<PAGE> 1
EXHIBIT 99.1
Independent Auditor's Report
The Board of Directors and Stockholders
Petstore.com, Inc.
We have audited the accompanying consolidated balance sheet of
Petstore.com, Inc. as of December 31, 1999, and the related consolidated
statements of operations, stockholders' equity and cash flows for the period
from January 28, 1999 (inception) to December 31, 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 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 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Petstore.com, Inc. as of December 31, 1999, and the consolidated results of its
operations and its cash flows for the period from January 28, 1999 (inception)
to December 31, 1999, in conformity with generally accepted accounting
principles.
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in note 9 to the
financial statements, the Company's net loss, accumulated deficit and
noncompliance with debt covenants raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters are
also described in note 9. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ KPMG LLP
Dated: March 10, 2000
F-1
<PAGE> 2
PETSTORE.COM, INC.
(A Subsidiary of Discovery Communications Inc.)
Consolidated Balance Sheet
December 31, 1999
<TABLE>
<CAPTION>
<S> <C>
ASSETS
Current assets:
Cash $ 1,963,428
Inventories 1,007,948
Prepaid advertising and promotions 2,258,900
Other current assets 352,122
Total current assets 5,582,398
Fixed assets, net 2,227,775
Deposits 221,592
Intangibles, net 55,128,614
Total assets $ 63,160,379
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,359,184
Accrued expenses 4,442,779
Short-term debt 12,085,731
Obligations under capital leases 32,904
Total current liabilities 18,920,598
Related party notes 4,000,000
Obligations under capital lease -- noncurrent 31,482
Total liabilities 22,952,080
Stockholders' equity:
Series A preferred stock, $0.0001 par value:
Authorized shares -- 7,117,451; issued and outstanding shares -- 5,636,915 564
Series B preferred stock, $0.0001 par value:
Authorized shares -- 13,305,303; issued and outstanding shares -- 13,305,303 1,331
Series C preferred stock, $0.0001 par value:
Authorized shares -- 2,128,074; issued and outstanding shares -- 1,591,895 159
Common stock, $0.0001 par value:
Authorized shares -- 40,000,000; issued and outstanding shares -- 2,267,327 227
Additional paid-in capital 129,884,717
Deferred equity-based charges (44,675,443)
Accumulated deficit (45,003,256)
Total stockholders' equity 40,208,299
Total liabilities and stockholders' equity $ 63,160,379
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<PAGE> 3
PETSTORE.COM, INC.
(A Subsidiary of Discovery Communications Inc.)
Consolidated Statement of Operations
Period from January 28, 1999 (inception) to December 31, 1999
<TABLE>
<CAPTION>
<S> <C>
Net sales $ 2,100,462
Cost of sales (5,161,253)
------------
Gross margin (3,060,791)
Operating expenses:
Sales and marketing 22,630,515
Product development 5,441,913
General and administrative 8,366,349
Stock-based employee compensation 627,839
------------
Total operating expenses 37,066,616
Loss from operations (40,127,407)
Interest expense, net 4,875,849
------------
Net loss $(45,003,256)
============
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 4
PETSTORE.COM, INC.
Consolidated Statement of Stockholders' Equity
Period from January 28, 1999 (inception) to December 31, 1999
<TABLE>
<CAPTION>
SERIES A PREFERRED STOCK SERIES B PREFERRED STOCK SERIES C PREFERRED STOCK
---------------------------- ---------------------------- ----------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at
January 28,
1999 (inception) -- $ -- -- $ -- -- $ --
Initial issuance
of common shares
to founders -- -- -- -- -- --
Common stock
issued in
connection with
the acquisition
of Flying Fish
Express -- -- -- -- -- --
Issuance of Series
A preferred stock 5,636,914 564 -- -- -- --
Common stock
issued in
connection with
the AAHA
agreement -- -- -- -- -- --
Issuance of Series
B preferred stock -- -- 13,305,303 1,331 -- --
Issuance of Series
C preferred stock -- -- -- -- 1,591,895 159
Issuance of
warrants for
services -- -- -- -- -- --
Issuance of stock
options for
services -- -- -- -- -- --
Issuance of
warrants with
short-term debt -- -- -- -- -- --
Issuance of
employee stock
options -- -- -- -- -- --
Amortization of
deferred
equity-based
charges -- -- -- -- -- --
Net loss -- -- -- -- -- --
----------- ----------- ----------- ----------- ----------- -----------
Balance at
December 31, 1999 5,636,914 $ 564 13,305,303 $ 1,331 1,591,895 $ 159
=========== =========== =========== =========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL DEFERRED TOTAL
---------------------------- PAID-IN EQUITY-BASED ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT CAPITAL CHARGES DEFICIT EQUITY
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at
January 28,
1999 (inception) -- $ -- -- -- -- --
Initial issuance
of common shares
to founders 1,723,745 172 690 -- -- 862
Common stock
issued in
connection with
the acquisition
of Flying Fish
Express 347,548 35 660,306 -- -- 660,341
Issuance of Series
A preferred stock -- -- 15,016,691 -- -- 15,017,255
Common stock
issued in
connection with
the AAHA
agreement 196,034 20 1,056,960 (1,056,980) -- --
Issuance of Series
B preferred stock -- -- 91,938,313 (32,000,000) -- 59,939,644
Issuance of Series
C preferred stock -- -- 10,999,835 (9,999,994) -- 1,000,000
Issuance of
warrants for
services -- -- 1,023,710 (1,011,000) -- 12,710
Issuance of stock
options for
services -- -- 332,830 (223,030) -- 109,800
Issuance of
warrants with
short-term debt -- -- 7,253,768 -- -- 7,253,768
Issuance of
employee stock
options -- -- 1,601,614 (1,601,614) -- --
Amortization of
deferred
equity-based
charges -- -- -- 1,217,175 -- 1,217,175
Net loss -- -- -- -- (45,003,256) (45,003,256)
----------- ----------- ----------- ----------- ----------- -----------
Balance at
December 31, 1999 2,267,327 $ 227 129,884,717 (44,675,443) (45,003,256) 40,208,299
=========== =========== =========== =========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 5
Consolidated Statement of Cash Flows
Period from January 28, 1999 (inception) to
December 31, 1999
<TABLE>
<S> <C>
Operating activities:
Net loss $(45,003,256)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 1,626,757
Amortization of equity-based charges 1,217,175
Amortization of debt discount 4,713,243
Changes in operating assets and liabilities:
Inventories (1,007,948)
Prepaid advertising (2,258,900)
Deposits and other (507,685)
Accounts payable 2,159,184
Accrued expenses 4,442,779
------------
Net cash used in operating activities (34,618,651)
Investing activities:
Purchases of fixed assets (2,381,563)
Acquisition of Flying Fish (500,000)
------------
Net cash used in investing activities (2,881,563)
Financing activities:
Proceeds from issuance of capital stock 20,018,117
Proceeds from issuance of warrants and options 7,376,278
Proceeds from short-term debt 8,372,488
Proceeds from related party notes 4,000,000
Principal payments of short-term debt (200,000)
Principal payments under capital leases (3,241)
Financing costs (100,000)
------------
Net cash provided by financing activities 39,463,642
Net increase in cash 1,963,428
Cash at beginning of period --
------------
Cash at end of period $ 1,963,428
Supplemental cash flow information:
Common stock issued in connection with acquisition $ 660,341
Conversion of short-term debt to capital stock 1,000,000
Capital stock issued for advertising and a license agreement 54,939,644
Fixed assets acquired under capital leases 67,627
Cash paid for interest 85,428
============
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 6
(1) ACCOUNTING POLICIES
(a) DESCRIPTION OF BUSINESS
Petstore.com, Inc. (Petstore.com or the Company) is a
leading online retailer of pet food, supplies and related
products. The Company was incorporated in January 1999 under the
name Truepet.com. In April 1999, the name of the Company was
changed to Petstore.com. In May 1999, the Company opened its
virtual doors on the web. In conjunction with the issuance of
Series B preferred stock, the Company became a majority-owned
subsidiary of Discovery Communications Inc.
(b) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts
of the Company and its wholly owned subsidiary. All significant
intercompany balances and transactions have been eliminated.
(c) USE OF ESTIMATES
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts
of assets and liabilities and 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.
(d) INVENTORIES
Inventories are valued at the lower of cost or market. The
Company purchases a majority of its products from three major
vendors. The Company's three major vendors accounted for 36%,
16% and 14% of the Company's inventory purchases during the
period from January 28,1999 (inception) to December 31, 1999. On
August 20, 1999, the Company entered into an exclusive five-year
strategic alliance with its largest supplier which guarantees
the availability of merchandise, particular payment terms, and
the right to purchase products at an agreed-upon price.
(e) FIXED ASSETS
Fixed assets are stated at cost less accumulated
depreciation. Fixed assets are depreciated on a straight-line
basis over the estimated useful lives of the assets (generally
three to seven years).
The Company capitalizes certain internal use software
costs in accordance with Statement of Position 98-1, Accounting
for Costs of Computer Software Developed or Obtained for
Internal Use. Capitalized internal use software costs with
expected useful lives in excess of one year are amortized on a
straight-line basis over their estimated useful lives. Internal
use software costs such as website development, which are
subject to continual change, are expensed as incurred.
(f) INTANGIBLES, NET
Intangibles include a license agreement and goodwill. The
license agreement is recorded at cost net of accumulated
amortization and is being amortized on a straight-line basis
over the term of the agreement (5 years). Goodwill represents
the excess of the purchase price over the fair value of assets
acquired. Goodwill is stated net of accumulated amortization and
is being amortized on a straight-line basis over 10 years.
(g) LONG-LIVED ASSETS
In accordance with Financial Accounting Standards Board
(FASB) Statement of Financial Accounting Standard (SFAS) No.
121, Accounting for the Impairment of Long-Lived Assets and for
F-6
<PAGE> 7
Long-Lived Assets to Be Disposed Of, the carrying value of
intangible assets and other long-lived assets is reviewed on a
regular basis for the existence of facts or circumstances, both
internally and externally, that may suggest impairment. To date,
no such impairment has been indicated. Should there be an
impairment in the future, the Company will measure the amount of
the impairment based on undiscounted expected future cash flows
from the impaired assets. The cash flow estimates that will be
used will contain management's best estimates, using appropriate
and customary assumptions and projections at the time.
(h) FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts for the Company's cash, prepaid
expenses other current assets, deposits, accounts payable,
accrued advertising, other liabilities and accrued expenses and
short-term debt approximate fair value.
(i) INCOME TAXES
The Company recognizes deferred tax assets and liabilities
based on differences between the financial reporting and tax
bases of assets and liabilities using the enacted tax rates and
laws that are expected to be in effect when the differences are
expected to be recovered.
(j) REVENUE RECOGNITION
The Company recognizes revenue from product sales, net of
discounts and coupon redemptions of $330,855, when the products
are shipped to customers. The Company provides an allowance for
sales returns, which has been insignificant, based on historical
experience.
(k) COST OF SALES
The Company's cost of sales consists primarily of the
costs of products sold to customers, fulfillment costs and the
net costs of outbound and inbound shipping.
(l) ADVERTISING
The cost of advertising is expensed as incurred. For the
period from January 28, 1999 (inception) to December 31, 1999,
the Company incurred advertising expense of $17,127,331.
(m) PRODUCT DEVELOPMENT
Product development expenses consist principally of
payroll and related expenses for development, editorial, systems
and telecommunications operations personnel and consultants,
systems and telecommunications infrastructure and costs of
acquired content.
(n) STOCK-BASED COMPENSATION
The Company has elected to follow Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees
(APB No. 25), and related interpretations, in accounting for its
employee stock options rather than the alternative fair value
accounting allowed by SFAS No. 123, Accounting for Stock-Based
Compensation. APB No. 25 provides that the compensation expense
relative to the Company's employee stock options is measured
based on the intrinsic value of the stock option. SFAS No. 123
requires companies that continue to follow APB No. 25 to provide
a pro forma disclosure of the impact of applying the fair value
method.
The Company follows SFAS No. 123 for equity instruments
issued to nonemployees.
F-7
<PAGE> 8
(o) START-UP ACTIVITIES
The Company has adopted the provisions of SOP 98-5,
Reporting Costs of Start-Up Activities. SOP 98-5 requires that
the costs of start-up activities, including organization costs,
be expensed as incurred. The adoption of SOP 98-5 did not have a
material impact to the Company's financial position, results of
operations or cash flows.
(p) COMPREHENSIVE INCOME (LOSS)
The Company has adopted SFAS No. 130, Reporting
Comprehensive Income, which establishes standards for the
reporting and display of comprehensive income and its components
in the financial statements. The Company does not currently have
any components of other comprehensive income. Therefore,
comprehensive income equals net income.
(q) NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133 (as amended by
SFAS No. 137) Accounting for Derivative Instruments and Hedging
Activities. SFAS No. 133 is effective for fiscal years beginning
after June 15, 2000. SFAS No. 133 requires that all derivative
instruments be recorded on the balance sheet at their fair
value. Changes in the fair value of derivatives are recorded
each period in current earnings or other comprehensive income,
depending on whether a derivative is designed as part of a hedge
transaction and, if it is, the type of hedge transaction. The
Company does not expect that the adoption of SFAS No. 133 will
have a material impact on its consolidated financial statements
because the Company does not currently hold any derivative
instruments.
(2) BUSINESS COMBINATIONS
On August 9, 1999, the Company acquired certain assets of Flying
Fish Express, an online retailer of marine life, operating as a sole
proprietorship. The purchase price of $1,360,341 consisted of $500,000
in cash, $200,000 in notes payable (note 6) and 347,548 shares of common
stock valued at $1.90 per share. In addition, the Company recorded an
additional $200,000 as goodwill as of December 31, 1999, payable to the
former owners of Flying Fish as Flying Fish Express exceeded certain
incentive goals for the year ended December 31, 1999. This additional
payment is included in accrued expenses as of December 31, 1999.
The transaction has been accounted for as a purchase and the
purchase price was allocated to the identifiable assets acquired, based
on their fair values. The purchase price in excess of the fair value of
the assets acquired of $1,553,450 has been recorded as goodwill.
The Company's consolidated statement of operations includes the
operations of Flying Fish Express from August 9, 1999 to December 31,
1999. The pro forma financial information in the following table
illustrates the combined results of the Company's operations and the
operations of Flying Fish Express for the period from January 28, 1999
(inception) to December 31, 1999, as if the acquisition of Flying Fish
had occurred as of January 28, 1999. The pro forma financial information
is presented for informational purposes and is not necessarily
indicative of the results of operations which would have occurred if the
Company had constituted a single entity as of January 28, 1999. The pro
forma information is also not necessarily indicative of the future
results of operations of the combined company.
<TABLE>
<S> <C>
Net sales $ 3,208,715
Cost of sales (5,616,014)
------------
Gross margin (2,407,299)
Operating expenses 40,236,751
Interest expense 4,875,849
------------
Net loss $ 47,519,899
============
</TABLE>
F-8
<PAGE> 9
The pro forma net loss includes the Company's net loss of
$47,725,673 and Flying Fish Express's net income of $302,925 less a pro
forma adjustment to include the amortization expense associated with
goodwill related to the acquisition.
(3) FIXED ASSETS
Fixed assets, at cost, consist of the following as of December 31, 1999:
<TABLE>
<S> <C>
Computers and equipment $ 2,365,575
Furniture and fixtures 13,390
Leasehold improvements 75,086
-----------
2,454,051
Less accumulated depreciation and amortization (226,276)
-----------
Fixed assets, net $ 2,227,775
===========
</TABLE>
Depreciation and amortization for the period from January 28, 1999
(inception) to December 31, 1999 was $226,276.
(4) INTANGIBLES
Intangibles, net at cost, consist of the following as of December 31,
1999:
<TABLE>
<S> <C>
License agreement (note 8(b)) $ 54,939,644
Goodwill (note 2) 1,553,450
------------
56,493,094
Less accumulated amortization (1,364,480)
------------
Total $ 55,128,614
============
</TABLE>
Amortization of the license agreement for the period from January
28, 1999 (inception) to December 31, 1999 of $1,308,086 was recorded as
sales and marketing expense in the consolidated statement of operations.
Amortization of goodwill during the same period of $56,394 was recorded
as general and administrative expense in the consolidated statement of
operations.
(5) SHORT-TERM DEBT
(a) TERM LOAN
During the period from September 1999 to December 1999,
the Company borrowed $10 million from a bank under a term loan
agreement. The term loan bears a stated interest rate at the
bank's prime rate plus 2.75% (11.25% as of December 31, 1999)
and matures on April 15, 2000. The loan contains a mandatory
prepayment feature whereby the loan must be paid in full no
later than 30 days subsequent to the acceptance of term sheets
for a new series of preferred stock. The term loan is secured by
all physical, intangible and intellectual property owned by the
Company.
F-9
<PAGE> 10
In connection with the term loan, the Company issued
36,179 warrants to purchase Series B preferred stock and 325,615
warrants to purchase Series C preferred stock. The warrants have
been valued at $127,965 and $1,656,404, respectively, and are
reflected as a discount on the term loan. In addition, the
Company sold 122,549 shares of Series A preferred stock to the
bank for $2.04 per share. The difference of $377,451 between the
sales price and the fair market value of the Series A preferred
stock of $5.12 on the date of sale was also recorded as a
discount on the note. Accordingly, the term loan balance of
$8,457,224 as of December 31, 1999 is reflected net of the
unamortized discount of $1,542,776. The effective interest rate
on the term loan is 74% as of December 31, 1999.
The term loan contains restrictive covenants such as
maximum monthly losses and a minimum level of monthly sales. As
of December 31, 1999, the Company was not compliance with these
covenants and has not obtained waivers from the bank.
(b) BRIDGE LOAN
On October 11, 1999, the Company borrowed $5,000,000 from
various venture capital groups. The notes bear a stated interest
rate of 8% and are due on June 1, 2000. The notes are
convertible to the next series of preferred stock at a
conversion rate of $4.00 per share.
In connection with the borrowings, the Company issued
1,249,997 warrants to purchase shares of the preferred stock
issued in the next offering at an exercise price of $4.00 per
share. The value of the warrants as of October 11, 1999 exceeded
the borrowings and thus were recorded as a $5,000,000 discount
on the bridge loan. The discount is being amortized through
January 31, 2000, the earliest date for conversion of the notes
into preferred stock. Accordingly, the bridge loan balance of
$3,628,507 as of December 31, 1999 is reflected net of the
unamortized discount of $1,371,493. The effective interest rate
on the bridge loan is 335% as of December 31, 1999.
(6) RELATED PARTY NOTES
In connection with the acquisition of Flying Fish Express, the
Company issued notes in the amount of $200,000 to the former owners. The
note holders are employed by the Company as of December 31, 1999. The
notes did not bear interest and were paid off with the proceeds from the
Series B preferred stock issuance in October 1999.
On December 17, 1999, the Company obtained a line of credit from
its parent company, Discovery Communications Inc. in the amount of
$15,000,000. The line is due on December 31, 2001, bears interest at 8%
and is convertible into the next series of preferred stock on December
31, 2001 at a price of $6.91 per share. As of December 31, 1999, the
Company had borrowings of $4,000,000 outstanding under this agreement.
(7) COMMITMENTS AND CONTINGENCIES
(a) LEASES
The Company currently leases office and distribution
center facilities and fixed assets under noncancelable operating
and capital leases. Rental expense under operating lease
agreements for the period from January 28, 1999 (inception) to
December 31, 1999 was $265,727.
F-10
<PAGE> 11
Future minimum commitments are as follows:
<TABLE>
<CAPTION>
CAPITAL LEASES OPERATING LEASES
-------------- ----------------
<S> <C> <C>
2000 $ 36,102 615,296
2001 10,572 593,246
2002 9,556 524,972
2003 9,048 183,600
2004 5,278 75,300
Thereafter -- --
----------- -----------
Total minimum lease payments 70,556 $ 1,992,414
===========
Less imputed interest (6,170)
-----------
Present value of net minimum lease payments 64,386
Less current portion (32,904)
-----------
Long-term capital lease obligation $ 31,482
===========
</TABLE>
(b) LEGAL PROCEEDINGS
From time to time, the Company is subject to legal
proceedings and claims in the ordinary course of business. The
Company currently is not aware of any such legal proceedings or
claims that it believes will have, individually or in the
aggregate, a material adverse effect on its business, prospects,
financial condition and operating results.
(8) STOCKHOLDERS' EQUITY
(a) SERIES A PREFERRED STOCK
In the period from April 1999 to June 1999, the Company
issued 3,995,100 shares of Series A convertible preferred stock
at a price of $2.04 per share, which reflected fair value. In
April 1999, the Company's short-term note holders converted such
notes into 490,191 shares of Series A convertible preferred
stock at a conversion price of $2.04 per share. In September
1999, the Company completed its final closing of Series A
convertible preferred stock, issuing 1,151,623 shares in return
for $2.04 per share in cash. The shares issued in September have
been reflected in the financial statements at an estimated fair
value of $5.12 per share. The difference between the estimated
fair value and the price paid for the shares issued to a bank in
September 1999 of $377,451 was recorded as a discount on the
corresponding term loan. The difference between the estimated
fair value and the price paid for the remaining shares issued in
September 1999 of $3,169,548 was recorded as general and
administrative expense in the consolidated statement of
operations.
The Series A shares have a liquidation preference of $2.04
per share and automatically convert into one share of common
stock at the time of an initial public offering. Each share of
Series A preferred stock has one vote for each share of common
stock into which it would be convertible.
(b) SERIES B PREFERRED STOCK
In October 1999, the Company issued 13,305,303 shares of
Series B convertible preferred stock to Discovery Communications
for $5 million in cash, a license agreement valued at $55
million, and promotions valued at $32 million. The total value
of the transaction was determined by a third party appraisal of
the preferred shares. The values of the license and the
advertising were determined based on Discovery Communications
prevailing market rates.
F-11
<PAGE> 12
The Series B shares have a liquidation preference of $6.91
per share and automatically convert into one share of common
stock at the time of an initial public offering. Each share of
Series B preferred stock has fifteen votes for each share of
common stock into which it would be convertible. In addition,
the Series B shares entitle the holder to a majority of the
Company's Board of Directors' seats.
The license agreement allows the Company to use Discovery
Communications content and logo for a seven-year period. The
license agreement has been recorded as an intangible asset and
is being amortized straight line over the term of the agreement.
The promotion agreement requires Discovery Communications to
provide promotions to the Company of $11,000,000 in each of the
first three years of the agreement and $10,000,000 in the final
year of the agreement. The value of the promotions has been
discounted to the net present value at a rate of 13% and
recorded as a deferred equity-based charge in the December 31,
1999 consolidated balance sheet. During the period from October
1999 to December 31, 1999, Discovery Communications provided the
Company with $200,335 in promotions which the Company recorded
as sales and marketing expense in the consolidated statement of
operations.
(c) SERIES C PREFERRED STOCK
In December 1999, the Company issued 1,591,895 shares of
Series C convertible preferred stock to Safeway Stores at a
price of $6.91 per share. Consideration for this sale consisted
of $1 million in cash and promotions valued at $10 million.
The Series C shares have a liquidation preference of $6.91
per share and automatically convert into one share of common
stock at the time of an initial public offering. Each share of
Series C preferred stock has one vote for each share of common
stock into which it would be convertible.
The value of the promotions has been recorded as a
deferred equity-based charge in the December 31, 1999
consolidated balance sheet. Safeway did not provide the Company
with any promotions during 1999.
(d) COMMON STOCK
On February 25, 1999, in conjunction with its initial
capitalization, the Company issued 1,723,745 shares of common
stock at a price of $.0005 per share. In July 1999, 196,034
shares of common stock were issued as part of an agreement with
the American Animal Hospital Association. Under the terms of the
agreement, the American Animal Hospital Association will provide
content and promotions to the Company in exchange for a
commission on sales made to referred customers. These shares
vest equally each month over the 48-month term of the service
and royalty agreement with the American Animal Hospital
Association. These shares were initially valued at $1.41 per
share. As the shares vest and a measurement date occurs, the
shares are adjusted to fair value which was $5.54 per share as
of December 31, 1999. The fair value of the unvested shares is
recorded as a deferred equity-based charge as of December 31,
1999. On August 9, 1999, 347,548 shares of common stock were
issued in conjunction with the acquisition of Flying Fish
Express at an estimated fair value of $1.90 per share.
(e) EMPLOYEE STOCK OPTION PLANS
The Company grants employee stock options under its 1999
Stock Option Plan. Shares reserved under the plan consist of
1,548,178 shares of common stock. Generally, options are granted
by the Company's Board of Directors at an exercise price set to
achieve the business goals of the Company. Options granted below
estimated fair value resulted in compensation expense of
$627,839. Each common stock option granted has a term of 10
years from the date of grant. Subject to Internal Revenue
Service limitations, options granted under the plan generally
become exercisable
F-12
<PAGE> 13
immediately. Options granted to employees generally vest at the
rate of 25% after year one and 2.083% (1/48) each month during
the second, third, fourth and fifth years.
In addition, the Company has promised the issuance of
392,115 stock options to employees; however, the Company's Board
of Directors has not formally set exercise prices nor approved
issuance. Since the options have not been legally granted and no
measurement date has been reached, they have not been reflected
in the Company's financial statements.
(f) EMPLOYEE STOCK OPTION ACTIVITY
The following summarizes the Company's stock option activity:
<TABLE>
<CAPTION>
WEIGHTED-AVERAGE
NUMBER OF SHARES EXERCISE PRICE
---------------- ----------------
<S> <C> <C>
Balance at January 28, 1999 -- $ --
Options granted 1,566,594 0.20
Options canceled (214,500) 0.20
Options exercised -- --
---------- ----------
Balance as of December 31, 1999 1,352,094 $ 0.20
========== ==========
</TABLE>
As of December 31, 1999, 196,084 shares of common stock were
available for future grant under the plans.
(g) DEFERRED EQUITY-BASED CHARGES
The Company recorded aggregate deferred equity-based
charges for the value of unearned equity issued of $45,892,618
in 1999. The amount recorded represents the estimated fair value
of promotions received, the estimated fair value of the common
stock issued to AAHA, the estimated fair value of warrants
issued for a product fulfillment and license agreement, the
estimated fair value of unvested nonemployee stock options
issued, and the difference between the grant price of unvested
employee stock options and the deemed fair value of the
Company's common stock at the date of grant. The amortization of
deferred equity-based charges is charged to operations over the
vesting period of the common stock and options, the term of the
product fulfillment and license agreement, and as promotions are
used. Total amortization recognized in 1999 was $1,217,175.
(h) WARRANTS
In June 1999, the Company issued 10,000 warrants to
purchase shares of its common stock in exchange for personnel
recruiting services. The exercise price is $0.20 per share and
the warrants have a term of seven years. At the date of issuance
of the warrants, the fair value of the common stock was $1.37
per share. The warrants have been recorded at a fair value of
$12,710 which was estimated at the date of issuance using a
Black-Scholes valuation model. The fair value of the warrants
was recorded as general and administrative expense in the
consolidated statement of operations.
F-13
<PAGE> 14
In December 1999, the Company issued 300,000 warrants to
purchase shares of its common stock in exchange for a product
fulfillment and license agreement with a supplier. The exercise
price is $6.91 per share and the warrants have a term of five
years. At the date of issuance of the warrants, the fair value
of the common stock was $5.54 per share. The warrants have been
recorded at a fair value of $1,011,000 which was estimated at
the date of issuance using a Black-Scholes valuation model.
In March 1999, the Company issued 980,382 warrants to
purchase shares of its Series A preferred stock outstanding in
conjunction with a convertible bridge loan for $1 million. The
exercise price of the warrants was $3.06 per share and the
warrants have a term of five years. On the date of issuance of
the warrants, the fair value of the Series A preferred stock was
$1.09 per share. The fair value of the warrants of $469,399 was
recorded as a discount on the bridge loan and recognized as
interest expense when the bridge loan was converted to Series A
preferred stock in April 1999. The fair value of the warrants
was estimated at the date of issuance using a Black-Scholes
valuation model.
During the period from October 1999 to December 1999, the
Company issued 36,179 warrants to purchase shares of its Series
B preferred stock and warrants to purchase 325,615 shares of its
Series C preferred stock in conjunction with a term loan for
$10,000,000. The exercise price is $6.91 per share and the
warrants have a term of seven years. On the date of issuance of
the warrants, the fair value of the Series B and Series C
preferred stock was $6.91 per share. The fair value of the
Series B and Series C warrants of $127,965 and $1,656,404,
respectively, was recorded as a discount on the term loan and is
being amortized as interest expense over the life of the loan.
The fair value of the warrants was estimated at the date of
issuance using a Black-Scholes valuation model.
During December 1999, the Company issued 1,249,997
warrants to purchase shares of the next series of preferred
stock issued in conjunction with a bridge loan of $5,000,000.
The exercise is $4.00 per share and the warrants have a term of
five years. On the date of issuance of the warrants, the
estimated fair value of the next series of preferred stock was
$6.91. The warrants have been recorded as a discount of
$5,000,000 on the bridge loan. The estimated fair value of the
warrants was estimated at the date of issuance using a
Black-Scholes valuation model.
(i) STOCK OPTIONS ISSUED FOR SERVICES
In August 1999, the Company issued 72,000 options to
purchase shares of its common stock in exchange for a purchase
discount and consulting services from one of the Company's
suppliers. The exercise price is $0.15 per share and the options
have a term of five years. Sixty-one thousand options vested
immediately and the remaining 11,000 options vest equally over
months 13 through 24 of the agreement. At the date of issuance
of the options the fair value of the Company's common stock was
$1.90 per share. The options that vested immediately have been
recorded as general and administrative expense in the
consolidated statement of operations at a fair value of $109,800
which was estimated at the date of issuance using a
Black-Scholes valuation model.
As of December 31, 1999, the fair value of the Company's
common stock was $5.54 per share. The 11,000 unvested options
have been recorded at a fair value of $59,730 as of December 31,
1999 using a Black-Scholes valuation model.
During July and August 1999, the Company issued 30,000
options to purchase shares of its common stock to three Advisory
Board Members. The exercise price is $.20 per share. Each option
has a term of 10 years and vests at a rate of 25% after year one
and 2.083% (1/48) each month during the second, third, fourth
and fifth years. As of December 31, 1999, the fair value of the
Company's common stock was $5.54 per share. The 30,000 unvested
options have been recorded at a fair value of $163,300 as of
December 31 1999 using a Black-Scholes valuation model.
F-14
<PAGE> 15
(j) VALUATION ASSUMPTIONS
The Company calculated the fair value of the warrants and
nonemployee stock options issued for services using a
Black-Scholes valuation model with the following assumptions:
risk-free rate of 5.5%; volatility of 75%; and a dividend yield
rate of 0.0%.
(k) PRO FORMA DISCLOSURE
The Company follows the intrinsic value method in
accounting for its stock options. Had compensation cost been
recognized based on the fair value at the date of grant for
options granted in 1999, the pro forma amounts of the Company's
net loss and net loss per share for the period ended December
31, 1999 would have been as follows:
<TABLE>
<S> <C>
Net loss - as reported $ 45,389,787
Net loss - pro forma 45,412,326
</TABLE>
The fair value for each option granted was estimated at
the date using the minimum value option pricing model, assuming
no expected dividends and the following weighted-average
assumptions:
<TABLE>
<S> <C>
Average risk-free interest rate $ 5.5%
Average expected life 5.62 years
Volatility 0.0%
</TABLE>
For purposes of the pro forma disclosures, the estimated
fair value of the options granted of $1,672,517 as of December
31, 1999 is amortized to expense over the options' vesting
period. Because the determination of fair value of all options
granted after such time as the Company may become a public
entity will include an expected volatility factor in addition to
the factors described above, the pro forma results above may not
be representative of future periods. In addition, the pro forma
effects may not be representative of future amounts since the
estimated fair value of stock options on the date of grant is
amortized to expense over the vesting period using the multiple
option approach as additional options may be granted in future
periods.
(9) INCOME TAXES
Income taxes for the year ended December 31, 1999 are comprised of the
following:
<TABLE>
<CAPTION>
CURRENT DEFERRED TOTAL
------- -------- -----
<S> <C> <C> <C>
Year ended December 31, 1999:
Federal $ -- -- --
State 800 -- 800
---- ---- ----
$800 -- 800
==== ==== ====
</TABLE>
Current year tax expense differs from computed tax expense due to
the valuation allowance which has been established against the Company's
deferred tax assets, including net operating loss carryforwards.
F-15
<PAGE> 16
The tax effect of temporary differences that give rise to
significant portions of the deferred tax assets and deferred tax
liabilities as of December 31, 1999 is presented below:
<TABLE>
<S> <C>
Deferred tax assets:
Net operating loss carryforwards $ 15,239,158
Organizational and start-up expenses 257,633
Accrued expenses 44,954
Stock-related compensation 469,615
Other 6,692
------------
Gross deferred tax assets 16,018,052
Valuation allowance (15,918,931)
------------
Net deferred tax assets $ 99,121
============
Deferred tax liabilities:
Tax depreciation in excess of book depreciation $ 99,121
Gross deferred tax liabilities 99,121
------------
Net deferred tax assets (liabilities) $ --
============
</TABLE>
As of December 31, 1999, the Company had net operating losses of
$38,256,275 for federal and state tax purposes, which begin to expire in
2019 for federal and 2007 for state. Under the provisions the Internal
Revenue Code, should substantial changes in the Company's ownership
occur, the utilization of net operating loss carryforwards may be
limited.
(10) GOING CONCERN
The Company's financial statements have been prepared assuming that
the Company will continue as a going concern. Since inception, the
Company has generated significant losses and will require additional
cash to sustain its operations throughout 2000. In addition, the Company
is not in compliance with certain debt covenants.
The Company presently has no future funding commitments. The
Company is currently in discussions with third parties to obtain funding
through either debt or equity instruments; however, at this time there
are no formal agreements in place.
F-16
