----------- -----------
FINANCING ACTIVITIES
Proceeds from issuance of convertible
notes payable to stockholders 200,000 1,115,000 987,790 (1,115,000)
Proceeds from issuance of notes payable to
stockholders -- 490,000 -- (490,000)
Proceeds from issuance of note payable to
bank -- 600,000 -- (600,000)
Principal payments on capital lease
obligations -- (68,899) (5,257) (39,604)
Proceeds from exercise of warrants 731 -- -- --
Proceeds from issuance of common stock -- -- -- 258
Proceeds from issuance of preferred stock,
net of offering costs 5,989,000 -- -- 13,081,311
----------- ------------ ----------- -----------
Net cash provided by financing activities 6,189,731 2,136,101 982,533 10,836,965
----------- ------------ ----------- -----------
Increase (decrease) in cash 3,078,606 (2,991,472) (2,145,901) 4,686,610
Cash at beginning of year 45,318 3,123,924 3,123,924 132,452
----------- ------------ ----------- -----------
Cash at end of year $ 3,123,924 $ 132,452 $ 978,023 $ 4,819,062
=========== ============ =========== ===========
</TABLE>
6
<PAGE> 8
Digital Archaeology Corporation
Statements of Cash Flows (continued)
<TABLE>
<CAPTION>
DECEMBER 31
1999 1998
--------- -------
<S> <C> <C>
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest $ 31,081 $ 1,433
======== ==========
SUPPLEMENTAL NONCASH INVESTING AND
FINANCING ACTIVITIES
Acquisition of equipment through the
issuance of capital lease obligations $154,469 $ --
======== ==========
Allocation of proceeds to common stock
warrants issued in conjunction with
notes payable $ 60,000 $ --
======== ==========
Conversion of convertible demand note
payable and accrued interest ($89,000)
to Series B preferred stock
$ -- $1,589,000
======== ==========
</TABLE>
See accompanying notes.
7
<PAGE> 9
1. SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
Digital Archaeology Corporation (the Company) provides software products and
support services to medium to large companies that require analytical analysis
of information from disparate systems, database or other data sources. The
Company's software products may be used in building a number of applications
that enable companies to identify, maintain and improve customer relationships
across e-commerce and traditional distribution channels. C-Discovery and
Discovery Suite, the Company's first products, enable rapid assembly and
analyzation of data regardless of structure or data type to support
"just-in-time" decision making in response to customer and market needs.
REVENUE RECOGNITION
The Company derives revenue from software licenses, post contract customer
support (PCS) and other professional services. Post contract customer support
includes, among other things, telephone support and rights to upgrades on a
when-and-if-available basis. In software arrangements that include rights to
software products, PCS and/or other services, the Company allocates the total
arrangement fee among each deliverable based on the relative fair value of each
of the deliverables determined based on vendor-specific objective evidence.
Software Licenses -- The Company recognizes the revenue allocable to software
licenses upon delivery of the software product to the end user, unless the fee
is not fixed or determinable or collectibility is not probable. The Company
provides a reserve for estimated returns under the standard acceptance terms at
the time the revenue is recorded.
Post contract Customer Support -- Revenue allocable to PCS is recognized on a
straight-line basis over the period the PCS is provided.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost and depreciated using the
straight-line method over the estimated useful lives of the assets, which range
from three to seven years. Repair and maintenance costs are charged to expense
as incurred.
INTANGIBLES
Since 1998, the Company has incurred $124,334 of costs related to filing a
patent application for the development and marketing of software applications.
Upon approval of the patent, the Company will begin amortizing the patent over
its estimated useful life.
SOFTWARE DEVELOPMENT COSTS
Costs incurred with respect to internally developed computer software products
are expensed in accordance with the provisions of Statement of Financial
Accounting Standards (SFAS) No. 86 until completion of the detail program
design. Thereafter, all software development costs are capitalized and
subsequently reported at the lower of amortized cost or net realizable value. As
of December 31, 1999 and 1998 and June 30, 2000, there have been no costs
capitalized related to software development.
8
<PAGE> 10
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK OPTIONS
The Company has elected to follow Accounting Principles Board (APB) Opinion No.
25, "Accounting for Stock Issued to Employees," and related interpretations in
accounting for its stock options and has adopted the pro forma disclosure
requirements under SFAS No. 123, "Accounting for Stock-Based Compensation."
Under APB No. 25, because the exercise price of the Company's stock options is
equal to or greater than the estimated fair value of the underlying stock as the
date of grant, no compensation expense is recognized.
INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes." Under SFAS No. 109, the liability method is used
in accounting for income taxes whereby deferred tax assets and liabilities are
determined based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
CONCENTRATION OF CREDIT RISK
The Company grants credit to customers who meet the Company's preestablished
credit requirements and generally does not require collateral to secure payment
of accounts receivable. The Company had one customer which accounted for
approximately 83% and 80% of the accounts receivable at December 31, 1999 and
1998, respectively, and two customers which accounted for approximately 27% and
100% of revenues for the years ended December 31, 1999 and 1998, respectively.
As of and for the six months ended June 30, 2000, four customers comprised 24%,
19%, 17% and 13%, respectively, of revenue. Credit risk is controlled by
management through credit limits and credit approvals.
9
<PAGE> 11
2. LEASES
The Company leases office space under an operating lease with an option to
extend the lease term for two additional and consecutive one-year terms. In
addition, the Company leases certain office equipment and furniture under
agreements accounted for as operating leases. Rent expense under all operating
leases for the year ended December 31, 1999 and 1998 and the six months ended
June 30, 2000 was $155,034, $143,318 and $65,576, respectively.
Future minimum lease payments under noncancelable operating leases over the next
four years ending December 31 are as follows:
<TABLE>
<S> <C> <C>
2000 $131,260
2001 4,553
2002 4,553
2003 2,276
</TABLE>
During 1999, the Company also began leasing certain furniture and equipment
under agreements accounted for as capital leases. Total assets under these
capital leases amounted to $154,469 at December 31, 1999 and June 30, 2000,
respectively. Total amortization expense for 1999 was $14,652 and for the six
months ended June 30, 2000 was $15,140. Future minimum lease payments over the
next two years as of December 31, 1999 are as follows:
<TABLE>
<S> <C>
2000 $85,292
2001 8,965
-------
Total minimum lease payments 94,257
Less amount representing interest 8,687
-------
Present value of net minimum lease payments 85,570
Less current portion 77,235
-------
$ 8,335
=======
</TABLE>
3. INCOME TAXES
Deferred income taxes are attributable to temporary differences between the
financial statement and tax bases of certain assets and liabilities, the most
significant of which relates to net operating loss carry forwards, start-up
costs capitalized for income tax purposes, depreciation differences and certain
accrued expenses. Deferred income taxes at December 31, 1999 and 1998 consist of
the following:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Deferred tax assets arising from deductible
temporary differences $4,423,565 $2,101,155
Valuation allowance 4,345,609 (2,091,343)
---------- ----------
77,956 9,812
Deferred tax liabilities arising from
taxable temporary differences (77,956) (9,812)
---------- ----------
$ -- $ --
========== ==========
</TABLE>
The Company has provided valuation reserves of $4,345,609 and $2,091,343 as of
December 31, 1999 and 1998, respectively, to fully reserve for net deferred tax
assets in the same amounts due to the uncertainty of their future realization.
10
<PAGE> 12
3. INCOME TAXES (CONTINUED)
At December 31, 1999, the Company had a net operating loss carry forward of
approximately $10,435,000 for federal income tax purposes, which is available to
offset future taxable income and expires beginning in 2009, if unused. Future
utilization of the net operating loss carry forward may be limited by income tax
provisions relating to changes in ownership of the Company.
4. STOCKHOLDERS' EQUITY
PREFERRED STOCK
Series A, Series B Series C and Series D preferred stockholders are entitled to
voting rights equivalent to common stockholders based on the number of shares of
common stock into which the Series A, Series B Series C and Series D preferred
shares can be converted, as adjusted from time to time in accordance with the
Company's articles of incorporation. As long as any Series A, Series B and
Series C preferred shares remain outstanding and not less than 15% of the Series
D remain outstanding, the Company may not make any changes regarding amendments
to the articles of incorporation and bylaws, authorization, issuance or
redemption of additional series of preferred stock, declaration or payment of
dividends on common stock, additional loans or authorization of a change in
control of the Company, among other things, without the consent of a majority of
the then-outstanding (i) Series A and Series B preferred stockholders as one
vote, (ii) the Series C preferred stockholders as a separate vote and (iii) 60%
of the Series D preferred stockholders as a separate vote.
SERIES A
The holders of Series A preferred stock are entitled to receive dividends based
on the number of shares of common stock into which the Series A preferred stock
can be converted, if any such dividends are declared, paid or set aside for
common stockholders.
Upon liquidation, Series A preferred stockholders are entitled to an aggregate
preference distribution of the stated issue price plus any declared and unpaid
dividends, after and subordinate to any distributions due Series B and Series C
preferred stockholders. Holders of Series A preferred stock have the right, at
their option, to convert shares of Series A preferred stock into common stock.
The conversion rate per share shall be the stated issue price per share of
Series A preferred stock of $1 per share, plus all declared and unpaid dividends
divided by $1, subject to adjustment from time to time in accordance with the
Company's articles of incorporation. In the event of a qualified public offering
of the Company's common stock as defined by the certificate of preference or
upon the vote of at least 51% of the Series A preferred stockholders, shares of
the Series A preferred stock automatically will be converted into common stock
under the terms described above.
By written notice, as defined by the certificate of preference, at any time
during the period from the fifth anniversary of the Series A preferred stock to
the 10th anniversary thereof, the holders of at least 51% of the
then-outstanding Series A preferred stock can require the Company to redeem all
shares of the Series A preferred stock based on the Company's value as
determined by an independent business appraiser or investment banker. The
redemption rights of Series A preferred stockholders are subordinate to the
redemption rights of Series B and Series C preferred shareholders, and no Series
A preferred shares shall be redeemed until all Series B and Series C preferred
shares designated by the holders thereof are redeemed in accordance with the
redemption terms of the Series B and Series C preferred stock.
SERIES B AND SERIES C
The holders of Series B and Series C preferred stock are entitled to receive
dividends based on the number of shares of common stock into which the Series B
or Series C preferred stock can be converted if any such dividends are declared,
paid or set aside for common stockholders.
11
<PAGE> 13
4. STOCKHOLDERS' EQUITY (CONTINUED)
Upon liquidation, Series B and Series C preferred stockholders are entitled to
an aggregate preference distribution of the original issue price of $2.05 and
$3.84, respectively, plus any declared and unpaid dividends. Series B preference
distributions are payable after, and are subordinate to, any distributions due
Series C and Series D preferred stockholders. Series C preference distributions
are payable after, and are subordinate to, any distributions due Series D
preferred stockholders. Holders of Series B and Series C preferred stock have
the right, at their option, to convert shares of Series B and Series C preferred
stock into common stock. The conversion rate per share shall be the original
issue price per share of Series B and Series C preferred stock plus all declared
and unpaid dividends divided by $2.05 for Series B preferred stock and $3.84 for
Series C preferred stock, subject to adjustment from time to time in accordance
with the Company's Articles of Incorporation. Each share of Series B and Series
C preferred stock shall be convertible into common stock, at the option of the
holder, any time after the date of issuance under the terms described above. In
the event of a qualified public offering of the Company's common stock, defined
in the Series B and Series C preferred stock agreements as a public offering
which values the Company at no less then $100 million and the proceeds to the
Company from such offering are not less than $20 million, shares of the Series B
and Series C preferred stock automatically will be converted into common stock
under the terms described above.
By written notice, as defined by the Series B and Series C certificates of
preference, at any time during the period from the fifth anniversary of the
Series B and Series C preferred stock to the 10th anniversary thereof, each
holder of Series B and Series C preferred stock can require the Company to
redeem all shares of the Series B and Series C preferred stock the redeeming
holder designates, payable in cash, based on the greater of the original issue
price or the Company's value, as determined by a qualified appraiser in
accordance with the Series B and Series C certificates of designation. The
redemption rights of Series B preferred stockholders are subordinate to the
redemption rights of Series C preferred shareholders, and no Series B preferred
shares shall be redeemed until all Series C preferred shares designated by the
holders thereof are redeemed in accordance with the redemption terms of the
Series C preferred stock. The redemption rights of Series C preferred
stockholders are subordinate to the redemption rights of Series D preferred
shareholders and no Series C preferred shares shall be redeemed until all Series
D preferred shares designated by the holders thereof are redeemed in accordance
with the redemption terms of the Series D preferred stock.
SERIES D
The holders of Series D preferred stock are entitled to receive dividends at the
annual rate per share (as a percentage of the issue price of $1,000 per share)
equal to 10% per annum. The Company has the option to pay the dividend in kind
by issuing shares of Series D preferred stock valued at $1,000 per share.
Upon liquidation, Series D preferred stockholders are entitled to an aggregate
preference distribution of the original issue price of $1,000 plus any accrued
and unpaid dividends. Holders of Series D preferred stock have the right, at
their option, to convert shares of Series D preferred stock into common stock.
The conversion rate per share shall be the quotient obtained by dividing the
original issue price plus any accrued and unpaid dividends by $2.22, subject to
adjustment from time to time in accordance with the Series D certificate of
designations. Each share of Series D preferred stock shall be convertible into
common stock, at the option of the holder, any time after the date of issuance
under the terms described above. In the event of a public offering of the
Company's common stock, defined in the Series D preferred stock agreements as a
public offering with proceeds to the Company not less than $20 million and at a
per share offering price to the public of not less than 250% of the common share
equivalent price of $2.22, shares of the Series D preferred stock automatically
will be converted into common stock under the terms described above.
By written notice, as defined by the Series D certificate of designation, at any
time from the fifth anniversary of the Series D original issuance and with
approval of 60% of the Series D holders, each holder of Series D preferred stock
can require the Company to redeem all shares of the Series D preferred stock the
redeeming holder designates, payable in cash, based on the greater of fair
market value of the Series D preferred stock or the liquidation value under the
terms described above.
12
<PAGE> 14
4. STOCKHOLDERS' EQUITY (CONTINUED)
Authorized but unissued shares of common stock were reserved for issuance at
June 30, 2000 as follows:
<TABLE>
<S> <C>
Series A preferred stock 1,000,000
Series B preferred stock 2,238,537
Series C preferred stock 1,101,663
Series D preferred stock 5,941,709
Warrants to purchase Series D preferred stock 297,106
Stock options under 1996 Plan (Note 5) 500,000
Stock options under 1998 Plan (Note 5) 1,941,979
----------
13,020,994
==========
</TABLE>
5. STOCK OPTIONS
In 1994, stock options for the purchase of 30,000 shares of common stock were
granted to an individual, for services rendered, with an exercise price of $1.00
per share. These stock options were subsequently incorporated into the 1996
Stock Option Plan.
In 1996, the Board of Directors approved the 1996 Stock Option Plan (the 1996
Plan), which authorizes up to 500,000 shares of common stock for granting both
incentive and nonqualified stock options to employees and consultants, although
incentive stock options are reserved exclusively for employees. The exercise
price and vesting period of the options are determined by the Board of Directors
at the date of grant. Options expire 10 years from the date of grant or such
shorter term as provided for in the stock option agreement except where options
are granted to an optionee who owns more than 10% of the voting power of all
classes of stock of the Company, in which case the options expire five years
from the date of grant or such shorter term as provided for in the stock option
agreement. Upon a change of control event, as defined by the 1996 Plan, options
granted under the Plan may, in the discretion of the Board of Directors, be
fully vested and exercisable.
In 1998, the Board of Directors approved the 1998 Stock Option Plan (the 1998
Plan), which authorizes up to 1,966,756 shares of common stock (as amended in
August and December 1998 and January 2000) for granting both incentive and
nonqualified stock options to employees and consultants. The exercise price and
vesting period of the options are determined by the Board of Directors at the
date of grant. Options expire 10 years from the date of grant or such shorter
term as provided for in the stock option agreement except where options are
granted to an optionee who owns more than 10% of the voting power of all classes
of stock of the Company, in which case the options expire five years from the
date of grant or such shorter term as provided for in the stock option
agreement. Upon a change of control event, as defined by the 1998 Plan, options
granted under the Plan may, in the discretion of the Board of Directors, be
fully vested and exercisable.
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<PAGE> 15
5. STOCK OPTIONS (CONTINUED)
A summary of stock option activity related to all of the Company's stock options
is as follows:
<TABLE>
<CAPTION>
WEIGHTED-
OPTION AVERAGE
NUMBER PRICE EXERCISE
OF SHARES PER SHARE PRICE
------------------------------------------------------
<S> <C> <C> <C>
Outstanding at December 31, 1997 446,500 $1.00 $1.00
Granted 1,384,592 .77 to 3.84 1.38
Repriced (853,396) 1.00 to 3.84 1.85
Canceled/forfeited (22,000) 1.00 to 2.05 2.00
----------
Outstanding at December 31, 1998 955,696 .77 to 1.00 .78
Granted 441,800 .77 .77
Canceled/forfeited (121,175) .77 .77
----------
Outstanding at December 31, 1999 1,276,321 .77 to 1.00 .78
==========
Granted 1,115,152 .77 .77
Canceled/forfeited (53,625) .77 .77
Exercised (24,776) 1.00 1.00
Outstanding at June 30, 2000 2,313,072 .77 to 1.00 .77
Exercisable at
December 31, 1998 294,437 .77 to 1.00
December 31, 1999 592,412 .77 to 1.00
June 30, 2000 975,440 .77 to 1.00
</TABLE>
During November 1998, the Company's Board of Directors approved the repricing of
all stock options other than the 30,000 stock options granted in 1994, lowering
the exercise price to $.77 per share, which management believes to be the
estimated fair market value of the Company's common stock at the time the
repricing was approved. The 853,396 stock options repriced in November 1998 are
included in the total stock options granted in 1998. The weighted-average
remaining contractual life of options outstanding under the plan at December 31,
1999 is 8.1 years. At December 31, 1999 and 1998, there were 14,675 and 335,300
shares, respectively, reserved for future grants under existing stock option
plans.
The fair values of options granted were estimated at the date of grant using the
minimum value option pricing model with the following weighted-average
assumptions: risk-free interest rates ranging from 5.00% to 5.50% depending on
the expected life of the option and year granted and a weighted-average expected
life of approximately 10 years for each of the years ended December 31, 1999 and
1998. Under the minimum value option pricing model, the volatility factor is
excluded. The Company assumed a 0% dividend yield over the expected life of the
options.
The minimum value option pricing model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions. Because the Company's stock options have characteristics
significantly different from those of traded options and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The effects of
applying SFAS No. 123 for pro forma disclosures are not likely to be
representative of the effects on reported net income or losses for future years.
The Company's pro forma net loss equals $5,645,502 and $3,317,507 for the years
ended December 31, 1999 and 1998, respectively.
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<PAGE> 16
6. CONVERTIBLE NOTES PAYABLE
In June 1999, the Company entered into a series of unsecured convertible note
payable agreements with certain stockholders under which the Company received
$915,000. Borrowings under these notes payable accrue interest at 8% per annum
and are payable at various maturity dates in 2000. Under the terms of the
agreements, all borrowings and interest thereon may be converted into a
subsequently authorized Series D preferred stock at the market price on date of
conversion. Additionally, the Company granted to the holders of convertible
notes payable warrants to purchase 201 shares of Series D preferred stock. The
warrants have an exercise price to be equal to the fair value of the underlying
Series D preferred stock at the date of its first issuance (see Note 9). The
warrants may be exercised anytime within five years of the grant date. At
December 31, 1999 and June 30, 2000, none of the warrants have been exercised.
The estimated value of the warrants at date of issuance, amounting to $32,000,
was recorded as a discount on the related notes payable and as additional
paid-in capital. The discount is being amortized over the expected term of the
convertible notes payable. In January 2000, all borrowings under these note
agreements were converted into 915 shares of Series D preferred stock. As such,
the December 31, 1999 balance of the convertible notes payable, amounting to
$912,689 (net of $2,311 in unamortized discount), has been classified as a
noncurrent liability in the accompanying 1999 balance sheet.
In October 1999, the Company entered into a convertible note payable agreement
under which the Company received $200,000. Borrowings under this note payable
accrue interest at a rate equal to prime plus 2% (10.5% at December 31, 1999)
and are payable in February 2000. This note payable is secured by a subordinate
interest in substantially all the assets of the Company. Under the terms of the
agreement, all borrowings and interest thereon may be converted into a
subsequently authorized Series D preferred stock at the market price on date of
conversion. Additionally, the Company granted to the holder warrants to purchase
12 shares of Series D preferred stock. The warrants have an exercise price to be
equal to the fair value of the underlying Series D preferred stock at the date
of its first issuance (see Note 9). The warrants may be exercised anytime within
five years of the grant date. At December 31, 1999 and June 30, 2000, none of
the warrants have been exercised. The estimated value of the warrants at date of
issuance, amounting to $7,000, was recorded as a discount on the related note
payable and as additional paid-in capital. The discount is being amortized over
the expected term of the convertible note payable. In February 2000, all
borrowings under this note agreement were converted into 200 shares of Series D
preferred stock. As such, the December 31, 1999 balance of the convertible note
payable, amounting to $197,546 (net of $2,454 in unamortized discount), has been
classified as a noncurrent liability in the accompanying 1999 balance sheet.
7. NOTES PAYABLE
During 1999, the Company entered into two note payable agreements with a bank
under which the Company borrowed $600,000. Borrowings under these note payable
agreements accrue interest at a rate equal to prime plus 2% (10.5% at December
31, 1999) and are payable in January 2000. These notes payable are secured by
substantially all the assets of the Company. The Company also granted to the
holder warrants to purchase 97 shares of Series D preferred stock. The warrants
have an exercise price to be equal to the fair value of the underlying Series D
preferred stock at the date of its first issuance (see Note 9). The warrants may
be exercised anytime within five years of the grant date. The estimated value of
the warrants at date of issuance, amounting to $21,000, was recorded as a
discount on the related notes payable and as additional paid-in capital. The
discount is being amortized over the expected term of the notes. In January
2000, all borrowings under these note agreements were fully repaid. At December
31, 1999, the recorded balance of the notes payable amounts to $596,588, net of
$3,412 in unamortized discount.
At various times throughout 1999, the Company entered into unsecured note
payable agreements with certain stockholders under which the Company received
$490,000. Borrowings under these note agreements accrue interest at a rate equal
to prime plus 2% (10.5% at December 31, 1999) and are payable in January 2000.
In January 2000, all borrowings under these note agreements were fully repaid.
15
<PAGE> 17
8. YEAR 2000 -- UNAUDITED
The Company recognizes the need to ensure that its operations will not be
impacted adversely by year 2000 software failures. The Company has coordinated
the identification, evaluation and implementation of changes to computer systems
and applications necessary to achieve a year 2000 date conversion with no effect
on customers or disruption to business operations. The Company has completed an
assessment of its computer systems and believes the year 2000 issue will not
pose significant operational problems for its computer systems.
9. SUBSEQUENT EVENTS
In January 2000, the Company amended its articles of incorporation to increase
the number of authorized common and preferred shares to 33,000,000 and
5,000,000, respectively.
Subsequent to December 31, 1999, the Company issued 13,190 shares of a newly
authorized Series D preferred stock in exchange for $13,081,311, net of offering
costs of $108,689. In conjunction with this offering, certain holders of notes
payable converted $1,115,000 of convertible notes payable into 1,115 shares of
Series D preferred stock. The Company intends to use the proceeds principally to
further develop their sales and marketing channels.
16
